What is a Mutual Fund?
The following are some of the more popular definitions of a Mutual Fund
A Mutual Fund is an investment tool that allows small investors access to a well-diversified portfolio of equities, bonds and other securities. Each shareholder participates in the gain or loss of the fund. Units are issued and can be redeemed as needed. The fund’s Net Asset Value (NAV) is determined each day.
Mutual Funds are financial intermediaries. They are companies set up to receive your money, and then having received it, make investments with the money Via an AMC. It is an ideal tool for people who want to invest but don’t want to be bothered with deciphering the numbers and deciding whether the stock is a good buy or not. A mutual fund manager proceeds to buy a number of stocks from various markets and industries. Depending on the amount you invest, you own part of the overall fund.
The beauty of mutual funds is that anyone with an investible surplus of a few hundred rupees can invest and reap returns as high as those provided by the equity markets or have a steady and comparatively secure investment as offered by debt instruments.
What are the benefits of investing in a Mutual Fund?
There are several benefits from investing in a Mutual Fund.
• Small investments : Mutual funds help you to reap the benefit of returns by a portfolio spread across a wide spectrum of companies with small investments. Such a spread would not have been possible without their assistance.
• Professional Fund Management : Professionals having considerable expertise, experience and resources manage the pool of money collected by a mutual fund. They thoroughly analyse the markets and economy to pick good investment opportunities.
• Spreading Risk : An investor with a limited amount of fund might be able to to invest in only one or two stocks / bonds, thus increasing his or her risk. However, a mutual fund will spread its risk by investing a number of sound stocks or bonds. A fund normally invests in companies across a wide range of industries, so the risk is diversified at the same time taking advantage of the position it holds. Also in cases of liquidity crisis where stocks are sold at a distress, mutual funds have the advantage of the redemption option at the NAVs.
• Transparency and interactivity : Mutual Funds regularly provide investors with information on the value of their investments. Mutual Funds also provide complete portfolio disclosure of the investments made by various schemes and also the proportion invested in each asset type. Mutual Funds clearly layout their investment strategy to the investor.
• Liquidity : Closed ended funds have their units listed at the stock exchange, thus they can be bought and sold at their market value. Over and above this the units can be directly redeemed to the Mutual Fund as and when they announce the repurchase.
• Choice : The large amount of Mutual Funds offer the investor a wide variety to choose from. An investor can pick up a scheme depending upon his risk / return profile.
• Regulations : All the mutual funds are registered with SEBI and they function within the provisions of strict regulation designed to protect the interests of the investor.
A Mutual Fund is not an alternative investment option to stocks and bond; rather it pools the money of several investors and invests this in stocks, bonds, money market instruments and other types of securities.
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities.
The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
CONCEPT
What does a Mutual Fund do with investor’s money?
Anybody with an investible surplus of as little as a few hundred rupees can invest in mutual funds. The investors buy units of a fund that best suits their investment objectives and future needs.
A Mutual Fund invests the pool of money collected from the investors in a range of securities comprising equities, debt, money market instruments etc. after charging for the AMC fees. The income earned and the capital appreciation realised by the scheme, are shared by the investors in same proportion as the number of units owned by them.
How are Mutual Funds different from portfolio management schemes?
In case of mutual funds, the investments of different investors are pooled to form a common investible corpus and gain/loss to all investors during a given period are same for all investors while in case of portfolio management scheme, the investments of a particular investor remains identifiable to him. Here the gain or loss of all the investors will be different from each other.
How is investment in a Mutual Fund Different from a Bank Deposit?
When you deposit money with the bank, the bank promises to pay you a certain rate of interest for the period you specify. On the date of maturity, the bank is supposed to return the principal amount and interest to you. Whereas, in a mutual fund, the money you invest, is in turn invested by the manager, on your behalf, as per the investment strategy specified for the scheme.
The profit, if any, less expenses of the manager, is reflected in the NAV or distributed as income. Likewise, loss, if any, with the expenses, is to be borne by you.
What are the types of returns one can expect from a Mutual Fund?
Mutual Funds give returns in two ways – Capital Appreciation or Dividend Distribution.
Capital Appreciation : An increase in the value of the units of the fund is known as capital appreciation. As the value of individual securities in the fund increases, the fund’s unit price increases. An investor can book a profit by selling the units at prices higher than the price at which he bought the units.
Dividend Distribution : The profit earned by the fund is distributed among unit holders in the form of dividends. Dividend distribution again is of two types. It can either be re-invested in the fund or can be on paid to the investor.
How are Mutual Funds classified?
Why do Mutual Funds come out with different schemes?
A Mutual Fund may not, through just one portfolio, be able to meet the investment objectives of all their Unit holders. Some Unit holders may want to invest in risk-bearing securities such as equity and some others may want to invest in safer securities such as bonds or government securities. Hence, the Mutual Fund comes out with different schemes, each with a different investment objective.
Does investing in Mutual Funds mean investing in equities only?
Mutual Funds can be divided into various types depending on asset classes. They can also invest in debt instruments such as bonds, debentures, commercial paper and government securities apart from equity.
Every mutual fund scheme is bound by the investment objectives outlined by it in its prospectus. The investment objectives specify the class of securities a mutual fund can invest in.
What are sector funds?
These are speciality mutual funds that invest in stocks that fall into a certain sector of the economy. Here the portfolio is dispersed or spread across the stocks in a particular sector.This type of scheme is ideal for the investor who has already made up his mind to confine his risk and return to one particular sector. Thus, a FMCG fund would invest in companies that manufacture fast moving consumer goods.
What is the difference between Growth Plan and Dividend Reinvestment Plan?
Under the Growth Plan, the investor realizes the capital appreciation of his/her investments while under the Dividend Reinvestment Plan, the dividends declared are reinvested automatically in the scheme.
What is a Portfolio?
A portfolio of a mutual fund scheme is the basket of financial assets held by that scheme. It comprises of investments in a variety of securities and asset classes. This diversification helps reduces the overall risk. A mutual fund scheme states the kind of portfolio it seeks to construct as well as the risks involved under each asset class.
What is Net Asset Value (NAV)?
Net Asset Value (NAV) is the actual value of one unit of a given scheme on any given business day. The NAV reflects the liquidation value of the fund’s investments on that particular day after accounting for all expenses. It is calculated by deducting all liabilities (except unit capital) of the fund from the realisable value of all assets and dividing it by number of units outstanding.
What is a load?
The charge collected by a Mutual Fund from an investor for selling the units or investing in it.
When a charge is collected at the time of entering into the scheme it is called an Entry load or Front-end load or Sales load. The entry load percentage is added to the NAV at the time of allotment of units.
An Exit load or Back-end load or Repurchase load is a charge that is collected at the time of redeeming or for transfer between schemes (switch). The exit load percentage is deducted from the NAV at the time of redemption or transfer between schemes.
Some schemes do not charge any load and are called “No Load Schemes”
What is a Sale Price?
It is the price paid by an investor when investing in a scheme of a Mutual Fund. This price may include the sales or entry load.
What is a Redemption/Repurchase Price?
Redemption or Repurchase Price is the price at which an investor sells back the units to the Mutual Fund. This price is NAV related and may include the exit load.
What is the Repurchase or Back End Load?
It is the charge collected by the scheme when it buys back the units from the unit holders.
What is a Switching Facility?
Switching facility provides investors with an option to transfer the funds amongst different types of schemes or plans. Investors can opt to switch units between Dividend Plan and Growth Plan at NAV based prices. Switching is also allowed into/from other select open-ended schemes currently within the Fund family or schemes that may be launched in the future at NAV based prices.
While switching between Debt and Equity Schemes, one has to take care of exit and entry loads. Switching from a Debt Scheme to Equity scheme involves an entry load while the vice versa does not involve an entry load.
What is the applicable NAV for switch?
Switch requests are effected the day the request for switch is received. The Applicable NAV for the switch will be the NAV on the day that the request for switch is received
What is an Account Statement?
An Account Statement is a non-transferable document that serves as a record of transactions between the fund and the investor. It contains details of the investor, the units allotted or redeemed and the date of transaction. The Account Statement is issued every time any transaction takes place.
Who is a Registrar?
A Registrar accepts and processes unitholders’ applications, carries out communications with them, resolves their grievances and despatches Account Statements to them. In addition, the registrar also receives and processes redemption, repurchase and switch requests.
The Registrar also maintains an updated and accurate register of unitholders of the Fund and other records as required by SEBI Regulations and the laws of India. An investor can get all the above facilities at the Investor Service Centres of the Registrar.
Who is a custodian?
Custodian is the agency which will have the physical possession of all the securities purchased by the mutual fund.
How do I track the performance of the Fund?
The NAVs are published in financial newspapers and also available on the AMFI website on a daily basis.
Can the NAV of a debt fund fall?
A debt fund invests in fixed-income instruments, where safety of capital and regular returns are assured. These include Commercial Paper, Certificates of Deposit, debentures and bonds.
While the rate of interest on these instruments stays the same throughout their tenure, their market value keeps changing, depending on how the interest rates in the economy move.
A debt fund’s NAV is the market value of its portfolio holdings at a given point in time. As interest rates change, so do the market value of fixed-income instruments – and hence, the NAV of a debt fund. Thus it is a misnomer that the debt fund’s NAV does not fall.
What is a Systematic Investment Plan?
This is an investment technique where you deposit a fixed, small amount regularly into the mutual fund scheme (every month or quarter as per your convenience) at the then prevailing NAV (Net Asset Value), subject to applicable load.
What is a Systematic Withdrawal Plan?
The unitholder may set up a Systematic Withdrawal Plan on a monthly, quarterly or semi-annual or annual basis to redeem a fixed number of units.
Besides the NAV, are there any other parameters which can be compared across different funds of the same cateogry?
Besides Net Asset Value the following parameters should be considered while comparing the funds :
AVERAGE RETURNS An investor should look at the returns given by the fund over a period of time. Care should be taken to see whether all dividends and bonuses have been accounted for. The higher and more consistent the returns the better is the fund.
VOLATILITY In addition to the returns one should also look at the volatility of the returns given by the fund. Volatility is essentially the fluctuation of the returns about the mean return over a period of time. A fund giving consistent returns is better than a fund whose returns fluctuate a lot.
CORPUS SIZE : A Large corpus is generally considered good because large funds have lower costs, as expenses are spread over large assets but at the same time a large corpus has some inefficiencies too. A large corpus may become unwieldy and thus difficult to manage.
PERFORMANCE VIS A VIS BENCHMARK OTHER SCHEMES
An investor should not only look at the returns given by the scheme he has invested in but also compare it with benchmarks like BSE Sensex, S & P Nifty, T-bill index etc depending on the asset class he has invested in. For a true picture it is advised that the returns should also be compared with the returns given by the other funds in the same category.
Thus it is prudent to consider all the above-mentioned factors while comparing funds and not rely on any one of them in isolation.
This is important because as of today there is no standard method for evaluation of un-traded securities.
What is CDSC?
Contingent Deferred Sales Charge (CDSC) is a charge imposed on unit holders exiting from the scheme within 4 years of entry. It is intended to enable the AMC to recover expenses incurred for promotion or propagation of the scheme.
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Sometimes the selling expenses of the fund are not charged to the fund directly but are recovered from the unit holders whenever they redeem their units. This load is called a CDSC and is inversely proportional to the period of unit holding.
What is the difference between contigent defered sales load and an exit load?
Contingent Deferred Sales charge (CDSC) is a charge imposed when the units of a fund are redeemed during the first few years of ownership. Under the SEBI Regulations, a fund can charge CDSC to unit holders exiting from the scheme within the first four years of entry.
Exit load is a fee an investor pays to a fund whenever he redeems his/her units. As per SEBI regulations, the maximum exit load applicable is 7%.
There is a further stipulation by SEBI that the entry load and exit load put together cannot exceed 7% of the sale price.
Does out performance of a benchmark index always connote good performance?
No, it is not necessary that out performance of a benchmark index always connotes good performance. The volatility does not permit the investor to rely on one factor only. The index performance is volatile and may be driven by a few scrips only, which may not be very reflective. So it is better to keep other factors like risk adjusted returns (volatility of returns) and NAV movement in mind while deciding to invest in a fund.
Does higher return necessarily mean a better fund?
Yes, on the face of it high return does connote good fund but there is also some a risk taken by the scheme to achieve these returns. Thus it is prudent to measure risk alsowhile considering returns to rank a scheme. Today there are a lot of statistical tools like Beta, Sharpe ratio, Alpha and Standard Deviation to measure this risk. A risk adjusted return is the best measure to use while judging a scheme. You can also refer to the ratings assigned by a reputed rating agency.
What should one keep in mind while choosing a good Mutual Fund?
Each individual has different financial goals, based on lifestyle, financial independence and family commitments and level of incomes and expenses and many other factors. Thus before investing your money you need to analyze the following factors :
• Define the Investment objective
Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments and level of income and expenses among many other factors. Therefore, the first step should be to assess your needs. You can begin by defining the investment objectives, which could be regular income, buying a home or finance a wedding or educate your children or a combination of all these needs. Also your risk appetite and cash flow requirements need to be taken into account.
• Choose the right Mutual Fund
Once the investment objective is clear in your mind the next step is choosing the right Mutual Fund scheme. Before choosing a mutual fund the following factors need to be considered:
o NAV performance in the past track record of performance in terms of returns over the last few years in relation to appropriate yardsticks and other funds in the same category.
o Risk in terms of volatility of returns
o Services offered by the mutual fund and how investor friendly it is.
o Transparency, which is reflected in the quality and frequency of its communications.
Go for a proper combination of schemes
Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals.
What is meant by recurring sales expenses?
The Asset management Company may charge the fund a fee for operating its schemes, like trustee fee, custodian fee, registrar fee, transfer fee etc. This fee is called recurring expense and is expressed as a percentage of the scheme’s average net assets.
