M2 -MUTUAL FUNDS

Mutual funds play very vital role in the growth of capital and economic development of any
country. In the modern world, capital move from one country to another country with
more attractions.

Meaning and Definition

A Mutual Fund is a Trust constituted for pooling the savings of large number of investors,
who share a common financial goal. These are organizations which absorb the risks
associated with the investment in capital market and offer higher return on
investment.
It is a mechanism by which, the savings of large number of small investors are pooled
and collective investment is made with the objective of high returns and capital
appreciation.
SEBI regulations define mutual fund as “a fund established in the form of a trust by a
sponsor, to raise money by the trustees through the sale of units to the public under one or
more schemes for investing in securities or gold related instruments and real estates in
accordance with the regulations.”

Characteristics of Mutual Funds

 Formation of a trust: A mutual fund is a trust constituted for raising money through
the sale of its units to the public under one scheme or the other for investing it in
securities.
 Issue of units: Mutual funds raise the required amount of trust fund by issue of units
of the mutual funds. Separate funds are raised through issue of distinguished units
under each scheme.
 Investment Opportunity: The basic characteristic of a mutual fund is that it provides
an ideal opportunity for investments. It also enables the investors to earn reasonably
high return.
 Professional Management: Mutual funds are managed by professionals having
knowledge, skill and expertise, through the asset management company.
 Reduced risk: The risk of mutual fund is minimum. This is because of expertise
management, diversification, liquidity, etc. The investment risk is also shared by the
members.
 Investment protection: Mutual funds are regulated by guidelines and legislative
provisions put in place by regulatory agencies such as SEBI. In order to protect the
investor interest the mutual funds have to follow the provisions laid down by the
regulators.
Classification of Mutual Funds Schemes

Classification on the basis of functions

 Open-ended Fund

An Open-ended Scheme is a mutual fund scheme in which the investors are able to
invest their money at any time during the year, as it is open for subscription
throughout the year. These schemes do not have a fixed maturity period during which
an investor can enter or walk out of the scheme at any time.
The scheme mostly preferred by investors as it provides easy liquidity. Usually, open
ended mutual fund units are not listed in stock exchanges and can be bought and sold
only through the mutual fund.
 Closed ended fund
A closed ended scheme is a mutual fund scheme in which the investors are able to
invest their money only during a specified period and its duration is prefixed and the
fund is closed on the expiry of the period. Once the subscription reaches the
predetermined level, the entry of investors is closed.
After the expiry of the specific period the entire corpus is disinvested and the proceeds
are distributed to the various holders in proportion to their holdings.
Classification on the basis of Portfolio

 Growth / Equity Oriented Scheme

A growth scheme is a mutual fund scheme which is intended for investors who are
interested in capital appreciation rather than on regular income. Therefore, a major
portion of the funds are invested in equities and convertible debentures. Such funds have
comparatively higher risk.

 Income / Debt Oriented Scheme

An income scheme is a mutual fund scheme that provides regular and steady income to
investors by way of dividend. The returns may be cumulative or non cumulative in
character. It is paid on monthly, quarterly, half-yearly or yearly basis. As the flow of
returns is steady and regular, the funds are invested in fixed income bearing securities
like Debenture, Bonds Government Promissory Note etc.
Such funds are less risky compared to equity schemes. The scheme is preferred by
conservative investors and retired employees.
 Special funds
The Special Funds are those kinds of mutual funds that can neither be categorized as
equity funds nor as the debt funds. These funds are unique and work well for those
investors who have specific financial objectives.
Specialized funds focus on very specific industries, including commodities, regions, or
other segments of the market. Using these funds, investors can gain access to banking,
real estate, chemicals, energy or telecommunications.

Classification on the basis of ownership

 Public sector funds
These funds are sponsored by the companies of the public sector, Such as, SBI
Mutual Fund, LIC Mutual Fund, Canbank Mutual Fund, etc.

 Private sector funds

These funds are sponsored by the companies of the private sector.
 Some of the well known private mutual funds are ICICI Mutual Fund, HDFC Mutual
Fund, DSP Merrill Lynch Mutual Fund, Reliance Mutual Fund, etc.
 Foreign funds
An international fund is a mutual fund that can invest in companies located anywhere in
the world outside of its investors' country of residence.
Examples are:
ICICI Prudential US Bluechip Equity Fund.
Edelweiss US Technology Equity Fund of Fund.

Miscellaneous Schemes

 Mid-Cap Funds
A mid-cap fund is a scheme which invests in equity shares of mid-size companies
which grow faster than large companies.
 Index Funds
Index funds are specifically designed funds whose expense ratio is less and is
normally invested based on NIFTY or on SENSEX basis,considering the top listed
Companies.
 Equity Linked Savings Schemes (ELSS)
This scheme invests in equity or equity related instruments for long-term capital
appreciation, with a minimum 3 years lock in period. It also enjoys tax benefit.
 Corporate Bond Funds
Corporate bond funds invest in bonds issued by companies to earn high income.
 Gilt Schemes / Funds
A gilt fund is one in which investment is made only in securities issued by the
government and government sector.
 Hybrid Fund
A Hybrid fund is an investment fund that is characterised by diversification among two or
more asset classes. These funds typically invest in a mix of stock and bonds
 Money Market Mutual Fund (MMMF)
 The Money Market Mutual Fund is a scheme in which investment is made in short-term
liquid instruments like Treasury bills and Commercial Papers. It provides safety and
liquidity to short term investment.

Exchange Traded Fund (ETF)

An Exchange Traded Funds is a marketable security of a mutual fund that tracks an index, a
commodity*, bond, or a basket of asset** like an index fund.
In simple terms, ETFs are funds that track indexes such as Nifty or BSE Sensex. They
provide to the investors funds that closely tracks the performance of an index with the ability to
buy/sell on an intra-day(throughout the day) basis.

Notes
*Commodity-A commodity market involves buying, selling, or trading a raw product,
such as oil, gold, or coffee
** basket of asset-Basket, in the financial context, refers to several securities bundled
together that can be bought or sold together for investment purposes or returns.
Features of ETFs

Index Funds : Exchange Traded Funds are essentially Index Funds that are listed and traded on
stock exchanges.
Traded in Stock exchange : An ETF trades like a common stock on a stock exchange. It can be
bought and sold on the stock exchanges, at prices that are usually close to the actual intra-day
NAV of the scheme.
Highly Flexible : The ETFs are highly flexible. They experience price changes throughout the
day as they are bought and sold. ETF can be used as a tool for gaining instant exposure to equity
markets.
Wider range of investment opportunities: Globally, ETFs have opened investment
opportunities to retail as well as institutional money managers. It is a pool or basket of
investment. ETFs are traded throughout the trading day like stocks.
Wider geographical area: They enable investors to gain broad exposure to entire stock markets
in different countries and specific sectors with relative ease, on a real – time basis and at a lower
cost than many other forms of investing.

Basket of Stocks: An ETF is a basket of stocks that reflects the composition of an Index, like
Nifty, BSE Sensex, S & P,

Transacted at real time price: Since it is traded on an exchange, people can buy it at real time
price and its NAV is not calculated at the end of the day like other mutual funds.

Advantages / Merits of Mutual Fund Investments

 Investment Avenue for Small Investors: Small Investors, who do not want to take the risks
associated with the stock market can invest their small savings in mutual funds.
 Simplicity: Investing in mutual funds is much easier and simpler. The investors need not
have any idea about the value of shares of companies in which the investment is done by
mutual fund.
 Diversification of Risks: As the money accepted from the investors are invested by the
mutual funds in diversified portfolios, the risks are also diversified.
 Professional Management of Funds: The amount pooled from the investors are to be
invested in diversified portfolios. In order to ensure safety, liquidity and profitability of
investments, the funds are managed by technically competent persons.
 Liquidity: As the securities are traded in the secondary market, the investors can convert
their investments into liquid cash at any time.
 Higher Returns: The investments in mutual funds yield higher returns because of the capital
appreciation in the value of shares.

Demerits of the Mutual Fund Investments

 High cost: Mutual funds have a high cost associated with them in relation to the returns they
produce. This is because the investors are not only charged for the price of the fund but also
for other charges.
 Return are not guaranteed: Unlike returns on bank deposits, no rate of return is guaranteed
on investments in mutual funds.
 Unsecured Investment: The investment in mutual funds are not secured by any asset of the
mutual fund company.
 Connection is impersonal: When investing in mutual funds, the investors do not usually
have any access to the person who makes the investing decision.
 No insurance coverage: Though, mutual funds are regulated by the government, they are
not insured against losses. It is possible that one can lose even his entire investment in a
scheme in a mutual fund.
 Poor performance: Returns on mutual funds are not guaranteed. On an average, around 75
percentage or all mutual funds fail to reach to the level of stock market indices.
 Loss of control: The managers of mutual funds make all decisions relating to the buying and
selling of securities. The investor has no control over it.
 Trading limitations: Although mutual funds are considered as highly liquid, most of the
mutual funds (open ended funds) cannot be traded in the middle of the trading day.

 Inefficiency of cash reserves: Mutual funds have to maintain large amount of cash reserves
to meet large number of simultaneous withdrawals by unit holders. This leads to maintenance
of idle money which do not yield any return.

Constitution and Management of Mutual Funds in India

Mutual fund is a major vehicle for the mobilization of savings, particle from the small and
household sectors for investment in stock market. The formal management of mutual fund is
well regulated by SEBI, RBI and the Central Government in order to provide investor protection.
In India the establishment of mutual fund is on three tier basis.
 A sponsor institution to promote the fund.
 A team of trustees to oversee the operations of the fund
 The Asset Management Company (AMC) to deal with the funds.

Sponsor

Sponsor is the company which sets up the mutual fund. The fund sponsor will form the trust
and appoints the Board of Trustees. The sponsors of a mutual fund should possess the
following eligibility requirements.
 A sponsor could be a registered company, scheduled bank or state level financial
institution.
 It should have 5 years track record as to net worth, dividend payment, profitability,
financial soundness, etc.
 The sponsors should have at least 40% share in the paid up capital of the Asset
Management Company.
The role of sponsors of mutual fund is to contribute in the paid up capital of Asset
Management Company and to take part in the administration of the funds by participation in
Board of Trustees.

Trustees
Trustees are people with long experience and good integrity in their respective fields who
carry on the responsibility of safeguarding the interest of investors in mutual funds. They
monitor the operations of the different schemes. With the approval of SEBI, they are
empowered to dismiss the Asset Management Companies.
Asset Management Company

The Asset Management Company invites the prospective investors to join the fund by
offering various schemes. The resources of individual investors are pooled together and the
investors are issued units or shares for the money invested. The amount so collected is invested
in capital market instruments like shares and debentures and money market instruments like
treasury bills, commercial paper etc.
The Asset management companies should execute the following functions.
1. Act as an investment advisor and administrator of the fund.
2. Select the portfolio investments in accordance with the objectives and policies of the scheme
or fund
3. Execute the transactions at the best possible price and cost.
4. Exercise the services within the ambit of the objectives of the fund. (do not act detrimental to
the interest of the fund)
5. Render administrative services like maintenance of office, circulation of fund related
information, periodical reports etc.

Association of Mutual Funds in India (AMFI)

The Association of Mutual Funds in India (AMFI) is a statutory body under the Government of
India, regulated by SEBI for developing the Mutual Fund Industry in India on professional,
healthy and ethical lines. It aims at enhancing and maintaining standards in all areas with a view
to protecting and promoting the interests of mutual funds and their unit holders. It is non-profit
organization in which all the Asset Management Companies are its members.

AMFI came into existence in 1995 to set ethical and transparent regulations in the area of Indian
mutual fund. Every mutual fund house is to be associated with it and should follow the
regulations and guidance issued by AMFI.
Objectives of AMFI
 Setting up standards: AMFI outlines supreme and uniform professional standards in every
mutual fund operation.
 Practice ethical business: AMFI encourages its members and investors to maintain ethical
business practices and regulations.
 Represent government bodies: AMFI represents the Finance Ministry, RBI and SEBI on
everything related to the industry.
 Providing awareness: AMFI provides awareness across the country on safe mutual fund
investments.
 Dissemination of information: AMFI disseminates information on Mutual Fund Sector and
conducts research and workshops on mutual funds.
 Maintaining and checking code of conduct: It keeps a check on Code of Conduct of
everyone associated with mutual funds and takes disciplinary action in case of violation of
rule.

AMFI Registration Number (ARN)

AMFI Registration Number (ARN) is a unique number assigned to mutual fund agents,
distributors and brokers who clear National Institute of Securities Market (NISM) Certification
and those who pass the Continuing Professional Education (CPE).Without this number, one
cannot invest in regular mutual funds.

Concept of Net Asset Value

Net asset value (NAV) represents the per unit market value of a fund. This is the price at which
investors buy fund units from a fund company or sell it back to the fund house. It is calculated by
dividing the net value of assets by its number of units. Net value means total value of all assets
minus all liabilities. The NAV of a fund is calculated by the mutual fund house itself or by an
accounting firm hired by the mutual fund.

NAV is calculated at the end of every market day, after taking into account the closing market
prices of the securities that the fund or scheme holds.