2. INTRODUCTION
The mutual fund industry in India began in 1963 with the formation of the Unit
Trust of India (UTI) as an initiative of the Government of India and the Reserve
Bank of India. Much later, in 1987, SBI Mutual Fund became the first non-UTI
mutual fund in India.
Subsequently, the year 1993 heralded a new era in the mutual fund industry. This
was marked by the entry of private companies in the sector. After the Securities
and Exchange Board of India (SEBI) Act was passed in 1992, the SEBI Mutual
Fund Regulations came into being in 1996. Since then, the Mutual fund companies
have continued to grow exponentially with foreign institutions setting shop in
India, through joint ventures and acquisitions.
As the industry expanded, a non-profit organization, the Association of Mutual
Funds in India (AMFI), was established on 1995. Its objective is to promote
healthy and ethical marketing practices in the Indian mutual fund Industry. SEBI
has made AMFI certification mandatory for all those engaged in selling or
marketing mutual fund products.
3. What is Mutual Fund?
An investment vehicle that is made up of a poolof funds collected from many
investors for the purposeof investing in securities suchas stocks, bonds, money
market instruments and similar assets. The securities are professionally managed
on behalf of the unit holders and each investor holds a pro-rata share of the
portfolio, that is, entitled to profits as well as losses. Income earned through these
investments and the capital appreciation realized is shared by its unit holders in
proportion to the number of units owned by them. A mutual fund is the most
suitable investment scopefor common people as it offers an opportunity to invest
in a diversified, professionally managed basket of securities at a relatively lower
cost.
4.
5. HISTORY OF MUTUAL FUNDS
The first mutual funds were established in Europe. One researcher credits a Dutch
merchant with creating the first mutual fund in 1774.
Mutual funds were introduced to the United States in the 1890s, and they became
popular in the 1920s. These early funds were generally closed-end funds with a
fixed number of shares that often traded at prices above the portfolio value.
The first open-end mutual fund, called the Massachusetts Investors Trust (now part
of the MFS family of funds), with redeemable shares was established on March 21,
1924. However, closed-end funds remained more popular than open-end funds
throughout the 1920s. In 1929, open-end funds accounted for only 5% of the
industry's $27 billion in total assets.
After the stockmarket crash of 1929, Congress passed a series of acts regulating
the securities markets in general and mutual funds in particular. The Securities Act
of 1933 requires that all investments sold to the public, including mutual funds, be
registered with the SEC and that they provide prospective investors with a
prospectus that discloses essential facts about the investment. The Securities and
Exchange Act of 1934 requires that issuers of securities, including mutual funds,
report regularly to their investors; this act also created the Securities and Exchange
Commission, which is the principal regulator of mutual funds. The Revenue Act of
1936 established guidelines for the taxation of mutual funds, while the Investment
Company Act of 1940 governs their structure.
When confidence in the stockmarket returned in the 1950s, the mutual fund
industry began to grow again. By 1970, there were approximately 360 funds with
$48 billion in assets. The introduction of money market funds in the high interest
rate environment of the late 1970s boosted industry growth dramatically. The first
6. retail index fund, First Index Investment Trust, was formed in 1976 by The
Vanguard Group, headed by John Bogle; it is now called the "Vanguard 500 Index
Fund" and is one of the world's largest mutual funds, with more than $195 billion
in assets as of January 31, 2015.
Fund industry growth continued into the 1980s and 1990s, as a result of three
factors: a bull market for both stocks and bonds, new productintroductions
(including tax-exempt bond, sector, international and target date funds) and wider
distribution of fund shares. Among the new distribution channels were retirement
plans. Mutual funds are now the preferred investment option in certain types of
fast-growing retirement plans, specifically in 401(k) and other defined contribution
plans and in individual retirement accounts (IRAs), all of which surged in
popularity in the 1980s. Total mutual fund assets fell in 2008 as a result of the
credit crisis of 2008.
In 2003, the mutual fund industry was involved in a scandalinvolving unequal
treatment of fund shareholders. Some fund management companies allowed
favored investors to engage in late trading, which is illegal, or market timing,
which is a practice prohibited by fund policy. The scandalwas initially discovered
by former New York Attorney General Eliot Spitzer and led to a significant
increase in regulation.
At the end of 2013, there were over 15,000 mutual funds in the United States with
combined assets of $17 trillion, according to the Investment Company Institute
(ICI), a trade association of U.S. investment companies. The ICI reports that
worldwide mutual fund assets were $30 trillion on the same date.
Mutual funds play an important role in U.S. household finances; by the end of
2013, funds accounted for 22% of household financial assets. Their role in
retirement planning is particularly significant. Roughly 60% of assets in 401(k)
plans and individual retirement accounts were invested in mutual funds.
7. DEFINITIONS
Definitions of key terms.
Net asset value
A fund's net asset value (NAV) equals the current market value of a fund's
holdings minus the fund's liabilities (sometimes referred to as "net assets"). It is
usually expressed as a per-share amount, computed by dividing net assets by the
number of fund shares outstanding. Funds must compute their net asset value
according to the rules set forth in their prospectuses. Funds computetheir NAV at
the end of each day that the New York StockExchange is open, though some funds
compute NAVs more than once daily.
Valuing the securities held in a fund's portfolio is often the most difficult part of
calculating net asset value. The fund's board typically oversees security valuation.
Expense ratio
The expense ratio allows investors to compare expenses across funds. The expense
ratio equals the 12b-1 fee plus the management fee plus the other fund expenses
divided by average daily net assets. The expense ratio is sometimes referred to as
the total expense ratio (TER).
Average annual total return
The SEC requires that mutual funds report the average annual compounded rates of
return for one-, five-and ten-periods using the following formula:
P(1+T)n = ERV
Where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at
the beginning of the one-, five-, or ten-year periods at the end of the one-,
five-, or ten-year periods (or fractional portion)
8. Turnover
Turnover is a measure of the volume of a fund's securities trading. It is expressed
as a percentage of average market value of the portfolio's long-term securities.
Turnover is the lesser of a fund's purchases or sales during a given year divided by
average long-term securities market value for the same period. If the period is less
than a year, turnover is generally annualized.
ESSENTIALS OF MUTUAL FUNDS
Professional Management
Each fund's investments are chosenand monitored by qualified professionals who
use this money to create a portfolio. That portfolio could consistof stocks, bonds,
money market instruments or a combination of those.
Fund Ownership
As an investor, you own shares of the mutual fund, not the individual securities.
Mutual funds permit you to invest small amounts of money, however much you
would like, but even so, you can benefit from being involved in a large poolof
cash invested by other people. All shareholders share in the fund's gains and losses
on an equal basis, proportionately to the amount they've invested.
Mutual Funds are Diversified
By investing in mutual funds, you could diversify your portfolio across a large
number of securities so as to minimize risk. By spreading your money over
9. numerous securities, which is what a mutual fund does, you need not worry about
the fluctuation of the individual securities in the fund's portfolio.
OBJECTIVES OF MUTUAL FUNDS
There are many different types of mutual funds, each with its own set of goals. The
investment objective is the goal that the fund manager sets for the mutual fund
when deciding which stocks and bonds should be in the fund's portfolio.
For example, an objective of a growth stockfund might be: This fund invests
primarily in the equity markets with the objective of providing long-term capital
appreciation towards meeting your long-term financial needs such as retirement or
a child's education.
10. STRUCTURE OF MUTUAL FUNDS
The following is the structureof typical Mutual fund:
Sponsor
Sponsoris the personwho either alone or in association with another corporate
body, establishes a mutual fund. The sponsormust contribute at least 40% of the
net worth of the investment managed and meet the eligibility criteria prescribed
under the Securities and Exchange Board of India (Mutual Funds) Regulations,
1996.The sponsoris not responsible or liable for any loss or shortfall resulting
11. from the operation of the schemes beyond the initial contribution made by it
towards setting up of the mutual fund.
Trust
The mutual fund is constituted as a trust in accordance with the provisions of the Indian Trusts
Act, 1882 by the sponsor. The trust deed is registered under the Indian Registration Act, 1908.
Trustee
The mutual fund is required to have an independent Board of Trustees, i.e. two
thirds of the trustees should be independent persons who are not associated with
the sponsors in any manner whatsoever. An AMC or any of its officers or
employees are not eligible to act as a trustee of any mutual fund. In case a
company is appointed as a trustee, then its directors can act as trustees of any other
trust provided that the object of such other trust is not in conflict with the object of
the mutual fund. Additionally, no personwho is appointed as a trustee of a mutual
fund can be appointed as a trustee of any other mutual fund unless he is an
independent trustee and prior approval of the mutual fund of which he is a trustee
has been obtained for such an appointment. The trustees are responsible for - inter
alia - ensuring that the AMC has all its systems in place, all key personnel,
auditors, registrars etc. have been appointed prior to the launch of any scheme. It is
also the responsibility of the trustees to ensure that the AMC does not act in a
manner that is favorable to its associates such that it has a detrimental impact on
the unit holders, or that the management of one scheme by the AMC does not
compromise the management of another scheme. The trustees are also required to
ensure that an AMC has been diligent in empanelling and monitoring any
securities transactions with brokers, so as to avoid any undue concentration of
business with any broker. The Mutual Fund Regulations further mandates that the
trustees should prevent any conflicts of interest between the AMC and the unit
holders in terms of deployment of net worth. The trustees are also responsible for
12. ensuring that there is no change carried out in the fundamental attributes of any
scheme or the trust or fees and expenses payable or any other change that would
modify the scheme and affect the interest of unit holders, unless each unit holder is
provided with written communication thereof. In addition, the unit holders must be
given the option to exit at the prevailing Net Asset Value (“ NAV ”) without any
exit load. They are obliged to perform a quarterly review of all transactions carried
out between the mutual funds, AMC and its associates. As far as professional
indemnity cover for the trustees or the AMC is concerned, industry practice in
India reveals that the insurance policy is taken out by an Indian insurance company
(as is required by the Insurance Act, 1938) while the risk is subsequently ceded to
an overseas re-insurer who underwrites the primary policy issued by the Indian
insurance company.
Asset Management Company (Amc)
The trustee, as the investment manager of the mutual fund, appoints the AMC. The
AMC is required to be approved by the Securities and Exchange Board of India
(SEBI) to act as an asset management company of the Mutual fund. At least 50%
of the directors of the AMC are independent directors who are not associated with
the sponsorin any manner. The AMC must have a net worth of at least Rs. 10
crores at all times. The sponsororthe trustees are required to appoint an AMC to
manage the assets of the mutual fund. Under the Mutual Fund Regulations, the
applicant must satisfy certain eligibility criteria in order to qualify to register with
SEBI as an AMC:
The sponsormusthave at least 40% stake in the AMC.
The directors of the AMC should be persons having adequate professional
experience in finance and financial services related field and not found
13. guilty of moral turpitude or convicted of any economic offence or violation
of any securities laws.
The AMC should have and must at all times maintain, a minimum net worth
of Rs. 100 million; the board of directors of suchAMC has at least 50%
directors, who are not associate of, or associated in any manner with, the
sponsororany of its subsidiaries or the trustees.
The Chairman of the AMC is not a trustee of any mutual fund.
In addition to the above eligibility criteria and other ongoing compliance
requirements laid down in the Mutual Fund Regulations, the AMC is
required to observe the following restrictions in its normal course of
business.
Any director of the AMC cannot hold office of a director in another AMC
unless such person is an independent director and the approval of the board
of the AMC of which such person is a director, has been obtained.
The AMC shall not act as a trustee of any mutual fund.
The AMC cannot undertake any other business activities except activities in
the nature of portfolio management services, management and advisory
services to offshore funds, pension funds, provident funds, venture capital
funds, management of insurance funds, financial consultancy and exchange
of research on commercial basis if any of such activities are not in conflict
with the activities of the mutual fund.
However, the AMC may, itself or through its subsidiaries, undertake such
activities if it satisfies the Board that the key personnel of the asset
management company, the systems, back office, bank and securities
14. accounts are segregated activity wise and there exist systems to prohibit
access to inside information of various activities.
The AMC shall not invest in any of its schemes unless full disclosure of its
intention to invest has been made in the offer. However, an AMC shall not
be entitled to charge any fees on its investment in that scheme.
The AMC is required to take all reasonable steps and exercise due diligence
to ensure that the investment of funds pertaining to any scheme are not
contrary to the provisions of the Mutual Fund Regulations and the trust deed.
An AMC cannot, through any broker associated with the sponsor, purchase
or sell securities, which is an average of 5% or more of the aggregate
purchases and sale of securities made by the mutual fund in all its schemes.
However, the aggregate purchase and sale of securities excludes the sale and
distribution of units issued by the mutual fund and the limit of 5% shall
apply only for a block of any three months.
Custodian
A trust company, bank or similar financial institution, registered with SEBI is
responsible for holding and safeguarding the securities owned within a mutual
fund. A mutual fund’s custodian may also act as its transfer agent. The mutual fund
is required, under the Mutual Fund Regulations, to appoint a custodian to carry out
the custodial services for the schemes of the fund. Only institutions with
substantial organizational strength, service capability in terms of computerization,
and other infrastructure facilities are approved to act as custodians. The custodian
must be totally de- linked from the AMC and must be registered with SEBI. Under
the Securities and Exchange Board of India (Custodian of Securities) Guidelines,
1996, any person proposingto carry on the business as a custodian of securities
15. must register with the SEBI and is required to fulfill specified eligibility criteria.
Additionally, a custodian in which the sponsororits associates holds 50% or more
of the voting rights of the share capital of the custodian or where 50% or more of
the directors of the custodian represent the interest of the sponsororits associates
cannot act as custodian for a mutual fund constituted by the same sponsororany of
its associate or subsidiary company.
Registrar and Transfer Agent
The AMC, if so authorized by the trust deed, appoints the registrar and transfer
agent to the mutual fund. The registrar processes the application form, redemption
requests and dispatches account statements to the unit holders. The registrar and
transfer agent also handles communication with investors and updates investor
records.
16. TYPES OF MUTUAL FUNDS
On the basis of Structure:
Open-Ended Schemes
Open-ended schemes are mutual funds that can issue and redeem their shares at
any time. Open-ended funds do not have restriction on the amount of shares the
fund will issue. They offer units for sale without specifying any duration for
redemption. If demand is high enough, the fund will continue to issue shares, no
matter how many investors are there. Open-ended funds also buy back shares when
investors wish to sell. Investors can conveniently buy and sell units of open-ended
17. funds directly from the fund house at the prevalent Net Asset Value (NAV) prices.
One of the key features of open-end schemes is the liquidity that these funds offer
to investors.
Close-Ended Schemes
Close-ended schemes are mutual funds with a fixed number of shares (or units).
Unlike open-ended funds, new shares/units are not created by managers to meet
demand from investors but the shares can only be purchased (and sold) in the
secondarymarket.
Close-ended funds raise a fixed amount of capital through a New Fund Offer
(NFO). The fund is then structured, listed and traded like a stock, on a stock
exchange. The price per share is determined by the market and is usually different
from the underlying value or net asset value (NAV) per share of the investments
held by the fund. The price is said to be at a discount or premium to the NAV when
it is below or above the NAV, respectively. A premium might be due to the
market's confidence in the investment manager’s ability to produceabove-market
returns. A discount might reflect the charges to be deducted from the fund in future
by the fund managers.
Some close-ended funds give an option of selling back the units to the mutual fund
through periodic repurchase at NAV related prices. SEBI regulations stipulate that
at least one of the two exit routes is provided to the investor, that is, either
repurchase facility or through listing on stockexchanges. These mutual funds
schemes disclose NAV generally on weekly basis.
18. On the basis of Investment:
Growth or Equity-Oriented Schemes
The aim of growth funds is to provide capital appreciation over medium to long-
term. These schemes normally invest a major part of their portfolio in equities and
have comparatively high risks. They provide different options to the investors like
dividend option, capital appreciation, etc. and investors may chooseone depending
on their preferences. The mutual funds also allow the investors to change the
options at a later date. Growth schemes are good for investors having a long-term
outlook seeking appreciation over a period of time.
It can be further classified into following depending upon objective:
Large-Cap Funds:These funds invest in companies from different sectors.
However, they put a restriction in terms of the market capitalization of a
company, i.e., they invest largely in BSE 100 and BSE 200 Stocks.
Mid-Cap Funds: These funds invest in companies from different sectors.
However, they put a restriction in terms of the market capitalization of a
company, i.e., they invest largely in BSE Mid Cap Stocks.
SectorSpecific Funds: These are schemes that invest in a particular sector,
for example, IT.
Thematic: These schemes invest in various sectors but restrict themselves to
a particular theme e.g., services, exports, consumerism, infrastructure etc.
Diversified Equity Funds: All non-theme and non-sector funds can be
classified as equity diversified funds.
Tax Savings Funds (ELSS): Investments in these funds are exempt from
income tax at the time of investment, upto a limit of Rs 1 lakh.
Income or Debt oriented Schemes
The aim of income funds is to provide regular and steady income to investors.
These schemes generally invest in fixed-income securities such as bonds, corporate
debentures, Government Securities and money-market instruments and are less
risky compared to equity schemes. However, opportunities of capital appreciation
are limited in such funds. The NAVs of such funds are impacted because of change
in interest rates in the economy. If the interest rates fall, NAVs of such funds are
likely to increase in the short run and vice versa. However, long-term investors do
19. not bother about these fluctuations.
Balanced Schemes
The aim of the balanced funds is to provide both growth and regular income as
such schemes invest both in equities and fixed income instruments in the
proportion indicated in their offer documents. These are appropriate for investors
looking for moderate growth. They generally invest between 65% and 75% in
equity and the rest in debt instruments. They are impacted because of fluctuation in
stockmarkets but NAVs of such funds are less volatile compared to pure equity
funds.
Money Market or Liquid Funds
These funds are also income funds and their aim is to provide easy liquidity,
preservation of capital and moderate income. These schemes invest exclusively in
safer short-term instruments such as Treasury Bills, Certificates of Deposits,
Commercial Paper and inter-bank call money, Government Securities, etc. Returns
of these schemes fluctuate much less than other funds. These are appropriate for
investors as a means of short-term investments.
Gilt Funds
These funds invest exclusively in Government Securities. NAVs of these schemes
also fluctuate due to change in interest rates and other economic factors as is the
case with income or debt-oriented schemes.
20. Fund of Funds Schemes
Fund of Funds invests in other mutual fund schemes. A traditional mutual fund
comprises a portfolio of shares, but a Fund of Funds comprises a portfolio of
different mutual fund schemes. A Fund of Funds helps the investor to reduce his
chances of selecting the wrong mutual fund.
Gold Exchange Traded Funds
It is an open-ended Exchange Traded Fund. The investment objective of the
scheme is to generate returns that are in line with the returns on investment in
physical gold, subject to tracking error.
Floating Rate Funds
These are open-ended income schemes seeking to generate reasonable returns with
commensurate risk from a portfolio which comprises floating rate debt instruments
and fixed rate debt instruments swapped for floating rate returns. The scheme may
also invest in fixed rate money market and debtinstruments.
Other schemes:
Tax-saving schemes
These schemes offer tax rebates to the investors under specific provisions of the
Income Tax Act, 1961 as the Government offers tax incentives for investment in
specified avenues like Equity Linked Savings Schemes (ELSS). ELSS is a type of
diversified equity mutual fund, which is qualified for tax exemption under Section
80C of the Income Tax Act, and offers the twin-advantage of capital appreciation
21. and tax benefits. It comes with a lock-in period of three years.
The Rajiv Gandhi Equity Savings scheme (RGESS), which was revised in the
Union Budget 2013-14, would provide a 50% tax deduction on investments up to
Rs. 50,000 to first time investors in equity whose annual taxable income is below
Rs. 12 lakhs.
Index Schemes
Index funds replicate the portfolio of a particular index such as the BSE Sensitive
index, S&P NSE 50 index (Nifty), etc. NAVs of such schemes would rise or fall in
accordancewith the rise or fall in the index, though not exactly by the same
percentage due to some factors known as "tracking error". Necessary disclosures in
this regard are made in the offer document of the scheme.
There are also exchange traded index funds launched by the mutual funds which
are traded on the stockexchanges.
Sector Specific schemes
These are the funds which invest in the securities of only those sectors or industries
as specified in the offer documents like Pharmaceuticals, Software, FMCG,
Petroleum stocks etc. The returns of these funds are dependent on the performance
of the respective sectors/industries. While these funds may give higher returns,
they are more risky compared to diversified funds. Investors need to keep a watch
on the performance of those sectors/industries and must exit at an appropriate time.
Load or No-Load Funds
A load fund is one that charges a percentage of NAV for exit. That is, each time
22. one sells units in the fund, a charge will be payable. This charge is used by the
Mutual fund for marketing and distribution expenses.
A no-load fund is one that does not charge for exit. It means the investors can exit
the fund at no additional charges during sale of units. In accordancewith the SEBI
circular no. SEBI/IMD/CIR No.4/168230/09 dated June 30, 2009, no entry load
will be charged for purchase / additional purchase / switch-in accepted by the fund
with effect from August 1, 2009. Similarly, no entry load will be charged with
respect to applications for registrations under Systematic Investment Plan/
Systematic Transfer Plan / Systematic Investment Plan Plus accepted by the fund
with effect from August 1, 2009.
Dividend Payout Schemes
Mutual Fund companies as when they keep on making profit, distribute a part of
the money to the investors by way of dividends. If one wants to keep on taking part
of profit regularly, he may select this option.
Dividend Reinvestment Schemes
This option is similar to the first option except that the dividend declared is re-
invested in the same fund on the same day’s NAV.
23. ADVANTAGES OF MUTUAL FUNDS
The advantages of investing in a Mutual Fund are:
Professional Management - Investor avail the services of experienced
and skill professionals who are backed by a dedicated investment research
team which analyses the performance and prospects ofcompanies and
selects suitable investments to achieve the objectives of the scheme.
Diversification - Mutual Fund invest in a number of companies across a
board cross-sectionof industries and sectors. This diversification reduces the
risk becauseseldom do all stockdecline at the same time and same
proportion.
Convenient Administration - Investing in a mutual fund reduces paper
work and helps investor to avoid many problems such as bad deliveries,
delayed payments and unnecessary follow up with brokers and companies.
Mutual funds save investor time and make investing easy and convenient.
24. Return Potential - Over a medium to long term, Mutual Fund have the
potential to provide a higher return as they invest in a diversified basket of
selected securities.
Low Cost - Mutual Fund are a relatively less expensive way to invest
compared to directly investing in the capital markets because the benefits of
scale in brokerage, custodial and other fees translate into lower costs for
investors.
Liquidity - In open ended schemes investors can get their money back
promptly at net asset value related prices from the mutual fund itself.
Transparency - Investors get regular information in the value of their
investment in addition to disclosure on the specific investments made by
scheme, the proportioninvested in each class of assets and the fund
manager’s investment strategy and outlook.
25. DISADVANTAGES OF MUTUAL FUND
There are certainly some benefits to mutual fund investing, but we should also be
aware of the drawbacks associated with mutual funds.
No Insurance - Mutual funds, although regulated by the government,
are not insured against losses. The Federal Deposit Insurance Corporation
(FDIC) only insured against certain losses at Banks, credit unions and
savings and loans not mutual funds.
Dilution - Although diversification reduces the amount of risk involved
in investing in mutual funds, It can also be a disadvantage due to dilution.
For Example: If a single security held by a mutual funds double in value
because that security is only one small part’s of funds holding.
26. Fees and expenses - Most mutual fund charge management and
operating fees that pay for the fund’s management expenses( usually
around 1.0% to 1.5%per year for actively managed funds.
Poor Performance - Returns on a Mutual Funds are by no means
guaranteed. In fact, on average, around 75% of all Mutual Funds fail to
beat the major market indexes like the S&P 500, and a growing number
of critics now question whether or not professional managers have better
stock-picking capabilities than the average investor.
Loss of Control - The managers of Mutual Fund make all of the
decisions about which securities are to buy or sell and what to do so.
Trading Limitations - Although Mutual Funds are highly liquid in
general, most mutual funds ( called open ended mutual funds) cannot be
bought or sold in the middle of the trading day.
Size - Some mutual Funds are too big to find enough good investments.
This is a especially true of funds that focus on small companies, given
that there are strict rules about how much of single company a fund may
own. Forexample if a mutual fund has $50 million in each, then it needs
to find at least 100 such companies to invest in, as a result the fund might
be forced to lower its standards when selecting companies to invest in.
Inefficiency of Cash Reserves - Mutual Funds usually maintain large
cash reserves as protection against a large number of simultaneous
withdrawals.
27. INVESTMENTS AND CLASSIFICATION
Mutual funds are normally classified by their principal investments, as described in
the prospectus and investment objective. The four main categories of funds are
money market funds, bond or fixed income funds, stockor equity funds and hybrid
funds. Within these categories, funds may be subclassified by investment
objective, investment approach or specific focus. The SEC requires that mutual
fund names be consistent with a fund's investments. Forexample, the "ABC New
Jersey Tax-Exempt Bond Fund" would generally have to invest, under normal
circumstances, at least 80% of its assets in bonds that are exempt from federal
income tax, from the alternative minimum tax and from taxes in the state of New
Jersey.
Bond, stock, and hybrid funds may be classified as either index (passively
managed) funds or actively managed funds.
Money market funds
Money market funds invest in money market instruments, which are fixed income
securities with a very short time to maturity and high credit quality. Investors often
use money market funds as a substitute for bank savings accounts, though money
market funds are not insured by the government, unlike bank savings accounts.
Money market funds strive to maintain a $1.00 per share net asset value, meaning
that investors earn interest income from the fund but do not experience capital
gains or losses. If a fund fails to maintain that $1.00 per share because its securities
have declined in value, it is said to "break the buck". Only two money market
funds have ever broken the buck—Community Banker's U.S. Government Money
Market Fund in 1994 and the Reserve Primary Fund in 2008.
In 2014, the SEC approved significant changes in money market fund regulation.
Beginning in October2016, money market funds that are sold to institutional
investors and that invest in non-government securities will no longer be allowed to
maintain a stable $1.00 per share net asset value. Instead, these funds will be
required to have a floating net asset value.
At the end of 2013, money market funds accounted for 18% of open-end fund
assets.
Bond funds
28. Bond funds invest in fixed income or debt securities. Bond funds can be
subclassified according to the specific types of bonds owned (such as high-yield or
junk bonds, investment-grade corporatebonds, government bonds or municipal
bonds)and by the maturity of the bonds held (short-, intermediate- or long-term).
Bond funds may invest in primarily U.S. securities (domestic or U.S. funds), in
both U.S. and foreign securities (global or world funds), or primarily foreign
securities (international funds).
At the end of 2013, bond funds accounted for 22% of open-end fund assets.
Stock funds
Stockor equity funds invest in common stocks which represent an ownership share
(or equity) in corporations. Stockfunds may invest in primarily U.S. securities
(domestic or U.S. funds), in both U.S. and foreign securities (global or world
funds), or primarily foreign securities (international funds). They may focus on a
specific industry or sector.
A stockfund may be subclassified along two dimensions: (1) market capitalization
and (2) investment style (i.e., growth vs. blend/core vs. value). The two dimensions
are often displayed in a grid known as a "style box".
Market capitalization ("cap")indicates the size of the companies in which a fund
invests, based on the value of the company's stock. Each company's market
capitalization equals the number of shares outstanding times the market price of
the stock. Market capitalizations are typically divided into the following
categories, with approximate market capitalizations in parentheses:
Micro cap (below $300 million)
Small cap (below $2 billion)
Mid cap
Large cap (at least $10 billion)
Funds can also be classified in these categories based on the market caps of the
stocks that it holds.
Stockfunds are also subclassified according to their investment style: growth,
value, or blend (or core). Growth funds seek to invest in stocks offast-growing
29. companies. Value funds seek to invest in stocks that appear cheaply priced. Blend
funds are not biased toward either growth or value.
At the end of 2013, stockfunds accounted for 52% of the assets in all U.S. mutual
funds.
Hybrid funds
Hybrid funds invest in both bonds and stocks or in convertible securities. Balanced
funds, asset allocation funds, target date or target risk funds and lifecycle or
lifestyle funds are all types of hybrid funds.
Hybrid funds may be structured as funds of funds, meaning that they invest by
buying shares in other mutual funds that invest in securities. Many fund of funds
invest in affiliated funds (meaning mutual funds managed by the same fund
sponsor), although some invest in unaffiliated funds (i.e., managed by other fund
sponsors)orsome combination of the two.
At the end of 2013, hybrid funds accounted for 8% of the assets in all U.S. mutual
funds.
Index (passively managed) versus actively managed
An index fund or passively managed fund seeks to match the performance of a
market index, such as the S&P 500 index, while an actively managed fund seeks to
outperform a relevant index through superior security selection.
EXPENSES
Investors in a mutual fund pay the fund's expenses. These expenses fall into five
categories: management fee, distribution charges (sales loads and 12b-1 fees), the
management fee, securities transaction fees, shareholder transaction fees and fund
services charges. Some of these expenses reduce the value of an investor's account;
others are paid by the fund and reduce net asset value.
Recurring fees and expenses—specifically the 12b-1 fee, the management fee and
other fund expenses—are included in a fund's total expense ratio (TER), often
30. referred to simply the "expense ratio". Because all funds must compute an expense
ratio using the same method, investors may compare costs acrossfunds.
There is considerable controversy about the level of mutual fund expenses.
Management fee
The management fee is paid to the management company or sponsorthat organizes
the fund, provides the portfolio management or investment advisory services and
normally lends its brand to the fund. The fund manager may also provide other
administrative services. The management fee often has breakpoints, which means
that it declines as assets (in either the specific fund or in the fund family as a
whole) increase. The management fee is paid by the fund and is included in the
expense ratio.
The fund's board reviews the management fee annually. Fund shareholders must
vote on any proposedincrease, but the fund manager or sponsorcan agree to waive
some or all of the management fee in order to lower the fund's expense ratio.
Distribution charges
Distribution charges pay for marketing, distribution of the fund's shares as well as
services to investors. There are three types of distribution charges:
Front-end load or sales charge. A front-end load or sales charge is a
commission paid to a broker by a mutual fund when shares are purchased. It
is expressed as a percentage of the total amount invested or the "public
offering price", which equals the net asset value plus the front-end load per
share. The front-end load often declines as the amount invested increases,
through breakpoints. The front-end load is paid by the shareholder; it is
deducted from the amount invested.
Back-end load. Some funds have a back-end load, which is paid by the
investor when shares are redeemed. If the back-end load declines the longer
the investor holds shares, it is called a contingent deferred sales charges
31. (CDSC). Like the front-end load, the back-end load is paid by the
shareholder; it is deducted from the redemption proceeds.
12b-1 fees. Some funds charge an annual fee to compensate the distributor
of fund shares for providing ongoing services to fund shareholders. This fee
is called a 12b-1 fee, after the SEC rule authorizing it. The 12b-1 fee is paid
by the fund and reduces net asset value.
A no-load fund does not charge a front-end load or back-end load under any
circumstances and does not charge a 12b-1 fee greater than 0.25% of fund assets.
Securities transaction fees
A mutual fund pays expenses related to buying or selling the securities in its
portfolio. These expenses may include brokerage commissions. Securities
transaction fees increase the costbasis of investments purchased and reduce the
proceeds from their sale. They do not flow through a fund's income statement and
are not included in its expense ratio. The amount of securities transaction fees paid
by a fund is normally positively correlated with its trading volume or "turnover".
Shareholder transaction fees
Shareholders may be required to pay fees for certain transactions. For example, a
fund may charge a flat fee for maintaining an individual retirement accountfor an
investor. Some funds charge redemption fees when an investor sells fund shares
shortly after buying them (usually defined as within 30, 60 or 90 days of purchase);
redemption fees are computed as a percentage of the sale amount. Shareholder
transaction fees are not part of the expense ratio.
Fund services charges
A mutual fund may pay for other services including:
Board of directors or trustees fees and expenses
Custodyfee: paid to a custodian bank for holding the fund's portfolio in
safekeeping and collecting income owed on the securities
Fund administration fee: for overseeing all administrative affairs such as
preparing financial statements and shareholder reports, SEC filings,
32. monitoring compliance, computing total returns and other performance
information, preparing/filing tax returns and all expenses of maintaining
compliance with state blue sky laws
Fund accounting fee: for performing investment or securities accounting
services and computing the net asset value (usually every day the New York
StockExchange is open)
Professional services fees: legal and auditing fees
Registration fees: paid to the SEC and state securities regulators
Shareholder communications expenses: printing and mailing required
documents to shareholders such as shareholder reports and prospectuses
Transfer agent service fees and expenses: for keeping shareholder records,
providing statements and tax forms to investors and providing telephone,
internet and or other investor supportand servicing
Other/miscellaneous fees
The fund manager or sponsormay agree to subsidize some of these other expenses
in order to lower the fund's expense ratio.
Controversy
Critics of the fund industry argue that fund expenses are too high. They believe
that the market for mutual funds is not competitive and that there are many hidden
fees, so that it is difficult for investors to reduce the fees that they pay. They argue
that the most effective way for investors to raise the returns they earn from mutual
funds is to invest in funds with low expense ratios.
Fund managers counter that fees are determined by a highly competitive market
and, therefore, reflect the value that investors attribute to the service provided.
They also note that fees are clearly disclosed.
SHARE CLASSES
A single mutual fund may give investors a choice of different combinations of
front-end loads, back-end loads and 12b-1 fees, by offering several different types
of shares, known as share classes. All of them invest in the same portfolio of
securities, but each has different expenses and, therefore, a different net asset value
and different performance results. Some of these share classes may be available
only to certain types of investors.
33. Funds offering multiple classes often identify them with letters, though they may
also use names such as "Investor Class", "Service Class", "Institutional Class", etc.,
to identify the type of investor for which the class is intended. The SEC does not
regulate the names of share classes, so that specifics of a share class with the same
name may vary from fund family to fund family.
Typical share classes for funds sold through brokers or other intermediaries are as
follows:
Class A shares usually charge a front-end sales load together with a small
12b-1 fee.
Class B shares usually do not have a front-end sales load; rather, they have a
high contingent deferred sales charge (CDSC) that gradually declines over
several years, combined with a high 12b-1 fee. Class B shares usually
convert automatically to Class A shares after they have been held for a
certain period.
Class C shares usually have a high 12b-1 fee and a modest contingent
deferred sales charge that is discontinued after one or two years. Class C
shares usually do not convert to another class. They are often called "level
load" shares.
Class I are usually subject to very high minimum investment requirements
and are, therefore, known as "institutional" shares. They are no-load shares.
Class R are usually for use in retirement plans such as 401(k) plans. They
typically do not charge loads, but do charge a small 12b-1 fee.
No-load funds often have two classes of shares:
Class I shares do not charge a 12b-1 fee
Class N shares charge a 12b-1 fee of no more than 0.25% of fund assets
Neither class of shares typically charges a front-end or back-end load.
34. HOW TO INVEST IN MUTUAL FUNDS?
Procedure
Prospective investor who wish to invest in mutual funds have to contact a
distributor / agent of mutual funds. Any good distributor/ agent would be able to
suggest us the appropriate funds from the plethora of funds available.
The normal procedure is to -
Fill up the required application form and submit it along with a cheque for
the amount of investment.
Cheque and demand drafts are accepted
Payment by cash is not allowed.
The agent/ Distributor would submit the application form with the cheque to
the mutual fund company.
The mutual fund company would issue us an Account Statement with 4
working days from the date of investment.
MINIMUM AMOUNT OF INVESTMENT
The minimum amount of investment differs from scheme to scheme and from
company to company. However, the lowest amount of minimum initial investment
is Rs. 1,000 and the minimum additional investment is Rs. 500.
35. WHO CAN INVEST IN MUTUAL FUNDS?
Resident Indians
Non- Resident Indians (NRI)
Persons of Indian Origin (POI)
Indian Public Sectors Undertakings
Indian Private Sectors Undertakings
Parents/ Guardians on behalf of Minors
Wakf Boards
Hindu Undivided Family
Sole Proprietorship Firms
Partnership Firms
Cooperative Societies
Charitable of Religious Trusts
Trustee, AMC or sponsoroftheir associates
Endowment or Registered Societies
Army/ Air force /navy and other eligible institutions
Scientific and/ or industrial research organizations
And other associations, institutions, bodies etc authorized to invest in mutual
funds.
36. IMPACT OF UNION BUDGET 2014-15 ON
MUTUAL FUNDS
Increase in the long ‐ term capital gains tax rate 20% with
indexation and the tenure from 1 to 3 years (other than a unit of
equity oriented fund): So far, the period of holding in debt mutual funds
for qualifying it as short ‐ term capital gain is not more than 12 months while
for qualifying as long ‐ term capital gain is more than 12 months. Now it is
proposedthat the short ‐ term capital gain is applicable for debt oriented
funds if the units are held for not more than 36 months. Further, the Finance
Minister has proposed to do away with the option of paying LTCG of 10.
3% (without indexation) meaning that these will now be taxed @ 20.6%
with indexation. So far, the long ‐ term capital gain is taxed at 20.6 % with
indexation or 10.3% without indexation whichever is lower. This will impact
the investments in debtmutual funds for investors those who want to invest
in with the time horizon of 1 to 3 years. Anyway, redemptions made in debt
mutual funds within one year are considered as short term and taxed as per
the investors’ tax bracket. So far, FMPs have been attractive option for
double indexation benefit with the maturity of not less than 366 days
wherein an investor can get the benefit of indexation by spreading the
investment across two or three Financial Years (if he invest in FMP with the
maturity of not less than 366 days on 31s t march of a year). Now, the FMPs
or any funds other than equity oriented funds will lose out the benefit.
However, the indexation benefit is available if the investments in FMPs or
any funds other than equity oriented funds for at least 3 years. This is
applicable from 1st April 2015. Doubt exists about applicability of new
37. provisions to amounts withdrawn after April 01, 2014. Interestingly,
investing in debt instruments such as listed NCDs still retain the benefit of
long ‐ term capital gains. That means the NCDs that are sold after a year are
long ‐ term capital assets and the gains are taxed with the rate of 10.3 % (the
indexation benefit is not available for bonds and debentures) . A sum of
more than 1.6 lakh crores has been invested in FMPs by various categories
of investors. If this proposalis implemented, most of these monies will not
get renewed and the month of Feb and Mar 2015 could see turbulence in the
interbank market to copewith this redemption (though it could be
temporary).
Change in the methodology of calculating Dividend Distribution
Tax (DDT): Any dividends which are declared from mutual funds are
exempted from tax in the hands of investors. However, in debtmutual funds,
AMCs pay Dividend Distribution Tax (DDT) from the distributable income
at the rate of 28.345% (including surcharge and cess)(for Individuals and
HUF investors). Interestingly, as far as effective tax rate on DDT is
concerned, the effective rates are lower for investors as the DDT is
calculated on actual dividend distributed and not on gross amount distributed
(including the tax impact). But for an investor, the tax saved is calculated
based on gross returns of his investment. For instance, out of Rs.1of
distributable income, the AMC has to pay DDT on the dividend of retail
investors based on the following formula. That is (x + 28.33% of x = Re 1).
Here, “x” denotes the dividend portion for retail investors. The result
becomes (0.7793 paisa dividend + 0.2207 paisa DDT = Re. 1). Hence, the
effective tax r ate for retail investors (on the income distributed) will come
close to 22.07% and not 28.33%. In a nutshell, we can say that the AMC has
38. to pay 28. 33% on the dividend of retail investors which is the same as 2
2.07% tax on the gross returns of the investment of the investors.
RECENT DEVELOPMENTS
To attract retail investors, mutual fund houses are tapping social media platforms
like WhatsApp and a host of other calling and messaging apps to facilitate
transactions in MF products. Thesenew facilities will help investors in buying or
selling mutual fund (MF) products in a simpler and faster manner, experts said.
Mutual fund houses that have adopted digital modes such as Internet and mobiles
for increasing distribution of MF products include Axis MF, Reliance MF, UTI
MF, L&T MF, Quantum MF and ICICI Prudential MF. Besides, several fund
houses are allowing customers to invest, redeem and switch funds using their
mobile phones and a host of mutual funds are gearing up to adoptdigital
technology to tap investors. Quantum MF is offering WhatsApp facility to either
transact or see mutual fund portfolios. L&T MF has introduced a new service
“Goinvest” where customers can track their investments on Facebook. Besides,
Axis MF's Easy Services that includes EasyCall, EasySms, EasyApp provide
customers an option to invest in MF schemes through an SMS, using a dedicated
application or by calling up on a designated mobile number. "Digitalization adds a
lot of convenience and comfort for investors in today's world. With the increase in
the Internet reach and number of smart phones, digitalization will always be
preferred by investors," Quantum AMC Head-Customer Delight Harshad
Chetanwala said. "MF houses have been focusing on the online platform for the
investors to transact. The idea is to keep it as simple as possible for the investor to
invest with the AMCs," he added. At present, many fund houses are offering
39. facility for online investment, but industry insiders say that there is a need to
promote and make it more user friendly for investors by improving the
infrastructure and efficiencies. Further, SEBI had also set up an expert panel to
suggest measures for increasing distribution of MF products through digital modes.
According to an estimate, number of Internet-enabled mobile phones in the country
is expected to increase from 10-15 million in 2010 to 300-400 million in 2015.
The Securities and Exchange Board of India (SEBI) is of the view that a greater
use of Internet as a distribution channel can help increase the penetration of mutual
funds, especially among young investors. As per the regulator, the online
phenomenon is growing rapidly as more and more people, especially the younger
generation, prefer to carry out most of transactions online suchas Internet banking,
shopping and ticketing. Nearly 45 fund houses together manage assets worth over
Rs 12 lakh crores in India, but fund mobilization has been a tough task for them in
the past few years. One of the biggest reasons behind this low fund mobilization is
the lack of healthy participation from a large part of the country. A SEBI-
conducted study had said that MF presence in the country is heavily skewed in
favour of top 60 districts. Out of 60 districts, a lion's share of MF presence
originates from Mumbai as the city houses the headquarters of most of the large
companies, thereby getting a bulk of investments through the non-retail or
institutional routes.
40. TAX BENEFITS ON MUTUAL FUNDS
Introduction to Equity Linked Savings Scheme (ELSS)
ELSS is a dedicated mutual fund scheme that allows investors to save tax. It
also provides an opportunity for long term capital appreciation. An ELSS
fund manager invests in a diversified portfolio, predominantly consisting of
equity and equity related instruments that carry high-risk and have the
potential to deliver high-returns.
Since it is an equity fund, the returns from this scheme are market
determined.
Features of ELSS Funds
1. Tax-saving
2. Three-year lock-in period
3. Can be held even after the completion of three years
4. Offers dividend as well as growth options
5. Tax Saving instrument
Tax Treatment
The returns from an ELSS fund are tax free in your hands. The long term
capital gains from an ELSS are tax free as well. This is because no tax is
levied on equities that are held for more than a year.
Since an ELSS falls under section 80C, you can claim up to Rs. 1, 00,000
from your investment as a deduction from your gross total income.
41. ADVANTAGES OF ELSS OVER OTHER
TAX SAVING SCHEMES
Lower Lock-in Period: An ELSS has a lower lock-in period as compared to
other tax saving instruments. I.e. while a Tax Saving Fixed Deposit needs to be
locked in for five years and a NCS for six years, an ELSS has a lock-in period of
only three years. PPF investments have the highest lock-in period of 15 years.
Opportunity for Long Term Capital Gains: Since an ELSS fund invests in
equities, and is dynamically managed by a professionalfund manager, it has the
potential to provide long term capital gains compared to other passively managed
asset classes.
Systematic Savings: You no longer have to worry about making hasty last-
minute lump-sum investments for saving tax. One can plan effectively and invest
in ELSS through the SIP (Systematic Investments Plans) route.
Challenges
One needs to bear in mind that the returns of the ELSS schemes are determined by
the performance of the equity market.
42.
43. CONCLUSION
Some of the measures taken by SEBI should help the mutual fund
Industry to move ahead with greater Confidence on its Growth
Trajectory.
However, Implementation challenges continue to be an area of
Focus for most mutual funds and the Growing size complexity
Of regulations and compliance requirements are often a source
Of Tension within such Organisation.
