AMFI Mutual Fund (Advisor) ModulePreparatory Training Program

Welcome Delegates

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Exam logistics AMFI Mutual Fund (Advisor) Module 2-hour examination – manual as well as online 72-74 MCQs

48Q 1 mark each and 26Q 2 marks each indicated with the question

Max marks 100 Passing marks 50% Negative Marking 25% of the question score Each candidate has a different question paper Each chapter has a weightage which is not disclosed One needs to be thorough with the entire syllabus The language is the tricky part The exam emphasis is on conceptual clarity.

Section 1Nuts and Bolts

1. Concept & Role of Mutual Funds2. Fund Structure and Constituents3. Legal & Regulatory Framework

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Concept of Mutual Fund A pool of money contributed by many investors

and collectively managed by an asset management company

Investments made in accordance with stated objectives

A financial intermediary that allows small investors to participate in the securities market

Ownership of the fund is mutual and beneficial An investor becomes part owner of the fund’s

assets when he buys into the fund The investor is allotted units for the amount

subscribed.

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What it means

Investors

Markets(volatile, has fluctuation)

Trust (pool of money)

Contribute money

Invest in markets

Receive dividend/capital

appreciation

Receive interest,

dividend or capital growth

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The MF Cycle

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Characteristics Investors own the mutual fund Everyone else associated with the

fund earns a fee Things which are mutual

Pool of money Investment objective Risk and return

Funds are invested in a portfolio of marketable securities reflecting the investment objective

Value of the portfolio and investors’ holdings change with change in the market value of investments.

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Advantages

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Disadvantages No Control Over

Costs No Tailor Made

Portfolios Managing a large

number of funds/types.

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History of Mutual Funds

Birthplace of Mutual Funds – USA History in India:

1964-1987 (Phase I) – Growth of Unit Trust of India 1987-1993 (Phase II) – Entry of Public Sector Funds 1993-1996 (Phase III) – Emergence of Private Funds 1996-1999 (Phase IV) – Growth and SEBI Regulation 1999-2004 (Phase V) – Emergence of large & uniform

Industry 2004 onwards (Phase VI) – Consolidation and Growth.

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Types of FundsExisting funds Open-ended (OEF) &

Close-ended (CEF) Growth, Income and

Hybrid Equity, Debt and Balance Load & No-Load Guaranteed & Non-

Guaranteed Tax-exempt & Non tax-

exempt

New Gen Mutual Funds Fund of Fund Commodity fund Real Estate fund Asset Allocation fund Exchange-traded fund Derivative fund Capital Protection

Oriented Fund.

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OEF & CEFOEF No fixed tenor Continuous sale & purchase

by the fund Subscription is not mandatory Redemption mandatory, with

certain obvious conditions Fund size changes everyday No secondary market trading Redemption pressure on fund

managers is higher Daily NAV (calc & disclosure)

CEF Fixed tenor – 1/3/5/7 years Sale of units only during NFO No subscription after closure of

NFO Redemption in 2 ways

Exit window – periodically repurchase of units by the fund

Listing – secondary market trading of units, like stocks

Fund size either constant or decreases

Lower redemption pressure on fund managers

Weekly NAV (calc weekly but disclosure daily).

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Equity-oriented Diversified Sectoral Thematic or Specialty

ASEAN fund, Infrastructure Fund Growth & Value Large, Mid & Small Cap Dividend Yield or Equity Income Index ELSS

Primary objective: growth or capital appreciation.

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Debt Oriented Diversified Debt Focussed/Sectoral Debt Gilt Fund Bond Fund Fixed Maturity/Term Plan (FMP/FTP) Liquid or Money Market MF

Primary objective: regular income.

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Balance Investment in more than one asset class

Debt and equity in various proportions

Primary objective: hybrid (regular income as well as capital appreciation).

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Fund of Funds Invest in other schemes of same or other

mutual fund Is considered like a Debt scheme for tax

purposes 2 advantages:

Since FOF is a mutual fund scheme, no tax on income generated from buying and selling securities

Allows fund managers to rebalance portfolio freely

Investor need not to decide when to sell units and execute transactions

Convenience to the investor.

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Commodity Fund specialize in investing in different

commodities directly or through shares of commodity companies or through commodity futures contracts. Example - Precious Metals Funds

As of date, Indian MF industry does not have commodity funds except the ones that invest in Gold.

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Real Estate Fund Invest in real estate directly, or fund real estate

developers, or buy shares of housing finance companies

Fund to invest min 30 % corpus in real estate projects Balance in equity, bonds/debentures of real estate

cos. Close-ended schemes with secondary market trading Move to bring transparency, documentation and fair

valuation of property Allow small investors with small investments to enjoy

upswing of property without downside of high stamp duty, legal expenses, high initial investment, element of black money and disposal at the right prices.

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Asset Allocation Fund Fund manager has the flexibility to change

the allocation of funds between equity and debt based on perception about direction of the market.

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Exchange-traded fund Passively managed fund that tracks a

benchmark index An ETF is like a hybrid financial instrument, a

cross between an index fund and a stock An equity-based ETF would invest in a basket of

stocks that reflects the composition of an index, say Nifty or Sensex

These funds are freely traded on the stock exchange and derive value from the underlying asset, i.e., stocks.

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Gold ETF Gold ETFs invest in physical gold and derive

their value from the underlying asset The price of gold ETFs will be directly linked to the

price of gold itself and hence the returns from a gold ETF will more or less equal to returns from gold bars or coins

Investors can buy or sell units of these schemes, like any other stock listed on the exchange, through brokers.

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Derivative fund Hedging

Futures Options

Arbitraging Stock Arbitrage Index Arbitrage.

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Capital Protection Oriented fund Close-ended with no exit option Debt scheme from a tax standpoint No guarantee by the AMC or sponsor Capital protection on account of the structure

Eg. Debt component of 80 in zero coupon bonds which give 100 on maturity and investment of the balance 20 in equity

With tools such as dynamic portfolio insurance, increase equity component by a multiplier

Rating of the scheme mandatory.

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Classification of funds Risk

Sectoral funds have higher risk

Liquid or Money Market funds have least risk

Tenor Equity funds require a long investment horizon

Liquid funds are for the short term liquidity needs

Investment objective Equity funds suit growth objective

Debt funds suit income objective.

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Risk-Return Hierarchy

Liquid funds

ST debt funds

Gilt funds

Debt Funds

Balanced funds

Risk

Index funds

Return

Equity funds

Sectoral funds

Mutual Fund Structure & Constituents

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MF Structure in IndiaA mutual fund has a 3-tier structure

Sponsor

Trustee

AMC

Trust

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MF Structure in other countriesStructure in USA Management Company – Similar to AMC Underwriter – for Sales Management Group – Similar to Sponsor Custodian

Structure in UK Open Ended - Unit Trusts – regulated by Securities

and Investment Board + by relevant SRO Closed Ended - Investment Trusts – like a

Company.

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MF Constituents in India

Sponsor

Trustee

AMC

Trust

Distributor

SEBI

R&T Agent

Securities Dealer / Broker

BankerCustodian & Depository

Securities Markets

Investor

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Trust Mutual funds in India constituted as a Public

Trust under Indian Trust Act, 1882 The trust is registered with the Office of Public

Trustee OPT reports to the Charity Commissioner The trust or the fund has no independent legal

capacity itself Acts in relation to the trusts are taken on its

behalf by the trustees Treated as a separate entity and a pass through

vehicle Has its own auditors, separate from the AMC.

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Sponsor Promoter of the mutual fund

Creates a Trust under Indian Trusts Act, 1882 and registers it with Office of Public Trustee

Appoints Board of trustees/trustee company

Creates AMC under Indian Companies Act, 1956

Fulfills necessary formalities and applies to SEBI for registration of the Trust as a Mutual Fund.

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Sponsor Criteria Min 5 years track record in financial services Bank, corporate or an FI Profit making in at least 3 out of past 5

years, including the previous year Positive Net Worth in last 5 years At least 40% of the capital of the AMC Net worth in the immediately preceding year

more than the capital contribution to the AMC.

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Trustee Appointed by sponsor with SEBI approval

Have Registered ownership of investments

Formed either as Board of Trustees or Trustee Company

Power to appoints all other constituents

Appoint AMC through the ‘Investment Management Agreement’ and delegate powers.

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Trustee Criteria Minimum number of trustees is 4

2/3rd should be independent trustees i.e. no connection of profit (what so ever) with the sponsor

Meet at least 4 times in a year to review functioning of AMC

Trustees hold the unit-holders money in fiduciary capacity

All major decisions need trustee approval

Right to seek regular information and take remedial action.

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AMC Required to be registered with SEBI

Appointed as Investment Manager of the mutual fund

Appointed by the trustees via an Investment Management

Agreement

Responsible for operational aspects of the mutual fund

Net Worth of at least Rs.10 crore at all times

At least 1/2 of the board members must be independent

Mostly, structured as a private limited company where

Sponsor and associates hold capital

Quarterly reporting to Trustees.

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Other Constituents

Custodian & Depository

Banker

Securities Dealer / Broker

R&T Agent

Distributor

Investment back-office

Purchase and sale of securities Not more than 5% through a related broker Research report to AMC

Investor records and transactions

Selling & Distributing schemes

Providing bank accounts & remittance services

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Role Restrictions Sponsor of a fund cannot be its custodian

Sponsor of a fund can be a distributor

Trustee of one mutual fund cannot be trustee of another mutual fund Exception is Independent trustees provided they

obtain approval of both the board of trustees

Trustee of one fund cannot be AMC of another

AMC of one fund cannot be Trustee of another

AMC cannot have any business interest other than fund advisory.

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Mergers & Takeovers Scheme Merger

Scheme merged with another scheme of the same AMC

AMC Takeover AMC is taken over by another set of sponsors

AMC Merger One AMC may merge with another AMC

Change of AMC/Trust Trustees decide to change the AMC and handover the

scheme to a new AMC Scheme Takeover

Just the schemes taken over by another set of trustees.

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Mergers & Takeovers Scheme takeover (HDFC–Zurich, Birla-Apple)

One AMC buys schemes of another AMC Organic growth in assets No change in AMC stakes

AMC merger (HB-Taurus) Two AMCs merge Similar to merger of companies Sponsor stakes change

AMC take-over (Zurich-ITC Threadneedle, Birla-Alliance)

Stake of one sponsor in a AMC bought out by another

Change in AMC and sponsor.

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Mergers & Takeovers

Investor rightsRight to be informed

No prior approval required

Option to exit at NAV without exit load.

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Regulatory framework

MoF

SAT

Supervisor of both SEBI & RBI

Created in 2003

Provide apex appeal mechanism

for actions taken by SEBI

Registration of AMC and Trustee CompanyRoC for Compliance RoC is supervised by DCADCA is a part of CLB which is under Ministry of Law and JusticeCLB is the interface for prosecution and penalties.

Companies Act

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Regulatory framework

Office of Public Trustee

SRO

Industry Association

Collective industry opinion Guidelines & recommendations Example: Association of Mutual Funds in India (AMFI).

Registration of Trust Board of Trustees is accountable to the OPT Complaints against individual trustees

Derive powers from regulatorAbility to make bye-laws Regulate own members in a limited wayExample : Stock exchanges – NSE, BSE etc.

Session 2The Process of Investing

4. The Offer Document5. Fund Distribution and Sales Practices7. Investor Services

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The process of investing Offer Document KIM Application and form of holding Distribution channels Investors rights & obligations.

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Offer Document

Most important document for a prospective investorLegal offer from AMC to investor

Contains vital information about fund and schemes

SEBI approved format.

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Offer Document

Contents Constitution of fund

Details of Sponsor, Trustee & AMC & key personnel – financial history for 3 years

Description of Scheme & Investment Objective/Strategy

Terms of Issue/Offer

Historical Statistics

Investor’s Rights and Services

Mandatory Disclaimer clause

Standard and Scheme-specific Risk Factors.

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Details of Scheme offered Dates of NFO

details regarding sale and repurchase Minimum Subscription and Face Value Initial Issue Expenses

current and past schemes Special facilities to investors Eligibility for investing

documentation Procedure for applying, and subsequent

operations relating to transfer, redemption, nomination, pledge and mode of holding of units.

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Load, Fee and Expenses Load and the annual recurring expenses

Proposed scheme and other schemes Comparison with offer document

numbers Scheme expenses for past 3 years Condensed financial information for 3 years.

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Unit holder rights Rights of unit holders

Right of proportionate beneficial ownership of scheme’s assets Right to timely service Right to information Right to approve changes in fundamental attributes Right to wind up a scheme Right to terminate AMC services Protection of rights and problem resolution

Details of information disclosure and their periodicity

Documents available for inspection Details of pending litigation and penalties.

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Unit holder rights Cannot sue the mutual fund

Can complain against AMC, sponsor and Board of Trustees

75% unit holders can

wind up a scheme

seek AMC termination

Prospective investor has no rights

Right to redeem without load in case of change in fundamental changes.

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Due Diligence SEBI approved format and content

Trustee Approval

Compliance Officer certifies that

Information contained therein is true and fair

Is in accordance with SEBI regulations

Fund constituents are all SEBI registered

entities

The AMC is responsible for the contents and the

accuracy of information.

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Offer Document Validity of OD

For New Schemes - 6 months from the date of receipt by the AMC of the letter containing observations from SEBI

Revised at least once every two years for OEFs OD is printed only once for CEFs

Updated for every major change Change in the AMC or Sponsor of the mutual fund Change in the load structures Changes in the fundamental attributes of the schemes Changes in the investment options to investors; inclusion or

deletion of options After completion of one year of an OEF,

condensed financial information mandatory in the OD & KIM.

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Fundamental Attributes Scheme type

Investment objective

Investment pattern

Terms of the scheme with regard to liquidity

Fees and expenses

Valuation norms and accounting policies

Investment restrictions.

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Changes in fundamental attributes Approval from Trustees & SEBI

Public announcement by AMC

In case of OEF - Investors have to be informed and option given to exit at NAV without any exit load

In case of CEF – investor approval is required

New OD.

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KIM Abridged OD KIM is mandatory with every application

form.

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OD & KIM Principle of ‘BUYER BEWARE’ applies

An investor who invests without studying the Offer Document cannot subsequently hold the fund responsible

Investor has no recourse for not having read the OD/KIM.

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Investor Rights & Obligations Investor’s Rights Investor’s Obligations

Study the OD Provide PAN Monitor investment

Complaints Redressal Bodies SEBI RoC/DCA/CLB.

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Sales Practices No mandatory guidelines for distributor role & service to

investor AMFI recommends certain practices for effective selling

To be fully aware of the important characteristics of the schemes Know their clients Identify clients Understand each client’s needs Help a client chose his investments Encourage regular investments Provide personalized after sales service

Distribution Commissions are paid by fund houses There are no rules governing the min and max

SEBI (vide Circular dated June 26, 2002) has banned rebating of commissions

AMFI has also prohibited rebating as specified in AGNI.

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Investor Services Applying for & Redeeming units

Cut-off timing of 3:00 pm for same day NAV the next day NAV is applied in case of application

received after 3:00 pm in case of liquid funds 11:00 am is cut-off for

applying previous day NAV Dividend Reinvestment Plan (DRP) Systematic Investment Plan (SIP) Systematic Withdrawal Plan (SWP) Systematic Transfer Plans (STP).

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Investor Services Telephone/Internet transactions Cheque Writing Periodic statement and tax information Loan against units

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Investment Options Investors can achieve income and growth

objectives Growth option Dividend-payout option

Regular Ad-hoc

Dividend Re-investment option Most funds provide multiple options and the

facility to switch between options.

Session 3Accounting, Valuation & Taxation

6. Accounting, Valuation and Taxation

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Accounting Policies Investments to be marked to market

according to SEBI Guidelines

Unrealised appreciation cannot be distributed

Profit or loss on average cost basis

Dividend on ex-dividend date

Sale and purchase accounted on trade date

Brokerage and stamp duties are capitalized and added to cost of acquisition or sale proceeds.

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Specific Disclosures Complete portfolio to be disclosed every six

months

Industry practice is monthly disclosure Any item of expenditure which is more than

10% of total expenses

NPAs, provisioning and NPAs as percent of total assets

Number of unit holders holding more than 25% of unit capital.

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Net Asset Value Frequency of NAV

Calculated and published at least every Wed for CEFs

Calculated and published daily for OEFs Updated on AMFI website by 8:00 pm

(as per text book) every business day NAVs are rounded off up to four decimal

places for liquid/money market schemes and upto two decimal places for all other schemes.

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Net Asset Value NAV = Net Assets of the Scheme/No. of Units

Outstanding Net Assets of the Scheme

+ Market Value of investments + Receivables + Other accrued income + Other assets - Accrued Expenses - Other payables - Other liabilities.

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Fees & Expenses Initial Issues Expenses Recurring Expenses Investment Management Fee Entry & Exit Load.

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Initial Issue expenses Expenses incurred in floating a new scheme Max 6% of funds mobilized charged to scheme; excess borne

by AMC/sponsor Only CEFs are permitted to charge IIE to the fund

Amortize on weekly basis until maturity

E.g. 6 crores amortized over a 5-year (260 weeks) tenor would mean Rs. 230,769 charged every week as expense

No-load fund i.e. funds which do not charge initial issue expenses can charge additional investment management fees of 1%

w.e.f. Apr 2006 OEFs cannot charge initial issue expenses to the scheme.

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Recurring Expenses Investment management fees Custodian’s fees Trustee Fees Registrar and transfer agent fees Marketing and distribution expenses Audit fees Legal expenses Costs of mandatory advertisements and

communications to investors.

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Expenses that cannot be charged Penalties and fines for infraction of laws Interest on delayed payments to unit holders Legal, marketing and publication expenses not

attributable to any scheme Expenses on investment and general management Expenses on general administration, corporate

advertising and infrastructure costs Expenses on fixed assets and software development

expenses Such other costs as may be prohibited by SEBI.

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Recurring Expenses Overall ceiling on expenses, including

Investment management and advisory fees Based on Weekly Average Net Assets (WANA) Equity Funds

First 100 Crores 2.50%100 - 400 Crores 2.25%400 – 700 Crores 2.00%Above 700 Crores 1.75%

For Bond funds, above figures are lower by 0.25%

Limit for FOFs is 0.75% of the Weekly Average Net Assets.

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Investment Management Fee SEBI Limits – Investment Management Fee

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

IMA can be 1% more for no load funds

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Loads Charged to recover sales and distribution expenses Entry Load

At the time of sale of units i.e. subscription by investor Charged on NAV and increases the sale price

Exit Load At the time of repurchase of units i.e. redemption by investor Charged on NAV and reduces the repurchase price

Load is a charge on the NAV Load is defined as a percentage

CDSC is variable exit load, lower for longer duration of holding Loads are subject to SEBI Regulations*

* Change expected in Jan 2008 - In case of Direct investment, no entry load to be charged to investor.

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SEBI Regulations - LoadsOEFs Maximum Exit load or Entry load : 7% of NAV Repurchase price more than or equal to 93%

of the Sale price

CEFs Max Entry or Exit Load: 5% of NAV Repurchase price more than or equal to 95%

of the Sale Price (NAV in this case)

w.e.f. Apr 2006, CEFs cannot charge entry load.

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Pricing of Units Sale and repurchase price are NAV-based

SALE PRICE = NAV + Entry Load

REPURCHASE PRICE = NAV – Exit Load

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Non Performing Asset An asset classified as non-performing if

interest or principal amount not been received or remained outstanding for one quarter from the due date

Deep Discount Bonds (DDBs) are classified as NPAs if, the grade falls to BB or below, OR

it is defaulting on other commitments, OR

in case of full Net worth erosion of the borrower.

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Treatment of NPAs Accrual to be stopped

Income accrued until date of classification to be provided for

Provisioning for principal due In graded manner after 3 months of

classification.

Complete write off in 15 months from classification.

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Valuation of Securities Equity

Traded Securities – Mark to Market – i.e., last quoted closing price on the stock exchange where it is ‘principally traded’

Thinly Traded Securities – Those securities which are traded for less than 5 lacs AND less than 50,000 shares – Complex valuation method is used if the security is not traded for more than 30 days otherwise last traded price.

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Valuation of Securities Debt

Traded Securities – as quoted in market upto last 15 days

Thinly Traded Securities – those securities (except GoI securities) where there is no trade in marketable lot of Rs 5 Cr on valuation date

Securities with maturity upto 182 days are valued on the basis of amortization cost + accrued interest.

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Taxation Mutual Fund is a pass through vehicle hence

not taxed Mutual funds are exempt from tax under

section 10(23D) of Income Tax Act, 1961 Taxation for investor

Dividend Capital Gain

Taxation as per ‘Equity’ fund (at least 65% of assets in domestic equity) or ‘Other than Equity’ fund.

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Equity Funds (Min 65% domestic equity)

Dividend

DDT

NIL

Investor

NIL

Capital Gain

Long-Term

(exceeding 12 months)

NIL

Short-Term

(not exceeding 12 months)

10% + SC +EC

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Other than Equity Funds

Liquid Other than Liquid

Individual/HUF 25% +

SC + EC

12.5% + SC + EC

Others 20.0% + SC + EC

Capital Gain

Long-Term

(exceeding 12 months)

Indexed Tax Rate

Short-Term

(not exceeding 12 months)

Marginal Tax Rate

Dividend

DDT

As per grid below

Investor

NIL

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Other tax aspects Securities Transaction Tax (STT) 54EC Section 80C Section 111A Dividend Stripping

Section 94(7) of the IT act reads – If a person buys or acquires securities or units within a period of three months prior to the record date fixed for declaration of dividend and sells or transfers the same within a period of nine months after such record date and the dividend recd is exempt, then the loss if any, arising from such purchase or sale shall be ignored to the extent such loss does not exceed the amount of such dividend income.

Session 4Mutual Funds & Securities Markets

8. Investment Management

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Mutual Funds & Securities Markets Equity

Market and products Asset classes Investment styles Value indicators

Debt Market and products Terminology Investment styles

Investment restrictions.

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Equity investing Equity implies ownership Equity instruments

Ordinary sharesPreference sharesConvertible debenturesEquity Warrants.

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Equity investingClassification of Equity

Large Cap/ Mid Cap/ Small CapGrowth/ Value/ Cyclical

Equity terminologyEarnings per ShareMarket Capitalization

RatiosP/E RatioDividend Yield.

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Equity portfolio management Approaches to Portfolio Management

Passive Active

Investment Styles Growth Value

Securities Research Fundamental Analysis Quantitative Analysis Technical Analysis

Portfolio Management Organization Structure Fund Managers Security Analysts & Researchers Dealers.

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Approaches to portfolio management Active management

Aim for Out-performance Higher feesSelection and timing

Passive ManagementReplicate a chosen IndexLow fees.

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Growth vs. Value

a. MPS?b. P/E?c. DY?

GrowthHigh Market price per shareHigh PE ratioLow div yield

ValueLow MPSLow PEHigh DY

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Debt Investing Debt implies lending/loan Types of debt instruments

Govt. Securities PSU Bonds FI Bonds Corporate Bonds Debentures Money Market Securities

Treasury Bills (T-Bills) Commercial Paper (CP) Certificate of Deposit (CD).

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Debt Classification Classification of Debt Securities

Tenor – long or short Credit quality

Government Securities/Corporate Securities/FI Bonds

Secured/Unsecured Market Traded/Non-traded Interest

Periodic or Discounted Fixed or Floating (Floater)

Call or Put option.

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Debt Terminology Par or Principal or Face Value Coupon or Interest Maturity or tenor Callable Puttable Yield.

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Price & Yield Increase in rates reduces

value of existing bonds Decrease in rates

increases value of existing bonds

Price and yield are inversely related

The relationship between yield and tenor can be plotted as the yield curve.

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Current Yield and YTM

Coupon amount as a percentage of current market price

If you bought an 8% bond at Rs. 110, the current yield is,

= (8/110)*100

= 7.27%.

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Interest Rate Sensitivity Measured by a number called duration If duration is 5 years, and interest changes

by 1%, price of the bond will change in the opposite direction, by 5%

Example: Duration of a bond is 3 years. Yield spreads increases by 1.5%. What is the change in price?

= 1.5 *3

= -4.5%.

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Risk in Bond Investing Types of Risk

Interest Rate RiskReinvestment RiskDefault/Credit Risk Inflation RiskLiquidity RiskCall Risk

Risk MeasuresYield Spreads & Credit RatingsDuration.

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Credit Risk Probability of default by the borrower Change in credit rating,

downgrade increases the yield & decreases the price

upgrade decreases the yield & increases the price.

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Debt Portfolio Management Buy & Hold

Portfolio exposed to interest rate risk Duration Management

increase duration if rates are expected to fall decrease duration if rates are expected to rise

Credit Selection Invest in low grade bonds that are likely to be

upgraded Prepayment Prediction.

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Investment Policy Investment policy of each scheme dictated by

the scheme’s objective SEBI imposes certain restrictions on mutual

funds to ensure investor protection Minimum 20 investors per scheme No one to hold more than 25% of the corpus

Record of Investment decisions to ensure transparency.

102

Minimum Portfolio Diversification Not more than 10% of NAV in a single company

Exceptions: Index & Sectoral funds Rated Investment grade debt of a single issuer

cannot be more than 15% of NAV (extendable to 20% with AMC Board and Trustees approval)

Un-rated instruments 10% of Net Assets for single issuer Overall 25% cap for investment in such securities

Unlisted shares Max 10% of Net Assets for CEFs Max 5% of Net Assets for OEFs.

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Investment Restrictions Invest only in marketable securities

Investment transactions only on delivery basis

Securities have to be bought in the name of the scheme

A mutual fund under all its schemes, cannot hold more than 10% of the paid-up capital of a company Equity with voting rights representing 10% of paid-up

capital of one stock.

104

Approved & Unapproved Investments Temporary Investment in Bank FDs – Max

15% of NAV ADR/GDR investment permitted

lower of, 10% of net assets or $200 million cap for mutual fund industry as a whole $4 billion

Limited investment in Treasury Bonds and AAA rated corporate debt issued outside India

No Lending.

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Investment in Sponsor No investment in unlisted securities of

sponsor or an associate or group company of the sponsor

No investment in privately placed securities of the sponsor or an associate

Investment in listed securities of the sponsor or associate company permitted Max 25% of the net assets of the scheme.

106

Inter-scheme transfer Transfers only on a delivery basis, at market

prices Such transfers should not result in

significantly altering the investment objectives of the schemes involved

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

One scheme can invest in another scheme, up to 5% of net assets. No fee is payable on these investments.

107

Other Restrictions Mutual funds can borrow up to 20% of net

assets for a period not exceeding 6 months Any change in investment objectives requires

information to investor, and provision of option to exit at NAV, without exit load.

Session 5Return Concepts

9. Measuring & Evaluating Mutual Fund Performance

109

Computing Return Return defined as Income earned for

amount invested over a given period of time Standardize as % per annum

Sources of return Dividend Change in NAV

Return Methods Change in NAV or Absolute Return Method Simple Total Return Method ROI or Return with Dividend Reinvestment Method CAGR Method.

110

Method 1: Change in NAV Method Suitable for computing returns between two

dates Annualize using 12/n or 365/n

(NAV at the end of Period-NAV at the beginning of Period)*100

NAV at the beginning of Period

111

NumericalQ. NAV at start of period was Rs. 13.70. at the

end of 16 months the NAV was 18.50.Calculate the change in NAV.

= (18.50 – 13.70) X 100 13.70= 35.04%

Annualized return= 35.04 X 12/16= 26.28%.

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Simple Total Return In this method, dividends distributed are

added to change in NAV to compute total return

(Change in NAV + Dividend)*100 NAV at the beginning of period

113

NumericalQ. NAV at start of period was Rs. 15.65. At the

end of the year it stood at Rs. 21.05. During the year, investor received 10% dividend. Calculate the return earned by the investor.

= ((21.05-15.65)+1.00) X 100 15.65

= 40.89%.

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ROI Method The method assumes that dividends are reinvested, at Ex-

Div NAV

Value at end of period – Value at beginning of period X 100Value at Beginning

Value of holdings at the beginning of the period = number of units at the beginning x begin NAV

Value of holdings end of the period = (number of units held at the beginning + number of units re-invested) x end NAV

Number of units re-invested = dividends/ex dividend NAV.

115

NumericalQ. On Jan 01, 2007 an investor bought 1000 units at 12.25.

He redeemed the investment on 01st Jan 2008 when the fund’s NAV stood at 19.50. During the year he received dividend at the rate of 10%. The ex-Div NAV was Rs. 15.10.Calculate his ROI.

= Value of holding at start – 1000 X 12.25 = 12,250= No of units reinvested – 1000 / 15.10 = 66.2252= Value of holding at end – 1066.2252 X 19.50 = 20,791.39= ROI – (20,791.39 – 12,250) X 100 12,250= 69.73%.

116

CAGR Compound Annual Growth Rate

rate at which investment has grown from begin point to the end point, on an annual compounding basis

A = P(1+r)n

V1 = V0(1+r)n

r = ((V1 / V0)1/n) -1

V1 = Amount at the end of PeriodV0 = Principalr = Rate of returnn = Number of periods.

117

NumericalQ. An investor buys 1000 units of a fund at Rs.

24.15 on Jan 07, 2007. On June 30, 2007 he receives dividends at the rate of 20%. The ex-dividend NAV was Rs. 30.60. On Jan 01, 2008 the fund’s NAV was Rs. 32.25.

Compute the CAGR.

118

Solution The value of investment at beginning

= 24.15 x 1000 = Rs. 24,150 Number of units reinvested

= 2000/30.60 = 65.36 units End period value of investment

= 1065.36 x 32.25 = Rs. 34,357.84 Holding period

= 01/01/08 - 07/01/07 = 359 days The CAGR is

= (34,357.84/24,150)365/359 - 1 x 100= 43.11%.

119

SEBI Regulation Standard measurements and computation CAGR for funds that are over 1 year old Return for 1,3 and 5 years, or since

inception, which ever is later No annualisation for periods less than a year.

120

Industry Practice Less then 1 year, simple return without

compounding or annualisation Growth Option: CAGR implicit in the change

in holding period NAVs Dividend Option: CAGR implicit in the change

in value over the holding period, assuming re-investment of dividend at ex-dividend NAV

Some funds use simple annualised return, without compounding.

121

Evaluating fund performance Evaluation of a fund

relative to the market as a whole relative to other mutual funds relative to other comparable investment options

Rankings by external agencies Economic Times Lipper CRISIL CPRs, RRR, CQR CRISIL Volatility Rating CRISIL Fund Management Practice.

122

Benchmarks Relative returns are important than absolute

returns for mutual funds Comparable passive portfolio is used as

benchmark Usually a market index is used Compare both risk and return, over the same

period for the fund and the benchmark.

123

SEBI Guidelines Benchmark should reflect the asset allocation Same as stated in the offer document Growth fund with more than 60% in equity to

use a broad based index Bond fund with more than 60% in bonds to

use a bond market index Balanced funds to use tailor-made index Liquid funds to use money market

instruments.

124

Other Measures of Performance Size and portfolio composition Credit quality

Rating profile of portfolio Expense ratio

Higher expense ratio hurts long term investors Tracking error

For index funds this should be nil Portfolio turnover

Higher for short term & lower for longer term funds.

Session 6Financial Planning & Mutual Funds

10. Helping Investors with Financial Planning11. Recommending Financial Planning Strategies to Investors12. Selecting the right Investment Products for Investors13. Helping Investors understand risks in Fund Investing14. Recommending Model Portfolios and Selecting the right

fund

126

Financial Planning & Mutual Funds Concept of financial planning Financial Planning Strategies Mapping life cycles & wealth cycles Alternate investment products Understanding Risk Asset allocation Model portfolios Fund selection.

127

Financial Planning

“It is an exercise aimed at identifying all the financial needs of an individual, translating the needs into monetarily measurable goals at different times in the future and planning the financial investments that will allow the individual to provide for and satisfy his future financial need and achieve his life goals.”

128

Who is a financial planner? Is a person who uses the financial planning

process to help another person determine how to meet his or her life goals

Key functions of a FP is to help people identify their financial planning needs, priorities and the products that are most suitable to meet their needs.

129

Benefits of Financial Planning To client

Provides direction and meaning to financial decisions

Helps understand how decision in one area effects other areas

Helps evaluate short and long term effects of decisions on one’s life goals

To Planner Ability to establish long term relationships Ability to build a profitable business.

130

Financial Planning Process

Establish & Define the Client Planner Relationship

Define the Client’s Goals

Gather and Analyze Data

Ascertain the Client’s Tax Situation

Recommend the appropriate Asset Allocation

Execute the Plan

Review Progress

Determine and Shape the Risk Tolerance level

131

Role of participants

FinancialPlanner

FundManager

PortfolioInvestments

DiscussionOf Goals& Asset

Allocation

Choice ofSchemes& Fund

Manager

Market Analysis& Choice ofSecurities

Client

132

Important factors

Set Measurable Financial GoalsSet Measurable Financial Goals

Understand the Effect of Each DecisionUnderstand the Effect of Each Decision

Re-evaluate Financial Situation PeriodicallyRe-evaluate Financial Situation Periodically

Start Planning ASAPStart Planning ASAP

Set realistic expectationsSet realistic expectations

Client is in-Charge of the processClient is in-Charge of the process

133

Classification of Investors Life Cycle Stages Wealth Cycle Stages

134

Life Cycle Stages Childhood Stage Young Unmarried Stage Young Married Stage Young Married with Children Stage Married with Older Children Stage Post family/Pre-retirement Stage Retirement Stage.

135

Wealth Cycle Stages Sowing or Accumulation Stage Transition Stage Reaping or Distribution Stage Intergenerational Wealth Transfer Change Sudden Wealth Surge Stage Affluent investors

Wealth preserving Wealth creating.

136

Other areas Constraints to Financial Planning Goal-Oriented Investing Planning for Affluent Investors

Wealth Creating Individuals: These are aggressive and tend to invest more in equity, maybe even 70% to 80%

Wealth Preserving Individuals: Conservative and thus tend to invest majority into income, gilt and liquid funds.

137

Strategies for Investors Invest whenever there is money! Start Planning & Investing Early Have realistic Expectations Invest Regularly Buy and Hold

may not be good strategy with stocks but is good in case of a mutual fund for the investor willing to wait out a full market cycle

When to cash out needs more thought and skill in case of stock – sell out as the price rises beyond reason or

when fundamentals start to deteriorate in case of mutual funds – redeem when the goals have arrived

and money is needed or if the market appears ‘overvalued’ in terms of fundamentals and historic valuations.

138

Useful Strategies Power of Compounding Rupee Cost Averaging (RCA) Value Averaging Jacob’s combined approach.

139

Power of Compounding Investing for the long term Higher the frequency, greater the growth

six-monthly compounding of 100 rupees for 10 years would yield Rs. 321 instead of Rs. 311 with annual compounding

140

Power of Compounding

FV = PV (1 + r) n

Save More

Earn More

Start Early

141

The legend of compoundingAmount Invested = Rs. 10,000Year of investment = 1977Growth rate = 49%Value of holding at the end of 2007 = ???

appx. 157 crores (156,88,73,952)

Which company am I?

142

Rupee Cost Averaging Invest a predetermined amount regularly Purchase more units when the market is low;

less when the markets are high Reduces the average cost of purchase

Implemented through SIP Disadvantage – it doesn’t tell you when to

buy, sell or switch.

143

RCA – An ExampleMont

h

Amount Invested

NAV per Unit

Units bough

t

Cumulative Number of

Units

Value of holding

1 5000 10

500.0

0 500.00 5,000

2 5000 15

333.3

3 833.33 12,500

3 5000 20

250.0

0 1,083.33 21,667

4 5000 12

416.6

7 1,500.00 18,000

5 5000 8

625.0

0 2,125.00 17,000

6 5000 5

1,000.

00 3,125.00 15,625

           

 

Average NAV

11.6

7

Average Cost/ Unit

9.60  

144

Value Averaging Invest regularly to achieve a predetermined

value Book profits at highs, and add units at the

lows Implemented through SWP Reduces the average cost of purchase Superior to RCA – allows you to redeem at

the right opportunity.

145

VA – another exampleMont

hTargetValue

NAV (Rs)Value ofHolding

Units to invest

Cum no of units

1 1,000 10.00 100.00 100.00 100.00

2 2,000 12.50 1,250.00 60.00 160.00

3 3,000 14.25 2,280.00 50.53 210.53

4 4,000 11.75 2,473.68 129.90 340.43

5 5,000 10.50 3,574.47 135.76 476.19

6 6,000 9.00 4,285.71 190.48 666.67

7 7,000 8.50 5,666.67 156.86 823.53

8 8,000 7.65 6,300.00 222.22 1,045.75

9 9,000 8.80 9,202.61 (23.02) 1,022.73

10 10,000 9.25 9,460.23 58.35 1,081.08

11 11,000 12.00 12,972.97 (164.41) 916.67

12 12,000 15.00 13,750.00 (116.67) 800.00

146

Jacob’s Approach Combine RCA and VA

Use an aggressive growth fund and a money market fund of the same family.

147

Asset Allocation Besides how much and for how long to invest,

the important question is where to invest Equity, debt and money market products are

called asset classes Asset allocation means determining the

percentage of investments to be held in equities, bonds and money market/cash instruments

Over 94% of returns on a managed portfolio come from the right level of asset allocation between stocks and bonds/cash

The approach must incorporate product, investor profile and preferences in the portfolio.

148

Types of Asset Allocation

Fixed Asset AllocationFixed Asset Allocation

Flexible Asset AllocationFlexible Asset Allocation

Tactical Asset AllocationTactical Asset Allocation

Portfolio is periodically re-balancedDisciplined approachProfit booking in rising & more investment in a falling market Better if stocks continue to return more than bonds

No re-balancing - proportions can vary when prices changeIf equity returns are higher than debt, equity allocation will go up fasterBetter if bond returns are close to equity

making changes in asset allocation within the overall percentage holding for extra return.

149

Asset Allocation Approaches Benjamin Graham’s 50/50 balance

a 50/50 split between debt and equity Graham’s 50:50 is the basic asset

allocation.

150

Graham’s PortfoliosPortfolio Type Portfolio Mix

Basic managed Portfolio

50% diversified equity ‘value’ fund25% Govt Securities fund25% High grade corporate bond

fund

Basic Indexed Portfolio 50% total stock market/index fund50% total bond market portfolio

Simple Managed Portfolio

85% Balanced 60/40 fund15% Medium term bond fund

Complex Managed Portfolio

20% diversified equity fund20% aggressive growth fund10% specialty fund

Readymade Portfolio 100% Single Index fund with 60/40 equity/bond holding

151

Accumulation Phase

Diversified Equity

Income and Gilt Funds

Liquid Funds5%

65-80%

15-30%

Jacob’s Investment Strategies

152

Jacob’s Investment Strategies

Distribution Phase

Diversified Equity

Income and Gilt Funds

Liquid Funds5%

65-80%

15-30%

153

Asset Allocation Approaches Bogle’s Approach

Bogle suggested variation to percentages based on age, financial circumstances and objectives

Bogle’s thumb rule debt portion of an investor’s portfolio

equal to investor’s age.

154

Bogle’s Asset Allocation Strategy

Accumulation Stage

Distribution Stage

Younger

Investor

80% Equity20% Debt

60% Equity

40% Debt

Older Investo

r

70% Equity30% Debt

50% Equity

50% Debt

Alternate Investment Products

156

Alternate Investment Products Physical/Real Assets vs. Financial Assets Physical Assets – Gold & Real Estate

High initial investment, liquidity concerns Financial Assets

By class: equity, debt, money market By issuer: Govt, FIs, Corporate, Banks Guaranteed vs. Non-guaranteed

Government - G-Secs, PPF, KVPs, NSCs, RBI Relief Bonds PSUs/FIs – Bonds Banks - FDs Corporate - Shares, Debentures, Bonds, FDs Insurer - Policies (With Profit or without profit, ULIPs) Mutual Fund – a combination asset.

157

Investment ProductsIssuer Product Available to

Bank Fixed Deposits Investor, MFs

Corporate

Shares Investor, MFs

Bonds, Debentures Investor, MFs

Fixed Deposits Investor, MFs

Government

Govt. Securities Investor, MFs

PPF Investor

Other personal investments

Investor

FIs Bonds Investor, MFs

Insurers Insurance policies Investor

158

Quick Wit Tenor of RBI Bonds? Min/Max investment in PPF? Who assigns credit rating to Corporate

securities? Borrowers with lower rating need to give

higher/lower interest? Tax benefit in NSC? Liquidity in Mutual Funds higher/lower than

equity? Tax aspects of life Insurance proceeds?

159

Comparison of financial products

Convenience

Return Safety Volatility Liquidity

Equity Moderate High Low High High-Low

FI Bonds High Moderate High Moderate Moderate

Corp Debentures Low Moderate Moderate Moderate Low

Company FDs Moderate Moderate Low Low Low

Bank Deposits High Low High Low High

PPF High Moderate High Low Low-Moderate

LI (Traditional) High Low High Low Low

LI (ULIPs) High High HighModerate -

HighLow-Moderate

Gold Low Moderate High Moderate Moderate

Real Estate Low High Moderate High Low

Mutual Funds High High High Moderate-High High

160

Mutual Fund vs. Direct EquityFeature Direct Equity Mutual

Fund

Stock selection ability Low High

Focussed activity Low High

Diversification Low High

Professional management Low High

Liquidity Low High

Transaction cost High Low

ConvenienceSwitchesCheque writing facilities

Low High

Investing time, knowledge & resources

High Low

161

Mutual Fund vs. Bank Deposit Deposits

Contractual agreement Guaranteed for repaymentNo direct holding of a

portfolio of investment Mutual Fund

No contractual agreement No guaranteeDirect holding of a portfolioReturn commensurate with

risk.

162

Investor PerspectiveInvestment Objective Risk Tolerance Investment Horizon

Equity Capital Appreciation High Long Term

FI Bonds Income Low Medium-Long Term

Corp Debentures Income High-Moderate-Low Medium-Long Term

Company FDs Income High-Moderate-Low Medium

Bank Deposits Income LowShort-Medium-Long

Term

PPF Income Low Long Term

Life Insurance (Traditional)

Risk Cover Low Long Term

Life Insurance (ULIPs)Risk Cover, Capital Growth,

IncomeHigh-Moderate-Low Medium-Long Term

Gold Inflation hedge Low Medium-Long Term

Real Estate Capital Growth, Income Low-Moderate Long Term

Mutual Funds Capital Growth, Income High-Moderate-LowShort-Medium-Long

Term

163

Why MF is the best option Combine the advantages of all investment

products

flexibility, convenience, affordability, liquidity,

potential for high returns

Dispense the short comings of the other

options

liquidity, low return expectation, risk diversification

Returns are adjusted for market movements

Commensurate with level of risk.

Risk in Mutual Fund Investing

165

Risk in MF investing What is Risk?

Volatility of earnings viz. deviation (+ & - ) from expected earnings

Possibility of Financial loss Risk can be built into the investment planning

by Defining the risk appetite of the investor and aligning

investment objectives to risk tolerance Evaluating and measuring risks of portfolio to keep in line

with the investor’s risk appetite The right level of risk tolerance of any investor

depends upon age, investable funds, circumstances including income level, job security, family size etc.

166

Jacob’s recommendation based on risk level

Jacob’s Recommendation of portfolio sub-allocation

Low-Risk (Conservative) portfolio

50% G Secs + 50% MMMF

Moderate Risk (Cautiously Aggressive) portfolio

40% in Growth & Income + 30% Govt Bonds + 20%

Growth Funds + 10% Index Funds

High Risk (Aggressive) Portfolio

25% Aggressive Growth Funds + 25%

International Funds + 25% Sector Funds + 15% High Yield Bond Funds +

10% Gold Funds

167

Type of risk in Equity Funds Company Specific Sector Specific Market Risk

Company and Sector risk can be reduced with diversification but market risk cannot be diversified

Market Cycles Portfolio performance over a market cycle Equity more rewarding in the long-term.

168

Measures of Risk Risk

Standard Deviation

BetaEx-marksAlpha

Risk-adjusted returnSharpe RatioTreynor Ratio.

169

Standard Deviation Best measure of risk Measure of absolute or total risk of a portfolio Dispersion around mean ‘Quality rating’ of the average Higher S.D. indicates more volatile returns

Lower deviation means less risk High S.D. need not mean poor performance

Sachin Tendulkar vs. Harbhajan Singh.

VOLATILITY!

170

Beta Shows how sensitive a fund is to market moves

If the Sensex moves by 25%, a fund’s bet number will tell you whether the fund’s return will be more or less than this

Beta value for an Index is taken as 1 Multiplying the beta value of a fund will expected

percentage movement of an index gives the expected movement in the fund

Higher beta means higher impact of market returns Lower beta means less risk

Higher beta funds do well in a rising market, lower beta funds do better in a falling market.

SENSITIVITY!

171

Ex-Marks or R-Squared Quality of Beta depends on Ex-marks

Beta depends upon the index used to calculate it Beta calculated for large cap fund against a mid-cap index has

no meaning Higher ex-marks means more reliable beta

Measures return from a fund and the market index and measures the extent of correlation in their movement

Lower ex-marks mean lower correlation with market returns

R-squared varies between 0 and 1 R-squared of an index fund would be 1 (or Ex-marks

100%).

SYMPATHY!

173

Sharpe & Treynor Ratio

Recommending model portfolios & Selecting the right fund

175

Jacobs’ Four-Step Program Develop long term goals

Investment avenues, time horizon, return and risk

Determine asset allocation

Allocation to broad asset classes

Determine sector distribution

Allocation of sectors of the mutual fund industry

Select specific fund managers and their schemes

Compare products & choose actual funds to invest in.

176

Jacob’s Model PortfoliosInvestor Recommended Model Portfolio

Young, Unmarried Professional

50% in Aggressive Equity Funds25% in High Yield Bond Funds and Growth and

Income Funds25% in Conservative Money Market Funds

Young Couple with two Incomes and two Children

10% in Money Market30% in Aggressive Equity Funds25% in High Yield Bond Funds35% in Municipal Bond Funds

Older Couple Single Income

30% in Short-term municipal Funds35% in long-term Municipal Funds25% in moderately aggressive equity10% in emerging growth equity

Recently retired couple

35% in conservative Equity funds25% in moderately Aggressive Equity40% in Money Market Funds

177

Fund Selection – Bogle’s ApproachEquity Category – Diversified, Sectoral, Index etc Strategy – Growth and Value Past Returns – Compare with benchmark and with

funds in same category over same time frames Fund Size, Age, Costs, Manager’s experience – Bigger

Size, Longer Age, Lower Costs and Higher Fund Manager’s experience are better

Characteristics – Lower Cash Position, Low Concentration, Lower portfolio turnover are generally better; Higher Cap assumes less risk

Risk Statistics – Low Beta, High Ex-Marks, High Div yield are generally better.

178

Fund Selection – Bogle’s ApproachDebt Type – Income/Gilt/Liquid etc Fund Age & Size – higher the age and larger

the size, the better Costs – lower the better Loads – lower the better Average Maturity – higher average maturity

means higher interest rate risk Credit Quality – More AAA rated securities,

more secure the fund.

179

Fund Selection – Bogle’s ApproachBalanced Portfolio Balance –match investor’s objective Debt Portfolio Quality – higher the better Costs – lower the better Portfolio Statistics – similar to equity funds.

180

Fund Selection – Bogle’s ApproachMMMF Costs – lower the expense ratio the better Yields – higher the better Quality – higher is essential

Liquidity and turnover rate

Shorter term instruments are turned over more

frequently

Principal protection

Limited NAV fluctuation due to low duration

and low levels of interest rate risk.

Session 7Business Ethics

15. Business Ethics and Mutual Funds

182

Meaning of business ethics Refers to rules of acceptable and good conduct

in business All persons engaged in business should comply

with rules of good conduct and have strong ethics

These rules may be set by those who own and manage the business, or by those agencies that have the right to regulate the business

Business ethics are hard to enforce, hence desirable that they be self imposed

In many countries, laws such as Consumer or Investor Protection Act exist.

183

Need for business ethics Have honest and fair business practices

Protect the interests of the customer or

investor

Good ethics also mean good business

Retention of customer and generates loyalty

Transparency in operations and to ensure

that both potential and existing customers

are treated at par.

184

Objectives of Business Ethics Honest and transparent dealings with

customers

Protect clients and customer from being

exploited or cheated

Level playing field among all participants

Healthy competition for the benefit of all

customers.

185

SEBI Objectives Funds always conduct all activities in

the best interest of investors Areas monitored by SEBI

Fund Structure & GovernanceExercise of Voting Rights by FundsFund Operations.

186

Implementing Business Ethics Fund Governance

Regulator prime concern is investor protection

Protect the investor through a system of independent controls or check and balances

Separation of functions Independence of organizations Independence of personnel.

187

Implementing Business Ethics Fund Operations

Insider TradingPreferential Treatment to Select

InvestorsPersonal trading by Fund Manager &

employeesCompliance Officer Code of Conduct for Distributors

AGNI.

Thank you for taking the journey with us;Good Luck!

The presentation has been prepared by I-PRU AMC & PIVOT TRAINING PVT. LTD.