MODULE 3

MUTUAL FUNDS AND FINANCIAL PLANNING ESSENTIALS

 Mutual fund
A mutual fund is an investment vehicle where many investors pool their money to
earn returns on their capital over a period. This corpus of funds is managed by an
investment professional known as a fund manager or portfolio manager. The gains or
losses on the investment are shared collectively by the investors in proportion to
their contribution to the fund.

 Expand: AMFI, ETF, FOF, NAV, SEBI

AMFI= Association of Mutual Funds in India
ETF= Exchange Traded Funds
FoF= Fund of Funds
NAV= Net Asset Value
SEBI= Securities and Exchange Board of India

 Advantages/ disadvantages of Mutual funds.

Advantages
A. Variety of investment structure
B. Affordable and accessible
C. Ability to make regular and systematic investments
D. Wealth creation
E. Liquidity
F. Well-regulated and controlled
G. Expertise of Fund manager
H. Tax benefits and deferrals
Disadvantages
A. Lack of portfolio control and choice
B. Choice overload
C. Lack of cost control

 Various schemes of Mutual fund.

A. Organisation Structure: - open ended, close ended, interval
B. Portfolio Management strategy- Active or Passive
C. Investment objective- Growth, Income, Liquidity
D. Underlying Portfolio- Equity, Debt, Hybrid, Money market instruments, multi-
Asset
E. Sector specific funds
F. Thematic / solution oriented- Tax saving, Retirement benefit, child welfare,
Arbitrage
G. Exchange Traded Funds
H. Fund of Funds

 Types of Mutual schemes.

1. By Organisation Structure
a. Open ended schemes: - These are perpetual, and open for subscription and
repurchase on a continuous basis on all business days at the current NAV.
b. Close ended schemes: - The units are issued at the time of the initial offer and
redeemed only on maturity.
c. Interval schemes: - These allow purchase and redemption during specified
transaction periods (intervals). The transaction intervals has to be for minimum 2
days and there should be at least a 15 days gap between 2 intervals.
2. By Portfolio Management Strategy
Active Funds: the fund manager is “active” in deciding whether to Buy, Hold or Sell
securities
Passive Funds: the fund manager has a passive role in deciding to buy, hold or sell,
decision is driven by Benchmark Index.
3. By investment objective
Growth Fund: Growth funds are typically designed to provide capital appreciation
(equity)
Income Fund: The objective of Income fund is to provide regular and steady income
to investors (debt)
Liquidity: Liquid Schemes, overnight funds and money market mutual funds are for
liquidity and principal protection with commensurate returns (commercial papers,
treasury bills)
4. By Underlying Portfolio
Equity scheme primarily invest in equity instruments
Debt scheme invests in fixed income securities
Money Market/ liquid schemes are those that invest in short term money market
instruments.
Multi Asset scheme / Hybrid scheme these invest in more than one asset class and
combined equity, debt and money market instruments
5. By Sector
Funds invest in a particular sector of the economy such as infrastructure, banking,
technology, pharmaceuticals, or FMCG. They limit diversification thus riskier.
6. By Themes/ solution oriented
Funds are oriented towards specific solution:-Tax saving (ELSS), Retirement Benefits,
Child welfare
7. Exchange Traded funds (ETF)
An ETF is a marketable security that tracks an index, a commodity, bonds or basket
of assets. ETF are listed on stock exchanges.
Unlike regular MF, an ETF trades like a common stock on a stock exchange.
ETF Units are compulsorily held in DEMAT mode
ETFs are passively managed
8. Fund of Funds
FoF are mutual funds schemes invest in other mutual funds.

 Net Asset Value and its calculation (Formula)

Net Asset value refers to the value of each unit of the scheme
NAV= (Total Assets - Liabilities/expenses) / No. Of units outstanding
  Key participants of Mutual fund Industry.
Sponsor: - A sponsor is a person or an entity that sets up a mutual fund
Trustee: - The trustees of a mutual fund hold the property of the fund for the benefit
of the unitholder, they monitor its performance and compliance with SEBI
Regulations
Asset Management Company: - AMC manages the funds by making investments in
various types of securities. This must be approved by SEBI.
Custodian: - The custodian holds the securities of various schemes of the fund in its
custody. The custodian must be registered with SEBI
Subscribers: - The investors are called subscribers
Registrar and transfer Agents: - acts as mediator or agent between investors and
mutual fund houses
Fund Manager: - A fund manager is a person who oversees the activities of a mutual
fund. He is responsible for implementing a fund’s investment strategy and managing
its trading activities.
Fund Accountant: - A fund accountant is responsible for the day-to-day aspects of
accounting of mutual fund. They also prepare NAV, yields, distributions and other
fund accounting outputs for subsequent reviews.

 Six levels of Risk –o- meter.

Low
Low to Moderate
Moderate
Moderately High
High
Very High

 Sharpe Ratio and its calculation

Sharpe ratio is a very commonly used measure of risk adjusted returns.
An investor can invest with the government and earn a risk-free rate of return (R f). T-
Bill index is a good measure of this risk-free return.
Through investment in a scheme, a risk is taken and a return is earned (R s).
The difference between the two returns i.e., R s - Rf is called risk premium. It is like
premium that the investor has earned for the risk taken, as compared to
governments risk free return.
This risk premium is to be compared with the risk taken. Sharpe Ratio uses Standard
Deviation as a measure of risk.
Sharpe Ratio = (Rs-Rf)/Standard Deviation

 Treynor Ratio and its calculation

Treynor Ratio is a risk premium per unit of risk.
For Risk, Treynor Ratio uses Beta.
Treynor Ratio=(Rs-Rf)/Beta

 Alpha? What does a positive Alpha/Negative alpha indicate?

Non index schemes too would have a level of return, which is in line with its higher
or lower beta as compared to the market. Let us call this the optimal return.
The difference between a schemes actual return and its optimal return is its Alpha - a
measure of the fund managers performance. Alpha, therefore, measures the
performance of the investment in comparison to a suitable market index.
Positive alpha is indicative of out performance by a fund manager; negative alpha
might indicate under performance.

 Beta
Beta is based on the Capital Asset Pricing Model (CAPM), which states that there are
two kinds of risk in investing in equities- Systematic risk and non-systematic risk.
Systematic risk is integral to investing in the market; it cannot be avoided.
Non-systematic risk can be diversified away, investors need to be compensated only
for systematic risk, according to CAPM. This systematic risk is measured by its Beta
Beta measures the fluctuation in periodic returns in a scheme, as compared to
fluctuation in periodic returns of a diversified stock index (representing the market)
over the same period.
The diversified stock index, by definition, has a Beta of 1. Companies or schemes,
whose beta is more than 1, are seen as riskier than the market and vice versa.

 Steps involved in Financial Planning

i. Establish and define the client planner relationship
ii. Gather client data, including goals
iii. Analyse and evaluate financial status
iv. Develop and present financial planning recommendations
v. Implement the financial planning recommendations
vi. Monitor the financial planning recommendations

Practical Questions

1. Mr. Ravi earns monthly Rs.20,000 & his wife earns Rs. 18,000. He owns two
houses. He & his family stays in one house & the other house has rented for Rs.
8000/ month. He has a home loan & its Monthly EMI Costs Rs.10000. His other
monthly expenses are: School fees of his only child (Instalment) Rs. 5000,
Insurance premium: Rs. 500, Food & groceries: Rs. 6000, Transportation: Rs.
3000, Mobile & Internet recharge Rs. 1000/-, Water Bill Rs. 100/-. other
miscellaneous expenses: Rs. 5000/-. Can you help Mr. Ravi to calculate his Net
savings? (Answer: 15400)

2. Imagine you have an Income of Rs. 25,000/-. Your monthly family & other
personal commitments costs to Rs. 15,000/-. Can you draft a imaginary
allocation of your savings keeping in mind the concept of liquidity, safety &
profitability
Ans: Savings = Income - Expenditure
=25000- 15000 = 10000 per month
A. Retirement fund: A good thumb rule is to contribute 10% of income towards
retirement. I would invest Rs. 2500 per month in a diversified equity mutual fund.
Over a long term, equity investments have potential to deliver optimum returns.
B. Emergency Fund: The size of the emergency fund be at least 12 months of one’s
living expenses. So, 15000x12=180000 should be the size of the fund. I will be
investing Rs.5000 per month for 3 years in a debt mutual fund to establish an
emergency fund of 180000.
C. Insurance - Health & Life
Every person should have a health cover of reasonable sum insured. For my age
premium shall be around Rs.5000 to Rs. 7000 per annum.
My family is dependent on me so I need a life cover too, Term life insurance can
provide a large cover for a reasonable premium. Life cover of Rs.50 lakhs will
approximately cost Rs.5000 per annum.
D. General Investment Fund: Remaining 1500 per month can be invested in a hybrid
mutual fund for all planned expenditures like higher education, down payment of
house/ vehicle, marriage, etc.

3. From the following Compute NAV of a Mutual Fund Unit Total Assets of the Fund
– Rs. 54,50,000, Liabilities – Rs. 4,85,000 & Total units - 325000. (Answer=15.28)

4. Calculate the NAV per unit from the following information:

Mutual fund scheme = Rs. 20,00,000
Face value of Units = Rs. 10
Number of outstanding units = 2,00,000
Market value of fund’s investment = Rs. 28,00,000
Bills Receivable = Rs. 40,000
Liabilities = Rs. 20,000
(Answer: 14.1)