Mutual Fund

By,

-Parth v. Purohit

Mutual Fund ??

• A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. 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 appreciation realized are shared by its unit holders in proportion to 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.

Concept of Mutual Fund

• A pool of money contributed by many investors and collectively managed by an asset management company

• A pool of money contributed by many investors and collectively managed by an asset management company

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

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

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

subscribed.

What it means

Investors

Markets(volatile, has fluctuation)

Trust (pool of money)

Contribute money

Invest in markets

Receive dividend/capital

appreciation

Receive interest, dividend or

capital growth

Organization of a Mutual Fund

The MF Cycle

Characteristics• Investors own the mutual fund

• Everyone else associated with the fund earns a fee

• Things which are mutual

– Pool of money

– Investment objective

– Risk and return

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

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

Advantages

Disadvantages

• No Control Over Costs

• No Tailor Made Portfolios

• Managing a large number of funds/types.

History of Mutual Funds

• Birthplace of Mutual Funds – USA

• History in India:

– 1964-1987 (Phase I) – Growth of Unit Trust of India

– 1987-1993 (Phase II) – Entry of Public Sector Funds

– 1993-1996 (Phase III) – Emergence of Private Funds

– 1996-1999 (Phase IV) – Growth and SEBI Regulation

– 1999-2004 (Phase V) – Emergence of large & uniform Industry

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

Types of Funds

Existing funds

• Open-ended (OEF) & Close-ended (CEF)

• Growth, Income and Hybrid

• Equity, Debt and Balance

• Load & No-Load

• Guaranteed & Non-Guaranteed

• Tax-exempt & Non tax-exempt

New Gen Mutual Funds

• Fund of Fund

• Commodity fund

• Real Estate fund

• Asset Allocation fund

• Exchange-traded fund

• Derivative fund

• Capital Protection Oriented Fund.

O.E.F & C.E.FO.E.F

• No fixed tenor• Continuous sale & purchase

by the fund• Subscription is not

mandatory • Redemption mandatory, with

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

fund managers is higher• Daily NAV (calc &

disclosure)

C.E.F• Fixed tenor – 1/3/5/7 years• Sale of units only during NFO• No subscription after closure of

NFO• Redemption in 2 ways

– Exit window – periodically repurchase of units by the fund

– Listing – secondary market trading of units, like stocks

• Fund size either constant or decreases

• Lower redemption pressure on fund managers

• Weekly NAV (calc weekly but disclosure daily).

Equity-oriented

• Diversified• Sectorial• Thematic or Specialty– ASEAN fund, Infrastructure Fund

• Growth & Value• Large, Mid & Small Cap• Dividend Yield or Equity Income• Index• ELSS

Primary objective: growth or capital appreciation.

Debt Oriented• Diversified Debt

• Focussed/Sectoral Debt

• Gilt Fund

• Bond Fund

• Fixed Maturity/Term Plan

(FMP/FTP)

• Liquid or Money Market MF

Primary objective: regular income.

Balance

• Investment in more than one asset class

– Debt and equity in various proportions

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

Fund of Funds

• Invest in other schemes of same or other mutual fund

• Is considered like a Debt scheme for tax purposes

• 2 advantages:

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

• Allows fund managers to rebalance portfolio freely

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

• Convenience to the investor.

Commodity Fund

• specialize in investing in different commodities directly or through shares of commodity companies or through commodity futures contracts. – Example - Precious Metals Funds

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

Real Estate Fund

• Invest in real estate directly, or fund real estate developers, or buy shares of housing finance companies

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

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

valuation of property • Allow small investors with small investments to

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

Asset Allocation Fund

• Fund manager has the flexibility to change the allocation of funds between equity and debt based on perception about direction of the market.

Exchange-traded fund

• Passively managed fund that tracks a benchmark index

• An ETF is like a hybrid financial instrument, a cross between an index fund and a stock

– An equity-based ETF would invest in a basket of stocks that reflects the composition of an index, say Nifty or Sensex

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

Gold ETF• Gold ETFs invest in physical gold and derive their value

from the underlying asset

– The price of gold ETFs will be directly linked to the price of gold itself and hence the returns from a gold ETF will more or less equal to returns from gold bars or coins

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

Capital Protection Oriented fund

• Close-ended with no exit option

• Debt scheme from a tax standpoint

• No guarantee by the AMC or sponsor

• Capital protection on account of the structure

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

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

• Rating of the scheme mandatory.

Classification of funds• Risk

– Sectoral funds have higher risk

– Liquid or Money Market funds have least risk

• Tenor

– Equity funds require a long investment horizon

– Liquid funds are for the short term liquidity needs

• Investment objective

– Equity funds suit growth objective

– Debt funds suit income objective.

Risk-Return Hierarchy

Liquid

funds

ST debt funds

Gilt funds

Debt Funds

Balanced funds

Risk

Index funds

ReturnEquity funds

Sectoral funds

Structure & Constituents

M.F Structure in IndiaA mutual fund has a 3-tier structure

Sponsor

Trustee

AMC

Trust

Trust

• Mutual funds in India constituted as a Public Trust under Indian Trust Act, 1882

• The trust is registered with the Office of Public Trustee

• OPT reports to the Charity Commissioner

• The trust or the fund has no independent legal capacity itself

• Acts in relation to the trusts are taken on its behalf by the trustees

• Treated as a separate entity and a pass through vehicle

• Has its own auditors, separate from the AMC.

Sponsor

• Promoter of the mutual fund

• Creates a Trust under Indian Trusts Act, 1882 and

registers it with Office of Public Trustee

• Appoints Board of trustees/trustee company

• Creates AMC under Indian Companies Act, 1956

• Fulfills necessary formalities and applies to SEBI for

registration of the Trust as a Mutual Fund.

Sponsor Criteria

• Min 5 years track record in financial services

• Bank, corporate or an FI

• Profit making in at least 3 out of past 5 years, including the previous year

• Positive Net Worth in last 5 years

• At least 40% of the capital of the AMC

• Net worth in the immediately preceding year more than the capital contribution to the AMC.

Trustee

• Appointed by sponsor with SEBI approval

• Have Registered ownership of investments

• Formed either as Board of Trustees or Trustee

Company

• Power to appoints all other constituents

• Appoint AMC through the ‘Investment

Management Agreement’ and delegate powers.

Trustee Criteria

• Minimum number of trustees is 4

– 2/3rd should be independent trustees i.e. no connection

of profit (what so ever) with the sponsor

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

AMC

• Trustees hold the unit-holders money in fiduciary capacity

• All major decisions need trustee approval

• Right to seek regular information and take remedial action.

Assets Mgnt.Company

• Required to be registered with SEBI

• Appointed as Investment Manager of the mutual fund

• Appointed by the trustees via an Investment Management

Agreement

• Responsible for operational aspects of the mutual fund

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

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

• Mostly, structured as a private limited company where

Sponsor and associates hold capital

• Quarterly reporting to Trustees.

MF Constituents

Sponsor

Trustee

AMC

Trust

R&T Agent

Securities Dealer / Broker

BankerCustodian & Depository

Distributor

SEBI

Securities Markets

Investor

Other Constituents

Custodian & Depository

Banker

Securities Dealer / Broker

R&T Agent

Distributor

Investment back-office

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

Investor records and transactions

Selling & Distributing schemes

Providing bank accounts & remittance services

Origin and growth

• Formation of UTI-1964

• Entry of public sector funds-1987

• Entry of private sector funds-1993

• A phase of retail investors- 2009.

How to choose a fund?

• Fund manager’s track record

• Portfolio quality

• Number of retail investors and average holding size

• Size of fund

• Weighted average maturity

• Sudden change in portfolio or NAV

• Dividend frequency

Buying Mutual Funds• Contacting the Asset Management Company directly– Web Site– Request for agent

• Agents/Brokers– Locate one on AMFI site

• Financial planners– Bajaj Capital etc.

• Insurance agents• Banks– Net-Banking – Phone-Banking – ATMs

• Online Trading Account– ICICI Direct– Motilal Oswal, Indiabulls- Send agents

What mutual funds are not?

• MFs are not ‘get rich quick investments’

• MFs are not ‘risk free investment’

• MFs are not ‘assured return investment’

• MFs are not ‘a universal solution to all investment needs’

Questions ?

Thank You