Mutual Funds:Introduction:Amutual fund is a collection of investment scheme that collects money fromseveral investors and invests that money in stocks, bonds, short-term moneymarket instruments and in other securities. Mutual fund has a fund manager whopools and invests money on behalf of investors buying, selling stocks, bondsetc.
At present in worldwide the value of mutual funds totals more than $US 26trillion. Foran investor there are many other investment options such as real estate, bankdeposits, shares, debentures etc. A mutual fund is one more type of InvestmentAvenue which is available to investors. There are many reasons why investorschoose mutual funds.
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Buying shares from market is one way of investing but itrequires spending time to find out the performance of the company whose shareis being purchased. Aninformed investor needs to do research before investing. However, manyinvestors find it cumbersome and time consuming to pore over so much ofinformation, get access to so much of details before investing in the shares.Investors therefore prefer the mutual fund route.
Types of Mutual Funds: Advantages of mutualfunds: · The investor need not bother withresearching hundreds of stocks. It leaves it to the mutual fund and it’sprofessional fund management team. · Another reason why investors prefermutual funds is because mutual funds offer diversification. · An investor’s money is invested by themutual fund in a variety of shares, bonds and other securities thusdiversifying the investor’s portfolio across different companies and sectors. Mutual Fund Structurein India:Mutualfund in India follows a 3 tier structure.
Sponsor:The one who starts mutual funds. Sponsor approaches SEBI which is marketregulator and also regulator of mutual funds.SEBI: SEBIchecks whether the person is with integrity, whether he has enough knowledgeand experience in financial sector etc. Once it is satisfied then it creates apublic trust.
Trustees: Trustees arethe authorized on behalf of trust. Trustee role is not to manage money but onlyto see whether the money is being properly is being managed as per objectives.Asset Management Company: Trusteesappoint the AMC to manage investor’s money. They in return charges fee for theservices provided. Directors of AMC are at least 50% independent directors. Ifa fund manager intends to buy or sell some securities, permissions of compliance officer is must. Complianceofficer is most important in AMC.
Mutual Funds productsand features:Mutualfunds offer variety of funds. It is important for investors to know thefeatures of these products, before money is invested in them. In mutual fundsthere are two different types of funds. Open ended and closed ended funds Open Ended Funds:Anopen ended fund’s allows investor to enter and exit anytime at his convenienceunder certain conditions. Closed Ended Funds:Closedended fund’s restricts investors from entry and exit. Equity funds:Equityfunds are those funds which have at least 65% of their Average Weekly NetAssets invested in Indian Equities.
This is important from taxation point ofview, as funds investing 100% in international equities are also equity fundsfrom the investors’ asset allocation point of view, but the tax laws do notrecognise these funds as Equity Funds and hence investors have to pay tax onthe Long Term Capital Gains made from such investments which they do not haveto in case of equity funds which have at least 65% of their Average Weekly NetAssets invested in Indian Equities). Equity Funds come in various flavours andthe industry keeps innovating to make products available for all types ofinvestors. Relatively safer types of Equity Funds include Index Funds and diversified LargeCap Funds, while the riskier varieties are the Sector Funds. However, since equities as an asset class are risky,there are no guaranteeing returns for any type of fund. Equity Funds can beclassified on the basis of market capitalisation of the stocks they invest in –namely Oron the basis of investment strategy the scheme intends to have 16 like IndexFunds Index Funds:EquitySchemes come in many versions and thus can be isolated according to their risklevels. At the lowest end of the equity funds risk – return matrix come theindex funds while at the highest end come the sectoral schemes or specialtyschemes.
However, since equities as an asset class are risky, there is noguarantee in returns for any type of fund.Theobjective of a typical Index Fund states – ‘This Fund will invest in stockscomprising the Nifty and in the same proportion as in the index’. Sectoral Funds:Fundsthat invest in stocks from a single sector or related sectors are calledSectoral funds. Examples of such funds are IT Funds, Pharma Funds,Infrastructure Funds, etc. Regulations do not permit funds to invest over 10%of their Net Asset Value in a single company. This is to ensure that schemesare diversified enough and investors are not subjected to undue risk. Thisregulation is relaxed for sectoral funds and index funds. There are many othertypes of schemes available in our country, and there are still many productsand variants that have yet to enter our markets.
While it is beyond the scopeof this curriculum to discuss all types in detail, there is one emerging typeof scheme, namely Exchange Traded Funds or ETFs, which is discussed in detailin the next section.Other Equity Funds: I. Arbitrage Funds:Theseinvest simultaneously in the cash and the derivatives market and take advantageof the price differential of a stock and derivatives by taking oppositepositions in the two markets (for e.
g. stock and stock futures). II. Multicap Funds: Thesefunds can, theoretically, have a smallcap portfolio today and a largecapportfolio tomorrow. The fund manager has total freedom to invest in any stockfrom any sector. III. Quant Funds:Atypical description of this type of scheme is that ‘The system is the fundmanager’, i.e.
there are some predefined conditions based upon rigorous backtesting entered into the system and as and when the system throws ‘buy’ and’sell’ calls, the scheme enters, and/ or exits those stocks. IV. P/ E Ratio Fund:Afund which invests in stocks based upon their P/E ratios. Thus when a stock istrading at a historically low P/E multiple, the fund will buy the stock, andwhen the P/E ratio is at the upper end of the band, the scheme will sell. V.
International EquitiesFund:Thisis a type of fund which invests in stocks of companies outside India. This canbe a Fund of Fund, whereby, we invest in one fund, which acts as a ‘feeder’fund for some other fund(s), i.e invests in other mutual funds, or it can be afund which directly invests in overseas equities. These may be further designedas ‘International Commodities Securities Fund’ or ‘World Real Estate and BankFund’ etc. VI. Growth Schemes:Growthschemes invest in those stocks of those companies whose profits are expected togrow at a higher than average rate. For example, telecom sector is a growthsector because many people in India still do not own a phone – so as they buymore and more cell phones, the profits of telecom companies will increase.Similarly, infrastructure; we do not have well connected roads all over the country;neither do we have best of ports or airports.
For our country to move forward,this infrastructure has to be of world class. Hence companies in these sectorsmay potentially grow at a relatively faster pace.Growthschemes will invest in stocks of such companies.VI.
ELSS:EquityLinked Savings Schemes (ELSS) is one of equity schemes, where stakeholders gettax benefit up to Rs. 1 Lakh under section 80C of the Income Tax Act. These areopen ended schemes and are locked for a period of 3 years. These schemes servethe dual purpose of equity investing as well as tax planning for the stakeholder;however it must be noted that stakeholders cannot, under any circumstances, gettheir money back before 3 years are over from the date of investment.
VII. Fund of Funds:Theseare funds which are not directly invested in stocks and shares but invested in unitsof other mutual funds which will perform well and give maximized returns. Infact these funds are dependent on the judgment of other fund managers. Debit Funds:Debt funds are funds which invest money in debt instruments such asshort and long term bonds, government securities, t-bills, corporate paper, commercialpaper, call money etc.
The fees in debt funds are lesser, on average, thanequity funds because the overall management costs are lesser. The maininvesting objectives of a debt fund is usually safeguarding of capital andgeneration of income. Performance against a benchmark is considered to be asecondary consideration. Investments in the equity markets are considered to befraught with uncertainties and volatility. These factors mayhave an impact on constant flow of returns. Which is why debt schemes,which are considered to be safer and less volatile have attracted investors.
Debtmarkets in India are wholesale in nature and hence retail investors generallyfind it difficult to directly participate in the debt markets. Not many understandthe relationship between interest rates and bond prices or difference between Couponand Yield. Therefore venturing into debt market investments is not common amonginvestors.
Investors can however participate in the debt markets through debtmutual funds.