1. Introduction of Mutual
Fund
-Arun Singh
(M.Sc Financial Mathematics)
(M.S.University, Faculty of Technology and
Engineering)
2. What is Mutual Fund?
A mutual fund is nothing more than a collection of stocks and/or bonds. You can
think of a mutual fund as a company that brings together a group of people
/corporate investor and invests their money in stocks, bonds, and other securities.
Each investor owns shares, which represent a portion of the holdings of the fund.
Mutual funds are considered as one of the best available investments as compare to
others they are very cost efficient and also easy to invest in, thus by pooling money
together in a mutual fund, investors can purchase stocks or bonds with much lower
trading costs than if they tried to do it on their own. But the biggest advantage to
mutual funds is diversification, by minimizing risk & maximizing returns.
How many types of Mutual Fund?
No matter what type of investor you are, there is bound to be a mutual fund that fits
your style. According to the last count there are more than 10,000 mutual funds in
North America! That means there are more mutual funds than stocks.
It's important to understand that each mutual fund has different risks and rewards.
In general, the higher the potential return, the higher the risk of loss. Although some
funds are less risky than others, all funds have some level of risk - it's never possible
to diversify away all risk. This is a fact for all investments.
Each fund has a predetermined investment objective that tailors the fund's assets,
regions of investments and investment strategies. At the fundamental level, there
are three varieties of mutual funds:
1) Equity funds (stocks)
2) Debt funds (bonds)
3) Balance funds (stocks & bonds)
3. (1) Equity fund:
These funds invest a maximum part of their corpus into equities holdings. The structure of
the fund may vary different for different schemes and the fund manager’s outlook on
different stocks. The Equity Funds are sub-classified depending upon their investment
objective, as follows:
Diversified Equity Funds
Mid-Cap Funds
Sector Specific Funds
Tax Savings Funds (ELSS)
Equity investments are meant for a longer time horizon, thus Equity funds rank high on the
risk-return matrix.
(2) Debt funds:
The objective of these Funds is to invest in debt papers. Government authorities,
private companies, banks and financial institutions are some of the major issuers of
debt papers. By investing in debt instruments, these funds ensure low risk and provide
stable income to the investors. Debt funds are further classified as:
Gilt Funds: Invest their corpus in securities issued by Government, popularly
known as Government of India debt papers. These Funds carry zero Default risk
but are associated with Interest Rate risk. These schemes are safer as they invest
in papers backed by Government.
Income Funds: Invest a major portion into various debt instruments such as
bonds, corporate debentures and Government securities.
MIPs: Invests maximum of their total corpus in debt instruments while they take
minimum exposure in equities. It gets benefit of both equity and debt market.
These scheme ranks slightly high on the risk-return matrix when compared with
other debt schemes.
Short Term Plans (STPs): Meant for investment horizon for three to six
months. These funds primarily invest in short term papers like Certificate of
Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also
4. invested in corporate debentures.
Liquid Funds: Also known as Money Market Schemes, These funds provides
easy liquidity and preservation of capital. These schemes invest in short-term
instruments like Treasury Bills, inter-bank call money market, CPs and CDs.
These funds are meant for short-term cash management of corporate houses
and are meant for an investment horizon of 1day to 3 months. These schemes
rank low on risk-return matrix and are considered to be the safest amongst all
categories of mutual funds.
(3) Balanced funds:
As the name suggest they, are a mix of both equity and debt funds. They invest in
both equities and fixed income securities, which are in line with pre-defined
investment objective of the scheme. These schemes aim to provide investors with
the best of both the worlds. Equity part provides growth and the debt part provides
stability in returns.
How can you make money through Mutual Fund? (Types of
Return)
You can make money from a mutual fund in three ways:-
1) Income is earned from dividends on stocks and interest on bonds. A fund pays out
nearly all of the income it receives over the year to fund owners in the form of a
distribution.
2) If the fund sells securities that have increased in price, the fund has a capital gain.
Most funds also pass on these gains to investors in a distribution.
3) If fund holdings increase in price but are not sold by the fund manager, the fund's
shares increase in price. You can then sell your mutual fund shares for a profit.
5. The risk return trade-off indicates that if investor is willing to take higher risk then
correspondingly he can expect higher returns and vise versa if he pertains to lower risk
instruments, which would be satisfied by lower returns. For example, if an investors opt
for bank FD, which provide moderate return with minimal risk. But as he moves ahead to
invest in capital protected funds and the profit-bonds that give out more return which is
slightly higher as compared to the bank deposits but the risk involved also increases in the
same proportion.
Thus investors choose mutual funds as their primary means of investing, as Mutual funds
provide professional management, diversification, convenience and liquidity. That doesn’t
mean mutual fund investments risk free. This is because the money that is pooled in are not
invested only in debts funds which are less riskier but are also invested in the stock
markets which involves a higher risk but can expect higher returns. Hedge fund involves a
very high risk since it is mostly traded in the derivatives market which is considered very
volatile.
Some Important Information:-
6. Which was the First Mutual Fund to be set up in India?
The first introduction of a mutual fund in India occurred in 1963, when the Government
of India launched Unit Trust of India (UTI). Until 1987, UTI enjoyed a monopoly in the
Indian mutual fund market. Then a host of other government-controlled Indian financial
companies came up with their own funds. These included State Bank of India, Canara Bank,
and Punjab National Bank. This market was made open to private players in 1993, as a
result of the historic constitutional amendments brought forward by the then Congress-led
government under the existing regime of Liberalization, Privatization
and Globalization (LPG). The first private sector fund to operate in India was Kothari
Pioneer, which later merged with Franklin Templeton.
Who is the Regulatory Body for Mutual Funds?
Securities Exchange Board of India (SEBI) is the regulatory body for all the mutual funds
mentioned above. All the mutual funds must get registered with SEBI. The only exception is
the UTI, since it is a corporation formed under a separate Act of Parliament.
How do mutual funds diversify their risks?
According to basis financial theory, which states that an investor can reduce his total risk
by holding a portfolio of assets instead of only one asset. This is because by holding all your
money in just one asset, the entire fortunes of your portfolio depend on this one asset. By
creating a portfolio of a variety of assets, this risk is substantially reduced.
Can mutual funds assumed to be risk-free investments?
No. Mutual fund investments are not totally risk free. In fact, investing in mutual funds
contains the same risk as investing in the markets, the only difference being that due to
professional management of funds the controllable risks are substantially reduced.
Disadvantages of Investing Mutual Funds:-
1. Professional Management- Some funds doesn’t perform in neither the market, as
their management is not dynamic enough to explore the available opportunity in the
market, thus many investors debate over whether or not the so-called professionals are
any better than mutual fund or investor him self, for picking up stocks.
7. 2. Costs – The biggest source of AMC income, is generally from the entry & exit load
which they charge from an investors, at the time of purchase. The mutual fund
industries are thus charging extra cost under layers of jargon.
3. Dilution - Because funds have small holdings across different companies, high
returns from a few investments often don't make much difference on the overall return.
Dilution is also the result of a successful fund getting too big. When money pours into
funds that have had strong success, the manager often has trouble finding a good
investment for all the new money.
4. Taxes - when making decisions about your money, fund managers don't consider
your personal tax situation. For example, when a fund manager sells a security, a
capital-gain tax is triggered, which affects how profitable the individual is from the sale.
It might have been more advantageous for the individual to defer the capital gains
liability.
What to Know Before You Shop:-
The performance of a particular scheme of a mutual fund is denoted by Net Asset
Value (NAV).
Mutual funds invest the money collected from the investors in securities markets. In
simple words, Net Asset Value is the market value of the securities held by the
scheme. Since market value of securities changes every day, NAV of a scheme also
varies on day to day basis. The NAV per unit is the market value of securities of a
scheme divided by the total number of units of the scheme on any particular date.
For example, if the market value of securities of a mutual fund scheme is Rs 200
lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors,
then the NAV per unit of the fund is Rs.20. NAV is required to be disclosed by the
mutual funds on a regular basis - daily or weekly - depending on the type of scheme.
The major fund houses which are operating in India today include:
There are 43 Mutual Funds company operating.
Fortis, Birla Sunlife, Bank of Baroda, HDFC, ING Vysya, ICICI Prudential, SBI Mutual
Fund, Tata, Kotak Mahindra, Unit Trust of India, Reliance, IDFC, Franklin Templeton,
Sundaram Mutual Fund, Religare Mutual Fund, Motilal Oswal , LIC, L&T, Principal
Mutual Fund etc.
8. Mutual funds are an under tapped market in India:
Despite being available in the market for over two decades now with assets under
management less than 10% of Indian households have invested in mutual funds. A
recent report on Mutual Fund Investments in India published by research and
analytics firm, Boston Analytics, suggests investors are holding back from putting
their money into mutual funds due to their perceived high risk and a lack of
information on how mutual funds work.
The primary reason for not investing appears to be correlated with city size. Among
respondents with a high savings rate, close to 40% of those who live in metros and
Tier I cities considered such investments to be very risky, whereas 33% of those in
Tier II cities said they did not how or where to invest in such assets.
On the other hand, among those who invested, close to nine out of
ten respondents did so because they felt these assets were more professionally
managed than other asset classes.
9. For Example:-
Reliance Diversified Power Sector Fund - Retail Plan (G)
56.522
0.88 (1.54%)
NAV as on Mar-19-2012
Most Important Thing:-
“Mutual Fund Investments are subject to market risks.
Please read the Statement of Additional Information
(SAI) and Scheme Information Document (SID) carefully
before investing. “