UNDERSTANDING MUTUAL FUNDS IN INDIA

 

1. INTRODUCTION OF MUTUAL FUNDS

A mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities as per the objectives as disclosed in the offer document of mutual funds. Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. A mutual fund is required to be registered with SEBI before it can collect funds from the public.

1.1 WHAT IS A MUTUAL FUND?

– A trust that raises money through the sale of units

– Gives investors exposure to different segments of markets

– Investors get access to professional management

– Plays an active role in building wealth and generating income for investors

– Source for corporates to raise money

1.2 WHY MUTUAL FUND

1. Professional Management: Investors avail the services of experienced and skilled professionals who are 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.

2. Diversification: Mutual funds invest in the number of companies across a broad section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion.

3. Convenient Administration: Investing in a mutual fund reduces paperwork and helps investors to avoid many problems such as bad deliveries, delayed payments and unnecessary follow up with brokers and companies. Mutual funds save investors 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.

5. Liquidity: In open-ended schemes, investors can get their money back promptly at net asset value related prices from the mutual fund itself. With close-ended schemes, investors can sell their units on a stock exchange at the prevailing market price.

6. Transparency: Investors get regular information on the value of their investment in addition to disclosure on the specific investments made by scheme, the proportion invested in each class of assets, and the fund manager’s investment strategy and outlook.

1.3 HOW MUTUAL FUNDS WORK

A mutual fund is set up in the form of a trust, which has a sponsor, trustees, an asset management company (“AMC”), and a custodian.

• SPONSOR: - Trust is established by a sponsor or more than one sponsor who is like a promoter of a company.

• TRUST: - Trustees of the mutual fund hold their property for the benefit of the unit-holders. Trustees are vested with the general power of superintendence and direction over AMC.

• ASSET MANAGEMENT COMPANY: - It is a team of experts approved by Sebi, manages the funds by making investments in various types of securities.

• CUSTODIAN: - It is registered with SEBI, holds the securities of various schemes of the fund in its custody.

• TRANSFER AGENT: - It is a person who has been granted a Certificate of Registration to conduct the business of transfer agent under the SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1996.

 

2. OVERVIEW OF MUTUAL FUNDS INDUSTRY IN INDIA

First Started with the introduction of Unit Trust of India (UTI) – in 1963.

Public sector companies started setting up mutual funds, beginning with SBI Mutual Fund in 1987.

Private sector mutual funds started in 1993; Franklin Templeton (erstwhile Kothari Pioneer) was the first of its kind.

2.1 Regulator: Securities and Exchange Board of India (SEBI)

– Regulates mutual funds, custodians and registrars & transfer agents

– The applicable guidelines for mutual funds are set out in SEBI (Mutual Funds) Regulations, 1996; updated periodically

2.2 Industry Body: Association of Mutual Funds in India (AMFI)

– All 44 AMCs are members of AMFI

– Recommends and promotes best business practices and code of conduct

– Disseminates information and carries out studies/research on the mutual fund industry

3. TYPES OF MUTUAL FUNDS

ON BASIS OF SCHEMES

BASIS	CLOSE- ENDED SCHEME	OPEN-ENDED SCHEME
CORPUS	Fixed corpus:- no new units can be offered beyond the limit	Variable corpus:- due to ongoing purchase and redemption
LISTING	Listed on the stock exchange for buying and selling	No listing on exchange, transaction done directly with the funds
PRICE	Net asset value (nav) and Market price	Only Net asset value (nav)
LIQUIDITY	Less Liquid	Highly Liquid
REDEMPTION	Fixed redemption period	No fixed redemption perio

ON BASIS OF PLANS

BASIS	REGULAR PLAN	DIRECT PLAN
SOLD	Sold through a distributor	Sold directly by Asset Management Company (AMC)
EXPENSE RATIO	Higher expense ratio (Due to commissions paid to the distributor)	Lower expense ratio (No commission paid to the distributor)
RETURNS	Lower returns	Higher returns
NAV	NAV is relatively lower	NAV is relatively higher

4. CLASSIFICATION OF MUTUAL FUNDS

The Schemes would be broadly classified in the following groups:-Equity Schemes, Debt Schemes, Hybrid Schemes, Solution Oriented Schemes, Other Schemes

4.1 Large-Cap, Mid-Cap and Small-Cap fund universe (SEBI Circular dated 6th October 2017)

To ensure uniformity in respect of the investment universe for equity schemes, SEBI has

defined large-cap, mid-cap, and small-cap as under:

Larger-Cap: 1st - 100th company in terms of full market capitalization

Mid-Cap: 101st - 250th company in terms of full market capitalization

Small-Cap: 251st company onwards in terms of full market capitalization

(Market capitalization is calculated as: - No of share issued × Market price per share)

5. SCHEMES ACCORDING TO INVESTMENT OBJECTIVE

Besides these, there are other types of mutual funds also to meet the investment needs of several groups of investors. Some of them include the following:

1.Growth Oriented Schemes: These funds offer growth potentialities associated with an investment in the capital market namely:

I. high source of income by way of dividend and

II. Rapid capital appreciation, both from holding of good quality scrips.

These funds, with a view to satisfying the growing needs of investors, primarily concentrate on the low risk and high yielding spectrum of equity scrips of the corporate sector.

2.Income Oriented Schemes: The fund primarily offers fixed income to investors. Naturally enough, the main securities in which investments are made by such funds are the fixed income yielding ones like bonds, corporate debentures, Government securities and money market instruments, etc.

3.Hybrid Schemes: These funds cater to both the investment needs of the prospective investors – namely fixed income (like bond & debenture) as well as growth orientation (equity). In fact, these funds utilize the concept of balanced investment management. These funds are, thus, also known as “balanced funds”.

4.High Growth Schemes: As the nomenclature depicts, these funds primarily invest in high risk and high return volatile securities in the market and induce the investors with a high degree of capital appreciation.

5.Capital Protection Oriented Scheme: It is a scheme that protects the capital invested in the mutual fund through the suitable orientation of its portfolio structure.

6.Tax Saving Schemes: These schemes offer tax rebates to the investors under tax laws as prescribed from time to time. This is made possible because the Government offers tax incentives for investment in specified avenues. For example, Equity Linked Saving Schemes (ELSS) and pensions schemes.

7.Special Schemes: This category includes index schemes that attempt to replicate the performance of particular indexes such as the BSE, Sensex, or the NSE-50.

8.Real Estate Funds: These are close-ended mutual funds which invest predominantly in real estate and properties.

9.Off-shore Funds: Such funds invest in securities of foreign companies with RBI permission.

10.Leverage Funds: Such funds, also known as borrowed funds, increase the size and value of the portfolio, and offer benefits to members from out of the excess of gains over the cost of borrowed funds. They tend to indulge in speculative trading and risky investments.

11.Hedge Funds: They employ their funds for speculative trading, i.e. for buying shares whose prices are likely to rise and for selling shares whose prices are likely to fall.

12.Fund of Funds: They invest only in units of other mutual funds. Such funds do not operate at present in India.

13.New Direction Funds: They invest in companies engaged in scientific and technological research such as birth control, anti-pollution, oceanography, etc.

14.Exchange Trade Funds (ETFs) are a new variety of mutual funds that first introduced in 1993. ETFs are sometimes described as mere “tax-efficient” than traditional equity mutual funds, since in recent years; some large ETFs have made the smaller distribution of realized and taxable capital gains than most mutual funds.

15.Money Market Mutual Funds: These funds invest in short- term debt securities in the money market like certificates of deposits, commercial papers, government treasury bills, etc. Owing to their large size, the funds normally get a higher yield on such short term investments than an individual investor.

16.Infrastructure Debt Fund: They invest primarily in debt securities or securitized debt investment of infrastructure companies.

6. CALCULATION OF NAV, HPR, EXPENSE RATIO

6.1 NET ASSET VALUE (NAV)

• The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV). In simple words, NAV is the market value of the securities held by the scheme.

• Mutual funds invest the money collected from investors in securities markets. Since the market value of securities changes every day, the NAV of a scheme also varies on day to day basis.

• The face value of NAV is Rs 10. If the face value is more than Rs 10 considered as appreciation in value and if the face value is less than 10 considered as depreciation.

• Unlike stocks (where the price is driven by the market and changes from minute-tominute), mutual funds don’t declare NAVs throughout the day. Instead, NAVs of all mutual fund schemes are declared at the end of the trading day after markets are closed, in accordance with SEBI Mutual Fund Regulations.

• How is it calculated?

Net Asset Value = Net Asset of the Scheme*

                               Number of units outstanding

*Net Asset of the Scheme = Market value of investments + Receivables+ other accrued income+ other assets

– Accrued Expenses- Other Payables- Other Liabilities

• Redemption Price Vs Public offer Price

– Redemption Price(Back End Load/ Exit Load)= This is a fixed fee payable by the investor at the time of redemption. It can be calculated in the following manner

Redemption Price = Net Asset value

                                    1+ Back End Load

– Public offer Price( Front End Load/ Entry Load)= This is one time fixed fee, which is paid by an investor when he buys the units of a scheme. It can be calculated in the following manner

Public offer Price= Net Asset Value

                                 1-Front End Load

6.2 HOLDING PERIOD RETURN

Holding period return is the total return received from holding an asset or portfolio of assets over a period of time, generally expressed as a percentage. Holding period return is calculated on the basis of total returns from the asset or portfolio – i.e. income plus changes in value. It is particularly useful for comparing returns between investments held for different periods of time.

Calculation of HPR

HPR = (Income + (end of period value- original value) x 100

                               Original Value

Income: - It consist of dividend and capital gain

End of period value: - NPV at the end of the year (NPV1)

Original value: - NPV at the beginning of the year (NPV0)

Investors make money from MF’s following are 3 ways: - Income distribution, Capital Gain, NAV appreciation

9.3 EXPENSE RATIO

The fees charged by the scheme to manage investors’ money.

What does it contain?

– Fees paid to service providers like trustees, Registrar & Transfer Agents, Custodian, Auditor, etc.

– Asset management expenses

– Commissions paid to distributors

– Other selling expenses including advertising expenses

– Expenses on investor communication, account statements, dividend/redemption, cheques/warrants

– Listing fees and Depository fees

– The daily NAV of a mutual fund is disclosed after deducting the expenses. Thus, the Total Expense Ratio has a direct bearing on a scheme’s NAV – the lower the expense ratio of a scheme, the higher the NAV.

– In terms of Regulation 52(1) of SEBI (Mutual Funds) Regulations, 1996, all scheme related expenses including commission paid to distributors, by whatever name it may be called and in whatever manner it may be paid, shall necessarily be paid from the scheme only within the regulatory limits and not from the books of the Asset Management Companies (AMC), its associate, sponsor, trustee or any other entity through any route. Any expenditure in excess of the limits specified in these regulations shall be borne by the asset management company or by the trustee or sponsors.

Calculation of Expense Ratio

Expense Ratio= Total Expense ÷ Total Asset

 

CONCLUSION

The Mutual Fund industry has emerged dominant financial intermediary in the Indian Capital Market. The main objective of investing in the mutual fund is to diversify risk as it is very seldom that all the sectors are underperformed at the same time as loss in one sector may be compensated with a profit of others. This study attempts to analyze the scheme operated in the market and find out their performance and to understand certain guidelines and circulars issued by SEBI. It helps to analyze to set your investment goal and select the best-suited scheme available in India which will help to achieve the objective at the right time. It also assists to understand tax applicability on gains of

mutual funds and evaluate schemes based on tax-saving criteria

 

Article Compiled by:-

Mayank Garg

+91 9582627751

Disclaimer: Every effort has been made to avoid errors or omissions in this material in spite of this, errors may creep in. Any mistake, error or discrepancy noted may be brought to our notice which shall be taken care of in the next edition In no event the author shall be liable for any direct indirect, special or incidental damage resulting from or arising out of or in connection with the use of this information Many sources have been considered including newspapers, Journals, Bare Acts, Case Material. Charted Secretary etc.

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