Unit 3 MUTUAL FUNDS AND BANKING INNOVATION

MUTUAL FUND
A mutual fund pools money from many investors and invests in stocks, bonds, short-term money-market
instruments, other securities or assets, or some combination of these investments. The combined holdings
the mutual fund owns are known as its portfolio. Each unit represents an investor's proportionate
ownership of the fund's holdings and the income those holdings generate.
FEATURES OF MUTUAL FUNDS
1. Liquidity
You can easily redeem the units of your mutual funds to meet any kind of financial emergency.
Based on the type of scheme, the redemption amount is usually credited to your bank account
within 3-4 business days from the date of redemption. In the case of liquid funds, the amount is
credited on the next business day.
2. Professional Management
Mutual funds are managed by professional fund managers who closely watch the markets and
make constant investment decisions based on the fund's stated objective. Therefore, you don't
have to worry about researching and individual stock picking once you invest in mutual funds.
3. Portfolio Diversification
One of the key features of investing in mutual funds is that you get a diversified portfolio
containing different types of equities and other options. Based on the scheme's objective, a
mutual fund can have proportionate exposure to various financial instruments like equities, debts,
or other asset classes such as gold, real estate, etc. Therefore, the risk is spread out over different
asset classes. So, even if one asset class performs poorly in adverse market conditions, the other
classes can still aim to balance your investment portfolio balance.
4. Income Tax Benefits
Both equity and debt funds carry their own unique tax benefits. For instance, while debt fund
investors benefit from indexation on long-term capital gains, equity funds allow you to earn
exempted returns up to Rs. 100,000 in a financial year as long as you stay invested for 12 months
or more.
Apart from this, there are ELSS (Equity Linked Savings Scheme) funds, which allow you to
invest up to Rs 1,50,000 in a year and deduce the same from your taxable income.
5. Investment Flexibility
One of the key features of mutual funds is the flexibility they offer. You can either invest a large
lump sum amount in the beginning or regularly invest small amounts (as low as Rs 500 per
month) in the form of a SIP (Systematic Investment Plan).
6. Low Cost
Mutual funds charge a small amount known as the expense ratio from investors. The expense
ratio is charged to cover operating expenses such as management, administration, etc., and other
charges.
7. Properly Regulated
The Securities and Exchange Board of India (SEBI) regulates the mutual fund market. Mutual
funds have to strictly comply with SEBI (Mutual Funds) Regulations, 1996, to ensure
transparency and protection of investors' wealth.
8. Ease of Purchasing
While you can invest easily through offline modes, online buying and selling of mutual funds has
made the lives of investors much easier. You don't need to visit a mutual fund house's office. Just
 visit the official website of the asset management company. Compare various mutual fund
products offered by the fund house and invest online. The entire process is easy. convenient, and
fast.
TYPES OF MUTUAL FUND PLANS
Mutual funds are gaining popularity among Indian investors. The reason is that these investment avenues
provide a range of benefits to investors. Such benefits include a diversified portfolio, expert portfolio
management, flexibility in investments through SIPs, and lump sum among others.
The mutual fund industry in India is regulated by the Securities and Exchange Board of India (SEBI).
Although SEBI has categorized mutual funds based on where they invest, there are other ways mutual
funds can be classified. The different types of mutual funds in India are:
1. Types of mutual funds based on their Structure
a. Open-ended mutual funds schemes
In open-ended mutual fund schemes, you can invest and redeem your Investments whenever you want.
There is no maturity tenure or a specific time for investment into the scheme. Open-ended mutual funds
are, therefore, liquid in nature.
b. Close-ended mutual fund schemes
Close-ended mutual fund schemes have a stipulated investment period and a specified maturity period.
c. Interval Mutual Funds Schemes Interval Mutual Funds allow you to invest or redeem from them at
intervals.
2. Types of mutual funds based on Asset Classes
Equity Funds:

Equity funds invest in equity (stocks) and related instruments. They carry the highest returns potential but
also come with the highest level of risk. Equity funds are recommended for investors with at least 3-5
years of investment duration. Equity funds can be of various types. They can be further classified based
on their market capitalisation.

Debt Funds:

Debt funds invest your money in debt instruments, such as government bonds, company debentures, and
other securities delivering fixed income. They are one of the safest types of mutual funds and can be
regarded as short-term and long-term investments. Just as equity funds, debt funds can be of various types
based on the maturity period of the debt and money market instruments.

Type of Debt Fund Maturity of Its Investments

Ultra-short Duration Funds 3-6 Months

Short Duration Funds 1-3 Years

Medium-duration Funds 3-4 Years

Medium-to-Long Duration Funds 4-7 years

Long-duration Debt Funds More than 7 year

Balance/Hybrid Funds: They are funds that invest in two or more asset classes as per the investment
objective and other factors. Hybrid funds further include:
Equity-oriented Hybrid Funds: When a fund invests 65% or more in equity and equity-related
instruments and the rest in debt, it is considered an equity-oriented fund. For taxation purposes, such
funds are considered equity funds.
Debt-oriented Fund:When 60% or more is invested in debt, it is a debt-oriented hybrid fund. For
taxation purposes, such funds are considered debt funds.
Arbitrage Fund:These are funds that invest majorly in the futures and options to generate returns. Since
they always have an equity exposure of more than 65%, they are considered as equity funds for taxation
purposes.
Type of Mutual Fund based on Investment Objectives
There are two options of mutual funds which you can choose, namely:
a. Growth Option: If you choose the Growth Option of any mutual fund scheme, the profits made by the
scheme would be invested back into the scheme for which the NAV (net asset value) or the price of each
mutual fund unit goes up. Similarly, if there is a loss, the NAV goes down. Thus, in order to get any profit
from the growth option of any mutual fund scheme, you would need to redeem the units.
b. Dividend Option: If you choose the Dividend Option of any mutual fund scheme, the profits made by
the scheme would be distributed to the investors at regular intervals (monthly, quarterly, or annually). The
profit is deducted from the NAV (net asset value), from the price of each mutual fund unit.
4. Type of Mutual Fund based on Portfolio Management
Mutual Funds can be categorized based on how the portfolio is managed. The two types are active and
passive mutual fund schemes.
a. Active Mutual Funds or actively managed mutual funds are those wherein the fund manager
continuously keeps looking for ways to generate better returns. The fund manager sells and buys stocks
whenever he sees an opportunity.
b. Passive Mutual Funds or passively managed funds are those wherein the fund manager does not
actively manage the portfolio. The portfolio reflects a specific Index, l.e., the money is allocated in the
exact same way as It is done in the underlying index. Any change in the portfolio is done only if there is a
change in the index composition.
NET ASSET VALUE (NAV)
 NAV stands for 'Net Asset Value.' NAV represents the price at which a mutual fund may be
bought by an investor or sold back to a fund house.
  A mutual fund's NAV is an indicator of its market value. Therefore, NAV can be viewed to assess
the current performance of a mutual fund.
 By determining the percentage increase or decrease in the NAV of a mutual fund, an investor can
calculate the increase or decrease in its value over time.
 A mutual fund's NAV is usually calculated by a fund accounting firm hired by the mutual fund or
the mutual fund house itself.
 It is mandatory, as per SEBI guidelines, that all mutual funds publicly display their NAV by
updating it on the AMC (Asset Management Company) & AMFI (Association of Mutual fund in
India) website on every business day.
Calculation of NAV
Net Asset Value = [Total Asset Value –Laibility ] / Number of Outstanding units
NAV = Market Price of Securities + Other Assets - Total Liabilities / Units Outstanding as at the NAV
date
Outstanding shares- Refers to a company’s stock currently held by all its shareholders.
EXAMPLE:
Let’s assume at the close of tradig yesterday that a particular mutual fund held Rs 1,05,00,000 worth of
securities, Rs 20,00,000 cash and Rs 5,00,000 liabilities. If the fund had 10,00,000 shares oustanding,
then yesterday’s NAV would be:
NAV = (Rs 1,0500,000 +Rs 20,00,000 – Rs 500,000) / 10,00,000 = Rs 12.00
CRITERIA FOR SELECTION OF MUTUAL FUNDS
(FACTORS FOR SELECTING A MUTUAL FUND CATEGORY)
Mutual funds are a preferred choice among investors today owing to their attractive returns and
diversified portfolio. However, as an investor one must remember that no single scheme or set of schemes
is suitable for everyone. A suitable mutual fund scheme for an investor is the one which suits his/her
investment objective and risk appetite among other factors.
Selecting a mutual fund is a 2-step process: Selection of the mutual fund category and selection of a
scheme in that category.
The following are the factors which an investor should consider while selecting a mutual fund scheme:
1) Investment Objective:
Investment objective refers to an investor's financial goal which he/she aims to accomplish with
the mutual fund investment. The investment objective can be any short-term or longterm financial
aspiration of the investor - buying a house/car, financing children's higher education, going on a
vacation, retirement, etc.
2) Time Horizon:
Time horizon refers to the time period for which an investor wishes to keep his/her money
invested in a mutual fund scheme. It can be either as short as 1 day or as long as more than 5
years. Different fund categories work best for different time horizons. This is because some funds
invest in shorter dated debt and others invest in longer dated debt. Equity funds should ideally be
chosen if the investment horizon is more than 5 years.
3) Risk tolerance:
Risk tolerance refers to the amount of risk an investor is willing to take with his/her invested
money. SEBI in 2015 made it mandatory for all mutual fund houses to display a riskometer which
consists of 5 levels of risk associated with the invested principal amount.
The 5 risk levels are
1. Low,
2. Moderately low,
3. Moderate,
4. Moderately high,
5. High.