Mutual Funds

What are Mutual Funds?

1. A mutual fund is an investment vehicle that pools funds from investors
and invests in equities, bonds, government securities, gold, and other
assets.
2. Companies that qualify to set up mutual funds, create Asset Management
Companies (AMCs) or Fund Houses, which pool in the money from
investors, market mutual funds, manage investments, and enable
investor transactions.
3. Mutual funds are managed by sound financial professionals known as
fund managers, who have the expertise in analyzing and managing
investments.
4. The funds collected from investors in mutual funds are invested by the fund
managers in different financial assets such as stocks, bonds, and other
assets, as defined by the fund’s investment objective.
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What are Mutual Funds?
5. Where and when to invest are some of the things taken care of by the
fund managers, amongst many other responsibilities.
6. For the fund’s management, the AMC charges a fee to the investor
known as the expense ratio.
7. It is not a fixed fee and varies from one mutual fund to another.
8. SEBI has defined the maximum limit of the expense ratio that can
be charged on the basis of the total assets of the fund.
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Mutual Fund - Mechanism?
 Mutual Funds
The Legal Structure of Mutual Funds
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Functions of Mutual Funds:
1. New fund offer (NFO) release:
a. An AMC can start a mutual fund scheme by launching its NFO.
b. It creates and shares the strategy of the scheme before its launch.
c. Investors can then decide whether and how much they should invest.
d. NFO units are often priced at a low ticket, such as Rs 10.
2. Pooling money:
a. After the NFO, fund houses receive funds from interested investors to
purchase shares in stocks, bonds, and other assets.
b. Investors who didn’t participate in the NFO can still buy the units of
the fund after it gets operational.
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Functions of Mutual Funds:
3. Investments in securities:
a. The scheme’s strategy determines how the fund manager will invest the funds.
b. The fund manager does extensive research on the economy, industries, and
companies before making an investment decision.
c. He then buys the most appropriate securities that will generate optimum
returns for unitholders.
4. Return of funds:
a. As mutual funds generate returns, the gains can be distributed among
investors or retained in the scheme for further growth.
b. Investors receive payouts if they choose the IDCW option (income
distribution cum capital withdrawal).
c. If they choose the growth option, the gains are retained in the scheme and
allowed to grow further.
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Types of Mutual Funds:
1. There are multiple ways in which mutual funds can be categorized, for
example, the way they are structured, the kind of securities they hold,
their investment strategies, etc.
2. The Securities and Exchange Board of India (SEBI) has classified mutual
funds based on where they invest:
Based on the structure:
a. Open-ended funds - are mutual funds that allows us to invest and
redeem investments at any time, i.e. they are perpetual in nature.
b. Close-ended schemes - have a fixed maturity date. One can invest at
the time of the new fund offer and redemption can only be done on
maturity.
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Based on Asset Class:
Equity Mutual Funds:
a. These funds invest at least 65% of their assets in stocks of companies listed
on the stock exchange.
b. They are more suitable as long-term investments (> 5 years) as stocks can
be volatile in the short term.
c. They have the potential to offer higher returns but also come with high risk.
Debt Mutual Funds:
a. Primarily invest in fixed-income instruments like Government securities,
corporate bonds, and other debt instruments.
b. They are not affected by stock market volatility and hence, can offer more
stable returns compared to equity mutual funds.
c. The types of debt mutual funds are differentiated on the basis of the maturity
period of the securities they hold..
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Based on Asset Class:
Hybrid Mutual Funds:
a. These funds invest in both equity and debt in varying proportions
depending on the investment objective of the fund.
b. These funds exhibits the diversified exposure to various asset
classes.
c. Hybrid funds are categorized on the basis of their allocation to
equity and debt.
Index Funds: Aims to replicate the performance of a specific stock
market index, like Nifty 50 or SENSEX. It is a passive approach.
Sector Funds: These funds concentrate on specific sectors of the
economy, such as technology, healthcare, banking, etc. They are
risky because of concentrated focus.
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Tax Saving Funds (ELSS): These funds offer tax benefits under Section
80C of the Income Tax Act. They have a lock-in period of three
months.
Liquid Funds: These funds invest in short-term money market
instruments, providing high liquidity and safety for short-term
parking of funds.
Gilt Funds: These funds invest in government securities, which are
considered to be among the safest investments. They are suitable for
conservative investors.
Gold Funds: These funds invest in gold-related instruments, offering
investors exposure to the price movement of gold without owning
physical gold.
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Thematic Funds: These funds invest in a specific theme or idea, such as
infrastructure, consumption, or sustainability.
Multi-Asset Allocation Funds: These funds invest in a mix of equity, debt,
and other assets to provide diversification across various asset classes.
Retirement Funds: Also called pension funds, these are designed to help
investors save for their retirement and offer tax benefits.
Dividend Yield Fund: These funds focus on investing in stocks that offer high
dividend yields, aiming to provide regular income to investors.
Aggressive Growth Funds: These funds aim for high capital appreciation by
investing in high-growth potential stocks.
International Funds: Also know as overseas funds, invest in international
markets and provide Indian investors exposure to global stocks and bonds.
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Overnight Funds: These funds invest in a one-day maturity securities,
overnight positions expose the traders to risk from adverse
movements that occur after normal trading closes often used by
corporates for parking.
Money Market Funds: MMFs focus on short-term government se(less
than a year maturity), considered to be ideal for stable, non volatile
investments with minimal interest risk.
Banking & PSU Funds: A minimum 80% of their investments are into
debt securities issued by banks, public sector undertakings
(PSUs), municipal bonds, and public financial institutions, among
others. These are suitable for short to medium-term investment
needs.
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Risk/Return trade-off by mutual fund category:
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Mutual Funds – Objectives?
Diversification:
a. It is usually advised not to put all your eggs in one basket.
b. Doing so can disproportionately increase your risk.
c. Mutual funds are inherently diversified.
d. They diversify across securities, assets, and even geographies.
Hence, they help lower the risk.
Capital protection:
a. Some mutual funds, such as money-market funds and liquid funds,
aim to protect your capital.
b. However, while they are relatively safer, they also have lower
returns.
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Mutual Funds – Objectives?
Capital growth:
a. Certain mutual funds, such as equity funds, focus on growth to
protect your investment against inflation.
b. These funds invest in stocks and have higher returns but also
come with higher risks.
Saving tax:
a. A certain class of mutual funds, called equity-linked savings
schemes (ELSS) or tax-saving funds, also provide income-tax
deductions up to Rs 1.5 lakh in a financial year in the old income-
tax regime.
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What is Mutual Fund NAV?
a. Mutual fund net asset value (NAV) represents a fund's per share
market value.
b. It is the price at which investors buy (bid price) fund shares from a
fund company and sell them (redemption price) to a fund company.
c. A fund's NAV is calculated by dividing the total value of all the cash
and securities in a fund's portfolio, less any liabilities, by the
number of shares outstanding.
NAV = (Assets - Liabilities) / Total number of outstanding shares.
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What is Mutual Fund NAV?
For example, let's say a mutual fund has $45 million invested in securities
and $5 million in cash for total assets of $50 million. The fund has
liabilities of $10 million. As a result, the fund would have a total value of
$40 million.
If the fund had 4 million shares outstanding, the price-per-share
value would be $40 million divided by 4 million, which equals a NAV
of $10 per share.
NAV per unit is the price at which investors can buy or redeem
their mutual fund investments.
Investors in mutual funds are allotted units proportional to their
investments and this is calculated on the basis of the NAV.
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How Mutual Funds Work?
NAV per unit is the price at which investors can buy or redeem
their mutual fund investments.
Investors in mutual funds are allotted units proportional to their
investments and this is calculated on the basis of the NAV.
For example, if you invest Rs 500 in a mutual fund with an NAV of Rs
10, you will get (500/10) = 50 units of the mutual fund.
a. The NAV of the mutual fund changes every day on the basis of the
performance of the assets in the mutual fund is invested in.
b. If a mutual fund invests in a particular stock whose price goes up
tomorrow, the same will reflect in the NAV of the mutual fund and vice
versa.
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How Mutual Funds Work?
So, in the above example, if the NAV of the mutual fund goes up to Rs 20,
then your 50 units that amounted to Rs 500 earlier will now amount to
Rs 1000 (500 units x Rs 20). Hence, the mutual fund’s performance is
driven by its underlying assets, which generate its returns to investors.
If you redeem your mutual fund units, you shall receive Rs 1000 against the
Rs 500 you originally paid. This gain of Rs 500 is known as a capital
gain.
The market value of the mutual fund portfolio is not fixed but varies
every day; consequently, NAV also tends to change daily, based on the
valuation of the fund portfolio. Hence, this gain of Rs 500 can be a loss also,
depending on how the NAV moves and the underlying assets perform. Since
mutual fund investments are market-linked, the returns are not
guaranteed and are also, dynamic in nature.
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How Mutual Funds Work?
Mutual fund returns (capital gains) are subject to tax, known as
capital gains tax.
Capital gains tax will impact when you choose to redeem your
investment; like in the example above you will be liable to pay a tax on
the Rs 500 you have earned. Bear in mind two things though:
a.The capital gains tax is applicable only if you redeem the investment
and not if you stay invested.
b.The extent of capital gains tax will depend on the types of mutual
funds and your investment holding.
Mutual funds are subject to short-term capital gains tax (STCG) and
long-term capital gains tax (LTCG). The periods of short-term and
long-term capital gains tax are defined differently for mutual funds.
 Mutual Funds - Growth in India
Growth of Indian Mutual Funds:
1. The Mutual Fund industry in India had its beginning in 1963.
2. The Unit Trust of India (UTI) was formed through a
Parliamentary act and was under the supervision of the Reserve
Bank of India (RBI).
3. UTI launched the first mutual fund scheme in India called Unit
Scheme 1964.
4. During the years 1987-1993, the mutual fund industry saw the inflow
of several funds started by public sector banks and state-run
insurance companies.
5. In 1987, the first ‘non-UTI’ fund was set up by the State Bank of
India. Following this Punjab National Bank, Canara Bank, Indian
Bank, Bank of Baroda and LIC set up mutual funds too.
 Mutual Funds - Growth in India
Growth of Indian Mutual Funds:
6. The establishment of the Securities Exchange Board of India (SEBI) in April 1992
helped in the promotion of a more mature and regulated Indian securities market, with
a focus on the protection of investors’ interests.
7. SEBI came up with the first set of guidelines for the mutual fund industry in 1993.
8. The year also saw the launch of the first private mutual fund Kothari Pioneer. By the
end of 1993, there were about Rs 47,000 crore in assets under management by
mutual funds.
9. The industry expanded in the subsequent years with many foreign sponsors setting
up mutual funds in India. At the end of January 2003, there were 33 mutual fund
houses with a total AUM (Assets Under Management) of more than Rs 1.2 lakh
crore.
10. The AUM of the mutual funds of India has witnessed steady growth from ₹ 8.11 trillion
in June 2013 to ₹44.39 trillion in June 2023, which is five times in the last ten
years.
 Mutual Funds – Regulation in India
Who regulates mutual funds in India?
 Mutual Funds – Regulation in India
Who regulates mutual funds in India?
1. Primarily, mutual funds are regulated by the Securities and Exchange
Board of India (SEBI).
2. A mutual fund should have the approval of RBI in order to provide a
guaranteed returns scheme.
3. The Ministry of Finance acts as a supervisor of RBI and SEBI and
appellate authority under SEBI regulations.
4. The Association of Mutual Funds in India (AMFI) has been made to
develop this Mutual Fund Industry of India on professional and
ethical lines and to enhance and maintain standards in all areas
with a view to protect and promote the interests of mutual
funds and their unit holders.
 Mutual Funds – Regulation in India
Role of SEBI in Mutual Funds
SEBI has categorized mutual funds in India into five major categories
based on their investment objectives and underlying assets:
1. Equity Mutual Funds
2. Mutual Debt Funds
3. Hybrid Mutual Funds or Balanced Funds
4. Solution-Oriented Mutual Funds
These funds focus on a particular subject or investing purpose, including
retirement planning or raising children. They are locked in for five years or
until the predetermined objective is reached.
5. Other Funds
Sector-specific funds, index funds, exchange-traded funds all fall under this
category. These are the funds that do not fit in the above mentioned four
categories.
 Mutual Funds – Regulation in India
SEBI Guidelines for Mutual Funds Investors:
SEBI provides guidelines for mutual fund investors to make informed investment
decisions. Here are some key guidelines:
1. Properly assessment of Risk Appetite
Consider the financial goals and risk tolerance before making a mutual fund
investment. Recognize the risks of various fund types and select investments that fit
your risk tolerance.
2. Diversification of Asset Allocation
Invest in various asset classes, including debt, equity, and hybrid funds. By
lessening the influence of any single investment's performance on your portfolio,
diversification helps to reduce risks.
3. Long-Term Investment
Long-term investing objectives are typically better suited for mutual funds. Invest
with a long-term outlook to take advantage of the market's potential development and
endure short-term market swings.
 Mutual Funds – Regulation in India
SEBI Guidelines for Mutual Funds Investors:
4. Keep your portfolio simple
Be careful to make your portfolio simple enough. Pick a select few funds that fit
your investment objectives and risk appetite.
5. Do Proper research on the Funds
Do extensive study on the mutual funds you are thinking about. Evaluate their
historical performance, investment strategy, fund manager's track record,
expense ratios, and risk factors. Consider professional advice, read scheme-related
documents, and utilize reliable sources to make informed investment decisions.
 Mutual Funds – Regulation in India
SEBI - Key Regulations
SEBI has put forward a series of guidelines to aid in the functioning of the
mutual funds industry and maintain transparency. They are:
1. SEBI (Mutual Funds) Regulations, 1996
These regulations provide a comprehensive framework for establishing,
operating, and regulating mutual funds in India. They cover various aspects,
including registration requirements, investment restrictions, valuation norms,
disclosure norms, and code of conduct for mutual funds.
2. SEBI Guidelines on Mutual Fund Advertising
These guidelines outline the norms and standards for advertisements and
marketing materials used by mutual funds. They aim to ensure that
advertisements are fair, accurate, and not misleading. The guidelines
prescribe requirements for disclosing key information and caution against
unrealistic promises or projections.
 Mutual Funds – Regulation in India
SEBI - Key Regulations
3. SEBI Guidelines on Portfolio Disclosures
These guidelines mandate mutual funds to disclose their portfolios
periodically. The disclosure includes details of securities held, asset
allocation, sector-wise exposure, and other relevant information. The
objective is to enable investors to make informed investment decisions.
4. SEBI Guidelines on Investor Protection
These include guidelines on investor grievance redressal, measures to
prevent insider trading and fraudulent practices, risk management
guidelines, and disclosures to ensure investors receive accurate and
timely information.
 Mutual Funds – Regulation in India
SEBI - Key Regulations
5. SEBI Guidelines on Asset Management Companies
SEBI has prescribed guidelines and norms for asset management
companies (AMCs) that manage mutual funds. To guarantee the effective
and moral operation of AMCs, these recommendations address various
topics, including the hiring and compensation of key staff, a code of
conduct, compliance standards, and risk management procedures.
These rules and directives from SEBI are intended to advance investor
protection, uphold market integrity, and guarantee openness and ethical
conduct in the Indian mutual fund sector.
 Mutual Funds – the Role of AMFI
What is AMFI:
1. The Association of Mutual Funds in India, or AMFI, is a dedicated
regulating authority established to protect mutual fund investors’
interests and maintain the industry’s proper functioning.
2. It is a non-profit organization in the Mutual Funds sector under
SEBI.
3. Since its incorporation in 1995, it has set various regulations to
maintain ethics and transparency in the Mutual Fund industry for
Indian investors.
 Mutual Funds – the Role of AMFI
Objectives of AMFI:
AMFI has been incorporated with several objectives on hand. Some of
them are mentioned below.
1. To define professional and ethical standards to be followed in the
Mutual Fund sector.
2. To interact with the Securities and Exchange Board of India (SEBI)
and report to them on all matters concerning the Mutual Fund industry.
3. To represent all the regulatory bodies on all matters relating to the
Mutual Fund industry.
4. To aid in policing distributor behavior, including sanctions
(cancellation of ARN-Application Reference Number) for Code of
Conduct infractions.
5. To increase financial literacy and help in increasing the penetration of
mutual funds investment in India.
 Mutual Funds – the Role of AMFI
Role of AMFI:
Some of Key Functions of AMFI are mentioned below.
1. AMFI is committed to advancing and maintaining standards and
promoting the Indian Mutual Fund Industry along moral and ethical
lines.
2. It aids in defending both the interests of asset management firms
and Indian investors.
3. AMFI helps to increase the accessibility and transparency of
investments to draw in additional investors.
4. AMFI keeps an eye on the transactions to guard against investors
being taken advantage of when they redeem their profits.
5. AMFI helps increase awareness so investors can choose their
investments more wisely.
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Committees of AMFI:
To ensure that AMFI fulfills all its objectives, it has formed several
committees to delegate responsibilities. Some of these committees
include
1. AMFI Financial Literacy Committee
2. AMFI Committee on Certified Distributors (ARN Committee)
3. AMFI ETF Committee
4. AMFI Committee on Operations, Compliance & Risk
5. AMFI Valuation Committee
6. AMFI Equity CIO Committee