Chapter I:
INTRODUCTION
INTRODUCTION
.Mutual funds are popular among all income levels. With a mutual fund, we get a diversified basket of stocks managed by a professional Barbara Stanny, author of Prince Charming Isnt Coming & How Women Get Smart About Money
A mutual fund is a company that brings together money from many people and invests it in stocks, bonds or other assets. The combined holdings of stocks, bonds or other assets the fund owns are known as its portfolio. Each investor in the fund owns shares, which represent a part of these holdings..
-The U.S. Securities and Exchange Commission
MUTUAL FUNDS
A Mutual Fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document.
Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unit holders.
The profits/losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public.
History of Mutual Funds in India & Role of SEBI : Unit Trust of India was the first mutual fund setup in India in the year 1963. In early 1990s, Government allowed public sector banks and institutions to set up mutual funds. In the year 1992, Securities and Exchange Board of India (SEBI) Act was passed. The objectives of SEBI are to protect the interest of investors in securities and to promote the development of and to regulate the securities market.
As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines to the mutual funds from time to time to protect the interest of investors.
All mutual funds whether promoted by public sector or private sector entities including those promoted by foreign entities are governed by the same set of Regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes launched by the mutual funds sponsored by these entities are of similar type. It may be mentioned here the Unit Trust of India (UTI) is not registered with SEBI as a mutual fund (as on January 15, 2002).
BENEFITS OF INVESTING IN MUTUAL FUNDS An investor gets following benefits while investing in Mutual Funds :
PROFESSIONAL MANAGEMENT
Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme.
DIVERSIFICATION
Mutual Funds invest in a number of companies across a broad cross -section of industries and sectors. This diversification reduces the risk b ecause seldom do all stocks decline at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own.
CONVENIENT ADMINISTRATION
Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient.
RETURN POTENTIAL
Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities.
LOW COSTS
Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors.
LIQUIDITY
In open-end schemes, the investor gets the money back promptly at net asset value related prices from the Mutual Fund. In closed-end schemes, the units can be sold on a stock exchange at the prevailing market price or the investor can avail of the facility of direct repurchase at NAV related prices by the Mutual Fund
FLEXIBILITY
Through features such as regular investment plans, regular withdrawal plans an d dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience.
AFFORDABILITY
Investors individually may lack sufficient funds to invest in high -grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy.
CHOICE OF SCHEMES
Mutual Funds offer a family of schemes to suit your varying needs over a lifetime.
WELL REGULATED
All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.
KEY FINANCIAL NUMBERS : As a participant in a mutual fund scheme, following things are necessary to understand :
1) ASSET MIX :
The asset mix of a scheme refers to the allocation of the corpus of a scheme across three broad categories, viz., stocks, bonds, and cash. An asset mix of 60:30:10 mean that 60 % of the corpus is invested in stocks, 30 % in bonds, and 10 % in cash.
2) NET ASSET VALUE :
The net asset value (NAV) is the actual value of a share/unit on any business day. It is computed as follows : NAV = Market value of the funds investments + Receivables + Accrued income Liabilities Accrued expenses
Number of shares or units outstanding
3) MARKET PRICE, REPURCHASE PRICE & REISSUE PRICE :
A closed-ended scheme has to be necessarily listed on a recognized stock exchange to ensure that its participants enjoy liquidity. Generally, the market price of a closed-ended scheme tends to be lower than its NAV. If the market price is lower than the NAV, the scheme is said to be selling at a discount; if it is higher, the scheme is said to be selling at a premium. In addition to listing, the mutual fund may also offer the facility of repurchase. The repurchase price is usually linked to the NAV.
Unlike a closed-ended scheme, an open-ended scheme is not ordinarily listed on the stock exchange. Hence, the mutual fund has to stand ready to repurchase and issue its units or
shares on a continuing basis. The repurchase and reissue prices are, of course, closely linked to the NAV. 4) RATE OF RETURN :
The periodic (the period may be one month, one quarter, one year or any other) rate of return on a mutual fund scheme is calculated as follows: Rate of Return = NAV at the end of the period NAV at the beginning of the for the period period + Dividend paid during the period.
NAV at the beginning of the period 5) STANDARD DEVIATION :
The standard deviation of returns, a measure of dispersion, is the square root of the mean of the square of deviations around the arithmetic average.
6) BETA :
Beta of a fund measures its past price volatility relative to a particular stock market index. It is a measure of risk that provides useful statistical information particularly when applied to portfolios. Most mainstream equity funds have betas in the range of 0.85 to 1.05.
7) GROSS DIVIDEND YIELD :
The Gross Dividend Yield is an important indicator of the investment characteristics of a mutual fund. Among the equity funds, value-oriented funds tend to have a higher gross dividend yield and growth-oriented funds tend to have a lower gross dividend yield. The gross dividend yield is a reliable differentiator of a funds investment philosophy.
8) PORTFOLIO TURNOVER RATIO :
Portfolio Turnover represents the churn in the portfolio. It is measured as follows: Portfolio Turnover Ratio = Lower of purchase or sales during a given period Average daily net assets The following chart portrays the relative shares of the different fund categories of the mutual fund industry in India across the development phases discussed above.
RISK HIERARCHY OF MUTUAL FUNDS
Money Market Funds
Gifts Funds
Debts Funds
Hybri d
Equity Funds Aggressive Funds
Flexible Asset Allocation Funds
Risk Level
High Yield Debt Funds
Growth funds Diversified Equity Funds Index Funds
Focused Debts Funds Growth and Income Funds
Value Funds
Gilt Funds Money market Funds
Diversified Debt Funds
Balanced Funds
Equity Income Funds
Type of fund
ORGANIZATIONAL STRUCTURE OF MUTUAL FUND
Sponsor Company (For eg. SBI MF)
Established MF as the trust Register the MF under SEBI
Managed by the board of trustee
Mutual Fund (for eg SBI mutual fund)
Hold unit holders fund in MF Enter into an agreement with SEBI and ensure Float MF funds, Manages the fund as SEBI Guidelines and AMC agreement Provides custodial services
AMC (eg. SBI MF AMC)
CUSTODIAN
REGISTER
Provides registrar and transfer service Provides the network for distribution of the schemes to the investor
DISTRIBUTORS
CLASSIFICATION OF MUTUAL FUNDS
Mutual fund schemes may be classified on the basis of its structure and its investment objective.
1) BY STRUCTURE
Open-ended Funds An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity.
Closed-ended Funds A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed.
Interval Funds Interval funds combine the features of open-ended and close-ended schemes. They are open for sale or redemption during pre-determined intervals at NAV related prices.
2) BY INVESTMENT OBJECTIVE
Growth Funds The aim of growth funds is to provide capital appreciation over the medium to long term. Such schemes normally invest a majority of their corpus in equities. It has been
proven that returns from stocks, have outperformed most other kind of investments hel d over the long term. Growth schemes are ideal for investors having a long -term outlook seeking growth over a period of time.
Income Funds The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and Government securities. Income Funds are ideal for capital stability and regular income.
Balanced Funds The aim of balanced funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls. These are ideal for investors looking for a combination of income and moderate growth.
Money Market Funds The aim of money market funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter -bank call money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market. These are ideal for corporate and individual investors as a means to park their surplus funds for short periods.
Load Funds A Load Fund is one that charges a commission for entry or exit. That is, each time you buy or sell units in the fund, a commission will be payable. Typically entr y and exit
loads range from 1% to 2%. It could be worth paying the load, if the fund has a good performance history.
No-Load Funds A No-Load Fund is one that does not charge a commission for entry or exit. That is, no commission is payable on purchase or sale of units in the fund. The advantage of a no load fund is that the entire corpus is put to work.
3) OTHER SCHEMES
Tax Saving Schemes These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws as the Government offers tax incentives for investment in specified avenues. Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed a deduction under the Income Tax Act, 1961.
Index Schemes Index Funds attempt to replicate the performance of a particular index such as the BSE sensex or the NSE 50
Sectoral Schemes Sectoral Funds are those, which invest exclusively in a specified industry or a group of industries or various segments such as 'A' Group shares or initial public offerings.
OPTIONS AVAILABLE TO INVESTORS Each plan of every mutual fund has three options Growth, Dividend Payout and Dividend Reinvestment.
DIVIDEND PAYOUT :
Under the dividend plan dividend are usually declared on quarterly or annual basis. Mutual fund reserves the right to change the frequency of dividend declared.
DIVIDEND REINVESTMENT OPTION :-
Instead of remittances of units through payouts, Units holder may choose to invest the entire dividend in additional units of the scheme at NAV related prices of the next working day after the record date. No sales or entry load is levied on dividend reinvest. GROWTH OPTION:Under this plan returns accrue to the investor in the form of capital appreciation as reflected in the NAV. The scheme will not declare the dividend under the Growth plan and investors who opt for this plan will not receive any income from the scheme. Instead of income earned on their units will remain invested within the scheme and will be reflected in the NAV.
RISK ASSOCIATED IN MUTUAL FUNDS Mutual funds and securities investment are subject to various risks and there is no assurance that a scheme objective will be achieved. These risks should be properly understood by investors so that they can understand how much risky their investment avenue is. Equity and fixed income bearing securities have different risks associated with them. Various risks associated with mutual funds can be described as below.
Risk associated to fixed income bearing securities are:
Interest Rate Risk As with all the securities, changes in interest rates may affect the schemes Net Asset Value (NAV) as the prices of the securities generally increase as interest rates decline and generally decrease as interest rates rise. Prices of long-term securities generally fluctuate more in response to interest rates changes than short term securities do. Indian Debt markets can be volatile leading to the possibility of price movements up or down in the fixed income securities and thereby to the possible movements in the NAV.
Liquidity or Marketable Risk This refers to the ease with which a security can be sold at near to its valuation yield to maturity. The primary measure of liquidity risk is the spread between the bid price and the offer price quoted by the dealer. Liquidity risk is inherent to the Indian Debt market.
Credit Risk Credit risk or default risk refers to the risk that an issuer of fixed income security may default (i.e., will be unable to make timely principal and interest payments on the security). Because of
this risk corporate debentures are sold at a yield above those offered on Government securities, which are sovereign obligations and free of credit risk. Normally the value of fixed income security will fluctuate depending upon the perceived level of credit risks well as the actual event of default. The greater the credit risk the greater the yield require for someone to be compensated for increased risk.
RISK ASSOCIATED TO EQUITIES
Market Risk The NAV of the scheme investing in equity will fluctuate as the daily prices of the individual securities in which they invest fluctuate and the units when redeemed may be worth more or less than the original cost.
Timing the Market It is difficult to identify which is the right time to invest and which is the right time to take out the money. There may be situations where stocks may not be rightly timed according to the market leading to loss in the value of scheme.
Liquidity Investment made in unlisted equities or equity related securities might only be realizable upon the listing of the securities. Settlement problems could cause the scheme to miss certain investment opportunities
