Definitions of Mutual Funds on the Web:
• These are open-end funds that are not listed for trading on a stock exchange and are issued by companies which use their capital to invest in other companies. Mutual funds sell their own new shares to investors and buy back their old shares upon redemption. Capitalization is not fixed and normally shares are issued as people want them. These are mutually owned funds invested in diversified securities. Shareholders are issued certificates as evidence of their ownership and participate proportionately in the earnings of the fund. An investment company that pools money and can invest in a variety of securities, including fixed-income securities and money market instruments. Typically consist of a group of stocks, bonds, or money-market securities from more than one source. There are three types—income funds )for people who need money to live on); growth funds (pay low dividends or one—works best for investors who can leave money in the fund so it can grow over a long period of time; and balanced funds (combination of stocks and bonds). Investment funds which are made up of other investments and often defined by themes. For example, a “Global” fund would invest in companies around the world, while a “Property” fund would invest primarily in real estate. a professionally managed investment in a group of stocks and/or bonds that are selected and diversified to meet the stated objective of the fund. The fund's investment strategy category as stated in the prospectus. There are more than 20 standardized categories. Invented in the 1920s, mutual funds are pools of money managed by an investment company or advisor. Different mutual funds have different goals. For example, funds may seek growth, growth and income, specific market cap sizes, sectors, etc. An investment company that pools the money of many individual investors and uses it to buy a diversified portfolio of securities. Back to Top A type of managed investment company in which the investor owns a share of the portfolio assets equal to his number of shares in the fund. are a method of investing in various underlying investments such as stocks, bonds, mortgages, treasury bills and real estate. Mutual funds provide the advantages of professional investment management, liquidity, investment record keeping and diversification. Investing through mutual funds is the indirect ownership of the underlying investment vehicles. A mutual fund enables investors to pool their money and place it under professional investment management. The portfolio manager trades the fund's underlying securities, realizing a gain or loss, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors. There are more mutual funds than there are individual stocks.
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What are the types of mutual funds?
Mutual Funds are broadly classified into three categories viz. Equity Funds, Debt Funds and Balanced Funds.
EQUITY FUNDS
These funds invest a major part of their corpus in equities. The composition of the fund may vary from scheme to scheme and the fund manager’s outlook on various scrips. The Equity Funds are sub-classified depending upon their investment objective, as follows:
Diversified Equity Funds Mid-Cap Funds • Sector Specific Funds • Tax Savings Funds (ELSS)
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Equity investments are meant for a longer time horizon. Equity funds rank high on the risk-return matrix.
DEBT FUNDS
These Funds invest a major portion of their corpus in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Debt funds are further classified as:
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Gilt Funds: Invest their corpus in securities issued by Government, popularly known as GoI debt papers. These Funds carry zero Default risk but are associated with Interest Rate risk. These schemes are safer as they invest in papers backed by Government. • Income Funds: Invest a major portion into various debt instruments such as bonds, corporate debentures and Government securities. MIPs: Invests around 80% of their total corpus in debt instruments while the rest of the portion is invested in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the riskreturn matrix when compared with other debt schemes. Short Term Plans (STPs): Meant for investors with an investment horizon of 3-6 months. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures. Liquid Funds: Also known as Money Market Schemes, These funds are meant to provide easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, interbank call money market, CPs and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. These schemes rank low on risk-return matrix and are considered to be the safest amongst all categories of mutual funds.
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BALANCED FUNDS
These funds, as the name suggests, are a mix of both equity and debt funds. They invest in both equities and fixed income securities, which are in line with pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns.
Each category of funds is backed by an investment philosophy, which is pre-defined in the objectives of the fund. The investor can align his own investment needs with the funds objective and invest accordingly.
Basic Rules of Mutual-Fund Investing
With mutual fund making a comeback like a roaring lion, the noise created by them often turns out to be a clutter of meaningless numbers, for the lay investor beginning to comprehend the mutual fund concept. It is not surprising. With over 200 fund coming in the past three years like monsoon clouds, investors are rightly bombarded by tempting mutual-fund advertisements. When you consider the overwhelming amount of information on stocks and bonds, which rapidly changes in financial markets, and an investors lack of time or inclination to know more about these investments, investing right are surely become difficult. There are plus and minuses of the change happening. On the negative, it has become very difficult to manage all the information available today. I can tell you based on my first hand experience. And it is easy to make mistakes. The good news, though, is that practically all the information you need to make smart investment choices is out there, whether you invest on your own or you use the services of an intermediary. And if you do a little homework, you'll find investing in funds really isn't that hard. And, it gets easier as you become more experienced. On the balance, you are a beneficiary as the enhanced transparency and disclosure is forcing greater fund accountability to their shareholders, i.e. you and has also made a relatively safer marketplace. Following are some rules to help invest better and attain your financial goals. Know Yourself -- The first step towards achieving your goals is that you must know yourself. Try to get an idea of how much risk you can handle. Do a tolerance test for yourself. If your Rs. 10000 investment turning into Rs. 6,000 upsets you--even if it could subsequently bounce back-perhaps an aggressive equity fund is not for you. Reality Check --. What are your goals? If you need to turn Rs 10,000 into Rs 50,000 in two years, a medium term bond fund may not be the right answer. Work on setting realistic expectations for both your goals and your funds. Know Your Portfolio -- Look for areas that are over-represented and for those that are lacking. For example, is your portfolio overly concentrated in the large-cap equities or too much of highly rewarding but wildly volatile infotech stocks. Are you missing investments in small-cap stocks? Know What You Are Buying -- Once you discovered yourself, spend some time for a close understanding of your funds. The stated objective of a fund as given in a prospectus is often incomplete and does not reveal much. Based on the readily available portfolio and fund manager's commentary, you can broadly understand the style and strategy followed by a fund. This will help you meaningfully diversify your portfolio. This will also help you assess potential risks. In general, large-cap value funds are less risky than small-cap growth funds. Examine sector weightings to find out what will drive the portfolio's returns-both up and down. And know that funds with large stakes in just one or two sectors will likely be more volatile than the more evenly diversified funds. Looking at a fund's sectors historically will help you gain a good
perspective. Does the manager move in and out of sectors frequently and dramatically? If so, the fund might get hurt, if the manager is ever caught on the wrong foot. Check out Your Fund's Concentration. A portfolio with just 20 or 30 stocks or one that puts most of its assets in just a few stocks will likely be more volatile than a fund that's spread among hundreds of stocks. But there could be rewards of concentration. A concentrated portfolio will also get more bang for its buck if its stocks work out. You may want to add a concentrated fund, one that owns fewer stocks or puts most of its assets in the top 10 or 20 stocks, to your portfolio. But largely, your core funds should probably be well a diversified and more predictable. Though a small allocation to a sector-oriented fund, a more-flexible fund, or a more-concentrated fund could boost your returns. Assess Performance Appropriately -- Past performance is no indicator of future results. Investors should commit this statutory quote from mutual fund prospectuses, advertisements and any other literature to memory. It should be recalled more readily than the your bank account number. It should be repeated anytime you consider sending money to any fund with a 100% three-month gain. Why? Chances are, that three-month boom will be followed by a three-month bust. To prove it, we took a look at the top 10 domestic equity funds as of September 30 for each of the past five years. What proportion of them landed in the top 10 for the ensuing three-month period? Don't laugh. It was just 10%. What's an investor to do? Not concentrate a mutual fund portfolio on a concentrated fund. And, above all, don't focus on short-term returns. When choosing a fund, look for above-average performance, quarter after quarter, year after year. Be A Disciplined Investor -- After you've chosen some funds, stick with them. Don't be afraid to go against the tide, as often the unpopular groups tend to outperform in subsequent years. In other words, small contrarian bets could be lucrative. And discipline is the key. Rupee-cost averaging, or investing a regular amount of money at regular intervals, tends to add value. With a systematic investment plan, you are likely to beat the fund returns. Know How Much You Pay -- Money saved is money earned. So it's always better to pay less than it is to pay more. Expenses are very important with your larger-cap, lower-risk funds, and less critical with small-cap funds and other higher-risk categories. For example, be wary of high expenses when you are considering bond funds. And you can afford to be lenient with the expense of a small-cap or a sector equity fund. The nuances of mutual fund investing can be endless. But the strength of the mutual fund idea lies in its simplicity. Don't get bogged by the noise and clutter. You could well be on your way reach your goals by following these basic guidelines and be a smarter investor.
What are Mutual Funds? Why do Mutual Funds come out with different schemes? What are the types of mutual fund scheme? What is the difference between the open ended and close ended Schemes? What are sector funds? What are the benefits of investing in a mutual fund? How is Investment in a Mutual Fund different From a Bank Deposit? How are mutual funds different from portfolio management schemes? Does Investing in mutual Funds means investing in equities? What is NAV, and how is it calculated? Does the NAV of RS. 10 indicate that the fund units are cheaper? Can the NAV of a debt Fund Fall? Besides the NAV, are there any other parameters, which can be compared across different funds of the same category? What is a Sales Load? What is repurchase or back end load ? What are No load Schemes? What is CDSC? What is difference between a contingent deferred sales load and an exit load ? What can one benchmark the performance of a mutual fund against? Does out performance of a benchmark index always connote good performance? Does higher return necessarily mean a better fund? Does investing in more than one fund family imply diversification? What should one keep in mind while choosing a good mutual fund? What is meant by recurring sales expenses?
What are Mutual Funds?
A mutual fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested in different types of securities.The income earned through these investments and the capital appreciation realized by thescheme are shared by the unit holders in proportion to the number of units held by them.
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Why do Mutual Funds come out with different schemes?
A Mutual Fund may not, through just one portfolio, be able to meet the investment objectives of all their Unit holders. Some Unit holders may want to invest in risk-bearing securities such as equity and some others may want to invest in safer securities such as bonds or government securities. Hence, the Mutual Fund comes out with different schemes, each with a different investment objective.
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What are the types of Mutual Funds Schemes?
There are different schemes catering to different needs, age profiles, financial positions and return expectations. By Structure there are basically two types of mutual fund schemes Open-ended schemes are open for subscription the whole year. They do not have a fixed maturity. You can buy and sell your units at the NAV related prices to the Mutual funds. Close-ended schemes can be subscribed to, only during the initial public offer and thereafter you can buy and sell the units of the scheme on the stock exchange where they are listed. They have a stipulated Maturity period the duration of which is generally 2 to 15 years.. They are usually traded at a discount to the NAV. By investments objective, there are 5 types of schemes:
Growth/Equity Schemes In such schemes, investment is made in equities and convertible debentures. The objective of these schemes is to provide capital appreciation over a period of time. The dividend may or may not be declared. Debt/income funds: These are funds that invest predominantly in income bearing instruments like bonds, debentures, government securities, commercial paper etc. Income bearing instruments are much less volatile, although they do carry credit risk. The objective of these schemes is to provide a regular and steady income to the investors. Balanced funds: Such funds invest both in equity shares and income-bearing instruments in the proportion indicated in their offer document. The objective is to provide both growth and income by periodically distributing a part of the income and capital gains they earn. Money Market Schemes. These schemes invest in Zero risk or safer, short term instruments like treasury bills, certificates of deposit, Commercial Paper and inter-bank call money. The objective of these schemes is to provide liquidity and moderate income and also preserve the capital. Equity linked saving schemes (ELSS) These schemes are open-ended growth schemes with a mandatory 3-year lock- in. These schemes offer the benefit of section 88 of IT Act, up to a maximum of Rs 10,000 (tax saving of 20% of 10,000 which is Rs. 2000) The main features of ELSS are (a) Repurchase: Repurchases are permitted after a period of 3 years. (b) Lock-in-period: The units under ELSS are prohibited from trading, pledging and transfer during the lock in period of 3 years. Lastly we have Specialty Schemes to cater to the investment objectives not covered by the other schemes: Index Schemes Sector Schemes · Index schemes replicate the performance of the stock Index such as BSE SENSEX or NSE 500. · Sectoral schemes are specialty mutual funds that invest in stocks that fall into a certain sector of the economy. Here the portfolio is dispersed or spread across the stocks of a particular sector.
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What is the difference between open ended and close ended schemes?
Open-ended funds do not have a fixed maturity whereas close-ended schemes have a stipulated maturity period. New investors can join the scheme by directly applying to the mutual fund at applicable Net Asset Value related prices in case of open-ended schemes whereas in case of close-ended schemes new investors can buy the units from secondary market only. This results in the unit capital of open ended schemes fluctuating daily unlike the close ended scheme where it remains constant.
What are sector funds?
These are specialty mutual funds that invest in stocks that fall into a certain sector of the economy. Here the portfolio is dispersed or spread across the stocks in a particular sector.This type of scheme is ideal for the investor who has already made up his mind to confine his risk and return to one particular sector. Thus, a FMCG fund would invest in companies that manufacture fast moving consumer goods.
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What are the benefits of investing in a mutual fund?
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Access to professional money managers. Buying units of a mutual fund gives you access to the trading decisions of a team of analysts and fund manager. The fund manager continuously takes care of investment to make sure that investment remains consistent with the funds investment objective Diversification. Mutual funds aim to reduce the volatility of returns through diversification by investing in a number of companies across a broad section of industries and sectors. This reduces the risk because of the spread. Thus with a small investible surplus also you can achieve a diversification which would not have been possible on your own. Liquidity. Since units of mutual funds are priced daily, and an open-end mutual fund is always willing to buy back its units, you are able to sell your units very easily. There is more liquidity in the open-ended schemes of mutual funds as compared to others because investor can sell his/her units whenever desired, whereas in case of stocks, bonds etc. investor has to first find the buyer Low transaction costs. Mutual funds are a relatively less expensive way to invest because Mutual Funds are institutional investors, who are able to pay lower brokerage commissions because of their size. Transparency: There are regular updates on the value of your investment. The portfolio is disclosed
regularly with the fund managers investment strategy and outlook. Regulations: All the mutual funds are registered with SEBI and they function under within the provisions of strict regulation designed to protect the interests of the investor. Small investments: Mutual funds help you to reap the benefit of returns by a portfolio spread across a wide spectrum of companies with small investments. Such a spread would not have been possible without their assistance.
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How is investment in a Mutual Fund Different from a Bank Deposit?
When you deposit money with the bank, the bank promises to pay you a certain rate of interest for the period you specify. On the date of maturity, the bank is supposed to return the principal amount and interest to you. Whereas, in a mutual fund, the money you invest, is in turn invested by the manager, on your behalf, as per the investment strategy specified for the scheme. The profit, if any, less expenses of the manager, is reflected in the NAV or distributed as income. Likewise, loss, if any, with the expenses, is to be borne by you.
How are mutual funds different from Portfolio Management Schemes?
In Mutual Funds, the investments of investors are pooled to form a common investible corpus and the gain/loss to all investors during a given period are same for all investors,whereas in the case of portfolio management scheme, the investment of a particular investor remains identifiable to him. Here the gain or loss of all the investors will be different from each other.
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Does investing in Mutual Funds mean investing in equities?
Mutual funds can be divided into various types depending on asset classes. They can also invest in debt instruments such as bonds, debentures, commercial paper and government securities apart from equity. Every mutual fund scheme is bound by the investment objectives outlined by it in its prospectus. The investment objectives specify the class of securities a mutual fund can invest in. Based on the investment objective, the following types of mutual funds currently operate in the country. Growth Schemes Income Schemes Balanced Schemes Money Market Schemes
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What is NAV and how is it calculated?
Net Asset value is the actual value of units of the scheme on a given business day. NAV reflects the market value of the fund's investments on that day after accounting for all the expenses.
Does the NAV of Rs. 10 indicate that the fund units are cheaper?
It is a wrong perception that if the mutual fund is offering units at Rs. 10 it is cheaper. Yes, you would at this price get more number of units than you would get if it were priced higher with the same investible surplus. But the number of units you get is a function of a scheme's NAV, and not an indicator of how cheap a scheme is. The scheme's NAV is the market value of its portfolio holdings at a given point of time and its performance is what determines your returns.
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Can the NAV of a debt fund fail?
A debt fund invests in fixed-income instruments, where safety of capital and regular returns are assured. These include Commercial Paper, Certificates of Deposit, debentures and bonds. While the rate of interest on these instruments stays the same throughout their tenure, their market value keeps changing, depending on how the interest rates in the economy move. A debt fund's NAV is the market value of its portfolio holdings at a given point in time. As interest rates change, so do the market value of fixed-income instruments - and hence, the NAV of a debt fund. Thus it is a misnomer that the debt fund's NAV does not fall.
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Besides the NAV, are there any other parameters which can be compared across different funds of the same cateogry?
Besides Net Asset Value the following parameters should be considered while comparing the funds: AVERAGE RETURNS An investor should look at the returns given by the fund over a period of time. Care should be taken to see whether all dividends and bonuses have been accounted for. The higher and more consistent the returns the better is the fund. VOLATILITY In addition to the returns one should also look at the volatility of the returns given by the fund. Volatility is essentially the fluctuation of the returns about the mean return over a period of time. A fund giving consistent returns is better than a fund whose returns fluctuate a lot. CORPUS SIZE: A Large corpus is generally considered good because large funds have lower costs, as expenses are spread over large assets but at the same time a large corpus has some inefficiencies too. A large corpus may become unwieldy and thus difficult to manage. PERFORMANCE VIS A VIS BENCHMARK OTHER SCHEMES An investor should not only look at the returns given by the scheme he has invested in but also compare it with benchmarks like BSE Sensex, S & P Nifty, T-bill index etc depending on the asset class he has invested in. For a true picture it is advised that the returns should also be compared with the returns given by the other funds in the same category. Thus it is prudent to consider all the above-mentioned factors while comparing funds and not rely on any one of them in isolation. This is important because as of today there is no standard method for evaluation of un- traded securities.
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What is a Sales Load?
A Sales Load is a charge collected by the scheme when it sells the units. It is also called the front end Load.
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What is the Repurchase or Back End Load?
It is the charge collected by the scheme when it buys back the units from the unit holders.
What are No Load Schemes?
The schemes, which do not charge any load, are called No Load Schemes.
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What is CDSC?
Contingent Deferred Sales charge (CDSC) is a charge imposed on unit holders exiting from the scheme within 4 years of entry. It is intended to enable the AMC to recover expenses incurred for promotion or propagation of the scheme. Or Sometimes the selling expenses of the fund are not charged to the fund directly but are recovered from the unit holders whenever they redeem their units. This load is called a CDSC and is inversely proportional to the period of unit holding.
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What is the difference between contigent defered sales load and an exit load?
Contingent Deferred Sales charge (CDSC) is a charge imposed when the units of a fund are redeemed during the first few years of ownership. Under the SEBI Regulations, a fund can charge CDSC to unit holders exiting from the scheme within the first four years of entry. Exit load is a fee an investor pays to a fund whenever he redeems his/her units. As per SEBI regulations, the maximum exit load applicable is 7%. There is a further stipulation by SEBI that the entry load and exit load put together cannot exceed 7% of the sale price.
What can one benchmark the performance of a mutual fund against?
A mutual fund scheme should be benchmarked against relevant indices, and that relevant index can be chosen after taking into consideration the asset class it represents. The Equity funds can be benchmarked against BSE Sensex, S & P Nifty etc.
The Debt funds can be benchmarked with T-Bill index or I-Bex etc.depending on the average maturity of the scheme. Performance of an equity fund must be compared over a 1-2 year horizon and for a debt fund a period of 6-12 months is considered ideal.
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Does out performance of a benchmark index always connote good performance?
No, it is not necessary that out performance of a benchmark index always connotes good performance. The volatility does not permit the investor to rely on one factor only. The index performance is volatile and may be driven by a few scrips only, which may not be very reflective. So it is better to keep other factors like risk adjusted returns (volatility of returns) and NAV movement in mind while deciding to invest in a fund.
Does higher return necessarily mean a better fund?
Yes, on the face of it high return does connote good fund but there is also some a risk taken by the scheme to achieve these returns. Thus it is prudent to measure risk alsowhile considering returns to rank a scheme. Today there are a lot of statistical tools like Beta,Sharpe ratio, Alpha and standard Deviation to measure this risk. A risk adjusted return is the best measure to use while judging a scheme. You can also refer to the ratings assigned by a reputed rating agency.
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Does investing in more than one fund family imply diversification?
No, Investing in more than one Mutual fund family does not necessarily imply diversification. What is more important is to measure exposure to different asset classes irrespective of which mutual fund manages your money.
What should one keep in mind while choosing a good mutual fund?
Each individual has different financial goals, based on lifestyle, financial independence, and family commitments, level of incomes and expenses and many other factors. Thus before investing your money you need to analyze the following factors: Define the Investment objective Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, and level of income and expenses among many other factors. Therefore, the first step should be to assess your needs. You can begin by defining the investment objectives, which could be regular income, buying a home or finance a wedding or educate your children or a combination of all these needs. Also your risk appetite of the investor and cash flow requirements need to be taken into account. Choose the right Mutual Fund Once the investment objective is clear in your mind the next step is choosing the right Mutual Fund scheme. Before choosing a mutual fund the following factors need to be considered: NAV performance in the past Track record of performance in terms of returns over the last few years in relation to appropriate yardsticks and other funds in the same category. Risk in terms of volatility of returns Services offered by the mutual fund and how investor friendly it is. Transparency, which is reflected in the quality and frequency of its communications. Go for a proper combination of schemes Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals.
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What is meant by recurring sales expenses?
The Asset management Company may charge the fund a fee for operating its schemes, like trustee fee, custodian fee, registrar fee, transfer fee etc. This fee is called recurring expense and is expressed as a percentage of the scheme's average net assets. The recurring expenses are subject to certain limits as per the regulations of SEBI. WEEKLY AVERAGE NET ASSETS RS. EQUITY SCHEMES DEBT SCHEMES FIRST 100 CRORES 2.50% 2.25%
NEXT 300 NEXT 300 BALANCE ASSETS
CRORES CRORES 1.75%
2.25% 2.00% 1.50%
2.00% 1.75%
MUTUAL FUND
Concept, Organisation Structure, Advantages and Types.
Topics Covered
• • • • • Concept Organisation of a Mutual Fund Advantages of Mutual Funds Types of Mutual Fund Schemes Frequently Used Terms
Concept
• • • A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
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Mutual Fund Operation Flow Chart
Organisation of a Mutual Fund
Advantages of Mutual Funds
• • • • • • • • • • • Professional Management Diversification Convenient Administration Return Potential Low Costs Liquidity Transparency Flexibility Choice of schemes Tax benefits Well regulated
Types of Mutual Fund Schemes
• Wide variety of Mutual Fund Schemes exist to cater to the needs such as financial position, risk tolerance and return expectations etc. • The figure in the next slide gives an overview into the existing types of schemes in the Industry.
Types of Schemes
• By Structure
– Open Ended Schemes – Close Ended Schemes – Interval Schemes
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By Investment Objectives
– – – – Growth Schemes Income Schemes Balance Schemes Money Market Schemes
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Other Schemes
– Tax Saving Schemes
Special Schemes
– Index Schemes – Sector Specific Schemes
Frequently Used Terms
• Net Asset Value (NAV) Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date. Sale Price Is the price you pay when you invest in a scheme. Also called Offer Price. It may include a sales load. Repurchase Price Is the price at which a close-ended scheme repurchases its units and it may include a back-end load. This is also called Bid Price.
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Frequently Used Terms
• Redemption Price Is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related. Sales Load Is a charge collected by a scheme when it sells the units. Also called, ‘Front-end’ load. Schemes that do not charge a load are called ‘No Load’ schemes. Repurchase or ‘Back-end’ Load Is a charge collected by a scheme when it buys back the units from the unit holders.
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What are the types of mutual funds?
Mutual Funds are broadly classified into three categories viz. Equity Funds, Debt Funds and Balanced Funds.
EQUITY FUNDS
These funds invest a major part of their corpus in equities. The composition of the fund may vary from scheme to scheme and the fund manager’s outlook on various scrips. The Equity Funds are sub-classified depending upon their investment objective, as follows:
Diversified Equity Funds Mid-Cap Funds • Sector Specific Funds • Tax Savings Funds (ELSS)
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Equity investments are meant for a longer time horizon. Equity funds rank high on the risk-return matrix.
DEBT FUNDS
These Funds invest a major portion of their corpus in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Debt funds are further classified as:
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Gilt Funds: Invest their corpus in securities issued by Government, popularly known as GoI debt papers. These Funds carry zero Default risk but are associated with Interest Rate risk. These schemes are safer as they invest in papers backed by Government. • Income Funds: Invest a major portion into various debt instruments such as bonds, corporate debentures and Government securities. MIPs: Invests around 80% of their total corpus in debt instruments while the rest of the portion is invested in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the riskreturn matrix when compared with other debt schemes. Short Term Plans (STPs): Meant for investors with an investment horizon of 3-6 months. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures. Liquid Funds: Also known as Money Market Schemes, These funds are meant to provide easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, interbank call money market, CPs and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. These schemes rank low on risk-return matrix and are considered to be the safest amongst all categories of mutual funds.
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BALANCED FUNDS
These funds, as the name suggests, are a mix of both equity and debt funds. They invest in both equities and fixed income securities, which are in line with pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns. Each category of funds is backed by an investment philosophy, which is pre-defined in the objectives of the fund. The investor can align his own investment needs with the funds objective and invest accordingly.
Mutual Fund - An Introduction
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested by the fund manager in different types of securities depending upon the objective of the scheme. These could range from shares to debentures to money market instruments. The income earned through these investments and the capital appreciation realized by the scheme are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed portfolio at a relatively low cost. The small savings of all the investors are put together to increase the buying power and hire a professional manager to invest and monitor the money. Anybody with an investible surplus of as little as a few thousand rupees can invest in Mutual Funds. Each Mutual Fund scheme has a defined investment objective and strategy.
Types of Mutual Fund Schemes
Mutual fund schemes may be classified on the basis of its structure and its investment objective. By Structure Open-end Funds An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity. Closed-end Funds A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor. Interval Funds Interval funds combine the features of open-ended and close-ended schemes. They are open for sale or redemption during pre-determined intervals at NAV related prices. By Investment Objective Growth Funds The aim of growth funds is to provide capital appreciation over the medium to long term.
Such schemes normally invest a majority of their corpus in equities. It has been proved that returns from stocks, have outperformed most other kind of investments held over the long term. Growth schemes are ideal for investors having a long term outlook seeking growth over a period of time. Income Funds The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and Government securities. Income Funds are ideal for capital stability and regular income. Balanced Funds The aim of balanced funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls. These are ideal for investors looking for a combination of income and moderate growth. Money Market Funds The aim of money market funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market. These are ideal for Corporate and individual investors as a means to park their surplus funds for short periods. Other Schemes Tax Saving Schemes These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws as the Government offers tax incentives for investment in specified avenues. Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction u/s 88 of the Income Tax Act, 1961. The Act also provides opportunities to investors to save capital gains u/s 54EA and 54EB by investing in Mutual Funds. Special Schemes
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Industry Specific Schemes
Industry Specific Schemes invest only in the industries specified in the offer document. The investment of these funds is limited to specific industries like Infotech, FMCG, Pharmaceuticals etc.
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Index Schemes
Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50
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Sectoral Schemes
Sectoral Funds are those which invest exclusively in a specified sector. This could be an industry or a group of industries or various segments such as 'A' Group shares or initial public offerings.
Benefits of Investing in Mutual Funds Professional Management Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme. Diversification Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own. Convenient Administration Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient. Return Potential Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities. Low Costs Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors. Liquidity In open-end schemes, the investor gets the money back promptly at net asset value related prices from the Mutual Fund. In closed-end schemes, the units can be sold on a stock exchange at the prevailing market price or the investor can avail of the facility of direct repurchase at NAV related prices by the Mutual Fund. Transparency You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook. Flexibility Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience. Affordability Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy. Choice of Schemes Mutual Funds offer a family of schemes to suit your varying needs over a lifetime. Well Regulated
All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI. How to invest in Mutual Fund Step One - Identify your Investment needs Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, and level of income and expenses among many other factors. Therefore, the first step is to assess your needs.You can begin by defining your investment objectives and needs which could be regular income, buying a home or finance a wedding or educate your children or a combination of all these needs, the quantum of risk you are willing to take and your cash flow requirements. Step Two - Choose the right Mutual Fund The important thing is to choose the right mutual fund scheme which suits your requirements. The offer document of the scheme tells you its objectives and provides supplementary details like the track record of other schemes managed by the same Fund Manager. Some factors to evaluate before choosing a particular Mutual Fund are the track record of the performance of the fund over the last few years in relation to the appropriate yardstick and similar funds in the same category. Other factors could be the portfolio allocation, the dividend yield and the degree of transparency as reflected in the frequency and quality of their communications. For selecting the right scheme as per your specific requirements, click here. Step Three - Select the ideal mix of Schemes Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals.
Step Four - Invest regularly The best approach is to invest a fixed amount at specific intervals, say every month. By investing a fixed sum each month, you buy fewer units when the price is higher and more units when the price is low, thus bringing down your average cost per unit. This is called rupee cost averaging and is a disciplined investment strategy followed by investors all over the world. You can also avail the systematic investment plan facility offered by many open end funds.
Step Five- Start early It is desirable to start investing early and stick to a regular investment plan. If you start now, you will make more than if you wait and invest later. The power of compounding lets you earn income on income and your money multiplies at a compounded rate of return. Step Six - The final step All you need to do now is to Click here for online application forms of various mutual fund schemes and start investing. You may reap the rewards in the years to come. Mutual Funds are suitable for every kind of investor - whether starting a career or retiring, conservative or risk taking, growth oriented or income seeking. Rights of a Mutual Fund Unitholder A unit holder in a Mutual Fund scheme governed by the SEBI (Mutual Funds) Regulations, is entitled to: 1. Receive unit certificates or statements of accounts confirming the title within 6 weeks from the date of closure of the subscription or within 6 weeks from the date of request for a unit certificate is received by the Mutual Fund. 2. Receive information about the investment policies, investment objectives, financial position and general affairs of the scheme. 3. Receive dividend within 42 days of their declaration and receive the redemption or repurchase proceeds within 10 days from the date of redemption or repurchase. 4. Vote in accordance with the Regulations to:a. Approve or disapprove any change in the fundamental investment policies of the scheme, which are likely to modify the scheme or affect the interest of the unit holder. The dissenting unit holder has a right to redeem the investment. b. Change the Asset Management Company. c. Wind up the schemes. 5. Inspect the documents of the Mutual Funds specified in the scheme's offer document. Mutual Funds - A Globally Proven Investment All investments whether in shares, debentures or deposits involve risk. Share value may go down depending upon the performance of the company, the industry, state of capital markets and the economy. Generally however, longer the term, lesser the risk. Companies may default in payment of interest and principal on their debentures/bonds/deposits. While risk cannot be eliminated, skillful management can minimize risk. Mutual Funds help to reduce risk through diversification and professional management. The experience and expertise of Mutual Fund managers in selecting fundamentally sound securities and timing their purchases and sales help them to build a diversified portfolio that minimizes risk and maximizes returns. Worldwide, the Mutual Fund, or Unit Trust as it is called in some parts of the world, have almost overtaken bank deposits and total assets of insurance funds. As of date, in the US alone there are over 5,000 Mutual Funds with total assets of over US $ 3 trillion (Rs.l00 lakh crores). In India there are 34 Mutual Funds and over 300 schemes with total assets of approximately Rs. 100,000 crores. All mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI)
Feature
Building a Mutual Fund Portfolio
12 Nov 2001
- By Sameer Chavan More often then not it is not enough to have just one fund in which to invest in. Like stocks, in mutual funds too, for optimal returns it is important to have a portfolio of mutual funds. The bedrock of a successful portfolio is largely dependent on three factors. Appropriate asset allocation, effective diversification and last but not the least suitable fund selection. This sounds easy but an investor can encounter many roadblocks in his quest to attain these goals. Here we will attempt to look at some common obstacles and how to avoid them.
Lack of strategy
Like in most things it is important to have a strategy in investing. However, the lack of an asset allocation strategy is probably the most frequent mistake in mutual fund investing. Most investors are quite clear in identifying their investment objective, but more often then not skip the vital step in establishing a successful portfolio, that of creating a detailed asset allocation strategy. A work well begun is half the work done. As such, without a welldefined and appropriate
asset allocation strategy that accurately reflects individual investment objectives and preferences (time horizon, return objectives, risk tolerance, etc), the selection of mutual funds is haphazard instead of logical. In most cases, the outcome of recklessly fund selection is inappropriate asset allocation of risk and reward, which in turn leads to ineffective diversification -- the ultimate result is poor or mediocre portfolio performance. The common pitfalls in asset allocation could be characterised by being over-weight in certain fund types or categories, underweighting of fund types and/or inappropriate fund types in the portfolio. To achieve effective allocation that fits ones investment objectives and preferences. Investment should be spread among different fund categories to achieve both a variety of distinct risk/reward objectives and a reduction in overall risk. Recognising the type of investor you are will go a long way towards helping you build a meaningful portfolio of investments. To get an indicative picture of your profile take the following questionnaire.
Asset concentration
Another common
mistake is that of having a very large portion of the portfolio assets concentrated in funds with very high risk/reward characteristics. This phenomenon has largely been bought about in the Indian markets due to the huge run up in Technology stocks which made investors flock to Infotech funds. Though the investments may actually reflect chosen investment objectives. The result is excessive volatility, which in many instances, can cause disappointing portfolio performance because the very large percentage of risk does not justify the potential reward -- in other words, the risk is highly disproportionate to overall profit potential. However, though being over weight in any one sector is more likely to be a problem in portfolios with aggressive risk tolerances. It can occur with any type of risk tolerance. Sectoral funds though volatile can fit into many portfolios, provided an investor adheres to the principles of effective diversification: distinct risk/reward objectives within a variety of fund types and a reduction in overall portfolio risk. A good portfolio would depend on the choices of aggressive, moderate or conservative risk tolerances and growth, balance or incomeoriented return
objectives. The key is to treat high risk, nondiversified funds as a suitable portfolio supplement without dramatically increasing overall risk.
Duplication of Fund Types
An investors tends to duplicate funds when one particular type of fund has given him good returns. Inefficient diversification occurs when an investor has two or more funds with identical objectives. If the fund has been chosen right it is usually best to represent a fund category with just one fund. As such, the underlying common factor in avoiding these three mistakes just boils down to detailed asset allocation. It promotes effective diversification and eliminates the problems associated with haphazard fund selection -- it is the key in establishing a successful mutual fund portfolio.
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Ask the Fund Manager – Mr Anup Maheshwari, Sr. Vice President & Head Equities, DSP MERRILL LYNCH Ask the Fund ManagerExpert Speak Your Investment Garden Time out!
Risk management and the mutual funds The basic objective of a mutual fund is to provide a diversified portfolio so as to reduce the risk in investments at a lower cost. The mutual fund industry worldwide is based on this premise. Investors who take up mutual fund route for investments believe that their risk is minimized at lower costs, and they get an optimum portfolio of securities that match their risk appetite. They are ignorant about the diverse techniques and hedging products that can be used for minimizing the market volatility and hence take the help of the fund managers. It is very daunting to note that the drop in the NAV of some of the schemes is higher than the erosion of value in some of the ICE stocks. The recent survey conducted by PricewaterhouseCoopers (PWC) on risk management by mutual funds has posted interesting as well as worrying results. According to the survey, as many as 50 percent of the respondent mutual funds are not managing risk properly. If this is not all, 50 percent of the respondents did not even have documented risk procedures or dedicated risk managers. The respondents included among others, some of the heavyweights of the Indian MF industry viz. Templeton, Alliance, Prudential and IDBI Principal MF. Worrisome news it is, for the investor who still believes MFs are a route to manage one’s money in a better and safe manner. The recent wild movements in the NAVs of several equity funds have belied all expectation of a diversified portfolio from the fund managers when the basic tenet behind portfolio management is risk management. Mr. Shyam Bhat, Fund Manager-Tata asset Management Ltd. said ‘Indian Mutual fund industry is not using statistical techniques of risk management but is using diversification effectively within the market limitations. As far as use of derivatives is concerned, they are not presently used because of the low volumes, low liquidity and absence of sufficient hedging products in the market ’. Aggression has been the key word followed by the AMCs when it comes to taking positions in stocks. With investment in volatile ICE sectors being the driver of growth last season, almost everybody had taken big exposures to them. Birla MF maintained its exposures in Infosys to almost 25 percent in all of its equity schemes throughout last year. The same is true of ING Savings Trust that has Rs. 60 crores invested in Wipro and Infosys out of the total fund size of 135 crores in its growth fund. The result of these exposures is that the fund witnessed a movement of almost 9 percent in a single day on budget when the market saw an appreciation of around 4.36 percent. In their quest for growth, many funds have seen very volatile movements in NAVs. The investor confidence may not be lost but such volatility sure dents it. The point is not whether AMCs should be chastised or not but just to question the practices as the fate of many investors is linked to it. An ordinary investor considers mutual funds as the experts in investment decisions and so naturally expects the decision of investing in mutual funds to bear fruit. However, AMCs often leave a lot to be desired as they falter on important fronts like NAV and portfolio disclosure besides posting high fluctuations and poor returns.
The Beta of some of the favorite stocks is shown below. The Table contains the Beta of some of the ICE scrips that constitute the top 10 holdings across various equity funds.
DSQ Software Ltd. Satyam Computer Services Ltd. SSI Ltd. Wipro Ltd.
2.09 2.00 1.98 1.87
Taurus Libra Leap (5.68%), DSP ML Tech. (6.06%) ING Growth Port (11.2%), Alliance Equity Fund (9.7%), Chola freedom Tech (11.51%) IL&FS eCom (9.63%), LIC Dhansamridhi (9.18%) ING Growth (23.8%), Magnum Sector Fund -Infotech (15%), Alliance Alliance New Millennium (10%) UTI Sector- Services (9.48%), Taurus
Himachal Futuristic Communications Ltd.
1.82
Discovery Stock (10.45%) Global Tele-Systems Ltd. Zee Telefilms Ltd. Infosys Technologies Ltd. 1.81 1.70 1.54 UTI US 92 (7.02%), ING Growth Portfolio (3.8%) UTI Sector- Services (7.21%), ING Growth Portfolio (10.06%), ING Growth Portfolio (20.5%), Alliance New Millennium (11.5%)
As can be seen, some of the stocks are too volatile and can cause wild movements in the NAVs of funds that have taken exposures in them. The standard deviation of the returns in some of these funds points to it. While Alliance Equity Fund has a Standard Deviation of 2.53, Birla Advantage has its Standard Deviation at 2.57. ING Growth has a standard deviation of 3.3, which is relatively high due to its exposure to two volatile ICE scrips. Birla Advantage has reduced its exposures to Infosys drastically in the last two months and taken steps to contain volatility. Similar steps are being planned by SBI Mutual Fund that is recasting its equity portfolio to reduce risks as they can scare investors. It is unfortunate that the fund managers are not taking due care for minimizing the risk and are in a race to post higher and higher returns during the phase of bull-run. They should understand that the investors forget the high returns posted in any specific period very soon but they take hell lot of time to forget the burns they get during periods of losses. Hence for maintaining the confidence of the retail investors it is very important to control wild fluctuations in the NAVs. The basic technique of portfolio management thrusts on diversification, which preaches inclusion of negative beta, stocks in the portfolio so as to minimize the impact of fluctuation in the market. Diversification always has a cost and investors are willing to pay for it if it is properly done. The fund manager should disclose what they are doing at the hedging front. They should come up and tell their investors as to what they do at times of high fluctuations. Normally it has been seen that they outperform the broad market indices during the bull-runs and under-perform the indices during the bear-phases. The industry needs to revise their attitude and try to streamline their actions with their objectives. Some mutual fund houses are quite disciplined but every body should embrace the same spirit. There are some infrastructural problems but fund managers need to be more vigilant on the market movements. Mr. Bhupinder Sethi, Fund Manager - Dundee Mutual Fund said ‘We are actively monitoring the market movements and taking calls accordingly. Though we are presently not using derivatives for hedging of risk because of lack of depth in the market for the product, but we go into cash when we see the expectations of huge corrections coming in.’ Poor performance, poor servicing to clients and failure of third party service providers, are the three major risk factors identified in the survey by PWC. These are also going to be crucial in a rapidly growing competitive scenario. Under this setting, it is not just growth that should be the focus area but also better management of all risks and hence, AMCs would do well to keep the investor and his interest in mind before taking any decision.
AMFI-MUTUAL FUND (BASIC) MODULE CURRICULUM
1. The Concept and Role of Mutual Funds • The concept of a Mutual Fund; Advantages of Mutual Fund investing- Portfolio Diversification, Professional Management, Reduction of Risk, Transaction Costs and Taxes, Liquidity and Convenience • History in India - Size of Industry, Growth Trends, UTI (its role in the MF sector, unique structure); MFs' Place in Financial Markets • Types of Funds
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Open-end Funds/Closed-end Funds/Fixed Term Plans, Load Funds/No Load Funds, Tax Exempt/Non Tax Exempt Funds Money Market Funds, Equity Funds, Debt Funds, Commodity Funds, Real Estate Funds-
2. Fund Structure and Constituents • Legal structure-
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Closed end and Open end Funds Asset Management Company, Trustees/Trust Companies Legal status of Fund Sponsors
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Rights and Responsibilities of the AMC Directors, Trustees (SEBI, Cos. Act) Fiduciary nature of relationship between Investor and Fund Legal Structure in the U.S.-Investment Companies, Management Companies & Advisors Legal Structure in the U. K.- Unit Trusts, Trustees Registrars, Bankers, Custodians, Depositories
Role, Functions, Rights and Responsibilities of other Market Constituents
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Marketing and Distribution Participants- Agents, Banks, NBFCs, Stock Brokers Fund mergers and Scheme Takeovers
Brokers, Sub-
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3. Legal and Regulatory Environment • Role of regulators in India ? SEBI, RBI, MoF, Stock Exchanges, RoC, CLB, DCA ? Unit Trust of India and UTI Act ? Non-UTI Mutual Funds and SEBI (MF) Regulations • Regulation versus Self Regulation- Role of AMFI, Investor Associations, Consumer Forums/Courts Rights and Obligations of the Investor 4. The Offer Document
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The Offer Document – What it is, Importance, Contents, Regulation and Investors Rights
Contents of the Offer Document ? Standard Offer Document for Mutual Funds (SEBI format) ? Summary Information ? Glossary of Defined Terms ? Risk Disclosures ? Legal and Regulatory Compliance ? Expenses ? Condensed Financial Information of Schemes ? Constitution of the Mutual Fund ? Investment Objectives and Policies ? Management of the Fund ? Offer Related Information
5. Fund Distribution and Sales Practices
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The Challenge of Distributing Mutual Funds Who can Invest in MFs in India Distribution channels Role of Direct Marketing by Mutual Funds in India Broker/Sub Broker Arrangements Individual Agents, Brokers, Sub-Brokers, Banks, NBFCs Sales Practices
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6. Accounting, Valuation and Taxation Accounting ? Domestic SEBI Regulations on Valuation Marking to Market Equity Valuation Norms- Listed, Unlisted, NPA, Untraded Debt Valuation Norms – Listed, Unlisted, Illiquid Money Market Instruments Valuation Norms Taxation Taxation of Mutual Funds Taxation of Income and Gains in the Hands of Investors
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7. Investor Services • Applying for or account opening with Mutual Fund -
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? Application/Agreement, Provisions of the Agreement, Point of Receipt, Form of Payment, First Time versus Continuing Payments, Certificate vs. No Certificate ? Registering a Mutual Fund Account- Individual, Joint, Corporate, Trusts, etc. ? Repurchase and redemption options ? Cut-off times for submissions of Requests, Historical vs. Prospective NAVs Different investment plans and services by Mutual Funds? Accumulation Plans, Systematic Investment Plans, Automatic Reinvestment Plans, Retirement Plans, Switching Within Family of Funds, Voluntary Withdrawal Plans, Redeeming Shares ? Services Performed by Mutual Funds- Nomination Facilities, Phone Transactions/Information, Check Writing, Pass Books, Periodic Statements and Tax Information - Statutory, Others ? Loans Against Units
8. Investment Management
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Equity portfolio management Stock Selection Review of the Indian Equity Market Types of Equity Instruments Equity Classes ? Approaches to Portfolio Management ? Organisation Structure of Equity Funds
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Debt Portfolio Management ? Classification of Debt Securities ? A Review of the Indian Debt Market ? Instruments in the Indian Debt Market ? Basic Characteristics of Money Market Securities ? Basic Characteristics of Debt Securities ? Measures of Bond Yields- Current Yield, YTM, Yield Curve ? Risks in Investing in Bonds ? Debt Investment Strategies ? Interest Rates and Debt Portfolio Management ? Use of derivatives for Debt Portfolio Management ? Organisation Structure of Debt Funds SEBI Investment Guidelines and Restrictions on Investment Portfolios- Structure, Timing of Investments, Permissible Instruments
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9. Measuring and Evaluating Fund Performance • Performance Measures? Equity Funds • NAV Growth, Total Return; Total Return with Reinvestment at NAV, Annualised Returns and Distributions, Computing Total Return (Per Share Income and Expenses, Per Share Capital Changes, Ratios, Shares Outstanding), the Expense Ratio, Portfolio Turnover Rate, Fund Size, Transaction Costs, Cash Flow, Leverage ? Debt Funds • Peer Group Comparisons, The Income Ratio, Industry Exposures and Concentrations, NPAs, besides NAV Growth, Total Return, Expense Ratio ? Money Market Funds • Fund Yield, besides NAV Growth, Total Return, Expense Ratio ? Differences between Active versus Passive Fund performance, Equity vs. Debt Fund Performance ? Passive Funds Performance against Base Index, Tracking Error, Expenses ? Performance Measurement- NAV change ? Analysing fund Management- Relative Importance of Factors: Total Return of Different Types of Funds • Concept of Benchmarking for Performance Evaluation ? Performance Benchmarks in the Indian Context• Tracking a Fund’s Performance- Newspapers, Periodicals, Research Reports, Annual Reports, Prospectus, Reports from Tracking Agencies, Internet and Websites of Mutual Funds; and Interpretation of Data
India Infoline Mutual Fund Research
Mutual Fund Scheme Analysis –Balanced Funds Analysis of Balanced Mutual Funds Equity markets have been booming in the past two years. Everyone is tempted to enter the equity markets and make a quick killing in the markets. However, this temptation is not new and has been witnessed in all the bull runs. But we should not forget that every Bull Run is preceded by sluggishness in the market. Here comes the benefit of investing in Balanced mutual funds which aim at taking exposure to Equity to give a ticker to the returns but at the same time takes some debt exposure which acts as a cushion in the volatile markets. Balanced Funds aim to achieve a balance between equities and debt investments, but the balance is often skewed depending upon the nature of the fund. Thus, depending on the equity exposure, the Balanced funds can be classified as: 1? Aggressive balanced funds 2? Semi-aggressive balanced funds 3? Conservative balanced funds Aggressive balanced funds are those, which have a high equity exposure, and it may range between 60-75% in equities, and the balance in debt. Such funds are meant for higher-risk investors who would like to invest in equity, but would also like to have a certain debt market exposure as a cushion. Semi-aggressive balanced funds are those, which invest 40-60% in equities and the balance in debt. Conservative balanced funds are basically tilted towards debt instruments, with a low to moderate exposure to equities. They are meant for the conservative investor, who is looking for that little something extra in terms of returns. We have done an analysis of Balanced funds which would be suitable for those investors who would like to take less risk in comparison to Diversified mutual funds. These funds invest around 60% in the equities while the remaining in Debt and Money market instruments, which acts as a savior in volatile and falling markets.
The following are the top 5 balanced schemes: Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 3 5 Since Name Month Months Months Year Years Years Years Inception HDFC Prudence Fund 7.0 7.5 22.0 43.0 65.4 62.1 48.0 63.6 SBI 6.2 5.7 22.1 49.1 82.1 53.6 14.7 36.0 Magnum
Balanced Tata Balanced Fund Kotak Balance Sundaram Balanced
3.1 5.5 2.3
4.2 2.6 0.7
18.5 20.7 5.9
42.6 42.5 26.0
63.9 54.4 43.9
48.5 44.2 33.9
25.3 24.9 --
32.3 26.1 20.6
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Scheme Analysis –Balanced Funds HDFC Prudence Fund HDFC Prudence Fund (the erstwhile Zurich India Prudence Fund) was launched way back in Jan 1994. The fund aims to provide periodic returns and capital appreciation over a long period of time, from a judicious mix of equity and debt investments, with the aim to prevent/ minimize any capital erosion.
Scheme Performance: Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 3 5 Since Name Month Months Months Year Years Years Years Inception HDFC Prudence 7.0 7.5 22.0 43.0 65.4 62.1 48.0 63.6 Indices Crisil Balanced Index 5.4 15.7 30.9 19.4 -Portfolio Analysis:
The fund has maintained its exposure to Top-5 sectors more or less same in the last 6 months, top sectors being Banks, Electricals & Electrical Equipments, Current assets and Auto & Auto ancillaries. The fund has maintained around 64% in the Equity instruments, 29% in Debt instruments & around 6% in cash & cash equivalents in the last one-year.
Company Name Instrument % of Net Assets Reverse Repo Reverse Repo 9.5 11.4% GOI (2008) Securities 5.3 Satyam Computer Equity 4.8 State Bank of India Equity 4.7 Century Textiles Equity 4.5 Bharat Heavy Electricals Equity 4.2 State Bank of India NCD 3.8 Crompton Greaves Equity 3.5 ACC NCD 3.5 Ultra Tech Cement NCD 3.3 Concentration Analysis:
The scheme has 31 scrips with an average exposure of 24 crores and the Top-10 equity instruments constitute around 22% of the AUM’s. Satyam Computer is the scrip with the largest exposure.
Basic Information: The minimum investment in the scheme is Rs5000 and is managed by Mr. Prashant Jain. The fund has an entry load of 2.25% if the investment is less than 5crores and nil if investment is greater than 5 crores. The fund does not levy any exit load.
Investment Rationale: HDFC Prudence Fund has a long-term consistent record of delivering good returns to its investors. The scheme has given simple annualized returns of 62% in the last 3 years while 48% in the last 5 years. The AUM’s have grown close to 6 times in the last 3 years. Further the consistent returns can also be attributed to the fact that HDFC followed a process driven approach while investing. The Fund has never gone beyond its mandate in terms of asset allocation. Thus, we believe that HDFC Prudence Fund should be a prudent choice to park you savings.
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Scheme Analysis –Balanced Funds SBI Magnum Balanced Fund – Growth SBI Magnum Balanced was launched in October 1995. The scheme aims to provide to its Investors growth through capital appreciation. It also plans to provide periodic income through declaration of dividends. It is ideal for investors who wish to benefit from equity growth without excessive volatility.
Scheme Performance:
Performance as on May 23,2005
Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 3 5 Since Nam Month Months Months Year Years Years Years Inception e SBI Magnum Balanced 6.2 5.7 22.1 49.1 82.1 53.6 14.7 36.0 Indices Crisil Balanced Index 5.4 15.7 30.9 19.4 -Portfolio Analysis: The scheme has increased exposure to banking sector to 15% from around 3% in the last 6 months. Apart From Banking, Finance and Metals are the other sectors on which the scheme is over-weighted sectors. The fund has maintained an average exposure of 66%
towards equity in the last one year while 25% is towards Debt instruments and 8% to cash & cash equivalent instruments.
Concentration Analysis: The corpus of the scheme has seen an appreciation of 13% in the last one year. The Top-10 instrument constitutes 36% of the assets under management while IVRCL is the scrip with the largest exposure. Fund Information: The scheme is managed by Mr. S. Sawarikar. The minimum investment is Rs.1000 and the scheme has an entry load of 2.25% for investment of less than 5crores while it does not levy any exit load. Investment Rationale:
Company Name Instrument % of Net Assets Company Name Instrument % of Net Assets Cash Cash 7.5 Cash UTI Bank Ltd Cash NCD 7.5 5.6 UTI Bank Ltd Industries NCD NCD 5.6 Hindalco 5.5 Hindalco Industries NCD NCD 5.5 EXIM 5.4 EXIM Citicorp Finance NCD NCD 5.4 5.3 Citicorp Finance NCD Equity 5.3 IVRCL 4.6 IVRCLInfrastructure Infrastructure Industries Equity Equity 4.6 Reliance 4.4 Reliance Industriesof India Equity Equity 4.4 State Bank 4.2 State Bank of India India Equity Equity 4.2 SKF Bearings 3.8 SKF Bearings India India Equity Equity 3.8 Jet Airways 3.5 Jet Airways India Equity 3.5
Magnum Balanced Fund has been amongst the top performer over the last few years and has done extremely well even when the markets have taken a hit in the last few months. The scheme has generated 50% annualized return in the last year against 19% annualized return by its benchmark, CRISIL Balanced Fund Index over the same period. The success of the scheme can be attributed to actively managed portfolio in terms of stock selection, sector allocation and to some extent asset allocation. The fund has been ranked at 2nd position. India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Portfolio Analysis: Fund Scheme Analysis –Balanced Funds Tata Balanced Fund – Growth The scheme has increased exposure to financial sector to 16% from 8.7% & around 8% in Tata Balanced2% in was last 6 months. The1995 .The scheme aims toaverage exposure ofdebt banking from Fund the launched in Oct 7, fund has maintained an invest in equity and 66% oriented equity in the last to give investor 25% is towards Debt instruments and 9% to cash & cash towards securities so as one year while balanced returns. Scheme Performance: equivalent instruments.
Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 3 5 Since Concentration Month Months Months Year Years Years Years Inception Nam Analysis: e The corpus of the scheme has seen an appreciation 18% in the last one year. It has a Tata 3.1 4.2 18.5 42.6 63.9 48.5 25.3 32.3 diversified Balanced of 55 stocks and the Top 15 scrips constitute 28%. Portfolio Fund Information: Indices The scheme is managed by M Venugopal. The minimum investment is Rs.5000. The Crisil Balanced an entry load of 2.25% for investment of less than 2crores .It does not 5.4 15.7 30.9 19.4 -scheme charges Index exit load. levy any Investment Rationale:
Tata Balanced fund is a well-diversified fund in its equity exposure, which has invested across 55 scrips to minimize the adverse impact of any scrip on its balanced nature. The scheme has generated 42% annualized return in the last one year against 19% annualized return by its benchmark, CRISIL Balanced Fund Index over the same period. The scheme is less volatile as seen by its standard deviation of 0.47. The fund has been ranked at 3rd position.
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Company Name Instrument % of Net Assets Scheme Analysis –Balanced Funds Reliance Energy Ltd CP 11.6 Kotak Balance Fund
CP 9.1 Kotak Mutual Fund launched J&K Bank CP 6.0 Kotak Balance in November ICICI BANK LTD. Call Money Call Money 5.3 1999.It is an open-ended Equity 5.0 balanced scheme, which Gujarat Gas Company Sundaram Finance Ltd CP 4.5 seeks to achieve growth by Equity 4.4 investing in equity and equity Coromandel Fertilisers Infosys Technologies Equity 4.1 related instruments, balanced Equity 4.0 with income generation by State Bank of India Simbhaoli Sugar Mills Equity 3.5 investing in debt and money market instruments. Scheme Performance: Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 5 Since 3 Years Name Month Months Months Year Years Years Inception Kotak Balance 5.5 2.6 20.7 42.5 54.4 44.2 24.9 26.1 Indices Crisil Balanced Index 5.4 15.7 30.9 19.4 -Portfolio Analysis:
The fund has increased its exposure to banking sector from 7% to 21% in the last 6 months. They have also taken exposure to Power Generation, Transmission & Equipments in the month of April’05. They keep on changing the levels of current assets according to their market view.
Concentration Analysis:
The Scheme is holding 22 scrips, Gujarat Gas Company being the scrip with the largest exposure. The top 15 scrips constitute around 49% of the Assets under management.
Fund Information:
The Kotak balance scheme is managed by Mr. Anand Shah & Ritesh Jain. The fund charges an entry load of 2.25% upto 3 crores. It does charges any Exit load.
Investment Rationale: Kotak Balance fund follows a bottom-up approach to stock picking keeping in mind the quality of management, cash flows and order books, its brand equity, its financial and business acumen. The fund believes in value investing and hence picks stocks that are trading at a significant discount to their intrinsic value, and holds them till they appreciate. This gives investors a strong potential upside and a limited downside.
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Scheme Analysis –Balanced Funds Sundaram Balanced Fund – Growth
Sundaram Balanced fund was launched in May 2000. The scheme aims to provide capital appreciation and current income from a balanced portfolio of equities and fixed income securities.
Scheme Performance: Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 5 Since 2 Years 3 Years Name Month Months Months Year Years Inception Sundaram Balanced 2.3 0.7 5.9 26.0 43.9 33.9 -20.6 Indices Crisil Balanced Index 5.4 15.7 30.9 19.4 -Portfolio Analysis: The scheme has increased exposure to financial sector to 16% from 8.7% & around 8% in banking from 2% in the last 6 months. The fund has maintained an average exposure of 66% towards equity in the last one year while 25% is towards Debt instruments and 9% to cash & Cash equivalent instruments. % of Company Net Name Instrument Assets Cash Cash 27.6 Indian Railway Finance Corp PTC 10.9 Power Finance Corporation NCD 10.6 Reliance Industries Ltd Equity 4.3 ONGC Equity 3.8 State Bank of India Equity 3.7 IDBI DDB 3.3 Wipro Equity 3.3 United Phosphorus Equity 3.2 Sesa Goa Ltd Equity 3.1 Concentration Analysis: The corpus of the scheme has seen an appreciation 82% in the last one year. It has a portfolio of
25 stocks and the Top 15 scrips constitute 38%. Fund Information: The scheme is managed by Mr. Anup Bhaskar.The minimum investment is Rs.5000. The scheme charges an entry load of 2.25% for investment of less than 2crores .It does not levy any exit load.
Investment Rationale: Sundaram Balanced Fund has in-built circuit breakers to monitor investments and to ensure against skews in equity, Thus whenever the equity rises above 60%, it is again brought back to 52%. In the process, fund realizes the gains of the market but does not go off balance. The fund has an internal policy, which caps the exposure to particular scrip to beyond 5% of the equity portion in any stock. However these have also impacted the returns due to which the returns are not in the top quartile. India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Scheme Analysis –Balanced Funds
Published in May 2005. All rights reserved. © India Infoline Ltd 2005-06. This report is for information purposes only and does not construe to be any investment, legal or taxation advice. It is not intended as an offer or solicitation for the purchase and sale of any financial instrument. Any action taken by you on the basis of the information contained herein is your responsibility alone and India Infoline Ltd (hereinafter referred as IIL) and its subsidiaries or its employees or directors, associates will not be liable in any manner for the consequences of such action taken by you. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, but do not represent that it is accurate or complete. IIL or any of its subsidiaries or associates or employees shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this publication. The recipients of this report should rely on their own investigations. IIL and/or its subsidiaries and/or directors, employees or associates may have interests or positions, financial or otherwise in the securities mentioned in this report.
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80
NAV India: India's largest database on Mutual funds.
The strength of the database is not only the depth, but also easily assimilated and analysed form. Spend time in decision making rather collating and cross-referencing. NAVIndia is vastly more varied and in-depth, database on Mutual fund industry. Database Coverage on the mutual fund industry covering 1,400 schemes of 30 AMC's. With a user-friendly data presentation the information's be it on an scheme/AMC, tracking NAV's, scheme details, performances, rankings, portfolios etc. Cross validation controls ensures data accuracy & views, analysis and reports, Fund managers profiles/commentaries & basic company profiles are some of the value additions to name a few, are some sections which would allow you for making well informed decisions and to stay on top. NAVINDIA - 5 Segments of data AMC's: AMCwise - AUM, Allocation of AUM in various categories, Company holding, Sectoral Holding, What's in-What's out, Performance. Single Scheme: Scheme wise - Basic information like Address, Tel No, Category, Load Structure, Dividend Details, Scheme Objective, Detailed Portfolio, and Portfolio Trend, What's in - What's out? Rating Details and Scheme Analysis. Multi Schemes: For a set of schemes - Performance, all major statistical ratios, ComparisonCompanywise, Sectorwise, Ratingwsie, Assetwise and Average Maturitywise, NAV with multiple options, Fund Manager Fancies (Inclination of FM based on certain parameters) News: All MF related news, which are classified in various news types, which makes your go through simplest.
Magnum Debt Fund Series Magnum Tax Profit 1994 Magnum Equity Linked Savings Scheme 95 Magnum Equity Linked Savings Scheme 96 Magnum Monthly Income Scheme 97 Magnum Monthly Income Scheme 98 (I) Magnum Monthly Income Scheme 98 (II)
Magnum Tax Profit 1994
Registrar NAV Information Archives Portfolio 27th December 1993 31st March 2004 Equity greater than 80% Liquid Instruments less than 20%
Date of Launch Date of Maturity Pattern of Investment Provision of Liquidity for Investors
Repurchase at NAV after lock-in of 3 year
Magnum Equity Linked Savings Scheme 95
Registrar NAV Information Archives Portfolio
Date of Launch Date of Maturity Pattern of Investment
29th December 1994 31st March 2005 Equity greater than 85% Liquid Instruments less than 15%
Provision of Liquidity for Investors
Repurchase at NAV after lock-in of 3 year
Magnum Equity Linked Savings Scheme 96
Registrar NAV Information Archives Portfolio
Date of Launch Date of Maturity Pattern of Investment Provision of Liquidity for Investors
15th December 1995 31st March 2006 Equity greater than 85% Liquid Instruments less than 15%
Repurchase at NAV after lock-in of 3 year
Magnum Monthly Income Scheme 97
Registrar NAV Information Archives Portfolio 1st July 1997 30th June 2003 Debt greater than Equity less than Money Market & Others Balance
Date of Launch Date of Maturity Pattern of Investment
80% Provision of Liquidity for Investors Record of Dividend
20%
Repurchase at NAV after lock-in of 1 year July 97 - June 98 July 98 - June 99 July 99 - June 00 July 00 - June 01 July 01 - June 02 : : : : : 15.00% 12.00% 10.75% 9.75% 8.00%
Nature of Guarantee / Assuarance
Returns were assured for 1st year only i.e.from 1.07.97 to 31.07.98 @ 15.00%
Magnum Monthly Income Scheme 98 (I)
Registrar NAV Information Archives Portfolio
Date of Launch Date of Maturity
1st April 1998 31st March 2003 Debt Equity less than 20% Money Market & Others Balance
Pattern of Investment
greater than 80%
Provision of Liquidity for Investors Record of Dividend Nature of Guarantee / Assuarance
Repurchase at NAV after lock-in of 1 year 12.5% p.a. Guaranteed for 5 years Returns are guaranteed for 5 yrs. @ 12.50%
The capital invested in the scheme will be protected at the time of redemption i.e. a minimum redemption value of Rs.10. under the monthly, quarterly & Annual option is guaranteed. Under the cumulative option a minimum redemption value of Rs.18.62 per magnum is guaranteed by the AMC at the end of 5 yrs.
Magnum Monthly Income Scheme 98 (II)
Registrar NAV Information Archives Portfolio
Date of Launch Date of Maturity
1st February 1999 31st January 2004 Debt Equity less than 20% Money Market & Others Balance
Pattern of Investment
greater than 80%
Provision of Liquidity for Investors Record of Dividend
Repurchase at NAV after lock-in of 1 year (1.2.99 - 31.01.00) Monthly 12.50% Quarterly 12.64% Annual 13.25% (1.2.00 - 31.01.01) Monthly 10.48% Quarterly 10.57% Annual 11.00%
(1.2.01 - 31.01.02) Monthly 10.25%
(1.2.02 - 31.01.03) Monthly 7.25%
Quarterly 10.34% Annual 10.75% Nature of Guarantee / Assuarance
Quarterly 7.30% Annual 7.50%
Returns were assured for 1st year only i.e. from 1.02.99 to 31.01.2000: Mly. 12.50% Qly. 12.64% Annual 13.25% The capital invested in the scheme will be protected at the time of final Redemption under all the options i.e. a minimum value of Rs.10 is guaranteed at the end of 5 yrs.
ss Mutual Funds: The Tax Angle Sumit Gulati / Manisha Gulati The obvious may not always be the best option. Investors seeking a regular income from mutual funds invariably opt for the dividend option. They assume that the tax-free dividend payout is more efficient than systematic redemption of units from a growth option. Calculations, however, show otherwise. There are many such interesting aspects to mutual fund investing where the obvious choice may not always be the best. To know more about such investment nuances, read on. The Structure Taxation of mutual funds needs to be highlighted from two main angles. One angle looks at taxation from the point of view of the fund itself and the other looks at the taxation aspect with respect to the fund investor. One of the most significant points to be noted about mutual funds is that their income-whether dividend or capital gain - is not subject to any tax unlike a corporate, which has to pay tax on its earnings. This benefit granted to it, by virtue of Section 10 (23D), comes on account of its status as pass through vehicle. No taxes on such income then serves to increase the amount of distributable income. As far as the investor angle is concerned, there are a variety of tax provisions that apply to mutual funds. It is necessary to be aware about some basic tax provisions that apply to all mutual fund schemes. These relate to:
1) Tax Deduction at Source - The important point to note about mutual funds, for resident investors, is that for any income credited or paid by the fund no tax is deducted at source. This provision applies both to dividend payouts made by funds and to proceeds of redemption. Sections 194 K and 196 A are the governing provisions for this. The provisions are, however, different for NRIs. While there is no TDS applicable on dividend payouts made to NRIs, TDS is supposed to be made whenever NRIs redeem their investment in a mutual fund scheme. 2) Wealth Tax - No wealth tax is leviable on mutual fund units. This benefit comes to mutual funds by virtue of the fact that mutual fund units are not treated as 'assets' under the Wealth Tax Act. 3) Capital Gains Tax - Capital gains tax needs to be paid on all mutual fund units. The difference between the purchase and redemption price (in case of open-end funds) is used to calculate capital gains. Time is also a factor for this purpose. Units held for a period of less than one year are eligible for short term capital gains while those held for a period of longer than one year are eligible for long term capital gain. Further, in the case of long term capital gain, the investor is given the option of choosing between a) 20 per cent tax rate with indexation benefit and b) 10 per cent tax rate without the benefit of indexation. What is more the latest budget has exempted capital gains from tax if the amount of gain is invested in Initial Public offerings (IPO). 4) Dividend tax free for investor - the provisions of the budget for the financial year 1999-2000 introduced some changes in the way mutual fund dividends were supposed to be taxed. That year Section 10(33) was modified to include dividends from Unit Trust of India and all other Mutual Funds. Section 10 is an all-encompassing section that lists the kinds of income that are to be excluded from calculation of total income. 5) Dividend distribution tax - while the modification of Section 10(33) made dividend tax free in the hands of all investors, another inclusion in the tax laws levied tax on dividends distributed by mutual funds. The tax, called Dividend Distribution Tax, is levied on all distributions of dividends made by mutual funds. However, the budget for the year 1999-2000 exempted UTI's US-64 and all open ended equity schemes from the purview of dividend distribution tax till the end of March 2002. The appropriate sections governing this provision are Sections 115 R to 115 T While the above tax provisions are attracted by all mutual fund
schemes irrespective of their type, genre and kind, some specific tax benefits and provisions are applicable to select schemes. Select schemes provide benefit under Section 88, Section 54 EA and Section 54 EB (till some time back) Schemes with Section 88 benefit. Mutual Fund schemes that carry the benefit of Section 88 can essentially be spread across three categories - ELSS, Insurance Linked and Pension. We will explain all these schemes and the benefits they carry. We will also look at tax efficient investment methods for each of these schemes. 1) ELSS - Short for Equity Linked Savings Schemes, these carry a tax rebate of 20 per cent of amount invested. However, only a maximum of Rs 10,000 is eligible for rebate in this category of schemes. These schemes come with a lock in period of 3 years. Further, appropriate legislation stipulates that atleast 80 per cent of the total corpus of these funds shall be invested in equity and related instruments. Currently, most mutual funds offer open-ended ELS schemes in which one can invest throughout the year. Details about the performance of these schemes can be accessed from the fund section. The unique structure and terms of these schemes necessitates that certain points be kept in mind while investing. For instance, one can benefit by choosing a scheme capable of distributing dividend. The benefit of dividend declaration is that the unitholder not only receives tax-free income but also pays lower capital gains at the time of redemption. This is because the dividend declared serves to reduce the NAV and the redemption price. More information and tips on ELS Schemes can be seen at Save tax through Equity Linked Saving Schemes. 2) Insurance Linked Schemes - Apart from ELSS schemes, mutual fund schemes with insurance benefits carry the benefit of Section 88. Such schemes piggy back an insurance benefit with a mutual fund. The Insurance Linked Schemes currently available are UTI's Unit Linked Insurance Plan (ULIP) and LIC's Dhanraksha '89. These schemes carry defined lock ins too. 3) Pension Plans - the mutual fund industry in India is constrained by law from offering full fledged pension plans on the lines of the 401 K plans available in the United States. So far, UTI and Kothari Pioneer Mutual Fund are the only two mutual funds offering full-fledged Pension Plans with benefit under Section 88. While UTI offers Retirement Benefit Plan, Kothari Pioneer Mutual Fund offers KP Pension Plan. Fund Tips The tax provisions, whatever they are, are unavoidable. However, there are some general observations that are required to be understood as they can lead to a lowering of the
tax liability. The choice, quite obviously, has to be made by the investor himself depending on his needs. Listed below are some useful observations: i) Aim for Double Indexation Benefit - it has been mentioned above that an investor can calculate capital gains by choosing between two options - 10 per cent without indexation or 20 per cent with indexation. An investor, at the time of withdrawal, should consider both and choose the lower tax option. At this point the concept of double indexation can be useful. Double indexation gives an investor the advantage of indexing his investment to inflation for two years while remaining invested for a period of slightly more than an year. This can be done if the investor puts in his money just before the end of a financial year and withdraws it immediately after the end of the next financial year. For instance, had an investor put in money in a fund on 25 March 2000 (6 days before the end of FY on 31 March 2000) and withdrawn it on 5 April 2001 (after the end of FY 20002001) he would have got benefit for two financial years (19992000, 2000-2001) since the investment was made in the FY before last (1999-2000). Depending on the quantum of gains in the scheme and the inflation index, the tax liability could be lowered by availing of double indexation. ii) Be sure of the option being chosen - switching optionsdividend to growth or vice versa-amounts to redemption from one option and fresh investment in the other option. And, this redemption attracts capital gains tax. So, it is important that an investor chooses the option carefully. This can be done through a careful analysis of one's cash flow needs. iii) Bonus Units offer only a liquidity advantage - Unlike the case with common stock, a bonus issue in mutual funds carries nothing but a liquidity and tax advantage and that too under a given set of assumptions. A bonus carries no value because the total wealth of the unitholder remains the same. However, as the NAV adjusts down, depending on the ratio in which the bonus is granted, it serves to lower the cost of exit on the existing units. In short it reduces capital gains payable. A bonus issue could, therefore, partially increase liquidity by facilitating early withdrawal for those fearing to redeem on account of tax liability. The flip side ofcourse is that the cost of bonus units is deemed to be zero for tax purposes and that whenever those are withdrawn a tax will be levied on the gains. So, while less tax on existing units is compensated for by greater tax liability on bonus units (because their value is deemed to be zero), the advantage is that withdrawal of existing units can be made even before the end of one year. This is because any gains in the units may have been reduced if not eliminated altogether due to the bonus issue.
iv) Choose to withdraw systematically instead of opting for dividend receipts - the prevailing tax provisions provide an interesting way of not only receiving regular income but also paying less tax. This can be done by systematically withdrawing the gains from the investment instead of claiming dividends. To do this an investor needs to opt for the Growth option of a mutual fund scheme and stay invested in the scheme for atleast one year. After one year, the investor can direct the mutual fund to systematically redeem units worth a fixed amount or units equivalent to the gains in the scheme. This way, the investor is assured of regular inflows. The benefit of doing this is that it is a more tax efficient way of receiving regular income. This is because whenever the units are withdrawn capital gains is charged on the difference between the purchase price and redemption price. So, if an amount equivalent to the gains is withdrawn then tax is levied on the amount of gains less the cost of units being redeemed to distribute this gain. Had these gains been distributed as dividend, tax would have been levied on the entire amount of gains. This would have meant a higher tax payout. v) Choose Dividend Reinvestment option for open-end equity schemes - tax laws prevailing at the moment specify that dividend payouts of all funds except UTI's US 64 and open ended equity schemes are subject to a distribution tax of 10 percent. This exemption granted to open end equity funds can be turned to one's advantage. An investor can take advantage of this provision by investing in the dividend reinvestment option of the scheme. The benefit of this is that due to the dividend declared in the units of the scheme the NAV declines by the amount of dividend. This, then brings down the redemption price of the units which in turn lowers the amount of capital gains. The advantage of dividend reinvestment therefore is twinfold. One, is that the amount of gains reduce and other is that dividend gets reinvested in the scheme automatically without any fresh procedural hassles. vi) Invest for the long term - apart from being one of the fundamental tenets of sound investing, investing for the long term is also smart from the tax angle. Units held for more than an year are eligible for long term capital gain unlike short term capital gain which is taxed as a part of the unitholder's total income. While the maximum tax that will need to be paid on long term gain is limited to 10 per cent, tax on short-term capital gain can vary depending on other components of the unitholder's total income. The Great Mutual Fund Tax Arbitrage Over the years funds have found favour with various finance ministers. The result, favourable tax provisions compared to other investment alternatives. These tax differentials therefore
go far in giving mutual funds a tax arbitrage. This arbitrage is most evident in the case of corporates and high income individuals. Most corporates attract a high corporate tax rate for even their income from investment. However, by investing in mutual funds corporates ensure that all income received is taxed at a low 10 per cent as compared to a much higher corporate tax rate. This is because income from funds is tax free in the hands of the investor and only a dividend distribution tax is payable in the case of some schemes. This tax arbitrage combined with loopholes in Capital Gains law combined to create the practice of Dividend Stripping and the speciality Serial Plan schemes in the year gone by.
A mutual fund is a form of collective investment that pools money from many investors and invests their money in stocks, bonds, short-term money market instruments, and/or other securities.[1] In a mutual fund, the fund manager trades the fund's underlying securities, realizing capital gains or losses, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors. The value of a share of the mutual fund, known as the net asset value per share (NAV), is calculated daily based on the total value of the fund divided by the number of shares currently issued and outstanding. Legally known as an "open-end company" under the Investment Company Act of 1940 (the primary regulatory statute governing investment companies), a mutual fund is one of three basic types of investment companies available in the United States.[2] Outside of the United States (with the exception of Canada, which follows the U.S. model), mutual fund is a generic term for various types of collective investment vehicle. In the United Kingdom and western Europe (including offshore jurisdictions), other forms of collective investment vehicle are prevalent, including unit trusts, open-ended investment companies (OEICs), SICAVs and unitized insurance funds. In Australia the term "mutual fund" is not used; the name "managed fund" is used instead. However, "managed fund" is somewhat generic as the definition of a managed fund in Australia is any vehicle in which investors' money is managed by a third party (NB: usually an investment professional or organization). Most managed funds are openended (i.e., there is no established maximum number of shares that can be issued); however, this need not be the case. Additionally the Australian government introduced a compulsory superannuation/pension scheme which, although strictly speaking a managed fund, is rarely identified by this term and is instead called a "superannuation fund" because of its special tax concessions and restrictions on when money invested in it can be accessed.
Contents
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1 History 2 Usage 3 Net asset value 4 Turnover 5 Expenses and TER's o 5.1 Management Fees o 5.2 Non-management Expenses o 5.3 12b-1/Non-12b-1 Service Fees o 5.4 Fees and Expenses Borne by the Investor (not the Fund) o 5.5 Brokerage Commissions 6 Types of mutual funds o 6.1 Open-end fund o 6.2 Exchange-traded funds o 6.3 Equity funds ? 6.3.1 Capitalization ? 6.3.2 Growth vs. value ? 6.3.3 Index funds versus active management o 6.4 Bond funds o 6.5 Money market funds o 6.6 Funds of funds o 6.7 Hedge funds 7 Mutual funds vs. other investments 8 Selecting a mutual fund o 8.1 Share classes o 8.2 Load and expenses 9 Criticism of managed mutual funds o 9.1 Scandals 10 See also
• 11 References [edit] History
Massachusetts Investors Trust was founded on March 21, 1924, and, after one year, had 200 shareholders and $392,000 in assets. The entire industry, which included a few closed-end funds, represented less than $10 million in 1924. The stock market crash of 1929 slowed the growth of mutual funds. In response to the stock market crash, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws require that a fund be registered with the Securities and Exchange Commission (SEC) and provide prospective investors with a prospectus that contains required disclosures about the fund, the securities themselves, and fund manager. The SEC helped draft the Investment Company Act of 1940, which sets forth the guidelines with which all SEC-registered funds today must comply.
With renewed confidence in the stock market, mutual funds began to blossom. By the end of the 1960s, there were approximately 270 funds with $48 billion in assets. The first retail index fund, the First Index Investment Trust, was formed in 1976 and headed by John Bogle, who conceptualized many of the key tenets of the industry in his 1951 senior thesis at Princeton University[3]. It is now called the Vanguard 500 Index fund and is one of the largest mutual funds ever with in excess of $100 billion in assets. One of the largest contributors of mutual fund growth was individual retirement account (IRA) provisions added to the Internal Revenue Code in 1975, allowing individuals (including those already in corporate pension plans) to contribute $2,000 a year. Mutual funds are now popular in employer-sponsored defined contribution retirement plans (401(k)s), IRAs and Roth IRAs. As of April 2006, there are 8,606 mutual funds that belong to the Investment Company Institute (ICI), the national association of investment companies in the United States, with combined assets of $9.207 trillion.[4]
[edit] Usage
Mutual funds can invest in many different kinds of securities. The most common are cash, stock, and bonds, but there are hundreds of sub-categories. Stock funds, for instance, can invest primarily in the shares of a particular industry, such as technology or utilities. These are known as sector funds. Bond funds can vary according to risk (e.g., high-yield or junk bonds, investment-grade corporate bonds), type of issuers (e.g., government agencies, corporations, or municipalities), or maturity of the bonds (short- or long-term). Both stock and bond funds can invest in primarily U.S. securities (domestic funds), both U.S. and foreign securities (global funds), or primarily foreign securities (international funds). Most mutual funds' investment portfolios are continually adjusted under the supervision of a professional manager, who forecasts the future performance of investments appropriate for the fund and chooses those which he or she believes will most closely match the fund's stated investment objective. A mutual fund is administered through a parent management company, which may hire or fire fund managers. Mutual funds are subject to a special set of regulatory, accounting, and tax rules. Unlike most other types of business entities, they are not taxed on their income as long as they distribute substantially all of it to their shareholders. Also, the type of income they earn is often unchanged as it passes through to the shareholders. Mutual fund distributions of tax-free municipal bond income are also tax-free to the shareholder. Taxable distributions can be either ordinary income or capital gains, depending on how the fund earned those distributions.
[edit] Net asset value
Main article: net asset value
The net asset value, or NAV, is the current market value of a fund's holdings, usually expressed as a per-share amount. For most funds, the NAV is determined daily, after the close of trading on some specified financial exchange, but some funds update their NAV multiple times during the trading day. Open-end funds sell and redeem their shares at the NAV, and so process orders only after the NAV is determined. Closed-end funds (the shares of which are traded by investors) may trade at a higher or lower price than their NAV; this is known as a premium or discount, respectively. If a fund is divided into multiple classes of shares, each class will typically have its own NAV, reflecting differences in fees and expenses paid by the different classes. Some mutual funds own securities which are not regularly traded on any formal exchange. These may be shares in very small or bankrupt companies; they may be derivatives; or they may be private investments in unregistered financial instruments (such as stock in a non-public company). In the absence of a public market for these securities, it is the responsibility of the fund manager to form an estimate of their value when computing the NAV. How much of a fund's assets may be invested in such securities is stated in the fund's prospectus..
[edit] Turnover
Turnover is a measure of the fund's securities transactions, usually calculated over a year's time, and usually expressed as a percentage of net asset value. This value is usually calculated as the value of all transactions (buying, selling) divided by 2 divided by the fund's total holdings; i.e., the fund counts one security sold and another one bought as one "turnover". Thus turnover measures the replacement of holdings. In Canada, under NI 81-106 (required disclosure for investment funds) turnover ratio is calculated based on the lesser of purchases or sales divided by the average size of the portfolio (including cash). Turnover generally has tax consequences for a fund, which are passed through to investors. In particular, when selling an investment from its portfolio, a fund may realize a capital gain, which will ultimately be distributed to investors as taxable income. The very process of buying and selling securities also has its own costs, such as brokerage commissions, which are borne by the fund's shareholders.
[edit] Expenses and TER's
Mutual funds bear expenses similar to other companies. The fee structure of a mutual fund can be divided into two or three main components: management fee, nonmanagement expense, and 12b-1/non-12b-1 fees. All expenses are expressed as a percentage of the average daily net assets of the fund.
[edit] Management Fees
The management fee for the fund is usually synonymous with the contractual investment advisory fee charged for the management of a fund's investments. However, as many fund companies include administrative fees in the advisory fee component, when attempting to compare the total management expenses of different funds, it is helpful to define management fee as equal to the contractual advisory fee + the contractual administrator fee. This "levels the playing field" when comparing management fee components across multiple funds. Contractual advisory fees may be structured as "flat-rate" fees, i.e., a single fee charged to the fund, regardless of the asset size of the fund. However, many funds have contractual fees which include breakpoints, so that as the value of a fund's assets increases, the advisory fee paid decreases. Another way in which the advisory fees remain competitive is by structuring the fee so that it is based on the value of all of the assets of a group or a complex of funds rather than those of a single fund.
[edit] Non-management Expenses
Apart from the management fee, there are certain non-management expenses which most funds must pay. Some of the more significant (in terms of amount) non-management expenses are: transfer agent expenses (this is usually the person you get on the other end of the phone line when you want to purchase/sell shares of a fund), custodian expense (the fund's assets are kept in custody by a bank which charges a custody fee), legal/audit expense, fund accounting expense, registration expense (the SEC charges a registration fee when funds file registration statements with it), board of directors/trustees expense (the disinterested members of the board who oversee the fund are usually paid a fee for their time spent at board meetings), and printing and postage expense (incurred when printing and delivering shareholder reports).
[edit] 12b-1/Non-12b-1 Service Fees
12b-1 service fees/shareholder servicing fees are contractual fees which a fund may charge to cover the marketing expenses of the fund. Non-12b-1 service fees are marketing/shareholder servicing fees which do not fall under SEC rule 12b-1. While funds do not have to charge the full contractual 12b-1 fee, they often do. When investing in a front-end load or no-load fund, the 12b-1 fees for the fund are usually .250% (or 25 basis points). The 12b-1 fees for back-end and level-load share classes are usually between 50 and 75 basis points but may be as much as 100 basis points. While funds are often marketed as "no-load" funds, this does not mean they do not charge a distribution expense through a different mechanism. It is expected that a fund listed on an online brokerage site will be paying for the "shelf-space" in a different manner even if not directly through a 12b-1 fee.
[edit] Fees and Expenses Borne by the Investor (not the Fund)
Fees and expenses borne by the investor vary based on the arrangement made with the investor's broker. Sales loads (or contingent deferred sales loads (CDSL)) are not included in the fund's total expense ratio (TER) because they do not pass through the
statement of operations for the fund. Additionally, funds may charge early redemption fees to discourage investors from swapping money into and out of the fund quickly, which may force the fund to make bad trades to obtain the necessary liquidity. For example, Fidelity Diversified International Fund (FDIVX) charges a 1 percent fee on money removed from the fund in less than 30 days.
[edit] Brokerage Commissions
An additional expense which does not pass through the statement of operations and cannot be controlled by the investor is brokerage commissions. Brokerage commissions are incorporated into the price of the fund and are reported usually 3 months after the fund's annual report in the statement of additional information. Brokerage commissions are directly related to portfolio turnover (portfolio turnover refers to the number of times the fund's assets are bought and sold over the course of a year). Usually the higher the rate of the portfolio turnover, the higher the brokerage commissions. The advisors of mutual fund companies are required to achieve "best execution" through brokerage arrangements so that the commissions charged to the fund will not be excessive.
[edit] Types of mutual funds [edit] Open-end fund
The term mutual fund is the common name for an open-end investment company. Being open-ended means that, at the end of every day, the fund issues new shares to investors and buys back shares from investors wishing to leave the fund. Mutual funds may be legally structured as corporations or business trusts but in either instance are classed as open-end investment companies by the SEC. Other funds have a limited number of shares; these are either closed-end funds or unit investment trusts, neither of which is a mutual fund.
[edit] Exchange-traded funds
Main article: Exchange-traded fund A relatively new innovation, the exchange traded fund (ETF), is often formulated as an open-end investment company. ETFs combine characteristics of both mutual funds and closed-end funds. An ETF usually tracks a stock index (see Index funds). Shares are issued or redeemed by institutional investors in large blocks (typically of 50,000). Investors typically purchase shares in small quantities through brokers at a small premium or discount to the net asset value; this is how the institutional investor makes its profit. Because the institutional investors handle the majority of trades, ETFs are more efficient than traditional mutual funds (which are continuously issuing new securities and redeeming old ones, keeping detailed records of such issuance and redemption transactions, and, to effect such transactions, continually buying and selling securities and maintaining liquidity position) and therefore tend to have lower expenses. ETFs are traded throughout the day on a stock exchange, just like closed-end funds.
Exchange traded funds are also valuable for foreign investors who are often able to buy and sell securities traded on a stock market, but who, for regulatory reasons, are unable to participate in traditional US mutual funds.
[edit] Equity funds
Equity funds, which consist mainly of stock investments, are the most common type of mutual fund. Equity funds hold 50 percent of all amounts invested in mutual funds in the United States. [5] Often equity funds focus investments on particular strategies and certain types of issuers. [edit] Capitalization Fund managers and other investment professionals have varying definitions of mid-cap, and large-cap ranges. The following ranges are used by Russell Indexes: [6]
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Russell Microcap Index - micro-cap ($54.8 - 539.5 million) Russell 2000 Index - small-cap ($182.6 million - 1.8 billion) Russell Midcap Index - mid-cap ($1.8 - 13.7 billion) Russell 1000 Index - large-cap ($1.8 - 386.9 billion)
[edit] Growth vs. value Another distinction made is between growth funds, which invest in stocks of companies that have the potential for large capital gains, and value funds, which concentrate on stocks that are undervalued. Growth stocks typically have the potential for a greater return; however, such investments also bear larger risks. Growth funds tend not to pay regular dividends. Sector funds focus on specific industry sectors, such as biotechnology or energy. Income funds tend to be more conservative investments, with a focus on stocks that pay dividends. A balanced fund may use a combination of strategies, typically including some level of investment in bonds, to stay more conservative when it comes to risk, yet aim for some growth. [edit] Index funds versus active management Main articles: Index fund and active management An index fund maintains investments in companies that are part of major stock (or bond) indices, such as the S&P 500, while an actively managed fund attempts to outperform a relevant index through superior stock-picking techniques. The assets of an index fund are managed to closely approximate the performance of a particular published index. Since the composition of an index changes infrequently, an index fund manager makes fewer trades, on average, than does an active fund manager. For this reason, index funds generally have lower trading expenses than actively managed funds, and typically incur fewer short-term capital gains which must be passed on to shareholders. Additionally, index funds do not incur expenses to pay for selection of individual stocks (proprietary
selection techniques, research, etc.) and deciding when to buy, hold or sell individual holdings. Instead, a fairly simple computer model can identify whatever changes are needed to bring the fund back into agreement with its target index. The performance of an actively managed fund largely depends on the investment decisions of its manager. Statistically, for every investor who outperforms the market, there is one who underperforms. Among those who outperform their index before expenses, though, many end up underperforming after expenses. Before expenses, a wellrun index fund should have average performance. By minimizing the impact of expenses, index funds should be able to perform better than average. Certain empirical evidence seems to illustrate that mutual funds do not beat the market and actively managed mutual funds under-perform other broad-based portfolios with similar characteristics. One study found that nearly 1,500 U.S. mutual funds underperformed the market in approximately half of the years between 1962 and 1992.[7] Moreover, funds that performed well in the past are not able to beat the market again in the future (shown by Jensen, 1968; Grimblatt and Titman, 1989.[8] However, as quantitative finance is in its early stages of development, more accurate studies are required to reach a decisive conclusion.[citation needed]
[edit] Bond funds
Bond funds account for 18% of mutual fund assets. [9] Types of bond funds include term funds, which have a fixed set of time (short-, medium-, or long-term) before they mature. Municipal bond funds generally have lower returns, but have tax advantages and lower risk. High-yield bond funds invest in corporate bonds, including high-yield or junk bonds. With the potential for high yield, these bonds also come with greater risk.
[edit] Money market funds
Money market funds hold 26% of mutual fund assets in the United States. [10] Money market funds entail the least risk, as well as lower rates of return. Unlike certificates of deposit (CDs), money market shares are liquid and redeemable at any time. The interest rate quoted by money market funds is known as the 7 Day SEC Yield.
[edit] Funds of funds
Funds of funds (FoF) are mutual funds which invest in other underlying mutual funds (i.e., they are funds comprised of other funds). The funds at the underlying level are typically funds which an investor can invest in individually. A fund of funds will typically charge a management fee which is smaller than that of a normal fund because it is considered a fee charged for asset allocation services. The fees charged at the underlying fund level do not pass through the statement of operations, but are usually disclosed in the fund's annual report, prospectus, or statement of additional information. The fund should be evaluated on the combination of the fund-level expenses and underlying fund expenses, as these both reduce the return to the investor.
Most FoFs invest in affiliated funds (i.e., mutual funds managed by the same advisor), although some invest in funds managed by other (unaffiliated) advisors. The cost associated with investing in an unaffiliated underlying fund is most often higher than investing in an affiliated underlying because of the investment management research involved in investing in fund advised by a different advisor. Recently, FoFs have be classified into those that are actively managed (in which the investment advisor reallocates frequently among the underlying funds in order to adjust to changing market conditions) and those that are passively managed (the investment advisor allocates assets on the basis of on an allocation model which is rebalanced on a regular basis). The design of FoFs is structured in such a way as to provide a ready mix of mutual funds for investors who are unable to or unwilling to determine their own asset allocation model. Fund companies such as TIAA-CREF, Vanguard, and Fidelity have also entered this market to provide investors with these options and take the "guess work" out of selecting funds. The allocation mixes usually vary by the time the investor would like to retire: 2020, 2030, 2050, etc. The more distant the target retirement date, the more aggressive the asset mix.
[edit] Hedge funds
Main article: Hedge fund Hedge funds in the United States are pooled investment funds with loose SEC regulation and should not be confused with mutual funds. Certain hedge funds are required to register with SEC as investment advisers under the Investment Advisers Act. [11] The Act does not require an adviser to follow or avoid any particular investment strategies, nor does it require or prohibit specific investments. Hedge funds typically charge a management fee of 1% or more, plus a "performance fee" of 20% of the hedge fund's profits. There may be a "lock-up" period, during which an investor cannot cash in shares.
[edit] Mutual funds vs. other investments
Mutual funds offer several advantages over investing in individual stocks, including diversification and professional management. A mutual fund may hold investments in hundreds or thousands of stocks, thus reducing the risk associated with owning any particular stock. Moreover, the transaction costs associated with buying individual stocks are spread around among all the mutual fund shareholders. Additionally, a mutual fund benefits from professional fund managers who can apply their expertise and dedicate time to research investment options. Mutual funds, however, are not immune to risks. Mutual funds share the same risks associated with the types of investments the fund makes. If the fund invests primarily in stocks, the mutual fund is usually subject to the same ups and downs and risks as the stock market.
[edit] Selecting a mutual fund
Picking a mutual fund from among the thousands offered is not easy. Following are some guidelines:
1. Prior to investing in a tax-exempt or tax-managed fund, it is best to determine if the tax savings will offset the possibly lower returns. Additionally, these funds are inappropriate for IRAs and other tax-sheltered types of account. 2. Investors should match the term of the investment to the time period they expect to keep the investment. Money that may be needed in the short term (for example, for car repairs) should generally be in a less volatile fund, such as a money market fund. Money not needed until a retirement date decades into the future (or for a newborn's college education) can reasonably be invested in longer-term, higherrisk investments, such as stock or bond funds. Investing short-term money in volatile investments puts the investor at risk of having to sell when the market is low, thereby incurring a loss. Investing over the long term in very stable investments, on the other hand, significantly reduces potential returns. 3. Fund expenses degrade investment performance, especially over the long term. Accordingly, all other things being equal, the lower the expenses, the better. A mutual fund's expense ratio is required to be disclosed in the prospectus. Expense ratios are critical in index funds, which seek to match the performance of bond or stock index. Actively managed funds must pay the manager for the active management of the portfolio, so they usually have a higher expense ratio than (passively managed) index funds. 4. Several sector funds often make the "best fund" lists each year. However, the "best" sector varies from year to year. Most sectors are vulnerable to industrywide events that can have a significant negative effect on performance. It is generally best to avoid making these a large part of one's portfolio. 5. Closed-end funds often sell at a discount to the value of their holdings. An investor can sometimes obtain extra return by buying such funds, but only if they are willing to hold the fund until the discount rebounds. Some hedge fund managers use this gambit. However, this also implies that buying at the original issue may be a bad idea, since the price often drops immediately because of liquidity concerns. 6. Mutual funds often make taxable distributions near the end of the year (semiannual and quarterly distributions are also fairly common). If an investor plans to invest in a taxable fund, he or she should check the fund company's website to see when the fund plans to distribute dividends and capital gains. Investing just prior to the distribution results in part of one's investment being returned as taxable income without increasing the value of the account. 7. Prospective investors in mutual funds should read the prospectus. The prospectus is required by law to disclose the risks will be taken with investors' money, among other vital topics. Potential investors should also compare the return and risk profile of a fund against its peers with similar investment objectives and against the index most closely associated with it, paying particular attention to performance over both the long term and the short term. A fund that gained 50% over a 1-year period (an impressive result) but only 10% over a 5-year period should create some suspicion, as that would imply that the returns in four out of those five years were actually very low (possibly even negative (i.e., losses)), as 10% compounded over 5 years is only 61%.
8. Diversification can reduce risk. Depending on an investor's risk tolerance and his or her investment horizon, it may be advisable to hold some stocks, some bonds, and some cash. For longer-term investments, it is advisable to invest in some foreign stocks. If all of an investor's mutual funds belong to the same family of funds, the investor's total portfolio might not be as diversified as it might seem. This is so because funds within the same family may share research and recommendations. The same is true for investors who own multiple funds with the same profile or investment strategy; their returns will likely be similar. Holding too large a number of funds, on the other hand, will tend to produce the same effect as holding an index fund, but with higher expenses. Buying individual stocks exposes investors to company-specific and industry-specific risks, and if investors buy a large number of stocks, the commissions may cost more than a fund would.
[edit] Share classes
Many mutual funds offer more than one class of shares. For example, you may have seen a fund that offers "Class A" and "Class B" shares. Each class will invest in the same "pool" (or investment portfolio) of securities and will have the same investment objectives and policies. But each class will have different shareholder services and/or distribution arrangements with different fees and expenses. These differences are supposed to reflect different costs involved in servicing investors in various classes; for example, one class may be sold through brokers with a front-end load, and another class may be sold direct to the public with no load but a "12b-1 fee" included in the class's expenses (sometimes referred to as "Class C" shares). Still a third class might have a minimum investment of $10,000,000 and be available only to financial institutions (a socalled "institutional" share class). In some cases, by aggregating regular investments made by many individuals, a retirement plan (such as a 401(k) plan) may qualify to purchase "institutional" shares (and gain the benefit of their typically lower expense ratios) even though no members of the plan would qualify individually. [12]As a result, each class will likely have different performance results. [13] A multi-class structure offers investors the ability to select a fee and expense structure that is most appropriate for their investment goals (including the length of time that they expect to remain invested in the fund). [13]
[edit] Load and expenses
Main article: Mutual fund fees and expenses A front-end load or sales charge is a commission paid to a broker by a mutual fund when shares are purchased, taken as a percentage of funds invested. The value of the investment is reduced by the amount of the load. Some funds have a deferred sales charge or back-end load. In this type of fund an investor pays no sales charge when purchasing shares, but will pay a commission out of the proceeds when shares are redeemed depending on how long they are held. Another derivative structure is a levelload fund, in which no sales charge is paid when buying the fund, but a back-end load may be charged if the shares purchased are sold within a year.
Load funds are sold through financial intermediaries such as brokers, financial planners, and other types of registered representatives who charge a commission for their services. Shares of front-end load funds are frequently eligible for breakpoints (i.e., a reduction in the commission paid) based on a number of variables. These include other accounts in the same fund family held by the investor or various family members, or committing to buy more of the fund within a set period of time in return for a lower commission "today". It is possible to buy many mutual funds without paying a sales charge. These are called no-load funds. In addition to being available from the fund company itself, no-load funds may be sold by some discount brokers for a flat transaction fee or even no fee at all. (This does not necessarily mean that the broker is not compensated for the transaction; in such cases, the fund may pay brokers' commissions out of "distribution and marketing" expenses rather than a specific sales charge. The purchaser is therefore paying the fee indirectly through the fund's expenses deducted from profits.) No-load funds include both index funds and actively managed funds. The largest mutual fund families selling no-load index funds are Vanguard and Fidelity, though there are a number of smaller mutual fund families with no-load funds as well. Expense ratios in some no-load index funds are less than 0.2% per year versus the typical actively managed fund's expense ratio of about 1.5% per year. Load funds usually have even higher expense ratios when the load is considered. The expense ratio is the anticipated annual cost to the investor of holding shares of the fund. For example, on a $100,000 investment, an expense ratio of 0.2% means $200 of annual expense, while a 1.5% expense ratio would result in $1,500 of annual expense. These expenses are before any sales commissions paid to purchase the mutual fund. Many fee-only financial advisors strongly suggest no-load funds such as index funds. If the advisor is not of the fee-only type but is instead compensated by commissions, the advisor may have a conflict of interest in selling high-commission load funds.
[edit] Criticism of managed mutual funds
Historically, actively managed mutual funds, over long periods of time, have not returned as much as comparable index mutual funds. This, of course, is a criticism of one type of mutual fund over another. Another criticism concerns sales commissions on load funds, an upfront or deferred fee as high as 8.5 percent of the amount invested in a fund. No-load funds typically charge a 12b-1 fee in order to pay for shelf space on the exchange the investor uses for purchase of the fund, but they do not pay a load directly to a mutual fund broker. Critics point out that high sales commissions represent a conflict of interest, as high commissions benefit the sales people but hurt the investors. High commissions can also cause sales people to recommend funds that maximize their income. Again, this is a criticism of one type of mutual fund over another.
Mutual funds are also seen by some to have a conflict of interest with regard to their size. Fund companies charge a management fee of anywhere between 0.5 percent and 2.5 percent of the fund's total assets. Theoretically, this should motivate the fund managers, since a well performing fund will cause the amount invested in the fund to rise and increasing the fee earned. It also could motivate the fund company to focus on advertising to attract more and more new investors, as new investors would also cause the fund assets to increase. Mutual fund managers may also have a conflict of interest due to the way they are paid. In particular fund managers may be encouraged to take more risks with investors money than they ought to: Fund flows (and therefore compensation) towards successful, market beating funds are much larger than outflows from funds that lose to the market. Fund managers may therefore have an incentive to purchase high risk investments in the hopes of increasing their odds of beating the market and receiving the high inflows, with relatively less fear of the consequences of losing to the market (1). Many analysts, however, believe that the larger the pool of money one works with, the harder it is to manage actively, and the harder it is to squeeze good performance out of it. Thus a fund company can be focused on attracting new customers, thereby hurting its existing investors' performance. A great deal of a fund's costs are flat and fixed costs, such as the salary for the manager. Thus it can be more profitable for the fund to try to allow it to grow as large as possible, instead of limiting its assets. Some fund companies, notably the Vanguard Group and Fidelity Investments, have closed some funds to new investors to maintain the integrity of the funds for existing investors. Other critisicms of mutual funds are that some funds allow market timing (although many fund companies tightly control this) and that some fund managers accept extravagant gifts in exchange for trading stocks through certain investment banks, which presumably charge the fund more for transactions than would non-gifting investment bank. As a result, many fund companies strictly limit -- or completely bar -- such gifts.
doc_492193464.doc
• These are open-end funds that are not listed for trading on a stock exchange and are issued by companies which use their capital to invest in other companies. Mutual funds sell their own new shares to investors and buy back their old shares upon redemption. Capitalization is not fixed and normally shares are issued as people want them. These are mutually owned funds invested in diversified securities. Shareholders are issued certificates as evidence of their ownership and participate proportionately in the earnings of the fund. An investment company that pools money and can invest in a variety of securities, including fixed-income securities and money market instruments. Typically consist of a group of stocks, bonds, or money-market securities from more than one source. There are three types—income funds )for people who need money to live on); growth funds (pay low dividends or one—works best for investors who can leave money in the fund so it can grow over a long period of time; and balanced funds (combination of stocks and bonds). Investment funds which are made up of other investments and often defined by themes. For example, a “Global” fund would invest in companies around the world, while a “Property” fund would invest primarily in real estate. a professionally managed investment in a group of stocks and/or bonds that are selected and diversified to meet the stated objective of the fund. The fund's investment strategy category as stated in the prospectus. There are more than 20 standardized categories. Invented in the 1920s, mutual funds are pools of money managed by an investment company or advisor. Different mutual funds have different goals. For example, funds may seek growth, growth and income, specific market cap sizes, sectors, etc. An investment company that pools the money of many individual investors and uses it to buy a diversified portfolio of securities. Back to Top A type of managed investment company in which the investor owns a share of the portfolio assets equal to his number of shares in the fund. are a method of investing in various underlying investments such as stocks, bonds, mortgages, treasury bills and real estate. Mutual funds provide the advantages of professional investment management, liquidity, investment record keeping and diversification. Investing through mutual funds is the indirect ownership of the underlying investment vehicles. A mutual fund enables investors to pool their money and place it under professional investment management. The portfolio manager trades the fund's underlying securities, realizing a gain or loss, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors. There are more mutual funds than there are individual stocks.
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What are the types of mutual funds?
Mutual Funds are broadly classified into three categories viz. Equity Funds, Debt Funds and Balanced Funds.
EQUITY FUNDS
These funds invest a major part of their corpus in equities. The composition of the fund may vary from scheme to scheme and the fund manager’s outlook on various scrips. The Equity Funds are sub-classified depending upon their investment objective, as follows:
Diversified Equity Funds Mid-Cap Funds • Sector Specific Funds • Tax Savings Funds (ELSS)
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Equity investments are meant for a longer time horizon. Equity funds rank high on the risk-return matrix.
DEBT FUNDS
These Funds invest a major portion of their corpus in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Debt funds are further classified as:
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Gilt Funds: Invest their corpus in securities issued by Government, popularly known as GoI debt papers. These Funds carry zero Default risk but are associated with Interest Rate risk. These schemes are safer as they invest in papers backed by Government. • Income Funds: Invest a major portion into various debt instruments such as bonds, corporate debentures and Government securities. MIPs: Invests around 80% of their total corpus in debt instruments while the rest of the portion is invested in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the riskreturn matrix when compared with other debt schemes. Short Term Plans (STPs): Meant for investors with an investment horizon of 3-6 months. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures. Liquid Funds: Also known as Money Market Schemes, These funds are meant to provide easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, interbank call money market, CPs and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. These schemes rank low on risk-return matrix and are considered to be the safest amongst all categories of mutual funds.
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BALANCED FUNDS
These funds, as the name suggests, are a mix of both equity and debt funds. They invest in both equities and fixed income securities, which are in line with pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns.
Each category of funds is backed by an investment philosophy, which is pre-defined in the objectives of the fund. The investor can align his own investment needs with the funds objective and invest accordingly.
Basic Rules of Mutual-Fund Investing
With mutual fund making a comeback like a roaring lion, the noise created by them often turns out to be a clutter of meaningless numbers, for the lay investor beginning to comprehend the mutual fund concept. It is not surprising. With over 200 fund coming in the past three years like monsoon clouds, investors are rightly bombarded by tempting mutual-fund advertisements. When you consider the overwhelming amount of information on stocks and bonds, which rapidly changes in financial markets, and an investors lack of time or inclination to know more about these investments, investing right are surely become difficult. There are plus and minuses of the change happening. On the negative, it has become very difficult to manage all the information available today. I can tell you based on my first hand experience. And it is easy to make mistakes. The good news, though, is that practically all the information you need to make smart investment choices is out there, whether you invest on your own or you use the services of an intermediary. And if you do a little homework, you'll find investing in funds really isn't that hard. And, it gets easier as you become more experienced. On the balance, you are a beneficiary as the enhanced transparency and disclosure is forcing greater fund accountability to their shareholders, i.e. you and has also made a relatively safer marketplace. Following are some rules to help invest better and attain your financial goals. Know Yourself -- The first step towards achieving your goals is that you must know yourself. Try to get an idea of how much risk you can handle. Do a tolerance test for yourself. If your Rs. 10000 investment turning into Rs. 6,000 upsets you--even if it could subsequently bounce back-perhaps an aggressive equity fund is not for you. Reality Check --. What are your goals? If you need to turn Rs 10,000 into Rs 50,000 in two years, a medium term bond fund may not be the right answer. Work on setting realistic expectations for both your goals and your funds. Know Your Portfolio -- Look for areas that are over-represented and for those that are lacking. For example, is your portfolio overly concentrated in the large-cap equities or too much of highly rewarding but wildly volatile infotech stocks. Are you missing investments in small-cap stocks? Know What You Are Buying -- Once you discovered yourself, spend some time for a close understanding of your funds. The stated objective of a fund as given in a prospectus is often incomplete and does not reveal much. Based on the readily available portfolio and fund manager's commentary, you can broadly understand the style and strategy followed by a fund. This will help you meaningfully diversify your portfolio. This will also help you assess potential risks. In general, large-cap value funds are less risky than small-cap growth funds. Examine sector weightings to find out what will drive the portfolio's returns-both up and down. And know that funds with large stakes in just one or two sectors will likely be more volatile than the more evenly diversified funds. Looking at a fund's sectors historically will help you gain a good
perspective. Does the manager move in and out of sectors frequently and dramatically? If so, the fund might get hurt, if the manager is ever caught on the wrong foot. Check out Your Fund's Concentration. A portfolio with just 20 or 30 stocks or one that puts most of its assets in just a few stocks will likely be more volatile than a fund that's spread among hundreds of stocks. But there could be rewards of concentration. A concentrated portfolio will also get more bang for its buck if its stocks work out. You may want to add a concentrated fund, one that owns fewer stocks or puts most of its assets in the top 10 or 20 stocks, to your portfolio. But largely, your core funds should probably be well a diversified and more predictable. Though a small allocation to a sector-oriented fund, a more-flexible fund, or a more-concentrated fund could boost your returns. Assess Performance Appropriately -- Past performance is no indicator of future results. Investors should commit this statutory quote from mutual fund prospectuses, advertisements and any other literature to memory. It should be recalled more readily than the your bank account number. It should be repeated anytime you consider sending money to any fund with a 100% three-month gain. Why? Chances are, that three-month boom will be followed by a three-month bust. To prove it, we took a look at the top 10 domestic equity funds as of September 30 for each of the past five years. What proportion of them landed in the top 10 for the ensuing three-month period? Don't laugh. It was just 10%. What's an investor to do? Not concentrate a mutual fund portfolio on a concentrated fund. And, above all, don't focus on short-term returns. When choosing a fund, look for above-average performance, quarter after quarter, year after year. Be A Disciplined Investor -- After you've chosen some funds, stick with them. Don't be afraid to go against the tide, as often the unpopular groups tend to outperform in subsequent years. In other words, small contrarian bets could be lucrative. And discipline is the key. Rupee-cost averaging, or investing a regular amount of money at regular intervals, tends to add value. With a systematic investment plan, you are likely to beat the fund returns. Know How Much You Pay -- Money saved is money earned. So it's always better to pay less than it is to pay more. Expenses are very important with your larger-cap, lower-risk funds, and less critical with small-cap funds and other higher-risk categories. For example, be wary of high expenses when you are considering bond funds. And you can afford to be lenient with the expense of a small-cap or a sector equity fund. The nuances of mutual fund investing can be endless. But the strength of the mutual fund idea lies in its simplicity. Don't get bogged by the noise and clutter. You could well be on your way reach your goals by following these basic guidelines and be a smarter investor.
What are Mutual Funds? Why do Mutual Funds come out with different schemes? What are the types of mutual fund scheme? What is the difference between the open ended and close ended Schemes? What are sector funds? What are the benefits of investing in a mutual fund? How is Investment in a Mutual Fund different From a Bank Deposit? How are mutual funds different from portfolio management schemes? Does Investing in mutual Funds means investing in equities? What is NAV, and how is it calculated? Does the NAV of RS. 10 indicate that the fund units are cheaper? Can the NAV of a debt Fund Fall? Besides the NAV, are there any other parameters, which can be compared across different funds of the same category? What is a Sales Load? What is repurchase or back end load ? What are No load Schemes? What is CDSC? What is difference between a contingent deferred sales load and an exit load ? What can one benchmark the performance of a mutual fund against? Does out performance of a benchmark index always connote good performance? Does higher return necessarily mean a better fund? Does investing in more than one fund family imply diversification? What should one keep in mind while choosing a good mutual fund? What is meant by recurring sales expenses?
What are Mutual Funds?
A mutual fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested in different types of securities.The income earned through these investments and the capital appreciation realized by thescheme are shared by the unit holders in proportion to the number of units held by them.
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Why do Mutual Funds come out with different schemes?
A Mutual Fund may not, through just one portfolio, be able to meet the investment objectives of all their Unit holders. Some Unit holders may want to invest in risk-bearing securities such as equity and some others may want to invest in safer securities such as bonds or government securities. Hence, the Mutual Fund comes out with different schemes, each with a different investment objective.
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What are the types of Mutual Funds Schemes?
There are different schemes catering to different needs, age profiles, financial positions and return expectations. By Structure there are basically two types of mutual fund schemes Open-ended schemes are open for subscription the whole year. They do not have a fixed maturity. You can buy and sell your units at the NAV related prices to the Mutual funds. Close-ended schemes can be subscribed to, only during the initial public offer and thereafter you can buy and sell the units of the scheme on the stock exchange where they are listed. They have a stipulated Maturity period the duration of which is generally 2 to 15 years.. They are usually traded at a discount to the NAV. By investments objective, there are 5 types of schemes:
Growth/Equity Schemes In such schemes, investment is made in equities and convertible debentures. The objective of these schemes is to provide capital appreciation over a period of time. The dividend may or may not be declared. Debt/income funds: These are funds that invest predominantly in income bearing instruments like bonds, debentures, government securities, commercial paper etc. Income bearing instruments are much less volatile, although they do carry credit risk. The objective of these schemes is to provide a regular and steady income to the investors. Balanced funds: Such funds invest both in equity shares and income-bearing instruments in the proportion indicated in their offer document. The objective is to provide both growth and income by periodically distributing a part of the income and capital gains they earn. Money Market Schemes. These schemes invest in Zero risk or safer, short term instruments like treasury bills, certificates of deposit, Commercial Paper and inter-bank call money. The objective of these schemes is to provide liquidity and moderate income and also preserve the capital. Equity linked saving schemes (ELSS) These schemes are open-ended growth schemes with a mandatory 3-year lock- in. These schemes offer the benefit of section 88 of IT Act, up to a maximum of Rs 10,000 (tax saving of 20% of 10,000 which is Rs. 2000) The main features of ELSS are (a) Repurchase: Repurchases are permitted after a period of 3 years. (b) Lock-in-period: The units under ELSS are prohibited from trading, pledging and transfer during the lock in period of 3 years. Lastly we have Specialty Schemes to cater to the investment objectives not covered by the other schemes: Index Schemes Sector Schemes · Index schemes replicate the performance of the stock Index such as BSE SENSEX or NSE 500. · Sectoral schemes are specialty mutual funds that invest in stocks that fall into a certain sector of the economy. Here the portfolio is dispersed or spread across the stocks of a particular sector.
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What is the difference between open ended and close ended schemes?
Open-ended funds do not have a fixed maturity whereas close-ended schemes have a stipulated maturity period. New investors can join the scheme by directly applying to the mutual fund at applicable Net Asset Value related prices in case of open-ended schemes whereas in case of close-ended schemes new investors can buy the units from secondary market only. This results in the unit capital of open ended schemes fluctuating daily unlike the close ended scheme where it remains constant.
What are sector funds?
These are specialty mutual funds that invest in stocks that fall into a certain sector of the economy. Here the portfolio is dispersed or spread across the stocks in a particular sector.This type of scheme is ideal for the investor who has already made up his mind to confine his risk and return to one particular sector. Thus, a FMCG fund would invest in companies that manufacture fast moving consumer goods.
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What are the benefits of investing in a mutual fund?
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Access to professional money managers. Buying units of a mutual fund gives you access to the trading decisions of a team of analysts and fund manager. The fund manager continuously takes care of investment to make sure that investment remains consistent with the funds investment objective Diversification. Mutual funds aim to reduce the volatility of returns through diversification by investing in a number of companies across a broad section of industries and sectors. This reduces the risk because of the spread. Thus with a small investible surplus also you can achieve a diversification which would not have been possible on your own. Liquidity. Since units of mutual funds are priced daily, and an open-end mutual fund is always willing to buy back its units, you are able to sell your units very easily. There is more liquidity in the open-ended schemes of mutual funds as compared to others because investor can sell his/her units whenever desired, whereas in case of stocks, bonds etc. investor has to first find the buyer Low transaction costs. Mutual funds are a relatively less expensive way to invest because Mutual Funds are institutional investors, who are able to pay lower brokerage commissions because of their size. Transparency: There are regular updates on the value of your investment. The portfolio is disclosed
regularly with the fund managers investment strategy and outlook. Regulations: All the mutual funds are registered with SEBI and they function under within the provisions of strict regulation designed to protect the interests of the investor. Small investments: Mutual funds help you to reap the benefit of returns by a portfolio spread across a wide spectrum of companies with small investments. Such a spread would not have been possible without their assistance.
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How is investment in a Mutual Fund Different from a Bank Deposit?
When you deposit money with the bank, the bank promises to pay you a certain rate of interest for the period you specify. On the date of maturity, the bank is supposed to return the principal amount and interest to you. Whereas, in a mutual fund, the money you invest, is in turn invested by the manager, on your behalf, as per the investment strategy specified for the scheme. The profit, if any, less expenses of the manager, is reflected in the NAV or distributed as income. Likewise, loss, if any, with the expenses, is to be borne by you.
How are mutual funds different from Portfolio Management Schemes?
In Mutual Funds, the investments of investors are pooled to form a common investible corpus and the gain/loss to all investors during a given period are same for all investors,whereas in the case of portfolio management scheme, the investment of a particular investor remains identifiable to him. Here the gain or loss of all the investors will be different from each other.
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Does investing in Mutual Funds mean investing in equities?
Mutual funds can be divided into various types depending on asset classes. They can also invest in debt instruments such as bonds, debentures, commercial paper and government securities apart from equity. Every mutual fund scheme is bound by the investment objectives outlined by it in its prospectus. The investment objectives specify the class of securities a mutual fund can invest in. Based on the investment objective, the following types of mutual funds currently operate in the country. Growth Schemes Income Schemes Balanced Schemes Money Market Schemes
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What is NAV and how is it calculated?
Net Asset value is the actual value of units of the scheme on a given business day. NAV reflects the market value of the fund's investments on that day after accounting for all the expenses.
Does the NAV of Rs. 10 indicate that the fund units are cheaper?
It is a wrong perception that if the mutual fund is offering units at Rs. 10 it is cheaper. Yes, you would at this price get more number of units than you would get if it were priced higher with the same investible surplus. But the number of units you get is a function of a scheme's NAV, and not an indicator of how cheap a scheme is. The scheme's NAV is the market value of its portfolio holdings at a given point of time and its performance is what determines your returns.
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Can the NAV of a debt fund fail?
A debt fund invests in fixed-income instruments, where safety of capital and regular returns are assured. These include Commercial Paper, Certificates of Deposit, debentures and bonds. While the rate of interest on these instruments stays the same throughout their tenure, their market value keeps changing, depending on how the interest rates in the economy move. A debt fund's NAV is the market value of its portfolio holdings at a given point in time. As interest rates change, so do the market value of fixed-income instruments - and hence, the NAV of a debt fund. Thus it is a misnomer that the debt fund's NAV does not fall.
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Besides the NAV, are there any other parameters which can be compared across different funds of the same cateogry?
Besides Net Asset Value the following parameters should be considered while comparing the funds: AVERAGE RETURNS An investor should look at the returns given by the fund over a period of time. Care should be taken to see whether all dividends and bonuses have been accounted for. The higher and more consistent the returns the better is the fund. VOLATILITY In addition to the returns one should also look at the volatility of the returns given by the fund. Volatility is essentially the fluctuation of the returns about the mean return over a period of time. A fund giving consistent returns is better than a fund whose returns fluctuate a lot. CORPUS SIZE: A Large corpus is generally considered good because large funds have lower costs, as expenses are spread over large assets but at the same time a large corpus has some inefficiencies too. A large corpus may become unwieldy and thus difficult to manage. PERFORMANCE VIS A VIS BENCHMARK OTHER SCHEMES An investor should not only look at the returns given by the scheme he has invested in but also compare it with benchmarks like BSE Sensex, S & P Nifty, T-bill index etc depending on the asset class he has invested in. For a true picture it is advised that the returns should also be compared with the returns given by the other funds in the same category. Thus it is prudent to consider all the above-mentioned factors while comparing funds and not rely on any one of them in isolation. This is important because as of today there is no standard method for evaluation of un- traded securities.
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What is a Sales Load?
A Sales Load is a charge collected by the scheme when it sells the units. It is also called the front end Load.
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What is the Repurchase or Back End Load?
It is the charge collected by the scheme when it buys back the units from the unit holders.
What are No Load Schemes?
The schemes, which do not charge any load, are called No Load Schemes.
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What is CDSC?
Contingent Deferred Sales charge (CDSC) is a charge imposed on unit holders exiting from the scheme within 4 years of entry. It is intended to enable the AMC to recover expenses incurred for promotion or propagation of the scheme. Or Sometimes the selling expenses of the fund are not charged to the fund directly but are recovered from the unit holders whenever they redeem their units. This load is called a CDSC and is inversely proportional to the period of unit holding.
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What is the difference between contigent defered sales load and an exit load?
Contingent Deferred Sales charge (CDSC) is a charge imposed when the units of a fund are redeemed during the first few years of ownership. Under the SEBI Regulations, a fund can charge CDSC to unit holders exiting from the scheme within the first four years of entry. Exit load is a fee an investor pays to a fund whenever he redeems his/her units. As per SEBI regulations, the maximum exit load applicable is 7%. There is a further stipulation by SEBI that the entry load and exit load put together cannot exceed 7% of the sale price.
What can one benchmark the performance of a mutual fund against?
A mutual fund scheme should be benchmarked against relevant indices, and that relevant index can be chosen after taking into consideration the asset class it represents. The Equity funds can be benchmarked against BSE Sensex, S & P Nifty etc.
The Debt funds can be benchmarked with T-Bill index or I-Bex etc.depending on the average maturity of the scheme. Performance of an equity fund must be compared over a 1-2 year horizon and for a debt fund a period of 6-12 months is considered ideal.
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Does out performance of a benchmark index always connote good performance?
No, it is not necessary that out performance of a benchmark index always connotes good performance. The volatility does not permit the investor to rely on one factor only. The index performance is volatile and may be driven by a few scrips only, which may not be very reflective. So it is better to keep other factors like risk adjusted returns (volatility of returns) and NAV movement in mind while deciding to invest in a fund.
Does higher return necessarily mean a better fund?
Yes, on the face of it high return does connote good fund but there is also some a risk taken by the scheme to achieve these returns. Thus it is prudent to measure risk alsowhile considering returns to rank a scheme. Today there are a lot of statistical tools like Beta,Sharpe ratio, Alpha and standard Deviation to measure this risk. A risk adjusted return is the best measure to use while judging a scheme. You can also refer to the ratings assigned by a reputed rating agency.
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Does investing in more than one fund family imply diversification?
No, Investing in more than one Mutual fund family does not necessarily imply diversification. What is more important is to measure exposure to different asset classes irrespective of which mutual fund manages your money.
What should one keep in mind while choosing a good mutual fund?
Each individual has different financial goals, based on lifestyle, financial independence, and family commitments, level of incomes and expenses and many other factors. Thus before investing your money you need to analyze the following factors: Define the Investment objective Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, and level of income and expenses among many other factors. Therefore, the first step should be to assess your needs. You can begin by defining the investment objectives, which could be regular income, buying a home or finance a wedding or educate your children or a combination of all these needs. Also your risk appetite of the investor and cash flow requirements need to be taken into account. Choose the right Mutual Fund Once the investment objective is clear in your mind the next step is choosing the right Mutual Fund scheme. Before choosing a mutual fund the following factors need to be considered: NAV performance in the past Track record of performance in terms of returns over the last few years in relation to appropriate yardsticks and other funds in the same category. Risk in terms of volatility of returns Services offered by the mutual fund and how investor friendly it is. Transparency, which is reflected in the quality and frequency of its communications. Go for a proper combination of schemes Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals.
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What is meant by recurring sales expenses?
The Asset management Company may charge the fund a fee for operating its schemes, like trustee fee, custodian fee, registrar fee, transfer fee etc. This fee is called recurring expense and is expressed as a percentage of the scheme's average net assets. The recurring expenses are subject to certain limits as per the regulations of SEBI. WEEKLY AVERAGE NET ASSETS RS. EQUITY SCHEMES DEBT SCHEMES FIRST 100 CRORES 2.50% 2.25%
NEXT 300 NEXT 300 BALANCE ASSETS
CRORES CRORES 1.75%
2.25% 2.00% 1.50%
2.00% 1.75%
MUTUAL FUND
Concept, Organisation Structure, Advantages and Types.
Topics Covered
• • • • • Concept Organisation of a Mutual Fund Advantages of Mutual Funds Types of Mutual Fund Schemes Frequently Used Terms
Concept
• • • A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
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Mutual Fund Operation Flow Chart
Organisation of a Mutual Fund
Advantages of Mutual Funds
• • • • • • • • • • • Professional Management Diversification Convenient Administration Return Potential Low Costs Liquidity Transparency Flexibility Choice of schemes Tax benefits Well regulated
Types of Mutual Fund Schemes
• Wide variety of Mutual Fund Schemes exist to cater to the needs such as financial position, risk tolerance and return expectations etc. • The figure in the next slide gives an overview into the existing types of schemes in the Industry.
Types of Schemes
• By Structure
– Open Ended Schemes – Close Ended Schemes – Interval Schemes
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By Investment Objectives
– – – – Growth Schemes Income Schemes Balance Schemes Money Market Schemes
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Other Schemes
– Tax Saving Schemes
Special Schemes
– Index Schemes – Sector Specific Schemes
Frequently Used Terms
• Net Asset Value (NAV) Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date. Sale Price Is the price you pay when you invest in a scheme. Also called Offer Price. It may include a sales load. Repurchase Price Is the price at which a close-ended scheme repurchases its units and it may include a back-end load. This is also called Bid Price.
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Frequently Used Terms
• Redemption Price Is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related. Sales Load Is a charge collected by a scheme when it sells the units. Also called, ‘Front-end’ load. Schemes that do not charge a load are called ‘No Load’ schemes. Repurchase or ‘Back-end’ Load Is a charge collected by a scheme when it buys back the units from the unit holders.
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What are the types of mutual funds?
Mutual Funds are broadly classified into three categories viz. Equity Funds, Debt Funds and Balanced Funds.
EQUITY FUNDS
These funds invest a major part of their corpus in equities. The composition of the fund may vary from scheme to scheme and the fund manager’s outlook on various scrips. The Equity Funds are sub-classified depending upon their investment objective, as follows:
Diversified Equity Funds Mid-Cap Funds • Sector Specific Funds • Tax Savings Funds (ELSS)
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Equity investments are meant for a longer time horizon. Equity funds rank high on the risk-return matrix.
DEBT FUNDS
These Funds invest a major portion of their corpus in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Debt funds are further classified as:
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Gilt Funds: Invest their corpus in securities issued by Government, popularly known as GoI debt papers. These Funds carry zero Default risk but are associated with Interest Rate risk. These schemes are safer as they invest in papers backed by Government. • Income Funds: Invest a major portion into various debt instruments such as bonds, corporate debentures and Government securities. MIPs: Invests around 80% of their total corpus in debt instruments while the rest of the portion is invested in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the riskreturn matrix when compared with other debt schemes. Short Term Plans (STPs): Meant for investors with an investment horizon of 3-6 months. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures. Liquid Funds: Also known as Money Market Schemes, These funds are meant to provide easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, interbank call money market, CPs and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. These schemes rank low on risk-return matrix and are considered to be the safest amongst all categories of mutual funds.
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BALANCED FUNDS
These funds, as the name suggests, are a mix of both equity and debt funds. They invest in both equities and fixed income securities, which are in line with pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns. Each category of funds is backed by an investment philosophy, which is pre-defined in the objectives of the fund. The investor can align his own investment needs with the funds objective and invest accordingly.
Mutual Fund - An Introduction
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested by the fund manager in different types of securities depending upon the objective of the scheme. These could range from shares to debentures to money market instruments. The income earned through these investments and the capital appreciation realized by the scheme are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed portfolio at a relatively low cost. The small savings of all the investors are put together to increase the buying power and hire a professional manager to invest and monitor the money. Anybody with an investible surplus of as little as a few thousand rupees can invest in Mutual Funds. Each Mutual Fund scheme has a defined investment objective and strategy.
Types of Mutual Fund Schemes
Mutual fund schemes may be classified on the basis of its structure and its investment objective. By Structure Open-end Funds An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity. Closed-end Funds A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor. Interval Funds Interval funds combine the features of open-ended and close-ended schemes. They are open for sale or redemption during pre-determined intervals at NAV related prices. By Investment Objective Growth Funds The aim of growth funds is to provide capital appreciation over the medium to long term.
Such schemes normally invest a majority of their corpus in equities. It has been proved that returns from stocks, have outperformed most other kind of investments held over the long term. Growth schemes are ideal for investors having a long term outlook seeking growth over a period of time. Income Funds The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and Government securities. Income Funds are ideal for capital stability and regular income. Balanced Funds The aim of balanced funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls. These are ideal for investors looking for a combination of income and moderate growth. Money Market Funds The aim of money market funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market. These are ideal for Corporate and individual investors as a means to park their surplus funds for short periods. Other Schemes Tax Saving Schemes These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws as the Government offers tax incentives for investment in specified avenues. Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction u/s 88 of the Income Tax Act, 1961. The Act also provides opportunities to investors to save capital gains u/s 54EA and 54EB by investing in Mutual Funds. Special Schemes
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Industry Specific Schemes
Industry Specific Schemes invest only in the industries specified in the offer document. The investment of these funds is limited to specific industries like Infotech, FMCG, Pharmaceuticals etc.
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Index Schemes
Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50
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Sectoral Schemes
Sectoral Funds are those which invest exclusively in a specified sector. This could be an industry or a group of industries or various segments such as 'A' Group shares or initial public offerings.
Benefits of Investing in Mutual Funds Professional Management Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme. Diversification Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own. Convenient Administration Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient. Return Potential Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities. Low Costs Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors. Liquidity In open-end schemes, the investor gets the money back promptly at net asset value related prices from the Mutual Fund. In closed-end schemes, the units can be sold on a stock exchange at the prevailing market price or the investor can avail of the facility of direct repurchase at NAV related prices by the Mutual Fund. Transparency You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook. Flexibility Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience. Affordability Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy. Choice of Schemes Mutual Funds offer a family of schemes to suit your varying needs over a lifetime. Well Regulated
All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI. How to invest in Mutual Fund Step One - Identify your Investment needs Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, and level of income and expenses among many other factors. Therefore, the first step is to assess your needs.You can begin by defining your investment objectives and needs which could be regular income, buying a home or finance a wedding or educate your children or a combination of all these needs, the quantum of risk you are willing to take and your cash flow requirements. Step Two - Choose the right Mutual Fund The important thing is to choose the right mutual fund scheme which suits your requirements. The offer document of the scheme tells you its objectives and provides supplementary details like the track record of other schemes managed by the same Fund Manager. Some factors to evaluate before choosing a particular Mutual Fund are the track record of the performance of the fund over the last few years in relation to the appropriate yardstick and similar funds in the same category. Other factors could be the portfolio allocation, the dividend yield and the degree of transparency as reflected in the frequency and quality of their communications. For selecting the right scheme as per your specific requirements, click here. Step Three - Select the ideal mix of Schemes Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals.
Step Four - Invest regularly The best approach is to invest a fixed amount at specific intervals, say every month. By investing a fixed sum each month, you buy fewer units when the price is higher and more units when the price is low, thus bringing down your average cost per unit. This is called rupee cost averaging and is a disciplined investment strategy followed by investors all over the world. You can also avail the systematic investment plan facility offered by many open end funds.
Step Five- Start early It is desirable to start investing early and stick to a regular investment plan. If you start now, you will make more than if you wait and invest later. The power of compounding lets you earn income on income and your money multiplies at a compounded rate of return. Step Six - The final step All you need to do now is to Click here for online application forms of various mutual fund schemes and start investing. You may reap the rewards in the years to come. Mutual Funds are suitable for every kind of investor - whether starting a career or retiring, conservative or risk taking, growth oriented or income seeking. Rights of a Mutual Fund Unitholder A unit holder in a Mutual Fund scheme governed by the SEBI (Mutual Funds) Regulations, is entitled to: 1. Receive unit certificates or statements of accounts confirming the title within 6 weeks from the date of closure of the subscription or within 6 weeks from the date of request for a unit certificate is received by the Mutual Fund. 2. Receive information about the investment policies, investment objectives, financial position and general affairs of the scheme. 3. Receive dividend within 42 days of their declaration and receive the redemption or repurchase proceeds within 10 days from the date of redemption or repurchase. 4. Vote in accordance with the Regulations to:a. Approve or disapprove any change in the fundamental investment policies of the scheme, which are likely to modify the scheme or affect the interest of the unit holder. The dissenting unit holder has a right to redeem the investment. b. Change the Asset Management Company. c. Wind up the schemes. 5. Inspect the documents of the Mutual Funds specified in the scheme's offer document. Mutual Funds - A Globally Proven Investment All investments whether in shares, debentures or deposits involve risk. Share value may go down depending upon the performance of the company, the industry, state of capital markets and the economy. Generally however, longer the term, lesser the risk. Companies may default in payment of interest and principal on their debentures/bonds/deposits. While risk cannot be eliminated, skillful management can minimize risk. Mutual Funds help to reduce risk through diversification and professional management. The experience and expertise of Mutual Fund managers in selecting fundamentally sound securities and timing their purchases and sales help them to build a diversified portfolio that minimizes risk and maximizes returns. Worldwide, the Mutual Fund, or Unit Trust as it is called in some parts of the world, have almost overtaken bank deposits and total assets of insurance funds. As of date, in the US alone there are over 5,000 Mutual Funds with total assets of over US $ 3 trillion (Rs.l00 lakh crores). In India there are 34 Mutual Funds and over 300 schemes with total assets of approximately Rs. 100,000 crores. All mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI)
Feature
Building a Mutual Fund Portfolio
12 Nov 2001
- By Sameer Chavan More often then not it is not enough to have just one fund in which to invest in. Like stocks, in mutual funds too, for optimal returns it is important to have a portfolio of mutual funds. The bedrock of a successful portfolio is largely dependent on three factors. Appropriate asset allocation, effective diversification and last but not the least suitable fund selection. This sounds easy but an investor can encounter many roadblocks in his quest to attain these goals. Here we will attempt to look at some common obstacles and how to avoid them.
Lack of strategy
Like in most things it is important to have a strategy in investing. However, the lack of an asset allocation strategy is probably the most frequent mistake in mutual fund investing. Most investors are quite clear in identifying their investment objective, but more often then not skip the vital step in establishing a successful portfolio, that of creating a detailed asset allocation strategy. A work well begun is half the work done. As such, without a welldefined and appropriate
asset allocation strategy that accurately reflects individual investment objectives and preferences (time horizon, return objectives, risk tolerance, etc), the selection of mutual funds is haphazard instead of logical. In most cases, the outcome of recklessly fund selection is inappropriate asset allocation of risk and reward, which in turn leads to ineffective diversification -- the ultimate result is poor or mediocre portfolio performance. The common pitfalls in asset allocation could be characterised by being over-weight in certain fund types or categories, underweighting of fund types and/or inappropriate fund types in the portfolio. To achieve effective allocation that fits ones investment objectives and preferences. Investment should be spread among different fund categories to achieve both a variety of distinct risk/reward objectives and a reduction in overall risk. Recognising the type of investor you are will go a long way towards helping you build a meaningful portfolio of investments. To get an indicative picture of your profile take the following questionnaire.
Asset concentration
Another common
mistake is that of having a very large portion of the portfolio assets concentrated in funds with very high risk/reward characteristics. This phenomenon has largely been bought about in the Indian markets due to the huge run up in Technology stocks which made investors flock to Infotech funds. Though the investments may actually reflect chosen investment objectives. The result is excessive volatility, which in many instances, can cause disappointing portfolio performance because the very large percentage of risk does not justify the potential reward -- in other words, the risk is highly disproportionate to overall profit potential. However, though being over weight in any one sector is more likely to be a problem in portfolios with aggressive risk tolerances. It can occur with any type of risk tolerance. Sectoral funds though volatile can fit into many portfolios, provided an investor adheres to the principles of effective diversification: distinct risk/reward objectives within a variety of fund types and a reduction in overall portfolio risk. A good portfolio would depend on the choices of aggressive, moderate or conservative risk tolerances and growth, balance or incomeoriented return
objectives. The key is to treat high risk, nondiversified funds as a suitable portfolio supplement without dramatically increasing overall risk.
Duplication of Fund Types
An investors tends to duplicate funds when one particular type of fund has given him good returns. Inefficient diversification occurs when an investor has two or more funds with identical objectives. If the fund has been chosen right it is usually best to represent a fund category with just one fund. As such, the underlying common factor in avoiding these three mistakes just boils down to detailed asset allocation. It promotes effective diversification and eliminates the problems associated with haphazard fund selection -- it is the key in establishing a successful mutual fund portfolio.
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Ask the Fund Manager – Mr Anup Maheshwari, Sr. Vice President & Head Equities, DSP MERRILL LYNCH Ask the Fund ManagerExpert Speak Your Investment Garden Time out!
Risk management and the mutual funds The basic objective of a mutual fund is to provide a diversified portfolio so as to reduce the risk in investments at a lower cost. The mutual fund industry worldwide is based on this premise. Investors who take up mutual fund route for investments believe that their risk is minimized at lower costs, and they get an optimum portfolio of securities that match their risk appetite. They are ignorant about the diverse techniques and hedging products that can be used for minimizing the market volatility and hence take the help of the fund managers. It is very daunting to note that the drop in the NAV of some of the schemes is higher than the erosion of value in some of the ICE stocks. The recent survey conducted by PricewaterhouseCoopers (PWC) on risk management by mutual funds has posted interesting as well as worrying results. According to the survey, as many as 50 percent of the respondent mutual funds are not managing risk properly. If this is not all, 50 percent of the respondents did not even have documented risk procedures or dedicated risk managers. The respondents included among others, some of the heavyweights of the Indian MF industry viz. Templeton, Alliance, Prudential and IDBI Principal MF. Worrisome news it is, for the investor who still believes MFs are a route to manage one’s money in a better and safe manner. The recent wild movements in the NAVs of several equity funds have belied all expectation of a diversified portfolio from the fund managers when the basic tenet behind portfolio management is risk management. Mr. Shyam Bhat, Fund Manager-Tata asset Management Ltd. said ‘Indian Mutual fund industry is not using statistical techniques of risk management but is using diversification effectively within the market limitations. As far as use of derivatives is concerned, they are not presently used because of the low volumes, low liquidity and absence of sufficient hedging products in the market ’. Aggression has been the key word followed by the AMCs when it comes to taking positions in stocks. With investment in volatile ICE sectors being the driver of growth last season, almost everybody had taken big exposures to them. Birla MF maintained its exposures in Infosys to almost 25 percent in all of its equity schemes throughout last year. The same is true of ING Savings Trust that has Rs. 60 crores invested in Wipro and Infosys out of the total fund size of 135 crores in its growth fund. The result of these exposures is that the fund witnessed a movement of almost 9 percent in a single day on budget when the market saw an appreciation of around 4.36 percent. In their quest for growth, many funds have seen very volatile movements in NAVs. The investor confidence may not be lost but such volatility sure dents it. The point is not whether AMCs should be chastised or not but just to question the practices as the fate of many investors is linked to it. An ordinary investor considers mutual funds as the experts in investment decisions and so naturally expects the decision of investing in mutual funds to bear fruit. However, AMCs often leave a lot to be desired as they falter on important fronts like NAV and portfolio disclosure besides posting high fluctuations and poor returns.
The Beta of some of the favorite stocks is shown below. The Table contains the Beta of some of the ICE scrips that constitute the top 10 holdings across various equity funds.
DSQ Software Ltd. Satyam Computer Services Ltd. SSI Ltd. Wipro Ltd.
2.09 2.00 1.98 1.87
Taurus Libra Leap (5.68%), DSP ML Tech. (6.06%) ING Growth Port (11.2%), Alliance Equity Fund (9.7%), Chola freedom Tech (11.51%) IL&FS eCom (9.63%), LIC Dhansamridhi (9.18%) ING Growth (23.8%), Magnum Sector Fund -Infotech (15%), Alliance Alliance New Millennium (10%) UTI Sector- Services (9.48%), Taurus
Himachal Futuristic Communications Ltd.
1.82
Discovery Stock (10.45%) Global Tele-Systems Ltd. Zee Telefilms Ltd. Infosys Technologies Ltd. 1.81 1.70 1.54 UTI US 92 (7.02%), ING Growth Portfolio (3.8%) UTI Sector- Services (7.21%), ING Growth Portfolio (10.06%), ING Growth Portfolio (20.5%), Alliance New Millennium (11.5%)
As can be seen, some of the stocks are too volatile and can cause wild movements in the NAVs of funds that have taken exposures in them. The standard deviation of the returns in some of these funds points to it. While Alliance Equity Fund has a Standard Deviation of 2.53, Birla Advantage has its Standard Deviation at 2.57. ING Growth has a standard deviation of 3.3, which is relatively high due to its exposure to two volatile ICE scrips. Birla Advantage has reduced its exposures to Infosys drastically in the last two months and taken steps to contain volatility. Similar steps are being planned by SBI Mutual Fund that is recasting its equity portfolio to reduce risks as they can scare investors. It is unfortunate that the fund managers are not taking due care for minimizing the risk and are in a race to post higher and higher returns during the phase of bull-run. They should understand that the investors forget the high returns posted in any specific period very soon but they take hell lot of time to forget the burns they get during periods of losses. Hence for maintaining the confidence of the retail investors it is very important to control wild fluctuations in the NAVs. The basic technique of portfolio management thrusts on diversification, which preaches inclusion of negative beta, stocks in the portfolio so as to minimize the impact of fluctuation in the market. Diversification always has a cost and investors are willing to pay for it if it is properly done. The fund manager should disclose what they are doing at the hedging front. They should come up and tell their investors as to what they do at times of high fluctuations. Normally it has been seen that they outperform the broad market indices during the bull-runs and under-perform the indices during the bear-phases. The industry needs to revise their attitude and try to streamline their actions with their objectives. Some mutual fund houses are quite disciplined but every body should embrace the same spirit. There are some infrastructural problems but fund managers need to be more vigilant on the market movements. Mr. Bhupinder Sethi, Fund Manager - Dundee Mutual Fund said ‘We are actively monitoring the market movements and taking calls accordingly. Though we are presently not using derivatives for hedging of risk because of lack of depth in the market for the product, but we go into cash when we see the expectations of huge corrections coming in.’ Poor performance, poor servicing to clients and failure of third party service providers, are the three major risk factors identified in the survey by PWC. These are also going to be crucial in a rapidly growing competitive scenario. Under this setting, it is not just growth that should be the focus area but also better management of all risks and hence, AMCs would do well to keep the investor and his interest in mind before taking any decision.
AMFI-MUTUAL FUND (BASIC) MODULE CURRICULUM
1. The Concept and Role of Mutual Funds • The concept of a Mutual Fund; Advantages of Mutual Fund investing- Portfolio Diversification, Professional Management, Reduction of Risk, Transaction Costs and Taxes, Liquidity and Convenience • History in India - Size of Industry, Growth Trends, UTI (its role in the MF sector, unique structure); MFs' Place in Financial Markets • Types of Funds
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Open-end Funds/Closed-end Funds/Fixed Term Plans, Load Funds/No Load Funds, Tax Exempt/Non Tax Exempt Funds Money Market Funds, Equity Funds, Debt Funds, Commodity Funds, Real Estate Funds-
2. Fund Structure and Constituents • Legal structure-
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Closed end and Open end Funds Asset Management Company, Trustees/Trust Companies Legal status of Fund Sponsors
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Rights and Responsibilities of the AMC Directors, Trustees (SEBI, Cos. Act) Fiduciary nature of relationship between Investor and Fund Legal Structure in the U.S.-Investment Companies, Management Companies & Advisors Legal Structure in the U. K.- Unit Trusts, Trustees Registrars, Bankers, Custodians, Depositories
Role, Functions, Rights and Responsibilities of other Market Constituents
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Marketing and Distribution Participants- Agents, Banks, NBFCs, Stock Brokers Fund mergers and Scheme Takeovers
Brokers, Sub-
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3. Legal and Regulatory Environment • Role of regulators in India ? SEBI, RBI, MoF, Stock Exchanges, RoC, CLB, DCA ? Unit Trust of India and UTI Act ? Non-UTI Mutual Funds and SEBI (MF) Regulations • Regulation versus Self Regulation- Role of AMFI, Investor Associations, Consumer Forums/Courts Rights and Obligations of the Investor 4. The Offer Document
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The Offer Document – What it is, Importance, Contents, Regulation and Investors Rights
Contents of the Offer Document ? Standard Offer Document for Mutual Funds (SEBI format) ? Summary Information ? Glossary of Defined Terms ? Risk Disclosures ? Legal and Regulatory Compliance ? Expenses ? Condensed Financial Information of Schemes ? Constitution of the Mutual Fund ? Investment Objectives and Policies ? Management of the Fund ? Offer Related Information
5. Fund Distribution and Sales Practices
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The Challenge of Distributing Mutual Funds Who can Invest in MFs in India Distribution channels Role of Direct Marketing by Mutual Funds in India Broker/Sub Broker Arrangements Individual Agents, Brokers, Sub-Brokers, Banks, NBFCs Sales Practices
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6. Accounting, Valuation and Taxation Accounting ? Domestic SEBI Regulations on Valuation Marking to Market Equity Valuation Norms- Listed, Unlisted, NPA, Untraded Debt Valuation Norms – Listed, Unlisted, Illiquid Money Market Instruments Valuation Norms Taxation Taxation of Mutual Funds Taxation of Income and Gains in the Hands of Investors
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7. Investor Services • Applying for or account opening with Mutual Fund -
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? Application/Agreement, Provisions of the Agreement, Point of Receipt, Form of Payment, First Time versus Continuing Payments, Certificate vs. No Certificate ? Registering a Mutual Fund Account- Individual, Joint, Corporate, Trusts, etc. ? Repurchase and redemption options ? Cut-off times for submissions of Requests, Historical vs. Prospective NAVs Different investment plans and services by Mutual Funds? Accumulation Plans, Systematic Investment Plans, Automatic Reinvestment Plans, Retirement Plans, Switching Within Family of Funds, Voluntary Withdrawal Plans, Redeeming Shares ? Services Performed by Mutual Funds- Nomination Facilities, Phone Transactions/Information, Check Writing, Pass Books, Periodic Statements and Tax Information - Statutory, Others ? Loans Against Units
8. Investment Management
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Equity portfolio management Stock Selection Review of the Indian Equity Market Types of Equity Instruments Equity Classes ? Approaches to Portfolio Management ? Organisation Structure of Equity Funds
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Debt Portfolio Management ? Classification of Debt Securities ? A Review of the Indian Debt Market ? Instruments in the Indian Debt Market ? Basic Characteristics of Money Market Securities ? Basic Characteristics of Debt Securities ? Measures of Bond Yields- Current Yield, YTM, Yield Curve ? Risks in Investing in Bonds ? Debt Investment Strategies ? Interest Rates and Debt Portfolio Management ? Use of derivatives for Debt Portfolio Management ? Organisation Structure of Debt Funds SEBI Investment Guidelines and Restrictions on Investment Portfolios- Structure, Timing of Investments, Permissible Instruments
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9. Measuring and Evaluating Fund Performance • Performance Measures? Equity Funds • NAV Growth, Total Return; Total Return with Reinvestment at NAV, Annualised Returns and Distributions, Computing Total Return (Per Share Income and Expenses, Per Share Capital Changes, Ratios, Shares Outstanding), the Expense Ratio, Portfolio Turnover Rate, Fund Size, Transaction Costs, Cash Flow, Leverage ? Debt Funds • Peer Group Comparisons, The Income Ratio, Industry Exposures and Concentrations, NPAs, besides NAV Growth, Total Return, Expense Ratio ? Money Market Funds • Fund Yield, besides NAV Growth, Total Return, Expense Ratio ? Differences between Active versus Passive Fund performance, Equity vs. Debt Fund Performance ? Passive Funds Performance against Base Index, Tracking Error, Expenses ? Performance Measurement- NAV change ? Analysing fund Management- Relative Importance of Factors: Total Return of Different Types of Funds • Concept of Benchmarking for Performance Evaluation ? Performance Benchmarks in the Indian Context• Tracking a Fund’s Performance- Newspapers, Periodicals, Research Reports, Annual Reports, Prospectus, Reports from Tracking Agencies, Internet and Websites of Mutual Funds; and Interpretation of Data
India Infoline Mutual Fund Research
Mutual Fund Scheme Analysis –Balanced Funds Analysis of Balanced Mutual Funds Equity markets have been booming in the past two years. Everyone is tempted to enter the equity markets and make a quick killing in the markets. However, this temptation is not new and has been witnessed in all the bull runs. But we should not forget that every Bull Run is preceded by sluggishness in the market. Here comes the benefit of investing in Balanced mutual funds which aim at taking exposure to Equity to give a ticker to the returns but at the same time takes some debt exposure which acts as a cushion in the volatile markets. Balanced Funds aim to achieve a balance between equities and debt investments, but the balance is often skewed depending upon the nature of the fund. Thus, depending on the equity exposure, the Balanced funds can be classified as: 1? Aggressive balanced funds 2? Semi-aggressive balanced funds 3? Conservative balanced funds Aggressive balanced funds are those, which have a high equity exposure, and it may range between 60-75% in equities, and the balance in debt. Such funds are meant for higher-risk investors who would like to invest in equity, but would also like to have a certain debt market exposure as a cushion. Semi-aggressive balanced funds are those, which invest 40-60% in equities and the balance in debt. Conservative balanced funds are basically tilted towards debt instruments, with a low to moderate exposure to equities. They are meant for the conservative investor, who is looking for that little something extra in terms of returns. We have done an analysis of Balanced funds which would be suitable for those investors who would like to take less risk in comparison to Diversified mutual funds. These funds invest around 60% in the equities while the remaining in Debt and Money market instruments, which acts as a savior in volatile and falling markets.
The following are the top 5 balanced schemes: Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 3 5 Since Name Month Months Months Year Years Years Years Inception HDFC Prudence Fund 7.0 7.5 22.0 43.0 65.4 62.1 48.0 63.6 SBI 6.2 5.7 22.1 49.1 82.1 53.6 14.7 36.0 Magnum
Balanced Tata Balanced Fund Kotak Balance Sundaram Balanced
3.1 5.5 2.3
4.2 2.6 0.7
18.5 20.7 5.9
42.6 42.5 26.0
63.9 54.4 43.9
48.5 44.2 33.9
25.3 24.9 --
32.3 26.1 20.6
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Scheme Analysis –Balanced Funds HDFC Prudence Fund HDFC Prudence Fund (the erstwhile Zurich India Prudence Fund) was launched way back in Jan 1994. The fund aims to provide periodic returns and capital appreciation over a long period of time, from a judicious mix of equity and debt investments, with the aim to prevent/ minimize any capital erosion.
Scheme Performance: Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 3 5 Since Name Month Months Months Year Years Years Years Inception HDFC Prudence 7.0 7.5 22.0 43.0 65.4 62.1 48.0 63.6 Indices Crisil Balanced Index 5.4 15.7 30.9 19.4 -Portfolio Analysis:
The fund has maintained its exposure to Top-5 sectors more or less same in the last 6 months, top sectors being Banks, Electricals & Electrical Equipments, Current assets and Auto & Auto ancillaries. The fund has maintained around 64% in the Equity instruments, 29% in Debt instruments & around 6% in cash & cash equivalents in the last one-year.
Company Name Instrument % of Net Assets Reverse Repo Reverse Repo 9.5 11.4% GOI (2008) Securities 5.3 Satyam Computer Equity 4.8 State Bank of India Equity 4.7 Century Textiles Equity 4.5 Bharat Heavy Electricals Equity 4.2 State Bank of India NCD 3.8 Crompton Greaves Equity 3.5 ACC NCD 3.5 Ultra Tech Cement NCD 3.3 Concentration Analysis:
The scheme has 31 scrips with an average exposure of 24 crores and the Top-10 equity instruments constitute around 22% of the AUM’s. Satyam Computer is the scrip with the largest exposure.
Basic Information: The minimum investment in the scheme is Rs5000 and is managed by Mr. Prashant Jain. The fund has an entry load of 2.25% if the investment is less than 5crores and nil if investment is greater than 5 crores. The fund does not levy any exit load.
Investment Rationale: HDFC Prudence Fund has a long-term consistent record of delivering good returns to its investors. The scheme has given simple annualized returns of 62% in the last 3 years while 48% in the last 5 years. The AUM’s have grown close to 6 times in the last 3 years. Further the consistent returns can also be attributed to the fact that HDFC followed a process driven approach while investing. The Fund has never gone beyond its mandate in terms of asset allocation. Thus, we believe that HDFC Prudence Fund should be a prudent choice to park you savings.
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Scheme Analysis –Balanced Funds SBI Magnum Balanced Fund – Growth SBI Magnum Balanced was launched in October 1995. The scheme aims to provide to its Investors growth through capital appreciation. It also plans to provide periodic income through declaration of dividends. It is ideal for investors who wish to benefit from equity growth without excessive volatility.
Scheme Performance:
Performance as on May 23,2005
Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 3 5 Since Nam Month Months Months Year Years Years Years Inception e SBI Magnum Balanced 6.2 5.7 22.1 49.1 82.1 53.6 14.7 36.0 Indices Crisil Balanced Index 5.4 15.7 30.9 19.4 -Portfolio Analysis: The scheme has increased exposure to banking sector to 15% from around 3% in the last 6 months. Apart From Banking, Finance and Metals are the other sectors on which the scheme is over-weighted sectors. The fund has maintained an average exposure of 66%
towards equity in the last one year while 25% is towards Debt instruments and 8% to cash & cash equivalent instruments.
Concentration Analysis: The corpus of the scheme has seen an appreciation of 13% in the last one year. The Top-10 instrument constitutes 36% of the assets under management while IVRCL is the scrip with the largest exposure. Fund Information: The scheme is managed by Mr. S. Sawarikar. The minimum investment is Rs.1000 and the scheme has an entry load of 2.25% for investment of less than 5crores while it does not levy any exit load. Investment Rationale:
Company Name Instrument % of Net Assets Company Name Instrument % of Net Assets Cash Cash 7.5 Cash UTI Bank Ltd Cash NCD 7.5 5.6 UTI Bank Ltd Industries NCD NCD 5.6 Hindalco 5.5 Hindalco Industries NCD NCD 5.5 EXIM 5.4 EXIM Citicorp Finance NCD NCD 5.4 5.3 Citicorp Finance NCD Equity 5.3 IVRCL 4.6 IVRCLInfrastructure Infrastructure Industries Equity Equity 4.6 Reliance 4.4 Reliance Industriesof India Equity Equity 4.4 State Bank 4.2 State Bank of India India Equity Equity 4.2 SKF Bearings 3.8 SKF Bearings India India Equity Equity 3.8 Jet Airways 3.5 Jet Airways India Equity 3.5
Magnum Balanced Fund has been amongst the top performer over the last few years and has done extremely well even when the markets have taken a hit in the last few months. The scheme has generated 50% annualized return in the last year against 19% annualized return by its benchmark, CRISIL Balanced Fund Index over the same period. The success of the scheme can be attributed to actively managed portfolio in terms of stock selection, sector allocation and to some extent asset allocation. The fund has been ranked at 2nd position. India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Portfolio Analysis: Fund Scheme Analysis –Balanced Funds Tata Balanced Fund – Growth The scheme has increased exposure to financial sector to 16% from 8.7% & around 8% in Tata Balanced2% in was last 6 months. The1995 .The scheme aims toaverage exposure ofdebt banking from Fund the launched in Oct 7, fund has maintained an invest in equity and 66% oriented equity in the last to give investor 25% is towards Debt instruments and 9% to cash & cash towards securities so as one year while balanced returns. Scheme Performance: equivalent instruments.
Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 3 5 Since Concentration Month Months Months Year Years Years Years Inception Nam Analysis: e The corpus of the scheme has seen an appreciation 18% in the last one year. It has a Tata 3.1 4.2 18.5 42.6 63.9 48.5 25.3 32.3 diversified Balanced of 55 stocks and the Top 15 scrips constitute 28%. Portfolio Fund Information: Indices The scheme is managed by M Venugopal. The minimum investment is Rs.5000. The Crisil Balanced an entry load of 2.25% for investment of less than 2crores .It does not 5.4 15.7 30.9 19.4 -scheme charges Index exit load. levy any Investment Rationale:
Tata Balanced fund is a well-diversified fund in its equity exposure, which has invested across 55 scrips to minimize the adverse impact of any scrip on its balanced nature. The scheme has generated 42% annualized return in the last one year against 19% annualized return by its benchmark, CRISIL Balanced Fund Index over the same period. The scheme is less volatile as seen by its standard deviation of 0.47. The fund has been ranked at 3rd position.
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Company Name Instrument % of Net Assets Scheme Analysis –Balanced Funds Reliance Energy Ltd CP 11.6 Kotak Balance Fund
CP 9.1 Kotak Mutual Fund launched J&K Bank CP 6.0 Kotak Balance in November ICICI BANK LTD. Call Money Call Money 5.3 1999.It is an open-ended Equity 5.0 balanced scheme, which Gujarat Gas Company Sundaram Finance Ltd CP 4.5 seeks to achieve growth by Equity 4.4 investing in equity and equity Coromandel Fertilisers Infosys Technologies Equity 4.1 related instruments, balanced Equity 4.0 with income generation by State Bank of India Simbhaoli Sugar Mills Equity 3.5 investing in debt and money market instruments. Scheme Performance: Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 2 5 Since 3 Years Name Month Months Months Year Years Years Inception Kotak Balance 5.5 2.6 20.7 42.5 54.4 44.2 24.9 26.1 Indices Crisil Balanced Index 5.4 15.7 30.9 19.4 -Portfolio Analysis:
The fund has increased its exposure to banking sector from 7% to 21% in the last 6 months. They have also taken exposure to Power Generation, Transmission & Equipments in the month of April’05. They keep on changing the levels of current assets according to their market view.
Concentration Analysis:
The Scheme is holding 22 scrips, Gujarat Gas Company being the scrip with the largest exposure. The top 15 scrips constitute around 49% of the Assets under management.
Fund Information:
The Kotak balance scheme is managed by Mr. Anand Shah & Ritesh Jain. The fund charges an entry load of 2.25% upto 3 crores. It does charges any Exit load.
Investment Rationale: Kotak Balance fund follows a bottom-up approach to stock picking keeping in mind the quality of management, cash flows and order books, its brand equity, its financial and business acumen. The fund believes in value investing and hence picks stocks that are trading at a significant discount to their intrinsic value, and holds them till they appreciate. This gives investors a strong potential upside and a limited downside.
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Scheme Analysis –Balanced Funds Sundaram Balanced Fund – Growth
Sundaram Balanced fund was launched in May 2000. The scheme aims to provide capital appreciation and current income from a balanced portfolio of equities and fixed income securities.
Scheme Performance: Performance as on May 23,2005 Absolute Returns % (P2P) Simple Annualized Returns % (P2P) Scheme 1 3 6 1 5 Since 2 Years 3 Years Name Month Months Months Year Years Inception Sundaram Balanced 2.3 0.7 5.9 26.0 43.9 33.9 -20.6 Indices Crisil Balanced Index 5.4 15.7 30.9 19.4 -Portfolio Analysis: The scheme has increased exposure to financial sector to 16% from 8.7% & around 8% in banking from 2% in the last 6 months. The fund has maintained an average exposure of 66% towards equity in the last one year while 25% is towards Debt instruments and 9% to cash & Cash equivalent instruments. % of Company Net Name Instrument Assets Cash Cash 27.6 Indian Railway Finance Corp PTC 10.9 Power Finance Corporation NCD 10.6 Reliance Industries Ltd Equity 4.3 ONGC Equity 3.8 State Bank of India Equity 3.7 IDBI DDB 3.3 Wipro Equity 3.3 United Phosphorus Equity 3.2 Sesa Goa Ltd Equity 3.1 Concentration Analysis: The corpus of the scheme has seen an appreciation 82% in the last one year. It has a portfolio of
25 stocks and the Top 15 scrips constitute 38%. Fund Information: The scheme is managed by Mr. Anup Bhaskar.The minimum investment is Rs.5000. The scheme charges an entry load of 2.25% for investment of less than 2crores .It does not levy any exit load.
Investment Rationale: Sundaram Balanced Fund has in-built circuit breakers to monitor investments and to ensure against skews in equity, Thus whenever the equity rises above 60%, it is again brought back to 52%. In the process, fund realizes the gains of the market but does not go off balance. The fund has an internal policy, which caps the exposure to particular scrip to beyond 5% of the equity portion in any stock. However these have also impacted the returns due to which the returns are not in the top quartile. India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80 Mutual Fund Scheme Analysis –Balanced Funds
Published in May 2005. All rights reserved. © India Infoline Ltd 2005-06. This report is for information purposes only and does not construe to be any investment, legal or taxation advice. It is not intended as an offer or solicitation for the purchase and sale of any financial instrument. Any action taken by you on the basis of the information contained herein is your responsibility alone and India Infoline Ltd (hereinafter referred as IIL) and its subsidiaries or its employees or directors, associates will not be liable in any manner for the consequences of such action taken by you. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, but do not represent that it is accurate or complete. IIL or any of its subsidiaries or associates or employees shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this publication. The recipients of this report should rely on their own investigations. IIL and/or its subsidiaries and/or directors, employees or associates may have interests or positions, financial or otherwise in the securities mentioned in this report.
India Infoline Ltd, 24 Nirlon Complex, Off Western Exp. Highway, Goregaon(E). Mumbai -63. Tel 56754478-80
NAV India: India's largest database on Mutual funds.
The strength of the database is not only the depth, but also easily assimilated and analysed form. Spend time in decision making rather collating and cross-referencing. NAVIndia is vastly more varied and in-depth, database on Mutual fund industry. Database Coverage on the mutual fund industry covering 1,400 schemes of 30 AMC's. With a user-friendly data presentation the information's be it on an scheme/AMC, tracking NAV's, scheme details, performances, rankings, portfolios etc. Cross validation controls ensures data accuracy & views, analysis and reports, Fund managers profiles/commentaries & basic company profiles are some of the value additions to name a few, are some sections which would allow you for making well informed decisions and to stay on top. NAVINDIA - 5 Segments of data AMC's: AMCwise - AUM, Allocation of AUM in various categories, Company holding, Sectoral Holding, What's in-What's out, Performance. Single Scheme: Scheme wise - Basic information like Address, Tel No, Category, Load Structure, Dividend Details, Scheme Objective, Detailed Portfolio, and Portfolio Trend, What's in - What's out? Rating Details and Scheme Analysis. Multi Schemes: For a set of schemes - Performance, all major statistical ratios, ComparisonCompanywise, Sectorwise, Ratingwsie, Assetwise and Average Maturitywise, NAV with multiple options, Fund Manager Fancies (Inclination of FM based on certain parameters) News: All MF related news, which are classified in various news types, which makes your go through simplest.
Magnum Debt Fund Series Magnum Tax Profit 1994 Magnum Equity Linked Savings Scheme 95 Magnum Equity Linked Savings Scheme 96 Magnum Monthly Income Scheme 97 Magnum Monthly Income Scheme 98 (I) Magnum Monthly Income Scheme 98 (II)
Magnum Tax Profit 1994
Registrar NAV Information Archives Portfolio 27th December 1993 31st March 2004 Equity greater than 80% Liquid Instruments less than 20%
Date of Launch Date of Maturity Pattern of Investment Provision of Liquidity for Investors
Repurchase at NAV after lock-in of 3 year
Magnum Equity Linked Savings Scheme 95
Registrar NAV Information Archives Portfolio
Date of Launch Date of Maturity Pattern of Investment
29th December 1994 31st March 2005 Equity greater than 85% Liquid Instruments less than 15%
Provision of Liquidity for Investors
Repurchase at NAV after lock-in of 3 year
Magnum Equity Linked Savings Scheme 96
Registrar NAV Information Archives Portfolio
Date of Launch Date of Maturity Pattern of Investment Provision of Liquidity for Investors
15th December 1995 31st March 2006 Equity greater than 85% Liquid Instruments less than 15%
Repurchase at NAV after lock-in of 3 year
Magnum Monthly Income Scheme 97
Registrar NAV Information Archives Portfolio 1st July 1997 30th June 2003 Debt greater than Equity less than Money Market & Others Balance
Date of Launch Date of Maturity Pattern of Investment
80% Provision of Liquidity for Investors Record of Dividend
20%
Repurchase at NAV after lock-in of 1 year July 97 - June 98 July 98 - June 99 July 99 - June 00 July 00 - June 01 July 01 - June 02 : : : : : 15.00% 12.00% 10.75% 9.75% 8.00%
Nature of Guarantee / Assuarance
Returns were assured for 1st year only i.e.from 1.07.97 to 31.07.98 @ 15.00%
Magnum Monthly Income Scheme 98 (I)
Registrar NAV Information Archives Portfolio
Date of Launch Date of Maturity
1st April 1998 31st March 2003 Debt Equity less than 20% Money Market & Others Balance
Pattern of Investment
greater than 80%
Provision of Liquidity for Investors Record of Dividend Nature of Guarantee / Assuarance
Repurchase at NAV after lock-in of 1 year 12.5% p.a. Guaranteed for 5 years Returns are guaranteed for 5 yrs. @ 12.50%
The capital invested in the scheme will be protected at the time of redemption i.e. a minimum redemption value of Rs.10. under the monthly, quarterly & Annual option is guaranteed. Under the cumulative option a minimum redemption value of Rs.18.62 per magnum is guaranteed by the AMC at the end of 5 yrs.
Magnum Monthly Income Scheme 98 (II)
Registrar NAV Information Archives Portfolio
Date of Launch Date of Maturity
1st February 1999 31st January 2004 Debt Equity less than 20% Money Market & Others Balance
Pattern of Investment
greater than 80%
Provision of Liquidity for Investors Record of Dividend
Repurchase at NAV after lock-in of 1 year (1.2.99 - 31.01.00) Monthly 12.50% Quarterly 12.64% Annual 13.25% (1.2.00 - 31.01.01) Monthly 10.48% Quarterly 10.57% Annual 11.00%
(1.2.01 - 31.01.02) Monthly 10.25%
(1.2.02 - 31.01.03) Monthly 7.25%
Quarterly 10.34% Annual 10.75% Nature of Guarantee / Assuarance
Quarterly 7.30% Annual 7.50%
Returns were assured for 1st year only i.e. from 1.02.99 to 31.01.2000: Mly. 12.50% Qly. 12.64% Annual 13.25% The capital invested in the scheme will be protected at the time of final Redemption under all the options i.e. a minimum value of Rs.10 is guaranteed at the end of 5 yrs.
ss Mutual Funds: The Tax Angle Sumit Gulati / Manisha Gulati The obvious may not always be the best option. Investors seeking a regular income from mutual funds invariably opt for the dividend option. They assume that the tax-free dividend payout is more efficient than systematic redemption of units from a growth option. Calculations, however, show otherwise. There are many such interesting aspects to mutual fund investing where the obvious choice may not always be the best. To know more about such investment nuances, read on. The Structure Taxation of mutual funds needs to be highlighted from two main angles. One angle looks at taxation from the point of view of the fund itself and the other looks at the taxation aspect with respect to the fund investor. One of the most significant points to be noted about mutual funds is that their income-whether dividend or capital gain - is not subject to any tax unlike a corporate, which has to pay tax on its earnings. This benefit granted to it, by virtue of Section 10 (23D), comes on account of its status as pass through vehicle. No taxes on such income then serves to increase the amount of distributable income. As far as the investor angle is concerned, there are a variety of tax provisions that apply to mutual funds. It is necessary to be aware about some basic tax provisions that apply to all mutual fund schemes. These relate to:
1) Tax Deduction at Source - The important point to note about mutual funds, for resident investors, is that for any income credited or paid by the fund no tax is deducted at source. This provision applies both to dividend payouts made by funds and to proceeds of redemption. Sections 194 K and 196 A are the governing provisions for this. The provisions are, however, different for NRIs. While there is no TDS applicable on dividend payouts made to NRIs, TDS is supposed to be made whenever NRIs redeem their investment in a mutual fund scheme. 2) Wealth Tax - No wealth tax is leviable on mutual fund units. This benefit comes to mutual funds by virtue of the fact that mutual fund units are not treated as 'assets' under the Wealth Tax Act. 3) Capital Gains Tax - Capital gains tax needs to be paid on all mutual fund units. The difference between the purchase and redemption price (in case of open-end funds) is used to calculate capital gains. Time is also a factor for this purpose. Units held for a period of less than one year are eligible for short term capital gains while those held for a period of longer than one year are eligible for long term capital gain. Further, in the case of long term capital gain, the investor is given the option of choosing between a) 20 per cent tax rate with indexation benefit and b) 10 per cent tax rate without the benefit of indexation. What is more the latest budget has exempted capital gains from tax if the amount of gain is invested in Initial Public offerings (IPO). 4) Dividend tax free for investor - the provisions of the budget for the financial year 1999-2000 introduced some changes in the way mutual fund dividends were supposed to be taxed. That year Section 10(33) was modified to include dividends from Unit Trust of India and all other Mutual Funds. Section 10 is an all-encompassing section that lists the kinds of income that are to be excluded from calculation of total income. 5) Dividend distribution tax - while the modification of Section 10(33) made dividend tax free in the hands of all investors, another inclusion in the tax laws levied tax on dividends distributed by mutual funds. The tax, called Dividend Distribution Tax, is levied on all distributions of dividends made by mutual funds. However, the budget for the year 1999-2000 exempted UTI's US-64 and all open ended equity schemes from the purview of dividend distribution tax till the end of March 2002. The appropriate sections governing this provision are Sections 115 R to 115 T While the above tax provisions are attracted by all mutual fund
schemes irrespective of their type, genre and kind, some specific tax benefits and provisions are applicable to select schemes. Select schemes provide benefit under Section 88, Section 54 EA and Section 54 EB (till some time back) Schemes with Section 88 benefit. Mutual Fund schemes that carry the benefit of Section 88 can essentially be spread across three categories - ELSS, Insurance Linked and Pension. We will explain all these schemes and the benefits they carry. We will also look at tax efficient investment methods for each of these schemes. 1) ELSS - Short for Equity Linked Savings Schemes, these carry a tax rebate of 20 per cent of amount invested. However, only a maximum of Rs 10,000 is eligible for rebate in this category of schemes. These schemes come with a lock in period of 3 years. Further, appropriate legislation stipulates that atleast 80 per cent of the total corpus of these funds shall be invested in equity and related instruments. Currently, most mutual funds offer open-ended ELS schemes in which one can invest throughout the year. Details about the performance of these schemes can be accessed from the fund section. The unique structure and terms of these schemes necessitates that certain points be kept in mind while investing. For instance, one can benefit by choosing a scheme capable of distributing dividend. The benefit of dividend declaration is that the unitholder not only receives tax-free income but also pays lower capital gains at the time of redemption. This is because the dividend declared serves to reduce the NAV and the redemption price. More information and tips on ELS Schemes can be seen at Save tax through Equity Linked Saving Schemes. 2) Insurance Linked Schemes - Apart from ELSS schemes, mutual fund schemes with insurance benefits carry the benefit of Section 88. Such schemes piggy back an insurance benefit with a mutual fund. The Insurance Linked Schemes currently available are UTI's Unit Linked Insurance Plan (ULIP) and LIC's Dhanraksha '89. These schemes carry defined lock ins too. 3) Pension Plans - the mutual fund industry in India is constrained by law from offering full fledged pension plans on the lines of the 401 K plans available in the United States. So far, UTI and Kothari Pioneer Mutual Fund are the only two mutual funds offering full-fledged Pension Plans with benefit under Section 88. While UTI offers Retirement Benefit Plan, Kothari Pioneer Mutual Fund offers KP Pension Plan. Fund Tips The tax provisions, whatever they are, are unavoidable. However, there are some general observations that are required to be understood as they can lead to a lowering of the
tax liability. The choice, quite obviously, has to be made by the investor himself depending on his needs. Listed below are some useful observations: i) Aim for Double Indexation Benefit - it has been mentioned above that an investor can calculate capital gains by choosing between two options - 10 per cent without indexation or 20 per cent with indexation. An investor, at the time of withdrawal, should consider both and choose the lower tax option. At this point the concept of double indexation can be useful. Double indexation gives an investor the advantage of indexing his investment to inflation for two years while remaining invested for a period of slightly more than an year. This can be done if the investor puts in his money just before the end of a financial year and withdraws it immediately after the end of the next financial year. For instance, had an investor put in money in a fund on 25 March 2000 (6 days before the end of FY on 31 March 2000) and withdrawn it on 5 April 2001 (after the end of FY 20002001) he would have got benefit for two financial years (19992000, 2000-2001) since the investment was made in the FY before last (1999-2000). Depending on the quantum of gains in the scheme and the inflation index, the tax liability could be lowered by availing of double indexation. ii) Be sure of the option being chosen - switching optionsdividend to growth or vice versa-amounts to redemption from one option and fresh investment in the other option. And, this redemption attracts capital gains tax. So, it is important that an investor chooses the option carefully. This can be done through a careful analysis of one's cash flow needs. iii) Bonus Units offer only a liquidity advantage - Unlike the case with common stock, a bonus issue in mutual funds carries nothing but a liquidity and tax advantage and that too under a given set of assumptions. A bonus carries no value because the total wealth of the unitholder remains the same. However, as the NAV adjusts down, depending on the ratio in which the bonus is granted, it serves to lower the cost of exit on the existing units. In short it reduces capital gains payable. A bonus issue could, therefore, partially increase liquidity by facilitating early withdrawal for those fearing to redeem on account of tax liability. The flip side ofcourse is that the cost of bonus units is deemed to be zero for tax purposes and that whenever those are withdrawn a tax will be levied on the gains. So, while less tax on existing units is compensated for by greater tax liability on bonus units (because their value is deemed to be zero), the advantage is that withdrawal of existing units can be made even before the end of one year. This is because any gains in the units may have been reduced if not eliminated altogether due to the bonus issue.
iv) Choose to withdraw systematically instead of opting for dividend receipts - the prevailing tax provisions provide an interesting way of not only receiving regular income but also paying less tax. This can be done by systematically withdrawing the gains from the investment instead of claiming dividends. To do this an investor needs to opt for the Growth option of a mutual fund scheme and stay invested in the scheme for atleast one year. After one year, the investor can direct the mutual fund to systematically redeem units worth a fixed amount or units equivalent to the gains in the scheme. This way, the investor is assured of regular inflows. The benefit of doing this is that it is a more tax efficient way of receiving regular income. This is because whenever the units are withdrawn capital gains is charged on the difference between the purchase price and redemption price. So, if an amount equivalent to the gains is withdrawn then tax is levied on the amount of gains less the cost of units being redeemed to distribute this gain. Had these gains been distributed as dividend, tax would have been levied on the entire amount of gains. This would have meant a higher tax payout. v) Choose Dividend Reinvestment option for open-end equity schemes - tax laws prevailing at the moment specify that dividend payouts of all funds except UTI's US 64 and open ended equity schemes are subject to a distribution tax of 10 percent. This exemption granted to open end equity funds can be turned to one's advantage. An investor can take advantage of this provision by investing in the dividend reinvestment option of the scheme. The benefit of this is that due to the dividend declared in the units of the scheme the NAV declines by the amount of dividend. This, then brings down the redemption price of the units which in turn lowers the amount of capital gains. The advantage of dividend reinvestment therefore is twinfold. One, is that the amount of gains reduce and other is that dividend gets reinvested in the scheme automatically without any fresh procedural hassles. vi) Invest for the long term - apart from being one of the fundamental tenets of sound investing, investing for the long term is also smart from the tax angle. Units held for more than an year are eligible for long term capital gain unlike short term capital gain which is taxed as a part of the unitholder's total income. While the maximum tax that will need to be paid on long term gain is limited to 10 per cent, tax on short-term capital gain can vary depending on other components of the unitholder's total income. The Great Mutual Fund Tax Arbitrage Over the years funds have found favour with various finance ministers. The result, favourable tax provisions compared to other investment alternatives. These tax differentials therefore
go far in giving mutual funds a tax arbitrage. This arbitrage is most evident in the case of corporates and high income individuals. Most corporates attract a high corporate tax rate for even their income from investment. However, by investing in mutual funds corporates ensure that all income received is taxed at a low 10 per cent as compared to a much higher corporate tax rate. This is because income from funds is tax free in the hands of the investor and only a dividend distribution tax is payable in the case of some schemes. This tax arbitrage combined with loopholes in Capital Gains law combined to create the practice of Dividend Stripping and the speciality Serial Plan schemes in the year gone by.
A mutual fund is a form of collective investment that pools money from many investors and invests their money in stocks, bonds, short-term money market instruments, and/or other securities.[1] In a mutual fund, the fund manager trades the fund's underlying securities, realizing capital gains or losses, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors. The value of a share of the mutual fund, known as the net asset value per share (NAV), is calculated daily based on the total value of the fund divided by the number of shares currently issued and outstanding. Legally known as an "open-end company" under the Investment Company Act of 1940 (the primary regulatory statute governing investment companies), a mutual fund is one of three basic types of investment companies available in the United States.[2] Outside of the United States (with the exception of Canada, which follows the U.S. model), mutual fund is a generic term for various types of collective investment vehicle. In the United Kingdom and western Europe (including offshore jurisdictions), other forms of collective investment vehicle are prevalent, including unit trusts, open-ended investment companies (OEICs), SICAVs and unitized insurance funds. In Australia the term "mutual fund" is not used; the name "managed fund" is used instead. However, "managed fund" is somewhat generic as the definition of a managed fund in Australia is any vehicle in which investors' money is managed by a third party (NB: usually an investment professional or organization). Most managed funds are openended (i.e., there is no established maximum number of shares that can be issued); however, this need not be the case. Additionally the Australian government introduced a compulsory superannuation/pension scheme which, although strictly speaking a managed fund, is rarely identified by this term and is instead called a "superannuation fund" because of its special tax concessions and restrictions on when money invested in it can be accessed.
Contents
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1 History 2 Usage 3 Net asset value 4 Turnover 5 Expenses and TER's o 5.1 Management Fees o 5.2 Non-management Expenses o 5.3 12b-1/Non-12b-1 Service Fees o 5.4 Fees and Expenses Borne by the Investor (not the Fund) o 5.5 Brokerage Commissions 6 Types of mutual funds o 6.1 Open-end fund o 6.2 Exchange-traded funds o 6.3 Equity funds ? 6.3.1 Capitalization ? 6.3.2 Growth vs. value ? 6.3.3 Index funds versus active management o 6.4 Bond funds o 6.5 Money market funds o 6.6 Funds of funds o 6.7 Hedge funds 7 Mutual funds vs. other investments 8 Selecting a mutual fund o 8.1 Share classes o 8.2 Load and expenses 9 Criticism of managed mutual funds o 9.1 Scandals 10 See also
• 11 References [edit] History
Massachusetts Investors Trust was founded on March 21, 1924, and, after one year, had 200 shareholders and $392,000 in assets. The entire industry, which included a few closed-end funds, represented less than $10 million in 1924. The stock market crash of 1929 slowed the growth of mutual funds. In response to the stock market crash, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws require that a fund be registered with the Securities and Exchange Commission (SEC) and provide prospective investors with a prospectus that contains required disclosures about the fund, the securities themselves, and fund manager. The SEC helped draft the Investment Company Act of 1940, which sets forth the guidelines with which all SEC-registered funds today must comply.
With renewed confidence in the stock market, mutual funds began to blossom. By the end of the 1960s, there were approximately 270 funds with $48 billion in assets. The first retail index fund, the First Index Investment Trust, was formed in 1976 and headed by John Bogle, who conceptualized many of the key tenets of the industry in his 1951 senior thesis at Princeton University[3]. It is now called the Vanguard 500 Index fund and is one of the largest mutual funds ever with in excess of $100 billion in assets. One of the largest contributors of mutual fund growth was individual retirement account (IRA) provisions added to the Internal Revenue Code in 1975, allowing individuals (including those already in corporate pension plans) to contribute $2,000 a year. Mutual funds are now popular in employer-sponsored defined contribution retirement plans (401(k)s), IRAs and Roth IRAs. As of April 2006, there are 8,606 mutual funds that belong to the Investment Company Institute (ICI), the national association of investment companies in the United States, with combined assets of $9.207 trillion.[4]
[edit] Usage
Mutual funds can invest in many different kinds of securities. The most common are cash, stock, and bonds, but there are hundreds of sub-categories. Stock funds, for instance, can invest primarily in the shares of a particular industry, such as technology or utilities. These are known as sector funds. Bond funds can vary according to risk (e.g., high-yield or junk bonds, investment-grade corporate bonds), type of issuers (e.g., government agencies, corporations, or municipalities), or maturity of the bonds (short- or long-term). Both stock and bond funds can invest in primarily U.S. securities (domestic funds), both U.S. and foreign securities (global funds), or primarily foreign securities (international funds). Most mutual funds' investment portfolios are continually adjusted under the supervision of a professional manager, who forecasts the future performance of investments appropriate for the fund and chooses those which he or she believes will most closely match the fund's stated investment objective. A mutual fund is administered through a parent management company, which may hire or fire fund managers. Mutual funds are subject to a special set of regulatory, accounting, and tax rules. Unlike most other types of business entities, they are not taxed on their income as long as they distribute substantially all of it to their shareholders. Also, the type of income they earn is often unchanged as it passes through to the shareholders. Mutual fund distributions of tax-free municipal bond income are also tax-free to the shareholder. Taxable distributions can be either ordinary income or capital gains, depending on how the fund earned those distributions.
[edit] Net asset value
Main article: net asset value
The net asset value, or NAV, is the current market value of a fund's holdings, usually expressed as a per-share amount. For most funds, the NAV is determined daily, after the close of trading on some specified financial exchange, but some funds update their NAV multiple times during the trading day. Open-end funds sell and redeem their shares at the NAV, and so process orders only after the NAV is determined. Closed-end funds (the shares of which are traded by investors) may trade at a higher or lower price than their NAV; this is known as a premium or discount, respectively. If a fund is divided into multiple classes of shares, each class will typically have its own NAV, reflecting differences in fees and expenses paid by the different classes. Some mutual funds own securities which are not regularly traded on any formal exchange. These may be shares in very small or bankrupt companies; they may be derivatives; or they may be private investments in unregistered financial instruments (such as stock in a non-public company). In the absence of a public market for these securities, it is the responsibility of the fund manager to form an estimate of their value when computing the NAV. How much of a fund's assets may be invested in such securities is stated in the fund's prospectus..
[edit] Turnover
Turnover is a measure of the fund's securities transactions, usually calculated over a year's time, and usually expressed as a percentage of net asset value. This value is usually calculated as the value of all transactions (buying, selling) divided by 2 divided by the fund's total holdings; i.e., the fund counts one security sold and another one bought as one "turnover". Thus turnover measures the replacement of holdings. In Canada, under NI 81-106 (required disclosure for investment funds) turnover ratio is calculated based on the lesser of purchases or sales divided by the average size of the portfolio (including cash). Turnover generally has tax consequences for a fund, which are passed through to investors. In particular, when selling an investment from its portfolio, a fund may realize a capital gain, which will ultimately be distributed to investors as taxable income. The very process of buying and selling securities also has its own costs, such as brokerage commissions, which are borne by the fund's shareholders.
[edit] Expenses and TER's
Mutual funds bear expenses similar to other companies. The fee structure of a mutual fund can be divided into two or three main components: management fee, nonmanagement expense, and 12b-1/non-12b-1 fees. All expenses are expressed as a percentage of the average daily net assets of the fund.
[edit] Management Fees
The management fee for the fund is usually synonymous with the contractual investment advisory fee charged for the management of a fund's investments. However, as many fund companies include administrative fees in the advisory fee component, when attempting to compare the total management expenses of different funds, it is helpful to define management fee as equal to the contractual advisory fee + the contractual administrator fee. This "levels the playing field" when comparing management fee components across multiple funds. Contractual advisory fees may be structured as "flat-rate" fees, i.e., a single fee charged to the fund, regardless of the asset size of the fund. However, many funds have contractual fees which include breakpoints, so that as the value of a fund's assets increases, the advisory fee paid decreases. Another way in which the advisory fees remain competitive is by structuring the fee so that it is based on the value of all of the assets of a group or a complex of funds rather than those of a single fund.
[edit] Non-management Expenses
Apart from the management fee, there are certain non-management expenses which most funds must pay. Some of the more significant (in terms of amount) non-management expenses are: transfer agent expenses (this is usually the person you get on the other end of the phone line when you want to purchase/sell shares of a fund), custodian expense (the fund's assets are kept in custody by a bank which charges a custody fee), legal/audit expense, fund accounting expense, registration expense (the SEC charges a registration fee when funds file registration statements with it), board of directors/trustees expense (the disinterested members of the board who oversee the fund are usually paid a fee for their time spent at board meetings), and printing and postage expense (incurred when printing and delivering shareholder reports).
[edit] 12b-1/Non-12b-1 Service Fees
12b-1 service fees/shareholder servicing fees are contractual fees which a fund may charge to cover the marketing expenses of the fund. Non-12b-1 service fees are marketing/shareholder servicing fees which do not fall under SEC rule 12b-1. While funds do not have to charge the full contractual 12b-1 fee, they often do. When investing in a front-end load or no-load fund, the 12b-1 fees for the fund are usually .250% (or 25 basis points). The 12b-1 fees for back-end and level-load share classes are usually between 50 and 75 basis points but may be as much as 100 basis points. While funds are often marketed as "no-load" funds, this does not mean they do not charge a distribution expense through a different mechanism. It is expected that a fund listed on an online brokerage site will be paying for the "shelf-space" in a different manner even if not directly through a 12b-1 fee.
[edit] Fees and Expenses Borne by the Investor (not the Fund)
Fees and expenses borne by the investor vary based on the arrangement made with the investor's broker. Sales loads (or contingent deferred sales loads (CDSL)) are not included in the fund's total expense ratio (TER) because they do not pass through the
statement of operations for the fund. Additionally, funds may charge early redemption fees to discourage investors from swapping money into and out of the fund quickly, which may force the fund to make bad trades to obtain the necessary liquidity. For example, Fidelity Diversified International Fund (FDIVX) charges a 1 percent fee on money removed from the fund in less than 30 days.
[edit] Brokerage Commissions
An additional expense which does not pass through the statement of operations and cannot be controlled by the investor is brokerage commissions. Brokerage commissions are incorporated into the price of the fund and are reported usually 3 months after the fund's annual report in the statement of additional information. Brokerage commissions are directly related to portfolio turnover (portfolio turnover refers to the number of times the fund's assets are bought and sold over the course of a year). Usually the higher the rate of the portfolio turnover, the higher the brokerage commissions. The advisors of mutual fund companies are required to achieve "best execution" through brokerage arrangements so that the commissions charged to the fund will not be excessive.
[edit] Types of mutual funds [edit] Open-end fund
The term mutual fund is the common name for an open-end investment company. Being open-ended means that, at the end of every day, the fund issues new shares to investors and buys back shares from investors wishing to leave the fund. Mutual funds may be legally structured as corporations or business trusts but in either instance are classed as open-end investment companies by the SEC. Other funds have a limited number of shares; these are either closed-end funds or unit investment trusts, neither of which is a mutual fund.
[edit] Exchange-traded funds
Main article: Exchange-traded fund A relatively new innovation, the exchange traded fund (ETF), is often formulated as an open-end investment company. ETFs combine characteristics of both mutual funds and closed-end funds. An ETF usually tracks a stock index (see Index funds). Shares are issued or redeemed by institutional investors in large blocks (typically of 50,000). Investors typically purchase shares in small quantities through brokers at a small premium or discount to the net asset value; this is how the institutional investor makes its profit. Because the institutional investors handle the majority of trades, ETFs are more efficient than traditional mutual funds (which are continuously issuing new securities and redeeming old ones, keeping detailed records of such issuance and redemption transactions, and, to effect such transactions, continually buying and selling securities and maintaining liquidity position) and therefore tend to have lower expenses. ETFs are traded throughout the day on a stock exchange, just like closed-end funds.
Exchange traded funds are also valuable for foreign investors who are often able to buy and sell securities traded on a stock market, but who, for regulatory reasons, are unable to participate in traditional US mutual funds.
[edit] Equity funds
Equity funds, which consist mainly of stock investments, are the most common type of mutual fund. Equity funds hold 50 percent of all amounts invested in mutual funds in the United States. [5] Often equity funds focus investments on particular strategies and certain types of issuers. [edit] Capitalization Fund managers and other investment professionals have varying definitions of mid-cap, and large-cap ranges. The following ranges are used by Russell Indexes: [6]
• • • •
Russell Microcap Index - micro-cap ($54.8 - 539.5 million) Russell 2000 Index - small-cap ($182.6 million - 1.8 billion) Russell Midcap Index - mid-cap ($1.8 - 13.7 billion) Russell 1000 Index - large-cap ($1.8 - 386.9 billion)
[edit] Growth vs. value Another distinction made is between growth funds, which invest in stocks of companies that have the potential for large capital gains, and value funds, which concentrate on stocks that are undervalued. Growth stocks typically have the potential for a greater return; however, such investments also bear larger risks. Growth funds tend not to pay regular dividends. Sector funds focus on specific industry sectors, such as biotechnology or energy. Income funds tend to be more conservative investments, with a focus on stocks that pay dividends. A balanced fund may use a combination of strategies, typically including some level of investment in bonds, to stay more conservative when it comes to risk, yet aim for some growth. [edit] Index funds versus active management Main articles: Index fund and active management An index fund maintains investments in companies that are part of major stock (or bond) indices, such as the S&P 500, while an actively managed fund attempts to outperform a relevant index through superior stock-picking techniques. The assets of an index fund are managed to closely approximate the performance of a particular published index. Since the composition of an index changes infrequently, an index fund manager makes fewer trades, on average, than does an active fund manager. For this reason, index funds generally have lower trading expenses than actively managed funds, and typically incur fewer short-term capital gains which must be passed on to shareholders. Additionally, index funds do not incur expenses to pay for selection of individual stocks (proprietary
selection techniques, research, etc.) and deciding when to buy, hold or sell individual holdings. Instead, a fairly simple computer model can identify whatever changes are needed to bring the fund back into agreement with its target index. The performance of an actively managed fund largely depends on the investment decisions of its manager. Statistically, for every investor who outperforms the market, there is one who underperforms. Among those who outperform their index before expenses, though, many end up underperforming after expenses. Before expenses, a wellrun index fund should have average performance. By minimizing the impact of expenses, index funds should be able to perform better than average. Certain empirical evidence seems to illustrate that mutual funds do not beat the market and actively managed mutual funds under-perform other broad-based portfolios with similar characteristics. One study found that nearly 1,500 U.S. mutual funds underperformed the market in approximately half of the years between 1962 and 1992.[7] Moreover, funds that performed well in the past are not able to beat the market again in the future (shown by Jensen, 1968; Grimblatt and Titman, 1989.[8] However, as quantitative finance is in its early stages of development, more accurate studies are required to reach a decisive conclusion.[citation needed]
[edit] Bond funds
Bond funds account for 18% of mutual fund assets. [9] Types of bond funds include term funds, which have a fixed set of time (short-, medium-, or long-term) before they mature. Municipal bond funds generally have lower returns, but have tax advantages and lower risk. High-yield bond funds invest in corporate bonds, including high-yield or junk bonds. With the potential for high yield, these bonds also come with greater risk.
[edit] Money market funds
Money market funds hold 26% of mutual fund assets in the United States. [10] Money market funds entail the least risk, as well as lower rates of return. Unlike certificates of deposit (CDs), money market shares are liquid and redeemable at any time. The interest rate quoted by money market funds is known as the 7 Day SEC Yield.
[edit] Funds of funds
Funds of funds (FoF) are mutual funds which invest in other underlying mutual funds (i.e., they are funds comprised of other funds). The funds at the underlying level are typically funds which an investor can invest in individually. A fund of funds will typically charge a management fee which is smaller than that of a normal fund because it is considered a fee charged for asset allocation services. The fees charged at the underlying fund level do not pass through the statement of operations, but are usually disclosed in the fund's annual report, prospectus, or statement of additional information. The fund should be evaluated on the combination of the fund-level expenses and underlying fund expenses, as these both reduce the return to the investor.
Most FoFs invest in affiliated funds (i.e., mutual funds managed by the same advisor), although some invest in funds managed by other (unaffiliated) advisors. The cost associated with investing in an unaffiliated underlying fund is most often higher than investing in an affiliated underlying because of the investment management research involved in investing in fund advised by a different advisor. Recently, FoFs have be classified into those that are actively managed (in which the investment advisor reallocates frequently among the underlying funds in order to adjust to changing market conditions) and those that are passively managed (the investment advisor allocates assets on the basis of on an allocation model which is rebalanced on a regular basis). The design of FoFs is structured in such a way as to provide a ready mix of mutual funds for investors who are unable to or unwilling to determine their own asset allocation model. Fund companies such as TIAA-CREF, Vanguard, and Fidelity have also entered this market to provide investors with these options and take the "guess work" out of selecting funds. The allocation mixes usually vary by the time the investor would like to retire: 2020, 2030, 2050, etc. The more distant the target retirement date, the more aggressive the asset mix.
[edit] Hedge funds
Main article: Hedge fund Hedge funds in the United States are pooled investment funds with loose SEC regulation and should not be confused with mutual funds. Certain hedge funds are required to register with SEC as investment advisers under the Investment Advisers Act. [11] The Act does not require an adviser to follow or avoid any particular investment strategies, nor does it require or prohibit specific investments. Hedge funds typically charge a management fee of 1% or more, plus a "performance fee" of 20% of the hedge fund's profits. There may be a "lock-up" period, during which an investor cannot cash in shares.
[edit] Mutual funds vs. other investments
Mutual funds offer several advantages over investing in individual stocks, including diversification and professional management. A mutual fund may hold investments in hundreds or thousands of stocks, thus reducing the risk associated with owning any particular stock. Moreover, the transaction costs associated with buying individual stocks are spread around among all the mutual fund shareholders. Additionally, a mutual fund benefits from professional fund managers who can apply their expertise and dedicate time to research investment options. Mutual funds, however, are not immune to risks. Mutual funds share the same risks associated with the types of investments the fund makes. If the fund invests primarily in stocks, the mutual fund is usually subject to the same ups and downs and risks as the stock market.
[edit] Selecting a mutual fund
Picking a mutual fund from among the thousands offered is not easy. Following are some guidelines:
1. Prior to investing in a tax-exempt or tax-managed fund, it is best to determine if the tax savings will offset the possibly lower returns. Additionally, these funds are inappropriate for IRAs and other tax-sheltered types of account. 2. Investors should match the term of the investment to the time period they expect to keep the investment. Money that may be needed in the short term (for example, for car repairs) should generally be in a less volatile fund, such as a money market fund. Money not needed until a retirement date decades into the future (or for a newborn's college education) can reasonably be invested in longer-term, higherrisk investments, such as stock or bond funds. Investing short-term money in volatile investments puts the investor at risk of having to sell when the market is low, thereby incurring a loss. Investing over the long term in very stable investments, on the other hand, significantly reduces potential returns. 3. Fund expenses degrade investment performance, especially over the long term. Accordingly, all other things being equal, the lower the expenses, the better. A mutual fund's expense ratio is required to be disclosed in the prospectus. Expense ratios are critical in index funds, which seek to match the performance of bond or stock index. Actively managed funds must pay the manager for the active management of the portfolio, so they usually have a higher expense ratio than (passively managed) index funds. 4. Several sector funds often make the "best fund" lists each year. However, the "best" sector varies from year to year. Most sectors are vulnerable to industrywide events that can have a significant negative effect on performance. It is generally best to avoid making these a large part of one's portfolio. 5. Closed-end funds often sell at a discount to the value of their holdings. An investor can sometimes obtain extra return by buying such funds, but only if they are willing to hold the fund until the discount rebounds. Some hedge fund managers use this gambit. However, this also implies that buying at the original issue may be a bad idea, since the price often drops immediately because of liquidity concerns. 6. Mutual funds often make taxable distributions near the end of the year (semiannual and quarterly distributions are also fairly common). If an investor plans to invest in a taxable fund, he or she should check the fund company's website to see when the fund plans to distribute dividends and capital gains. Investing just prior to the distribution results in part of one's investment being returned as taxable income without increasing the value of the account. 7. Prospective investors in mutual funds should read the prospectus. The prospectus is required by law to disclose the risks will be taken with investors' money, among other vital topics. Potential investors should also compare the return and risk profile of a fund against its peers with similar investment objectives and against the index most closely associated with it, paying particular attention to performance over both the long term and the short term. A fund that gained 50% over a 1-year period (an impressive result) but only 10% over a 5-year period should create some suspicion, as that would imply that the returns in four out of those five years were actually very low (possibly even negative (i.e., losses)), as 10% compounded over 5 years is only 61%.
8. Diversification can reduce risk. Depending on an investor's risk tolerance and his or her investment horizon, it may be advisable to hold some stocks, some bonds, and some cash. For longer-term investments, it is advisable to invest in some foreign stocks. If all of an investor's mutual funds belong to the same family of funds, the investor's total portfolio might not be as diversified as it might seem. This is so because funds within the same family may share research and recommendations. The same is true for investors who own multiple funds with the same profile or investment strategy; their returns will likely be similar. Holding too large a number of funds, on the other hand, will tend to produce the same effect as holding an index fund, but with higher expenses. Buying individual stocks exposes investors to company-specific and industry-specific risks, and if investors buy a large number of stocks, the commissions may cost more than a fund would.
[edit] Share classes
Many mutual funds offer more than one class of shares. For example, you may have seen a fund that offers "Class A" and "Class B" shares. Each class will invest in the same "pool" (or investment portfolio) of securities and will have the same investment objectives and policies. But each class will have different shareholder services and/or distribution arrangements with different fees and expenses. These differences are supposed to reflect different costs involved in servicing investors in various classes; for example, one class may be sold through brokers with a front-end load, and another class may be sold direct to the public with no load but a "12b-1 fee" included in the class's expenses (sometimes referred to as "Class C" shares). Still a third class might have a minimum investment of $10,000,000 and be available only to financial institutions (a socalled "institutional" share class). In some cases, by aggregating regular investments made by many individuals, a retirement plan (such as a 401(k) plan) may qualify to purchase "institutional" shares (and gain the benefit of their typically lower expense ratios) even though no members of the plan would qualify individually. [12]As a result, each class will likely have different performance results. [13] A multi-class structure offers investors the ability to select a fee and expense structure that is most appropriate for their investment goals (including the length of time that they expect to remain invested in the fund). [13]
[edit] Load and expenses
Main article: Mutual fund fees and expenses A front-end load or sales charge is a commission paid to a broker by a mutual fund when shares are purchased, taken as a percentage of funds invested. The value of the investment is reduced by the amount of the load. Some funds have a deferred sales charge or back-end load. In this type of fund an investor pays no sales charge when purchasing shares, but will pay a commission out of the proceeds when shares are redeemed depending on how long they are held. Another derivative structure is a levelload fund, in which no sales charge is paid when buying the fund, but a back-end load may be charged if the shares purchased are sold within a year.
Load funds are sold through financial intermediaries such as brokers, financial planners, and other types of registered representatives who charge a commission for their services. Shares of front-end load funds are frequently eligible for breakpoints (i.e., a reduction in the commission paid) based on a number of variables. These include other accounts in the same fund family held by the investor or various family members, or committing to buy more of the fund within a set period of time in return for a lower commission "today". It is possible to buy many mutual funds without paying a sales charge. These are called no-load funds. In addition to being available from the fund company itself, no-load funds may be sold by some discount brokers for a flat transaction fee or even no fee at all. (This does not necessarily mean that the broker is not compensated for the transaction; in such cases, the fund may pay brokers' commissions out of "distribution and marketing" expenses rather than a specific sales charge. The purchaser is therefore paying the fee indirectly through the fund's expenses deducted from profits.) No-load funds include both index funds and actively managed funds. The largest mutual fund families selling no-load index funds are Vanguard and Fidelity, though there are a number of smaller mutual fund families with no-load funds as well. Expense ratios in some no-load index funds are less than 0.2% per year versus the typical actively managed fund's expense ratio of about 1.5% per year. Load funds usually have even higher expense ratios when the load is considered. The expense ratio is the anticipated annual cost to the investor of holding shares of the fund. For example, on a $100,000 investment, an expense ratio of 0.2% means $200 of annual expense, while a 1.5% expense ratio would result in $1,500 of annual expense. These expenses are before any sales commissions paid to purchase the mutual fund. Many fee-only financial advisors strongly suggest no-load funds such as index funds. If the advisor is not of the fee-only type but is instead compensated by commissions, the advisor may have a conflict of interest in selling high-commission load funds.
[edit] Criticism of managed mutual funds
Historically, actively managed mutual funds, over long periods of time, have not returned as much as comparable index mutual funds. This, of course, is a criticism of one type of mutual fund over another. Another criticism concerns sales commissions on load funds, an upfront or deferred fee as high as 8.5 percent of the amount invested in a fund. No-load funds typically charge a 12b-1 fee in order to pay for shelf space on the exchange the investor uses for purchase of the fund, but they do not pay a load directly to a mutual fund broker. Critics point out that high sales commissions represent a conflict of interest, as high commissions benefit the sales people but hurt the investors. High commissions can also cause sales people to recommend funds that maximize their income. Again, this is a criticism of one type of mutual fund over another.
Mutual funds are also seen by some to have a conflict of interest with regard to their size. Fund companies charge a management fee of anywhere between 0.5 percent and 2.5 percent of the fund's total assets. Theoretically, this should motivate the fund managers, since a well performing fund will cause the amount invested in the fund to rise and increasing the fee earned. It also could motivate the fund company to focus on advertising to attract more and more new investors, as new investors would also cause the fund assets to increase. Mutual fund managers may also have a conflict of interest due to the way they are paid. In particular fund managers may be encouraged to take more risks with investors money than they ought to: Fund flows (and therefore compensation) towards successful, market beating funds are much larger than outflows from funds that lose to the market. Fund managers may therefore have an incentive to purchase high risk investments in the hopes of increasing their odds of beating the market and receiving the high inflows, with relatively less fear of the consequences of losing to the market (1). Many analysts, however, believe that the larger the pool of money one works with, the harder it is to manage actively, and the harder it is to squeeze good performance out of it. Thus a fund company can be focused on attracting new customers, thereby hurting its existing investors' performance. A great deal of a fund's costs are flat and fixed costs, such as the salary for the manager. Thus it can be more profitable for the fund to try to allow it to grow as large as possible, instead of limiting its assets. Some fund companies, notably the Vanguard Group and Fidelity Investments, have closed some funds to new investors to maintain the integrity of the funds for existing investors. Other critisicms of mutual funds are that some funds allow market timing (although many fund companies tightly control this) and that some fund managers accept extravagant gifts in exchange for trading stocks through certain investment banks, which presumably charge the fund more for transactions than would non-gifting investment bank. As a result, many fund companies strictly limit -- or completely bar -- such gifts.
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