A Mutual Fund is a body corporate that pools the savings of a number of investors and invests the same in a variety of different financial instruments, or securities. Mutual funds can thus be considered as financial intermediaries in the investment business who collect funds from the public and invest on behalf of the investors. The Investment objectives outlined by a Mutual Fund in its prospectus are binding on the Mutual Fund scheme. The investment objectives specify the class of securities a Mutual Fund can invest in. Mutual Funds invest in various asset classes like equity, bonds, debentures, commercial paper and government securities.
An Asset Management Company (AMC) is a highly regulated organization that pools money from investors and invests the same in a portfolio.
NAV or Net Asset Value of the fund is the cumulative market value of the assets of the fund net of its liabilities. NAV per unit is simply the net value of assets divided by the number of units outstanding. Buying and selling into funds is done on the basis of NAV-related prices. NAV is calculated as follows:
NAV= Market value of the fund's investments + Receivables + Accrued Income - Liabilities - Accrued Expenses __________________________________________________________________________________
Number of Outstanding units
Number of Outstanding units
NAVs are helpful in keeping an eye on your mutual fund's price movement, but NAVs are not the best way to keep track of performance. The reason for this is mutual fund distributions. Mutual funds are forced by law to distribute at least 90% of its' realized capital gains and dividend income each year. When a fund pays out this distribution, the NAV drops by the amount paid. This is important because an investor may become frightened when they see their fund's NAV drop by Rs.3 even though they haven't lost any money (the Rs.3 was paid out to the shareholder).
The percentage of total fund assets that is used to cover expenses associated with the operation of a mutual fund. This amount is taken out of the fund's assets and lowers the return that fund holders achieve. These expenses include management fees and operating expenses. The management fee is the fee that is charged to the fund by the portfolio manager, and it is often a fixed percentage. The operating expenses are the expenses that the fund incurs through operation and this can include brokerage fees, taxes, investor services and interest expenses.
- Professional Management - Qualified and experienced professionals manage Mutual Funds. Generally, investors, by themselves, may have reasonable capability, but to assess a financial instrument a professional analytical approach is required in addition to access to research and information and time and methodology to make sound investment decisions and keep monitoring them.
- Diversification - Since Mutual Funds make investments in a number of stocks, the resultant diversification reduces risk. They provide the small investors with an opportunity to invest in a larger basket of securities.
- Regulated- Mutual Funds are registered with SEBI. SEBI monitors the activities of Mutual Funds.
- Liquidity- In case of open-ended funds, the investment is very liquid as it can be redeemed at any time with the fund unlike direct investment in stocks/bonds.
Mutual Funds do not provide assured returns. Their returns are linked to their performance. They invest in shares, debentures and deposits. All these investments involve an element of risk. The unit value may vary depending upon the performance of the company and companies may default in payment of interest/principal on their debentures/bonds/deposits. Besides this, the government may come up with new regulation which may affect a particular industry or class of industries. All these factors influence the performance of Mutual Funds.
(a) On the basis of Objective
Equity Funds/ Growth Funds - Funds that invest in equity shares are called equity funds. They carry the principal objective of capital appreciation of the investment over the medium to long-term. The returns in such funds are volatile since they are directly linked to the stock markets. They are best suited for investors who are seeking capital appreciation. There are different types of equity funds such as Diversified funds, Sector specific funds and Index based funds.
Diversified funds - These funds invest in companies spread across sectors. These funds are generally meant for risk-taking investors who are not bullish about any particular sector.
Sector funds - These funds invest primarily in equity shares of companies in a particular business sector or industry. These funds are targeted at investors who are extremely bullish about a particular sector.
Index funds - These funds invest in the same pattern as popular market indices like S&P 500 and BSE Index. The value of the index fund varies in proportion to the benchmark index.
Tax Saving Funds - These funds offer tax benefits to investors under the Income Tax Act. Opportunities provided under this scheme are in the form of tax rebates U/s 88 as well saving in Capital Gains U/s 54EA and 54EB. They are best suited for investors seeking tax concessions.
Debt / Income Funds - These Funds invest predominantly in high-rated fixed-income-bearing instruments like bonds, debentures, government securities, commercial paper and other money market instruments. They are best suited for the medium to long-term investors who are averse to risk and seek capital preservation. They provide regular income and safety to the investor.
Liquid Funds / Money Market Funds - These funds invest in highly liquid money market instruments. The period of investment could be as short as a day. They provide easy liquidity. They have emerged as an alternative for savings and short-term fixed deposit accounts with comparatively higher returns. These funds are ideal for Corporate, institutional investors and business houses who invest their funds for very short periods.
Gilt Funds - These funds invest in Central and State Government securities. Since they are Government backed bonds they give a secured return and also ensure safety of the principal amount. They are best suited for the medium to long-term investors who are averse to risk.
Balanced Funds - These funds invest both in equity shares and fixed-income-bearing instruments (debt) in some proportion. They provide a steady return and reduce the volatility of the fund while providing some upside for capital appreciation. They are ideal for medium- to long-term investors willing to take moderate risks.
Hedge Funds - These funds adopt highly speculative trading strategies. They hedge risks in order to increase the value of the portfolio.
(b) On the basis of Flexibility
Open-ended Funds - These funds do not have a fixed date of redemption. Generally they are open for subscription and redemption throughout the year. Their prices are linked to the daily net asset value (NAV). From the investors' perspective, they are much more liquid than closed-ended funds. Investors are permitted to join or withdraw from the fund after an initial lock-in period.
Close-ended Funds - These funds are open initially for entry during the Initial Public Offering (IPO) and thereafter closed for entry as well as exit. These funds have a fixed date of redemption. One of the characteristics of the close-ended schemes is that they are generally traded at a discount to NAV; but the discount narrows as maturity nears. These funds are open for subscription only once and can be redeemed only on the fixed date of redemption. The units of these funds are listed (with certain exceptions), are tradable and the subscribers to the fund would be able to exit from the fund at any time through the secondary market.
Interval funds - These funds combine the features of both open-ended and close-ended funds wherein the fund is close-ended for the first couple of years and open-ended thereafter. Some funds allow fresh subscriptions and redemption at fixed times every year (say every six months) in order to reduce the administrative aspects of daily entry or exit, yet providing reasonable liquidity.
(c) On the basis of geographic location
Domestic funds - These funds mobilize the savings of nationals within the country.
Offshore Funds - These funds facilitate cross border fund flow. They invest in securities of foreign companies. They attract foreign capital for investment.
Growth Plan and Dividend Plan - A growth plan is a plan under a scheme wherein the returns from investments are reinvested and very few income distributions, if any, are made. The investor thus only realizes capital appreciation on the investment. This plan appeals to investors in the high income bracket. Under the dividend plan, income is distributed from time to time. This plan is ideal to those investors requiring regular income.
Dividend Reinvestment Plan - Dividend plans of schemes carry an additional option for reinvestment of income distribution. This is referred to as the dividend reinvestment plan. Under this plan, dividends declared by a fund are reinvested on behalf of the investor, thus increasing the number of units held by the investors.
A Load is a charge, which the AMC may collect on entry and/or exit from a fund. A load is levied to cover the up-front cost incurred by the AMC for selling the fund. It also covers one time processing costs. Some funds do not charge any entry or exit load. These funds are referred to as 'No Load Fund'. Funds usually charge an entry load ranging between 1.00% and 2.00%. Exit loads vary between 0.25% and 2.00%.
For e.g. Let us assume an investor invests Rs. 10,000/- and the current NAV is Rs.13/-. If the entry load levied is 1.00%, the price at which the investor invests is Rs.13.13 per unit. The investor receives 10000/13.13 = 761.6146 units. (Note that units are allotted to an investor based on the amount invested and not on the basis of no. of units purchased).
Let us now assume that the same investor decides to redeem his 761.6146 units. Let us also assume that the NAV is Rs 15/- and the exit load is 0.50%. Therefore the redemption price per unit works out to Rs. 14.925. The investor therefore receives 761.6146 x 14.925 = Rs.11367.10
Sales/Purchase price is the price paid to purchase a unit of the fund. If the fund has no entry load, then the sales price is the same as the NAV. If the fund levies an entry load, then the sales price would be higher than the NAV to the extent of the entry load levied.
Redemption price is the price received on selling units of open-ended scheme. If the fund does not levy an exit load, the redemption price will be same as the NAV. The redemption price will be lower than the NAV in case the fund levies an exit load.
Repurchase price is the price at which a close-ended scheme repurchases its units. Repurchase can either be at NAV or can have an exit load.
Some Mutual Funds provide the investor with an option to shift his investment from one scheme to another within that fund. For this option the fund may levy a switching fee. Switching allows the Investor to alter the allocation of their investment among the schemes in order to meet their changed investment needs, risk profiles or changing circumstances during their lifetime.
There is no lock-in period in the case of open-ended funds. However in the case of tax saving funds a minimum lock-in period is applicable. The lock-in period in case of Tax Savings Schemes (ELSS) is 3Yrs.
The performances of Mutual funds are influenced by the performance of the stock market as well as the economy as a whole. Equity Funds are influenced to a large extent by the stock market. The stock market in turn is influenced by the performance of the companies as well as the economy as a whole. The performance of the sector funds depends to a large extent on the companies within that sector. Bond-funds are influenced by interest rates and credit quality. As interest rates rise, bond prices fall, and vice versa. Similarly, bond funds with higher credit ratings are less influenced by changes in the economy.
Choice of any scheme would depend to a large extent on the investor preferences. For an investor willing to undertake risks, equity funds would be the most suitable as they offer the maximum returns. Debt funds are suited for those investors who prefer regular income and safety. Gilt funds are best suited for the medium to long-term investors who are averse to risk. Balanced funds are ideal for medium- to long-term investors willing to take moderate risks. Liquid funds are ideal for Corporates, institutional investors and business houses who invest their funds for very short periods. Tax Saving Funds are ideal for those investors who want to avail tax benefits. An important aspect while selecting a particular scheme is the duration of the investment. Depending on your time horizon you can select a particular scheme. Besides all this, factors like promoter's image, objective of the fund and returns given by the funds on different schemes should also be taken into account while selecting a particular scheme.
Tax Benefit for Mutual Fund Investments: ELSS (Equity Linked Saving Schemes) is eligible for Tax Deduction u/s 80C of Income Tax Act. Up to a maximum of Rs.100000/-
Long Term Capital Gain: If the investment tenure in equity fund is more that 1Yr i.e. at least 366 days then it is treated as Long Term Capital Gain. As per the current Income Tax Laws, it is Tax free in the hands of investors.
Short Term Capital Gain: If the investment tenure in equity fund is less than 365 days, then it is treated as Short Term Capital Gain. As per the current Tax Laws, it is taxed @10%.
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