Mutual Funds Handbook

What is Mutual Fund?
Mutual Fund is defined as trust that pools the savings of investors who
share common financial objective. Collected money then invested by
professional Fund Manager in different type of securities such as Equity, Debt,
Gold according to investment objective. Income earned through these
investments & capital appreciation realized by the schemes then shared by its
unit holders in proportion to number of units owned by them.
So, to simply put, a mutual fund is the money pooled in by a large
number of investors and offers an opportunity to invest in a diversified and
professionally managed basket of securities at a relatively lower cost.

How do you make money from Mutual Funds
1. Capital appreciation:
As the value of securities in the fund increases, the fund's unit price will also
increase. You can make a profit by selling the units at a price higher than at which
you bought
2. Coupon / Dividend Income:
Fund will earn interest income from the bonds it holds or will have dividend income
from the shares
3. Income Distribution:
The fund passes on the profits it has earned in the form of dividends

Advantages of Mutual Funds
1. Professional Management:
Investing is hard work. There are hundreds of companies to track & their prospects
could change without warning. Mutual fund appoint skilled professionals whose job
is to continuously research & monitor companies in mutual fund portfolio & take
appropriate actions for the benefits of the investor.
2. Diversification:
By putting your money in just a few shares, you are subject to considerable risk.
Major decline in any single share can have adverse impact on investment. Mutual
fund spreads the money across large no. of shares. This spread is balanced across
different companies, sectors thus providing optimum safety.
3. Liquidity:
The best feature any Investment can offer is the access to your money when you
needed the most. Mutual fund offer the much required liquidity while investing.

Advantages of Mutual Funds
4. Transparent & Well Regulated:
Mutual funds are obligated by law to release comprehensive data about their
operations & investments. All funds release NAVs daily & most release their
complete portfolio every month. SEBI regulates the fund industry very tightly to
protect investor better.
5. Tax Efficiency:
When you sell mutual fund units you have to pay capital gain tax (depending upon
tenure of your holding) which is lesser than personal tax you have to pay. If you
invest in ELSS or RGESS, it is permissible investments under Section 80 which will
help you to reduce your tax liability.
6. Low Entry Level:
In the case of mutual funds, minimum investment required is as low as Rs.5,000/- .
Since there are not many quality shares which you can buy with Rs.5,000/- in hand,
it is encouraging for investors who start small & at the same time take exposure to
25 to 30 stocks.

Mutual Fund Unit
Mutual Fund units represent your extent of ownership in a mutual fund. So if NAV of Mutual Fund is Rs.10/- &
you invest Rs. 1000/- then you will receive 100 units.
NAV
NAV is mutual fund's price per unit. The per-unit amount of the fund is calculated by dividing the total value of
all the securities in its portfolio, less any liabilities, by the number of units outstanding. All mutual funds' buy
and sell orders are processed at the NAV of the trade date.
Asset Management Company (AMC)
A company part of Mutual Fund, which takes investment decisions for the mutual fund , & manages the assets
of the mutual fund.
NFO
When Mutual Fund launched for the first time it is called New Fund Offer. A NFO is similar to Initial Public
Offering or IPOs of Company.
Benchmark
An unmanaged group of securities whose performance is used as a standard to measure investment
performance. Commonly known as a market index. Some well-known benchmarks are the BSE Sensex and NSE
Nifty.
Technical Terms used in Mutual Funds

Equity
Stock or share representing an ownership interest in the company.
Debt
A debt investment with which the investor loans money to an entity (company or government) that
borrows the funds for a defined period of time at a specified interest rate. For e.g. Bank Fixed Deposits,
Company Fixed Deposits, Government Bonds etc.
Asset Allocation
The process of diversifying the investments in different kinds of assets such as stocks, bonds, real estate,
cash in order to reduce risk.
Redemption
When you sell your mutual fund units, it is called redemption.
Market Capitalization
Market Capitalization is simply multiplying the issued and outstanding shares of the company by its
current market price.
Technical Terms used in Mutual Funds

Types of Mutual Funds
Mutual Funds are classified mainly on the basis of tenor
1. Open- Ended Mutual Funds:
These funds available for buying & selling on all business days throughout the
year. These funds do not have fixed tenure i.e. it won’t mature after fixed time
period. Investors have the flexibility to buy & sell any part of their investments
at any time at prevailing price i.e. NAV.
2. Close Ended Mutual Funds:
These mutual funds are available for buying in specific period only ; generally NFO
period. You can not buy units of these mutual fund after NFO period. One can not
sell these mutual funds before its maturity. These mutual funds matures at fixed
pre decided maturity date & amount is directly credited to investors bank account.
Fixed Maturity Plan or FMPs is example of Close Ended Mutual Fund.

Investor can invest their money in different asset classes such as Equity, Debt, Gold,
Real Estate. Mutual Funds provide an opportunity to invest in such asset classes. On
the basis of asset classes Mutual Fund further classified as
1. Equity Funds
Equity Funds invest money in equity i.e. Shares/ Stocks, Rights, Warrants etc. Equity
funds invest money in companies across sectors & market capitalization.
Suitability -: Equity Funds are suitable for investors with an appetite & tolerance for
high risk & looking for better real rate of return.
2. Debt Funds
Debt funds invest money in Government Securities, Corporate bonds, Debentures &
all kind of different Fixed Income instruments.
Suitability -: Debt Funds are suitable for investors who are risk averse & do not mind
compromising on real returns & generally have near or short term financial goals.

3. Hybrid Funds
Hybrid Funds invest in multiple asset classes which could invest in Equity, Debt or even
Gold. They are mandated to invest certain portion of their AUM in the respective asset
classes. Depending upon their dominant exposure to equity or debt they are
classified as equity-oriented hybrid funds and debt-oriented hybrid funds. Balanced
Fund is an example of equity-oriented hybrid fund while Monthly Income Plans
(MIPs) is example of debt-oriented hybrid funds .
Suitability -: Hybrid funds can be suitable for investors who want to tactically allocate
their assets; but the selection therein should be done as per their risk appetite and
tolerance
4. Gold Funds
Gold Funds invest money exclusively in Gold or companies which involved in activities
related with Gold such as Mining, Trading or Safe Vault the Gold.
Suitability -: Gold Funds are suitable for investors who looks to diversify their portfolio
assuming high risk thereto.

Equity Mutual Funds further classified on the basis of market Capitalization
1. Large Cap Mutual Funds
These funds are usually mandated to invest a predominant portion of their assets in large cap
companies which have the market capitalization over Rs.1000 Crores. These are companies
with well established business & stable profits. Their performance is more predictable & have
ability to weather unfavorable economic conditions.
Suitability-: Large cap funds are an indispensable part of the equity portfolio, irrespective of the
risk appetite of the equity investor.
2. Mid Cap Mutual Funds
These funds are usually mandated to invest a predominant portion into mid cap companies
which have the market capitalization between 200 to 1000 Crores. They are well established
but have potential to grow as they are yet in growth stage of their business cycle. They are more
volatile as they tend to show fluctuations in profits & at times even struggle to sustain in
challenging circumstances.
Suitability-: Mid caps show a tendency to do well during the upside of the market, they also tend
to plunge during the downside of equity markets. Hence although one could invest as permitted
by risk appetite, it is imperative to stay invested for the long-term to strike a better risk-return
trade-off.

3. Small Cap Mutual Funds
These funds usually mandated to invest predominant portion into small companies which fall below
the market capitalization of Rs 200 Crores. Small caps carries highest risk as not many of these
companies have capacity to sustain any adverse economic condition. But they all have potential to
generate super normal returns if they found way to sustain any economic condition.
Suitability-: Small cap funds are suitable for those who are willing to assume very high risk in their
endeavor to clock super-normal returns.
4. Multi Cap Mutual Funds
These funds are facilitated by their mandate to invest across market capitalization, i.e. large caps, mid
caps and small caps. Thus by doing so they spread their risk across market capitalization and even
capture investment opportunities across segments.
Suitability-: Multi cap funds are appropriate if you are willing and / or want to take exposure across
market capitalization to tap opportunities, and at the same time want to diversify risk.
5. Sector / Thematic Funds
These funds focus to invest in particular sector or invest following theme like Infrastructure or
Consumption.
Suitability -: Investors who are willing to take very high risk and are adequately diversified but yet wish
to follow their conviction of investing in sectors / themes may consider such funds.

Debt Funds are further classified on the basis of maturity profile of the securities
they hold. One should carefully choose debt funds according to time period they
wish to remain invested.
1. Liquid Funds
These funds mainly invest in very short term money market instruments with maturity up to 91 days.
2. Ultra Short Term Funds
These funds invest in Portfolio comprises a mix of certificate of deposits, commercial paper, call money and
other money market instruments with slightly higher maturity than the instruments held in liquid funds but
maturity less than 1 yr.
3. Short Term Funds
These funds have exposure to short-term bonds, deposits and NCDs. They may also invest in T-bills and
Government securities with maturity of less than 3 years.
4. Long Term Income Funds
These Funds invest in bonds and debentures with maturity of more than 5 years. They can also invest in
Government securities with maturity profile of 5 to 10 years.

5. Dynamic Bond Funds
These funds invest in short-term as well as long-term bonds and NCDs according to the interest
rate cycle. They may also invest in Government securities with maturity of up to 5 years . But
these funds carry highest risk among debt funds as its returns depends upon fund
manager’s ability to predict the trend of interest rate cycle .
6. Gilt Funds or G-Sec Funds
These funds invest exclusively in securities issued by Central or State Governments. Since
Government Securities are highly traded market instruments they are generally over sensitive to
any movement in the interest rates. Fiscal deficit & Current Account Deficit also have adverse
impact on the market price of Government securities.
7. Fixed Maturity Plans or FMPs
FMPs are close-ended schemes with fixed tenure that cease to exist thereafter. They invest in debt
& money market instruments of similar maturity as the stated maturity of the plan which means a
90 day FMP will invest in debt & money market instruments that mature within 90 days like 3-
month Certificate of Deposits (CDs), 3-month Commercial Papers (CPs). FMPs do not provide
investors with an option to exit before Maturity. FMPs are suitable to those who wish to clock
better post-tax returns as against bank or corporate FDs; but who are willing to take slightly
high risk & do not require money before Maturity .

1. Lump Sum or One Time Investments
Lump Sum Mode helps Invest all your Investible surplus at one go. You should invest in lump
sum only if you have an appetite for higher risk as chances are high that, you may see your
investments in the negative for some time. Ideally while investing in lump sum, you should have a
longer time horizon. Or, on a cautious note, if you have a short term horizon, then you should
invest your lump sum money in less risky options like liquid funds. This mode is more suitable if
you are ready to take High Risk in anticipation of High Return
2. Systematic Investment Plan (SIP)
This is most popular mode of investment in Mutual Funds. SIP is a disciplined Mode of
Investment, through SIP you can invest a fixed sum of money on a regular basis, in a mutual fund
scheme. SIPs provide you the benefit of Rupee Cost Averaging . Through SIP, you invest a fixed
amount every month, irrespective of the market movements. As the investment happens on a
regular basis, you get an opportunity to invest at various market levels. So when the markets fall,
you buy more units with the same amount; while if the market trends higher, you buy less units
and simultaneously the value of your existing units grow. So in the long run your cost of buying is
averaged out and your Average Cost per Unit may work out to be lesser than the Average Price
per Unit. It is suitable for person who can invest fixed amount on regular basis i.e. monthly or
Quarterly & looking to reduce the risk of market volatility in the long term.
How to invest in Mutual Funds?

3. Systematic Transfer Plan ( STP)
Though less popular, STP is an advanced version of SIP, which functions with a similar objective .
In STP mode you make lump sum investment in one mutual fund scheme then periodically
transfer certain amount from this scheme to another. Generally in STP the investor initially
invests in less risky liquid funds that may offer better returns, and over time gradually or
systematically transfer a certain amount from the scheme to another scheme which may be an
equity fund from the same fund house. STP is a relatively safer investment method than lump
sum investment with the benefit of Rupee Cost Averaging like SIP. As all your money is not
invested directly in risky asset class, STP may turn out to be a relatively safe investment strategy.
It is Suitable for Investor who have large savings but do not wish to take high risk of lump sum
investing. Investors who can not set aside fixed amount regularly but wish to reduce risk of
market volatiltiy, can also look for this option.
4. Systematic Withdrawal Plan (SWP)
SWP is a smart way to plan for your future needs by withdrawing amounts systematically . SWP
helps Systematically Withdraw an amount of money from the invested mutual fund scheme on
a regular basis . SWP offers Fixed Withdrawal as well as Appreciation Withdrawal facility.
Through fixed withdrawal, you as an Investor can specify the amount you wish to withdraw from
your investment on a monthly or quarterly basis, while under Appreciation Withdrawal you can
withdraw the appreciated amount on a monthly or quarterly basis. It is suitable for person who
wish to manage regular expenses without keeping the savings idle
How to invest in Mutual Funds?

Dividend Option
This option facilitates investors to book profits in the form of dividend and provides further sub-options:
i. Dividend Payout
This option proposes to timely pay distributable surplus / profits to investors in the form of dividends
either through cheques or ECS credits, thereby facilitating them to book profits.
Suitability -: This option can be selected by those who are in need of cash flows during the investment
horizon .
ii. Dividend Re-investment
Under this option instead of paying dividend cheques or providing ECS credits…) The dividend
amount declared by a mutual fund scheme, goes in to buy additional units of the same scheme
Suitability -: This option is suitable for investors who are not in need for cash flows in the form of
dividend during the investment horizon; but instead would prefer to add additional units to the same
scheme
It should be noted that selecting the dividend option in no way makes it mandatory for the fund
house to declare dividends. It is solely subject to the performance of the respective mutual
fund scheme, availability of distributable surplus and discretion of the Trustees.
Growth Option
This option facilitates compounded growth in value of your mutual fund scheme, subject to the
investment bets taken by the fund manager.
Suitability -: This option is suitable for those investors who are not in need for cash flows in the form of
dividend during the investment horizon; but would instead prefer to invest their hard earned money for
compounding their wealth.
Investment Options in Mutual Funds?

Risk is an inherent aspect of every form of investment. For Mutual Fund investments, risks would
include variability, or period-by-period fluctuations in total return.
Market Risk
Mutual Fund investments are subject to market risk, as the underlying investments where mutual
funds invest – such as stocks and bonds - show uncertain movement. Do not forget the prices of these
underlying instruments are driven by market sentiment and over a time period it may lead to volatility
in the performance of the funds.
Interest Rate Risk
Interest rates and bond prices are inversely related. Any upside movement in interest rates may lead
to downside movement in bond prices and thus impact its portfolio valuation, especially of debt mutual
funds. However the impact of this risk may fade over time.
Fund Manager Risk
Fund manager risk can be experienced when the fund manager fails to execute the fund's investment
strategy or meet its investment objective. Also a frequent change in fund managers may lead to such
risk. However process driven fund houses are well placed to avoid such risk for its investors.
Currency Risk
A swift upside or downside movement in currency may impact one's investment in offshore
instruments. An Indian investor investing in a U.S. focused fund may earn high return in a scenario
where the Indian Rupee suffers a huge depreciation against the U.S. dollar and vice versa.
Types of risks associated with Mutual
Fund Investment

Standard Deviation (SD)
It is the measure of risk taken or volatility born by the mutual fund. SD measures by how much
the investor could diverge from the average return either upwards or downwards. It highlights the
element of risk associated with the fund. Higher SD indicates the scheme carries higher risk. So if 2
schemes generated identical returns then you should choose scheme with lower SD as it has
managed to deliver returns at relatively lower risk.
Beta
It is measure of the volatility of the scheme in comparison to the market indices. A beta of less
than 1.0 will indicate that the scheme is less volatile than the benchmark index; while beta of more
than 1.0 will indicate that the scheme is more volatile than the benchmark index.
Duration
It measures a bond's sensitivity to changes in interest rates . Duration shows the change in value
of fixed income instrument that will result from a 1% change in interest rate. Longer the duration of a
bond, higher the sensitivity and vice versa. . If you have a low risk appetite, debt funds with higher
duration may not be suitable for you.
You can find all these indicators in Mutual Fund Fact Sheets which are readily available on Mutual Fund
websites.
Indicators for Mutual Fund Risk

Sharpe Ratio
A measure developed to calculate risk-adjusted returns. Sharpe Ratio measures how much return you can expect
over and above a certain risk-free rate (for example, the bank deposit rate), for every unit of risk i.e. Standard Deviation
of the scheme.
Sharpe Ratio = (Portfolio Return – Risk Free Return)
Standard Deviation of the Portfolio
If 2 schemes have delivered similar returns, you should choose the one with the higher Sharpe Ratio, as it has
shown its ability to deliver better risk adjusted returns.
Treynor Ratio
It measures risk-adjusted return based on systematic risk. It is similar to the Sharpe ratio, with the difference being
that the Treynor ratio uses Beta as the measurement of volatility, while the Sharpe ratio uses Standard Deviation.
Treynor Ratio = (Portfolio Return – Risk Free Return)
Beta of the Portfolio
A scheme with a higher Treynor Ratio should be preferred as it indicates the scheme has excess return per
unit of systematic risk or Beta.
Alpha
It represents the difference between actual returns of the scheme vis-à-vis the expected returns of the scheme,
over a period of time . Alpha indicates the ability of the fund manager to generate additional returns for investors. So
one should choose fund with positive Alpha.
You can find these ratios available with Mutual Fund Research & Analytics websites such as Value Research,
CRISIL, CARE Ratings, Morning Star
Indicators for Measuring Mutual Fund
Performance on Risk Return Parameters

Absolute Return or Simple Return
It is return that asset achieves from day of its purchase to the day of its sale regardless how much time has elapsed in
between .
Absolute Return = (END value – Initial Value) X 100
Initial Value
Generally Mutual Fund Returns for period less than 1 year are expressed in absolute returns form.
Compounded Annual Growth Rate (CAGR)
CAGR show you year on year growth rate of your investment over period of time,. It is calculated as
Mutual Fund Returns for period more than 1 year are expressed in CAGR. CAGR returns are superior to Absolute
returns because it accurately measures uniform growth over the years. CAGR & Absolute returns are incomparable
since CAGR returns includes compounding effect. For e.g. Asset A & B purchased at 100. If asset A delivers 10%
CAGR return over 2 years & Asset B delivers 10% Absolute return over same period , then value of both Assets are
not the same at the end of 2 years. Value of Asset B at the end of 2 years is 110 only; while because of compounding
effect value of Asset A increased to 121.
Mutual fund helps in compounding of your investments which creates Wealth in the long term.
Calculating Mutual Fund Returns

Mutual Fund invest money only in share market
Mutual fund make their investments according to investment objective set for mutual fund. So if
objective of mutual fund is growth & capital appreciation in long term, then it will invest money in
equity or ‘Share Market’. If objective set for mutual fund is generating regular income, then it will invest
money in debt or fixed income instruments like deposits, bonds.
Mutual Fund with low NAV is ‘Great Buy’ or you should buy Mutual Fund in NFO
because they are cheap
This fallacy is due to the fact that investors perceive the NAV of a mutual fund (MF) as similar to the
price of equity shares. NAV per se does NOT tell you anything about a fund's performance. Instead, it is
the change in NAV over a time period (i.e. the returns) that you should be measuring. For E.g. fund with
NAV of Rs. 10 increased to Rs. 11 in 1 year has produced equal returns like fund with NAV of Rs. 100
increased to Rs. 110 in a year.
Selling a Rs10 NAV NFO as a 'cheap' one was a common fraud perpetrated by agents till the regulator
cracked down on them. NFO’s are more risky than the existing mutual funds as they don’t have track
record to compare. There is no advantage with NFO when it comes to investments unless they have
very strong strategy and unique and strong idea. Still NFO should not be more than 5% of entire
portfolio.
One should buy Mutual Funds of reputed banks or Government Companies
Investors Often make mistake of assuming mutual fund scheme belongs to renowned companies are
worth investing in. Mutual fund companies are independent entities & as per regulation do not give
guarantees on the performance of your investment. So mutual fund scheme from SBI Mutual fund is not
the one offered by SBI bank & its performance will be totally dependent on securities it has invested in
& Fund manager’s ability to make necessary changes to portfolio for the benefit of investors.
Myths About Mutual Funds

SIP Mutual Fund Schemes are different from Lump sum Mutual Fund Schemes
The fact is SIP is just the mode of investing. There are no special mutual fund schemes for SIP
investments.
I’ll be penalized if I Miss one or two SIP dates
Since an ECS mandate is usually signed, the question of missing SIP dates doesn’t arise. Also on the SIP
date if you do not have sufficient funds in your bank account, you aren’t penalized by the AMC (but your
bank will charge you for missing ECS); you will simply miss that SIP instalment, but your account will
remain active.
However if you miss 3 consecutive SIP installments then your SIP will be terminated. You won’t be
charged for SIP termination neither AMC nor your bank will penalized you for the same.
In case of SIP in ELSS, Entire Money can be Withdrawn after 3 Years
The fact is, your every instalment of SIP should have completed the lock-in tenure of 3 years for you to
be in a position to withdraw. So say if you put in Rs 5,000 through SIP in the month of Jun 2014, the
lock-in period for this instalment will get over or free in Jun 2017. So if you have started SIP in ELSS from
Jun 2014 to May 2015, then you can withdraw entire money on May 2018 & not on Jun 2017 . Because
on Jun 2017 ,only your first SIP installment get lock free & you can redeem only those units.

After completion of SIP period, amount will automatically get credited with bank
You only allowed to do SIP in open ended mutual funds since they are available for purchase on all
business days. Open Ended Mutual funds do not have fixed maturity period. They are perpetual in
nature. So even if SIP period ends your money remained invested & continue to grow. But if you wish to
withdraw your money, you have to give separate redemption request.
I should not put all my money into one fund. I should hold a diverse basket
This is true of stocks, not of funds. A mutual fund already does the diversification for you, by holding
several stocks. You can get little additional benefit by diversifying into several funds. In fact, you risk
making your portfolio fragmented and difficult to manage.
Ideally you should invest in5-6 different mutual funds across asset classes & market capitalization
according to your risk appetite & financial goals.
I should check & review my fund portfolio daily
Generally people invest their money in Mutual Fund as they don’t have time to track the markets & take
investment decisions. So it is very ironic when you invest your money in mutual fund & review it on
daily basis. It is unnecessary & counterproductive in general. This has nothing to do with improving the
returns prospects of your portfolio.
Review of mutual fund portfolio once or twice in year is just sufficient to check whether your mutual
performance aligned with market performance & more importantly in line with your financial goal.

To Summarize,
Mutual Fund is professionally managed pool of money which invest across all the asset
classes such as Equity, Debt, Gold etc; according to its investment objective.
Mutual Fund is very unique financial product since it is capable to serve your all
financial goals like saving money for your child education or saving for down payment
of your home.
Mutual funds are market linked & carries risk but all the data from portfolio
disclosures to risk parameters periodically made available by mutual funds itself ,
helps investors to take informed decision & mitigate risk.
Each Mutual Fund Scheme is unique & caters to certain risk profile & investment
objective. So always decide what are your financial goals & your risk appetite before
investing in mutual funds.
Do not rely heavily on star ratings. Most star ratings are on principles of “one size fits
all” which is not the case in reality. Take your financial advisor help to select mutual
fund scheme that fits your requirement.
SUMMARY

Mutual Funds Handbook

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