MUTUAL FUNDS
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 invested in
capital market instruments such as shares, debentures, and other securities.
The income earned through these investments is shared by its unit holders in
proportion to the number of units owned by them. Thus a Mutual Fund is the most
suitable investment for the common man as it offers an opportunity to invest in
a diversified, professionally managed basket of securities at a relatively low
cost.
ADVANTAGES OF MUTUAL FUNDS:
Mutual fund investments in stocks, bonds and other instruments
require considerable expertise and constant supervision, to allow an investor
to take the right decisions. Small investors usually do not have the necessary
expertise and time to undertake any study that can facilitate informed
decisions. While this is the predominant reason for the popularity of mutual
funds, there are many other benefits that make mutual funds appealing.
Diversification Benefits:
Diversified investment improves the risk return profile of the
portfolio. Optimal diversification has limitations due to low liquidity among
small investors. The large corpus of a mutual fund as compared to individual
investments makes optimal diversification possible. Due to the pooling of
capital, individual investors can derive benefits of diversification.
Low Transaction Costs:
Mutual fund transactions are generally very large. These large
volumes attract lower brokerage commissions and other costs as compared to
smaller volumes of the transactions that individual investors enter into. The
brokers quote a lower rate of commission due to two reasons. The first is
competition for the institutional investors business. The second reason is that
the overhead cost of executing a trade does not differ much for large and small
orders. Hence for a large order these costs spread over a large volume enabling
the broker to quote a lower commission rate.
Availability of Various Schemes:
There are four basic types of mutual funds: equity, bond, hybrid
and money market. Equity funds concentrate their investments in stocks.
Similarly bond funds primarily invest in bonds and other securities. Equity,
bond and hybrid funds are called long-term funds. Money market funds are
referred to as short-term funds because they invest in securities that
generally mature in about one year or less. Mutual funds generally offer a
number of schemes to suit the requirement of the investors.
Professional Management:
Management of a portfolio involves continuous monitoring of
various securities and innumerable economic variables that may affect a
portfolio's performance. This requires a lot of time and effort on part of the
investors along with in-depth knowledge of the functioning of the financial
markets. Mutual funds are managed by fund managers generally with knowledge and
experience whose time is solely devoted to tracking and updating the portfolio.
Thus investment in a mutual fund not only saves time and effort for the
investor but is also likely to produce better results.
Liquidity:
Liquidating a portfolio is not always easy. There may not be a
liquid market for all securities held. In case only a part of the portfolio is
required to be liquidated, it may not be possible to see all the securities
forming a part of the portfolio in the same proportion as they are represented
in the portfolio; investing in mutual funds can solve these problems. A fund
house generally stands ready to buy and sell its units on a regular basis. Thus
it is easier to liquidate holdings in a Mutual Fund as compared to direct
investment in securities.
Returns:
In India dividend received by investors is tax-free. This enhances
the yield on mutual funds marginally as compared to income from other
investment options. Also in case of long-term capital gains, the investor
benefits from indexation and lower capital gain tax.
Flexibility:
Features of a MF scheme such as regular investment plan, regular
withdrawal plans and dividend reinvestment plan allows investors to
systematically invest or withdraw funds according to the needs and convenience.
Well Regulated:
All mutual funds are registered with SEBI and
they function within the provisions of strict regulations designed to protect
the interest of investors. The SEBI regularly monitors the operations of an
AMC.
STRUCTURE OF MUTUAL FUNDS IN INDIA:
In India, the mutual fund industry is highly regulated with a view
to imparting operational transparency and protecting the investor's interest.
The structure of a mutual fund is determined by SEBI regulations. These
regulations require a fund to be established in the form of a trust under the
Indian Trust Act, 1882. A mutual fund is typically externally managed. It is
now an operating company with employees in the traditional sense.
Instead, a fund relies upon third parties that are either affiliated organizations or independent contractors to carry out its business activities such as investing in securities. A mutual fund operates through a four-tier structure. The four parties that are required to be involved are a sponsor, Board of Trustees, an asset management company and a custodian.
Sponsor: A sponsor is a body corporate who establishes a mutual fund. It
may be one person acting alone or together with another corporate body.
Additionally, the sponsor is expected to contribute at least 40% to the net
worth of the AMC. However, if any person holds 40% or more of the net worth of
an AMC, he shall be deemed to be a sponsor and will be required to fulfill the
eligibility criteria specified in the mutual fund regulation.
Board Of Trustees: A mutual fund house must
have an independent Board of Trustees, where two-thirds of the trustees are
independent persons who are not associated with the sponsor in any manner. The
Board of Trustees of the trustee company holds the property of the mutual fund
in trust for the benefit of the unit-holders. They are responsible for
protecting the unit-holder's interest.
Asset Management Company: The role of an AMC is highly significant in the
mutual fund operation. They are the fund managers i.e. they invest investors'
money in various securities (equity, debt and money market instruments) after
proper research of market conditions and the financial performance of individual
companies and specific securities in the effort to meet or beat average market
return and analysis. They also look after the administrative functions of a
mutual fund for which they charge management fee.
Custodian: The mutual fund is
required by law to protect their portfolio securities by placing them with a
custodian. Nearly all mutual funds use qualified bank custodians. Only a
registered custodian under the SEBI regulation can act as a custodian to a
mutual fund. Over the years, with the involvement of the RBI and SEBI, the
mutual fund industry has evolved in a big way giving investors an opportunity
to make the most of this investment avenue. With a proper structure in place,
the industry has been able to cater to more number of investors. With the increase
in awareness about mutual funds several new players have joined the bandwagon.
14
Important Steps Taken by SEBI for Regulating Mutual Funds in India
(1) Formation:
Certain structural changes have also been made in the mutual fund industry, as
part of which mutual funds are required to set up asset management companies
with fifty percent independent directors, separate board of trustee companies,
consisting of a minimum fifty percent of independent trustees and to appoint
independent custodians.
This is to
ensure an arm’s length relationship between trustees, fund managers and
custodians, and is in contrast with the situation prevailing earlier in which
all three functions were often performed by one body which was usually the
sponsor of the fund or a subsidiary of the sponsor.
Thus, the
process of forming and floating mutual funds has been made a tripartite
exercise by authorities. The trustees, the asset management companies (AMCs)
and the mutual fund shareholders form the three legs. SEBI guidelines provide
for the trustees to maintain an arm’s length relationship with the AMCs and do
all those things that would secure the right of investors.
With funds
being managed by AMCs and custody of assets remaining with trustees, an element
of counter-balancing of risks exists as both can keep tabs on each other.
(2)
Registration: In January 1993, SEBI
prescribed registration of mutual funds taking into account track record of a
sponsor, integrity in business transactions and financial soundness while
granting permission.
This will
curb excessive growth of the mutual funds and protect investor’s interest by
registering only the sound promoters with a proven track record and financial
strength. In February 1993, SEBI cleared six private sector mutual funds viz. 20th
Century Finance Corporation, Industrial Credit & Investment Corporation of
India, Tata Sons, Credit Capital Finance Corporation, Ceat Financial Services
and Apple Industries.
(3)
Documents: The offer documents of
schemes launched by mutual funds and the scheme particulars are required to be
vetted by SEBI. A standard format for mutual fund prospectuses is being
formulated.
(4)
Code of advertisement: Mutual funds
have been required to adhere to a code of advertisement.
(5)
Assurance on returns: SEBI has introduced
a change in the Securities Control and Regulations Act governing the mutual
funds. Now the mutual funds were prevented from giving any assurance on the
land of returns they would be providing. However, under pressure from the
mutual funds, SEBI revised the guidelines allowing assurances on return subject
to certain conditions.
Hence, only
those mutual funds which have been in the market for at least five years are
allowed to assure a maximum return of 12 per cent only, for one year. With
this, SEBI, by default, allowed public sector mutual funds an advantage against
the newly set up private mutual funds.
As per
basic tenets of investment, it can be justifiably argued that investments in
the capital market carried a certain amount of risk, and any investor investing
in the markets with an aim of making profit from capital appreciation, or
otherwise, should also be prepared to bear the risks of loss.
(6)
Minimum corpus: The current SEBI
guidelines on mutual funds prescribe a minimum start-up corpus of Rs.50 crore
for a open-ended scheme, and Rs.20 crore corpus for closed-ended scheme,
failing which application money has to be refunded.
The idea
behind forwarding such a proposal to SEBI is that in the past, the minimum
corpus requirements have forced AMCs to solicit funds from corporate bodies,
thus reducing mutual funds into quasi-portfolio management outfits. In fact,
the Association of Mutual Funds in India (AMFI) has repeatedly appealed to the
regulatory authorities for scrapping the minimum corpus requirements.
(7)
Institutionalisation: The efforts of
SEBI have, in the last few years, been to institutionalise the market by
introducing proportionate allotment and increasing the minimum deposit amount
to Rs.5000 etc. These efforts are to channel the investment of individual
investors into the mutual funds.
(8)
Investment of funds mobilised: In
November 1992, SEBI increased the time limit from six months to nine months
within which the mutual funds have to invest resources raised from the latest
tax saving schemes. The guideline was issued to protect the mutual funds from
the disadvantage of investing funds in the bullish market at very high prices
and suffering from poor NAV thereafter.
(9)
Investment in money market: SEBI
guidelines say that mutual funds can invest a maximum of 25 per cent of
resources mobilised into money-market instruments in the first six months after
closing the funds and a maximum of 15 per cent of the corpus after six months
to meet short term liquidity requirements.
Private
sector mutual funds, for the first time, were allowed to invest in the call
money market after this year’s budget. However, as SEBI regulations limit their
exposure to money markets, mutual funds are not major players in the call money
market. Thus, mutual funds do not have a significant impact on the call money
market.
(10)
Valuation of investment: The
transparent and well understood declaration or Net Asset Values (NAVs) of
mutual fund schemes is an important issue in providing investors with
information as to the performance of the fund. SEBI has warned some mutual
funds earlier of unhealthy market
(11)
Inspection: SEBI inspect mutual funds
every year. A full SEBI inspection of all the 27 mutual funds was proposed to
be done by the March 1996 to streamline their operations and protect the
investor’s interests. Mutual funds are monitored and inspected by SEBI to
ensure compliance with the regulations.
(12)
Underwriting: In July 1994, SEBI
permitted mutual funds to take up underwriting of primary issues as a part of
their investment activity. This step may assist the mutual funds in
diversifying their business.
(13)
Conduct: In September 1994, it was
clarified by SEBI that mutual funds shall not offer buy back schemes or assured
returns to corporate investors. The Regulations governing Mutual Funds and
Portfolio Managers ensure transparency in their functioning.
(14)
Voting rights: In September 1993,
mutual funds were allowed to exercise their voting rights. Department of
Company Affairs has reportedly granted mutual funds the right to vote as
full-fledged shareholders in companies where they have equity investments.
Different Types and Kinds of
Mutual Funds
The mutual fund industry of India is continuously evolving. Along
the way, several industry bodies are also investing towards investor education.
Yet, according to a report by Boston Analytics, less than 10% of our households
consider mutual funds as an investment avenue. It is still considered as a
high-risk option.
In fact, a basic inquiry about the types of mutual funds reveals
that these are perhaps one of the most flexible, comprehensive and hassle free
modes of investments that can accommodate various types of investor needs.
Various types of mutual funds categories are designed to allow investors to choose a scheme based on the risk they are willing to take, the investable amount, their goals, the investment term, etc.
I. Open-Ended – This scheme allows investors to buy or sell units at any point in time. This does not have a fixed maturity date.
Various types of mutual funds categories are designed to allow investors to choose a scheme based on the risk they are willing to take, the investable amount, their goals, the investment term, etc.
I. Open-Ended – This scheme allows investors to buy or sell units at any point in time. This does not have a fixed maturity date.
1. Debt/ Income -
In a debt/income scheme, a major part of the investable fund are channelized
towards debentures, government securities, and other debt instruments. Although
capital appreciation is low (compared to the equity mutual funds), this is a
relatively low risk-low return investment avenue which is ideal for investors
seeing a steady income.
2. Money Market/ Liquid – This is ideal for investors looking to utilize their surplus
funds in short term instruments while awaiting better options. These schemes invest
in short-term debt instruments and seek to provide reasonable returns for the
investors.
3. Equity/ Growth – Equities are a popular mutual fund category amongst retail
investors. Although it could be a high-risk investment in the short term,
investors can expect capital appreciation in the long run. If you are at your
prime earning stage and looking for long-term benefits, growth schemes could be
an ideal investment.
3.i. Index Scheme – Index schemes is a widely popular concept in the west. These follow
a passive investment strategy where your investments replicate the movements of
benchmark indices like Nifty, Sensex, etc.
3.ii. Sectoral Scheme – Sectoral funds are invested in a specific sector like infrastructure, IT, pharmaceuticals, etc. or segments of the capital market like large caps, mid caps, etc. This scheme provides a relatively high risk-high return opportunity within the equity space.
3.iii. Tax Saving – As the name suggests, this scheme offers tax benefits to its investors. The funds are invested in equities thereby offering long-term growth opportunities. Tax saving mutual funds (called Equity Linked Savings Schemes) has a 3-year lock-in period.
3.ii. Sectoral Scheme – Sectoral funds are invested in a specific sector like infrastructure, IT, pharmaceuticals, etc. or segments of the capital market like large caps, mid caps, etc. This scheme provides a relatively high risk-high return opportunity within the equity space.
3.iii. Tax Saving – As the name suggests, this scheme offers tax benefits to its investors. The funds are invested in equities thereby offering long-term growth opportunities. Tax saving mutual funds (called Equity Linked Savings Schemes) has a 3-year lock-in period.
4. Balanced – This scheme allows investors to enjoy growth and income at
regular intervals. Funds are invested in both equities and fixed income
securities; the proportion is pre-determined and disclosed in the scheme
related offer document. These are ideal for the cautiously aggressive
investors.
II. Closed-Ended – In India, this type of scheme has a stipulated maturity period and investors can invest only during the initial launch period known as the NFO (New Fund Offer) period.
1. Capital Protection – The primary objective of this scheme is to safeguard the principal amount while trying to deliver reasonable returns. These invest in high-quality fixed income securities with marginal exposure to equities and mature along with the maturity period of the scheme.
2. Fixed Maturity Plans (FMPs) – FMPs, as the name suggests, are mutual fund schemes with a defined maturity period. These schemes normally comprise of debt instruments which mature in line with the maturity of the scheme, thereby earning through the interest component (also called coupons) of the securities in the portfolio. FMPs are normally passively managed, i.e. there is no active trading of debt instruments in the portfolio. The expenses which are charged to the scheme, are hence, generally lower than actively managed schemes.
II. Closed-Ended – In India, this type of scheme has a stipulated maturity period and investors can invest only during the initial launch period known as the NFO (New Fund Offer) period.
1. Capital Protection – The primary objective of this scheme is to safeguard the principal amount while trying to deliver reasonable returns. These invest in high-quality fixed income securities with marginal exposure to equities and mature along with the maturity period of the scheme.
2. Fixed Maturity Plans (FMPs) – FMPs, as the name suggests, are mutual fund schemes with a defined maturity period. These schemes normally comprise of debt instruments which mature in line with the maturity of the scheme, thereby earning through the interest component (also called coupons) of the securities in the portfolio. FMPs are normally passively managed, i.e. there is no active trading of debt instruments in the portfolio. The expenses which are charged to the scheme, are hence, generally lower than actively managed schemes.
III. Interval – Operating as a combination of open and closed ended schemes, it
allows investors to trade units at pre-defined intervals.
References:
1.
vinodkothari.com/wp-content/uploads/2014/01/Brief-on-Mutual-Funds.pdf
2.
https://www.slideshare.net/gurmeetvirk/presentation-on-mf
4.
https://www.sec.gov/investor/pubs/sec-guide-to-mutual-funds.pdf
6.
http://www.investogram.net/mutual-funds/advantages-and-disadvantages-of-mutual-funds/
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