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| What Is a Mutual Fund ? |
A vehicle for investing in stocks and bonds
A mutual fund is not an alternative investment option to stocks and bonds, rather it pools the money of several investors and invests this in stocks, bonds, money market instruments and other types of securities. The owner of a mutual fund unit gets a proportional share of the fund’s gains, losses, income and expenses.
Each mutual fund has a specific stated objective
The fund’s objective is laid out in the fund's prospectus, which is the legal document that contains information about the fund, its history, its officers and its performance.
Some popular objectives of a mutual fund are -
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| Fund Objective |
What the fund will invest in |
| Equity (Growth) |
Only in stocks |
| Debt (Income) |
Only in fixed-income securities |
| Money Market (including Gilt) |
In short-term money market instruments (including government securities) |
| Balanced |
Partly in stocks and partly in fixed-income securities, in order to maintain a 'balance' in returns and risk |
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Managed by an Asset Management Company (AMC)
The company that puts together a mutual fund is called an AMC. An AMC may have several mutual fund schemes with similar or varied investment objectives. The AMC hires a professional money manager, who buys and sells securities in line with the fund's stated objective.
All AMCs Regulated by SEBI, Funds governed by Board of Directors
The Securities and Exchange Board of India (SEBI) mutual fund regulations require that the fund’s objectives are clearly spelt out in the prospectus.In addition, every mutual fund has a board of directors that is supposed to represent the shareholders' interests, rather than the AMC’s.
Why Choose Mutual Funds?
Mutual funds are investment vehicles, and you can use them to invest in asset classes such as equities or fixed income. Dani Shares & Stocks Pvt. Ltd. (DSSL) recommends that you use the mutual fund investment route rather than invest yourself, unless you have the required temperament, aptitude and technical knowledge.
We are not all investment professionals
We go to a doctor when we need medical advice or a lawyer for legal guidance. Similarly, mutual funds are investment vehicles managed by professional fund managers. And unless you rate highly on the Investment IQ Quiz, we recommend you use this option for investing. Mutual funds are like professional money managers, however a key factor in their favour is that they are more regulated and hence offer investors the ability to analyse and evaluate their track record.
Investing is becoming more complex
There was a time when things were quite simple - the market went up with the arrival of the first monsoon showers and every year around Diwali. Since India started integrating with the world (with the start of the liberalisation process), complex factors such as an increase in short-term US interest rates, the collapse of the Brazilian currency or default on its
debt by the Russian government, have started having an impact on the Indian stock market.
Although it is possible for an individual investor to understand Indian companies (and investing) in such an environment, the process can become fairly time consuming. Mutual funds (whose fund managers are paid to understand these issues and whose asset management company invests in research) provide an option of investing without getting lost in the complexities.
Mutual funds provide risk diversification
Diversification of a portfolio is amongst the primary tenets of portfolio structuring. And a necessary one to reduce the level of risk assumed by the portfolio holder. Most of us are not necessarily well qualified to apply the theories of portfolio structuring to our holdings and hence would be better off leaving that to a professional. Mutual funds represent one such option.
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Types of mutual fund schemes |
There are a wide variety of Mutual Fund schemes that cater to your needs, whatever your age, financial position, risk tolerance and return expectations. Whether as the foundation of your investment programme or as a supplement, Mutual
Fund schemes can help you can help you meet your financial goals.
(A) By Structure
Open-Ended Schemes
These do not have a fixed maturity. You deal directly with the Mutual Fund for your investments and redemptions. The key feature is liquidity. You can conveniently buy and sell your units at net asset value ("NAV") related prices.
Close-Ended Schemes
Schemes that have a stipulated maturity period (ranging from 2 to 15 years) are called close-ended schemes. You can invest directly in the scheme at the time of the initial issue and thereafter you can buy or sell the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchange could vary from the scheme's NAV on account of demand and supply situation, unitholders' expectations and other market factors. One of the characteristics of the close-ended schemes is that they are generally traded at a discount to NAV; but closer to maturity, the discount narrows. Some close-ended schemes give you an additional option of selling your units directly to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations ensure that at least one of the two exit routes are
Provided to the investor.
Interval Schemes
These combine the features of open-ended and close- ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.
(B) By Investment Objective
Growth Schemes
Aim to provide capital appreciation over the medium to long term. These schemes normally invest a majority of their funds in equities and are willing to bear short- term decline in value for possible future appreciation.
These schemes are not for investors seeking regular income or needing their money back in the short-term.
Investors seeking growth over the long-term
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Income Schemes
Aim to provide regular and steady income to investors. These
schemes generally invest in fixed income securities such as
bonds and corporate debentures. Capital appreciation in such
schemes may be limited.
- Retired people and others with a need for capital stability
and regular income.
- Investors who need some income to supplement their earnings.
Balanced Schemes
Aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. They invest in both shares and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls.
Investors looking for a combination of income and moderate growth.
Money Market Schemes
Aim to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer, short-term instruments, such as treasury bills, certificates of deposit, commercial paper and inter- bank call money. Returns on these schemes may fluctuate, depending upon the interest rates prevailing in the market.
Corporates and individual investors as a means to park their surplus funds for short periods or awaiting a more favourable investment alternative.
Other Schemes
Tax Saving Schemes
These schemes offer tax rebates to the investors under tax laws as prescribed from time to time. This is made possible because the Government offers tax incentives for investment in specified avenues. For example, Equity Linked Savings Schemes (ELSS) and Pension Schemes. Recent amendments to the Income Tax Act provide further opportunities to investors to save capital gains by investing in Mutual Funds. The details of such tax savings are provided in the relevant offer documents.
Investors seeking tax rebates.
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Special Schemes
This category includes index schemes that attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50, or industry specific schemes (which invest in specific industries) or sectoral schemes (which invest exclusively in segments such as 'A' Group shares or initial public offerings). Index fund schemes are ideal for investors who are satisfied with a return approximately equal to that of an index. Sectoral fund schemes are ideal for investors who have already decided to invest in a particular sector or segment. Keep in mind that any one scheme may not meet all your requirements for all time. You need to place your money judiciously in different schemes to be able to get the combination of growth, income and stability that is right for you. Remember, as always, higher the return you seek higher the risk you should be prepared to take.
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| Benefits of Investing Through Mutual Funds |
- Professional Money Management.
Fund managers are responsible for implementing a consistent investment strategy that reflects
the goals of the fund. Fund managers monitor market and economic trends
and analyse securities in order to make informed investment decisions.
- Diversification. Diversification is one of the best ways to reduce risk.
Mutual funds offer investors an opportunity to diversify across assets depending on their investment needs.
- Liquidity.Investors can sell their mutual fund units on any business day and receive the
current market value on their investments within a short time period.
- Affordability.The minimum initial investment for a mutual fund is fairly low for most
funds (as low as Rs500 for some schemes).
- Convenience. Most private sector funds provide you the
convenience of periodic purchase plans,
automatic withdrawal plans and the automatic reinvestment of interest and dividends.
- Flexibility and variety . You can pick from conservative, blue-chip stock funds,
sectoral funds, funds that aim to provide income with modest growth or those that take big risks in the search for returns.
You can even buy balanced funds, or those that combine stocks and bonds in the same fund.
- Tax benefits on Investment in Mutual Funds.
Mutual funds have historically been more efficient from the tax point of view. A debt fund pays a dividend
distribution tax of 12.5 per cent before distributing dividend to an individual investor or an HUF, whereas it
is 20 per cent for all other entities. There is no dividend tax on dividends from an equity fund for individual investor.
Capital Gains Tax to be lower of -
10% on the capital gains without factoring indexation benefit and
20% on the capital gains after factoring indexation benefit.
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| The Basics of Mutual Funds |
- Net Asset Value or NAV .
NAV is the total asset value (net of expenses) per unit of the fund and is
calculated by the AMC at the end of every business day
- NAV calculation.The value of all the securities in the portfolio in calculated daily.
From this, all expenses are deducted and the resultant
value divided by the number of units in the fund is the fund’s NAV.
- Expense Ratio.AMCs charge an annual fee, or expense ratio that covers
administrative expenses, salaries, advertising expenses, brokerage fee, etc. A 1.5% expense ratio means
the AMC charges Rs1.50 for every Rs100 in assets under management.A fund's expense ratio is typically
to the size of the funds under management and not to the returns earned. Normally, the costs of running a fund grow slower
than the growth in the fund size - so, the more assets in the fund, the lower should be its expense ratio.
- Load.Some AMCs have sales charges, or loads, on their funds (entry load and/or exit
load) to compensate for distribution costs.
Funds that can be purchased without a sales charge are called no-load funds
- Open-Ended Funds.At any time during the scheme period, investors can enter and exit
the fund scheme (by buying/ selling fund units) at its NAV (net of any load charge).
Increasingly, AMCs are issuing mostly open-ended funds.
- Close-Ended Funds.Redemption can take place only after the period of the scheme is over.
However, close-ended funds are listed on the stock exchanges and investors
can buy/ sell units in the secondary market (there is no load).
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| Mutual Fund Investing Checklist |
- Draw up your asset allocation.
Allocate available assets across different asset classes based on your level of risk capacity and risk tolerance.
- Identify funds that fall into your Buy List
Find mutual funds that meet your preferences. Check the objective of the fund whether the same is in line with your investment goal.
- Obtain and read the offer documents
Offer documents informs about the fund’s objective which is the legal document that contains information about the fund, its history, its officers and its performance. You could do this by either asking your broker or the asset management companies.
- Match your objectives
Read through the offer documents and check to see whether the mutual funds identified meet your investment needs in terms of equity share and bond weightings, downside risk protection, tax benefits offered, dividend payout policy, sector focus and other parameters of relevance to you.
- Check out performance comparison
Refer to the past t performance of the fund and take appropriate decision in selecting the fund though the repetition of the past Performance is not guarantee in future. comparisons must be used only to compare the same type of fund. They are meaningless otherwise.
- Think hard about investing in sector funds
Investing in specific sector funds is recommended for aggressive investors. However, if you are not
in close touch with the developments in the sector or do not review your portfolio regularly, we would not recommend investing in sector funds.
- Look for 'load' costs
Management fees, annual expenses of the fund and sales loads can take away a significant portion of your returns.
As a general rule, 1% towards management fees and 0.6% towards annual expenses should be acceptable.
Try and avoid funds that have a sales load, unless of course they have a consistent track record of being a top-performer.
- Does the fund change fund managers often?
Since you will be giving past track record a consideration, you are inadvertently relying on the continuity of the fund manager. Stay away from mutual funds whose fund managers change often.
- Look for size and credentials
As far as possible avoid investing in funds with an asset base of less than Rs25 crores. Which means that we are recommending you invest in funds only after they have established a track record. And unless it is a really exciting new (theme) fund that fits into your asset allocation plan, try and avoid new funds.
- Customer Service
Check out the customer service delivery mechanism of the mutual fund you choose. Can you get in touch with them easily? How long do they take to disburse payments? How often do they send you portfolio updates? And investor newsletters? These questions are important to address because shortcomings on any of these factors could affect your overall returns.
- Diversify, but not too much
Do not hold just one fund in each asset category. Its good to diversify your risk between different funds, but do not overdo it.
- Style, not returns matter first in the long-term
Don't let a top performing fund veer you away from a disciplined approach. Stick to your chosen asset allocation plan.
- Monitor regularly and review
Try to review your mutual fund holdings atleast once a quarter. If you follow the same principles to review as you did to identify the mutual funds you invested in, you will be able to take `sell decisions' very easily.
- Invest regularly, choose the M-I-P
Try to make mutual fund investing an integral part of your savings and wealth-building plan. The monthly investment plan option offered by some mutual funds is a strongly recommended approach for you to execute this process.
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