Chapter 7 – Mutual Funds

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What is a Mutual Fund?
Mutual Fund is a trust that pools together the resources of investors
to make a foray into investments in the capital market thereby
making the investor to be a part owner of the assets of the mutual
fund. The fund is managed by a professional money manager who
invests the money collected from different investors in various stocks,
bonds or other securities according to specific investment objectives
as established by the fund.

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EVOLUTION OF THE INDIAN MUTUAL FUND
INDUSTRY
First Phase – 1964-87
Unit Trust of India (UTI) was established in 1963 by an Act of
Parliament. The MF scheme was Unit Scheme – 64.
Second Phase – 1987-1993 (Entry of Public Sector Funds)
1987 marked the entry of non- UTI, public sector mutual funds set up
by public sector banks, Life Insurance Corporation of India (LIC) and
General Insurance Corporation of India (GIC).
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EVOLUTION OF THE INDIAN MUTUAL FUND
INDUSTRY
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. SEBI came out with SEBI(Mutual Fund) Regulations, 1996.

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EVOLUTION OF THE INDIAN MUTUAL FUND
INDUSTRY
Fourth Phase – since February 2003- April 2014
In February 2003, following the repeal of the Unit Trust of India Act 1963,
UTI was bifurcated into two separate entities. One represented the assets
of US 64 Scheme and the second one was established as UTI Mutual Fund
and sponsored by SBI, PNB, BOB and LIC.

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EVOLUTION OF THE INDIAN MUTUAL FUND
INDUSTRY
Fifth Phase – since May 2014
To ‘re-energies’ the Indian Mutual Fund industry and increase in its
penetration, SEBI introduced several measures. With formation of new
Government and success measures taken in reversion of negative trend,
the situation improved significantly. Hence, since May 2014, the industry
has witnessed steady inflow and increase in number of investors as well as
of AUM.

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CLASSIFICATION OF MUTUAL FUNDS
There are three different types of classification of mutual funds - (1)
Functional (2) Portfolio and (3) Ownership.

Functional Classification
Funds are divided into:

(1) Open-Ended funds

(2) Close-Ended funds and

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Functional Classification
In an Open-Ended scheme, the investor can make entry and exit at any
time. Also, the capital of the fund is unlimited, and the redemption period
is indefinite.
On the contrary, in a Close-Ended scheme, the investor can buy into the
scheme during Initial Public offering or from the stock market after the
units have been listed. The scheme has a limited life at the end of which
the corpus is liquidated. The investor can make his exit from the scheme by
selling in the stock market, or at the expiry of the scheme or during
repurchase period at his option.
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Portfolio Classification
Funds are classified into Equity Funds, Debt Funds and Special Funds.

Equity Funds
Equity Funds are of the following types viz.

• Growth Funds: They seek to provide long term capital

appreciation to the investor and are best to long term investors.

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Portfolio Classification
Equity Funds
• Aggressive Funds: They look for super normal returns for which
investment is made in start-ups, IPOs and speculative shares. They
are best to investors willing to take risks.

• Income Funds: They seek to maximize present income of investors

by investing in safe stocks paying high cash dividends and in high
yield money market instruments.

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Portfolio Classification
Debt Funds
Debt Funds are of two types viz.

• Bond Funds: They invest in fixed income securities e.g.

government bonds, corporate debentures, convertible debentures,
money market.

• Gilt Funds: They are mainly invested in Government securities.

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Portfolio Classification
Special Funds
Following are the types of Special Funds viz.

• Index Funds: They are passive funds which invests in market indexes like
Nifty and Sensex. They are low cost funds and they should be invested
with a long term perspective.

• International Funds: A mutual fund located in India to raise money in

India for investing globally.

• Offshore Funds: A mutual fund located in India to raise money

globally for investing in India.
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Portfolio Classification
Sector Funds: They invest their entire fund in a particular industry e.g.
utility fund for utility industry like power, gas, public works.
Money Market Funds: These are predominantly debt-oriented schemes,
whose main objective is preservation of capital, easy liquidity and moderate
income. Liquid funds invest predominantly in safer short-term instruments
like Commercial Papers, Certificate of Deposits, Treasury Bills, G-Secs etc.
Fund of Funds: Fund of Funds (FoF) as the name suggests are schemes
which invest in other mutual fund schemes.

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Portfolio Classification
Capital Protection Oriented Fund: The term ‘capital protection oriented
scheme’ means a mutual fund scheme which is designated as such and
which endeavours to protect the capital invested therein through suitable
orientation of its portfolio structure.
Gold Funds: The objective of these funds is to track the performance of
Gold. The units represent the value of gold or gold related instruments
held in the scheme.

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Ownership Classification

Funds are classified into Public Sector Mutual Funds, Private Sector Mutual
Funds and Foreign Mutual Funds. Public Sector Mutual Funds are
sponsored by a company of the public sector. Private Sector Mutual Fund is
sponsored by a company of the private sector. Foreign Mutual Funds are
sponsored by companies for raising funds in India, operate from India and
invest in India.

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Direct Plans in Mutual Funds

Mutual fund direct plans are those plan where Asset Management
Companies or mutual fund Houses do not charge distributor
expenses, trail fees and transaction charges. NAV of the direct plan
are generally higher in comparison to a regular plan.

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TYPES OF SCHEMES
Balanced Funds
Balanced funds make strategic allocation to both debt as well as equities. It
mainly works on the premise that while the debt portfolio of the scheme
provides stability, the equity one provides growth.

Equity Diversified Funds

A Diversified funds is a fund that contains a wide array of stocks. The fund
manager of a diversified fund ensures a high level of diversification in its
holdings, thereby reducing the amount of risk in the fund.
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Equity Diversified Funds
• Flexicap/ Multicap Fund: These are by definition, diversified funds. The
only difference is that unlike a normal diversified fund, the offer
document of a multi-cap/flexi-cap fund generally spells out the limits
for minimum and maximum exposure to each of the market caps.
• Contra fund: A contra fund invests in those out-of-favour companies
that have unrecognized value. It is ideally suited for investors who want
to invest in a fund that has the potential to perform in all types of
market environments as it blends together both growth and value
opportunities.
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Equity Diversified Funds

• Dividend Yield fund: A dividend yield fund invests in shares of

companies having high dividend yields.
• Equity Linked Savings Scheme (ELSS): ELSS is one of the options for
investors to save taxes under Section 80 C of the Income Tax Act. They
also offer the perfect way to participate in the growth of the capital
market, having a lock -in- period of three years.

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Thematic Funds: A Thematic fund focuses on trends that are likely to
result in the ‘out -performance’ by certain sectors or companies. The
theme could vary from multi-sector, international exposure, commodity
exposure etc. Unlike a sector fund, theme funds have a broader outlook.

Arbitrage Funds: Arbitrage fund seeks to capitalize on the price

differentials between the spot and the futures market. These funds are
ideal for investors who want to benefit from high volatility by taking
minimum risk.

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Hedge Fund: These funds are aggressive funds that take advantage
of derivatives position in both domestic and international markets.
Cash Fund: Cash Fund is an open ended liquid scheme that aims to
generate returns with lower volatility and higher liquidity through a
portfolio of debt and money market instrument.

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Exchange Traded Funds: An Exchange Traded Fund (ETF) is a hybrid
product that combines the features of an index fund. These funds are listed
on the stock exchanges and their prices are linked to the underlying index.
ETFs can be bought and sold like any other stock on an exchange. In other
words, ETFs can be bought or sold any time during the market hours at
prices that are expected to be closer to the NAV at the end of the day.

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Fixed Maturity Plans: Fixed Maturity Plans (FMPs) are closely ended
mutual funds in which an investor can invest during a New Fund Offer
(NFO). FMPs usually invest in Certificates of Deposits (CDs), Commercial
Papers (CPs), Money Market Instruments and Non-Convertible Debentures
over fixed investment period. Sometimes, they also invest in Bank Fixed
Deposits.

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ADVANTAGES OF MUTUAL FUND
• Professional Management

• Diversification

• Convenient Administration

• Higher Returns

• Low Cost of Management

• Liquidity

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ADVANTAGES OF MUTUAL FUND
• Transparency

• Highly Regulated

• Economies of scale

• Flexibility

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DRAWBACKS OF MUTUAL FUND
• No guarantee of Return

• A diversified portfolio does not maximize returns

• Selection of Proper Fund only on the basis of past performance

• Cost Factor

• Unethical Practices

• Taxes

• Difficulties when a managed portfolio is switched to a different financial firm

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TERMS ASSOCIATED WITH MUTUAL FUNDS
Net Asset Value (NAV)
It is value of net assets of the funds. The investor’s subscription is treated as the
unit capital in the balance sheet of the fund and the investments on their behalf
are treated as assets. The fund’s net assets are defined as the assets less
liabilities.
NAV per unit = Net asset of the scheme/Number of units outstanding
Net Assets of the Scheme = Market value of investments + Receivables + Other
accrued income + other assets - Accrued Expenses - Other Payables - Other
Liabilities
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TERMS ASSOCIATED WITH MUTUAL FUNDS
Entry and Exit Load in Mutual Funds

Entry load is charged at the time an investor purchases the units of a

scheme. The entry load percentage is added to the prevailing NAV at the
time of allotment of units.
Exit load is charged at the time of redeeming (or transferring an
investment between schemes). The exit load percentage is deducted from
the NAV at the time of redemption (or transfer between schemes).

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TERMS ASSOCIATED WITH MUTUAL FUNDS
Trail Commission
It is the amount that a mutual fund investor pays to his advisor each year.
The purpose of charging this commission from the investor is to provide
incentive to the advisor to review their customer’s holdings and to give
advice from time to time.
Distributors usually charge a trail commission of 0.30-0.75% on the value
of the investment for each year that the investor's money remains
invested with the fund company.

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TERMS ASSOCIATED WITH MUTUAL FUNDS
Expense Ratio
It is the percentage of the assets that were spent to run a mutual fund. It
includes things like management and advisory fees, travel costs and
consultancy fees. The expense ratio does not include brokerage costs for
trading the portfolio. It is also referred to as the Management Expense
Ratio (MER).

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TERMS ASSOCIATED WITH MUTUAL FUNDS
Side Pocketing
A Side Pocketing in Mutual Funds leads to separation of risky assets from
other investments and cash holdings. Whenever, the rating of a mutual
fund decreases, the fund shifts the illiquid assets into a side pocket so
that current shareholders can be benefitted from the liquid assets.
Consequently, the Net Asset Value (NAV) of the fund will then reflect the
actual value of the liquid assets.

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TERMS ASSOCIATED WITH MUTUAL FUNDS
Tracking Error
Tracking error can be defined as the divergence or deviation of a fund’s
return from the benchmark return it is following. The passive fund
managers closely follow or track the benchmark index. Although they
design their investment strategy on the same index but often it may not
exactly replicate the index return. In such situation, there is possibility of
deviation between the returns. Higher the tracking error higher is the risk
profile of the fund.

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How to Contact us
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