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Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
Performance evaluation of mutual funds
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Performance evaluation of mutual funds

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HELP YOU TO MAKE MUTUAL FUND PROJECT. IT IS SUMMER PROJECT

HELP YOU TO MAKE MUTUAL FUND PROJECT. IT IS SUMMER PROJECT

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  • 1. A PROJECT REPORT ON PERFORMANCE EVALUATION OF MUTUAL FUNDS By NAVNIT P. KASUNDRA IN PARTIAL FULFILLMENT OF POST GRADUATE PROGRAM IN FINANCIAL SERVICES UNITEDWORLD SCHOOL OF BUSINESS (2009 – 2011) 1
  • 2. ACKNOWLEDGEMENT A summer project is a golden opportunity for learning and self development. It is really a matter of great pleasure for me to present this creative and practical work. At this stage, project report is an important part of learning and it is presented by every student to get practical knowledge. I consider myself very lucky and honored to have so many wonderful people lead me through in completion of this project I take this opportunity to express my sincere thanks to all those who helped me in the preparation of this report. I would like to express my thanks to all those who assisted me in the preparation of the project. My grateful thanks to Mr. Raghavendra Poddar, Proprietor who in spite of being extraordinarily busy with his duties, took time out to hear, guide and keep me on the correct path. I do not know where I would have been without him. A humble „Thank you‟ Sir. Prof. Mala Subramaniam whose patience I have probably tested to the limit. She was always so involved in the entire process, shared her knowledge, and encouraged me to think. Thank you, Dear Madam. I would like to thanks Mr. Amit Sir, a placement manager Unitedworld School of Business, for his efforts and help provided to me to get such an excellent opportunity. Last but not the least there were so many who shared valuable information that helped in the successful completion of this project. Navnit Kasundra 2
  • 3. DECLARATION I the undersigned, NAVNIT P. KASUNDRA the student of PGPM of Unitedworld School of Business hereby declare that the project work presented in this report is my own work and has been carried out under the supervision and guidance of Prof. Mala madam and Project Gide from JD Financial Services Mr. Raghavedra Podder. This work has not been previously submitted to any other intuition or university for examination. Date: Place: Signature, (Navnit Kasundra) 3
  • 4. INDEX Sr. No. Particular Page No. 1 Title Page 1 2 Acknowledgement 2 3 Declaration 3 4 Table of Content 4 5 List of table 4 6 Abstract 5 7 Experience at Internship 5 8 Brief of Mutual Fund 7 9 History of Mutual Fund in India 8 10 Terms of Mutual Funds 12 11 Tax Benefit in Mutual Funds 14 13 Rights of Investors 17 14 Advantages of Mutual Funds 17 15 Selection of Best Mutual Funds 19 16 Risk Involve in Investing in Mutual Funds 21 17 Different Types of Mutual Funds 22 18 Analysis of Mutual Fund Performance 26 19 Data and Data Analysis Methodology 28 20 Analysis of Performance of Sample Funds 29 21 Outcome of Evaluation 30 22 ICICI Prudential Discovery Funds 31 23 Summary and Conclusion 37 24 Recommendation 37 25 Learning 37 26 Bibliography and Reference 37 List of Tables and Graphs Graph of growth of assets in Mutual Funds 10 Risk Return Graph 21 Performance Measurement Table 30 Rank of Diversified Funds 30 ICICI fund feature and Facts 32 ICICI Graph of Fund Performance Vs. S&P CNX Nifty 33 ICICI History of Return and Risk Measurement Table 34 ICICI Portfolio Allocation Table 36 4
  • 5. ABSTRACT I prepared these papers as a part of internship. In this report I included activities at internship Company, mainly general information about Mutual Fund product and evaluate the performance of 10 Equity Diversified Mutual Funds of India. I gave brief description of various terms of Mutual Fund. What is Mutual Fund, various types of Mutual Funds, advantages, risk associated with funds, growth history of Mutual fund, how to select best mutual fund, tax benefit available, etc. I use risk adjusted performance measures suggested by Treynor, Sharpe, and Jensen to analyze the selected funds. From the evaluation of funds, I found that all ratios i.e. Treynor, Sharpe, and Jensen show almost same result. ICICI Prudential Discovery Fund obtains first rank in all three measurements. So further I give detail analysis of these funds to help investors in how to evaluate particular fund. I was as interns in JD Financial Services. I was selected there for Mutual Fund area. There I evaluate all types of Mutual Funds and select best performing mutual funds to recommend the investors. Here in this report I describe what I have done to study Mutual Funds. EXPERIENCE AT INTERNSHIP Objective Internship is a part of my study of P.G.P.M. I joined JD financial services as summer internship program. The objective to do internship is to get practical knowledge, in addition to theoretical knowledge. After joining JD Financial Services as an intern in area of Mutual Funds, my objective was to study all types of Mutual Funds, advise investors and help them to invest in Mutual Funds. And I did it. Activities at SIP  After I got selected in JD Financial Services in area of Mutual Funds, I started understanding Mutual Fund products by surfing the net. I had basic knowledge of Mutual Funds before my internship began. I cleared AMFI test which is required before I started working as mutual fund distributer. This helped me to go ahead.  In the first week, I studied about mutual funds, understood the difference between all types of funds, became aware about terminologies of mutual funds, studied the application form for mutual fund investment, understood the available options in mutual funds, specific benefits of particular fund types and option, etc. Shortly, I collected general information about mutual funds and how to fill up common application form in first week.  After I obtained the general information, I started evaluating mutual funds in equity diversified and ELSS areas. I studied past performance of funds, return for 6 months, 1 year, 3 years, 5 years, etc., after analyzing funds, I selected best performing mutual funds who are always in top 10 since 6 months, 1 years, 3 years, and 5 years. I did this to recommend investors, the best possible funds.  Now we began the marketing and actual activities as mutual fund advisors to help investors and sell mutual fund products. I had a company data base to contact people who want to invest in mutual funds. Company subscribed mutual fund investor alert from “Just Dial”. I got contact details from “Just Dial” and approached investors to invest in mutual funds.  When investors show interest to invest, I request them for an appointment and meet him/her at the prescribed place. 5
  • 6.  I got great, valuable experience from conversation with clients. All the persons whom I call are different. Some don‟t talk with me, some cut call without replying, some were insurance agents who offer me to join insurance company and sell insurance. The main part of my learning in internship is how to approach clients and convince him/her to invest.  I learned that different age group investors demand different mutual fund product according to risk and return, young prefer equity related product and senior people prefer balance funds and debt funds. At present, investment through SIP is most preferable in market scenario.  The company gave me an opportunity to go Rajkot (Gujarat) to study market there for mutual funds. When I went there I faced following problems: o Most of people had already invested in ULIPS. They were facing problems like; low return, high commission to agents, etc. So they didn‟t want to invest in mutual funds also. o Many even don‟t know about mutual funds, how it work and what return of investments is. o Trust is main thing to invest earning, people don‟t trust on me who don‟t know me. o In Gujarat, many people have money, but they don‟t know how to earn money on money. Mainly they invest money in business and earn money, but they don‟t know other options. o Market showed worst performance in last 2 years, it also one of the hinders for mutual fund.  Mutual funds in India cover tier 1 and metro cities, but there is great opportunity in tier 2 & 3. There is need of awareness in such small and medium cities. There is big money in small cities and villages, which is lying idle without any use. Mutual funds houses should establish their distributors‟ channels in such areas.  As a success, I met 80 people in Gujarat. They don‟t know about mutual funds and how it works, in spite of that I convinced 18 people to invest.  As a part of finance I learned how to evaluate particular fund and how to give a rank according to return, risk, performance and diversification. I used performance measurement ratios of Treynor‟s, Sharpe‟s, and Jensen‟s to evaluate diversified funds and gave rank accordingly.  As a conclusion, I have learnt the marketing and financial aspect of mutual fund product.  Here, I prepared report on performance evaluation of mutual funds on the base of what I have learnt at internship. 6
  • 7. MUTUAL FUNDS A BRIEF OF MUTUAL FUNDS Definition Mutual funds are investment companies that pool money from investors at large and offer to sell and buy back its shares on a continuous basis and use the capital thus raised to invest in securities of different companies. The stocks these mutual funds have are very fluid and are used for buying or redeeming and/or selling shares at a net asset value. Mutual funds posses shares of several companies and receive dividends in lieu of them and the earnings are distributed among the share holders. Mutual funds can be either or both of open ended and closed ended investment companies depending on their fund management pattern. An open-end fund offers to sell its shares (units) continuously to investors either in retail or in bulk without a limit on the number as opposed to a closed-end fund. Closed end funds have limited number of shares. Mutual funds have diversified investments spread in calculated proportions amongst securities of various economic sectors. Mutual funds get their earnings in two ways. First is the most organic way, which is the dividend they get on the securities they hold. Second is by the redemption of their shares by investors will be at a discount to the current NAVs (net asset values). Basically, 1. Collect money from investors 2. Invest through well diversified portfolio according to investors‟ requirement 3. Earning as dividend, or assets appreciation 4. Redeem whenever investor want in open ended and at certain time in close ended Above cycle show the process of invest in Mutual Fund 7
  • 8. HISTORY OF MUTUAL FUNDS IN INDIA The mutual fund industry is a lot like the film star of the finance business. Though it is perhaps the smallest segment of the industry, it is also the most glamorous – in that it is a young industry where there are changes in the rules of the game everyday, and there are constant shifts and upheavals. The mutual fund is structured around a fairly simple concept, the mitigation of risk through the spreading of investments across multiple entities, which is achieved by the pooling of a number of small investments into a large bucket. Yet it has been the subject of perhaps the most elaborate and prolonged regulatory effort in the history of the country. The mutual fund industry started in India in a small way with the UTI Act creating what was effectively a small savings division within the RBI. Over a period of 25 years this grew fairly successfully and gave investors a good return, and therefore in 1989, as the next logical step, public sector banks and financial institutions were allowed to float mutual funds and their success emboldened the government to allow the private sector to foray into this area. The initial years of the industry also saw the emerging years of the Indian equity market, when a number of mistakes were made and hence the mutual fund schemes, which invested in lesser-known stocks and at very high levels, became loss leaders for retail investors. From those days to today the retail investor, for whom the mutual fund is actually intended, has not yet returned to the industry in a big way. But to be fair, the industry too has focused on brining in the large investor, so that it can create a significant base corpus, which can make the retail investor feel more secure. A Retrospect: The last year was extremely eventful for mutual funds. The aggressive competition in the business took its toll and two more mutual funds bit the dust. Alliance decided to remain in the ring after a highly public bidding war did not yield an acceptable price, while Zurich has been sold to HDFC Mutual. The growth of the industry continued to be corporate focused barring a few initiatives by mutual funds to expand the retail base. Large money brought with it the problems of low retention and consequently low profitability, which is one of the problems plaguing the business. But at the same time, the industry did see spectacular growth in assets, particularly among the private sector players, on the back of the continuing debt bull run. Equity did not find favor with investors since the market was lack-luster and performances of funds, barring a few, were quite disappointing for investors. The other aspect of this issue is that institutional investors do not usually favor equity. It is largely a retail segment product and without retail depth, most mutual funds have been unable to tap this market. The tables given below are a snapshot of the AUM story, for the industry as a whole and for debt and equity separately. The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank of India. The history of mutual funds in India can be broadly divided into four distinct phases First Phase – 1964-87 Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory and administrative control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs. 6,700 crores of assets under management. 8
  • 9. Second Phase – 1987-1993 (Entry of Public Sector Funds) 1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990. At the end of 1993, the mutual fund industry had assets under management of Rs. 47,004 crores. Third Phase – 1993-2003 (Entry of Private Sector Funds) With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993. The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996. The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs. 44,541 crores of assets under management was way ahead of other mutual funds. Fourth Phase – since February 2003 In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs. 29,835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India, functioning under an administrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations. The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs. 76,000 crores of assets under management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place among different private sector funds, the mutual fund industry has entered its current phase of consolidation and growth. The following graph indicates the growth of assets over the years. 9
  • 10. Impact of local and international developments During the year we had two major political developments that affected the mutual fund industry. The standoff between India and Pakistan at the beginning of the financial year saw the debt market being extremely volatile. Investors pulled out of funds and this also put pressure on fund managers to hold returns and at the same time meet redemption commitments. The equity markets were equally subdued but the industry did not react greatly to this since equity funds were in any case not a significant part of the mobilization in the last few years. With the stand down on the Indian side, the debt markets recovered and with that the inflow of funds into our industry soared once again. But at the end of the year the industry was hit by another war – the impending US attack on Iraq and consequent oil price pressures once again made the debt market volatile. It is a mark of the maturing of the Indian investor that redemptions were only need based and the industry did not see as much outflows as one feared. Product innovations With the bond yields plateauing and with the mutual fund industry trying to attract people to the equity market, the year also saw some remarkable products flavors for Indian investors. Birla Sunlife Mutual Fund led the pack with an equity fund focused on dividend yield stock, a bond index fund and a bond-for-units swap product. Some of the other innovative products were the series of exchange-traded funds from Benchmark, including a liquid index traded fund. Prudential- ICICI also launched an exchange-traded fund, the SPICE, in association with BSE. The industry focused also on making existing products more attractive by adding on a number of service features and cost control measures. Same day redemption in liquid funds, “institutional” plans which would reduce the overall cost of investment and bonus units in lieu of dividend were some of these features. 10
  • 11. A new Emphasis on Risk Management The year also saw a tremendous emphasis on risk management. A number of mutual funds were already taking steps to mitigate risks not only in operations as in the past, but also in the area of management of funds. A committee constituted by AMFI carried the initiative taken under the FIRE Project forward and developed a risk management framework for the industry. The subsequent circular by SEBI is perhaps one of the most comprehensive attempts to address the issue of risk in the mutual fund business and carries with it the added advantage of phase wise escalation starting with mandatory items and moving towards best practices. AMFI and its role One of the most effective industry bodies today is probably the Association of Mutual Funds in India (“AMFI”). It has been a forum where mutual funds have been able to present their views, debate and participate in creating their own regulatory framework. The association was created originally as a body that would lobby with the regulator to ensure that the fund viewpoint was heard. Today, it is usually the body that is consulted on matters long before regulations are framed, and it often initiates many regulatory changes that prevent malpractices that emerge from time to time. This year some of the major initiatives were the framing of the risk management structure, a code of conduct and registration structure for mutual fund intermediaries, which were subsequently mandated by SEBI. In addition, this year AMFI was involved in a number of developments and enhancements to the regulatory framework. AMFI works through a number of committees, some of which are standing committees to address areas where there is a need for constant vigil and improvements and other which are ad hoc committees constituted to address specific issues. These committees consist of industry professionals from among the member mutual funds. There is now some thought that AMFI should become a self-regulatory organization since it has worked so effectively as an industry body. An Overview: Overall FY2003 can be summed up as the year of the maturing of the mutual fund industry. It was a year when fund houses went through turmoil and consolidation and the strong ones emerged stronger. Investors too became savvier, and began investing based on far more scientific criteria than in the past, and with clearly defined investment horizons. Distribution gave way increasingly to intermediation and more and more distributors graduated to providing technical advice to their clients. Thus the industry has come of age in FY2003, and we hope that FY2004 and beyond will see us come out of a stormy adolescence to become a trusted avenue for saving. 11
  • 12. TERMS OF MUTUAL FUNDS Asset Management Company An Asset Management Company (AMC) is a highly regulated organization that pools money from investors and invests the same in a portfolio. They charge a small management fee, which is normally 1.5 per cent of the total funds managed. NAV 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 How often is the NAV declared? The NAV of a scheme has to be declared at least once a week. However many Mutual Fund declare NAV for their schemes on a daily basis. As per SEBI Regulations, the NAV of a scheme shall be calculated and published at least in two daily newspapers at intervals not exceeding one week. However, NAV of a close-ended scheme targeted to a specific segment or any monthly income scheme (which is not mandatorily required to be listed on a stock exchange) may be published at monthly or quarterly intervals. What is Exit Load? The non refundable fee paid to the Asset Management Company at the time of redemption/ transfer of units between schemes of mutual funds is termed as exit load. It is deducted from the NAV (selling price) at the time of such redemption/ transfer. What is redemption price? 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. What is repurchasing price? 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. What is a Switch? 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. What is Shut-Out Period? After the closure of the Initial Offer Period, on an ongoing basis, the Trustee reserves a right to declare Shut-Out period not exceeding 5 days at the end of each month/quarter/half-year, as the case may be, for the investors opting for payment of dividend under the respective Dividends Plans. The declaration of the Shut-Out period is envisaged to facilitate the 12
  • 13. AMC/the Registrar to determine the Units of the unit holders eligible for receipt of dividend under the various Dividend Options. Further, the Shut-Out period will also help in expeditious processing and dispatch of dividend warrants. During the Shut-Out period investors may make purchases into the Scheme but the Purchase Price for subscription of units will be calculated using the NAV as at the end of the first Business Day in the following month/quarter/half-year as the case may be, depending on the Dividend Plan chosen by the investor. Therefore, if investments are made during the Shut -Out period, Units to the credit of the Unit holder's account will be created only on the first Business Day of the following month/ quarter/half year, as the case may be, depending on the dividend plan chosen by the investor. The Shut-Out period applies to new investors in the Scheme as well as to Unit holders making additional purchases of Units into an existing folio. The Trustee reserves the right to change the Shut-Out period and prescribe new Shut- Out period, from time to time. Minimum lock-in period for investment 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 for different tax saving schemes are as follows: section minimum lock-in period U/s 88 3 yrs. U/s 54EA 3 yrs. U/s 54EB 7 yrs. Who are the issuers of Mutual funds in India? Unit Trust of India was the first mutual fund which began operations in 1964. Other issuers of Mutual funds are Public sector banks like SBI, Canara Bank, Bank of India, Institutions like IDBI, ICICI, GIC, LIC, and Foreign Institutions like Alliance, Morgan Stanley, Templeton and Private financial companies like Kothari Pioneer, DSP Merrill Lynch, Sundaram, Kotak Mahindra, and Cholamandalam etc. there are many new upcoming fund houses like Edelweiss, J.P. Morgan, Axis, SYSTEMATIC INVESTMENT PLAN SIP is an investment option that is presently available only with mutual funds. The other investment option comparable to SIPs is the recurring deposit schemes from Post office and banks. Basically, under an SIP option an investor commits making a regular (monthly/quarterly) investment in a particular mutual fund/deposit. Investor can now use auto debit (ECS) facility from Banks to automatically debit SIP amount from your account. There is no need to give bulk of cheques for SIP. For that you should have account in nationalized banks. For SIP through ECS, you have to provide bank details like account no., branch name, MICR no. etc. 13
  • 14. TAX BENEFITS IN MUTUAL FUNDS When we talk about a mutual fund for taxation purposes, we mean the legally constituted trust that holds the investors‟ money. It is trust that earns and receives income from investments it makes on behalf of the investors. Most countries do not impose any tax on this entity – the trust – because the income it earns is meant for the investors. The trust is considered to be only a pass-through vehicle. It would amount to double taxation if the trust first pays a tax and then investor also is made to pay. Generally, the trust that is exempted and the investor pay the taxes on his share of the income. After the 1999-2000 Budget, the investors are totally exempt from paying any tax on the dividend income they receive from the mutual funds, while certain types of schemes pay some taxes. This section explains what the fund or the trust pays by way of tax. Tax Provision  Generally, income earned by mutual fund registered with SEBI is exempt from tax.  However, income distributed to unit-holders by a closed-end debt fund is liable to a dividend distribution tax at a rate stipulated by the Government. This tax is not applicable to distributions made by open-end equity-oriented funds. Impact on the Fund and the Investor  It should be noted that although this tax is payable by the fund on its distributions and out of its income, the investor are indirectly since the fund‟s NAV, and therefore the value of his investment will come down by the amount of tax paid by the fund. For example, if a closed-end or debt fund declares a dividend distribution of Rs. 100, Rs. 10.20, if tax rate is 10.20%) will be the tax in the hands of the fund. While the investor will get Rs. 100, the fund will have Rs. 10.20 less to invest. The fund‟s current cash flow will diminish by Rs. 10.20 paid as tax, and its impact will be reflected in the lower value of the fund‟s NAV and hence investor‟s investment on a compounded basis in future periods.  Also, the tax bears no relationship to the investor‟s tax bracket and is payable by the fund even if the investor‟s income does not exceed the taxable limit prescribed by the Income Tax Act.  In fact, since the tax is on distributions, it makes income schemes less attractive in comparison to growth schemes, because the objective of income schemes is to pay regular dividends.  The fund cannot avoid the tax eve if the investor chooses to reinvest the distribution back into the fund. For example, the fund will still pay Rs. 10.20 tax on the announced distribution, even if the investor chooses to reinvest his dividends in the concerned scheme. Tax benefits to the Investor Dividends Received From Mutual Funds  Income distributed by a fund is exempted in the hands of investors  No TDS on any income distribution by mutual fund Capital Gains on Sale of Units However, if the investor sells his units and earns “Capital Gains”, the investor is subject to the Capital Gains Tax as under: 14
  • 15.  If units are held for not more than 12 months, they will be treated as short term capital asset, otherwise as long term capital asset.  Tax law definition of Capital Gains = Sale consideration – (Cost of Acquisition + Cost of Improvements + Cost of transfer)  If the units were held for over one year, the investor gets the benefit of “Indexation”, which means his purchase price is marked up by an inflation index, so his capital gains amount is less than otherwise. Purchase Price of a long term capital asset after Indexation is computed as, Cost of acquisition or improvement = actual cost of acquisition or improvement * cost inflation index for year of transfer / cost inflation index for year of acquisition or improvement or for 1981, whichever is less. Since, April 1, 2003, all dividends, declared by debt-oriented mutual funds (i.e. mutual funds with less than 50% of assets in equities), are tax-free in the hands of the investor. A dividend distribution tax of 12.5% (including surcharge) is to be paid by the mutual fund on the dividends declared by the fund. Long-term debt funds, government securities funds (G-sec/gilt funds), monthly income plans (MIPs) are examples of debt-oriented funds. Dividends declared by equity-oriented funds (i.e. mutual funds with more than 50% of assets in equities) are tax-free in the hands of investor. There is also no dividend distribution tax applicable on these funds under section 115R. Diversified equity funds, sector funds, balanced funds are examples of equity-oriented funds. Amount invested in tax-saving funds (ELSS) would be eligible for deduction under Section 80C, however the aggregate amount deductible under the said section cannot exceed Rs 100,000. Section 2(42A): Under Section 2(42A) of the Act, a unit of a mutual fund is treated as short- term capital asset if the same is held for less than 12 months. The units held for more than twelve months are treated as long-term capital asset. Section 10(38): Under Section 10(38) of the Act, long term capital gains arising from transfer of a unit of mutual fund is exempt from tax if the said transaction is undertaken after October 1, 2004 and the securities transaction tax is paid to the appropriate authority. This makes long-term capital gains on equity-oriented funds exempt from tax from assessment year 2005-06. Short-term capital gains on equity-oriented funds are chargeable to tax @10% (plus education cess, applicable surcharge). However, such securities transaction tax will be allowed as rebate under Section 88E of the Act, if the transaction constitutes business income. Long-term capital gains on debt-oriented funds are subject to tax @20% of capital gain after allowing indexation benefit or at 10% flat without indexation benefit, whichever is less. Short-term capital gains on debt-oriented funds are subject to tax at the tax bracket applicable (marginal tax rate) to the investor. Section 112: Under Section 112 of the Act, capital gains, not covered by the exemption under Section 10(38), chargeable on transfer of long-term capital assets are subject to following rates of tax:  Resident Individual & HUF -- 20% plus surcharge, education cess.  Partnership firms & Indian companies -- 20% plus surcharge.  Foreign companies -- 20% (no surcharge). 15
  • 16. Capital gains will be computed after taking into account the cost of acquisition as adjusted by Cost Inflation Index, notified by the central government. 'Units' are included in the proviso to the sub-section (1) to Section 112 of the Act and hence, unit holders can opt for being taxed at 10% (plus applicable surcharge, education cess) without the cost inflation index benefit or 20% (plus applicable surcharge) with the cost inflation index benefit, whichever is beneficial. Under Section 115AB of the Income Tax Act, 1961, long term capital gains in respect of units, purchased in foreign currency by an overseas financial, held for a period of more than 12 months, will be chargeable at the rate of 10%. Such gains will be calculated without indexation of cost of acquisition. No surcharge is applicable for taxes under section 115AB, in respect of corporate bodies. Offset the capital loss on a mutual fund investment after a dividend declaration This is a practice that is popularly referred to as 'dividend stripping.' The capital loss from a dividend declaration can be offset if you have remained invested in the mutual fund 3 months before and 9 months after the dividend declaration. If you haven't adhered to this guideline then you cannot offset the capital loss arising from a dividend declaration. Avoid payment of capital gains on mutual fund investments The capital gain, which is not exempt from tax as explained above, can be invested in the specified asset, mentioned below, within 6 months of the sale. Specified asset means any bond redeemable after 3 years:  Issued on or after April 1, 2000 by NABARD (National Bank for Agriculture and Rural Development or NHA (National Highways Authority of India  Issued on or after April 1, 2001 by the Rural Electrification Corporation Ltd.  Issued on or after April 1, 2002 by the National Housing Bank or by the Small Industries Development Bank of India. Such capital gains can also be invested in any residential house property in accordance with Section 54F of the Act and one can claim exemption from capital gains. 16
  • 17. THE RIGHTS OF INVESTORS As per SEBI Regulations on Mutual Funds, an investor is entitled to 1. Receive Unit certificates or statements of accounts confirming your title within 6 weeks from the date your request for a unit certificate is received by the Mutual Fund. 2. Receive information about the investment policies, investment objectives, financial position and general affairs of the scheme; 3. Receive dividend within 42 days of their declaration and receive the redemption or repurchase proceeds within 10 days from the date of redemption or repurchase 4. The trustees shall be bound to make such disclosures to the unit holders as are essential in order to keep them informed about any information which may have an adverse bearing on their investments 5. 75% of the unit holders with the prior approval of SEBI can terminate the AMC of the fund. 6. 75% of the unit holders can pass a resolution to wind-up the scheme. 7. An investor can send complaints to SEBI, who will take up the matter with the concerned Mutual Funds and follow up with them till they are resolved. Are Mutual Funds Risk Free and What are the Advantages? One must not forget the fundamentals of investment that no investment is insulated from risk. Then it becomes interesting to answer why mutual funds are so popular. To begin with, we can say mutual funds are relatively risk free in the way they invest and manage the funds. The investment from the pool is well diversified across securities and shares from various sectors. The fundamental understanding behind this is not all corporations and sectors fail to perform at a time. And in the event of a security of a corporation or a whole sector doing badly then the possible losses from that would be balanced by the returns from other shares. This logic has seen the mutual funds to be perceived as risk free investments in the market. Yes, this is not entirely untrue if one takes a look at performances of various mutual funds. This relative freedom from risk is in addition to a couple of advantages mutual funds carry with them. So, if you are a retail investor and planning an investment in securities, you will certainly want to consider the advantages of investing in mutual funds. The advantages of investing in a Mutual Fund are: Management Convenient Administration Return Potential 17
  • 18. Professional expertise: Investing requires skill. It requires a constant study of the dynamics of the markets and of the various industries and companies within it. Anybody who has surplus capital to be parked as investments is an investor, but to be a successful investor, you need to have someone managing your money professionally. Just as people who have money but not have the requisite skills to run a company (and hence must be content as shareholders) hand over the running of the operations to a qualified CEO, similarly, investors who lack investing skills need to find a qualified fund manager. Mutual funds help investors by providing them with a qualified fund manager. Increasingly, in India, fund managers are acquiring global certifications like CFA and MBA which help them be at the cutting edge of the knowledge in the investing world. Diversification: There is an old saying: Don't put all your eggs in one basket. There is a mathematical and financial basis to this. If you invest most of your savings in a single security (typically happens if you have ESOPs (employees stock options) from your company, or one investment becomes very large in your portfolio due to tremendous gains) or a single type of security (like real estate or equity become disproportionately large due to large gains in the same), you are exposed to any risk that attaches to those investments. In order to reduce this risk, you need to invest in different types of securities such that they do not move in a similar fashion. Typically, when equity markets perform, debt markets do not yield good returns. Note the scenario of low yields on debt securities over the last three years while equities yielded handsome returns. Similarly, you need to invest in real estate, or gold, or international securities for you to provide the best diversification. If you want to do this on your own, it will take you immense amounts of money and research to do this. However, if you buy mutual funds -- and you can buy mutual funds of amounts as low as Rs 500 a month! -- you can diversify across asset classes at very low cost. Within the various asset classes also, mutual funds hold hundreds of different securities (a diversified equity mutual fund, for example, would typically have around hundred different shares). Low cost of asset management: Since mutual funds collect money from millions of investors, they achieve economies of scale. The cost of running a mutual fund is divided between a larger pool of money and hence mutual funds are able to offer you a lower cost alternative of managing your funds. Equity funds in India typically charge you around 2.25% of your initial money and around 1.5% to 2% of your money invested every year as charges. Investing in debt funds costs even less. If you had to invest smaller sums of money on your own, you would have to invest significantly more for the professional benefits and diversification. Liquidity: Mutual funds are typically very liquid investments. Unless they have a pre-specified lock-in, your money will be available to you anytime you want. Typically funds take a couple of days for returning your money to you. Since they are very well integrated with the banking system, most funds can send money directly to your banking account. Ease of process: If you have a bank account and a PAN card, you are ready to invest in a mutual fund: it is as simple as that! You need to fill in the application form, attach your PAN (typically for transactions of greater than Rs 50,000) and sign your cheque and you investment in a fund is made. 18
  • 19. In the top 8-10 cities, mutual funds have many distributors and collection points, which make it easy for them to collect and you to send your application to. Well regulated: India mutual funds are regulated by the Securities and Exchange Board of India, which helps provide comfort to the investors. Sebi forces transparency on the mutual funds, which helps the investor make an informed choice. Sebi requires the mutual funds to disclose their portfolios at least six monthly, which helps you keep track whether the fund is investing in line with its objectives or not. SELECTION OF BEST MUTUAL FUND 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. When your investment purpose is for saving for retirement, then risk minimization should be your mantra. And one of the best avenues for you to invest now is mutual funds as they have an average of 50 stocks in each portfolio for diversification and cushioning the risks. Selecting best mutual funds mean a lot more than deciding by indices and their past performances. However, you need to remember one thing that there is no quick gratification in investments of any kind. Let us discuss the dos and don'ts of selecting the best mutual funds. These points should serve as guidelines for making decision on whether your pick is among the best in the industry or not. Dos In Selecting the Best Mutual Fund 1. Draw down your investment objective. There are various schemes suitable for different needs. For example retirement plan, capital growth etc. Also get clear about your time frame for investment and returns. Equity funds are not advisable for short term because of their long term nature. You can consider money market and floating rate funds for short term gains. This equals asking - What kind of mutual fund is right for me? 2. Once you have decided on a plan or a couple of them, collect as much information as possible on them from different sources offering them. Funds' prospectus and advisors may help you in this. 3. Pick out companies consistently performing above average. Mutual funds industry indices are helpful in comparing different funds as well as different plans offered by them. Some of the industry standard fund indices are Sensex, Nifty, BSE 500 etc. with the latter rating the Socially Responsible Funds only. Also best mutual funds draw good results despite market volatility. 19
  • 20. 4. Get a clear picture of fees & associated cost, taxes (for non-tax free funds) for all your short listed funds and how they affect your returns. Best mutual funds have lower cost out go. 5. Best mutual funds maximize returns and minimize risks. A number called as Sharpe Ratio explains whether a fund is risk free based on its expected returns compared against a risk free money market fund. 6. Some funds have the advantage of low minimum initial investments. You can start investing even with Rs. 1000 a month. This is advisable for building asset bases over a long period with small regular investment Don'ts In Selecting Best Mutual Funds Like there are pit falls in every investment sphere you must be careful about even while investing in mutual funds. Here is a list of don'ts you must consider for selecting best performing mutual funds  Don't go by the past performance alone. For, an average of performance over a period will not tell you whether the performance is growing or at least maintained in the recent years.  Don't go by hearsay about the reputations of a fund. There are various rating agencies which index the mutual funds regularly based on multiple factors. It forms your first step in finding the best performing mutual funds.  Don't invest huge sums of money in a single fund or all the money in one go. Spread out your investments rationally. For example: Index funds for high returns, bond funds for lower risks, 401 (k) retirement plans and so on.  Don't ignore absolute returns. NAVs and percentage growths don't factor-in the taxes and charges. Higher loads can diminish you in absolute returns. Some of the funds load you at both buying as well as selling. Even no load funds have fees such as Rule 12-b fees.  Don't chase a mutual fund because it is performing great in a bull run in the stock market. Once the market stagnates or the trend reverses these funds will follow suit.  Don't compare a mutual fund across the category. This means a diversified fund should not be compared with index fund. While choosing a best one compare funds from the same category regardless of the promoting companies. It is definitely not easy to pick a few best mutual funds from those in the market. It is like searching for the proverbial needle in the stack of hay. However, a best mutual fund is one that charges low fees, that sticks to principles and investment styles, which puts your interest on top of everything else. The most important character of best mutual funds is they don't just know how to ride a bull run but also a bear market 20
  • 21. Risks involved in investing in Mutual Funds 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. 21
  • 22. Different types 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. 22
  • 23. 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 Corporates, 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 23
  • 24. 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. (b) 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. Is there is any tax applicable on the redemption of mutual funds? Yes. The tax applicable is called as STT i.e. Security transaction tax which is 0.25%. STT is applicable only in case of redemption of equity linked schemes Different plans that Mutual Funds offer 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. Automatic Investment Plan Under the Automatic Investment Plan (AIP) also called Systematic Investment Plan (SIP), the investor is given the option for investing in a specified frequency of months in a specified scheme of the Mutual Fund for a constant sum of investment. AIP allows the investors to plan their savings through a structured regular monthly savings program. Automatic Withdrawal Plan Under the Automatic Withdrawal Plan (AWP) also called Systematic Withdrawal Plan (SWP), a facility is provided to the investor to withdraw a pre-determined amount from his fund at a pre-determined interval. 24
  • 25. What are the factors that influence the performance of Mutual Funds 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. Expense Ratio Mutual funds charge fees, sometimes high fees. A mutual fund's EXPENSE RATIO is the most important fee to understand. And is made up of the following: The investment advisory fee or management fee is the money used to pay the manager(s) of the mutual fund. This is usually taken annually as a percentage of the fund's assets. Administrative costs are the costs of record keeping, mailings, maintaining a customer service line, etc. These are all necessary costs, though they vary in size from fund to fund. The thriftiest funds can keep these costs below 0.2 per cent of fund assets. Distribution fee: This fee is spent on marketing, advertising and distribution services. If you're in a fund with a 12b-1 fee, you're paying every year for the fund to run commercials and try to sell it. Only one third of all equity, mutual funds provided returns greater than the S&P 500, and that was before fees and expenses which range from 0.5% to 2.0% and 2.0%, respectively. So the next issue raised was if traditionally used methods of evaluation were accurate indicators of performance. Academicians criticized the frequently used measures of percentage annual growth rate of net asset value and absolute dollar value today of an investment made at some point in the past because these two approaches failed to adjust for the riskiness of a mutual fund. After adjustments were made for the riskiness of a fund, mutual funds were reported as being able to perform up to the market on gross returns, but were underperforming, as compared to the market, after the various expenses were factored in. Many analysts suggested that the average 1.3% expense ratio of mutual funds and the need for the retainment of cash as the culprits of such underperformance. Risk Risk can be a great ally when trying to estimate the reward potential of a stock investment. The greater the stock volatility, or risk, the greater also is the reward. There are several new risk measurements that give guidance for selecting mutual stocks that provide higher returns for lower risk. Time Horizon: The time horizon of an individual will also influence the performance measures he/she will look at more closely. If you are investing for less than four years, you need a fund with consistent performance, so all your money will be there when you need it. You also do not have time to earn back a large commission charge on the front end. Conversely, if you plan to invest your money for 30 years, neither consistency nor load is very important: you have plenty of time for the market to recover. With a long-term horizon, your biggest enemies are poor performance and high annual expenses, both of which can erode that all-important compounding. 25
  • 26. ANALYSIS OF MUTUAL FUND PERFORMANCE Mutual fund performance can be analyzed through performance measurement ratios which are use in portfolio analysis. We here are using Treynor, Sharpe, and Jensen ratio to evaluate mutual funds and rank accordingly. Composite portfolio performance measures have the flexibility of combining risk and return performance into a single value. The most commonly used composite measures are: Treynor, Sharpe and Jensen measures. While Treynor measures only the systematic risk summarized by beta, Sharpe concentrates on total risk of the mutual fund. Treynor’s performance index: Treynor (1965) was the first researcher developing a composite measure of portfolio performance. He measures portfolio risk with beta, and calculates portfolio‟s market risk premium relative to its beta: Where: Ti = Treynor‟s performance index R  R  Rp = Portfolio‟s actual return during a specified time period  P f  Rf = Risk-free rate of return during the same period Treynor     βp = beta of the portfolio P Whenever Rp> Rf and βp > 0 a larger T value means a better portfolio for all investors regardless of their individual risk preferences. In two cases we may have a negative T value: when Rp < Rf or when βp < 0. If T is negative because Rp < Rf, we judge the portfolio performance as very poor. However, if the negativity of T comes from a negative beta, fund‟s performance is superb. Finally when Rp- Rf, and βp are both negative, T will be positive, but in order to qualify the fund‟s performance as good or bad we should see whether Rp is above or below the security market line pertaining to the analysis period (Reilly, 1992). Demonstration of Comparative Treynor Measures: Assume we have the following data for three mutual funds; ZBY, with their respective annual rate of return and systematic risk, Beta. The risk free rate is 8 %. The systematic risk for M (market) is 1.0 and the rate of return for M is 14%. Investment Manager Rate of Return Beta Z 0.12 0.90 B 0.16 1.05 Y 0.18 1.2 M 0.14 1.0 We can calculate the T values for each investment manager: Tm: (0.14-0.08)/1.00 =0.06 TZ: (0.12-0.08)/0.90 =0.044 TB: (0.16-0.08)/1.05 =0.076 TY: (0.18-0.08)/1.20 =0.083 These results show that Z did not even "beat-the-market." Y had the best performance, and both B and Y beat the market. 26
  • 27. 2- Sharpe’s Performance index Sharpe (1966) developed a composite index which is very similar to the Treynor measure, the only difference being the use of standard deviation, instead of beta, to measure the portfolio risk, in other words except it uses the total risk of the portfolio rather than just the systematic risk: R  R  Where:  P f  Si = Sharpe performance index Sharpe    σp = Portfolio standard deviation  P This formula suggests that Sharpe prefers to compare portfolios to the capital market line(CML) rather than the security market line(SML). Sharpe index, therefore, evaluates funds performance based on both rate of return and diversification (Sharpe 1967). For a completely diversified portfolio Treynor and Sharpe indices would give identical rankings. Demonstration of Comparative Sharpe Measures: Sample returns and SDs for four portfolios (and the calculated Sharpe Index) are given below: Portfolio Avg. Annual RofR SD of return Sharpe measure B 0.13 0.18 0.278 O 0.17 0.22 0.409 P 0.16 0.23 0.348 Market 0.14 0.20 0.30 Thus, portfolio O did the best, and B failed to beat the market. We could draw the CML given this information. The trouble with both Sharpe and Treynor techniques for evaluating "risk-adjusted" returns is that they equate risk with short-term volatility. Therefore these measures may not be applicable in evaluating the relative merits of long-term investments. 3- Jensen’s Alpha: Jensen (1968), on the other hand, writes the following formula in terms of realized rates of return, assuming that CAPM is empirically valid:   Jensen    R   R    R  R  Rjt = Rf + βj (Rm - Rf ) + ujt P P  f P M  f   Subtracting Rf from both side he obtains: Rjt - Rf = βj (Rm - Rf ) + ujt This formula says that risk premium earned on jth portfolio is equal to the market risk premium times βj plus a random error term. In this form, one would not expect an intercept for the regression equation, if all securities are in equilibrium. But if certain superior portfolio managers can persistently earn positive risk premiums on their portfolios, the error term ujt will always have a positive value. In such a case, an intercept value which measures positive differences from the model must be included in the equation as follows: Rjt - Rf = αj + βj (Rm - Rf) + ujt Jensen uses αj as his performance measure. A superior portfolio manager would have a significant positive αj value because of the consistent positive residuals. Inferior managers, on the other hand, would have a significant negative αj. Average portfolio managers having no forecasting ability but, still, cannot be considered inferior would earn as much as one could expect on the basis of the CAPM. 27
  • 28. Jensen performance criterion, like the Treynor measure, does not evaluate the ability of portfolio managers to diversify, since the risk premiums are calculated in terms of β. If the value is positive, then the portfolio is earning excess returns. In other words, a positive value for Jensen's alpha means a fund manager has beat the market with his or her stock picking skills Analysis: While studying the performance measurement of mutual funds, one particular area caught my attention. The fact that Sharpe uses STDV as a measurement of risk which is the total risk and Treynor uses Beta or systematic risk, but yet it is claimed that, if we are examining a well-diversified portfolio, the rankings should be similar for all three methods. This interesting theory aroused my curiosity and made me think why not test this hypothesis: Are there funds which are fully diversified? If such funds exist then they ought to be ranked identically according to all three; Sharpe-, Treynor- and Jensen‟s performance measurement. DATA For my analysis I have selected 10 mutual funds from Indian market. All funds are in diversified category. I collect data from money control, value research online, and mutual fund India web sites. I have selected such funds which are mostly preferable by investors. Fix deposit return was selected as risk free return, that is 7.5% p.a. I have collected NAV of funds of each month for 12 months and define return. DATA ANALYSIS/ METHODOLOGY  Select mostly preferable funds from Indian Market.  Define NAVs for each month of period April- 2009 to March- 2010.  Find return for every month of each funds  Define standard deviation on base of monthly return  Find average return  Define beta of funds and market, S&P CNX Nifty index return take as market return.  Find Treynor, Sharpe and Jensen ratio and performance  Rank according to each ratio  Evaluate ICICI Prudential Discovery Fund individually to show how to select particular fund 28
  • 29. Analysis of Performance of Sample Funds Sr. Avg. Treynor Sharpe's No. NAME OF FUNDS Return S.D. BETA Ratio Ratio Jensen Icici Prudential Discovery 1 Fund 0.085109 9.933534 0.8865027 0.088955 0.007939 0.039378 2 DSP BR Small and Mid Cap 0.081446 11.02536 0.9618964 0.078175 0.00682 0.032358 3 Icici Prudential Emerging Star 0.077039 10.44761 0.903064 0.078387 0.006776 0.030571 4 IDFC Premier Fund Plan A 0.066173 7.854794 0.6979008 0.085862 0.007629 0.028842 SBI Magnum Emerging 5 Business 0.087394 13.87804 1.2073479 0.067209 0.005847 0.027375 6 Birla SL Midcap Plan A 0.082959 12.72428 1.1264585 0.068097 0.006029 0.026542 7 Birla SL Dividend Yield 0.0638 9.013342 0.8017708 0.071779 0.006385 0.021843 Sundaram BNP Paribas 8 SMILE Fund 0.07684 12.43841 1.1003115 0.064154 0.005675 0.021587 9 UTI dividend Yield Fund 0.055069 7.279117 0.6644231 0.073476 0.006707 0.019229 Reliance Regular Saving 10 Eqity Fund 0.067936 11.05717 0.9934204 0.062094 0.005579 0.017444 Above table shows performance of various funds by using treynor, sharpe and Jensen ratio. Now we can rank funds according to all ratios, higher ratio of fund get higher rank and so on. The table on next page shows rank of funds according to each ratio. Ran k Treynor Rank Sharpe Rank Jensen 1 Icici Dis 1 Icici Dis 1 Icici Dis 2 IDFC Pre 2 IDFC Pre 2 DSP S&M 3 Icici Emer 3 DSP S&M 3 Icici Emer 4 DSP S&M 4 Icici Emer 4 IDFC Pre 5 UTI Div 5 UTI Div 5 SBI Emer 6 Birla Div 6 Birla Div 6 Birla Mid 7 Birla Mid 7 Birla Mid 7 Birla Div SundaramSMIL 8 SBI Emer 8 SBI Emer 8 E SundaramSMIL SundaramSMIL 9 E 9 E 9 UTI Div 10 Reliance RSF 10 Reliance RSF 10 Reliance RSF 29
  • 30. Outcome of Evaluation From above table, we can evaluate that ICICI Pru. Discovery find get highest rank in all three ratio, and there is also good correlation between all ratio results. From the above table which shows performance analysis by using measurement ratios, we can define well diversified funds among all funds. We can use same method for all funds available in market and rank accordingly. Arrange funds according to ascending order of Sharpe ratio, Treynor ratio, and Jensen ratio and then give first rank to highest ratio, second to second highest and so on. Here we can see that well diversified fund rank among top five funds. Top five funds in ranking are almost same in all three measurements. So as a conclusion we can say that all three measurement ratios are equally valuable and show actual and reasonable result. From my analysis I found that ICICI Prudential Discovery Fund secure highest rank in all three ratios. So here I further analyze ICICI Discovery fund to so investors that how to choose particular fund. 30
  • 31. ICICI Prudential Discovery Fund ICICI Prudential Discovery Fund is at top among all analyzed funds. Here I am exploring this fund to show how to analyze particular fund before investing. There should be harmony between investor‟s requirement and fund‟s activities. I included fund objective, investment options , return compare with market return, assets allocation, etc. INVESTMENT OBJECTIVE To generate return through a combination of dividend income and capital appreciation by investing primarily in a well diversified portfolio of value stocks. Value stocks are those, which have attractive valuations in relation to earning or book value or current and/or future dividends. Here, investors should compare their investment objective with fund objective. Both objectives, of investors and fund should match and should in same direction. Fund Features Fund Manager S Naren , Rajat Chandak . SIP STP SWP Expense ratio(%) 2.04 Portfolio Turnover Ratio(%) 136 Last Divdend Declared NA Minimum Investment (Rs) 5000 Purchase Redemptions Daily NAV Calculation Daily Entry Load Entry Load is 0%. Exit Load If redeemed bet. 0 Year to 1 Year; Exit load is 1%. Fund features show information of investment option, facilities available to invest, transfer and redeem, minimum investment plan, expense incur to invest, NAV valuation method, other charges, etc. 31
  • 32. FUND FACTS Increase/Decrease in Fund Size since Apr 30, 117.26 2010 (Rs. in crores) Mutual Fund ICICI Prudential Mutual Fund 8th Floor, Peninsula Tower, Ganpatrao Kadam Marg, Off Senapati Bapat Marg, Lower Parel Mumbai Tel.-24997000 ,24999777 Asset Management Company ICICI Prudential Asset Management Company Ltd. 3rd Floor, Hallmark Business Plaza Sant Dyaneshwar Marg, Bandra (East), Mumbai - 400051 Tel.- 26428000 , Registrar Computer Age Management Services Private Limited A&B, Lakshmi Bhavan 609, Anna Salai , Chennai We can find fund house location, location of AMC and registrar, so we can contact in future for any help regarding mutual fund, query for repurchase, withdrawal, change in SIP, stop SIP investment, procedure to redeem, current investment statement, etc. Fund Performance Vs S & P CNX Nifty Above graph show the performance against Index performance in term of return. From above graph of ICICI Discovery Fund, we can tall that this fund is aggressive. When market goes up, it gives more return than index benchmark and when market goes down, it goes down more than market. So the investors who are aggressive in investment and want to take high risk should invest in this fund. 32
  • 33. History 2004 2005 2006 2007 2008 2009 2010 NAV (Rs) 12.88 21.09 27.14 37.9 17.22 40.35 44.44 Total Return (%) 63.74 28.69 39.65 -54.56 134.32 10.14 S&P CNX Nifty 27.40 -11.14 -15.12 -2.77 58.56 11.88 Sensex 21.41 -18.01 -7.50 -2.11 53.29 12.67 Rank (Fund/Category) 7/100 101/145 148/162 92/193 3/214 7/256 52 Week High (Rs) 21.09 28.98 37.90 39.66 40.35 - 52 Week Low (Rs) 2.41 18.70 23.52 14.36 14.69 - Net Assets (Rs.Cr) 932.45 1117.59 613.41 204.96 590.05 1088.60 Expense Ratio (%) 11.95 2.08 2.03 2.23 2.34 2.04 From above table, we can analyze historical NAV movement and fund return as compare to market return. Total fund value which is invested by investors in this fund show growth in assets and increase in trust of investors. From last year, this fund rank first by valuable analyst, so more investors attract to invest in this fund. Expense ratio show the percentage that fund house charge to maintain investors‟ fund. It charges annually. Absolute Returns (in %) Year Qtr 1 Qtr 2 Qtr 3 Qtr 4 Annual 2010 5.6 - - - - 2009 -5.7 62.0 34.5 10.0 128.9 2008 -32.5 -8.5 -4.3 -22.6 -55.8 2007 -11.0 21.9 3.2 26.3 38.8 2006 19.1 -15.2 19.8 3.7 28.1 2005 1.5 9.4 28.8 6.8 60.6 Returns (as on Jun 11, 10) Period Returns (%) Rank # 1 mth 1.1 55 3 5.9 29 mths 6 13.1 12 mths 1 year 63.9 2 2 year 31.3 2 3 year 17.7 7 5 year 24.3 19 Above two table show return history of Discovery fund. First table show absolute return quarterly for last five years and second table show annual return for last 1 month, 3 months, 6 months, 1 year, 3 years, and 5 years and rank according to performance among other diversified funds. 33
  • 34. Risk Measurement Mean -0.48 Treynor -0.71 Standard Deviation 5.13 Sortino -0.19 Sharpe -0.11 Correlation 0.81 Beta 0.82 Fama 0.06 Risk measurement table evaluate fund return, probability of return, deviation in return for specific time and define standard deviation, measure Beta associate with fund as compare to market. By using S.D. and Beta of fund, we can find sharpe and treynor ratio which are measurement of performance of fund. Portfolio Attributes Style Box P/E 21.72 as on May - 2010 P/B 2.93 as on May - 2010 Dividend Yield 1.26 as on May - 2010 Market Cap (Rs. 30,716.39 as on in crores) May - 2010 Large 32.37 as on May - 2010 Mid 43.47 as on May - 2010 Small 10.87 as on May - 2010 Top 5 Holding (%) 22.26 as on May - 2010 No. of Stocks 58 Expense Ratio (%) 2.04 Whats in Whats out Standard Chartered Bank Maruti Suzuki India Ltd. ICICI Bank Ltd. State Bank of India Grasim Industries Ltd. Corporation Bank Akzo Nobel India Ltd ICI Ltd. 34
  • 35. Top 10 Holding Stock Sector P/E Percentage Qty Value Percentage of Net of Change Assets with last month Bharti Airtel Telecom 10.57 5.73 2,372,570 62.37 24.29 Ltd Services Cadila Pharmaceuticals 24.77 4.38 782,948 47.71 9.59 Healthcare & Biotechnology Ltd. Standard Banks NA 4.36 NA 47.44 NA Chartered Bank United Fertilizers, 44.24 4.29 2,562,370 46.67 8.76 Phosphorus Pesticides & Limited Agrochemicals (New) Sterlite Non Ferrous 59.77 3.50 574,689 38.07 -1.56 Industries metals (India) Ltd FDC Ltd Pharmaceuticals 12.02 3.32 3,796,140 36.10 6.91 & Biotechnology Great Eastern Shipping 19.22 3.07 1,116,580 33.40 -3.47 Shipping Company Ltd Oil & Natural Petroleum, Gas 14.89 3.05 284,708 33.25 -24.83 Gas Corpn and Ltd petrochemical products ICICI BANK Banks 24.02 3.03 379,611 32.96 NA LTD. Rain Construction 7.78 3.01 2,386,870 32.75 64.47 Commodities materials Ltd. 35
  • 36. Sector Allocation (%) Auto & Auto Ancillaries 4.90 Banks 12.85 Chemicals 2.33 Computers - Hardware and Peripherals 0.67 Construction and Infrastructure 0.15 Construction materials 7.85 Current Assets 8.43 Engineering and Capital Goods 0.43 Fertilizers, Pesticides & Agrochemicals 7.18 Food & Food Processing, Beverages 2.45 NBFC 2.47 Non Ferrous metals 3.50 Paper and Natural fibre 3.15 Petroleum, Gas and petrochemical products 3.17 Pharmaceuticals & Biotechnology 9.71 Power Generation 3.55 Power Transmission 1.02 Shipping 3.07 Software and Consultancy Services 6.59 Steel and Ferrous Metal 3.31 Sugar 1.95 Telecom Services 5.73 Textiles 2.92 Utilities - Gas, Power 2.60 By portfolio analysis, we can come to know investment objective, major stake, contribution of top 10 holding, risk associated, investment style, changes in portfolio, contribution of sectors, dominate sectors, etc. ICICI Prudential Discovery is:  Well diversified, because it invests almost in all sectors. In addition, top 10 holdings do not contribute more than 30%, no any sector, other than banking; contribute more than 10% holding. So it decrease standard deviation i.e. risk.  It invests in all three areas i.e. large, mid, and small cap companies.  Banking, agriculture, pharmaceutical, and I.T. are major contributor in this fund. As per my opinion, these sectors always show high growth and it will give good return in future also. 36
  • 37. SUMMARY & CONCLUSION Mutual funds are one of the most highly growing products in financial services market. Mutual funds are suitable for all types of investors from risk adverse to risk bearer. Mutual funds have many options of return, risk free return, constant return, market associated return, etc. mutual funds are suitable to all age of investors, businessmen, salary person, etc. Investors need not to be expert in equity market; mutual funds can satisfy their need. Fund managers are expert in this area and invest fund in well diversified portfolio, high return with low risk is possible inn mutual fund. In today‟s world, investors are showing more trust in mutual fund than any other financial product. There is no need of a financial consultant, if you have good knowledge of mutual funds and their type to invest. Mutual fund is subject to market risk, despite of that it have low risk than stock market. This is proved in performance evaluation section of this report. Performance evaluation measurement ratios i.e. Treynor‟s, Sharpe‟s and Jensen‟s are used by fund managers to take decision of investment and to diversify portfolio. RECOMMENDATION  Mutual Fund is subject to market risk, analyzing particular fund before investing.  Study historical return of funds, risk measurement ratios to evaluate fund.  There should be similarity in your and fund‟s objective.  For high return invest in diversified funds, for tax saving invest in ELSS equity funds, for moderate risk and return invest in balance funds, for assure return invest in debt and liquid funds.  As per my opinion, investor should invest around 30% in mutual fund. LEARNING  Performance measurement of funds  How to choose best funds  How to convince investors  Upto some extend I realize life as an employee  How to recommend suitable fund to investors BIBILIOGRAPHY AND REFERENCE  AMFI test workbook  www.moneycontrol.com  www.valueresearchonline.com  www.mutualfundindia.com  www.bseindia.com  www.icicidirect.com  www.rediff.com 37

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