Introduction of Mutual Fund -Arun Singh (M.Sc Financial Mathematics) (M.S.University, Faculty of Technology and Engineering)
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. Its 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 - its never possible to diversify away all risk. This is a fact for all investments. Each fund has a predetermined investment objective that tailors the funds 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)
(1) Equity fund:These funds invest a maximum part of their corpus into equities holdings. The structure ofthe fund may vary different for different schemes and the fund manager’s outlook ondifferent stocks. The Equity Funds are sub-classified depending upon their investmentobjective, 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 therisk-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
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 inboth equities and fixed income securities, which are in line with pre-definedinvestment objective of the scheme. These schemes aim to provide investors withthe best of both the worlds. Equity part provides growth and the debt part providesstability in returns.How can you make money through Mutual Fund? (Types ofReturn)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 outnearly all of the income it receives over the year to fund owners in the form of adistribution.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 fundsshares increase in price. You can then sell your mutual fund shares for a profit.
The risk return trade-off indicates that if investor is willing to take higher risk thencorrespondingly he can expect higher returns and vise versa if he pertains to lower riskinstruments, which would be satisfied by lower returns. For example, if an investors optfor bank FD, which provide moderate return with minimal risk. But as he moves ahead toinvest in capital protected funds and the profit-bonds that give out more return which isslightly higher as compared to the bank deposits but the risk involved also increases in thesame proportion.Thus investors choose mutual funds as their primary means of investing, as Mutual fundsprovide professional management, diversification, convenience and liquidity. That doesn’tmean mutual fund investments risk free. This is because the money that is pooled in are notinvested only in debts funds which are less riskier but are also invested in the stockmarkets which involves a higher risk but can expect higher returns. Hedge fund involves avery high risk since it is mostly traded in the derivatives market which is considered veryvolatile.Some Important Information:-
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 Governmentof India launched Unit Trust of India (UTI). Until 1987, UTI enjoyed a monopoly in theIndian mutual fund market. Then a host of other government-controlled Indian financialcompanies 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 aresult of the historic constitutional amendments brought forward by the then Congress-ledgovernment under the existing regime of Liberalization, Privatizationand Globalization (LPG). The first private sector fund to operate in India was KothariPioneer, 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 fundsmentioned above. All the mutual funds must get registered with SEBI. The only exception isthe 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 riskby holding a portfolio of assets instead of only one asset. This is because by holding all yourmoney in just one asset, the entire fortunes of your portfolio depend on this one asset. Bycreating 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 fundscontains the same risk as investing in the markets, the only difference being that due toprofessional 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.
2. Costs – The biggest source of AMC income, is generally from the entry & exit loadwhich they charge from an investors, at the time of purchase. The mutual fundindustries are thus charging extra cost under layers of jargon.3. Dilution - Because funds have small holdings across different companies, highreturns from a few investments often dont make much difference on the overall return.Dilution is also the result of a successful fund getting too big. When money pours intofunds that have had strong success, the manager often has trouble finding a goodinvestment for all the new money.4. Taxes - when making decisions about your money, fund managers dont consideryour personal tax situation. For example, when a fund manager sells a security, acapital-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 gainsliability. 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.
Mutual funds are an under tapped market in India:Despite being available in the market for over two decades now with assets undermanagement less than 10% of Indian households have invested in mutual funds. Arecent report on Mutual Fund Investments in India published by research andanalytics firm, Boston Analytics, suggests investors are holding back from puttingtheir money into mutual funds due to their perceived high risk and a lack ofinformation on how mutual funds work.The primary reason for not investing appears to be correlated with city size. Amongrespondents with a high savings rate, close to 40% of those who live in metros andTier I cities considered such investments to be very risky, whereas 33% of those inTier 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 often respondents did so because they felt these assets were more professionallymanaged than other asset classes.
For Example:-Reliance Diversified Power Sector Fund - Retail Plan (G)56.522 0.88 (1.54%)NAV as on Mar-19-2012Most 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. “