Mutual Fund

Mutual fund is a mechanism for pooling money by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in the offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is diversified because all stocks may not move in the same direction in the same proportion at the same time. Mutual funds issue units to the investors in accordance with the quantum of money invested by them. Investors of mutual funds are known as unitholders.

The profits or losses are shared by investors in proportion to their investments. Mutual funds normally come out with many schemes which are launched from time to time with different investment objectives. A mutual fund is required to be registered with the Securities and Exchange Board of India (SEBI) before it can collect funds from the public.

Unit Trust of India was the first mutual fund set up in India in the year 1963. In the late 1980s, the Government allowed public sector banks and institutions to set up mutual funds. In the year 1992, Securities and Exchange Board of India (SEBI) Act was passed. The objectives of SEBI are – to protect the interest of investors in securities and to promote the development of and to regulate the securities market.

As far as mutual funds are concerned, SEBI formulates policies, regulates, and supervises mutual funds to protect the interest of the investors. SEBI notified regulations for mutual funds in 1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines through circulars to mutual funds from time to time to protect the interests of investors.

All mutual funds whether promoted by the public sector or private sector entities including those promoted by foreign entities are governed by the same set of Regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI.

A mutual fund is set up in the form of a trust, which has sponsor, trustees, Asset Management Company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unit holders. AMC approved by SEBI manages the funds by making investments in various types of securities. Custodian, who is required to be registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI Regulations by the mutual fund.

SEBI Regulations require that at least two-thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be independent.
All mutual funds are required to be registered with SEBI before they launch any scheme.

The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV).

Mutual funds invest the money collected from investors in securities markets. In simple words, NAV is the market value of the securities held by the scheme. Since the market value of securities changes every day, NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is INR 200 lakh and the mutual fund has issued 10 lakh units of INR 10 each to the investors, then the NAV per unit of the fund is INR 20 (i.e.200 lakh/10 lakh). NAV is required to be disclosed by the mutual funds daily.

The NAV per unit of all mutual fund schemes has to be updated on AMFI‟s website and the Mutual Funds‟ website by 9 p.m. of the same day. Fund of Funds is allowed time till 10 a.m. the following business day to update the information.

Liquid schemes – Subscription

1. Where the application is received up to 2.00 p.m. on a day and funds are available for utilization before 2:00 p.m. without availing any credit facility, the closing NAV of the day immediately proceeding the day of receipt of
2. Where the application is received after 2.00 p.m. on a day and funds are available for utilization on the same day without availing any credit facility, the closing NAV of the day immediately preceding the next business day; and
3. Irrespective of the time of receipt of application (before or after 2:00 p.m. on a day), where the funds are not available for utilization before 2:00 p.m. without availing any credit facility, the closing NAV of the day immediately preceding the day on which the funds are available for

Liquid schemes – Redemption

1. Where the application is received up to 3.00 pm – the closing NAV of the day immediately preceding the next business day; and
2. Where the application is received after 3.00 pm – the closing NAV of the next business

Other than Liquid Schemes – Subscription

For amount less than INR 2 lakh

1. Where the application is received up to 3:00 p.m., closing NAV of the day on which the application is
2. Where the application is received after 3:00 p.m., closing NAV of the next business

For amount equal to or more than INR 2 lakh

1. Where the application is received up to 3:00 p.m. and funds are available for utilization before 3:00 p.m., closing NAV of the day on which the application is
2. Where the application is received after 3:00 p.m. and funds are available for utilization, closing NAV of the next business
3. Irrespective of the time of receipt of application (before or after 3:00 p.m.), where the funds are not available for utilization, closing NAV of the day on which the funds are available for utilization.

Other than Liquid Schemes – Redemption

1. Where the application is received up to 3.00 pm – closing NAV of the day on which the application is received; and

Where the application is received after 3.00 pm – closing NAV of the next business day.

Schemes according to Maturity Period:

A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period.

Open-ended Fund/Scheme:

An open-ended fund or scheme is available for subscription and repurchase continuously. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) per unit which is declared daily. The key feature of open-end schemes is liquidity.

Close-ended Fund/Scheme:

A close-ended fund or scheme has a stipulated maturity period e.g. 3-5 years. The fund is open for subscription only during a specified period at the time of the launch of the scheme. Investors can invest in the scheme at the time of the new fund offer and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges.

Schemes according to Investment Objective:

A scheme can also be classified as a growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:

Growth/Equity Oriented Scheme:

The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, growth, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.

Income/Debt Oriented Scheme:

The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities, and money market instruments. Such funds are less risky compared to equity schemes.

However, opportunities for capital appreciation are also limited in such funds. The NAVs of such funds are affected because of changes in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

Balanced/Hybrid Scheme:

The aim of balanced schemes is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.

Money Market or Liquid Schemes:

These schemes are also income schemes and their aim is to provide easy liquidity, preservation of capital and moderate income.

These schemes invest exclusively in short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared with other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.

Gilt Funds:

These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes.

Index Funds:

Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index (Sensex), NSE 50 index (Nifty), etc. These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors are known as “tracking error” in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.

These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents, e.g., Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, Information Technology (IT), Banks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are riskier compared with diversified funds, investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek the advice of an expert.

These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues, for example, Equity Linked Savings Schemes (ELSS) under section 80C and Rajiv Gandhi Equity Saving Scheme (RGESS) under section 80CCG of the Income Tax Act, 1961. Pension schemes launched by mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.

ETFs are mutual fund units that investors can buy or sell at the stock exchange. This is in contrast to a normal mutual fund unit that an investor buys or sells from the AMC (directly or through a distributor). In the ETF structure, the AMC does not deal directly with investors or distributors. Units are issued to a few designated large participants called Authorised Participants (APs). The APs provide buy and sell quotes for the ETFs on the stock exchange, which enable investors to buy and sell the ETFs at any given point of time when the stock markets are open for trading.

ETFs therefore, trade like stocks and experience price changes throughout the day as they are bought and sold. Buying and selling ETFs requires the investor to have Demat and trading accounts.

A capital protection-oriented scheme is typically a hybrid scheme that invests significantly in fixed-income securities and a part of its corpus in equities. These are close-ended schemes that come in tenors of fixed maturity e.g. three to five years.

Structure of the scheme – Example

If the fund collects INR 100, it invests INR 80 in fixed-income securities and INR 20 in equities or equity related instruments. The money is invested in such a way that the INR 80 portion is expected to grow to become INR 100 in three years (assuming that the scheme has a maturity period of three years). Thus, the aim is to preserve the INR 100 capital till the maturity of the scheme.

Thus, the scheme is oriented towards the protection of capital and not with guaranteed returns. Further, the orientation towards the protection of capital originates from the portfolio structure of the

Scheme and not from any bank guarantee or insurance cover. Investors are neither offered any guaranteed/indicated returns nor any guarantee on repayment of capital by the scheme.

A Load Fund is one that charges a percentage of NAV for entry or exit and the load structure in a scheme has to be disclosed in its offer documents. Suppose the NAV per unit is INR 10. If the entry as well as exit load charged is 1%, then the investors who buy would be required to pay INR 10.10 (10 + 1% of 10) per unit and those who offer their units for repurchase to the mutual fund will get only INR 9.90 (10 – 1% of 10) per unit. Currently, in India, the exit load charged is credited to the scheme. The investors should consider the loads while investing as these affect their returns. However, the investors should also consider the performance track record and service standards of the mutual fund which are more important. A no-load fund does not charge for entry or exit. It means the investors can enter the fund/scheme at NAV and no additional charges are payable on the purchase or sale of units.

SEBI has mandated that no entry load can be charged for any mutual fund scheme in India.

The price or NAV a unit holder is charged while investing in an open-ended scheme is called sales price.

Repurchase or redemption price is the price or NAV at which an open-ended scheme purchase or redeems its units from the unit holders. It may include exit load, if applicable.

Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund’s daily net assets. Operating expenses of a scheme are administration, management, advertising related expenses, etc.

An expense ratio of 1% per annum means that each year 1% of the fund’s total assets will be used to cover expenses. Information on the expense ratio that may be applicable to a scheme is mentioned in the offer document. Currently, in India, the expense ratio is fungible, i.e., there is no limit on any particular type of allowed expense as long as the total expense ratio is within the prescribed limit. For limits on expense ratio, refer to regulation 52 of the SEBI (Mutual Funds) Regulations, 1996.

CAS details all the transactions and investor‟s holding at the end of the month including transaction charges paid to the distributor, across all schemes of all mutual funds, by an investor.

A CAS for each calendar month is issued to the investors in whose folios transactions have taken place during that month.

A CAS every half yearly (September/ March) is issued, detailing holding at the end of the six months, across all schemes of all mutual funds, to all such investors in whose folios no transaction has taken place during that period.

As stated above, no entry load can be charged for any mutual fund scheme. An investor can choose to pay a distributor based on the investor‟s assessment of various factors including the service rendered by the distributor. However, for investments made through a distributor, the commission is paid directly by AMC to the distributor such that the total expense ratio for an investor is within the limits on expense ratio specified under regulation 52 of the SEBI (Mutual Funds) Regulations, 1996. Hence, the cost borne by investors remains within the limit prescribed under SEBI Regulations.

Transaction Charge:

Further, a transaction charge of INR 150 and INR 100 per subscription of INR 10,000 and above by a new and an existing investor, respectively, can be levied by the distributor. This transaction charge can be levied only if a distributor has opted in to levy a transaction charge for that type of mutual fund scheme. Further, the transaction charge, if any, is to be deducted by the AMC from the subscription amount and paid to the distributor; and the balance is to be invested.

Can a mutual fund change the asset allocation while deploying funds of investors?

Considering the market trends, any prudent fund manager can change the asset allocation, i.e., he can invest higher or lower percentage of the fund in equity or debt instruments compared to what is disclosed in the offer document. It can be done on a short term basis on defensive considerations i.e. to protect the NAV. Hence, the fund managers are allowed certain flexibility in altering the asset allocation considering the interest of the investors. In case the mutual fund wants to change the asset allocation on a permanent basis, they are required to inform the unit holders and give them the option to exit the scheme at prevailing NAV without any load.

Investors can contact the agents and distributors of mutual funds who are spread all over the country for necessary information and application forms. Investors must ensure that they invest through Association of Mutual Funds in India (AMFI) registered distributors and that the distributor has a valid AMFI Registration Number (ARN).

Whether a distributor is AMFI registered or not and whether he/she has been suspended/terminated from doing mutual fund business may be checked at http://www.amfiindia.com/locate-the-nearest-financial-advisor. An employee of a corporate distributor is also required to have an Employee Unique Identification Number (EUIN).

The distributors are required to disclose all the commissions (in the form of trail commission or any other mode) payable to them for the different competing schemes of various mutual funds from amongst which the scheme is being recommended to the investor.

Forms can be deposited with mutual funds through the agents and distributors who provide such services. These days, post offices and banks also distribute the units of mutual funds. However, the investors may please note that the mutual fund schemes being marketed by banks and post offices should not be taken as their schemes and no assurance of returns is given by them. The only role of banks and post offices is to help in the distribution of mutual funds schemes to the investors.

Investors should not be carried away by commission/gifts, if any, given by agents/distributors for investing in a particular scheme. On the other hand, they must consider the track record of the mutual fund/scheme and should take objective decisions.

Investors also have the option to invest directly with the mutual fund either by visiting the mutual fund branch or online through the Mutual Fund website.

Investors should also refer to the product labeling of the scheme. All the mutual funds are required to label their schemes on the following parameters:

1. Nature of scheme such as to create wealth or provide regular income in an indicative time horizon (short/ medium/ long term).
2. A brief about the investment objective (in a single line sentence) followed by the kind of product in which the investor is investing (Equity/Debt).
3. Level of risk depicted by a pictorial meter (known as a riskometer) as under:
   • Low – principal at low risk
   • Moderately Low – principal at moderately low risk
   • Moderate – principal at moderate risk

• Moderately High – principal at moderately high risk
• High – principal at high risk

However, investors should consult their financial advisers if they are not clear about the suitability of the product.

Product label is prominently disclosed in:

1. Frontpage of initial offering application forms, Key Information Memorandum (KIM), and Scheme Information Documents (SIDs).
2. Common application form – along with the information about the

Scheme advertisements.

An investor must mention clearly his name, address, number of units applied for, and such other information as required in the application form. Know your Customer (KYC) documents need to be submitted by a first time investor.

SEBI has mandated mutual funds to compulsorily launch a direct plan for direct investments, i.e., investments not routed through a distributor, from 01 January 2013. Such a separate plan has a lower expense ratio excluding distribution expenses, commission, etc., and no commission is to be paid from such plans. The plan also has a separate NAV.

Investment can be made in a lump sum, i.e. a onetime payment, or through a Systematic Investment Plan (SIP).

A SIP allows an investor to invest regularly. One puts in a small amount every month that is invested in a mutual fund.

A SIP allows one to take part in the stock market without trying to second-guess its movements.

For example

X decides to invest INR 1,000 per month for a year.

When the market price of shares fall, X benefits by purchasing more units; and is protected by purchasing less when the price rises as explained below.

Within one year, X has 1,186 units by investing just INR 1,000 every month at an average cost of 12000/1186.15 = 10.1170. This is as against 12,000/10 = 1,000 units or 12000/11.5 = 1043.5 units or 12000/9 = 1,333.3 units if X had invested lump sum on 1 Jan, 1 Jun or 1 May, respectively.

An investor should take into account his risk taking capacity, age factor, financial position, etc. As already mentioned, the schemes invest in a different type of securities as disclosed in the offer documents and offer different returns and risks.

Investors may also consult financial experts before taking decisions.

An abridged offer document [known as Key Information Memorandum (KIM)], which contains very useful information, is required to be given to the prospective investor by the mutual fund.

The application form for subscription to a scheme is an integral part of the offer document. SEBI has prescribed minimum disclosures in the offer document. Mutual fund investments are subject to market risks. An investor should carefully read all the scheme related documents. Due care must be given to portions relating to main features of the scheme, risk factors and recurring expenses to be charged to the scheme, loads, sponsor‟s track record, educational qualification and work experience of the key personnel including fund managers, the performance of other schemes launched by the mutual fund in the past, pending litigations and penalties imposed, etc.

As a unit holder, how much time will it take to receive dividends/repurchase proceeds?

A mutual fund is required to dispatch to the unit holders the dividend warrants within 30 days of the declaration of the dividend and the redemption or repurchase proceeds within 10 working days from the date of redemption or repurchase request made by the unit holder.

In case of failure to dispatch the redemption/repurchase proceeds within the stipulated time period, Asset Management Company is liable to pay interest as specified by SEBI from time to time (15% at present) for the period of delay.

The performance of a scheme is reflected in its NAV which is disclosed on daily basis. The NAVs of mutual funds are required to be published on the websites of mutual funds. All mutual funds are also required to put their NAVs on the website of Association of Mutual Funds in India (AMFI) www.amfiindia.com and thus the investors can access NAVs of all mutual funds in one place. Also, each MF is required to have a dashboard on its website providing performance and key disclosures pertaining to each scheme managed by AMC.

The mutual funds are also required to publish their performance in the form of half-yearly results which also include their returns over a period of time i.e. last six months, 1 year, 3 years, 5 years, and since the inception of schemes. Investors can also look into other details like percentage of expenses of total assets as these affect the return and other useful information in the same half-yearly format.

The mutual funds are also required to send annual reports or abridged annual reports to the unit holders at the end of the year.

Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity oriented schemes with the benchmarks like BSE Sensitive Index, Nifty, etc.

Based on the performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme.

The mutual funds are required to disclose full portfolios of all of their schemes on a monthly basis on their website. Portfolio disclosure on a half yearly basis is published in the newspapers. Mutual funds may also send the disclosure of half-yearly portfolios to their unit holders.

The scheme portfolio shows investment made in each security i.e. equity, debentures, money market instruments, government securities, etc., and their quantity, market value, and % to NAV. These portfolio statements are also required to disclose illiquid securities in the portfolio, the investment made in rated and unrated debt securities, non-performing assets (NPAs), etc.

Some of the investors have the tendency to prefer a scheme that is available at lower NAV compared to the one available at higher NAV. Sometimes, they prefer a new scheme which is issuing units at INR 10 whereas the existing schemes in the same category are available at much higher NAVs. Investors may please note that in the case of mutual fund schemes, lower or higher NAVs of similar types of schemes of different mutual funds have no relevance. On the other hand, investors should choose a scheme based on its merit considering the performance track record of the mutual fund, service standards, professional management, etc. This is explained in an example given below.

Suppose scheme A is available at a NAV of INR 15 and another scheme B at INR 90. Both schemes are diversified equity oriented schemes. An investor has put INR 9,000 in each of the two schemes. He would get 600 units (9000/15) in scheme A and 100 units (9000/90) in scheme B. Assuming that the markets go up by 10% and both the schemes perform equally good and it is reflected in their NAVs. NAV of scheme A would go up to INR 16.50 and that of scheme B to INR 99.

Thus, the market value of investments would be INR 9,900 (600* 16.50) in scheme A and it would be the same amount of INR 9900 in scheme B (100*99). The investor would get the same return of 10% on his investment in each of the schemes. Thus, lower or higher NAV of the schemes and allotment of the higher or lower number of units within the amount an investor is willing to invest, should not be the factors for making an investment decision. Likewise, if a new equity oriented scheme is being offered at INR 10 and an existing scheme is available for INR 90, NAV should not be a factor for decision making by the investor. Similar is the case with income or debt-oriented schemes.

On the other hand, it is likely that the better managed scheme with higher NAV may give higher returns compared to a scheme which is available at lower NAV but is not managed efficiently. Similar is the case of fall in NAVs. An efficiently managed scheme at higher NAV may not fall as much as inefficiently managed scheme with lower NAV. Therefore, the investor should give more weightage to the professional management of a scheme instead of lower NAV of any scheme. He may get a much higher number of units at lower NAV, but the scheme may not give higher returns if it is not managed efficiently.

Almost all mutual funds have their own websites. Investors can also access the NAVs of all mutual funds at the website of Association of mutual funds in India (AMFI) www.amfiindia.com.

Investors can log on to the website of SEBI www.sebi.gov.in and go to “Mutual Funds” section for information on SEBI regulations and guidelines, data on mutual funds, draft offer documents filed by mutual funds, etc. Also, in the annual reports of SEBI available on the website, information on mutual funds is given.

There are a number of other websites which give a lot of information about various schemes of mutual funds including returns over a period of time. Many newspapers also publish useful information on mutual funds on a daily and weekly basis.
Investors may also approach their financial experts and distributors to guide them in this regard.

Mutual Funds provide on their website, the list of names and addresses of investors in whose folios there are unclaimed amounts (dividend/redemption). The information provided herein shall contain the name of the investor, address of investor, and name of Mutual Fund/s with whom unclaimed amount lies.

The website of Mutual Funds is also required to provide information on the process of claiming the unclaimed amount and the necessary forms/documents required for the same.

The information on the unclaimed amount along with its prevailing value (based on income earned on the deployment of such unclaimed amount)is separately disclosed to investors through the periodic statement of accounts/CAS sent to the investors.