What is Mutual Fund? - Meaning, Definition, Features, Advantages, Disadvantages and Net Asset Value

A mutual fund is a financial intermediary in the capital market that pools collective investments in form of units from retail and corporate investors and maintains a portfolio of various schemes which invest that collective investments in equity and debt instruments on behalf of these investors.

Mutual fund is an expert entity which helps an investor invest in equity and debt instruments indirectly rather than taking risk of investing money directly in these instruments. An ordinary investor has no expertise or knowledge to invest money directly into the equity market in India and most of the time investors lose their money due to wrong selection of equity shares, or bonds.

A mutual fund is a professionally managed type of collective investment plan that pools money from many investors and invests typically in investment securities (stocks, bonds, short-term money market instruments, other mutual funds, other securities, and/or commodities such as precious metals).

Praveen N Shroff defines a mutual fund as “a portfolio of stock market instruments built with funds collected from investors whose primary concern is security of investment.”

Contents

Introduction to Mutual Fund
Meaning of Mutual Fund
Definitions of Mutual Fund
Concept of Mutual Funds
Features of Mutual Fund
Importance of Mutual Funds
Significance of Mutual Funds
Types of Mutual Funds
Classification of Mutual Funds
Kinds of Mutual Funds
Portfolio Classification of Mutual Funds
Legal Framework of Mutual Funds
Categories of Mutual Funds
Parties to a Mutual Fund
Criterias in Selection of Mutual Fund
SEBI Guidelines for Mutual Funds
Net Asset Value of a Mutual Fund
Mutual Funds in India
Historical Evolution and Growth of Mutual Funds in India
History of Mutual Funds in India
Organisation Structure of Mutual Funds in India
Policies and Strategies of Mutual Funds in India
Performance of Mutual Funds in India
Money Market Mutual Funds in India
Mutual Funds Good or Bad for India
Role of Mutual Funds in Indian Capital Market Development
Suggestions to Make Indian Mutual Funds More Effective
Evolution and Growth of Mutual Funds Abroad
Components of Fee Structure of Mutual Fund
Mutual Funds vs. Other Investments
Advantages of Mutual Funds for the Capital Market
Advantages of Mutual Funds
Benefits of Mutual Funds
Disadvantages of Mutual Fund
Drawbacks of Mutual Funds

What are Mutual Funds: Meaning, Definition, Concept, Features, Importance, Types, Classification, Legal Framework, Categories, Advantages, Drawbacks and More…

Mutual Fund – Introduction

Hence, mutual funds as intermediary provide expertise of portfolio management actively and diversify risk by spreading investments from all investors in various equity shares and debt instruments. This helps investors earn good returns at low risk compared to returns at high risk if investors invest on their own directly in the capital market.

A mutual fund is a collective reservoir or pool of funds which is managed by a qualified and expert Fund Manager. It is a trust that takes funds from a number of investors who have a common investment goal and invests those funds in equities, bonds, money market instruments and other securities.

The income generated from this combined portfolio is distributed proportionately amongst the investors after subtracting relevant expenses and levies, by calculating a scheme’s ‘Net Asset Value’ or NAV. Simply placed, the money pooled in by a large number of investors are allotted in units by a mutual fund scheme.

This pooled money invested in equity or bonds or short term securities shall grow or go down depending upon the performance of these investments. This shall get reflected in the value of NAV.

Mutual funds are perfect for investors who either lack large sums for investment, or for those who neither have the knowledge nor the time to research the market, yet want to grow their wealth. In return, the fund house charges a small fee for their professional expertise which is subtracted from the investment.

The fees charged by mutual funds are restricted to certain limits stated by the Securities and Exchange Board of India (SEBI). During the past few years mutual funds have achieved a favoured status when investors have been investing regularly in equity/balanced schemes through them.

Mutual Fund – Meaning

The mutual fund will have a fund manager that trades (buys and sells) the fund’s investments in accordance with the fund’s investment objective. In the U.S., a fund registered with the Securities and Exchange Commission (SEC) under both SEC and Internal Revenue Service (IRS) rules must distribute nearly all of its net income and net realized gains from the sale of securities (if any) to its investors at least annually.

Most funds are overseen by a board of directors or trustees (if the U.S. fund is organized as a trust as they commonly are) which is charged with ensuring the fund is managed appropriately by its investment adviser and other service organizations and vendors, all in the best interests of the fund’s investors.

Since 1940 in the U.S., with the passage of the Investment Company Act of 1940 (the ’40 Act) and the Investment Advisers Act of 1940, there have been three basic types of registered investment companies- open-end funds (or mutual funds), Unit Investment Trusts (UITs); and closed-end funds.

Other types of funds that have gained in popularity are Exchange Traded Funds (ETFs) and hedge funds. Similar types of funds also operate in Canada, however, in the rest of the world, mutual fund is used as a generic term for various types of collective investment vehicles, such as unit trusts, Open- Ended Investment Companies (OEICs), unitized insurance funds, Undertakings for Collective Investments in Transferable Securities (UCITS, pronounced “YOU-sits”) and SICAVs.

Mutual Fund – Definitions

1. “Mutual fund is a non-depository non-banking financial Intermediary”

2. “Mutual funds are corporations which pool funds and reduce risk by diversification”.

Mutual Fund is a professionally managed company that combines the money of people whose goals are similar. It invests this money in a wide variety of securities. There are different kinds of mutual funds to serve the needs of different investors with diverse objectives.

A mutual fund pools the savings of the community and invests them after careful research and analysis, in various types of securities and offers the individual saver advantages of reasonable dividends and capital appreciation, coupled with safety and liquidity.

Basically, the mutual fund is similar, in structure and objective, to an investment club. The investor, instead of making direct purchases of shares and bonds through original subscription or stock exchanges and taking the risk of loss, can do so now through mutual funds.

Praveen N Shroff defines a mutual fund as “a portfolio of stock market instruments built with funds collected from investors whose primary concern is security of investment.”

A mutual fund is an indirect investment where individual investor’s investment is invested by professionals and experts in the capital market investments.

Formation and Management of Mutual Fund:

Mutual Funds in India are established under Indian Trust Act of 1882. They are registered and regulated by SEBI under SEBI (MUTUAL FUNDS) Regulations 1996. A mutual fund is formed by a Trust. Mutual Fund business is established by the sponsor. The money collected from the investors invested by AMC (Asset. Management Company). The mutual fund operations are managed by trustees.

Concept of Mutual Funds

Mutual fund concept, which has been in vogue in the Western world since long, is gaining popularity in developing countries including India as an institutional device to bridge the gap between supply and demand of capital in the market. An understanding of the concept of the mutual fund and its significance in economic development and state of mutual fund in India is, therefore, inescapable.

Mutual fund is an American concept and the terms, ‘Investment Trust’, ‘Investment company’, ‘Mutual fund’, ‘Money Fund’, etc., are used interchangeably in American literature. Mutual funds are corporations which accept dollars to buy stocks, long-term bonds, and short-term debt. Instruments issued by business or government units.

These corporations pool funds and thus, reduce risk by diversification. The term ‘mutual’ signifies that all gains or losses resulting from the investment accrue to all the investors in proportion to their subscription. Mutual fund is thus, a concept of mutual help of the subscribers for portfolio investment and management of these investments by experts in the field.

According to Hirch, a mutual fund is a professionally managed investment company that combines the money of many people whose goals are similar and invest this money in a wide variety of securities.

As per the UK Investment Trust and Companies, a mutual fund is a vehicle that enables a number of investors to pool their money and have it jointly managed by professional money managers.

Investment company institute, USA defines the term mutual fund as a type of Investment Company that gathers assets from investors and collectively invests those assets in stock, bonds or money market instruments.

Securities and Exchange Board of India (Mutual Fund) Regulations, 1996 defines a mutual fund as a fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one or more schemes for investing in securities including money market instruments.

Mutual fund generally refers to an open-end investment trust whose distinctive feature is regular sale and purchase of securities. Further, mutual funds must redeem their shares at the funds current net asset value at the time the shareholders request redemption.

In sum, mutual funds are a form of collective investment brought in by a large group of investors for the mutual benefit of savers as well as investors. Each fund is divided into equal portions or units. Anyone investing in the fund is allocated units in proportion to the size of one’s investment.

The price of these units is governed principally by value of the underlying investment held by the fund. The flow chart, as brought out in Chart 36.1 presents the working of mutual funds.

The above chart throws lurid light on the rationale of mutual funds. They receive money from many investors, pool them and then purchase securities. The individual investors receive the benefits of professional management and diversified portfolios at relatively low cost with much convenience and flexibility.

Top 8 Features of Mutual Fund

Following are the features of mutual fund:

1. The mutual fund is a trust.

2. It is a financial intermediary.

3. Ownership is joint and proportional to the amount contributed.

4. The investor gets back units of the mutual funds in return for the money invested.

5. Dealings in units are on the basis of the net market value of the investment.

6. The managers of the mutual funds are obliged to redeem any units in issue on demand or on certain specified periods.

7. All dividend income that the mutual fund receives on its investment is paid out to unit holders.

8. Professionally qualified fund managers manage the funds of mutual funds.

Importance of Mutual Funds

Importance of mutual funds are summarized below:

Mutual funds are financial intermediaries concerned with mobilizing savings of those who have surplus income and channelization of these savings in those avenues where there is demand for funds.

These institutions employ their resources in such a manner as to afford for their investors the combined benefits of low risk, steady return, high liquidity and capital appreciation through diversification and expert management.

Savers of moderate means in the underdeveloped regions are generally reluctant to invest in corporate securities because of their lack of adequate knowledge about complicated investment affairs.

Moreover, their resources being small, they can at best hold securities of one or two or just a few industrial concerns only and as such, the fate of their savings and prospects of earnings therefore are tied to the fate of such units or units.

Investment in securities of mutual funds takes care of both these problems, for such investment, in effect, represents a part of the funds’ entire portfolio diversified in terms of securities, units, industries and geographical regions.

These institutions employ expert investment analysts and thus professional knowledge and expertise go into the selection and supervision of their investment portfolio. Diversification and expert investment knowledge ensure steady and regular earnings to the fund and a share in the general prosperity.

Accordingly, investors in shares of mutual funds are assured of low risk, steady return, liquidity and capital appreciation. By taking upon themselves the problems which confront the small savers in investing their savings and dealing with them effectively, mutual funds help mobilize savings of the people and promote thrift.

Mutual funds also provide benefits of flexibility in as much as investors can systematically invest or withdraw funds, or switch to other schemes according to their needs, through features provided under their different schemes, such as regular investment, withdrawal plans and dividend reinvestment options.

Tax benefits to investors in certain schemes constitute an added attraction for mutual funds. Dividends paid by mutual funds to unit holders are taxed only at the time of distribution of dividends. These dividends after this deduction are tax-free in the hands of investors. On the contrary, investment in bonds or other deposits that earn interest (over and above Rs.12,000 that is eligible for exemption under section 80L) is taxed at 30 per cent.

Savings pooled by mutual funds are invested largely in industrial securities. They usually finance long-term business requirements largely by way of direct subscription to share capital of industrial enterprise.

Mutual funds, while themselves raising resources from a large number of small savers, make funds available to industrial concerns in relatively bigger lots and thus reduce their burden and botheration involved in raising finance directly from individual savers.

Thus, by playing the role of financial intermediation mutual funds provide a convenient and effective link between savings and investment. Well managed mutual funds would be mutually beneficial arrangement.

While, on the one hand, they help the investing community by offering share of corporate growth, on the other they have a salutary impact on the stock markets. By blending caution with aggression and analysis with intuition, the funds can successfully convert market opportunities into lucrative returns for the investors.

Role of the mutual funds is not limited to the domestic sphere only. In addition to attracting domestic savings, these funds can offer their units abroad and attract foreign capital just as UTI has recently done by offering India Fund, and India Growth fund schemes. Similarly, they may serve as useful institutions for securing profitable investment avenues abroad for domestic savings.

Investment in foreign industrial securities requires fairly detailed knowledge of the state of the foreign economy in general and of industries in particular as also of the fiscal position of industrial enterprises and their future prospects.

As a result, despite attractive investment prospects abroad for surplus domestic savings, individual investors would find it an extremely difficult task to make foreign investment on their own. Mutual funds have, as in the case of domestic investment, stepped in to solve these problems for the savers.

7 Main Significance of Mutual Funds

Capital market growth is a necessity for economic progress of a nation. Growth of the capital market is directly connected with the savings of the public. The savings are to be channelized to the capital market.

Investing in the capital market requires necessary know how and financial expertise. An average investor in India doesn’t have this technical knowhow. Hence, a special agency, who has this expertise, takes up these works to help the investor. Mutual funds provide this agency service. Thus, mutual funds provide an opportunity to the small investor to participate in the corporate activities. It serves as a financial intermediary for the development of the capital market.

A small investor has only limited access to price sensitive information on the stock exchanges. He is unable to minimize his risk by spreading his limited funds over different industries. This forces him to depend heavily on brokers whose transactions are not transparent enough and who may charge high brokerage.

In this situation, the mutual funds come to the help of small investors. Thus, mutual funds serve as a suitable investment channel for the common man. It offers him an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

The significance of Mutual fund is summarized in the following points:

1. Growth and diversification of the economy of the country.

2. Channelization of resources to the growing sectors of economy.

3. With limited resources a small investor may not be able to buy blue chip shares. But buying the units of mutual funds will help him to get the benefits of blue chip shares.

4. In some cases a small investor may get full allotment of dead shares. He may not be able to diversify his funds. But while participating in the mutual funds he can get the benefits of diversification also.

5. An average investor will have only limited access to price sensitive information. But the mutual funds will be able to get all the sensitive information and will know all the new developments in the capital market and in the industry.

6. MF is an ideal investment route for conservative investors and retired persons and pensioners. These categories of persons do not like to take risks. In an inflationary economy and in the absence of any source of income these categories of investors switch over from the bank deposits and fixed deposits of companies to MFs.

7. It provides security and liquidity to the funds of investors.

Top 12 Types of Mutual Funds

Types of mutual funds are as follows:

Type # 1. Gilt Funds:

Gilts are Government securities with medium to long-term maturities. Gilt funds invest in government securities. Since Government is the issuer these funds have little risk of default.

Type # 2. Diversified Debt Funds/Equity Funds:

A debt/Equity Fund that invests in all available types of debt/securities, issued by entities across all industries and sectors is a properly diversified debt/equity fund. It has the benefit of risk reduction through diversification.

Type # 3. Mortgage Backed Bond Funds:

These funds invest in special securities created after securitization of loan receivables of housing finance companies.

Type # 4. Assured Return Funds:

In this fund, Returns were indicated in advance for all of the future years of these close end schemes. Assured return or guaranteed monthly plans are essentially Debt/Income funds. E.g. Monthly income plans of UTI.

Type # 5. Mid-Cap or Small-Cap Equity Funds:

These funds invest in shares of companies with relatively lower market capitalization. In terms of risk characteristics, small company funds may be aggressive growth or just growth types.

Type # 6. Option Income Fund:

A mutual fund often attempts to increase current income through continual option writing. Option income funds write options on a significant part of their portfolio. Conservative option funds invest in large dividend paying companies, and then sell options against their stock positions. This ensures a stable income stream in the form of premium income through selling options and dividends.

Type # 7. ELSS Fund:

ELSS means Equity Linked Saving Schemes. It is a sub-class of diversified equity funds. Investments in an ELSS fetch tax deduction U/S 80C of the Income Tax Act. An ELSS fund operates much like an equity fund, except a lock-in-period of three years.

Type # 8. Value Funds:

Value funds are diversified equity funds, which pursue the value style of investing. It involves identifying fundamentally sound companies whose shares are currently under priced in the market. Usually the fund manager buys these stocks and holds them until the mis-pricing in the stock value gets corrected E.g. Templeton India Growth Fund.

Type # 9. Balanced Funds:

A balanced fund is one that has a portfolio comprising debt instruments convertible securities, and preference and equity shares. Their assets generally held m more or less equal proportions between debt/money market securities and equities.

By investing in a mix of debt and equity, balanced funds seek to attain the objectives of income, moderate capital appreciation and preservation of capital and are ideal for investors with a conservative and long-term orientation. It is a category of hybrid funds.

Type # 10. Commodity Funds:

Commodity funds specialize in investing in different commodities directly or through shares of commodity companies or through commodity futures contracts e.g. Gold Fund.

Type # 11. Exchange Traded Funds (ETF):

An exchange traded fund is a mutual fund scheme which combines the best features of open end and close end schemes. It tracks a market index and trades like a single stock on the stock exchange. Its pricing is linked to the index and units can be bought/sold on the stock exchange. It is different from index funds which can be brought directly from the AMC at a unique net asset value. But ETFs are traded on stock exchanges and its unit price is determined in the market place and will keep changing from time to time.

Type # 12. Gold Exchange Traded Fund (GTF):

In 2006 RBI permitted the introduction of GTFs. They primarily invest in gold and gold related instruments. It is a listed security backed by allocated gold held in the custody of a bank on behalf of the investor. GTFs allow the investor to participate in the bullion market without taking physical delivery of gold E.g., GOLD BEes.

One of the long term measures invariably suggested to boost the present capital market is the setting up of Mutual Funds to encourage investors with substantial liquidity to enter the share market.

The experience of some of the advanced countries, especially the US, has been very encouraging and within a short period of time excellent results have been achieved in mobilising resources for faster economic growth and investors are being given the widest ever opportunity to invest their funds to best serve their purpose.

Statistics revealed that mutual funds have witnessed phenomenal growth in many countries during the last five years ranging from 80 percent of the total investments in the USA to 70 per cent in Italy, 60 per cent in Japan and 50 per cent in the UK are institutionalized in mutual funds. In US, there were 1531 mutual funds, with 30 million fund investors and $ 252 billion in assets at the end of 1986.

The objectives of this two-fold:

1. To attempt to study various advantages of mutual funds as a financial service to boost the capital market; and

2. To study its suitability for investors in Indian financial environment.

3 Major Classification of Mutual Funds – Functional, Portfolio and Geographical Classification

So as to cater to the varying needs and preferences of a large number of savers across the country and abroad, many types of mutual funds have come into existence. Choice of a fund by a saver would depend on what he desires his money to earn for him and how much risk he is willing to assume.

Three major classification of mutual funds are as follows:

1. Functional classification

2. Portfolio classification

3. Geographical classification

1. Functional Classification:

Functional classification, based on basic characteristic of the mutual fund schemes opened for public subscription, can be grouped into-

i. Open-ended funds

ii. Close-ended funds

iii. Interval funds

i. Open-Ended Funds:

It continuously offers new shares for sale and always stands ready to buy securities at any time. The capitalization of the funds is constantly changing as investors buy and sell their shares directly with the fund. US-64, CanClgr and Franklin Blue Chip are examples of such funds.

Open-Ended Dynamic Bond Funds:

In view of uncertainty of interest rates, a number of fund houses (IDBI Mutual Fund, Pramerica MF Union KBC, Daiwa MF and Principal MF) have, of late, launched open-ended dynamic bond funds.

Dynamic bond funds are able to take advantage of rate cuts or rises by altering their portfolio. But here lies the danger as well. Sometimes, fund managers can get their churning right or it can go haywire as well.

So returns can widely fluctuate. The trick in these funds lies in being made to predict the fluctuations correctly and change the portfolio. When the interest rate is rising, bond prices fall and the fund manager should be able to decrease the duration of the bond; short-term bonds face a lower impact. In contrast when the interest rate is falling, they should be able to increase the duration of the bond.

ii. Closed-Ended Mutual Funds:

They are open for subscription only once and can be redeemed only after a fixed investments period. These funds have a fixed number of shares that can be owned by the investing public. Morgan Stanley Growth fund, Canpep 95, UTI Master Equity 98, Pru ICICI premier, UTI/UGS — 5,000 are some examples of such funds.

iii. Interval Funds:

They are the variations of the above stated two concepts. Some funds are close-ended for the first couple of years and become open-ended after some time, some funds allow fresh subscriptions and redemptions as fixed intervals every year in order to reduce the hassles of daily entry and exist, yet providing reasonable liquidity.

2. Portfolio Classification:

Mutual funds can be categorized according to the type of instruments in which the funds have been invested. As such, different funds are designed to meet the diverse notions of savers and generally designated as Stock funds, Bond funds, Balanced funds, Money market / liquid funds and other funds.

i. Stock Funds:

These funds invest primarily in common stocks. There is a broad range of common stock funds from those that invest solely in the new, un-established companies. There may be several sub-divisions of stock funds. Thus, Growth and Income funds place relatively equal weight on capital growth and dividend income and accordingly invest in equity stock and preference shares.

Growth funds invest their funds in common stocks primarily for capital growth purposes. They meet the investors’ need for appreciation, high risk-bearing capacity and ability to defer liquidity. As such, the investments by growth-oriented funds are predominantly made in equities. Income funds aim at ensuring to their investors high current income; growth in the value of the portfolio is of small importance.

Such funds employ their funds in high yielding common stock. There are two basic groups within the income funds: those that focus on constant income possible even with the use of leverage. Naturally, the greater the anticipated return of any investment, the higher the potential risk of the investment.

ii. Bond Funds:

Bond funds obviously employ their funds in bonds so as to ensure regular and fixed income to their investors. In the U.S.A., it is common to have two types of bond funds, one emphasizing high-yielding but risky bonds and the other low-yielding but high grade bonds.

iii. Balanced Funds:

Balanced funds combine bonds and/or preferred stocks with the ownership of common stock, usually at some pre-determined percentage relationship. Several balanced funds keep one-half of the portfolio in common stocks and one-half in bonds and preferred stocks. Balanced portfolios are more conservative than common stock funds and they generally do not have significant price movement either up or down.

The main purpose of balanced funds is to earn an adequate return in the form of interest and dividends from the fixed portion of the portfolio, while at the same time gaining a modest growth in the common stock portion. Balanced funds are most suited for the investors who have an appetite for some risk, but are wary of taking the 100 percent equity route through an equity fund.

iv. Money Market/Liquid Funds:

These funds invest in highly liquid money market instruments such as Treasury Bills (issued by the Government), certificates of deposits (issued by banks) and commercial papers (issued by companies). Hallmarks of such funds are safety and high liquidity. Pru ICICI liquid funds, Birla Cash plus and Templeton India Liquid fund are some examples of liquid funds.

Other Schemes:

Within each of the above categories, there can be further variants of the funds, For instance, debt funds may be diversified debt funds, focused debt funds and high yield debt funds. Likewise, equity funds may be diversified funds, sector funds, index funds and equity linked savings schemes.

a. Diversified Funds:

It has investment portfolios spread across industries and companies. Choice of stock is the discretion of the fund managers. An equity diversified fund is the example of such funds. HDFC Top 200 fund is another diversified equity fund.

b. Sector Funds:

It deploys funds in stocks of a particular business sector or industry, like information technology (IT), fast moving consumer goods (FMCG) or pharma. The degree of diversification of risk is very limited in this type of fund, making it extremely risky.

Of course, the potential earnings can be high if the sector does very well. Franklin pharma, Franklin FMCG, Franklin Infotech, Kotak Tech, Tata Life Science and Tech, UTI Petro and UTI Pharma and Health-care are some examples of this type of fund.

c. Index Funds:

Index funds are equity funds that replicate a particular equity index by investing in stocks that the index tracks. As each stock has different weight age in an index, the portfolio of an index fund is allocated in a way to mirror that of the index.

For example, if Reliance Industries has a weightage of 10 per cent in an index, a fund based on the index would also allocate 10 percent of its portfolio to the stock. Investing in index funds has the advantages of no risk for fund management, lesser portfolio churning, low expense ratio and greater marketability.

3. Geographical Classification:

Mutual funds can also be grouped according to geographical boundaries of their operations, as domestic mutual funds, off-shore funds and overseas funds.

i. Domestic Funds:

They are open for mobilizing savings for nationals within the country. These funds may be of various kinds, as outlined above under the portfolio and functional groups.

ii. Off-Shore Funds:

It represents mutual funds with investments source abroad. Thus, subscription to these funds is mobilized from international financial markets for its investment in the economies and capital market instruments of specific countries.

These funds are cross border investments facilitating capital movement of investible surpluses from cash rich countries to high growth or potentially high growth economies of the world. Kotak Global India Fund, SBI’s Magnum Global and Global Opportunity Fund are few examples of overseas funds.

Indian mutual funds have been permitted to invest in foreign debt securities in countries with fully convertible currencies. In the recent past, mutual funds have also been permitted to invest in equity shares of listed overseas companies having shareholding of at least 10 per cent in an Indian company listed on a recognized stock exchange in India.

Thus, a host of mutual funds have come into existence to garner savings from the savers for investment outside the country. Such kinds of mutual funds are called ‘Overseas’ funds. There are three types of overseas funds, viz., global funds, international funds and country funds.

While global funds invest in the domestic funds as well as foreign stocks and bonds, international funds invest strictly in foreign countries. Country funds invest in the stocks and bonds of a particular country or region.

The basic idea underlying formation of overseas mutual funds is to exploit the bright investment opportunities abroad and thereby augment the fund’s overall rate of return.

Top 7 Kinds of Mutual Funds

Kinds of mutual funds are as follows:

Kind # 1. Open-End Fund, Forms of Organization, Other Funds:

The term mutual fund is the common name for what is classified as an open-end investment company by the SEC. Being open-ended means that, at the end of every day, the fund continually issues new shares to investors buying into the fund and must stand ready to buy back shares from investors redeeming their shares at the then current net asset value per share.

Mutual funds must be structured as corporations or trusts, such as business trusts, and any corporation or trust will be classified by the SEC as an investment company if it issues securities and primarily invests in non-government securities.

An investment company will be classified by the SEC as an open-end investment company if they do not issue undivided interests in specified securities (the defining characteristic of unit investment trusts or UITs) and if they issue redeemable securities. Registered investment companies that are not UITs or open-end investment companies are closed-end funds.

Closed-end funds are like open end except they are more like a company which sells its shares a single time to the public under an initial public offering or “IPO”.

Subsequently, the fund’s shares trade with buyers and sellers of shares in the secondary market at a market-determined price (which is likely not equal to net asset value) such as on the New York or American Stock Exchange. Except for some special transactions, the fund cannot continue to grow in size by attracting more investor capital like an open-end fund may.

Kind # 2. Exchange-Traded Funds:

A relatively recent innovation, the exchange-traded fund or ETF, is often structured as an open-end investment company. ETFs combine characteristics of both mutual funds and closed-end funds.

ETFs are traded throughout the day on a stock exchange, just like closed-end funds, but at prices generally approximating the ETF’s net asset value. Most ETFs are index funds and track stock market indexes. Shares are issued or redeemed by institutional investors in large blocks.

Most investors purchase and sell shares through brokers in market transactions. Because institutional investors normally purchase and redeem in kind transactions, ETFs are more efficient than traditional mutual funds (which are continuously issuing and redeeming securities and, to effect such transactions, continually buying and selling securities and maintaining liquidity positions) and therefore tend to have lower expenses.

Exchange-traded funds are also valuable for foreign investors who are often able to buy and sell securities traded on a stock market, but who, for regulatory reasons, are limited in their ability to participate in traditional U.S. mutual funds.

Kind # 3. Equity Funds:

Equity funds, which consist mainly of stock investments, are the most common type of mutual fund. Equity funds hold 50 Per cent of all amounts invested in mutual funds in the United States. Often equity funds focus investments on particular strategies and certain types of issuers.

Capitalization:

Fund managers and other investment professionals have varying definitions of mid-cap, and large-cap ranges.

The following ranges are used by Russell Indexes:

1. Russell Microcap Index – micro-cap ($54.8 – 539.5 million)

2. Russell 2000 Index – small-cap ($182.6 million – 1.8 billion)

3. Russell Midcap Index – mid-cap ($1.8 – 13.7 billion)

4. Russell 1000 Index – large-cap ($1.8 – 386.9 billion)

Growth vs. Value:

Another distinction is made between growth funds, which invest in stocks of companies that have the potential for large capital gains, and value funds, which concentrate on stocks that are undervalued. Value stocks have historically produced higher returns; however, financial theory states this is compensation for their greater risk.

Growth funds tend not to pay regular dividends. Income funds tend to be more conservative investments, with a focus on stocks that pay dividends. A balanced fund may use a combination of strategies, typically including some level of investment in bonds, to stay more conservative when it comes to risk, yet aim for some growth.

Index Funds versus Active Management:

An index fund maintains investments in companies that are part of major stock (or bond) indexes, such as the S&P 500, while an actively managed fund attempts to outperform a relevant index through superior stock-picking techniques.

The assets of an index fund are managed to closely approximate the performance of a particular published index. Since the composition of an index changes infrequently, an index fund manager makes fewer trades, on average, than does an active fund manager.

For this reason, index funds generally have lower trading expenses than actively managed funds, and typically incur fewer short-term capital gains which must be passed on to shareholders. Additionally, index funds do not incur expenses to pay for selection of individual stocks (proprietary selection techniques, research, etc.) and deciding when to buy, hold or sell individual holdings. Instead, a fairly simple computer model can identify whatever changes are needed to bring the fund back into agreement with its target index.

Certain empirical evidence seems to emphasise that mutual funds do not beat the market and actively managed mutual funds under-perform other broad-based portfolios with similar characteristics. One study found that nearly 1,500 U.S. mutual funds under-performed the market in approximately half of the years between 1962 and 1992. Moreover, funds that performed well in the past are not able to beat the market again in the future.

Kind # 4. Bond Funds:

Bond funds account for 18% of mutual fund assets. Types of bond funds include term funds, which have a fixed set of time (short, medium, or long-term) before they mature. Municipal bond funds generally have lower returns, but have tax advantages and lower risk. High-yield bond funds invest in corporate bonds, including high-yield or junk bonds. With the potential for high yield, these bonds also come with greater risk.

Kind # 5. Money Market Funds:

Money market funds hold 26% of mutual fund assets in the United States. Money market funds entail the least risk, as well as lower rates of return. Unlike certificates of deposit (CDs), money market shares are liquid and redeemable at any time.

Kind # 6. Funds of Funds:

Funds of funds (FoF) are mutual funds which invest in other mutual funds (i.e., they are funds composed of other funds). The funds at the underlying level are often funds which an investor can invest in individually, though they may be ‘institutional’ class shares that may not be within reach of an individual shareholder.

A fund of funds will typically charge a much lower management fee than that of a fund investing in direct securities because it is considered a fee charged for asset allocation services which is presumably less demanding than active direct securities research and management.

The fees charged at the underlying fund level are a real cost or drag on performance but do not pass through the FoF’s income statement (statement of operations), but are usually disclosed in the fund’s annual report, prospectus, or statement of additional information.

FoF’s will often have a higher overall/combined expense ratio than that of a regular fund. The FoF should be evaluated on the combination of the fund- level expenses and underlying fund expenses, as these both reduce the return to the investor.

Most FoFs invest in affiliated funds (i.e., mutual funds managed by the same advisor), although some invest in unaffiliated funds (those managed by other advisors) or both.

The cost associated with investing in an unaffiliated underlying fund may be higher than investing in an affiliated underlying because of the investment management research involved in investing in a fund advised by a different advisor.

Recently, FoFs have been classified into those that are actively managed (in which the investment advisor reallocates frequently among the underlying funds in order to adjust to changing market conditions) and those that are passively managed (the investment advisor allocates assets on the basis of on an allocation model which is rebalanced on a regular basis).

The design of FoFs is structured in such a way as to provide a ready mix of mutual funds for investors who are unable to or unwilling to determine their own asset allocation model. Fund companies such as TIAA-CREF, American Century Investments, Vanguard, and Fidelity have also entered this market to provide investors with these options and take the “guesswork” out of selecting funds.

The allocation mixes usually vary by the time the investor would like to retire- 2020, 2030, 2050, etc. The more distant the target retirement date, the more aggressive the asset mix.

Kind # 7. Hedge Funds:

Hedge funds in the United States are pooled investment funds with loose, if any, SEC regulation, unlike mutual funds. Some hedge fund managers are required to register with the SEC as investment advisers under the Investment Advisers Act of 1940.

The Act does not require an adviser to follow or avoid any particular investment strategies, nor does it require or prohibit specific investments. Hedge funds typically charge a management fee of 1% or more, plus a “performance fee” of 20% of the hedge fund’s profit.

There may be a “lock-up” period, during which an investor cannot cash in shares. A variation of the hedge strategy is the 130-30 fund for individual investors.

Portfolio Classification of Mutual Funds

Portfolio classification of mutual funds are as follows:

1. Equity Fund:

Those mutual funds who invest only in equity shares of companies are known as equity funds.

2. Growth Fund:

Mutual funds which invest their funds in growth securities which assure capital appreciation in the long run are known as growth funds. These are also known as “Nest eggs.” The portfolio of such funds may mainly contain equities with good growth potential, smaller proportion of fixed income securities and money market instruments.

3. Income Fund:

Mutual funds which invest in high yielding securities are income funds. The objective of such a fund is to maximize the current income of the investors.

4. Real Estate Fund:

These are close-ended mutual funds with investments in real estates and properties only.

5. Off-Shore Fund:

These kinds of mutual funds mobilize saving from foreign countries in foreign currencies. They may invest them in Indian companies. The company needs RBI permission for operation of the scheme.

6. Leverage Fund:

In this type, investable funds are borrowed from the market. These are used to increase the size of the value of a portfolio. Members benefit by gains arising out of excess of gains over the cost of borrowed funds. Such mutual funds make capital gains by speculative trading, short selling, etc.

7. Hedge Funds:

Mutual funds which employ their funds by speculative trading are known as Hedge funds.

8. Tax Exempt Funds:

They invest their funds in such investments which receive tax benefits.

9. Liquid Funds:

They are specialized in investing short term money market instruments like certificates of deposits, T Bills, etc. The emphasis is given on liquidity even though there is a low rate of return for this.

10. Special Funds:

This type of funds invests only in specialized channels like Gold & Silver or a specified country (India Development Fund) or a specific category of companies etc.

11. Index-Linked Funds:

This fund invests only in those shares which are included in the market indices. Whenever the market index goes up, the value of such index linked funds also goes up.

12. Funds of Funds:

Mutual funds which invest only in other mutual funds are called funds of funds.

13. Capital Appreciation Fund:

These funds invest only in such securities where capital appreciation is assured.

14. Load and No-Load Funds:

Load funds are funds with sales charge. No load funds are bought and sold at NAV without any sales charge or commission.

4 Legal Framework of Mutual Funds – Sponsors, Trustees, Asset Management Company and Custodian

Mutual funds have to work in a legal framework. SEBI has constituted a four-tier system for managing the affairs of mutual funds.

Accordingly, there are 4 legal framework to MF, viz.:

I. The Sponsor

II. The Trustees

II. The Asset Management Company (AMC)

IV. The Custodian.

I. Sponsors:

Sponsor means any company who, acting alone or in collaboration with another body corporate, establishes a MF. They are the promoters of mutual funds. The sponsor has to abide by the rules and regulations of SEBI and other related agencies for promoting a MF. The authorization is given by SEBI. An application in prescribed form accompanied with fees should be forwarded for registration.

SEBI will grant registration on the basis of the sound track record of the sponsor. 5 years’ experience in the field of financial services is a requirement for this. Professional competence, financial soundness, dividend paying capacity, fairness and integrity in business transactions are other criteria for granting registration. Every registered MF is also required to pay annual fee. In case of default SEBI will prohibit launching of new schemes. The sponsor should contribute 40% of the net worth of AMC. The sponsor will be liable for any loss of the scheme up to this initial contribution.

II. Trustees:

The board of trustees of the MF is persons who hold the property of mutual fund. They keep the properties in trust for the benefit of unit holders. They have responsibility to safeguard the interest of investors. They should see that the AMC acts in the best interest of the investors.

The trustees shall consist of eminent independent members who are not in any way affiliated to the sponsoring company. They should also have wide experience in investment matters, finance, administration etc. The management of the MF is subject to the control and superintendence of the board of trustees.

The trustees should act as per the regulations of the trust deed.

The trust deed shall contain the following points:

1. Board policies regarding allocation of payments to capital.

2. It should forbid the MF or the AMC making or guaranteeing loans except with the prior approval of trustees and SEBI.

3. No amendment to the trust deed shall be carried out without the prior approval of SEBI and unit holders.

4. The removal of the trustees would also require the prior approval of SEBI.

5. The trust deed shall be available for inspection to any member of the public at the registered office.

6. It shall not contain a clause limiting or extinguishing the obligations and liabilities of the trust.

7. It should not indemnify the trustees or the AMC for loss or damage caused by their negligence.

Obligations of the Trustee:

The trustees are responsible for ensuring that the AMC complies with SEBI registration. They are also accountable for and be the custodian of the property of the respective schemes. They shall get executed all documents necessary to secure the acquisition, disposal etc. of the property.

They shall ensure that the transactions are in accordance with the provisions of the trust deed. The trustee shall be the responsible for the calculation of any income to be paid to the MF.

The trustees have a right to obtain the information from the AMC concerning the management of the MF. They may also call for periodical reports from AMC. The trustees are liable to submit a six monthly report to the SEBI on the activities of the MF.

III. Asset Management Company (AMC):

An Asset Management Company is formed and registered under the Companies Act, 1956 and approved by the SEBI for managing the funds of the various schemes of a MF. A MF can operate only by a separately established agency. AMC operates under the supervision and guidance of the trustees. The AMC has the specific task of mobilizing funds under various schemes.

The primary objective of an AMC is to manage the assets of MF and other activities, viz., managing the pension fund, entering into venture capital funds etc. SEBI insists that an AMC should have a minimum net worth of Rs. 10 crores. This has to be available with the AMC on a continuous basis and to be monitored by the board of trustees.

The sponsor or the trustees, if authorized by the sponsor, shall appoint the AMC. It should be approved by the SEBI. The application for approval must be submitted to SEBI along with the copies of Memorandum of Association and Articles of Association.

Approval of SEBI:

SEBI will grant approval to an AMC basing on the following particulars:

1. A sound track record, general reputation and fairness in transaction. A sound track record means net worth, dividend paying capacity, profitability etc.

2. The directors of AMC should be persons of high repute, professional expertise, administrative abilities etc.

3. 50% of the directors should not be in any way affiliated or associated with sponsors or trustees or any of its subsidiaries.

4. The Chairman of AMC should not be the director of the Trustee Company.

5. The AMC shall have a minimum net worth of Rs. 10 crore. Disclosure to unit holders

The AMC shall disclose the basis of calculating the repurchase price and net asset value of the various schemes to the unit holders.

The trustee shall have the power to dismiss the agency under specific events with the approval of SEBI. The agency may also give a notice in writing for terminating the assignment.

IV. Custodian:

A custodian means any person carrying on the activities of safe keeping of the securities or participating in any clearing system on behalf of the clients to effect deliveries of the securities. The custodian shall be registered with SEBI.

SEBI will particularly look into the following matters while granting registration:

1. Sound track record, general regulation, and fairness in transaction.

2. The custodian has experience in the field.

3. They have sufficient infrastructure, office and personnel to provide custodian service.

4. The custodian is not found guilty of any economic offence.

5. The approval is not in any way associated with AMC.

6. The custodian is not the sponsor or trustee of any other MF.

7. The custodian cannot act as custodian of more than one MF without prior approval of SEBI.

4 Major Categories of Mutual Funds – Liquid Funds, Ultra-Short Term Debt Funds, Short Term Debt Funds and Long Term Debt Funds

We shall now discuss the various categories of open-ended mutual funds. If we speak exclusively of Fixed Income Securities, Mutual Fund products can be categorized based on their ‘portfolio maturity’ and the extent of ‘mark to market’. Portfolio maturity is the weighted average maturity of the securities in the portfolio.

Mark to market refers to the extent to which the daily NAV of the mutual fund is based on the movements in the underlying market. But first, let us understand the various categories of Fixed Income Mutual Funds based on their portfolio maturity.

The need for bringing out different categories of mutual funds is that they cater to specific investment and risk objectives of investors. Clearly, ‘one size can’t fit all’. These categories ensure that the investors’ funds are managed in line with their objectives.

Category # 1. Liquid Funds:

Liquid Funds cater to the needs of investors with very short investment horizon. If you are in a situation where you may need your money any time soon but don’t want to keep your money idle till then, liquid funds are for you. Liquid Funds are a type of Open-Ended Mutual fund. These funds exclusively invest in the short-duration money market instruments.

The average maturity of the instruments in the portfolio ranges from as low as a month or so, to as much as 91 days. As per the SEBI Guidelines, if a mutual fund wants to be classified as a ‘liquid fund’ it cannot invest in securities with residual maturity of more than 91 days.

This means that the portfolio maturity of a liquid fund can never exceed 91 days. It may be lower since there would be securities in the fund with maturity less than 91 days and after all, portfolio maturity is only a weighted average number.

People are used to keeping temporary surplus cash balances at the Bank, as a matter of habit, convenience and also due to the safety offered by Banks. To make it more attractive, interest rates on savings accounts of Banks are going up as well. Once upon a time, the interest on savings accounts balances used to be calculated on the minimum balance between the 10th and last day of the month.

This method of calculation was changed to the average balance method by the regulators. The rate of interest, which used to be 3.5% p.a. earlier, was raised to 4% and has now been deregulated altogether by the RBI, giving Banks the freedom to offer a higher rate of interest as per market competition. Few Banks have already raised the rate of interest on savings accounts to 6% and other Banks may follow suit as per their requirements of funds and competition.

Category # 2. Ultra-Short Term Debt Funds:

Ultra Short Term Debt Funds are non-liquid debt funds which have the flexibility of investing in securities with more than 91 day maturity. However, the portfolio managers normally do not invest in much longer maturities in order to maintain the fund in line with its conservative positioning.

The motivation for investing in ‘ultra-short term funds’ instead of ‘liquid funds’ is that their returns are marginally higher than those of liquid funds. In case you want to keep your money readily available but do not have any specific expenditure to be met in a very short time, investing in these ultra-short term funds would be a good option. Like liquid funds, these ultra-short term debt funds are also a type of open-ended fund.

Category # 3. Short Term Debt Funds:

The next in line, in terms of portfolio maturity are the short term debt funds. These too are a type of open-ended fund. These funds have a portfolio maturity ranging between one to four years depending on the portfolio manager’s view of the market. Like ultra-short term funds, these funds also have the freedom to invest in any fixed income security – money market instruments, dated government securities or other corporate securities.

However, to ensure that the portfolio remains in line with the objective of the fund, these funds too are tilted more toward short term debt instruments and money market instruments.

You should invest in these funds only when your target investment horizon is adequate to cover market cycles, typically 6 months, by which time the portfolio accrual usually catch up with any adverse market movement.

Category # 4. Long Term Debt Funds:

For longer portfolio maturities, the fund is usually classified as a long term fund. Long term debt funds are those mutual funds that invest in longer duration securities – dated government securities, corporate bonds / debentures et cetera. Their returns are usually higher than the short term debt funds, provided the investment horizon is 1 year and longer.

The reason for this is that in case when interest rates move in an unfavorable direction, the required holding period, to achieve the desired returns, could be longer than one year (say two or even three) to benefit from favorable market movement.

Their portfolio maturity is usually in the range of two to three years at the lower end and seven to eight years at the higher end. The portfolio maturity that the manager wishes to have depends on his view of the market.

When the portfolio manager has a bullish view on the market (he expects yields to fall) he would increase the portfolio maturity while if he has a bearish view on the market (he expects yields to rise) he would reduce the portfolio maturity. The reason for this is based on the concept of duration. The higher the duration, the magnified is the impact of interest rate movements.

While this covers the types of mutual funds in terms of portfolio maturities, it is important that we clarify a few points before we proceed.

5 Major Parties to a Mutual Fund – Sponsor, Asset Management Company (AMC), Trustees, Unit Holder and Mutual Fund

For the total functioning of a mutual fund (including formation), there are five major parties and three market agents or intermediaries.

The major parties to a Mutual Fund:

1. Sponsor

2. Asset Management Company (AMC)

3. Trustees

4. Unit-holder

5. Mutual Fund

The three market intermediaries:

(a) Custodian

(b) Transfer Agents

1. Sponsor:

A sponsor is similar to a promoter of a company. The sponsor initiates the idea of setting up a mutual fund. Sponsor means an individual or a body corporate or body corporates establishes a mutual fund. Sponsor also creates a Board of Trustees. Every mutual fund is established with the name of a sponsor.

E.g. UTI Sponsored UTI Mutual Fund, HDFC Sponsored HDFC Mutual Fund, Canara Bank sponsored can bank Mutual Fund etc.

Functions of a Sponsor:

(i) Promotion of a mutual fund as per Indian Trust Act.

(ii) Sponsor appoints, Trustees, AMC, Brokers, agents, depository participants, bankers, Auditors etc. as per SEBI guidelines.

(iii) Sponsor must have a track record of operating in the stock market for at least 5 years.

(iv) Out of 5 years of track record, he must earn profit at least in 3 years.

(v) He must contribute at least 40% of the capital of AMC.

2. Asset Management Company (AMC):

Asset Management Company is a company registered under Indian Companies Act. to manage the money invested in mutual funds and to operate the schemes of the mutual fund. The AMC has skilled professional money managers who look after the corpus of mutual funds which are invested in profitable avenues of investment.

The AMC has three departments:

(i) Fund Management

(ii) Sales and Marketing

(iii) Operating and Accounting

AMC has a minimum net worth of Rs.10 crore and at least 40% of this is to be contributed by the sponsor. In the Board of Director of AMC, at least 50% must be independent i.e., not associated with the sponsor.

3. Trustees:

A mutual fund is established as a trust. This trust is headed by the Board of Trustees. The trustees look after the property of the mutual fund in trust for the benefit of unit holders.

The trustees have the duty to regulate and monitor the operating functions of AMC as per SEBI Regulations and see that the operations and functions of AMC are not against the interest of the unit holders. They must safeguard the interests of the unit holders.

4. Unit Holder:

A unit holder is an individual or an entity holding an undivided share in the total assets of a mutual fund scheme.

5. Mutual Fund:

A mutual fund is established under the Indian Trust Act to raise the money through the sale of units to the public for investing in the capital market. The funds collected are passed on to the AMC for investment purposes. A mutual fund has to be registered with SEBI.

The three market intermediaries to a mutual fund are:

(a) Custodian:

A custodian is a person who renders custodial services to the investors. He has been granted a Certificate of Registration to conduct the business of custodial services under SEBI (Custodial of Services) Act 1996.

Functions:

(i) A custodian maintains accounts of clients’ securities.

(ii) He converts the securities purchased into demat form.

(iii) He receives interest and dividend on mutual fund investments.

(iv) He takes necessary steps as regards to bonus issue, right issue, buy-back of shares etc.

(b) Transfer Agents:

A transfer agent performs the function of transfer of investment documents and records. A transfer agent has been granted a Certificate of Registration to conduct the business of transfer under SEBI Regulations.

He performs the following duties:

(i) Issue and redemption of mutual fund units for unit holders.

(ii) Preparation of transfer documents

(iii) Maintenance of Investment records.

(c) Depository:

A depository is a corporate or a bank or a financial service company who carries out the transfer of units to the unit holders in dematerialised form and maintains the records.

Depository participants are opening and operating demat accounts on behalf of the inventors either with the NSDL (National Securities Depository Limited) or CDSL (Central Depository Securities Limited).

The other functionaries of mutual funds are brokers, selling agents and distributors, legal advisors, bankers and auditors.

Top 7 Criterias in Selection of Mutual Fund

It is very important to carefully analyze a mutual fund before one selects the right fund for himself.

The following are a set of criterias to be looked into in a mutual fund:

Criteria # 1. Fund Manager’s Track Record:

The fund manager should have a proven track record as efficient fund management is able to create confidence in the mind of the investor.

Criteria # 2. Portfolio Quality:

If the poor quality investments don’t backfire, a fund might generate high returns. High credit ratings of investments, means that the fund is investing in low risk instruments, indicating portfolio safety.

Criteria # 3. Number of Retail Investors and Average Holding Size:

It is easier to deploy and manage a small fund but even if a few investors leave it, a small fund could be in trouble.

Criteria # 4. Size of Fund:

Critical mass gives access to opportunities not available to smaller funds.

Criteria # 5. Weighted Average Maturity:

Longer maturities hedge against downward movement in interest rates while it could lose out on short-term upswings in interest rates. Short maturities protect against rising interest rates.

Criteria # 6. Sudden Change in Portfolio or NAV:

This might be a case of a revamp of the portfolio for good but also beware that it might suddenly be open to more risk due to a change in investments.

Criteria # 7. Dividend Frequency:

Tax-free dividends are good for those looking for regular returns but frequent dividends can hinder capital growth through redeployment.

SEBI Guidelines for Mutual Funds

SEBI (Mutual Funds) Regulations 1996 lays down the following guidelines:

i. A mutual fund should be constituted in the form of a trust, duly registered under the provisions of the Indian Registration Act, 1908 and managed by separately formed AMC. The minimum net worth of AMC shall be 10 Crores of which the sponsor should contribute 40%.

ii. The sponsor should have a good track record with minimum experience of 5 years in the relevant field of financial services.

iii. The MF should have a custodian not in any way associated with AMC.

iv. Schemes of Mutual funds launched by the asset management company should be approved by the trustees.

v. MFs cannot deal in carry forward transactions on securities.

vi. A MF may enter into short selling or derivatives transactions subject to the framework specified by SEBI.

vii. The offer document of New Fund Offer (NFO) should contain disclosures which are adequate in order to enable the investors to make informed investment decision

viii. Investments under an individual scheme should not exceed 5% of the corpus of any company’s share.

ix. Investment under all the schemes cannot exceed 15% of the funds in the shares and debentures of a single company.

x. Every close ended scheme, other than an equity linked savings scheme, should be listed on a recognized stock exchange.

xi. The minimum amount to be raised in a close-ended scheme is 20 crores and in open- ended scheme are 50 crores. In case a minimum amount is not collected within the prescribed time limit which is different for various schemes, the entire amount shall be refundable.

xii. A MF should maintain books of accounts, expenses and appropriation of expenses among individual schemes.

xiii. MFs are obliged to publish scheme wise annual reports, annual statements of accounts, furnish half yearly unaudited accounts, quarterly statements of movements and Net Asset Value (NAV) and quarterly portfolio statements to SEBI.

xiv. The Net Asset Value of the scheme shall be calculated and published at least in two daily newspapers at intervals of not exceeding one week. NAV of a close ended scheme shall be calculated on daily basis and published in at least two daily newspapers having circulation all over India.

xv. SEBI is empowered to appoint one or more persons as inspecting authority to inspect the MF.

xvi. SEBI is empowered to appoint an auditor to investigate into the books of account.

xvii. SEBI can suspend registration in case of violations of the provisions.

Net Asset Value of a Mutual Fund (NAV) – Meaning, Formula and Computation

What is ‘NAV’?

Just like an equity share has a market price which is determined through trading in stock exchanges, a mutual fund unit has Net Asset Value per Unit (NAV) based on the closing price of shares and bonds which are part of the respective portfolio of a mutual fund scheme.

The NAV is the combined market value of the shares, bonds and securities held by a fund on any particular day in a portfolio of a particular mutual fund scheme (as reduced by legitimate expenses and charges).

NAV per Unit denotes the market value of all the shares/debentures/bonds or any other instrument in a mutual fund scheme on a given day, net of all expenses and liabilities plus income accrued, divided by the outstanding number of Units in the scheme.

NAV = Market Price of Securities + Other Assets – Total Liabilities + Units Outstanding as at the NAV date

NAV = Net Assets of the Scheme + Number of units outstanding, that is, Market value of investments + Receivables + Other Accrued Income + Other Assets – Accrued Expenses – Other Payables – Other Liabilities + No. of units outstanding as at the NAV date

Net Asset Value (NAV) of a Mutual Fund:

The investors are the owners of the mutual fund. Funds collected on a particular scheme are known as “Corpus” or “Assets” under management. The corpus is invested in different securities. The ownership interest of the unit holders is represented by these securities. The investment made by the investors is represented by the units. A unit is a currency of a fund.

Net Asset Value (NAV) refers to the ownership interest per unit of the mutual fund. In other words, the NAV refers to the amount which a unit holder would receive per unit if the scheme is closed.

The NAV of any scheme tells us how much each unit is worth.

Computation of NAV:

E.g. An amount of Rs.50,00,000 collected by a mutual fund by the issue of 5,00,000 units of Rs.10 each. The amount is invested in different securities and market value of these securities at present Rs.56,00,000 and the mutual fund has a liability of Rs.4,50,000 in respect of expenses. The NAV of the fund i.e.-

Mutual Funds in India – Unit Trust of India, Offshore Funds, SBI Mutual Fund, India Magnum Fund N.V. and Other Funds

Mutual funds in india are as follows:

1. Unit Trust of India:

The UTI was created with the aim of tapping the savings of the small man and to deploy the funds for productive purposes, offering an attractive return and growth to the investors while minimising the risk element for individual investors.

Being the first of its kind and that too in the public sector, the UTI has been vested with both management and trusteeship functions in one body which is the Board of Trustees. The Unit Trust of India Act, 1963, under which UTI was constituted, did not initially permit it to take up activities other than dealing in “units” defined under the Act, investment and dealing in securities and other business arising out of the formulation of any unit scheme.

These restrictions have now been removed and the UTI has been permitted to take up such other activities as direct lending of funds, bill rediscounting, leasing, financing of housing projects, and hire-purchase financing and to set up subsidiaries for many financial services and banking.

The growth in the business of UTI, especially during the eighties, has been spectacular. The gross sales of units (under all schemes) which has amounted to Rs. 10 crores in the first year, i.e., in 1964-65, recorded a rapid growth, especially since 1982-83 and rose to Rs. 3,701 crores in 1988-9, and further to Rs. 4,122 crores in 1990-91. UTI along with all its funds have a total investible funds of about Rs. 70,000 crores, at end March 2002, when it was split up into two units UTI-I and UII-II.

UTI Schemes for Resident Indians:

The UTI offers a variety of investment schemes (funds) to the investing public. As in March 2002, It had, in all, six open-ended investment schemes, viz., Unit Scheme 1964, Unit Scheme 1971 (Unit-Linked Insurance Plan), Unit Scheme for Charitable and Religious Trusts and Registered Societies 1981, Capital Gains Unit Scheme 1983, Children’s Gift Growth Fund Unit Scheme 1986 and Parents’ Gift and Growth Fund Unit Scheme 1987, catering to the various sections of society.

A special mention needs to be made here of the more popular amongst the open-ended schemes, viz., those of 1964, 1971 and 1983. The US 64 of UTI was involved in a scam in 2000-01 due to gross mismanagement. UTI has lost the confidence of investors and was in for liquidity problems.

Of the close-ended schemes, a majority are Monthly Income Schemes, specifically aimed at the retired and aged investors, giving the latter an assured level of income with a total safety of capital. Among the close-ended ones, the Monthly Income Schemes with Extra Bonus and Growth benefits seem to be more popular with the investors.

For domestic investors, the UTI introduced a growth-oriented mutual fund known as “Master-shares” in September 1986. The scheme was very popular, attracting funds of Rs. 1.58 billion against the original target of Rs. 500 million. The NAV of master-shares has moved up and down many times since then, but is even quoted below par value of Rs. 10, many times before its closure.

2. Offshore Funds:

The Unit Trust of India took the initiative of entering the international arena by launching the close-ended ‘India Fund’, in 1986, providing an opportunity for non-resident Indians and other foreign individuals and institutions to make portfolio investments in the Indian capital market. The fund is quoted on the London Stock Exchange.

This was followed in July 1988 by the ‘India Growth Fund’, also close-ended, and quoted on the New York Exchange. The issue price for the fund is $10 and the NAV and the current quotations are substantially higher.

The initial subscriptions to the two funds were limited to £128 million $60 million, respectively. There are presently more than six off-shore funds setup since 1984, by the UTI whose market value has crossed 1 billion by end January 2000. There are of course many other offshore funds, set up by SBI, IDBI and other public sector units.

3. SBI Mutual Fund:

The SBI Markets Limited, SBI’s merchant banking and leasing arm, floated the SBI Mutual Fund (SBIMF) as manager and trustee in 1987. The SBIMF has so far developed many schemes for the benefit of the domestic investing public: Magnum Regular Income Scheme (MRIS), 1987, Magnum Tax Saving Scheme (MTSS) 1988-89, Magnum Regular Income Scheme (MRIS) 1989 and Magnum Monthly Income Scheme (MMIS) 1989 (MTSS) 1990, (MRIS) 1990 etc. The last mentioned scheme was kept open for more than a month.

All the four schemes are basically income-oriented in nature, although an element of capital appreciation is built into them. As the name itself suggests, MTSS 1988- 89 provided for a tax rebate of 50% of the amount invested therein under Section 80 CC of the Income Tax Act, 1961, subject to a maximum of Rs. 20,000, inclusive of other investments eligible under this Section.

Similarly, the two MRIS conferred on investors a rebate on income up to Rs. 12,000 under Section 80L of the Income-tax Act, 1961. The first three close-ended funds launched by SBIMF in the span of a year and a quarter enabled it to mobilise funds to the tune of Rs. 2.47 billion and created investible resources of about Rs. 2.60 billion by March 1989. There are a number of other Schemes floated by the SBI cap later on.

4. India Magnum Fund N.V.:

Although a relatively new entrant in the mutual fund industry, the SBI Mutual Fund has made remarkable strides in a short span of time. The government has approved the State Bank of India’s proposal to launch an off-shore Mutual Fund named “Indian Magnum Fund N.V.”

This close-ended fund, constituted in Netherlands Antilles, is managed by the SBI Capital Markets Limited, in association with Morgan Stanley Asset Management, New York, a well-known international investment management institution. The targeted amount of mobilisation is US$ 100 million and the duration of the fund is 25 years. It garnered $ 157 million by end-October, 1989, when it was closed.

5. Other Funds:

Another public sector bank to enter the mutual fund field is Canara Bank who, through its subsidiary Canbank Financial Services Limited, has created the Canbank Mutual Fund (CMF). The Canbank Mutual Fund has launched many schemes so far, viz., “Canshare”, a growth-oriented fund with no guaranteed fixed return and “Canstock”, a purely income-oriented fund on the lines of SBIMF’s Magnum 1.

Both these close-ended funds have fared well in the market and have declared handsome return to the investors. To cater to the demands of the corporate sector, the CMF floated two other pure money market funds — Cancigo and Cangilt — which are purely liquid funds created to attract the surplus funds of the corporate sector. Other funds called “CanGrowth” and “CanStar” were floated in 1989, for the public investors and a host of other schemes were floated later on.

Close on the heels of these mutual fund companies, the Life Insurance Corporation of India (LIC) has also constituted its own mutual fund named “LIC Mutual Fund” (LICMF). The fund was launched, on June 19, 1989, and many products have been offered for investment.

The three schemes opened first for investment are:

(i) “Dhanashree” close-ended income and growth-oriented scheme, open till October 31, 1989, of units with a face value of Rs. 10 each and a minimum number of units 100, with a guaranteed rate of return of 11% p.a.;

(ii) “Dhanaraksha” — open-ended recurring investment scheme, the maximum amount of investment under which is Rs. 60,000 (spread over a period of 10 or 15 years), and which offers life and accident cover;

(iii) “Dhanvriddhi” — an open- ended fixed investment scheme with investment spread over 7 years to 10 years, the starting insurance cover being equal to the amount invested, subject to a maximum of Rs. 40,000. All these schemes of the LICMF are similar to the schemes offered by other mutual funds, with the additional benefit of life and accident insurance cover in the case of “Dhanraksha” and “Dhanvriddhi.”

While several mutual funds as above are already in operation other commercial banks like the Indian Bank, Central Bank of India, Punjab National Bank of Baroda and Bank of India and financial institutions like the General Insurance Corporation of India, have either singly or jointly, taken steps to set up their own mutual funds and their schemes were also in operation.

Early in 1992, the Government Policy was changed to allow private sector mutual funds also to operate on equal terms with public sector mutual funds.

4 Distinct Phases of Historical Evolution and Growth of Mutual Funds in India – Phase I – 1964-1987, Phase II – 1987-1993, Phase III – 1993-2003 and Phase IV – 2003 Onwards

Historical evolution and growth of mutual funds in India can be divided into four distinct phases, viz.:

Phase I – 1964-1987

Phase II – 1987-1993

Phase III – 1993-2003

Phase IV – 2003 onwards

Phase I – 1964-1987:

The Shroff Committee, in its report submitted in 1954, recommended for the establishment of unit trusts both in public and private sectors as they were most suited to India, where in order to increase capital available for industries, small savings could be drawn into the investment market. However, the Government did not take cognizance of this recommendation.

In 1963 when the whole stock market was in a state of despondency, and uncertainty engulfed the entire economy, joint stock companies found it difficult to raise capital from the market owing to the diffidence of investors, with the result that industrial development of the country came to grinding halt.

The Government, therefore, undertook aggressive programmes to mobilize the long-term savings of the people and direct them into productive channels with a view to fostering industrial growth in the country. The emergence of the Unit Trust of India in 1964 was part of these efforts.

The Trust was established in 1964 by the enactment of the Unit Trust Act, 1963 to afford the small savers as a means of acquiring a share in the widening prosperity based on a steady industrial growth of the country through facilities for investment combining the benefits of wide diversification, a reasonable return and expertise of management.

The Trust commenced its operations from July 1, 1964. The first decade of UTI operations (1964-74) was the formative stage. It introduced a unit-linked insurance plan (ULIP) in 1971. During the period 1984-87, the Trust launched several new schemes such as Children’s Gift Growth Fund (1986) and Master Share (1987).

The first Indian offshore fund was brought out. The total investible funds of the UTI which amounted to Rs.24.67 crore at the end of June 1965, surged to Rs.4,56,368 crore by the end of June 1987.

Phase II – 1987-1993:

The UTI enjoyed a monopoly position till 1987 when the Banking Regulation Act was amended to permit commercial banks to launch mutual funds in the country. Financial corporations were also permitted to engage in mutual fund business. This infused some degree of competition in the industry.

The SBI was the first bank to launch a mutual fund called SBI Mutual Fund in July 1987. This was followed by Canbank Mutual fund (December, 1987), Punjab National Bank Mutual Fund (August, 1989), Indian Bank Mutual Fund (November, 1989), Bank of India (June, 1990), Bank of Baroda Mutual Fund (October, 1992).

LIC set its mutual fund in June 1989 with a view to providing easy accessibility of the investment media including the stock market in the country to one and all especially the small investors in rural and semi-urban areas. The GIC entered in the field of mutual fund business when it brought out two schemes viz., GIC Safe 1991 and GIC Rise 1995.

The IDBI floated an offshore mutual fund in 1991. The Fund is being managed by a subsidiary set up in the joint sector, viz., ‘Fidelity International’ — The World’s largest privately managed Investment Company.

Thus, the mutual fund industry came to be ruled by 7 PSBs in addition to LIC, GIC and UTI. From 1987-1993, the mutual fund industry registered almost seven times expansion in terms of assets, rising from Rs.6,700 (in 1987-88) to Rs.47,000 crore (in 1992-93).

Phase III – 1993-2003:

Until 1992, the mutual funds were in the public sector. So as to enhance degree of competitiveness and provide the investors with wider outlets for investment, Dave committee recommended that the private sector should also be permitted to sponsor mutual funds through asset management companies. Accordingly, the Government permitted entry of the private sector in mutual fund business.

Mutual Fund Regulations came into being in 1993 and SEBI was empowered to regulate and control all mutual funds except UTI. For the time in February 1993 SEBI allowed six private sector mutual funds, viz., 20th Century Finance Corporation, Tata Sons, Credit Capital Finance Corporation, ICICI, Cat Financial Services and Apple Industries.

Kothari group was also granted the premium of floating mutual fund scheme in October, 1993. Morgan Stanley, Taurus Mutual Fund, JM, Shivram, CRB, Alliance and Birth Mutual Fund were also allowed to operate in mutual fund business. The total funds mobilized by all mutual funds reached Rs.75,050 crore by March end, 1995.

Interestingly, foreign fund management companies were also permitted to operate in India in association with Indian partners. The private sectors mutual funds brought sufficient dynamism in their operations through product innovations, investments management techniques and investor servicing technology.

An important development took place in 1996, when a comprehensive set of regulations, viz., SEBI (Mutual Fund) Regulations was introduced for unified governance of all mutual funds operating in India.

Further, Union Government Budget 1999 provided a big fillip to the growth of the industry by exempting all mutual fund dividends from income tax in the hands of investors. This resulted in tremendous growth in assets of the mutual funds in just one year from over Rs.68,000 crore in 1998-99 to Rs.1,13,005 crore in 1999-2000.

The number of mutual funds also increased during this period. There were several mergers and acquisitions. As at the end of January 2003, there had existed 33 mutual funds with total assets of Rs.1,21,705 crore.

Phase IV – 2003 Onwards:

A significant development took place in February 2003, when the UTI was bifurcated into UTI-I and UTI-II. UTI-I is the specified undertaking of the UTI (SUVTI) with assets under management of Rs.44,541 crore as at the end of January, 2003. It manages the assets of the US-64 scheme and 25 assumed return schemes as also the development reserve fund of the UTI.

This specified undertaking is managed by an administrator and governed by the rules framed by the Government of India. It does not come under the purview of SEBI. UTI-II, known as UTI Mutual Fund Ltd., is sponsored by SBI, PNB, Bank of Baroda and LIC, each holding 25 per cent stake.

The UTI-II comprises 36 net asset value schemes of UTI. The UTI mutual fund is managed by the Asset Management Company (AMC). The AMC is registered with SEBI and subject to Mutual Fund Regulations 1996. It had total assets of Rs.19,847 crore as at the end of April, 2004. The basic objective of restricting UTI was to protect the interests of small investors.

There were in all 34 registered mutual funds in India with a corpus of Rs.1,98,662 crore by the end of March, 2004. The number of registered mutual funds increased to 49 at the end of March, 2011 with a corpus of Rs.5,92,250 crore. The AUM of the mutual fund industry has doubled over the last five years to around Rs.6 lakh crore as of December, 2011.

If surged to Rs.8,623 crore in 20014. With r e-entry of Bank of India in mutual fund industry on May 28, 2012 by forging a joint venture with AXA Investment Managers, the number of mutual funds increased to 49 on May 28, 2012.

Phases of History of Mutual Funds in India – First, Second, Third, Fourth and Fifth Phase since 2012

A robust financial market with funds flowing from retail investors is essential for a developed economy. First mutual fund was set up in 1963, by Unit Trust of India (UTI), at the initiative of the Government of India and RBI with a view to boost savings and investments.

Participation in the income, profits and gains earned by UTI from the acquisition, holding, management and disposal of securities was made available to retail investors.

Phases of history of mutual funds in India:

First Phase:

In 1978, UTI was de-linked from the RBI and IDBI took over the regulatory and administrative control of UTI.US-64 was the first scheme launched by UTI which was the best scheme of UTI for a long period of time.

Second Phase:

SBI Mutual Fund was the first non-UTI mutual fund set up in June 1987, followed by Can bank Mutual Fund (Dec. 1987), PNB Mutual Fund (Aug. 1989), Indian Bank (Nov. 1989), Bank of India (Jun. 1990) and Bank of Baroda Mutual Fund (Oct. 1992).

Third Phase:

The Former Kothari Pioneer (now merged with Franklin Templeton MF) was the first private sector MF registered in July 1993. A new era started in the Indian MF industry in 1993 when private sector mutual funds entered the fray, providing Indian investors a diverse choice of MF products.

Fourth Phase:

In February 2003, the UTI Act, 1963 was repealed and UTI was bifurcated into two separate entities e.g. the Specified Undertaking of the Unit Trust of India (SUUTI) and UTI Mutual Fund which functions under the SEBI MF Regulations, 1996.

Fifth Phase since 2012:

Taking note of the lack of penetration of Mutual Funds, especially in tier II and tier III cities, and keeping in view of the interest of various stakeholders, SEBI initiated several positive measures in September 2012 to revive the sluggish Indian Mutual Fund industry and to increase MFs’ penetration in the remote corners of the country.

Organisation Structure of Mutual Funds in India – Sponsor, Trustee, AMC, Custodian, Registrar and Transfer Agent

Three key players namely the sponsor, the AMC and the mutual fund trust are involved in setting up a mutual fund business in India. They are supported by banks, registrars, transfer agents, depository participants and custodians to perform mutual funds activities smoothly.

Organisation structure of mutual funds in india are as follows:

(1) Sponsor:

Promoter of the Mutual Fund Company is known as sponsor of the mutual fund. Sponsor either on his own or in partnership with another company establishes a mutual fund with a purpose to earn money from fund management through its subsidiary company. The company which manages the funds as Investment Manager of the Fund is called AMC.

(2) Trustee:

Sponsors create trust through trust deeds in the favour of trustees. Trustees manage the trust and they are primarily responsible as guardians to investors in Mutual Funds. Primary responsibility of Trustees is to ensure that due diligence is complied with. All Funds floated by the AMC have to be authorised by the trustees.

(3) AMC:

Sponsor start Asset Management Company and AMC manages funds of the Trust. It charges a small fee to manage trust funds. The AMC plans all schemes, launches the scheme and sources the initial amount, manages the funds and gives services to the investors. Fund Managers are appointed by AMC to manage various MF schemes floated by an AMC.

(4) Custodian:

In Mutual funds, AMC purchases different securities like Shares, bonds, gold etc. in various schemes. These Securities are purchased in the name of Trust but they are not kept in the custody of the Trust. The responsibility of safe keeping the securities is with the custodian Now a days the custody of financial securities are in demat form.

(5) Registrar and Transfer Agent:

Registrar and Transfer agent is a separate entity. Registrar & Transfer agent has a responsibility of performing many administrative jobs like processing applications of investors, generating units when new application is received, removing units when investors submit redemptions, managing full record of investors and processing dividend payments on behalf of its mutual fund client.

Policies and Strategies of Mutual Funds in India

Policies and strategies of mutual funds in india is summarized below:

Mutual funds in India seem to have pursued a policy of garnering their resources from the corporate sector. This is more so in the case of private sector and joint sector funds that confine their operations in metropolitan and other big cities.

To attract resources from the corporate sector, customized schemes are brought out frequently. In recent years, they are drifting towards retail investors so as to widen their customer base.

For mobilization of resources the industry is to employ agents and distributors, train and develop their skills so that they can educate the investors properly and offer them suitable products to meet their requirements.

Rationalization of product distribution arrangements, continuous R & D for improving product handling and phased shift from scheme-oriented investor services to single window personalized client-oriented services are the hallmarks of Indian mutual funds’ strategies.

The crux of investment policy of mutual funds is management of its portfolio assets, consisting primarily of industrial securities. Management, therefore, requires constant vigilance over the trends emerging in the financial markets.

The broad aim of the investment strategy should, therefore, be to maximize income on the portfolios as a whole, given the conditions in the capital and stock markets.

In formulating investment strategy, the management is guided mainly by considerations of the safety of funds, reasonable return and capital appreciation on the security instruments.

Most of the funds have decided to build and maintain a balanced portfolio, comprising both variable dividend and fixed income-yielding securities so as to strike a proper balance between the two fundamental principles of the safety of the principal and return on capital.

Marketability of the securities is an important consideration for the mutual funds in India so that investors may avail the benefits of capital appreciation and a reasonably high return on their investments.

Accordingly, the strategy of the majority of the mutual funds has been to invest a major chunk of the funds of growth schemes in equities while bulk of investible funds of income schemes is deployed in fixed-yielding securities so as to be able to honour their commitment of paying the assured return to their investors.

In view of the carnage in the stock markets following the snowballing global financial crisis during 2008-09, mutual funds decided to trim their exposure to equity and increase holding on to cash looking for the best opportunity (over 12 percent of their corpus).

In their endeavour to ensure security of capital and a reasonable return, mutual funds in India have adopted the principle of diversification as the basic tenet of its investment policy. Accordingly, they have decided to diffuse their investible resources over different types of securities of about 25 companies belonging to 10-11 industry groups. A ceiling in terms of proportion of the resources to be deployed in an individual company and industry is fixed, keeping in view the SEBI framework.

Within the overall guidelines laid down by the trustees, managers have high levels of freedom and flexibility to bring about change in the portfolio in consonance with the changing economic and business conditions.

In view of the immense potentiality of the infrastructural sector in the economic development of India and the concomitant government policy directives to financial institutions, public sector mutual funds have recently decided to invest in equity issues of infrastructural projects. It could subscribe to the ‘start up’ capital for core projects in power, telecom, ports and roads.

Of late, mutual funds have decided to tap investors’ appetite for global markets with schemes aimed at investing in other countries which would also as a hedge against fall in the domestic stock market.

Performance of Mutual Funds in India – A Synoptic View: Performance in Terms of Assets, Financial Intermediation and Return (With Tables and Critical Appraisal)

1. Performance in Terms of Assets:

Mutual fund industry in India witnessed continued growth after 2001.

During the period 2001-2013, the industry surged by about fold, touching an all-time peak level of Rs.8,62,300 crore as on March end, 2014 (Table 36.1).

Major Driving Forces that have Contributed to the Surge in the Industry’s Growth are:

1. Buoyant domestic growth coupled with a booming stock market.

2. Conducive regulatory regime as manifested in the increased efforts by the SEBI to improve the market surveillance and protect investors’ interest.

3. Increased focus on product and distribution innovation by the fund players.

4. Launching of slew of customized fund schemes.

5. Lesser outflow of cash.

6. Large inflows into liquid funds due to record low call rates below 10% for all of the month of July, 2007.

7. Mega size public offers leading to spurt in size of liquid funds flowing to MFs.

A notable feature of this growth has been the predominance of the private sector funds on less than one-half of the assets to over three-fourths during this period. Assess under management (AUM) for the sector in 2015 are a new record at Rs.11.85 lakh crore.A couple of factors are helping the equity segment of the sector.

First, strong gains in the stock market have attracted a lot of new investors to MFs. Further, those who had stopped investing through systematic investment plans (SIPs) are back into the market. Finally, the rising number of new fund offers in the space has helped raise the number of investors.

Reliance Mutual Fund maintains its top position as the country’s largest fund house with AUM of Rs.66,420 crore as on July end, 2007. ICICI Prudential remained at the second slot with total wealth of Rs.48,688.55 crore. PSU major UTI MF holds the third rank with assets worth Rs.42,547.60 crore as at July end, 2007.

Recent rise of the foreign investment cap for MFs by the RBI has given fillip to mutual funds to go global on a larger scale with schemes aimed at investing in other countries. While DSP Merrill Lynch and Kotak MF have launched their global funds in July, 2007, one of the country’s biggest fund houses UTI MF and HSBC Asset Management Company are also planning to launch new schemes that would invest overseas.

Besides, there are various schemes from Sundaram BNP Paribas, Principal MF, Fidelity International and Franklin Templeton that provide an opportunity to Indian investors to get an exposure to global markets. A diversified portfolio spread across the boundaries is likely to protect the investors against the bouts of volatility in the domestic stock market.

An Interesting development that took place during 2007 was MF houses’ rush to launch infrastructure funds and at least three of them relatively opened schemes primarily dedicated to this sector.

While strange performance of existing infrastructure funds have given enough reasons for fund houses to launch schemes dedicated to this sector, the government’s keenness to develop India’s infrastructure is another reason managers are bullish on these schemes.

Enthused by its 150% return during the last two years, the fund house launched Indo Global Infrastructure Fund, which in addition to investing in Indian infrastructure related firms, will also look for global players.

Lotus India MF is the other player to launch its scheme for the sector while DBS Cholamandalam MF closed its scheme. Apart from scheme’s growth potential, another driver is diversification of portfolio.

During 2010-11 assets of the mutual fund industry registered decline. This was mainly due to economic slowdown both in domestic and overseas economies, uncertainty in equity markets, high rate of inflation and. reluctance of investors to invest in mutual funds schemes.

As amongst 48 mutual funds as on December-end 2011, the top ten managed assets to the tune of Rs.5,22,308.27 crore which accounted for over 80 per cent of the total assets under management. HDFC Mutual Fund with average assets under management of Rs.88,628 crore topped the list followed closely by Reliance Mutual Fund with assets of Rs.82,305 crore. (Table 36.2)

Despite exponential growth of mutual fund sector in 2014. The sector has gone through consolidation with a slow of mergers and acquisitions. Thus, the year began with the surprise exit of Morgan stanley, acquired by HDFC MF. In May, 2014, Birla Sunlife MF acquired ING MF.

The third deal was between Kotak MF and Pine Bridge Investments in September. The exit of the three small fund houses was due to the challenging landscape in MFs, dominated by larger entities.

Scheme-wise analysis of net assets held by the mutual funds industry in India reveals that (Table 36.3) open-end schemes have been more popular than close-end schemes, like any other developed market. Thus, the open-end schemes pocketed assets to the tune of Rs.5,44,815 crore, which represented over 80 per cent of the total assets under management.

Among the open-end schemes, income-oriented schemes dominated the market, accounting for the largest share of the assets followed closely by equity and money market schemes.

Two striking developments have taken place during the last three years (2009-12). One such development is big investors’ shift to debt mutual fund schemes from equity fund schemes because of uncertainty in the security market and the falling rate of return on equities.

According to the Association of mutual funds in India, gross equity sales in November 2011 were Rs.3,183 crore, the lowest since April 2009 Interestingly, among the ten top performing fund categories, seven are debt funds, with ultra-short-term schemes being the best performing of income funds. This momentum will tend to increase.

Another major development has been the edge of close-ended mutual fund schemes over the open-ended schemes. According to the Association of Mutual Funds in India, the number of close-ended schemes reached 368 in 2011 as against 202 last year.

In contrast, the number of open-ended schemes grew by 15 per cent only. The majority of the rise happened in the income category with a number of schemes more than doubled, registering growth of 134 per cent. It is mainly on the back of the story’s emerging preference for fixed maturity plans.

2. Performance in Terms of Financial Intermediation:

Mutual funds in India have come into existence to mobilize savings of the people and channel them into productive outlets so as to ensure triple benefits of certainty of income, safety of funds and liquidity to the investors.

Regarding mobilization of resources, it may be noticed from Table 36.4 that since the beginning of the decade of 1970s till 1986-87, UTI, the solitary institution in the industry, garnered resources through its diverse schemes to the tune of Rs.4,016 crore.

There was a phenomenal surge in the amount of resources raised by the mutual funds during the period 1978-88 — 1991-92 in as much as funds mopped up during this period amounted to Rs.32,000 crore, almost eight fold increase over what was raised during 1970-71 – 1986-87.

This was partly because of entry of public sector banks in the industry but mainly due to expansion of the operations of the UTI and incredible efforts made by the Trust to mobilize funds through several innovative schemes and planned publicity and aggressive promotional efforts.

However, performance of the mutual funds industry suffered heavily during the period 1992-93 – 1996-97 when total resources procured from the market declined substantially to an all-time low level of Rs.27,669 crore, even though mutual funds in the private sector also started raising resources since 1994 and could mop up about Rs.3,900 crore during the period.

The primary factor responsible for the declining trend was failure of UTI and public sector mutual funds to sustain their tempo. Further, there was a greater amount of outflow of funds than the inflow in the case of the UTI during the period 1995-96 and 1996-97.

The subsequent period 1997-98 — 2001-02 witnessed a spectacular spurt in the amount of resources garnered by the mutual funds. Major portion of the resources mopped during this period was by the private sector mutual funds.

A peculiar trend was noticeable during the three years of 2002-03 — 2004-05 when private sector mutual, funds mobilized net resources to the tune of Rs.62,594.8 crore as against negative trend in the case of UTI mainly because of the steep increase in redemptions and repurchases of the order of Rs.11,000 crore. This led to sharp decline in the amount of funds garnered during the period.

It, thus, emanates from the above analysis that private sector funds have played a crucial role in mobilizing savings of the public, accounting for about 70 per cent of the resources garnered since 1993.

This is attributable to the introduction of a host of innovative saving schemes carrying features suiting the needs of diverse sections of the society, vigorous and planned publicity, promotional drive, relatively attractive rates of return and better service standard. Further, private sector funds were found more investor friendly and efficiently managed, compared to their public sector counterparts.

During the next two years 2005-07, a whopping sum of Rs.3,20,000 crore was mobilized by the mutual funds industry. This is primarily due to launching of a large number of innovative savings schemes and smart and customer friendly marketing and distribution strategies. The contribution of private sector funds has been astoundingly very high. The emerging trend is indicative of growing investor’s confidence.

A new concept of investing in gold through a mutual fund is now evolving. A handful of mutual funds have, of late, decided to offer this investment option. The first gold mutual fund product was launched by Benchmark Mutual Fund in 2006 and DSP Merrill Lynch World Gold Fund in July 2007.

Others like UTI Mutual Fund and Prudential ICICI too are getting ready with their schemes. Under this scheme, the money is deployed to purchase gold in physical form, As such; the performance of the fund would depend on the price movement in gold.

During 2008-09, net resource mobilization by mutual funds turned negative; there was a net outflow of Rs.28,297 crore during the year as compared to a net inflow of Rs.1,53,801 crore during 2007-08. Both the number of schemes and net resource mobilization declined steeply, reflecting uncertainty in the stock markets and redemption pressures from banks and corporate on account of tight liquidity conditions prevailing at that time.

The year 2009-10 witnessed significant improvement in the resource mobilization efforts of the mutual fund industry when net resources of the order of Rs.78,545 crore were garnered. This was because of improved economic conditions and a boom in equity markets. Major portion of the resources was mobilized by the private sector funds.

Economic slump, global crisis, high inflation rate and sluggish security market during 2010-11, hurt the sentiments of the investors resulting in a net outflow of Rs.47,917 crore during the period. However, there was a remarkable surge in funds mobilisation activity of mutual funds during 2012-13.

Among 53 mutual funds opening in India, ten top funds have displayed sterling performance so far as net resources garnered by them (Table 36.5) during 2012-13. They together mobilized resources to the tune of Rs.67,918 crore during 2012-13 accounting for over 80 per cent of the total net resources mobilized by all the 53 funds.

Scheme-wise analysis of resources garnered by the mutual funds industry (Table 36.6) reveals that the bulk of the resources mobilized during 2000-01 to 2007-08 were under liquid/money market schemes and growth/equity-oriented schemes.

Mobilization under debt schemes, which have traditionally been garnering the largest amount of resources, declined sharply during the year 2004-05 due to a hardening of yields. Equity oriented schemes attracted higher funds mainly due to attractive returns in buoyant secondary markets.

Net resources mobilized under the equity oriented schemes increased by about five times during 2005-06 to Rs.35,231 crore from Rs.7,100 crore in the previous year, driven by attractive returns from these schemes in view of buoyant secondary market conditions.

In line with the recent trend, the bulk of the net resources mobilized by mutual fund during 2007-08 was accounted for by income/debt-oriented schemes and equity oriented schemes. While higher interest rates seemed to have made the debt schemes more attractive to the investors, resource mobilization through growth/equity oriented schemes during the year was supported by the robust performance of the domestic stock markets.

During 2008-09, income/debt oriented schemes witnessed a net outflow of Rs.32,161 crore, while growth/equity schemes registered a net inflow of Rs.4,024 crore.

In the wake of the tight liquidity condition since June 2008, mutual funds have faced redemption pressure. For instance, while sale of new schemes amounted to 11,476 crore for the month ended February 29, 2012, the amount of redemption during the period amounted to over Rs.5,00,000 crore. This is why most fund managers have adopted a cautious approval and preference to invest only in non-convertible debentures.

As regards deployment of funds, the Indian mutual fund sector invested Rs.1,18,575 crore in equity schemes of companies during April, 14 to January, 15, only Rs.7,700 crore less than the previous record of Rs.1.26 Lakh crore during the peak of previous bull run, in 2007-08.

After showing downward trend in mutual funds inflows in equities since 2010-11, there was remarkable surge in mutual fund inflows in equity shares in 2014-15, indicating that Indian mutual fund sector might soon record the highest investor flow into equity offerings in a financial year. Rising trend can be explained by sustained gains in the stock markets, improvement in the macro economy and Ropes of reform from the new governments that have attracted investors to the sector.

3. Performance in Terms of Return:

Until recently, the majority of investors were not satisfied with the performance of the mutual funds because of poor returns, i.e., less than expected income and even loss of capital in several cases. Shockingly, most of the investors in growth funds and the US-64 scheme expressed loss of faith in mutual funds.

However, the scenario has remarkably changed in recent few years. Indian mutual funds are rewarding their investors better than any other funds in the world. According to a report by Lipper, a leading market research agency, Indian funds have grabbed eight of the top ranks over a 10-year period.

If one takes the last five years, they account for 7 out of the top 10 and over a 3-year period, six of the 10 best performing mutual funds are from India.

A bird’s eye view of top performers may be had from Table 36.7.

A peep into table 36.7 shows that rate of return on different schemes of the mutual funds has surged significantly in the year 2011. For instance, Reliance Pharma Fund – Dividend offered as high as 91.52 per cent and Franklin Pharma Fund – Dividend 89.67 during the year. Rates of return in the case of other outstanding players ranged between 46.93 per cent and 67.90 per cent.

Profitability performance of the mutual fund industry has not improved during the year 2010-11. Twenty-three of the 44 fund houses for which data are available have been carrying forward losses and among the profitable AMCs, 12 saw their profits decline in 2010-11. Many have blamed big-shift regulations, including the ban on entry loads since August, 2009 for the industry’s woes.

It is generally believed that the profitability of the mutual fund industry may not improve significantly in future due to increasing cost incurred to develop distribution channels and falling margins due to greater competition among fund houses.

However, top players in the industry have continued to remain profitable. Thus, Reliance Mutual Fund continued to remain the most profitable asset manager in the industry during 2011-12 with Rs.2.07 crore as net profit HDFC MF, the country’s largest fund house, grew faster to Rs.269 crore as compared with Rs.242 crore in 2010-11. ICICI AMC, the third largest fund house, grew fastest in terms of profitability at 22.5 per cent to Rs.88 crore against Rs.72 crore earlier.

A Critical Appraisal:

Mutual funds in India are ostensibly vehicles of democratic capitalism. They allow millions of ordinary investors to own equity, and this is one reason why the industry is lavished with tax breaks. But in the real world, mutual funds have become vehicles of power and privilege instead, doing all they can to help a few favoured investors.

Contrary to the philosophy of mutual funds of focusing on individual investors, in India the industry particularly in the private and joint sectors is highly focused on corporates, deriving 60-80 per cent of their corpus from them, giving scant attention to the retail investors.

When mutual funds were set up, everyone who mattered sang poems to the significant reforms that would contribute to the wealth generation of India’s retail investors. However, this expectation has been dashed as evidenced from decline in retail investor’s contribution as a percentage of AUM from 28 percent in 2011 to 23 percent in 2013.

Nevertheless the Rs. 8.2 lakh crore (as on March 2013) industry has growth at a Compound Annual Growth Rate (CAGR) of 21 percent in terms of assets during the past 20 years, the growth in equity assets, which account for almost 80 percent of investors is just 14 percent as the BSE Sensex’s market cap during the same period has risen by 19 per cent.

Comparative numbers of some of the emerging countries also show the industry in poor light. According to data from global agency Investment Company Institute, the Indian mutual funds industry’s CAGR in assets under management has been just 1.07 percent (in dollar terms) during the past 5 years, is much lower than South Africa (8.80%) and Brazil (11.72%)

Retail investors’ disappointment with the mutual funds is not only because of dwindling return and high fees charged by the mutual fund managers but also of loss of trust. Household savers have learned that their own incentives are not always solidly aligned with those of the sellers. And this is the fault of misplaced regulation.

Regulation has focused on ensuring that funds are not misstating their claims of future growth, on their providing ‘full information’ to investors and on growing ‘financial literacy’ among investors. Unfortunately, nothing is said about what third-party sellers, including banks, state about the mutual funds on offer. And the “full information” offered to households is frequently too vast and complex for part-time investors to fathom.

Given the returns, therefore, the hassle for household savers is too high, especially when alternative hedges against inflation are available, such as gold or real estate. Thus, if equity mutual funds are not achieving in India what was promised 20 years ago, the fault is partly the industry’s in failing to sell itself directly and more transparently, and partly that of regulators, in not putting in place consumer – friendly systems.

There exist structural flows in the business models of the mutual fund industry. First there is sharp variance in the investor mix. Corporate investors account for less than one percent of the mutual fund population. But their share of AUM stood at 46.7 per cent in September 2011.

Again, high net-worth individuals account for less than two per cent of the investor population, yet their share of AUM was 23.7 per cent. But retail investors, who make up 97.4% of the investor population, accounted for a mere 23.6 percent of the industry’s AUM.

This is in sharp contrast to the United States, where retail investors owned 87 per cent of the $11.8 trillion invested in mutual funds as of December, 2010. Thus, in India, the mutual fund industry, which ostensibly exists to multiply investor’s hard-earned money, has been hijacked by corporate India.

Another disconcerting trend in respect of the mutual fund industry in India is its low penetration. The percentage of household savings in the share of the fund is a meagre 4 per cent in India compared to 16 per cent in the West. Close to three-fourth of the fund industry’s assets were only from the country’s top five cities, viz., Mumbai, Delhi, Bengal war, Chennai and Kolkata.

The total number of mutual funds branches in the cities beyond the top 15 is just 52, while the total number of branches is 1,600. No wonder the top five cities shall account for 74 percent of the total AUMs. These facts call for serious introspection on the part of the industry.

In connivance with mutual funds, fund managers and corporate investors have been found indulging in numerous irregular practices and the SEBI has remained a mute spectator to such unethical practice being adopted by fund managers as ‘front-running.’ In this, the fund manager buys the shares of a company through his secret account merely hours before his and buys them.

Prices normally rise when a lager fund picks up thousands of shares of a particular company. Once the prices rise, the fund manager would quietly sell his holdings and make a neat profit. This has become common practice among funds, managers but SEBI has failed to curb this practice.

Late trading and rapid trading are another kind of unethical practices pursued by big investors with the help of asset management companies. Inappropriate NAVs have been given to large investors for a long time.

The biggest culprits have been public sector financial institutions and banks that have been arm twisting MFs, especially debt and liquid funds. Late trading deflates NAVs of the funds they manage and NAV performance is what fund managers are judged by. SEBI does not have any mechanism to check past late trades.

Rapid trading practices are being indulged by most of the private sector mutual funds in India to help the institutional investors to pull out money in uncertain or volatile times. For this purpose, the funds go to the extent of selling its liquid holdings first just to repay the large investors with the result that the long-term investors, who typically react later to the market developments, are left with relatively illiquid ones.

This problem is compounded because the funds also offer lower or zero exit loads to larger investors. So while a retail investor may need to pay a 0.5 per cent exit load for leaving a fund within six months, big investors pay nothing or a much lower load. This encourages frequent by large investors. Unfortunately, SEBI has so far not been able to take effective steps to curb this nefarious practice.

Still another irregular practice indulged in by mutual funds in India is dominance of a fund by single or few large investors. As of March end, 2004, a whopping 110 or nearly one-third, out of the total 350 schemes in the industry were single-investor schemes.

Although SEBI has advised mutual funds that no single investor should hold more than 25 per cent of the funds’ assets, this does not serve the purpose much, for the fact that a big investor or a fund can easily rope in 19 small investors into the scheme to meet the legal requirements. Even a maximum holding of 25 per cent for a single investor is too large to marginalize other investors with their moves.

Several fund houses have reportedly been offering assured returns to Provident Funds (PFs) and indulging in unethical practices. In their bid to increase the size of assets under their management, funds are paying scant attention to the means adopted to show results. In the case of PFs, for instance, money meant for investing in gilts was diverted to equities in order to earn a higher rate of return.

This despite the fact that PFs are prohibited by law from investing in equities. Such instances do nothing for investors’ trust in MFs. As it is, many common investors view MFs suspiciously. This is why funds have failed to become as popular in India as they are in other markets.

Higher up front commissions currently being offered on recently launched closed-ended equity schemes are likely to bring back the menace of mis-selling by mutual fund distributors. Although the SEBI has taken several measures to curb mis-selling, higher commissions are so tempting as to rule out mis-selling.

Reliance MF, ICICI Prudential MF, Axis MF and Union KBC are among the fund houses which have recently launched such closed-ended products. As such, investors should understand the risks in such offerings.

Mutual funds in India have been found splurging on marketing expenses. When 75 per cent of assets under a fund’s managements are in commoditized debt and cash funds, differentiating one scheme from another depends on what the fund houses can do for distributors – from giving extra commission in particular periods or on meeting some targets, to furnishing their offices, gifting them cell phones, laptops and sending them abroad on pleasure trips.

Although SEBI is aware of the mad short-term incentivisation going around in the industry, it has yet to take concrete steps to control cozy distribution deals and marketing incentives.

It has also been noted with concern that some Indian mutual funds turn over their portfolios so many times in a year that moderate hedge funds would be put to shame. The industry claims this is because the Indian investors only invest for the short-term and there is no equity cult to speak of in the country.

However, distributors have a huge role to play here. In fact, retail investors rarely shift funds. It is distributors who keep encouraging high-net worth individuals to churn their investors so that they upfront commissions ranging between 1.5-1.75 per cent. SEBI is either unaware of the games mutual funds play, or it prefers to ignore.

Another disturbing trend is that investor’s profiles have not changed over the years because of geographical reasons. The top five cities still account for a whopping 73 per cent of the industry AUM, with Mumbai alone accounting for 44.59 per cent, according to data from Association of Mutual Funds of India.

Another weakness of Indian mutual fund industry is that it suffers from the copycat syndrome. Within days of an AMC launching a fund, the others follow suit and try to lure the same investor.

It is interesting to note from the data from the Association of Mutual funds in India (Amfi) that assets contributed from the cities of Mumbai, Delhi, Kolkata, Bangalore and Chennai declined to 72.9 percent of the total at the end of March 2014 from 74.3 percent in Sept. 2012. AUM from beyond 15 cities contributed 13.65 percent of the total at the March end 2014 quarter, compared to 12.97 percent in Sept. 2012.

One of the major factors contributing to this trend is the initiative taken by the SEBI since September, 2012 to provide extra incentives to fund houses to attract investors from small centres.

Above all, there are a large number of non-serious players in the mutual fund industry. This is evident from the fact that the top 10 players from India’s 45 asset management companies control 77 from, percent of the AUM, while the bottom 10 just one percent in the business.

In view of the above, the bulk of the estimated 20 million investors across the length and breadth of the country, appear to be reposing more faith in investment alternatives other than MF schemes; these include plain vanilla bank deposits, or insurance products or buying stocks, etc.

Money Market Mutual Funds in India (With Summary, Features and Important Relaxation)

MMMFs in India is summarized below:

Until 1991, the impact of various measures taken to widen and deepen the Indian money market was limited in terms of imparting stability, activating the secondary markets in CDs and treasury bills to a desired extent and developing specialised institutional infrastructure to facilitate the role of the Discount and Finance House of India (DFHI) as a market maker.

On the other hand, the household sector, which provided a major chunk of savings, had, over the years, become conscious of return on investment.

Although the mutual funds catered to the needs of small investors with investible surplus, yet these funds concentrated mainly on capital markets and long-term instruments. As the money market instruments stipulated relatively high minimum transactions, they became inaccessible to smaller investors.

Thus, arising out of the felt-needs, i.e., – (i) to widen and deepen the money market, and (ii) to provide an additional lucrative avenue for short-term investible surplus of the smaller investors, the idea of MMMFs was mooted.

The MMMFs, by collecting funds in smaller lots to be invested in various specified short-term money market instruments of high quality, will provide the investors the advantage of block purchases, diversification of investments, professional expertise and optimum yield.

During the year 1991-92, the Reserve Bank of India laid the broad framework within which the MMMFs were to be developed. To fully develop this broad framework, a Task Force, headed by Mr. D. Basu, and consisting of representatives of the RBI and banks was set up. Consequent upon the submission of the report by the Task Force, the RBI in its Credit Policy for the first half (Slack Season Credit Policy) of 1992-93, announced the details of the scheme.

The various features are as follows:

(i) Eligibility to Set Up MMMFs:

MMFs can now be set up by scheduled commercial banks and public financial institutions as defined under Section 4A of the Companies Act, 1956 or through their existing Mutual Fund/Subsidiaries engaged in Funds Management as well as mutual funds set up in the private sector.

Private sector mutual funds can set up MMMFs with the prior approval of Reserve Bank of India, subject to other extent terms and conditions stipulated under the Scheme and should also get Securities & Exchange Board of India (SEBI) clearance to ensure that there is no infringement of SEBI guidelines on money market investments for amount/duration.

(ii) Structure of MMMFs:

(a) MMMFs can be set up departmental in the form of a division/department of the banks/financial institutions/mutual funds/subsidiaries, i.e., “in house” MMMFs wherein the assets and liabilities of such MMMFs would form part of the eligible institutions’ balance sheet or as separate entities i.e., as a “Trust”.

(b) MMMFs can be operated either as Money Market Deposit Accounts (MMDAs) or Money Market Mutual Funds (MMMFs). MMDAs schemes could be operated either by issuing Deposit receipt or through issue of Pass Book without cheque book facility. MMMFs could float both open-ended and close-ended schemes.

(c) Where MMMFs are set up as a Trust, a Board of Trustees should be appointed by the sponsoring institution to manage it. The day-to-day management of the schemes under the Fund is set up as a Trust, should be looked after by a full time Executive Trustee or a separate Fund Manager if set up as a Division of bank/financial institution/mutual fund/subsidiary.

(d) Banks and public financial institutions are free to formulate special schemes as per their requirements subject to the guidelines stipulated by the Reserve Bank of India. MMMFs should forward the details of the scheme together with copies of offer letter, application form etc. to forward the details of the scheme together with copies of offer letter application form etc. to the Reserve Bank of India at least one month before announcing the launching of any scheme.

(iii) Size of MMMFs:

The minimum size of a MMMF of Rs. 50 crores stipulated in our circular of April 29, 1992 is withdrawn. Likewise, the prescription of a ceiling for raising resources under various schemes by MMMFs set up by banks/financial institutions/mutual funds/subsidiaries is also withdrawn.

(iv) Subscription:

As the MMMFs are primarily intended to be a vehicle for individual investors to participate in the money markets, the units/shares of MMMFs can be issued only to individuals. Individual Non-Resident Indians (NRIs) may also subscribe to share/units of MMMFs on a non-repatriable basis.

(v) Investment Size:

MMMFs would be free to determine the minimum size of investment by a single investor. The investors cannot be guaranteed a minimum rate of return.

(vi) Lock-in Period:

The minimum lock-in period for investment would be 46 days.

(vii) MMMFs’ Investments:

The resources mobilised should be invested exclusively in various money market instruments subject to certain lower and upper limits (as per cent of investible resources of MMMFs).

The instrument-wise-details of the limits are as follows-

(a) Treasury bills and dated government securities having an unexpired maturity up to one year — minimum 25 per cent,

(b) Call/notice money — maximum 30 per cent,

(c) CP — maximum 15 per cent, and the exposure to CP issued by an individual company should not be more’ than 3 per cent,

(d) Commercial bills accepted/co-accepted by banks — maximum 20 per cent, and (e) CDs — no limit.

These limits were designed, basically with a view to ensuring safety and liquidity to the investor.

(viii) Reserve Requirements:

In the case of MMMFs set up by banks, the resources mobilised by them would not be considered as part of their net demand and time liabilities for purposes of reserve requirements, and as such these resources would be free from any reserve requirements.

(ix) Stamp Duty:

The shares/units issued by MMMFs would be subject to stamp duty.

(x) Regulatory Authority:

The setting up of MMMFs would require the prior authorisation of the Reserve Bank. Furthermore, the MMMFs to be set up by banks, their subsidiaries and public financial institutions would be required to comply with the guidelines and directives that may be issued by the RBI from time to time.

Although the guidelines were issued in 1992-93, yet no institution has so far come forward to establish a MMMF The major hurdle has been the stringent limits for investments prescribed by the RBI. Moreover, the relative quietness on the money market front led to the absence of the ‘necessity’ factor to establish MMMFs.

However, in 1995, the call money market experienced severe bouts of volatility, with rates scaling such heights as 140 per cent. Although the time-specific factors were many, yet the fundamental problem was that the money market was not wide and deep enough to absorb the shocks of excess demand as and when they surfaced.

Therefore, in November 1995, the RBI permitted the private sector mutual funds to set up MMMFs, with a view to providing greater liquidity and depth to the money market. While allowing the private sector MFs, the RBI also relaxed some of the earlier guidelines.

The important relaxations were:

(i) Ceiling for raising resources and minimum size of Rs. 500 million withdrawn;

(ii) Minimum limit of 25 per cent while investing in T-bills and the Government of India papers of residual maturity up to 1 year withdrawn;

(iii) Maximum limit of 30 per cent while investing in call/notice money withdrawn;

(iv) Maximum limit of 15 per cent while investing in CPs withdrawn;

(v) Maximum limit of 20 per cent while investing in commercial bills withdrawn;

(vi) Dividend/income on subscriptions by individual NRIs in MMMFs can be repatriated, but not principal; and

(vii) Private sector MMMFs should need the RBI and the Securities and Exchange Board of India (SEBI) approval. Currently, the RBI and the SEBI are preparing the operational instructions, regulatory norms and supervisory guidelines for the MMMFs.

The idea of instituting MMMFs is full of expectations. With the liberalisation measures having swept almost all segments of the economy, the money market requires change in a stable and sustained manner so that it adequately subserves the changes in the real sector. The immediate impact of the MMMFs will be two-fold.

Firstly, the MMMFs will help smoothen the off-repeated bouts of volatility in the Indian call money market, and their induced repercussions on other segments of the financial and the real sectors. This is important particularly when the markets are getting more and more integrated. Secondly, the MMMFs will help augment the savings position of the Indian economy, which, of late is on a sliding course.

It will induce savings not only directly through schemes offering all the avowed benefits of MMMFs but also indirectly by offering competition to other mobilisers of savings, who, in turn, will be enthused either to improve upon their existing schemes or to come out with new schemes to counter the competition posed. Besides, it may also reduce, to some extent, the compulsion on the part of the Indian banks to subscribe to the government papers.

Mutual Funds Good or Bad for India (With RBI Guidelines and Conclusion)

Mutual funds are ideally suited to Indian financial environment. The suitability for investors in India has been legitimised by the Union government by amending the Banking Regulations Act to provide for setting up of mutual funds by Banking Companies as a legal activity. The notification enables commercial banks to set up subsidiaries which could be members of the stock exchanges.

The notification specified that mutual funds would engage in business of acquisition, holding, management, trading or disposal of securities, participation certificates or any other instrument. Mutual funds could also engage themselves in the generation of income or growth participation business as also involved in the different schemes of the Unit Trust.

The funds will be open to participation by the members of the public through the subscription of shares or units or otherwise for the purpose of providing facilities for participation in or distribution of the income, profits or gains arising from these activities to the participating members.

The mutual funds are legally allowed to make investment in a wide variety of operations. It includes all types of shares, debentures, bonds of any company, corporate body, company deposits, deposits with other corporate bodies, scheduled banks and similar institutions, any commercial paper or securities floated by the central Government, State Government, the Reserve Bank of India or any local authority outside of India and approved by the Reserve Bank of India. Also, the Mutual Funds will be allowed to invest in government securities as defined in the public debt Act, 1944.

Following are the main points in support of the applicability of Mutual Funds in India:

1. India, being a poor country, has predominance of small investors who have the ability to save small amounts. In recent years, they are also willing to invest in shares and debentures, but hesitate to do so because of lack of market information, their inability to reach the market quickly, difficulties they faces, in transacting business and obtaining liquidity in the secondary market.

In India, even regular investors, do not possess requisite expertise needed for security analysis and for selecting appropriate investment portfolios. A need for professionally managed mutual funds has grown in recent years as stock exchanges are becoming more volatile and complex.

2. The size of the investing population in Indian stock exchanges is quite large. It is the largest next, only to that of the USA and Japan. It is extremely difficult to arrange for direct individual participation on stock exchanges for the investing population. Indirect participation through mutual funds is an ideal solution to this problem.

3. At present, more than 90 per cent of the total value of shares and debentures is held by the urban population residing in the industrially advanced, educationally forward and financially sophisticated western region of the country. The population of the rest of the urban and the entire rural and semi-urban regions has command over an enormous pool of savings.

Yet, it is financially unsophisticated to deal directly with the stock exchanges. The stock exchanges in their turn do not have well developed administrative machinery to reach them. Under these circumstances, mutual funds could be the ideal financial intermediaries bringing an investing population which is denied access to stock exchanges which are unable to reach them because of administrative inadequacies.

4. There has been a poor balance of trade situation and mounting deficits, it has increasingly become necessary to tap the savings of foreign investors (including non-resident Indians) through a number of mutual funds since foreign investors have no expert knowledge about Indian companies and rules and regulations governing investments in India for efficient management of their portfolios.

5. The various segments of the capital market, primary issue market, secondary markets in shares and debentures, markets for gilt-edged securities, even money markets could be developed and integrated into one financial market through operation of mutual funds which are active simultaneously on more than one market.

6. India, like the USA is a counter of continental size with a diversity of investing population. There is great need and scope for a large variety of mutual funds in India. The scope of mutual fund is so broad that it covers the entire spectrum of investment requirements of the investors both domestic and foreign.

The Unit Trust of India (UTI) has been the country’s first financial institution to have successfully launched various mutual fund schemes mainly because of the unique tax advantage it enjoys. Similar tax advantages will be made available to mutual funds started by nationalised banks and the amendment to the companies Act regarding this, is expected to be introduced in the parliament very soon.

Thus, the income from such mutual funds will be tax-free in the hands of holders and no tax will be deducted at source while distributing income, under section 80C and 80L of the Indian Income Tax Act 1961.

Taking the advantage of the liberalised policy and obtaining necessary approval from the government, the State Bank of India (SBI) has taken the lead and become the first commercial bank in India to set up a mutual fund. The fund, called SBI Mutual Fund, intends to offer a diversified investment portfolio to subscribers with tax free incomes.

The fund launched on September, 1st. 1987 with an amount of Rs.100 crores, is both income and growth oriented. The fund shall be managed by the bank’s wholly owned merchant banking subsidiary SBI Capital Market Ltd., and will invite subscription for seven years. It is a close ended fund for a fixed amount and for a specific period.

Two way prices, namely bid and offer prices, are proposed to be quoted by the fund periodically to ensure liquidity to the subscribers with a wide choice of investment. Unlike units it would not be listed on the stock market but traded over the counter.

This is expected to save the investor heartburns following the eventuality of the units being quoted below par. These recent developments augur well for future financial development on the capital market in India.

RBI Guidelines:

Reserve Bank of India has recently announced guidelines governing the functioning of Mutual Funds to ensure their orderly working and inspire investor confidence.

Some of the important features of the guidelines are as follows:

1. All Mutual Funds shall be constituted under the Indian Trust Act.

2. An ‘Arm’s Length’ relationship shall be maintained between sponsor banks and those who manage the funds so that there is no clash of interests between the sponsor bank and beneficiaries.

3. Sponsor banks shall have stake equivalent to 1 per cent of the fund.

4. Investment objectives shall be made clear to the investing public.

5. Mutual Funds shall not undertake lending and money market operations. However, temporary investment in money market instruments is permitted.

6. Speculation through short sales/purchases is not permitted.

7. Investment in other Mutual funds is not permitted.

8. With a view to spread risk, any one single scheme shall not hold more than 5 per cent of the subscribed capital or debenture stock of any company. In case of more than one scheme of the Mutual fund, total shall not exceed 15 per cent.

9. Total investment in any one fund shall not exceed 15 percent of the schemes fund.

10. Spread between purchase and sale shall not be more than 15 per cent.

11. Income distribution shall not be made on the basis of revaluation.

Conclusion:

The above compelling arguments in favour of Mutual Funds clearly reveal that mutual funds can be ideally suited to Indian financial environment. It is a fund which can be tailored to suit every purpose to cover the entire spectrum of investment population requirements, in the country.

The Government of India is encouraging such institutions through many amendments in- Banking regulation Act, Securities contract Act, Companies Act, Controller of Capital Issues Act and Securities Exchange board of India (SEBI) in April 1991, to help in increasing the investment by the general public on the one hand and the corporate sector in getting their capital requirements with little difficulty.

Top 4 Role of Mutual Funds in Indian Capital Market Development

The Indian Mutual Fund segment is one of the fastest expanding segments of our Economy. During the last ten year period the industry has grown at nearly 22 per cent CAGR. With assets of US $ 125 billion, India ranks 19th and one of the rapid growing countries of the world.

The factors leading to the development of the industry are large market Potential, high savings rate, comprehensive regulatory framework, tax policies, innovations of new schemes, aggressive role of distributors, investor education awareness by SEBI, and past performance.

Mutual funds are not only providing growth to the capital market through channelization of savings of retail investors but themselves playing an active role as active investors in Indian companies in secondary as well as primary market. Let’s examine mutual funds’ role in capital market development in detail.

Role of mutual funds in indian capital market development are as follows:

Role # (1) Mutual fund as a source of household sector savings mobilization:

Mutual fund industry has come a long way to assist the transfer of savings to the real sector of the economy. Total AUM of the mutual fund industry clocked a CAGR of 12.4 per cent over FY 07-16. That shows how mutual funds have played a pivotal role in mobilising retail investors’ savings into the capital market in the last 10 years in India.

By the end of March, 2017 AUM with Mutual funds is around Rs. 17.5 lakh crores. In 2017 itself, investors poured Rs. 3.4 lakh crores across all the categories of Mutual funds in India.

Role # (2) Mutual Fund as Financial service or Intermediary:

The financial services sector is the second-largest component after trade, hotels, transport and communication all combined together, and contributes around 15 per cent to India’s GDP. With the rapid growth, mutual funds have become increasingly important suppliers of debt and equity funds.

In fact, corporations with access to the low interest rates and increased share prices of the capital markets have benefited from the expansion in mutual fund assets. In recent years, mutual funds as a group have been the largest net purchaser of equities and a major purchaser of corporate bonds.

All the MFs collect funds from both individual investors and corporate to invest in the financial assets of other companies. The number of fund houses is also increasing each year in the fast growing Indian economy. As of FY 16, 42 asset management companies were operating in the country.

Role # (3) Mutual funds popularity among small investors:

Small investors have lots of problems like limited funds, lack of expert advice, lack of access to information etc. Mutual funds have come as a great help to all retail investors. It is a special type of institutional mechanism or an investment method through which the small as well as large investors pool their savings which are invested under the advice of a team of professionals in large variety of portfolios of corporate securities Safety with good return on investment is the outcome of these professional investment in mutual funds.

It forms a significant part of the capital market, providing the advantage of a well-diversified portfolio and expert fund manager to a large number, particularly retail investors. An ordinary investor who applies for shares in an IPO of any company is not sure of any guaranteed allotment. But mutual funds who invest in the particular capital issue made by companies get confirmed allotment of shares, therefore, the investment in good IPO’s can be achieved through investment in a mutual fund.

Role # (4) Mutual Funds as part of financial inclusion policy of Govt, of India:

Now SEBI is motivating mutual funds to spread in smaller cities and in rural India to attract small savings and making rural people aware of new investment avenues like mutual funds providing good returns at low risk. So Govt, of India’s policy of financial inclusion to mobilise savings of unbanked people of India is being supported actively by mutual funds now.

In its effort to encourage investments from smaller cities, SEBI allowed AMCs to hike expense ratio up to 0.3 per cent on the condition of generating more than 30 per cent inflow from smaller cities. Mutual funds and AMFI undertake Investor awareness programmes for this purpose of financial inclusion.

Suggestions to Make Indian Mutual Funds More Effective (With Steps)

Suggestions to make indian mutual funds more effective is summarized below:

Nevertheless the transparency level in terms of disclosure of portfolios of the schemes is higher in the mutual fund industry compared to other establishments such as banks, post offices and provident-funds; there is still scope for mutual funds to further enhance it through more disclosures.

Specifically, they need to explain the risk factors in detail, disclosure portfolio turnover and associated transaction costs, exhibit their financial performance, profile of the managers, distribution expense, percentage of fees charged by SEBI and total expense ratio.

So far mutual funds in India have confined themselves to urban areas, leaving vast savings potentials in rural hinterlands untapped. By penetrating in rural areas and introducing saving schemes tailored to the diverse preferences in rural communities and by educating them about the benefits of the schemes, mutual funds can raise burgeoning resources which can be gainfully employed for national development.

For wooing the retail investors, the MF industry has got to focus sharply on two fronts- Performance and products areas where most fund managers will agree, Indian MFs have yet to deliver.

While it is fine to advertise good performance of a particular scheme by a fund in order to attract more investment, the times are fast approaching when an honest view based approach would compel a mutual fund to advise investors on “sell” or “switch” between schemes, as emphatically as it would advise on the purchase.

So as to attract investors, it is, therefore, advisable to mutual funds to offer this sort of counseling which will certainly make a mutual fund different from other institutions.

In order to improve penetration of the mutual fund industry, it is necessary to expand the reach beyond established markets and top cities and for that purpose focus has to be on the distribution network and smaller branches need to be set up in rural areas to bring in new investors. It is also strongly used to develop an awareness programme to educate the masses about investment nuances.

The industry also needs to sharpen distribution and adopt new models. AMCs need to go beyond traditional channels such as independent financial advisors and large bank branches and tap into intermediaries with low-cost access to remote locations. Tying up with India post, public sector and RRBs, self-help groups, microfinance institutions and the like will also help expand the investor base.

Broadening the market will encourage the launch of more innovative products. Of late, the industry has many innovative products, such as the Reliance ATM Card. This card, issued by a partner bank, is linked to mutual fund schemes and allows investors to withdraw cash at ATMs or make payments at merchant establishments. The investor has the opportunity to earn market-linked returns every day and he also gets liquidity through the ATM Card.

In order to ensure that mutual funds are operating in the vital interests of retail investors.

The SEBI must take the following steps without further delay:

(i) SEBI should ensure that monthly portfolios of mutual funds are published in at least one national newspaper in English, in addition to, a regional newspaper in local language.

(ii) For effective implementation of the code of conduct for the mutual fund intermediaries, it is desirable to have more specific guidelines instead of laying them down in general terms.

(iii) So as to prevent late trading practices, the SEBI should ask mutual funds to vouch to their boards and endorse it in their prospectus that their house has never done late trading.

(iv) With a view to checking rapid trading practices of mutual funds, the SEBI should adopt the rules existing in other nations and apply its mind a bit.

(v) In its endeavour to discourage the existing practices of dominance of single investor in investor’s portfolio of funds schemes. The SEBI should make it mandatory to mutual funds to disclose on a regular basis as to how many investors hold more than 10 per cent, 20 per cent or 25 percent of the NAV.

Fund managers should also disclose what the possible impact of these investors would be how they would deal with such situations.

(vi) The SEBI should also make it mandatory to the intermediaries to disclose that they are tied agents of specified mutual funds and the rate of commission earned by them. This information should be placed in their offices so that it is clearly visible to the investors.

(vii) So as to curb unethical practices of the mutual funds. The SEBI, apart from improving its market intelligence, setting up a system that allows investors and even mutual funds participants blow the whistle on unethical practices, strict follow up action and stiff punishment, whenever such a practice comes to light, will go a long way in disciplinary industry participants.

(viii) The Government should give powers to the SEBI to punish the wrong doers. Stringent punishment needs to be given to those involved in misleading advertisements of the scheme. SEBI should also expose such defaulters in public through the print and electronic media.

In view of the surging economy and its various segments, growing awareness of investors and tremendous potential of mutual funds, the industry has a bright future, provided the Government, the RBI and SEBI take concrete steps.

Evolution and Growth of Mutual Funds Abroad

Evolution and growth of mutual funds abroad is summarized below:

The USA is a pace setter in the development of mutual funds in terms of growth of number of household investors, funds and types of schemes.

The origin of mutual funds dates back to 1822 when — societe General De Belgique was established in Belgium, employing the concept of risk sharing. The birth of the modern fund industry, however, can be traced back to 1968 when the foreign and colonial investments trust (F & CIT) was formed in London.

It introduced the concept of close-ended funds for the first time. It is still one of the most successful investment trusts in the U.K. Most of the early British investment companies or trusts resembled today’s close-ended funds by issuing a fixed number of shares to groups of investors whose pooled assets were invested in various companies.

The Scottish American Investment Trust, constituted in February, 1873 by Fund Pioneer, Robert Fleming was significant, in as much as it invested in the economic potential of the US, chiefly through American railroad bonds.

Many other trusts that followed this Trust not only targeted investment in America but also led to the introduction of the investment fund concept on the US shares in the late 1980s and early 1990s.

The formation of the Massachusetts Investor’s Trust in the USA in 1924 paved the way for modern day open- ended funds. These funds introduced important innovations to the investment company concept by establishing a simplified capital structure, continuous offering of shares, the ability to redeem them and a set of clear investment restrictions and policies.

By 1929, a handful of mutual funds were formed, managing funds to the tune of $ 140 million. The stock market crash of 1929 followed by the Great Depression gave a big jolt to the growth of mutual fund industry until a succession of landmark securities laws, beginning with the Securities Act of 1933 and concluding with the Investment Company Act of 1940, re-engendered investor’s confidence in funds, resulting into relatively steady growth in industry asset from $ 448 million in 1940 to $ 7.4 trillion by year-end 2003.

It is interesting to note that worldwide individual investors have over the years shown rising interest in the securities market. There has been marked change in their investment behaviour, as reflected by a shift in their preference from bank deposits to acquire financial instruments, to obtain higher returns and capital gains. This phenomenon gave a fillip to the growth of the mutual fund industry.

Although at the beginning of 1960 the concept of mutual fund was familiarized in most of the developed nations, it made tremendous growth only in the 1980s. During the 1980s mutual funds had recorded a big surge in many developed countries. For instance, mutual funds in Italy grew at 200 per cent, Japan 600 per cent, the UK 350 and Germany 330 per cent.

There has been tremendous growth of the mutual fund industry in the USA, with the number of various kinds of mutual funds having soared from 1,243 in 1984 to 8,034 in February 2005. Net assets of mutual funds in the USA stand at, $ 124.5 billion as of February, 2005.

One of the basic reasons for attraction of the US citizens to mutual funds is stringent regulatory framework administered by Securities and Exchange Commission (SEC) which safeguards investors’ interests through strict regulation of the mutual fund industry to conform to the desirable norms offering stability and liquidity of the investment, credibility of mutual fund companies, assuring fair play in disbursement of income to the investors in the form of return and growth.

A peep into the number of mutual funds in the world reveals that there were 55,528 mutual funds in operation at the end of 2004. USA with 14,067 mutual funds topped the list of the countries followed distantly by France (7,908), Luxemburg (6,855), Republic of Korea (6,636), Spain (2,599), Japan (2,552), Ireland (2,088), U.K. (1,710), Belgium (1,281), Italy (1,142) and Germany (1,041).

Globally, the total net assets of mutual funds as at the end of 2004 amounted to $ 16,152,429 million. The US with $ 16,152,429 million has been at the top of the world in terms of assets generated followed distantly by Luxemburg ($ 13,96,131 million), France ($ 1,370,954 millions), Italy ($ 5,11,733 millions), U.K. ($ 492,726 millions) and Japan ($ 3,99,462 millions).

Thus, the US mutual fund industry is the largest in the world, accounting for half of the $ 16.2 trillion total net assets.

3 Main Components of Fee Structure of Mutual Fund

Mutual funds bear expenses similar to other companies. The fee structure of a mutual fund can be divided into two or three main components: management fee, non-management expense, and 12b-l/non-12b-l fees. All expenses are expressed as a percentage of the average daily net assets of the fund.

Component # 1. Management Fees:

The management fee for the fund is usually synonymous with the contractual investment advisory fee charged for the management of a fund’s investments. However, as many fund companies include administrative fees in the advisory fee component, when attempting to compare the total management expenses of different funds, it is helpful to define management fee as equal to the contractual advisory fee plus the contractual administrator fee. This “levels the playing field” when comparing management fee components across multiple funds.

Contractual advisory fees may be structured as “flat-rate” fees, i.e., a single fee charged to the fund, regardless of the asset size of the fund. However, many funds have contractual i fees which include breakpoints so that as the value of a fund’s assets increases, the advisory fee paid decreases.

Another way in which the advisory fees remain competitive is by structuring the fee so that it is based on the value of all of the assets of a group or a complex of funds rather than those of a single fund.

Component # 2. Non-Management Expenses:

Apart from the management fee, there are certain non-management expenses which most funds must pay. Some of the more significant (in terms of amount) non-management expenses are- transfer agent expenses custodian expense (the fund’s assets are kept in custody by a bank which charges a custody fee), legal/audit expense, fund accounting expense, registration expense (the SEC charges a registration fee when j funds file registration statements with it), board of directors/ trustees expense (the members of the board who oversee the fund are usually paid a fee for their time spent at meetings), and printing and postage expense (incurred when printing and delivering shareholder reports).

Component # 3. 12b-1/Non-12b-1 Service Fees:

In the United States, 12b-1 service fees/shareholder servicing fees are contractual fees which a fund may charge to cover the marketing expenses of the fund. Non-12b-1 service fees are marketing/shareholder servicing fees which do not fall under SEC rule 12b-1. While funds do not have to charge the full contractual 12b-1 fee, they often do. When investing in a front-end load or no-load fund, the 12b-1 fees for the fund are usually.250% (or 25 basis points).

The 12b-1 fees for back-end and level-load share classes are usually between 50 and 75 basis points but may be as much as 100 basis points. While funds are often marketed as “no- load” funds, this does not mean they do not charge a distribution expense through a different mechanism. It is expected that a fund listed on an online brokerage site will be paying for the “shelf-space” in a different manner even if not directly through a 12b-1 fee.

Component # 4. Brokerage Commissions:

An additional expense which does not pass through the fund’s income statement (statement of operations) and cannot be controlled by the investor is brokerage commissions. Brokerage commissions are incorporated into the price of securities bought and sold and, thus, are a component of the gain or loss on investments. They are a true, real cost of investing though.

The amount of commissions incurred by the fund and are reported usually 4 months after the fund’s fiscal year ends in the “statement of additional information” which is legally part of the prospectus, but is usually available only upon request or by going to the SEC.’s or fund’s website.

Brokerage commissions, usually charged when securities are purchased and again when sold) are directly related to portfolio turnover which is a measure of trading volume/velocity (portfolio turnover refers to the number of times the fund’s assets are bought and sold over the course of a year). Usually, higher rate of portfolio turnover (trading) generates higher brokerage commissions.

The advisors of mutual fund companies are required to achieve “best execution” through brokerage arrangements so that the commissions charged to the fund will not be excessive as well as also attaining the best possible price upon buying or selling.

Component # 5. Investor Fees and Expenses:

Fees and expenses borne by the investor vary based on the arrangement made with the investor’s broker. Sales loads (or Contingent Deferred Sales Loads (CDSL) are included in the fund’s Total Expense Ratio (TER) because they pass through the statement of operations for the fund.

Additionally, funds may charge early redemption fees to discourage investors from swapping money into and out of the fund quickly, which may force the fund to make bad trades to obtain the necessary liquidity. For example- Fidelity Diversified International Fund (FDIVX) charges a 10 Per cent fee on money removed from the fund in less than 30 days.

Mutual Funds vs. Other Investments

Mutual funds offer several advantages over investing in individual stocks. For example- the transaction costs are divided among all the mutual fund shareholders, which allows for cost-effective diversification. Investors may also benefit by having a third party (professional fund managers) apply expertise and dedicate time to manage and research investment options, although there is dispute over whether professional fund managers can, on average, outperform simple index funds that mimic public indexes.

Yet, the Wall Street Journal reported that separately managed accounts (SMA or SMAs) performed better than mutual funds in 22 of 25 categories from 2006 to 2008. This included beating mutual funds’ performance in 2008, a tough year in which the global stock market lost US$21 trillion in value.

In the story, Morningstar, Inc. said SMAs outperformed mutual funds in 25 of 36 stock and bond market categories. Whether actively managed or passively indexed, mutual funds are not immune to risks. They share the same risks associated with the investments made. If the fund invests primarily in stocks, it is usually subject to the same ups and downs and risks as the stock market.

Share Classes:

Many mutual funds offer more than one class of shares. For example- you may have seen a fund that offers “Class A” and “Class B” shares. Each class will invest in the same pool (or investment portfolio) of securities and will have the same investment objectives and policies. But each class will have different shareholder services and/or distribution arrangements with different fees and expenses.

These differences are supposed to reflect different costs involved in servicing investors in various classes; For example- one class may be sold through brokers with a front-end load, and another class may be sold direct to the public with no load but a “12b-l fee” included in the class’s expenses (sometimes referred to as “Class C” shares). Still a third class might have a minimum investment of $10,000,000 and be available only to financial institutions (a so-called “institutional” share class).

In some cases, by aggregating regular investments made by many individuals, a retirement plan (such as a 401(k) plan) may qualify to purchase “institutional” shares (and gain the benefit of their typically lower expense ratios) even though no members of the plan would qualify individually. As a result, each class will likely have different performance results.

A multi-class structure offers investors the ability to select a fee and expense structure that is most appropriate for their investment goals (including the length of time that they expect to remain invested in the fund).

Load and Expenses:

A front-end load or sales charge is a commission paid to a broker by a mutual fund when shares are purchased, taken as a percentage of funds invested.

The value of the investment is reduced by the amount of the load. Some funds have a deferred sales charge or back- end load. In this type of fund an investor pays no sales charge when purchasing shares, but will pay a commission out of the proceeds when shares are redeemed depending on how long they are held.

Another derivative structure is a level-load fund, in which no sales charge is paid when buying the fund, but a back-end load may be charged if the shares purchased are sold within a year.

Load funds are sold through financial intermediaries such as brokers, financial planners, and other types of registered representatives who charge a commission for their services. Shares of front-end load funds are frequently eligible for breakpoints (i.e., a reduction in the commission paid) based on a number of variables.

These include other accounts in the same fund family held by the investor or various family members, or committing to buy more of the fund within a set period of time in return for a lower commission “today”.

It is possible to buy many mutual funds without paying a sales charge. These are called no-load funds. In addition to being available from the fund company itself, no-load funds may be sold by some discount brokers for a flat transaction fee or even no fee at all.

(This does not necessarily mean that the broker is not compensated for the transaction; in such cases, the fund may pay brokers’ commissions out of “distribution and marketing” expenses rather than a specific sales charge. The purchaser is therefore paying the fee indirectly through the fund’s expenses deducted from profits.)

No-load funds include both index funds and actively managed funds. The largest mutual fund families selling no- load index funds are Vanguard and Fidelity, though there are a number of smaller mutual fund families with no-load funds as well. Expense ratios in some no-load index funds are less than 0.2% per year versus the typical actively managed fund’s expense ratio of about 1.5% per year. Load funds usually have even higher expense ratios when the load is considered.

The expense ratio is the anticipated annual cost to the investor of holding shares of the fund. For example- on a $100,000 investment, an expense ratio of 0.2% means $200 of annual expense, while a 1.5% expense ratio would result in $1,500 of annual expense. These expenses are before any sales commissions paid to purchase the mutual fund.

Many fee-only financial advisors strongly suggest no-load funds such as index funds. If the advisor is not of the fee-only type but is instead compensated by commissions, the advisor may have a conflict of interest in selling high-commission load funds.

Advantages of Mutual Funds for the Capital Market

There are different financial products in the capital market catering to the different needs of investors. Yet, as the market became complex due to sophisticated instruments, variety of instruments etc. and investors find it difficult to participate directly in the market. Mutual funds emerged in this situation for the help of the investors.

The following specific advantages of mutual funds for the capital market could be identified:

Advantage # 1. Entry of Small Investors into the Capital Market:

Capital market instruments are large lot size. Hence, small investors are unable to buy shares or other scripts. However, when he buys the units of a mutual fund he enters into the capital market. The capital market thus gets additional fund.

Advantage # 2. Investable Funds:

All the 35 funds and their various schemes have affected a total of Rs. 1,13,005 crores in India. These funds are available to various companies for capital investment.

Advantage # 3. Contribution to the Equity Market:

The equity market is very often volatile. Therefore, investors are reluctant to invest. However, as mutual funds offer diversified portfolios backed by professional management set-up, investors are encouraged to invest in the stock market. Thus, mutual funds contribute to the buying and selling process in the equity market.

Advantages of Mutual Funds

The important advantages of mutual funds are given below:

1. Professional Management

The mutual funds are managed by skilled and experienced fund managers.

2. Risk free administration

There is no risk of administration of funds as many mutual funds offer services in a demat form which save investors time and delay.

3. Diversification in Mutual Fund Schemes

Mutual funds offer diversified schemes which reduces the risks of the investors.

4. Higher returns on investment

For a long term investment, the investors always get higher returns on mutual funds as compared to other avenues of investment.

5. Provision of Liquidity

In open-ended funds, the liquidity is provided by direct sales/ repurchase of units.

In case of close-ended funds, the liquidity is provided by listing the units on stock exchanges.

6. Transparency in dealings

As per SEBI Regulations all the mutual funds in India should disclose their portfolio on half yearly basis. The NAVs are calculated on daily basis in case of open-ended schemes and they are published through AMFI in newspapers.

7. Low cost on management

There is a restriction on the cost of management of mutual funds in India. No mutual fund can increase cost beyond the prescribed limit of 2.5% maximum and any additional cost of management is to be borne by the AMC.

8. Registration with Regulatory Authority

In India, all the mutual funds are registered with SEBI and regulated by Mutual Fund Regulations. This provides sufficient protection to the investors.

9. Offers flexible investment schemes

An investor under mutual fund investment can opt for systematic investment plan (SIP), Systematic withdrawal plan (SWP) etc. to plan his returns based on his convenience.

10. Benefit of bulk investment

The structure of a mutual fund itself provides a natural advantage of large scale operation. Mutual fund investment is cheaper as compared to direct investment in the capital market by the investors. The direct capital market investment involves higher costs.

11. Investors Education

The mutual fund convinces the investors about various schemes of investments through brochures and catalogues. The investors get educated in the fundamentals of investments through this process.

12. Other Benefits

Development of the money market, liquid stock market, investment research, savings mobilisation etc. are other benefits of a mutual fund.

Benefits of Mutual Funds

Mutual funds are managed by professionals organised firm called AMC (Asset Management Company) through professional fund managers who actively manage investment portfolio of various mutual fund schemes which deliver following benefits to investors-

Benefit # (1) Portfolio Diversification:

Mutual Funds invest in a diversified portfolio of financial instruments which enables a small investor to hold a diversified investment portfolio even if the amount of investment is small.

Benefit # (2) Low Risk:

Even with a small amount of investment, Investors can acquire a diversified portfolio of financial instruments. The risk in a diversified portfolio of mutual fund schemes is lesser than investing directly in only 2 or 3 shares or bonds.

Benefit # (3) Low Transaction Costs:

Due to the economies of scale mutual funds incur lesser transaction costs. These benefits are shared with the investors.

Benefit # (4) Liquidity:

Units of a mutual fund can be redeemed easily with the funds being credited directly to the investors account though ECS payment.

Benefit # (5) Choice:

Mutual funds offer investors a variety of schemes with diverse investment objectives. Investors, therefore, have plenty of investing in a scheme matching their financial goals. These schemes further provide various plans/options e.g. dividend option or growth option or reinvestment option etc.

Benefit # (6) Transparency:

Funds provide investors with the latest information related to the markets and the schemes. All material facts are revealed to investors as per the guidelines of SEBI and AMFI. They provide on a daily basis the latest NAV to investors.

Benefit # (7) Flexibility:

Investors are also provided flexibility by Mutual Funds. Investors can transfer their units from a debt scheme to an equity scheme or a balanced scheme through systematic transfer plan option (STP). Option of systematic investment through monthly/quarterly installments (SIP) and systematic withdrawal at regular intervals (SWP) is also offered to the investors in open-ended schemes.

Benefit # (8) Safety:

The Mutual Fund industry is fully regulated under SEBI rules where the interests of the investors are safeguarded. All funds have to be registered with SEBI and complete compliance with the rules and transparency is ensured.

Benefit # (9) Professional Management:

Mutual funds’ portfolios are managed by expert professional managers possessing skills and qualifications to analyse the performance and prospects of companies. They actively manage portfolios through close monitoring on a daily basis, which is not possible for a retail investor.

Top 6 Disadvantages of Mutual Fund

The disadvantages of mutual fund are listed below:

(1) No guarantee of return on investment

There is no guarantee that all the mutual funds are successfully performing. There may be some mutual funds who may underperform the benchmark Index. This leads to less or no return to the unit holders.

(2) Disadvantage of diversification of funds

The diversification of funds among various schemes reduces risk but does not ensure maximum return on investment.

(3) Difficulty of selection of a mutual fund

Generally, investors can select a mutual fund based on its past performance and track record. But the past cannot predict the future profitability and prosperity.

(4) Effects of cost on returns

White investing in a mutual fund the investor has to pay entry fees and when leaving he has to pay exit load. These costs generally reduce the income from mutual funds.

(5) Personal Tax Considerations

While making decisions about investment of investors’ money, the fund managers do not consider the personal tax situations of the individual investor.

(6) Transfer difficulties

The complications arise when a managed portfolio of investment is switched to another financial firm, the liquidating a mutual fund investment portfolio may increase the risk. This results in an increase of commission fees and creates capital gain taxes.

4 Major Drawbacks of Mutual Funds

The drawbacks of mutual funds are as follows:

Drawback # 1. No Control over Costs:

An investor in a mutual fund has no control over the overall cost of investing. He pays investment management fees as long as he owns units in the fund. Commission is usually a certain percentage of investment, payable irrespective of the rise or decline of the fund value.

Drawback # 2. No Tailor made Portfolios:

Skilled or professional investors build their own portfolios of shares, bonds and other securities with a clear objective. Investing through mutual funds means transfer of this function to the fund managers. High net worth individuals or large corporate investors may find this be a constraint in achieving their objectives.

Drawback # 3. Difficulty in Selection of Fund:

A large variety of mutual fund schemes often makes the choice difficult for a common investor. One may need professional advice in selecting the most appropriate scheme.

Drawback # 4. Fund Manager’s Shifting Loyalties:

Performance of funds could be severely affected by shift of fund managers or their loyalties.