Strategy of operations of mutual funds with special emphasis on debt funds
Summer Internship Project Report onSTRATEGY OF OPERATIONS OF MUTUAL FUNDS WITH SPECIAL EMPHASIS ON DEBT FUNDS By Sudhanshu Gupta A0101910253 MBA (Class of 2012) Under the Supervision of Ms. Lakhwinder Kaur Dhillon Department of Finance In Partial Fulfillment of the Requirements for the Degree of Master of Business Administration – General At AMITY BUSINESS SCHOOL AMITY UNIVERSITY UTTAR PRADESHSECTOR 125, NOIDA - 201303, UTTAR PRADESH, INDIA 2012
Reliance Mutual Funds Sudhanshu Gupta DECLARATIONTitle of Project Report – Strategy of Operations of Mutual Funds with Special Emphasis onDebt FundsI declare (a) That the work presented for assessment in this Summer Internship Report is my own, that it has not previously been presented for another assessment and that my debts (for words, data, arguments and ideas) have been appropriately acknowledged. (b) That the work conforms to the guidelines for presentation and style set out in the relevant documentation.Date: 25th July, 2011 Sudhanshu Gupta A0101910253 MBA – Class of 2012 ii | P a g e
Reliance Mutual Funds Sudhanshu Gupta CERTIFICATEI Ms. Lakhwinder Kaur Dhillon hereby certify that Sudhanshu Gupta student of Masters ofBusiness Administration – General at Amity Business School, Amity University UttarPradesh has completed the Project Report on ―Strategy of Operations of Mutual FundsWith Special Emphasis on Debt Funds‖, under my guidance. Ms. Lakhwinder Kaur Dhillon Department of Finance iii | P a g e
Reliance Mutual Funds Sudhanshu Gupta ACKNOWLEDGEMENTSAn undertaking of work life - this is never an outcome of a single person; rather it bears theimprints of a number of people who directly or indirectly helped me in completing the presentstudy. I would be failing in my duties if I don‗t say a word of thanks to all those who made mytraining period educative and pleasurable one. I am thankful to RELIANCE MUTUAL FUND,NOIDA for giving me an opportunity to do summer training in the company.First of all, I am extremely grateful to Mr. Saurabh Kapoor (Relationship Manager) for hisguidance, encouragement and tutelage during the course of the internship despite his extremelybusy schedule. My very special thanks to him for giving me the opportunity to do this projectand for his support throughout as a mentor.My thanks to Mr. Harsh Chaturvedi (Opulence Services Ltd) and the whole staff of RelianceMutual Funds who gave me continuous support in every possible manner to gain practicalknowledge in the Industry.I would also like to thank all the respondents for giving their precious time and relevantinformation and experience, I required, without which the Project would have beenincomplete.Finally I would like to thank all lecturers, friends and my family for their kind support and to allwho have directly or indirectly helped me in preparing this project report. And at last I amthankful to all divine light and my parents, who kept my motivation and zest for knowledgealways high through the tides of time. iv | P a g e
Reliance Mutual Funds Sudhanshu GuptaTABLE OF CONTENTSDECLARATION ............................................................................................................................................... iiCERTIFICATE ................................................................................................................................................. iiiACKNOWLEDGEMENTS ................................................................................................................................ ivTABLE OF CONTENTS..................................................................................................................................... vABSTRACT..................................................................................................................................................... viCHAPTER 1: INTRODUCTION TO THE COMPANY – RELIANCE MUTUAL FUND ............................................. 1CHAPTER 2: INTRODUCTION TO MUTUAL FUNDS ........................................................................................ 6CHAPTER 3: INDUSTRY ANALYSIS – MUTUAL FUNDS IN INDIA................................................................... 16CHAPTER 4: INTRODUCTION TO THE STUDY............................................................................................... 25CHAPTER 5: INVESTMENT AVENUES FOR MUTUAL FUNDS ........................................................................ 27CHAPTER 6: FIXED INCOME FUNDS ............................................................................................................ 34CHAPTER 7: REVIEW OF LITERATURE .......................................................................................................... 40CHAPTER 8: RESEARCH METHODOLOGY .................................................................................................... 43CHAPTER 9: DATA ANALYSIS AND INTERPRETATIONS ................................................................................ 45CHAPTER 10: CONCLUSIONS AND RECOMMENDATIONS ........................................................................... 63REFERENCES ................................................................................................................................................ 65ANNEXURES ................................................................................................................................................ 67 Annexure 1 – Copy of Questionnaire ..................................................................................................... 67 Annexure 2 – Demographic Profile of Respondents............................................................................... 71 v|Page
Reliance Mutual Funds Sudhanshu GuptaABSTRACT A mutual fund is a professionally managed type of collective investment that poolsmoney from many investors to buy stocks, bonds, short-term money market instruments, and/orother securities. Reliance Mutual Fund (RMF/ Mutual Fund) is one of India‘s leading MutualFunds, with Average Assets under Management (AAUM) of Rs. 101259 Crores and an investorcount of over 66.90 Lakh folios. Mutual funds have become an invaluable tool for a wide range of investors, fromindividuals seeking to save for retirement to sophisticated socialites focused on preserving theirassets and businessman determined to create wealth. Mutual funds have opened new vistas tomillions of small investors by virtually taking investment to their very doorstep. The scientificinvestment approach and investor oriented benefits has made the industry grow to over ` 6500trillion by current estimates. This report aims at studying the Mutual Fund industry in the Indian economy, understandits operations and study the regulations and other legal requirements of the industry. The studyalso comprises of a survey of retail investors to study their fund selection behavior and extractthe factors affecting their behavior using Principal Component Extraction Method of FactorAnalysis. As per the study, the most important fund related qualities are Intrinsic Fund Qualities,Flexibility and Consistency, and Brand Image. Similarly, the most important Investor RelatedServices are Transparency in Disclosures, Customer Comfort and Accessibility, and AfterSale Benefits and Services. MF industry in India has a large untapped market in urban areas besides the virginmarkets in semi-urban and rural areas. This market potential can be tapped by scrutinizinginvestor behavior to identify their expectations and articulate investors own situation and riskpreference and then apply to an investment strategy that combines the usual four: cash andequivalents, Government-backed bonds, debt, and equity. vi | P a g e
Reliance Mutual Funds Sudhanshu Gupta Page |1 CHAPTER 1: INTRODUCTION TO THE COMPANY – RELIANCE MUTUAL FUND Reliance Mutual Fund (RMF/ Mutual Fund) is one of India‘s leading Mutual Funds, with Average Assets under Management (AAUM) of Rs. 101259 Crores and an investor count of over 66.90 Lakh folios. Reliance Mutual Fund, a part of the Reliance Group, is one of the fastest growing mutual funds in India. RMF offers investors a well-rounded portfolio of products to meet varying investor requirements and has presence in 159 cities across the country. Reliance Mutual Fund constantly endeavors to launch innovative products and customer service initiatives to increase value to investors. Reliance Capital Asset Management Limited (‗RCAM‘) is the asset manager of Reliance Mutual Fund. RCAM a subsidiary of Reliance Capital Limited, which holds 93.37% of the paid-up capital of RCAM, the balance paid up capital being held by minority shareholders. Reliance Capital Ltd. is one of India‘s leading and fastest growing private sector financial services companies, and ranks among the top 3 private sector financial services and banking companies, in terms of net worth. Reliance Capital Ltd. has interests in asset management, life and general insurance, private equity and proprietary investments, stock broking and other financial services. The main objectives of the Reliance Mutual Fund are:• To carry on the activity of a Mutual Fund as may be permitted at law and formulate and devise various collective Schemes of savings and investments for people in India and abroad and also ensure liquidity of investments for the Unit holders;• To deploy Funds thus raised so as to help the Unit holders earn reasonable returns on their savings and• To take such steps as may be necessary from time to time to realize the effects without any limitation.
Reliance Mutual Funds Sudhanshu Gupta Page |2Vision Statement To be a globally respected wealth creator with an emphasis on customer care and aculture of good corporate governanceMission Statement To create and nurture a world-class, high performance environment aimed at delightingour customers.The Sponsor: Reliance Mutual Fund schemes are managed by Reliance Capital Asset ManagementLimited, a subsidiary of Reliance Capital Limited, which holds 92.93% of the paid-up capital ofReliance Capital Asset Management Limited, the balance paid up capital being held by minorityshareholders. Reliance Mutual Fund (RMF) has been sponsored by Reliance Capital Ltd (RCL). The promoter of RCL is AAA Enterprises Private Limited.Reliance Capital Limited is a Non-Banking Finance Company and is one of the India‘s leadingand fastest growing financial services companies, and ranks among the top three private sectorfinancial services and banking companies in India, in terms of net worth.SCHEMES OF RELIANCE MUTUAL FUND The aim of growth funds is to provide capital appreciation over the medium to long-term. Such schemes normally invest a major part of their corpus in equities. Such funds havecomparatively high risks. These schemes provide different options to the investors like dividendoption, capital appreciation, etc. and the investors may choose an option depending on theirpreferences
Reliance Mutual Funds Sudhanshu Gupta Page |3Equity/growth schemes The aim of growth funds is to provide capital appreciation over the medium to long-term. Such schemes normally invest a major part of their corpus in equities. Such funds havecomparatively high risks. These schemes provide different options to the investors like dividendoption, capital appreciation, etc. and the investors may choose an option depending on theirpreferences. The investors must indicate the option in the application form. The mutual fundsalso allow the investors to change the options at a later date. Growth schemes are good forinvestors having a long-term outlook seeking appreciation over a period of time. • Diversified large cap • Diversified multi cap • Diversified mid cap and small cap • Index • Balanced • Tax saverDebt/Income Schemes The aim of income funds is to provide regular and steady income to investors. Suchschemes generally invest in fixed income securities such as bonds, corporate debentures,Government securities and money market instruments. Such funds are less risky compared toequity schemes. These funds are not affected because of fluctuations in equity markets.However, opportunities of capital appreciation are also limited in such funds. The NAVs of suchfunds are affected because of change in interest rates in the country. If the interest rates fall,NAVs of such funds are likely to increase in the short run and vice versa. However, long terminvestors may not bother about these fluctuations. • Ultra short term • Short term funds • Monthly income plans
Reliance Mutual Funds Sudhanshu Gupta Page |4 • Money market funds • Long term fundsGold Schemes Gold is seen as a symbol of security and a sign of prosperity. Indian consumers considergold jewelry as an investment and are well aware of gold‘s benefits as a store of value. Gold isalso recognized as a form of money in India, a tradable liquid asset. It is one of the foundationassets for Indian households and a means to accumulate wealth from a long term perspective.Gold investment has been in the culture of Indian tradition and has been on rise amongst themodern investors as well due to the financial uncertainty and inflationary pressures. • Gold exchange traded funds • Gold saving fundsTHE CORPORATE GOVERNANCEThe Corporate Governance Policy: Reliance Capital Asset Management Limited has a vision of being a leading player in themutual fund business and has achieved significant success and visibility in the market.However, an imperative part of growth and visibility is adherence to good conduct in themarketplace. At Reliance Capital Asset Management Limited, the implementation andobservance of ethical processes and policies has helped it in standing up to the scrutiny of itsdomestic and international investors.Management: The management at Reliance Capital Asset Management Limited is committed to goodcorporate governance, which includes transparency and timely dissemination of information toits investors and unit holders. The Board of Directors of RCAM is a professional bodyconstituting inter-alia of, well-experienced and knowledgeable independent members. Regularaudit committee meetings are conducted to review the operations and performance of thecompany.
Reliance Mutual Funds Sudhanshu Gupta Page |5Employees: Reliance Capital Asset Management Limited has at present, a code of conduct for all itsofficers. It has a clearly defined prohibition on insider trading policy and regulations. Themanagement believes in the principles of propriety and utmost care is taken while handlingpublic money, making proper and adequate disclosures. All personnel at RCAM are made aware of their rights, obligations and duties as part ofthe Dealing Policy laid down in terms of SEBI guidelines. They are taken through a well-designed HR program, conducted to impart work ethics, the Code of Conduct, informationsecurity, Internet and e-mail usage and a host of other issues. One of the core objectives of RCAM is to identify issues considered sensitive by globalcorporate standards, and implement policies/guidelines in conformity with the best practices asan ongoing process.
Reliance Mutual Funds Sudhanshu Gupta Page |6CHAPTER 2: INTRODUCTION TO MUTUAL FUNDS Mutual funds have become an invaluable tool for a wide range of investors, fromindividuals seeking to save for retirement to sophisticated socialites focused on preserving theirassets and businessman determined to create wealth. In its most basic form, a mutual fund is a company that pool money from a group ofpeople with common investment goals to buy securities such as stocks, bonds, money marketinstruments, a combination of these investments, or even other funds. It is a professionallymanaged type of collective investment scheme that pools money from many investors andinvests it in stocks, bonds, short-term money market instruments and other securities. Mutualfunds have a fund manager who invests the money on behalf of the investors by buying / sellingstocks, bonds etc. Currently, the worldwide value of all mutual funds totals more than $US 26trillion. There are various investment avenues available to an investor such as real estate, bankdeposits, post office deposits, shares, debentures, bonds etc. A mutual fund is one more type ofInvestment Avenue available to investors. Mutual fund is a trust that pools the savings of a number of investors who share acommon financial goal. This pool of money is invested in accordance with a stated objective.The joint ownership of the fund is thus ―Mutual‖, i.e. the fund belongs to all investors. Themoney thus collected is then invested in capital market instruments such as shares, debenturesand other securities. The income earned through these investments and the capital appreciationsrealized are shared by its unit holders in proportion the number of units owned by them. Thus aMutual Fund is the most suitable investment for the common man as it offers an opportunity toinvest in a diversified, professionally managed basket of securities at a relatively low cost. AMutual Fund is an investment tool that allows small investors access to a well- diversifiedportfolio of equities, bonds and other securities. Each shareholder participates in the gain or lossof the fund. Units are issued and can be redeemed as needed. The funds‘ Net Asset value (NAV)is determined each day.
Reliance Mutual Funds Sudhanshu Gupta Page |7 Investments in securities are spread across a wide cross-section of industries and sectorsand thus the risk is reduced. Diversification reduces the risk because all stocks may not move inthe same direction in the same proportion at the same time. Mutual fund issues units to theinvestors in accordance with quantum of money invested by them. Investors of mutual funds areknown as unit holders. CONCEPT OF MUTUAL FUNDS Many investors with common financial objectives pool their money. Investors, on a proportinate basis , get mutual fund units for the sum contributed to the pool The money collected from investors is invested into shares, debentures and other securities by the fund manager. The fund manager realizes gains or losses, and collects dividend or interest income. Any capital gains or losses from such investments are passed on to the investors in proportion of the number of units held by them.
Reliance Mutual Funds Sudhanshu Gupta Page |8 When an investor subscribes for the units of a mutual fund, he becomes part owner of theassets of the fund in the same proportion as his contribution amount put up with the corpus (thetotal amount of the fund). Mutual Fund investor is also known as a mutual fund shareholder or aunit holder. Any change in the value of the investments made into capital market instruments (such asshares debentures etc.) is reflected in the Net Asset Value (NAV) of the scheme. NAV is definedas the market value of the Mutual Fund schemes assets net of its liabilities. NAV of a scheme iscalculated by dividing the market value of schemes assets by the total number of units issued tothe investors.ADVANTAGES OF MUTUAL FUNDS: If mutual funds are emerging as the favorite investment vehicle, it is because of the manyadvantages they have over other forms and the avenues of investing, particularly for the investorwho has limited resources available in terms of capital and the ability to carry out detailedresearch and market monitoring. The following are the major advantages offered by mutualfunds to all investors:1. Portfolio Diversification: Each investor in the fund is a part owner of all the fund‘s assets, thus enabling him to hold a diversified investment portfolio even with a small amount of investment that would otherwise require big capital.2. Professional Management: Even if an investor has a big amount of capital available to him, he benefits from the professional management skills brought in by the fund in the management of the investor‘s portfolio. The investment management skills, along with the needed research into available investment options, ensure a much better return than what an investor can manage on his own.
Reliance Mutual Funds Sudhanshu Gupta Page |93. Reduction/Diversification of Risk: When an investor invests directly, all the risk of potential loss is his own, whether he places a deposit with a company or a bank, or he buys a share or debenture on his own or in any other from. While investing in the pool of funds with investors, the potential losses are also shared with other investors. The risk reduction is one of the most important benefits of a collective investment vehicle like the mutual fund.4. Reduction of Transaction Costs: What is true of risk as also true of the transaction costs. The investor bears all the costs of investing such as brokerage or custody of securities. When going through a fund, he has the benefit of economies of scale; the funds pay lesser costs because of larger volumes, a benefit passed on to its investors.5. Liquidity: Often, investors hold shares or bonds they cannot directly, easily and quickly sell. When they invest in the units of a fund, they can generally cash their investments any time, by selling their units to the fund if open-ended, or selling them in the market if the fund is close-end. Liquidity of investment is clearly a big benefit.6. Convenience and Flexibility: Mutual fund management companies offer many investor services that a direct market investor cannot get. Investors can easily transfer their holding from one scheme to the other; get updated market information and so on.7. Choice of Schemes: Mutual Funds offer a family of schemes to suit your varying needs over a lifetime8. Well Regulated: All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 109. Transparency: You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund managers investment strategy and outlook.DISADVANTAGES OF INVESTING THROUGH MUTUAL FUNDS:1. No Control over Costs: An investor in a mutual fund has no control of the overall costs of investing. The investor pays investment management fees as long as he remains with the fund, albeit in return for the professional management and research. Fees are payable even if the value of his investments is declining.2. No Tailor-Made Portfolio: Investors who invest on their own can build their own portfolios of shares and bonds and other securities. Investing through fund means he delegates this decision to the fund managers. The very-high-net-worth individuals or large corporate investors may find this to be a constraint in achieving their objectives.3. Managing A Portfolio of Funds: Availability of a large number of funds can actually mean too much choice for the investor. He may again need advice on how to select a fund to achieve his objectives, quite similar to the situation when he has individual shares or bonds to select.4. The Wisdom of Professional Management: Thats right, this is not an advantage. The average mutual fund manager is no better at picking stocks than the average nonprofessional, but charges fees.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 115. No Control: Unlike picking your own individual stocks, a mutual fund puts you in the passenger seat of somebody elses car6. Dilution: Mutual funds generally have such small holdings of so many different stocks that insanely great performance by a funds top holdings still doesnt make much of a difference in a mutual funds total performance.7. Buried Costs: Many mutual funds specialize in burying their costs and in hiring salesmen who do not make those costs clear to their clientsFUNDS TYPES1- Based on structure: By Structure Open-Ended Funds Closed-Ended Funds Interval Funds Mutual funds, or unit trusts, are called open-end funds because they are required to buyback shares, or units, from the shareholders at any time at a price based on the current value ofthe fund‘s net assets. They are available for subscription all throughout the year. These do nothave a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV")related prices. The key feature of open-end schemes is liquidity.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 12 Closed-end funds, or investment trusts, are another type of fund that issues a fixednumber of shares, as in the case of open-end funds. If the shareholders want to exit the fund theymust sell their shares on the market. A closed-end fund has a stipulated maturity period whichgenerally ranging from 3 to 15 years. The fund is open for subscription only during a specifiedperiod. Investors can invest in the scheme at the time of the initial public issue and thereafterthey can buy or sell the units of the scheme on the stock exchanges where they are listed. Inorder to provide an exit route to the investors, some close-ended funds give an option of sellingback the units to the Mutual Fund through periodic repurchase at NAV related prices. SEBIRegulations stipulate that at least one of the two exit routes is provided to the investor. Interval funds are funds that issue or redeem units at pre-specified periods at regularintervals. These combine the features of both open ended and closed ended funds providing anoptimum mix between stability and flexibility. However, interval funds are not very common inthe Indian mutual fund industry and are not much preferred by investors mainly due to lack ofawareness.2- Based on nature By Nature Equity funds Debt funds Balanced funds Gold Funds1. Equity Funds: These funds invest a maximum part of their corpus into equities holdings. The structureof the fund may vary different for different schemes and the fund manager‘s outlook on differentstocks. The Equity Funds are sub-classified depending upon their investment objective, asfollows:
Reliance Mutual Funds Sudhanshu Gupta P a g e | 13 Diversified Equity Funds Mid-Cap Funds Small Cap Funds Sector Specific Funds Tax Savings Funds (ELSS) Equity investments are meant for a longer time horizon, thus Equity funds rank high onthe risk-return matrix.2. Debt Funds: The objective of these Funds is to invest in debt papers. Government authorities, privatecompanies, banks and financial institutions are some of the major issuers of debt papers. Byinvesting in debt instruments, these funds ensure low risk and provide stable income to theinvestors.3. Balanced Funds: As the name suggest they, are a mix of both equity and debt funds. They invest in bothequities and fixed income securities, which are in line with pre-defined investment objective ofthe scheme. These schemes aim to provide investors with the best of both the worlds. Equity partprovides growth and the debt part provides stability in returns. Further the mutual funds can bebroadly classified on the basis of investment parameter viz, each category of funds is backed byan investment philosophy, which is pre-defined in the objectives of the fund. The investor canalign his own investment needs with the funds objective and invest accordingly.4. Gold Funds: A recent addition to the portfolio of the Mutual funds, Gold funds primarily invest inPhysical Gold and related articles like jewelry, gold-bars, coins etc. A common practice intoday‘s industry is to make FoFs (Fund of Funds) of Gold ETFs so as to open the Gold funds toretail investors.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 143- Based on investment objectiveType of fund Main InvestmentsMoney market Short-term fixed income securities like treasury billsGrowth or equity Equities like stocks or income trust unitsBalanced A mix of equities and fixed income securitiesIndex Equities or fixed income securities chosen to mimic a specific index, such as the S&P/TSX Composite IndexIncome Fixed income securities like government bonds and corporate bondsTax Saving Schemes Equity Linked Savings Scheme (ELSS)1. Money Market Schemes: Money Market Schemes aim to provide easy liquidity, preservation of capital andmoderate income. These schemes generally invest in safer, short-term instruments, such astreasury bills, certificates of deposit, commercial paper and inter-bank call money.2. Growth Schemes: Growth Schemes are also known as equity schemes. The aim of these schemes is toprovide capital appreciation over medium to long term. These schemes normally invest a majorpart of their fund in equities and are willing to bear short-term decline in value for possiblefuture appreciation.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 153. Balanced Schemes: Balanced Schemes aim to provide both growth and income by periodically distributing apart of the income and capital gains they earn. These schemes invest in both shares and fixedincome securities, in the proportion indicated in their offer documents (normally 50:50).4. Index Schemes: Index schemes attempt to replicate the performance of a particular index such as the BSESensex or the NSE 50. The portfolio of these schemes will consist of only those stocks thatconstitute the index. The percentage of each stock to the total holding will be identical to thestocks index weightage. And hence, the returns from such schemes would be more or lessequivalent to those of the Index.5. Income Schemes: Income Schemes are also known as debt schemes. The aim of these schemes is to provideregular and steady income to investors. These schemes generally invest in fixed incomesecurities such as bonds and corporate debentures. Capital appreciation in such schemes may belimited.6. Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from timeto time. Under Sec.88 of the Income Tax Act, contributions made to any Equity Linked SavingsScheme (ELSS) are eligible for rebate.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 16CHAPTER 3: INDUSTRY ANALYSIS – MUTUAL FUNDS IN INDIA The economic development model adopted by India in the post-independence era hasbeen characterized by mixed economy with the public sector playing a dominating role and theactivities in private industrial sector control measures emaciated from time to time. Theindustrial policy resolution was introduced by the government in the 1948, immediately after theindependence. This outlined the approach to industrial growth and development. The last twodecades have seen a phenomenal expansion in the geographical coverage and financial spread ofour financial system. The spread of the banking system has been a major factor in promotingfinancial intermediation in the economy and in the growth of financial savings. With thisevolution of the financial sector, the mutual fund industry has also come to occupy an importantplace.Origin By the early - 1930s quite a large number of close - ended mutual funds were in operationin the U.S.A. Much latter in 1954, the committee on finance for the private sector recommendedmobilization of savings of the middle class investors through unit trusts. Finally in July 1964, theconcept took root in India when Unit Trust of India was set up with the twin objective ofmobilizing household savings and investing the funds in the capital market for industrial growth.Household sector accounted for about 80 percent of nation‘s savings and only about one third ofsuch savings was available to the corporate sector; it was felt that UTI could be an effectivevehicle for channelizing progressively larger shares of household savings to productiveinvestments in the corporate sector. The process of economic liberalization in the eighties notonly brought in dramatic changes in the environment for Indian industries, corporate sector andthe capital market but also led to the emergence of demand for newer financial services such asissue management, corporate counseling, capital restructuring and loan syndication. After twodecades of UTI monopoly, recently some other public sector organizations like LIC (1989), GIC(1991), SBI (1987), Can Bank (1987), Indian Bank (1990), Bank of India (1990), PunjabNational Bank (1990) were permitted to set up mutual funds.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 17Current state: Indian Mutual Fund Industry The Indian mutual fund industry has evolved from a single player monopoly in 1964 to afast growing, Competitive market on the back of a strong regulatory framework.AUM Growth The Assets under Management (AUM) have grown at a rapid pace over the past fewyears, at a CAGR of 35 percent for the five-year period from 31 March 2005 to 31 March 20091. Over the 10-year period from 1999 to 2009 encompassing varied economic cycles, theindustry grew at 22 percent CAGR2. This growth was despite two falls in the AUM-the first being after the year 2001 due to thedotcom bubble burst, and the second in 2008 consequent to the global economic crisis (the firstfall in AUM in March 2003 arising from The UTI split).AUM to GDP Ratio The ratio of AUM to India‘s GDP gradually increased from 6 percent in 2005 to 11percent in 2009. Despite this however, this continues to be significantly lower than the ratio indeveloped countries, where the AUM Accounts for 20-70 percent of the GDP.Share of Mutual Funds in Household Financial Savings Investment in mutual funds in India comprised 7.7 Percent of the gross householdfinancial savings in FY 2008, a significant increase from 1.2 percent in FY 2004. The householdsin India continue to hold 55 Percent of their savings in fixed deposits with banks, 18 percent in
Reliance Mutual Funds Sudhanshu Gupta P a g e | 18insurance and 10 percent in currency as of FY 2008. In 2008, the UK had more than thrice theinvestments into mutual funds as a factor of total household savings (26 percent), than India hadin the same time period. As of December 2008, UK households held 61 percent of the totalsavings in bank deposits, 11.6 percent in equities and 1 percent in bonds.The Indian Mutual Fund Industry – Key CharacteristicsCustomers The Indian mutual fund industry has significantly high Ownership from the institutionalinvestors. Retail investors comprising 96.86 percent in number terms held approximately 37percent of the total industry AUM as at the end of March 2008, significantly lower than the retailparticipation in the US at 82 percent of AUM as at December 2008. As per the Invest India Incomes and Savings Survey 2007 of individual wage earners inthe age group 18 to 59 years conducted by IIMS Dataworks, only 1.6 percent invested in mutualfunds. Ninety percent of the savers interviewed were not aware of mutual funds or of investing inmutual funds through a Systematic Investment Plan (SIP). The mutual fund penetration amongthe paid Indian workforce with annual household income less than INR 90,000 was 0.1 percent.In the last few years, the retail investor participation, in particular, in Tier 2 and Tier 3 towns, hasbeen on the rise aided by the buoyant equity markets.Products The Indian mutual fund industry is in a relatively nascent stage in terms of its productofferings, and tends to compete with products offered by the Government providing fixedguaranteed returns. As of December 2010, the total number of mutual fund schemes was 1,182 incomparison to 11,369 funds in the US. Debt products dominate the product mix and comprised 49 percent of the total industryAUM as of FY 2009, while the equity and liquid funds comprised 26 percent and 22 percent
Reliance Mutual Funds Sudhanshu Gupta P a g e | 19respectively. Open-ended funds comprised 99 percent of the total industry AUM as of March2009. As of December 2008, the US mutual fund market comprised money market funds, equityfunds, debt/bond funds and hybrid funds at 40, 39, 16 and 5 percent of the total AUMrespectively.Markets While the mutual fund industry in India continues to be metro and urban centric, themutual funds are beginning to tap Tier 2 and Tier 3 towns as a vital component of their growthstrategy. The contribution of the Top 10 cities to total AUM has gradually declined fromapproximately 92 percent in 2005 to approximately 80 percent currently.Industry Structure The Indian mutual fund industry currently consists of 38 players that have been givenregulatory approval by SEBI. The industry has witnessed a shift has changed drastically in favorof private sector players, as the number of public sector players reduced from 11 in 2001 to 5 in2009. The public sector has gradually ceded market share to the private sector. Public sectormutual funds comprised 21 percent of the AUM in 2009 as against 72 percent AUM share in200122. The industry concentration has been stagnant in the four-year period from 2005 to 2008;the top 5 players comprising 50-52 percent of industry AUM. However, as of March 2009, theshare of Top 5 players increased to 58 percent, as against 38 percent in the US. The AUM shareof the Top 10 players has consistently been in the vicinity of 75 percent. The mutual fund houses based on product portfolio and distribution strategy, the keyelements of competitive strategy, can be segmented into three categories: • The market leaders having presence across all product segments
Reliance Mutual Funds Sudhanshu Gupta P a g e | 20 • Players having dominant focus on a single product segment - debt or equity • Players having niche focus on an emerging product category or distribution channels. The market leaders have focused across product categories for a more diversified AUMbase with an equitable product mix that helps maintain a consistent AUM size. Although theIndian market has relatively low entry barriers given the low minimum net worth required toventure into mutual fund business, existence of a strong local brand and a wide and deepdistribution footprint are the key differentiators.Operations A Mutual Fund is a trust that pools the savings of a number of investors who share acommon financial goal. The money thus collected is then invested in capital market instrumentssuch as shares, debentures and other securities. The income earned through these investmentsand the capital appreciation realized is shared by its unit holders in proportion to the number ofunits owned by them. Thus a Mutual Fund is the most suitable investment for the common manas it offers an opportunity to invest in a diversified, professionally managed basket of securitiesat a relatively low cost. The flow chart below describes broadly the working of a mutual fund: 1) Raising of Money – The asset management companies (AMCs) that manage the mutual funds define avenues where they think profitable opportunities exist. For example, currently many AMCs believe that small and medium cap stocks will yield significant
Reliance Mutual Funds Sudhanshu Gupta P a g e | 21 return over the medium to long term. Hence, they launch a fund (called a new fund offer: NFO) which seeks to bring all those investors together who believe similarly. The AMC releases a prospectus wherein it details the objective of the fund, the credentials of the company and the fund manager and the avenues where the money will be invested. Based on this information, the investor needs to decide whether this fund meets his objective or not. If the investor (or his advisor) believes that the new fund fits his required risk-return profile, the investor invests in the fund.2) Investing – Mutual funds, unlike companies do not take the risk of a business directly. For example, Reliance faces the risk of change in refining margins and Hindalco faces the risk of fall in aluminum prices. Companies take the risk head-on and craft strategies to maximize their competitive position and profits. Mutual funds, however, take one step back and invest in the companies which take on business risks. Funds which invest in the shares (or equity) of the company are called equity mutual funds. Funds like PruICICI Power or Reliance Growth are examples of such funds. Similarly, funds can invest in government securities (bonds issued by central or state governments, PSUs or other government entities) or corporate debt (issued by companies and banks). These funds are called debt funds. Funds like Reliance Income Fund invest primarily in medium and long-tenor debt. Again, there are funds that invest in very short term loans (typically overnight to up to three months): these funds are called money market mutual funds. Examples include HDFC Cash Management - savings plan. Funds may also invest in Precious metals like gold or silver and also commodities like copper or magnesium for instance. While the above four are the basic avenues for the funds to invest, many funds combine the three types in various proportions and produce hybrid or balanced funds. HDFC Prudence and SBI Magnum Balanced are examples.3) Performance and Disclosures - Based on where the funds invest, they expect returns and have corresponding risks. Equity funds are the most risky followed by gold funds and
Reliance Mutual Funds Sudhanshu Gupta P a g e | 22 then debt funds; cash funds are considered almost risk less. Based on the standard theory of finance, the riskiest funds are expected to deliver the highest returns over the long run. Based on the current value of the investments of the fund, the daily NAV (Net Asset Value) is declared by most of the AMCs now-a-days. The NAV is calculated on a per unit basis (i.e. total value of the investment portfolio divided by the total number of units). 4) Distribution of Returns – Based on the option the investor chooses (growth or dividend), the profits or surplus cash is used to declare dividends on regular intervals (monthly, weekly or even daily as specified by the fund). These dividends are then distributed to the investors by either electronic transmission (direct credit to bank accounts) or shipping of cheques. The investors may also liquidate their capital appreciations without any exit load once the mandatory lock-in period (defined in the fund-prospectus) has matured. The Indian mutual fund industry while on a high growth path needs to address efficiencyand customer centricity. AMCs have successfully been using outsourced service providers suchas custodians, Registrar and Transfer Agents (R&T) and more recently, fund accountants, so thatmutual funds can focus on core aspects of their business such as product development anddistribution. Functions that have been outsourced are custody services, fund services, registrarand transfer services aimed at investor servicing and cash management. Managing costs andensuring investor satisfaction continue to be the key goals for all mutual funds today. However,there is likely to be scope for optimizing operations costs given the trend of rising administrativeand associated costs as a percentage of AUM.Regulations Mutual Funds in India are governed by the SEBI (Mutual Fund) Regulations 1996 asamended from time to time. The most recent Master Circular regarding the same was issued bySEBI on January 07, 2011. The Indian mutual fund industry is undergoing a transformation,
Reliance Mutual Funds Sudhanshu Gupta P a g e | 23adapting to the various regulatory changes that are coming about. Some of the key ones whichhave undergone an amendment, impacting the industry as a whole are highlighted here.However, all of them primarily would seem to have the interest of the investor in mind. 1) Entry Load In recent years, the industry regulator, Securities and Exchange Board of India (‗SEBI‘)has focused more on investor protection, introducing a number of regulations to empower retailinvestors in Mutual Funds (‗MFs‘). SEBI began by prohibiting the charging of initial issueexpenses, which were permitted for closed-ended schemes, and mandating that such MF schemesshall recover sales and distribution expenses through entry load only. These steps aimed atcreating more transparency in fees paid by investors and helping make informed investmentdecisions. Subsequently, w.e.f. August 1, 2009, SEBI banned the entry load that was deducted fromthe invested amount, and instead allowed customers the right to negotiate and decidecommissions directly with distributors based on investor‘s assessment of various factors andrelated services to be rendered. The objective was to bring about more transparency incommissions and encourage long-term investment. Though the intent of the amendment was tobenefit the investor, it has hit the margins of the Asset Management Companies (‗AMCs‘). Further, higher distributor commission on Unit Linked Insurance Products (issued byInsurance companies) is giving tough competition to the business of mutual funds. 2) No Additional Management Fees on schemes launched on ―no load ‖ basis SEBI has scrapped the additional management fee of 1% charged by AMCs on schemeslaunched on a no load basis leading to a further squeeze in margins earned by the AMC. 3) Direct Tax Code With the Direct Tax Code (‗DTC‘) on the anvil, taxability of income from mutual funds,at the hands of investors will also have a bearing on the growth of the mutual fund industry.Unlike the extant tax provisions, DTC does not provide for any benefit for investment in equitylinked savings scheme, and also proposes to increase the compliance in the hands of MFs bywidening the scope of deduction of tax to include payments made to residents. The code has also
Reliance Mutual Funds Sudhanshu Gupta P a g e | 24created an anomaly on the taxability of the MF investors. It is unclear whether the income earnedwill be exempt or taxed in the hands of the investors on accrual basis, as stated in the DiscussionPaper on the DTC. 4) Documentation In December 2009, SEBI had made it mandatory for all AMCs to maintain a copy of fullinvestor documentation including Know Your Customer i.e. KYC details. Such documentationwas earlier maintained by the respective MF distributors who have now been asked to give acopy of the same to the fund houses. 5) Disclosure of Investor Complaints in the Annual Report In order to improve the transparency in the ‗grievance redressal mechanism‘, SEBI hasrecently issued a Circular that requires MFs to include details of investor complaints in theirAnnual Report as part of the Report of the Trustees, beginning with the annual report for the year2009-10. MFs provide abridged booklets of the Annual Reports to all the unitholders.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 25CHAPTER 4: INTRODUCTION TO THE STUDYObjectives of the Study – 1) To study the concept of Mutual Funds and its operation and functioning. 2) To analyze the Mutual Fund Industry in India and the competitive position of Reliance Mutual Funds 3) To understand the importance of Debt Funds and study the functional concerns, issues and specific management of the same 4) To study the fund selection behavior of individual investors with special reference to Delhi NCR a. To assess the savings objectives among individual investors. b. To identify the preferred savings avenue among individual investors c. To understand the preferential feature in the savings instrument among individual investors. d. To evaluate fund qualities that would affect the selection of Mutual funds. e. To evaluate investor related services that would affect the selection of Mutual funds 5) To study the various mutual funds managed by Reliance Mutual Funds with special reference to FAST.Context of the study – In India, though the MF industry has been in existence since 1964, (with theestablishment of UTI), very few major studies have been done regarding the investor behavioralaspect with specific reference to MFs, in India. It should be noted that the ―expectations ‖ ofinvestors play a vital role in the financial markets. They influence the price of the securities, thevolume traded and various other financial operations in actual practice. These ‗expectations‘ ofinvestors are influenced by their ―perception‖ and humans generally relate perception to action.The beliefs and actions of many investors are influenced by the dissonance effect andendowment effect.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 26 In general, rules for investment, the analysis of investment and discussion of financialbehavior tend to assume behavior, which is logical and internally consistent in various ways.Investor behavior does not; however, always appear to conform to such expectational norms.Quite the reverse often appears to be the case; Kahneman and Riepe speak of ―CognitiveIllusion‖ the mental equivalent of optical illusion, the assumption being that just as an opticalillusion might lead to inconsistent physical performance relative to the world outside theindividual, so too cognitive illusion will result in inconsistent decision making with respect to theoutside world. Much of economic and financial theory is based on the notion that individuals actrationally and consider all available information in the decision making process. However, in the financial literature, there are no clear models, which explain theinfluence of ―perception‖ and ―beliefs‖ on ―expectations‖ and ―decision making ‖.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 27CHAPTER 5: INVESTMENT AVENUES FOR MUTUAL FUNDSEquity and Equity Related InvestmentsShares In equity share, the shareholders of a company are its owners. As owners, they participatein the management of the company by appointing its board of directors and voicing theiropinions, and voting in the general meetings of the company. At its incorporation, everycompany is authorized to issue a fixed number of shares, each priced at par value, or face valuein India. The face value of shares is usually set at nominal levels (Rs. 10 or Re. 1 in India for themost part). Corporations generally retain portions of their authorized stock as reserved stock, forfuture issuance at any point in time. Shares are usually valued much higher than the face value and this initial investment inthe company by shareholders represents their paid-in capital in the company. The company thengenerates earnings from its operating, investing and other activities. A portion of these earningsare distributed back to the shareholders as dividend, the rest retained for future investments. Thesum total of the paid-in capital and retained earnings is called the book value of equity of thecompany. In India, shares are mainly of two types: equity shares and preference shares. In additionto the most common type of shares, the equity share, each representing a unit of the overallownership of the company, there is another category, called preference shares. These preferredshares have precedence over common stock in terms of dividend payments and the residual claimto its assets in the event of liquidation. However, preference shareholders are generally notentitled to equivalent voting rights as the common stockholders.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 28Fixed Income (Debt) InvestmentsBonds Bonds are debt instruments that are issued by companies and governments to raise fundsfor financing their capital expenditure. By purchasing a bond, an investor loans money for afixed period of time at a predetermined interest rate. While the interest is paid to the bond holderat regular intervals, the principal amount is repaid at a later date, known as the maturity date.While both bonds and stocks are securities, the principle difference between the two is that bondholders are lenders, while stockholders are the owners of the organization. The main types of bonds are: Government Bonds: These are fixed-income debt securities issued by the government.Government bonds are further categorized on the basis of the term (maturity duration). (a) Government Bills: These are government bonds with a maturity period of less than one year. (b) Government Notes: These are government bonds with a maturity period from one year to ten years. (c) Government Bonds: These are government bonds with a maturity period that exceeds ten years. Corporate Bonds: These are debt instruments issued by a company and backed by itsability to generate profits or by the current value of its physical assets.Non-Convertible Debentures NCDs are secured debt instruments with longer maturity. Non-Convertible simply meansthat the bond can‘t be converted into equity of the company. There still could be other options(call/put) attached to the bond. A callable bond could be called or redeemed by the issuer before
Reliance Mutual Funds Sudhanshu Gupta P a g e | 29the maturity of the bond. Issuer will call away the bond when the bond was issued in a highinterest rate environment and interest rates fall subsequently. Investor will lose the high interestor coupon payments and will be left with redemption proceeds to be invested in a lower interestrate environment. A putable bond works in an exactly opposite way where the investor can sellthe bond to the issuer at a specified price before the maturity of the bond if the interest rates goup after the issuance and investor has higher yielding investment options available.Treasury Bills T-Bills or treasury bills are largely risk-free (guaranteed by the Government and hencecarry only sovereign risk - risk that the government of a country or an agency backed by thegovernment, will refuse to comply with the terms of a loan agreement), short-term, very liquidinstruments that are issued by the central bank of a country. The maturity period for T-billsranges from 3-12 months. T-bills are circulated both in primary as well as in secondary markets. T-bills are usually issued at a discount to the face value and the investor gets the facevalue upon maturity. The issue price (and thus rate of interest) of T-bills is generally decided atan auction, which individuals can also access. Once issued, T-bills are also traded in thesecondary markets. In India, T-bills are issued by the Reserve Bank of India for maturities of 91-days, 182 days and 364 days. They are issued weekly (91-days maturity) and fortnightly (182-days and 364-days maturity).Pass through certificates A PASS through certificate (PTC) is a certificate that is given to an investor againstcertain mortgaged-backed securities that lie with the issuer. The certificate can be compared tosecurities (like bonds and debentures) that may be issued by banks and other companies toinvestors. The only difference being that they are issued against underlying securities.The interest that is paid to the issuer on these securities comes to the investor in the form of a
Reliance Mutual Funds Sudhanshu Gupta P a g e | 30fixed income. Investors in such instruments are usually financial institutions like banks, mutualfunds and insurance companies. In a pass through certificate, interest earned on the receivable isdirectly passed to the holders, whereas, in a pay through certificate, interest received from thereceivables is not passed to the holder of the unit. All the PTCs in the market are rated byagencies like Crisil or Fitch ratings, among others. The ratings tell the investor about the qualityof the underlying securities.Commercial papers Commercial papers (CP) are unsecured money market instruments issued in the form of apromissory note by large corporate houses in order to diversify their sources of short-termborrowings and to provide additional investment avenues to investors. Issuing companies arerequired to obtain investment-grade credit ratings from approved rating agencies and in somecases, these papers are also backed by a bank line of credit. CPs is also issued at a discount totheir face value. In India, CPs can be issued by companies, primary dealers (PDs), satellitedealers (SD) and other large financial institutions, for maturities ranging from 15 days period to1-year period from the date of issue. CP denominations can be Rs. 500,000 or multiples thereof.Further, CPs can be issued either in the form of a promissory note or in dematerialized formthrough any of the approved depositoriesCertificates of Deposit A certificate of deposit (CD) is a term deposit with a bank with a specified interest rate.The duration is also pre-specified and the deposit cannot be withdrawn on demand. Unlike otherbank term deposits, CDs are freely negotiable and may be issued in dematerialized form or as aUsance Promissory Note. CDs are rated (sometimes mandatory) by approved credit ratingagencies and normally carry a higher return than the normal term deposits in banks (primarilydue to a relatively large principal amount and the low cost of raising funds for banks). Normalterm deposits are of smaller ticket-sizes and time period, have the flexibility of premature
Reliance Mutual Funds Sudhanshu Gupta P a g e | 31withdrawal and carry a lower interest rate than CDs. In many countries, the central bank providesinsurance (e.g. Federal Deposit Insurance Corporation (FDIC) in the U.S., and the DepositInsurance and Credit Guarantee Corporation (DICGC) in India) to bank depositors up to a certainamount (Rs. 100000 in India). CDs are also treated as bank deposit for this purpose. In India, scheduled banks can issue CDs with maturity ranging from 7 days – 1 year andfinancial institutions can issue CDs with maturity ranging from 1 year – 3 years. CD is issued fordenominations of Rs. 1, 00,000 and in multiples thereof.Gold Of all the precious metals, gold is the most popular as an investment. Investors generallybuy gold as a hedge or harbor against economic, political, or social fiat currency crises(including investment market declines, burgeoning national debt, currency failure, inflation, warand social unrest). The gold market is subject to speculation as are other markets, especiallythrough the use of futures contracts and derivatives. The history of the gold standard, the roleof gold reserves in central banking, golds low correlation with other commodity prices, and itspricing in relation to fiat currencies during the financial crisis of 2007–2010, suggest that goldbehaves more like a currency than a commodity. In the final analysis, gold is a financial asset. It also is a commodity: The price of goldrises and falls based on its role as a financial asset, like a currency, a stock or a bond, thatinvestors buy and sell based on a complex web of factors. More importantly, gold has been afinancial asset, a store of value and an investment that has held its own for five millennia. Goldhas stood the test of time repeatedly and has outlasted all other financial and monetary assets.Throughout history, gold has served three functions. It has been a financial asset, held byindividual investors as a store of wealth and a portfolio diversifier. It has been a commodity,used primarily in jewelry but also in electronics, dentistry, and many other applications. Finally,it has been a monetary asset, used by governments as a reserve asset, as a form of money, and asa backing for their own currencies.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 32Risks associated with Mutual Funds Most mutual funds are not guaranteed—you could lose money on your investment. Thelevel of risk in a mutual fund depends on what it invests in. For example, stocks are usuallyriskier than bonds, so you would expect an equity fund to be riskier than a fixed income fund. Different types of investments generally come with different types of risk. This tableshows some of the common types of risk and how they could affect a fund‘s performance:Type of risk Type of investment affected How the fund could lose money The value of a foreign investment declines because of political changes orCountry risk Foreign investments instability in the country where the investment was issued. If a bond issuer can‘t repay a bond, it may end up being a worthlessCredit risk Fixed income securities investment. Investments denominated in a If the other currency declines against theCurrency risk currency other than the Canadian Canadian dollar, the investment will lose value. dollar The value of fixed income securitiesInterest rate risk Fixed income securities generally falls when interest rates rise. The fund can‘t sell an investment that‘s declining in value because there are noLiquidity risk All types buyers. The value of its investments decline because of unavoidable risks that affect the entire marketMarket risk All types
Reliance Mutual Funds Sudhanshu Gupta P a g e | 33 1. Country risk: Changes in government policy and political decision can change theinvestment environment. They can create a favorable environment for investment or vice versa. 2. Credit Risk: The debt servicing ability (May it be interest payments or repayment ofprincipal) of a company through its cash flows determines the Credit Risk faced by you. Thiscredit risk is measured by independent rating agencies like CRISIL who rate companies and theirpaper. An ‗AAA‘ rating is considered the safest whereas a ‗D‘ rating is considered poor creditquality. A well-diversified portfolio might help mitigate this risk. 3. Currency risk: The risk that a business operations or an investments value will beaffected by changes in exchange rates. For example, if money must be converted into a differentcurrency to make a certain investment, changes in the value of the currency relative to theAmerican dollar will affect the total loss or gain on the investment when the money is convertedback. 4. Interest Rate Risk: In a free market economy interest rates are difficult if notimpossible to predict. Changes in interest rates affect the prices of bonds as well as equities. Ifinterest rates rise the prices of bonds fall and vice versa. Equity might be negatively affected aswell in a rising interest rate environment. A well-diversified portfolio might help mitigate thisrisk. 5. Liquidity Risk: Liquidity risk arises when it becomes difficult to sell the securitiesthat one has purchased. Liquidity Risk can be partly mitigated by diversification, staggering ofmaturities as well as internal risk controls that lean towards purchase of liquid securities. 6. Market Risk: Sometimes prices and yields of all securities rise and fall. Broad outsideinfluences affecting the market in general lead to this. This is true, may it be big corporations orsmaller mid-sized companies. This is known as Market Risk. A Systematic Investment Plan(―SIP‖) that works on the concept of Rupee Cost Averaging (―RCA‖) might help mitigate thisrisk.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 34CHAPTER 6: FIXED INCOME FUNDS Debt funds are funds which invest money in debt instruments such as short and long termbonds, government securities, T-bills, corporate paper, commercial paper, call money etc. Thefees in debt funds are lower, on average, than equity funds because the overall management costsare lower. The main investing objectives of a debt fund are usually preservation of capital andgeneration of income. Performance against a benchmark is considered to be a secondaryconsideration. Investments in the equity markets are considered to be fraught with uncertaintiesand volatility. These factors may have an impact on constant flow of returns. This is why debtschemes, which are considered to be safer and less volatile, have attracted investors. Debt markets in India are wholesale in nature and hence retail investors generally find itdifficult to directly participate in the debt markets. Not many understand the relationshipbetween interest rates and bond prices or difference between Coupon and Yield. Thereforeventuring into debt market investments is not common among investors. Investors can howeverparticipate in the debt markets through debt mutual funds. Debt paper is issued by Government, corporates and financial institutions to meet fundingrequirements. A debt paper is essentially a contract which says that the borrower is taking somemoney on loan and after sometime the lender will get the money back as well as some interest onthe money lent. Before discussing more about debt fund schemes, a few terms and concepts need to beseen – 1) Yield to Maturity The yield to maturity (YTM) of a bond is the IRR that a buyer would receive if theypurchased the bond at the current market price. This is also called the redemption yield.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 35 As an IRR measure, YTM suffers from the same flaws. The flaws are less serious in thiscase, because of the characteristics of bonds: cash flows are always positive, and the variation inthe rates at which income can be re-invested is lower. YTM is, nonetheless, generally a much better measure than flat yield, and is probably themost accurate of the commonly used measures of bond yield. A full evaluation of a bond needsto consider whether the yield spread is sufficient compensation for risk, and how it compareswith alternatives over the same term. 2) Average duration The sensitivity of a portfolio of bonds such as a bond mutual fund to changes in interestrates can also be important. The average duration of the bonds in the portfolio is often reported.The duration of a portfolio equals the weighted average maturity of all of the cash flows in theportfolio. If each bond has the same yield to maturity, this equals the weighted average of theportfolios bonds durations, with weights proportional to the bond prices. Otherwise theweighted average of the bonds durations is just a good approximation, but it can still be used toinfer how the value of the portfolio would change in response to changes in interest rates. 3) Modified duration Modified duration is a modified version of the Macaulay model that accounts forchanging interest rates. Because they affect yield, fluctuating interest rates will affect duration,so this modified formula shows how much the duration changes for each percentage change inyield. For bonds without any embedded features, bond price and interest rate move in oppositedirections, so there is an inverse relationship between modified duration and an approximate 1%change in yield.Modified duration = D ÷ (1+r)Where D is the duration and r is the interest rate paid per period: coupon payment divided byprice.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 36 The percentage change in the price is equal to the change in interest rates multiplied bythe modified duration. This is an approximation and becomes less accurate for larger interest ratechanges. Interest rate changes are usually small and the approximation is more than goodenough. 4) Credit Rating and Credit Rating Agencies A credit rating estimates the credit worthiness of an individual, corporation, or even acountry. It is an evaluation made by credit bureaus of a borrower‘s overall credit history. Acredit rating is also known as an evaluation of a potential borrowers ability to repay debt. Creditratings are calculated from financial history and current assets and liabilities. Typically, a creditrating tells a lender or investor the probability of the subject being able to pay back a loan.However, in recent years, credit ratings have also been used to adjust insurance premiums,determine employment eligibility, as a factor considered in obtaining security clearances andestablish the amount of a utility or leasing deposit. The Credit ratings for corporation are assigned by credit rating agencies. In India,commercial credit rating agencies include CRISIL, CARE, ICRA and Brickwork Ratings. Thecredit bureaus for individuals in India are Credit Information Bureau (India) Limited (CIBIL)and Credit Registration Office (CRO). These Ratings help an investor assess the credit quality ofa particular scheme before making an investment. Just like IPO grading, mutual fund gradinglooks at the past performance of the scheme. Credit rating agencies (CRAs) assign ratings to all Bonds, NCDs, and other debtinstruments (excluding Public Deposits). The ratings are based on the overall exposure to defaultrisk, with regard to timely receipt of payments from the investments the scheme has made. CRAssuch as CRISIL, ICRA and CARE have been rating long-term as well as short-term instruments.So far, the ratings have been based on in-house parameters.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 37 For long term rating scale (with original maturity exceeding one year) ICRA uses thegrade LAAA, LAA, LA, LBBB, LBB, LB, LC, and LD whereas CRISIL grade them as AAA,AA, A , BBB, BB, B , C, D and NM. For short term rating scale ( All instruments with original maturity within one year.)ICRA use the grade A1, A2, A3, A4 and A5 while CRISIL use P1, P2, P3, P4, P5 and NM. Credit rating agencies (CRAs) also assign ratings to mutual fund (MF) schemes whichinvest entirely, or mostly, in debt. The ratings are based on the overall exposure to default risk,with regard to timely receipt of payments from the investments the scheme has made. CRAs suchas Crisil, ICRA and CARE have been rating long-term as well as short-term debt mutual fundschemes. So far, the ratings have been based on in-house parameters. CRISIL rates MF schemeson a scale of 1 to 5, with 1 considered the best. ICRA uses the grades AAA, AA, BBB and C,among others, to rate the same schemes. In July 2011, SEBI asked CRAs to use standardized rating symbols. So now long-termdebt schemes with the highest degree of safety will be rated as AAAmfs. AAmf and Amf meanthey have high and adequate levels of safety, respectively. BBBmfs and BBmfs-rated schemescarry moderate risk. A Bmf-rated scheme has high degree of risk. A scheme with Cmf rating hasa very high level of risk. Rating companies can use the ‗+‘ or ‗-‘ symbol, along with the rating, toreflect the comparative standing within the category. For a short-term debt fund scheme, a rating of A1mfs will be the highest. A2mfs andA3mfs-rated schemes reflect a strong and moderate degree of safety, respectively. A4mfs-ratedschemes have the least degree of safety.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 38Debt Mutual Fund Schemes 1. Fixed Maturity Plans FMPs have become very popular in the past few years. FMPs are essentially close endeddebt schemes. The money received by the scheme is used by the fund managers to buy debtsecurities with maturities coinciding with the maturity of the scheme. There is no rule whichstops the fund manager from selling these securities earlier, but typically fund managers avoid itand hold on to the debt papers till maturity. Investors must look at the portfolio of FMPs beforeinvesting. If an FMP is giving a relatively higher ‗indicative yield‘, it may be investing inslightly riskier securities. Thus investors must assess the risk level of the portfolio by looking atthe credit ratings of the securities. Indicative yield is the return which investors can expect fromthe FMP. Regulations do not allow mutual funds to guarantee returns, hence mutual funds giveinvestors an idea of what returns can they expect from the fund. An important point to note hereis that indicative yields are pre-tax. Investors will get lesser returns after they include the taxliability. 2. Capital Protection Funds These are close ended funds which invest in debt as well as equity or derivatives. Thescheme invests some portion of investor‘s money in debt instruments, with the objective ofcapital protection. The remaining portion gets invested in equities or derivatives instruments likeoptions. This component of investment provides the higher return potential. It is important tonote here that although the name suggests ‗Capital Protection‘, there is no guarantee that at alltimes the investor‘s capital will be fully protected. 3. Gilt Funds These are those funds which invest only in securities issued by the Government. This canbe the Central Govt. or even State Govts. Gilt funds are safe to the extent that they do not carryany Credit Risk. However, it must be noted that even if one invests in Government Securities,interest rate risk always remains.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 39 4. Balanced Funds These are funds which invest in debt as well as equity instruments. These are also knownas hybrid funds. Balanced does not necessarily mean 50:50 ratio between debt and equity. Therecan be schemes like MIPs or Children benefit plans which are predominantly debt oriented buthave some equity exposure as well. From taxation point of view, it is important to note howmuch portion of money is invested in equities and how much in debt. 5. MIPs Monthly Income Plans (MIPs) are hybrid funds; i.e. they invest in debt papers as well asequities. Investors who want a regular income stream invest in these schemes. The objective ofthese schemes is to provide regular income to the investor by paying dividends; however, there isno guarantee that these schemes will pay dividends every month. Investment in the debt portionprovides for the monthly income whereas investment in the equities provides for the extra returnwhich is helpful in minimizing the impact of inflation. 6. Child Benefit Plans These are debt oriented funds, with very little component invested into equities. Theobjective here is to capital protection and steady appreciation as well. Parents can invest in theseschemes with a 5 – 15 year horizon, so that they have adequate money when their children needit for meeting expenses related to higher education.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 40CHAPTER 7: REVIEW OF LITERATURE MFs have attracted a lot of attention and kindled the interest of both academic andpractitioner communities. Compared to the developed markets, very few studies on MFs aredone in India. The literature review reveals Investor behavior studies which can be groupedunder two themes – 1) Studies relating to General Financial Behavior of Investors 2) Fund Selection Behavior Studies 1) General Financial Behavior Studies: Daniel Kahneman and Amos Tversky (1979) originally described ―Prospect Theory‖ andfound that individuals were much more distressed by prospective losses than they were happy byequivalent gains. Some economists have concluded that investors typically consider the loss of$1 twice as painful as the pleasure received from a $ gain. Individuals will respond differently toequivalent situations depending on whether it is presented in the context of losses or gains. Langer (1983) suggests that when these preferences are based on choices, there is moreego involvement and attachment to the preferences, suggesting heightened level of preferencebias. This phenomenon is consistent with the prediction from Cognitive Dissonance theory ofFestinger (1957). Robert J. Shiller (1993) reported that many investors do not have data analysis andinterpretation skills. This is because, data from the market supports the merits of index investing,passive investors are more likely to base their investment choices on information received fromobjective or scientific sources. Phillip (1995) reported that there is a change in financial decision-making and investorbehavior as a result of participating in investor education programmes sponsored by employees.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 41 Hirshleifer (2001) categorized different types of cognitive errors that investors make i.e.self-deception, occur because people tend to think that they are better than they really are;heuristic simplification, which occurs because individuals have limited attention, memory andprocessing capabilities; disposition effect, individuals are prone to sell their winners too quicklyand hold on to their losers too long (http://www.investorhome.com/psych.htm). 2) Fund Selection Behavior Studies: Investor fund selection Behavior influences marketing decisions of fund management andhas captured the attention of researchers. The findings are reported below: Ippolito (1992) and Bogle (1992) reported that fund selection by investors is based onpast performance of the funds and money flows into winning funds more rapidly than they flowout of losing funds. Vidyashankar (1990), Agarwal G.D. (1992), Gupta L.C. (1993) Atmaramani (1996),Madhusudan (1996) and Ajay Srinivasan (1999) and others have conducted extensive researchregarding investor expectations, protection, awareness and fund selection behavior. Few strikingones among the other studies are given below. Gupta L.C. (1993) conducted a household investor survey with the objective to providedata on investor preferences on MFs and other financial assets. Madhusudhan V. Jambodekar (1996) conducted a study to assess the awareness of MFsamong investors, to identify the information sources influencing the buyer decision and thefactors influencing the choice of a particular fund. The study revealed that income schemes andopen-ended schemes are preferred over growth schemes and close-ended schemes during theprevalent market conditions. Investors look for Safety of Principal, Liquidity and CapitalAppreciation in order of importance; Newspapers and Magazines are the first source ofinformation through which investors get to know about MFs / Schemes and the investor serviceis the major differentiating factor in the selection of MFs.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 42 An attempt was made by the NCAER in 1964 to understand the attitude and motivationfor the savings of individuals, for which a survey of households was undertaken. AnotherNCAER study in 1996 analyzed the structure of the capital market and presented the views andattitudes of individual shareholders. SEBI-NCAER survey (2000) was carried out to estimate thenumber of households and the population of individual investors, their economic anddemographic profile, portfolio size, and investment preference for equity as well as other savingsinstruments. This is a unique and comprehensive study of individual investors, for, data wascollected from 3, 00,000 geographically dispersed rural and urban households. Some of therelevant findings of the study are: Households preference for instruments match their riskperception; Bank Deposit has an appeal across all income class; 43% of the non-investorhouseholds (estimated around 60 million households) apparently lack awareness about stockmarkets; and, compared with low income groups, the higher income groups have a higher shareof investments in MFs signifying that MFs have not truly become the investment vehicle forsmall investors; the number of households owning units of mutual funds is more (9%) than theinvestor households owning investments in shares and debentures (8%). The Review of Literature reveals that in developed markets lot of study has been done,but developing markets also deserve an extensive research.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 43CHAPTER 8: RESEARCH METHODOLOGY 1) Research Design – Exploratory Research 2) Data Collection Method – Most of the data has been collected secondarily from published sources. The primary survey was conducted through a structured closed ended questionnaire. 3) Sampling – The study mainly deals with the financial behavior of Individual Investors towards Mutual funds in Mumbai city. The required data was collected through a pretested questionnaire administered on a combination of convenience and judgment sample of 100 educated individual investors. Judgment sample selection is due to the time and financial constraints. . Respondents were screened and inclusion was purely on the basis of their knowledge about Financial Markets, MFs in particular. This was necessary, because the questionnaire presumed awareness of some basic terminology about Mutual Funds. The purpose of the survey was to understand the behavioral aspects of individual investors, mainly their fund selection behavior, various factors influencing this behavior and also the conceptual awareness level among individual investors. Sample of the questionnaire is given in Annex. A. The unit of observation and analysis of survey is only among Individual Investors whose definition is ―An Individual who has currently invested (i.e. as on May or June 2011) in any Mutual Funds and this does not include high net worth individuals (i.e., those who earn above Rs. 10,00,000/- per annum) and institutions. Since it is an exploratory study no specific hypothesis is formulated. 4) Fieldwork and Data Collection – The field work associated with the survey was conducted accordingly and data was collected on field. 5) Instruments Used – Questionnaire
Reliance Mutual Funds Sudhanshu Gupta P a g e | 446) Analysis and Interpretation – The analysis of the data collected has been performed appropriately and inferences have been drawn. The data collected has been presented in forms of line graphs and thus the trend arising therefrom has been analyzed. Also for finding out factors that affect the fund selection behavior of investors, factor analysis using principal component extraction has been performed. This tool of SPSS was extensively used to classify a large number of variables into smaller number of factors. Factor Analysis was used to determine whether there was any common constructs that represented investor concerns. 25 variables were analyzed using the Varimax Algorithm of Orthogonal Rotation, the most commonly used method. Evaluation of the resulting constructs and naming of the factors is largely subjective. Hence, to identify investors‘ underlying Fund/Scheme selection criteria, so as to group them into specific factors, which would further identify Investor types, to enable the designing of appropriate marketing strategies, Factor Analysis was done using Principal Component Analysis.7) Limitations of the study – a. Sample size is limited to 100 educated individual investors in the city of Delhi NCR. The sample size may not adequately represent the national market. b. Simple Random and judgment sampling techniques is due to time constraints. c. This study has not been conducted over an extended period of time having both ups and downs of stock market conditions which a significant influence on investor‘ s buying pattern and preferences. d. The research is only exploratory, no conclusion may finally be drawn from it, but only direction may be sought. e. This is an independent study and the observations may not comply with those would have been made by an experienced professional.
Reliance Mutual Funds Sudhanshu Gupta P a g e | 45 CHAPTER 9: DATA ANALYSIS AND INTERPRETATIONS 1) Analysis of Various Fixed Income Mutual Funds managed by Reliance Capital Asset Management LimitedMoney Market Instruments includes Commercial Papers, Certificate of Deposits & Treasury Bills. Equity includes index, stock futures & equity shares. Corporate Debt includes Debenture. Source: Reliance Mutual Fund
Reliance Mutual Funds Sudhanshu Gupta P a g e | 46 2) Analysis of investor‘s preferences The survey conducted to capture investor behavior pattern in selection of MFs, revealsthe following. a. Savings Objective of Individual Investors Objective of Savings Others 2 For purchase of assets 55 For children’s education 24 To meet contingencies 59 For tax reduction 49 To provide for Retirement 29 0 10 20 30 40 50 60 Savings Objective of the majority of Individual Investors is ‗To meet contingencies‘ or―For Purchase of Assets‖, thus throwing light on the need of capital appreciation and flexibility.AMC can attract a pool of investors by designing products with flexible investment plans.