introduction to mutual fund and its various st prati

8/3/2019 Introduction to Mutual Fund and Its Various St Prati

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INTRODUCTION TO MUTUAL FUND AND ITS VARIOUS

ASPECTS.

Mutual fund is a trust that pools the savings of a number of investors who share a

common financial goal. This pool of money is invested in accordance with a

stated objective. The joint ownership of the fund is thus Mutual, i.e. the fund

belongs to all investors. The money thus collected is then invested in capital

market instruments such as shares, debentures and other securities. The income

earned through these investments and the capital appreciations realized are shared

by its unit holders in proportion the number of units owned by them. Thus a

Mutual Fund is the most suitable investment for the common man as it offers an

opportunity to invest in a diversified, professionally managed basket of securities

at a relatively low cost. A Mutual Fund is an investment tool that allows small

investors access to a well-diversified portfolio of equities, bonds and other

securities. Each shareholder participates in the gain or loss of the fund. Units are

issued and can be redeemed as needed. The funds Net Asset value (NAV) is

determined each day.

Investments in securities are spread across a wide cross-section of industries and

sectors and thus the risk is reduced. Diversification reduces the risk because all

stocks may not move in the same direction in the same proportion at the same

time. Mutual fund issues units to the investors in accordance with quantum of

money invested by them. Investors of mutual funds are known as unit holders.


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When an investor subscribes for the units of a mutual fund, he becomes part

owner of the assets of the fund in the same proportion as his contribution amount

put up with the corpus (the total amount of the fund). Mutual Fund investor is also

known as a mutual fund shareholder or a unit holder.

Any change in the value of the investments made into capital market instruments

(such asshares, debentures etc) is reflected in the Net Asset Value (NAV) of the

scheme. NAV is defined as the market value of the Mutual Fund scheme's assets

net of its liabilities. NAV of a scheme is calculated by dividing the market value

of scheme's assets by the total number of units issued to the investors.
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HISTORY OF THE INDIAN MUTUAL FUND INDUSTRY

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. Though

the growth was slow, but it accelerated from the year 1987 when non-UTI players

entered the Industry.

In the past decade, Indian mutual fund industry had seen a dramatic improvement,

both qualities wise as well as quantity wise. Before, the monopoly of the market

had seen an ending phase; the Assets Under Management (AUM) was Rs67

billion. The private sector entry to the fund family raised the Aum to Rs. 470

billion in March 1993 and till April 2004; it reached the height if Rs. 1540 billion.

The Mutual Fund Industry is obviously growing at a tremendous space with the

mutual fund industry can be broadly put into four phases according to the

development of the sector. Each phase is briefly described as under.

First Phase1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament by the

Reserve Bank of India and functioned under the Regulatory and administrative

control of the Reserve Bank of India. 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. The first scheme launched by UTI was

Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of assets under

management.


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Second Phase1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non- UTI, public sector mutual funds set up by public

sector banks and Life Insurance Corporation of India (LIC) and General Insurance

Corporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund

established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab

National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank

of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its

mutual fund in June 1989 while GIC had set up its mutual fund in December

1990.At the end of 1993, the mutual fund industry had assets under management

of Rs.47,004 crores.

Third Phase1993-2003 (Entry of Private Sector Funds)

1993 was the year in which the first Mutual Fund Regulations came into being,

under which all mutual funds, except UTI were to be registered and governed. The

erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first

private sector mutual fund registered in July 1993.

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. As at the end of

January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores.

Fourth Phasesince February 2003


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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 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.

consolidation and growth. As at the end of September, 2004, there were 29 funds,

which manage assets of Rs.153108 crores under 421 schemes.

WORKING OF MUTUAL FUND:-

A Mutual Fund is a collection of stocks, bonds, or other securities owned by

a groupof investors and managed by a professional investment

company. For an individualinvestor to have a diversified portfolio is difficult.

But he can approach to such companyand can invest into shares.

Mutual funds have become very popular since they makeindividual

investors to invest in equity and debt securities easy. When investors

invest a particular amount in mutual funds, he becomes the unit holder

of corresponding units. Inturn, mutual funds invest unit holders money

in stocks, bonds or other securities that earninterest or dividend. This

money is distributed to unit holders. If the fund gets money byselling

some stocks at higher price the unit holders also are liable to get capital

gains.


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CATEGORIES OF MUTUAL FUND:


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Mutual funds can be classified as follow:

Based on their structure:

Open-ended funds: Investors can buy and sell the units from the fund, at any

point of time.

Close-ended funds: These funds raise money from investors only once.

Therefore, after the offer period, fresh investments can not be made into the fund. If

the fund is listed on a stocks exchange the units can be traded like stocks (E.g.,

Morgan Stanley Growth Fund). Recently, most of the New Fund Offers of close-

ended funds provided liquidity window on a periodic basis such as monthly or

weekly. Redemption of units can be made during specified intervals. Therefore,

such funds have relatively low liquidity.

Based on their investment objective:

Equity funds: These funds invest in equities and equity related instruments.

With fluctuating share prices, such funds show volatile performance, even losses.

However, short term fluctuations in the market, generally smoothens out in the

long term, thereby offering higher returns at relatively lower volatility. At the

same time, such funds can yield great capital appreciation as, historically, equities

have outperformed all asset classes in the long term. Hence, investment in equity

funds should be considered for a period of at least 3-5 years. It can be further

classified as:


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i) Index funds- In this case a key stock market index, like BSE Sensex or Nifty

is tracked. Their portfolio mirrors the benchmark index both in terms of

composition and individual stock weightages.

ii) Equity diversified funds- 100% of the capital is invested in equities spreading

across different sectors and stocks.

iii|) Dividend yield funds- it is similar to the equity diversified funds except that

they invest in companies offering high dividend yields.

iv) Thematic funds- Invest 100% of the assets in sectors which are related

through some theme.

e.g. -An infrastructure fund invests in power, construction, cements sectors etc.

v) Sector funds- Invest 100% of the capital in a specific sector. e.g. - A banking

sector fund will invest in banking stocks.

vi) ELSS- Equity Linked Saving Scheme provides tax benefit to the investors.

Balanced fund: Their investment portfolio includes both debt and equity. As a

result, on the risk-return ladder, they fall between equity and debt funds. Balanced funds

are the ideal mutual funds vehicle for investors who prefer spreading their risk across

various instruments. Following are balanced funds classes:

i) Debt-oriented funds -Investment below 65% in equities.


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ii) Equity-oriented funds -Invest at least 65% in equities, remaining in debt.

Debt fund: They invest only in debt instruments, and are a good option for

investors averse to idea of taking risk associated with equities. Therefore, they

invest exclusively in fixed-income instruments like bonds, debentures,

Government of India securities; and money market instruments such as

certificates of deposit (CD), commercial paper (CP) and call money. Put your

money into any of these debt funds depending on your investment horizon and

needs.

i) Liquid funds- These funds invest 100% in money market instruments, a large

portion being invested in call money market.

ii) Gilt funds ST- They invest 100% of their portfolio in government securities of

and T-bills.

iii) Floating rate funds - Invest in short-term debt papers. Floaters invest in debt

instruments which have variable coupon rate.

iv) Arbitrage fund- They generate income through arbitrage opportunities due to

mis-pricing between cash market and derivatives market. Funds are allocated to

equities, derivatives and money markets. Higher proportion (around 75%) is put in

money markets, in the absence of arbitrage opportunities.


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v) Gilt funds LT- They invest 100% of their portfolio in long-term government

securities.

vi) Income funds LT- Typically, such funds invest a major portion of the

portfolio in long-term debt papers.

vii) MIPs- Monthly Income Plans have an exposure of 70%-90% to debt and an

exposure of 10%-30% to equities.

viii) FMPs- fixed monthly plans invest in debt papers whose maturity is in line

with that of the fund.


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INVESTMENT STRATEGIES

1. Systematic Investment Plan: under this a fixed sum is invested each month on

a fixed date of a month. Payment is made through post dated cheques or direct

debit facilities. The investor gets fewer units when the NAV is high and more

units when the NAV is low. This is called as the benefit of Rupee Cost Averaging

(RCA)

2. Systematic Transfer Plan: under this an investor invest in debt oriented fund

and give instructions to transfer a fixed sum, at a fixed interval, to an equity

scheme of the same mutual fund.

3. Systematic Withdrawal Plan: if someone wishes to withdraw from a mutual

fund then he can withdraw a fixed amount each month.


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RISK V/S. RETURN:


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s i m i l a r l y , a s e c t o r s t o c k f u n d ( w h i c h i n v e s t s i n a s i n

g l e i n d u s t r y , s u c h a s t el ec ommu ni ca ti on s) i s a t ri sk t ha t i ts

pr ic e wi ll de cl in e due to deve lo pme nts in it sindustry. A stock fund that

invests across many industries is more sheltered from this risk defined as industry

risk.

Following is a glossary of some risks to consider when investing in mutual funds:CALL

RISK:-The possibility that falling interest rates will cause a bond issuer to

redeem or call itshigh-yielding bond before the bond's maturity date.

COUNTRY RISK:-The possibility that political events (a war, national elections), financial problems

(risinginflation, government defaul t), or natural disasters (an earthquake, a

poor harvest) willweaken a country's economy and cause investments in that

country to decline.CREDIT RISK:-

The possibility that a bond issuer will fail to repay interest and principal

in a timelymanner. Also called default risk.

CURRENCY RISK:-The possibili ty that returns could be reduced for Americans investi

ng in foreignsecurities because of a rise in the value of the U.S. dollar against

foreign currencies. Alsocalled exchange-rate risk.

INCOME RISK:-The possibility that a fixed-income fund's dividends will decline as a

result of fallingoverall interest rates.

INDUSTRY RISK:-The possibility that a group of stocks in a single industry will decline in

price due todevelopments in that industry.

INFLATION RISK:-The possibility that increases in the cost of living will reduce or eliminate

a fund's realinflation-adjusted returns.

INTEREST RATE RISK:-The possibility that a bond fund will decline in value because of an

increase in interestrates.MANAGER RISK:-

The possibility that an actively managed mutual fund's investment adviser

will fail

toexecute the fund's invest ment strategy effectively resulting in the

fa ilure of st at ed objectives


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Market risk

The possibility that stock fund or bond fund prices overall will decline over short

or evenextended periods. Stock and bond markets tend to move in cycles,

with periods when prices rise and other periods when prices fall.

PRINCIPAL RISK:-The possibility that an investment will go down in value, or "lose money,"

from theoriginal or invested amount.

HOW RISK IS MEASURED:-There are two ways in which you can determine how risky a fund is.

STANDARD DEVIATION:-Standard Deviation is a measure of how much the actual performance of a

fund over a period of time deviates from the average performance.

SinceStandard Deviation is a measure of risk, a low Standard Deviation isgood.

SHARPE RATIO:-T h i s r a t i o l o o k s a t b o t h , r e t u r n s a n d r i s k , a n d d e l i v e r s a s i n g l

e me a s u r e t h a t i s proportional to the risk adjusted returns.

Since Sharpe Ratio is a measure of risk-adjusted returns, a high

Sharpe Ratio is good."

Advantages & Disadvantages of Mutual Funds1.Professional Management

Mutual Funds provide the services of experienced and skilled professionals,

backed by a

dedicated investment research team that analyses the performance and prospects of

companies

and selects suitable investments to achieve the objectives of the scheme. This risk

of default by

any company that one has chosen to invest in, can be minimized by investing in

mutual funds as

the fund managers analyze the companies financials more minutely than an

individual can do as

they have the expertise to do so. They can manage the maturity of their portfolio

by investing ininstruments of varied maturity profiles.

2.Diversification

Mutual Funds invest in a number of companies across a broad cross-section of

industries and

sectors. This diversification reduces the risk because seldom do all stocks decline

at the same


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time and in the same proportion. You achieve this diversification through a Mutual

Fund with far

less money than you can do on your own.

3.Convenient Administration

Investing in a Mutual Fund reduces paperwork and helps you avoid many

problems such as bad

deliveries, delayed payments and follow up with brokers and companies. Mutual

Funds save

your time and make investing easy and convenient.

4.Return Potential

Over a medium to long-term, Mutual Funds have the potential to provide a higher

return as they

invest in a diversified basket of selected securities. Apart from liquidity, these

funds have also

provided very good post-tax returns on year to year basis. Even historically, wefind that some of

the debt funds have generated superior returns at relatively low level of risks. On

an average debt

funds have posted returns over 10 percent over one-year horizon. The best

performing funds

have given returns of around 14 percent in the last one-year period. In nutshell we

can say that

these funds have delivered more than what one expects of debt avenues such as

post office

schemes or bank fixed deposits. Though they are charged with a dividend

distribution tax on

dividend payout at 12.5 percent (plus a surcharge of 10 percent), the net income

received is still

tax free in the hands of investor and is generally much more than all other avenues,

on a post tax

basis.

5.Low Costs

Mutual Funds are a relatively less expensive way to invest compared to directly

investing in thecapital markets because the benefits of scale in brokerage, custodial and other fees

translate into

lower costs for investors.

6.Liquidity

In open-end schemes, the investor gets the money back promptly at net asset value

related prices


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from the Mutual Fund. In closed-end schemes, the units can be sold on a stock

exchange at the

prevailing market price or the investor can avail of the facility of direct repurchase

at NAV

related prices by the Mutual Fund. Since there is no penalty on pre-mature

withdrawal, as in the

cases of fixed deposits, debt funds provide enough liquidity. Moreover, mutual

funds are betterplaced to absorb the fluctuations in the prices of the securities as a

result of interest rate variation

and one can benefits from any such price movement.

7.Transparency

Investors get regular information on the value of your investment in addition to

disclosure on the

specific investments made by your scheme, the proportion invested in each class of

assets andthe fund manager's investment strategy and outlook.

8.Flexibility

Through features such as regular investment plans, regular withdrawal plans and

dividend

reinvestment plans; you can systematically invest or withdraw funds according to

your needs and

convenience.

9.Affordability

A single person cannot invest in multiple high-priced stocks for the sole reason that

his pockets

are not likely to be deep enough. This limits him from diversifying his portfolio as

well as

benefiting from multiple investments. Here again, investing through MF route

enables an

investor to invest in many good stocks and reap benefits even through a small

investment.

Investors individually may lack sufficient funds to invest in high-grade stocks. A

mutual fund

because of its large corpus allows even a small investor to take the benefit of itsinvestment

strategy.

10.Choice of SchemesMutual Funds offer a family of schemes to suit your varying

needs over a lifetime.

11.Well Regulated


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All Mutual Funds are registered with SEBI and they function within the provisions

of strict

regulations designed to protect the interests of investors. The operations of Mutual

Funds are

regularly monitored by SEBI.

12.Tax Benefits

Last but not the least, mutual funds offer significant tax advantages. Dividends

distributed by

them are tax-free in the hands of the investor. They also give you the advantages of

capital gains

taxation. If you hold units beyond one year, you get the benefits of indexation.

Simply put,

indexation benefits increase your purchase cost by a certain portion, depending

upon the yearly

cost-inflation index (which is calculated to account for rising inflation), therebyreducing the gap

between your actual purchase costs and selling price. This reduces your tax

liability. Whats

more, tax-saving schemes and pension schemes give you the added advantage of

benefits under

Section 88. You can avail of a 20 per cent tax exemption on an investment of up to

Rs 100000 in

the scheme in a year.

Disadvantages of mutual fundsMutual funds are good investment vehicles to navigate the complex and

unpredictable world of

investments. However, even mutual funds have some inherent drawbacks.

Understand these

before you commit your money to a mutual fund.

1.No assured returns and no protection of capital

If you are planning to go with a mutual fund, this must be your mantra: mutual

funds do not offer

assured returns and carry risk. For instance, unlike bank deposits, your investment

in a mutualfund can fall in value. In addition, mutual funds are not insured or guaranteed by

any government

body (unlike a bank deposit, where up to Rs 1 lakh per bank is insured by the

Deposit and Credit

Insurance Corporation, a subsidiary of the Reserve Bank of India). There are strict

norms for any


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fund that assures returns and it is now compulsory for funds to establish that they

have resources

to back such assurances. This is because most closed-end funds that assured returns

in the early-

nineties failed to stick to their assurances made at the time of launch, resulting in

losses to

investors. A scheme cannot make any guarantee of return, without stating the name

of the

guarantor, and disclosing the net worth of the guarantor. The past performance of

the assured

return schemes should also be given.

2.Restrictive gains

Diversification helps, if risk minimization is your objective. However, the lack of

investment

focus also means you gain less than if you had invested directly in a singlesecurity.Assume, Reliance appreciated 50 per cent. A direct investment in the

stock would appreciate by

50 per cent. But your investment in the mutual fund, which had invested 10 per

cent of its corpus

in Reliance, will see only a 5 per cent appreciation.

3.Taxes

During a typical year, most actively managed mutual funds sell anywhere from 20

to 70 percent

of the securities in their portfolios. If your fund makes a profit on its sales, you will

pay taxes on

the income you receive, even if you reinvest the money you made.

4.Management risk

When you invest in a mutual fund, you depend on the fund's manager to make the

right decisions

regarding the fund's portfolio. If the manager does not perform as well as you had

hoped, you

might not make as much money on your investment as you expected. Of course, if

you invest in

Index Funds, you forego management risk, because these funds do not employmanagers.

Fund Management Style & Structuring of Portfolio

Factors affecting Management style of a scheme

Its one thing to understand mutual funds and their working; its another to ride on

this potent


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investment vehicle to create wealth in tune with your risk profile and investment

needs. Here are

seven factors that go a long way in helping an AMC meet its investors investmentobjectives.

The factors listed below evaluate factors affecting the management style of a

mutual fund

scheme.

Knowing the profile

Investors investments reflect his risk-taking capacity. Equity funds might lurewhen the

market is rising and peers are making money, but if you are not cut out for the risk

that

accompanies it, dont bite the bait. So, check if the investors objective matchesyours.

Investors will invest only after they have found their match. If they are racked byuncertainty,

they seek expert advice from a qualified financial advisor.

Identifying the investment horizon

How long on an average does the investor want to stay invested in a fund is as

important as

deciding upon your risk profile. Investors would invest in an equity fund only if

they are

willing to stay on for at least two years. For income and gilt funds, have a one-year

perspective at least. Anything less than one year, the only option among mutual

funds is

liquid funds.Declare and Inform

Watch what you commit. Investors look out for the Offer Document and Key

Information

Memorandum (KIM) before they commit their money to a fund. The offer

document contains

essential details pertaining to the fund, including the summary information (type of

scheme,

name of the Asset Management Company and price of units, among other things),

investmentobjectives and investment procedure, financial information and risk factors.

The fund fact sheet

Fund fact sheets give investors valuable information of how the fund has

performed in the

past. It gives investors access to the funds portfolio, its diversification levels andits


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performance in the past. The more fact sheets they examine, the better is their

comfort level.

Diversification across fund housesIf Investors are routing a substantial sum through mutual funds, they would

diversify across

fund houses. That way, they spread their risk.

Chasing incentivesSome financial intermediaries give upfront incentives, in the form of a percentage

of the

investors initial investment, to invest in a particular fund. Many amateur investors

get lured

into such incentives and invest in such attractive schemes, which may not meet

their future

expectations. The ideal investors focus would be to find a fund that matches his

investmentneeds and risk profile, and is a performer.Tracking investments

The investors job doesnt end at the point of making the investment. They do track

your

investment on a regular basis, be it in an equity, debt or balanced fund.

Portfolio management is an important foundation of mutual fund business. The

performance of

the fund measured by the risk adjusted returns produced by the investor arises

largely by

successful portfolio management function. After collecting the investors funds,

effective

portfolio management will have to give returns acceptable to the investor; else, the

investor may

move to better performing funds.

From the investors perspective, the need for successful portfolio management

function is

obviously paramount. However, in the complex world of financial markets,

portfolio

management is a specialist function.

Now how a fund manager manages the portfolio would depend on the type of thefund he is

managing. The funds can be broadly classified as equity funds and debt funds.

Equity Portfolio Management:

When the fund contains more than 65% equity, it is called as an equity fund. Thus

such type of a

fund would need equity portfolio management.


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An equity portfolio managers task consists of two major steps:a)Constructing a portfolio of equity shares or equity linked instruments that is

consistent

with the investment objective of the fund and

b)Managing or constantly re-balancing the portfolio to produce capital appreciation

and

earnings that would reward the investors with superior returns.

How To Identify Which Kind Of Stocks To Include?The equity portfolio manager has available to him a whole universe of equity

shares and other

instruments such as preference shares, warrants or convertible debentures issued by

many

companies. Even within each category of equity instruments, shares of one

company may bevery different in terms of their potential than shares of other companies. So how

does the fund

manager go about choosing the different types of stocks, in order to construct his

portfolio? The

general answer is that his choice of shares to be included in funds portfolio must

reflect the

investment objective of the fund. More specifically, the equity portfolio manager

will choose

from a universe of invisible shares in accordance with:

a)The nature of the equity instrument, or a stocks unique characteristics, andb)A certain investment style or philosophy in the process of choosing.

Thus, you may see a mutual funds equity portfolio include shares of diversecompanies.

However, in reality, the group of stocks selected will have certain unique

characteristics, chosen

in accordance with the preferred investment style, such that the portfolio as a

whole is consistent

with the schemes objectives.

Indian economy is going through a period of both rapid growth and rapidtransformation. Thus,

the industries with the growth prospects or blue chip shares of yesterday are no

longer certain to

continue to be in that category tomorrow. New sectors like software or

technology stocks have


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matured and newer sectors such as biotechnology are now making an entry in the

investment

markets. In this process of rapid change, the stock selection task of an active fund

manager in

India is by no means simple or limited. We will therefore, review how different

stocks are

classified according to their characteristics.

Ordinary shares:Ordinary shareholders are the owners if the company and each share entitles the

holder to

ownership privileges such as dividends declared by the company and voting rights

at the

meetings. Losses as well as the profits are shared by the equity shareholders.

Without any

guaranteed income or security, equity share are a risk investment, bringing withthem the

potential for capital appreciation in return for the additional risk that the investor

undertakes.

Preference Shares:

Unlike equity shares, preference shares entitle the holder to dividends at the fixed

rates subject to

availability of profits after tax. If preference shares are cumulative, unpaid

dividends for years of

inadequate profits are paid in subsequent years. Preference shares do not entitle the

holder to

ownership privileges such as voting rights at the meetings.

Equity Warrants:

These are long term rights that offer holders the right to purchase equity shares in a

company at a

fixed price (usually higher than the current market price) within specified period.

Warrants are in

the nature of options on stocks.

Convertible Debentures:

As the term suggests, these are fixed rate debt instruments that are converted intospecified

number of equity shares at the end of the specified period. Clearly, convertible

debentures are

debt instruments until converted; when converted, they become equity shares.


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EQUITY CLASSES:Equity shares are generally classified on the basis of either the market

capitalization or the

anticipated movement of company earnings. it is imperative for the fund manager

to understand

these elements of the stocks before he selects them for inclusion in the portfolio.

Classification in terms of Market Capitalization

Market Capitalization is equivalent to the current value of a company, i.e., current

market

price per share times the number of outstanding shares. There are Large

Capitalization

Companies, MidCap Companies and SmallCap Companies. Differentschemes of a fund

may define their fund objective as a preference for the Large or mid or the SmallCap

Companies shares. For example, the tax plan of ICICI Prudential AMC isessentially a mid-

cap fund where as the tax plan of Reliance is large-cap fund. Large Cap shares are

more

liquid and hence easily tradable. Mid or Small Cap shares may be thought of as

having

greater growth potential. The stock markets generally have different indices

available to track

these different classes of shares.

Classification in terms of Anticipated Earnings

In terms of anticipated earnings of the companies, shares are generally classified

on the basis

of their market price relation to one of the following measures:

Price/Earning Ratio is the price of the share divided by the earnings per share and

indicated what the investors are willing to pay for the companys earning potential.

Young and fast growing companies usually have high P/E ratios and theestablished

companies in the mature industries may have lower P/E ratios.

Dividend Yield for a stock is the ratio of dividend paid per share to the current

market


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price. In India, at least in the past, investors have indicated the preference for the

high

dividend paying shares. What matters to the fund managers is the potential

dividend

yields based on earning prospects.

Cyclical Stocks are the shares of companies whose earnings are correlated with the

state of the economy.

Growth Stocks are shares of companies whose earnings are expected to increase at

the

rates that exceed the normal market levels.

Value Stocks are share of companies in mature industries and are expected to yield

low growth in earnings. These companies may, however, have assets whose valueshave not been recognized by investors in general. Funds manager may try to

identify

such currently undervalued stocks that in their opinion can yield superior returns

later.

Approaches to Portfolio Management (Fund Management Style):

Mutual funds can be broadly classified into two categories in terms of the fund

management

style i.e. actively managed funds and passively managed funds (popularly referred

to as index

funds).

Actively managed funds are the ones wherein the fund manager uses his skills and

expertise to

select invest-worthy stocks from across sectors and market segments. The sole

intention ofactively managed funds is to identify various investment opportunities

in the market in order to

clock superior returns, and in the process outperform the designated benchmark

index. in active

fund management two basic fund management styles that are prevalent are:

)Growth Investment Style: wherein the primary objective of equity investment is to

obtain capital appreciation. This investment style would make the funds manager

pick

and choose those shares for investment whose earnings are expected to increase at

the

rates that exceed the normal market levels. They tend to reinvest their earnings and


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generally have high P/E ratios and low Dividend Yield ratio.

)

Value Investment Style: wherein the funds manager looks to buy shares of those

companies which he believes are currently under valued in the market, but whose

worth he estimates will be recognized in the market valuation eventually.

On the contrary, passively managed funds/index funds are aligned to a particular

benchmark

index like the S&P CNX Nifty or the BSE Sensex. The endeavor of these funds is

to mirror the

performance of the designated benchmark index, by investing only in the stocks of

the index

with the corresponding allocation or weightage.

Investing in index funds is less cumbersome as compared to investing in actively

managed funds.

Broadly speaking, investors need to consider two important aspects i.e. the expenseratio and the

tracking error (i.e. the difference between the returns clocked by the designated

index and index

fund).

Conversely, investing in actively managed funds demands a deeper review and

understanding of

the fund house's investment philosophy; also the investor needs to decide on the

kind of funds he

wishes to invest in - a large cap/mid cap/small cap fund among othersSuccessful

Equity Portfolio Management:

Portfolio Management skills are innate in nature and strong intuitive traits from the

portfolio

manager. Nevertheless, there are certain principles of good equity management

that any portfolio

manager can follow to improve his performance.

Set realistic target returns based on appropriate benchmarks.

Be aware of the level of flexibility available while managing the portfolio.

Decide on appropriate investment philosophy, i.e., whether to capitalize on

economiccycles, or to focus on the growth sectors or finding the value stocks.

Develop an investment strategy based on the investment objective, the time frame

for the

investment and economic expectations over this period.

Avoid over diversification. Although diversification is a major strength ofmutual


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funds, the portfolio manager must avoid the temptation to invest into very large

number

of securities so as to maintain focus and facilitate sound tracking.

Develop a flexible approach to investing. Markets are dynamic and it is

impossible to buy

stocks for all seasons

Debt Portfolio Management:

Debt portfolio management has to contend with the construction and management

of portfolio of

debt instruments, with the primary objective of generating income. Just as the

equity fund

manager has to identify suitable stocks from a larger universe of equity shares, a

debt fund

manager has to select from a whole universe of debt securities he wants to invest

in.Debt schemes of a mutual fund have a short maturity period, generally up to oneyear.

Nevertheless, some schemes regarded as debt schemes do have maturity period a

little longer

than a year, say, eighteen months. Thus in the context of debt mutual funds,depending upon

the maturity period of the scheme, the funds managers invest more in market-traded

instruments or the debt securities. The difference in market-traded instruments

and debt

securities is that the former matures before one year and the later after a year.

Instruments in Indian Debt Market:

The objective of a debt fund is to provide investors with a stable income stream.

Hence, a debt

fund invests mainly in instruments that yield a fixed rate of return and where the

principal is

secure. The debt market in India offers the following instruments for investment by

mutual

funds.

Certificate of Deposit:Certificate of Deposits (CD) are issued by scheduled commercial banks excluding

regional rural

banks. These are unsecured negotiable promissory notes. Bank CDs have a

maturity period of 91

days to one year, while those issued by financial institutions have maturities

between one and


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three years.

Commercial Paper:

Commercial Paper (CP) is a short term, unsecured instrument issued by corporate

bodies (public

and private) to meet short term working capital needs. Maturity varies between 3

months and 1

year. This instrument can be issued to the individuals, banks, companies and other

corporate bodies registered or incorporated in India. CPs can be issued to NRIs on

nonrepairable andnontransferable basis.

Corporate Debentures:

Debentures are issued by manufacturing companies with physical assets, as

secured instruments,

in the form of certificates. They are assigned credit rating by the rating agencies.

All publiclyissued debentures are listed on the exchanges.

Floating Rate Bond (FRB):

These are short to medium term interest bearing instruments issued by financial

intermediaries

and corporations. The typical maturity is of these bonds is 3 to 5 years. FRBs

issued by the

financial institutions are generally unsecured while those form private corporations

are secured.

Government Securities:

These are medium to long term interestbearing obligations issued through theRBI by the

Government of India and state governments.

Treasury Bills:

T-bills are short term obligations issued through the RBI by the Government of

India at a

discount. The RBI issues T-bills for tenures: now 91 days and 364 days. These

treasury bills are

issued through an auction procedure. The yield is determined on the basis of bids

tendered andaccepted Public Sector Undertakings (PSU) Bonds:

PSU are medium and long term obligations issued by public sector companies in

which the

government share holding is generally greater than 51%. Some PSU Bonds carry

tax exemptions.


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The minimum maturity is 5 years for taxable bonds and 7 years for tax-free bonds.

PSU bonds

are generally not guaranteed by the government and are in the form of promissory

notes

transferable by endorsement and delivery.

Credit Selection:

Some debt managers look to investing in a bond in anticipation of changes on OTS

credit rating.

An upgrade of a bonds credit rating would lend to increase in its price, therebyleading to a

superior return. The fund would need to analyze the bonds credit quality so as toimplement this

strategy. Usually, debt funds will specify the proportion of assets they will hold in

instruments

of different credit quality/ratings, and hold these proportions. Active creditselection strategy

would imply frequent trading of bonds in anticipation of changes in ratings. While

being an

active risk management strategy, it does not take away the interest rate,

prepayment or credit

risks that are faced by any debt fund.

Prepayment Prediction:

As noted earlier some bonds allow the issuers the option to call for redemption

before maturity. a

fund which holds bonds with this provision is exposed to the risk of high yielding

bonds being

called back before maturity when interest rates decline. The fund manager would

therefore strive

to hold bonds with low prepayment risk relative to yield spread. Or try to predict

the course of

the interest rates and decide what the prepayment is likely to be, and then increase

or decrease his exposure. In any case, the risks faced by such fund managers are

the same as any other. What

matters at the end is the yield performance obtained by the fund manager.Interest Rates and Debt Portfolio Management:

No matter which investment strategy is followed by a debt fund manager, debt

securities are

always exposed to interest rate risk, as their price is directly dependent on them.

While they may


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yield fixed rates of returns, their market values are dependent on interest rate

movements, which

in turn affect the performance of fund portfolio of which they are a part. Hence, it

is essential to

understand the factors that affect the interest rates. While this is an intricate subject

in itself, we

have summarized below some key elements that have a bearing on interest rate

movements:

Inflation: simply put, inflation is the percentage by which prices of goods and

services in the

economy increase over a period of time. This increase may be on account of

factors arising

within the countrychange in production levels, mechanisms for distribution ofgoods, etc,

and/or on account of changes in the countrys external balance of paymentsposition. In India,

inflation is generally measured by the Wholesale Price Index although t he

Consumer Price

Index is also tracked. When the inflation rate rises, money becomes dearer, leading

to an increase

in the general level of interest rates.

Exchange Rate: a key factor in determining exchange rates between any two

currencies is their

relative purchasing power. Over a period, the relative purchasing power between

two currencies

may change based on the performance of the respective economies. The

consequent change in

exchange rates can affect interest rate levels in the country.Policies of the Central

Bank: the central bank is the apex authority for regulation of the

monetary system in a country. In India, this role is played by the Reserve Bank.

The RBIspolicies have a strong bearing on interest rate levels in the economy. If the RBI

wishes to curb

excess liquidity in a monetary system, it could impose a higher liquidity ratio onbanks and

institutions. This would restrict credit leading to an increase in interest rates.

Similarly, and

increase in RBIs bank rate has the effect of increasing interest rate levels. RBI

may also


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undertake open operations in Treasury Bills and Government securities with the

intention of

restricting / relaxing liquidity, thereby impacting the interest rates.

Use of Derivatives for Debt Portfolio Management:

As explained above, a debt portfolio is always exposed to the interest rate risk.

Hence,

derivatives contracts can be used to reduce or alter the risk profile of the portfolios

containing

debt instruments. Interest rate derivatives contracts can be exchange traded or

privately traded

(on the OTC market). Thus, a portfolio manager can sell interest rate futures or buy

interest rate

put options, usually on an exchange, to protect the value of his debt portfolio. Hecan also buy

or sell forward contracts or swaps bilaterally with other market players on OTCmarket. In India,

interest rate swaps and forward rate agreements were introduced in 1999, though

the market for

these contracts has not yet fully developed. In 2004, the National Stock Exchange

has introduced

futures on Interest Rates. Interest rate options are not yet available for trading on

exchange.

introduction to mutual fund and its various st prati

Documents