Notes By Abhishek Kamdi E-Mail abhishek_kamdi@rediffmail.

com

Chapter 1 : Concept and Role of Mutual Funds

Learning Objective This unit seeks to introduce the concept of mutual funds, highlight the advantages they offer, and describe the salient features of various types of mutual fund schemes. Mutual funds are a vehicle to mobilize moneys from investors, to invest in different markets and securities The primary role of mutual funds is to assist investors in earning an income or building their wealth, by participating in the opportunities available in the securities markets. In order to accommodate investor preferences, mutual funds mobilize different pools of money. Each such pool of money is called a mutual fund scheme. Mutual funds address differential expectations between investors within a scheme, by offering various options, such as dividend payout option, dividend reinvestment option and growth option. An investor buying into a scheme gets to select the preferred option also. The investment that an investor makes in a scheme is translated into a certain number of Units in the scheme. The number of units multiplied by its face value (Rs10) is the capital of the scheme its Unit Capital. When the profitability metric is positive, the true worth of a unit, also called Net Asset Value (NAV) goes up. When a scheme is first made available for investment, it is called a New Fund Offer (NFO). The money mobilized from investors is invested by the scheme as per the investment objective committed. Profits or losses, as the case might be, belong to the investors. The investor does not however bear a loss higher than the amount invested by him. The relative size of mutual fund companies is assessed by their assets under management (AUM). The AUM captures the impact of the profitability metric and the flow of unitholder money to or from the scheme. Investor benefits from mutual funds include professional management, portfolio diversification, economies of scale, liquidity, tax deferral, tax benefits, convenient options, investment comfort, regulatory comfort and systematic approach to investing. Limitations of mutual funds are lack of portfolio customization and an overload of schemes and scheme variants.

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Notes By Abhishek Kamdi E-Mail [email protected] Open-ended funds are open for investors to enter or exit at any time and do not have a fixed maturity. Investors can acquire new units from the scheme through a sale transaction at their sale price, which is linked to the NAV of the scheme. Investors can sell their units to the scheme through a re-purchase transaction at their re-purchase price, which again is linked to the NAV. Close-ended funds have a fixed maturity and can be bought and sold in a stock exchange. Interval funds combine features of both open-ended and closed ended schemes. Actively managed funds are funds where the fund manager has the flexibility to choose the investment portfolio, within the broad parameters of the investment objective of the scheme. Passive funds invest on the basis of a specified index, whose performance it seeks to track. Gilt funds invest in only treasury bills and government securities Diversified debt funds on the other hand, invest in a mix of government and nongovernment debt securities Junk bond schemes or high yield bond schemes invest in companies that are of poor credit quality. Fixed maturity plans are a kind of debt fund where the investment portfolio is closely aligned to the maturity of the scheme. Floating rate funds invest largely in floating rate debt securities Liquid schemes or money market schemes are a variant of debt schemes that invest only in debt securities of less than 91-days maturity. Diversified equity funds invest in a diverse mix of securities that cut across sectors. Sector funds invest in only a specific sector. Thematic funds invest in line with an investment theme. The investment is more broadbased than a sector fund; but narrower than a diversified equity fund.

A mutual fund is a pool of money collected from Investors and is invested according to stated investment objectives. The birth place of Mutual Fund is U.S.A. Mutual fund investors are like shareholders and they own the fund. Mutual fund investors are not lenders or deposit holders in a mutual fund.

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Notes By Abhishek Kamdi E-Mail [email protected]

Everybody else associated with a mutual fund is a service provider, who earns fee. The money in the mutual fund belongs to the investors and nobody else. Mutual funds invest in marketable securities according to the investment objective. The value of the investments can go up or down, changing the value of the investors holdings. The net asset value (NAV) of a mutual fund fluctuates with market price movements. The market value of the investors funds is also called as net assets. Investors hold a proportionate share of the fund in the mutual fund. New investors come in and old investors can exit at prices related to net asset value per unit. Advantages of mutual funds to investors are: o Increases the purchasing power of the investors o Portfolio diversification o Professional management o Reduction in risk o Reduction in transaction cost o Liquidity o Convenience and flexibility Disadvantages of mutual funds to investors are: o No control over costs o No tailor made portfolios o Problems of managing a large portfolio of funds Important Milestones in the MF history in India o 1963: UTI (special privileges assured return schemes, guarantees, loans) o 1987: Public Sector MFs o 1993: Private Sector MFs o 1995: AMFI was set-up (internal checks & balances, representation to the govt and consumer education publish a book titled Making Mutual Funds Work for You an Investors Guide) o 1996: SEBI (MF) Regulations o 1999: Dividend income made tax free in the hands of investor o 2003: UTI Act repealed (level playing field, UTI split, UTIMF created) o 2004-onwards: Consolidation & Growth (AUM at the end of FY 2004-05 was appx. Rs.153,000 crores) UTI was the only mutual fund during the period 1963-1988. UTI was the only fund for a long period and enjoyed monopoly status. UTI is governed by the UTI Act, 1963 In 1987 banks, financial institutions and insurance companies in the public sector were permitted to set up mutual funds.

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Notes By Abhishek Kamdi E-Mail [email protected]

SEBI got regulatory powers in 1992. SBI Mutual Fund was the first bank-sponsored mutual fund to be set up. The first mutual fund product was UTIs Master Share in 1986. The private sector players were allowed to set up mutual funds in 1993. In 1996 the mutual fund regulations were substantially revised and modified. In 1999 dividends from mutual funds were made tax exempt in the hands of investors. Mutual funds can be open ended or closed ended, Load or No-Load, Taxable or Tax exempt, Commodities and Real Estate funds. In an open ended fund, sale and repurchase of units happen on a continuous basis, at NAV related prices, from the fund itself. The corpus of open ended funds, therefore, changes everyday. A closed end fund offers units for sale only in the NFO. It is then listed in the market. In closed end fund investors wanting to buy or sell units have to do so in the stock markets. The corpus of a closed end fund remains unchanged. Mutual funds also offer equity linked savings schemes (ELSS) that have the following features: o 3 year lock in o Minimum investment of 90% in equity markets at all times o Open ended or closed end o Rebate under section 80C for investments up to Rs. 1,00,000/Gilt funds are funds that invest only in government securities Sectoral funds are also called as specialty funds. Equity funds are risky; liquid funds have the lowest risk. Equity funds are for the long term; liquid funds are for the short term. Investors choose funds based on their objectives, risk appetite, time horizon and return expectations. Load is charged to the investor when the investor buys or redeems (repurchases) units. Load is an adjustment to the NAV, to arrive at the price. Load that is charged on sale of units is called as Entry Load. An entry load will increase the price, above the NAV, for the investor. Load that is charged when the investor redeems his units is called an Exit Load. Exit load reduces the redemption proceeds of the investor. Load is primarily used to meet the expenses related to sale and distribution of units. An exit load that varies with the holding period of an investor is called a (Contingent Deferred Sales Charge) CDSC. The repurchase price cannot be less than 95% of the sale price.

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 2: Fund Structure and Constituents

Learning Objective In this unit, you will understand the salient features of the legal structure of mutual funds in India and the role of key constituents that make up the overall mutual fund eco-system. Mutual funds in India are governed by SEBI (Mutual Fund) Regulations, 1996, as amended till date. The regulations permit mutual funds to invest in securities including money market instruments, or gold or gold related instruments or real estate assets. Mutual funds are constituted as Trusts. The mutual fund trust is created by one or more Sponsors, who are the main persons behind the mutual fund operation. Every trust has beneficiaries. The beneficiaries, in the case of a mutual fund trust, are the investors who invest in various schemes of the mutual fund. In order to perform the trusteeship role, either individuals may be appointed as trustees or a Trustee company may be appointed. When individuals are appointed trustees, they are jointly referred to as Board of Trustees. A trustee company functions through its Board of Directors. Day to day management of the schemes is handled by an AMC. The AMC is appointed by the sponsor or the Trustees. Although the AMC manages the schemes, custody of the assets of the scheme (securities, gold, gold-related instruments & real estate assets) is with a Custodian, who is appointed by the Trustees. Investors invest in various schemes of the mutual fund. The record of investors and their unit-holding may be maintained by the AMC itself, or it can appoint a Registrar & Transfer Agent (RTA). The sponsor needs to have a minimum 40% share holding in the capital of the AMC. The sponsor has to appoint at least 4 trustees atleast two-thirds of them need to be independent. Prior approval of SEBI needs to be taken, before a person is appointed as Trustee. AMC should have networth of at least Rs10crore. At least 50% of the directors should be independent directors. Prior approval of the trustees is required, before a person is

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Notes By Abhishek Kamdi E-Mail [email protected] appointed as director on the board of the AMC.

Mutual funds in India have a 3-tier structure of Sponsor-Trustee-AMC. The mutual fund is formed as trust in India, and not as a company. In the US mutual funds are formed as investment companies. Investors money is held in the Trust (the mutual fund).

The Sponsor:

Sponsor is defined under the SEBI regulations as any person who, acting alone or in combination with another body corporate, establishes a mutual fund. Sponsor is the promoter of the fund. Sponsor could be a bank, a corporate or a financial institution. Sponsors then form Trust and appoint Board of Trustees. The sponsor also appoints Custodian. As per SEBI regulations, sponsor must contribute at least 40% of the net worth of the AMC and possess a sound financial track record over five years prior to registration. Sponsor signs the trust deed with the trustees. Sponsor creates the AMC and the trustee company and appoints the board of directors of companies, with SEBI approval. Sponsor should have at least a 5 year track record in the financial services business and should have made profit in at least 3 out of the 5 years. The AMCs capital is contributed by the sponsor. Sponsor should contribute at least 40% of the capital of the AMC.

The Trustees:

A mutual fund in India is form as Trust under Indian Trust Act, 1882. The trust-mf is managed by Board of Trustees. The board of Directors i.e. Trustees do not manage the portfolio of securities directly rather they appoint as AMC (Asset Management Company) Trustees ensure that fund is managed by stated objective and as per SEBI regulations. Trusts always work for the interest of unit holders. The trust is created through a document called Trust Deed that is executed by sponsor in favors of Trustees. The Trustees being the primary guardians of unit holders funds and assets. Trustees must ensure that the investors interests are safeguarded and that the AMC operations are as per regulation laid down by SEBI. SEBI mandates a minimum of 2/3rd independent directors on the board of the trustee company. Trustees are appointed by the sponsor with SEBI approval. Trustees are required to meet at least 4 times a yea to review the AMC.

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Notes By Abhishek Kamdi E-Mail [email protected]

The trustees make sure that the funds are managed according to the investors mandate.

Rights of Trustees:

The trustee appoints AMC with prior approval of SEBI. They also approve each new scheme floated by AMC. They have the right to request any necessary information from the AMC concerning the operations of various schemes. The trustees may take any necessary action against AMC if they found AMC operations are not as per the SEBI regulations. Manages the mutual fund and look after the operations of the appointed AMC. Trustees approve each MF scheme floated by AMC Trustees receive fee for their services. The investments are held by the Trustee Trustees can seek remedial actions from AMC Trustees can dismiss the AMC The trustees have the right to ensure that, based on their quarterly review of AMCs net worth; any shortfall in the net worth is made by the AMC.

Obligations of Trustees:

To ensure that funds transactions as per SEBI regulations To ensure that the proper key person of AMC has been appointed. And also operations of other staffs of AMC. To ensure that the due diligence (care) has been given for empanelment of brokers. Trustees Manages the Mutual Fund and look after the operations of the appointed AMC The investments are held by the Trustee At least 4 members should be there in Board of Trustees. 2/3 members in the Board of Trustees should be independent. Sponsors execute and register Trust Deed in favors of Trustees. Trustee of one MF can not be a trustee of another MF, unless he/she is an independent trustee in both the cases. The appointment of all trustees has to be done with prior approval of SEBI. Trusts are formed through Trust Deed Trust ensures that AMC has not given any undue advantage to any associates. Trustee ensures that AMC is managing the fund as per SEBI regulations Meeting of Trustees should held once in every two months. SEBI categorizes the Obligations of Trustees as o General Due Diligence &

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Notes By Abhishek Kamdi E-Mail [email protected]

o

Specific Due Diligence 1. General Due Diligence Appointment of AMC & its directors Observance of AMC functioning and desirability of its continuance Protection of Trust property Ensuring that all constituents and associations are registered entities Review of service contracts and terms Reporting to SEBI any special developments in the mutual fund 1. Specific Due Diligence Trust must appoint independent auditor and obtain from them periodic internal audit reports from AMC Obtain compliance test reports from the AMC once every two months. These reports are to be discussing in meeting of trustees. Trustees set a code of ethics for trustees and for AMC personnel

AMC-Appointments and Functions

The role of AMC is to act as investment manager of trust The AMC (as appointed by trust/sponsor) require approving by a SEBI The AMC supervision under its own board of directors and also the directors of trustees and SEBI The trustees are empowered to terminate the appointment of AMC and appoint a new AMC with prior approval of SEBI and unit holders. The AMC is the name of the Trust; manage different investment schemes as per investment management agreement with the trustees. The AMC of a MF must have a net worth of at least Rs.10 Crores at all times. Director of AMC should have complete finance professional experience. The AMC can not act as a trustee of any other MF. The AMC always act in the interest of unit holders (investor) The AMC gets a fee for managing the funds, according to the mandate of the investors At least of the AMCs Board should be of independent members An AMC can not engage in any business other than portfolio advisory and management An AMC of one fund cannot be Trustee of another fund AMC should be registered with SEBI AMC signs an investment management agreement with the trustees

Obligation of AMC & its directors

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Notes By Abhishek Kamdi E-Mail [email protected]

Investment of the fund according to the SEBI regulation & trust deed. They are answerable to the trustees and must submit quarterly reports to them on AMC activities and compliance with SEBI regulations Each day NAV is updated on AMFI website by 9 pm In the event of merger or consolidation of schemes, the unit holders are intimated through a letter giving them option to exit at prevailing NAV without exit load.

Custodians & Depositories

For safekeeping of physical securities of MF custodian is appointed by board of trustees. The custodian should be registered with SEBI. Dematerialized forms of securities are held in the custody of Depositories Participant. The investors fund and the investments are held by the custodian, who is the guardian of the funds and assets of the investors. Sponsor and the Custodian cannot be the same entity

Function of Custodian

Responsible for the securities held in the mutual funds portfolio Keep an investment record of the mutual fund Collect dividends and investment payments due on the mutual funds investment Track corporate actions like bonus issues, right offers, offer for sale, buy back and open offers for acquisition.

Registrars & Transfer Agents

They are responsible for issuing and redeeming units of the MF and providing other MF related services to investors Register and Transfer (R&T) Agents manage the sale and repurchase of units and keep the unit holders accounts.

Functions of Registrars

Process investors application Record details of investors Send information to investor Process dividend payout Incorporate changes in investor information Keeping investor information up to date

Distributors

AMC appoints a distributor (also called MF advisor, agent, broker, intermediaries etc) who sells units MF to investors on the behalf of fund house.

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Notes By Abhishek Kamdi E-Mail [email protected]

A sponsor or an associate may act as distributors of AMC. For example, Bank which is sponsor of Mutual Fund Company may act as distributor also for selling its mutual funds products AMC has the right whether to impaneled (appoint) or not distributor for selling his MF scheme. They also have the right of commission structure which they offer to distributor You may find different commission structure for different AMC scheme. A distributor can act for several or all MF For all employees and distributors of MF, AMFI certification test has been made mandatory by SEBI All distributors are required to be registered with AMFI and obtain AMFI Registration Number (ARN) The commission received by the distributors is split into initial commission which is paid on mobilization of funds and trial commission which is paid depending on the time the investors stay with the fund.

Fund Mergers & Takeovers A running fund constitution can change in the following possible ways 1. 2. 3. 4. 5. Trustees may decide to change the AMC and handover the scheme to a new AMC The scheme may be merged with another scheme of the same AMC The AMC is taken over by another set of sponsors One AMC may merge with another AMC Just the schemes may be taken over by another set of trustees Trustee Approval Yes Yes Yes Yes Yes SEBI Approval Yes Yes Yes Yes Yes High Court Approval No Yes No No No

Transaction Type

AMC Takeover by new sponsor AMC Merger Trustees changing AMC Schemes taken over by another AMC Scheme Merger

Example of AMC Merger - HB & Taurus Two MF companies in India which merged using the AMC merger route Example of AMC Takeover - Zurich acquired Threadneedle globally and bought out ITC Threadneedles India business. Zurich similarly acquired Kemper Twentieth Century Finance. In recent times Alliance was taken over by Birla. Example of Scheme Takeover Zurich finally exited MF business in India and sold all its schemes in India to HDFC (technically the AMC was not sold but just the schemes)

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 3: Legal and Regulatory Environment

Learning Objective The focus of this unit is on the overall regulatory environment of mutual funds in India, with a focus on the investor. SEBI regulates mutual funds, depositories, custodians and registrars & transfer agents in the country. AMFI is an industry body, but not a self regulatory organization. The AMFI Code of Ethics sets out the standards of good practices to be followed by the Asset Management Companies in their operations and in their dealings with investors, intermediaries and the public. AMFI has framed AGNI, a set of guidelines and code of conduct for intermediaries, consisting of individual agents, brokers, distribution houses and banks engaged in selling of mutual fund products. Investment objective defines the broad investment charter. Investment policy describes in greater detail, the kind of portfolio that will be maintained. Investment strategies are decided on a day-to-day basis by the senior management of the AMC. At least 65% of the corpus should, in the normal course, be invested in the kind of securities / sectors implied by the schemes name. Statement of accounts is to be sent to investors within 5 days of closure of the NFO. Investor can ask for a Unit Certificate for his Unit Holding. This is different from a Statement of Account. NAV has to be published daily, in at least 2 newspapers NAV, Sale Price and Re-purchase Price is to be updated in the website of AMFI and the mutual fund The investor/s can appoint a nominee, who will be entitled to the Units in the event of the demise of the investor/s. The investor can also pledge the units. This is normally done to offer security to a financier.

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Notes By Abhishek Kamdi E-Mail [email protected] Dividend warrants have to be dispatched to investors within 30 days of declaration of the dividend Redemption / re-purchase cheques would need to be dispatched to investors within 10 working days from the date of receipt of request. Unit-holders have proportionate right to the beneficial ownership of the assets of the scheme. Investors can choose to change their distributor or go direct. In such cases, AMCs will need to comply, without insisting on No Objection Certificate from the existing distributor. Investors can choose to hold the Units in dematerialised form. The mutual fund / AMC is bound to co-ordinate with the RTA and Depository to facilitate this. In the case of unit-holding in demat form, the demat statement given by the Depository Participant would be treated as compliance with the requirement of Statement of Account. The mutual fund has to publish a complete statement of the scheme portfolio and the unaudited financial results, within 1 month from the close of each half year. In lieu of the advertisement, the mutual fund may choose to send the portfolio statement to all Unitholders. Debt-oriented, close-ended / interval, schemes /plans need to disclose their portfolio in their website every month, by the 3rd working day of the succeeding month. Scheme-wise Annual Report, or an abridged summary has to be mailed to all unit-holders within 6 months of the close of the financial year. The Annual Report of the AMC has to be displayed on the website of the mutual fund. The Scheme-wise Annual Report will mention that Unit-holders can ask for a copy of the AMCs Annual Report. The trustees / AMC cannot make any change in the fundamental attributes of a scheme, unless the requisite processes have been complied. This includes option to dissenting unit-holders to exit at the prevailing Net Asset Value, without any exit load. This exit window has to be open for at least 30 days. The appointment of the AMC for a mutual fund can be terminated by a majority of the trustees or by 75% of the Unit-holders (in practice, Unit-holding) of the Scheme. 75% of the Unit-holders (in practice, Unit-holding) can pass a resolution to wind-up a scheme If an investor feels that the trustees have not fulfilled their obligations, then he can file a suit against the trustees for breach of trust.

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Notes By Abhishek Kamdi E-Mail [email protected] Under the law, a trust is a notional entity. Therefore, investors cannot sue the trust (but they can file suits against trustees, as seen above). The principle of caveat emptor (let the buyer beware) applies to mutual fund investments. The investor can claim his moneys from the scheme within 3 years. Payment will be based on prevailing NAV. If the investor claims the money after 3 years, then payment is based on the NAV at the end of 3 years If a security that was written off earlier is now recovered, within 2 years of closure of the scheme, and if the amounts are substantial, then the amount is to be paid to the old investors. In other cases, the amount is to be transferred to the Investor Education Fund maintained by each mutual fund. PAN No. and KYC documentation is compulsory for mutual fund investments. Only exception is micro-SIPs. Investors need to give their bank account details along with the redemption request. Adequate safeguards exist to protect the investors from the possibility of a scheme going bust.

In 1992, Government of India constituted SEBI (Securities & Exchange Board of India) by an act of parliament. It is mandatory for all the MFs to register with SEBI Mutual Funds are regulated by the SEBI (Mutual Fund) Regulations, 1996. SEBI is the regulator of all funds, except offshore funds. Bank-sponsored mutual funds are jointly regulated by SEBI and RBI If there is a bank-sponsored fund, it can not provide a guarantee without RBI permission. RBI regulates money and government securities markets, in which mutual funds invest. Listed mutual funds are subject to the listing regulations of stock exchanges. Since the AMC and Trustee Company are companies, any complaints against their board can be made to the CLB (Company Law Board) Investors can not sue the trust, as they are the same as the trust and cannot sue themselves. UTI does not have a separate sponsor and AMC. UTI is governed by the UTI Act, 1963 and is voluntarily under SEBI Regulations.

RBI The Money Market Regulator

RBI act as Supervisor of Bank owned Mutual Funds Bank MF comes under regulatory of RBI All MF come under SBI regulation but bank owned AMC came under RBI regulation.

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Notes By Abhishek Kamdi E-Mail [email protected]

RBI banned all non banking entities access to the inter-bank call money market. This means that liquid funds can no longer invest in the call money market. The ministry of Finance supervises both the RBI & SEBI In 2003, a Securities Appellate Tribunal (SAT) has been created to provide the apex appear mechanism for any decision taken by SEBI. SAT works as independent judicial authority.

CLB, DCA, RoC

AMC are registered under companies act 1956 and hence answerable to regulatory authorities empowered by the companies act. Registrar of Companies (RoC) is the legal interface for all companies RoC, in turns is supervised by the Department of Company Affairs (DCA) Above DCA there is the Company Law Board (CLB) which is part of Ministry of Law & Justice of the Govt. of India.

Self Regulatory Organisations (SRO)

Stock Exchanges are Self Regulatory Organisations supervised by SEBI Many closed ended schemes are listed on stock exchanges through a signing agreement between the fund and the stock exchange. SRO is an association representing a group of market participants which is specially empowered by the apex regulatory authority to exercise pre-defined authority over the regulation of their members. Theses activities of the funds are regulated by respective SROs that report to the main regulatory body like SEBI The SROs are given powers to regulate the criterion & procedures for admission of its members, set a code of conduct for their members market activities, and determine the professional rules & by laws of the association & so on. To become SRO, need granted specific powers & approval by the government, appropriate laws & recognition by the regulatory authority. SROs are the second tier in the regulatory structure SROs get their powers from the apex regulating agency, act on their instructions and regulate their own members in a limited manner. SROs cannot do any legislation on their own. All stock exchanges are SROs Stock Exchanges in most countries are granted the status of SRO AMFI is an industry association of mutual funds. AMFI is not yet a SEBI registered SRO. AMFI is not a SRO.

Association of Mutual Fund in India (AMFI)

AMFI was incorporated in 1995 AMFI has the powers to deny registration to distributors for failing the test or violating AMFI code of conduct given in AGNI (AMFI Guidelines & Norms for Intermediaries)

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Notes By Abhishek Kamdi E-Mail [email protected]

For all employees and distributors of MF, AMFI certification test has been made mandatory by SEBI All distributors are also required to be registered with AMFI & obtain AMFI Registration Number (ARN) AMFI is regulated by its own board made up of its members.

AMFI main objectives

To promote the interest of MFs and units holders, interact with SEBI, RBI, and Government for same. To set and maintain ethical, commercial and professional standards in the industry To recommend and promote best business practices and code of conduct in the MF industry. To increase public awareness and understanding for MF To develop a team of well trained professional MF distributors Implement a training and certification for all intermediaries engaged in MF industry.

Rights of Investor

Investors are beneficial owner of scheme asset which they own. Investors are entitled to receive dividends declared in a scheme within 30 days. Redemption proceeds have to be sent to investors within 10 days otherwise investor has the right to receive dividend with interest, borne by AMC. If an investor fails to claim the dividend or redemption proceeds he has rights to claim up to a period of 3 years from the due date at the then prevailing NAV Mutual funds have to allot units within 30 days of the IPO/NFO Mutual funds have to publish their half yearly results in at least one national daily and publish their entire portfolios, at least once in 6 months. Such disclosures should be done within 30 days from 6 monthly account closing dates of the fund. Trustees will have to ensure that any information having a material impact on the unit holders investments should be made publicly the mutual fund. If 75% of the unit holders so decide, 1) The scheme can be wound up 2) Meeting of unit holders can be called 3) Appointment of the AMC of the mutual fund can be terminated. If there is any change in the fundamental attributes of the scheme, the unit holders have to be notified through a letter. they also have a right to repurchase at NAV without any load, before such change is effected.

Investors Obligations

Study OD Provide PAN Monitor their investment

Investors Complaints Redressal Mechanism

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Notes By Abhishek Kamdi E-Mail [email protected]

Investor Grievances can be addressed to Trustee SEBI is the primary body to address MF complaints Investors cannot seek redressal under Companies Act since fund investors are neither share holders nor depositors in AMC

Limitations of Investor

Investors can not sue the trust as they are not distinct from the trust Investors can lodge complaints with SEBI for non-compliance. Investors can not be compensated if the performance of the fund is below expectations.

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 4. The Offer DocumenLearning Objective

This unit will give you a good idea of what goes into a New Fund Offer and the legalities underlying the offer documents which are a key source of information for investors and prospective investors. Under the SEBI guidelines, NFOs other than ELSS can remain open for a maximum of 15 days. Allotment of units or refund of moneys, as the case may be, should be done within 5 business days of closure of the scheme. Further, open-ended schemes have to reopen for sale / re-purchase within 5 business days of the allotment. Investors get to know the details of any NFO through the Offer Document, which is one of the most important sources of information about the scheme for investors. Investments by the investor are governed by the principle of caveat emptor i.e. let the buyer beware. Mutual Fund Offer Documents have two parts: (a) Scheme Information Document (SID), which has details of the scheme (b) Statement of Additional Information (SAI), which has statutory information about the mutual fund that is offering the scheme. In practice, SID and SAI are two separate documents, though the legal technicality is that SAI is part of the SID. Both documents need to be updated regularly. Offer Documents in the market are vetted by SEBI, though SEBI does not formally approve them. KIM is essentially a summary of the SID and SAI. It is more easily and widely distributed in the market. As per SEBI regulations, every application form is to be accompanied by the KIM.

Offer document is the most important source of information for investors

Contents of the OD

Details of the sponsor and the AMC Description of the scheme and the investment objective Terms of issue Historical statistics Investors rights and services Fee structure and expenses Information on income and expenses of existing schemes

Front page of the offer document contains its date of publication, name & type of fund and its major objectives. Specifically the following http://mbafin.blogspot.com

Notes By Abhishek Kamdi E-Mail [email protected]

Name of Mutual Fund Name of Scheme Type of Scheme (Equity/Income/Balanced) Name of AMC Unit Price Opening, Closing & Earliest Closing date Name of Guarantor if the scheme is an assured return SEBI disclaimer Statement to the effect that it is important for a prospective investor to read it and retain for future reference

More about OD:

Abridged version of the OD is called as Key Information Memorandum (KIM) Investors are required to read and understand the offer document before investing in mutual funds No recourse is available to investors for not reading the OD or KIM, as they sign the form stating that they have read the OD OD is issued by the AMC on behalf of the Trustees KIM has to be compulsorily made available along with the application form. Closed end funds issue an offer document at the time of the NFO Open ended funds have to update OD at least once in 2 years. Trustees approve the contents of the OD and KIM The format and content of the OD has to be as per SEBI guidelines. The AMC prepares the OD and is responsible for the information contained in the OD The Compliance Officer has to sign the due diligence certificate. He is usually an AMC employee The due diligence certificate states that:
o o o

Information in the OD is according to SEBI formats Information is verified and is a true and fair representation of facts All constituents of the fund are SEBI registered

SEBI does not approve or certify the contents of the OD

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Notes By Abhishek Kamdi E-Mail [email protected]

Factors common all funds are called as standard risk factors. These include market risk, no assurances of return, etc. Factors specific to a scheme are scheme-specific risk factors in the Offer Document. These include restrictions on liquidity such as lock-in period, risks of investing in the first scheme of a fund etc. Fundamental attributes of a scheme include its basic features For any change in the fundamental attributes, investor approval is not needed. Trustees and SEBI should approve the change. Each investor should be informed through a communication and given the option to exit without paying any exit load. A scheme can not make any guarantee or return, without stating the name of the guarantor, and disclosing the net worth of the guarantor. The past performance of the assured return schemes should also be given. Information on existing schemes and financial summary of existing schemes to be given for 3 years Information on transaction with associate companies to be provided for past 3 years If any expense incurred is higher than what was stated in the OD, for past schemes, explanation should be given. There is no information on other mutual funds, their product or performance in the OD Investors rights are stated in the OD The borrowing instructions on the mutual fund should be disclosed. This includes the purposes and the limits on borrowing Investors have the right to inspect a number of documents. These are:
o o o o o o

Trust deed Investment management agreement SEBI (MF) Regulations AMC annual reports Unabridged Offer Document Annual reports of existing schemes

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Notes By Abhishek Kamdi E-Mail [email protected]

o

3 years track records of investors complaints and redressal should be disclosed in OD

Any pending cases or penalties against sponsors or AMC should be disclosed in the OD The offer document contains detailed information, while the KIM is a summary form of the OD If any information is crucial to the investor, it will be found in both KIM and OD. For example, the details of guarantee if the scheme is an assured return scheme. The name and addresses of the Trustees and AMC directors will be found in the KIM, but the details of their role, responsibilities and duties will not be found in the KIM, but only in the OD The OD and KIM are documents of a mutual fund and there will be no information about other mutual funds in an OD. There will be no comparisons are data on performance of other mutual funds. The OD and KIM will not contain names of securities in which the mutual fund plans to invest. Only broad allocation will be given.

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 5. Fund Distribution and Channel Management Practices

Learning Objective This unit seeks to give you an understanding of the distribution channels through which mutual fund schemes reach the investors, and how these channels are managed. The changing competitive context has led to the emergence of institutional channels of distribution, to supplement the individuals who distribute mutual funds. Institutional channels build their reach through employees, agents and sub-brokers. AMCs keep exploring newer channels of distribution to increase the size of assets managed. The internet has increased the expectations of advice that investors have from their distributors. The stock exchange brokers have become a new channel for distribution of mutual funds. These brokers too need to pass the prescribed test, get the AMFI Registration No. and get them empanelled with AMCs whose schemes they want to distribute. The scheme application forms carry a suitable disclosure to the effect that the upfront commission to distributors will be paid by the investor directly to the distributor, based on his assessment of various factors including the service rendered by the distributor. AMCs pay a trail commission for the period the investment is held in the scheme. Since trail commission is calculated as a percentage on AUM, distributors get the benefit of valuation gains in the market.

Investor, such as a trust or a company can invest in a fund, depends on the list of eligible investors in the OD Any investor, who becomes a foreign citizen after investing in a fund, has to be compulsorily redeeming the units after obtaining foreign citizenship. Therefore any Indians seeking foreign citizenship should redeem their units. FIIs can invest in mutual funds. They invest through the Non-resident rupee account called NRE account. Investors have the right to receive redemption proceeds within 10 days. Investors cannot sue the Trust as they are the Trust and cant sue themselves

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Notes By Abhishek Kamdi E-Mail [email protected]

An open ended fund opens for sale and repurchase within 30 days from the date of closure of the IPO/NFO With the approval of 75% investors of the unit capital, the AMCs services can be terminated, or the scheme can be wound up. If a fund does not redress their complaint investors can go to SEBI

Who can invest in Mutual Fund in India

Residents of Indian including,

o o o o o o o

Resident Indian Individual/HUF Indian companies/Partnership Firms Indian Trusts/Charitable Institutions Banks/Finance Institutions Non-Banking Finance Companies (NBFC) Insurance Companies Provident Funds

Non Resident Including

o o

Non-Resident Indian, & persons of Indian origin Overseas Corporate Bodies (OCBs)

Foreign entities like FIIs (Foreign Institutional Investors) Registered with SEBI (Foreign Citizens/entities are not allowed to invest in MF in India)

Individual Agents & Distributors (National Distributors)

An individual agent (advisor) is the broker between fund and the investor. Instead of having to deal with several individual distributors, a fund can interact with Distribution Company that has several employees or sub broker under it. These sub brokers are the agents of main distributors and these sub brokers will not at all having any relation with AMC. All persons engaging in MF sales have to pass AMFI certification test. Even employees of distributors, bank etc has to clear AMFI exam. It is mandatory to get ARN (AMFI Registration Number) from AMFI after passing the AMFI exam. Agents can sell products of multiple mutual funds.

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Notes By Abhishek Kamdi E-Mail [email protected]

Agents are appointed after they clear the AMFI exam and sign an agreement with the AMC on non-judicial stamp paper.

Commission Rates for MF Distributors

Commission payable to distributor is not fixed. It varies from AMC to AMC and Scheme to Scheme. Upfront commission for open ended scheme may vary from 1.5% to 2.5% whereas for ELSS scheme it varies from 2% to 3.5% Apart from upfront commission, agent also entitled to get Trail commission which varies from 0.4% to 0.6% paid on quarterly basis. As per SEBI rules, Distributor (MF Advisor) get commission on investments made through them but they are not entitled to get commission in their own investment.

SEBI Advertising Code

The dividends declared or paid shall be mentioned in rupees per unit along with the face value of each unit of that scheme Only compounded annualized yield can be advertised if the scheme has been in existence for more than 1 year. Annualized yield when used must be shown for lat 1 year, 3 years, 5 years ad since launch of the scheme For funds in existence for less than 1 year, performance may be advertised in terms of total returns and such returns should not be annualized. Performance should compare with appropriate benchmarks only. Advertisements showing yields should display a sentence that Past performance may or may not sustained in future

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 6. Accounting, Valuation & Taxation

Learning Objectives Your learning of mutual funds is incomplete, if you do not know a few aspects of accounting of mutual fund schemes, valuation of securities in the schemes portfolio, calculation of net asset value, and the impact of taxation on various types of mutual fund schemes and investors in these schemes. The unit-holders funds in the scheme is commonly referred to as net assets. Net asset includes the amounts originally invested, the profits booked in the scheme, as well as appreciation in the investment portfolio. It goes up when the market goes up, even if the investments have not been sold. A scheme cannot show better profits by delaying payments. While calculating profits, all the expenses that relate to a period need to be considered, irrespective of whether or not the expense has been paid. In accounting jargon, this is called accrual principle. Similarly, any income that relates to the period will boost profits, irrespective of whether or not it has been actually received in the bank account. This again is in line with the accrual principle. In the market, when people talk of NAV, they refer to the value of each unit of the scheme. Higher the interest, dividend and capital gains earned by the scheme, higher would be the NAV. Higher the appreciation in the investment portfolio, higher would be the NAV. Lower the expenses, higher would be the NAV. The difference between the NAV and Re-purchase Price is called the exit load. Schemes can also calibrate the load when investors offer their units for re-purchase. Investors would be incentivized to hold their units longer, by reducing the load as the unit holding period increased. Such structures of load are called Contingent Deferred Sales Charge (CDSC) SEBI has banned entry loads. So, the Sale Price needs to be the same as NAV. Exit loads / CDSC in excess of 1% of the redemption proceeds have to be credited back to the scheme immediately i.e. they are not available for the AMC to bear selling expenses. Exit load structure needs to be the same for all unit holders representing a portfolio. Initial issue expenses need to be met by the AMC. There are limits to the recurring expenses that can be charged to the scheme. These are linked to the nature of the scheme and its net assets. Dividends can be paid out of distributable reserves. SEBI has prescribed a conservative approach to its calculation.

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Notes By Abhishek Kamdi E-Mail [email protected] NAV is to be calculated upto 4 decimal places in the case of index funds, liquid funds and other debt funds. NAV for equity and balanced funds is to be calculated upto at least 2 decimal places. Investors can hold their units even in a fraction of 1 unit. However, current stock exchange trading systems may restrict transacting on the exchange to whole units. Detailed norms on valuation of debt and equity securities determine the valuation of the portfolio, and therefore the NAV of every scheme. Mutual funds are exempt from tax. However, Securities Transaction Tax (STT) is applicable on investments in equity and equity mutual fund schemes. Additional tax on income distributed (Dividend distribution tax) is applicable on dividends paid by debt mutual fund schemes. Taxability of capital gains, and treatment of capital losses is different between equity and debt schemes, and also between short term and long term. Upto 1 year investment holding is treated as short term. There is no Tax Deducted at Source (TDS) on dividend payments or re-purchase payments to resident investors. Withholding tax is applicable for some non-resident investors. Setting of capital losses against capital gains and other income is subject to limitations to prevent tax avoidance. Investment in mutual fund units is exempt from Wealth Tax. Net Asset Value (NAV): NAV = Net assets of the scheme / No. of units outstanding = [(market value of investments + Receivables + Other Accrued Income + Other Assets Accrued Expenses Other payables Other Liabilities)] / No. of units outstanding on valuation date

The maximum limit on the expense that can be charged to an equity mutual funds are:
o o o o o

For net assets up to Rs.100 Crore:-2.5% For the next Rs.300 Crore of net assets:-2.25% For the next Rs.300 Crore of net assets:-2% For the remaining net assets:-1.75% These limits are lower by 0.25% for debt funds

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Notes By Abhishek Kamdi E-Mail [email protected]

These regulatory ceilings are applied on the weekly average net assets of the mutual fund scheme. The investment management fees are regulated by SEBI as follows:
o o

For the first Rs.100 crore of net assets:-1.25% For net assets exceeding Rs.100 crore:-1.00%

Valuation of equity shares is done on basis of traded price; provided that price is not more than 30 days old. Illiquid securities can not be more than 15% of the portfolios net assets. Any illiquid assets above this limit have to be valued at zero. Thinly Traded Equity / Equity Related Securities: Equity / equity related instruments are thinly traded if:
o o o o o o

Monthly trading value is less than Rs. 5 lacs and value less than 50,000 share volume. When trading is suspended up to 30 days take the last traded price. Trading is suspended for more than 30 days AMC/Trustee to make valuation Thinly Traded Debt Securities: Traded value (other than g-sec) is less than Rs. 15 crore for a period of 30 days prior to valuation date. Non-Traded Securities: When not traded on any Stock Exchange for 30 days prior to valuation date. Non-traded/thinly traded securities shall be valued in good faith by AMC

The following expenses cannot be charged to the scheme:

Penalties and fines Interest on delayed payment to unit holders Expenses which is not related with schemes Expenses on investment management Expenses on general administration, corporate advertising and infrastructure costs Software development cost Other costs which are prohibited by SEBI

Tax Structure in Mutual Fund:

Mutual funds themselves pay no tax on the incomes they earn. They are fully exempt from tax. If an investor holds units for 12 months or less, any gain from selling the units is called as short-term capital gain

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Notes By Abhishek Kamdi E-Mail [email protected]

Short-term capital gains are taxable at the marginal rate of taxation of the investor If an investors holding period is more than 12 months, any gain or loss from sale is called as long-term capital gain. Long-term capital gain can be indexed for inflation Indexing refers to the updating of the purchase price, based on the cost of inflation index published by CBDT. The formula for indexation is purchase price X (index in the year of sale/index in the year of purchase) Investors can pay either 10% tax (plus surcharge) on the capital gain tax without indexation or 20% tax (plus surcharge) on capital gains after indexation, which ever is lower.

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 7. Investor Services

Learning Objectives Who can invest in mutual funds in India? What documentation is required? How do the sale and re-purchase transactions really get implemented? Individual and non-individual investors are permitted to invest in mutual funds in India. Foreign nationals, foreign entities and OCBs are not permitted to invest. Since FIIs are permitted to invest, foreign entities can take this route. The Who can invest section of the Offer Document is the best source to check on eligibility to invest. All investments of Rs 50,000 and above need to comply with KYC documentation viz. Proof of Identity, Proof of Address, PAN Card and Photograph. Once an investor obtains a Mutual Fund Identification Number (MIN) from CDSL Ventures Ltd, the investor can apply with any mutual fund. Micro SIPs i.e. SIPs with annual investment below Rs 50,000 is exempted from the PAN Card requirement. Simplified documentation has been prescribed in such cases. Besides KYC, non-individual investors need to provide additional documentation to support their investment. Demat makes it possible to trade in Units in the stock exchange. Full application form is to be filled for a first time investment in a mutual fund. Thereafter, additional investments in the same mutual fund are simpler. Only transaction slip would need to be filled. Investors can pay for their Unit purchases through cheque / DD, Net-based remittances, ECS / Standing Instructions or ASBA. MBanking is likely to increase in importance in the days to come. Non-resident investment on repatriation basis has to be paid through cheque on NRE account, or a bankers certificate that investment is made out of moneys remitted from abroad. Transaction Slip can be used for re-purchase. Investors can indicate the amount to repurchase or the number of units to repurchase. Cut-off timings have been specified for different types of schemes and different contexts to determine the applicable NAV for sale and re-purchase transactions. These are not applicable for NFOs and International Schemes. Time Stamping is a mechanism to ensure that the cut-off timing is strictly followed. NSEs platform is called NEAT MFSS. BSEs platform is BSE STAR Mutual Funds Platform.

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Notes By Abhishek Kamdi E-Mail [email protected] Dividend payout, Dividend investment and Growth are 3 possible options within a scheme. Each option has different implications on the investors bank account, investors taxation and scheme NAV. A constant amount is regularly invested in SIP, withdrawn in SWP and transferred between schemes in STP. These minimize the risk of timing the decisions wrongly. Triggers are another way of bring discipline into investing. Nomination and Pledge options are available for mutual fund investors. Investment Pattern:

The investment pattern of the fund is primarily dictated by the fund objectives A fund manager whose style is value investing, will prefer to invest in established profit making companies, and will buy only if the price is right. He will look for undervalued shares, which have value proposition that is yet to be recognized by the market. A fund manager, whose style is growth, is more aggressive and is willing to invest in companies with future profit potential. He is willing to buy even if the stock looks expensive. He focuses on sectors that are expected to do well in future, and will be willing to buy them even at higher prices. Equity stocks can be classified as large cap and small cap stocks Large cap stocks are liquid and trade every day. They are established companies offering normal profit potential. Small cap stocks provide higher return potential. But they are generally not very liquid. Cyclical stocks are those whose performance is closely linked to macro economical factors. P/E ratio is the ratio of earnings per share (EPS) to market price per share. Growth shares sell at higher P/E ratios than value shares. Dividend yield is the ratio between the dividend per share and market price per share. Growth shares have lower dividend yields than value shares.

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Notes By Abhishek Kamdi E-Mail [email protected]

If market prices move up, P/E ratios are higher and dividend yields are lower. An active fund manager hopes to do better than the market by selecting companies, which he believes, will outperform the market. A passive fund manager simply replicates the index, and hopes to do as well as the index. A passive fund manager tries to keep costs down and has to rebalance his portfolio if the composition of the index changes. Fundamental analysis is the analysis of the profit potential of a company, based on the numbers relating to products, sales, costs, profits etc. and the management of a company. Technical analysis is an analysis of market price and volumes, to identify clues to the market assessment of a stock. A fund manager focuses on asset allocation; a dealer buys and sells shares; and an analysts researches company and recommends them for buy and sell.

Investment Plans:

Automatic Reinvestment Plan (ARP): Reinvestment plan reinvest the amount of dividends in the same scheme instead of receiving cash. Systematic Investment Plan (SIP): It requires the investor to invest a fixed amount periodically and hence save investing amount in a disciplined manner. Rupee Cost Averaging is one of the most important benefits of SIP. Systematic Withdrawal Plans (SWP): It allows investor to withdraw some amount either fixed or variable amount from scheme. Systematic Transfer Plan (STP): It allows the investor to transfer on a periodic basis a specified amount from one scheme to another with the same fund family.

Debt Instruments:

Debt instruments are issued by government, banks and companies They can pay interest on fixed rates, floating rates or on discounted basis If no interest is paid, such an instrument is zero coupon instruments Debt markets are wholesale markets in which large institutional investors operate

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Notes By Abhishek Kamdi E-Mail [email protected]

Banks are the largest players in the debt markets About 96% of secondary market trading happens in government securities Principle values, par value, or face value is the amount representing the principle borrowed and the rate of interest is calculated on this sum. On redemption this amount is payable. Coupon is the interest paid periodically to the investor. Maturity date is the date on which a bond is redeemed. Term to maturity or tenor is the period remaining for the bond to mature. Put option refers to the option to the investor to redeem the bond before maturity Call option is the option to the borrower to redeem before maturity If interest rates go up, above the coupon rate, investors may exercise the put option. If interest rates fall below the coupon rate, issuers may exercise the call option. Current yield is the ration of coupon amount to market price of a bond. If a bond, paying coupon at 8% is selling in the market for Rs.105, the current yield is 8/105=7.62% Changes in interest rates impacts bond values, in the opposite direction. An increase in interest rates leads to a fall in bond values; a decrease in interest rates leads to an increase in bond values. Duration of a bond helps measure the interest rate risk of a bond. It is weighted average maturity of a bond. Credit risk refers to the risk of default The base rate or benchmark rate in the bond market is the rate at which the government borrows in the market. All other borrowers pay a rate that is higher, due to the presence of credit risk. The difference between the benchmark rate and the rate that is paid by other borrowers is called the credit spread. (Called as yield spread in the AMFI book).

Investment by Mutual Fund:

Mutual funds can invest in only marketable securities

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Notes By Abhishek Kamdi E-Mail [email protected]

A mutual fund, under all its schemes, cannot hold more than 10% of the paid-up capital of a company. Except in the case of Sectoral funds and index funds, a mutual fund scheme cannot invest more than 10% of its NAV in a single company. Investments in rated investment grade issues of a single issuer cannot exceed 15% of the net assets and can be extended to 20% with the approval of the trustees Investment in unrated securities can not exceed 10% of the net assets for one issue and 25% of net assets for all such issues Investment in unlisted shares cannot exceed 5% of net assets of an open-ended scheme, and 10% of net assets for a closed end scheme Inter scheme transfers are allowed by the SEBI regulations, provided, Such transfers happens on a delivery basis, at market prices Such transfers do not result in significantly altering the investment objectives of the schemes involved. Such transfer is not of illiquid securities, as defined in the valuation norms A mutual fund can borrow a sum not exceeding 20% of its net assets, for a period not exceeding 6 months. This facility is clearly designed as a stopgap arrangement, and is not a permanent source of funds for the scheme. A fund can borrow only to meet liquidity requirements for paying dividend or meeting redemptions All investment made in the marketable securities of the sponsor and its associated companies must be disclosed by the mutual fund in its annualized report and offer document. A mutual fund scheme cannot invest in unlisted securities of the sponsor or an associate or group company of the sponsor. A mutual fund scheme cannot invest in privately placed securities of the sponsor or its associates. Investment by a scheme in listed securities of the sponsor or associate companies or group companies of sponsor cannot exceed 25% of the net assets of the scheme Mutual funds were allowed to make use of Future & Options contracts in Equities for Portfolio risk management Portfolio Rebalancing

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Notes By Abhishek Kamdi E-Mail [email protected]

Since September 2005 SEBI has also allowed mutual fund to trade in Derivatives contracts to enhance portfolio returns, to launch schemes which invest mainly in Future & Options

Equity Derivatives:

Equity derivatives instruments are specially designed contracts They derive their value from an underlying asset They are traded separately in F&O segment of Exchange Mainly derivative instruments are Future and Options In a future contract you can buy and sell the underlying equity at a specified future date at agreed price. Contract is liquidated before maturity date without taking or giving delivery of underlying asset. In option contract the buy gets the right to buy or sell the underlying equity at agreed price on a future date only if he exercises the options & for this right he pays a price called Premium. Option contracts are of two types: If Fund manager expects the equity market to decline: he may not sell the equity in the Cash Market. But can sell the index Future at the current price for future delivery. If markets fall the equity portfolio value will decline, but future contract will show a corresponding profit, since fund manager has sold future contract at a higher price. If market rises equity portfolio value will rise but future contract will show corresponding loss, since fund manager has sold future contract at lower price. This is called Hedging Portfolio risk. Other method of hedging investment portfolio risk by buying a Put Option (an option to sell the underlying equity at an agreed price) by paying premium A fund manager can execute the option only if the price falls, since he has right to sell at a higher price If the price rises he will not execute the option and forgo the premium.

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 8. Return, Risk & Performance of Funds

Learning Objectives This unit is an invaluable guide to understanding the risk and return aspects of mutual fund schemes. Here, you will understand the nitty-gritty of how to calculate the returns from a mutual fund, and gain an overview of how risk can be measured. Benchmarking and risk adjusted returns are other key concepts discussed in this unit. The portfolio is the main driver of returns in a mutual fund scheme. The underlying factors are different for each asset class. Fundamental Analysis and Technical Analysis are two disciplines of securities analysis. Fundamental Analysis entails review of the companys fundamentals viz. financial statements, quality of management, competitive position in its product / service market etc. Technical analysts study price-volume charts of the companys share prices. It is generally agreed that longer term investment decisions are best taken through a fundamental analysis approach, while technical analysis comes in handy for shorter term speculative decisions, including intra-day trading. Even where a fundamental analysisbased decision has been taken on a stock, technical analysis might help decide when to implement the decision i.e. the timing. Growth investment style entails investing in high growth stocks. Value investment style is an approach of picking up stocks which are valued lower, based on fundamental analysis. In a top-down approach, sector allocation is the key decision. Stock selection is important in bottom-up approach. The returns in a debt portfolio are largely driven by interest rates and yield spreads. If the portfolio manager expects interest rates to rise, then the portfolio is switched towards a higher proportion of floating rate instruments; or fixed rate instruments of shorter tenor. On the other hand, if the expectation is that interest rates would fall, then the manager increases the exposure to longer term fixed rate debt securities. This additional return offered by a non-government issuer, above the yield that the government offers, is called yield spread. Better the credit quality, lower the yield spread. Gold is a truly international asset, whose quality can be objectively measured. The value of gold in India depends on the international price of gold (which is quoted in foreign currency), the exchange rate for converting the currency into Indian rupees, and any duties on the import of gold. Unlike gold, which is a global asset, real estate is a local asset. It cannot be transported

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Notes By Abhishek Kamdi E-Mail [email protected] and its value is driven by local factors. Returns can be measured in various ways Simple Returns, Annualised Returns, Compounded Returns, Compounded Annual Growth Rate. CAGR assumes that all dividend payouts are reinvested in the scheme at the ex-dividend NAV. SEBI guidelines govern disclosures of return by mutual fund schemes. Loads and taxes pull the investors returns below that earned by the Scheme. Investor returns are also influenced by various actions of the investor himself. Risks in mutual fund schemes would depend on the nature of portfolio, its liquidity, outside liabilities and composition of unit holders. Fluctuation in returns is a measure of risk. Variance and Standard Deviation are risk measures for all kinds of schemes; beta is relevant for equity; modified duration and weighted average maturity are applicable for debt schemes. Benchmarking is a form of relative returns comparison. It helps in assessing underperformance or out-performance. Choice of benchmark depends on scheme type, choice of investment universe, choice of portfolio concentration and the underlying exposure. Sharpe Ratio, Treynor Ratio and Alpha are bases to evaluate a fund managers performance based on risk-adjusted returns. Quantitative measures are based on historical performance, which may or may not be replicated in future. Scheme evaluation is an art, not a science. Classification of Equity Shares:

Classification in terms of Market capitalization: Large-Cap, Mid-Cap & SmallCap Capitalization companies. Classification in terms of Earnings: Earnings of the companies are generally classified on the basis of their market price in relation to one of the following measures:

Price/Earning Share:

It is the price of a share divided by the earnings per share, and indicates what the investors are willing to pay for the companys earning potential.

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Notes By Abhishek Kamdi E-Mail [email protected]

Young and/or fast growing companies usually have high P/E ratios. Established companies may have lower P/E

Dividend Yield:

DY of the stock is the ratio of dividend paid per share to current market price. Low P/E stocks usually have high dividend yields.

Cyclical Stocks:

These are shares of companies whose earnings are correlated with this state of the economy.

Growth Stocks:

These are shares of companies whose earnings are expected to increase at above normal market level. They reinvest the profit.

Value Stock:

These are stocks of companies in mature industries and are expected to yield low growth in earnings.

Portfolio Management:

Portfolio Management has two styles: 1. Passive 2. Active Passive Fund Management: There are mutual funds that offer stock index funds whose objectives is to track a specified share index and offer returns equal to the return from that index. The investment style is passive only in the sense that the fund manager does not have to go through the process of stock selection. Active Fund Management: There are two basic investment styles in active fund management: Growth Investment Style: Invest only in growth stocks which give above average earnings growth. Value Investment Style: Invest in companies that are currently undervalued in the market, but whose worth they estimate will be recognized in the market valuations. Securities Research in Active Fund Management: Following are the three major categories are in Securities Research. Fundamental Analysis: It involves research into the operations and finances of a company.

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Notes By Abhishek Kamdi E-Mail [email protected]

Technical Analysis: It involves the study of historical data on the companys share-price movements and trading volume. Quantitative Analysis: It uses mathematical models for equity valuation and may use fundamental and technical information. Now a days computer based models (exclusively made sophisticated high level software) are uses for such analysis. Portfolio Management Organization Structure: Three types of skilled employees in the equity portfolio management function: Fund Managers: They take overall decisions on asset allocations industry exposures. Security Analysts & Researchers: They support the fund managers with continuous tracking of the funds target sectors, companies and the overall markets. Both fundamental and technical analyses are performed by the analysts. Security Dealers: Executes the actual buy and sell orders originated by the fund managers. Debt Instruments: Following are the debt instruments available in the market Certificate of Deposit (CD): CD is issued scheduled commercial banks. Its having maturity period of 91 days to one year. Commercial Paper: This is a short term, unsecured instrument issued by corporate bodies to meet short term working capital requirements. These instruments can be issued to individual, banks, companies etc. Corporate Debentures: These are issued by manufacturing companies with physical asset as secured instruments in the form of certificates. They are assigned a credit rating by rating credit agencies. Floating Rate Bonds: These are short to medium term interest-bearing instruments issued by financial intermediaries and corporations. Maturity of these bonds is 3 to 5 years. Treasury Bills: Treasury bills are also called as T-Bills. These are short term obligations issued through the RBI by the government of India at a discount for 91 days to 364 days. Theses are issued through an auction procedure. The yield is determined on the basis of bids tendered and accepted. Bank/FI Bonds: These are negotiable certificates issued by FI such as the IDBI/ICICI etc. Theses have been issued both as regular income bonds and as discounted long term instruments (deep discount bonds)

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Notes By Abhishek Kamdi E-Mail [email protected]

Public Sector Undertakings (PSU) Bonds: These are medium and long term obligations by public sector companies in which the government share holding is generally greater than 51%. Some PSU bonds carry tax exemptions having minimum maturity of 5 years for taxable bonds and 7 years for tax free bonds.

SEBI guidelines in different investments:

A mutual fund is not allowed to own more than 10% of any companys equities. This is to prevent MF fund sponsors trying to acquire control pf any company through fund investment route. A scheme may invest in another scheme under the same AMC without charging any fees, provided investments limits of 5% of the NAV of Mutual Fund. This limit does not apply to a fund of fund scheme. Debt securities should be rated as investment grade by at least one recognized rating agency. Mutual funds are allowed to buy and sell only delivery based securities. Mutual funds are not allowed to advance any loans but may lend securities as per SEBI stock lending regulations. Mutual funds are restricted to invest not more than 25% of the net assets of any of mf schemes to the companies of sponsor. A fund of funds invests in schemes of other mutual funds. But a normal mutual fund scheme cannot invest in any FOF scheme. Also, a FOF scheme cannot invest in another FOF scheme.

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 9. Scheme Selection

Learning Points This unit will help you do this. It also informs you about the sources where you can easily access data related to mutual fund schemes. Asset allocation is the approach of spreading ones investments between multiple asset classes to diversify the underlying risk. The sequence of decision making in selecting a scheme is: Step 1 Deciding on the scheme category (based on asset allocation); Step 2 Selecting a scheme within the category; Step 3 Selecting the right option within the scheme. While investing in equity funds, a principle to internalize is that markets are more predictable in the long term, than in the short term. So, it is better to consider equity funds, when the investment horizon is adequately long. In an actively managed diversified fund, the fund manager performs the role of ensuring higher exposure to the better performing sectors or stocks. An investor, investing or taking money out of a sector fund has effectively taken up the role of making the sector choices. It can be risky to invest in mid-cap / small cap funds during periods of economic turmoil. As the economy recovers, and investors start investing in the market, the valuations in front-line stocks turn expensive. At this stage, the mid-cap / small cap funds offer attractive investment opportunities. Over longer periods, some of the mid/small cap companies have the potential to become large cap companies thus rewarding investors. Arbitrage funds are not meant for equity risk exposure, but to lock into a better riskreturn relationship than liquid funds and ride on the tax benefits that equity schemes offer. The comparable for a liquid scheme in the case of retail investors is a savings bank account. Switching some of the savings bank deposits into liquid schemes can improve the returns for him. Businesses, which in any case do not earn a return on their current account, can transfer some of the surpluses to liquid schemes. Balanced schemes offer the benefit of diversity of asset classes within the scheme. A single investment gives exposure to both debt and equity. Investors need to understand the structure of the gold schemes more closely, before investing. Equity investors would like to convince themselves that the sectors and companies where the scheme has taken higher exposure, are sectors / companies that are indeed promising.

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Notes By Abhishek Kamdi E-Mail [email protected] Debt investors would ensure that the weighted average maturity of the portfolio is in line with their view on interest rates. Investors in non-gilt debt schemes will keep an eye on credit quality of the portfolio and watch out for sector concentration in the portfolio, even if the securities have a high credit rating. Any cost is a drag on investors returns. Investors need to be particularly careful about the cost structure of debt schemes. Amongst index schemes, tracking error is a basis to select the better scheme. Lower the tracking error, the better it is. Similarly, Gold ETFs need to be selected based on how well they track gold prices. Mutual fund research agencies assign a rank to the performance of each scheme within a scheme category (ranking). Some of these analyses cluster the schemes within a category into groups, based on well-defined performance traits (rating). Seeking to be invested in the best fund in every category in every quarter is neither an ideal objective, nor a feasible target proposition. Indeed, the costs associated with switching between schemes are likely to severely impact the investors returns. The underlying returns in a scheme, arising out of its portfolio and cost economics, is what is available for investors in its various options viz. Dividend payout, dividend reinvestment and growth options. Dividend payout option has the benefit of money flow to the investor; growth option has the benefit of letting the money grow in the fund on gross basis (i.e. without annual taxation). Dividend re- investment option neither gives the cash flows nor allows the money to grow in the fund on gross basis. Taxation and liquidity needs are a factor in deciding between the options. The advisor needs to understand the investors situation before advising. Many AMCs, distribution houses and mutual fund research houses offer free tools in their website to help understand performance of schemes.

Investors generally compute Return on Investment (ROI). Change in NAV is a very easy approach to find out the ROI. The following are the important characteristics:

The Expense Ratio:

It is the ratio of total expenses to average net assets of the fund.

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Notes By Abhishek Kamdi E-Mail [email protected]

It indicates the funds efficiency and cost effectiveness. It is important to note that brokerage commissions on the funds transactions are not included in the fund expenses figure while computing this ratio. The expense ratio is most important in case of bond funds or debt funds, since such funds performance can be adversely affected if a large proportion of its income is spent on expenses.

The Income Ratio:

It is the net investment income divided by its net assets for the period. For evaluating income oriented fund, particularly debt funds.

Portfolio Turnover Rate:

It is defined as the lesser of assets purchased or sold divided by the funds net assets. Portfolio turnover rate measures the amount of buying and selling of securities done by a fund. And hence net return can be lower with high transactions costs.

Transaction Costs:

It includes all expenses related to trading such as the brokerage commissions paid, stamp duty on transfers, registration fees and custodians fees. Brokerage commission is an important component of transaction costs. Transaction costs therefore have a significant bearing on fund performance and its total return. Funds with small size or small returns have to be judged more on their expense ratios and transactions costs, given their impact on total return.

Fund Size:

Fund size can affect performance. Small funds are easier to manage and can achieve their objectives in a focused manner with limited holdings. Large funds benefit from economies of scale with lower expense ratios and superior fund management skills. They also gain through greater risk bearing and management capacity.

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Notes By Abhishek Kamdi E-Mail [email protected] Cash Holdings:

Mutual funds allocate their assets among equity shares, debt securities and cash or bank deposits. The percentage of the funds portfolio held in cash equivalent can be an important element in its successful performance. A large cash holding allows the fund to strengthen its position in preferred securities without liquidation its other portfolios. Cash also allows the fund a cushion against decline in the market prices of shares or bonds.

Benchmark:

There are 3 types of Benchmarks for evaluating funds performance. Benchmarking relative to the market: If invested need to choose equity index fund than investor should compare return to the index fund with index only. This is passive investment management style. The fund would invest in the index stocks and expect its NAV changes to mirror the changes in the index itself. Benchmarking relating to the other similar MFs: These are those which compare the performance of different schemes with that of other fund managers schemes. Such comparisons are called peer group comparisons. Only average annualized compound returns are comparable. Benchmarking relative to other investment options or financial products: Means comparing with the market other financial products like FD, PPF, and NSC etc.

Ranking by external agencies:

Lipper Analytical Services, CRISIL, etc are the Credit rating agency which evaluated the fund performance of MF. CRISIL evaluates fund performance and ranks the schemes by performance. CRISIL ranks both debt and equity funds. The basic thing here for evaluating performance is funds financial performance, income/expense ration and total return etc. AMFIs Website: www.amfiindia.com provides meaningful guidance like past NAV history of fund, benchmark for all MF schemes etc. Financial Press like daily news paper the economic times, business standard etc

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Notes By Abhishek Kamdi E-Mail [email protected]

Fund Tracking agencies like www.valueresearchonline.com or www.moneycontrol.com etc. News letters by AMCs, renowned national stock brokers etc, Offer Document and KIM

Borrowing by MF:

In India, MF is not allowed to borrow to increase their corpus. SEBI regulations allow MF to borrow only for the purpose of meeting temporary liquidity needs for a period not exceeding six months and to the extent of 20% of its net assets. Hence, it would be uncommon to be fund schemes with borrowings on their balance sheets, and if borrowings are seen, caution may need to be exercised in evaluating the fund performance.

Tracking Error:

In order to obtain the same returns as the index, an index fund invests in all of the stock included in the index calculation, in the same proportion the stocks weightage in the index. An index funds actual return may, however, be better or worse by what is called the tracking error The tracking error arises from the practical difficulties faced by the fund manager in trying to always buy or sell stocks to remain in line with the weightage that the stocks enjoy in the index.

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 10. Selecting the Right Investment Products for Investors

Learning Objectives Investors tend to block their money in physical assets. This unit compares physical assets with financial assets. Distributors and financial advisors perform an invaluable role in helping investors decide on investment products. Mutual fund schemes are just one of the various alternatives that investors consider for investment. This unit discusses some of these alternatives in the context of mutual fund schemes. Physical assets like land, building and gold have value and can be touched, felt and used. Financial assets have value, but cannot be touched, felt or used as part of their core value. Shares, debentures, fixed deposits, bank accounts and mutual fund schemes are all examples of financial assets that investors normally invest in. The difference in comfort is perhaps a reason why nearly half the wealth of Indians is locked in physical assets. There are four financial asset alternatives to holding gold in physical form ETF Gold, Gold Sector Fund, Gold Futures & Gold Deposits. Wealth Tax is applicable on gold holding (beyond the jewellery meant for personal use). However, mutual fund schemes (gold linked or otherwise) and gold deposit schemes are exempted from Wealth Tax. Real estate in physical form has several disadvantages. Therefore, investors worldwide prefer financial assets as a form of real estate investment. Bank deposits and mutual fund debt schemes have their respective merits and demerits. Pension Funds Regulatory and Development Authority (PFRDA) is the regulator for the New Pension Scheme. Two kinds of pension accounts are envisaged: Tier I (Pension account), is non withdrawable. Tier II (Savings account) is withdrawable to meet financial contingencies. An active Tier I account is a pre-requisite for opening a Tier II account. The NPS offers fewer portfolio choices than mutual funds. However, NPS offers the convenience of a single Personal Retirement Account Number (PRAN), which is applicable across all the PFMs where the investors money is invested. Further, the POPs offer services related to moneys invested with any of the PFMs. Financial Planning

Financial Planning is the overall process of advising clients on how to achieve their financial goals.

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Notes By Abhishek Kamdi E-Mail [email protected]

The objective of financial planning is to ensure that the right amount of money is available in the right hands at the right point in the future to achieve an individuals financial goal. Financial planning is the process that helps a person work out where he/she is now, what he/she may need in the future and what he/she must do to reach the defined goals. The role of financial planner is one of the most respected professions in the developed countries. It is for the same reason the profession for financial planning is emerging. Financial health is as important as physical and spiritual health and people should approach a financial planner who can advise them on achieving financial fitness. The Financial Planner is someone who uses the financial planning process to help another person determine how to meet his or her life goals. The planner can look at all of clients needs including budgeting and saving, taxes, investments, insurance and retirement planning. Risk tolerance of an investor is not dependent on the market, but his own situations.

Characteristics of Good Financial Planner:

Capacity to build trust with the client Good knowledge of financial products Familiarity with taxation Knowledge of life and wealth cycle Regular in touch with clients Client need focus rather than own benefit focus

Financial Plan:

It is the document that details clearly in writing the financial goals, available resources, time frame for investment, asset allocation and implementing the financial planners recommendations. The life cycle stages of an investor can be classified as follows:
o o o o o

Childhood stage Young unmarried stage Young marriage with children stage Married with older children stage Pre-retirement stage

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Notes By Abhishek Kamdi E-Mail [email protected]

o

Retirement stage

The income level of investors, the saving potential, the time horizon and the risk appetite of an investor depend on his life cycle. Younger investors have higher income and saving potential, take longer-term view and may be willing to take risks. Older investors may have limited income and saving, shorter time horizon, and unwilling to risk their savings. There are 3 wealth cycle stages for investors: Accumulation Stage is when investors are earning and have limited need for investment income. They focus on saving and accumulating wealth for long term. Equity investments are preferred in this stage. Transition Stage is when financial goals are approaching investors still earn incomes, but have also draw on their earnings. Investors choose balanced portfolios that have both debt and equity. Reaping Stage or Distribution Stage: In this stage, investors need the income from their investment, and cannot save further. They reap the benefits of their savings. They prefer debt investments and preserving of capital at this stage. Inter-generational fund transfer refers to transfer of wealth to an investor. Such sudden wealth surge refers to winning in games and lotteries investors should be advised to temporarily park their funds in money market investments and create a long-term plan after thinking through the plan. They must also take into account the impact of tax.

Affluent investors are of two types: 1. Wealth preserving investors who are risk-averse and like to invest in debt 2. Wealth creating investors who prefer growth and are willing to take the risk of equity investments Steps of Financial Planning & Closing:

Establishing and defining the client relationship Gathering client data, defining client goals Gather and Analyze data, assess the current resources and future income potential of the client Determine and shape the risk tolerance level of the client Analyzing and evaluating a clients financial status Determine the clients tax situation

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Notes By Abhishek Kamdi E-Mail [email protected]

Developing and presenting financial planning recommendations and options Recommend the appropriate asset allocation, and specific investments Executing the plan and making the client invest Implementing the financial planning recommendations Reviewing progress and portfolio rebalancing

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 11. Helping Investors with Financial Planning

Learning Objective Financial Planning is an approach to building long term relationships with clients. It is also a need for large sections of investors. This unit introduces the concept of financial planning. Financial planning is a planned and systematic approach to provide for the financial goals that will help people realise their aspirations, and feel happy. The costs related to financial goals, in todays terms, need to be translated into the rupee requirement in future. This is done using the formula A = P X (1 + i) n The objective of financial planning is to ensure that the right amount of money is available at the right time to meet the various financial goals of the investor. An objective of financial planning is also to let the investor know in advance, if some financial goal is not likely to be fulfilled. The process of financial planning helps in understanding the investor better, and cementing the relationship with the investors family. This becomes the basis for a long term relationship between the investor and the financial planner. A goal-oriented financial plan is a financial plan for a specific goal. An alternate approach is a comprehensive financial plan where all the financial goals of a person are taken together, and the investment strategies worked out on that basis The Certified Financial Planner Board of Standards (USA) proposes the following sequence of steps for a comprehensive financial plan: Establish and Define the Client-Planner Relationship Gather Client Data, Define Client Goals Analyse and Evaluate Clients Financial Status Develop and Present Financial Planning Recommendations and / or Options Implement the Financial Planning Recommendations Monitor the Financial Planning Recommendations Life Cycle and Wealth cycle approaches help understand the investor better

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Notes By Abhishek Kamdi E-Mail [email protected]

The first step in financial planning process and the basic tool needed to translate financial plans into action is what is known as Asset Allocation.

Financial Planning Strategies: Buy & Hold:

It is the most common strategy, and the most common mistake that investor make. Rather you should track your investments, discard the non performances stock and keep the good performers stock in your portfolio. Long term investment doesnt mean buy and hold without adjusting the portfolio to sort out winners from losers.

Rupee Cost Averaging:

Rupee Cost Averaging is regular discipline in which investor never loses. But there is the one limitations of rupee cost averaging i.e. it doesnt tell investor exactly when to buy or sell a fund. But in the long term investor always gain in the systematic investor plan because of rupee cost averaging.

Value Averaging:

The investor keeps the target value of his investment constant by investing the amount by which the investment value has come down or by cashing the increased value of his investment or by doing nothing if the value is unchanged.

Investing for long term:

Long term gives you the power of compounding In any MF scheme growth option means reinvestment of dividend. It is nothing but the power of compounding

Jacobs Recommendation:

It combines the rupee cost averaging and value averaging method. To accomplish this, Jacobs recommends using an aggressive growth fund and a money market fund of the same family. Place Rs.X in a liquid fund every month. Set a target value for the aggressive equity fund. Later if the value of equity fund has declined, transfer 100 from the liquid fund to the equity fund.

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Notes By Abhishek Kamdi E-Mail [email protected]

If the equity fund value has increased by 100 do nothing if the value has risen by 200 transfer 100 from equity fund to the liquid and book the profit.

Asset Allocation:

Asset allocation means determining the percentage of your investments to be held in equities, bonds and money market/cash instruments. Asset allocation is about allocating money between equities, debt and money market segments Asset allocation varies from investor to another depending on their situation financial goals and goals and risk appetites. Asset allocation depends for an investor on his life cycle and wealth cycle

Boggle Recommends following strategic allocations:

Older investors in distribution phase: 50/50 (equity/debt) Younger investors in distribution phase: 60/40 Older investors in accumulation phase: 70/30 Younger investors in accumulation phase: 80/20

Steps in developing a model portfolio for the investors:

Develop long term goals Determine asset allocation Determine sector distribution Select specific fund schemes for investment Boggle gives a simple thumb rule asset allocation i.e. debt proportion portfolio should equivalence to investor age. Example if investor age is 30yrs than its asset allocation would be 70/30 (equity/debt) and so on.

Benjamin Grahamins 50/50 Balance:

Benjamin Grahamin advocates 50/50 split between equities and bonds. When value of equities goes up, balance can be restored by liquidating part of the equity portfolio and vice versa.

As per Benjamin Graham Basic managed portfolio: Diversified Equity Value funds 50%

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Notes By Abhishek Kamdi E-Mail [email protected] Govt. Sec funds 25% High grade corporate bond fund 25% Basic Indexed portfolio: Stock Market Index Fund 50% Bond Market Index Fund 50% Simple Managed portfolio: Balanced Fund 85% Medium Term Bond Fund 15% Complex Managed Portfolio: Diversified Equity Fund 20% Aggressive Growth Fund 20% Specialty Fund 10% Long Term Bond Fund 30% Short Term Bond Fund 20% Readymade Portfolio: Single Index Fund with equity 60% & Debt 40% As per Jacobs Model Portfolio Accumulation Phase: Diversified Equity 65 to 80% Income & Gilt funds 15 to 30% Liquid funds 5% Distribution Phase:

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Notes By Abhishek Kamdi E-Mail [email protected] Diversified Equity 15 to 30% Income and gilt funds 65 to 80% Liquid funds 5%

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Notes By Abhishek Kamdi E-Mail [email protected]

Chapter 12. Recommending Model Portfolios and Financial Plans

Learning Objective This concluding Unit discusses three key aspects of financial planning how to understand the risk profile of investors, how to decide on an asset allocation mix for the investor, and an approach to deciding on model portfolios. There are differences between investors with respect to the levels of risk they are comfortable with (risk appetite). Risk profiling is an approach to understand the risk appetite of investors - an essential pre-requisite to advice investors on their investments. Risk profilers have their limitations. Risk profile is influenced by personal information, family information and financial information. Spreading ones exposure across different asset classes (equity, debt, gold, real estate etc.) balances the risk. Some international researches suggest that asset allocation and investment policy can better explain portfolio performance, as compared to being exposed to the right asset classes (asset allocation) is a more critical driver of portfolio profitability than selection of securities within an asset class (stock selection) and investment timing. Strategic Asset Allocation is the ideal that comes out of the risk profile of the individual. Tactical Asset Allocation is the decision that comes out of calls on the likely behaviour of the market. Financial planners often work with model portfolios the asset allocation mix that is most appropriate for different risk appetite levels. The financial planner would have a model portfolio for every distinct client profile. Asset Types: There are two types of Assets, 1. Physical Asset and 2. Financial Asset Physical Asset:

Real Estate and Gold are examples of physical assets Recently, the union Finance Minister has announced Gold Linked Unit Scheme launched by MF scheme. Real Estate has also been a preferred investment alternative with the Indian investor. However the capital required is often beyond the means of the small individual investor.

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Notes By Abhishek Kamdi E-Mail [email protected]

Quick liquidity is also one of the restrictions to enter into real estate. Good is news is that the investors who wants to invest in real estate but having less amount and also wants liquidity can invest through Real Estate MF scheme. Government has given green signal for Real Estate MF scheme which is going to be launched AMCs

Financial Asset:

In the financial asset category, Indian category have generally had guaranteed or fixed return products. Such as Bank Deposits, Company Deposits and Government savings instruments such as public provident fund, Indira Vikas Patra, National Saving Certificate etc Financial assets include capital market securities such as equity shares, bonds/debenture (issued by companies or FI), money market instruments such as commercial paper or certificates of deposits. Individual investor can buy capital market instruments but do not have any direct access to money markets instruments.

Major type of Financial Assets: Banks:

Bank Deposit have been a favored investment option with the Indian investor, mainly because of the liquidity and safety benefits, they think which is not so in most of cases. In fact the real reason of investment in banks FD by most of the common people is the unawareness about the other debt products and unawareness cause of very few MF advisors in the market. Yield on bank deposit is negligible after accounting for inflation and tax. While the return on the capital is guaranteed by the bank, deposit is not a secured investment, its perceived safety coming from the soundness of the bank management or ownership Investors should be advised to park only a part of their savings in bank deposits.

Corporate:

The corporate borrowers companies also issue debentures paying fixed rates of interest. Companies pays different rates of interest depending upon how strong their rating Credit Rating given by Credit rating agencies such as CRISIL, ICRA, CARE etc decides the secured ness of the companies debentures and hence its effect on interest rate given to the investor. Less the rating more the interest rate will given to investor and hence high would be the risk for investor and vice versa.

Financial Institutions (FI):

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Notes By Abhishek Kamdi E-Mail [email protected]

FI such as ICICI, IDBI issues bonds on a regular basis. These bonds issued with the intent of financing infrastructure development in the country. These bonds qualify for a tax deduction under section 80C. Because of its government utility purpose they are been treated much secured one.

Government:

Public Provident Fund (PPF): PPF is a government obligation, hence virtually risk free. PPF carries tax free interest of 8% PA and eligible for tax rebate under section 80C Indira & Kisan Vikas Patra (IVP/KVP): The current yield is 8% over the 6 years but fully taxable hence less attractive. RBI Relief Bond: These issued by the RBI pay interest at 8% which is taxable and have maturity period of 5 years. Other National Saving Scheme: Other National scheme such as Post Office accounts, Recurring Deposits etc. Now a days it not so popular. Government Securities: This is Government paper normally issued on a long term basis. The amount required for direct investments can be large. Hence, for large investors, they are best accessible through MF.

Life Insurance:

Premium paid on life insurance qualifies for deduction under sec 80C and maturity is also tax free under sec 10(10)D Hence investors prefer life insurance because it also acts as forced saving apart from tax saving and life insurance But careful evaluation proved that investor should buy insurance, not just as an investment but mainly to provide for his dependents in as of his untimely death. ULIP: A recently developed phenomenon between MF and insurance companies has been the development of Unit Linked Insurance Plans offered both life insurance as well as investment in MF by life insurance organization. ULIP combines the benefits of MF investing with the added benefit of life insurance.

Features of PPF:

15 year deposit product made available through banks Risk-free government obligation Open to individuals and HUFs Only one account permitted per entity Offers tax-free interest of 8% P.A. and contribution up to Rs.70,000 (min Rs.500) are eligible for deduction under sec 80C Option to withdraw 50% of 4th year balance in the 7 year Restriction on withdrawal reduces liquidity Interest receipt and withdrawal of principal exempt from tax. Only individuals and HUFs are eligible to invest

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Notes By Abhishek Kamdi E-Mail [email protected] Features of RBI Relief Bonds:

Issued by RBI on behalf of the Government of India A 5-year investment product with 8% interest offering Interest is currently taxable (used to be tax free earlier) and payable semi-annually Free of risk of default

Government Securities:

Long term government paper Risk-free government obligation Low-return and define the benchmark rate of return on the yield curve Specially appointed Primary dealers deal in G-Secs Generally high ticket investments Best accessible to small investors through mutual funds

Features of other Government Schemes

Indira Vikas Patra and KVP issued by central government and sold by post offices Current yield on IVP is 8% Interest is taxable Investor identity is protected and investment in cash is possible

Direct Equity Investment (Share Trading) vs Investment through Mutual Funds

Investment through mutual funds is more secured, easy, convenient and profitable than direct equity investment because o In direct investment investor need to identify good return stock by themselves which is very critical and need specialization with time and infrastructure. o Whereas MF specialize in this area which carry out the research and analysis by team of fund managers whom are dedicated for that job only. o MF gives investor a broad diversification and hence risk reduction even by investing small amount which is not possible in direct investment o MF provides much professional management advice which is not in direct investment o Tax saving along with market linked investment return is only in MF o Low level of transaction cost in MF because of economies of scale. o MF gives investors a complete satisfaction, complete peace of mind with convenience.

Bank Deposit vs. Debt Funds

Bank deposit is guaranteed by the bank for repayment of principal and interest Any risk associated with investment of the investors funds have to be borne by the bank

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Notes By Abhishek Kamdi E-Mail [email protected]

The depositor has a contractual commitment from the bank to pay A mutual fund, on the other hand, invests at the risk of the investor Hence, there is no contractual guarantee for repayment of principal or interest to the investor The investor need to assess the risk in terms of the credit rating of the bank, which provides an indication of the financial soundness of the bank. In case of investments in debt funds, investor needs to know whether the fund invests in high quality assets or lower rated debt. It can be seen that the bank deposits are not totally free from risk A conservative debt fund can give higher returns than a bank deposit.

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