Mutual Fund Distributors

Certification Examination
Jun-2010
Version 2.16

AGENDA
Chapter No.

Chapter Name

Concept & Role of a Mutual Fund

Fund Structure & Constituents

Legal & Regulatory Environment

Offer Document

Fund Distribution & Channel Management Practices

Accounting, Valuation & Taxation

Investor Services

Return, Risk & Performance of Funds

Scheme Selection

10

Selecting the Right Investment Products for Investors

11

Helping Investors with Financial Planning

12

Recommending Model Portfolios & Financial Plans

Learning Objective
y
y
y

Concept of Mutual Funds

Advantages
of
Mutual
Funds
Types of schemes

Chapter 1
Role & Concept of
Mutual Fund

Concept of Mutual Fund

y

Vehicle to mobilize money from investors to invest

in different markets and securities as per agreed
investment objectives
Primary role of a mutual fund is to assist investors
earn an income or build wealth by participating in
the opportunities in the securities markets
Different MF schemes have different investment
objective.

Role of Mutual Funds

y
y
y

y
y
y

A key participant in the capital market

Money raised from investors ultimately benefits governments,
companies and other entities directly or indirectly
Projects facilitated through such financing generates
employment, increases earning and thus increasing
consumption of goods and services
As a large investor, MFs can keep a check on operations of an
investee company and their corporate and ethical standards
MF industry offers livelihood to a large number of employees,
distributors, registrars and other service providers
Employability, income and output boosts the revenue
collection of the government through taxes, in turn promoting
economic development and nation building.

How do MFs operate?

y

Investments into a scheme are translated into

units
y Units have a face value of Rs. 10
y Number of units X face value = Unit capital of a
scheme
Income earned by Schemes
y dividend or interest
y Capital gains (or losses) upon sale and
purchase are called realized capital gains or
realized capital losses
y Value based on market price of investments (or
securities) are called valuation gains (or losses).
6

How do MFs operate?

y

Profitability metric of an MF Scheme:

z
z
z
z
z
z
z

Profit and loss of a scheme belong to the investors

z

(A) Interest Income

(B) + Dividend Income
(C) + Realized Capital Gains
(D) + Valuation Gains
(E) Realized capital Losses
(G) Valuation Losses
(H) Scheme Expenses
Investors losses are limited to the amount of investment

Net Asset Value (NAV), the true worth of units,

increases when investment activity is profitable
and vice versa.
7

How do MFs operate?

New Fund Offer (NFO)
z When a scheme is first made available for investment it is called an NFO
z Investors have a chance to buy units at Face Value during an NFO
z Post-NFO, investors pay a price linked to the NAV
y Scheme Options
z MFs offer different options to address different expectations of investors
on how profits are to be handled
z Dividend payout, Dividend Re-investment and Growth are the options
available in MF schemes
y Assets under Management (AUM)
z AUM helps assess the relative size of MF companies
z At launch AUM is the amount mobilized from investors
z Subsequently the AUM increases (decreases) if a scheme has positive
(negative) profitability metric.
z If subsequent contributions are accepted from investors, AUM increases
z If scheme pays dividends or allows redemptions, AUM decreases
z AUM captures the profitability metric and flow of unit-holder money to
and from the scheme.
y

Advantages of MF investing
y

Professional management
y
y
y

Portfolio Diversification
y
y

Investing in line with investment objective

Investing based on adequate research
Prudence in investment processes
Dont put all eggs in one basket reduce risks
Access to a range of securities held in the
investment portfolio of a scheme

Economies of Scale
y
y
y

Pooling of money from a large number of investors

allows a mutual fund to engage professionals
Costs related to investment research and office
space get spread
Higher transaction volumes allow better terms with
bankers, brokers and other service providers.
9

Advantages of MF investing
y

Liquidity
y
y

Tax Deferral
y
y

Investors can recover the value of moneys

invested from the mutual fund itself
Based on structure, liquidity is offered either at
any time, or at specific intervals, or on closure
of scheme or through the stock exchange.
MFs do not pay tax on income they earn
Scheme options allow investors to defer tax
liability

Tax benefits
y

Certain schemes (ELSS) offer benefit of

deduction of invested amount from income
that is liable to tax
Dividend income from MFs is tax free in the
investors hands.
10

Advantages of MF investing
y

Convenience
y

Investment comfort
y

Once documentation is done the first time,

subsequent purchases in a scheme is very simple

Regulatory comfort
y

Options under a scheme allow investors to

structure their investments in line with liquidity
preference and tax position

The regulator, SEBI has mandated strict checks

and balances in MF structure and activities

Systematic Approach
Investors can opt to invest regularly through (SIP)
or withdraw (SWP) or move money between
schemes (STP)
y Systematic approach and Investment discipline
promotes long-term wealth creation and
protection.
y

11

Limitations of MF Investing
y

Lack of portfolio customization

z Investment management is left to the
fund manager
z Unit-holder cannot influence investment
decisions

Portfolio Management Services (PMS)

offered by Securities Houses allow the
investors better control on what securities
are bought or sold

However, investors usually lack time and

knowledge to make portfolio choices
thus this is not a serious limitation

Choice overload
z Over 800 schemes are offered by 38 fund
houses sometimes choosing the right
scheme is difficult

Widespread
availability
of
industry
information and professional advisors can
help investors handle this overload.

12

Types of Funds

13

Types of Funds
y

Open-ended, Close-ended and Interval funds

z Open-ended fund
No fixed maturity
Entry or exit permitted at any time, even after the NFO
Ongoing entry and exit implies that Unit Capital changes
Investors buying units = A sale transaction, at a sale price equal to NAV
Investors redeeming units = A repurchase transaction, at a repurchase price
linked to NAV (NAV less Exit Load)
All sale (re-purchase) of units happen at a single price
z Close-ended fund
Fixed maturity
Investors can buy units from the fund only during NFO
Once NFO is closed, scheme gets listed to allow transactions through the stock
exchange
Listing is compulsory
Unit-capital is stable since buying and selling is between investors and not from
the fund
z Interval fund
Largely close-ended
Become open-ended at pre-specified intervals
Benefit to investors is reduced dependence on stock exchange to buy or sell
units.
14

Types of Funds

15

Types of Funds
y

Active and Passive Funds

y

Actively managed funds

y
y
y

Fund manager has flexibility to choose investment

portfolio
Higher expenses
Investors expect performance better than the market

Passive or Index funds

y
y
y
y
y

Invest in a specified index and track its performance

E.g. BSE Sensex fund would attempt to invest in
constituent shares in the same proportion
Portfolio is determined by the underlying index
Lower running costs
Designed to mirror the performance of the index.

16

Types of Funds
y

Debt, Equity and Hybrid Funds

y

Equity schemes
y

Debt funds
y

Invest in equity, equity-related instruments and

convertible debentures
Invest in treasury bills, govt. securities, bonds
and debentures

Hybrid funds
y

Based on investment charter, invest in a mix of

debt and equity.

17

Types of Funds
y

Debt Funds sub-types

z

Gilt fund
Invest in Treasury Bills and Govt Securities
No credit risk (risk of default by the issuer)

Diversified Debt fund

Invest in a mix of govt and non-govt debt securities

High Yield Bond or Junk Bond scheme

Invest in companies of poor credit quality
Expect that attractive returns of the investee companies to compensate
for the losses from a few defaulters

Fixed Maturity Plan (FMP)

Investment portfolio is aligned to maturity of the scheme

No money is accepted post-NFO
AMCs tend to structure the scheme around pre-identified investments
Fund manager has limited ongoing role in investment decisions
Comparable to holding investment to maturity as in Fixed Deposits.

18

Types of Funds
y

Debt Funds sub-types

y Floating Rate Fund
Invest in floaters viz. securities where
interest rate payable by issuer changes in
line with market
y NAV of such schemes fluctuate less than
that of debt funds which invest in securities
with fixed interest rates
y

Liquid or Money Market Scheme

Invest in debt securities with tenor of upto
91-days
y Lowest risk among all kinds of MF
schemes.
y

19

Types of Funds
y

Equity Funds sub-types

z

Diversified Equity
Invest in a mix of securities across sectors

Sector funds
Invest in a specific sector e.g. banking, pharma, gold sector

Thematic funds
Invest in line with an investment theme e.g. Infrastructure thematic fund may invest in

construction, toll-collection, cement, steel, power, telecom, banking etc.

More broad-based than sector but narrower than diversified
z

Equity Linked Savings Scheme (ELSS)

Invest in predominantly equity (at least 90%)
Lock-in of 3 years from date of investment
Tax benefit

Equity Income / Dividend Yield Scheme

Invest in shares whose value fluctuates less and dividend represents a larger proportion of

returns on shares
NAV is expected to fluctuate lesser than other categories of equity schemes
z

Arbitrage Fund
Taking advantage of price difference in different markets to earn a return
E.g. buying a share in BSE and simultaneously selling on NSE at a higher price
Usually the contrarian positions are in equity and Futures and Options (F&O) segments of the

market.

20

Types of Funds
y

Hybrid Funds sub-types

z

Monthly Income Plans

Seek to declare a dividend each month
Invest largely in debt securities with a small percent in
equity to boost the yield
Monthly Income is a misnomer and scheme should not be presumed to
be offering an income every month

Capital Protected Schemes

Close-ended schemes
Structured to protect the principal by investing in zero-coupon (issued
at discount, no interest is paid, maturity includes accumulated interest)
govt. securities with maturity aligned to scheme maturity
E.g. A 7500 investment in a G-Sec which will mature to 10000 at
maturity after 5 years ensures that scheme will repay the principal to
the investor; the remaining 2500 can then be invested in riskier
securities s.a. equity
Capital Protection Oriented Scheme is a variant where investment is
made in good quality debt rather than Central Govt Securities.

21

Types of Funds
y

Gold Fund
y Invest in gold and gold-related securities
y Gold Exchange Traded Fund
An index fund investing in gold
y NAV moves in line with gold prices in the market
y

Gold Sector Fund

A type of an equity fund
y Invest in shares of companies engaged in gold mining
and processing
y Share prices are closely linked to profitability and gold
reserves of the company
y NAV does not closely mirror the gold prices.
y

22

Types of Funds
y

Real Estate Fund

Take exposure to real estate
y Although permitted by law, RE MFs yet to hit
the markets
y

Commodity Fund
Commodity as an asset class includes food crops, spices,
fibre, metals, energy products, precious metals
y Structured as Commodity ETF or Commodity Sector
Fund
y Mutual Fund Schemes are not permitted to invest in
commodities
y Commodity funds available in the market are Commodity
Sector Funds, a type of an equity fund.
y

23

Types of Funds
y

International Fund
y Invest outside the country
y Investing abroad by hiring requisite people will
add to the costs
y Alternatively, tie up with a foreign fund
Identify a host fund abroad and launch a feeder fund
in India
y Investors put their money into feeder fund which
invests in host fund and gain from performance of the
host
y Feeder fund can be country specific or diversified
across countries, subject to legal and regulatory
requirements of India and host country.
y

24

Types of Funds
y

Fund of Funds
Funds which invest in other funds, in India or abroad
z Pre-specified mutual funds and/or schemes into which they
will invest
z

Exchange Traded Funds (ETF)

An open-ended index fund traded on the stock exchange
z Large investors are allowed to buy and sell from the scheme
z To allow exchange trading, mutual fund appoints market
makers, those who offer a price quote for buying and selling at
all times
z

More buyers mean that more securities can be bought and units can
be offered to investors
More sellers mean that units are offered back to mutual fund which
would release (sell) underlying securities to generate liquidity to pay
the unit holders

Investors buy and sell units at market prices

z Cost-effective than normal index funds, although involve a
brokerage cost.
z

25

Key Developments in the Industry

y
y
y

Public sector mutual funds were permitted in late-80s

Private sector funds commenced operations in mid-90s
Growth of mutual funds driven by
z Rise in Institutional distributors
z Emergence of stock exchange brokers as a channel of distribution
z Growth in convenience arising from technological developments
z Higher financial literacy
Key Statistics as on Feb 2010
z 38 fund houses - 800 schemes
z Industry AUM Rs. 766,869 crores
z AUM stands at 10% of bank deposits immense potential
z Open-ended funds contributed 92% of the AUM
z Income Funds 62%; Equity Funds 22% and Liquid Funds 10%
z High proportion in debt indicates that there is scope for course correction
Several changes to reduce costs and increase convenience have been
introduced to make mutual funds a vehicle of capital mobilization for larger
benefit of the economy.

26

Learning Objective
y
y

Legal Structure of MFs in

India
Role of key constituents in
the mutual fund ecosystem

Chapter 2
Fund Structure &
Constituents

27

Legal Structure of Mutual Funds

y
y

SEBI (MF) Regulations, 1996

Key features of a mutual fund
y All MFs are established as a trust
y Raise money through sale of units
y Units are sold under one or more schemes
y Schemes invest in securities including money
market instruments or gold or gold related
instruments or real estate assets.

28

Legal Structure of Mutual Funds

y
y
y
y
y

y
y
y
y

Constituted as trust
Created by one or more Sponsors
Every trust has beneficiaries, in case of mutual fund the investors
who invest in various schemes are beneficiaries
Trust Deed governs the operations, is executed by the Sponsors;
clauses are laid down by SEBI
Trust acts through its Trustees, whose role is to protect the interest
of the beneficiaries (investors); the first trustees are named in the
Trust Deed
Trustees can be individuals (board of trustees) or a company (board
of directors)
Asset Management Company (AMC), appointed by Sponsor or
Trustees, manages the day to day affairs of the schemes
Custodian, appointed by Trustees, has the custody of assets of the
scheme (securities, gold, real estate assets)
Registrar & Transfer Agent (RTA), appointed by the AMC, maintains
record of investors and their unit-holding.
29

MF Constituents

Mutual Fund Trust

ICICI Prudential Mutual Fund

Sponsor

ICICI Bank Ltd and Prudential Inc, UK

Trustee

ICICI Prudential Trust Ltd

AMC

ICICI Prudential Asset Management Co

Ltd

Custodian
RTA

30

Key Constituents
y

Sponsor
z
z
z

Applies to SEBI for registration of a mutual fund

Invests in the capital of the AMC
Eligibility criteria includes:

Sound track record, reputation of fairness and integrity

Carrying financial services business for at least 5 years
Can be an institution (LIC), Indian private entity (Kotak) foreign entity
(Fidelity, Franklin), predominantly foreign (HSBC, Morgan Stanley) or
predominantly Indian joint venture (Birla Sun life & ICICI Prudential)
Have positive net worth (share capital plus reserves minus
accumulated losses) for each of those 5 years
Latest net worth more than capital contributed to the AMC
Earned profit, after providing depreciation and interest, in 3 out of
previous 5 years, including latest year
Should be a fit and proper person for this kind of operation
Needs minimum 40% shareholding of the capital of the AMC
{ Anyone with more than 40% holding is considered a sponsor and
thus must fulfill the eligibility criteria.
31

Key Constituents
y

Trustee
Ensure compliance with regulations and protect
unit-holder rights
z Perform general and specific due diligence
z SEBI requirements
z

Person of ability, integrity and standing

Not guilty of moral turpitude
Never convicted of economic offence or violation of securities
law
SEBI approval is required in Trustee appointment
Minimum 4 trustees in case of individual trustees and
minimum 4 directors in case of a trustee company
At least 2/3rd trustees are independent i.e. not associated with
the sponsor in any way.

32

Key Constituents
y

Asset Management Company (AMC)

z Handle day to day operations of the fund
z Arrange for requisite offices, infrastructure, engage employees, handle
advertising and sales promotion, interact with regulators and
service providers
z Ensure investments made are compliant with SEBI regulations and the trust deed
z Exercise due diligence and care in all investment decisions
z SEBI requirements
Directors of AMC to have adequate professional experience in finance and
financial services related fields
Key personnel not be guilty of moral turpitude or convicted of any economic
offense or violation of securities laws
Should not have worked for any AMC or MF or intermediary during the period of
suspension or cancellation of license at any time by SEBI
Appointment are Director requires Trustee approval
50% independent directors i.e. not associated with sponsor or subsidiaries or
trustees
Minimum Net Worth Rs. 10 crore
AMC cannot invest in own schemes, unless disclosed in the Offer Document no
fee can be charged for such investment
Changes in AMC require SEBI and unit-holder approval
75% of the unit-holders can terminate the appointment of an AMC.
33

Key Constituents
y

Asset Management Company (AMC)

{
{
{

{
{

AMC operations are headed by Managing Director,

Executive Director or CEO
Other functionaries include
Chief Investment Officer (CIO) responsible for overall
investment of the fund; assisted by Fund Managers who can
manage multiple schemes; every scheme must have a fund manager
Securities Analyst support the CIO through research inputs; can be
fundamental or technical analysts; some schemes also have economists
Securities Dealer help in putting the transactions through in the market
Chief Marketing Officer (CMO) responsible for mobilizing money under
the schemes; supported by Direct Sales Team (focus on large investors),
Channel Managers (manage the distributors) and Advertising and Sales
Promotion teams
Chief Operations Officer (COO) handle all operational issues
Compliance Officer ensures all legal compliances; signs the due-diligence
certificate in the Offer Document that all regulations are complied with, all
intermediaries have requisite statutory registrations and approvals; reports
directly to the head of the AMC and works closely with the Trustees.
34

Other Service Providers

y

Custodian
y Custody or safekeeping of assets of the fund
y Accept and give delivery of securities for sale
and purchase transactions
y Appointed by the trustees through a custodial
agreement
y Custodian cannot be an entity controlled by the
Sponsor
Independence of custodian is important
y In case sponsor or associates hold 50% or more of
the shares of the custodian, it cannot be appointed to
the mutual fund operation of the sponsor
y

All Custodians are registered with SEBI.

35

Other Service Providers

y

RTA
z
z
z
z
z

Maintain investor records and handling investor

documentation
Serve as Investor Service Centres (ISCs)
Appointed by AMC
RTA is not compulsory, AMC can do this activity in-house
All RTAs need SEBI registration

Auditors
Responsible for audit of accounts
z Accounts of scheme need to be kept independence of
accounts of AMC
z Scheme auditor to be different from AMC auditor
z Scheme auditor is appointed by Trustee and AMC auditor
by the AMC.
z

36

Other Service Providers

y

Fund Accountants
z

Distributors
z
z

Role of calculating fund NAV by collecting information

about assets and liabilities of each scheme
AMC can appoint a service provider or do the activity in-house
Key role in selling suitable type of units to clients
Need to pass the prescribed examination and register with AMFI

Collecting Bankers
z
z

z
z

Scheme moneys are parked in bank accounts maintained with

collecting bankers
Payment instruments against applications submitted with AMC or
RTA are banked with collecting bankers to ensure availability for
investment by the scheme
AMC appoints the collecting bankers
Provide convenience to investors by accepting investments at
their branches.
37

Learning Objective
y

Overall regulations of
mutual funds in India

Chapter 3
Legal & Regulatory
Environment

38

Regulatory Environment
y

Securities Exchange Board of India (SEBI)

z
z

SEBI (Mutual Funds) Regulations, 1996 are applicable to MF

business
SEBI regulates MFs, Depositories, Custodians, RTAs and also
Stock Exchanges

Other Regulatory Bodies

z

Some segments of financial markets have own independent

regulators e.g. money markets and foreign exchange markets are
regulated by RBI

MFs need to comply with RBIs regulations related to investment in

money market, investments outside the country, investments from
people other than resident Indians, remittances (inward and outward)
of foreign currency etc.

Stock exchanges have their own listing, trading and margining

rules

MFs need to comply with rules of the exchange with which they
choose to list their schemes

39

Regulatory Environment
y

Self-Regulatory Organizations (SROs)

Regulate own members
z Wherever SROs are present, the regulator only lays down
broad policy framework and micro-regulation is done by
the SRO
z E.g. Institute of Chartered Accountants of India (ICAI)
regulates own members
z MF business has no SRO and is regulated directly by SEBI
z

Association
MFs in India are members of AMFI
z AMFI promotes the interest of MF Industry (similar to CII
and NASSCOM)
z AMFI is not an SRO.
z

40

AMFI Objectives
y
y
y
y
y
y
y

High professional and ethical standards

Best business practices and code of conduct
Interact with SEBI
Represent MF industry to govt, RBI and other
bodies
Training
and
certification
program
for
intermediaries
Investor awareness programme
Undertake studies and research on the industry.

41

AMFI Code of Ethics (ACE)

y
y

Standards of good practices for AMCs in dealing

with investors, intermediaries and the public
ACE supplements the Code of Conduct specified in
the Fifth Schedule of SEBI (MF) Regulations to
encourage higher standards for the benefit of
investors.

42

AMFI Guidelines & Norms for Intermediaries

(AGNI)
Guidelines and code of conduct for intermediaries, comprising
individual agents, brokers, distribution houses and banks
engaged in selling of MF products
y SEBI has made it mandatory for intermediaries to follow the
Code of Conduct
y Steps provided for in case of breach of code of conduct:
y

z
z

z
z

Write to the intermediary with copies of complaint and other

documents and ask for an explanation within 3 weeks
In case of no or unsatisfactory explanation, AMFI will issue a
warning letter indicating that a subsequent violation will result in
cancellation of MF registration
In case of a second violation by the intermediary, registration is
cancelled and intimation sent to all AMCs
Intermediary has the right of appeal to AMFI.

43

Investment Restrictions for Schemes

y
y

Restrictions exist on type of investments, individual

limits and aggregate limits
Investment Objectives
Broad investment charter
z A diversified equity scheme may read to generate capital
appreciation from a portfolio of predominantly equity
related securities
z A diversified debt scheme may read to generate income
by investing predominantly in a wide range of debt and
money market securities
z A balance fund may read to achieve growth by investing
in equity and equity related investments, balanced with
income generation by investing in debt and money market
securities.
z

44

Investment Restrictions for Schemes

y

Investment Policy
y The kind of portfolio that will be maintained
y E.g. The portfolio will generally comprise of
equity and equity related instruments of around
30 companies, which may go upto 39
companies
y Investments will predominantly be in mid-cap
stocks
y When a scheme name implies a particular kind
of security or sector, at least 65% of the corpus
should be in that security or sector in normal
times
y Investment objective and policy are a part of the
Scheme Information Document.
45

Investment Restrictions for Schemes

y

Investment Strategy
y Day to day investment approach
y Provide details s.a. Should we increase
liquidity component or Should we go
overweight on cement sector
y Practice of CIO and Fund Managers meeting
every morning to discuss change in investment
strategy.

46

Other Regulatory Aspects

y

Service Standards for a Mutual Fund

z Schemes, other than ELSS, allot units or refund moneys within 5
business days of closure of NFO
z Open-ended schemes, other than ELSS, have to re-open for
ongoing sale / repurchase within 5 business days of allotment
z Statement of accounts to be sent to investors

In case of NFO, within 5 business days of closure of NFO

On an ongoing basis statement of account to be sent to investors within
10 working days of investment
In case of SIP, STP and SWP, statement of account to be sent to
investors within 10 working days
Initial transactions 10 working days
Ongoing once every calendar quarter (Mar, Jun, Sep, Dec) within 10
working days
On specific requests within 5 working days at no cost
To dormant investors (i.e. not transacted in past 6 months) along with
portfolio statement / annual return with the latest position on number
and unit value
If mandated by investor, soft copy to be e-mailed every month.
47

Other Regulatory Aspects

y

NAV
Must be published daily, in at least 2 newspapers
z NAV, Sale and Repurchase Price is to be updated on the
website of AMFI and the mutual fund
z

y
y

In case of Fund of Funds, by 10am the following day

In case of other schemes, by 9pm the same day

Dividend warrants must be dispatched to investors

within 30 days of dividend declaration
Redemption/re-purchase
cheques
must
be
despatched to investors within 10 working days
from date of receipt of transaction request
In case of delay in despatch of dividend warrants or
redemption/repurchase cheques, interest @ 15%
p.a. is payable by the AMC and cannot be charged
to the scheme.
48

Other Regulatory Aspects

y

Scheme Portfolio and Unaudited Financial Results

Mutual fund to publish complete statement of scheme
portfolio and unaudited financial results within 1 month
from close of each half year
z Advertisement to appear in one National English daily and
one Newspaper in language of the region where the head
office of the mutual fund is situated
z

Portfolio Disclosure
z

Debt-oriented, close-ended / interval schemes to disclose

their portfolio in their website every month, by the 3rd
working day of succeeding month

Annual Report
z

Annual Report of the AMC has to be displayed on the

website of the mutual fund.
49

Investor Rights
y

Unit Certificate
y A certificate of unit holding that an investor can
ask for
y Unit Certificate mentions number of units held
by investor while statement of account shows
opening balance, transactions and closing
balance
y Unit Certificate is like a Balance Confirmation
Certificate issued by a Bank, while Statement of
Account is like a Passbook
y Unit Certificates are non-transferable and have
no transactional convenience
y If a unit-holder asks for it, AMC must issue it
within 30 days of receipt of request.
50

Investor Rights
y

Nomination
y
y
y

Investors can nominate upto 3 nominees

Investor can specify the percentage distribution
between nominees
If no percentage is indicated, an equal
distribution is presumed

Investors can pledge units as a security.

51

Other Investor Rights

y
y

Investors have proportionate right to the beneficial

ownership of the schemes assets
Investors can choose to change a distributor or go
direct
z AMC need to comply without insistence on a No
Objection Certificate (NOC)
Investors can hold units in dematerialized form
z AMC is bound to coordinate with RTA and
Depository to facilitate this
z Demat statement given by Depository Participant
(DP) is treated as compliant with requirement of
Statement of Account.
52

Other Investor Rights

y
y

A fund can choose to send portfolio statement to its investors

in lieu of newspaper advertisement
Unit-holders have right to inspect key documents s.a. trust
deed, investment management agreement, custodial services
agreement, RTA agreement and Memorandum & Articles of
Association of the AMC
Scheme-wise annual report or an abridged summary has to
be mailed to all unit-holders within 4 months of close of the
financial year
Annual Report of the AMC, displayed on the website, will
mention that unit-holders can ask for a copy of the AMCs
annual report
In the event of any issue with a scheme, an investor can
approach investor service center, failing which take it up with
the AMC and if not redressed, then write to SEBI with details.
53

Other Investor Rights

y

Scheme Information Document has details of

number of complaints and their disposal; pending
complaints can be a ground for SEBI to refuse
permission to an AMC to launch new schemes (Pls.
delete highlighted in red this is factually correct
but can still be deleted)
Changes in fundamental attributes by Trustees /
AMC can be made, provided
Written communication is sent to each unit-holder
z Advertisement is issued in an English newspaper with
nationwide circulation and in a newspaper published in the
language of region where the head office of the AMC is
located
z Existing unit-holders are given the option to exit at
prevailing NAV without exit load; window to be open for at
54
least 30 days.
z

Other Investor Rights

y

y
y

Appointment
of AMC can be terminated by
majority of trustees or 75% of unit-holders (in
practice, such investors holding 75% of the units)
Scheme can be would up by a resolution passed
by 75% unit-holders
Unit-holder consent is required by Trustees
Whenever required by SEBI
z Whenever required to do so by 75% of unit-holders
z When trustees decide to wind up or prematurely redeem
the scheme
z

Investors can file a suit against Trustees for breach

of trust in case they feel that trustees have not
fulfilled their obligations.
55

Limitations of Investor Rights

y
y

y
y

Investors cannot sue the trust, a notional entity

Investors cannot seek protection on grounds of not
being aware, especially about provisions of law
and matters fairly and transparently stated in the
offer document (principle of caveat emptor let
the buyer beware)
Unit-holders can proceed against Trustees, AMC
but prospective investors do not have the rights
Protection under Companies Act, 1956 is not
available
z Investor in a scheme is not a share-holder nor a
fixed deposit holder and the scheme is in any
case not a company.
56

Misc Provisions
y

Unclaimed Accounts
Mutual fund must deploy these funds in the money market
z AMC can recover a maximum of 0.05% as investment
management and advisory fee
z An investor can claim the money
z

within 3 years - payment is based on prevailing NAV i.e. after

adding the income earned on the unclaimed money
After3 years payment is based on the NAV at the end of 3
years

AMC must make continuous efforts to remind investors

through letters to claim their dues
z Annual Report must mention unclaimed amount and the
number of such investors for each scheme.
z

57

Misc Provisions
y

Illiquid Securities
y Securities which are treated as wholly or
partially non-recoverable at maturity or winding
up and may subsequently yield a higher
amount to the scheme
If recovered within 2 years and are substantial, then it
must be paid to the old investors
y In other cases, the amount is to be transferred to the
Investor Education Fund maintained by each mutual
fund.
y

58

Investor Obligations
y

PAN and KYC documentation are mandatory for

MF investments
y Micro-SIPs are an exception (annual investment
upto 50,000)
Bank details are mandatory with redemption
request.

59

Can a Scheme go bust?

y

Appropriate checks and balances

AMC manages investments and Custodian holds the assets
and both operate under Trustee control
z Investor is protected from frauds and misappropriate of
funds
z

Structural Protection
z

Custodian has custody of investments and is an entity

independent of Sponsor and AMC

Mutual funds cannot vanish

Sponsors who wish to exit would need to bring in new
sponsors, acceptable to SEBI, before they can exit
z The new sponsor would put the framework of trustees,
AMC etc. in place
z In case of change in sponsorship, option to exit at full NAV
for a 30-day period is given to all existing investors.
z

60

Learning Objective
y
y

Chapter 4
Scheme Information
Document

What goes into a New Fund

Offer (NFO)
Legalities underlying the
offer document - the key
source of information for
investors and prospective
investors

61

New Fund Offer

Units are offered to investors for the first time through an
NFO
y 3 important dates are:
y

z
z
z

NFO Open date date from which investors can invest in the NFO
NFO Close date date upto which investors can invest in the NFO
Scheme Re-Opening date applicable only to open-ended funds;
date from which investors can offer their units for re-purchase to
the scheme or buy new units; sale and repurchase prices are
announced from Re-Opening date

Other than ELSS, NFOs can remain open for maximum of 15

days
y Allotment of units or refund of moneys should be done within
5 business days of closure of NFO
y Open-ended schemes have to re-open for sale/re-purchase
within 5 business days of the allotment.
y

62

Steps leading to an NFO

1.
2.
3.

4.
5.
6.
7.

AMC decides on a scheme basis inputs from CIO

& CMO
AMC
prepares
the
Scheme
Information
Document (SID) and Trustees approve it
SID is filed with SEBI and observations are
incorporated; after final approval from SEBI, SID
is released in the market during NFO
AMC decides a time-table for the issue
AMC launches advertising, PR campaigns
AMC holds events for intermediaries and the
press
SID & Application forms are distributed /
circulated after filing the same with SEBI.
63

Role of the SID

y

y
y
y
y

SID contains information about the fundamental

attributes - nature of scheme, investment
objectives and the term
SID is a legal document
The most important source of information for
investors to evaluate merits of the scheme
Is useful post-investment as well to check how the
commitments are being lived upto
Investor is presumed to have read the SID, even if
he has not (principle of caveat emptor or buyer
beware applies)
Investor cannot claim lack of awareness about
something which was disclosed in the SID.
64

SID Components
y

SID has 2 parts:

z Scheme

Information Document (SID)

Provides

details of the scheme

z Statement

of Additional Information (SAI)

Statutory

information about the mutual fund

Single SAI is relevant for all schemes of a mutual fund
z The

2 are separate documents but technically the

SAI should read in conjunction with the SID
z SID and SAI are prepared in the format prescribe
by SEBI and are submitted to SEBI
z SID is vetted by SEBI and not approved by it
SEBI

does not approve or disapprove SIDs, it gives its

observations which need to be incorporated in the SID
offered in the market.
65

Scheme Information Document

y

Cover page contains

z Name & type of fund
Open-ended / close-ended Interval (Structure)
Equity / Balance / Income / Debt / Liquid / ETF (Expected nature of
scheme)

Face Value of units being offered

z Relevant NFO Dates (opening, closing, re-opening)
z Date of SID
z Name of the mutual fund
z Name and contact info of the AMC and Trustee Company
z Standard Clauses
Draft SID is a public document and available for viewing on SEBI
website for 21 working days
Final SID has to be hosted on AMFI website 2 days before the issue
opens
SID for all current schemes is available for download on a mutual
funds website.
z

y
y
y

66

SID Updates
y

Regular
Scheme launched within first 6 months of a financial year (say Jun
2010) first update is due within 3 months of the end of the financial
year (Jun 2011)
y Scheme launched in the second 6 months of a financial year (say Oct
2010) first update is due within 3 months of the end of the next
financial year (Jun 2012)
y Thereafter, SID is to be updated every year
y

Need-based
y

Change in fundamental attributes

y

Must be updated immediately after the lapse of time period given

to existing investors to exit the scheme

Other changes
Addendum is distributed along with SID until SID is updated
y If changed further, addendum required only for latest change
y Change is to be published in an English one regional newspaper
y Change is to be updated on the mutual fund website.
y

67

Scheme Additional Information

y

y
y
y
y
y

y
y
y

Information about Sponsors, AMC and Trustee Company

(contact info, shareholding pattern, responsibilities, names of
directors, profile of key personnel, contact info of service
providers)
Condensed financial information of schemes launched in last
3 years
How to apply
Rights of unit-holders
Investment valuation norms
Tax, legal and general information (investor grievance
mechanism, data on complaints of past 3 years and of
current year-to-date)
Provision for download of SAI from website of all mutual
funds
Investors have a right to ask for a printed copy of SAI
AMFI website contains SAI of all mutual funds.
68

SAI Updates
y

Regular Updates
y End of 3 months of every financial year
Material changes
y Updated on ongoing basis
y Uploaded on websites of mutual funds and
AMFI.

69

Key Information Memorandum

y

Role of KIM
z
z
z

Contents of KIM
z
z
z
z
z
z
z
z
z
z

Summary of SID and SAI

More widely distributed and circulated
Every application form is to be accompanied by the KIM
Name of AMC, Mutual Fund, Trustee and Fund Manager of the Scheme
Dates of issue opening, closing and re-opening
Plans and options under the scheme
Risk profile of scheme
Price, minimum amount/units for initial & additional purchase and re-purchase
Benchmark
Dividend policy
Performance of scheme over past 1, 3, 5 years and since inception
Loads and expenses
Contact information of Registrar for taking up investor grievances

KIM Updates
z

Updated at least once in a year

70

Learning Objective
y
y

Distribution Channels of
mutual funds
Management of channels

Chapter 5
Fund Distribution &
Channel Management
Practices

71

Distribution Channels - Traditional

y

Individual Agents/IFAs
z Previously, Individual agents were selling a whole gamut of financial
products s.a. mutual funds, insurance, post office schemes, fixed
deposits, shares etc.
z Several changes led to emergence of other channels

Several new insurance and mutual fund players entered business

Universe of investments products multiplied
More aware Investors
Technology multiplied accessibility and reach
Geographical spread of companies
Need for generating higher volumes in the market

Institutional Channels
z Brokerage and securities distribution companies or Banks keen to earn
fee-based income
z Enjoy the benefit of reach/scale
z Channel Managers appointed by AMCs handle these large distributors
z Engage individual agents as sub-brokers
y Alternative channels
z Post offices
y Self-help groups.
y

72

Distribution Channels New Gen

y

Internet
Scope for direct contact and transactions thus lower costs
z Convenience for investors
z Future of intermediation lies in leveraging technology to
provide value-add service and advise
z

Stock Exchange
Cost effective all-India network of brokers and trading
terminals
z Successful model of high-volume low-margin business
z Both BSE and NSE have MF transaction engines
z Strong linkage already exists:
z

Close-ended funds are listed on an exchange

ETFs are traded on an exchange.

73

Becoming an MF Distributor
Distributor can be an individual, company, bank, NBFC
y No SEBI permission is required
y SEBI has prescribed a Certifying Examination (NISM
Examination for MF Distributors w.e.f. 01-Jun-2010)
y

Compulsory for anyone selling mutual funds

y Compulsory for anyone who interacts with mutual fund investors,
including investor relations teams and employees of call centers
y Distributors/Employees above the age of 50 and with at least 5 years
work experience as on Sep 30, 2003 were exempt but need to attend a
prescribed refresher course
y

Register with AMFI allotted an AMFI Registration Number

(ARN)
y Empanel with the AMCs or become agents of Distributors
who already are empanelled to be able to earn the
commissions
y Institutions who are into distribution of mutual funds need to
register with AMFI and all employees who are selling mutual
funds need an ARN.
74

Conditions for Empanelment

y

Standard request form

z
z
z

z
z
z
z

Personal information name, age, trade name, contact info, ARN,

PAN, Income Tax Category
Name and contact info of key people handling sales and
operations
Business details s.a. office area, number of branches, number of
employees, geographical area covered, years of experience,
number of investors, number of agents / sub-brokers, fund
houses already empanelled with, size of AUM
Bank details / preference for direct credit of commissions
Preference regarding receiving info from AMC
Nominee
Sign a Declaration

correctness, confidentiality, commitment to abide by codes, not to

issue advertisement other than pre-approved by AMC, mention risk
factors along with performance, provide info to AMC from time to time,
ensure ARN for relevant employees, not to rebate commission etc.
75

Channel Management Practices

y

Commission Structures
z
z
z
z
z

No SEBI regulations regarding min or max commission that

distributors can earn
SEBI has laid down limits on total expenses in a scheme
Excess expenses are to be borne by the AMC and cannot
be charged to the scheme
Commission structure varies between AMCs and within an
AMC between schemes
2 types:

Initial or Upfront on the amount mobilized by the distributor;

fee is paid directly by the investor based on assessment of
service, advise etc.
Trail percent of net assets attributable to units sold by the
distributor; normally paid quarterly and for as long as
investors money is held in the fund.

76

Multi-level Distribution Channel

y
y
y
y
y

Large distributors have agents / sub-brokers

working under them
Being the principal, the distributor is bound by the
acts of agents / sub-brokers
Distributor needs to ensure that agents comply
with the regulations
AMC-Distributor relationship is usually structured
as Principal-Principal
The AMC is not bound by the acts of the
distributor, or its agents / sub-brokers.

77

SEBI Regulations & Sales Practices

y

Distributors can claim commission on investments

made through them by clients and not their own
investments
Distributor must disclose all commissions (trail or
any other mode) payable to them for the different
competing schemes of different mutual funds from
amongst
which
the
scheme
is
being
recommended to the investor
Practice of rebating i.e. sharing commission with
investors, is banned.

78

SEBI Advertising Code

y
y
y
y

Advertising shall be truthful, fair and clear

Statements
should
be
substantiated
with
disclosures in SID and SAI
Risks in MF investing to be clearly stated
No
exaggerated
or
unwarranted
claims,
superlatives and opinions, future forecasts and
estimates of growth
Statutory Warning Mutual Fund investments.
On hoardings/posters: to be displayed in black letters on
white background of at lest 8 inches height or covering 10%
of the display is mandatory
z In audio-visual media: to be displayed on screen for at least
5 seconds, clearly legible font size covering 80% of screen
space and accompanied by voice over reiteration.
z

79

SEBI Advertising Code

y

Tombstone advertising can contain:

z Basis info about MF registered with SEBI
z Scheme already in existence
z Name of the Mutual Fund and the AMC
z Scheme name and classification
z Logo or trademark or corporate symbol
z General services offered i.e. frequency of NAV disclosure,
liquidity etc.
z Contact details
z Entry/exit loads
Tombstone advertising restrictions include:
z Declaration of NAV and performance of scheme
z Promise of return, except in case of assured schemes
z Comparison and usage of ranking given by a third party
z Product launches all advertisement in the period that an NFO is
open
z Risk factors may not be mentioned.

80

SEBI Advertising Code

Product Launch Advertising
y
y
y
y
y
y
y
y
y
y
y
y

Name of MF and AMC

Scheme name and classification
Investment objective, asset allocation or highlights
Terms of issue and mode of sale/repurchase of units
Investor benefits and general services i.e. frequency of NAV
disclosure
In case of assured return schemes, the backup resources
Logo or trademark or corporate symbol
Risk factors as stated in SID
Applicable load structure
Contact information for obtaining SID, SAI and KIM
Statement that investor should read SID and SAI before investing
Must not contain:
Declaration of NAV and performance figures of previous schemes
y Comparison with other MFs or schemes
y Ranking by any ranking entity.
y

81

SEBI Advertising Code

Performance Advertising
y
y
y
y
y
y
y
y
y
y
y

Nature of Scheme and basic Investment objective

Dividend declared or paid
Only compounded annualized yield for scheme more than 1 year
Returns will be shown for last 1,3, 5 years and since inception
Only total (absolute) returns (not annualized) shall be advertised for
schemes in existence for less than a year
Simple annualization in case of money market or cash or liquid plans
Advertisement displaying returns must be followed by past
performance may or may not.. in the main body and in same font
Data must not be older than the most recent calendar quarter
Appropriate benchmarks be used for comparisons
In case distribution taxes are excluded in calculations disclose the
same
No use of ranking except those developed by an independent
ranking entity.

82

SEBI Advertising Code

Headline or Prominent Statements
No implication that the AMC or the mutual fund is the best in a
category unless actually so
y All ranking advertisement must disclose
y

z
z
z
z
z
z
z
z
z
z
z

Name of the category

Number of AMCs/MFs in the category
Name of the ranking entity
Length of the period and end date, or start and end date
Criteria
Whether account sales charge are factored
Disclosure of effect of fee/expense waiver
Publisher of ranking data
Meaning of symbols (e.g. 4-Star rating)
Indicate that past performance is no a guarantee of future results
All ranking must be current to the most recent quarter.

83

SEBI Advertising Code

Headline or Prominent Statements
y

All ranking advertisement must disclose

y

For schemes other than money market:

y Ranking based on yields for a period of at least 1 year
y Ranking based on compounded annualized yield must be
based on rankings supplied by same entity, related to same
category and the same time period
y Ranking to be based on returns for
y 1 year schemes in existence for at least 1 year
y 1 and 5 year periods schemes in existence for at least
5 years
y 1, 5 and 10 year periods for schemes in existence for
at least 10 years
y In case no such period ranking are published, rankings
to represent short, medium and long term performance
y Shall not offer any indicative portfolio and indicative yield.

84

SEBI Advertising Code

Headline or Prominent Statements
y

Disclosure of risk factors in advertisements

Announcing launch of a scheme
y Performance advertising
y Advertisements with only latest NAV, sale and repurchase
price without reference to past figures may not disclose all
the risk factors but include investors are advised to read
the Scheme Information Document before investing in the
scheme.
y

85

Learning Objective
y
y
y
y

Chapter 6
Accounting, Valuation &
Taxation

Accounting aspects of mutual

fund schemes
Valuation of securities in the
schemes portfolio
Calculation of Net Asset Value
Impact of taxation on MF
schemes and investors

86

Net Assets of a Scheme

Amount (Rs. cr)
Liabilities
Unit Capital (10 crore units of Rs 10 each)

100

Profit [Interest and Dividend Received {5 cr} (-) expenses paid

{2 cr} (-) expenses payable {1 cr}]

Capital Appreciation on Investments held [10% of 50 crores]

Unit-holders funds in the scheme (Net Assets)

107

Expenses payable

Scheme Liabilities

108

Assets
Market Value of Investments (50 cr + 10%)

55

Bank Deposits [Original amount {50 cr} + Interest and Dividend

{5 cr} (-) expenses paid {2 cr}]

53

Scheme Assets

108

The above table is only for illustration and for better understanding of the concept.
87
The actual result may substantially vary.

Net Assets of a Scheme

y
y
y

Net Assets - Unit-holders funds in the scheme

Includes original investment + Profits booked +
Appreciation in the investment portfolio
Net Assets go up when the market prices of
securities, even if the investments have not been
sold
Accrual concept applies to income and expenses
y

Expenses that relate to a period need to be considered while

calculating profits, irrespective of whether or not the
expense has been paid
Likewise, income pertaining to a period will boost profits,
irrespective of whether it has been received in the bank or
not.

88

Net Asset Value

NAV is value of each unit of a scheme
y Net Assets (Unit-holders funds) / No. of Units
= 107 / 10 = Rs. 10.7 per unit
y Alternatively,
[ Total Assets (-) Total Liabilities other than to Unit
Holders] / No. of units
= 108 (-) 1 / 10 = Rs. 10.7 per unit
y NAV Rules
y

Higher the interest, dividend and capital gains, higher the

NAV
z Higher the appreciation in investment portfolio, higher the
NAV
z Lower the expenses, higher the NAV.
z

The above table is only for illustration and for better understanding of the concept.
89
The actual result may substantially vary.

Net Asset Value

Profitability Metric
Interest Income
2. + Dividend Income
3. + Realized Capital Gains
4. + Valuation Gains
5. - Realized Capital Losses
6. - Valuation Losses
7. - Scheme Expenses
1.

90

Mark to Market
y

y
y

Process of valuing each security in the investment

portfolio of the scheme at its market value
z NAV reflects the true worth of each unit and
forms the basis of buying and selling decision of
investors
z Valuing shares at acquisition cost is meaningless
and does not capture the movement of the
market price
MTM helps investors buy and sell units at a fair
price
MTM helps assessing the performance of the
scheme/fund manager.

91

Sale, Re-purchase Price & Loads

y

Sale = scheme selling units

z

Re-purchase = scheme buying back units

z

Sale Price = NAV + Entry Load

Re-purchase Price = NAV Exit Load

Contingent Deferred Sales Charge (CDSC)

Lower exit load for longer holding
z E.g. 4% if investor exits in year 1, 3% in year 2 and so on.
z

Position w.e.f. 01-Aug-2009

No Entry loads
z Exit loads need to be the same for all unit-holders
representing a portfolio
z Exit Load/CDSC in excess of 1% of redemption proceeds
are credited back to the scheme and available to the AMC to
bear selling expenses.
z

92

Scheme Expenses
- Initial Issue Expenses
y
y
y

One-time expenses at the time of NFO

Borne by the AMC
Previously, 6% IIE were permitted
y Treatment 1 - An immediate expense (writtenoff) and cause a drastic fall in NAV
y Treatment 2 Permitted as a deferred load
(written off over the term of the scheme); the
portion pertaining to periods that have passed
treated as written-off and the part related to
future time period treated as an asset called
Issue Expenses Not Written Off.

93

Scheme Expenses
- Recurring Expenses

Charged to the scheme and reduce the NAV

y SEBI has laid down the expenses
y

y
y
y
y
y

Fee of Service Providers such as Trustee, AMC, RTA, Custodian and

Auditor
Selling Expenses including Advertising & Commissions
Expenses on investor communication, account statements, dividend/
redemption cheques/ warrants
Listing and depository fee
Service tax

Expenses that cannot be charged

Penalties and fines for infraction of laws

Interest in delayed payment to the unit-holders
Legal, marketing, publication & general expenses not attributable to a scheme
Fund accounting fee
Expenses on investment & general management
Expenses on general administration, corporate advertising & infrastructure

Depreciation on fixed assets and software development expenses.

y
y
y
y
y

94

Scheme Expenses
- Recurring Expenses
Net Assets (Rs Cr)

Equity Schemes

Debt Schemes

Upto 100 cr

2.50%

2.25%

Next 300 cr
(100-400 cr)

2.25%

2.00%

Next 300 cr
(400-700 cr)

2.00%

1.75%

Excess over
700 cr

1.75%

1.50%

Note: Calculated on the daily or average weekly Net Assets of the Scheme
95

Scheme Expenses
- Investment Management Fee
Net Assets (Rs Cr)

Equity Schemes

Upto 100 cr

1.25%

Above 100 cr

1.00%

Notes:
1.IMF is included within the Recurring Expenses
2.IMF cannot be charged by liquid schemes and other debt schemes on
the funds parked in short term deposits of commercial banks.

96

Recurring Expenses
- Index Schemes, ETFs & FoFs
Index Schemes & ETF

Expense Limit

Recurring Expenses Limit

(Including Management Fee)

1.50%

Management Fee

0.75%

Fund of Funds

Expense Limit

Recurring Expenses Limit

(Including Management Fee)

0.75%

97

Dividends & Distributable Reserves

Existing Position
y

Conservative approach to calculating distributable

reserves
Income and Expenses can be accrued but valuation gains
cannot be accrued
z Capital gains need to be realized i.e. securities need to be
sold
z Dividends are paid out of real profits after adjusting for all
possible losses
z

SEBI guidelines stipulate that dividends can be paid

out of the distributable reserves
All profits earned are treated available for distribution
z Valuation gains are ignored but losses need to be adjusted
against profits
z Portion of sale price attributable to valuation gains is not
available as a distributable reserve.
z

98

Dividends & Distributable Reserves

New Position
y
y

Dividend Distribution from realized profits only

Some Mutual Fund houses used to pay dividends from

their Unit Premium Reserve instead of booked profits
E.g. A fund XYZ has an initial NAV of Rs. 10
The amount Rs. 10 goes to an account called as Unit
Capital or Face Value
y Let us say the NAV grows to Rs. 15. The appreciation
amount of Rs. 5 goes into a separate account called as Unit
Premium Reserve (UPR)
y
y

This ruling might affect many fund houses which used

to declare dividends as a marketing gimmick to attract
inflows
y After this ruling, many fund houses have cancelled the
dividends declared.
y

99

Accounting & Reporting Requirements

y
y
y

y
y
y

Scheme accounts are to be kept distinct from AMC

accounts
Scheme & AMC Auditor must be different
Norms are prescribed for when interest, dividend,
bonus issues, rights issue etc. should be reflected
for in accounts
NAV is calculated upto 4 decimal places in case of
index, liquid and other debt funds
NAV is calculated upto at least 2 decimal places in
case of equity and balance funds
Investors can hold units even in fraction of 1 unit
z

Stock exchange trading systems may restrict transactions

to whole units.
100

Valuation
y
y

Consider closing price of security on valuation date

In case securities are thinly traded or untraded on
the date of valuation, a formula based on Earnings
per Share, Book Value and peer group valuation
y

In case an untraded or thinly traded security is more than 5% of

a scheme, an independent valuer has to be appointed

Debt Securities not traded on the date of valuation

are valued basis yield matrix based on credit rating
and maturity profile
Norms exist for treatment of a security as a NonPerforming Asset (NPA), written-off (treat as loss),
added back to the asset value (treat as income) and
treatment of NPA as standard asset.

101

Taxation
y
y
y

Mutual Fund trust is exempt from tax

Trustee company is liable to tax on profits
Taxation depends on nature of schemes
z Equity Scheme: at least 65% of assets are
invested in equity shares of domestic company
Average

of opening and closing percentage is calculated

for each month and then the average taken for 12
months in a financial year

z Other

than Equity: less than 65% in domestic

equity
z Money Market Scheme: set up with the objective
of exclusively investing in money market
instruments i.e. short term debt.
102

Securities Transaction Tax

Tax on the value of transactions in equity shares, derivatives and equity
mutual fund units
On Equity Oriented Schemes
On Purchase of equity shares in stock exchange

0.125%

On Sale of equity shares in stock exchange

0.125%

On Sale/Purchase of Futures & Options in stock

exchange

0.017%

On Investors in Equity Oriented Schemes

On Purchase of units in stock exchange

0.125%

On Sale of units in stock exchange

0.125%

On Re-Purchase of Units (by AMC)

0.250%

Not applicable on transactions in debt or debt-oriented mutual fund units

Prospective investors are advised to consult their own legal, tax and financial advisors to determine possible tax,
legal and other financial implication or consequence of subscribing to the units of the Schemes
103

Dividend Distribution Tax

Tax on dividend distributed by debt-oriented mutual fund schemes
Type of Fund

Rate

Money Market / Liquid Scheme

25% + Surcharge +
Education Cess

Other Debt Funds (investors who are Individual /

HUF)

25% + Surcharge +
Education Cess

Other Debt Funds (Other Investors

25% + Surcharge +
Education Cess

Note:
Tax on income distributed is not payable on dividend distributed by
equity-oriented schemes
In case of both equity and debt schemes, the dividend would be tax
exempt in the hands of the investor
Prospective investors are advised to consult their own legal, tax and financial advisors to determine possible tax,
legal and other financial implication or consequence of subscribing to the units of the Schemes
104

Capital Gains Tax

Capital Gain is the difference between Sale and Purchase
price of the investment
y Mutual funds are exempt from tax
y Capital gains tax applies to investors
y

Equity-oriented Scheme
STT
Paid

STT Not
Paid

Long Term
(holding >
1year)

NIL

As per
Debt-fund

Short Term
(holding <=
1year)

15% +
SC + EC

As per
Debt fund

Debt-oriented Scheme
Long Term
(holding >
1year)

Lower of: 10%

without
Indexation &
20% with
Indexation

Short Term
(holding < =
1year)

As per tax
slabs

Prospective investors are advised to consult their own legal, tax and financial advisors to determine possible tax,
legal and other financial implication or consequence of subscribing to the units of the Schemes
105

TDS, With-holding Tax & Wealth Tax

y

TDS
z

No TDS on Dividend distribution or re-purchase proceeds to

Resident Investors

With-holding tax
z

Applicable in certain cases of non-resident investments;

rates depend on:
Nature of investor (Indian / Foreign and Individual /
Institutional), nature of investment (equity / debt) and nature of
income (dividend / capital gain)
z Double Taxation Avoidance Agreement (DTAA) with other
countries
With-holding tax rate is the lower of the income tax rates and tax
rates specified in the DTAA of the country where the investor
resides
z

Wealth Tax
z

Investments in Mutual Funds are exempt from Wealth Tax.

Prospective investors are advised to consult their own legal, tax and financial advisors to determine possible tax,
legal and other financial implication or consequence of subscribing to the units of the Schemes
106

Taxability of Mutual Fund Investor

Equity-Oriented Scheme
Pay STT on value of the transaction of

sale (0.125%) of units in the stock

exchange; or on re-purchase (0.25%)
of the units by the AMC

Debt-oriented Scheme
Not bear any STT
Bear a long term capital gains tax at
the lower of 20% with indexation or
10% without indexation

Be exempt from capital gains tax, if

the units were held for more than a
year

Bear a tax on short-term capital

gains as per investors tax slab

Pay capital gains tax at 15%, if the

units were held for 1 year or less

Receive dividends free of tax, the

scheme would have paid dividend
distribution tax. For Individuals it is
12.5%+ Surcharge+ Educational
cess ; For Corporates it is 20%+
surcharge +Edu. cess

Receive dividends free of tax; the

scheme also does not incur dividend
distribution tax

Prospective investors are advised to consult their own legal, tax and financial advisors to determine possible tax,
legal and other financial implication or consequence of subscribing to the units of the Schemes
107

Setting off Gains and Losses

y

Capital losses
z
z
z
z

Capital loss cannot be set off against other heads of income

Short term capital loss can be set or against short term or long
term capital gain
Long term capital loss can be set off against long term capital
gain only
Long term loss from equity oriented funds cannot be set-off since
such long term capital gain is exempt from tax

Dividend
z
z
z

When dividend is paid the NAV (ex-Dividend) goes down

Dividend is exempt from tax in the hands of investor
Dividend stripping is a tax avoidance approach

If units are bought within 3 months prior to the dividend record date
and sold within 9 months after the record date, any capital loss arising
from the transaction cannot be set off upto the extent of the dividend
income exempted

Prospective investors are advised to consult their own legal, tax and financial advisors to determine possible tax,
legal and other financial implication or consequence of subscribing to the units of the Schemes
108

Setting of Gains and Losses

y

Bonus Units
y Capital loss is treated as the cost of acquisition
of the bonus units
y Capital loss cannot be offset against capital
gains, if original units were bought within a
period of 3 months prior to the record date for
the bonus issue and sold off within a period of 9
months after the record date
y

E.g. an investor buys into a scheme at Rs. 30. the

scheme declares 1:1 bonus issue; The NAV is likely to
be Rs. 15 now, if the investor sells at this stage, there
is a capital loss [original price (Rs. 30) (-) realized price
(Rs. 15)]. Such losses cannot be set-off against capital
gains.
109

Learning Objective
y
y
y
y

Who can invest in mutual funds

in India
Documentation requirement
Implementation of sale and
repurchase transactions
Operational aspects of MF
business

Chapter 7
Investor Services

110

Mutual Fund Investors

y

Eligibility to Invest
y Individual Investors
Resident Indians above the age of 18 singly or jointly
(3 names)
y Minors through parent/legal guardian
y HUFs through its Karta the applicant name would
carry suffix HUF to show that investment belongs to a
family
y Non Resident Indians (NRI) / Persons of Indian Origin
(PIO) PIO or OCI (Overseas Citizen of India) card is
required
y Investment can be either on full-repatriation or
non-repatriation basis.
y

111

Mutual Fund Investors

y

Eligibility to Invest
z

Non-Individual Investors
z

Companies/Corporate bodies, registered in India

Registered and Cooperative Societies

Religious & Charitable trusts
Trustees of private trusts
Partners of partnership firms
Association of Persons or Body of Individuals, whether incorporated
or not
Banks (including Cooperative Banks and Regional Rural Banks) and
Financial Institutions and Investment Institutions
Other Mutual Funds registered with SEBI ,Foreign Institutional
Investors (FIIs) registered with SEBI
International Multi-lateral Agencies approved by Govt of India
Army/Navy/Air Force/Para-military units and other eligible institutions
Scientific and Industrial Research Organizations
Universities and Educational Institutions.

z
z
z
z
z
z
z
z
z
z

112

Mutual Fund Investors

y

Not Eligible to Invest

y Foreign National
y

Entity that is not an Indian resident as per FEMA

y

Except NRI or PIO/OCI Cardholder

Except FII registered with SEBI or has a sub-account
with SEBI-registered FII

Overseas Corporate Bodies (OCBs) i.e. societies

/ trusts held, directly or indirectly, to the extent
of over 60% by NRIs, or trusts where more than
60% of the individual interests is held by such
OCBs.

113

Sources of Info on Eligibility

y
y

The who can invest section of the offer document

has details of eligible investors
Specific schemes have specific class of nonindividual investors
y Special Gilt Funds are open only for provident
funds, superannuation and gratuity funds,
pension funds, religious and charitable trusts
and private trusts
y ETFs permit only authorized participants and
large investors in an NFO.

114

KYC & MF Investments

Compulsory for all investments above Rs. 50,000
y Prescribed by Anti-Money Laundering Act, 1992 and SEBI circulars
y KYC Documents include
z Proof of Identity
z Proof of Address
z PAN Card
z Photograph
y CDSL Ventures Ltd, a subsidiary of Central Depository Services Ltd (CDSL) is
the authority which facilitates KYC-compliance
z Points of Service (POS) select branches/offices of mutual funds,
registrars and large distributors
y

Original documents or true copy attested by a Notary Public, Gazette Officer or

Manager of a Scheduled Commercial Bank are required for verification

POS can access CVL system and generate an acknowledgement with a

Mutual Fund Identification Number (MIN)
z KYC is to be done only ONCE with CVL acting through PoS
z In case of minor, KYC compliance of the Guardian is mandatory
z In case of investments by a Power of Attorney holder on behalf of an
investor, KYC compliance is required by both investor and POA-holder.
z

115

PAN & Micro-SIPs

y
y

PAN is compulsory for all MF investments

Micro-SIP is where annual investment in a financial year does not
exceed Rs. 50,000
Micro-SIP investments by individuals, minors and sole-proprietor firms are
exempted from PAN requirements
z Relaxation is not permitted for HUFs and non-individuals
z Relaxation permitted for NRIs but not PIOs
z A Photo Identification document is required
z

Voter ID Card
Driving License
Govt/Defense ID Card
Passport
Photo Ration Card
Photo Debit Card
Employee ID Card of companies registered with SEBI
Photo ID Card issued by Bank Managers of Scheduled Commercial Banks / Gazette
Officer / Elected Representatives of Legislative Assembly / Parliament
Employee ID Card of Scheduled Commercial / State / District Cooperative Banks
Senior Citizen / Freedom Fighter ID Card issued by Govt
Cards issued by Universities / Deemed Universities or Institutes under Statutes s.a.
ICAI, ICWAI, ICSI
Permanent Retirement Account Number (PRAN) card issued to New Pension Scheme
(NPS) subscribers by CRA (NSDL)
Any other photo ID card issued by Central Government / State Government /
Municipal Authorities / Govt Organizations like ESIC / EPFO.
116

Documentation for Institutional

Investors
y

Eligibility to invest
Incorporation documentation s.a. trust deed or
MoA/AoA to establish
y In some states, permission from the Charitable
Commissioner is required in case of charitable
and religious trusts
Authorization to invest & establishment of an
authorized signatory
y Usually in the form of a board resolution.
y

117

Demat Account
y

Dematerialization conversion of holding in physical form

(paper) to electronic form (digital record)
Reduce cumbersome paperwork
y Allows for automatic adjustment of sale / purchase transactions
y Settlement in the stock exchange need to be done in demat form
y

Demat facility for mutual funds has allowed for screen-based

platforms at NSE/BSE for sale/ purchase
y
y
y
y
y

Demat facility is initiated by an MF by tying up with a depository (NSDL

/CSDL)
Investors can go to a Depository Participant (bank or broking house)
and demat their investment holding
DP will insist on a demat account and KYC
Upon dematerialization, investors unit-holding is added to the demat
account and units reduced upon sale of units
Benefit of less paperwork, direct credit o bonus and rights units, single
point of service s.a. change of address etc.

Rematerialization conversion of demat units into physical

form.
118

MF Transactions
y

Fresh Purchase
z
z

Additional Purchase
z
z

Application forms available with offices of AMCs, Distributors, ISC

and downloadable from AMCs website
Folio gets allotted when an application, with KIM attached, is
submitted along with necessary docs
Transaction slips along with requisite payment
Pre-printed transaction slips attached to statement of account or
blank slips available with branches of AMC, distributors, ISC or
downloadable from the website

Online Transactions
z
z
z
z

Facility available to existing investors

Application form to be submitted with Registrar
User Name and Password is allotted
Purchase and re-purchase requests can be made.

119

Payment Mechanism for Purchase

No cash is accepted
y Only banking channels permitted
y

Cheque / Demand Draft (DD) in favour of the scheme

y Drawn on local bank account or at par instrument in case of
outstation bank account
y DD should mention place of payment as location where application
is submitted
y Payment should not be post-dated (beyond current date except for
future SIP installment) or stale (more than 6 months old)
y Direct payment to bank account of scheme
y Real Time Gross Settlement (RTGS) or National Electronic Funds
Transfer (NEFT) for transfers within India and SWIFT transfer for
transfers from abroad
y RTGS is instant and NEFT is batch-run at different times in the day;
SWIFT has multiple banks and levels thus faces delays
y Proof of remittance to be submitted along with application form /
transaction slip
y Electronic Clearing Scheme (ECS) / Standing Instructions or Direct Debit
are convenient for SIP investing.
y

120

Payment Mechanism for Purchase

y

Application Supported by Blocked Amount (ASBA)

Authorization to bank to block application money in
investors bank account
z Money goes out of the account only on allotment
z

Exact amount of application money is transferred

No interest loss
No wait for refund

Originally for public issues in capital market, now extended

to Mutual Fund NFOs

Mobile-banking (M-Banking)
Nascent stage
z Banks permitted to offer facility of transferring upto Rs.
50000 through mobile connections.
z

121

Payment Mechanism for Purchase

y

NRI/PIO Applications
y Payment by Cheque - drawn on NRO Account
for non-repatriation investments
y Payment by DD a bankers certificate
confirming that moneys are remitted from
abroad; upon receipt of redemption amount,
the banker would issue a Foreign Inward
Remittance Certificate (FIRC) as evidence that
the money was remitted from abroad.

122

Allotment of Units
y

During NFO
z

Ongoing Sales
z

No. of units = Invested Amount / NAV (No Entry Load)

Rights Issue
z

No. of units = Invested Amount / Rs. 10

No. of units = Invested Amount / Rights Price (predetermined)

Bonus Issue
Free units are allotted to investor e.g. 1:3 Bonus Issue
means that 1 unit is allotted for 3 units already held
z Net Assets of the Scheme remain the same, the number of
units increases and NAV reduces proportionately.
z

123

Repurchase of Units
y
y
y
y
y
y

Available in open-ended schemes

Only the transaction slip is required
Repurchase amount or units can be specified
Repurchase price = NAV () Exit Load
Equivalent units are reduced from the folio
In case investment holding in the folio goes below
the minimum limit, all units may be re-purchased
and investment folio closed
Payment mechanism for repurchase can be either
Cheque or Direct Credit
Redemption proceeds are always in local currency (INR)
z In case of repatriation, exchange rate risk is to be borne by
investor (NRI/PIO).
z

124

Cut-off Time Sale

Scheme Type
Liquid (if funds
available for utilization
the same day)

Liquid (if funds NOT

available for utilization
the same day)

Cut-off Time

Applicable NAV

Received
upto 12 noon

Closing NAV of
previous day

Closing NAV of
Received
day preceding next
after 12 noon
day
Received
anytime

Closing NAV of
day preceding day
on which funds are
available
125

Cut-off Time Sale

Scheme Type

Other than Liquid

(Upto 1 cr)

Other than Liquid

(1 cr & above)

Cut-off Time

Applicable NAV

Received upto 3pm

with local cheque

Closing NAV of date

the application is
received

Received after 3pm

with local cheque

Closing NAV of next

business day

Received with
outstation cheque /
DD irrespective of
time

Closing NAV of day the

cheque/DD is credited
to bank account

Received anytime

Closing NAV of day

funds are available for
utilization
126

Cut-off Time Re-purchase

Scheme Type

Liquid Scheme

Other than Liquid

Cut-off Time

Applicable NAV

Closing NAV of
Received before 3
day preceding next
pm
business day
Received after 3
pm

Closing NAV of
next business day

Received before 3
pm

Closing NAV of
same day

Received after 3
pm

Closing NAV of
next business day
127

Time Stamping
y
y

Mechanism to capture time at which sale/repurchase applications are received

Cut-off time applicable to submission of
transaction requests at Points of Acceptance
(POAs) and not with the distributor
Time stamp automatically generates the location
code, machine identifier, serial number, date and
time
y Application, payment instrument and investor
acknowledgement all get a similar stamp.

128

Stock Exchange Transactions

y

Platforms for MF trading

z
z
z

y
y
y
y
y

BSE - Star Mutual Funds Platform

NSE - NEAT MFSS
Open for trading from 9am-3pm on all working days

Fresh subscription, additional purchase and redemptions,

both in physical and demat form, are permitted
Transactions generally based on proposed value;
Redemption requests can be in number of units
Transaction slip generated by broking system also has a time
stamp which serves as investors acknowledgement
Stock exchange along with clearing corporation handles the
subscription or re-purchase request (1st leg of transaction)
Sending units against subscription or money against repurchase (2nd leg of transaction) is the responsibility of RTA.

129

Investment Plans & Services

y

Dividend Payout, Re-investment & Growth

y Different options within a scheme
y Portfolio returns are same for all the options
y Structure of cash flows and income accruals for
investors vary across options
y Unit-holder taxability, number of units and value
differs.

130

Investment Plans & Services

Parameter

Dividend Payout
Option

Dividend Reinvestment Option

Growth Option

Dividend Received
in bank account

Yes

No

No

Dividend
Distribution Tax

Yes, for Debt

Schemes

Yes, for Debt

Schemes

No

Increase in number
of units

No

Yes

No

NAV Change

NAV Declines to
extent of Div and
DDT

NAV Declines to
extent of Div and
DDT

NAV Captures
the full portfolio
changes

131

SIP, SWP & STP

SIP

SWP

STP

Investing constant
amount at constant
intervals
Helps avoid
acquisition of all units
at market highs (peaks)
Allows averaging of
cost of acquisition of
units Rupee Cost
Averaging
Encourages discipline
& continuity of
investing
Convenience of PDCs,
ECS or SI

Re-purchase a constant value

of units
Helps avoid exiting all units
at market lows (troughs)
Allows averaging the
redemption price
Investors can specify the
amount, frequency and period
of SWP
option to withdraw only the
dividend or the appreciation
helps meet liquidity needs
and en-cashing profits
In case of debt scheme, repurchase is preferable over
Dividends (DDT)

Also called Switch,

STP is a variant of
SWP
withdrawn amount
is invested in
another scheme of
the same mutual
fund
STP is a
combination of SWP
+ SIP
Cost-effective and
convenient to move
between schemes

132

Other Services
y

Trigger
Mechanism to help investors not miss opportunities for buying and
selling due to instructions not being issued in time
y Trigger option allows automatic re-purchase at certain market levels
y

Statement of Account & Unit Certificate

y

SOA provides transaction details, relevant NAV, number of units,

closing balance of units and value of units

Nomination
y
y
y
y
y

Authorization to transfer units to nominee in event of unit-holders

demise
In case of minor nominee, guardian details required
In case of joint-holding, all unit-holders to sign nomination form
In case of joint-holding, units continue to be held by surviving joint
holder upon death of any one joint holder
In case of demise of sole unit-holder or all joint-holders, units are
transferred to nominee
y Death Certificate of Unit-holder, Nominees KYC & Indemnity bond
required.
133

Other Services
y

Pledge
Banks, NBFCs and other financiers lend against pledge of
units by unit-holder
z Pledge form pledgor pledgee to be established
z Once pledged, units can be bought and sold only after NOC
from pledgee to release the pledge
z

Other Services
Online access to information on investments, consolidated
view of folios that relate to different family members
z Daily NAV and other developments through SMS/e-mail
z Info on portfolio valuation, income booked, returns earned,
capital gains working for income tax purposes etc.
z

134

Learning Objective
y
y

Chapter 8
Return, Risk &
Performance of Funds

Calculating returns from a

mutual fund investment
Overview
of
risk
measurement
Benchmarking and riskadjusted returns

135

Drivers of Returns in a Scheme

Equity Schemes
y
y
y

Security Analysis is an important aspect of actively managed

schemes
Disciplines include Fundamental & Technical Analysis
Fundamental Analysts review of companys fundamentals i.e.
financial statements, quality of management, competitive
position of products/ service
Technical Analysts study the price-volume charts of the
companys shares to decide support, resistance levels and
break outs
Both are important tools
z
z
z

Fundamental analysis approach works for long term investment

decisions
Technical analysis approach works for short term speculative calls,
including intra-day trading
Technical analysis helps decide the timing of long term decisions
made using fundamental analysis.
136

Fundamental Analysis
y

Fundamental Analysts set price targets based on:

z

Earnings Per Share (EPS)

Price to Earnings ratio (PE Ratio)

Indication of how much investors are willing to pay in relation

to the companys earnings
Calculated on projected EPS for a future period (forward EPS)
High (low) PE need not indicate expensive (cheap)

Book Value per Share (BV)

Net Profit After Tax / No of Equity Shares

Shows profit earned for each share owned

Worth of each share based on companys own accounts

(historical perspective)

Price to Book Value (PB)

Indication of how much investors are willing to pay in relation

to its book value.
137

Investment Styles Growth & Value

y

Growth investing
y
y
y

Value investing
y
y
y
y

Investing in high growth stocks i.e. ones expected to grow

faster than the economy
These are preferred (blue-chip) stocks; valuations are higher
In event of market correction these decline more
Picking stocks which are undervalued based on fundamental
analysis
Belief in their value being unrecognized by market (rough
diamonds)
Intrinsic value is expected to be realized when market
recognizes their value (value stocks)
Usually longer horizons for holding, two years or more

Blended approach
y
y

In initial phases of bull run, growth stocks deliver good returns

When markets heat up, value picks end up being safer.
138

Portfolio Building Approach

Top Down and Bottom Up
y

Top Down Approach

Country Sector Stocks
z Sector allocation is the key decision
z Reduces chances of exposure to a poor sector
z

Bottom-Up Approach
Stock picking
z Stock Selection is the key decision
z Ensures good stocks irrespective of a poor sector
z

y
y

Equity returns are a function of sector and stock

selection
Diversified equity would have secular growth when
the economy does well.
139

Debt Definitions
Debt is issued by Central Govt, State Govt, Banks, Financial
Institutions, Public Sector Undertakings (PSUs), Private
Companies, Municipalities etc.
y Money market securities debt that are to mature in less than
a year
y Govt. Securities or G-Sec or Gilt issued by Govt
y Bonds or Debentures debt of tenor beyond a year
y

z
z

Govt/PSU tend to issue Bonds

Companies tend to issue Debentures

Treasury Bills or T-Bills short term debt issued by RBI on

behalf of GoI
y Certificate of Deposit issued by Banks (91-364 days) or FIs
(1-3 years)
y Commercial Paper short term debt issued by companies
(upto 1 year).
y

140

Debt Definitions
y
y
y
y
y
y
y
y

y
y

Returns in form of interest and principal

Tenor pre-specified time period
Maturity the end date of investment
Redemption process of repaying amounts due on maturity
Yield return likely to be earned on a debt security;
combination of interest and capital gain (or loss)
Yield Spread difference in yield on Gilt and yield on nongovt debt
Returns are driven by interest rates and yield spreads
Credit Rating - Default Risk of non-govt issuer measured by
companies such as CRISIL, ICRA, CARE and Fitch; e.g. AAA is
CRISILs indicator of highest safety in a debenture
Higher the credit risk - higher the likely yield
Higher the rating - lower the likely yield.

141

Interest Rates & Yield Spreads

y

Interest Rates
z
z
z
z
z
z

Modified Duration
z
z

When interest rates increase, prices fall

Yield and prices have inverse relationship for such debt which offer a fixed rate of
interest
In floater, when yields go up, issuer pays higher interest and lower interest when
yields fall floaters tend to hold value despite changes in yield
If interest rates are expected to rise, portfolio is switched to floaters or fixed
instruments of shorter tenor
If interest rates are expected to fall, exposure to longer term fixed debt securities is
increased
Calls on interest rate scenarios are key to debt funds
Long-term securities fluctuate more than short-term securities
Debt analysts study modified duration to assess likely fluctuation in response to
changes in interest rates

Yield Spread
z
z

Improvement in credit rating implies acceptance of lower yield spread and thus value
of debt security increases
Portfolio manager explores opportunities for gains by anticipating changes in credit
quality and changes in yield spreads between different market benchmarks.

142

Gold Fundamentals
y

Gold
z
z
z
z
z
z

z
z
z

An international asset
Price and thus returns in India depends on international price,
exchange rate and import duties
Gold seen as a safe haven, a store of value, hedge against
inflation
Gold prices go up in the event of economic or political turmoil
Countries hold their foreign exchange reserves in gold
Agencies s.a. IMF have large reserves and when they sell gold,
prices weaken; also when large countries buy, the prices tend to
push up
Inflation of inflation, foreign currency flows help analysts
anticipate trends in foreign currency rates
When rupee strengthens, rupee value (thus returns) of gold
portfolio falls
When rupee weakens, the rupee value (thus returns) of gold
portfolio rises.
143

Real Estate Fundamentals

y
y

Real estate is a local asset; cannot be transported

Factors determining value
Economic scenario a weak economy may lead to
postponement of real estate purchases thus weaker prices;
when economy recovers, real estate prices tend to keep
pace
z Infrastructure development when infrastructure improves
in an area, real estate values go up
z Interest Rate cheap credit encourages more people to buy
real estate, thus raising prices; rise in interest rates softens
the real estate market
z Nature of real estate residential, commercial, industrial,
retail etc. determines value
z

Real Estate analysts assess the future direction of all

kinds of real estate and structure exposure to them.
144

Measures of Return
y

4 measures of return 1st 3 applicable to growth schemes

Simple Return
Later Value (-) Initial Value
. X 100
Initial Value

Annualized Return
Simple Return X 12

Period of Simple Return (in months)

Compound Return
(Later Value / Initial Value) ^ (1/n) 1

Compound Annual Growth Rate

z
z

When a dividend is paid and compounding is to be considered

the CAGR technique is used
Based on assumption that dividend would be re-invested at the
ex-Dividend NAV.
145

Measures of Return
y

SEBI Norms
MFs cannot promise any returns, except in assured return
schemes
z Assured Return schemes call for a guarantor named in the
OD
z Guarantor will need to write out a cheque in case the
scheme is not able to pay the assured return
z

Scheme Returns and Investor Returns

Investor profit may be different than scheme returns due to
the loads and taxes
z Investor returns may be lower than scheme returns due to
the loads
z Return formulas can use Initial Value (IV) as (NAV + Entry
Load) and Later Value (LV) as (NAV Exit Load) to reflect
investor returns.
z

146

Risk in Mutual Fund Schemes

y
y

y
y
y

Valuation in the market may go up or down

Accordingly, value of portfolio and NAV of the
scheme fluctuate
Risk factors of a scheme are mentioned in the SID
Scheme-specific risk factors find mention in KIM
Despite risks, MF investing is not a gamble
z
z
z

Professional fund managers with inherent understanding of risks

Portfolios are designed to moderate or enhance the risks of a
portfolio as per investment philosophy of the scheme
Quantitative tools are available for portfolio optimization but these
rely on past behaviour of markets

Because all swans you have seen are white, it does not
mean that black swans do not exist investment thoughts of
Nasim Nichoas Taleb abnormal behaviour may be rare but
when it occurs, it can cause a lot of damage.
147

Liquidity in Schemes
y

Portfolio liquidity
y
y
y
y

Liquidity in investments indicate a transparent market to

benchmark value
Prescribed limits on illiquid investments in the net assets of a
scheme
Open ended schemes have a greater need for liquidity thus lower
limits on illiquid investments
Open-ended schemes reserve the right to limit or stop repurchases in extreme cases of financial market illiquidity or
volatility
Schemes maintain certain proportions of liquid assets for 2
reasons
y Markets are over-heated and wait for next buying opportunity
y Provide for contingencies such as dividend payment or repurchase expectations
Liquid investments have lower yields and can drag scheme
returns; on the other hand protect the scheme from distress sale of
investments.
148

Scheme Liabilities
y
y
y

y
y
y

Net Assets of a Scheme are Total Assets Outside liabilities (other

than to unit-holders)
Outside liabilities are payable irrespective of portfolio performance
thus add to the risk
Outside liabilities are a part of business when a scheme purchases
an investment, it is liable to pay for it; until the payment is made as
per stock exchange settlement cycle, it will be a liability
Leveraging the practice of taking liabilities beyond what is inherent
to normal business of a mutual fund
Leveraged funds are common internationally
SEBI regulations regarding leveraging
z Minimize the risks arising from balance sheet structure in Indian
mf schemes
z Mutual fund scheme cannot borrow more than 20% of its assets
z Borrowing cannot be for more than 6 months
z Borrowing is permitted to meet the cash flow needs of investor
servicing viz. dividend payment or re-purchase payments.
149

Use of Derivatives
y
y
y
y

y
y
y

Derivatives are instruments whose value is derived from value of one

or more underlying exposures
Underlying could be shares, exchange rate, interest rate, commodity,
precious metals, index, weather etc.
Common derivative contracts are forwards, futures, swaps and
options
Use of derivatives
z Hedging against risk designed such that when portfolio value
falls derivative contracts rise in value; useful risk management
approach
z Re-balancing portfolio vary the sector weightages without having
to buy or sell stocks; economical way to manage investment
exposures
z Leveraging taking large positions with a small outlay of funds
Mutual funds are permitted to use derivatives for hedging and
rebalancing but not leveraging
Investment in derivatives must be specified in SID
Investor approval is required in case not provided for in the SID.
150

Unit-holder Churn
y
y

If re-purchase requests exceed levels of liquid

assets, scheme is forced to sell its investments
During difficult market conditions a large number
of institutional investors have made re-purchase
requests forcing schemes to sell assets below
intrinsic value; such liquidity pressures hurt retail
investors
SEBI stipulates 20:25 rule to protect retail investors
y

Scheme must have at least 20 investors and no investor

shall represent more than 25% of the net assets.

151

Risk in Equity Funds

y

Generic
y

Equity markets reflect value in real economy

y Economy is cyclical 2009 was gloomy, 2010 has shown economy recovery
Equity markets tend to be volatile
y In the short-run markets can be over-pessimistic or over-optimistic, leading to
spells of fear and greed

Specific
y
y
y
y
y
y
y

Sector funds concentration risk entire exposure in single sector

Thematic funds multiple sectors connected to a theme thus less risky than
sectoral
Diversified equity funds well spread and thus less risky than sectoral or thematic
Mid-cap funds less liquid & less researched stocks than frontline stocks liquidity
risk exists riskier in periods of economic turmoil
Contra funds take positions contrarian to the market high risk of misjudgments
Dividend Yield funds invest in shares with lower fluctuations and offering
attractive returns in the form of dividend equity exposure with lower downside
Arbitrage funds risks are cancelled out between cash and F&O markets lowest
risk among equity funds equivalent lower returns, comparable to liquid funds
exposed to basis risk i.e. both positions cannot be reversed at the same time the
time gap in the unwinding can be adverse to the scheme.

152

Risk in Debt Funds

y

Generic
z Safety of repayment on maturity safer than
equity safety is of the issuer
z Fluctuations due to change in yield in overall
market
z Interest rates fluctuate due to several factors,
including Govt and RBI policy
z Calls on direction of interest rate movement
impact scheme performance
z Liquidity risk exists in securities esp. non-govt
segment possibility of not finding a buyer
z RBI has to step in when markets turn illiquid
z SEBI portfolio valuation guidelines aim to
enhance transparency of NAV.
153

Risk in Debt Funds

y

Specific
y
y

y
y

y
y

Liquid Schemes - Short maturity securities fluctuate less liquid

schemes have the least risk among all kinds of schemes
Gilt Schemes higher risk than liquid schemes due to changes in yield;
higher proportion of longer maturity securities higher the NAV
fluctuation
Fixed Maturity Plans yield is predictable around maturity in the
interim NAVs can fluctuate if structured basis non-govt paper, credit
risk also exists
Portfolio concentration risk concern for MIPs, FMPs and Liquid
Schemes
Securitized Debt - complex and innovative debt structures not fully
understood even by regulators - lesser understanding of debtor/issuer
means increased reliance on credit rating agencies
Capital Guaranteed Scheme sovereign or non-sovereign debt based
if non-sovereign then credit risk exists and schemes are capital
protection oriented rather than capital guaranteed
Junk bond schemes high yield bond schemes invest in securities of
poor credit quality not offered by Indian mutual funds
SEBI restricts investment in unrated debt and below investment grade
debt.
154

Risk in Balance Funds

y
y

Mix of Equity & Debt 2 distinct asset classes

reduce overall risk
Monthly Income Plans - combine large debt
portfolio with yield-kicker in the form of equity
component
Possible that equity losses eat into the debt profits
z If scheme has no profits to distribute, no dividends are
declared and investor may not get the monthly income as
the name suggests
z

Flexible asset allocation scheme portfolio

managers can switch a large part of portfolio
between debt and equity depending on view
Possibility of wrong asset allocation calls
z Treatment as debt or equity may be unknown.
z

155

Risk in Gold Funds

y
y
y
y

International commodity transparent pricing

less prone to manipulation
A good hedge against inflation risk
Choice of gold sector fund and gold ETF
Better performance when
y other financial markets are in turmoil
y In case of political turmoil such as war causing
weakening of a countrys currency.

156

Risk in Real Estate funds

y
y
y
y
y
y
y
y

Valuation is subjective
Non-transparent - curse of black money
Liquidity is low
Unorganized chain of intermediaries
High transaction costs stamp duty, registration
fee etc
Litigation risks and other encumbrances
Poor corporate governance standards in real estate
development and construction companies
Real estate funds are a lower risk than direct
investment in real estate.

157

Measurement of Risk
y

Variance & Standard Deviation (volatility)

z
z
z

Fluctuations in periodic returns of a scheme as compared to its

own average return
Standard Deviation is the square root of variance
Relevant for both debt and equity schemes

Beta (sensitivity)
z
z
z
z
z
z

Measure of systematic risk in investment

Measures fluctuation in periodic returns of a scheme relative to
periodic returns of a diversified stock index
A diversified stock index has beta of 1
Companies of beta more than 1 is indicative of more risk than the
market
High beta companies rise (fall) more than the market in rising
(falling) markets)
Beta is relevant only for equity schemes.

158

Measurement of Risk
y

Modified Duration
z Relevant for debt schemes
z Sensitivity of value of a debt security to changes
in interest rates
z Higher the modified duration, higher the interest
sensitive risk in a debt portfolio
Weighted Average Maturity
z Indicative of interest rate sensitivity in a scheme
z Longer the maturity of a debt security, higher the
interest rate sensitivity
Professionals rely on modified duration as a
measure of interest rate sensitivity.
159

Benchmarks & Performance

y

y
y
y
y
y
y

Standard for measuring performance of a scheme

z should be aligned to the investment objective
z Should be calculated by an independent agency in a transparent
manner and published regularly
z Usually created by stock exchanges, credit rating agencies,
security research houses or financial publications
Tracking error gaps between scheme and benchmark performance
Benchmark decided by AMC in consultation with Trustees
Offer document mentions the benchmark
Performance information carries scheme and benchmark
performance
Change in benchmark is done by AMC and trustees and must be
justified and documented
Benchmark can be the average returns by all schemes in a category
or the best performer in the category e.g. diversified equity funds.

160

Benchmarks for Equity Schemes

Scheme type
z Sectoral fund use a sectoral index e.g. BSE Bankex, BSE FMCG or CNX
Energy Index
z Diversified fund would have a diversified index s.a. BSE Sensex of S&P
CNX Nifty or BSE 200 or BSE 500 or CNX 100 or S&P CNX 500
y Choice of Investment Universe
z Mid-cap, small-cap, large-cap
z Different criteria by different agencies - indicative range is Rs. 1,50010,000 crore market cap for mid-caps
z Diversified equity index with mid-cap stocks as investment universe may
select CNX Midcap or Nifty Midcap 50 or BSE Midcap
y Choice of Portfolio Concentration
z Sensex or Nifty for Schemes with focus on fewer stocks
z BSE 100 or BSE 200 or S&P CNX 500 for schemes that propose to invest
in more number of companies
y Underlying Exposure
z Arbitrage funds invest in equities but underlying exposure is not equity
opposite positions in equity and F&O markets - benchmark used is a short
term money market index.
y

161

Benchmarks for Debt Schemes

y

Developed by research and credit rating agencies

recommended by AMFI - CRISIL, ICICI Securities
and BSE have developed such indices
y
y

NSE MIBOR based on short-term money market

NSE Indices for Govt. Securities Market available for different
variations Composite, 1-3 years, 3-8 yrs, 8+ yrs, T-Bills Index
etc.
ICICI Securities Sovereign Bond Index (I-Bex) is calculated
based on govt. securities 1 umbrella index and 3 sub-indices
Si-Bex (1-3 years) Mi-Bex (3-7 years) Li-Bex (more than 7
years)
CRISIL provides CRISIL Gilt Bond and AAA Corporate Bond
Index
y CRISIL CompBEX Composite Bond Index
y CRISIL LiquiFEX Liquid Fund Index
y CRISIL STBEX Short-term Bond Index
y CRISIL Debt Hybrid Index - 60:40
y CRISIL Debt Hybrid Index - 75:25
162

Benchmarks for Other Schemes

y

Balance Funds
Index with a mix of equity (65%) and debt (35%) a
synthetic index calculated as 65% of BSE Sensex and 35%
of I-Bex
z CRISIL Blended Indices - CRISIL MIPEX for Monthly Income
Plans CRISIL BalanCEX for Balance funds
z

Gold ETF
z

Real Estate Funds

z

Benchmark against gold prices

Real estate indices developed by real estate companies

International Funds
z

Depends on scheme proposed Chinese fund would use a

Chinese Index (Hang Seng) S&P 500 for schemes
investing in US markets a scheme across countries can
use a synthetic index.
163

Measuring Fund Manager

Performance
y

Absolute & Relative Return

Better than benchmark indicates outperformance
z Poorer than benchmark indicates underperformance
z Relative returns are reviewed by AMC and trustees
z

Risk-adjusted Return
z

Evaluating performance basis risk levels assumed to

generate the given returns

z Measurement

of Risk-Reward relationship

Scheme which has taken higher level of risk ought to

provide higher returns to justify the risk taken
z Measures of risk-adjusted returns are Sharpe Ratio,
Treynor Ratio and Alpha.
z

164

Risk-Adjusted Returns
y

Risk Premium = (Rs Rf)

where,

Rs = Scheme Return
Rf = Scheme Return

Sharpe Ratio , S = (Rs Rf) / SD

Risk premium per unit of risk
z Higher the Sharpe Ratio, better the scheme
z Relevant for comparable schemes
z Used as a ranking criteria
z

Treynor Ratio, T = (Rs Rf) / Beta

Risk premium per unit of risk
z Relevant for diversified equity schemes
z

Alpha
z
z
z
z
z

Difference between a schemes actual return and optimal return

Index funds track underlying index measured by tracking error
Non-Index funds have an expected level of return based on beta
measured by optimal return
Alpha is a measure of fund managers performance positive alpha is
outperformance and negative alpha is underperformance
Alpha depends on beta also relevant for diversified schemes.
165

Learning Objective
y
y

Sources of information
about MF Schemes
Tools & Techniques for
selection of appropriate
schemes

Chapter 9
Scheme Selection

166

Scheme Selection

167

Debt Fund

Hybrid Fund

Equity Fund

High Risk

Sector Fund
Balance Fund based
on Flexible AA
Growth Fund
High Yield Debt
Diversified Equity
Index Fund
Value Fund
Equity Income /
Dividend Yield
Balance Fund based
on Fixed AA

Low Risk

Monthly Income Plan

Capital Protection
Oriented Plan
Diversified Debt
Gilt Fund
Money Market / Liquid
Scheme
168

Scheme Selection Principles Equity

Funds
y

Time horizon
z

5 years and above means that probability of losing money is

negligible

Active or Passive
z
z
z
z
z

Index funds are passive i.e. offer returns in line with market
Investors with modest objective of an equity growth
component in their portfolio can consider index funds
Several pension funds are limited by their charter to take
equity exposure only through index funds
Investment in an active fund bears a higher cost of fund
management and higher risk
Returns ought to be higher i.e. beat the benchmark but may
not happen in actual practice, hence the risk.

169

Scheme Selection Principles Equity

Funds
y

Open-ended or Close-ended
z

Open-ended funds offer liquidity i.e. current value of unitholding without a loss

Units are bought back by the scheme at NAV less Exit Load
Maximum load permitted by SEBI is 7%; in practice it is upto
5% and that too upon redemption within 1 year of investment
Due to redemption pressure, part of the portfolio is maintained
in liquid assets, which can dilute the overall returns
Fluctuations due to continuous sale and repurchase puts
pressure on the fund managers

Close-ended funds offer liquidity through listing in a stock

exchange

Low trading levels reduce the liquidity

Price tends to be lower than the NAV; towards maturity the
discount reduces and market price converges towards NAV.
170

Scheme Selection Principles Equity

Funds
y

Diversified, Sector or Thematic

z

Diversified funds have multi-sector exposure, thus less risky

In an actively managed diversified fund, the fund manager

ensures higher exposure to better performing sectors
Should be part of core portfolio of every investor
Investors can save time and effort by investing in such schemes

An investor in a sector fund has made the sector choices

Skilled investors should consider this option

Sometimes themes are selected by investors (e.g.
infrastructure) rather than specific sectors (e.g. cement, steel)
Exposure to sector-funds should be limited to 3-5 different
sectors.

171

Scheme Selection Principles Equity

Funds
y

Large, Mid and Small Cap Funds

During economic downturn, the resource strength of frontline stocks
help them survive while mid-cap and small-cap companies may not
have the resources
z During economic recovery, as investors return, valuations in frontline
stocks turn expensive and at this stage, mid and small cap funds are
attractive
z

Growth vs. Value funds

Growth funds offer good returns in initial phases of a bull run
z As growth stocks get fully valued, value funds perform better
z Value funds yield benefit over longer holding periods
z In a market correction, growth funds can decline much more than
value funds.
z

172

Scheme Selection Principles Equity

Funds
y

Fund Size
y
y
y

Fund size is contextual to the proposed investment universe

Small fund sizes mean that scheme may not benefit from economies of scale
Say, a sector fund with net assets of Rs. 1000 cr will find investment challenging if
all companies in the sector are worth only about Rs. 10,000 cr

Portfolio Turnover
y
y
y

Frequent sale and purchase entails broking costs

High turnover maybe an indication of unsteady investment management.
Calculated as:
Value of Purchase and Sale of Securities during a period
--------------------------------------------------------------------------------Average size of Net Assets of the Scheme during the period
E.g. say, 10,000 cr & 5,000 cr respectively. Then portfolio turnover ratio is 200%;
thus on an average investments are held for 12 / 2 = 6 months
Needs to viewed in light of investment style 6 months may be too short for value
investing but acceptable to a scheme which wants to benefit from shift in
momentum.

173

Scheme Selection Principles Equity

Funds
y

Arbitrage Fund
Lock into a better risk-return relationship than liquid funds
and ride the tax benefits that equity funds offer
y Not meant for equity risk exposure
y

Domestic vs. International Equity Fund

y

International equity investment means

y
y

Exposure to foreign equity market

Exposure to exchange rate of INR (If during the investment
period, the USD becomes stronger, the investor benefits &
vice-versa).

International investing can be considered if:

Investor feels that overall returns (equity upturn + exchange rate
movement) will be attractive
y Taking an asset allocation call of diversifying risk.
y

174

Scheme Selection Principles Debt Funds

y

Regular vs. MIP

z MIP has equity element
z Investors who do not wish to take equity
exposure can choose a regular debt fund
Open-ended vs. FMP
z FMP is suited for investors looking for a
predictable return superior to a fixed deposit
z Ideal when investment horizon is in sync with
maturity of the scheme
z In case funds could be required anytime, normal
open-ended debt funds are preferable
z Portfolio risk needs to be considered.
175

Scheme Selection Principles Debt Funds

y

Gilt vs. Diversified Debt Fund

Diversified debt invests in a mix of Govt Securities (safer)
and non-govt securities (higher yield but subject to credit
risk)
z A diversified fund that can manage its credit risk well can
generate superior returns than a Gilt Fund
z

Long-Term vs. Short-Term Fund

Long-term securities fluctuate more than short-term ones
z NAVs of Long-term debt funds are more volatile
z Value (Price) is inversely related to yield
z

In a declining interest rate scenario, it is sensible to go with

long-term debt funds
In a rising interest rate scenario, it is safer to go with short-term
funds.
176

Scheme Selection Principles Debt Funds

y

Money-market /Liquid Funds

z Liquid
funds have the lowest risk and
commensurate lower returns
z Comparable to savings bank account with
marginally better interest rates
z Businesses can transfer surpluses of current
accounts to liquid schemes
z Liquid Plus schemes are not more liquid these
are similar to short-term debt funds with
investment in slightly longer tenor than the
regular liquid schemes
As

tenor increases, risk increases

SEBI has now disallowed use of the term liquid plus as a
fund type.
177

Scheme Selection Principles Debt Funds

y

Regular Debt Funds vs. Floaters

y Regular debt funds are subject to risk of NAV
fluctuations
y Floaters i.e. floating rate debt securities hold
their values even if interest rates fluctuate,
hence NAV of floaters tend to be steady
y Floaters are safer in uncertain interest rate
scenarios
y in rising interest rate scenarios, floaters can be
considered over liquid/short-term funds.

178

Scheme Selection Principles Balance

Funds
y

Diversification implies
y Investing in a mix of equity and debt schemes
Wide array of scheme options
y However, more decisions required
selection
y

on

scheme

Investing in a balance scheme, which in turn

invests in a mix of debt and equity securities
Fewer scheme selection decisions are required from
investor
y However, equity-debt mix is pre-determined by the
scheme
y Flexible asset allocation schemes, a variant of balance
funds have a higher risk potential
y Taxation as an equity or a debt fund depends on
investment portfolio.
y

179

Scheme Selection Principles - Gold

y

Gold ETF vs. Gold Sector Fund

y Gold Sector Fund invests in companies
involved in mining and processing of gold
y Fund performance is linked to profitability and
gold reserves of the gold companies
y Gold ETFs track the prices of gold metal
y When gold metal prices go up, the companies
with large reserves can appreciate a lot more
than the gold metal and likewise, fall more
when prices decline.

180

Scheme Selection within a Category

y

An investor needs to be comfortable with the AMCs

philosophy
y

All 35+ AMCs have different approaches, styles and value systems

An investor is essentially buying a portfolio

AMCs share portfolio of all schemes in their website on monthly basis
y Equity investors would want to be sure of the sectors where the scheme
has taken higher exposure
y Long-term watchers develop views on AMCs/Fund Managers who
are more skilled in identifying trends
y Research can identify how true the fund manager is to a promised
investment style
y Debt investors would ensure weighted average maturity of the portfolio
in line with their view on interest rates
y Lower weighted average maturity and higher exposure to floaters
during periods of rising interest rates
y Higher weighted average maturity during periods of declining
interest rates
y Non-Gilt Investors would examine the credit quality of the portfolio and
watch out for sector concentration, even if securities have a high credit
rating.
y

181

Scheme Selection Parameters

y

Fund Age
y Track record that can be studied is more
acceptable than a new fund or mediocre fund
management record
y Relevant for equity schemes, given more
investment options and diverse performance
within the same category
Scheme Running Expenses
y Index funds follow a passive investment
strategy, hence should have low cost structure
y Debt funds should be careful about cost
structure, since returns tend to be lower than
equity schemes.
182

Scheme Selection Parameters

y

Tracking Error
z The basis for selection of index funds and Gold
ETFs
Lower

the tracking error, better the fund

Gold ETFs need to be selected basis how well they track
gold prices
y

Regular Income Yield Portfolio

z Higher regular income yield is a strong positive
for a scheme
Schemes

income comes from regular income (dividends

for equity schemes and interest for debt schemes) and
capital gains
Regular income are seen as a more stable source of
income than capital gains.
183

Scheme Selection Parameters

y

Ranking & Rating

Research agencies assign a rank to performance of each
scheme within a scheme category
z Some analyses cluster schemes within a category into
groups, based in well-defined performance traits
z Some agencies follow a star system for the rating
z

A 5-star scheme is better than a 4-star scheme and so on

Quarterly performance ranking of schemes shows that best

ranking fund in one quarter may not be so in the next

Based on historical performance

See beyond performance and examine the loads
Seeking to invest in the best fund in each category is neither an
ideal objective nor feasible due to costs involved
Investors can aim to stay invested in schemes that in top few
(say 3-5, or top 10-15%) in their category on a consistent basis.
184

Selecting an Option within a Scheme

Taxation and Liquidity are primary factors
y Dividend payout, Dividend Re-investment
Options
y

and

Growth

Dividend payout money flows to the investor

y Growth money grows in the fund on gross basis (i.e. without annual
taxation)
y Dividend Re-investment no cash flows nor money to grow in the fund
y

Re-purchase
Sale of units by the investor
y Element of capital gain (or loss)
y Book a capital gain (or loss) to set-off against some loss (or gain),
where such set-off is permitted
y In equity schemes, repurchase is subject to STT but no DDT
y Better to receive money as dividend rather than repurchase units
y Useful option to meet the need for regular income
y Dividend is subject to distributable surplus
y SWP for the requisite amount can be requested although this will
have STT and capital gains tax implications.
y

185

Tracking Mutual Fund Performance

y
y

Performance reviews are data intensive

AMCs, Distribution houses and research houses
offer tools on their websites
z Performance, ranking, rating, comparisons can
be ascertained
Agencies which offer content (free and paid):
z Credence
Analytics
(www.credenceanalystics.com)
z CRISIL (www.crisil.com)
z Lipper (www.lipperweb.com)
z Morning Star (www.morningstar.com)
z Value Research (www.valueresearchonline.com)
186

Learning Objective
y
y
Chapter 10
Selecting the Right
Investment Products for
Investors

Comparison of real assets

and financial assets
Alternate
Investment
Options
Investment decision making

187

Financial and Physical Assets

y

Physical or Real Assets

y Assets which one can touch, feel and use i.e.
are tangible
y E.g. land and building, plant & machinery, gold
& jewellery, painting etc.
Financial Assets
y Assets which have value but are intangible i.e.
cannot be touched or felt or used as part of
their core value
y E.g. shares, debentures, fixed deposits, bank
accounts and mutual funds schemes their
value is not the paper or receipt but in what
they are entitled to e.g. a share in the fortune of
a company etc.
188

Implication of Financial Assets

y

Comfort
Physical assets are in possession of the investor and can
be used, whatever happens in the outside world
z Financial assets depend on the investee company for value
enhancement
z The difference in comfort is why nearly half the wealth of
Indians is locked in physical assets
z

Unforeseen events
Hazards s.a. earthquake, floods etc. can damage a physical
asset and cause erosion of value
z Entitlement to financial assets is not impacted by
unforeseen events s.a. theft, fire or floods
z Entitlement can be claimed basis company records and
other documentary evidence dematerialization makes the
process simpler.
z

189

Implication of Financial Assets

y

Economic Context
y Investments in physical assets do not benefit
the economy
y Financial assets are productive for the economy
Money mobilized from govt. securities can be used for
social well being
y Money raised by a company through shares can boost
production, jobs and national income
y Banks can lend money in fixed deposits for lending to
companies and in turn help the wheels of business
turning
y Mutual fund schemes effectively help in building the
nation and the economy.
y

190

Gold Physical or Financial?

y

Physical form
z Storage cost
z Risk of loss through theft
z Wealth tax applicable (beyond the jewellery meant for personal
use)
z No nomination facility
Financial form
z Gold ETF, Gold Deposit Scheme, Gold Sector Fund & Gold Futures
at MCX and NCDEX
z Exempt from wealth tax
z Nomination facility is available for deposit and mutual fund
schemes
z Gold ETF is an open-ended scheme with no fixed maturity

An investor can hold the position indefinitely

Gold Deposit Scheme of Banks

Similar to a fixed deposit in gold
Promise to payback the same quantity of gold or equivalent value on
maturity
Interest (pre-specified rate) is paid during the period of deposit.
191

Gold Physical or Financial?

y

Futures do not require full payment, only a margin

payment the practice is called leveraging
E.g. say, Gold Price is 18,000 per 10 grams. A gold future
that can be bought at a margin of say, 5%. The initial
payment required would only be Rs. 18,000 X 5% = Rs.
900. With 900, one can take a position worth 18,000 and
gain from upward movement of gold prices
z Investors need to be cautious about the associated risk as
well, since a 5% decline in prices could wipe out the entire
investment
z By extension, if investor has Rs. 18,000 to invest, he can
take position worth 18,000 / 5% i.e. Rs. 360,000
z Futures contract have a limited contract period, typically 13 months. Continuing the exposure would mean a roll-over
of the position effectively a fresh contract has
associated costs.
z

192

Real Estate Physical or Financial?

y

Physical Form
z
z
z

z
z
z
z
z

Large ticket size i.e. the minimum amount required for

investing is high
Risk of loss on account of fire and other hazards
High concentration risk unless budget is very high and
value of properties is low, since most investors would end
up with 1-2 high value properties
Legal and other disputes, encroachments especially vacant
land
Illiquid market for real estate, non-standardized product, no
transparent prices, time to execute deals can be very long
High transaction costs s.a. stamp duty and registration
charges sometimes non-transparent and cumbersome
Ownership risk (let out property claimed by tenant)
Credit risk (unable to pay the rent).
193

Real Estate Physical or Financial?

y

Financial Form
y
y
y
y
y

Flexible ticket size

High liquidity
Transparent price
Transaction time is less
Professionals to manage risks and issues related with real
estate investment.

194

Fixed Deposit or Debt Scheme

y

Where FDs score over MFs:

Deposits are insured ( 1 lakh per depositor in a bank,
across branches); no such insurance in MFs
z Premature closure of deposits is permitted
z

Where MFs score over FDs:

Return potential is higher
z High returns are possible in falling interest rate scenarios the same rates are a matter of worry for depositors
z Tax-exempt nature of MF investments against FD interest
which is taxable
z Switching/Transfers can be done between different kind of
MF schemes.
z

195

New Pension Scheme

PFRDA is the regulator of the NPS
y Two kinds of pension accounts
y

Tier I (Pension Account) non-withdrawable

y Tier II (Savings Account) withdrawable to meet financial contingencies; an
active Tier I account is a pre-requisite for opening a Tier II account
y

Investors can invest through the Points of Presence (POP)

y Allocation can be made between 3 kinds of portfolios:
y

Asset Class E : predominantly Equity

y Asset Class C : Debt securities other than Govt. Securities
y Asset Class G : Govt. Securities
y

The 3 asset classes are managed by 6 Pension Fund

Managers
y Investor can also opt for a life-cycle fund where based on
age, the system will decide a mix between the 3 asset classes
y NPS offers the convenience of a single Personal Retirement
Account Number (PRAN).
y

196

Learning Objective
y
y

Chapter 11
Helping Investors with
Financial Planning

Concept of financial
planning
Approach to building long
term relationship with
clients

197

Financial Planning
y

Needs and aspirations call for financial

commitment and providing for the same becomes
a financial goal
Financial Planning is a planned and systematic
approach to provide for the financial goals that will
help people realize their needs and aspirations, and
be happy
Objective of financial planning is to ensure that the
right amount of money is available at the right time
to meet the financial goals of the investor (goalbased financial planning approach)
z

As a corollary, to let the investor know in advance, if some

financial goal is not likely to be fulfilled.
198

Financial Planning Considerations

y
y
y
y

Current costs how much would be the

expense, if it were incurred today?
Time period how many years down the
line, the expense will be incurred?
Inflation during this period, how much will
the expense rise on account of price rise?
Exchange rate if any of the expenses are to
be incurred in foreign currency, how would
the changes in exchange rate affect the
financial commitment?

199

Future Value Calculator

A = P (1 + I) ^ n
A = future requirement
P = current costs
I = inflation
N = number of years into the future, when the expense will be incurred

Financial Planning Considerations

y

Investment Horizon
Year-wise financial goals statement throws up the
investment horizon
y E.g. equity investments may be a viable option for
expenses starting year 4 and thus investments today may
be required to fund only part of financial goals; the other
part may be funded from current regular income
y

Assessing fund requirement

y

Using the future value formula [ A = P(1+r)^n ].

201

Benefits of Financial Planning

y

Provides advance information to allow corrective

action
Reviewing need vs. desire and postpone the desires
so that more desirable objectives can be met
y Reviewing recurring expenses and savings, building
additional income sources
y Reviewing capital expense s.a. type of housing, purchase
or rent, to release more capital for important needs
y

Financial planning is the basis for a long term

relationship between investor and financial planner
y
y

Helps investors realize their aspirations and feel happy

Helps financial planner understand the investor better and
cement the relationship with the investors family.

202

Need for financial planners

y

FPs are in a position to advise investors on all the

financial aspects of their life
z
z
z
z

z
z

Calculation of financial goals in money terms

Know-how of how and where to invest
Selection of appropriate financial products and assist with
the actual investment
Help investors decide on the optimal source of borrowing
should the need arise and the structure of the loan
arrangement with the lender
Help investors with tax planning so as to optimize tax
outflows
Help investors plan for contingencies, including advise on
insurance products, inheritance issues.

203

Alternative Financial Planning Approaches

y

Goal-based financial plan

z Specific goal related to aspirations, say to make son an engineer
or daughters marriage
Comprehensive financial plan
z All financial plans taken together and investment strategies
worked out
z Captures the estimate of inflows from various sources and
outflows for various financial goals
z Requires significant time commitment on part of both investor
and planner and can run into several decades
z 6-step process proposed by Certified Financial Planner Board of
Standards (USA)

Establish and define client-partner relationship

Gather client data, define client goals
Analyze and evaluate clients financial status
Develop and present financial planning considerations and/or options
Implement the financial planning recommendations
Monitor the financial planning recommendations.
204

Life Cycle in Financial Planning

y Childhood

Primary focus on education

Dependent, rather than earning member
Potential sources of income are pocket money, cash gifts and
scholarships
z The age to imbibe virtues of saving, balance and prudence
z
z
z

y Young Unmarried

z Start of earning years

z The age to start disciplined savings habit SIP and Whole Life
policies are great ways to forced thrift
z Right age to start investing in equity
z Personal plans on marriage, transportation and residence
determine liquidity needs.

205

Life Cycle in Financial Planning

y Young Married

z Income levels, early saving habits determine financial comfort

z Insurance is required, but not so critical
When only one spouse is working, life insurance is critical term
insurance should be explored as an option
Health insurance must also be planned starting early helps avoid
future rejections from Insurers on grounds of pre-existing illnesses;
Cashless facility of health cover must also be examined.

y Married with Young Children

z Insurance needs both life and health increase with every

child
z Planner is well placed to advice on type and level of insurance
cover, mix of policies to plan for contingencies and lifestyle
maintenance
z Adequate planning is required for pre-schooling to normal
schooling to higher education.

206

Life Cycle in Financial Planning

y Married with Older Children
z Rising costs associated with housing, marriage etc.
z Investments started early in life in assets like real
and shares help ensure that children enjoy the
lifestyle

estate
same

y Pre-Retirement
z Children are likely to start earning and contributing to
family expenses
z Loans taken for purchase of car or house, education of
children are likely to be extinguished
z Time to plan for retirement expected lifestyle and
means of meeting regular expenses.

207

Life Cycle in Financial Planning

Retirement

At this stage there ought to be adequate corpus, the

interest on which can help meet regular expenses
Need to dip into capital should arise only in case of
contingencies
Availability of pension and its coverage will determine
the corpus requirement
Portfolio to be largely debt assets to cover regular
expenses, and some growth assets like shares to protect
from inflation during the retirement years.

208

Wealth Cycle in Financial Planning

Accumulation
Stage of wealth building
Covers the earning years i.e. Young Unmarried
to pre-retirement phases
Transition
When financial goals are in horizon e.g. house
to be purchased, childrens education or
marriage approaching
Given the approaching need, portfolio to
increase proportion of liquid assets viz. money
in bank, liquid schemes
209

Wealth Cycle in Financial Planning

Inter-Generational Transfer

Time to plan for orderly transfer of wealth to next

generation, in the event of death
Planner to explain inheritance and tax issues and help in
preparation of will and validate documents related to
assets and liabilities of the investor
Ideal age to do is around 50; given the stress faced by
many people in the process

Reaping/Distribution

Stage when the investor requires regular money

Parallel of Retirement phase in the life cycle

210

Wealth Cycle in Financial Planning

Sudden Wealth

Unexpected inheritance, unusual capital gains, winning

from lottery are occasions of sudden wealth
The money is to be channelized for the long term
benefit of the investors family
Suggested approach is
Firstly, block the money in a liquid scheme and
then start an STP from the liquid scheme into equity
schemes
Given the change in context and likely enhancement of
lifestyle expectations, a review of the comprehensive
financial plan is also advisable in such situations.

211

Learning Objective
y

Key aspects of financial

planning
y
y

Chapter 12
Recommending Model
Portfolios & Financial
Plans

Risk profiling of investors

Asset allocation mix
Model portfolio approach

212

Key aspects of financial planning

y

Risk Profiling
y

An important pre-requisite to investment advice

y Different schemes have different risk levels
y Different investors have different risk appetites
y

Important to differentiate the risk that investors think they

are comfortable with and the risk they ought to be
comfortable with

Risk Profiling Tools

y

Risk profiling tools are offered on

websites of AMCs, Securities Research
houses & Banks
y

Tools have limited use based on investors

truthfulness.

213

Factors Influencing Investors Risk Profile

Factor

Influence on Risk Appetite

Family Information

Earning Members

Risk Appetite increases as number of earning members increase

Dependent Members

Risk Appetite decreases as number of dependent members increase

Life Expectancy

Risk Appetite is higher when life expectancy is longer

Personal Information

Age

Lower the age, higher the risk appetite

Employability

Higher the skill and qualification, higher the risk appetite

Nature of Job

More steady the job, better the risk appetite

Psyche

Daring/adventurous people have higher acceptance of downside of risk

Financial Information

Capital base

Larger the capital base, better the ability to handle downside

Income regularity

Regular income allows higher risk taking

214

Asset Allocation
The old proverb Dont put all your eggs in one basket
applies to investments
y Distribution of an investors portfolio between different
asset classes is called Asset Allocation
y Asset allocation and investment policy can better
explain portfolio performance, rather than stock
selection and investment timing
y

215

Types of Asset Allocation

At fund level
z Fixed vs. Flexible Asset Allocation framework
y At individual level
z Strategic Asset Allocation
y

Based on risk profile

E.g. following the thumb rule that Debt portfolio = Age; as age
increases, debt component increases is a Strategic AA strategy

Tactical Asset Allocation

Based on calls on the likely behaviour of the market
E.g. overweight on equities because of expected buoyancy in
industry and stock market is a tactical AA call
Suitable for seasoned investors with large investible surplus
Important to limit the size of portfolio on which such calls would be
taken from time to time.

216

Model Portfolios
Investor Category

Model Portfolio

Young Call Center/BPO

Employee with No
Dependents

50% - Diversified Equity Fund

(SIP)
20% - Sector Funds
10% - Gold ETF

10% - Diversified Debt

Fund
10% - Liquid Fund

Young Married Single

Income Family with 2
School-going Kids

35% - Diversified Equity Fund

10% - Sector Funds
15% - Gold ETF

30% - Diversified Debt

10% - Liquid Fund

Single Income Family

with Grown-up Children
who are yet to settle
down

35% - Diversified Equity Fund

15% - Gold ETF
15% - Gilt Fund

15% - Diversified Debt

20% - Liquid Fund

Couple in their Seventies,

with no Immediate Family
Support

15% - Diversified Equity Fund

10% - Gold ETF
30% - Gilt Fund

30% - Diversified Debt

15% - Liquid Fund

217

AGENDA
Chapter No.

Chapter Name

Concept & Role of a Mutual Fund

Fund Structure & Constituents

Legal & Regulatory Environment

Offer Document

Fund Distribution & Channel Management Practices

Accounting, Valuation & Taxation

Investor Services

Return, Risk & Performance of Funds

Scheme Selection

10

Selecting the Right Investment Products for Investors

11

Helping Investors with Financial Planning

12

Recommending Model Portfolios & Financial Plans

218

END OF SESSION

219

This document is prepared by ICICI Prudential Asset Management Company

Limited for general information and educational purposes only and should
not be construed as an offer or solicitation of an offer for purchase of any of
the funds of ICICI Prudential Mutual Fund. The recipient shall note that there
may be various methods of calculation of the aforesaid ratio and shall
contact their financial advisor before adopting any particular ratio. The
contents are based on publicly available information and are not intended to
provide professional advice and should not be relied upon in that regard.
Statutory Details: ICICI Prudential Mutual Fund (the Fund) was set up as a
Trust sponsored by Prudential plc (through its wholly owned subsidiary
namely Prudential Corporation Holdings Ltd) and ICICI Bank Ltd. ICICI
Prudential Trust Limited (the Trust Company), a company incorporated
under the Companies Act, 1956, is the Trustee to the Fund. ICICI Prudential
Asset Management Company Ltd (the AMC), a company incorporated under
the Companies Act, 1956, is the Investment Manager to the Fund. ICICI Bank
Ltd and Prudential Plc (acting through its wholly owned subsidiary namely
Prudential Corporation Holdings Ltd) are the promoters of the AMC and the
Trust Company.

Risk Factors: All investments in mutual funds and securities are

subject to market risks and the NAV of the schemes may go up or
down depending upon the factors and forces affecting the
securities market and there can be no assurance that the fund's
objectives will be achieved.. Past performance of the Sponsors,
AMC/Fund does not indicate the future performance of the
Schemes of the Fund. The Sponsors are not responsible or liable
for any loss resulting from the operation of the Schemes beyond
the contribution of an amount of Rs.22.2 lacs, collectively made by
them towards setting up the Fund and such other accretions and
additions to the corpus set up by the Sponsors.
All figures and other data given in this document is dated. The
same may or may not be relevant at a future date. Prospective
investors are therefore advised to consult their own legal, tax and
financial advisors to determine possible tax, legal and other
financial implication or consequence of subscribing to the units of
ICICI Prudential Mutual Fund.
y

 Disclaimer: In the preparation of the material contained in this document, ICICI Prudential
Asset Management Company Ltd. (the AMC) has used information that is publicly available,
including information developed in-house. Some of the material used in the document may
have been obtained from members/persons other than the AMC and/or its affiliates and which
may have been made available to the AMC and/or to its affiliates. Information gathered and
material used in this document is believed to be from reliable sources. The AMC however
does not warrant the accuracy, reasonableness and / or completeness of any information. ICICI
Prudential Asset Management Company Limited (including its affiliates), the Mutual Fund, The
Trust and any of its officers, directors, personnel and employees, shall not liable for any loss,
damage of any nature, including but not limited to direct, indirect, punitive, special, exemplary,
consequential, as also any loss of profit in any way arising from the use of this material in any
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material.