What Is A Mutual Fund?
Mutual fund is a collective investment scheme that pools money from a number of investors who share a common financial goal. The money pooled is then invested in various financial securities such as shares, debentures, money market securities and other securities according to the investment objective of the scheme. The income earned through these investments is shared among the investors in proportion to their investment in the mutual fund scheme which is denoted by the units held by them.
Types Of Mutual Funds:-
There are various types of mutual fund schemes:-
(A) Based On The Maturity Period:-
Open-ended funds are open for the investors to enter and exit at anytime even after the New fund offer (NFO). The investors can buy the units of the open-ended fund from the fund itself at the current Net asset value (NAV) of the fund and the existing investors can return the units of the open-ended fund to the fund itself and get their money back at the current re-purchase price of the fund. Open-ended funds do not have a fixed maturity period. Some existing investors exit the fund while some new investors enter the fund because of which the unit capital of an open-ended fund keeps changing on a continuous basis.
Close-ended funds have a fixed maturity period. Close-end funds allow the investors to enter the fund only during its New fund offer (NFO) and the existing investors to exit the fund only after the end of the specified maturity period. The investors can buy the units of the close-ended fund from the fund itself only during its New fund offer (NFO). Thereafter the investors who want to buy units of close-ended fund can buy them from a seller on the stock exchange where the units are listed. Similarly existing investors can return the units of the close-ended fund to the fund itself and get their money back only after the end of the specified maturity period. The existing investors who want their money back before the end of maturity period can sell their units to a buyer on the stock exchange where the units are listed. The unit capital of an close-ended fund does not change as the sale and purchase of its units takes place between the buyers and sellers on the stock exchange after the New fund offer (NFO) and not to or from the fund itself.
Interval funds combine the features of both open-end and close-end mutual funds. They are largely close-ended but become open-ended at pre-specified intervals. During the interval period the investors can purchase units from the fund itself at the current Net asset value (NAV) and the existing investors can return their units to the fund itself and get their money back at the current re-purchase price. After the end of the interval period the fund again becomes a close-ended fund.
(B) Based On The Investment Objective:-
Equity funds are also called as growth funds. In the equity fund schemes, major portion of the investors money is invested in the equity shares of different companies. The net asset value (NAV) of equity funds fluctuate with the fluctuations in share prices of the companies in which the fund has invested. The aim of equity funds is to provide capital appreciation over medium to long-term to the investors. Equity fund schemes are more risky than the other schemes.
Debt funds are also called as income funds. In the debt fund schemes, major portion of the investors money is invested in debt securities such as debentures, bonds, government securities, etc. The aim of debt funds is to provide regular and steady income to the investors while preserving the capital. Debt fund schemes are less risky compared to the equity fund schemes.
Hybrid funds are also called as balanced funds. In the hybrid fund schemes, investors money is invested in equity shares as well as in the debt securities according to a specified proportion. The aim of hybrid funds is to provide both capital appreciation and regular income to the investors. Hybrid fund schemes are less risky than the equity schemes but more risky than the debt schemes.
Liquid funds are also called as money market funds. In the liquid fund schemes, investors money is invested in short-term money market instruments such as treasury bills, commercial papers, certificates of deposit, etc. The aim of liquid funds is to provide easy liquidity and preservation of capital while earning moderate income. Liquid fund schemes are less risky than the other schemes.
(c) Other Funds:-
In sector fund schemes, investors money is invested in the equity shares of companies that belong to a specific sector or industry such as pharmaceuticals, IT, automobiles, etc. The returns on these funds are dependent on the performance of the respective sectors or industries.
Tax saving funds:-
Tax saving fund schemes offer tax benefit to the investors like the Equity linked savings scheme (ELSS). In ELSS, investors money is invested in equity and equity related securities. Investment in ELSS qualifies for tax deduction under section 80c of the Indian Income Tax Act. The scheme has a lock-in period of 3 years.
Index funds replicate the performance of a particular stock market index such as Nifty or Sensex. In index fund schemes, investors money is invested in only those stocks of companies who represent the index and in the same proportion of those stocks weightage in the index. The aim of index funds is to achieve approximately the same return as the index. Net asset value (NAV) of index funds rise and fall according to the rise and fall in the index but not exactly by the same percentage due to the tracking error.
Exchange traded funds (ETF):-
Exchange traded funds (ETF) are index funds that are listed and traded on the stock exchanges like stocks. ETF track a particular stock market index and its units are bought and sold on the stock exchange through market makers who offer a price quote for buying and selling units at all times. Only big investors can buy and sell units of ETF from the fund itself. Retail investors have to buy and sell units of ETF on the stock exchange through market makers. ETF prices change throughout the day as they are bought and sold. Apart from Equity ETF, there are also other types of ETF such as Gold ETF that track the price of gold.
Fund of funds:-
In Fund of funds scheme, investors money is invested in the units of other mutual fund schemes. Just as other mutual funds where investors money is invested in different securities, in Fund of funds scheme the investors money is invested in the units of different mutual fund schemes. The aim of Fund of funds is to achieve even greater diversification than the other mutual fund schemes. The expenses of Fund of funds schemes are higher than the other mutual fund schemes because they also include the expenses of those mutual fund schemes in which the Fund of funds invest.
Advantages Of Mutual Funds:-
Following are the advantages of investing in mutual funds:-
– There is professional management of the investors money by the fund managers who are highly skilled and experienced and are backed by a dedicated investment research team.
– Mutual funds invest the investors money in various securities of different companies and in different sectors. This portfolio diversification reduces the risk significantly.
– Mutual funds are relatively less expensive way to invest compared to direct investing as the they benefit from the economies of scale and pay lower transaction costs which results into lower costs for the investors.
– Mutual funds are liquid investments. The investors can exit the mutual fund scheme and get their money back anytime they want at the Net asset value (NAV) price in case of open-ended funds and they can sell their units in the stock exchange at the prevailing market price in case of close-ended funds.
– Investing in mutual fund save investors time as they do not have to do any research and analysis regarding their investment as the fund manager of the scheme along with his research analysts does this for the investors.
– In India dividend earned on mutual funds is tax free in the hands of the investors.
– All the mutual funds in India are regulated and regularly monitored by the Securities and Exchange Board of India (SEBI) who makes strict regulations to protect the interests of the investors.
Disadvantages Of Mutual Funds:-
Following are the disadvantages of investing in mutual funds:-
– Investors do not have any control on their invested money as all the investment decisions are taken by the fund manager.
– There are costs and expenses associated with mutual fund investment such as entry or exit loads, management fees, etc.
– There are many mutual fund schemes available for investors to choose from. Choosing the right mutual fund scheme according to the requirement is not easy.
New Fund Offer (NFO):-
Launch of a new mutual fund scheme is called New Fund Offer (NFO). It is an invitation to the investors to invest their money in the mutual fund scheme by subscribing to its units. Units of a mutual fund scheme are offered to the investors for the first time through NFO. The NFO of a mutual fund scheme is open for a fixed period during which the investors can buy the units of the scheme. In case of open-ended schemes, the investors can buy units even after the end of NFO period from the fund itself at the prevailing Net Asset Value (NAV) when the open-ended scheme opens again for subscription after the initial allotment of units in the NFO. In case of close-ended schemes, the investors can buy the units only during the period of NFO from the fund itself. After the end of NFO period they can only buy the units on the stock exchange where the scheme is listed.
Mutual Fund Loads:-
Some mutual fund companies charge their investors to cover their marketing and distribution expenses. Such charge imposed on the investors by the mutual fund companies is called as load. There are two types of load which can be charged by the mutual funds.
(1) Entry load:- Entry load is also called as Front-end load. It is the load which is charged to the investors at the time of their entry into the mutual fund scheme i.e when they purchase the units from the fund. The entry load percentage is added to the prevailing Net Asset Value (NAV) at the time of allotment of units.
(2) Exit load:- Exit load is also called as Back-end load. It is the load which is charged to the investors at the time of their exit from the mutual fund scheme i.e when they return the units to the fund. The exit load percentage is deducted from the prevailing Net Asset Value (NAV) at the time of redemption of units.
Net Asset Value (NAV):-
The performance of a particular scheme of mutual fund is denoted by its Net Asset Value (NAV). Net Asset Value is the market value of the assets of the scheme minus its liabilities.
Market value of assets= market value of securities held by the scheme + dividend accrued + interest accrued + cash.
This is the total Net Asset Value of the scheme.
To calculate the Net Asset Value per unit, total net asset value is divided by the number of outstanding units of the scheme.
Example of Net Asset Value calculation:-
The market value of the securities held by a mutual fund scheme is rs 5000000. Dividend accrued is rs 400000 and interest accrued is rs 300000. The scheme has cash of rs 100000. The liabilities of the scheme are rs 1000000. The scheme has 200000 units outstanding.
The total Net Asset Value of the scheme would be:-
rs 5000000 + rs 400000 + rs 300000 + rs 100000 – rs 1000000
rs 5800000 – rs 1000000
= rs 4800000
The Net Asset Value per unit would be:-
= rs 24
Constituents Of Mutual Funds:-
Following are the important constituents of mutual funds in India:-
sponsor is a person who, acting alone or in combination with another body corporate, establishes a mutual fund. The Sponsor gets the mutual fund registered with Securities and Exchange Board of India (SEBI).
Mutual funds in India are established in the form of a trust and are managed by either a board of trustees or a trust company. Trustees protect the interest of the unit holders i.e the investors and are the primary guardians of their funds and assets.
Asset management company:-
Asset management company is appointed by the trustees. It is the investment management firm that invests the funds of the investors in the securities according to the stated investment objective of the mutual fund scheme. Asset management company manages various schemes of a mutual fund and invests the funds raised under various schemes according to the provisions of the trust deed.
Custodian and depositories:-
Mutual funds buy and sell securities in large volumes. So keeping a track of such transactions is a specialized activity. For this purpose custodians are appointed for safekeeping of physical securities while dematerialized securities are held in depository through a depository participant.
Registrars and transfer agents:-
Registrar and transfer agents are responsible for issuing and redeeming units of the mutual fund schemes and providing other related services such as preparation of transfer documents and updating investor records.
Association Of Mutual Funds In India (AMFI):-
Association of Mutual Funds in India (AMFI) is the association of Securities and Exchange Board of India (SEBI) registered mutual funds in India. It was incorporated on 22nd August, 1995 as a non-profit organization to develop the Indian mutual fund industry and to protect and promote the interests of mutual funds and their investors. AMFI also conducts the training and certification of all intermediaries such as distributors and others who are engaged in the mutual fund industry and regulates the conduct of distributors and takes disciplinary action against them for violations of code of conduct. AMFI also undertakes nationwide investor awareness programmes to promote proper understanding of the concept and working of mutual funds. For more information about AMFI you can visit the site www.amfiindia.com