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What is a mutual fund? A mutual fund is a common pool of money into which investors place their contributions that are to be invested in different types of securities in accordance with the stated objective Each investor has a right to a proportional share of the assets of the fund and any income it earns Company sells shares to the public and invests the proceeds in a pool of securities Jointly owned by the fund’s investors Invested according to the objective of the fund
Fund Sponsor Trustees Asset Management Company Depository Agent Custodian Fund Structure
Advantages of Mutual Funds Diversification Professional Management Ease of buying and selling Small amount of money required to open an account Multiple withdrawal options Distribution or reinvestment of income and capital gains Switching privileges in fund family Multiple services
Disadvantages of Mutual Funds Purchase and withdrawal costs Management fees Potential poor performance No control over capital gains distribution Complicated tax reporting issues Potential market risk with all investments Aggressive or unethical sales personnel
Computing Net Asset Value For investors, the performance of their investment depends on what happens to the fund’s per share value, or net asset value (NAV) NAV= Market Value of Assets – Liabilities Number of Shares Outstanding
Mutual Fund Returns Three sources of return: Income distributions (ID) Bond interest, stock dividends Capital gain distributions (CGD) Realized gains/losses from selling assets Changes in NAV (NAV) From unrealized gains/losses from assets
Closed-end and Open-end Funds 13-6 Closed-end funds Shares are issued by an investment company only when the fund is originally set up After all original shares are sold you can only purchase shares from another investor Open-end funds Shares are issued and redeemed by the investment company at the request of investors. Investors can buy and sell shares at the net asset value.
Load Vs. No-load Funds Marketing a new mutual fund scheme involves initial expenses. These expenses are charged to the investors through loads and are recovered from the investors in different ways: Front-end or entry load is charged to the investor at the time of his entry into the scheme.SEBI has since disallowed this load Back-end or exit load is charged to the investor at the time of his exit from the scheme. Deferred load is charged to the investor over a period of time. Contingent deferred sales charge: Different amount of loads are charged to the investor depending upon the time period the investor has stayed with the fund. The longer he stays with the fund, lesser the amount of exit fund he is charged. Very often, AMC’s do not charge any initial expenses to the investor in the IPO. These are hence are no-load funds. In no-load funds, the investors get units for the complete amount invested.
Types of Mutual Funds Funds classified according to the type of security in which they invest Examples: Stock Funds Taxable Bond Funds Municipal Bond Funds Stock and Bond Funds Money Market Funds
Common Stock Funds Most popular type of fund Wide variety with different objectives and levels of risk Growth Industry or sector funds Geographic areas International or Global Equity Index funds
Bond Funds Generally seek to generate current income with limited risk Can vary by maturity Short-term, Intermediate-term, Long-term Can vary by type of bond Government Corporate Municipal International/Global Bond Index funds Infrastructure funds Life style fund
Stock and Bond Funds Seek to provide a combination of income and value appreciation Different names Balanced funds Hybrid funds Flexible funds Asset Allocation funds
Money Market Funds Provide safe, current income with high liquidity Invest in money market securities T-bills, Bank CD’s, Commercial paper, etc. Provide an alternative to bank deposits
Total Assured Return Close End Open End Structure Nature
4323 Balanced - 790 3533 539 ELSS 1761 - 1222 Gilt 5955 - - 5955 23022 - 1498 21524 Growth 64571 Income 65396 - 825 45200 - - 45200 Liquid/Money Market 141322 Total 145657 - 4335 Assets Under Management as on February29, 2004 Amount in Rs. Crores
Mutual Fund Prospectus Must be available to and should be reviewed by investors Contains: Fund’s investment objective Investment strategy Principal risks faced by investors Recent investment performance Expenses and fees
Mutual Fund Investment Strategies Choose in funds consistent with your objectives, constraints, and tax situation Consider index funds for a large portion of your fund portfolio When possible, invest in no-load funds with below-average expense and turnover ratios Invest. Don’t speculate. Be regular Own funds in different asset classes and consider life-cycle investing
When should you sell? Personal considerations Portfolio rebalancing Be aware of capital gains with selling fund shares Fund considerations Change in portfolio manager Change in investment style Fund is growing “too large” or “too fast” Persistent bad performance
references Investments, Fifth Edition, William F. Sharpe ICRA Money and Finance www.mutualfundsindia.com www.amfiindia.com www.nseindia.com www.moneycontrol.com