amfi advisors module notes

8/6/2019 Amfi Advisors Module Notes

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Notes By Abhishek Kamdi

E-Mail [email protected]

Chapter 1 : Concept and Role of Mutual Funds

Learning Objective

This unit seeks to introduce the concept of mutual funds, highlight the advantages theyoffer, and describe the salient features of various types of mutual fund schemes.

Mutual funds are a vehicle to mobilize moneys from investors, to invest in differentmarkets and securities

The primary role of mutual funds is to assist investors in earning an income or buildingtheir wealth, by participating in the opportunities available in the securities markets.

In order to accommodate investor preferences, mutual funds mobilize different pools of

money. Each such pool of money is called a mutual fund scheme. Mutual funds addressdifferential expectations between investors within a scheme, by offering various options,

such as dividend payout option, dividend reinvestment option and growth option. An

investor buying into a scheme gets to select the preferred option also.

The investment that an investor makes in a scheme is translated into a certain number of

Units in the scheme. The number of units multiplied by its face value (Rs10) is thecapital of the scheme its Unit Capital.

When the profitability metric is positive, the true worth of a unit, also called Net Asset

Value (NAV) goes up.

When a scheme is first made available for investment, it is called a New Fund Offer

(NFO).

The money mobilized from investors is invested by the scheme as per the investment

objective committed. Profits or losses, as the case might be, belong to the investors. Theinvestor does not however bear a loss higher than the amount invested by him.

The relative size of mutual fund companies is assessed by their assets under management(AUM). The AUM captures the impact of the profitability metric and the flow of unit-

holder money to or from the scheme.

Investor benefits from mutual funds include professional management, portfoliodiversification, economies of scale, liquidity, tax deferral, tax benefits, convenient

options, investment comfort, regulatory comfort and systematic approach to investing.

Limitations of mutual funds are lack of portfolio customization and an overload of

schemes and scheme variants.

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Open-ended funds are open for investors to enter or exit at any time and do not have a

fixed maturity. Investors can acquire new units from the scheme through a sale

transaction at their sale price, which is linked to the NAV of the scheme. Investors cansell their units to the scheme through a re-purchase transaction at their re-purchase price,

which again is linked to the NAV.

Close-ended funds have a fixed maturity and can be bought and sold in a stock exchange.

Interval funds combine features of both open-ended and closed ended schemes.

Actively managed funds are funds where the fund manager has the flexibility to choose

the investment portfolio, within the broad parameters of the investment objective of the

scheme.

Passive funds invest on the basis of a specified index, whose performance it seeks to

track.

Gilt funds invest in only treasury bills and government securities

Diversified debt funds on the other hand, invest in a mix of government and non-

government debt securities

Junk bond schemes or high yield bond schemes invest in companies that are of poorcredit quality.

Fixed maturity plans are a kind of debt fund where the investment portfolio is closelyaligned to the maturity of the scheme.

Floating rate funds invest largely in floating rate debt securities

Liquid schemes or money market schemes are a variant of debt schemes that invest only

in debt securities of less than 91-days maturity.

Diversified equity funds invest in a diverse mix of securities that cut across sectors.

Sector funds invest in only a specific sector.

Thematic funds invest in line with an investment theme. The investment is more broad-

based than a sector fund; but narrower than a diversified equity fund.

A mutual fund is a pool of money collected from Investors and is invested

according to stated investment objectives.

The birth place of Mutual Fund is U.S.A.

Mutual fund investors are like shareholders and they own the fund.

Mutual fund investors are not lenders or deposit holders in a mutual fund.



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Everybody else associated with a mutual fund is a service provider, who earns

fee.

The money in the mutual fund belongs to the investors and nobody else.

Mutual funds invest in marketable securities according to the investment

objective.

The value of the investments can go up or down, changing the value of theinvestors holdings.

The net asset value (NAV) of a mutual fund fluctuates with market price

movements.

The market value of the investors funds is also called as net assets.

Investors hold a proportionate share of the fund in the mutual fund.

New investors come in and old investors can exit at prices related to net asset

value per unit.

Advantages of mutual funds to investors are:

o Increases the purchasing power of the investors

o

Portfolio diversificationo Professional management

o Reduction in risk

o Reduction in transaction cost

o Liquidity

o Convenience and flexibility

Disadvantages of mutual funds to investors are:

o No control over costs

o No tailor made portfolios

o Problems of managing a large portfolio of funds

Important Milestones in the MF history in Indiao 1963: UTI (special privileges assured return schemes, guarantees, loans)

o 1987: Public Sector MFs

o 1993: Private Sector MFs

o 1995: AMFI was set-up (internal checks & balances, representation to the

govt and consumer education publish a book titled Making Mutual

Funds Work for You an Investors Guide)o 1996: SEBI (MF) Regulations

o 1999: Dividend income made tax free in the hands of investor

o 2003: UTI Act repealed (level playing field, UTI split, UTIMF created)

o 2004-onwards: Consolidation & Growth (AUM at the end of FY 2004-05was appx. Rs.153,000 crores)

UTI was the only mutual fund during the period 1963-1988.

UTI was the only fund for a long period and enjoyed monopoly status.

UTI is governed by the UTI Act, 1963

In 1987 banks, financial institutions and insurance companies in the public sector

were permitted to set up mutual funds.



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SEBI got regulatory powers in 1992.

SBI Mutual Fund was the first bank-sponsored mutual fund to be set up.

The first mutual fund product was UTIs Master Share in 1986.

The private sector players were allowed to set up mutual funds in 1993.

In 1996 the mutual fund regulations were substantially revised and modified.

In 1999 dividends from mutual funds were made tax exempt in the hands ofinvestors.

Mutual funds can be open ended or closed ended, Load or No-Load, Taxable or

Tax exempt, Commodities and Real Estate funds.

In an open ended fund, sale and repurchase of units happen on a continuous basis,

at NAV related prices, from the fund itself.

The corpus of open ended funds, therefore, changes everyday.

A closed end fund offers units for sale only in the NFO. It is then listed in themarket.

In closed end fund investors wanting to buy or sell units have to do so in the stock

markets.

The corpus of a closed end fund remains unchanged. Mutual funds also offer equity linked savings schemes (ELSS) that have the

following features:

o 3 year lock in

o Minimum investment of 90% in equity markets at all times

o Open ended or closed end

o Rebate under section 80C for investments up to Rs. 1,00,000/-

Gilt funds are funds that invest only in government securities

Sectoral funds are also called as specialty funds.

Equity funds are risky; liquid funds have the lowest risk.

Equity funds are for the long term; liquid funds are for the short term. Investors choose funds based on their objectives, risk appetite, time horizon and

return expectations.

Load is charged to the investor when the investor buys or redeems (repurchases)

units.

Load is an adjustment to the NAV, to arrive at the price.

Load that is charged on sale of units is called as Entry Load.

An entry load will increase the price, above the NAV, for the investor.

Load that is charged when the investor redeems his units is called an Exit Load.

Exit load reduces the redemption proceeds of the investor. Load is primarily used to meet the expenses related to sale and distribution of

units. An exit load that varies with the holding period of an investor is called a

(Contingent Deferred Sales Charge) CDSC.

The repurchase price cannot be less than 95% of the sale price.



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Chapter 2: Fund Structure and Constituents

Learning Objective

In this unit, you will understand the salient features of the legal structure of mutual fundsin India and the role of key constituents that make up the overall mutual fund eco-system.

Mutual funds in India are governed by SEBI (Mutual Fund) Regulations, 1996, as

amended till date.

The regulations permit mutual funds to invest in securities including money market

instruments, or gold or gold related instruments or real estate assets.

Mutual funds are constituted as Trusts. The mutual fund trust is created by one or moreSponsors, who are the main persons behind the mutual fund operation.

Every trust has beneficiaries. The beneficiaries, in the case of a mutual fund trust, are the

investors who invest in various schemes of the mutual fund.

In order to perform the trusteeship role, either individuals may be appointed as trustees or

a Trustee company may be appointed.

When individuals are appointed trustees, they are jointly referred to as Board of Trustees.

A trustee company functions through its Board of Directors.

Day to day management of the schemes is handled by an AMC.

The AMC is appointed by the sponsor or the Trustees. Although the AMC manages theschemes, custody of the assets of the scheme (securities, gold, gold-related instruments &

real estate assets) is with a Custodian, who is appointed by the Trustees.

Investors invest in various schemes of the mutual fund. The record of investors and their

unit-holding may be maintained by the AMC itself, or it can appoint a Registrar &Transfer Agent (RTA).

The sponsor needs to have a minimum 40% share holding in the capital of the AMC.

The sponsor has to appoint at least 4 trustees atleast two-thirds of them need to be

independent. Prior approval of SEBI needs to be taken, before a person is appointed asTrustee.

AMC should have networth of at least Rs10crore. At least 50% of the directors should be

independent directors. Prior approval of the trustees is required, before a person is



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appointed as director on the board of the AMC.

Mutual funds in India have a 3-tier structure of Sponsor-Trustee-AMC.

The mutual fund is formed as trust in India, and not as a company.

In the US mutual funds are formed as investment companies. Investors money is held in the Trust (the mutual fund).

The Sponsor:

Sponsor is defined under the SEBI regulations as any person who, acting alone orin combination with another body corporate, establishes a mutual fund.

Sponsor is the promoter of the fund.

Sponsor could be a bank, a corporate or a financial institution.

Sponsors then form Trust and appoint Board of Trustees.

The sponsor also appoints Custodian.

As per SEBI regulations, sponsor must contribute at least 40% of the net worth ofthe AMC and possess a sound financial track record over five years prior to

registration.

Sponsor signs the trust deed with the trustees.

Sponsor creates the AMC and the trustee company and appoints the board ofdirectors of companies, with SEBI approval.

Sponsor should have at least a 5 year track record in the financial services

business and should have made profit in at least 3 out of the 5 years.

The AMCs capital is contributed by the sponsor.

Sponsor should contribute at least 40% of the capital of the AMC.

The Trustees:

A mutual fund in India is form as Trust under Indian Trust Act, 1882.

The trust-mf is managed by Board of Trustees.

The board of Directors i.e. Trustees do not manage the portfolio of securities

directly rather they appoint as AMC (Asset Management Company)

Trustees ensure that fund is managed by stated objective and as per SEBIregulations.

Trusts always work for the interest of unit holders.

The trust is created through a document called Trust Deed that is executed bysponsor in favors of Trustees.

The Trustees being the primary guardians of unit holders funds and assets.

Trustees must ensure that the investors interests are safeguarded and that theAMC operations are as per regulation laid down by SEBI.

SEBI mandates a minimum of 2/3rd independent directors on the board of the

trustee company.

Trustees are appointed by the sponsor with SEBI approval. Trustees are required to meet at least 4 times a yea to review the AMC.



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The trustees make sure that the funds are managed according to the investors

mandate.

Rights of Trustees:

The trustee appoints AMC with prior approval of SEBI.

They also approve each new scheme floated by AMC.

They have the right to request any necessary information from the AMCconcerning the operations of various schemes.

The trustees may take any necessary action against AMC if they found AMC

operations are not as per the SEBI regulations.

Manages the mutual fund and look after the operations of the appointed AMC.

Trustees approve each MF scheme floated by AMC Trustees receive fee for their services.

The investments are held by the Trustee

Trustees can seek remedial actions from AMC

Trustees can dismiss the AMC

The trustees have the right to ensure that, based on their quarterly review ofAMCs net worth; any shortfall in the net worth is made by the AMC.

Obligations of Trustees:

To ensure that funds transactions as per SEBI regulations

To ensure that the proper key person of AMC has been appointed. And alsooperations of other staffs of AMC. To ensure that the due diligence (care) has been given for empanelment of

brokers.

Trustees Manages the Mutual Fund and look after the operations of the appointedAMC

The investments are held by the Trustee

At least 4 members should be there in Board of Trustees.

2/3 members in the Board of Trustees should be independent.

Sponsors execute and register Trust Deed in favors of Trustees.

Trustee of one MF can not be a trustee of another MF, unless he/she is an

independent trustee in both the cases. The appointment of all trustees has to be done with prior approval of SEBI.

Trusts are formed through Trust Deed

Trust ensures that AMC has not given any undue advantage to any associates.

Trustee ensures that AMC is managing the fund as per SEBI regulations

Meeting of Trustees should held once in every two months.

SEBI categorizes the Obligations of Trustees aso General Due Diligence &



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o Specific Due Diligence

1. General Due Diligence

Appointment of AMC & its directors Observance of AMC functioning and desirability of its

continuance Protection of Trust property Ensuring that all constituents and associations are

registered entities

Review of service contracts and terms

Reporting to SEBI any special developments in the mutualfund

1. Specific Due Diligence

Trust must appoint independent auditor and obtain from

them periodic internal audit reports from AMC

Obtain compliance test reports from the AMC once everytwo months.

These reports are to be discussing in meeting of trustees. Trustees set a code of ethics for trustees and for AMC

personnel

AMC-Appointments and Functions

The role of AMC is to act as investment manager of trust

The AMC (as appointed by trust/sponsor) require approving by a SEBI

The AMC supervision under its own board of directors and also the directors of

trustees and SEBI The trustees are empowered to terminate the appointment of AMC and appoint a

new AMC with prior approval of SEBI and unit holders.

The AMC is the name of the Trust; manage different investment schemes as per

investment management agreement with the trustees.

The AMC of a MF must have a net worth of at least Rs.10 Crores at all times.

Director of AMC should have complete finance professional experience.

The AMC can not act as a trustee of any other MF.

The AMC always act in the interest of unit holders (investor)

The AMC gets a fee for managing the funds, according to the mandate of the

investors

At least of the AMCs Board should be of independent members An AMC can not engage in any business other than portfolio advisory and

management

An AMC of one fund cannot be Trustee of another fund

AMC should be registered with SEBI

AMC signs an investment management agreement with the trustees

Obligation of AMC & its directors



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Investment of the fund according to the SEBI regulation & trust deed.

They are answerable to the trustees and must submit quarterly reports to them on

AMC activities and compliance with SEBI regulations

Each day NAV is updated on AMFI website by 9 pm

In the event of merger or consolidation of schemes, the unit holders are intimated

through a letter giving them option to exit at prevailing NAV without exit load.

Custodians & Depositories

For safekeeping of physical securities of MF custodian is appointed by board of

trustees.

The custodian should be registered with SEBI. Dematerialized forms of securities

are held in the custody of Depositories Participant. The investors fund and the investments are held by the custodian, who is the

guardian of the funds and assets of the investors.

Sponsor and the Custodian cannot be the same entity

Function of Custodian

Responsible for the securities held in the mutual funds portfolio

Keep an investment record of the mutual fund

Collect dividends and investment payments due on the mutual funds investment

Track corporate actions like bonus issues, right offers, offer for sale, buy back and

open offers for acquisition.

Registrars & Transfer Agents

They are responsible for issuing and redeeming units of the MF and providingother MF related services to investors Register and Transfer (R&T) Agents manage the sale and repurchase of units and

keep the unit holders accounts.

Functions of Registrars

Process investors application

Record details of investors

Send information to investor

Process dividend payout

Incorporate changes in investor information Keeping investor information up to date

Distributors

AMC appoints a distributor (also called MF advisor, agent, broker, intermediaries

etc) who sells units MF to investors on the behalf of fund house.



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A sponsor or an associate may act as distributors of AMC. For example, Bank

which is sponsor of Mutual Fund Company may act as distributor also for selling

its mutual funds products

AMC has the right whether to impaneled (appoint) or not distributor for selling

his MF scheme.

They also have the right of commission structure which they offer to distributor You may find different commission structure for different AMC scheme.

A distributor can act for several or all MF

For all employees and distributors of MF, AMFI certification test has been mademandatory by SEBI

All distributors are required to be registered with AMFI and obtain AMFI

Registration Number (ARN)

The commission received by the distributors is split into initial commission whichis paid on mobilization of funds and trial commission which is paid depending on

the time the investors stay with the fund.

Fund Mergers & Takeovers

A running fund constitution can change in the following possible ways

1. Trustees may decide to change the AMC and handover the scheme to a new AMC2. The scheme may be merged with another scheme of the same AMC

3. The AMC is taken over by another set of sponsors

4. One AMC may merge with another AMC5. Just the schemes may be taken over by another set of trustees

Transaction Type Trustee

Approval

SEBI

Approval

High Court

Approval

AMC Takeover by new sponsor Yes Yes No

AMC Merger Yes Yes Yes

Trustees changing AMC Yes Yes No

Schemes taken over by another AMC Yes Yes No

Scheme Merger Yes Yes No

Example of AMC Merger - HB & Taurus Two MF companies in India which mergedusing the AMC merger route

Example of AMC Takeover - Zurich acquired Threadneedle globally and bought out

ITC Threadneedles India business. Zurich similarly acquired Kemper Twentieth Century

Finance. In recent times Alliance was taken over by Birla.

Example of Scheme Takeover Zurich finally exited MF business in India and sold all

its schemes in India to HDFC (technically the AMC was not sold but just the schemes)



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Chapter 3: Legal and Regulatory Environment

Learning Objective

The focus of this unit is on the overall regulatory environment of mutual funds in India,

with a focus on the investor.

SEBI regulates mutual funds, depositories, custodians and registrars & transfer agents in

the country.

AMFI is an industry body, but not a self regulatory organization.

The AMFI Code of Ethics sets out the standards of good practices to be followed by theAsset Management Companies in their operations and in their dealings with investors,

intermediaries and the public.

AMFI has framed AGNI, a set of guidelines and code of conduct for intermediaries,

consisting of individual agents, brokers, distribution houses and banks engaged in selling

of mutual fund products.

Investment objective defines the broad investment charter. Investment policy describes in

greater detail, the kind of portfolio that will be maintained. Investment strategies aredecided on a day-to-day basis by the senior management of the AMC. At least 65% of the

corpus should, in the normal course, be invested in thekind of securities / sectors implied by the schemes name.

Statement of accounts is to be sent to investors within 5 days of closure of the NFO.

Investor can ask for a Unit Certificate for his Unit Holding. This is different from aStatement of Account.

NAV has to be published daily, in at least 2 newspapers

NAV, Sale Price and Re-purchase Price is to be updated in the website of AMFI and the

mutual fund

The investor/s can appoint a nominee, who will be entitled to the Units in the event of the

demise of the investor/s.

The investor can also pledge the units. This is normally done to offer security to a

financier.



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Dividend warrants have to be dispatched to investors within 30 days of declaration of the

dividend

Redemption / re-purchase cheques would need to be dispatched to investors within 10

working days from the date of receipt of request.

Unit-holders have proportionate right to the beneficial ownership of the assets of the

scheme.

Investors can choose to change their distributor or go direct. In such cases, AMCs will

need to comply, without insisting on No

Objection Certificate from the existing distributor. Investors can choose to hold the Unitsin dematerialised form. The mutual fund / AMC is bound to co-ordinate with the RTA

and

Depository to facilitate this. In the case of unit-holding in demat form, the dematstatement given by the Depository Participant would be treated as compliance with the

requirement of Statement of Account.

The mutual fund has to publish a complete statement of the scheme portfolio and the

unaudited financial results, within 1 month from the close of each half year. In lieu of the

advertisement, the mutual fund may choose to send the portfolio statement to all Unit-holders.

Debt-oriented, close-ended / interval, schemes /plans need to disclose their portfolio intheir website every month, by the 3rd working day of the succeeding month.

Scheme-wise Annual Report, or an abridged summary has to be mailed to all unit-holderswithin 6 months of the close of the financial year.

The Annual Report of the AMC has to be displayed on the website of the mutual fund.The Scheme-wise Annual Report will mention that Unit-holders can ask for a copy of the

AMCs Annual Report.

The trustees / AMC cannot make any change in the fundamental attributes of a scheme,unless the requisite processes have been complied. This includes option to dissenting

unit-holders to exit at the prevailing Net Asset Value, without any exit load. This exit

window has to be open for at least 30 days.

The appointment of the AMC for a mutual fund can be terminated by a majority of the

trustees or by 75% of the Unit-holders (in practice, Unit-holding) of the Scheme. 75% ofthe Unit-holders (in practice, Unit-holding) can pass a resolution to wind-up a scheme If

an investor feels that the trustees have not fulfilled their obligations, then he can file a

suit against the trustees for breach of trust.



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Under the law, a trust is a notional entity. Therefore, investors cannot sue the trust (but

they can file suits against trustees, as seen above).

The principle of caveat emptor (let the buyer beware) applies to mutual fund investments.

The investor can claim his moneys from the scheme within 3 years. Payment will bebased on prevailing NAV. If the investor claims the money after 3 years, then payment is

based on the NAV at the end of 3 years

If a security that was written off earlier is now recovered, within 2 years of closure of the

scheme, and if the amounts are substantial, then the amount is to be paid to the old

investors. In other cases, the amount is to be transferred to the Investor Education Fund

maintained by each mutual fund.

PAN No. and KYC documentation is compulsory for mutual fund investments. Only

exception is micro-SIPs.

Investors need to give their bank account details along with the redemption request.

Adequate safeguards exist to protect the investors from the possibility of a scheme goingbust.

In 1992, Government of India constituted SEBI (Securities & Exchange Board of

India) by an act of parliament.

It is mandatory for all the MFs to register with SEBI

Mutual Funds are regulated by the SEBI (Mutual Fund) Regulations, 1996.

SEBI is the regulator of all funds, except offshore funds.

Bank-sponsored mutual funds are jointly regulated by SEBI and RBI If there is a bank-sponsored fund, it can not provide a guarantee without RBI

permission.

RBI regulates money and government securities markets, in which mutual fundsinvest.

Listed mutual funds are subject to the listing regulations of stock exchanges.

Since the AMC and Trustee Company are companies, any complaints againsttheir board can be made to the CLB (Company Law Board)

Investors can not sue the trust, as they are the same as the trust and cannot sue

themselves.

UTI does not have a separate sponsor and AMC.

UTI is governed by the UTI Act, 1963 and is voluntarily under SEBI Regulations.

RBI The Money Market Regulator

RBI act as Supervisor of Bank owned Mutual Funds

Bank MF comes under regulatory of RBI All MF come under SBI regulation but bank owned AMC came under RBI

regulation.



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RBI banned all non banking entities access to the inter-bank call money market.

This means that liquid funds can no longer invest in the call money market.

The ministry of Finance supervises both the RBI & SEBI

In 2003, a Securities Appellate Tribunal (SAT) has been created to provide the

apex appear mechanism for any decision taken by SEBI.

SAT works as independent judicial authority.

CLB, DCA, RoC

AMC are registered under companies act 1956 and hence answerable to

regulatory authorities empowered by the companies act.

Registrar of Companies (RoC) is the legal interface for all companies

RoC, in turns is supervised by the Department of Company Affairs (DCA) Above DCA there is the Company Law Board (CLB) which is part of Ministry of

Law & Justice of the Govt. of India.

Self Regulatory Organisations (SRO)

Stock Exchanges are Self Regulatory Organisations supervised by SEBI

Many closed ended schemes are listed on stock exchanges through a signing

agreement between the fund and the stock exchange.

SRO is an association representing a group of market participants which isspecially empowered by the apex regulatory authority to exercise pre-defined

authority over the regulation of their members.

Theses activities of the funds are regulated by respective SROs that report to the

main regulatory body like SEBI The SROs are given powers to regulate the criterion & procedures for admission

of its members, set a code of conduct for their members market activities, anddetermine the professional rules & by laws of the association & so on.

To become SRO, need granted specific powers & approval by the government,

appropriate laws & recognition by the regulatory authority.

SROs are the second tier in the regulatory structure

SROs get their powers from the apex regulating agency, act on their instructions

and regulate their own members in a limited manner.

SROs cannot do any legislation on their own.

All stock exchanges are SROs

Stock Exchanges in most countries are granted the status of SRO

AMFI is an industry association of mutual funds. AMFI is not yet a SEBI

registered SRO. AMFI is not a SRO.

Association of Mutual Fund in India (AMFI)

AMFI was incorporated in 1995

AMFI has the powers to deny registration to distributors for failing the test or

violating AMFI code of conduct given in AGNI (AMFI Guidelines & Norms forIntermediaries)



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For all employees and distributors of MF, AMFI certification test has been made

mandatory by SEBI

All distributors are also required to be registered with AMFI & obtain AMFIRegistration Number (ARN)

AMFI is regulated by its own board made up of its members.

AMFI main objectives

To promote the interest of MFs and units holders, interact with SEBI, RBI, andGovernment for same.

To set and maintain ethical, commercial and professional standards in the industry

To recommend and promote best business practices and code of conduct in the

MF industry. To increase public awareness and understanding for MF

To develop a team of well trained professional MF distributors

Implement a training and certification for all intermediaries engaged in MF

industry.

Rights of Investor

Investors are beneficial owner of scheme asset which they own.

Investors are entitled to receive dividends declared in a scheme within 30 days.

Redemption proceeds have to be sent to investors within 10 days otherwise

investor has the right to receive dividend with interest, borne by AMC.

If an investor fails to claim the dividend or redemption proceeds he has rights to

claim up to a period of 3 years from the due date at the then prevailing NAV Mutual funds have to allot units within 30 days of the IPO/NFO

Mutual funds have to publish their half yearly results in at least one national dailyand publish their entire portfolios, at least once in 6 months. Such disclosuresshould be done within 30 days from 6 monthly account closing dates of the fund.

Trustees will have to ensure that any information having a material impact on the

unit holders investments should be made publicly the mutual fund.

If 75% of the unit holders so decide, 1) The scheme can be wound up 2) Meeting

of unit holders can be called 3) Appointment of the AMC of the mutual fund can

be terminated.

If there is any change in the fundamental attributes of the scheme, the unit holders

have to be notified through a letter. they also have a right to repurchase at NAV

without any load, before such change is effected.

Investors Obligations

Study OD

Provide PAN

Monitor their investment

Investors Complaints Redressal Mechanism



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Investor Grievances can be addressed to Trustee

SEBI is the primary body to address MF complaints

Investors cannot seek redressal under Companies Act since fund investors areneither share holders nor depositors in AMC

Limitations of Investor

Investors can not sue the trust as they are not distinct from the trust

Investors can lodge complaints with SEBI for non-compliance.

Investors can not be compensated if the performance of the fund is below

expectations.



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Chapter 4. The Offer DocumenLearning Objective

This unit will give you a good idea of what goes into a New Fund Offer and the legalities

underlying the offer documents which are a key source of information for investors andprospective investors.

Under the SEBI guidelines, NFOs other than ELSS can remain open for a maximum of

15 days. Allotment of units or refund of moneys, as the case may be, should be donewithin 5 business days of closure of the scheme. Further, open-ended schemes have to re-

open for sale / re-purchase within 5 business days of the allotment.

Investors get to know the details of any NFO through the Offer Document, which is one

of the most important sources of information about the scheme for investors. Investments

by the investor are governed by the principle of caveat emptor i.e. let the buyer beware.

Mutual Fund Offer Documents have two parts: (a) Scheme Information Document (SID),

which has details of the scheme (b) Statement of Additional Information (SAI), which

has statutory information about the mutual fund that is offering the scheme.

In practice, SID and SAI are two separate documents, though the legal technicality is that

SAI is part of the SID. Both documents need to be updated regularly.

Offer Documents in the market are vetted by SEBI, though SEBI does not formally

approve them.

KIM is essentially a summary of the SID and SAI. It is more easily and widelydistributed in the market. As per SEBI regulations, every application form is to be

accompanied by the KIM.

Offer document is the most important source of information for investors

Contents of the OD

Details of the sponsor and the AMC

Description of the scheme and the investment objective

Terms of issue Historical statistics

Investors rights and services

Fee structure and expenses

Information on income and expenses of existing schemes

Front page of the offer document contains its date of publication, name & type of

fund and its major objectives. Specifically the following



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Name of Mutual Fund

Name of Scheme

Type of Scheme (Equity/Income/Balanced)

Name of AMC

Unit Price

Opening, Closing & Earliest Closing date Name of Guarantor if the scheme is an assured return

SEBI disclaimer

Statement to the effect that it is important for a prospective investor to read it andretain for future reference

More about OD:

Abridged version of the OD is called as Key Information Memorandum (KIM)

Investors are required to read and understand the offer document before investing

in mutual funds

No recourse is available to investors for not reading the OD or KIM, as they signthe form stating that they have read the OD

OD is issued by the AMC on behalf of the Trustees

KIM has to be compulsorily made available along with the application form.

Closed end funds issue an offer document at the time of the NFO

Open ended funds have to update OD at least once in 2 years.

Trustees approve the contents of the OD and KIM

The format and content of the OD has to be as per SEBI guidelines.

The AMC prepares the OD and is responsible for the information contained in the

OD

The Compliance Officer has to sign the due diligence certificate. He is usually an

AMC employee

The due diligence certificate states that:

o Information in the OD is according to SEBI formats

o Information is verified and is a true and fair representation of facts

o All constituents of the fund are SEBI registered

SEBI does not approve or certify the contents of the OD



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Factors common all funds are called as standard risk factors. These include

market risk, no assurances of return, etc.

Factors specific to a scheme are scheme-specific risk factors in the OfferDocument.

These include restrictions on liquidity such as lock-in period, risks of investing in

the first scheme of a fund etc.

Fundamental attributes of a scheme include its basic features

For any change in the fundamental attributes, investor approval is not needed.Trustees and SEBI should approve the change.

Each investor should be informed through a communication and given the option

to exit without paying any exit load.

A scheme can not make any guarantee or return, without stating the name of the

guarantor, and disclosing the net worth of the guarantor. The past performance ofthe assured return schemes should also be given.

Information on existing schemes and financial summary of existing schemes to be

given for 3 years

Information on transaction with associate companies to be provided for past 3years

If any expense incurred is higher than what was stated in the OD, for pastschemes, explanation should be given.

There is no information on other mutual funds, their product or performance in

the OD

Investors rights are stated in the OD

The borrowing instructions on the mutual fund should be disclosed. This includes

the purposes and the limits on borrowing

Investors have the right to inspect a number of documents. These are:

o Trust deed

o Investment management agreement

o SEBI (MF) Regulations

o AMC annual reports

o Unabridged Offer Document

o Annual reports of existing schemes



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o 3 years track records of investors complaints and redressal should be

disclosed in OD

Any pending cases or penalties against sponsors or AMC should be disclosed inthe OD

The offer document contains detailed information, while the KIM is a summary

form of the OD

If any information is crucial to the investor, it will be found in both KIM and OD.

For example, the details of guarantee if the scheme is an assured return scheme.

The name and addresses of the Trustees and AMC directors will be found in the

KIM, but the details of their role, responsibilities and duties will not be found in

the KIM, but only in the OD

The OD and KIM are documents of a mutual fund and there will be noinformation about other mutual funds in an OD. There will be no comparisons are

data on performance of other mutual funds.

The OD and KIM will not contain names of securities in which the mutual fund

plans to invest. Only broad allocation will be given.



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Chapter 5. Fund Distribution and Channel Management Practices

Learning Objective

This unit seeks to give you an understanding of the distribution channels through which

mutual fund schemes reach the investors, and how these channels are managed.

The changing competitive context has led to the emergence of institutional channels of

distribution, to supplement the individuals who distribute mutual funds. Institutionalchannels build their reach through employees, agents and sub-brokers.

AMCs keep exploring newer channels of distribution to increase the size of assetsmanaged.

The internet has increased the expectations of advice that investors have from their

distributors.

The stock exchange brokers have become a new channel for distribution of mutual funds.

These brokers too need to pass the prescribed test, get the AMFI Registration No. and getthem empanelled with AMCs whose schemes they want to distribute.

The scheme application forms carry a suitable disclosure to the effect that the upfrontcommission to distributors will be paid by the investor directly to the distributor, based

on his assessment of various factors including the service rendered by the distributor.

AMCs pay a trail commission for the period the investment is held in the scheme.

Since trail commission is calculated as a percentage on AUM, distributors get the benefitof valuation gains in the market.

Investor, such as a trust or a company can invest in a fund, depends on the list of

eligible investors in the OD

Any investor, who becomes a foreign citizen after investing in a fund, has to becompulsorily redeeming the units after obtaining foreign citizenship.

Therefore any Indians seeking foreign citizenship should redeem their units.

FIIs can invest in mutual funds. They invest through the Non-resident rupee

account called NRE account.

Investors have the right to receive redemption proceeds within 10 days.

Investors cannot sue the Trust as they are the Trust and cant sue themselves



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An open ended fund opens for sale and repurchase within 30 days from the date

of closure of the IPO/NFO

With the approval of 75% investors of the unit capital, the AMCs services can beterminated, or the scheme can be wound up.

If a fund does not redress their complaint investors can go to SEBI

Who can invest in Mutual Fund in India

Residents of Indian including,

o Resident Indian Individual/HUF

o Indian companies/Partnership Firms

o Indian Trusts/Charitable Institutions

o Banks/Finance Institutions

o Non-Banking Finance Companies (NBFC)o Insurance Companies

o Provident Funds

Non Resident Including

o Non-Resident Indian, & persons of Indian origin

o Overseas Corporate Bodies (OCBs)

Foreign entities like FIIs (Foreign Institutional Investors) Registered with SEBI

(Foreign Citizens/entities are not allowed to invest in MF in India)

Individual Agents & Distributors (National Distributors)

An individual agent (advisor) is the broker between fund and the investor.

Instead of having to deal with several individual distributors, a fund can interact

with Distribution Company that has several employees or sub broker under it.

These sub brokers are the agents of main distributors and these sub brokers will

not at all having any relation with AMC.

All persons engaging in MF sales have to pass AMFI certification test. Evenemployees of distributors, bank etc has to clear AMFI exam.

It is mandatory to get ARN (AMFI Registration Number) from AMFI after

passing the AMFI exam.

Agents can sell products of multiple mutual funds.



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Agents are appointed after they clear the AMFI exam and sign an agreement with

the AMC on non-judicial stamp paper.

Commission Rates for MF Distributors

Commission payable to distributor is not fixed. It varies from AMC to AMC andScheme to Scheme.

Upfront commission for open ended scheme may vary from 1.5% to 2.5%

whereas for ELSS scheme it varies from 2% to 3.5%

Apart from upfront commission, agent also entitled to get Trail commission whichvaries from 0.4% to 0.6% paid on quarterly basis.

As per SEBI rules, Distributor (MF Advisor) get commission on investments

made through them but they are not entitled to get commission in their own

investment.

SEBI Advertising Code

The dividends declared or paid shall be mentioned in rupees per unit along with

the face value of each unit of that scheme

Only compounded annualized yield can be advertised if the scheme has been in

existence for more than 1 year.

Annualized yield when used must be shown for lat 1 year, 3 years, 5 years ad

since launch of the scheme

For funds in existence for less than 1 year, performance may be advertised in

terms of total returns and such returns should not be annualized.

Performance should compare with appropriate benchmarks only.

Advertisements showing yields should display a sentence that Past performance

may or may not sustained in future



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Chapter 6. Accounting, Valuation & Taxation

Learning Objectives

Your learning of mutual funds is incomplete, if you do not know a few aspects of

accounting of mutual fund schemes, valuation of securities in the schemes portfolio,calculation of net asset value, and the impact of taxation on various types of mutual fundschemes and investors in these schemes.

The unit-holders funds in the scheme is commonly referred to as net assets.

Net asset includes the amounts originally invested, the profits booked in the scheme, as

well as appreciation in the investment portfolio. It goes up when the market goes up, evenif the investments have not been sold.

A scheme cannot show better profits by delaying payments. While calculating profits, all

the expenses that relate to a period need to be considered, irrespective of whether or notthe expense has been paid. In accounting jargon, this is called accrual principle.

Similarly, any income that relates to the period will boost profits, irrespective of whetheror not it has been actually received in the bank account. This again is in line with the

accrual principle.

In the market, when people talk of NAV, they refer to the value of each unit of the

scheme. Higher the interest, dividend and capital gains earned by the scheme, higher

would be the NAV. Higher the appreciation in the investment portfolio, higher would be

the NAV. Lower the expenses, higher would be the NAV.

The difference between the NAV and Re-purchase Price is called the exit load.

Schemes can also calibrate the load when investors offer their units for re-purchase.

Investors would be incentivized to hold their units longer, by reducing the load as the unit

holding period increased. Such structures of load are called Contingent Deferred SalesCharge (CDSC)

SEBI has banned entry loads. So, the Sale Price needs to be the same as NAV. Exitloads / CDSC in excess of 1% of the redemption proceeds have to be credited back to the

scheme immediately i.e. they are not available for the AMC to bear selling expenses. Exit

load structure needs to be the same for all unit holders representing a portfolio.

Initial issue expenses need to be met by the AMC. There are limits to the recurring

expenses that can be charged to the scheme. These are linked to the nature of the scheme

and its net assets.

Dividends can be paid out of distributable reserves. SEBI has prescribed a conservative

approach to its calculation.



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NAV is to be calculated upto 4 decimal places in the case of index funds, liquid funds

and other debt funds. NAV for equity and balanced funds is to be calculated upto at least2 decimal places.

Investors can hold their units even in a fraction of 1 unit. However, current stockexchange trading systems may restrict transacting on the exchange to whole units.

Detailed norms on valuation of debt and equity securities determine the valuation of theportfolio, and therefore the NAV of every scheme.

Mutual funds are exempt from tax. However, Securities Transaction Tax (STT) is

applicable on investments in equity and equity mutual fund schemes. Additional tax onincome distributed (Dividend distribution tax) is applicable on dividends paid by debt

mutual fund schemes.

Taxability of capital gains, and treatment of capital losses is different between equity anddebt schemes, and also between short term and long term. Upto 1 year investment

holding is treated as short term.

There is no Tax Deducted at Source (TDS) on dividend payments or re-purchase

payments to resident investors. Withholding tax is applicable for some non-resident

investors.

Setting of capital losses against capital gains and other income is subject to limitations to

prevent tax avoidance.

Investment in mutual fund units is exempt from Wealth Tax.

Net Asset Value (NAV):

NAV = Net assets of the scheme / No. of units outstanding

= [(market value of investments + Receivables + Other Accrued Income + Other Assets

Accrued Expenses Other payables Other Liabilities)] / No. of units outstanding on

valuation date

The maximum limit on the expense that can be charged to an equity mutual fundsare:

o For net assets up to Rs.100 Crore:-2.5%

o For the next Rs.300 Crore of net assets:-2.25%

o For the next Rs.300 Crore of net assets:-2%

o For the remaining net assets:-1.75%

o These limits are lower by 0.25% for debt funds



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These regulatory ceilings are applied on the weekly average net assets of the

mutual fund scheme.

The investment management fees are regulated by SEBI as follows:

o

For the first Rs.100 crore of net assets:-1.25%o For net assets exceeding Rs.100 crore:-1.00%

Valuation of equity shares is done on basis of traded price; provided that price is

not more than 30 days old.

Illiquid securities can not be more than 15% of the portfolios net assets. Anyilliquid assets above this limit have to be valued at zero.

Thinly Traded Equity / Equity Related Securities: Equity / equity related

instruments are thinly traded if:

o Monthly trading value is less than Rs. 5 lacs and value less than 50,000

share volume.

o When trading is suspended up to 30 days take the last traded price.

o Trading is suspended for more than 30 days AMC/Trustee to make

valuation

o Thinly Traded Debt Securities: Traded value (other than g-sec) is less than

Rs. 15 crore for a period of 30 days prior to valuation date.

o Non-Traded Securities: When not traded on any Stock Exchange for 30

days prior to valuation date.

o Non-traded/thinly traded securities shall be valued in good faith by

AMC

The following expenses cannot be charged to the scheme:

Penalties and fines

Interest on delayed payment to unit holders

Expenses which is not related with schemes Expenses on investment management

Expenses on general administration, corporate advertising and infrastructure costs

Software development cost

Other costs which are prohibited by SEBI

Tax Structure in Mutual Fund:

Mutual funds themselves pay no tax on the incomes they earn. They are fully

exempt from tax.

If an investor holds units for 12 months or less, any gain from selling the units iscalled as short-term capital gain



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Short-term capital gains are taxable at the marginal rate of taxation of the investor

If an investors holding period is more than 12 months, any gain or loss from sale

is called as long-term capital gain.

Long-term capital gain can be indexed for inflation

Indexing refers to the updating of the purchase price, based on the cost ofinflation index published by CBDT. The formula for indexation is purchase price

X (index in the year of sale/index in the year of purchase)

Investors can pay either 10% tax (plus surcharge) on the capital gain tax withoutindexation or 20% tax (plus surcharge) on capital gains after indexation, which

ever is lower.



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Chapter 7. Investor Services

Learning Objectives

Who can invest in mutual funds in India? What documentation is required? How do the

sale and re-purchase transactions really get implemented?

Individual and non-individual investors are permitted to invest in mutual funds in India.

Foreign nationals, foreign entities and OCBs are not permitted to invest. Since FIIs are

permitted to invest, foreign entities can take this route. The Who can invest section ofthe Offer Document is the best source to check on eligibility to invest.

All investments of Rs 50,000 and above need to comply with KYC documentation viz.Proof of Identity, Proof of Address, PAN Card and Photograph. Once an investor obtains

a Mutual Fund Identification Number (MIN) from CDSL Ventures Ltd, the investor can

apply with any mutual fund.

Micro SIPs i.e. SIPs with annual investment below Rs 50,000 is exempted from the PAN

Card requirement. Simplified documentation has been prescribed in such cases.

Besides KYC, non-individual investors need to provide additional documentation to

support their investment.

Demat makes it possible to trade in Units in the stock exchange.

Full application form is to be filled for a first time investment in a mutual fund.

Thereafter, additional investments in the same mutual fund are simpler. Only transaction

slip would need to be filled.

Investors can pay for their Unit purchases through cheque / DD, Net-based remittances,ECS / Standing Instructions or ASBA. MBanking is likely to increase in importance in

the days to come. Non-resident investment on repatriation basis has to be paid through

cheque on NRE account, or a bankers certificate that investment is made out of moneysremitted from abroad.

Transaction Slip can be used for re-purchase. Investors can indicate the amount to re-purchase or the number of units to repurchase.

Cut-off timings have been specified for different types of schemes and different contextsto determine the applicable NAV for sale and re-purchase transactions. These are notapplicable for NFOs and International Schemes.

Time Stamping is a mechanism to ensure that the cut-off timing is strictly followed.

NSEs platform is called NEAT MFSS. BSEs platform is BSE STAR Mutual Funds

Platform.



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Dividend payout, Dividend investment and Growth are 3 possible options within a

scheme. Each option has different implications on the investors bank account, investorstaxation and scheme NAV.

A constant amount is regularly invested in SIP, withdrawn in SWP and transferredbetween schemes in STP. These minimize the risk of timing the decisions wrongly.

Triggers are another way of bring discipline into investing.

Nomination and Pledge options are available for mutual fund investors.

Investment Pattern:

The investment pattern of the fund is primarily dictated by the fund objectives

A fund manager whose style is value investing, will prefer to invest in established

profit making companies, and will buy only if the price is right. He will look for

undervalued shares, which have value proposition that is yet to be recognized

by the market.

A fund manager, whose style is growth, is more aggressive and is willing to invest

in companies with future profit potential. He is willing to buy even if the stock

looks expensive. He focuses on sectors that are expected to do well in future, and

will be willing to buy them even at higher prices.

Equity stocks can be classified as large cap and small cap stocks

Large cap stocks are liquid and trade every day. They are established companies

offering normal profit potential.

Small cap stocks provide higher return potential. But they are generally not very

liquid.

Cyclical stocks are those whose performance is closely linked to macro

economical factors.

P/E ratio is the ratio of earnings per share (EPS) to market price per share. Growthshares sell at higher P/E ratios than value shares.

Dividend yield is the ratio between the dividend per share and market price pershare.

Growth shares have lower dividend yields than value shares.



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If market prices move up, P/E ratios are higher and dividend yields are lower.

An active fund manager hopes to do better than the market by selecting

companies, which he believes, will outperform the market.

A passive fund manager simply replicates the index, and hopes to do as well asthe index.

A passive fund manager tries to keep costs down and has to rebalance his

portfolio if the composition of the index changes.

Fundamental analysis is the analysis of the profit potential of a company, basedon the numbers relating to products, sales, costs, profits etc. and the management

of a company.

Technical analysis is an analysis of market price and volumes, to identify clues to

the market assessment of a stock.

A fund manager focuses on asset allocation; a dealer buys and sells shares; and ananalysts researches company and recommends them for buy and sell.

Investment Plans:

Automatic Reinvestment Plan (ARP): Reinvestment plan reinvest the amount of

dividends in the same scheme instead of receiving cash.

Systematic Investment Plan (SIP): It requires the investor to invest a fixed

amount periodically and hence save investing amount in a disciplined manner.Rupee Cost Averaging is one of the most important benefits of SIP.

Systematic Withdrawal Plans (SWP): It allows investor to withdraw some

amount either fixed or variable amount from scheme.

Systematic Transfer Plan (STP): It allows the investor to transfer on a periodic

basis a specified amount from one scheme to another with the same fund family.

Debt Instruments:

Debt instruments are issued by government, banks and companies

They can pay interest on fixed rates, floating rates or on discounted basis

If no interest is paid, such an instrument is zero coupon instruments

Debt markets are wholesale markets in which large institutional investors operate



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Banks are the largest players in the debt markets

About 96% of secondary market trading happens in government securities

Principle values, par value, or face value is the amount representing the principle

borrowed and the rate of interest is calculated on this sum. On redemption thisamount is payable.

Coupon is the interest paid periodically to the investor.

Maturity date is the date on which a bond is redeemed. Term to maturity or tenor

is the period remaining for the bond to mature.

Put option refers to the option to the investor to redeem the bond before maturity

Call option is the option to the borrower to redeem before maturity

If interest rates go up, above the coupon rate, investors may exercise the put

option. If interest rates fall below the coupon rate, issuers may exercise the call

option.

Current yield is the ration of coupon amount to market price of a bond. If a bond,paying coupon at 8% is selling in the market for Rs.105, the current yield is

8/105=7.62%

Changes in interest rates impacts bond values, in the opposite direction. An

increase in interest rates leads to a fall in bond values; a decrease in interest rates

leads to an increase in bond values.

Duration of a bond helps measure the interest rate risk of a bond. It is weighted

average maturity of a bond.

Credit risk refers to the risk of default

The base rate or benchmark rate in the bond market is the rate at which thegovernment borrows in the market. All other borrowers pay a rate that is higher,

due to the presence of credit risk.

The difference between the benchmark rate and the rate that is paid by otherborrowers is called the credit spread. (Called as yield spread in the AMFI book).

Investment by Mutual Fund:

Mutual funds can invest in only marketable securities



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A mutual fund, under all its schemes, cannot hold more than 10% of the paid-up

capital of a company.

Except in the case of Sectoral funds and index funds, a mutual fund schemecannot invest more than 10% of its NAV in a single company.

Investments in rated investment grade issues of a single issuer cannot exceed 15%

of the net assets and can be extended to 20% with the approval of the trustees

Investment in unrated securities can not exceed 10% of the net assets for one issue

and 25% of net assets for all such issues

Investment in unlisted shares cannot exceed 5% of net assets of an open-ended

scheme, and 10% of net assets for a closed end scheme

Inter scheme transfers are allowed by the SEBI regulations, provided,

Such transfers happens on a delivery basis, at market prices

Such transfers do not result in significantly altering the investment objectives ofthe schemes involved.

Such transfer is not of illiquid securities, as defined in the valuation norms

A mutual fund can borrow a sum not exceeding 20% of its net assets, for a period

not exceeding 6 months. This facility is clearly designed as a stopgap

arrangement, and is not a permanent source of funds for the scheme.

A fund can borrow only to meet liquidity requirements for paying dividend or

meeting redemptions

All investment made in the marketable securities of the sponsor and its associated

companies must be disclosed by the mutual fund in its annualized report and offerdocument.

A mutual fund scheme cannot invest in unlisted securities of the sponsor or an

associate or group company of the sponsor.

A mutual fund scheme cannot invest in privately placed securities of the sponsoror its associates.

Investment by a scheme in listed securities of the sponsor or associate companies

or group companies of sponsor cannot exceed 25% of the net assets of the scheme

Mutual funds were allowed to make use of Future & Options contracts in Equities

for Portfolio risk management Portfolio Rebalancing



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Since September 2005 SEBI has also allowed mutual fund to trade in Derivatives

contracts to enhance portfolio returns, to launch schemes which invest mainly in

Future & Options

Equity Derivatives:

Equity derivatives instruments are specially designed contracts

They derive their value from an underlying asset

They are traded separately in F&O segment of Exchange

Mainly derivative instruments are Future and Options

In a future contract you can buy and sell the underlying equity at a specified

future date at agreed price. Contract is liquidated before maturity date without

taking or giving delivery of underlying asset.

In option contract the buy gets the right to buy or sell the underlying equity at

agreed price on a future date only if he exercises the options & for this right hepays a price called Premium.

Option contracts are of two types:

If Fund manager expects the equity market to decline: he may not sell the equity

in the Cash Market.

But can sell the index Future at the current price for future delivery. If marketsfall the equity portfolio value will decline, but future contract will show a

corresponding profit, since fund manager has sold future contract at a higher

price.

If market rises equity portfolio value will rise but future contract will showcorresponding loss, since fund manager has sold future contract at lower price.

This is called Hedging Portfolio risk.

Other method of hedging investment portfolio risk by buying a Put Option (an

option to sell the underlying equity at an agreed price) by paying premium

A fund manager can execute the option only if the price falls, since he has right tosell at a higher price

If the price rises he will not execute the option and forgo the premium.



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Chapter 8. Return, Risk & Performance of Funds

Learning Objectives

This unit is an invaluable guide to understanding the risk and return aspects of mutual

fund schemes. Here, you will understand the nitty-gritty of how to calculate the returnsfrom a mutual fund, and gain an overview of how risk can be measured. Benchmarkingand risk adjusted returns are other key concepts discussed in this unit.

The portfolio is the main driver of returns in a mutual fund scheme. The underlyingfactors are different for each asset class.

Fundamental Analysis and Technical Analysis are two disciplines of securities analysis.Fundamental Analysis entails review of the companys fundamentals viz. financial

statements, quality of management, competitive position in its product / service market

etc. Technical analysts study price-volume charts of the companys share prices.

It is generally agreed that longer term investment decisions are best taken through a

fundamental analysis approach, while technical analysis comes in handy for shorter term

speculative decisions, including intra-day trading. Even where a fundamental analysis-based decision has been taken on a stock, technical analysis might help decide when to

implement the decision i.e. the timing.

Growth investment style entails investing in high growth stocks. Value investment style

is an approach of picking up stocks which are valued lower, based on fundamental

analysis.

In a top-down approach, sector allocation is the key decision. Stock selection is importantin bottom-up approach.

The returns in a debt portfolio are largely driven by interest rates and yield spreads.

If the portfolio manager expects interest rates to rise, then the portfolio is switchedtowards a higher proportion of floating rate instruments; or fixed rate instruments of

shorter tenor. On the other hand, if the expectation is that interest rates would fall, then

the manager increases the exposure to longer term fixed rate debt securities.

This additional return offered by a non-government issuer, above the yield that the

government offers, is called yield spread. Better the credit quality, lower the yield spread.

Gold is a truly international asset, whose quality can be objectively measured. The value

of gold in India depends on the international price of gold (which is quoted in foreign

currency), the exchange rate for converting the currency into Indian rupees, and anyduties on the import of gold.

Unlike gold, which is a global asset, real estate is a local asset. It cannot be transported



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and its value is driven by local factors.

Returns can be measured in various ways Simple Returns, Annualised Returns,Compounded Returns, Compounded Annual Growth Rate. CAGR assumes that all

dividend payouts are reinvested in the scheme at the ex-dividend NAV.

SEBI guidelines govern disclosures of return by mutual fund schemes.

Loads and taxes pull the investors returns below that earned by the Scheme. Investorreturns are also influenced by various actions of the investor himself.

Risks in mutual fund schemes would depend on the nature of portfolio, its liquidity,

outside liabilities and composition of unit holders.

Fluctuation in returns is a measure of risk. Variance and Standard Deviation are risk

measures for all kinds of schemes; beta is relevant for equity; modified duration and

weighted average maturity are applicable for debt schemes.

Benchmarking is a form of relative returns comparison. It helps in assessing under-performance or out-performance.

Choice of benchmark depends on scheme type, choice of investment universe, choice of

portfolio concentration and the underlying exposure.

Sharpe Ratio, Treynor Ratio and Alpha are bases to evaluate a fund managers

performance based on risk-adjusted returns.

Quantitative measures are based on historical performance, which may or may not be

replicated in future. Scheme evaluation is an art, not a science.

Classification of Equity Shares:

Classification in terms of Market capitalization: Large-Cap, Mid-Cap & Small-

Cap Capitalization companies.

Classification in terms of Earnings: Earnings of the companies are generallyclassified on the basis of their market price in relation to one of the following

measures:

Price/Earning Share:

It is the price of a share divided by the earnings per share, and indicates what the

investors are willing to pay for the companys earning potential.



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Young and/or fast growing companies usually have high P/E ratios. Established

companies may have lower P/E

Dividend Yield:

DY of the stock is the ratio of dividend paid per share to current market price.

Low P/E stocks usually have high dividend yields.

Cyclical Stocks:

These are shares of companies whose earnings are correlated with this state of the

economy.

Growth Stocks:

These are shares of companies whose earnings are expected to increase at abovenormal market level.

They reinvest the profit.

Value Stock:

These are stocks of companies in mature industries and are expected to yield low

growth in earnings.

Portfolio Management:

Portfolio Management has two styles: 1. Passive 2. Active

Passive Fund Management: There are mutual funds that offer stock index funds

whose objectives is to track a specified share index and offer returns equal to the

return from that index. The investment style is passive only in the sense that thefund manager does not have to go through the process of stock selection.

Active Fund Management: There are two basic investment styles in active fund

management: Growth Investment Style: Invest only in growth stocks which give

above average earnings growth. Value Investment Style: Invest in companies that

are currently undervalued in the market, but whose worth they estimate will berecognized in the market valuations.

Securities Research in Active Fund Management: Following are the three

major categories are in Securities Research.

Fundamental Analysis: It involves research into the operations and finances of a

company.



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Technical Analysis: It involves the study of historical data on the companys

share-price movements and trading volume.

Quantitative Analysis: It uses mathematical models for equity valuation and mayuse fundamental and technical information. Now a days computer based models

(exclusively made sophisticated high level software) are uses for such analysis.

Portfolio Management Organization Structure: Three types of skilled

employees in the equity portfolio management function:

Fund Managers: They take overall decisions on asset allocations industryexposures.

Security Analysts & Researchers: They support the fund managers with

continuous tracking of the funds target sectors, companies and the overall

markets. Both fundamental and technical analyses are performed by the analysts.

Security Dealers: Executes the actual buy and sell orders originated by the fund

managers.

Debt Instruments: Following are the debt instruments available in the market

Certificate of Deposit (CD): CD is issued scheduled commercial banks. Its

having maturity period of 91 days to one year.

Commercial Paper: This is a short term, unsecured instrument issued by

corporate bodies to meet short term working capital requirements. These

instruments can be issued to individual, banks, companies etc.

Corporate Debentures: These are issued by manufacturing companies withphysical asset as secured instruments in the form of certificates. They are assigned

a credit rating by rating credit agencies.

Floating Rate Bonds: These are short to medium term interest-bearing

instruments issued by financial intermediaries and corporations. Maturity of thesebonds is 3 to 5 years.

Treasury Bills: Treasury bills are also called as T-Bills. These are short term

obligations issued through the RBI by the government of India at a discount for91 days to 364 days. Theses are issued through an auction procedure. The yield isdetermined on the basis of bids tendered and accepted.

Bank/FI Bonds: These are negotiable certificates issued by FI such as the

IDBI/ICICI etc. Theses have been issued both as regular income bonds and as

discounted long term instruments (deep discount bonds)



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Public Sector Undertakings (PSU) Bonds: These are medium and long term

obligations by public sector companies in which the government share holding is

generally greater than 51%. Some PSU bonds carry tax exemptions havingminimum maturity of 5 years for taxable bonds and 7 years for tax free bonds.

SEBI guidelines in different investments:

A mutual fund is not allowed to own more than 10% of any companys equities.

This is to prevent MF fund sponsors trying to acquire control pf any company

through fund investment route.

A scheme may invest in another scheme under the same AMC without charging

any fees, provided investments limits of 5% of the NAV of Mutual Fund.

This limit does not apply to a fund of fund scheme.

Debt securities should be rated as investment grade by at least one recognized

rating agency.

Mutual funds are allowed to buy and sell only delivery based securities. Mutual

funds are not allowed to advance any loans but may lend securities as per SEBI

stock lending regulations.

Mutual funds are restricted to invest not more than 25% of the net assets of any ofmf schemes to the companies of sponsor.

A fund of funds invests in schemes of other mutual funds. But a normal mutualfund scheme cannot invest in any FOF scheme. Also, a FOF scheme cannot invest

in another FOF scheme.



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Chapter 9. Scheme Selection

Learning Points

This unit will help you do this. It also informs you about the sources where you can easily

access data related to mutual fund schemes.

Asset allocation is the approach of spreading ones investments between multiple asset

classes to diversify the underlying risk.

The sequence of decision making in selecting a scheme is: Step 1 Deciding on the

scheme category (based on asset allocation); Step 2 Selecting a scheme within the

category; Step 3 Selecting the right option within the scheme.

While investing in equity funds, a principle to internalize is that markets are more

predictable in the long term, than in the short term. So, it is better to consider equity

funds, when the investment horizon is adequately long.

In an actively managed diversified fund, the fund manager performs the role of ensuring

higher exposure to the better performing sectors or stocks. An investor, investing ortaking money out of a sector fund has effectively taken up the role of making the sector

choices.

It can be risky to invest in mid-cap / small cap funds during periods of economic turmoil.

As the economy recovers, and investors start investing in the market, the valuations in

front-line stocks turn expensive. At this stage, the mid-cap / small cap funds offer

attractive investment opportunities. Over longer periods, some of the mid/small cap

companies have the potential to become large cap companies thus rewarding investors.

Arbitrage funds are not meant for equity risk exposure, but to lock into a better risk-return relationship than liquid funds and ride on the tax benefits that equity schemes

offer.

The comparable for a liquid scheme in the case of retail investors is a savings bank

account. Switching some of the savings bank deposits into liquid schemes can improve

the returns for him. Businesses, which in any case do not earn a return on their currentaccount, can transfer some of the surpluses to liquid schemes.

Balanced schemes offer the benefit of diversity of asset classes within the scheme. Asingle investment gives exposure to both debt and equity.

Investors need to understand the structure of the gold schemes more closely, before

investing.

Equity investors would like to convince themselves that the sectors and companies where

the scheme has taken higher exposure, are sectors / companies that are indeed promising.



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Debt investors would ensure that the weighted average maturity of the portfolio is in line

with their view on interest rates.

Investors in non-gilt debt schemes will keep an eye on credit quality of the portfolio

and watch out for sector concentration in the portfolio, even if the securities have a highcredit rating.

Any cost is a drag on investors returns. Investors need to be particularly careful aboutthe cost structure of debt schemes.

Amongst index schemes, tracking error is a basis to select the better scheme. Lower the

tracking error, the better it is. Similarly,

Gold ETFs need to be selected based on how well they track gold prices.

Mutual fund research agencies assign a rank to the performance of each scheme within ascheme category (ranking). Some of these analyses cluster the schemes within a category

into groups, based on well-defined performance traits (rating).

Seeking to be invested in the best fund in every category in every quarter is neither an

ideal objective, nor a feasible target proposition. Indeed, the costs associated with

switching between schemes are likely to severely impact the investors returns.

The underlying returns in a scheme, arising out of its portfolio and cost economics, is

what is available for investors in its various options viz. Dividend payout, dividend re-investment and growth options.

Dividend payout option has the benefit of money flow to the investor; growth option hasthe benefit of letting the money grow in the fund on gross basis (i.e. without annual

taxation). Dividend reinvestment option neither gives the cash flows nor allows the

money to grow in the fund on gross basis. Taxation and liquidity needs are a factor indeciding between the options. The advisor needs to understand the investors situation

before advising.

Many AMCs, distribution houses and mutual fund research houses offer free tools in theirwebsite to help understand performance of schemes.

Investors generally compute Return on Investment (ROI). Change in NAV is a

very easy approach to find out the ROI. The following are the importantcharacteristics:

The Expense Ratio:

It is the ratio of total expenses to average net assets of the fund.



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It indicates the funds efficiency and cost effectiveness.

It is important to note that brokerage commissions on the funds transactions are

not included in the fund expenses figure while computing this ratio.

The expense ratio is most important in case of bond funds or debt funds, sincesuch funds performance can be adversely affected if a large proportion of its

income is spent on expenses.

The Income Ratio:

It is the net investment income divided by its net assets for the period. Forevaluating income oriented fund, particularly debt funds.

Portfolio Turnover Rate:

It is defined as the lesser of assets purchased or sold divided by the funds netassets.

Portfolio turnover rate measures the amount of buying and selling of securitiesdone by a fund. And hence net return can be lower with high transactions costs.

Transaction Costs:

It includes all expenses related to trading such as the brokerage commissions paid,

stamp duty on transfers, registration fees and custodians fees.

Brokerage commission is an important component of transaction costs.Transaction costs therefore have a significant bearing on fund performance and its

total return.

Funds with small size or small returns have to be judged more on their expense

ratios and transactions costs, given their impact on total return.

Fund Size:

Fund size can affect performance.

Small funds are easier to manage and can achieve their objectives in a focusedmanner with limited holdings.

Large funds benefit from economies of scale with lower expense ratios and

superior fund management skills.

They also gain through greater risk bearing and management capacity.



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