Mutual Fund

1. Mutual Fund

2. Investor Perspective Risk Aversion Risk Management Mutual Funds Bank Deposits, PPF, NSC, Insurance, Kisan Vikas Patra etc. Basics of Investments: Low Risk/Low Return Managed Risk/High Return

3. Myths about Mutual Funds 1. Mutual Funds invest only in shares. 2. Mutual Funds are prone to very high risks/actively traded. 3. Mutual Funds are very new in the financial market. 4. Mutual Funds are not reliable and people rarely invest in them. 5. The good thing about Mutual Funds is that you don’t have to pay attention to them.

4. Facts about Mutual Funds 1. Equity Instruments like shares form only a part of the securities held by mutual funds. Mutual funds also invest in debt securities which are relatively much safer. 2. The biggest advantage of Mutual Funds is their ability to diversify the risk. 3. Mutual Funds are their in India since 1964. Mutual Funds market is very evolved in U.S.A and is there for the last 60 years. 4. Mutual Funds are the best solution for people who want to manage risks and get good returns.

5. Facts about Mutual Funds 5. The truth is as an investor you should always pay attention to your mutual funds and continuously monitor them. There are various funds to suit investor needs, both as a long term investment vehicle or as a very short term cash management vehicle. 6. US-64 is very much a part of the market and is not immune to its vagaries. The crisis has risen due to mismanagement of the fund.

6. Mutual Funds A mutual fund is a common pool of money into which investors place their contributions that are to be invested in different types of securities in accordance with the stated objective. An equity fund would buy equity assets – ordinary shares, preference shares, warrants etc. A bond fund would buy debt instruments such as debenture bonds, or government securities/money market securities. A balanced fund will have a mix of equity assets and debt instruments. Mutual Fund shareholder or a unit holder is a part owner of the fund’s asset.

7. Mutual Funds Operations Flow Chart (Reference: amfiindia.com)

8. History of Mutual Funds Phase I – 1964 – 87: In 1963, UTI was set up by Parliament under UTI act and given a monopoly. The first scheme launched by UTI was Unit Scheme-64. Later in ’70’s and ’80’s, UTI started offering some special purpose schemes like ULIP and Children’s Gift Growth Fund. Master share, the first equity fund was launched in 1986. These were launched to suit the needs of different class of investors. Phase II – 1987 – 93: 1987 marked the entry of non-UTI, Public Sector mutual funds. Some of the mutual funds launched during this period are SBI Mutual Fund, Canbank Mutual Fund, LIC Mutual Fund, Indian Bank Mutual Fund, GIC Mutual Fund and PNB Mutual Fund. Also marked a spurt in launch of assured funds like

9. History of Mutual Funds Cantriple, Magnum Triple, BOI Double Square Plus. Equity funds with assured returns were launched which later ended in disaster. Phase III – 1993 – 96: Permission was granted for entry of private sector funds. It gave greater choice to the Indian Investors. These private funds have brought in with them the latest product innovations, investment management techniques and investor servicing technology that makes the Indian mutual fund industry vibrant and growing. This phase also marked the launch of an open-end funds. Phase IV – 1996: Investor friendly regulatory measures have been taken both by SEBI to protect the investor, and by the government to enhance investor’s returns through tax benefits.

10. Advantages of Mutual Funds Portfolio diversification: It enables him to hold a diversified investment portfolio even with a small amount of investment like Rs. 2000/-. Professional management: The investment management skills, along with the needed research into available investment options, ensure a much better return as compared to what an investor can manage on his own. Reduction/Diversification of Risks: The potential losses are also shared with other investors. Reduction of transaction costs: The investor has the benefit of economies of scale; the funds pay lesser costs because of larger volumes and it is passed on to the investors. Wide Choice to suit risk-return profile: Investors can chose the fund based on their risk tolerance and expected returns.

11. Advantages of Mutual Funds Liquidity: Investors may be unable to sell shares directly, easily and quickly. When they invest in mutual funds, they can cash their investment any time by selling the units to the fund if it is open-ended and get the intrinsic value. Investors can sell the units in the market if it is closed-ended fund. Convenience and Flexibility: Investors can easily transfer their holdings from one scheme to other, get updated market information and so on. Funds also offer additional benefits like regular investment and regular withdrawal options. Transparency: Fund gives regular information to its investors on the value of the investments in addition to disclosure of portfolio held by their scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook

12. Disadvantages of Mutual Funds No control over costs: The investor pays investment management fees as long as he remains with the fund, even while the value of his investments are declining. He also pays for funds distribution charges which he would not incur in direct investments. No tailor-made portfolios: The very high net-worth individuals or large corporate investors may find this to be a constraint as they will not be able to build their own portfolio of shares, bonds and other securities. Managing a portfolio of funds: Availability of a large number of funds can actually mean too much choice for the investor. So, he may again need advice on how to select a fund to achieve his objectives. Delay in redemption: It takes 3-6 days for redemption of the units and the money to flow back into the investor’s account.

13. Broad Types of Mutual Funds

14. Open-end Vs. Closed-end Funds Open-end Fund Available for sale and repurchase at all times based on the net asset value (NAV) per unit. Unit capital of the fund is not fixed but variable. Fund size and its total investment go up if more new subscriptions come in than redemptions and vice-versa. Closed-end Fund One time sale of fixed number of units. Investors are not allowed to buy or redeem the units directly from the funds. Some funds offer repurchase after a fixed period. For example, UTI MIP offers a repurchase after 3 years. Listed on stock exchange and investors can buy or sell units through the exchange. Units maybe traded at a discount or premium to NAV based on investor’s perception about the funds future performance and other market factors.

15. Load Vs. No-load Funds Marketing a new mutual fund scheme involves initial expenses. These expenses are charged to the investors through loads and are recovered from the investors in different ways: Front-end or entry load is charged to the investor at the time of his entry into the scheme. Back-end or exit load is charged to the investor at the time of his exit from the scheme. Deferred load is charged to the investor over a period of time. Contingent deferred sales charge: Different amount of loads are charged to the investor depending upon the time period the investor has stayed with the fund. The longer he stays with the fund, lesser the amount of exit fund he is charged. Very often, AMC’s do not charge any initial expenses to the investor in the IPO. These are hence are no-load funds. In no-load funds, the investors get units for the complete amount invested.

16. Mutual Fund Types Money Market Funds/Cash Funds Invest in securities of short term nature I.e. less than one year maturity. Invest in Treasury bills issued by government, Certificates of deposit issued by banks, Commercial Paper issued companies and inter-bank call money. Aim to provide easy liquidity, preservation of capital and moderate income. Gilt Funds Invest in Gilts which are government securities with medium to long term maturities, typically over one year. Gilt funds invest in government paper called dated securities. Virtually zero risk of default as it is backed by the Government. It is most sensitive to market interest rates. The price falls when the interest rates goes up and vice-versa.

17. Debt Funds Debt Funds/Income Funds Invest in debt instruments issued not only by government, but also by private companies, banks and financial institutions and other entities such as infrastructure companies/utilities. Target low risk and stable income for the investor. Have higher price fluctuation as compared to money market funds due to interest rate fluctuation. Have a higher risk of default by borrowers as compared to Gilt funds. Debt funds can be categorized further based on their risk profiles. Carry both credit risk and interest rate risks.

18. Equity Funds Equity Funds: Invest a major portion of their corpus in equity shares issued by companies, acquired directly in initial public offering or through secondary market and keep a part in cash to take care of redemptions. Risk is higher than debt funds but offer very high growth potential for the capital. Equity funds can be further categorized based on their investment strategy. Equity funds must have a long-term objective.

19. Hybrid Funds Balanced Funds: Has a portfolio comprising of debt instruments, convertible securities, preference and equity shares. Almost equal proportion of debt/money market securities and equities. Normally funds maintain a Equity-Debt ratio of 55:45 or 60:40. Objective is to gain income, moderate capital appreciation and preservation of capital. Ideal for investors with a conservative and long-term orientation.

20. Options Available to the Investor

21. Mutual Funds Vs. Other Investments

22. Mutual Funds Vs. Other Investments

23. Mutual Funds Vs. Other Investments

24. Bank Deposits Vs. Debt Funds Bank Deposits cater to investor class that look for safety and accepts a relatively low return. They cannot be compared with equity funds but with debt funds. A bank deposit is guaranteed by the bank for repayment of principal and interest whereas a debt fund has no contractual guarantee for repayment of principal or interest. In bank deposits, the investor has to assess the risk in terms of credit ratings of the bank which gives an indication of the financial soundness of the bank. However, a debt fund is not rated by any agency. The investor has to assess the risk on the portfolio held by the fund. Bank deposits are not totally free from risk and generally give lower returns. A conservative debt fund can give higher returns than a bank deposit, even though there is no contractual guarantee as in a deposit.

25. Mutual Funds Prove Best! While instruments like shares give high returns at the cost of high risk, instruments like NSC and bank deposits give lower returns and higher safety to the investor. Mutual Funds aim to strike a balance between risk and return and give the best of both to the investor.

26. Fund Structure and its Constituents

27. Fund Sponsor Fund Structure Trustees Asset Management Company Depository Agent Custodian

28. Fund Sponsor The Fund Sponsor Any person or corporate body that establishes the Fund and registers it with SEBI. Form a Trust and appoint a Board of Trustees. Appoints Custodian and Asset Management Company either directly or through Trust, in accordance with SEBI regulations. SEBI regulations also define that a sponsor must contribute at least 40% to the net worth of the asset management company.

29. Trustees Trustees Created through a document called the Trust Deed that is executed by the Fund Sponsor and registered with SEBI. The Trust-the mutual fund may be managed by a Board of Trustees- a body of individuals or a Trust Company- a corporate body. Protector of unit holders interests. 2/3 of the trustees shall be independent persons and shall not be associated with the sponsors.

30. Trustees Rights of Trustees: Approve each of the schemes floated by the AMC. The right to request any necessary information from the AMC. May take corrective action if they believe that the conduct of the fund's business is not in accordance with SEBI Regulations. Have the right to dismiss the AMC, Ensure that, any shortfall in net worth of the AMC is made up.

31. Trustees Obligations of the Trustees: Enter into an investment management agreement with the AMC. Ensure that the fund's transactions are in accordance with the Trust Deed. Furnish to SEBI on a half-yearly basis, a report on the fund's activities Ensure that no change in the fundamental attributes of any scheme or the trust or any other change which would affect the interest of unit holders is happens without informing the unit holders. Review the investor complaints received and the redressal of the same by the AMC.

32. Asset Management Company Acts as an invest manager of the Trust under the Board Supervision and direction of the Trustees. Has to be approved and registered with SEBI. Will float and manage the different investment schemes in the name of Trust and in accordance with SEBI regulations. Acts in interest of the unit-holders and reports to the trustees. At least 50% of directors on the board are independent of the sponsor or the trustees.

33. Asset Management Company Obligation of Asset Management Company: Float investment schemes only after receiving prior approval from the Trustees and SEBI. Send quarterly reports to Trustees. Make the required disclosures to the investors in areas such as calculation of NAV and repurchase price. Must maintain a net worth of at least Rs. 10 crores at all times. Will not purchase or sell securities through any broker, which is average of 5% or more of the aggregate purchases and sale of securities made by the mutual fund in all its schemes. AMC cannot act as a trustee of any other mutual fund. Do not undertake any other activity conflicting with managing the fund.

34. Structure of Mutual Funds Custodian Has the responsibility of physical handling and safe keeping of the securities. Should be independent of the sponsors and registered with SEBI. Depositories Indian capital markets are moving away from physical certificates for securities to ‘dematerialized’ form with a Depository. Will hold the dematerialized security holdings of the Mutual Fund.

35. Distribution Channels

36. Distribution Channels Mutual Funds are primary vehicles for large collective investments, working on the principle of pooling funds. A substantial portion of the investments happen at the retail level. Agents and distributors are a vital link between the mutual funds and investors. Agents Is a broker between the fund and the investor and acts on behalf of the principal. He is not exclusive to the fund and also sells other financial services. This in a way helps him to act as a financial advisor. Distribution Companies Is a company which sells mutual funds on behalf of the fund. It has several employees or sub-broker under it. It manages distribution for several funds and receives commission for its services.

37. Distribution Channels Banks and NBFCs Several banks, particularly private and foreign banks are involved in a fund distribution by providing similar services like that of distribution companies. They work on commission basis. Direct Marketing Mutual funds sell their own products through their sales officers and employees of the AMC. This channel is normally used to mobilise funds from high net worth individuals and institutional investors.

38. Sales Practices Agent Commissions No rules prescribed for governing the maximum or minimum commissions payable by a fund to its agents. As per SEBI regulations, 1996 all initial expenses including brokerage charges paid to agents cannot exceed 6% of resources raised under the scheme. Excess distribution charges have to be borne by the AMC. A no-load fund is authorised to charge the schemes with the commissions paid to agents as part of the regular management and marketing expenses allowed by SEBI.

39. Accounting and Taxation

40. Accounting Calculating Net Asset Value Unit Capital is the investor’s subscriptions. In mutual funds it is not treated as a liability. Investments made on behalf of the investors are reflected on the assets side of the balance sheet. There are liabilities of short-term nature. Fund’s Net Asset = Asset – Liabilities Net Asset Value = Net Assets of the scheme / No. of Outstanding Units i.e NAV = (Market value of investments + Receivables + Other Accrued Income + Other assets – Accrued Expenses – Other Payables – Other liabilities) / ( No. of Units Outstanding as at the NAV date)

41. Accounting The factors affecting the NAV are as following: Capital Gains or Losses on the sale or purchase of the Investment securities. Dividend and income earned on the assets. Capital Appreciation in the underlying value of the stocks held in the portfolio. Other assets and liabilities. Number of units sold or purchased.

42. Accounting SEBI regulations for NAV The day on which NAV is calculated by a fund is called valuation date. NAV of all schemes must be calculated and published at least weekly. This is applicable to both open-end and closed-end fund. Some closed end funds (Monthly Income Schemes) that are not listed on stock exchange may publish it monthly-quarterly.

43. Accounting SEBI Guidelines for Pricing of Units: The mutual fund shall ensure that the re-purchase price is not lower than 93% of the NAV. The sale price is not higher than 107% of the NAV.Repurchase price of closed end scheme shall not be lower than 95% of the NAV. The difference between the repurchase price and the sale price of the units shall not exceed 7% of the sale price.

44. Accounting Since investments held by a mutual fund in its portfolio are to be marked to the market, the NAV includes two components: Realized gains or losses. Unrealized gains or losses. As per SEBI guidelines, unrealized appreciation cannot be distributed by a fund, whereas the realized gain can be distributed.

45. Accounting Investment Management Fees and Advisory Fees: 1.25% of the first Rs.100 crores of weekly average net assets outstanding in the accounting year. 1% weekly average net assets in excess of Rs. 100 crores. A no load scheme can charge an additional management fee up to 1% of weekly average net assets outstanding in the accounting year.

46. Accounting Total expenses charged by the AMC to a scheme, excluding issue or redemption expenses but including investment management and advisory fees have following limits: 2.5% - On the first Rs. 100 crores of average weekly net assets 2.25% - On the next Rs. 300 crores of average weekly net assets 2% - On the next Rs. 300 crores of average weekly net assets 75% - On the balance of average weekly net assets For bond funds, the above percentages are required to be lower by 0.25%

47. Taxation Taxation in the Hands of the Fund Income earned by any mutual fund registered with SEBI or set up by a public sector bank/Financial Institution or authorised by RBI is exempt from tax. Income distributed to unit holders by a closed-end or debt fund has to pay a distribution tax of 10% plus surcharge of 1% I.e. a tax of 11%. This tax is also applicable to distributions made by open-end funds which have less than 50% allocation to equity. The Impact on the Fund and the Investor Due to the tax payment by the fund, the NAV and the value of the investor’s investment will come down. The tax bears no relationship to the investor’s tax bracket. This tax makes the income schemes less attractive than growth schemes. The fund cannot avoid tax even if the investor chooses to reinvest the distribution back into the fund.

48. Taxation Taxation in the Hands of the Investor Tax Rebate available on Subscriptions to Mutual Funds (In accordance with Section 88 of Income Tax Act) Investments up to Rs. 60,000 in units of any specified mutual fund qualifies for tax rebate to the extent of 20% of such investment. In case of ‘Infrastructure Bonds, investments up to Rs. 70,000 is eligible for 20% tax rebate. Total investment eligible for tax rebate cannot exceed Rs. 60,000. Investment up to Rs. 10,000 in an equity linked saving scheme (ELSS) qualifies for tax rebate of 20%.

49. Taxation Taxation in the Hands of the Investor Dividend Tax :The tax paid by the investor on receiving dividends from a mutual fund. There is no dividend tax to be paid at the investor’s end. There is no dividend tax deduction from NAV in all funds which are open-end and with over 50% allocation of investment to equities. Tax of 10.2% is deducted from the NAV by the fund in the following cases: - All closed end funds including equity. - All open end funds with less than 50% allocation in equity.

50. Taxation Taxation in the Hands of the Investor Capital Gains on Sale of Units: Capital Gains tax is charged when something is sold at profit. If the investor sells his units and earns “Capital Gains”, the investor is subject to the Capital Gains Tax. If the units are held for less than 12 months, they will be treated as short term capital gain. Otherwise,t hey are called long term capital gains. For short term, capital gains = Sale consideration – (Cost of Acquisition + Cost of Improvements + Cost of Transfer) The tax charged depends on the income bracket of the investor. For long term capital gains, the investor gets the benefit of ‘Indexation’ by which his purchase price is marked up by an inflation index. Cost of acquisition or improvement = actual cost of acquisition or improvement * cost of inflation index for year of transfer/cost of inflation index for year of acquisition or improvement. The tax charged is either 10% or (20% - rate of inflation).