chapter 1 overview of mutual fund 1.1...
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Chapter - 1 : Overview of Mutual Fund
1
CHAPTER 1
OVERVIEW OF MUTUAL FUND
1.1 INTRODUCTION
During the past decade, the Indian financial market has witnessed
remarkable development. The reason can be attributed to the Liberalization,
Privatization, Globalization (LPG) process launched in 1991 under the
guidance of Prime Minister Mr P.V. Narsimha Rao and the then finance
minister Dr. Man Mohan Singh.
It is a fact beyond doubt that every one wants to be secured against
future uncertain events. Financial security is considered to be the most
important factor in any individual‟s life. Investment is the sacrifice of certain
present value of the uncertain future reward. It involves the decisions like,
where to invest, when to invest and how much to invest. Even though the
capital market attracts people, there are a number of problems associated with
it. The reason is that while investing directly in the capital market an individual
investor has to be very careful to judge the valuation of the stocks and to be
able to understand clearly the complexities involved in the stock market
operations as well as fluctuations in stock prices.
In last few years, there has been a mixture of investment opportunities
that has been made accessible for an investor to choose from. Investors have a
basic choice either they can invest directly in individual securities, or they can
invest indirectly through a financial intermediary or collective investment
vehicles. Financial intermediary or collective investment vehicle collect savings
from small and scattered investors and invest these funds in a portfolio of
Chapter - 1 : Overview of Mutual Fund
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financial assets. Mutual fund is one form of such financial intermediary. It is one
of those areas of financial services which have grown rapidly. Mutual funds are
playing a major part in channelising individual savings in productive areas.
A mutual fund is type of financial intermediary that pools the savings of
investors who seeks the same general investment objective and there by invest
such savings in a diversified portfolio of securities. The term “mutual” is used in
the sense that all its returns, minus its expenses, are shared by the particular
fund‟s unit holders.
Mutual fund, a financial innovation provides a novel way of mobilizing
savings from small investors thus permitting them to enjoy the participation in
the equity & other securities of leading company‟s with less amount of risk
involvement, which otherwise would had been impossible for them. In other
words, Mutual fund is a mechanism for pooling the resources by issuing units to
the investors & investing funds in securities as per the objective as disclosed in
offer document issued by the respective mutual fund company.
A MF represents a vehicle for collective investment. When an investor
participates in the scheme of a mutual fund, he automatically becomes part
owner of the investment held under that scheme. The investors get a
proportional share in the gain as well as losses of the fund. A mutual fund
companies invest in equity shares, debentures, bonds, money market
instruments, government securities. Originally, mutual funds were devised as
investment options for retail investors, but now corporate investors are also
forming an important part of the investors‟ base.
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While the mf industry in India has registered a healthy growth over the
last 15 years, it is still very small in relation to other intermediaries like banks
and insurance companies.
Table 1.1
Profiles of Mutual Fund investors among working age Indians with cash
income (in %).
How First Attracted to invest Frequent
Investor
One time
investor
Self motivated 39.5 30.6
Recommended by an agent 28.6 24.2
Recommended by social network 12.8 23.1
Recommended by family member 6 10.8
Recommended by financial advisor/accountant 7 6.8
Convinced by advertising 5.3 4.1
Others 0.8 0.4
Main Reason for Remaining Invested Frequent
Investor
One time
investor
Higher returns 55.4 37.8
Wealth creation 13.3 17.9
Appreciation of investment 9.6 14.3
Tax savings 5.8 5.3
Secure investment 4.2 6.1
Flexibility/Liquidity 3.9 5.8
Simpler than equities 2 4.9
Systematic nature of saving 3 3.3
Others 2.8 4.5 Source The Economic Times : 25/02/2008
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1.1.1 ECONOMICS OF MUTUAL FUND
The most important reason of under development of a country is the
poor capital formation as it is sine qua non for development. The famous
economist, Prof. Ragnar Nurkse‟s concept of vicious circle of poverty
undoubtedly established this fact. The mobilization of small saving is one of the
important aspects of introduction to capital formation in a country. Even though
the Nurksian theory takes a different route to make the circle virtuous, the spirit
of the theory hovers around the capital formation concept. Mutual funds are the
investment venues which constantly are engaged in mobilization of small
savings in the economy and perform the most crucial part in the capital
formation of the country as well as for the development of country.
A mutual fund serves as a link between the investor and securities
market by mobilizing savings from the investor and investing them in the
securities market to generate income. In case of mutual funds, savings of small
investors are pooled under a scheme and the returns are distributed in the
same percentage in which the investments are made by the unit-holders.
Through the chief objective of maximum return, it has been a money-
spinning avenue for investment particularly in the reforms era in the Indian sub
continent.
1.1.2 CONCEPT OF MUTUAL FUNDS.
Mutual Fund is investment product that operates on the principle of
“strength of numbers”. The concept of Mutual fund is based on “Drops
make an ocean”.
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Mutual Funds are association or trusts of public members who wish to
make investment in the financial assets or corporate sector for the mutual
benefit of its members.
The fund collects the moneys of these members from their savings and
invests them on the behalf of investors in a diversified portfolio of financial
assets with a view to reduce risks and to maximize their income and capital
appreciation for distribution to its members on a pro-rata basis. A portfolio of a
mutual fund scheme is the basket of financial assets held by that particular
scheme. It comprises of investment in a variety of securities and asset
category. This collecting or “pooling” permits a number of investors to
contribute to, according to their amount and capacity of investment, the
performance of the fund that is managed with what is acknowledged to be
expertise. Hence, the small investors enjoy collectively the benefits of expertise
in investment by specialist in the trust, which no single individual by himself
could enjoy. By means of the number of options in the form of stocks, bonds or
other financial securities available in the fund‟s portfolio the investors gain
access to wide range of securities, which otherwise would have been only a
dream. Managers of mutual funds along with diversification and risk reduction,
also endow with a variety of services not otherwise reachable to the small
investors.
Mutual Fund is thus a concept of mutual help of subscribers for portfolio
investment and management of these investments by specialist and expert in
the field. Mutual funds play an imperative role in mobilizing the savings of small
investors and then channelizing the same for productive ventures in the Indian
Chapter - 1 : Overview of Mutual Fund
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economy. These funds are set up under the Indian Trusts Act (1882).UTI is
governed by its own Act. From time to time Securities Exchange Board of India
(SEBI) provides necessary guidelines to regulate mutual fund companies.
Mutual Funds diversify their activities in the following areas:
Portfolio management services
Management of offshore funds
Providing advice to offshore funds
Management of pension or provident funds
Management of venture capital funds
Management of money market funds
Management of real estate funds
Figure 1.1
Mutual Fund Operation Flow Chart
Source: www.amfiindia.com
1.2 CHARACTERISTICS OF MUTUAL FUNDS
Some noteworthy distinctiveness of mutual funds which are considered
to be universal in nature irrespective of the type of fund is summarized as
under.
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1. Mobilization of funds: Mutual fund helps to mobilize the savings
of small investor by launching schemes which are specially designed to meet
their investment preferences. In this way the scattered savings of small
investors are accumulated into a common fund of considerable amount and
then invested in a number of financial instruments available in the capital
market. Hence the retail investors get an opportunity to participate in the
prosperity of a large number of companies.
2. Diversification of risks: Mutual funds with the collected funds
from small investors can ensure diversification. The investment collected from
various investors of a mutual fund scheme are invested in the scrip of a number
of companies so as to make certain the diversification of the portfolio, which
results in the diminution of magnitude of risk.
3. Allocation of returns with fellow investors: Returns earned on
the plentiful of scrip of various companies, that constitute the portfolio of a
mutual fund scheme are distributed among the investors after the deduction of
administration expenditure. The degree of returns earned depends on the value
of the underlying portfolio and as well on the proceeds earned on the various
scrips that make up the portfolio of an individual investor.
4. Expert services: Mutual fund employs experts and professional
managers to take the investment decision and to efficiently manage the
portfolio of the individual investors. Thus the professional insight and the
dynamic approach towards the investment of the resources provide these
managers an edge over the individual investor in dealing with risk of capital
market securities.
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1.2.1 Merits of Mutual Funds
1. Diversification: Retail investors owing to financial constraints cannot
do diversification of portfolio, which is a necessity for risk minimization. Also an
investor undertakes risk if he invests all his funds in a particular scrip without
diversifying.
Mutual funds invest the „pool‟ of funds accumulated in number of
companies across a broad cross-section of industries and sectors available for
investments purpose. Thus, this well-diversified portfolio, which has the
features of debt as well as equity instruments, reduces the risk phenomenon
considerably because seldom do all stocks decline at the same time and in the
same proportion. In this way, even if a part of investor‟s portfolio were to go
through a down turn, profit from other performing stocks can check the erosion
in its value. Moreover, each investor in a fund is a part owner of all of the fund‟s
assets. This enables an investor to possess a basket of diversified investment
opportunities shaped in a well-managed portfolio even with a small amount of
money, which would otherwise call for a huge capital.
Chapter - 1 : Overview of Mutual Fund
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Figure 1.2
Investment Pyramid
2. Professional Management: As soon as an investor invests in a
mutual fund scheme, he is relieved of the chores and tensions associated with
managing investments on their own as they cede all the control to heir expert
fund managers. Also many of the investors are ignorant of the financial market
operations and it is not only expensive to „hire the services‟ of an expert but it is
more difficult to identify a real expert, whose main concern will be to invest
fairly on behalf of the investor. The fund manager of a mutual fund is a
professional, performing the job to handle the investors‟ investment so that he
does not have to worry about where to invest, as very few people have the
required time, knowledge, experience and the inclination to understand and
analyze financial markets, on their own to succeed in today‟s fast moving,
global and sophisticated world. Even if the investor has a big amount of capital
available to him, he gets the much deserved benefits from the professional
Capital Preservation
Risk: Low to Medium
Period: Less than 1 year
Income Risk: Medium to Low
Period: 1 to 3 years
Capital Growth Risk: Medium to High
Period: 3 to 5 years
Investor Portfolio Composition
Growth
Funds
Stock
s
Income/Bond Funds Company Fixed Deposits
Bonds
Debentures
Money Market Funds
Short-term Deposits /Government Paper
Chapter - 1 : Overview of Mutual Fund
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management skills brought in by the fund in the management of the investor‟s
portfolio. The investment management skills along with the needed research
into available investment options ensure a much better return than what an
investor can manage themselves.
The fund manager is concerned about following areas of managing an
investor‟s investment.
1. Protection of value of the original investment.
2. Generation of a stable return on the original investment.
3. Facilitation of capital appreciation.
The investors avail of the services of the experienced and skilled
professionals who are backed by a committed investment team which analyses
the performance and prospects of companies and select suitable investment to
achieve the objective of the scheme as specified in the offer document of the
scheme. The fund manager makes possible an organized investment strategy,
which is hardly possible for an individual investor at a small scale.
3. Convenient Administration: Mutual fund companies offer services
such as updated information on the status of the investment through the fund‟s
newsletter. Investing in a mutual fund company results in the reduction of
paperwork and also assist an investor to avoid many problems for example bad
deliveries, delayed payments of dividends and any unnecessary follow up with
the brokers and companies. Also investors can easily transfer their holdings
from one scheme to the other without any difficulty as well they don‟t have to
make payment for brokerage. Hence providing these important services,
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mutual fund save investor‟s time and make investing trouble-free and
convenient.
4. Liquidity: Generally investors cannot sell the securities held by them
easily and quickly, as selling of these securities can be a painful proposition.
Investment in a mutual fund scheme is fairly liquid as compared to many
corporate shares. In an open-ended scheme, an investor can get back his
money promptly at the net asset value related prices from the mutual fund
itself. On the other hand, in case of a close-ended scheme, an investor can sell
the units on a stock exchange at the existing market prices or can avail of the
facility of direct repurchase at NAV related prices which some close-ended and
interval schemes offer the investors occasionally. Thus when there is
requirement of immediate cash, the units of the mutual fund scheme can be
liquidated by the respective investor without any impediment.
5. Return Potential: Mutual fund have the potential to provide higher
return over a long term as they yield to diversification of securities according to
the objectives which are mentioned clearly and specifically in an offer
document. In a mutual fund, dividend and capital gains earned by the investor
can be repeatedly reinvested, thus compounding the reinvestments.
6. Assured Allotment: Mutual fund houses endow with assurance to
the potential investors of firm allotment (typically it is total, some time it is
partial) when an application has been made for the units of the mutual fund
schemes. Obviously, under the tax-savings schemes, there is limit on
investment.
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7. Low Cost: Investment in a mutual fund scheme proves to be
relatively less expensive as compared to directly investing in the capital market.
A direct investor bears all the costs of investing for example brokerage or
custody of securities. While, investing through a mutual fund, the investor has
the advantage of economies of scale; the funds pay lesser costs because of
larger volumes of funds available for investment. In this way even a small
investor will obtain the benefits of economies of scale, if resorts to mutual fund
investment option. Moreover, the entry and exit load are nominal as well as
administration expenses are also economical.
8. Transparency: Investment in a mutual fund is perhaps considered
the most transparent financial intermediary. When investors invests in a
scheme of a mutual fund house, the investor knows the investment objective,
the asset allocation pattern, net asset value, expenses, and any other
information which is important before investment is made. The investors
receives regular information on the value of investment in addition to disclosure
on specific investment made by the scheme, the proportion of money invested
in each category of assets and the fund manager‟s investment strategy and
outlook. In addition to this, mutual fund clearly declares their portfolio every
month. Thus an investor has the idea of where his money is being deployed
and in case they are not satisfied with their portfolio construction, they can
withdraw at a short notice. With the help of such transparency an investor can
track the performance of the mutual fund scheme periodically.
9. Flexibility: Investing in a mutual fund scheme provides elasticity to
the investors. Various investment options are offered to the investors which
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may cater to the individual requirements. Through features of regular
investment plans, regular withdrawal plan, reinvestment option, dividend option,
growth plans an investor can systematically invest according to the necessity
and convenience. Along with this, mutual fund offers a family of schemes or
investment patterns such as equity, debt, liquid or balanced funds and an
investor have the option of transferring their holdings from one scheme to the
other within the same fund house.
10. Tax Benefits: Some mutual fund schemes offer tax rebates to the
investors under specific provisions of the Income Tax Act, 1961 as the
Government offers tax incentives for investment in specified avenues, for
example, Equity Linked Savings Schemes (ELSS). Pension schemes launched
by the mutual funds also offer tax benefits. These schemes are growth oriented
and invest pre-dominantly in equities. Their growth opportunities and risks
associated are like any equity-oriented scheme.
11. Asset Allocation: Investment in a mutual funds helps in allocating
money into diverse investment options, keeping the risk aptitude and tolerance
in mind. If Rs10000 is invested in a fund, then the money can be allocated in
debt or equity instruments, as per the risk appetite of the individual investor.
12. Career Planning: Mutual fund offers the option of Systematic
Investment Plan (SIP) which proves to be an ideal way of investment for young
people who are on the threshold of commencing their career and require
building wealth over a long period of time. Through systematic investment plan
an investor can invest money at regular interval in a mutual fund scheme. This
will also help in escalating the habit of savings among younger generation.
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13. Retirement Planning: Besides the concern for younger people,
mutual fund also offers Systematic Withdrawal Plan (SWP), which is ideal for
retired or nearing retirement persons. Under these plans one can make
investments in a mutual fund scheme and can withdraw money at regular
interval to take care of the old age expenditure.
14. Stability To Stock Market: As mutual fund houses have a large
amount of pooled funds at their discretion, it provides those economies of scale
by which they can absorb any losses in the stock market and can continue
investing in the stock market. In addition, mutual fund increases liquidity in the
money and capital market.
15. Equity Research: Mutual fund houses are able to afford information
and data required for investment in performing companies and sectors as they
have availability of large amount of funds, resources, and dedicated equity
research teams.
16. Well Regulated: Registration of mutual fund houses are made
mandatory by Securities Exchange Board of India (SEBI). All the mutual fund
companies are required to function within provision of strict regulations
designed to protect the interest of investors. Moreover, the operations of mutual
fund are regularly monitored by SEBI.
17. Small Investments: Even a small investor can become a part of
mutual fund scheme without any difficulty. Most mutual fund schemes keep the
minimum investment between Rs 1000 to 5000. No other avenue of investment
offers such a wide array of choice for such an affordable sum by retail
investors.
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18. Simplicity: Investments in mutual fund is measured to be
straightforward, in contrast to other available instruments in the market. Most
Asset Management Company also has automatic purchase plans whereby
units of the mutual fund can be purchased from as little as Rs 2000, as also
where systematic investment plan starts with just Rs.50 per month basis.
19. Freedom from Tracking Investments: Investors are relieved from
tracking the performance of their investments on a regular basis. The important
task of checking the scheme‟s performance is done by experts appointed by
the mutual fund house, who buy and sell securities on the behalf of investor to
achieve the preset objectives for them. Investors are only required to track the
performance of the mutual fund house.
20. Essentials: Investors are required to match their wants with the
detailed benefits that are provided by mutual fund. This will make certain that
the investor makes a better choice and gets the maximum advantages of
various schemes.
1.2.2 Demerits of Mutual Funds
1. No Control Over Cost: Investors who invest in a mutual fund do
not have any control over the overall cost of investing. People who invest in mf
are subject to pay management fees as long as they are part of the fund. In
return, they get professional management and research. The fees is payable as
a percentage of the value invested by the investor irrespective of the fund‟s
performance. A mutual fund investor is also bound to pay distribution cost,
which he would not incur in direct investment. On the other hand, this
shortcoming only means that there is a cost to get hold of the expert services of
Chapter - 1 : Overview of Mutual Fund
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a mutual fund house and this cost is often less compared to the cost incurred
by the investor in direct investment. Above and beyond Securities Exchange of
Board of India has prescribed a ceiling on the maximum expenses that the fund
managers of a mutual fund company can charge on the schemes, thereby
minimizing the investors‟ expenditure of making investment in a mutual fund
company.
2. No Tailor Made Portfolio: Mutual fund has no tailor made
schemes which will be able to suit an individual investor‟s objectives of
investment. The reason for the same is that accomplished and proficient
investors construct their own portfolio of shares, bonds and other securities
with an unambiguous objective. Whereas investing through mutual fund means
transfer of this function to the fund manager. Now the decision of designing a
portfolio vests in the hands of fund managers. It depends on the fund managers
that how and where they mobilize the investments of individual investors
collectively. High-net-worth individuals or large corporate investors may find it
to be a constraint in accomplishing their goals. However, majority of the mutual
fund companies overcome this limitation by offering a variety of schemes under
the same fund. Also each scheme provides several plans and options for the
convenience of the investors. A particular investor can select from different
investment schemes/options/plans and can devise an investment portfolio
according to his preferences and requirements.
3. Difficulty in Managing Portfolio of Fund’s: Due to availability of
large number of funds the selection of appropriate funds itself becomes a brain
storming situation, as this will provide varied opportunities to retail investor.
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One may need professional advice for making a decision of selecting the most
appropriate scheme. Some times it may be difficult for the investor to make a
right choice from the basket of funds, quite similar to a situation where he
selects individual shares and bonds when he opts for direct investment.
Fortunately, India now has a large number of Association of Mutual Fund in
India (AMFI) - registered fund distributors and financial planners who are
competent enough to provide right guidance at the right time for the right
investment opportunities to the investors.
4. No Guaranteed Returns: There is no assurance to unit holders
as to the returns on their investment in a mutual fund scheme because the Net
Asset Value of the scheme may go up or down depending upon the factors and
forces affecting the securities market. The mutual fund schemes are exposed
to usual risk associated with capital and money market such as price/interest
rate risk, credit risk etc.
5. Inadequacy of Professional Management: Due to limitation of
professional management, some funds don‟t perform in the capital market. The
reason following this situation may the management which is not dynamic
enough to explore the available opportunity in the market. Hence, the investor
ponders over the question of whether assigning their hard earned money to be
invested by a professional manager of a mutual fund scheme or to directly
invest in the capital market themselves. Also due to lack of practical approach
on the part of fund manager can also detain an investor from investing in a
mutual fund scheme.
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6. Dilution: As funds of a single investor have small holdings across
different companies, high returns from a few investments often don‟t make
much variation on the overall return. Dilution is also the consequence of a
successful fund getting too big to manage. Once money pours into funds that
have had strong success, the managers often have to face dilemma of finding a
good investment for all the fresh money.
7. Taxes: A fund manager of a mutual fund scheme does not reflect
on the personal tax situation of an individual investor. For instance, when a sale
of security is made by fund manager, the capital-gain tax is triggered, which
influences the profitability of an investor from such sales. It might have been
more beneficial for the investors to put off the capital gain liability.
8. Shifting Of Loyalty Of A Fund Manager: Performance of the
mutual fund schemes of a mutual fund company could be severely affected if a
fund manager shifts his loyalty for the particular mutual fund house. It can
prove to be a loss for the investors whose investments were managed by that
fund manager.
1.3 HISTORY OF MUTUAL FUND
The origin of today‟s Mutual funds can be found in the early nineteenth
century‟s English Investment Trust and Investment Companies. The investment
company concept dates back to Europe in the late 1700s, according to K. Geert
Rouwenhorst in The origin of mutual funds “a Dutch merchant and broker …
invited subscription from investors to form a trust … to provide an opportunity to
diversify for small investors with limited means”. A mutual fund is a type of
Chapter - 1 : Overview of Mutual Fund
19
Investment Company that gathers assets from investors and collectively invests
those assets in stocks, bonds, or money market instruments.
Historians are uncertain of the origins of investment funds; some cite the
closed-end investment companies launched in the Netherlands in 1822 by King
William I formed “Societe Generale de Belique”,at Brussels,which appears to
be the first mf, while others point to a Dutch merchant named Adriaan van
Ketwich whose investment trust created in 1774 may have given the king the
idea. Van Ketwich probably theorized that diversification would increase the
appeal of investments to smaller investors with minimal capital. The name of
van Ketwich's fund, Eendragt Maakt Magt, translates to "unity creates
strength". The next wave of near-mutual funds included an investment trust
launched in Switzerland in 1849, followed by similar vehicles created in
Scotland in the 1880s.
The idea of pooling resources and spreading risk using closed-end
investments soon took root in Great Britain and France, making its way to the
United States in the 1890s. The Boston Personal Property Trust, formed in
1893, was the first closed-end fund in the U.S. The creation of the Alexander
Fund in Philadelphia, Pennsylvania, in 1907 was an important step in the
evolution toward what we know as the modern mutual fund. The Alexander
Fund featured semi-annual issues and allowed investors to make withdrawals
on demand. While the mutual fund had its origin in Belgium, it did not take firm
root in continental soil but flourished when transplanted in UK and USA
surroundings.
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1.3.1 Collective Investment Vehicle
Historically, mf in UK and USA began as private enterprise, known as
investment trust. An investment trust would be founded by a single individual
who used his financial abilities and judgment for the benefit of a group and
who, in turn for his advice and allowed to retain a percentage of profits made
from the group‟s joint investment.
Over a period of time, mf industry has undergone numerous changes.
MF evolved in response to the market condition marking notable changes in
their organization structure and the economics of the industry.
1.3.2 Mutual Fund Industry in UK
The first investment trust, Foreign and Colonial, set out its investment
aims “to give investors of moderate means, the same advantage as the large
capitalist” in its prospectus of 1868. 1880s was the period of boom for this
innovative investment opportunity in UK. Though some investment trusts failed
during the British crash of 1890, most of them survived. By 1900there were
more 100 investment trusts, many of them are still around. These investment
trusts are close-ended funds.
The years from 1900 to 1914 were marked by an increasing tendency on
the part of British investment manager to invest their clients‟ funds in American
securities, especially in stocks and bonds of American railways. With advent of
the First World War, this situation changed drastically. From 1914-1918, British
mutual fund sold a large proportion of their American investment, and a large
part of the money obtained from the sale of American stocks and bonds was
Chapter - 1 : Overview of Mutual Fund
21
promptly invested in the war loans of the British government. Though less
remunerative, yet this strategy enabled the survival of the industry.
A. Emergence of Unit Trust
In US, many small investors lost their fortunes in the years following the
Wall street crash of 1929. But not even one investment trust failed during those
troubled years (1890s) in UK. However, some structural changes started taking
place in the industry. The most important one was the emergence of unit trust.
Unit trusts are created by trust deed. The first unit trust appeared in 1931,
shortly after the Wall Street crash. It was a period when income was more
important consideration than growth. Unit trusts conform to the basic pattern of
open-ended investment funds in UK.
Investment trusts continued to be popular with private investor‟s right up
until the middle of 1960s. The unit trust industry expended rapidly till October
1987 crash. By January, 1998 there were almost 1200 unit trust managed by
more than 160 groups. These trusts became popular mainly because of the
range of investment opportunities they made available to the investors. The
stock market crash at the end of 1987 brought significant changes in the unit
trust industry. The other main event affecting the unit trust industry during and
after post 1988 is the implementation of the financial services act. The
Financial services Act brought the investors greater protection and large
number of restriction on the industry.
By the end of 1997 there was $237 billion of asset managed by 1455
open-ended funds. In the last decade, a lot of changes have taken place in the
industry. Increased investor sophistication, wealth and power have led to
Chapter - 1 : Overview of Mutual Fund
22
significant influence on the growth of mf market. Investors are demanding
better levels of services, transparency in prices and more product variety. On
the political front there is a drive for lower costs and standardization to
encourage saving. The competition in UK fund industry has increased due to
low entry barriers encouraging new players. The increased level of competition
is putting pressures on prices. There has been a trend in the industry to focus
on core activities and outsource the rest.
The pace of change is very rapid, resulting in steep increase in volumes.
New products are launched, and newer distribution methods are explored. The
mf industry in UK is witnessing a restructuring wave and the outcome is
powerful brand leaders.
1.3.3 Mutual Fund Industry in USA
The origin of mf in the USA could be traced to the private trustee system
in Boston during the second half of 19th century. One of the first investment
trusts, the Boston Personal Property Trust, was organized in 1893.It advertised
that it “was organized for the purpose of giving persons of small means an
opportunity to invest in diversified lists of securities held by a trust which was
managed by professional trustees which is regular line of business in Boston".
It was the Alexander Fund established in Philadelphia in 1907 by W. Wallace
Alexander that seems to have originated many of the ideas adopted by mutual
funds. Like 1924s M.I.T. and State Street Investors mutual fund, the Alexander
fund began as an investment vehicle for a small circle of friends and eventually
expanded to include the general public. As the United States economy grew,
Chapter - 1 : Overview of Mutual Fund
23
investment companies were formed in Boston, New York and many other
states.
The creation of the Massachusetts Investors' Trust in Boston,
Massachusetts, heralded the arrival of the modern mutual fund in 1924. The
fund went public in 1928, eventually spawning the mutual fund firm known
today as MFS Investment Management. State Street Investors' Trust was
the custodian of the Massachusetts Investors' Trust. Later, State Street
Investors started its own fund in 1924 with Richard Paine, Richard Saltonstall
and Paul Cabot at the helm. Saltonstall was also affiliated with Scudder,
Stevens and Clark, an outfit that would launch the first no-load fund in 1928. A
momentous year in the history of the mutual fund, 1928 also saw the launch of
the Wellington Fund, which was the first mutual fund to include stocks and
bonds, as opposed to direct merchant bank style of investments in business
and trade.
A. Regulation and Expansion
By 1929, there were 19 open-end mutual funds challenging with nearly
700 closed-end funds. With the stock market crash of 1929, the dynamic began
to change as highly-leveraged closed-end funds were wiped out and small
open-end funds managed to survive.
Government regulators also began to take notice of the fledgling mutual
fund industry. The creation of the Securities and Exchange Commission (SEC),
the passage of the Securities Act of 1933 and the enactment of the Securities
Exchange Act of 1934 put in place safeguards to protect investors: mutual
funds were required to register with the SEC and to provide disclosure in the
Chapter - 1 : Overview of Mutual Fund
24
form of a prospectus. The Investment Company Act of 1940 put in place
additional regulations that required more disclosures and sought to minimize
conflicts of interest.
The mutual fund industry continued to expand. At the beginning of the
1950s, the number of open-end funds topped 100. In 1954, the financial
markets overcame their 1929 peak, and the mutual fund industry began to grow
in earnest, adding some 50 new funds over the course of the decade. The
1960s saw the increase of aggressive growth funds, with more than 100 new
funds established and billions of dollars in new asset inflows.
Hundreds of new funds were launched throughout the 1960s until the
bear market of 1969 cooled the public appetite for mutual funds. Money flowed
out of mutual funds as quickly as investors could redeem their shares, but the
industry's growth later resumed.
In the USA, mutual fund industry evolved in three phases.
1. Pre 1940,
2. 1940-1970,
3. 1970 to the present.
The first stage that is the period before 1940 was the stage of infancy of
the mutual fund industry. Mutual funds, in those days, were small and dissimilar
to the extent that these entities were not even given the status of a separate
industry. Close-ended funds were the dominant form of mutual funds to
mobilize money (1929 assets mobilized under close ended schemes accounted
for 95% of the total assets of the industry). However, by the end of 1940s the
share of close-ended funds started shrinking in favor of open-ended fund.
Chapter - 1 : Overview of Mutual Fund
25
In the second stage, assets managed by mutual funds witnessed rapid
and steady growth and mutual fund evolved into an established industry.
Assets under management were $450 million. In 1940, it rose to $47.6 billion
by the end of 1970. During this phase open-ended funds became the dominant
form of mutual funds.
The most striking feature of the phase (1970 to present) has been the
innovation in the investment objective. Till this phase most of the money was
mobilized under the objective of providing the benefit of diversification in equity
investing. While there were five type of funds offered in 1970, there were 22
different types in 1987. The money market mutual fund is considered the most
innovative launch of that time, as this product was quite different in contrast
with the then existing equity product and was, in many respect very close to the
products offered by banks. It widened the scope of competition for mf with
banks on account of similarity in the product.
Another important happening of that time was the innovative steps taken
by the fund to improve the quality of investor servicing. An example can be
given of the exchange privilege given to the investors to shift from one fund to
another. Another significant development post-1970 has been the reduction or
elimination of sales loads, thereby increasing the mobility of investors. In 1971,
William Fouse and John McQuown of Wells Fargo Bank established the first
index fund, a concept that John Bogle would use as a foundation on which to
build The Vanguard Group, a mutual fund powerhouse renowned for low-cost
index funds. The 1970s also saw the rise of the no-load fund. This new way of
doing business had an enormous impact on the way mutual funds were sold
Chapter - 1 : Overview of Mutual Fund
26
and would make a major contribution to the industry's success. The total assets
under management by the end of 1997 were $ 4465 billion managed by 6900
funds.
The decade 1990-2000 was particularly favorable to mutual fund
industry in USA as by the end of 2000 the asset managed by the industry
increased to $7 trillion. The increased demand for mutual funds in the 1990s
led to the creation of a large number of new mutual fund companies. The
number rose from 2900 at the beginning of the decade to about 8200 by the
end of 2000. As stocks and other financial assets earned relatively high returns
in 1990s, households shifted their asset allocation away from real estates and
other tangible assets to financial assets.
During this shift, households showed an increasing preference to
investment through mf than buying securities directly. The number of
households owing mf reached to 50.6 million in 2000 as against 23.4 million in
1990. World equity funds were also an important element in the growth of mf,
as investors increasingly sought to diversify their financial assets through
overseas investment. With the rising demand for mf in 1990s, fund companies
and distribution companies developed new outlets for selling mf and expanded
traditional sales channels. Many funds primarily marketed directly to investors
turned increasingly to third parties and intermediaries for distribution. Funds
that were traditionally sold through a sales force of brokers shifted increasingly
to non-traditional sources of sales such as employee-sponsored pension plans,
banks and life insurance companies in the 1990s.
Chapter - 1 : Overview of Mutual Fund
27
With the 1980s and '90s came bull market mania and previously obscure
fund managers became superstars; Max Heine, Michael Price and Peter Lynch,
the mutual fund industry's top gunslingers, became household names and
money poured into the retail investment industry at a stunning pace. More
recently, the burst of the tech bubble and a spate of scandals involving big
names in the industry took much of the shine off of the industry's reputation.
Shady dealings at major fund companies demonstrated that mutual funds aren't
always benign investments managed by folks who have their shareholders'
best interests in mind and who treat all investors equally.
Despite the 2003 mutual fund scandals, the story of the mutual fund is
far from over. In fact, the industry is still growing, opening up new markets
around the world. The first Korean mutual fund, the Mirae Asset Park Hyun-joo
Fund, was launched in Dec 1998. Today there are 20 trillion Korean won (about
US$19.32 billion) invested in Korea's funds. In the U.S. alone there are more
than 10,000 mutual funds, and if one accounts for all share classes of similar
funds, fund holdings are measured in the trillions of dollars. Despite the launch
of separate accounts, exchange-traded funds and other competing products,
the mutual fund industry remains healthy and fund ownership continues to
grow.
1.3.4 Mutual Funds Industry in India
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 India. The purpose of establishing the Unit Trust of India was to give a
fillip to equity market. In the wake of Indo-China war of 1961, there was
Chapter - 1 : Overview of Mutual Fund
28
shortage of savings going into industrial investment for economic development.
There was a need to mobilize adequate amount of risk capital for industrial
enterprises. The household savings were sought to be channelized into the
primary and secondary share market through units. However in the initial years,
the emphasis in UTI was on income products.
The Indian mutual fund industry has evolved over distinct stages. The
growth of mutual fund industry in India can be divided into four phases:
(1) Phase I (1964-87)
(2) Phase II (1987-92)
(3) Phase III (1992-97)
(4) Phase IV (beyond 1997)
1. Phase I: 1964 – 87
The mutual fund concept was introduced in India with setting up of UTI
Act in 1963. The Unit Trust of India (UTI) was the first mutual fund set up under
the UTI Act, 1963, a special act of the Parliament. Unit Trust of India (UTI) was
established on 1963 by an Act of Parliament. It was set up by the Reserve
Bank of India and functioned under the Regulatory and administrative control of
the Reserve Bank of India. It became operational in 1964 with a major objective
of mobilizing savings through the sale of units and investing them in corporate
securities for maximizing yield and capital appreciation. In 1978 UTI was de-
linked from the RBI and the Industrial Development Bank of India (IDBI) took
over the regulatory and administrative control in place of RBI. This phase
commenced with launch of unit scheme 1964 (US-64) the first open-ended and
Chapter - 1 : Overview of Mutual Fund
29
the most popular scheme. UTI‟s investible funds, at market value (and including
the book value of fixed assets) grew as under:
Table 1.2
Growth of UTI’s Investible Funds
during Phase I : 1964 - 87
Year Investment
1965 49 Crore
1970 – 71 219 Crore
1980 – 81 1126 Crore
1987 5068 Crore
Its investor base had also grown to about 2 million investors. It launched
innovative schemes during this phase. Its fund family included five income-
oriented, open-ended schemes, which were sold largely through its gent
network built up over the years. Master shares were the real close-ended
scheme floated by UTI. It launched Indian fund in 1986-the first Indian offshore
fund for overseas investors, which was listed on the London Stock Exchange
(LSE). UTI maintained its monopoly and experienced a consistent growth till
1987.
2. Phase II: 1987-92 (Entry of Public sector)
The second phase witnessed the entry of Mutual Fund Company
sponsored by nationalized banks and insurance companies. In 1987, SBI
Mutual fund and Canbank Mutual fund were set up as trusts under the Indian
Trust Act, 1882. In 1988, UTI floated another offshore fund, namely T he Indian
Growth Fund which was listed on the New York Stock Exchange (NYSE). By
Chapter - 1 : Overview of Mutual Fund
30
1990, the two nationalized insurance giants, LIC and GIC, and nationalized
banks, namely, Indian bank, Bank of India, and Punjab National Bank had
started operations of wholly-owned mutual fund subsidiaries. The assured
return type of schemes floated by the mutual funds during this phase was
perceived to be another banking product offered by the arms of sponsor banks.
In October 1989, the first regulatory guidelines were issued by the Reserve
Bank of India, but they were applicable only to the mutual funds sponsored by
banks. Subsequently, the Government of India issued comprehensive
guidelines in June 1990 covering all mutual funds. These guidelines
emphasized compulsory registration with SEBI and an arms length relationship
be maintained between the sponsor and asset management company (AMC).
With the entry of public sector funds, there was a tremendous growth in the
size of the mutual fund industry with investible funds, at market value,
increasing to Rs 53,462 crore and the number of investors increasing to over
23 million. The buoyant equity market in 1991-92 and tax benefits under equity-
linked saving schemes enhanced the attractiveness of equity funds.
3. Phase III: 1992-97 (Entry of Public Sector Funds)
The year 1993 marked a turning point in the history of mutual funds in
India. With the entry of private sector funds in 1993, a new era started in the
Indian mutual fund industry, giving the Indian investors a wider choice of fund
families. The Securities and Exchange Board of India (SEBI) issued the Mutual
Fund Regulations in January 1993. SEBI notified regulations in bringing all
mutual funds except UTI under a common regulatory framework. Private
domestic and foreign players were allowed entry in the mutual fund industry.
Chapter - 1 : Overview of Mutual Fund
31
Kothari group of companies, in joint venture with Pioneer, a US fund company,
set up the first private mutual fund the Kothari Pioneer Mutual Fund, in 1993.
Kothari Pioneer introduced the first open-ended fund Prima in 1993. Several
other private sector mutual funds were set up during this phase. UTI launched
a new scheme, Master-gain, in May 1992, which was a phenomenal success
with subscription of RS 4,700 crore from 63 lakh applicants. The industry‟s
investible funds at market value increased to Rs 78,655 crore and the number
of investor accounts increased to 50 million. The 1993 SEBI (Mutual Fund)
Regulations were substituted by a more comprehensive and revised Mutual
Fund Regulations in 1996.
The industry now functions under the SEBI (Mutual Fund) Regulations
1996. However, the year 1995 was the beginning of the sluggish phase of the
mutual fund industry. During 1995 and 1996, unit holders saw an erosion in the
value of their investment due to a decline in the NAV‟s of the equity funds.
Moreover, the service quality of mutual funds declined due to a rapid growth in
the number of investor accounts, and the inadequacy of service infrastructure.
A lack of performance of the public sector funds and miserable failure of foreign
funds like Morgan Stanley eroded the confidence of investors in fund
managers. Investor‟s perception about mutual funds gradually turned negative.
Mutual funds found it increasingly difficult to raise money. The average sales
declined from about Rs 13,000 crore in 1991-94 to about Rs 9000 crore in 1995
and 1996.
The number of mutual fund houses went on increasing, with many
foreign mutual funds setting up funds in India and also the industry has
Chapter - 1 : Overview of Mutual Fund
32
witnessed several mergers and acquisitions. As at the end of January 2003,
there were 33 mutual funds with total assets of Rs. 1, 21,805 crores. The Unit
Trust of India with Rs.44, 541 crores of assets under management was way
ahead of other mutual funds.
4. Phase IV: 1997 – 98
During this phase, the flow of funds into the kitty of mutual funds sharply
increased. This significant growth was aided by a more positive sentiment in
the capital market, significant tax benefits, and 2000 to over Rs 1,10,000 croe
with UTI having 68% of the market share. During 1999-2000 sales mobilization
reached a record level of Rs 73000 crore as against Rs 31,420 crore in the
preceding year. This trend was, however, sharply reversed in 2000-01. The UTI
dropped a bombshell on the investing public by disclosing the NAV of US-64-
its flagship scheme as on December 28, 2000, just at Rs 5.81 as against the
face value Rs 10 and the last sale price of Rs 14.50. The disclosure of NAV of
the country‟s largest mutual fund scheme was the biggest shock of the year to
investors. Crumbling global equity markets, a sluggish economy coupled with
bad investment decision made life tough for big funds across the world in 2001-
02. The effect of these problems was felt strongly in India also. Pioneer ITI, JP
Morgan and Newton Investment Management pulled out from the Indian
market. Bank of India MF liquidated all its schemes in 2002.
The Indian MF industry has stagnated at around Rs 1, 00,000 crore
assets since 2000-01. This stagnation is partly a result of stagnated equity
markets and the indifferent performance by players. As against this, the
aggregate deposit of Scheduled Commercial Banks (SCBs) as on May 3, 2002,
Chapter - 1 : Overview of Mutual Fund
33
stood at Rs 11,86,468 crore. Mutual fund assets under management (AUM)
form just around 10 % of deposits of SCBs.
5. Phase V: 1999-2004 (Emergence of a large and uniform industry)
The other major development in the fund industry has been the creation
of a level playing field for all mutual funds operating in India. This happened in
February 2003, when the UTI Act was repealed. In February 2003, following
the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two
separate entities.
One is the Specified Undertaking of the Unit Trust of India 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
other schemes. 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 under the purview of the Mutual Fund Regulations.
The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB
and LIC. It is registered with SEBI and functions under the Mutual Fund
Regulations. With the bifurcation of the erstwhile UTI which had in March 2000
more than Rs.76, 000 crores of assets under management and with the setting
up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations,
and with recent mergers taking place among different private sector funds, the
mutual fund industry entered in the fourth phase of consolidation and growth.
As at the end of September, 2004, there were 29 funds, which manage assets
of Rs.153108 crores under 421 schemes.
Chapter - 1 : Overview of Mutual Fund
34
Unit Trust of India no longer has a special legal status as a trust
established by an Act of Parliament. Instead, it has also adopted the same
structure as any other fund in India-a trust and an Asset Management
Company. UTI Mutual Fund is the present name of the erstwhile Unit Trust of
India. While UTI functioned under a separate law of Indian parliament earlier,
UTI Mutual Fund is now under the SEBI‟s (Mutual Funds) Regulations, 1996
like all other mutual funds in India. UTI Mutual Fund is still the largest player in
the Indian fund industry. All SEBI compliant schemes of the erstwhile UTI are
under its charge. All new schemes offered by UTI Mutual Fund are SEBI
approved. Other schemes (US 64, Assured Return Schemes) of erstwhile UTI
have been placed with a special undertaking administered by the Government
of India. These schemes are being gradually wound up.
The emergence of uniform industry with the same structure, operation
and regulations makes it easier for distributors and investors to deal with any
fund house in India.
1999 marked the beginning of a new phase in the history of the mutual
fund industry in India, a phase of significant growth in terms of both amounts
mobilized from investors and assets under management.
Between 1999 and 2005, the size of the industry has doubled in terms of
assets under management which has gone from about Rs 68,000 crores to
over Rs 150,000 crores. Within the growing industry, the relative market share
of different players in terms of amount mobilized and assets under
management have also undergone changes.
Chapter - 1 : Overview of Mutual Fund
35
6. Phase 6 – 2004 onwards: Consolidation and Growth of Mutual
Fund Industry.
The industry has lately witnessed a spate of mergers and acquisitions,
most recent ones being the acquisition of schemes of Alliance Mutual Fund by
Birla Sun Life, Sun F&C Mutual Fund by Principal and PNB Mutual Fund by
principal. At the same time, more international players continue to enter India,
including Fidelity, one of the largest funds in the world. The stage is set now for
growth through consolidation and entry of new international and private sector
players. AS at the end of March 2006, there were 29 funds.
Figure -1.3
Growth In Assets Under Management
Source AMFI
1.4 ORGANISATION OF MF
Mutual fund industry has shown a remarkable growth in performance
over the last few years and is still enduring to do so. It is considered to be the
safest investment avenues because of its well-diversified portfolio and strict
follow up by SEBI. SEBI, the market regulator, has outlined clearly the role,
Chapter - 1 : Overview of Mutual Fund
36
responsibilities and duties of each entity, which form a mutual fund. In India, the
entities which are involved in a mutual fund operation are specified as under.
Figure 1.4
Working Of Mutual Funds
source : amfi
1. Sponsor
2. Trust
3. Asset management company
4. Custodian and depositories
5. Bankers
6. Transfer agent
7. Distributors
8. Registrar
1.4.1 Sponsor
What a promoter is to a company, a sponsor is to a mutual fund. In clear
terms a sponsor is a person who initiates the idea of establishing a mutual fund
company. The sponsor could be a financial services company, a bank or a
Chapter - 1 : Overview of Mutual Fund
37
financial institution. The sponsor will form a trust and appoint the board of
trustees. The sponsor will also generally appoint an Asset Management
Company as fund managers. The sponsor, either directly or through the
trustees, will appoint a Custodian to hold the fund assets. All these
appointments are made in accordance with SEBI Regulation. The sponsor
takes big- picture decision related to the mf. In order to establish a mf in India,
the sponsor is required to obtain a license from SEBI.
A. Eligibility norms for sponsor
1. The sponsor‟s contribution must be a minimum of 40% of the net
worth of AMC.
2. The sponsor is also required to have carried on business in
financial services for a period of not less than five years.
3. It is desirable that the sponsor should have positive net worth in
all the immediate preceding five years of functioning.
4. The net worth of the immediately preceding year should more
than the capital contribution of the sponsor in AMC and the sponsor should
show profit after providing depreciation, interest, and tax for the three out of the
immediate preceding five years.
5. The sponsor and any of the directors or principal officers to be
employed by the mutual fund, should not have been found guilty of fraud or
convicted of an offence involving moral turpitude or guilty of economic offences.
6. Those who qualify the above mentioned criteria are granted
permission by the SEBI to establish a mutual fund.
Chapter - 1 : Overview of Mutual Fund
38
1.4.2 Mutual fund as Trust
Mutual Fund Company is to be formed under the Indian Trust Act of
1882, and is registered with SEBI. The sponsor contributes towards the initial
capital as well as appoints trustee to acquire the assets of the trust for the unit-
holders who are the beneficiaries of such trust. The instrument of trust is
executed by the sponsor in favor of trustees and is registered under the Indian
Registration Act, 1908. The fund thus established invites the prospective
investors to contribute money in the common pool, by subscribing to “units”
issued by various schemes established by the trust. The units acquired by the
investor provide the proof of their beneficial interest in the fund. Under the
Indian Trust Act, 1882 the fund has no independent legal capacity; it is the
trustees who have the legal capacity.
1.4.3 Trustees
The MF company should have board of trustees and trust deed. The
trustees of the mutual fund are appointed by the sponsor. The mutual fund is
managed by the Board of Trustees, who could be- a body of individuals, or a
trust company- a corporate body. The trust is shaped through a document
called the Trust Deed that is executed by the Fund Sponsor in favor of the
trustees. It should be kept in mind that the trustees do not manage the portfolio
of securities directly. This function is performed by the Asset Management
Company, appointed by the trustees or the sponsor, as per the authorization
specified by the Trust Deed.
The trustees are the primary guardian of the unit holders‟ funds and
assets, a trustee is required to be a person of high reputation and integrity. The
Chapter - 1 : Overview of Mutual Fund
39
trustees can be compared as internal regulator in a MF. The responsibility
assigned to trustees is to protect the interests of unit holders. They ensure that
the fund is managed by the AMC according to the defined objectives and in
compilation with the Trust Deed and SEBI Regulation. It is made mandatory by
the SEBI that out of the total number of trustees two-third of the trustees should
be independent- that is, not have any association with the sponsor, to ensure
they are impartial and fair in their dealings.
A. Rights of Trustees
The trustees appoint the AMC with the prior approval of SEBI
They also approve each of the schemes floated by the AMC
They have the right to request any necessary information from the
AMC concerning the operations of various schemes managed by the AMC as
often as required, to ensure that the AMC is in compliance with the Trust Deed
and the regulations
The trustees may take remedial action if they believe that the
conduct of the fund‟s business is not in accordance with SEBI Regulations. In
certain specific events, the Trustees have the right to dismiss the AMC, with the
approval of SEBI and in accordance with the regulations
The trustees have the right to ensure that, based on their
quarterly review of the AMC‟s networth, any shortfall in the networth is made up
by the AMC.
Chapter - 1 : Overview of Mutual Fund
40
B. Obligations of Trustees
The trustees must enter into an investment management
agreement with the AMC. This agreement must be in accordance with the
Fourth Schedule of SEBI (MF) Regulations, 1996.
They must ensure that the fund‟s transactions are in accordance
with the Trust Deed.
The trustees are responsible for ensuring that the AMC has
proper systems and procedures in place and has appointed key personnel
including Fund Managers and a Compliance officer, besides other constituents
such as the auditors and registrars.
The trustees must ensure due diligence on the part of the AMC
for empanelment of brokers.
The trustees must ensure that the AMC is managing schemes
independent of other activities and that the interests of unit-holders of one
scheme are not compromised with those of other schemes/activities. For
example, the trustees must ensure that A MC has not given any undue
advantage to any associates.
The trustees must furnish to SEBI on a half-yearly basis, a report
on the fund‟s activities and a certificate stating that the AMC has been
managing the schemes independently of other activities.
1.4.4 Asset Management Company
An AMC is registered under the Companies Act, 1956, thus giving it a
legal entity. The asset management company also known as Investment
Manager is appointed by the Sponsor, or the trustees, if so authorized by the
Chapter - 1 : Overview of Mutual Fund
41
Trust Deed. To form an AMC the approval of SEBI is also required. It should
have a certificate from SEBI to act as a portfolio manager under SEBI (portfolio
managers) Rules and Regulations, 1993. It is the responsibility of AMC to
recruit fund managers and analysts and other personnel to implement the
decision taken by the sponsor. The AMC has to manage all operational matters
which includes from designing schemes to launching schemes to efficient
handling of investments to communicating with investors. AMC mobilizes the
investment of the investors by making investment in various types of securities.
It acts as the investment manager to the trust under the supervision and
guidance of the trustees.
Minimum required net worth for the AMC is Rs. 10 crores at all times
and this net worth should be in the form of cash. At least 50% of the directors of
the board should be independent, that is, they should not be associated with
the sponsor or its subsidiaries or the trustees. The AMC cannot act as an
AMC/Trustee to any other Mutual Fund. No person can be a director of more
than one AMC or Director of Trust company operated by same AMC.
In return for rendering services, the AMC charges investment
management fees and advisory fess, on an annual basis, according to the size
of the scheme launched by the mutual fund. At present the fees is having the
limit as prescribed by SEBI: on the first Rs 100 crores of the weekly average
net assets – 1.25%; On the balance of net assets – 1.00%.
Chapter - 1 : Overview of Mutual Fund
42
Figure 1.5 Organizational Structure of AMC
Table 1.3 Table Showing Assets Under Management of Certain MF Companies
as on 1st May 2006
Sr. No. Asset Management Company AUM Rs.(in cr.) As on
May 1, 2006 %
1 Prudential ICICI 32151 12
2 UTI 30551 11
3 Reliance 27915 10
4 HDFC 23650 9
5 Franklin Templeton 22360 8
6 Birla Sun Life 16991 6
7 SBI 13670 5
8 DSP Meryll Linch 13308 5
9 Kotak Mahindra 11818 4
10 Tata 10464 4
11 Others 73122 26
Total 276000 100 Source : Investopedia.com
Chief Executive Officer Head of Asset Management Company
Chief Investment Officer Designs the fund’s investment philosophy
Fund Managers
Manages the schemes of the fund
Team of Analysts track market, sectors and companies
Chapter - 1 : Overview of Mutual Fund
43
Figure 1.6
Asset Under Management
12%
11%
10%
9%
8%6%5%
5%
4%
4%
26%
Prudential ICICI UTI Reliance
HDFC Franklin Templeton Birla Sun Life
SBI DSP Meryll Linch Kotak Mahindra
Tata Others
1.4.5 Custodian
The custodian is appointed by the board of trustees. A custodian is
responsible for the maintenance of back office of a mf. The custodian should be
registered with SEBI, to be eligible to become a custodian of mf. The custodian
of the mutual fund company holds the physical securities of various schemes of
the fund in its custody. The duties performed by the custodian can be summed
as receipt and delivery of securities, collection of income, distribution of
dividends, and segregation of assets between schemes. It is important to note
here that the sponsor of a mf cannot act as a custodian to the fund, so as to
ensure that the assets of mutual fund is not in the hands of its sponsor.
Chapter - 1 : Overview of Mutual Fund
44
Custodian
1. HDFC Bank
2. SHCIL
3. Citi Bank
4. Deutsche Bank
5. ABN AMRO
6. IIT Corporate Services
7. SBI India
8. Standard Chartered Bank
1.4.6 Bankers
Mutual funds activities involve dealing with money on a continuous basis
primarily with respect to buying and selling of units, paying for investment
made, receiving the proceeds on sale of investment and discharging its
obligation towards operating expenses. A fund‟s banker therefore plays a
crucial role with respect to its financial dealings by holding its bank accounts
and providing it with remittance services.
1.4.7 Distributor
Mutual fund operates on the principle of accumulating funds from a large
number of investors and then investing on a big scale. For a fund to sell units
across a wide retail base of individual investors, an established network of
distribution agents is essential. Distributors are given agency to sell the
products of mutual fund company in return of a commission.
Chapter - 1 : Overview of Mutual Fund
45
1.4.8 Registrar / Transfer Agent
The registrar is assigned with task of maintaining the accounts of
investors for the purpose of investment as well as disinvestments. The
responsibility undertaken by the registrar includes issuing and redeeming units,
sending fact sheets and annual reports. It depend upon the respective fund
house to manage such purpose in house or outsource it to SEBI- approved
registrars and transfer agents for example Karvy, CAMS etc.
R & TA
1. CAMS
2. Karvy
3. MCS Limited
4. Datamatics
5. MN Dastoor & Co.
6. IIT Corporate Services‟
7. MN Dastoor & Co.
8. Computeronics
9. Tata Consultancy Services
10. CanBank Computer Services
11. ICICI Infotec
12. MCS software solution ltd.
13. PCS Industries ltd.
14. Tata Share Registry
15. UTI ISL.
Chapter - 1 : Overview of Mutual Fund
46
1.4.9 Investor
The people who invest in Mutual Fund Company are known as
investors. The following persons are eligible to buy mf units:
1. Residents including:
a. Adult individuals (or minors through their parents or
guardians) holding singly or jointly (not exceeding three in all);
b. Hindu Undivided Families through their respective Kartas;
c. Companies, corporate bodies, partnership, associations of
persons or bodies of individuals, religious and charitable trusts and other
societies registered under the Societies Registration Act, 1860 (so long
as the purchase of units is permitted under their respective constituent
documents);
d. Religious and charitable trust and private trusts, subject to
receipt of necessary approvals as “public Securities” wherever required
e. Association of persons or body of individuals.
f. Mutual funds registered with SEBI.
g. Army/Air Force/Navy other paramilitary units and bodies created
by such institution besides other eligible institution.
2. Foreign Institutional Investors registered with SEBI
3. Multilateral funding agencies/bodies corporate incorporated out-
side India with permission of Government of India/Reserve Bank of India.
4. Overseas financial organizations which have entered into an
arrangement for investment in India, inter-alia with a Mutual fund registered
with SEBI and which arrangements are approved by Central Government.
Chapter - 1 : Overview of Mutual Fund
47
5. NRIs, OCBs, FIIs and persons of Indian origin residing abroad, on
a full repatriation basis/non-repatriation basis.
6. Other schemes of same mutual fund subject to the conditions and
limits prescribed by SEBI Regulations.
7. The Trustees/Trust, AMC or Sponsor or their affiliates, their
associate companies and subsidiaries.
8. Provident / pension / Gratuity / Superannuation and such other
retirement and employee benefit and other similar funds.
1.5 RISK/RETURN ASSOCIATED WITH MUTUAL FUND
Mutual funds in this era are considered to be less risky than the direct
investment in share market. Mutual Fund can diversify across asset class by
investing part of pooled money in equities, part in debt, and so on. That way
even if a part of investors‟ portfolio were to go through a downturn, profit from
other can check the erosion in its value. Mutual Fund are also relatively less
expensive way to invest compared to directly investing in the capital market
because benefit of scale in brokerage, custodial and other fees translate into
lower cost for investors. The following figure clearly presents the risk return
relationship between investment in Mutual Funds and other Direct investment.
Chapter - 1 : Overview of Mutual Fund
48
Figure 1.7 Risk / Return Matrix
Source: Yahoo finance
1.5.1 Risk associated with Mutual Fund Investments
Every investment avenue comes with a certain degree of risk and
uncertainty. Even an insured bank account is subject to the possibility that
inflation will rise faster than the returns, leaving a person with less amount of
real purchasing power than when one started (Rs 100 now gets one lesser
than it got his/her grand-parents when they were of the same age). Mutual
Funds Investment is also prone to risks which influence the financial market.
There are following type of risk associated with the mutual funds investment.
1. Market risk: At times, the price of all the instruments in particular
market rise or fall due to broad outside influences. The result of such kind of
fluctuation will be that the stock prices of both an outstanding highly profitable
company and a fledging corporation may be affected. This change is due to
„market risk‟.
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49
2. Inflation risk: Whenever inflation sprints forward faster than the
earnings on investments, an investor runs the risk that actually purchases less
and not more. Hence, sometimes the inflation risk is also referred as „loss of
purchasing power‟. Inflation risk can also occur when the prices rise faster than
the returns on investments.
3. Credit risk: This type of risk involves the analysis of how stable is
the company to which one lends money in the form of investment and the
certainty that it will be able to pay the interest promised, or repay the principal
amount when the investment gets matured.
1.6 CLASSIFICATION OF MUTUAL FUND SCHEMES.
Henry Ford, founder of Ford Motor Company, has once quoted,” The
customer can have any color he wants as long as it‟s black.” The Indian Mutual
Fund investors in 1990s must have felt a bit like the American car buyer in the
1930s, who had as much freedom of choice in terms of car colors as Ford
warranted. Previously, every mutual fund offering resembled the other in terms
of kinds of schemes.
Mutual funds schemes are allocated to a vast number of investors based
on their individual needs and objectives. The requirement and the risk
undertaking ability of a retired man will be certainly different from a young man
of thirty years old. Hence, various types of mutual funds try to cater to the
requirement and objective of investors. The selection of a fund will depend on
an investor according to his income and risk taking capacity.
Subject to SEBI regulations, a Mutual Fund Company is free to construct
to its schemes or products to be offered to the potential investors. These
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50
schemes will cater to the vast requirements of the different types of investors.
Mutual Funds in India presently offer more than 400 products across various
categories.
There are many types of mutual funds available to the investor.
However, these different types of funds can be grouped into certain
classification as under: Figure 1.8
Mutual Fund Products / Schemes
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1.6.1 Functional classification
a) Open-ended schemes
b) Close-ended schemes
c) Interval schemes
d) Load funds
e) No-Load funds
f) Tax-exempt funds
(a) Open-ended schemes
In open ended scheme, the mutual fund constantly offers to sell and
repurchase its units at net asset value (NAV) or NAV related prices.Net Asset
Value can obtained by dividing the amount of the market value of the fund‟s
assets (plus accrued income minus the fund‟s liabilities) by the number of units
outstanding. Investors have the opportunity to enter and exit the scheme any
time during the life of fund. Open- ended funds do not require to be listed on
the stock exchange and can also put forward repurchase soon after allotment.
The open-ended funds do not have a permanent „unit capital‟. The corpus of
fund is subject to increase or decrease, depending on the acquisition or
redemption of units by investors.
There is no fixed period for of units in case of open-ended schemes; the
period can be terminated at whatever time the need arises. The open-ended
fund offers a redemption price at which the unit holder can sell units to the fund
and exit. Moreover, the investor has the facility to enter the fund again by
buying the units from the fund at its offer price. The funds declare sale and
repurchase prices from time to time.
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The key feature of open-ended funds is degree of liquidity provided by
such funds to the investors.
(b) Close-ended fund
The „unit capital‟ of a close-ended fund is fixed, the reason, as it makes
a one time sale of a fixed number of units. Close-ended funds have a
predetermined maturity period ranging between 2 to 5 years. After the offer
closes, these funds do not permit the investors to buy or redeem units directly
from the funds. However, to present the much required liquidity to investors,
close-ended funds are listed on a stock exchange. Investors are able to trade
through a stock exchange, in the similar style as buying or selling shares of a
company in direct investment. The fund‟s units may be traded at a discount or
premium to NAV based on investors‟ perceptions about the fund‟s future
performance and other market factors affecting the demand for or supply of the
fund‟s units.
The number of outstanding units of a close ended fund does not differ on
account of trading in the fund‟s units at the stock exchange. Now and then, a
close ended funds do offer „buy-back of fund units”, thus offering another
possibility for liquidity to close ended fund investors.
(c) Interval schemes
Interval schemes are combination of both the features of open-ended
and close-ended funds. Interval funds are available for sale or redemption
during prearranged intervals at NAV-related prices.
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(d) Load funds
Promotion of mutual funds involves preliminary expenses. The mutual
fund company recovers such expenses from the investors in different ways at
different times. The usual ways in which the expense can be recovered from
the investors may be categorized as:
At the time of investor‟s entry into the fund, by deducting a
specific amount from his contribution – Entry load
By charging the fund with a fixed amount each year, during a
specified number of years – Deferred load
At the time of investor‟s exit from the fund, by deducting s
specified amount from the redemption proceeds payable to the investor – Exit
load
The fund that charges entry, exit, or deferred loads is called Load funds.
(e) No-Load funds
Mutual funds that make no entry, exit, or deferred charges for sale
expenses are known as no-load funds. It may be noted here that a no-load fund
only means a fund that does not charge marketing expenses. All funds still
charge the schemes for management fees and other recurring expenses; it is
only that an investor in a no-load fund enters or exits at the net NAV of the
fund, calculated after accounting for these expenses, but without paying any
further marketing expenses from the particular NAV.
Some funds charge only an entry load and some only an exit loads.
Such funds may be termed as Partial load funds.
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(f) Tax-exempt funds
A mutual fund which invests in tax-exempt securities, are termed as a
tax-exempt funds. In India, any income received by the mutual fund is tax-free.
After the 1999 Union Government Budget, all the dividend income received
from any mutual fund is tax-free in the hands of investors. On the other hand,
funds other than open-ended equity oriented funds have to pay a distribution
tax, before distributing income to investor.
1.6.2 Nature / Objective of investment
1) Money market mutual funds
2) Debt funds
3) Hybrid Funds
4) Equity funds
5) Other Funds
1) Money market / Liquid funds
Liquid funds are characterized as the lowest stair in the order of risk
level as they invest in debt securities of short term nature. These investments
are mainly done in the securities of less than one-year maturity. MMMFs offer
diversification of short-term assets, in terms of issues, maturity, and size,
thereby spreading the risk for the investors.
Foundation of MMMF
In India, Reserve Bank of India outlined the extensive framework for
setting up MMMF in its credit policy in April 1991. The objective was “Providing
an additional short-term avenue to investors and to bring money market
instruments within the reach of individuals.” RBI allotted a task force to work
Chapter - 1 : Overview of Mutual Fund
55
out the comprehensive effective guidelines and documentation for MMMFs with
Mr.D Basu (Deputy MD, State Bank of India) as the chairman. Based on the
recommendation presented by the task force under the chairmanship of Mr D
Basu, the Reserve Bank of India declared a detailed scheme for money market
mutual funds on April 1992.
Money market mutual funds invest in the following securities:
(a) Treasury bills issued by Government: Treasury bills are the
instruments which are issued by Reserve Bank of India at a discount to the
face value and form an essential part of money market. In India the treasury
bills are issued in four different maturities period viz. 14 days, 90 days, 182
days, and 364 days.
(b) Certificate of Deposits issued by banks: Certificates of deposits
are issued by banks in denomination of Rs 5 lakhs and have maturity period
ranging anywhere between 30 days to 3 years. Banks are allowed to issue
certificates of deposits with a maturity of less than one year whereas financial
institutions are allowed to issue certificate of deposits having maturity period of
at least one year.
(c) Commercial paper issued by companies: A Commercial Paper
(CP) is a Usance Promissory Note issued by companies to raise short-term
funds in the money market. Commercial Paper was introduced in the Indian
financial market by the Reserve Bank of India on January 1, 1990 as per the
recommendations of the Working Group on Money Market under the
chairmanship of Sri N. Vaghul. In India, corporate, primary dealers (PD),
satellite dealers (SD) and financial institutions are having the rights to issue
Chapter - 1 : Overview of Mutual Fund
56
these notes. Companies having very good ratings are active in the commercial
paper market, though Reserve Bank of India has given permission of a
minimum credit rating of CRISIL-P2. The tenure of commercial paper can be
anything between 15 days to one year, though the most popular duration is of
90 days. Investment in Commercial Paper is used by the companies to save
interest cost.
(d) Call or Notice money: The call money market has registered a
tremendous growth in volume of activity since its inception in 1955-56. The call-
money market is a market for very short-term funds, repayable on demand and
with a maturity period varying from one day to fortnight. When money is
borrowed or lent for a day it is known as call or (overnight) money. Intervening
holidays and Sundays are excluded for this purpose.
When money is borrowed for more than a day and up to a period of 14
days, it is known as Notice money. No collateral security is required to cover
these transactions. The call money market is highly liquid market, with the
liquidity being exceeded only by cash. It is highly risky and extremely volatile as
well.
The key strength of liquid funds is liquidity and security of the principal
that the investors can normally anticipate from short-term investments. MMMfs
also offer the advantage of bulk purchases, access to short term markets,
expertise of a professional fund manager, lower transaction cost. Investors with
monthly income for example, salaried class, provident funds etc., also have the
benefit of parking their funds in money market instruments till a long term
investment avenue of their individual choice emerges. Retail investors do not
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57
have ready access to either Treasury bills or call lending. MMMFs make it
possible for such retail investors to earn relatively higher yields offered by
money markets.
As also money market mutual funds are ideally suited for short-term
investments, especially, when the tenure is not indeterminate, as the
investments earns money market interest rates while at the same time,
assuring the investor of liquidity. Though interest rate risk is present the impact
is low as the investment instruments‟ maturities are short.
2) Debt funds
Debt funds invest in debt instruments issued by Government as well as
private companies, banks, financial institution and other entities such as
infrastructure companies. The main objective of investing in debt funds is low
risk and stable income for the investor. Though, these funds are more risky
than liquid funds as the do have higher price fluctuation risk, since they invest
in long term securities. Likewise, debt funds do have higher risk of default by
their borrowers as compared to Gilt funds.
Debt funds are basically considered as Income funds as they primarily
invest in fixed income generating debt instrument. They do not target capital
appreciation but look for current income, and therefore allocate a considerable
part of their surplus to investor.
Debt funds can be further classified according to the different investment
objective and risk profile.
1. Gilt funds: In India, we have Government Securities or Gilt Funds
that invest in government paper called dated securities. Gilt securities are the
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58
securities which are meant for medium to long-term investments, typically of
over one year. Since the issuer is the Government/s of India/States, these
funds have little risk of default and consequently offer better safeguard of
principal. Gilt securities are issued by Reserve Bank of India on behalf of the
Government. These instruments form a part of the borrowing program
approved by Parliament in the Finance Bill each year (Union Budget). Gilt funds
have a maturity period of 1 year to 20 years. Gilts are issued through the
auction route but RBI can sell or purchase in its Open Market Operation
(OMO). OMO includes conducting repos as well and are used by RBI to
manipulate short-term liquidity and thereby the interest rates to desired levels.
The other types of Government securities are as:
Inflation linked securities
Zero coupon bonds
State Government Securities (State loans)
However, Gilt securities, like all debt securities, face interest rate risk.
Debt securities‟ prices fall when interest rate level increases and rises when
interest rate level decreases. It is the responsibility of investors to realize the
potential changes in NAV of guilt funds on account of changes in interest rates
in the economy.
2. Diversified Debt fund: Diversified Debt Fund can be explained as a
debt funds that invest in all accessible types of debt securities, issued by
entities across all industries and sectors. A diversified debt fund has the
advantage of risk reduction through diversification. In addition, all debt mutual
Chapter - 1 : Overview of Mutual Fund
59
funds lead to risk reduction for the individual investor as any losses by a debt
issuer are shared by a huge number of investors in the fund.
3. Focused Debt Fund: Focused debt funds are funds with less
diversification in its investment. These funds invest in sector, specialized, and
off-shore funds. They have a major part of their portfolio invested in debt
instrument and are more income oriented and inherently less risky.
Other example of focused funds includes those that invest only in
Corporate Debentures and Bonds or only in Tax Free Infrastructure or
Municipal bonds. But these funds may take some time to materialize as a real
choice for the Indian investor.
One category of specialized funds that invest in the housing sector, but
offers greater security and safety than other debt instrument, is the Mortgage
Backed Bond Funds that invest in distinctive securities created after
securitization of (and thus secured by) loan receivables of housing finance
companies. As the Indian financial markets observe the escalation of
securitization, such funds may emerge on the mutual funds prospect soon.
4. High Yield Debt Funds: Usually, Debt funds control the default risk
by investing in securities issued by borrowers who are rated by credit rating
agencies and are considered to be of “investment grade”. High Yield Debt
Funds, however, seek to earn higher interest returns by investing in debt
instrument that are considered “below investment grade”. High Yield debt funds
invest in instruments with high yield, consistent with risk tolerance. In the
U.S.A., funds that invest in debt instrument that are not backed by tangible
assets and rated below investment grade (popularly known as junk bonds) are
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60
called Junk Bond Funds. These funds tend to be more volatile than other debt
funds, although they may earn at times higher returns as a result of the higher
risks taken.
5. Assured Return Funds – an Indian Variant: In India, UTI and other
funds had offered “assured return” schemes to investors. The most accepted
variant of such schemes was the Monthly Income Plans (MIP) of UTI. Returns
were indicated in advance for all the future years of these close-ended
schemes. In assured return schemes the loss, if any, is borne by the sponsor or
Asset Management Company. Assured return debt funds undoubtedly diminish
the risk to the investor, but only to the degree that the guarantor has the
required financial strength. Hence, the market regulator SEBI permits only
those funds whose sponsors have sufficient net-worth to recommend
assurance of returns.
If Assured return scheme is offered, unambiguous guarantee is required
from a guarantor whose name has to be specified in advance in the offer
document of the scheme. The risk that the investor faces was clearly confirmed
when the assured return schemes of UTI faced large shortfall in their payment
obligations. In case of UTI, the Government bailed it out and took over the
scheme obligation on itself. Assured return schemes are no longer offered by
AMC‟s though possible.
Despite the fact that Assured Return Schemes offer lowest risk to the
investor, they are not to be termed as risk – free instrument, as the investors
have to usually lock their funds for specified time such as three years. Because
of such lock in, the investor may lose the chance to acquire higher returns in
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61
other debt or equity securities, as changes in financial market may take place.
In addition, the investor is likely to face the credit risk of the guarantor who
must remain solvent enough to honor his guarantee throughout the lock in
period.
6. Fixed Term Plan Series – an Indian variant: A mutual fund scheme
would generally be either open-end or close-end. However, in Indian context,
mutual funds have developed an innovative middle option between the two, in
response to investor requirements. If a scheme is open-ended scheme, the
fund issues new units and redeems them at any time. The fund does not
provide a stated maturity or fixed term of investment as such. Fixed Term Plan
Series offer a combination of both these features to the respective investors, as
a series of plans are offered and units are issued by the fund at frequent
intervals for short plan duration.
Fixed Term Plan are essentially close-ended in nature, in that case the
AMC issues a fixed number of units for each series only once and closes the
issue after an initial offering period, like a close-ended scheme. Though. A
close-ended scheme would normally make a one-time initial offering of units,
for a fixed duration generally exceeding one year depending upon the policy of
the particular scheme. The individual investors have to hold the units until the
end of the stated time period, or sell them on a stock exchange if listed. Fixed
Term Plan is close-ended, but usually for shorter period, they are also not listed
on stock exchange. The scheme under which Fixed Term Plan Series are
offered are likely to be an Income Scheme, since the objective is clear for the
Chapter - 1 : Overview of Mutual Fund
62
AMC to attempt to reward investors with an expected return within a short
period.
3) Hybrid Funds – Quasi Equity/Quasi Debt
Hybrid securities are classic example of capital management tools,
combining elements of debt and equity in a flexible and cost-effective manner.
Hybrid schemes invest in mix of equity and debt instruments. Hybrid funds do
not specialize in a particular security. These funds are designed to meet
individual objectives for example, rapid growth, matching a market index, or
investing in any area of the economy. Hybrid funds thus use combination of
securities to achieve their pre-determined goals.
Merits of Hybrid funds
Hybrid funds plays the role of a catalyst as a risk diversification tool
and fulfills the investor‟s dream of making money without taking too much risk
and provide a smooth sailing in the market that is low volatility.
Hybrid funds prove advantageous to the investors who don‟t have
sufficient money to diversify into several funds.
They prove beneficial in rupee-cost-averaging strategies where an
investor wants to get both stock and bond in one easy monthly purchase.
Investors who do not wish to take the trouble of allocating their
respective funds in different investments options, with the help of Hybrid funds
can avail the services of expert portfolio managers.
Hybrid funds are also desired by the retired investors who are looking
for income but still wish to have some stock market growth opportunities.
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63
1. Balanced funds: A balanced fund comprises debt instruments,
convertible securities, preference shares and equity shares in its portfolio.
Balanced funds invest in more or less equal proportions between debt/money
market and equities. As a result of investing in combine nature, balanced funds
seek to achieve the objectives of income, moderate capital appreciation and
preservation of capital. These funds are more suitable for investors who are
conservative and long-term players. The remarkable feature of such funds is
that the investor is very much conscious of the need of diversification of their
portfolios and they generally do not keep “all the eggs in the same basket”.
That is why a combination of debt and equity have formed a major chunk of
their portfolio.
2. Growth-and-Income Funds: Growth-and-Income Funds endeavor to
strike equilibrium between capital appreciation and income for the respective
investor. The portfolios consist of a mix between companies with good dividend
paying records and those with potential for capital appreciation.
3. Asset allocation Funds: The percentage of money to be invested in
a particular category of asset is predefined. Many funds permit variable asset
allocation policies and move in and out of an asset class (equity, debt, money
market, or even non-financial assets) depending upon their outlook for specific
market. The fund manager is provided with the elasticity to transfer towards
equity when equity market is estimated to do well and shift towards debt when
the debt market is expected to do well.
Chapter - 1 : Overview of Mutual Fund
64
Figure 1.9
Asset Allocation Suitability Graph
4) Equity Funds
Equity funds are characterized as funds involving high risk as well as
high returns. Equity funds invest a major portion of their corpus in equity shares
issued by companies, acquired directly in initial public offerings or through the
secondary market. Equity funds are exposed to the equity price fluctuation risk
at the market level, at the industry or sector level and at the company-specific
level. Equity funds‟ Net Asset Value fluctuates with all these price movements,
which are caused by a number of external factors such as political, social and
economic. Equity funds can appreciate in value in line with the issuer‟s earning
potential, and thus propose the greatest possibility for growth in capital.
However, an investor should not overlook that Equity funds are considered at
the higher end of the risk spectrum among all available funds in the financial
market. But whenever the question of higher returns turn up it is the equity
oriented Mutual fund which glitters more than debt investment. Whether look at
Investment
Horizon
Risk/Return
Short term debt
Days 1 Yr 3 Yrs
Deb
t
Equit
y
Chapter - 1 : Overview of Mutual Fund
65
a 1, 3, 5, or 10- year time frame, debt mutual funds have given among the
lowest returns, while equity seems a much better option. (The Times of India
March 1, 2008). The following returns from various investment avenues are
represented in the figure:
Equity funds implement diverse investment strategies resulting in
different levels of risk. For this reason they are generally categorized into
different types in terms of their investment styles.
1. Aggressive Growth Funds: As the name suggests, aggressive
growth funds aim at obtaining maximum capital appreciation, invest in less
researched or speculative shares and may adopt speculative investment
strategies to accomplish their objective of high returns for the investor.
Accordingly, they tend to be more unpredictable and riskier than other funds.
2. Growth Funds: The key objective of Growth funds is capital
appreciation over a three to five year span. To achieve this target the growth
funds invest in companies whose earnings are estimated to rise at an above
average rate. These companies may be operating in sectors like technology
considered having a growth potential, but not completely unproven and
speculative.
3. Specialty Funds: Specialty Funds invest in only those companies
that meet pre-defined criteria. For example, at the height of the South African
apartheid regime, many funds in U.S. offered plans that promised not to invest
in South African companies. Also, funds which exclude tobacco companies
from their portfolios come under this category. Funds which invest in particular
area for example, Middle East or ASEAN countries are also examples of
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66
specialty funds. Specialty funds have a propensity to be more volatile as
diversification is limited to one type of investment or they are more
concentrated funds. Following are the kinds of specialty funds:
Sector funds
Foreign securities funds
Mid-cap or Small-cap Equity funds
Option income funds
i) Sector funds
Portfolios of sector funds consist of investment in only one industry or
sector of the market for example Information Technology, Pharmaceuticals or
Fast Moving Consumer Goods. Sector funds carry a higher level of sector and
company specific risk as these funds do not diversify into multiple sectors so
that the risk could be spread out.
ii) Foreign Securities Fund
Foreign Securities Fund invests in foreign countries thereby achieving
diversification across the national borders. However, they also have additional
risks, for example, foreign exchange rate risk as well as their performance
depends on the economic circumstances of the countries they invest in.
Foreign Securities fund may invest in one foreign country than it becomes risky
due to concentration and if investment is made in more than one country the
funds becomes more diversified.
iii) Mid-Cap or Small-Cap Fund
Mid-Cap or Small-Cap Funds invest in the shares of the companies
which have relatively lower market capitalization. These funds, therefore, prove
Chapter - 1 : Overview of Mutual Fund
67
to be more volatile, as mid-size or smaller companies‟ shares are not very
liquid in markets. While pointing about risk features, small company funds may
be aggressive-growth or just growth type. In terms of investment styles, some
of these funds may also be “value investors” (AMFI pg. 124)
iv) Option Income Fund
Option Income funds do not yet exist in India, but option Income Funds
write options on a significant part of their portfolio. Though these funds are risky
instruments, they may in fact help out to control the volatility, if appropriately
used. Conventional option funds invest in large, dividend paying companies,
and then sell options against their stock positions. This ensures steady income
stream in the form of premium through selling option and dividends. Now that
option on individual shares has become obtainable in India, such funds
possibly will be introduced.
4. Diversified Equity Funds: Diversified Equity Funds seeks to invest
only in equities, except for a very small portion in liquid money market
securities. These funds are not focused on any one particular sector or shares,
hence termed as diversified equity funds. Though these types of funds are
vulnerable to all equity price risk, these funds lessen the sector or stock specific
risks through diversification. Diversified Equity Funds are also exposed to the
equity market risk.
(a) Equity Linked Saving Schemes: (ELSS) an Indian Variant
In India, investors have been given tax concessions to encourage them
to invest in equity market through these special schemes. The key feature of
such schemes is that they entitles the holder to claim an income tax rebate, but
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68
generally has a lock-in period. The ELSS has no specific constraint on the
investment objective for the fund managers.
5. Equity Index Funds: An index fund tracks the performance of
specific stock market index. The key feature of this fund is to match the
performance of the stock market by tracking an index that represents the
overall market. The Index funds invest in the shares that comprise the index
and in the same percentage as the index. Main advantage of these funds are
that they take only the overall market risk, while reducing the sector and stock
specific risks through diversification. Some index funds have a narrow
approach as they invest in sectoral index for example Pharma index or Bank
index.
6. Value Funds: Value funds may be characterized as those funds
which try to seek out basically sound companies whose shares are presently
under-priced in the market, but are considered to have growth potential in
future. Value funds will invest only in those shares to their portfolios that are
selling at low price-earning ratios, low market to book value ratios and are
assumed to be undervalued compared to their true potential.
Value funds are subject to equity market risk. Value funds frequently
come from cyclical industries, for example, Templeton fund, which includes
Cement or Aluminium company‟s shares and other cyclical industry in its
portfolio built-up. Prices of such shares may rise and fall more often than the
overall market. Yet, proponents of the Value Investment propose it as a long-
term approach.
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69
7. Equity Income or Dividend Yield Funds: Equity funds that are
designed to give the investor a high level of current income along with some
stable capital appreciation, investing mainly in shares of companies with high
dividend yields, are categorized under equity funds. To accomplish the
objective of steady income and capital appreciation, the Equity income fund
would invest in Power or Utility companies‟ shares of established companies
that pay higher dividends and as well as the prices of such companies do not
fluctuate as much as other shares. Hence, these funds have the merits of
stability and safety.
8. Exchange Traded Funds: An Exchange Traded Fund is the hybrid of
open-end index fund and close-end index funds. They are listed on stock
exchanges, just like a close ended fund and trade like individual stocks on the
stock exchange. ETF‟s pricing is linked to the index and units can be
bought/sold on the Stock Exchange. ETFs do not sell their shares directly to
investors for cash. The shares are offered to investors over the stock
exchange. Since they are listed on stock exchanges, it is possible to buy and
sell them throughout the day and their price is determined by the demand-
supply forces in the market. The key features of an Exchange Traded fund can
be explained as under:
1. The open-end side of an ETF is restricted to a limited set of
participants known as Authorized Participants and a certain minimum size is
prescribed for the creation/redemption of units.
2. The creation/redemption of units happens in kind. Authorized
Participants who want new ETF units have to pay in the form of a basket of
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70
stocks that mirrors the underling index. Likewise, when Authorized Participants
wants the ETF units to be redeemed they are paid in the form of basket of
stocks that mirrors the underlying index.
3. As ETF units are listed on the secondary market investors can buy
and sell ETF units in cash.
4. In the secondary market ETF units tend to trade very near to their fair
value (NAV). If the market price of ETF units can exceeds their NAV,
Authorized Participants would sell ETF units from their inventory, buy the
underlying basket of stocks from the exchange, and deliver the basket of stocks
to the ETF to replenish their inventory of ETF units and make an arbitrage
profit. Likewise, if the market price of ETF units is less than their NAV,
Authorized Participants would buy ETF units from the market , redeem the units
with the ETF, get the underlying basket of stocks, sell the same in the market
and make an arbitrage profit.
The first exchange traded fund was launched in USA in 1993 under the
name of Standard and Poor‟s Depository Receipt (SPDR – also called Spider).
ETFs were launched in Europe and Asia in 2001. The first ETF to be
introduced in India is Nifty Bench mark Exchange – Traded Scheme (Nifty
BeES). It is an open-ended ETF, launched towards the end of 2001 by
Benchmark Mutual Funds. The fund is listed in the capital market segment of
the NSE and trades the S&P CNX Nifty Index. The benc mark Asset
Management Company has become the first company in Asia (excluding
Japan) to introduce ETF.
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ETF offers investors the benefit of flexibility of holding a single share as
well as the diversification and cost efficiency of an index. ETFs offer quite a lot
of distinct advantages which can be summed up as:
ETFs make possible the facility to trade intra-day at prices that are
usually close to the actual intra-day NAV of the scheme which makes it nearly
real-time trading.
As ETFs are simple to be understood by the investors, therefore
they have the potential to attract the small investors who are deterred to trade
in index futures because of necessity of minimum contract size. Small investor
can have the privilege of trading intra-day by buying minimum one unit of ETF,
and placing limit orders.
ETFs can be used to arbitrate successfully between index futures
and spot index.
Diversified index funds are another advantage provided by the
Exchange Traded Funds. The investors can gain from the elasticity of stock as
well as the diversification of index.
ETFs are basically passively managed funds and hence they have
somewhat higher NAV against an index fund of the same portfolio. The
operating expenses of ETFs are lesser than even those of parallel index funds
as they do not have to service investors who deal in shares through stock
exchange.
Financial institution can utilize ETF in employing idle cash,
managing redemptions, modifying sector allocations, hedging market exposure.
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1.6.3 Other Funds
1. Commodity Funds: A commodity fund specializes in investing in
different commodities directly or through shares of commodity companies or
through commodity future contracts.
A most familiar example of such funds is the Precious Metals Funds.
Gold funds invest in gold, gold futures or shares of gold mines. Platinum or
silver are also available in other countries for investment. In India, the Union
Finance Minister recently announced a Gold Linked Unit scheme- like a Gold
fund. A large number of commodity futures contracts are now available for
trading on commodity exchange, popularizing the commodity funds.
2. Real Estate Funds: The latest entrant in the field of mutual fund is
Real Estate Mutual Fund. Real estate funds invest in real estate directly, or
may fund real estate developers, or lend to them, or buy shares of housing
finance companies or may even buy their securitized assets. Real estate funds
may have the objective of growth orientation or regular income.
REIF (Real Estate Investment Fund) has three categories:
I. Equity REIT: own and operate real estate.
II. Mortgage REIT: lend money directly or indirectly to real estate
owners.
III. Hybrid REID: own both property and lend money to real estate
owners.
Securities and Exchange Board of India and Association of Mutual
Funds in India together has set up a committee to recommend on the
introduction of REMF so that such funds would be available for the investment
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73
purpose. After submission of the report prepared by SEBI and AMFI, on June
26, 2006 SEBI permitted the guidelines for dealing in REMF.
Real Estate can be explained as land including the air above it and the
ground below it and any piece of structure constructed on it. It includes
residential house, commercial offices, trading areas for example shopping
malls, hotels, etc. It also includes purchase, sale and development of land,
building and structures. The players are landlords, developers, builders,
tenants and buyers to name a few in this market.
According to market regulator, SEBI has defined REMF as a scheme of
mutual funds which has investment objective to invest directly or indirectly in
the real estate property.
The REMF will be governed by the guidelines under SEBI (Mutual funds)
Regulation. These have evolved greatly in USA where they are referred to as
Real Estate Investment Trust. To point out the basic difference between REIT
and REMF is that in case of REIT, tax liability is minimal as it is a trust, while in
the case of REMF; tax rules are applicable as per other mutual funds.
The REMF can invest in real estate properties within India, mortgage
backed securities, equity shares, bonds, debentures of listed or unlisted
companies, which deal in real estate and also undertake property development
in other securities. According to SEBI guide lines, the REMF should invest at
least 35% of it in property and 40% of it can be invested in shares and
securities of realty companies. These funds possess properties, commercial
space and earn income in the way of rent and also in the form of capital
appreciation. They acquire, Develop and sell the property and the benefit is
shared with investors.
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74
Segment in India.
The introduction of REMF is projected to set in motion land acquisition
by realty developers across the country, which had slowed down over the last
couple of months after the RBI norms have dejected banks from providing
funds to developers for purchasing land. Banks are permitted to loan funds only
after the property developers have taken all the compulsory approvals from the
state and local authorities.
The commencement of REMFs will not only direct to improve investment
options, but will also boost the starving housing sector. There are a number of
mutual fund scheme that offer a chance to invest in a specific sector, but the
appearance of REMF will give the retail investor a possibility to invest in real
estate and earn the prospective returns from the real estate market.
The setting of REMF can also present some support to the cash-starved
housing sector. Though the mutual fund industry in India has received a
remarkable boost, presently mutual funds are not allowed to hold real estate
assets. But there already are sector funds where the investor invests money
exclusively in companies belonging to one particular sector.
Prerequisites for REMF.
For introducing and dealing in REMF, certain conditions are to be
followed by the players which are mentioned below:
1. Primarily the structure of REMFs will be close-ended.
2. It has been made mandatory for REMF, by the SEBI guidelines to
be listed on the stock exchange.
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75
3. To make REMF and the respective developers accountable to the
investors, the disclosure of Net Assets Value (NAV) of the scheme has to be
made on a daily basis.
4. The REMF are compulsorily required to appoint a custodian
having a certificate of registration to carry on the business of custodian of
securities.
5. It is essential for the custodian to continue the title of real estate
properties held by REMFs.
3. Funds of Funds: A regular Mutual fund invests in stocks, bonds, and
fixed income securities depending upon the objectives as specified in offer
document. A fund of fund scheme, instead of investing in a portfolio of
securities such as debt, equity, invests in a portfolio of the units of other mutual
funds scheme. The concept of diversification is applicable to Fund of funds.
Fund of fund assist the respective investor to pick the right funds from a wide
variety of schemes presented by various Asset Management Companies. As
also investors in such funds have the benefit of diverse management styles.
For example, Prudential ICICI Advisor series, the first Indian Fund of Fund
scheme offers five plans:
1) Very cautious (no equity, 100% debt)
2) Cautious (up to 35% equity)
3) Moderate (40-60% equity)
4) Aggressive (50-80% equity)
5) Very aggressive (90-100% equity)
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Merits of Fund of Fund:
(a) Fund of Fund schemes provides a high degree of diversification
thereby reducing the risk factor.
(b) It is argued that fund of fund are more tax-efficient rather than
investing in mutual funds directly.
(c) As far as risk is concerned, there will be lower level of risk in such
holdings.
(d) The investor will benefit from the expertise and the skill of different
leading fund managers.
(e) Convenience is another plus point. In the times when the market is
performing well in one section and dull in the other one, the fund manager will
take complete care of portfolio of the investors.
However, these funds prove to be expensive as the expenses of AMC
that manages the fund of funds get added to the expenses of other schemes it
invests in. As also fund of fund schemes invests in solely in the schemes of the
same mutual fund. This may not be in the interest of the investors, if the sister
schemes are not the best of their kind.
4. Domestic Funds: A domestic fund mobilizes the resources only from
a particular geographical locality like a country or region. The market is limited
and confined to the national boundaries in which the fund operates. Hence,
domestic funds can invest only in securities which are issued and traded within
the market of national boundaries.
5. Offshore Funds: An offshore fund invests in securities of foreign
countries. These funds are known to facilitate cross-border fund flow which
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77
leads to an augment in foreign currency and foreign exchange reserve. They
open domestic capital market to international investors. In short, offshore funds
attract the foreign capital for investment in the country of the issuing company.
6. Ethical Funds: Ethical funds are an innovative product which is
introduced recently in mutual funds products. Ethical funds assimilate personal
values and social concern with that of investment decision making process and
performance. Investment management of ethical funds is popularly known as
„socially responsible investing‟. The Ethical funds take into account both the
investor‟s financial requirements and an investment‟s influence on society and
surroundings. The most important objective of ethical funds is to confine the
investment universe to such companies, which come under the purview of the
ethical criteria. These criteria essentially concentrate on social, environmental
and ethical concerns of the investors. Securities from companies that adhere to
social, moral, religious and/or environmental beliefs are a few examples.
Ethical funds generally do not invest in companies producing tobacco or
liquor; some of them do not invest in companies whose chief action involves
producing military products. In addition to basic quantitative analysis, a socially
responsible portfolio manager takes into account a company's community
investment, environmental responsibility, protection of human rights,
employment diversity, animal testing and product offering. Some of the Ethical
funds focus on environmental responsibilities such as non-polluting companies,
organic farming etc. Ethical investors include individuals and institutions such
as Trusts, Universities, Hospitals, Foundations, Non-profit organizations, Non-
government organizations, Religious establishments, temple, Churches. Ethical
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78
funds managers‟ Endeavour‟s to apply the above mentioned investment criteria
of investing in companies which fulfills the ethical norms, by adopting
appropriate financial screening methodology that will support the investment
decision with the intensely held values of this class of investors. Some might
include only equities or bonds, while others might hold a combination of the
two. Furthermore, some funds might specialize in being free of securities from
alcohol, casino and tobacco companies, while others might invest exclusively in
companies that are environmentally responsible. Securities that have been
screened for socially responsible criteria are then combined to achieve a
specific investing style and goal. A portfolio manager will decide whether the
fund will be made up of:
equity, fixed income or both (balanced)
domestic or international securities
small, mid, or large cap stocks
On average, their performance has been comparable to that of regular
mutual funds. According to KLD Indexes, the Domini 400 Social Index YTD
return as of September 30, 2007 was 7.19%, compared to the S&P 500 return
of 9.13%.
7. Gold Exchange Traded Funds: It was Benchmark Asset
Management Company in India, which conceptualized the idea of Gold
Exchange Traded Funds (GETFs), in May 2002 when they filed a proposal with
the Securities Exchange Board of India. The primary motive of Gold Bullion
securities was to give financial and private investors the capability to have
possession of gold and achieve exposure to price. With the launch of the
GETFs in India, the investors can buy gold-linked units that would be traded on
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79
the stock exchange. One unit of GETFs is equal to the value of one gram of
gold. The daily price of each unit is linked to the prices of gold in the physical
market. The investor is able to purchase and redeem the units GETF from the
stock market.
A Mutual fund house introducing a Gold ETF appoints „Authorized
Participants‟ who at the outset buy the units of Gold ETF from the mutual fund
by exchanging pure gold for the units of Gold ETF. These „Authorized
Participants‟ facilitate secondary market trading of the Gold ETF units through
the stock exchange where investors can buy or sell gold units on payment. The
underlying asset is gold, which is held by Mutual fund house in a physical form
through a gold receipt which provides the right of ownership. Authorized
Participants are provided with the facility that they can go back to the mutual
fund house to redeem the GETF units and can also demand the equivalent
value of actual pure gold at any time.
Gold, over the past years, has demonstrated to be a good hedge against
inflation and has maintained a long term value. For this reason Gold ETF offer
a well diversified option and reduction of overall risk and unpredictability of
investments.
8. Leveraged Funds: Leveraged funds are the funds which increase the
value of the portfolio and provide benefit to the unit holders by gains exceeding
the cost of borrowed funds. The leveraged funds invest in speculative and risky
instruments, like short sales to take the advantage of declining market.
Leveraged funds are not common in India because of the risk associated with
it.
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9. Hedge Funds: The main objective of Hedge funds is to hedge risks in
order to increase the value of the investors‟ portfolio. Hedge funds employ
speculative trading principles while investing in financial instruments. These
funds provide hedge by purchasing shares whose prices are likely to rise and
selling those shares whose prices are likely to fall. Hedge funds are not
common in India.
1.7 INVESTMENT ORIENTATION OF MUTUAL FUND SCHEMES:
Mutual funds invest in three broad categories of financial assets which
are described as:
(a) Stocks: Equity and equity-related instrument.
(b) Bonds: Debt instrument that have a maturity period of more than
one year for example; treasury bonds, quasi-government bonds, corporate
debentures, and asset-based securities.
(c) Cash: Debt instrument that have a maturity period of less than
one year for example; treasury bills, commercial paper, certificates of deposits,
reverse repos, call money, and bank deposits.
1.8 ASSOCIATION OF MUTUAL FUNDS IN INDIA (AMFI)
Realizing the requirement for a common forum for addressing the issues
that were affecting the mutual fund industry as a whole, the association of
mutual funds in India (AMFI) was established in 1993, with a joint effort of all
the mutual funds, with the exception of UTI. AMFI is committed in developing
the Indian mutual fund industry on professional, health and ethical lines. As
also to augment and sustain standards in all areas with a vision to protect and
promote the interests of mutual funds and their unit-holders.
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1.8.1 Objectives of AMFI:
To recommend and promote best business practices and code of
conduct to be followed by members and others engaged in the activities of
mutual fund and asset management, including agencies connected and
involved in the field of capital market and financial services.
To identify and preserve high proficient and moral standards in all
areas of function of mutual fund industry.
To interact with the Securities and Exchange Board of India and
to represent to SEBI on all matters concerning mutual fund industry.
To represent to the Government, Reserve Bank of India and other
governing bodies on all matters relating to the mutual fund industry.
To develop a cadre of well trained agent distributors and to
implement a programme of training and certification for all intermediaries and
others engaged in the industry.
To undertake nationwide investor awareness programme so as to
promote proper understanding of the concept and workings of mutual funds.
To disseminate information on mutual fund industry and to
undertake studies and research directly and in association with other bodies.
AMFI continues to play a major part as a catalyst for setting new
standards and refining existing ones in many areas, specifically in the field of
valuation of securities.
During the year 2001-02 an important initiative was launched by AMFI in
the form of registration of AMFI Certified Intermediaries as well as providing
appreciation and status to the distributor agents.
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AMFI maintains a liaison with different regulators such as SEBI, IRDA,
and RBI to prevent any over-regulation that may stifle the growth of industry.
AMFI has set up a working group to devise draft guidelines for pension scheme
by mutual funds for submission to IRDA. It holds meetings and deliberations
with SEBI regarding matters relating to mutual fund industry. Moreover, it also
makes representations to the Government for elimination of constraints and
bottlenecks in the augmentation of mutual fund industry.
AMFI recently launched suitable market indices which will enable the
investors to appreciate and make meaningful comparison of the returns of their
investments in mutual fund schemes. While in the case of equity funds, a
number of benchmarks like the BSE sensex and the S&P CNX Nifty are
available, there was a lack of relevant benchmark for debt funds.
AMFI took the initiative of developing eight new indices jointly with
Crisil.com and ICICI securities. These indices have been constructed to
yardstick the presentation of different types of debt schemes such as liquid,
income, monthly income, balanced fund, and guilt fund schemes. These eight
new market indices are Liquid Fund Index (Liqui fex), Composite Bond Fund
Index (Compbex), Balanced Fund Index (Balance EX), MIP Index (MIPEX),
Short Maturity Gilt Index (Si-Bex), Medium Maturity Gilt Index (Mi-Bex), Long
Maturity Gilt Index (Li-Bex) and the Composite Gilt Index.
In the case of liquid funds, the index comprises a commercial paper (CP)
component with a 60% weightage and an inter-bank call money market
component with a 40% weightage. The CP component of the index is
computed using the weighted average issuance yield on new 91 days CPs
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83
issued by top rated manufacturing companies. In the case bond funds, the
index comprises a corporate bond component with 55% weightage, gilt
component with a 30% weightage call component with 10% weightage and
commercial paper with 5% weightage. The index‟s 55% bond component is
split based on 40 point share of AA rated bonds, and 15 points share of AA
rated bonds.
Mutual funds have to disclose also the performance of appropriate
market indices along with the performance of scheme both in the offer
document and in the half-yearly results. Further, the trustees‟ are required to
review the performance of the scheme on periodical basis with reference to
market indices. These indices will be useful to distribution companies, agents,
brokers, financial consultant, and investor. AMFI also conducts investor
awareness programme regularly. AMFI is in the process of becoming self-
regulatory organization (SRO).
1.8.2 Promoters of Association Of Mutual Funds in India.
A. Bank Sponsored
1. Joint Ventures - Predominantly Indian
Canara Robeco Asset Management Company Limited
SBI Funds Management Private Limited
2. Others
BOB Asset Management Company Limited
UTI Asset Management Company Ltd
Canbank Investment Management Services Ltd
B. Institutions
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84
LIC Mutual Fund Asset Management Company Limited
GIC Asset Management Company Ltd
Jeevan Bima Sahayog Asset Management Company Ltd
C. Private Sector
Indian
Benchmark Asset Management Company Pvt. Ltd.
DBS Cholamandalam Asset Management Ltd.
Deutsche Asset Management (India) Pvt. Ltd.
Escorts Asset Management Limited
JM Financial Asset Management Private Limited
Kotak Mahindra Asset Management Company Limited (KMAMCL)
Quantum Asset Management Co. Private Ltd.
Reliance Capital Asset Management Ltd.
Sahara Asset Management Company Private Limited
Tata Asset Management Limited
Taurus Asset Management Company Limited
Foreign
AIG Global Asset Management Company (India) Pvt. Ltd.
Franklin Templeton Asset Management (India) Private Limited
Mirae Asset Global Investment Management (India) Pvt. Ltd.
Joint Ventures - Predominantly Indian
Birla Sun Life Asset Management Company Limited
DSP Merrill Lynch Fund Managers Limited
HDFC Asset Management Company Limited
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85
ICICI Prudential Asset Mgmt.Company Limited
Sundaram BNP Paribas Asset Management Company Limited
Joint Ventures - Predominantly Foreign
ABN AMRO Asset Management (India) Ltd.
Bharti AXA Investment Managers Private Limited
Fidelity Fund Management Private Limited
HSBC Asset Management (India) Private Ltd.
ING Investment Management (India) Pvt. Ltd.
JPMorgan Asset Management India Pvt. Ltd.
Lotus India Asset Management Co. Private Ltd.
Morgan Stanley Investment Management Pvt.Ltd.
Principal Pnb Asset Management Co. Pvt. Ltd.
Standard Chartered Asset Management Company Private Limited
1.9 GROWTH AND PERFORMANCE OF MUTUAL FUNDS IN INDIA
As per the study conducted by Associated Chambers of Commerce
and Industry of India (ASSCH), mutual fund industry is growing rapidly and is
expected to grow to Rs 4 lakh crore by 2010.
The Indian Mutual Fund industry has grown tremendously in the last
decade. There are mutual funds with assets under management of around Rs 1
lakh crore (Table 17.3). Assets under Management (AUM) crossed Rs.
1,00,000 crore during the year 1999-2000 recording a growth rate of 65 per
cent. Beside, vast majority of equity schemes out-performed the market.
However, in the subsequent year, that is, 2000-01, AUM sharply declined by
about 20 per cent to Rs 90,587 crore due to extreme volatility in the market and
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86
depressed equity market conditions. The mutual fund industry witnessed such
a sharp decline for the first time in the last two decades. There was a
turnaround in the year 2001-02. The AUM grew by 11 per cent to Rs 1,00,594
crore. During the year 2001-02 while there was an increase in AUM by around
11 percent, UTI lost more than 11 per cent in AUM. It is evident that UTI is
losing out to other private sector players. The AUM of more than 11 sector
mutual funds rose by around 60 per cent during year 2001-02 (Table 17.4).
During the year 2001-02, 90 new schemes were launched-74 of which
were open ended and 16 close ended. Income schemes predominated with 53
schemes collecting Rs 2,744 crore which accounted for 82 per cent of total
collection of Rs 3,355 crore from new schemes. Almost 96 per cent of the
money raised from new scheme launches were invested in the debt/money
market. Sales under Growth, Balanced, and ELSS schemes declined during
the year (Table 17.6).
The gross mobilization from the sale of 417 schemes increased by 77
per cent to Rs 1,64,523 crore but on a net basis, the mobilization was down by
27 per cent to Rs 7,175 crore. Redemption during the year were Rs 1,57,348
crore-88 per cent higher than the previous year.
The asset allocation showed a marked shift towards debt and
government securities. Debt schemes made extraordinary return on account of
cut-in bank rate and by the RBI. Equity schemes remained generally depressed
in line with the conditions (Table 17.5)
Out of a total of 3.08 crore investors in the mutual fund industry, 2.44
crore or 79.15 per cent of the total investors are in UTI (Table 17.8). The
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87
percentage of total investors in private sector mutual funds, is 13.50per cent
(0.41 crore) and public sector mutual funds is 7.35 per cent (0.23 crore). Thus,
UTI has the largest number of small individual investors who contribute 72.61
per cent to UTI‟s total net assets. However, corporates and institutions are the
largest contributors to the net assets of private and public sector mutual funds.
The mutual fund industry has been remarkably resilient over the last
decade in spite of varying economic conditions, capital market scams, and
increasing competition. At present, 417 schemes are offered but this number is
a miniscule fraction of the 13,000 odd schemes offered by the mutual funds in
the US. Moreover, in the US, there is more money in mutual funds that in bank
deposits. Mutual funds in India have tapped only one per cent of the urban
population and rural penetration is negligible. In urban areas, the mutual fund
activity is more concentrated in the eight metros. Debt funds can have an edge
over banks as banks cannot offer attractive rates on deposits due to statutory
reserves and priority sector lending.
According to AMFI data, the total value of equity fund investments
depreciated by over Rs 6,200 crore over a three-and-a-half year period
between April 99 and September 2002. Hence, debt funds are emerging as the
most preferred investment option. Debt funds are characterized as low-risk and
high liquidity investments. Mutual funds worldwide have mobilized savings
more through income funds than equity funds. This is so because mutual funds
are able to offer diverse products based on the investors‟ risk return appetite.
For example, there are liquid funds, government securities funds, AAA rated
bond funds, and so on. The Government Securities Funds have no credit risk
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88
but interest rate risk element comported to bond funds with both credit and
interest rate risk. It is expected that returns from debt funds will increase in the
future in view of the Reserve Banks medium-term objective of reducing the
Cash Reserve Ratio (CRR) to 3 per cent.
1.10 ROLE OF MUTUAL FUNDS IN THE STOCK MARKET.
Mutual funds are proved to be an ideal investment vehicle by small and
scattered investors in the stock market may be for the following reasons:
Mutual Funds provide an investment opportunity to small investors
collectively thereby increasing their participation.
As Mutual Funds are institutional investors, they can invest in market
analysis usually not available to individual investor, providing thereby informed
decisions to small investors.
Portfolio Diversification can be made possible in a better way
because of expertise knowledge and availability of funds.
Mutual funds in India, because of their small size and slower
development in the recent past, have tended to play only a restricted part in the
stock market. In January 2000, the share of mutual funds in total turnover of the
stock market (BSE and NSE), was 4.9% which later on declined to 3.6% in
January 2003. The reason for such decline may be attributed to portfolio
composition of mutual funds companies which directed from equity to debt due
to passive equity market situation.
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89
1.11 RATING OF MUTUAL FUNDS SCHEMES.
Benchmark is a standard against which the performance of a security,
mutual fund or investment manager can be measured. Generally, broad market
and market-segment stock and bond indexes are used for this purpose.
When evaluating the performance of any investment, it's important to
compare it against an appropriate benchmark. In the financial field, there are
dozens of indexes that analysts use to gauge the performance of any given
investment including the S&P 500, the Dow Jones Industrial Average, the
Russell 2000 Index and the Lehman Brothers Aggregate Bond Index.
In India, rating of fixed income securities such as bonds and money
market instruments is in practice, though limited to only a few credit rating
agencies.
Rating of mutual funds schemes has assumed an essential place in the
contemporary and developed financial market. It is like a boon to mutual fund
companies and investors. It facilitates the companies in collecting fund from
small investors and assists the investors to decide their risk-return trade off.
Mutual fund schemes are occasionally evaluated by independent
institutions. The prominent credit rating agencies are the Credit Rating
Information and Services of India Limited (CRISIL) and India Credit Rating
Agencies Limited (ICRA).
Rating of mutual funds performed by CRISIL the Composite
Performance Ranking- tracking (CPR) is relative performance ranking.
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90
1.11.1 CRISIL
A credit rating and information service of India Limited (CRISIL) was
jointly promoted, in 1988, by India‟s leading financial institutions, ICICI and UTI.
CRISIL went public in 1992. In 1995, CRISIL entered into a strategic alliance
with Standard & Poor‟s to extend its credit rating services to borrowers from the
overseas market. CRISIL undertakes Composite Performance Rankings that
cover up all open-ended schemes that discloses their complete portfolio
composition and have NAV information for at least two years. The rankings of
CRISIL are based on the following criteria, which are; risk-adjusted return of the
scheme‟s NAV, diversification of the portfolio, liquidity, size of the asset, asset
quality (debt schemes). The weights allocated to these criteria differ from
category to category. Within each category, the top 10% are considered very
good, the next 20% are considered good, the next 40% are considered
average, the next 20% below average, and the last 10% poor. CRISIL currently
ranks schemes in five categories, which are, Equity scheme, Debt scheme, Gilt
scheme, Balanced scheme, and Liquid schemes.
a) CRISIL METHODOLOGY
For a comprehensive evaluation of the credit risk associated with each
debt instrument, CRISIL considers all factors which affect the credit worthiness
of borrowing companies. On receipt of request for credit rating by a company,
CRISIL assigns an analytical team of professionally qualified persons. This
team obtains data, analyses information, meets key personnel in the company
to discuss strategies, plans and other relevant issues, and interacts with a
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91
back-up team which would have also collected industry information. The key
areas which are considered for analysis are:
1. Business Analysis: This analysis includes industry risk, market
position of the company within the industry, operating efficiency of the
company, and legal position (terms of prospectus, trustees and their
responsibilities: systems for timely payment and for protection against
forgery/fraud etc.).
2. Financial Analysis: This analysis probes into accounting quality,
earnings protection, adequacy of cash flows, and financial flexibility.
3. Management Evaluation: Track record of management, planning
and control systems, depth of managerial talent, succession plans, goals,
philosophy and strategies, and evaluation of the capacity to overcome adverse
situation are some of the factors considered for evaluating the competence of
management.
4. Regulatory and Competitive Environment: The factors considered
for analyzing this are structure and regulatory framework of financial system,
trends in regulation/deregulation and their impact on the company. These
factors are especially important for a finance company.
5. Fundamental Analysis: The team considers liquidity management,
asset quality, profitability and financial position, and interest and tax sensitivity
in this analysis.
After evaluating both qualitative and quantitative factors, the team
presents its findings to rating committee which comprises of some directors not
connected with any CRISIL shareholders. This committee finally decides the
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92
ratings. The rating is them communicated to the company. If the company
wishes to furnish any additional information at this share, CRISIL welcomes it.
The whole process takes four to six weeks.
b) CRISIL RATINGS
CRISIL ratings indicate the current assessment of credit risk associated
with specific instruments like debentures, preference shares and fixed deposits
of company. The rating symbols and their meanings are given below:
Debenture Rating Symbols
The grades for safety and timely repayment of principal and interest in
the descending order are:
1. High Investment Grades: This grade consists of two ratings:
(i) AAA : Which indicates highest safety.
(ii) AA : Which indicates high safety.
2. Investment Grade: It comprises of two ratings:
(i) A : This indicates adequate safety.
(ii) BBB : This indicates moderate safety.
3. Speculative Grades: The speculative grade indicates that there is risk
associated with payment of interest and principal. This grade consists of four
ratings:
(i) BB : This indicates inadequate safety.
(ii) B : This indicates that there is high risk.
(iii) C : This indicates that there is substantial risk.
(iv) D : This indicates that either there is already default of
interest and/or principal as per terms or expected to
default on maturity.
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CRISIL has also the policy of assigning „+‟ or „-„sings for ratings from
„AA‟ to „D‟ to reflect comparative standing within the category.
Preference Share Rating Symbols
The rating symbols for preference share are identical to debenture rating
symbols described above except that the letters „pf‟ are prefixed to the rating
symbols. For example, „pfAAA‟ „PFAA” etc. are the rating symbols used for
preference shares.
Fixed Deposit Rating Symbols
The ratings for fixed deposits which indicate the degree of safety
regarding timely payment of interest and principal are:
(i) FAAA : Highest Safety.
(ii) FAA : High Safety.
(iii) FA : Adequate Safety.
(iv) FB : Inadequate Safety.
(v) FC : High risk.
(vi) FD : Default.
CRISIL applies „+‟ or „-„sings to indicates the relative degree of safety for
symbols „FAA‟ to „FC‟.
Ratings for Short-term Instruments
The ratings for short-term instruments like Commercial Paper indicate
the degree of safety regarding timely payment on instrument. These ratings are
indicated below:
(i) P1 : Very Strong.
(ii) P2 : Strong.
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(iii) P3 : Adequate.
(iv) P4 : Minimal.
(v) P5 : In Default.
CRISIL may apply „+‟ or „-„signs for grades P1 to P3 to indicate the
relative degree of safety within the grades.
The above ratings of CRISIL are only the indicators of the relative
degree of safety of investments in a specific instrument. These are surely not
the recommendations/discouragement to investors. Investors have to make
ultimate investment decisions based on risk-return trade-offs. It is very
important to note that different instruments of a company may carry different
CRISIL ratings. This is because CRISIL assigns ratings to a specific debt
instrument and not to a company as a whole.
Apart from CRISIL, these are two main rating agencies which are
involved in credit rating in India. The ratings assigned by these two are
discussed below.
1.11.2 Value Research India Ratings
Value research India rates schemes in dissimilar categories. Each
scheme is assigned a risk grade and return grade and a composite measure of
performance is calculated by subtracting the risk grade from the return grade.
Within each category, the top 10% are considered five stars, the next 22.5%
four star, the next 35% three star, the next 22.5% two star, and the last 10%
one star.
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1.11.3 Economic Times Lipper
The Economic Times, powered by Lipper, evaluates mutual funds
scheme using a return-risk ratio which is defined as average return divided by
standard deviation of return. The Economic Times from time to time reports the
return-risk ratio for top performing mutual fund schemes along with a few other
parameters.
1.12 OPTIONS OFFERED BY MUTUAL FUND SCHEMES.
No single gun is suitable for all types of hunting. Nor is one fishing rod
appropriate for all types of fishing. Due to the growing competition in the mutual
fund industry, mutual funds offer various options which cater according to the
requirements and capacity of investors.
1.12.1 Dividend option
Dividend option offers the gains of the particular scheme to be paid out
at regular intervals in the form of dividends. Dividend distribution depends on
the funds policy to offer daily, weekly, monthly, quarterly, half-early, or annual
dividend option.
1.12.2 Growth option
Under growth option, investments gains are subject to be ploughed back
into the scheme and announcement of dividend is not done.
1.12.3 Systematic Investment Plan (SIP)
Systematic investment Plan is an option offered by the mutual funds to
assist one save regularly. It resembles the recurring deposit with small money.
The investor is provided the facility of investing regular sums of money every
month to buy units of a mutual fund scheme. The minimum amount of
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investment in Mutual fund SIP is Rs 500 either monthly or quarterly depending
on the policies of the fund house. As the investment is made on a regular
basis, the investor buys more units when the prices are low and fewer units
when the prices are high. Basically it means the respective investor resorts to
Rupee Cost Averaging. SIP helps the investor to make money over the long
time.
1.12.4 Systematic Withdrawal Plan (SWP)
The systematic withdrawal plan allows the investor to extract a fixed
amount every month. The investor can select the withdrawal of a fixed sum
every month or a certain percentage of the capital appreciation in the NAV of
the scheme.
1.12.5 Retirement Pension Plan
Some schemes offered by he mutual fund houses are linked with
retirement pensions. Individual investors participate in these plans to safeguard
their retired lives and corporates for their employees‟ benefit.
1.12.6 Insurance Plan
Some schemes launched by Unit Trust of India and Life Insurance
Corporation provide insurance cover up to the respective investors.
1.13 VALUE-ADDED SERVICES OFFERED BY MUTUAL FUNDS
Time was when mutual funds in India took several weeks to send
redemption cheques. When they revealed precious little of where the money of
investor‟s was invested. But today the tables have turned. Mutual Funds are
paying greater attention to investors servicing, putting a place system to make
investing experience a breeze. And what is a visible trend, fund houses, having
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the basic investor servicing foundation in place, are looking to offer an investor
handy value-added services – at no additional cost. The emphasis is on helping
an investor to save money and time. Mutual fund offers value-added services to
the investors in the following way;
1.13.1 Redemption over phone
Some mutual funds offer investors the facility of making a redemption
demand or switch among the available schemes of a particular mutual fund
over the phone. All fund houses allow easy access – walk-in, phone or over the
Net – to investors. A few fund houses even have toll-free numbers, where
investors can call in for inquiry and update information.
1.13.2 Triggers
A trigger is an actionable facility that lets the investors pre-specify exit
targets for his mutual fund investment. Usually, triggers are based on value or
time duration of a mutual fund scheme. When the target is reached, the fund
house will automatically redeem the units of the investor.
1.13.3 Alerts
Under the alerts services, the fund house intimates to the investors – by
phone, post, or e-mail – when a certain trigger point has been reached. It
depends upon the investor to take the decision of redeeming the units or to
remain invested.
1.13.4 Cheque Book facility
Some fund houses provide investors in certain schemes generally a debt
scheme, the option to take a redemption cheque worth 75% of the investment
value subject to some limit, at the time of investment itself. Encashment of the
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cheque is deemed as withdrawal by the investor, at the scheme‟s NAV on the
day the cheque is deposited. Of course, the investor has to contact the fund
house to get the balance amount.
1.13.5 New point of purchase
Technology is a greater enabler, and fund houses are constantly finding
ways to use it to their benefit. Providing convenience to the investors, fund
houses are supplementing conventional channels of distribution with more
points-of-purchase. For example, HDFC Mutual fund permits its investors to
buy and sell through ATMs. As also Prudential ICICI and Templeton Mutual
fund sell units of their schemes On line to the potential investors who possess a
Net banking account with an of the banks these mutual funds have tied up.
1.13.6 Switching facility between schemes
Switching facility provides investors with an option to transfer the funds
amongst different types of schemes or plans. Investors can take the decision to
switch units between Dividend plans or Reinvestment plan at Net Asset Value
based prices. One has to take care when switching between Debt and Equity
schemes about the exit and entry loads. As switching between debt and equity
schemes involves an entry load while switching between equity and debt
schemes does not involve an entry load.
1.14 NEW FUND OFFERING (NFO)
New fund offering is the first issue of units of a mutual fund scheme to
investors. It resembles an Initial Public Offering (IPO) where the company
makes the first issue of its security to the public for subscription. In order to
make the NFO victorious, most of the mutual funds houses offer attractive
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commissions and incentives on the sale of units done by distributors and sub-
distributors.
Figure 1.10 Process of NFO
Earlier, mutual fund schemes which were offered to the investors for the
first time used the term “Initial Public Offering”. According to Securities
Exchange Board of India, because of this resemblance at the time of bull
markets of early 2003-04, led to misinformed decision-making by many
investors who were ignorant of the technical differences between an offer by a
mutual fund and that of a company. A lot of mutual funds benefited from this
gross negligence on the part of investors. Due to this misguidance created by
such IPO term, Securities exchange board of India made it mandatory for all
new schemes offered to investors to use the term “New Fund offering”.
1.14.1 Rules framed by SEBI for governing NFOs.
1. SEBI has made it compulsory that any new fund offering of a mutual
fund scheme should not exceed 30 days of subscription.
AMC SEBI
(1) Files Offer Documents
(2) Receives Clearance
(3) Pre-NFO activities like
marketing and advertisement
(4) NFO period – Subscription by
the public and institutions
(5) Screening for valid
applications and subsequent
allotment of units
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2. It has also been made mandatory for the fund house to allot the units
for all valid applications within the time frame of 30 days after the closure of the
NFO.
3. In case of failure of the scheme to collect the minimum subscription
amount, the fund house refunds the money to the applicants. In addition to this
rule, refund of subscription money on account of invalid application has to be
made within six weeks after the close of the NFO period.
4. If the refund money is not made within six weeks limit, interest @
15% per annum shall be paid by the Asset Management Company.
5. In recent times, SEBI has also considered an array of similar funds
being launched and has made it compulsory for the trustees of mutual fund to
personally certify that their new scheme which are launched are different from
earlier schemes.
1.14.2 Important Points to be considered before Investing in NFO
1. An investor should evaluate his current portfolio and then decide
whether any new funds will be an add-on and will help in diversifying and
increasing returns.
2. In rising market it is pretty easy for almost all funds to beat the
benchmarks, but the real test for any fund is how it performs during the bearish
phase of the market. A regular evaluation of the fund house and its various
schemes launched during the previous years can give the investors a fair idea
on how the new offering would fare.
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3. It is important for an investor to be aware of the objectives of the
scheme launched, asset allocation and risk factors along with reputation of the
fund house and credibility of the fund manager.
4. A vigilant observation of the fund house will assist the investor know
about the number of NFOs it is coming up with. If the frequency is too high
without any innovative addition to its range of offerings, the investors can
consider skipping the scheme.
5. NAV should not be criteria for investment in NFOs. Investments in
NFOs should be made if the fund is offering some innovative product which
matches the investment objectives of a particular investor.
1.15 BUILDING AND MANAGING PORTFOLIO WITH MUTUAL FUNDS
While building an investment portfolio there are three main
considerations – Liquidity, Income and Growth. It is very important that you
build a portfolio of assets that meet your individual needs and help you to
achieve your investments goals. Investing is about ensuring financial growth
and security in the long term. These goals could include: availability of cash for
emergencies, education for children, maintaining family lifestyle, retirement,
acquiring or selling a business, estate planning, financial independence or
personal objectives such as a special vacation or second home (Chart 1). To
achieve these goals in life, it is necessary to take steps at every income and
age level to make a more efficient use of assets and to make a more efficient
use of assets and ensure a secure financial future. Financial Planning is thus a
process of developing strategies for using financial resources to achieve short,
intermediate and long-term goals.
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The objective of Financial Planning is to achieve the highest potential
rate of return in keeping with the investors‟ risk tolerance. The right allocation of
investments depends on investors‟ objectives, risk profile, time horizon over
which investors want to achieve the financial and personal goals. The investor‟s
attitude towards risk is key element in customizing the portfolio and analyzing
the risk is the next important step in order to determine the appropriate mix of
assets. Another key factor to understand is where you can invest your money.
There are many ways to make money in today‟s market, but the one strategy
that has truly proven itself over the long term is investments thorough Mutual
Funds. Mutual funds have become one of the largest investment vehicles in the
world, currently controlling over 7trn dollars in assets in the US and over 3trn
euros in assets in Europe (Table 1).
Indian financial scene too presents multiple avenues to the investors.
With Indian long-term story firmly in place, mutual funds are going to be an
important vehicle of savings and capital market intermediation. It is going to be
a boon to the uninformed retail investors. The Barclays capital Wealth
Management Survey, involving the world‟s leading wealth mangers, has
predicted Asia‟s top three wealth markets of China, India and Korea to grow by
an much as 17% a year for the next three years. After nearly 40 years, the
industry has finally moved from infancy to adolescence particularly in the past
five years. The industry has made a leap to become an important and dynamic
sector of the capital markets and is expected to grow annually at 20% in the
coming years. It is going to stay as the main driver of wealth creation. India,
though certainly not the best or deepest of markets in the world, has ignited the
growth rate in mutual fund industry to provide reasonable options for a layman
to invest.
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Investments in stocks, bonds and other financial instruments require
considerable expertise and constant supervision to take such financial
decisions. Small investors usually do not have the necessary expertise and the
time to undertake any such monitoring that can facilitate informed decision-
making. By investing in mutual funds, investors can gain the expert assistance
of professional fund mangers who often specialize in selecting specific types of
investments to reflect a particular objective or strategy. Investing in mutual fund
is actually buying an interest in the many different investments that the fund
holds. This diversification reduces your overall investment risk, as a decline in
one investment in the mutual fund may be offset by the strength of other
investments in the fund. Most individual investors cannot readily match the
level of diversification available through a mutual fund.
Table 1.4 Table showing comparison of Life Insurance, Registered Pensions and
Mutual Funds as percentage of GDP
Penetration as % of GDP in Different Countries
Country Life Insurance
Registered Pensions
Mutual Funds
France 60.3 3.5 61.2
US 33.1 66 69.9
Korea 22.8 3.9 25.3
Chile 18.7 59.4 11.1
Thailand 6.2 8 10
Mexico 3.8 0.2 6.1
Poland 4.6 9.5 4.6
Brazil 1.2 20.4 39.6
India 13.3 4.2 4.6 Source : Economic Times
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1.15.1 Playing Safe with Mutual Funds and Managing Return
Expectations
Indian MF industry offers a plethora of schemes and serves broadly all
type of investors. It is important to understand that each mutual fund has
different risks and rewards. In general, the higher the potential returns, the
higher the risk of loss. Although some funds are less risky than others, all funds
have some level of risk. Each fund has a predetermined investment objective
that tailors the fund‟s assets, investment process and investment strategies. At
the fundamental level, there are three categories of mutual funds. Index funds
try to replicate broad market indices such as S&P Nifty and BSE Sensex in an
effort to returns, close to benchmark indexes. Others differentiate according to
perceived investment criteria such as size (large, medium, or small firms), and
style (value, growth, or blend). Moreover, some funds specialize in sectors of
the economy, such s information technology, pharma, banking, while others
may invest in international portfolios. When held over long periods of time,
broad portfolios of stocks and bonds have produced returns that substantially
exceed the interest rate paid on less risky.
1.15.2 Investment through Mutual Fund
Mutual funds normally come out with an advertisement in newspapers
publishing the date of launch of the new schemes. Investors can also contact
the agents and distributors of mutual funds who are spread all over the country
for necessary information and application forms. Forms can be deposited with
mutual funds through the agents and distributors who provide such services.
Now a days, the post offices and banks also distribute the units of mutual
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funds. However, the investors may please note that the mutual funds schemes
being marketed by banks and post offices should not be taken as their own
schemes and no assurance of returns is given by them. The only role of banks
and post offices is to help in distribution of mutual funds schemes to the
investors.
Investors should not be carried away by commission/gifts given by
agents/distributors for investing in a particular scheme. On the other hand they
must consider the track record of the mutual fund and should take objective
decisions.
1.15.3 Returns from Mutual Funds
Investors who invest in a mutual fund are subject to following returns.
1. Dividends: The dividend income of a mutual fund company from
its investment in shares, both equity and preference, are passed on to the unit
holders. All income received by investors from mutual fund is exempt from tax.
A mutual fund can receive dividends from the stocks that it owns. Dividends are
shares of corporate profits paid to the stockholders of public companies. The
fund might have money in the bank that earns interest, or it might receive
interest payments from bonds that it owns. These are all sources of income for
the fund. Mutual funds are required to distribute this income to shareholders.
Generally they do this twice a year; in a move that's called an income
distribution.
2. Capital gains: At the end of the year, a fund makes another kind
of distribution, this time from the profits they might make by selling stocks or
bonds that have gone up in price. These profits are known as capital gains, and
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the act of passing them out is called a capital gains distribution. Mutual fund
unit holders, thus gets the benefits of capital gain also which are realized and
distributed to them in cash or kind.
3. Appreciation in Net Asset Value (NAV): Although mutual funds do
not earn high rates of returns, they possess the capability of reducing risk to the
systematic level of market fluctuations. The increase or decrease in the Net
Asset Value of a mutual fund scheme is the unrealized gains or losses on the
portfolio holdings owned by a particular mutual fund. As the value of individual
securities in the fund increases, the fund‟s unit price increases. An investor can
book a profit by selling the units at price which is higher than the price at which
the units were purchased by the investor. The majority of mutual fund schemes
earn in a long run, an average rate of return that exceeds the return on bank
term deposits.
1.15.4 Costs of Investing in a Mutual Fund
Whenever an investor has to invest in any type of investment avenue
he/she has to incur some expenditure. Mutual Funds are no exception. There
are four types of costs associated with mutual fund investing: initial issue
expenses, entry load, exit load, and annual recurring expenses.
1. Initial issue expenses: Initial issue expense include items for
example brokerage fees and commission, marketing and advertising expenses,
printing and distribution costs, and so on which are incurred by the fund house
when the scheme is launched. Initial expenses upto 6 percent of the amount
mobilized can be charged to the scheme. What is incurred in excess of 6
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percent has to be borne by the respective Asset Management Company
(AMC). Generally AMCs bear all the initial expenses.
2. Entry load: Entry load or sales load is the load imposed when the
units are purchase by the investors to become a part of Mutual Fund Scheme.
It may be upto 2% - of course for many schemes No entry load is charge from
the investors. If the entry load is 2 percent, it means that when an investor buy
the units of a mutual fund scheme which has a net asset value per unit of say
Rs 12 the investor have to pay Rs 12.24 (Rs 12 plus 2 percent thereof).
Schemes that have an entry load are called load schemes and schemes that
have no entry load are called no-load schemes.
3. Exit load: Exit load or redemption load is the load imposed when the
units are sold back to the mutual fund. In practice it varies from 0 percent to 3
percent. This load is imposed to deter investors from withdrawing from the
scheme. In some cases a contingent deferred sales charge of 0.5 percent to
1.0 percent is levied when the investor redeems the units before a certain
holding period (say 6 months). Normally exit load or contingent deferred sales
charge is not applicable when there is an entry load.
4. Annual recurring expenses: Annual recurring expenses refer to the
investment management and advisory fees charged by the AMC and costs,
trustee fees, custodian fees, audit fees, costs of investor communications,
costs of providing account statement and dividend/redemption cheques and
warrants, and costs of statutory advertisements.
The investment management and advisory fees chargeable by the AMC
is subject to the following restrictions: 1.25 percent of net assets upto Rs 100
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crore and 1.00 percent of net assets above Rs. 100 crore. For schemes
launched on a no load basis, the AMC shall be entitled to collect an additional
management fees not exceeding 1 percent of weekly average net assets
outstanding in each financial year.
The annual recurring expenses shall be subject to the following limits:
On the first Rs 100 crore of the average weekly net assets : 2.50 %
On the next Rs 300 crore of the average weekly net assets : 2.25%
On the next Rs 300 crore of the average weekly net assets : 2.00%
On the balance of net assets : 1.75%
In respect of a debt scheme, the ceiling mentioned above has to be
lowered by 0.25%. In case of a fund of funds scheme, the total recurring
expenses of the scheme shall not exceed 0.75% of the daily or weekly average
net assets, depending on whether the NAV of the scheme is calculated on daily
or weekly basis.
There is one large cost, which is invisible and therefore is often ignored.
It is the cost incurred in executing portfolio transactions. When a mutual fund
buys and sells securities it incurs commissions as well as market impact costs.
Transaction costs depend on the rate of portfolio turnover and the degree of
liquidity and marketability of the securities included in the portfolio. These costs
may range between 0.5% to 2% of the assets of the fund.
When the costs (visible and invisible) of mutual fund investing are high,
they impose a significant haul on fund returns. The haul will be quite
burdensome if the gross returns are low. For example, when the costs are 3
percent and gross returns are 12 percent, the costs will absorb 25 percent of
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the returns. The lesson in simple: costs matter. Hence an investor should be
aware of their potential impact on investment returns.
1.16 STRATEGIC CHOICES IN MUTUAL FUND BUSINESS
Mutual fund industry is one industry which has undergone the most
dramatic transformation in the post-liberalization period of the nineties, in the
field of financial service sector. There has been a paradigm change in the
quality and quantity of product and services offered by mutual fund companies.
After being serviced by the monopoly players in the country for decades with
hardly any choice in product offerings, the Indian customer in the present time
is being wooed by virtually who‟s who of global as well as Indian players and
that also with a choice that was unbelievable a decade back. Based on this
background the strategic marketing choices which the mutual fund companies
implement for their respective products to survive and thrive in this extremely
promising industry in the face of cut throat competition.
1.16.1 Trends in the marketing of mutual fund in India
The changing marketing trends in the mutual fund industry can be easily
linked and traced to its history of growth. The changes in marketing strategies
can be characterized by four stages which have evolved along with the growth
and evolution of the industry. (The four stage model was first proposed by
freeman and co, a consulting company providing advisory services to
financial services industry.)
a. Product focus
b. Distribution focus
c. Client ownership focus
d. Specialized product and service sector
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a) Product Focus
For the first three decades of the industry, from the setting up of UTI till
the entry of private sector players, the only focus of the marketing strategy was
different product offering. UTI and various other public sector mutual funds
focused on introducing an array of products falling in different categories. The
categorization was primarily based on two factors: one was the way the
scheme were traded and the other through different composition of debt and
equity securities in the schemes.
Schemes according to trading:
Open-ended schemes
Close-ended schemes
In an open ended scheme there were no limits on the total size of the
corpus. Investors are permitted to enter and exit the open-ended scheme at
any point of time at a price that is linked to the net asset value (NAV). In case
of close-ended scheme, the total size of the corpus is limited by the size of the
initial public offer. The entry and exit of investor is possible only by trading on
the stock exchange. Due to liquidity constraints posed by close-ended funs,
they were soon rendered obsolete and most of the prevailing schemes are
today open-ended schemes.
Schemes according to composition of debt and equity
Growth schemes
Income schemes
Balanced schemes
Money market schemes
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The products were also differentiated by the composition of equity and
debt in various schemes. Growth schemes invest predominantly in equities
whereas Income schemes invest only n fixed income debt securities. Balanced
schemes try to derive the benefits of both equity and debt by investing in both.
Money market schemes invest in short term liquid securities like money market
instruments for example, treasury bills, commercial papers, government
securities, commercial bills, certificates of deposits etc so that they serve as
appropriate products for investing in short term funds.
There were other niche schemes to fulfill specific needs, such as Tax
saving schemes, Sector specific schemes, Index schemes and so on.
In the Product focus stage, the main aim of the mutual fund companies
was to introduce a wide variety of products and due to oligopolistic competition;
there was no dearth of subscribers. The only parameter on which the selling
was based was the relative performance of the products.
b) Distribution Focus
Product focus continued for two to three years even after the entry o
private sector players in 1993. Initially, the private sector players introduced the
same products available from the public sector and promised superior
performance. When they realized that they needed to differentiate on some
other parameter as well, they focused on distribution. As it was difficult and
time consuming to replicate the wide spread distribution structure of agents set
up by UTI, they encouraged third-party distribution companies to distribute their
products all over India. Specialist distribution companies such as Karvy, Bajaj
Capital, Integrated Enterprises etc. had emerged. Special focus was given to
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investor so that investors could experience superior servicing standards from
private players. Some groups such as Birla Mutual Fund even set up their own
distribution companies such as Birla Distribution.
While the focus on improved distribution and investors servicing did help
the private players establish themselves against large players like UTI, it had
also resulted in a lot of problems. In the rush to gain volumes and thereby
commission incomes, the distribution companies many a time sold the wrong
product to the wrong customer. A growth product, which invests primarily in
risky instruments like equities, was sold to old, retired people looking for
regular, steady income as pension. The ensuing dissatisfaction has thus paved
the way at last or the most critical area for marketing, the Customer ownership
focus.
c) Customer Ownership Focus
Mutual fund companies began to segment their target customer and
position their various products based on the target segment they proposed to
address. The target segment was broadly divided into institutional segment and
individual investor segment. The institutional segment consisted of treasury
departments of corporate, trusts etc and suitable products such as Institutional
Income schemes and Money Market schemes were targeted at them. The
individual investors were in turn divided into various segments such as Young
families with small or no children, Middle-aged people saving for retirement and
Retired people looking for steady income. Suitable products such as Growth
and Balanced schemes for young families and Income schemes for retired
people were marketed.
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By proper segmentation and by targeting the right product to the right
customer, mutual fund companies hoped to win the confidence of their
customer and „own‟ them for life time.
d) Specialized Product & Service Focus
If one observes the trends in the recent past, companies have been
taking the above customer focus further by designing and launching specialized
products and services. As awareness levels of individual investors go up, focus
is on identifying one‟s investment needs depending on one‟s financial goals,
risk taking ability and time horizon. Investor chose companies, which help them
in the above through specialized products and services.
For example, a common financial goal is to save and invest for meeting
the education needs of the children. A number of mutual fund companies such
as Prudential ICICI mutual fund and UTI mutual fund have launched products
that are designed to serve this specific need. The scheme is aimed at helping
investors plan for the education needs of their children. There are two sub-
parts: Gift plan- If the child is in the age group of 1-13 years and one is looking
to save over a long horizon. Gift plan invests between 51-60 percent in equities
and 40-49 percent in debt instruments.
Study plan: If the child is between 13-17 years and one is looking to
meet education expenses in a short time frame. Study plan invests between
85-100 percent in debt and 0-15 percent in equity. A similar need is planning
for a comfortable retirement.
In addition there is a need for specialized services that help investors
assess their risk taking ability and chose product accordingly. Some mutual
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fund companies are launching a new product called „fund of funds‟ which
invests in a combination of other mutual fund schemes (growth, income
schemes etc.), based on the investment objective and risk profile of the
investor.
1.17 SYSTEMATIC INVESTMENT PLAN (SIP) – WAY TO WEALTH
CREATION
A number of facilities are offered by mutual fund schemes so that the
investors can cater these services as per their convenience. Systematic
Investment Plan is straightforward and time-honored mutual fund scheme
constructed to help the low earning investors to accumulate wealth in a
systematic manner over a long period thereby plan a more estimable future for
them.
SIP are regular investment plan available on almost all kinds of mutual
fund schemes, though they are the most effective in equity schemes, as equity
is more volatile asset class than debt. SIP helps an investor to profit from
volatility by automatically buying more units when prices are falling and fewer
units when prices are rising, thus lowering the average purchase price, while
inculcating some much-required discipline into an investor‟s saving and
investing habits. SIP is a disciplined way of investing, where an investor can
invest fixed amounts at regular intervals trough a mutual fund scheme and
includes the following technical benefits:
Chapter - 1 : Overview of Mutual Fund
115
1.17.1 Benefit of SIP
a. Rupee cost averaging
b. Power of compounding
c. Low investment
d. Disciplined investment habit
e. Convenience
f. Commensurate returns
g. No entry load
a) Rupee Cost Averaging: Different investors have different objectives
of investing in a mutual fund scheme as majority of them want to
obtain maximum returns on their investments. Investment will be
simple and smooth if one can identify the right time to purchase units
or sell them. However, it proves to be a tiring and complex task of
keeping a track of the market consistently as it is not everybody‟s
„cup of tea‟. One has to face the loss in near future. An automatic
market-timing mechanism like Rupee cost Averaging is required to
track the investment and to save the time efficiency with a minimal
gain if not loss, if the circumstances are unfavorable.
With Rupee Cost Averaging there is no need to be concerned
about the rise and fall in prices shares of companies in which the
mutual fund has invested. An investor can merely invest a fixed
amount at regular intervals, irrespective of the Net Asset Value of the
scheme. The concept is that one has to purchase fewer units when
the NAV is high and more units when the NAV is low. This is in line
with the natural desire to “buy low and sell high”.
Chapter - 1 : Overview of Mutual Fund
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Table 1.5
Benefits of Rupee Cost Averaging
Thus we see that the average unit cost under Systematic
Investment Plan will always be less than the unit cost when you make a one-
time investment.
However, rupee cost averaging does not guarantee a profit.
But with a sensible and long-term investment approach, rupee
cost averaging can smooth out the market's ups and downs and considerably
reduce the risks of investing in volatile markets.
b) Power of Compounding: The power of compounding stresses the
importance of starting the procedure of investment at young age. The
power of compounding involves “Future value of Annuity”, a series of
equal payments that occur at evenly spaced intervals. Hence under
the Systematic Investment Plan an investor can invest in a fixed
amount every month, for a pre-decided period of time, usually 6
months to 1 year, through post-dated cheques, at the applicable
NAV-related prices.
Rupee Cost Averaging - The power of disciplined investment
Month
Investment Rs.
NAV Rs.
No. of units
1
2
3
4
5
TOTAL
1000
1000
1000
1000
1000
5000
10
12
10
8
10
50
100.00
83.333
100.00
125
100
508.333
The average NAV = 50/5=Rs.10
Average price= Total investment/total no. of units
=5000/508.33= Rs.9.84
Chapter - 1 : Overview of Mutual Fund
117
Table 1.6
Power of Compounding (An Illustration)
Year Invest/Year Total Inv. Accumulation Int. % Interest Value
1 12000 12000 12000 18% 2160 14160
2 12000 24000 26160 18% 4709 30869
3 12000 36000 42869 18% 7716 50585
4 12000 48000 62585 18% 11265 73851
5 12000 60000 85851 18% 15453 101304
6 12000 72000 113304 18% 20395 133698
7 12000 84000 145698 18% 26226 171924
8 12000 96000 183924 18% 33106 217030
9 12000 108000 229030 18% 41225 270256
10 12000 120000 282256 18% 50806 333062
11 12000 132000 345062 18% 62111 407173
12 12000 144000 419173 18% 75451 494624
13 12000 156000 506624 18% 91192 597816
14 12000 168000 609816 18% 109767 719583
15 12000 180000 731583 18% 131685 863268
16 12000 192000 875268 18% 157548 1032816
17 12000 204000 1044816 18% 188067 1232883
18 12000 216000 1244883 18% 224079 1468962
19 12000 228000 1480962 18% 266573 1747536
20 12000 240000 1759536 18% 316716 2076252
21 12000 252000 2088252 18% 375885 2464137
22 12000 264000 2476137 18% 445705 2921842
23 12000 276000 2933842 18% 528092 3461934
24 12000 288000 3473934 18% 625308 4099242
25 12000 300000 4111242 18% 740024 4851265
26 12000 312000 4863265 18% 875388 5738653
27 12000 324000 5750653 18% 1035118 6785771
28 12000 336000 6797771 18% 1223599 8021369
29 12000 348000 8033369 18% 1446006 9479376
30 12000 360000 9491376 18% 1708448 11199824
Chapter - 1 : Overview of Mutual Fund
118
Figure 1.11
Power of Compounding
0
2000000
4000000
6000000
8000000
10000000
12000000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
year
Year
Total Inv.
Value
c) Low investment: In the SIP method, huge investment are not
required, even an investment as low as Rs 50 can be made. It is
suitable for small investors who don‟t have fixed and regular income.
d) Disciplined investment habit: Through Systematic Plan an
individual can cultivate the practice of saving and disciplined
investment habit. This will ultimately result in creation of capital in an
economy for better future. As also through disciplined and steady
investment, the investor can cease to worry about when and how
much to invest.
e) Convenience: An investor is relieved of all the cumbersome work of
tracking the fund‟s performance in the busy hectic schedule. By
starting an account with the mutual fund house and providing post-
dated cheques of periodic investments (monthly, quarterly, etc.),
Chapter - 1 : Overview of Mutual Fund
119
based on the individual investor will provide the necessity of
investment. Also while buying, one can adopt the installment
method, but selling can be done as and when required. Withdrawals
can also be done through installments known as Systematic
Withdrawal Plan (SWP).
f) Commensurate returns: Systematic Investment Plan offer adequate
returns to an investor as rupee average costing and power of
compounding can be experienced. A one time huge amount of
investment leads to a major impact through the ups and downs of the
sensex. Investment through the SIP in the way of installments gives
an average rate of gain, though fluctuations in market prevail.
g) No Entry load: Mutual Fund Schemes do not charge entry load for
SIP schemes, thereby providing a decline in the cost of investing in a
mutual fund.
1.17.2 Beneficiaries of SIP
1. SIP enables the retail people to invest in mutual funds with low
investments as the monthly SIP installments start as low as Rs 50.
2. SIP method of investing proves beneficial to low income groups
as risk is very low and Rupee Average Cost is available.
3. For a common retailer who is risk averse and prefers to gain more
by investing at the right time, the SIP proves to be hassles free investment
option with risk free unlike open share market.
4. SIP is suitable to the investors who lack sufficient time to track the
performance of their portfolio.
Chapter - 1 : Overview of Mutual Fund
120
1.17.3 How to get best out of SIP
1 Investment objective: An objective assigns investment an indicative
time horizon and provides a better and clearer idea of how much to invest. For
example money assigned for retirement will obviously have a longer term than
the money earmarked for a car.
2) Fixed periodic investment amount: An investor should allocate
a fixed amount of money which he can set aside periodically to realize the
objectives. Conservatism should be followed while investing through SIP.
3) Decide on the periodicity: Most mutual funds offer two options
on SIP: monthly and quarterly. Between the two, the monthly option is the
smarter alternative. The more frequently investment is made and the longer the
investment is continued the smoother the average cost graph will become.
4) Selection of scheme category: The selection of the scheme to
invest as SIP depends much upon the risk profile and investment objective of
the investor. Hence the risk averse investor should stick to either debt funds
only.
5) Selection of a reliable fund house: An investor should select a
fund house which has proven its worth in the market and has gained reputation
as well.
6) Avoid the market trends: A falling market might make investor to
reconsider the method of SIP whether to continue or to take step back. An
investor has not to consider the volatility of the market because the investor
gets an opportunity to buy greater number of units, which brings down the
average cost price. And when the market recovers, gains are magnified.
Chapter - 1 : Overview of Mutual Fund
121
7) Review: Eventually, the success of SIP will depend on its
corresponding scheme‟s performance. Hence a review should be kept of the
scheme and if a scheme is underperforming consistently, an investor should
consider switching to another scheme.
1.17.4 SIP- Indian Context
In a country like India, where a majority of the people is either poor or
from lower middle class, the small saving from their hard earned is the only
reserve for their future needs. These investors generally prefer protection to
wealth creation while deciding about their investment choices. Though mutual
funds are also subject to market risks and fluctuations yet the SIPs are a very
convenient and useful savings method without any specific loss incurred to the
investor, with a minimum average gain in unfavorable situation.
In Indian context, Unit Trust of India is the first to offer Systematic
Investment Plan in mutual funds. Reliance mutual fund launched SIP with
minimum monthly installment of Rs. 100 for the rural investors. Stepping a little
further, ICICI Prudential Mutual Fund launched the Micro Systematic
Investment Plan (MSIP) in association with Konrad-Adenauer-Stiftung (KAS)
Foundation, a microfinance institution and reduced the minimum investment to
Rs. 50. Majority of other mutual companies are also introducing SIP in their
mutual funds. SIP facility is available in the following mutual fund schemes:
1. Income fund
2. Monthly Income Plan
3. Child Benefit Fund (Career, Building Plan only)
4. Balanced Fund
Chapter - 1 : Overview of Mutual Fund
122
5. Index Fund
6. Growth Fund
7. Equity fund
8. Tax Saving Fund
Table 1.7
Some of the Mutual Fund Houses with their Minimal SIP Installment
Name of the Mutual Fund House Minimal SIP installment for a month
(in Rs)
Prudential ICICI 50
Reliance Mutual Fund 100
SBI Mutual Fund 500
Franklin Templeton Fund 500
Unit trust of India 100
HDFC Mutual Fund 500
Source : ValueResearchOnline
1.18 SYSTEMATIC TRANSFER PLAN.
Small investors usually fancy a safe method to create wealth while
making investment selection. Investment requirement of person differ from one
individual to another individual and they need a more favorable and systematic
investment avenues. Investment made through Mutual Funds provides the
much needed safety of money as well diversification and liquidity. The
enormous growth of the equity market has induced the investor to reap the
benefits of high growth potentials of the Indian Money Market without taking the
inbuilt high risk, which can be possible only through Mutual Fund Investment.
Chapter - 1 : Overview of Mutual Fund
123
No doubt Mutual Fund has rightly proved to be a right investment avenue for
the investors to enter the stock market indirectly. Earlier Mutual fund
companies were slow in sending redemption cheques and to reveal where the
money collected by a number of investors was invested. But today, the
scenario is completely changed. In the age of cut-throat competition the mutual
fund companies are providing a number of facilities to attract the attention of
the possible investors. Systematic Transfer Plan is one such facility provided by
most of the Fund Houses.
1.18.1 Meaning of Systematic Transfer Plan.
The Systematic Transfer Plan is a facility wherein the investor can
transfer a fixed amount or capital appreciation from one mutual fund scheme to
another scheme periodically. Investor can take the benefit of STP on a monthly
or quarterly basis from one plan to another in the same scheme or to another
scheme within the fund. STP facilitate an investor to invest a certain amount at
periodic intervals without decreasing his resources while simultaneously
building up a pool of assets to cater to the growing needs.
It is very similar to the Systematic Investment Plan (SIP), but differs in
source from which the amount is transferred. In the case of SIP, the amount is
transferred from the bank account of the investor whereas in STP, the sum is
transferred from another mutual fund scheme. The STP is often called as “Drip
Investment” as it helps to invest the capital appreciation in different small
installments.
Chapter - 1 : Overview of Mutual Fund
124
1.18.2 Categories of STPs.
Fixed option STP that allows the unit-holders to transfer a fixed
sum at periodic intervals into another fund.
Appreciation STP that is set in motion only when the capital
appreciation on the existing investment crosses a limit that has been set by the
investor.
1.18.3 Working Mechanism of STP
Systematic investment Plan provides the diversification within the
scheme as soon as the one scheme reaches a predestined goal. Among the
various strategies followed by Mutual Fund Houses Systematic Transfer Plan
provides an excellent opportunity to switch investment from one scheme to the
other scheme within the same fund.
Unit-holders may take the advantage of this plan by specifically applying
for it by filling up the relevant portion of the transaction form. In order to
illustrate how the STP works, let us assume that an investor has invested Rs.
1,00,000 either in debt instruments or in any other capital market related
scheme. Then he can have a STP with the existing scheme. As per that, the
investor can instruct the fund manger of the existing scheme to transfer Rs.
1,000 to another mutual fund scheme periodically. The other scheme can be
Equity Fund, a Balanced Fund or any other type of fund. In order to transfer the
amount to the new scheme, some of the units in the existing scheme will be
sold. The growth in the units of the existing scheme will neutralize the reduction
in the number of units. Table 1.8 provides the Net Asset Value (NAV) of the
funds at the beginning and the net amount at the end of each month.
Chapter - 1 : Overview of Mutual Fund
125
Table 1.8 STP (An Illustration)
Month NAV No of Units to be Sold to
Transfer Rs. 1,000
Remaining Units
NAV at the End of the Month
0 10.00 - 10,000 1,00,000
1 10.40 97 9,903 1,02,992
2 10.80 93 9,810 1,05,948
3 10.20 98 9,718 99,062
4 9.80 102 9,616 94,237
5 10.580 96 9,520 99,260
6 11.00 91 9,429 1,03,719
7 11.30 89 9,340 1,05,542
8 11.50 87 9,253 1,06,409
9 11.40 88 9,165 1,04,481
10 12.00 84 9,081 1,08,972
The above Table 1.8 clearly shows that at the end of the first month, an
investor has to sell 97 units to transfer Rs. 1,000. However, at the end of the
tenth month, only 84 units should be transferring a sum Rs. 1,000. This is
possible due to the increase in the NAV of the existing units.
1.18.4 Beneficiaries of STP
STP can be effective for several classes of investor. Some are listed
below:
Investors who want to invest large amounts in schemes with
stable returns and ensure small exposure to equity schemes, in order to avail
themselves of the high growth potentials through equities.
Chapter - 1 : Overview of Mutual Fund
126
Investors who want to re-balance their portfolio or to phase out
investments in a particular fund over a period.
Investors who like to re-balance their equity investments and hold
them within a desirable limit by transferring from equity to debt.
1.18.5 Convenience of STP
An investor can easily enroll himself for a STP just by filling an
application form.
The fund manger transfers the amount on the requested date,
credits the units to the investor‟s account and sends a confirmation for the
basis.
In a STP, the investor has the option of transferring the sum
either on monthly or quarterly basis.
Most of the mutual funds do not charge any entry and exit load for
switches within the funds during the 365-day period.
1.18.6 Benefits of STP
It facilitates the investor to save as well as accumulate wealth at
the same time.
It permit the investor to enter at various market levels (averages
out the possible risk associated with the equity market).
Hassle-free mechanism (one-time arrangement-instructions are
given out the possible of initial transaction).
Uses the power of compounding to its advantages. Due to the
consistent savings over a period of time, the periodic installments aggregate to
a considerable amount.
Chapter - 1 : Overview of Mutual Fund
127
The initial amount invested is not kept idle. The unit-holder can
earn better returns on the initial amount than the bank return.
1.18.7 STP : Indian Scenario
In India, various fund houses such as Prudential ICICI, Kotak, Birla Sun
Life, UTI, HDFC Mutual, Franklin Templeton, etc., are offering the STPs in their
mutual fund schemes (Table 3). They usually offer monthly quarterly STPs, but,
a few funds such as Prudential ICICI, allow systematic transfers even at weekly
intervals.
The fund houses allow an investor to invest a lumpsum in a liquid or
floating rate fund and leave instructions to transfer Rs. 1,000 every month into
an equity fund. He can also transfer a fixed sum every month from a debt to an
equity fund. While many fund houses permit STPs from debt to equity funds,
only a few allow the reverse. Franklin Templeton, Prudential ICICI and Birla
Sun Life allow systematic transfers out o their debt schemes and into their
equity funds, but not the reverse. Kotak Mutual Fund permits two-way STP.
Though the STP has become a powerful tool to diversify risks and create
wealth over time, it also suffers from certain demerits:
Chapter - 1 : Overview of Mutual Fund
128
Table 1.9
STP Facilities Offered By Select Mutual Fund Houses
Fund Houses Facilities Offered On Which
Fund
Terms
Kotak Mutual STP-Weekly/ Monthly/
Quarterly
Equity/ Debt/
Hybrid
Min. Installment:
Rs. 1,000,6
months
Prudential ICICI
Mutual
STP-Weekly/ Monthly/
Quarterly
From Debt/
Liquid/ MIP
to
Equity/Hybrid
Min. Installment:
Rs. 1,000,6
months
Franklin
Templeton
STP-Monthly/ Quarterly From Debt/
MIP to
Equity/
Min. Balance: Rs.
25,000
Installment: Rs.
1,000,6 months
Birla Sun Mutual STP-Monthly/ Quarterly From Debt/
MIP to Equity
Min. Installment:
Rs. 500 , 12
months months;
Min. Balance: Rs.
6,000
HDFC Mutual STP-Monthly/ Quarterly Equity
/ Debt/Hybrid
Min. Installments:
Rs. 1,000, 6
months;
Min. Balance: Rs.
25,000
Source: coolavenues.com
Chapter - 1 : Overview of Mutual Fund
129
Firstly, the investor can transfer the amount from on scheme to
another only within that particular fund house.
Secondly the growth factor of the units within the scheme
depends upon the strength and weakness of the particular mutual fund.
Thirdly in downward market, a STP does not guarantee income,
but only safeguard one from incurring losses.
Mutual fund schemes have their own ups and downs as part of their
business. At the time of making choice, an investor should weigh the benefits
and downsides of each scheme. STP is an ideal investment option for risk-
averse small investors who are otherwise not able to enjoy the benefits of
investing in the equity market. It is more useful to investors who want to play for
high profit in the equity market without affecting the initial investment as the
saying goes. An ideal investor has to position in between both.
“Too many eggs in one basket is not good,
Putting eggs in too many baskets is also not good”
1.19 MUTUAL FUND WRAPS
The mutual fund industry is enormous. It offers to the investors a large
basket of schemes and options to choose from. An investor can select from the
available schemes any particular scheme which suits the requirements and
objectives of the respective investor. The Investment Company Institute (ICI), a
trade organization representing mutual fund providers, cites more than 8,300
U.S.-based mutual funds, with combined assets of about $8 trillion as of end-
March 2005. And worldwide, there are about 54,986 mutual funds, with assets
totaling about $16 trillion, according to the ICI. With so many funds to choose
Chapter - 1 : Overview of Mutual Fund
130
from, selecting one can be a real challenge. An investor can be under the
impression of a dilemma of what to choose and which fund to opt. Building and
monitoring a diversified portfolio can be an overwhelming burden. To ease this
burden, the industry has created the mutual fund advisory program, also known
as the mutual fund wrap.
1.19.1 Mutual Fund Wrap Working:
The mutual fund advisory program comes in two versions:
(a) Discretionary
(b) Non-discretionary.
(a) Discretionary: A discretionary mutual fund advisory program provides a
variety of portfolios that incorporate multiple mutual funds into pre-
selected asset allocation models. One model may offer an asset allocation of
80% equity and 20% fixed income while another may offer 80% fixed income
and 20% equity. Many of the portfolios divide the equity and fixed-income
portions among multiple mutual funds, each fund representing a specific
discipline
Investors work with a professional financial advisor to map out their
personal financial goals. Based on those goals, the advisor reviews the
offerings in the mutual fund advisory program and selects the asset allocation
model that matches the investor's goals. For example, a conservative investor
interested in income generation would be guided to select a portfolio that
allocates the majority of its assets to fixed-income investments. An aggressive
investor primarily interested in capital appreciation would be guided to select a
portfolio that allocates the majority of its assets to equity investments.
Chapter - 1 : Overview of Mutual Fund
131
The structure of a discretionary mutual fund advisory program is similar
to the structure of a multi-discipline account. Like a multi-discipline account, a
mutual fund advisory program offers a diversified portfolio, professional advice
and guidance, ongoing due diligence of the investments in the portfolio and
automatic rebalancing of the portfolio to maintain the desired asset allocation.
The discretionary mutual fund advisory program delegates authority to the
program sponsor (often the financial advisor's employer or a subsidiary of the
advisor's employer) to make changes to the asset allocation model and to add
or remove mutual funds from the portfolio without approval from the investor.
(b) Non-discretionary: In the non-discretionary program, the investor and the
financial advisor review a list of mutual funds that have been pre-screened and
selected for inclusion in the program, and choose funds from that list to create
a customized asset allocation model. The investor is responsible for providing
approval of the rebalancing of the portfolio and for the decision to replace any
of the mutual funds.
Both the discretionary and non-discretionary programs are considered to
be entry-level managed-money products because they offer professional
advice and guidance, no commissions for trading and a single fee based on
assets under management. Mutual fund advisory programs offer significantly
lower minimum investment requirements than other managed-money products.
Some mutual fund advisory programs are available at investment minimums as
low as $25,000, compared to $100,000 or more for other managed-money
offerings. Both discretionary and non-discretionary mutual fund advisory
Chapter - 1 : Overview of Mutual Fund
132
programs provide consolidated performance reporting, making it easy for
investors to review results at the portfolio level.
While mutual fund advisory programs offer many of the same benefits
provided by their more expensive managed-money cousins, there is also an
important difference. Assets in a mutual fund advisory program are not
separate and distinct from the accounts of other investors. Mutual funds, as the
name implies, are mutual investments. The basic premise of a mutual fund
involves a group of investors who pool their assets so that they can afford the
services of a professional money manager. The money manager then makes
portfolio management decisions on behalf of the collected pool of investors.