1. What is Mutual Fund?
Mutual Funds pools the money of several investors and invests in stocks, bonds, money market instruments and other types of securities in accordance with objectives as disclosed in offer document. Or you can think of a mutual fund as a company that brings together a group of people invests their money in stocks, bonds, and other securities. Each investor owns shares, which represent a portion of the holdings of the fund. Investments in securities are diversified which reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public. SEBI formulates policies and regulates the mutual funds to protect the interest of the investors. Like all investments, they also carry certain risks. The investors should compare the risks and expected yields after adjustment of tax on various instruments while taking investment decisions. The investors may seek advice from experts and consultants including agents and distributors of mutual funds schemes while making investment decisions.
2. Why Mutual Funds?
There are numerous benefits of investing in mutual funds.
A mutual fund invests in a portfolio of assets, i.e. bonds, shares, etc. depending upon the investment objective of the scheme. An investor can buy in to a portfolio of equities, which would otherwise be extremely expensive. Each unit holder thus gets an exposure to such portfolios with an investment as modest as Rs.500/-. This amount today would get you less than quarter of an Infosys share! Thus it would be affordable for an investor to build a portfolio of investments through a mutual fund rather than investing directly in the stock market.
Mutual Funds offering multiple schemes allow investors to switch easily between various schemes. This flexibility gives the investor a convenient way to change the mix of his portfolio over time.
Investor‘s money spread across different securities (stocks, bonds, money market instruments, real estate, fixed deposits etc.) and different sectors (auto, textile, information technology etc.). This kind of a diversification may add to the stability of your returns, for example during one period of time equities might underperform but bonds and money market instruments might do well enough to offset the effect of a slump in the equity markets. Similarly the information technology sector might be faring poorly but the auto and textile sectors might do well and may protect your principal investment as well as help you meet your return objectives.
Mutual funds offer a tremendous variety of schemes. This variety is beneficial in two ways: first, it offers different types of schemes to investors with different needs and risk appetites; secondly, it offers an opportunity to an investor to invest sums across a variety of schemes, both debt and equity. For example, an investor can invest his money in a Growth Fund (equity scheme) and Income Fund (debt scheme) depending on his risk appetite and thus create a balanced portfolio easily or simply just buy a Balanced Scheme.
Qualified investment professionals who seek to maximize returns and minimize risk monitor investor's money. When you buy in to a mutual fund, you are handing your money to an investment professional who has experience in making investment decisions. It is the Fund Manager's job to (a) find the best securities for the fund, given the fund's stated investment objectives; and (b) keep track of investments and changes in market conditions and adjust the mix of the portfolio, as and when required.
Tax benefits Specific schemes of mutual funds (Equity Linked Savings Schemes) give investors the benefit of deduction of the amount subscribed(upto Rs. 150,000 in a financial year), from their income that is liable to tax. This reduces their taxable income, and therefore the tax liability. The Rajiv Gandhi Equity Savings Scheme (RGESS) offers a rebate to first time retail investors (in equity or mutual funds)with annual income uptoRs. 12lakhs. Mutual funds announce specific equity – oriented schemes that are eligible for the RGESS benefit.
The RGESS benefit is linked to amount invested (excluding brokerage, securities transaction tax, service tax, stamp duty and all taxes appearing in the contract note). Rebate of 50% of the amount invested upto Rs. 50, 000,can be claimed as a deduction from taxable income. The investment limit of Rs. 50,000is applicable for a block of three financial years, starting with the year of first investment. Thus, if an investor invests Rs. 30,000 in RGESS schemes in a financial year, then he can reduce his taxable income for that previous year by 50% of Rs. 30,000 i.e. Rs. 15,000. In the following year, he still has an investment limit of Rs. 20,000 available. The maximum deduction that can be made from the taxable income over the period of three financial years is 50% of Rs. 50,000 i.e. Rs. 25,000.
Dividends received from mutual fund schemes are tax-free in the hands of the investors. However,dividends from certain categories of schemes are subject to dividend distribution tax, which is paid by the scheme before the dividend is distributed to the investor. Long term capital gains arising out of sale of somecategories of schemesare subject to ong term capital gains tax, which may be taxed at a different (and often lower) rate of taxor even entirely tax exempt.
Securities Exchange Board of India (“SEBI”), the mutual funds regulator has clearly defined rules, which govern mutual funds. These rules relate to the formation, administration and management of mutual funds and also prescribe disclosure and accounting requirements. Such a high level of regulation seeks to protect the interest of investors.
3. Schemes in Mutual Funds
A scheme can a be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended. Mainly it is classified as follows:
Growth / Equity Oriented Scheme
The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.
Income / Debt Oriented Scheme
The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.
The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.
Tax Saving Funds
These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues. e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.
Money Market or Liquid Fund
These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.
These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes.
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.
There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges.
These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.
Funds of funds
A scheme that invests primarily in other schemes of the same mutual fund or other mutual funds is known as a FoF scheme. An FoF scheme enables the investors to achieve greater diversification through one scheme. It spreads risks across a greater universe.
4. How to invest in a scheme of a mutual fund?
Mutual funds normally come out with an advertisement in newspapers publishing the date of launch of the new schemes. Investors can also contact the distributors of mutual funds who are spread all over the country for necessary information and application forms. Forms can be deposited physical or online.
Investors should not be carried away by commission/gifts given by agents/distributors for investing in a particular scheme. On the other hand they must consider the track record of the mutual fund and should take objective decisions.
5. How to choose a scheme for investment from a number of schemes available?
As already mentioned, the investors must read the offer document of the mutual fund scheme very carefully. They may also look into the past track record of performance of the scheme or other schemes of the same mutual fund. They may also compare the performance with other schemes having similar investment objectives. Though past performance of a scheme is not an indicator of its future performance and good performance in the past may or may not be sustained in the future, this is one of the important factors for making investment decision. In case of debt oriented schemes, apart from looking into past returns, the investors should also see the quality of debt instruments which is reflected in their rating. A scheme with lower rate of return but having investments in better rated instruments may be safer. Similarly, in equities schemes also, investors may look for quality of portfolio. They may also seek advice of experts.
6. How Investor can make money from Mutual Fund?
Investor can make money from a mutual fund in three ways:
1) Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution.
2) If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.
3) If fund holdings increase in price but are not sold by the fund manager, the fund's shares increase in price. You can then sell your mutual fund shares for a profit.
7. Mutual Fund Offer Documents –SID/SAI/KIM
Mutual fund offer documents have two parts:
Scheme Information Document (SID), which has details of the particular scheme.
Statement of Additional Information (SAI), which has statutory information about the mutual fund, that is offering the scheme.
It stands to reason that a single SAI is relevant for all the schemes offered by a mutual fund. In practice, SID and SAI are two separate documents, though the legal technicality is that SAI is part of the SID. Both documents are prepared in the format prescribed by SEBI, and submitted to SEBI. The contents need to flow in the same sequence as in the prescribed format. The mutual fund is permitted to add any disclosure, which it feels, is material for the investor. Since investors are not sophisticated experts of finance or law, the documents are prepared in simple language, and in clear, concise and easy to understand style.
Key Information Memorandum (KIM) is essentially a summary of the SID and SAI. It contains the key points of the offer document that is essential for the investor to know to make a decision on the suitability of the investment for their needs. It is more easily and widely distributed in the market. As per SEBI regulations, every application form is to be accompanied by the KIM.
8. What should an investor look into an offer document?
An abridged offer document, which contains very useful information, is required to be given to the prospective investor by the mutual fund. The application form for subscription to a scheme is an integral part of the offer document. SEBI has prescribed minimum disclosures in the offer document. An investor, before investing in a scheme, should carefully read the offer document. Due care must be given to portions relating to main features of the scheme, risk factors, initial issue expenses and recurring expenses to be charged to the scheme, entry or exit loads, sponsor’s track record, educational qualification and work experience of key personnel including fund managers, performance of other schemes launched by the mutual fund in the past, pending litigations and penalties imposed, etc.
9. What is Net Asset Value (NAV) of a scheme?
The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV).
Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs.20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme.
10. What is a sales or repurchase/redemption price?
The price or NAV a unit holder is charged while investing in an open-ended scheme is called sales price. It may include sales load, if applicable.
Repurchase or redemption price is the price or NAV at which an open-ended scheme purchases or redeems its units from the unit holders. It may include exit load, if applicable.
Funds will also usually give you a choice either to receive a check for distributions or to reinvest the earnings and get more shares.
11. As a unitholder, how much time will it take to receive dividends/repurchase proceeds?
A mutual fund is required to despatch to the unitholders the dividend warrants within 30 days of the declaration of the dividend and the redemption or repurchase proceeds within 10 working days from the date of redemption or repurchase request made by the unitholder.
In case of failures to dispatch the redemption/repurchase proceeds within the stipulated time period, Asset Management Company is liable to pay interest as specified by SEBI from time to time (15% at present).
12. How much should one invest in debt or equity oriented schemes?
An investor should take into account his risk taking capacity, age factor, financial position, etc. As already mentioned, the schemes invest in different type of securities as disclosed in the offer documents and offer different returns and risks. Investors may also consult financial experts before taking decisions. Agents and distributors may also help in this regard.
13. Port folio Management : Strategic vs Tactical asset allocation
Strategic Asset Allocation is the ideal that comes out of the risk profile of the individual, the return requirement to meet the goals and the investment horizon. Risk profiling is key to deciding on the strategic asset allocation. The allocation to the various asset classes is not driven by their expected performance. The most simplistic risk profiling thumb rule is to have as much debt in the portfolio, as the number of years of age. As the person grows older, the debt component of the portfolio keeps increasing. This is an example of strategic asset allocation. As part of the financial planning process, it is essential to decide on the strategic asset allocation that is advisable for the investor. The asset allocation will change if there is a change in the risk and return preferences of the investor.
Tactical Asset Allocation is the decision that comes out of calls on the likely behavior of the market. An investor who decides to go overweight on equities i.e. take higher exposure to equities, because of expectations of buoyancy in industry and share markets, is taking a tactical asset allocation call. Tactical asset allocation is suitable only for seasoned investors operating with large investible surpluses. Even such investors might like to set a limit to the size of the portfolio on which they would take frequent tactical asset allocation calls.
14. National Payments Corporation of India (NPCI)/ National Automated Clearing House NACH
It is an Indian company setup to act as the umbrella organization for all retail payment systems in India for the benefit of all the member banks and their customers. The NPCI was incorporated in December 2008 and the Certificate of Commencement of Business was issued in April 2009. Presently, there are ten core promoter banks (State Bank of India, Punjab National Bank, Canara Bank, Bank of Baroda, Union Bank of India, Bank of India, ICICI Bank, HDFC Bank, Citibank and HSBC).
The corporation service portfolio now and in the future include:
The National Payments Corporation of India (NPCI) offers to banks, financial institutions, Corporates and Government/s a service termed as “National Automated Clearing House (NACH)”which includes both Debit and Credit. It shall be referred to as NACH. NACH (Debit) & NACH (Credit) aims at facilitating interbank high volume, low value debit/credit transactions, which are repetitive in nature, electronically using the NPCI service.
NACH Debit is the product of NPCI to provide a better & efficient Mandate based debit services to the banks.
Benefits of NACH debit are as follows:
15. How to know the performance of a mutual fund scheme?
The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on daily basis in case of open-ended schemes and on weekly basis in case of close-ended schemes. The NAVs of mutual funds are required to be published in newspapers. The NAVs are also available on the web sites of mutual funds. All mutual funds are also required to put their NAVs on the web site of Association of Mutual Funds in India (AMFI) www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place .
The mutual funds are also required to publish their performance in the form of half-yearly results which also include their returns/yields over a period of time i.e. last six months, 1 year, 3 years, 5 years and since inception of schemes. Investors can also look into other details like percentage of expenses of total assets as these have an affect on the yield and other useful information in the same half-yearly format.
The mutual funds are also required to send annual report or abridged annual report to the unitholders at the end of the year.
Various studies on mutual fund schemes including yields of different schemes are being published by the financial newspapers on a weekly basis. Apart from these, many research agencies also publish research reports on performance of mutual funds including the ranking of various schemes in terms of their performance. Investors should study these reports and keep themselves informed about the performance of various schemes of different mutual funds.
Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity oriented schemes with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc.
On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme.
16. Higher net worth of the sponsor, guarantee for better returns?
In the offer document of any mutual fund scheme, financial performance including the net worth of the sponsor for a period of three years is required to be given. The only purpose is that the investors should know the track record of the company which has sponsored the mutual fund. However, higher net worth of the sponsor does not mean that the scheme would give better returns or the sponsor would compensate in case the NAV falls.
17. How to know where the mutual fund scheme has invested money mobilised from the investors?
The mutual funds are required to disclose full portfolios of all of their schemes on half-yearly basis which are published in the newspapers. Some mutual funds send the portfolios to their unitholders.
The scheme portfolio shows investment made in each security i.e. equity, debentures, money market instruments, government securities, etc. and their quantity, market value and % to NAV. These portfolio statements also required to disclose illiquid securities in the portfolio, investment made in rated and unrated debt securities, non-performing assets (NPAs), etc.
Some of the mutual funds send newsletters to the unitholders on quarterly basis which also contain portfolios of the schemes.
18. Importance of Nominee in Mutual Funds
A nominee is the person who has been authorized by the owner of an asset, to become its custodian (i.e. the asset will be transferred to the nominee) in the event of death of the holder of the asset. A nomination does not necessarily mean that you have transferred your investment ownership fully and finally to your nominee. A will would normally over-ride the nomination. This is the legal position. However, where a financial institution is concerned, it will transfer a financial product to the nominee in the event of the death of the owner and thereby legally discharge itself from any liability. Beyond that, if any heirs have an objection, the matter would need to be settled in a Court of Law. The process of mutual fund nomination is as simple as filling out your form details, while making an application for an investment. An investor has the option to nominate upto three individuals (including a minor). Some AMCs also allow the percentage share to be defined for each nominee. One can also change the nomination any number of times during the tenure of the investment. If an investor makes a further investment in the same folio, the nomination is applicable to the new investment as well. There is one drawback; if the investment is in the name of a minor, then no nomination is permitted. Another grey area is that the investor can appoint anyone, including a third person, as a nominee; there is no restriction. This could lead to litigation in future. Where the AMC is concerned, by transferring the investment in mutual funds to the nominee, they are legally discharged and in case any person is aggrieved or there is a Will, then the beneficiaries in the Will can take legal recourse against the nominees only and not against the AMC.
19. If mutual fund scheme is wound up, what happens to money invested?
In case of winding up of a scheme, the mutual funds pay a sum based on prevailing NAV after adjustment of expenses. Unit holders are entitled to receive a report on winding up from the mutual funds which gives all necessary details.