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Nowadays, bank rates have fallen down and are generally below the inflation rate. Therefore, keeping large amounts of money in bank is not a wise option, as in real terms the value of money decreases over a period of time. One of the options is to invest the money in stock market. But a common investor is not informed and competent enough to understand the intricacies of stock market. This is where mutual funds come to the rescue. Mutual Fund is an instrument of investing money.
A mutual fund is a group of investors operating through a fund manager to purchase a diverse portfolio of stocks or bonds. Mutual funds are highly cost efficient and very easy to invest in. By pooling money together in a mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they tried to do it on their own. Also, one doesn't have to figure out which stocks or bonds to buy. But the biggest advantage of mutual funds is diversification.
Diversification means spreading out money across many different types of investments. When one investment is down another might be up. Diversification of investment holdings reduces the risk tremendously.
Different investment avenues are available to investors. Mutual funds also offer good investment opportunities to the investors. Like all investments, they also carry certain risks. The investors should compare the risks and expected yields after adjustment of tax on various instruments while taking investment decisions. The investors may seek advice from experts and consultants including agents and distributors of mutual funds schemes while making investment decisions.
Lower per capita income, apprehensions of loss of capital and economic insecurity significantly influence the investment decisions of the investors. Nevertheless, the avowed objective of every investor is to reduce the risk as low as possible and ensure the returns as fast high as possible. Mutual funds, obviously, are them most popular channel in the investment activity as they, by and large, not only guarantee repayment of the principal money invested but assures a reasonable and regular return. But, there are some exemptions to this phenomenon. Mutual funds, being an institution/investment agency, are treated as a suitable vehicle specifically for small investors, who normally feel shy of the capital market and are unable to predict its conditions through different schemes.
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. The history of mutual funds in India can be broadly divided into four distinct phases:
The Act of Parliament established Unit Trust of India (UTI) ON 1963. It was set 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.
Second Phase—1987-1993 (Entry of Public Sector Funds)
1987 marked the entry of non-UTI, public sector mutual fund 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 1987 followed +by Canbank Mutual Fund (Dec.87). Punjab National Bank Mutual Fund (Aug.89), Indian Bank Mutual Fund (Nov.89), Bank of India (June 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.
Third Phase—1993-2003 (Entry of Private Sector Funds)
With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. Also, 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 Regulations 1996.
The number of Mutual Funds went on increasing, with many foreign mutual funds setting up funds in India and also the industry has 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 UTI with Rs. 44,541 crores of assets under management was way ahead of other mutual funds.
Fourth Phase—since February 2003
In February 2003, following the repeal of the UTI Act 1963 UTI was bifurcated into two separate entities. One is the Specified Undertaking of the UTI 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 schemes. The specified undertaking of UTI, 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 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 the recent mergers taking place among different private sector funds, the mutual fund industry has entered its current phase of consolidation and growth. As at the end of October 31, 2003,there were 31 funds, which manage assets of Rs. 126726 crores under 386 schemes.
The graph indicates the growth of assets over the years.
Mutual Fund Industry
Note: Erstwhile UTI was bifurcated into UTI Mutual Fund and the Specified Undertaking of the Unit Trust of India effective from February 2003. The Assets under management of the Specified Undertaking of the Unit Trust of India has therefore been excluded from the total assets of the industry as a whole from February 2003 onwards.
SOME DEFINITIONS OF MUTUAL FUNDS
According to SEBI (MF) Regulations, 1996 “ Mutual Fund means a fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one or more schemes for investing in securities, including money market instruments.”
The other common and well-known definitions of Mutual Funds are as follows:
“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 fund's Net Asset Value (NAV) is determined each day.”
“Mutual Funds are financial intermediaries. They are companies set up to receive your money, and then having received it, make investments with the money via an AMC. It is an ideal tool for people who want to invest but don't want to be bothered with deciphering the numbers and deciding whether the stock is a good buy or not. A mutual fund manager proceeds to buy a number of stocks from various markets and industries. Depending on the amount you invest, you own part of the overall fund.”
“A Mutual Fund is a company that pools the money of many investors, its shareholders - to invest in a variety of different securities.”
“The beauty of mutual funds is that anyone with an investible surplus of a few hundred rupees can invest and reap returns as high as those provided by the equity markets or have a steady and comparatively secure investment as offered by debt instruments.”
In conclusion, we can say that Mutual Fund collects the money of individuals, partnership firms, association of persons/body of individuals, trust, HUFs, banks, company/body corporate, society, financial institutions, foreign individuals, foreign financial institutions or any other person, or of public or any part of public at large and deploys the collected fund according to the scheme into the diversified portfolio of equities, bonds, financial market instruments and other securities to generate returns. As and when any person redeems his/her units, the Mutual Fund Asset Management Company (AMC) will pay him his invested amount with the return generated depending on the option chosen by the person.
CONCEPT OF MUTUAL FUND
A Mutual Fund is not an alternative investment option to stocks and bond; rather it pools the money of several investors and invests this in stocks, bonds, money market instruments and other types of securities.
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 appreciations realized are shared by its unit holders in proportion to the number of units owned by them. Thus, 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. The flow chart below describes broadly the working of a mutual fund:
MUTUAL FUND OPERATION FLOW CHART
Anybody with an investible surplus of as little as a few hundred rupees can invest in mutual funds. The investors buy units of a fund that best suit their investment objectives and future needs. A Mutual Fund invests the pool of money collected from the investors in a range of securities comprising equities, debt, money market instruments etc. after charging for the AMC fees. The income earned and the capital appreciation realized by the scheme, are shared by the investors in same proportion as the number of units owned by them.
In case of mutual funds, the investments of different investors are pooled to form a common investible corpus and gain/loss to all investors during a given period are same for all investors while in case of portfolio management scheme, the investments of a particular investor remains identifiable to him. Here the gain or loss of all the investors will be different from each other.
When you deposit money with the bank, the bank promises to pay you a certain rate of interest for the period you specify. On the date of maturity, the bank is supposed to return the principal amount and interest to you. Whereas, in a mutual fund, the money you invest, is in turn invested by the manager, on your behalf, as per the investment strategy specified for the scheme. The profit, if any, less expenses of the manager, is reflected in the NAV or distributed as income. Likewise, loss, if any, with the expenses, is to be borne by you.
A Mutual Fund may not, through just one portfolio, be able to meet the investment objectives of all their Unit holders. Some Unit holders may want to invest in risk-bearing securities such as equity and some others may want to invest in safer securities such as bonds or government securities. Hence, the Mutual Fund comes out with different schemes, each with a different investment objective.
Mutual funds can be divided into various types depending on asset classes. They can also invest in debt instruments such as bonds, debentures, commercial paper and government securities apart from equity.
Every mutual fund scheme is bound by the investment objectives outlined by it in its prospectus. The investment objectives specify the class of securities a mutual fund can invest in.
There are many entities involved and the diagram below illustrates the organizational set up of a mutual fund
Mutual funds have a unique structure not shared with other entities such as companies or firms. It determines the rights and responsibilities of the fund's constituent's viz. sponsors, trustees, custodian, transfer agent, and the fund and the asset management company. The legal structure also drives the inter relationships between these constituents.
Structure of mutual funds in India
Like other countries, India has a legal framework within which mutual funds must be constituted. In India, all mutual funds are constituted along one unique structure as unit trusts. A mutual fund in India is allowed to issue open-end and closed-end schemes under a common legal structure. Therefore, a mutual fund may have several different schemes (open and closed-end) under it i.e. under one unit trust, at any point of time.
The structure, which is required to be followed by mutual funds in India, is laid down under SEBI (Mutual Fund) Regulations, 1996.
Rights of the Mutual funds Unit Holders
* Receive unit certificates or statements of accounts confirming the title within 6 weeks from the date of closure of the subscription or within 6 weeks from the date of request for a unit certificate is received by the Mutual Fund.
* Receive information about the investment policies, investment objectives, financial position and general affairs of the scheme.
* Receive dividend within 42 days of their declaration and receive the redemption or repurchase proceeds within 10 days from the date of redemption or repurchase.
* Right of beneficial ownership of the schemes assets as well as any dividend or income declared under the scheme.
* Right to information regarding any adverse happening.
* Right to inspect major documents of the fund i.e. material contracts, the investment management agreement, the custodian services agreement, registrar and transfer agency agreement, memorandum and articles of association of the AMC, recent audited financial statements and the offer document of the scheme.
* Vote in accordance with the Regulations to:
1. Approve or disapprove any change in the fundamental investment policies of the scheme, which are likely to modify the scheme or affect the interest of the unit holder. The dissenting unit holder has a right to redeem the investment.
2. Change the Asset Management Company.
3. Wind up the schemes.
* Legal Limitations to Investor's Rights:
1. Unit holder cannot sue the trust but they can initiate proceedings against the trustees, if they feel that they are being cheated.
2. Except in certain circumstances AMC cannot assure a specified level of return to the investors. AMC cannot be sued to make good any shortfall in such schemes.
REGULATION/CONSTITUTION OF MUTUAL FUNDS
SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)
(INVESTMENT IN MUTUAL FUNDS)
CONSTITUTION OF A MUTUAL FUND
In India, a mutual fund is allowed to issue both close ended and open-ended funds under the common law. This is against the practice as followed in UK. A mutual fund in India is constituted in the form of trust created under the Indian Trusts Act, 1882. The fund sponsor acts as the Settler of the trust, contributing to its initial capital and appoints a Trustee to hold the assets of the trusts for the benefit of the unit holders, who are the beneficiaries of the trust. Under the Indian Trusts Act, the trust or the fund has no independent legal capacity itself, rather it is the trustee or trustees who have the legal capacity and therefore all acts in relation to the trust are taken on its behalf by the trustees. The trustees hold the unit holders money in a fiduciary capacity i.e. the money belongs to the unit holders and it is entrusted to the fund for the purpose of investment. The fund sponsor can be compared to a promoter of a company. The Asset Management Company (AMC) is appointed to act as the investment manager of the trust under the Board supervision and direction of the trustees. The sponsor appoints the AMC, which would in the name of trust, float and then manage the different investment schemes as per SEBI guidelines.
The above aspects can be understood easily in the following paragraphs.
* Who can establish a mutual
A mutual fund is to be established through the medium of a sponsor - A sponsor means anybody corporate who, acting alone or in the combination with another body corporate, establishes a mutual fund after completing the formalities prescribed in the SEBI's Mutual Funds Regulations. The sponsor should have a sound track record and general reputation of fairness and integrity in all his business transactions.
“Sound track record” shall mean that the sponsor should:
1 Be carrying on business in financial services for a period of not less than five years.
2 The net worth is positive in all the immediately preceding five years.
3 The net worth in the immediately preceding year is more than the capital contribution of the sponsor in the asset management company.
4 The sponsor has profits after providing for depreciation, interest and tax in three out of the immediately preceding five years, including the fifth year.
5 The sponsor should be a fit and proper person.
* How to establish a mutual fund
1 The mutual fund has to be established as a trust and the instrument of trust shall be in the form of a deed. The deed shall be executed by the sponsor in favour of the trustees named in the instrument of trust. The trust deed shall be duly registered under the provisions of the Indian Registration Act, 1908. The trust deed shall contain clauses specified in the Third Schedule of the Regulations.
2 An Asset Management Company, who holds an approval from SEBI. Is to be appointed to manage the affairs of the mutual fund and it should operate the schemes of such fund.
3 The sponsor should contribute at least 40% to the net worth of the Asset Management Company.
4 The Trustee should hold the property of the mutual fund in trust for the benefit of the unit holders.
“Trustee means the Board of Trustees or the Trustee Company who hold the property of the Mutual Fund in trust for the benefit of the unit holders.”
Eligibility for Appointment as Trustee
1. No person shall be eligible to be appointed as a trustee unless:
Ø He is person of ability, integrity and standing;
Ø Has not been found guilty of moral turpitude;
Ø Has not been convicted of any economic offence or violation of any
Ø securities laws; and
Ø Has furnished particulars as specified in Form C specified in SEBI Regulations
2. An asset management company or any of its officers or employees shall not be eligible to act as a trustee of any mutual fund.
3. No person who is appointed as a trustee of a mutual fund can be appointed a trustee of any other mutual fund unless:
Ø Such a person is an independent trustee, and
Ø Prior approval of the mutual fund of which he is a trustee has been Obtained for such an appointment.
4. Two-thirds of the trustees shall de independent persons and shall not be associated with the sponsors or be associated with them in any manner whatsoever.
5. In case a company is appointed as a trustee then its directors can act as trustees of any other trust provided that the object of the trust is not in conflict with the object of the mutual fund, trustee shall initially or any other time thereafter be appointed without prior approval of SEBI.
* Rights and Obligations of the Trustees - Operation of the Trust
1. The trustee shall have a right to obtain from the Asset Management Company such information as is considered necessary by the trustees.
2. If the trustees have reason to believe that the business of the Mutual Fund is not conducted in conformity with the SEBI regulations, they shall forthwith take such remedial steps as are necessary to rectify the situation and keep SEBI informed of the violation and the action taken by them.
3. The trustees shall ensure that the transactions entered into by the Asset Management Company are in accordance with the SEBI Regulations and the scheme.
4. The trustees shall be accountable for and be the custodian of the property of the respective schemes and shall hold the same in trust for the benefit of the unit holders in accordance with the SEBI Regulations and the provisions of the trust deed.
5. The trustees shall be responsible for calculation of any income due to be paid to the mutual fund and also of any income received in the mutual fund for the holders of the units of any scheme in accordance with the SEBI Regulations and the trust deed.
The trustees shall ensure that an Asset Management Company has been diligent in empanelling the brokers, in monitoring securities transactions with brokers and avoiding undue concentration of business with any broker.
The trustees shall ensure that the Asset Management Company has not given any undue or unfair advantage to any associates or dealt with any of the associates of the asset management company in any manner detrimental to interest of the unit holders.
The trustees shall ensure that the Asset Management Company has not given any undue or unfair advantage to any associates or dealt with any of the associates of the asset management company in any manner detrimental to interest of the unit holders.
The trustees shall ensure that the Asset Management Company has been managing the mutual fund schemes independently of other activities and have taken adequate steps to ensure that the interest of investors of on scheme are not being compromised with those of any other scheme or other activities of the Asset Management Company.
The trustees shall call for the details of transactions in securities by the key personnel of the Asset Management Company in his own name or on behalf of the asset Management Company on a six monthly basis and shall repot to SEBI, as and when required.
The trustees shall quarterly review all transactions carried out between mutual funds, Asset Management Company and its associates.
The trustee shall quarterly review the net worth of the asset Management company and in case of any shortfall, ensure that the Asset Management Company make up for the shortfall as per clause (f) of sub-regulation (1) of regulation 21.
The trustees shall ensure that there is no conflict of interest between the manner of deployment of its net worth by the Asset Management Company and the interest of the unit holders. Each trustee shall file the details of his transactions of dealings in securities with the Mutual Fund on a quarterly basis.
* Report to SEBI The trustees shall furnish to SEBI on a half yearly basis:
1. A report on the activities of the mutual fund,
2. A certificate stating that the trustees have satisfied themselves that there have been no instances of self-dealing or front running by any of the trustees, directors and key personnel of the Asset Management Company,
3. A certificate to the effect that the Asset Management Company has been managing the scheme independently of any other activities and in case of activities of the nature referred to in the regulation 24 have been undertaken by the Asset Management Company and has taken adequate steps to ensure that the interest of the unit holders are protected,
4. The independent trustees referred to in regulation 16 shall give their comments on the report received from the Asset Management Company regarding the investments by the mutual fund in the securities of group companies of the sponsor.
* Due Diligence by Trustees
1. General Due Diligence:
Ø The trustees shall be discerning in the appointment of the Board of the Asset Management Company.
Ø Trustees shall review the desirability of continuance of Management Company if substantial irregularities are observed of the schemes and shall not allow the asset management to float new schemes.
Ø The trustees shall ensure that the trust property is properly held and administered by proper reasons and by a proper number of such persons.
Ø The trustees shall ensure that all service providers are holding the registrations from SEBI or concerned regulatory authority.
Ø The trustees shall arrange for test checks for service contracts.
Ø Trustees shall immediately report to SEBI of any special development in the mutual fund.
2. Specific Due Diligence
The trustee shall-
Ø Obtain internal audit reports at regular intervals from independent auditors appointed by the trustees,
Ø Obtain compliance certificates at regular intervals from the Asset Management Company,
Ø Hold meeting of trustees more frequently,
Ø Consider the reports of the independent auditor and compliance reports of Asset Management Company at the meetings of trustees for appropriate action,
Ø Maintain records of the decisions of the trustees at their meetings and of the minutes of the meetings,
Ø Prescribe and adhere to a code of ethics by the trustees, Asset Management Company and its personnel,
Ø Communicate in writing to the Asset Management Company of the deficiencies and checking on the rectification of deficiencies.
. Reports to Trustees The AMC shall submit a monthly report to the trustees giving details and adequate justification about the purchase and sale of the securities of the group companies of the sponsor or the AMC, as the case may be, by the mutual fund during the said quarter.
The AMC shall submit to the trustees, quarterly reports of each year on its activities and the compliance with SEBI.
ASSET MANAGEMENT COMPANY (AMC)
* Who can be Asset Management Company
A company formed and registered under the Companies Act, 1956 and which has obtained the approval of SEBI to function as the sponsor of the mutual fund may appoint an Asset Management Company as such.
If the trust deed of a mutual fund authorizes the trustees, the later shall appoint the aforesaid terminated by majority of the trustees or by seventy five percent of the unitholders of the scheme. Any change in the appointment of the Asset Management Company shall be subject to prior of SEBI and unitholders.
SEBI's approval of an Asset Management Company - before granting an approval to the Asset Management Company, SEBI will take into account the following factors:
1. All matters that are relevant to efficient and orderly conduct of the affairs of the Asset Management Company.
2. The existing Asset Management Company has a sound track record, general reputation and fairness in transactions. For this purpose, sound track record means the net worth, and the profitability of the Asset Management Company.
3. The Asset Management Company is a fit and proper person.
4. The directors of the Asset management Company are persons having adequate professional experience in finance and financial service related field and not found guilty of moral turpitude or convicted of any economic offence or violation of any securities laws.
5. The Board of Directors of the Asset Management Company has at least fifty percent directors, who are not associate of or associated in a manner with the sponsors or any of its subsidiaries or the Trustees.
6. The Chairman of the Asset Management Company should not be trustee of any mutual fund.
7. The Asset Management Company shall have a minimum net worth of rupees ten crores. If an Asset Management Company was already granted approval under the provisions of SEBI (Mutual Fund) Regulations, 1993, it shall, within a period of 12 months from the date of notification of SEBI (Mutual Funds) Regulations, 1996, increase its net worth to rupees ten crores.
Ø The period of 12 months referred to above may be extended by SEBI upto three years in appropriate cases for reasons to be recorded in writing. However, no new schemes should be allowed to be launched or managed by such Asset Management Company till the net worth has been raised to rupees ten crores.
Ø Net Worth - It means the aggregate of paid up capital and free reserves of the AMC after deducting there from miscellaneous expenditure to the extent not written off or adjusted or deferred revenue expenditure, intangible assets and accumulated losses.
The key personnel of the Asset Management Company have not been found guilty of moral turpitude or convicted of economic offence or violation of securities laws or worked for any Asset Management Company or Mutual Fund or any intermediary during the period when registration has been suspended or cancelled at any time by SEBI.
* Conditions to be fulfilled by the Asset Management Company
1. Any director of the AMC shall not hold the place of a director in another AMC unless such person is independent director referred to in clause (d) of Sub-regulation (1) of Regulation 21 of the Regulations and approval of the Board of AMC of which such person is a director, has been obtained.
2. The AMC shall forthwith inform SEBI of any material change in the information or particulars previously furnished which have a bearing on the approval granted by SEBI.
3. No appointment of a director of an AMC shall be made without the prior approval of the trustees.
4. The AMC undertakes to comply with SEBI (Mutual Funds) Regulations, 1996.
5. No change in controlling interest of the AMC shall be made unless prior approval of the trustees and SEBI is obtained:
Ø A written communication about the proposed change is sent to each unit holder and an advertisement is given in one English daily newspaper having nationwide circulation and in a newspaper published in the language of the region where the Head Office of the mutual fund is situated.
Ø The unit holders are given an option to exit at the prevailing Net Asset Value without any exit load.
Ø The AMC shall furnish such information and documents to the trustees as and when required by the trustees.
* Obligation of the Asset Management Company
1. The AMC shall manage the affairs of the mutual fund and operate the schemes of such fund.
2. The AMC shall take all reasonable steps and exercise due diligence to ensure that the investment of the mutual funds pertaining to any scheme is not contrary to the provisions of SEBI Regulations and the trust deed of the Mutual Fund. The AMC shall exercise due diligence and care in all its investment decisions as would be exercised by other persons engaged in the same business. Recording of investment decisions - SEBI has advised AMCs to maintain records in support of each investment decision.
The AMC shall be responsible for the acts of commissions by its employees or the persons whose services have been obtained by that company.
CUSTODIAN AND DEPOSITORIES
Custodian is a person appointed for safe keeping of the securities. Mutual funds deal in buying and selling of large number of securities. AMC appoints a Custodian for safe keeping of these securities and for participating in clearing system on its behalf. In case of dematerialized securities, holdings will be held by Depository through Depository participant.
Custodian means a person who has been granted a certificate of registration by SEBI to carry on the business of custodian of securities under the Securities and Exchange Board of India (Custodian of Securities) Regulations, 1996. The mutual fund shall appoint a custodian to carry out the custodial services for the schemes of the fund and send intimation of the same to SEBI within fifteen days of the appointment of the custodian..No custodian in which the sponsor or its associates hold 50% or more of the voting rights of the share capital of the custodian or where 50% or more of the directors of the custodian represent the interest of the sponsor or its associates shall act as custodian for a mutual fund constituted by the same sponsor or any of its associate or subsidiary company.
Agreement with Custodian The mutual fund shall enter into a custodian agreement with the custodian, which shall contain the clauses that are necessary for the efficient and orderly conduct of the affairs of the custodian. The agreement, the service contract, terms and appointment of the custodian shall be entered into with the prior approval of the trustees.
BANKERS The AMC of the mutual fund appoints bankers to the mutual funds. It provides facilities like receiving the proceeds on sale of investments, enchasing high value cheques, giving multi city cheque book facilities etc.
TRANSFER AGENTS He is responsible for issuing and redeeming units of mutual funds. He prepares transfer documents and update investor records.
TYPES OF SCHEMES/FUNDS
I. By Structure II. By Investment Objective III. Other Schemes
1. Open - Ended Scheme 1. Growth Scheme 1. Tax Saving
2. Close - Ended Scheme 2. Income Scheme 2. Index Scheme
3. Interval Schemes 3. Balanced Scheme 3. Sector Specific
4. Money Market 4. Real Estate Schemes 5. Gilt Schemes
* Open ended Schemes
The units offered by these schemes are available for sale and repurchase on any business day at NAV based prices.
Unit capital of the schemes keeps changing each day.
Offer very high liquidity to investors and are becoming increasingly popular in India.
· Closed ended Schemes
The unit capital of close-ended products is fixed as it makes a one-time sale of fixed number of units.
Are launched with a New Fund Offer (NFO) with a stated maturity period after which the units are fully redeemed at NAV linked prices.
In the interim, investors can buy or sell units on the stock exchanges where they are listed.
Unlike open-ended schemes, the unit capital in closed-ended schemes usually remains unchanged.
After an initial closed period, the scheme may offer direct repurchase facility to the investors.
6. Are usually more illiquid as compared to open-ended schemes and hence trade at a discount to the NAV.
· Interval Scheme
1. Basically a close ended scheme with a peculiar feature that every year for a specified period (interval) it is made open.
2. Prior to and such interval the scheme operates as close ended.
3. During the said period, mutual fund is ready to buy or sell the units directly from or to the investors.
· Growth Schemes
Commonly called as Equity Schemes.
Seek to invest a majority of their funds in equities and a small portion in money market instruments and have the potential to deliver superior returns over the long term.
They are exposed to fluctuations in value especially in the short term.
Hence not suitable for investors seeking regular income or needing to use their investments in the short-term. Ideal for investors who have a long-term investment horizon and risk bearing capacity.
5. The return comes in two sizes in this type of schemes, one is small i.e. dividend and another is medium i.e. at redemption time.
GENERAL PURPOSE EQUITY SCHEMES
· Income Schemes
Commonly known as Debt Schemes.
These schemes invest in money markets, bonds and debentures
These schemes primarily target current income instead of capital appreciation. They therefore distribute a substantial part of their distributable surplus to the investor by way of dividend distribution.
4. Such schemes usually declare quarterly dividends and are suitable for conservative investors who have medium to long term investment horizon and are looking for regular income through dividend or steady capital appreciation.
The prices of these schemes tend to be more stable compared with equity schemes and most of the returns to the investors are generated through dividends or steady capital appreciation.
These schemes are ideal for conservative investors or those not in a position to take higher equity risks, such as retired individuals.
7. However, as compared to the money market schemes they do have a higher price fluctuation risk and compared to a Gilt fund they have a higher credit risk.
GENERAL PURPOSE DEBT SCHEMES
· Balanced Schemes
Aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities.
Appropriate for investors looking for moderate growth.
They generally invest 40-60% in equity and debt instruments.
NAVs of such funds are likely to be less volatile and bear lower risk compared to pure equity funds.
5. Theses funds are also known as Hybrid Schemes.
· Money Market Schemes
Invest in short term instruments such as Commercial Paper (“CP”), Certificates of Deposit (“CD”), Treasury Bills and Call Money.
Least volatile of all the types of schemes because of their investments in money market instrument with short-term maturities.
3. Are popular with institutional investors and high net worth individuals having short-term surplus funds.
* Tax Saving Schemes
1. Investors (individuals and Hindu Undivided Families (“HUFs”)) are being encouraged to invest in equity markets through Equity Linked Savings Scheme (ELSS) by offering them a tax deduction u/s 80(C).
2. The deduction is allowable upto the limit of Rs. 1lac U/S 80C.
* Index Schemes
Replicate the portfolio of a particular index such as the BSE Sensitive Index, S&P NSE 50 index (Nifty), etc
Invest in the securities in the same weight age comprising of an index.
NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms.
Exchange traded index funds launched by the mutual funds which are traded on the stock exchanges.
The primary purpose of an Index is to serve as a measure of the performance of the market as a whole, or a specific sector of the market.
· Sector Specific Schemes
These schemes restrict their investing to one or more pre-defined sectors, e.g. technology sector, pharma sector, power sector etc.
Depend upon the performance of select sectors only, these schemes are inherently more risky than general-purpose schemes.
3. They are suited for informed investors who wish to take a view and risk on the concerned sector.
· Real Estate Schemes
Specialized real estate funds would invest in real estates directly, or may fund real estate developers or lend to them directly or buy shares of housing finance companies or may even buy their securitized assets.
* Gilt Schemes
This scheme primarily invests in Government Debt. Hence the investor usually does not have to worry about credit risk since Government Debt is generally credit risk free.
TYPES OF RETURNS
Mutual Funds give returns in two ways - Capital Appreciation or Dividend Distribution.
* Capital Appreciation
An increase in the value of the units of the fund is known as capital appreciation. 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 prices higher than the price at which he bought the units.
* Dividend Distribution
The profit earned by the fund is distributed among unit holders in the form of dividends. Dividend distribution again is of two types. It can either be re-invested in the fund or can be on paid to the investor.
Under the Growth Plan, the investor realizes the capital appreciation of his/her investments while under the Dividend Reinvestment Plan, the dividends declared are reinvested automatically in the scheme.
FREQUENTLY USED TERMS
* Net Asset Value (NAV) Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date.
* Sale Price Sale price is the price you pay when you invest in a scheme. Also called Offer Price. It may include a sales load.
* Repurchase Price Repurchase price is the price at which a close-ended scheme repurchases its units and it may include a back-end load. This is also called Bid Price.
* Redemption Price Redemption price is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related.
* Sales or Entry Load Sale load is a charge collected by a scheme when it sells the units. Also called, ‘Front-end' load. Schemes that do not charge a load are called ‘No Load' schemes.
* Repurchase, Exit or Back-end Load Repurchase load is a charge collected by a scheme when it buys back the units from the unit holders.
A FEW INTERESTING TERMS
FLOATING RATE FUNDS
A floating rate fund is a fund that by its investments in floating rate instruments seeks to provide stable returns with low level of interest rate risk and volatility. A Floating Rate Instrument is a debt instrument whose interest rate (coupon) is not fixed and is linked to a benchmark rate and is adjusted periodically. For example the Grindlays Floating Rate Fund invests primarily in: -
Floating rate debentures and bonds
Short tenor fixed rate instruments
Long tenor fixed rate instrument swapped to floating rate (Interest Rate Swaps).
* Floating Rate Funds, Why?
In a declining interest rate scenario older securities issued at higher coupon rates (interest paid on the face value of a debt instrument) appear much more attractive than the ones that are currently issued. Consequently older higher interest bearing securities would go at a premium. Thus long term income funds by virtue of their investments in longer maturing securities would see a rise in their Net Asset Values. However, when interest rates are on the rise newer securities appear more attractive than the ones that were issued earlier, as they offer higher coupons than their predecessors. The lesser paying older securities therefore will be sold at a discount. So the same income fund with a majority of investment in longer maturing securities, now start earning you lesser as newer securities continues to earn higher returns than the ones in the portfolio.
This bearish scenario lasts as long as interest rates continue to show an upward trend. It is during these times that floating rate funds offer the best utility.
* Right time to Invest in Floating Rate Funds
In a rising interest rate scenario, the interest rate on a Floating Rate instrument is periodically reset to a higher level due to the fact that accompanying benchmark rate is anyway at a higher level. On account of this periodic reset the difference in returns between a floating rate fund and a security that is issued currently is marginal. So the price difference is marginal leading to a marginal impact on the NAV. Floating Rate funds are protective funds and shield your investments from interest rate fluctuations.
* Benchmark Rate
A benchmark or a reference rate is a rate that is an accurate measure of the market price. In the fixed income market, it is an interest rate that the market respects and closely watches. A benchmark rate should be from an unbiased source, be representative of the market, transparent, reliable and continuously available and most importantly be widely acceptable to the market as the benchmark rate. Such benchmark rates issued by unbiased sources are the Treasury Bill T-Bill) rate issued by the Government of India, the bank rate as decided by the Reserve Bank of India, the Mumbai Inter Bank Offering Rate (MIBOR) released by the National Stock Exchange of India and GOI Securities.
An Example: A company issues debentures at 1 year GOI Security yield + 100 basis points (simply 1%) with a tenor of 5 years, periodically reset every six months. If the1 year GOI security is currently ruling at 5.75%, the interest rate that is fixed for the first six months is 5.75% +1%=6.75%.
One more convenient method of investing is provided by the Mutual Funds. In this option one can invest the Dividend declared in a particular scheme in other scheme. The Dividends (net of TDS if any) earned by the Unit holder will be sweeped/ transferred into any desired Scheme or Plan. This facility helps the unit holder to build up his wealth continuously. No load will be applicable for sweep in, even if the Scheme in which the sweep is taking place has an entry load.
There are no minimum amount restrictions. Further there is no facility for transfer of partial dividend or transfer of dividend to multiple schemes. With the introduction of above option, the Investor can either opt for:-
* Pay out of full Dividend, subject to deduction of tax
· Reinvestment of full dividend into the same scheme, subject to payment of tax
· Transfer of full dividend to some other plan in the same scheme of other schemes
Investors may avail any of the above facilities by ticking the appropriate box in the Application Form or may contact the ISCs or the AMC for further details.
Triggers are options provided to the unit holder as part of systematic withdrawal plan to enable automatic redemption on the happening of the desired event. Triggers can help Investor make the most of market movements without the hassle of constant tracking. Triggers can also be used as an efficient downside protection tool.
* How to opt for Triggers A unit holder may opt for this facility at any time by submitting a written application or by filling the relevant form. Under this option, the entire account will be redeemed when the chosen event occurs.
* Cancellation of Triggers A mandate of triggers could be cancelled by giving a letter to that effect mentioning information like Folio No, Name of the scheme, the transaction for which Trigger is to be cancelled etc When a request is made for canceling a trigger, it may take up to a maximum 5 business days to implement it.
* How to opt for Triggers
A unit holder may opt for this facility at any time by submitting a written application or by filling the relevant form. Under this option, the entire account will be redeemed when the chosen event occurs.
* Different Trigger Options
Following are the types of triggers offered by UTI Mutual Fund:
1. The Value Trigger: Redemption will be triggered when your investment reaches a value that you have defined. For example - You have invested Rs 10,000 with us, and have set the Trigger at Rs 15,000/-. We will automatically redeem you when the repurchase value reaches Rs 15,000/-
2. The Date Trigger: Redeem on a date specified by you.
For example - You may want to redeem your investment on a specific date - Your 25th Wedding Anniversary, your retirement date, three years from today, when your son reaches the age of 21 etc.
3. Capital Gains Distribution and Reinvestment Facility: Allows you to redeem or reinvest when the requisite period for realization of long-term capital gain is reached.
4. Triggers at Transaction Level: An investor carries out two separate investment transactions with the Fund at two different times (even within the same folio), he could specify separate triggers for each of his transactions and these triggers could be of different types.
5. Downside Triggers: For Value Trigger, an investor now can specify the desired value being lower than the investment amount i.e. a Stop Loss Concept. For example- if an investor invest say Rs. 10,000/-, he can specify a Value Trigger of 8,000/-. In case of depreciation in NAV, as and when his investment value reaches 8,000/- or lower, the Trigger would be fired.
· Switch Option for Triggers Earlier redemption was the only available option on the happening of a particular event. Now investors can switch to other Plan within the same Scheme or another Scheme of the UTI Mutual Fund as and when the Trigger is fired. The Switch option is available ONLY for Date, Value and Index Trigger and not for Capital Gains Trigger.
* Index Based Triggers
All equity schemes can now avail a new trigger based on NSE Nifty / BSE Sensex
values. An investor has to specify the Index value on reaching of which, investments should be redeemed/ switched.
* Alerts Instead of Redemption or Switch, an investor may only opt to be alerted as and when the Trigger gets fired (happening of specified event). The alert option is available ONLY for Date, Value and Index Triggers and an email will be sent to the investor informing him about the happening of event. Email address of the investors is a must for this option.
Mutual Funds: Universal Appeal
Savings form an important part of the economy of any nation. With savings invested in various options available to the people, the money acts as the driver for growth of the country. Indian financial scene too presents multiple avenues to the investors. Though certainly not the best or deepest of markets in the world, it has ignited the growth rate in mutual fund industry to provide reasonable options for an ordinary man to invest his savings.
Investment goals vary from person to person. While somebody wants security, others might give more weightage to returns alone. Somebody else might want to plan for his child's education while somebody might be saving for the proverbial rainy day or even life after retirement. With objectives defying any range, it is obvious that the products required will vary as well.
Though still at a nascent stage, Indian MF industry offers a plethora of schemes and serves broadly all type of investors. The range of products includes equity funds, debt, liquid, gilt and balanced funds. There are also funds meant exclusively for young and old, small and large investors. Moreover, the setup of a legal structure, which has enough teeth to safeguard investors' interest, ensures that the investors are not cheated out of their hard-earned money. All in all, benefits provided by them cut across the boundaries of investor category and thus create for them, a universal appeal.
Investors of all categories could choose to invest on their own in multiple options but opt for mutual funds for the sole reason that all benefits come in a package.
Let us see how.
An investor normally prioritizes his investment needs before undertaking an investment. So different goals will be allocated different proportions of the total disposable amount. Investments for specific goals normally find their way into the debt market as risk reduction is of prime importance. This is the area for the risk-averse investors and here, mutual funds are generally the best option. The reasons are not difficult to see.
One can avail of the benefits of better returns with added benefits of anytime liquidity by investing in open-ended debt funds at lower risk. Many people have burnt their fingers by investing in fixed deposits of companies who were assuring high returns but have gone bust in course of time leading to distraught investors as well as pending cases in the Company Law Board.
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 in instruments of varied maturity profiles. 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 better placed 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.
Apart from liquidity, these funds have also provided very good post-tax returns on year to year basis. Even historically, we find 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 10 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.
Moving up in the risk spectrum, we have people who would like to take some risk and invest in equity funds/capital market. However, since their appetite for risk is also limited, they would rather have some exposure to debt as well. For these investors, balanced funds provide an easy route of investment. Armed with the expertise of investment techniques, they can invest in equity as well as good quality debt thereby reducing risks and providing the investor with better returns than he could otherwise manage. Since they can reshuffle their portfolio as per market conditions, they are likely to generate moderate returns even in pessimistic market conditions.
Next come the risk takers. Risk takers by their very nature, would not be averse to investing in high-risk avenues. Capital markets find their fancy more often than not, because they have historically generated better returns than any other avenue, provided, the money was judiciously invested. Though the risk associated is generally on the higher side of the spectrum, the return-potential compensates for the risk attached.
Capital markets interest people, albeit not all for there are several problems associated. First issue is that of expertise. While investing directly into capital market one has to be analytical enough to judge the valuation of the stock and understand the complex undertones of the stock. One needs to judge the right valuation for exiting the stock too. It is very difficult for a small investor to keep track of the movements of the market. Entrusting the job to experts, who watch the trends of the market and analyze the valuations of the stocks will solve this problem for an investor. Mutual funds specialize in identification of stocks through dedicated experts in the field and this enables them to pick stocks at the right moment. Sector funds provide an edge and generate good returns if the particular sector is doing well.
Next problem is that of funds/money. A single person can't 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. This not only diversifies the portfolio and helps in generating returns from a number of sectors but reduces the risk as well. Though identification of the right fund might not be an easy task, availability of good investment consultants and counselors will help investors take informed decision.
RISK AND RETURN GRID:
Risk Tolerance/Return Expected
Benefits offered by MFs
Bank/ Company FD, Debt based Funds
Liquidity, Better Post-Tax returns
Partially Debt, Partially Equity
Balanced Funds, Some Diversified Equity Funds and some debt Funds, Mix of shares and Fixed Deposits
Liquidity, Better Post-Tax returns, Better Management, Diversification
Capital Market, Equity Funds (Diversified as well as Sector)
Diversification, Expertise in stock picking, Liquidity, Tax free dividends
Their appeal is not just limited to these categories of investors. Specific goals like career planning for children and retirement plans are also catered to by mutual funds. Children funds have found their way in a big way with many of the fund houses already having launched a children fund. Essentially debt oriented, these schemes invite investments, which are locked till the child attains majority and requires money for higher education. You can invest today and assure financial support to your child when he/she requires them. The schemes have given very good returns of around 14 percent in the last one-year period. These schemes are also designed to provide tax efficiency. The returns generated by these funds come under capital gains and attract tax at concessional rates.
Besides this, if the objective was to save taxes, the industry offers equity linked savings schemes as well. Equity-based funds, they can take long-term call on stocks and market conditions without having to worry about redemption pressure as the money is locked in for three years and provide good returns. Some of the ELSS have been exceptional performers in past and cater to equity investor with good performances. The industry offered tax benefits under various sections of the IT Act. For e.g. dividend income is free in the hands of the investor while capital gains are taxed after providing for cost inflation indexation. Hitherto, the benefits under section 54 EA/EB were available to take benefits of the tax provisions for capital gains but have now been removed.
The benefits listed so far have essentially been for the small retail investor but the industry can attract investments from institutional and big investors as well. Liquid funds offer liquidity as well as better returns than banks and so attract investors. Many funds provide anytime withdrawal enabling a big investor to take maximum benefits.
Like we said earlier, the appeal of mutual funds cuts across investor classes.
In other developed countries, mutual funds attract much more investments as compared to the banking sector but in India the case is reverse. We lack awareness about the benefits that are offered by these schemes. It is time that investors irrespective of their risk capacities, made intelligent decisions to generate better returns and mutual funds are definitely one of the ways to go about it.
OPPORTUNITY TO INVEST IN MUTUAL FUNDS ACROSS YOUR LIFE STAGES:
Advantages of Mutual Funds:
If mutual funds are emerging as the favorite investment vehicle, it is because of the many advantages they have over other forms and avenues of investing, particularly for the investor who has limited resources available in terms of capital and ability to carry out detailed research and market monitoring. The following are the major advantages offered by mutual funds to all investors: -
Ø Portfolio diversification: Each investor in a fund is a part owner of all of the fund's assets, thus enabling him to hold a diversified investment portfolio even with a small amount of investment that would otherwise require a big capital.
Ø Professional management: Even if an investor has a big amount of capital available to him, he benefits from the professional 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 on his own. Few investors have the skills
And resources of their own to succeed in today's fast-moving, global and sophisticated markets.
Ø Reduction/Diversification of Risk: When an investor invests directly, all the risk of potential loss is his own, whether he places a deposit with a company or a bank, or buys a share of debenture on his own or in any other form. While investing in the pool of funds with other investors, the potential losses are also shared with other investors. This risk reduction is one of the most important benefits of a collective investment vehicle like the mutual fund.
Ø Reduction of transaction costs: What is true of risk is also true of the transaction costs. The investor bears all the costs of investing such as brokerage or custody of securities. When going through a fund, he has the benefit of economies of scales; the funds pay lesser costs because of larger volumes, a benefit passed on to its investors.
Ø Liquidity: Often, investors hold shares or bonds they cannot directly, easily and quickly sell. When they invest in the units of a fund, they can generally cash their investment any time, by selling their units to the fund if open ended, or selling them in the market if the fund is closed end. Liquidity of investment is clearly a big benefit.
Ø Convenience and flexibility: Mutual fund management companies offer many investor services that a direct market investor cannot get. Investors can easily transfer their holdings from one scheme to the other, get updated market information, and so on.
Ø Identifying stocks that have growth potential is a difficult process involving detailed research and monitoring of the market. Mutual funds specialise in the area and process the requisite resources to carry out research and continuous market monitoring. This is clearly beyond the capability of most individual investors.
Ø Mutual funds focus their investment activities based on investment objectives such as income, growth or tax savings. An investor can choose a fund that has investment objectives in line with his objectives. Therefore, funds provide the investor with a vehicle to attain his objectives in a planned manner.
It is clear that investing through mutual funds is far superior to direct investing except perhaps for the investor who has a truly large portfolio and the tine, knowledge and resources required for direct investing.
Disadvantages of investing through mutual funds
While the benefits of investing through mutual funds far outweigh the disadvantages, an investor and his advisor will do well to be aware of a few shortcomings of using the mutual funds as investments vehicles.
Ø No control over costs: An investor in a mutual fund has no control over the overall cost of investing. He pays investment management fees as long a he remains with the fund, albeit in return for the professional management and research. Fees are payable even while the value of his investments may be declining. A mutual fund investor also pays fund distribution costs, which he would not incur in direct investing. However, this shortcoming only means that there is a cost to obtain the benefits of mutual fund services.
Ø No tailor made portfolios: Investors who invest o