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Mutual Funds: the complete reckoner30 August, 2007: InceptionThe concept of mutual funds was introduced in India with the formation of Unit Trust of India in 1963. The first scheme launched by UTI was the now infamous Unit Scheme 64 in 1964. UTI continued to be the sole mutual fund until 1987, when some public sector banks and Life Insurance Corporation of India and General Insurance Corporation of India set up mutual funds. It was only in 1993 that private players were allowed to open shops in the country. Today, 32 mutual funds collectively manage Rs 6713575.19 cr under hundreds of schemes. DefinitionA mutual fund is a trust that pools the savings of a number of investors with common financial goals. The collected money is invested in various instruments like debentures, shares, etc. The income generated from these instruments and the capital appreciation is shared by the investors in proportion to the number of units owned by them. Short historyThe government of India set up Unit
Trust of India in 1963 by an act on
parliament. UTI functioned under the
regulatory and administrative control
of the Reserve Bank of India till
1978. The Industrial Development Bank
of India took over the regulatory and
administrative control that year. The
first scheme launched by UTI was Unit
Scheme 1964 or the infamous Unit 64.
The second phase of the mutual fund
industry began with the public sector
banks and Life Insurance Corporation
of India and General Insurance
Corporation of India setting up their
own mutual funds in 1987. Finally, in
1993 Kothari Pioneer (now merged with
Franklin Templeton) became the first
private sector mutual fund to start
operations in the country. A host of
private sector as well as foreign
funds set up shop after that. In 1996,
a comprehensive and revised Mutual
Fund regulation was put in place. The
industry now functions under Sebi
(Mutual Fund) regulations, 1996. Conception and performance in IndiaThe industry has steadily grown over the decade. For example, before the public sector mutual fund’s entry, UTI was managing around Rs 6,700 crore on its own. Public sector mutual funds also helped accelerate the growth of assets under management. UTI and its public sector counterparts were managing around Rs 47,000 crore when Kothari Pioneer, the first private sector mutual fund, set up shop in 1993. Before the US 64 fiasco, there were 33 mutual funds with total assets of Rs 1,21,805 crore as on January 2003. The UTI was way ahead of other mutual funds with Rs 44,541 crore assets under management. The industry overall has performed well over the years. Of course, there were a few funds houses, which disappointed investors. However, overall performance has been good. However, lack of awareness still impedes the growth of the mutual fund industry. Unlike developed countries, most of the household savings still go to bank deposits in India. Working of mutual fundsA mutual fund is set up by a
sponsor. However, the sponsor cannot
run the fund directly. He has to set
up two arms: a trust and Asset
Management Company. The trust is
expected to assure fair business
practice, while the AMC manages the
money. All mutual funds except UTI
functions under Sebi (Mutual Fund)
regulations 1996. Various Mutual Fund schemes and their implicationsMutual fund schemes are classified on the basis of its structure and investment objective. By StructureOpen–ended funds: Investors can buy and sell units of open-ended funds at NAV-related price every day. Open-end funds do not have a fixed maturity and it is available for subscription every day of the year. Open-end funds also offer liquidity to investments, as one can sell units whenever there is a need for money. Close-ended funds: These funds have a stipulated maturity period, which may vary from three to 15 years. They are open for subscription only during a specified period. Investors have the option of investing in the scheme during initial public offer period or buy or sell units of the scheme on the stock exchanges. Some close-ended funds repurchase the units at NAV-related prices periodically to provide an exit route to the investors. Interval Funds: These funds combine the features of both open and close-ended funds. They are open for sale and repurchase at a predetermined period. By Investment objectiveGrowth funds: They normally invest most of their corpus in equities, as their objective is to provide capital appreciation over the medium-to-long term. Growth schemes are ideal for investors with risk appetite. Income funds: As the name suggests, the aim of these funds is to provide regular and steady income to investors. They generally invest their corpus in fixed income securities like bonds, corporate debentures, and government securities. Income funds are ideal for those looking for capital stability and regular income. Balanced funds: The objective of balanced funds is to provide growth along with regular income. They invest their corpus in both equities and fixed income securities as indicated in the offer documents. Balanced funds are ideal for those looking for income and moderate growth. Money market funds: These funds strive to provide easy liquidity, preservation of capital and modest income. MMFs generally invest the corpus in safer short-term instruments like treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes hinges on the interest rates prevailing in the market. MMFs are ideal for corporate and individual investors looking to park funds for short periods. Other schemesTax saving schemes: Tax saving schemes or equity-linked savings schemes offer tax rebates to investors under section 88 of the Income Tax Act. They generally have a lock-in period of three years. They are ideal for investors looking to exploit tax rebates as well as growth in investments. Special schemes: These schemes invest only in the industries specified in the offer document. Examples are Infotech funds, FMCG funds, pharma funds, etc. These schemes are meant for aggressive and well-informed investors. Index funds: Index Funds invest their corpus on the specified index such as BSE Sensex, NSE index, etc. as mentioned in the offer document. They try to mimic the composition of the index in their portfolio. Not only the shares, even their weightage is replicated. Index funds are a passive investment strategy and the fund manager has a limited role to play here. The NAVs of these funds move along with the index they are trying to mimic save for a few points here and there. This difference is called tracking error. Sector specific schemes: These funds invest only specified sectors like an industry or a group of industries or various segments like ‘A’ Group shares or initial public offerings. Why invest through a Mutual FundAffordability: Mutual funds allow you to start with small investments. For example, if you want to buy a portfolio of blue chips of modest size, you should at least have a few lakhs of rupees. A mutual fund gives you the same portfolio for meagre investment of Rs 1,000-5,000. A mutual fund can do that because it collects money from many people and it has a large corpus. Professional management: The major advantage of investing in a mutual fund is that you get a professional money manager for a small fee. You can leave the investment decisions to him and only have to monitor the performance of the fund at regular intervals. Diversification: Considered the essential tool in risk management, mutual funds makes it possible for even small investors to diversify their portfolio. A mutual fund can effectively diversify its portfolio because of the large corpus. However, a small investor cannot have a well-diversified portfolio because it calls for large investment. For example, a modest portfolio of 10 blue-chip stocks calls for a few a few thousands. Convenience: Mutual funds offer tailor-made solutions like systematic investment plans and systematic withdrawal plans to investors, which is very convenient to investors. Investors also do not have to worry about the investment decisions or they do not have to deal with their brokerage or depository, etc. for buying or selling of securities. Mutual funds also offer specialized schemes like retirement plan, children’s plan, industry specific schemes, etc. to suit personal preference of investors. These schemes also help small investors with asset allocation of their corpus. It also saves a lot of paper work. Cost effectiveness: A small investor will find that a mutual fund route is a cost effective method. AMC fee is normally 2.5% and they also save a lot of transaction costs as they get concession from brokerages. Also, they get the service of a financial professional for a very small fee. If they were to seek a financial advisor's help directly, they may end up pay more. Also, the size of the corpus should be large to get the service of investment experts, who offer portfolio management. Liquidity: You can liquidate your investments anytime you want. Most mutual funds dispatch checks for redemption proceeds within two or three working days. You also do not have to pay any penal interest in most cases. However, some schemes charge an exit load. Tax breaks: You do not have to pay any taxes on dividends issued by mutual funds. You also have the advantage of capital gains taxation. Tax-saving schemes and pension schemes give you the added advantage of benefits under Section 88. Investments up to Rs 10,000 in them qualify for tax rebate. Transparency: Mutual funds offer daily NAVs of schemes, which help you to monitor your investments on a regular basis. They also send quarterly newsletters, which give details of the portfolio, performance of schemes against various benchmarks, etc. They are also well regulated and Sebi monitors their actions closely. Selecting a Mutual FundSelection parametersYour objective: The first point to note before investing in a fund is to find out whether your objective matches with the scheme. It is necessary, as any conflict would directly affect your prospective returns. For example, a scheme that invests heavily in mid-cap stocks is not suited for a conservative equity investor. He should be better off in a scheme, which invests mainly in blue chips. Similarly, you should pick schemes that meet your specific needs. Examples: pension plans, children’s plans, sector-specific schemes, etc. Your risk capacity and capability: this dictates the choice of schemes. Those with no risk tolerance should go for debt schemes, as they are relatively safer. Aggressive investors can go for equity investments. Investors that are even more aggressive can try schemes that invest in specific industry or sectors. Fund Manager’s and scheme track record: Since you are giving your hard earned money to someone to manage it, it is imperative that he manages it well. It is also essential that the fund house you choose has excellent track record. It also should be professional and maintain high transparency in operations. Look at the performance of the scheme against relevant market benchmarks and its competitors. Look at the performance of a longer period, as it will give you how the scheme fared in different market conditions. Cost factor: Though the AMC fee is regulated, you should look at the expense ratio of the fund before investing. This is because the money is deducted from your investments. A higher entry load or exit load also will eat into your returns. A higher expense ratio can be justified only by superlative returns. It is very crucial in a debt fund, as it will devour a few percentages from your modest returns. Purchasing mutual fundsPurchasing during IPO: Like companies, even mutual funds offer initial public offering. It is when they launch the scheme for the first time. You can buy units at par on this occasion. However, it is not always advantageous to buy a mutual fund during IPO. You can always wait and see the performance before investing in it. Purchasing existing mutual fund units: You can buy units of an open-end scheme anytime at NAV-related price. Most mutual funds charge an entry load of up to 2%. That means you have to pay an additional 2% of the NAV to get into the scheme. You can buy the plan directly from the mutual fund or brokerage. You can even buy them via the Internet. Selling mutual fundsYou can sell or redeem units very easily. As per Sebi guidelines, a mutual fund unit holder has the right to receive redemption or repurchase proceeds within 10 days of the redemption or repurchase. Most funds do not charge an exit load these days. When should you sell a mutual fund unit is a crucial question. Ideally, you should sell it when you have met your target profit. The other reason is that you need the money or your profile has changed due to some changes in your life. Other than this, you should sell the units if you find that the fund has been taken over by another fund, which you do not approve of. Any major changes in the objective of the fund or a sharp rise in expenses could also be valid reasons to redeem units. Following a favorite fund manager is also a usual practice. However, it need not be always rewarding. Income from mutual funds: the optionsMutual funds distribute their income as dividend. An investor has the option of receiving the dividend or opting for the dividend reinvestment. If an investor needs the income, he can opt for dividend payout option. However, if you do not need the money, he can opt for dividend reinvestment. Another choice before him is the growth or cumulative option. Here the income generated from sale of securities or capital appreciation is automatically reinvested. Speedy investment, redemption and income receiptsThanks to the Electronic Clearing Services (ECS), mutual fund investor now has the option of automatic credit of dividends and redemptions into bank account. This will save a lot of paperwork, for both you and the fund. You can also instruct your bank to automatically withdraw a certain sum towards systematic investment plan. Alternatively, you can also directly receive systematic withdrawal proceeds in your bank account. Tracking mutual funds’ performanceObjective parametersThe NAV of the scheme will reflect the performance of the scheme. The fund will also give you returns for various periods such as one month, three months, six months, one year, three years, since inception, etc. This will give you an idea about the performance of the fund. Funds also provide comparison with relevant benchmarks. This should tell you whether the fund manager has performed better than the benchmark. However, financial experts believe that these returns do not give the complete picture. They believe that the return should be risk-adjusted. Various publications and Internet sites provide such returns. The computation is complicated and they use various formulas for this purpose. Subjective parameters The performance alone does not make a fund house a winner. Equally important is the service standards and transparency in actions. It is also essential that the fund offer speedy solutions to grievances of investors. The reputation of the fund house among its investors and public at large indicates how well the fund scores on this front. Information sources Every financial daily offers daily NAV of all mutual fund schemes. Magazines also come out with annual survey of mutual funds. There are even magazines dedicated entirely towards mutual fund industry. Internet is also a great place for information. There are dedicated sites as well as financial sites, which offer information on mutual funds. Association of Mutual Funds of India (AMFI) home page is also a great place for information. Resolving grievances Mutual funds are regulated by Sebi (mutual fund) regulation 1996. Therefore, an investor always has the recourse to approach the watchdog. Various investor forums also take up the case of individual investors. You can also turn to judiciary as a last resort. GlossaryNAV: NAV is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units. Sale price: The price you pay when you invest in a scheme. It is also called offer price. Repurchase price: The price at which a close-ended scheme repurchases its units. It is also called bid price. Redemption price: The price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. This price is NAV related. Entry load: The extra amount you pay when you invest in a scheme. It is also called front-end load or sales load. Exit load: Amount collected when you are selling or redeeming units.
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