an analysis of mutual fund industry – theoratical perspective

8/7/2019 AN ANALYSIS OF MUTUAL FUND INDUSTRY THEORATICAL PERSPECTIVE

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AN ANALYSIS OF MUTUAL FUND INDUSTRY THEORATICAL PERSPECTIVE

Concept of Mutual Funds (Back To Top)

A Mutual Fund is a trust that pools the savings of a number of investors who share acommon financial goal. The money thus collected is then invested in capital marketinstruments such as shares, debentures and other securities. The income earned throughthese investments and the capital appreciation realised are shared by its unit holders inproportion to the number of units owned by them. Thus a Mutual Fund is the most suitableinvestment for the common man as it offers an opportunity to invest in a diversified,professionally managed basket of securities at a relatively low cost. The flow chart belowdescribes broadly the working of a mutual fund

History of Indian Mutual Fund Industry (Back To Top)

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India,at the initiative of the Government of India and Reserve Bank of India. The history ofmutual funds in India can be broadly divided into four distinct phases

First Phase - 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up bythe Reserve Bank of India and functioned under the Regulatory and administrative controlof the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the IndustrialDevelopment Bank of India (IDBI) took over the regulatory and administrative control inplace of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988UTI had Rs.6,700 crores of assets under management.

Second Phase - 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non- UTI, public sector mutual funds set up by public sectorbanks and Life Insurance Corporation of India (LIC) and General Insurance Corporation ofIndia (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89),Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct92). LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in
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December 1990.

At the end of 1993, the mutual fund industry had assets under management of Rs.47,004crores.

Third Phase - 1993-2003 (Entry of Private Sector Funds)

With the entry of private sector funds in 1993, a new era started in the Indian mutual fundindustry, giving the Indian investors a wider choice of fund families. Also, 1993 was theyear in which the first Mutual Fund Regulations came into being, under which all mutualfunds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer (nowmerged with Franklin Templeton) was the first private sector mutual fund registered in July1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive andrevised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (MutualFund) Regulations 1996.

The number of mutual fund houses went on increasing, with many foreign mutual fundssetting up funds in India and also the industry has witnessed several mergers andacquisitions. As at the end of January 2003, there were 33 mutual funds with total assets ofRs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets undermanagement was way ahead of other mutual funds.

Fourth Phase - since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI wasbifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust ofIndia with assets under management of Rs.29,835 crores as at the end of January 2003,representing broadly, the assets of US 64 scheme, assured return and certain otherschemes. The Specified Undertaking of Unit Trust of India, functioning under an

administrator and under the rules framed by Government of India and does not come underthe purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registeredwith SEBI and functions under the Mutual Fund Regulations. With the bifurcation of theerstwhile UTI which had in March 2000 more than Rs.76,000 crores of assets undermanagement and with the setting up of a UTI Mutual Fund, conforming to the SEBI MutualFund Regulations, and with recent mergers taking place among different private sectorfunds, the mutual fund industry has entered its current phase of consolidation and growth.

The graph indicates the growth of assets over the years.


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Organization of a Mutual Fund (Back To Top)

There are many entities involved and the diagram below illustrates the organisational setup of a mutual fund:
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Types of Mutual Fund Schemes (Back To Top)

There are a wide variety of Mutual Fund schemes that cater to your needs, whatever yourage, financial position, risk tolerance and return expectations.

By Structure

Open Ended Schemes: An open-end fund is one that is available for subscription allthrough the year. These do not have a fixed maturity. Investors can conveniently buyand sell units at Net Asset Value ("NAV") related prices. The key feature of open-endschemes is liquidity.

Closed Ended Schemes: These funds have a pre-specified maturity period. The 'UnitCapital' of such schemes is fixed as it makes a onetime sale of a fixed number of units.

After the offer closes, closed ended funds do not allow investors to buy or redeemunits directly from funds.

Interval Schemes: These combine the features of open-ended and close-endedschemes. They may be traded on the stock exchange or may be open for sale orredemption during predetermined intervals at NAV related prices.

By Nature

Equity funds:These funds invest a maximum part of their corpus into equities. The structure of thefund may vary different for different schemes and the fund manager's outlook ondifferent stocks. The Equity Funds are sub-classified depending upon their investmentobjective, as follows:

o Diversified Equity Funds

o Mid-Cap Funds

o Sector Specific Funds

o Tax Savings Funds (ELSS)

Equity investments are meant for a longer time horizon, thus Equity funds rank high onthe risk-return matrix.


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Debt funds:The objective of these Funds is to invest in debt papers. Government authorities,private companies, banks and financial institutions are some of the major issuers ofdebt papers. By investing in debt instruments, these funds ensure low risk and providestable income to the investors. Debt funds are further classified as:

Gilt Funds:Invest their corpus in securities issued by Government of India, popularly known as"Gilts". These Funds carry zero default risk but are associated with interest rate risk.These schemes are safer as they invest in papers backed by Government.

Gilt Funds:Invest their corpus in securities issued by Government of India, popularly known as

"Gilts". These Funds carry zero default risk but are associated with interest rate risk.These schemes are safer as they invest in papers backed by Government.

Income Funds:Invest a major portion into various debt instruments such as bonds, corporatedebentures and government securities.

Monthly Income Plans (MIPs):

Invests maximum of their total corpus in debt instruments while they take minimumexposure in equities. It gets benefit of both equity and debt market. These schemeranks slightly high on the risk-return matrix when compared with other debt schemes.

Short Term Plans (STPs):Meant for investment horizon for three to six months. These funds primarily invest inshort term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs).Some portion of the corpus is also invested in corporate debentures.

Liquid Funds:Also known as Money Market Schemes, these funds provide easy liquidity andpreservation of capital. These schemes invest in short-term instruments like TreasuryBills, inter-bank call money market, CPs and CDs. These funds are meant for short-term cash management with an investment horizon of 1day to 3 months. Theseschemes are considered to be the safest amongst all categories of mutual funds.


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Balanced funds:As the name suggest they, are a mix of both equity and debt funds. They invest in bothequities and fixed income securities, which are in line with pre-defined investmentobjective of the scheme. These schemes aim to provide investors with the best of both

the worlds. Equity part provides growth and the debt part provides stability in returns.

By Investment Objective

Growth Schemes: Aims to provide capital appreciation over the medium to long term.These schemes normally invest a majority of their funds in equities and are willing tobear short term decline in value for possible future appreciation.

Dividend/Income Schemes: Aim to provide regular and steady income to investors.These schemes generally invest in fixed income securities such as bonds and corporatedebentures. Capital appreciation in such schemes may be limited.

Balanced Schemes: Aim to provide both growth and income by periodicallydistributing a part of the income and capital gains they earn. They invest in bothshares and fixed income securities in the proportion indicated in their offerdocuments.

Money Market / Liquid Schemes: Aim to provide easy liquidity, preservation of capitaland moderate income. These schemes generally invest in safer, short term instrumentssuch as treasury bills, certificates of deposit, commercial paper and interbank callmoney.

Other Equity related Schemes

Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under taxlaws prescribed from time to time. Under Sec.88 of the Income Tax Act, contributionsmade to any Equity Linked Savings Scheme (ELSS) are eligible for rebate.

Index Schemes: Index schemes attempt to replicate the performance of a particularindex such as the BSE Sensex or the NSE Nifty. The portfolio of these schemes willconsist of only those stocks that constitute the index, and with the same weightage as


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in the index it replicates. Hence, the returns from such schemes would be more or lessequivalent to those of the index it replicates.

Sector Specific Schemes: These schemes invest in the securities of specific sectors,e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleumstocks, etc. The returns in these funds are dependent on the performance of therespective sectors/industries.

Fund of Funds: As the name suggests, these Mutual funds invest in other mutual fundschemes offered by different AMCs. Fund of Funds maintain a portfolio comprising ofunits of other mutual fund schemes.

Advantages of Mutual Funds (Back To Top)

Portfolio Diversification: Mutual funds are a convenient and affordable way of investing ina wide range of investments which would be very difficult and time-consuming to purchaseand manage individually. Mutual funds typically invest in a broad cross-section of industriesand sectors, and thereby offer a degree of diversification that would be difficult to achieveon your own.

Professional management: Mutual Funds appoint experienced, professional Fund Managerswho devote themselves exclusively to tracking the markets, analyzing securities andimplementing a consistent investment strategy. The Fund Managers are backed bydedicated Research Teams, who actively analyze the overall market conditions as well as

individual securities and assist the Fund Manager in selecting the best opportunities forinvestment

Flexibility: Mutual Funds employing a variety of investment strategies are available to helpmeet the needs of every type of investor, from conservative to very aggressive.

Also, through features such as Systematic Investment Plans (SIP), Systematic Transfer Plans(STP), Systematic Withdrawal Plans (SWP) and dividend reinvestment plans; you cansystematically invest or withdraw funds according to your needs and convenience.

Hassle-free Administration: Investing in a Mutual Fund reduces paperwork and helps avoidmany problems such as bad deliveries, delayed payments and unnecessary follow up with

brokers and companies. Moreover, you can track your portfolio online - anywhere, anytime.

Sound Returns: A well-selected portfolio of Mutual Funds has the potential to deliversatisfactory returns over the medium to long term, with low volatility.

Transparency: Regular information on the value of your investment in addition todisclosure on the specific investments made by your scheme, the proportion invested ineach class of assets and the fund manager's investment strategy and outlook, is provided byeach Mutual Fund.


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Well-Regulated: All Mutual Funds are registered with SEBI and they function within thelimits of strict regulations designed to protect the interests of investors. Also theAssociation of Mutual Funds in India (AMFI) reassures the investors in units of mutual fundsthat the mutual funds function within the strict regulatory framework.

Mutual Fund Terminology (Back To Top)

Net Asset Value (NAV)Net Asset Value (NAV) is a term used to describe the value of an entity's assets less thevalue of its liabilities. The term is commonly used in relation to collective investmentschemes. For Mutual Fund Schemes, the NAV is the total value of the fund's portfolio lessits liabilities. Its liabilities may be money owed to lending banks or fees owed toinvestment managers.

Assets under Management (AUM)In general, the market value of assets an investment company manages on behalf ofinvestors. There are widely differing views on what the term means. Some financialinstitutions include bank deposits, mutual funds and institutional money in theircalculations. Others limit it to funds under discretionary management where the clientdelegates responsibility to the company.

UnitsA Mutual Fund unit is what individual investors buy which gives them a "pro rata" share ofthe value of the investments of the fund. The unit value of the fund is struck by adding upthe values of all the investments at their market prices, subtracting amounts owed by thefund and dividing by the number of units held.

New Fund Offer (NFO)

A NFO is a security offering in which investors can purchase units of a Mutual Fund. A newfund offer occurs when a mutual fund is launched, allowing the firm to raise capital forpurchasing securities. A new fund offer is similar to an initial public offering. Bothrepresent attempts to raise capital to further operations.

Entry / Exit LoadMutual Fund Companies incur some expenses to float a fund and also they have manyadministrative and operative expenses. So to meet those expenses they collect apercentage of fees from the investors, which are called loads. If they collect the fee whenyou buy the units, then it is called as entry load. If they charge that fee when you sell yourunits back to them then it is called as exit load.

DiversificationDiversification is a risk management technique, related to hedging, that mixes a widevariety of investments within a portfolio. Diversification minimizes the risk from any oneinvestment. It strives to smooth out unsystematic risk events in a portfolio so that thepositive performance of some investments will neutralize the negative performance ofothers.

Fund ManagerThe person(s) responsible for implementing a fund's investing strategy and managing its


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portfolio trading activities. A fund can be managed by one person, by two people as co-managers and by a team of three or more people. Fund managers are paid a fee for theirwork, which is a percentage of the fund's average assets under management.

Asset AllocationAsset allocation is a term used to refer to how an investor distributes his or her

investments among various classes of investment vehicles. A large part of financial planningis finding an asset allocation that is appropriate for a given person in terms of theirappetite for and ability to shoulder risk. Examples of various asset classes are: Equity,Bonds, Fixed Deposits, Real Estate, Cash, etc.

an analysis of mutual fund industry – theoratical perspective

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