Today, an investor has varied options available for investment. Mutual funds are an easy investment avenue that offers interesting and innovatively packaged solutions and convenience that you as an individual may not be able to enjoy if you traded in the market directly.
However, there are many myths associated with mutual funds that confuse and deter investors. This section attempts to demystify and explain the concept of a mutual fund in an easy-to-understand Q&A format.
A. A mutual fund is a professionally-managed trust that pools the savings of many investors and invests them in securities like stocks, bonds, short-term money market instruments etc.
Investors in a mutual fund share a common financial goal and their money is invested in different asset classes in accordance with the fund's investment objective. A capital gain or loss from such investments is passed on to the investors in proportion to the number of units held by them.
The pooling of resources enables investors to enjoy economies of scale (benefit of larger volumes) and purchase securities at a lower transaction cost. Diversification is another advantage associated with mutual funds. Diversification reduces the risk for an investor because all stocks may not move in the same direction in the same proportion at the same time. Best of all, invest-ments in a mutual fund can involve relatively small amounts, giving small retail investors the advantage of having finance professionals manage their money even if it is a few thousand rupees.
The investment experts who make investments on behalf of the investors of the scheme are known as Fund Managers. While the fund manager takes decisions regarding the selection of securities and the proportion of investments to be made into them, these decisions have to be taken in accordance to the investment objective of the scheme and regulatory guidelines.
Q. How is a mutual fund set up?
A. A mutual fund is set up in the form of a trust that has Sponsor, Trustees, Asset Management Company (AMC) and Custodian.
The trust is established by a sponsor(s) who is like a promoter of a company and registered with Securities and Exchange Board of India (SEBI). The Trustees of the mutual fund hold its property for the benefit of unit holders. An Asset Management Company (AMC) approved by SEBI manages the fund by making investments in various types of securities. The Custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The Trustees are vested with the general power of superintendence and direction over the AMC and monitor the performance and compliance of SEBI Regulations by the mutual fund.
SEBI Regulations require that at least two thirds of the directors of the trustee company or board of trustees must be independent, i.e. they should not be associated with the sponsors. Also, 50% of the directors of the AMC must be independent.
Q. What is the Net Asset Value (NAV) of a scheme?
A. It is the market value of the assets of the scheme minus its liabilities. The per-unit NAV is the net asset value of the scheme divided by the number of units outstanding on any particular date.
In order to calculate the NAV of a mutual fund, you need to take the current market value of the fund's net assets (securities held by the fund minus the liabilities, if any) and divide it by the number of shares outstanding. The formula for NAV is:
For instance, if schemes' assets by the end of a trading day at Rs. 1,00,000, the liabilities and
expanses stand at Rs. 20,000 and the number of units outstanding is 4000, then the NAV would be: 20.
Q. What are the different types of mutual fund schemes?
A.Mutual Fund schemes can be broadly classified based on their maturity periods and their investment objectives. 1. By structure Open-ended Funds
An Open-ended Fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices.
A Close-ended Fund has a stipulated maturity period, which generally ranges from 3 to 15 years. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the new fund offer and thereafter they can buy or sell the units of the scheme on the Stock Exchanges, if they are listed. The market price at the stock exchange could vary from the scheme's NAV on account of demand and supply situation, unit holders' expectations and other market factors.
2. By investment objective Growth Funds
The aim of Growth Funds is to provide capital appreciation over the medium to long term. Such schemes normally invest a majority of their corpus in equities. Growth schemes are ideal for investors who have a long-term outlook and are seeking growth over a period of time.
The aim of Income Funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and Government securities.
Income Funds are ideal for capital stability and regular income. Capital appreciation in such funds may be limited, though risks are typically lower than that in a growth fund.
The aim of Balanced Funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. This proportion affects the risks and the returns associated with the balanced fund - in case equities are allocated a higher proportion, investors would be exposed to risks similar to that of the equity market.
Balanced funds with equal allocation to equities and fixed income securities are ideal for investors looking for a combination of income and moderate growth.
Money market Funds
The aim of Money Market Funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as Treasury Bills, Certificates of Deposit, Commercial Paper and Inter-Bank Call Money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market.
These are ideal for corporate and individual investors as a means to park their surplus funds for short periods.
3. Other equity related schemes Tax saving schemes
These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws, as the Government offers tax incentives for investment in specified avenues.
Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction under Section 88 of the Indian Income Tax Act, 1961.
Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE S&P CNX 50.
Sectoral Funds are those which invest exclusively in specified sector(s) such as FMCG, Information Technology, Pharmaceuticals, etc. These schemes carry higher risk as compared to general equity schemes as the portfolio is less diversified, ie restricted to specific sector(s) / industry (ies).
Q. What are the benefits of investing in a mutual fund?
A.The following are the various asset classes available to an investor:
Mutual funds provide the retail investor with the opportunity to invest in varied investment schemes at relatively lower amount. Diversification allows investors to spread their portfolio across sectors and industries, in turn reducing the overall risk on their portfolio.
Mutual funds provide the benefits of having professional management of money by experts.
It is ideal for retail investors who do not have time or know-how about the markets to invest in them.
Low Transaction Cost
Due to economies of scale (benefit of larger volumes), mutual funds pay lower transaction costs. The benefits are passed on to a mutual fund investor, which may not be enjoyed by an individual who enters the market directly.
An investor may not be able to sell some of the shares held by him very easily and quickly whereas mutual fund units can always be redeemed either on every business day in the case of open-ended schemes or during specific intervals as outlined by the fund in case of close-ended schemes.
Funds provide investors with updated information pertaining to the markets and schemes through fact-sheets, offer documents, annual reports etc.
Investors benefit from the convenience and flexibility offered by mutual funds to invest in a wide range of schemes. The option of systematic (at regular intervals) investment and withdrawal is also offered to investors in most open-ended schemes.
The Mutual Fund industry in India is well-regulated by the Securities and Exchange Board of India (SEBI). All funds are registered with SEBI and complete transparency is enforced..