Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. The primary role of mutual funds is to assist investors in earning an income or building their wealth, by participating in the opportunities available in the securities markets.
The investment that an investor makes in a scheme is translated into a certain number of 'Units' in the scheme. Thus, an investor in a scheme is issued units of the scheme. When the investment activity is profitable, the true worth of a unit goes up; when there are losses, the true worth of a unit goes down. The true worth of a unit of the scheme is otherwise called Net Asset Value (NAV) of the scheme.
These are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. All the profits earned (based on accrual of income and expenses as detailed above) are treated as available for distribution. The dividends declared or paid shall also be mentioned in Rupees per unit along with the face value of each unit and the prevailing NAV at the time of declaration.
Investment is time, energy, or matter spent in the hope of future benefits actualized within a specified date or time frame. Investment has a different meaning in finance from that in economics. In finance, investment is buying or creating an asset with the expectation of capital appreciation, dividends (profit), interest earnings, rents, or some combination of these returns.
Mutual funds offer several such schemes to cater to the needs of different types of investors. They are closely regulated by Securities & Exchange Board of India (SEBI) with a view to protect investors. SEBI (Mutual Funds) Regulations, 1996 sets out the regulatory framework. Association of Mutual Funds in India (AMFI) is an industry body constituted by mutual funds in the country. It works closely with SEBI to address various mutual fund related regulatory issues, and ensure smooth functioning of the industry
Mutual funds announce the investment objective for every scheme they float, and seek investments from the public. When a scheme is open for investment for a limited period, initially, it is called a New Fund Offer (NFO). Depending on how it is structured, the scheme may be open to accept money from investors only during the NFO (closed-end scheme), or it may accept money post-NFO too (open-end scheme).
The investment that an investor makes in a scheme is translated into a certain number of 'Units' in the scheme. Thus, an investor in a scheme is issued units of the scheme. For example, if an investor has invested Rs. 1,000 in units issued at Rs10, he will be entitled to Rs. 1,000 ÷ Rs. 10 i.e. 100 units
The purchase of units by the investor from the scheme is also called subscription. Refund of money to the investor by the scheme is called redemption.
Under the law, every unit has a face value of Rs10. (However, older schemes in the market may have a different face value). The face value is relevant from an accounting perspective. The number of units multiplied by its face value (Rs10) is the capital of the scheme – its Unit Capital.
The scheme earns interest income or dividend income on the investments it holds. Further, when it purchases and sells investments, it earns capital gains or incurs capital losses. These are called realized capital gains or realized capital losses as the case may be.
Investments owned by the scheme may be quoted in the market at higher than the cost paid. Such gains in values on securities held are called valuation gains or unrealised gains. Similarly, there can be valuation losses or unrealised losses, when securities are quoted in the market at a price below the cost at which the scheme acquired them.
The practice of marking securities to their market value is called marked to market (MTM) valuation. The true worth of each unit of every scheme i.e. its Net Asset Value (NAV) is calculated based on MTM valuation of the investment portfolio. Thus, it captures all the gains and losses, realised and unrealised. Under the regulations, MTM is to be done daily. This is the principal reason the NAV of the scheme fluctuates, even if there is no change in the investments held in the portfolio of the scheme.
A fall in the security values in the market at the end of a day can cause a drop in NAV; the following day, if the market recovers, the NAV too will recover. Thus, while NAV of mutual fund schemes fluctuate, the fluctuation is of little relevance to a long term investor; the investor's actual returns depend on the price at which he buys or sells the units of the scheme, and the dividend he receives from the scheme during the period he holds the units. Running the scheme entails costs viz. scheme running expenses. The expenses pull down the profits of the scheme and the NAV of the units. This brings down the returns for the investors. Therefore, SEBI has restricted the expenses that can be charged to mutual fund schemes. This has helped in positioning mutual funds among the lowest cost investment products in India.
The scheme's investment operation can be said to have been handled profitably, if the following profitability metric is positive: (A) Interest income (B) + Dividend income (C) + Realized capital gains (D) + Valuation gains (E) – Realized capital losses (F) – Valuation losses (G) – Scheme running expenses It may be noted, (D) and (F) are a result of MTM valuation. When the investment activity in a scheme is profitable, the NAV goes up; when there are losses, the NAV goes down
Investing in a mutual fund is like an investment made by a collective. An individual as a single investor is likely to have lesser amount of money at disposal than say, a group of friends put together. Now, let's assume that this group of individuals is a novice in investing and so the group turns over the pooled funds to an expert to make their money work for them. This is what a professional Asset Management Company does for mutual funds. The AMC invests the investors' money on their behalf into various assets towards a common investment objective.
They are investments instruments which are capable of giving high returns . An average mutual fund scheme returns easily beats inflation in longer run and a good scheme can give far superior returns.
Our Mutual Fund industry is one of the best regulated industry in the world. They are governed by the strict guidelines layed down by SEBI(Securities & Exchange Board of India).
Investments decision of a Mutual Fund is taken by their AMCs and Fund Managers. They are experts who make investments decisions after doing intensive research and analysis of a company & industry. (Individuals generally don't have time and resources to do research hence best option is to let MF manage your investments)
This industry is highly liquid. Even more liquid than stock markets. Payments are generally made through cheques or in some cases they are directly credited to your bank accounts , If your bank is allowing RTGS & electronic clearing and mutual fund AMC is providing such facility.
Investments are diversified into many companies & sectors. Which make our investments safer and consistent growth prospects. Diversifying is usually not done by small investors , for such a actions one requires lots of funds.
Tax treatments- Governments encourage investments in capital markets and has given many tax sops. Under i) 80(c) investments done upto one lakh in specific mutual funds schemes which is called ELSS(Equity Linked Saving Schemes.) are exempt from tax. ii) Any units held for more than one year if redeemed is treated under long term capital gain tax which is zero percent currently i.e. the whole profit is tax free. If one plans to redeem before one year then he has to pay tax of only15% on the profits.
Mutual Funds are much cheaper compared to direct exposure to capital market since one does not need demat account ,annual charge to maintain account, charges imposed on demat holdings, stamp duty on transaction are not levied .
Now, let's assume that this group of individuals is a novice in investing and so the group turns over the pooled funds to an expert to make their money work for them. This is what a professional Asset Management Company does for mutual funds. The AMC invests the investors' money on their behalf into various assets towards a common investment objective.
Hence, technically speaking, a mutual fund is an investment vehicle which pools investors' money and invests the same for and on behalf of investors, into stocks, bonds, money market instruments and other assets. The money is received by the AMC with a promise that it will be invested in a particular manner by a professional manager (commonly known as fund managers). The fund managers are expected to honour this promise. The SEBI and the Board of Trustees ensure that this actually happens.
Tenor refers to the 'time'. Mutual funds can be classified on the basis of time as under:
These funds are available for subscription throughout the year. These funds do not have a fixed maturity. Investors have the flexibility to buy or sell any part of their investment at any time, at the prevailing price (Net Asset Value - NAV) at that time.
These funds begin with a fixed corpus and operate for a fixed duration. These funds are open for subscription only during a specified period. When the period terminates, investors can redeem their units at the prevailing NAV.
These funds invest in shares. These funds may invest money in growth stocks, momentum stocks, value stocks or income stocks depending on the investment objective of the fund.
These funds invest money in bonds and money market instruments. These funds may invest into long-term and/or short-term maturity bonds.
These funds invest in a mix of both equity and debt. In order to retain their equity status for tax purposes, they generally invest at least 65% of their assets in equities and roughly 35% in debt instruments, failing which they will be classified as debt oriented schemes and be taxed accordingly. (Please see our Tax Section on Page 39 for more information.) Monthly Income Plans (MIPs) fall within the category of hybrid funds. MIPs invest up to 25% into equities and the balance into debt.
These funds invest in physical assets such as gold, platinum, silver, oil, commodities and real estate. Gold Exchange Traded Funds (ETFs) and Real Estate Investment Trusts (REITs) fall within the category of real asset funds.
These funds diversify the equity component of their Asset Under Management (AUM), across various sectors. Such funds avoid taking sectoral bets i.e. investing more of their assets towards a particular sector such as oil & gas, construction, metals etc. Thus, they use the diversification strategy to reduce their overall portfolio risk.
These funds are expected to invest predominantly in a specific sector. For instance, a banking fund will invest only in banking stocks. Generally, such funds invest 65% of their total assets in a respective sector.
These funds seek to have a position which replicates the index, say BSE Sensex or NSE Nifty. They maintain an investment portfolio that replicates the composition of the chosen index, thus following a passive style of investing.
These funds are open-ended funds which are traded on the exchange (BSE / NSE). These funds are benchmarked against the stock exchange index. For example, funds traded on the NSE are benchmarked against the Nifty. The Benchmark Nifty BeES is an example of an ETF which links to the stocks in the Nifty. Unlike an index fund where the units are traded at the day's NAV, in ETFs (since they are traded on the exchange) the price keeps on changing during the trading hours of the exchange. If you as an investor want to buy or sell ETF units, you can do so by placing orders with your broker, who will in-turn offer a two-way real time quote at all times. The AMC does not offer sale and re-purchase for the units. Today, ETFs are available for pre-specified indices. We also have Gold ETFs. Silver ETFs are not yet available.
These funds invest their money in other funds of the same mutual fund house or other mutual fund houses. They are not allowed to invest in any other FOF and they are not entitled to invest their assets other than in mutual fund schemes/funds, except to such an extent where the fund requires liquidity to meet its redemption requirements, as disclosed in the offer document of the FOF scheme.
These funds are basically income/debt schemes like Bonds, Debentures and Money market instruments. They give a fixed return over a period of time. FMPs are similar to close ended schemes which are open only for a fixed period of time during the initial offer. However, unlike closed ended schemes where your money is locked for a particular period, FMPs give you an option to exit. Remember though, that this is subject to an exit load as per the funds regulations. FMPs, if listed on the exchange, provide you with an opportunity to liquidate by selling your units at the prevailing price on the exchange. FMPs are launched in the form of series, having different maturity profiles. The maturity period varies from 3 months to one year.
These funds invest in securities (equity and/or debt) of a specific country or region with an underlying belief that the chosen country or region is expected to deliver superior performance, which in turn will be favourable for the securities of that country. The returns on country fund are affected not only by the performance of the market where they are invested, but also by changes in the currency exchange rates.
These funds mobilise money from investors for the purpose of investment within as well as outside their home country. so we have seen that funds can be categorised based on tenor, investment philosophy, asset class, or geographic region. Now, let's get down to simplifying some jargon with the help of a few definitions, before getting into understanding the nitty-gritty of investing in mutual funds.
NAV is the sum total of all the assets of the mutual fund (at market price) less the liabilities (fund manager fees, audit fees, registration fees among others); divide this by the number of units and you get the NAV per unit of the mutual fund.
SD is the measure of risk taken by, or volatility borne by, the mutual fund. Mathematically speaking, SD tells us how much the values have deviated from the mean (average) of the values. SD measures by how much the investor could diverge from the average return either upwards or downwards. It highlights the element of risk associated with the fund.
SR is a measure developed to calculate risk-adjusted returns. It measures how much return you can expect over and above a certain risk-free rate (for example, the bank deposit rate), for every unit of risk (i.e. Standard Deviation) of the scheme. Statistically, the Sharpe Ratio is the difference between the annualised return (Ri) and the risk-free return (Rf) divided by the Standard Deviation (SD) during the specified period. Sharpe Ratio = (Ri-Rf)/SD. Higher the magnitude of the Sharpe Ratio, higher is the performance rating of the scheme.
The year-over-year growth rate of an investment over a specified period of time.
The compound annual growth rate is calculated by taking the nth root of the total percentage growth rate, where n is the number of years in the period being considered.
This can be written as follows:
These are the simple returns, i.e. the returns that an asset achieves, from the day of its purchase to the day of its sale, regardless of how much time has elapsed in between. This measure looks at the appreciation or depreciation that an asset - usually a stock or a mutual fund - achieves over the given period of time. Mathematically it is calculated as under:
Generally returns for a period less than 1 year are expressed in an absolute form.
Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. The primary role of mutual funds is to assist investors in earning an income or building their wealth, by participating in the opportunities available in the securities markets.