What is Mutual Fund?

 A mutual fund is a type of investment fund that is professionally managed by a set of

investors by pooling in money from multiple investors for the purpose of initiating
investment in securities that are individually held to provide an enhanced level of
liquidity, greater diversification, lower level of risks, etc.

A mutual fund is a pool of investment managed professionally for the purpose of

purchasing various securities and culminating them into a strong portfolio that will offer
attractive returns over and above the risk-free returns which are currently being offered
by the market.

A mutual fund is a financial product that invests in stocks or bonds. Owning a mutual
fund is like getting a smaller slice of an apple. Investors get units of the fund in
proportion to their investments. Suppose a mutual fund has total assets of $5000 and
someone invests $500, he/she will get 10% units of the fund.
Benefits of Mutual Fund?
 The higher level of diversification since the basket of a portfolio will be aimed at
spreading the investment in order to offer protection against concentration risks.

 Provide regular liquidity as shareholders of open-ended funds may sell their holdings
back to the fund at regular intervals at a price equal to the NAV of the fund’s holdings.

Managed by professional investors who have rich experience in investment and can
understand the nerves of the market. Also, affordability is a big benefit.

Since mutual funds are regulated by a Government body i.e. AMFI in India, it offers
protection and comfort to the investors.

All the mutual funds are required to report the same level of information to the investors
which makes it relatively easier for comparison in case of diversification.

These funds provide regular reports of their performance.

Investment Objectives

Goal-Based Investing

Investment Growth

Tax Saving
Structure of Mutual Funds

 The structure of Mutual Funds in India is a

three-tier one. There are three distinct entities
involved in the process – the sponsor (who
creates a Mutual Fund), trustees and the asset
management company (which oversees the fund
management).

The structure of Mutual Funds has come into

existence due to SEBI (Securities and Exchange
Board of India) Mutual Fund Regulations, 1996.
Under these regulations, a Mutual Fund is created
as a Public Trust.
Structure of Mutual Funds – 3 Layers
 Fund sponsor - is any person/entity that can set up a MF to earn money by fund management. This fund management is
done through an associate company which manages the investment of the fund. A sponsor can be seen as the promoter of
the associate company. A sponsor has to approach SEBI to seek permission for a setting up a MF. Once SEBI agrees to the
inception, a Public Trust is formed under the Indian Trust Act, 1882 and is registered with SEBI. Trustees are appointed to
manage the trust and an AMC is created complying with the Companies Act, 1956. There are certain eligibility criteria
given by SEBI for the fund sponsor.

 Trust and trustees - A trust is created by the fund sponsor in favour of the trustees, through a document called a trust
deed. The trust is managed by the trustees and they are answerable to investors. They can be seen as primary guardians of
fund and assets. Trustees can be formed by two ways – a Trustee Company or a Board of Trustees. The trustees work to
monitor the activities of the Mutual Fund and check its compliance with SEBI (Mutual Fund) regulations. They also
monitor the systems, procedures, and overall working of the asset management company. Without the trustees’ approval,
AMC cannot float any scheme in the market.

Asset Management Companies – They acts as the fund manager or as an investment manager for the trust. A small fee
is paid to the AMC for managing the fund and is responsible for all the fund-related activities. It initiates various schemes
and launches the same. The AMC is bound to manage funds and provide services to the investor along with other elements
like brokers, auditors, bankers, registrars, lawyers, etc. and works with them. To ensure that there is no conflict between the
AMCs, there are certain restrictions imposed on the business activities of the companies.
Structure of Mutual Funds – Other Components
 Custodian - A custodian is responsible for the safekeeping of the securities of the Mutual Fund. They manage the
investment account of the Mutual Fund, ensure the delivery and transfer of the securities. They also collect and track
the dividends & interests received on the Mutual Fund investment.

 Registrar and Transfer Agents (RTAS) - These are the entities who provide services to Mutual Funds. RTAs are
more like the operational arm of Mutual Funds. Since the operations of all Mutual Fund companies are similar, it is
economical in scale and cost effective for all the AMCs to seek the services of RTAs. CAMS, Karvy, Sundaram,
Principal, Templeton, etc are some of the well-known RTAs in India. Their services include:
Processing investors’ application , Keeping a record of investors’ details
Sending out account statements to the investors and periodic reports
Processing the payouts of the dividends, Updating the investor details

 Auditor - Auditors audit and scrutinise record books of accounts and annual reports of various schemes. Each AMC
hires an independent auditor to analyse the books so as to keep their transparency and integrity intact.

 Brokers - AMC uses the services of brokers to buy and sell securities on the stock market. The AMCs uses research
reports and recommendations from many brokers to plan their market moves.
HOW MUTUAL FUND WORKS?
 Step-by-Step Process to Invest in Mutual Funds
Financial Goals

Identify ‘What to Buy’

Evaluate Funds from various Mutual Fund Cos.

Online Offline
Banks,
Financial Svc. Cos.,
Mutual Fund Co. and others Financial Distributor
Brokers,
Individual Agents
Fill Up Form

Attach Relevant Documents

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Advantages & Disadvantages of Mutual Funds
 Types of Mutual Funds
Based on Based on Based on
Based on Risk Special Type
Underlying Asset Structure Investment
Growth/
Equity Closed-ended High Gilt, Index
Aggressive

Debt Open-ended Income Medium Sector

https://www.moneycontrol.com/news/business/httpswww-moneycontrol-comnewsbusinessmutual-funddifferent-types-of-mutual-
fund-pf11-4637921.html
Hybrid /
Interval Funds Liquid Low Foreign, Global
Balanced

Tax-Saving Very-Low Real Estate

Capital
Commodity
Protection

Fixed Maturity
Plans/Pension
MUTUAL FUND TYPES – RISK / RETURN GRAPH

Hybrid & Monthly Income Plans Sectoral Funds

Debt Equity
>> Return <<

>> Return <<

GILT & Bond Funds Diversified Funds (ELSS)

Short Term Funds Balanced Funds

Ultra Short Term Funds Arbitrage Funds

Liquid fund Index Fund

Lo Med Hi Lo Med Hi
>> Risk << >> Risk <<
Risks with Mutual Funds
 Risk is an inherent aspect of every form of investment. For Mutual Fund investments, risks would include
variability, or period-by-period fluctuations in total return.

 Market risk: At times the prices or yields of all the securities in a particular market rise or fall due to broad
outside influences. This change in price is due to 'market risk'.

 Inflation risk: Sometimes referred to as 'loss of purchasing power'. Whenever the rate of inflation exceeds
the earnings on investment, you run the risk that you'll actually be able to buy less, not more.

 Credit risk: In short, how stable is the company or entity to which you lend your money when you invest?
How certain are you that it will be able to pay the interest you are promised, or repay your principal when the
investment matures?

 Interest rate risk: Interest rate movements in the Indian debt markets can be volatile leading to the
possibility of large price movements up or down in debt and money market securities and thereby to possibly
large movements in the NAV.

 Investment risks: Liquidity risk, Changes in the government policy.

SEBI AMFI
NEW

FUND

OFFER
http://portal.amfiindia.com/spages/12125.pdf

https://files.hdfcfund.com/s3fs-public/KIM/HDFC_Long_Term_Adva
ntage_Fund_KIM.pdf
 Most

Important

Term to

Understand in

MFs
Net Asset Value (NAV)
 The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV). In simple words, NAV is
the market value of the securities held by the scheme. NAV varies on day to day basis. The NAV of a mutual fund is always
calculated at the end of the market day. This is because the market value of securities changes on a daily basis

NAV = (Assets(Market Value of investments) – Liabilities(Expenses)) / No. of Outstanding units

Suppose the net market value of the securities of a mutual fund scheme is Rs 500 lakh. The mutual fund issues 10 lakh
units of Rs 10 each to its investors. So, the NAV per unit of the fund is Rs 50.

Suppose you invest in two mutual fund schemes, X and Y. Scheme X has a NAV of Rs 10 and Scheme Y has a NAV of Rs
50. You make an investment of Rs 1 lakh in both schemes. It may seem that Scheme X is cheaper because you get 10,000
mutual fund units, while Scheme Y gets you only 2,000 units. Now suppose both schemes give a return of 10% after a month.
This means that the NAV of Scheme X is Rs 11 and the NAV of Scheme Y is Rs 55. For both schemes, your investment value
is Rs 1.1 lakh. The only difference here is that you get more units with Scheme X than with Scheme Y. So, the NAV of a
mutual fund is irrelevant when it comes to the performance of the fund.

The NAV of a mutual fund is its book value. When investing in mutual funds, you should check the performance of the
fund, not its NAV. You can do this by looking at the returns the fund has generated over the years.
Performance Evaluation of Mutual Funds
 Portfolios contain groups of securities that are selected to achieve the highest return for a given level of risk.
How well this is achieved depends on how well the portfolio manager or investor is able to forecast economic
conditions and the future prospects of companies, and to accurately assess the risk of each security under
consideration.

Many investors and some portfolio managers adopt a passive portfolio management strategy by simply
holding a basket of securities that is weighted to reflect a market index, or by buying securities based on a
market index, such as most exchange-traded funds.

Some investors and portfolio managers think they can do better than the market, and so engage in active
portfolio management, buying and selling securities as conditions change. Most active portfolio managers use
sophisticated financial models to base their investment decisions.

However, most studies have shown that few portfolio managers outperform the market, especially over a long
time
Returns from Mutual Funds

1. Capital appreciation:
As the value of securities in the fund increases, the fund's unit price will also increase. You can make a
profit by selling the units at a price higher than at which you bought

2. Coupon / Dividend Income:

Fund will earn interest income from the bonds it holds or will have dividend income from the shares.
Performance Evaluation Ratios

Sharpe Treynor
Ratio Ratio
Jensen’s
Alpha
 Sharpe Ratio
 The Sharpe ratio (aka Sharpe's measure), developed by William F. Sharpe, is the ratio of a portfolio's total
return minus the risk-free rate divided by the standard deviation of the portfolio, which is a measure of its risk.

 Risk Premium = Total Portfolio Return – Risk-free Rate

 Sharpe Ratio = Risk Premium / Standard Deviation of Portfolio Return

 Sharpe ratio measures the performance of the portfolio compared to the risk taken — the higher the Sharpe
ratio, the better the performance and the greater the profits for taking on additional risk.

 Example:

If a fund has a return of 12% and a standard deviation of 15%, and if the risk-free rate is 2%, then what is its
Sharpe ratio?

Solution:
Sharpe Ratio = (12% – 2%) / 15% = 10% / 15% = 66.7% or 0.667
 Treynor Ratio
 While the Sharpe ratio measures the risk premium of the portfolio over the portfolio risk, or its standard
deviation, Treynor's ratio, popularized by Jack L. Treynor, compares the portfolio risk premium to the systematic
risk of the portfolio as measured by its beta.

 Risk Premium = Total Portfolio Return – Risk-free Rate

 Treynor Ratio = Risk Premium / Beta of the Portfolio

 Note that since the beta of the general market is defined to be 1, the Treynor Ratio of the market equals its
return minus the risk-free rate. The Treynor ratio measures the return per unit risk: it is higher with either higher
portfolio returns or lower portfolio betas.

 Example:

If a fund has a return of 12% and a beta of 1.4, and if the risk-free rate is 2%, then what is its Trenor ratio?
Solution:
Treynor Ratio = (12% – 2%) / 1.4 = 10% / 1.4 = 7.14
 Jensen’s Alpha
 The Jensen's measure, or Jensen's alpha, is a risk-adjusted performance measure that represents the average
return on a portfolio or investment, above or below that predicted by the capital asset pricing model (CAPM),
given the portfolio's or investment's beta and the average market return.

Jensen’s Alpha = Portfolio Return – CAPM Expected Return

To analyze the performance of an investment manager, an investor must look not only at the overall return of a
portfolio but also at the risk of that portfolio to see if the investment's return compensates for the risk it takes. Ex
- if two MFs have a 12% return, a rational investor should prefer the less risky fund. Jensen's measure is one of
the ways to determine if a portfolio is earning the proper return for its level of risk. If the value is positive, then
the portfolio is earning excess returns. In other words, a positive value for Jensen's alpha means a fund
manager has "beat the market" with their stock-picking skills.

 Example:
If a fund has a return of 12% and a beta of 1.4, and if the risk-free rate is 2%, and market return rate is 8%,
calculate Jensen’s Alpha?
Solution:
Jensen’s Alpha = 12% – (2% + 1.4 * (8% - 2%) = 1.6
 Portfolio Evaluation Example
 Given below are three funds with their results during a three-year period:

Funds Average Annual Return (%) Standard Deviation (%) Beta

A 8.5 15.2 0.38

B 19.0 21.2 0.75
C 12.0 8.2 0.98
Market 13.0 12.0 ?
10-Year G-Sec Yield 6.0

 Evaluate the portfolios based on Sharpe Ratio, Treynor ratio and Jensen’s Alpha. Compare the performance
with market also.
Portfolio Evaluation Solution

Funds Sharpe Ratio Treynor Ratio Alpha

A 0.16 6.58 -0.16

B 0.61 17.33 7.75
C 0.73 6.12 -0.86
Market 0.58 7.00 0.00
 Short Term Capital Gains Long Term Capital Gains
Type of Scheme Particulars
Tax Tax

Holding Period Up to 12 months More than 12 months

Equity oriented schemes
Tax Rate 15% 10%*

Holding Period Up to 36 months More than 36 months

Non-equity oriented schemes

Income Tax Slab Rate of
Tax Rate 20% after indexation
Investor

*Long-term capital gains on equity mutual funds are exempt up to Rs. 1 lakh per annum. For example, if your long-
term capital gain in FY 2018-19 is Rs 1.5 lakh, only Rs. 50,000 will be taxable as LTCG.

According to the recent budget for FY 2020-21, Dividend is taxable at the hands of the investor and not the fund house.
Hence, as it stands Dividend Distribution Tax has been abolished under the new tax regime.
Investment Menu Card
Instrument Tax Benefit Return Duration

EPF √ 8.5% Long Term

PPF √ 8.1% Long Term
NSC √ 8% Long Term
FD’s – Banks & Post √ 5.70 to 8.50% Short Term
Office

Senoir Citizen Savings √ 9% Long Term

Scheme
Mutual Funds √ Market Linked Long Term & Short
Term
ULIP √ Market Linked Long Term
NPS √ Market Linked Long Term
Direct Equity √ Market Linked Long Term
Gold √ Market Linked Short Term
Real Estate √ Market Linked Long Term
Never depend on single income. Make investment to
create a second source.

- Warren buffet