Mutual of investment scheme that collects money from several

Mutual Funds:

Introduction:

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A
mutual fund is a collection of investment scheme that collects money from
several investors and invests that money in stocks, bonds, short-term money
market instruments and in other securities. Mutual fund has a fund manager who
pools and invests money on behalf of investors buying, selling stocks, bonds
etc. At present in worldwide the value of mutual funds totals more than $US 26
trillion.

 

For
an investor there are many other investment options such as real estate, bank
deposits, shares, debentures etc. A mutual fund is one more type of Investment
Avenue which is available to investors. There are many reasons why investors
choose mutual funds. Buying shares from market is one way of investing but it
requires spending time to find out the performance of the company whose share
is being purchased.

 

An
informed investor needs to do research before investing. However, many
investors find it cumbersome and time consuming to pore over so much of
information, get access to so much of details before investing in the shares.
Investors therefore prefer the mutual fund route.

 

Types of Mutual Funds:

Advantages of mutual
funds:

 

·        
The investor need not bother with
researching hundreds of stocks. It leaves it to the mutual fund and it’s
professional fund management team.

·        
Another reason why investors prefer
mutual funds is because mutual funds offer diversification.

·        
An investor’s money is invested by the
mutual fund in a variety of shares, bonds and other securities thus
diversifying the investor’s portfolio across different companies and sectors.

 

Mutual Fund Structure
in India:

Mutual
fund in India follows a 3 tier structure.

Sponsor:
The one who starts mutual funds. Sponsor approaches SEBI which is market
regulator and also regulator of mutual funds.

SEBI: SEBI
checks whether the person is with integrity, whether he has enough knowledge
and experience in financial sector etc. Once it is satisfied then it creates a
public trust.

Trustees: Trustees are
the authorized on behalf of trust. Trustee role is not to manage money but only
to see whether the money is being properly is being managed as per objectives.

Asset Management Company: Trustees
appoint the AMC to manage investor’s money. They in return charges fee for the
services provided. Directors of AMC are at least 50% independent directors. If
a fund manager intends to buy or sell some securities, permissions of compliance officer is must. Compliance
officer is most important in AMC.

 

Mutual Funds products
and features:

Mutual
funds offer variety of funds. It is important for investors to know the
features of these products, before money is invested in them. In mutual funds
there are two different types of funds. Open ended and closed ended funds

 

 

Open Ended Funds:

An
open ended fund’s allows investor to enter and exit anytime at his convenience
under certain conditions.

Closed Ended Funds:

Closed
ended fund’s restricts investors from entry and exit.

 

Equity funds:

Equity
funds are those funds which have at least 65% of their Average Weekly Net
Assets invested in Indian Equities. This is important from taxation point of
view, as funds investing 100% in international equities are also equity funds
from the investors’ asset allocation point of view, but the tax laws do not
recognise these funds as Equity Funds and hence investors have to pay tax on
the Long Term Capital Gains made from such investments which they do not have
to in case of equity funds which have at least 65% of their Average Weekly Net
Assets invested in Indian Equities). Equity Funds come in various flavours and
the industry keeps innovating to make products available for all types of
investors. Relatively safer types of Equity Funds include Index Funds and diversified Large
Cap Funds, while the riskier varieties are the Sector Funds. However, since equities as an asset class are risky,
there are no guaranteeing returns for any type of fund. Equity Funds can be
classified on the basis of market capitalisation of the stocks they invest in –
namely

 

 

Or
on the basis of investment strategy the scheme intends to have 16 like Index
Funds

 

Index Funds:

Equity
Schemes come in many versions and thus can be isolated according to their risk
levels. At the lowest end of the equity funds risk – return matrix come the
index funds while at the highest end come the sectoral schemes or specialty
schemes. However, since equities as an asset class are risky, there is no
guarantee in returns for any type of fund.

The
objective of a typical Index Fund states – ‘This Fund will invest in stocks
comprising the Nifty and in the same proportion as in the index’.

 

Sectoral Funds:

Funds
that invest in stocks from a single sector or related sectors are called
Sectoral funds. Examples of such funds are IT Funds, Pharma Funds,
Infrastructure Funds, etc. Regulations do not permit funds to invest over 10%
of their Net Asset Value in a single company. This is to ensure that schemes
are diversified enough and investors are not subjected to undue risk. This
regulation is relaxed for sectoral funds and index funds. There are many other
types of schemes available in our country, and there are still many products
and variants that have yet to enter our markets. While it is beyond the scope
of this curriculum to discuss all types in detail, there is one emerging type
of scheme, namely Exchange Traded Funds or ETFs, which is discussed in detail
in the next section.

Other Equity Funds:

      
I.           
Arbitrage Funds:

These
invest simultaneously in the cash and the derivatives market and take advantage
of the price differential of a stock and derivatives by taking opposite
positions in the two markets (for e.g. stock and stock futures).

   
II.           
Multicap Funds:

These
funds can, theoretically, have a smallcap portfolio today and a largecap
portfolio tomorrow. The fund manager has total freedom to invest in any stock
from any sector.

 III.           
Quant Funds:

A
typical description of this type of scheme is that ‘The system is the fund
manager’, i.e. there are some predefined conditions based upon rigorous back
testing entered into the system and as and when the system throws ‘buy’ and
‘sell’ calls, the scheme enters, and/ or exits those stocks.

 
IV.           
P/ E Ratio Fund:

A
fund which invests in stocks based upon their P/E ratios. Thus when a stock is
trading at a historically low P/E multiple, the fund will buy the stock, and
when the P/E ratio is at the upper end of the band, the scheme will sell.

    
V.           
International Equities
Fund:

This
is a type of fund which invests in stocks of companies outside India. This can
be a Fund of Fund, whereby, we invest in one fund, which acts as a ‘feeder’
fund for some other fund(s), i.e invests in other mutual funds, or it can be a
fund which directly invests in overseas equities. These may be further designed
as ‘International Commodities Securities Fund’ or ‘World Real Estate and Bank
Fund’ etc.

 

 
VI.           
Growth Schemes:

Growth
schemes invest in those stocks of those companies whose profits are expected to
grow at a higher than average rate. For example, telecom sector is a growth
sector because many people in India still do not own a phone – so as they buy
more and more cell phones, the profits of telecom companies will increase.
Similarly, infrastructure; we do not have well connected roads all over the country;
neither do we have best of ports or airports. For our country to move forward,
this infrastructure has to be of world class. Hence companies in these sectors
may potentially grow at a relatively faster pace.

Growth
schemes will invest in stocks of such companies.

VI.             
ELSS:

Equity
Linked Savings Schemes (ELSS) is one of equity schemes, where stakeholders get
tax benefit up to Rs. 1 Lakh under section 80C of the Income Tax Act. These are
open ended schemes and are locked for a period of 3 years. These schemes serve
the dual purpose of equity investing as well as tax planning for the stakeholder;
however it must be noted that stakeholders cannot, under any circumstances, get
their money back before 3 years are over from the date of investment.

VII.          
 Fund of Funds:

These
are funds which are not directly invested in stocks and shares but invested in units
of other mutual funds which will perform well and give maximized returns. In
fact these funds are dependent on the judgment of other fund managers.

 

Debit Funds:

Debt funds are funds which invest money in debt instruments such as
short and long term bonds, government securities, t-bills, corporate paper, commercial
paper, call money etc. The fees in debt funds are lesser, on average, than
equity funds because the overall management costs are lesser. The main
investing objectives of a debt fund is usually safeguarding of capital and
generation of income. Performance against a benchmark is considered to be a
secondary consideration. Investments in the equity markets are considered to be
fraught with uncertainties and volatility. These factors may

have an impact on constant flow of returns. Which is why debt schemes,
which are considered to be safer and less volatile have attracted investors. Debt
markets in India are wholesale in nature and hence retail investors generally
find it difficult to directly participate in the debt markets. Not many understand
the relationship between interest rates and bond prices or difference between Coupon
and Yield. Therefore venturing into debt market investments is not common among
investors. Investors can however participate in the debt markets through debt
mutual funds.