awareness about mutual funds

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Awareness about mutual funds

INTRODUCTION OF MUTUAL FUNDS:-

A mutual fund is a company that invests in a diversified portfolio of

securities. People who buy shares of a mutual fund are its owners or shareholders.

Their investments provide the money for a mutual fund to buy securities such as

stocks and bonds. A mutual fund can make money from its securities in two ways: a

Security can pay dividends or interest to the fund or a security can rise in value.

A fund can also lose money and drop in value. Mutual fund is a mechanism for

pooling the resources by issuing units to the investors and investing funds in securities

in accordance with objectives as disclosed in offer document. A mutual fund pools the

money of many investors to invest in a variety of stocks, bonds or other securities.

Each fund has its own investment Objective, with some funds investing more

aggressively and others Investing more conservatively. When you invest money in a

mutual fund, you receive shares of the fund. Each share represents an interest in the

funds portfolio and the value of your mutual fund shares will raise and fall depending

upon the performance of the securities in the portfolio. While the returns of mutual

funds are not guaranteed, they do offer many advantages, especially for the

inexperienced investor. Mutual Funds allow you to invest in a variety of industries

and investments, performance of the securities in the portfolio which may be difficult

to do individually without having large amounts of money to invest. The purpose of

this publication is to help you understand how mutual funds work and assist you in

selecting funds to create a well-balanced Portfolio.

Pools the money of many investors to invest in a variety of stocks, Bonds or other

securities

A mutual fund is a professionally managed type of collective investment scheme that

pools money from many investors and invests it in stocks, Bonds, short- term money

market instrument and other securities. Mutual funds have a fund manager who

invests the money on beta. lf of the investors by buying / selling stocks, bonds etc.

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INTRODUCTION OF MUTUAL

FUNDS

CHAPTER 1 INTRODUCTION OF MUTUAL FUNDS

CHAPTER 1 INTRODUCTION OF MUTUAL FUNDSCHAPTER 1 INTRODUCTION OF MUTUAL FUNDS


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Currently, the worldwide value of all mutual funds totals more than $US 26 trillion.

The United States leads with the number of mutual fund schemes. There are more

than 8000 mutual fund schemes in the U.S.A. Comparatively, India has around 1000

mutual fund schemes, but this number has grown exponentially in the last few years.

The Total Assets under Management in India of all Mutual funds put together

touched a peak of Rs. 5, 44,535 crs. at the end of August 2008. There are various

investment avenues available to an investor such as real estate, bank deposits, post

office deposits, shares, debentures, bonds etc. A mutual fund is one more type of

Investment Avenue available to investors. There are many reasons why investors

prefer mutual funds. Buying shares directly from the market is one way of investing.

But this requires spending time to find out the performance of the company whose

share is being purchased, understanding the future business prospects of the

company, finding out the track record of the promoters and the dividend, bonus issue

history of the company etc. An informed investor needs to do research before

investing. However, many investors find it cumbersome and time consuming to pore

over so much of information, get access to so much of details before investing in the

shares. Investors therefore prefer the mutual fund route. They invest in a mutual

fund scheme which in turn takes the responsibility of investing in stocks and shares

after due analysis and research. The investor need not bother with researching

hundreds of stocks. It leaves it to the mutual fund and its professional fund

management team. Another reason why investors prefer mutual funds is because

mutual funds offer diversification. An investors money is invested by the mutual

fund in a variety of shares, bonds and other securities thus diversifying the

investors portfolio across different companies and sectors. This diversification

helps in reducing the overall risk of the portfolio. It is also less expensive to invest in

a mutual fund since the minimum investment amount in mutual fund units is fairly

low (Rs. 500 or so). With Rs. 500 an investor may be able to buy only a few stocks

and not get the desired diversification. These are some of the reasons why mutual

funds have gained in popularity over the years.

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HISTORY OF MUTUAL FUNDS:-

The mutual fund industry in India started in 1963 with the formation of Unit Trust ofIndia, at the initiative of the Government of India and Reserve Bank of India. The

history of mutual funds in India can be broadly divided into four distinct phases First

Phase 1964-87 Unit Trust of India (UTI) was established on 1963 by an Act of

Parliament. It was set up by the Reserve Bank of India and functioned under the

Regulatory and administrative control of the Reserve Bank of India. In 1978 UTI was

de-linked from the RBI and the Industrial Development Bank of India (IDBI) took

over the regulatory and administrative control in place of RBI. The first scheme

launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6, 700

crores of assets under management. Second Phase 1987-1993 (Entry of Public

Sector Funds) 1987 marked the entry of non- UTI, public sector mutual funds set up

by public sector banks and Life Insurance Corporation of India (LIC) and General

Insurance Corporation of India (GIC). SBI Mutual Fund was the first non- UTI

Mutual Fund established in June 1987 followed by Can bank Mutual Fund (Dec 87),

Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89),

Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its

mutual fund in June 1989 while GIC had set up its mutual fund in December 1990. At

the end of 1993, the mutual fund industry had assets under management of Rs.47, 004

crores. Third Phase 1993-2003 (Entry of Private Sector Funds) with the entry of

private sector funds in 1993, a new era started in the Indian mutual fund industry,

giving the Indian investors a wider choice of fund families. Also, 1993 was the year in

which the first Mutual Fund Regulations came into being, under which all mutual

funds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer

(now merged with Franklin Templeton) was the first private sector mutual fund

registered in July 1993. The 1993 SEBI (Mutual Fund) Regulations were substituted

by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry

now functions under the SEBI (Mutual Fund) Regulations 1996. The number of

mutual fund houses went on increasing, with many foreign mutual funds setting up

funds in India and also the industry has witnessed several mergers and acquisitions.

As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,

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21,805 crores. The Unit Trust of India with Rs.44, 541 crores of assets under

management was way ahead of other mutual funds. Fourth Phase since February

2003 In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI

was bifurcated into two separate entities. One is the Specified Undertaking of the Unit

Trust of India with assets under management of Rs.29, 835 crores as at the end of

January 2003, representing broadly, the assets of US 64 scheme, assured return and

certain other schemes. The Specified Undertaking of Unit Trust of India, functioning

under an administrator and under the rules framed by Government of India and does

not come under the purview of the Mutual Fund Regulations. The second is the UTI

Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and

functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile

UTI which had in March 2000 more than Rs.76, 000 crores of assets under

management and with the setting up of a UTI Mutual Fund, conforming to the SEBI

Mutual Fund Regulations, and with recent mergers taking place among different

private sector funds, the mutual fund industry has entered its current phase of

consolidation and growth. The graph indicates the growth of assets over the years.

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CONCEPT OF MUTUAL FUNDS:-

A Mutual Fund is a trust that pools the savings of a number of investors who share a

common financial goal. The money thus collected is then invested in capital marketinstruments such as shares, debentures and other securities. The income earned

through these investments and the capital appreciation realised are shared by its unit

holders in proportion to the number of units owned by them.

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DEFINITION OF MUTUAL FUNDS:-

The securities and exchange board of India regulations, 1993 defines a mutual fundas a fund establish in the form of the trust by a sponsor, to raise monies by the trustees

through the sale of units to the public, under one or more schemes, for investing in

securities in accordance with these regulations.

According to Weston j. Fred and Brigham, Eugene f., unit trusts are corporations

which accept dollars from savers and then use this dollar to buy stock, long term

bonds, short term debt instruments issued by business or government units; these

corporations pool funds and thus reduce risk by diversification

Thus a Mutual Fund is the most suitable investment for the common man as it offers

an opportunity to invest in a diversified, professionally managed basket of securities

at a relatively low cost. The flow chart below describes broadly the working of a

mutual fund:

Mutual Fund Operations Flow Chart

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There are many entities involved and the diagram below illustrates the organisational

set up of a mutual fund:

ORGANISATION OF A MUTUAL FUND

A mutual fund is set up in the form of a trust, which has sponsor, trustees, asset

Management Company (AMC) and custodian. The trust is established by a sponsor or

more than one sponsor who is like promoter of a company. The trustees of the mutual

fund hold its property for the benefit of the unit holders. Asset Management Company

(AMC) approved by SEBI manages the funds by making investments in various types

of securities. Custodian, who is registered with SEBI, holds the securities of various

schemes of the fund in its custody. The trustees are vested with the general power of

superintendence and direction over AMC. They monitor the performance and

compliance of SEBI Regulations by the mutual fund.

SEBI Regulations require that at least two thirds of the directors of trustee company

or board of trustees must be independent i.e. they should not be associated with the

sponsors. Also, 50% of the directors of AMC must be independent. All mutual funds

are required to be registered with SEBI before they launch any scheme.

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A TYPICAL MUTUAL FUND IN INDIA HAS THE FOLLOWING

CONSTITUENTS:-

FUND SPONSOR:-

A sponsor is a person who, acting alone or in combination with another

corporate body, establishes a MF. In order to register with SEBI as MF, the sponsor

should have a sound financial track record of over five years and general reputation of

fairness and integrity in all his business transaction. The sponsor should contribute at

least 40% of the net worth of the AMC.The sponsor initiates the idea to set up a

mutual fund. It could be a registered company, scheduled bank or financial institution.

For Birla Mutual Fund, the sponsor is Birla Growth Funds. In a joint venture like Sun

F&C Mutual Fund, Foreign & Colonial Emerging Markets is the sponsor and SUN

Securities (India) Ltd, the co-sponsor. A sponsor has to satisfy certain conditions,

such as on capital, track record (at least five years' operation in financial services),

default-free dealings and a general reputation of fairness. The sponsor appoints the

trustees, AMC and custodian. Once the AMC is formed, the sponsor is just a

stakeholder. However, sponsors do play a key role in bailing out an AMC during a

crisis

MUTUAL FUND:-

A MF is established in the form of a trust under the Indian Trusts Act, 1882.

The instrument of trust is executed by the sponsor in favour of trustees and is

registered under the Indian Registration act, 1908. The investor subscribes to the units

issued by the Mutual Funds. These assets are held by the trustee for the benefit of unit

holders.

TRUSTEES:-

The MF can either be managed by the Board of Trustees, which is the body

of individuals, or by Trust Company, which is the corporate body. Most of the funds

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in India are managed by a Board of Trustees. The trustees are appointed with the

approval of SEBI. The Trustees, however, do not directly manage the portfolio of MF.

It is managed by the AMC as per the defined objectives.

Trustees hold a fiduciary responsibility towards unit holders by protecting their

interests. Sometimes, as with Canara Bank, the trustee and the sponsor are the same.

For others, like SBI Funds Management, State Bank of India is the sponsor and SBI

Capital Markets the trustee. Trustees float and market schemes, and secure necessary

approvals. They check if the AMC's investments are within defined limits, whether

the fund's assets are protected, and also ensure that unit holders get their due returns.

Trustees also review any due diligence done by the AMC. For major decisions

concerning the fund, they have to take unit holders' consent. They submit reports

every six months to SEBI; investors get an annual report. Trustees are paid annually

out of the fund's assets -- 0.05 per cent of the weekly average net asset value.

ASSET MANAGEMENT COMPANY:-

The AMC, appointed by the sponsor or the Trustees and approved by

SEBI, acts like the investment manager of the Trust. The AMC should have at least a

net worth of Rs. 10 crore. It functions under the supervision of its Board of Directors,

Trustees and the SEBI. The regulations require non-interfering relationship between

the fund sponsors, trustees, custodians and AMC. The AMC appoints distributors or

brokers to sell units on behalf of the Fund, also serve as investment advisers. They are

the ones who manage your money. An AMC takes investment decisions, compensates

investors through dividends, maintains proper accounting and information for pricing

of units, calculates the NAV, and provides information on listed schemes and

secondary market unit transactions.

It also exercises due diligence on investments, and submits quarterly reports to the

trustees. A fund's AMC can neither act for any other fund nor undertake any business

other than asset management. Its net worth should not fall below Rs 10 crore. And, its

fee should not exceed 1.25 per cent if collections are below Rs 100 crore and 1 per

cent if collections are above Rs 100 crore. SEBI can pull up an AMC if it deviates

from its prescribed role.

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CUSTODIAN:

Often an independent organisation, it takes custody of securities and

other assets of a mutual fund. Among public sector mutual funds, the sponsor ortrustee generally also acts as the custodian. A custodian's responsibilities include

receipt and delivery of securities, collecting income, distributing dividends,

safekeeping of units and segregating assets and settlements between schemes. Their

charges range between 0.15-0.2 per cent of the net value of the holding. Custodians

can service more than one fund.

STRUCTURE OF MUTUAL FUNDS:-For anybody to become well aware about mutual funds, it is imperative for him or

her to know the structure of a mutual fund. How does a mutual fund come into

being? Who are the important people in a mutual fund? What are their roles? etc.

We will start our understanding by looking at the mutual fund structure in brief.

Mutual Funds in India follow a 3- tier structure. There is a Sponsor (the First tier),

who thinks of starting a mutual fund. The Sponsor approaches the Securities &

Exchange Board of India (SEBI), which are the market regulator and also the

regulator for mutual funds.

Not every one can start a mutual fund. SEBI checks whether the person is of

integrity, whether he has enough experience in the financial sector, his net worth etc.

Once SEBI is convinced, the sponsor creates a Public Trust (the Second tier) as per

the Indian Trusts Act, 1882. Trusts have no legal identity in India and cannot enter

into contracts, hence the Trustees are the people authorized to act on behalf of the

Trust. Contracts are entered into in the name of the Trustees. Once the Trust is

created, it is registered with SEBI after which this trust is known as the mutual

fund. It is important to understand the difference between the Sponsor and the Trust.

They are two separate entities. Sponsor is not the Trust; i.e. Sponsor is not the

Mutual Fund. It is the Trust which is the Mutual Fund. The Trustees role is not to

manage the money. Their job is only to see, whether the money is being managed as

per stated objectives. Trustees may be seen as the internal regulators of a mutual

fund.

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IMPORTANCE:-

When you invest in a mutual fund, you are investing in a company that, in

turn, buys shares of stock and debt obligations issued by companies and governments.

Mutual funds are called pass-through investments since federal law requires them to

distribute, or "pass through," most of the earnings on their investments to

shareholders. Mutual funds have been around since the 1920s and are regulated by the

Investment Company Act of 1940.A mutual fund sells you shares of itself to raise

cash. The fund invests these proceeds in aportfolio ofsecurities. These securities are

also referred to as a portfolio's holdings.

A team of professional fund managers and analysts is tasked with managing a mutual

fund. The team selects individual securities that have the risk-return characteristics

that are consistent with the fund's investment strategy. The fund team monitors the

investment performance of the portfolio daily. If one of the portfolio's holdings falls

out of favor, the team may sell the security and buy another. Alternatively, instead of

immediately reinvesting the cash elsewhere, it may decide to park the money

temporarily and earn a risk-free interest rate until a better investment opportunity

comes along.

1) WIDE PORTFOLIO INVESTMENT:-

Small and medium investors used to burn their fingers in stock exchange

operations with a relatively modest outlay. If they invest in a select few

shares, some may even sink without a trace never to rise again. Now, these

investors can enjoy wide portfolio investment held by mutual fund.

2) OFFERING TAX BENEFITS:-

Certain fund offers tax benefits to its customers. Thus, apart from

dividend, interest and capital appreciation, investors also stand to get the

benefit of tax concession.

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ROLE AND IMPORTANCE OF

MUTUAL FUNDS

FUNDS


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3)SUPPORTING CAPITAL MARKET:-

Mutual funds play a vital role in supporting the development of capital

markets. The mutual funds make the capital market active by means ofproviding a sustainable domestic source of demand for capital market

instruments. In other words, the savings of the people are directed towards

investments in capital market through these mutual funds.

4) CHANNELISING SAVINGS FOR INVESTMENT:-

Mutual funds act as a vehicle in galvanizing the savings of the people by

offering various schemes to the various classes of customers for thedevelopment of the economy as a whole. A number of schemes are being

offered by Mutual Funds so as to meet the varied requirements of the

masses, and thus, savings are directed towards capital investments directly.

5)PROVIDING BETTER YIELDS:-

The pooling of funds from a large number of customers enables the fund to

have large funds at its disposal. Due to these large funds are able to buycheaper and sell dearer than the small and medium investors. Thus they are

able to command better yields to their customers. They also enjoy the

economies of large scale and can reduce the cost of capital market

participation.

6)PROMOTE INDUSTRIAL DEVELOPMENT:-

The economic development of any nation depends upon its industrialadvancement and agricultural development. All industrial units have to

raise their funds by resorting to the capital market by the issue of shares

and debentures.

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7)RENDERING EXPERTISED SERVICE AT LOW COST:-

The management of the fund is generally assigned to professionals who

are well trained and have experience in the field of investment. Theinvestments decisions of these professionals are always backed by

informed judgment and experience. Thus investors are assured of quality

services in their best interest.

8)PROVIDING RESEARCH SERVICE:-

A mutual fund is able to command vast resources and hence it is possible

for it to have an in-depth study and carry out research on corporatesecurities. Each fund maintains a large research team which constantly

analyses the companies and the industries, recommends the fund to buy or

sell particular share.

9)INTRODUCING FLEXIBLE INVESTMENT SCHEDULE:-

Some mutual funds have permitted the investors to exchange their units

from one scheme to another and this flexibility is a great boon to investors.Income units can be exchanged for growth units depending upon the

performances of the funds.

10) REDUCING THE MARKETING COST OF NEW ISSUES:-

Moreover the mutual funds help to reduce the marketing cost of new

issues. The promoters used to alloy a major share of Initial Public Offering

to the mutual funds and thus they are saved from the marketing cost ofsuch issues.

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11) SIMPIFIED RECORD KEEPING:-

An investor with just an investment in 500 shares or so in 3 or 4

companies has to keep proper records of dividend payments, bonus issues,price movements, purchase or sale instruction, brokerage or related items.

It is very tedious and consumes a lot of time. One may even forget to

record the right issue and may have to forfeit the same. Thus, record

keeping is the biggest problem for small and medium investors.

12) ACTING AS SUBSTITUTE FOR INITIAL PUBLIC

OFFERINGS:In most cases investors are not able to get allotment in IPOs of

companies because they are often oversubscribed many times. Moreover

they have to apply for minimum of 500 shares which is very difficult

particularly for small investors. But, in mutual funds, allotment is more or

less guaranteed.

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15

TYPES OF MUTUAL

FUNDS

FUNDS

CHAPTER 1 INTRODUCTION OF MUTUAL

FUNDS


FUNDSCHAPTER 1 INTRODUCTION OF MUTUALFUNDS


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TYPES OF MUTUAL FUNDS:-

1. On The Basis Of Execution & Operation.2. On The Basis Of yield & Investment Pattern.

ON THE BASIS OF EXECUTION & OPERATION:-

A. CLOSE-ENDED FUNDS:-

Under this scheme, the corpus of the fund and its duration are prefixed. In other

words, the corpus of the fund and the number of units are determined in advance.

Once the subscription reaches the predetermined level, the entry of investors is closed.

After the expiry of the fixed period, the entire corpus is disinvested and the proceeds

are distributed to the various unit holders in proportion to their holding. Thus, the

fund ceases to be a fund, after the final distribution.

A closed-end mutual fund has a set number of shares issued to the public through an

initial public offering. These funds have a stipulated maturity period generally ranging

from 3 to 15 years. The fund is open for subscription only during a specified period.

Investors can invest in the scheme at the time of the initial public issue and thereafter

they can buy or sell the units of the scheme on the stock exchanges where they are

listed.

Once underwritten, closed-end funds trade on stock exchanges like stocks or bonds.

The market price of closed-end funds is determined by supply and demand and not by

net-asset value (NAV), as is the case in open-end funds. Usually closed mutual funds

trade at discounts to their underlying asset value.

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B. OPEN-ENDED FUNDS:-

It is just the opposite of close ended funds. Under this scheme, the size of the fundand the period of the fund are not pre-determined. The investors are free to buy and

sell any number of units at any point of time. For instance, the Unit Scheme (1964) of

the Unit Trust of India is an open-ended one, both in terms period and target amount.

Anybody can buy this unit at any time and sell it also at any time at his discretion.

Open end funds are operated by a mutual fund house which raises money from

shareholders and invests in a group of assets, as per the stated objectives of the fund.

Open-end funds raise money by selling shares of the fund to the public, in a manner

similar to any other company, which sell its stock to raise the capital. An open-end

mutual fund does not have a set number of shares. It continues to sell shares to

investors and will buy back shares when investors wish to sell. Units are bought and

sold at their current net asset value.

Open-end funds are required to calculate their net asset value (NAV) daily. Since the

NAV of an open-end fund is calculated daily, it serves as a useful measure of its fair

market value on a per-share basis. The NAV of the fund is calculated by dividing the

fund's assets minus liabilities by the number of shares outstanding. Open-end funds

usually charge an entry or exit load from the investors.

Most of the open-end funds are actively managed and the fund manager picks the

stocks as per the objective of the fund. Open-end funds keep some portion of their

assets in short-term and money market securities to provide available funds for

redemptions. A large portion of most open mutual funds is invested in highly liquid

securities, which enables the fund to raise money by selling securities at prices very

close to those used for valuations.

Some of the benefits of open-end funds include diversification, professional money

management, liquidity and convenience. But open-end funds have one negative as

compared to closed-end funds. Since open-end funds are constantly under redemption

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pressure, they always have to keep a certain amount of money in cash, which they

otherwise would have invested. This lowers the potential returns.

ON THE BASIS OF YIELD AND INVESTMENT :-

I. EQUITY FUNDS:-

Equity Funds are defined as those funds which have at least 65% of their Average

Weekly Net Assets invested in Indian Equities. This is important from taxation point

of view, as funds investing 100% in international equities are also equity funds from

the investors asset allocation point of view, but the tax laws do not recognize these

funds as Equity Funds and hence investors have to pay tax on the Long Term CapitalGains made from such investments (which they do not have to in case of equity funds

which have at least 65% of their Average Weekly Net Assets invested in Indian

Equities).

AGGRESSIVE GROWTH FUNDS:-

These funds are just the opposite of bond

funds. These funds are capital gains oriented and thus the thrust area of these funds iscapital gains. Hence these funds are generally invested in speculative stocks. In

Aggressive Growth Funds, fund managers aspire for maximum capital appreciation

and invest in less researched shares of speculative nature. Because of these

speculative investments Aggressive Growth Funds become more volatile and thus, are

prone to higher risk than other equity funds.

GROWTH FUNDS (Growth Oriented Funds):-Unlike the income funds, growth funds concentrate mainly

on long run gains i.e. capital appreciation. They do not offer regular income and they

aim at capital appreciation in the long run. Hence, they have been described as Nest

Eggs investments. Growth Funds also invest for capital appreciation (with time

horizon of 3 to 5 years) but they are different from Aggressive Growth Funds in the

sense that they invest in companies that are expected to outperform the market in the

future. Without entirely adopting speculative strategies, Growth Funds invest in thosecompanies that are expected to post above average earnings in the future.

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EQUITY INCOME OR DIVIDEND YIELD:-

As the very name suggests, this Fund aims at generating and

distributing regular income to the members on a periodical basis. It concentrates more

on the distribution of regular return is higher than that of the income from bank

deposits. The objective of Equity Income or Dividend Yield Equity Funds is to

generate high recurring income and steady capital appreciation for investors by

investing in those companies which issue high dividends (such as Power or Utility

companies whose share prices fluctuate comparatively lesser than other companies'

share prices). Equity Income or Dividend Yield Equity Funds are generally exposed

to the lowest risk level as compared to other equity funds.

DIVERSIFIED EQUITY FUNDS (ELSS):-

Equity Linked Savings Schemes (ELSS) are equity schemes, where investors

get tax benefit upto Rs. 1 Lakh under section 80C of the Income Tax Act.

These are open ended schemes but have a lock in period of 3 years. These

schemes serve the dual purpose of equity investing as well as tax planning for

the investor; however it must be noted that investors cannot, under any

circumstances, get their money back before 3 years are over from the date of

investment.

EQUITY INDEX FUNDS:-

Equity Schemes come in many variants and thus can besegregated according to their risk levels. At the lowest end of the equity funds risk

return matrix come the index funds while at the highest end come the sectoral

schemes or Specialty schemes. These schemes are the riskiest amongst all types

Schemes as well. However, since equities as an asset class are risky, there are no

guaranteeing returns for any type of fund. Index Funds invest in stocks comprising

indices, such as the Nifty 50, which is a broad based index comprising 50 stocks.

There can be funds on other indices which have a large number of stocks such as the

CNX Midcap 100 or S&P CNX 500. Here the investment is spread across a large

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number of stocks. In India today we find many index funds based on the Nifty 50

index, which comprises large, liquid and blue chip 50 stocks.

VALUE FUNDS:

Value Funds invest in those companies that have sound

fundamentals and whose share prices are currently under-valued. The portfolio of

these funds comprises of shares that are trading at a low Price to Earning Ratio

(Market Price per Share / Earning per Share) and a low Market to Book Value

(Fundamental Value) Ratio. Value Funds may select companies from diversified

sectors and are exposed to lower risk level as compared to growth funds or speciality

funds. Value stocks are generally from cyclical industries (such as cement, steel,

sugar etc.) which make them volatile in the short-term. Therefore, it is advisable to

invest in Value funds with a long-term time horizon as risk in the long term, to a large

extent, is reduced

SPECIALISED FUNDS:-

Besides the above, a large number of specialized funds are

in existence abroad. They offer special schemes so as to meet the specific needs of

specific categories of people like pensioners, widows, etc. There are also funds for

investments in securities of specified area. For instance Japan fund, South Korea fund,

etc.

Again, certain funds may be confined to one particular sector

or industry like fertilizer, automobiles, petroleum, etc. These funds carry heavy risks

since the entire investors who prefer this type of fund, of course, in such cases; the

rewards may commensurate with the risk taken. The best example of this type is the

Petroleum Industry Funds in the USA.

SECTOR FUNDS:-

Funds that invest in stocks from a single sector or related

sectors are called Sectoral funds. Examples of such funds are IT Funds, Pharma

Funds, Infrastructure Funds, etc. Regulations do not permit funds to invest over 10%of their Net Asset Value in a single company. This is to ensure that schemes are

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diversified enough and investors are not subjected to undue risk. This regulation is

relaxed for sectoral funds and index funds.

FOREIGN SECURITIES FUNDS:-

Foreign Securities Equity Funds have the option to invest in one or

more foreign companies. Foreign securities funds achieve international diversification

and hence they are less risky than sector funds. However, foreign securities funds are

exposed to foreign exchange rate risk and country risk.

MID-CAP OR SMALL-CAP FUNDS:-

Funds that invest in companies having lower market capitalization

than large capitalization companies are called Mid-Cap or Small-Cap Funds. Market

capitalization of Mid-Cap companies is less than that of big, blue chip companies

(less than Rs. 2500 crores but more than Rs. 500 crores) and Small-Cap companies

have market capitalization of less than Rs. 500 crores. Market Capitalization of a

company can be calculated by multiplying the market price of the company's share bythe total number of its outstanding shares in the market. The shares of Mid-Cap or

Small-Cap Companies are not as liquid as of Large-Cap Companies which gives rise

to volatility in share prices of these companies and consequently, investment gets

risky.

OPTION INCOME FUNDS:-

While not yet available in India, Option Income Funds writeoptions on a large fraction of their portfolio. Proper use of options can help to reduce

volatility, which is otherwise considered as a risky instrument. These funds invest in

big, high dividend yielding companies, and then sell options against their stock

positions, which generate stable income for investors.

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II. MONEY-MARKET MUTUAL FUNDS (MMMFS):-

These funds are basically open ended mutual funds and as

such they have all features of the open ended fund. But, they invest in highly liquid

and safe securities like commercial paper, bankers acceptances, certificates of

deposits, treasury bills, etc. These instruments are called money market instruments.

They take place of shares, debentures and bonds in a capital market. They pay money

market rates of interest. These funds are called money funds in the USA and they

have been functioning since 1972. Investors generally use it as a Parking Place or

stop gap arrangements for their cash resources till they finally decide about the proper

avenue for their investment i.e., long term financial assets like bonds and stocks.

Since MMMFs are a new concept in India, the RBI has laid down certain stringent

regulations. For instance, the entry to MMMFs is restricted only to scheduled

commercial banks and their subsidiaries.

III. HYBRID FUNDS:-

As the name suggests, hybrid funds are those funds whose portfolio includes a

blend of equities, debts and money market securities. Hybrid funds have an equal

proportion of debt and equity in their portfolio. There are following types of

hybrid funds in India:

BALANCED FUNDS:-

This is otherwise called income-cum-growth fund. It is nothing but

a combination of both income and growth funds. It aims at distributing regular income

as well as capital appreciation. This is achieved by balancing the investments between

the high growth equity shares and also the fixed income earning securities

GROWTH-AND-INCOME FUNDS:-

Funds that combine features of growth funds and income funds are known as

Growth-and-Income Funds. These funds invest in companies having potential for

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capital appreciation and those known for issuing high dividends. The level of risks

involved in these funds is lower than growth funds and higher than income funds.

ASSET ALLOCATION FUNDS:-

Mutual funds may invest in financial assets like equity, debt,

money market or non-financial (physical) assets like real estate, commodities etc..

Asset allocation funds adopt a variable asset allocation strategy that allows fund

managers to switch over from one asset class to another at any time depending upon

their outlook for specific markets. In other words, fund managers may switch over to

equity if they expect equity market to provide good returns and switch over to debt if

they expect debt market to provide better returns. It should be noted that switching

over from one asset class to another is a decision taken by the fund manager on the

basis of his own judgment and understanding of specific markets, and therefore, the

success of these funds depends upon the skill of a fund manager in anticipatingmarket trends.

DEBT/INCOME FUNDS:-

Funds that invest in medium to long-term debt

instruments issued by private companies, banks, financial institutions, governments

and other entities belonging to various sectors (like infrastructure companies etc.) are

known as Debt / Income Funds. Debt funds are low risk profile funds that seek to

generatefixed current income (and not capital appreciation) to investors. In order toensure regular income to investors, debt (or income) funds distribute large fraction of

their surplus to investors. Although debt securities are generally less risky than

equities, they are subject to credit risk (risk of default) by the issuer at the time of

interest or principal payment. To minimize the risk of default, debt funds usually

invest in securities from issuers who are rated by credit rating agencies and are

considered to be of "Investment Grade". Debt funds that target high returns are more

risky. Based on different investment objectives, there can be following types of debt

funds:

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DIVERSIFIED DEBT FUNDS:-

Debt funds that invest in all securities issued by entities belonging to all

sectors of the market are known as diversified debt funds. The best feature of

diversified debt funds is that investments are properly diversified into all sectors

which results in risk reduction. Any loss incurred, on account of default by a debt

issuer, is shared by all investors which further reduces risk for an individual investor.

FOCUSED DEBT FUNDS:-

Unlike diversified debt funds, focused debt funds are narrow focus funds that

are confined to investments in selective debt securities, issued by companies of a

specific sector or industry or origin. Some examples of focused debt funds are sector,

specialized and offshore debt funds, funds that invest only in Tax Free Infrastructure

or Municipal Bonds. Because of their narrow orientation, focused debt funds are more

risky as compared to diversified debt funds. Although not yet available in India, these

funds are conceivable and may be offered to investors very soon.

HIGH YIELD DEBT FUNDS:-

As we now understand that risk of default is present in all debt funds, and

therefore, debt funds generally try to minimize the risk of default by investing in

securities issued by only those borrowers who are considered to be of "investment

grade". But, High Yield Debt Funds adopt a different strategy and prefer securities

issued by those issuers who are considered to be of "below investment grade". The

motive behind adopting this sort of risky strategy is to earn higher interest returns

from these issuers. These funds are more volatile and bear higher default risk,

although they may earn at times higher returns for investors.

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ASSURED RETURN FUNDS:-

Although it is not necessary that a fund will meet its objectives or provide

assured returns to investors, but there can be funds that come with a lock-in period

and offer assurance of annual returns to investors during the lock-in period. Any

shortfall in returns is suffered by the sponsors or the Asset Management Companies

(AMCs). These funds are generally debt funds and provide investors with a low-risk

investment opportunity. However, the security of investments depends upon the net

worth of the guarantor (whose name is specified in advance on the offer document).

To safeguard the interests of investors, SEBI permits only those funds to offer assured

return schemes whose sponsors have adequate net-worth to guarantee returns in the

future. In the past, UTI had offered assured return schemes (i.e. Monthly IncomePlans of UTI) that assured specified returns to investors in the future. UTI was not

able to fulfill its promises and faced large shortfalls in returns. Eventually,

government had to intervene and took over UTI's payment obligations on itself.

Currently, no AMC in India offers assured return schemes to investors, though

possible.

FIXED TERM PLAN SERIES:-

Fixed Term Plan Series usually are closed-end

schemes having short term maturity period (of less than one year) that offer a series of

plans and issue units to investors at regular intervals. Unlike closed-end funds, fixed

term plans are not listed on the exchanges. Fixed term plan series usually invest in

debt / income schemes and target short-term investors. The objective of fixed term

plan schemes is to gratify investors by generating some expected returns in a short

period.

IV. GILT FUNDS:-

Also known as Government Securities in India, Gilt Funds invest

in government papers (named dated securities) having medium to long term maturity

period. Issued by the Government of India, these investments have little credit risk

(risk of default) and provide safety of principal to the investors. However, like all debt

funds, gilt funds too are exposed to interest rate risk. Interest rates and prices of debt

securities are inversely related and any change in the interest rates results in a change

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in the NAV of debt/gilt funds in an opposite direction.

V. OTHERS:-

Other types of Mutual Funds are as follows:

COMMODITY FUNDS:-

Those funds that focus on investing in different

commodities (like metals, food grains, crude oil etc.) or commodity companies or

commodity futures contracts are termed as Commodity Funds. A commodity fund that

invests in a single commodity or a group of commodities is a specialized commodity

fund and a commodity fund that invests in all available commodities is a diversified

commodity fund and bears less risk than a specialized commodity fund. "Precious

Metals Fund" and Gold Funds (that invest in gold, gold futures or shares of gold

mines) are common examples of commodity funds.

REAL ESTATE FUNDS:-

Funds that invest directly in real estate or lend to real

estate developers or invest in shares/securitized assets of housing finance companies,

are known as Specialized Real Estate Funds. The objective of these funds may be to

generate regular income for investors or capital appreciation.

EXCHANGE TRADED FUNDS (ETFS):-

Exchange Traded Funds provide investors with

combined benefits of a closed-end and an open-end mutual fund. Exchange Traded

Funds follow stock market indices and are traded on stock exchanges like a single

stock at index linked prices. The biggest advantage offered by these funds is that they

offer diversification, flexibility of holding a single share (tradable at index linked

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prices) at the same time. Recently introduced in India, these funds are quite popular

abroad.

FUND OF FUNDS:-

Mutual funds that do not invest in financial or physical

assets, but do invest in other mutual fund schemes offered by different AMCs, are

known as Fund of Funds. Fund of Funds maintain a portfolio comprising of units of

other mutual fund schemes, just like conventional mutual funds maintain a portfolio

comprising of equity/debt/money market instruments or non financial assets. Fund of

Funds provide investors with an added advantage of diversifying into different mutual

fund schemes with even a small amount of investment, which further helps in

diversification of risks. However, the expenses of Fund of Funds are quite high on

account of compounding expenses of investments into different mutual fund schemes.

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1)MARKET RISK:-

In general there are certain risks associated with every kind

of investment on shares. They are called as market risk. These market risks can be

reduced, but cannot be eliminated even by a good investment management. The

prices of the shares are subject to wide price fluctuations depending upon market

conditions over which nobody has a control. Moreover, every economy has to pass

through a cycle-Boom, Recession, Slump and Recovery. The phase of the business

cycle affects the market conditions to a larger extent.

2)SCHEME RISK :-

There are certain risks inherent in the scheme itself. It all

depends upon the nature of the scheme. For instance, in a pure growth scheme, risks

are greater. It is obvious because if one expects more returns as in case of a growth

scheme, one has to take more risks.

3) INVESTMENT RISK:-

Whether the mutual funds makes money in shares or losses

depends upon the investment expertise of the Asset Management Company (AMC).

If the investment advice goes wrong, the fund has to suffer a lot. The investment

expertise of various funds different and it is reflected on the returns which they offer

to investors.

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TYPES OF RISK

FUNDS


FUNDS


FUNDSCHAPTER 1 INTRODUCTION OF MUTUALFUNDS


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4)BUSSINESS RISK :-

The corpus of the mutual fund might have been invested

in a companys shares. If the business of that company suffers any set back, it cannot

declare any dividend. It may even go to the extent of winding up its business.Through the mutual fund can withstand such a risk, its incoming paying capacity is

affected.

5) POLITICAL RISKS :-

SUCCESSIVE Governments bring with them fancy new economic

ideologies and policies. It is often said many economic decisions are politicallymotivated. Changes in government bring in the risk of uncertainty which every

player in the financial service industry has to face. So mutual funds are no exception

to it.

6) INTEREST RATE RISK :-

This risk can be reduced by adjusting the maturity of the debt fund

portfolio, i.e. the Buyer of the debt paper would buy debt paper of lesser maturity sothat when the paper matures; he can buy newer paper with higher interest rates. So, if

the investor expects interest rates to rise; he would be better off giving short term

Loans (when an investor buys a debt paper, he essentially gives a loan to the issuer of

the paper). By giving a short-term loan, he would receive his Money back in a short

period of time. As interest rates would have risen by then, he would be able to give

another loan (again short term), this time at the new higher interest rates. Thus in a

rising interest rate scenario, the investor can reduce interest rate risk by investing in

debt paper of extremely short-term maturity.

7)INVESTOR PSYCHOLOGY RISK:-

The investor psychology is such that most of the investors, be it

Mutual Fund Investors or Direct Capital Market Investors, behave like reactionaries.

E.g. they enter the market when the share prices starts rising and they get panicky &

exit as soon as share prices starts falling. Therefore, whether it is shares of company

or mutual fund unit investors, investors resort to selling their investments when

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market starts looking down. Because of this, there will be more than normal demand

on Mutual Fund manager to redeem the units. To honor the redemption demands of

the exiting unit holders during the worst market times, Mutual Funds are forced to sell

more stocks at the prevailing low prices. As a result of this, all the unit holders who

have invested in the fund suffer. This means, irrespective of one being a long-term

buy and hold investor or not, he suffers because of investing in Mutual Fund.

8) CHOICE RISKS:-

All the experts recommend different schemes/ funds.

Naturally, all of them cannot be and will not be right. Investors are also advised to

stay invested for long-term to reap good returns. These experts also suggest different

funds at different times. Of course, to be in the well-being fund, one needs to move

from fund to fund intermittently. In an tempt to stay invested for a long-term and to be

in the well-doing fund, the investor, whether educated and informed, will have to be

satisfied with disappointment.

9)COST RISKS: -

Mutual Funds charge huge fees that they can get away with and

that too in the most confusing manner possible. The fund managers never intend to

make their costs clear to their clients. It would not be painful for the investors to pay

for the expenses and costs of the funds when they derive satisfactory returns. But, the

irony is that investors have to pay for the sales charges, annual fees and many other

expenses irrespective of how the fund has performed.

10)PREDICTION RISKS: -

Nobody can predict the capital market perfectly and can always

find good investments. Similarly, the fund manager's predictions of future actions and

outcomes are, of necessity, subject to error.

11)JARGON RISKS: -

The newsletters and other documents that are distributed to the

investors do report so much and that too in such a language filled with technical

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jargons that it will not be very easy for an investor to understand and follow the

report.

12) COMPETITION RISKS: - Return is ultimate measure of job performance for any

investment, be it in a mutual fund or otherwise. Performance is the matter of

comparison and the evaluation is intended to measure how the fund has performed

vis--vis its past performance, peers and market. At present, Mutual Funds are

required to report their performance including returns on a quarterly basis. Therefore,

to prove that the fund is performing well, managers focus on quarterly returns. Buying

& Selling of stocks at the end of quarter will be done to report better quarterly returns

and to make funds holdings look better based on recent market action. In this process,

where the competition is not really productive, fund managers incur expenses &

losses that are naturally passed on to the unit holders.

13)RISK OF REDEMPTION RESTRICTIONS: -

Whether informed in writing or not, normally the

liquidity of schemes investments may be restricted by the trading volumes settlement

period and transfer procedures.

14) MANAGEMENT CHANGE RISKS: -

It is not uncommon for a Mutual Fund to have changes in

its management. The change in the funds management may effect the achievement of

the objectives of the fund. The fund company may, for various reasons, replace a fund

manager or may be the fund manager himself may resign from his job for any reason.

This change will be significant since the fund manager controls the fund investments.

15) JUDGEMENT RISKS: -

Investors may not know more than the fund manager about

the investment strategy and whatever judgments the investor makes will not be fool

proof.

16) FORWARD PRICING RISKS:-

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The prices of a Mutual Fund do not change during the day.

Order placed up to a cut off time of 3:00 p.m. get that day's Net Asset Value (NAV)

and orders placed after 3:00 p.m. receive the next day's NAV. This is called the rule

of forward pricing. This system assures a level playing field for investors. No investor

is supposed to have the benefit of post 3:00 p.m. information prior to making an

investment decision.

17) BREAKPOINT RISKS: -

Mutual Fund charge loads such as front end & back end. Few

Mutual Fund charge front end sales load will charge lower sales loads for larger

investments. The investment level required to obtain a reduced sales load are known

as breakpoints. These breakpoints lure investors to invest huge funds to avail the

discounts on volumes and end up losing focus on his planned diversification for his

Mutual Fund investments.

18)RISKS OF BLIND DIVERSIFICATION : -

It may happen that a fund is heavily committed to a particular

area of the economy at any given time. This is called blind diversification risk and any

investor would like to invest in Mutual Fund that concentrate in asset classes that he

himself has not invested at his own.

19) RISKS OF CHANGES IN THE REGULATORY NORMS:-

Mutual Funds are constantly regulated by SEBI and

investors are subject to risk of the changes in the norms for the Mutual Funds. Besides

the above risks, Mutual Funds will also have the common risks that any investment

has. In fact, risk is present in every decision made with regard to the investments in

capital markets. Following is the list of some common risks involved while investing

in the capital markets and particularly in the mutual funds:

20) COUNTRY RISK:-

This risk arises from the possibility that political events

such as war, national elections etc. and financial problems such as rising inflation or

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natural disasters such as an earthquake, a poor harvest etc. will weaken a country's

economy and cause investments in that country to decline.

21)CREDIT RISK :-This is a risk that arises from the possibility that a bond issuer will fail to

repay interest and principal in a timely manner. This risk is also called as default risk.

22)CURRENCY RISK :-

This risk arises from the possibility that returns could be

reduced for Indians investing in foreign securities because of a rise in the value of the

Indian rupee against dollar, euro or yen etc. This is also known as Exchange Rate

Risk.

23)INDUSTRY RISK: -

This risk arises from the possibility that a group of stocks in a

single industry will decline in price due to developments in that industry.

24)MANAGER RISK: -

This risk arises from the possibility that an actively managed

mutual fund's investment adviser will fail to execute the fund's investment strategy

effectively, resulting in the failure of the sated objectives.

25)PRINCIPAL RISK :-

This risk arises from the possibility that an investment will

go down in value, or lose money from the original or invested amount.

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CHALLENGES AHEAD IN MUTUAL FUND INDIUSRTY:-

Marketing of funds is indeed a difficult topic to discuss,

particularly in the present difficult situation for the mutual fund industry when we

consider marketing, we have to see the issues in totality, because we cannot judge an

elephant by its trunk or by its tail but we have to see it in its totality. When we say

marketing of mutual funds, it means, includes and encompasses the following aspects;

assessing of investor needs & market research, responding to investors needs, product

designing, studying the macro environment, timing of launch of the product etc.

widening, broadening and deepening the markets.

There are certain issues which are directly linked with the

marketing Mutual funds the first of which is widening, broadening and deepening of

the markets for the mutual fund products. Considering the vast nature of this country

the first priority is the geographic spread has to be widened and the market has to be

deepening secondly, the MF must try to spread their wings not only within the

country but also outside the country.

A.MARKETS IN RURAL AND SEMI-URBAN AREAS:-

The Mutual Fund industry a collectively undertake

this job of creating awareness among the rural population about the M F as a new form of

savings and translate that awareness into increased fund mobilization.

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B. OVERSEAS MARKETS:-

The second aspect with respect to widening anddeepening the market is expanding the overseas investor base. The expansion of the

distribution network and quick dissemination of information, coupled with M F as

such should consider tapping these markets for expanding the scope of mobilization.

CHALLENGES IN MUTUAL FUND INDUSTRY:-

A.INVESTOR PREFRENCES:-

The challenge for Mutual Funds is in the tailoring the

right products that will help mobilization saving by targeting investors needs. It is

necessary that the common investor understands very clearly and salient and different

features of funds. The Indian investor is essentially risk averse and is more passive

than active. Our experience

B. PRODUCT INNOVATION:-

With the debt markets now getting developed, mutual

funds can tap the investors who require steady income with safety, by floating funds

that are designed to primarily have debt instruments can also design separate funds to

attract semi urban & rural investors, keeping their seasonal requirements in mind for

havent season, festival season, sowing season to name a few.

C. DISTRIBUTION NETWORK:-

I would now focus on the distribution network, namely

retail network versus the wholesale network. It is realize that the character of the

market is undergone rapid charge. The market is moving favorably also attract direct

investments from retail investor.

D. RETAILING THROUGH AGENTS:-

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The alternative distribution channels that are available are

retail selling or using lead managers and brokers along with sub-brokers for selling

units. The experience of unit trust of India her been that, if necessary motivation and

incentive is provided to retailer agents. In such system one achieves brand loyalty

through continuous interaction between agents and investors.

E. ADVERTISEMENT AND PUBLICITY:-

There are certain issues with reference to

advertisement, publicity literature and offer document which deserve attention. Most

of Mutual Funds advertisements look similar, focusing on scheme features, returns &

incentives

F. MUTUAL FUND INDUSTRY TO FACE GREATER OBSTACLES:

The mutual fund industry in India, although 15 years

old, is still to develop into a credible competitor to other segments of the financial

services industry, especially insurance. On the face of it, mutual fund investments (in

equity schemes) seem more attractive than insurance products, but on the ground the

reverse is true. More Indians trust life insurance companies with their savings than

they do with mutual funds. According to figures from the Central Statistical

Organisation (CSO), life insurance funds accounted for 12% of total household

savings in India. In contrast equity & debentures only attracted 7% of household

savings in financial year ending March 2008.

There are 35 asset management companies (AMCs) in India managing Rs 6, 70,012

crore, according to independent investment information provider, Value Research.

The industrys penetration is estimated at 4-5 % as against 10-15 % for insurance.

There are around 3 million agents for insurance products and just 80,000 distributors

for mutual funds. Both industries, which started almost half a century ago in India

with a single player, now have several competing companies. Still, low customer

awareness levels and poor financial literacy have largely stymied the popularity of

financial products in India.

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But in the case of insurance, rampant mis-selling has made it more popular

than mutual funds. While insurance is indeed an investment for covering your life, it

is sold more as a tax-saving investment tool. In rural areas, agents mis-sell it as a

fixed deposit and the idea has been so well rooted that in many Indian villages, There

is little scope for mis-selling in case of mutual funds - the mis-selling is limited to the

extent that the agent assures investors a return that the fund may not able to deliver.

In terms of selling, both mutual funds and insurance are push products.

However, a distributor has a higher incentive to sell the latter because of the

opportunity to earn a higher commission. An agent selling insurance earns a

commission of 30-40 % of the initial premium and a trail commission of around 5%.

However, the commission in case of mutual funds is never more than 2-2 .5%.

Insurance generally is a product that cannot be sold multiple times to one

investor. Hence, the agent has to be given a high commission to push the product. In

case of mutual funds, the agent gets multiple opportunities to sell more than one

product to the same investor. As a result, distributors and mutual fund houses exhibit

limited interest in continuously engaging with customers post closure of sale as the

commissions and incentives are largely in the form of upfront fees from product sales.

Limited use of the public sector banks network and post offices to distribute mutual

funds has also impeded the growth of the industry. The insurance industry, on the

other hand, has been able to leverage this to its advantage.

While setting up an AMC is relatively easy, getting business during a downturn

and withstanding redemption pressures during times of low

liquidity is the difficult part. The insurance business is one with a long gestation

period and requiring sufficient capital to cover incremental actuarial liability. The

breakeven time for an insurance business in India is at least seven years. In this

scenario, the most important challenge for the company is to have a robust agency

network.

Mutual Funds have to face a stricter regulatory environment as the industry is

regulated by the conservative capital market regular SEBI. As a result, there is limited

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flexibility in fixing fees and pricing. Insurance companies have a relatively less

stringent environment as the industry is regulated by IRDA, which is less

conservative in its regulation. This allows more flexibility for companies to structure

their products and fees.

ADVANTAGES OF MUTUAL FUNDS:-

A Mutual Fund can be defined as a trust wherein the savings

of the investors with the same financial goal are pooled in. The collected money then

goes for investment in capital market instruments. These can include debentures,

shares and other such securities. These investments in turn yield an income. The

income and capital appreciation are distributed amongst its unit holders. The

advantages of mutual funds are many. Some of the advantages of mutual funds in

India are listed below:

PROFESSIONAL MONEY MANAGEMENT & RESEARCH:-

Mutual funds are managed by professional fund managers

who regularly monitor market trends and economic trends for taking investmentdecisions. They also have dedicated research professionals working with them who

make an in depth study of the investment option to take an informed decision.

Investing requires skill. It requires a constant study of the dynamics of the markets

and of the various industries and companies within it. Anybody who has surplus

capital to be parked as investments is an investor, but to be a successful investor, you

need to have someone managing your money professionally. Just as people who have

money but not have the requisite skills to run a company (and hence must be content

as shareholders) hand over the running of the operations to a qualified CEO, similarly,

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investors who lack investing skills need to find a qualified fund manager. Mutual

funds help investors by providing them with a qualified fund manager. Increasingly,

in India, fund managers are acquiring global certifications like CFA and MBA which

help them be at the cutting edge of the knowledge in the investing world.

MUTUAL FUNDS COME IN MANY VARIETIES:-

A mutual fund comes in many types and styles. There

are stock funds, bond funds, sector funds, target-date mutual funds, money market

mutual funds and balanced funds. Mutual funds allow you to invest in the market

whether you believe in active portfolio management (actively managed funds) or you

prefer to buy a segment of the market with no interference from a manager (passive

funds and index mutual funds). The availability of different types of mutual funds

allows you to build a diversified portfolio at low cost and without much difficulty.

RISK DIVERSIFICATION:-

Diversification reduces risk contained in a portfolio byspreading it. It is about not putting all your eggs in one basket. As mutual funds have

huge corpuses to invest in, one can be part of a large and well-diversified portfolio

with very little investment.There is an old saying: Don't put all your eggs in one

basket. There is a mathematical and financial basis to this. If you invest most of your

savings in a single security (typically happens if you have ESOPs (employees stock

options) from your company, or one investment becomes very large in your portfolio

due to tremendous gains) or a single type of security (like real estate or equity become

disproportionately large due to large gains in the same), you are exposed to any risk

that attaches to those investments.

In order to reduce this risk, you need to invest in different types of securities such that

they do not move in a similar fashion. Typically, when equity markets perform, debt

markets do not yield good returns. Note the scenario of low yields on debt securities

over the last three years while equities yielded handsome returns. Similarly, you need

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to invest in real estate, or gold, or international securities for you to provide the best

diversification.

If you want to do this on your own, it will take you immense amounts of money and

research to do this. However, if you buy mutual funds -- and you can buy mutual

funds of amounts as low as Rs 500 a month! -- you can diversify across asset classes

at very low cost. Within the various asset classes also, mutual funds hold hundreds of

different securities (a diversified equity mutual fund, for example, would typically

have around hundred different shares).

TRANSPARENCY:-

Funds provide investors with updated information pertaining tothe markets and the schemes. All material facts are disclosed to investors as required

by the regulator.

FLEXIBILITY:-

Investors also benefit from the convenience and

flexibility offered by Mutual Funds. Investors can switch their holdings from a debt

scheme to an equity scheme and vice-versa. Option of systematic (at regular intervals)investment and withdrawal is also offered to the investors in most open-end schemes.

CONVENIENCE:-

With features like dematerialized account statements,

easy subscription and redemption processes, availability of NAV and performance

details through journals, newspapers and updates and lot more; Mutual Funds are sure

a convenient way of investing.

ECONOMIES OF SCALE:-

Because a mutual fund buys and sells large amounts of

securities at a time, its transaction costs are lower than you as an individual would

pay. Since mutual funds collect money from millions of investors, they achieve

economies of scale. The cost of running a mutual fund is divided between a larger

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pool of money and hence mutual funds are able to offer you a lower cost alternative of

managing your funds.

Equity funds in India typically charge you around 2.25% of your initial money and

around 1.5% to 2% of your money invested every year as charges. Investing in debt

funds costs even less. If you had to invest smaller sums of money on your own, you

would have to invest significantly more for the professional benefits and

diversification.

SYSTEMATIC INVESTING AND WITHDRAWALS WITH

MUTUAL FUNDS:-It is simple to invest regularly in a mutual fund.

Many mutual fund companies allow investors to invest as little as $50 per month

directly into a mutual fund. Money can be pulled directly from a bank account and

invested directly in the mutual fund. On the other hand, money can be regularly

withdrawn from a mutual fund and be deposited into a bank account. There are

generally no fees for this service.

LIQUIDITY:-

One of the greatest advantages of Mutual Fund investment

is liquidity. Open-ended funds provide option to redeem on demand, which is

extremely beneficial especially during rising or falling Markets

REDUCTION IN COSTS:-

Mutual funds have a pool of money that they have to

invest. So they are often involved in buying and selling of large amounts of securities

that will cost much lower than when you invest on your own

TAX ADVANTAGES:-

Investment in mutual funds also enjoys several tax

advantages. Dividends from Mutual Funds are tax-free in the hands of the investor

(This however depends upon changes in Finance Act). Also Capital Gain accrued

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from Mutual Fund investment for a period of over one year is treated as long term

capital appreciation and is tax free.

EASE OF PROCESS:-

If you have a bank account and a PAN card, you are

ready to invest in a mutual fund: it is as simple as that! You need to fill in the

application form, attach your PAN (typically for transactions of greater than Rs

50,000) and sign your cheque and you investment in a fund is made. In the top 8-10

cities, mutual funds have many distributors and collection points, which make it easy

for them to collect and you to send your application to.

WELL REGULATED:-

India mutual funds are regulated by the Securities and

Exchange Board of India, which helps provide comfort to the investors. SEBI

forces transparency on the mutual funds, which helps the investor make an

informed choice. SEBI requires the mutual funds to disclose their portfolios at

least six monthly, which helps you keep track whether the fund is investing in

line with its objectives or not.

However, most mutual funds voluntarily declare their portfolio once every month. We

will look at some of the risks of investing in a mutual fund and the costs of the same

in the next article.

FAMILY OF FUNDS:-

Many mutual funds are part of a family of funds (a

group of funds managed by the same company but with different investment

objectives). The advantage to this is an option known as an exchange privilege

or fund switching. Fund switching has become quite popular as fund companies

have made it easy to move your money from one fund to another, usually with

only a toll-free telephone call.

Switching is an easy and convenient way to take advantage of changing market

conditions. If the stock market began to decline, for instance, and your money was in

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a stock fund, you might consider switching your investment into a money market fund

within the same family

DISADVANTAGES OF MUTUAL FUNDS:-

FLUCTUATING RETURNS:-

Mutual funds are like many other investments without a

guaranteed return. There is always the possibility that the value of your mutual fund

will depreciate. Unlike fixed-income products, such as bonds and Treasury bills,

mutual funds experience price fluctuations along with the stocks that make up the

fund. When deciding on a particular fund to buy, you need to research the risks

involved - just because a professional manager is looking after the fund, that doesn't

mean the performance will be stellar.

MISLEADING ADVERTISEMENTS:-

The misleading advertisements of different funds can

guide investors down the wrong path. Some funds may be incorrectly labeled as

growth funds, while others are classified as small-cap or income. The SEC requires

funds to have at least 80% of assets in the particular type of investment implied in

their names. The remaining assets are under the discretion solely of the fund

manager.

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The different categories that qualify for the required 80% of the assets, however,

may be vague and wide-ranging. A fund can therefore manipulate prospective

investors by using names that are attractive and misleading. Instead of labeling itself

a small cap, a fund may be sold under the heading growth fund. Or, the "Congo

High-Tech Fund" could be sold with the title "International High-Tech Fund".

MUTUAL FUNDS HAVE HIDDEN FEES:-

If fees were hidden, those hidden fees would

certainly be on the list of disadvantages of mutual funds. The hidden fees that are

lamented are properly referred to as 12b-1 fees. While these 12b-1 fees are no fun to

pay, they are not hidden. The fee is disclosed in the mutual fundprospectus and can

be found on the mutual funds web sites. Many mutual funds do not charge a 12b-1

fee. If you find the 12b-1 fee onerous, invest in a mutual fund that does not charge

the fee. Hidden fees cannot make the list of disadvantages of mutual funds because

they are not hidden and there are thousands of mutual funds that do not charge 12b-

1 fees.

MUTUAL FUNDS LACK LIQUIDITY:-

How fast can you get your money if you sell a

mutual fund as compared to ETFs, stocks and closed-end funds? If you sell a mutual

fund, you have access to your cash the day after the sale. ETFs, stocks and closed-

end funds require you to wait three days after you sell the investment. I would call

the lack of liquidity disadvantage of mutual funds a myth. You can only find more

liquidity if you invest in your mattress.

NO INSURANCE:-

Mutual funds, although regulated by the government,

are not insured against losses. TheFederal Deposit Insurance Corporation (FDIC)

only insures against certain losses atbanks,credit unions, and savings and loans, not

mutual funds. That means that despite the risk-reducing diversification benefits

provided by mutual funds, losses can occur, and it is possible (although extremely

unlikely) that you could even lose your entire investment.

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DILUTION:-

Although diversification reduces the amount of risk

involved in investing in mutual funds, it can also be a disadvantage due to dilution.

For example, if a singlesecurityheld by a mutual fund doubles invalue, the mutual

fund itself would not double in value because that security is only one small part of

the fund's holdings. By holding a large number of different investments, mutual

funds tend to do neither exceptionally well nor exceptionally poorly.

FEESAND EXPENSES:-

Most mutual funds charge management and operating

fees thatpay for the fund's management expenses (usually around 1.0% to 1.5%per

year). In addition, some mutual funds charge high sales commissions, 12b-1 fees, and

redemption fees. And some funds buy and tradesharesso often that the transaction

costs add up significantly. Some of these expensesare charged on an ongoing basis,

unlike stockinvestments, for which a commission ispaid only when you buy andsell

EVALUATING FUNDS:-

Another disadvantage of mutual

funds is the difficulty they pose for investors interested in researching

and evaluating the different funds. Unlike stocks, mutual funds do not

offer investors the opportunity to compare the P/E ratio, sales growth,

earnings per share, etc. A mutual fund's net asset value gives investors

the total value of the fund's portfolio less liabilities, but how do you

know if one fund is better than another?

POOR PERFORMANCE:-

Returns on a mutual fund are by no means guaranteed.

In fact, on average, around 75% of all mutual funds fail to beat the major market

indexes, like the S&P 500, and a growing number of critics now question whether or

not professional money managers have better stock-picking capabilities than the

average investor.

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