mutual funds

[nitish06]

A COMPREHENSIVE STUDY ON MUTUAL FUND PARAMETERS AND RESEARCH ON RELIANCE INFRASTRUCTURE FUND


Submitted towards the partial fulfillment of Graduate Degree in
Bachelor of Finance and Investment Analysis

Submitted to:

COMPANY GUIDE FACULTY GUIDE
DEEPAK CHAUHAN PRIYA JHAMB
RELATIONSHIP MANAGER- AMITY COLLEGE
BANKING COMMERECE AND FINANCE
(RELIANCE CAPITAL ASSET) (NOIDA), AMITY UNIVERSITY
MANAGEMENT LTD. ) UTTAR PRADESH.

Submitted by:
Nitish Khurana
Bachelor of Finance and Investment Analysis (2008-09)

Amity University


CERTIFICATE OF ORIGIN

This is to certify that Mr. Nitish Khurana, student of Amity College of Commerce and Finance, Amity University, Noida has undergone six week training in our branch as part of his BFIA program with effect from 8th June 09 to 20th July 09.
He has gained the knowledge of Financial Market in this training period.
We wish him success in his future endeavors.










Signature Signature
Mrs. Priya Jhamb Deepak Chauhan







ACKNOWLEDGEMENT


“Knowledge is an experience gained in life, it is the choicest
possession, which should not be shelved but should be happily shared with
others”.

This report bears the imprint of many people. Right from the experienced staff of Reliance Mutual fund (Lakshmi Nagar), HDFC Bank(Noida) and Amity College of Commerce and Finance without whose support and guidance I would have not got the unique opportunity to successfully complete my internship in this esteemed organization.

Also I am indebted for the rich guidance, knowledge and suggestions provided by my guide, Mr. Deepak Chauhan who took sincere efforts and illustrated the Concepts of Mutual Funds with his vast knowledge in the field, which helped me in carrying out my internship.

I am gratified to Mrs. Priya Jhamb for her earnest coordination owing to which, I had the leg-up of undertaking the internship at the prominent organization, Reliance Capital Asset Management Ltd.

Last but not least, I also thank all those people whom I met in the Industry and bank during my internship and helped me to accomplish my assignments in the most efficient and effective manner.



Signature
(Nitish Khurana)




Executive Summary

In few years Mutual Fund has emerged as a tool for ensuring one’s financial well being. Mutual Funds have not only contributed to the India growth story but have also helped families tap into the success of Indian Industry. As information and awareness is rising more and more people are enjoying the benefits of investing in mutual funds. The trick for converting a person with no knowledge of mutual funds to a new Mutual Fund customer is to understand which of the potential investors are more likely to buy mutual funds and to use the right arguments in the sales process that customers will accept as important and relevant to their decision.
This Project gave me a great learning experience and at the same time it gave me enough scope to implement my analytical ability. The analysis and advice presented in this Project Report is based on market research on the saving and investment practices of the investors and preferences of the investors for investment in Mutual Funds. This Report will help to know about the investors Preferences in Mutual Fund means:
1. Do they prefer any particular Asset Management Company (AMC)?
2. Which type of Product they prefer?
3. Which Option (Growth or Dividend) they prefer? or
4. Which Investment Strategy they follow (Systematic Investment Plan or One time Plan)?







This Project is divided into four parts:
1. The first part is about an insight about Mutual Fund.
2. The second part of the project consists of Company Profile of Reliance Capital Asset Management Ltd.
3. The third part of the project explains about recently launched Mutual Fund- Reliance Infrastructure Fund.
4. The fourth and the last part of the Project is a data analysis. Data has been collected through survey done on 200 investors.
This Project covers the topic “A COMPREHENSIVE STUDY ON MUTUAL FUND PARAMETERS AND RESEARCH ON RELIANCE INFRASTRUCTURE FUND”
The data collected has been well organized and presented to my best potential.








Table of Contents
Certificate of Origin pg no.-2
Acknowledgement pg no.-3
Executive summary pg no.-4
Chapter I pg no.-6
• Introduction to Mutual Funds
Chapter II pg no.-52
• Company Profile
Chapter III pg no.-67
• Reliance Infrastructure Fund
Chapter IV pg no.-82
• Facts & Findings
• SWOT Analysis

Conclusion pg no.-94
Recommendations pg no.-97
Suggestions pg no.-98
References pg no.-99
Annexure pg no.-100


CHAPTER-I
Mutual Funds
What Is Mutual Fund?
A mutual fund is just the connecting bridge or a financial intermediary that allows a group of investors to pool their money together with a predetermined investment objective. The mutual fund will have a fund manager who is responsible for investing the gathered money into specific securities (stocks or bonds). When you invest in a mutual fund, you are buying units or portions of the mutual fund and thus on investing becomes a shareholder or unit holder of the fund.
Mutual funds are considered as one of the best available investments as compare to others they are very cost efficient and also easy to invest in, thus by pooling money together in a mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they tried to do it on their own. But the biggest advantage to mutual funds is diversification, by minimizing risk & maximizing returns.
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. The flow chart below describes broadly the working of a mutual fund





History of mutual funds
The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank.

The history of mutual funds in India can be broadly divided into five distinct phases-:

First Phase – Establishment and Growth of Unit Trust of India - 1964-87:

• Unit Trust of India (UTI) established on 1963 by an Act of Parliament.
• Set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the RBI.
• In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India
(IDBI) took over the regulatory and administrative control in place of RBI.
• The first scheme launched by UTI was Unit Scheme 1964.
• At the end of 1988 UTI had Rs.6,700 crores of assets under management.

Second Phase - Entry of Public Sector Funds – 1987-1993:

• 1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC).
• SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian
Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990.
• At the end of 1993, the mutual fund industry had assets under management of Rs.47,004 crores.







Third Phase – Entry of Private Sector Funds - 1993-2003:

• Entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families.
• Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed.
• The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.
• The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996.
• At the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets under management was way ahead of other mutual funds.

Fourth Phase – Growth and SEBI Regulation - 1996-2004:

• The mutual fund industry witnessed robust growth and stricter regulation from the SEBI after the year 1996.
• The mobilization of funds and the number of players operating in the industry reached new heights as investors started showing more interest in mutual funds
• Investors’' interests were safeguarded by SEBI and the Government offered tax benefits to the investors in order to encourage them.
• SEBI (Mutual Funds) Regulations, 1996 was introduced by SEBI that set uniform standards for all mutual funds in India.
• The Union Budget in 1999 exempted all dividend incomes in the hands of investors from income tax.
• Various Investor Awareness Programmes were launched during this phase, both by SEBI and AMFI, with an objective to educate investors and make them informed about the mutual fund industry
• In February 2003, the UTI Act was repealed and UTI was stripped of its Special legal status as a trust formed by an Act of Parliament.

. The primary objective behind this was to bring all mutual fund players on the same level.
UTI was re-organized into two parts: 1. The Specified Undertaking, 2. The UTI Mutual Fund
• At the end of September, 2004, there were 29 funds, which manage assets of Rs.153108 crores under 421 schemes.

Phase V - Growth and Consolidation - 2004 Onwards

The industry also witnessed several mergers and acquisitions recently, examples of which are acquisition of schemes of Alliance Mutual Fund by Birla Sun Life, Sun F&C Mutual Fund and PNB Mutual Fund by Principal Mutual Fund. Simultaneously, more international mutual fund players have entered India like Fidelity, Franklin Templeton Mutual Fund etc. There were 29 funds as at the end of March 2006. This is a continuing phase of growth of the industry through consolidation and entry of new international and private sector players.

As at the end of March 2008, there were 33 mutual funds, which managed assets of Rs. 5,05,152 crores (US $ 126 Billion)* under 956 schemes.




























Overview of existing schemes existed in mutual fund category
Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial position, risk tolerance and return expectations etc. The table below gives an overview into the existing types of schemes in the Industry.


MUTUAL FUND – A GLOBALLY PROVEN INVESTMENT AVENUE
Worldwide, Mutual Fund or Unit Trust as it is referred to in some parts of the world, has a long and successful history. The popularity of Mutual Funds has increased manifold in developed financial markets, like the United States. As at the end of March 2008, in the US alone there were 8,064 mutual funds with total assets of about US$ 11.734 trillion (Rs.470 lakh crores)*. In India, the mutual fund industry started with the setting up of the erstwhile Unit Trust of India in 1963. Public sector banks and financial institutions were allowed to establish mutual funds in 1987. Since 1993, private sector and foreign institutions were permitted to set up mutual funds.
In February 2003, following the repeal of the Unit Trust of India Act 1963 the erstwhile UTI was bifurcated into two separate entities viz. The Specified Undertaking of the Unit Trust of India, representing broadly, the assets of US 64 scheme, schemes with assured returns and certain other schemes and UTI Mutual Fund conforming to SEBI Mutual Fund Regulations.
As at the end of March 2008, there were 33 mutual funds, which managed assets of Rs. US $ 126 Billion (5,05,152 crores)* under 956 schemes. This fast growing industry is regulated by the Securities and Exchange Board of India (SEBI).
Net Asset Value (NAV):
Net Asset Value or NAV of a Mutual Fund is the value of one unit of investment in the fund, in NET ASSETS terms.
(MV of Investments+ Current Assets + Accrued
NAV= Income – Current Liabilities – Accrued Expenses)
Total Number of units outstanding



Sale Price:
It is the price paid by an investor when investing in a scheme of a Mutual Fund. This price may include the sales or entry load.
Load: The charge collected by a Mutual Fund from an investor for selling the units or investing in it.
When a charge is collected at the time of entering into the scheme it is called an Entry load or Front-end load or Sales load.
An Exit load or Back-end load or Repurchase load is a charge that is collected at the time of redeeming or for transfer between schemes (switch). The exit load percentage is deducted from the NAV at the time of redemption or transfer between schemes.
Repurchase Price:
It is the price at which an investor sells back the units to the Mutual Fund. This price is NAV related and may include the exit load.
Switching Facility:
Switching facility provides investors with an option to transfer the funds amongst different types of schemes or plans.
Switching is also allowed into/from other select open-ended schemes currently within the Fund family or schemes that may be launched in the future at NAV based prices.






Type of Mutual Fund Schemes
BY STRUCTURE
Open Ended Schemes
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.
Close Ended Schemes
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 Schemes
Interval Schemes are that scheme, which combines the features of open-ended and close-ended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.





BY NATURE
Under this the mutual fund is categorized on the basis of Investment Objective. By nature the mutual fund is categorized as follow:
1. Equity fund:
These funds invest a maximum part of their corpus into equities holdings. The structure of the fund may vary different for different schemes and the fund manager’s outlook on different stocks. 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)
Equity investments are meant for a longer time horizon, thus Equity funds rank high on the risk return matrix.
2. Debt funds:
The objective of these Funds is to invest 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:
• Gilt Funds: Invest their corpus in securities issued by Government, popularly known as Government of India 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.
• MIP: Invests maximum of their total corpus in debt instruments while they take minimum exposure in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the risk-return matrix when compared with other debt schemes.
• Short Term Plans (STPs): Meant for investment horizon for three to six 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 provides easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, inter-bank 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.

3. Balanced funds: As the name suggest they, 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.


Further the mutual funds can be broadly classified on the basis of investment parameter,
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.
BY INVESTMENT OBJECTIVE
• Growth Schemes: Growth Schemes are also known as equity schemes. The aim of these schemes is to provide capital appreciation over medium to long term. These schemes normally invest a major part of their fund in equities and are willing to bear short-term decline in value for possible future appreciation.
• Income Schemes: Income Schemes are also known as debt schemes. The aim of these schemes is to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited.
• Balanced Schemes: Balanced Schemes aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. These schemes invest in both shares and fixed income securities, in the proportion indicated in their offer documents (normally 50:50).
• Money Market Schemes: Money Market Schemes aim 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.





OTHER SCHEMES
• Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time to time. Under Sec.88 of the Income Tax Act, contributions made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate.
• Index Schemes: Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks that constitute the index. The percentage of each stock to the total holding will be identical to the stocks index weightage. And hence, the returns from such schemes would be more or less equivalent to those of the Index.
• Sector Specific Schemes: These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time.
SPECIAL SCHEMES

This category includes index schemes that attempt to replicate the performance of a particular index such as the BSE Sensex, the NSE 50 (NIFTY) or sector specific schemes which invest in specific sectors such as Technology, Infrastructure, Banking, Pharma etc.

Besides, there are also schemes which invest exclusively in certain segments of the capital market, such as Large Caps, Mid Caps, Small Caps, Micro Caps, 'A' group shares, shares issued through Initial Public Offerings (IPOs), etc.
Fixed Maturity Plans
Fixed Maturity Plans (FMPs) are investment schemes floated by mutual funds and are close ended with a fixed tenure, the maturity period ranging from one month to three/five years. These plans are predominantly debt-oriented, while some of them may have a small equity component.

The objective of such a scheme is to generate steady returns over a fixed-maturity period and protect the investor against market fluctuations. FMPs are typically passively managed fixed income schemes with the fund manager locking into investments with maturities corresponding with the maturity of the plan. FMPs are not guaranteed products.

Exchange Traded Funds (ETFs)

Exchange Traded Funds are essentially index funds that are listed and traded on exchanges like stocks. Globally, ETFs have opened a whole new panorama of investment opportunities to retail as well as institutional investors. ETFs enable investors to gain broad exposure to entire stock markets as well as in specific sectors with relative ease, on a real-time basis and at a lower cost than many other forms of investing.

An ETF is a basket of stocks that reflects the composition of an index, like S&P CNX Nifty, BSE Sensex, CNX Bank Index, CNX PSU Bank Index, etc. The ETF's trading value is based on the net asset value of the underlying stocks that it represents. It can be compared to a stock that can be bought or sold on real time basis during the market hours. The first ETF in India, Benchmark Nifty Bees, opened for subscription on December 12, 2001 and listed on the NSE on January 8, 2002.

Capital Protection Oriented Schemes

Capital Protection Oriented Schemes are schemes that endeavor to protect the capital as the primary objective by investing in high quality fixed income securities and generate capital appreciation by investing in equity / equity related instruments as a secondary objective. The first Capital Protection
Oriented Fund in India, Franklin Templeton Capital Protection Oriented Fund opened for subscription on October 31, 2006.

Gold Exchange Trade Funds (GETFs)

Gold Exchange Traded Funds offer investors an innovative, cost-efficient and secure way to access the gold market. Gold ETFs are intended to offer investors a means of participating in the gold bullion market by buying and selling units on the Stock Exchanges, without taking physical delivery of gold. The first Gold ETF in India, Benchmark GETF, opened for subscription on February 15, 2007 and listed on the NSE on April 17, 2007.

Quantitative Funds

A quantitative fund is an investment fund that selects securities based on quantitative analysis. The managers of such funds build computer based models to determine whether or not an investment is attractive. In a pure "quant shop" the final decision to buy or sell is made by the model. However, there is a middle ground where the fund manager will use human judgment in addition to a quantitative model. The first Quant based Mutual Fund Scheme in India, Lotus Agile Fund opened for subscription on October 25, 2007.

Funds Investing Abroad

With the opening up of the Indian economy, Mutual Funds have been permitted to invest in foreign securities/ American Depository Receipts (ADRs) / Global Depository Receipts (GDRs). Some of such schemes are dedicated funds for investment abroad while others invest partly in foreign securities and partly in domestic securities. While most such schemes invest in securities across the world there are also schemes which are country specific in their investment approach.

Fund of Funds (FOFs)

Fund of Funds are schemes that invest in other mutual fund schemes. The portfolio of these schemes comprise only of units of other mutual fund schemes and cash / money market securities/ short term deposits pending

deployment. The first FOF was launched by Franklin Templeton Mutual Fund on October 17, 2003.

Fund of Funds can be Sector specific e.g. Real Estate FOFs, Theme specific e.g. Equity FOFs, Objective specific e.g. Life Stages FOFs or Style specific e.g. Aggressive/ Cautious FOFs etc.

Please bear in mind that any one scheme may not meet all your requirements for all time. You need to place your money judiciously in different schemes to be able to get the combination of growth, income and stability that is right for you.

Remember, as always, higher the return you seek higher the risk you should be prepared to take.

Some Important terms
Modified Duration :Measure of the price volatility and interest rate sensitivity of a fixed-income financial instrument such as an interest bearing bond. Actually the Macaulay duration adjusted for compounding, it indicates the percentage change in the value of the instrument for each one percentage point change in prevailing interest rates.
YTM :The Yield to maturity (YTM) or redemption yield is the yield promised to the bondholder on the assumption that the bond or other fixed-interest security such as gilts will be held to maturity, that all coupon and principal payments will be made and coupon payments are reinvested at the bond's promised yield at the same rate as the original principal invested. It is a measure of the return of the bond. This technique in theory allows investors to calculate the fair value of different financial instruments. The YTM is almost always given in terms of Annual Percentage Rate (A.P.R.).
The calculation of YTM is identical to the calculation of internal rate of return.
Asset-backed security: An asset-backed security is a security whose value and income payments are derived from and collateralized (or "backed") by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually. Pooling the assets into financial instruments allows them to be sold to general investors, a process called securitization, and allows the risk of investing in the underlying assets to be diversified because each security will represent a fraction of the total value of the diverse pool of underlying assets. The pools of underlying assets can include common payments from credit cards, auto loans, and mortgage loans, to esoteric cash flows from aircraft leases, royalty payments and movie revenues.
Default Risk: The possibility that a bond issuer will default, by failing to repay principal and interest in a timely manner. Bonds issued by the federal government, for the most part, are immune from default (if the government needs money it can just print more). Bonds issued by corporations are more likely to be defaulted on, since companies often go bankrupt. It is also called credit risk.
Convertible Debt: Security which can be exchanged for a specified amount of another, related security, at the option of the issue rand/or the holder. It is also called convertible.
Government Securities: Bonds, notes, and other debt instruments sold by a government to finance its borrowings. These are generally long-term securities with the highest market ratings.

Commercial Paper: An unsecured obligation issued by a corporation or bank to finance its short-term credit needs, such as accounts receivable and inventory. Maturities typically range from 2 to 270 days. Commercial paper is available in a wide range of denominations, can be either discounted or interest-bearing, and usually have a limited or nonexistent secondary market. Commercial paper is usually issued by companies with high credit ratings, meaning that the investment is almost always relatively low risk.
Treasury Bill (T-bill): Short-term (usually less than one year, typically three months) maturity promissory note issued by a national (federal) government as a primary instrument for regulating money supply and raising funds via open market operations. Issued through the country's central bank, T-bills commonly pay no explicit interest but are sold at a discount, their yield being the difference between the purchase price and the par-value (also called redemption value). This yield is closely watched by financial markets and affects the yield on municipal and corporate bonds and bank interest rates. Although their yield is lower than on other securities with similar maturities, T-bills are very popular with institutional investors because, being backed by the government's full faith and credit, they come closest to a risk free investment. Issued first time in 1877 in the UK and in 1929 in the US.
Repo Rate: Discount rate at which a central bank repurchases government securities from the commercial banks, depending on the level of money supply it decides to maintain in the country's monetary system. To temporarily expand the money supply, the central bank decreases repo rates (so that banks can swap their holdings of government securities for cash), to contract the money supply it increases the repo rates. Alternatively, the central bank decides on a desired level of money supply and lets the market determine the appropriate repo rate.

CBO: Collateralized Bond Obligation. An investment-grade bond backed by a large, diversified pool of junk bonds. Usually broken down into tiers with varying degrees ofrisk and varying interest rates.
Risk Factor: Measurable characteristic or element, a change in which can affect the value of an asset, such as exchange rate, interest rate, and market price.


Types of returns:
There are three ways, where the total returns provided by mutual funds can be enjoyed by investors:
• Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly all income it receives over the year to fund owners in the form of a distribution.
• If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.
• If fund holdings increase in price but are not sold by the fund manager, the fund's shares increase in price. You can then sell your mutual fund shares for a profit. Funds will also usually give you a choice either to receive a check for distributions or to reinvest the earnings and get more shares.




Risk in Mutual Fund Strategies

• Identifying individual risk tolerance is one of the basic factors in determining an optimum investment strategy for a mutual fund portfolio. Regardless of the return objectives and time horizon within a portfolio, risk tolerance affects both asset allocation and especially the selection of fund categories (i.e., large value, small growth, international, short-term bond, intermediate-term bond, etc.).
• As the level of risk increases, both volatility and total return potential proportionately increase; conversely, as the level of risk decreases, both volatility and total return potential proportionately decrease. This standard risk/reward rule is often illustrated
with risk and reward both escalating over a broad spectrum beginning with cash reserves, changing to bonds and then ending with stocks:





Risks involved while investing in Mutual Funds.

• Call Risk: The possibility that falling interest rates will cause a bond issuer to redeem-or call its high-yielding bond before the bond's maturity date.
• Country Risk: The possibility that political events (a war, national elections), financial problems (rising inflation, government default), or natural disasters (an earthquake, a poor harvest) will weaken a country's economy and cause investments in that country to decline.
• Credit Risk: The possibility that a bond issuer will fail to repay interest and principal in a timely manner. Also called default risk.


• Currency Risk: The possibility that returns could be reduced for Americans investing in foreign securities because of a rise in the value of the U.S. dollar against foreign currencies. Also called exchange-rate risk.
• Income Risk: The possibility that a fixed-income fund's dividends will decline as a result of falling overall interest rates.
• Industry Risk: The possibility that a group of stocks in a single industry will decline in price due to developments in that industry.
• Inflation Risk: The possibility that increases in the cost of living will reduce or eliminate a fund's real inflation-adjusted returns.
• Interest Rate Risk: The possibility that a bond fund will decline in value because of an increase in interest rates.
• Manager Risk: The possibility that an actively managed mutual fund's investment adviser will fail to execute the fund's investment strategy effectively resulting in the failure of stated objectives.
• Market Risk: The possibility that stock fund or bond fund prices overall will decline over short or even extended periods. Stock and bond markets tend to move in cycles, with periods when prices rise and other periods when prices fall.
• Principal Risk: The possibility that an investment will go down in value, or "lose money," from the original or invested amount.


The Risk- Return Trade Off

The risk-return tradeoff is the balance an investor must decide on between the desire for the lowest possible risk for the highest possible returns. It’s a fact that low levels of uncertainty (low risk) are associated with low potential returns and high levels of uncertainty (high risk) are associated with high potential returns. The following chart shows an example of the risk/return tradeoff for investing. A higher standard deviation means a higher risk:











Risk Return Grid


We can figure out from the above diagram that, Liquid funds are the least risky and hence the expected returns are also the least. Whereas the equity sector funds are the most risky and hence the returns offered are also the maximum.


Relation between Diversification and Risk

Proper levels of diversification can be used to minimize risk while still allowing appreciating securities to dominate a portfolio. Diversification can eliminate non-market risk from a portfolio, that is, risk associated with owning a particular company. Diversification is not the same as the number of investments held in a portfolio. Diversification is minimizing the correlation between each investment held in a portfolio. This is usually accomplished in a stock portfolio by holding stocks of differing industries.



What is proper diversification, as opposed to over or under diversification?

The graph below shows the maximum reduction in portfolio risk for each security added to a portfolio. As can be seen, the level of risk is reduced from 50% to 20.3% with as little as ten properly diversified securities. Adding another 1000 securities to the portfolio would reduce the risk to 20.1%. The first ten securities in a portfolio diversify away over 97% of the non-market risk. Diversification, or elimination of the non-market risk, can lower the risk of a common stock portfolio to 20%, which is the level of market risk that every portfolio holds. Market risk, the risk associated with the stock market in general, can never be eliminated or reduced.



Under-Diversification Produces Large Amounts of Unnecessary Non-Market Risk

Holding five or fewer securities allows for a high level of non-market risk in a portfolio and is generally not recommended. An example of an exception to this rule is company founders and officers that hold vast amounts of a single security. They can afford the high levels of non-market risk because of their wealth.
Most industry specific mutual funds are quite under-diversified in spite of the high numbers of securities owned by each mutual fund. Each security in an industry specific mutual fund is quite susceptible to common industry factors which create a high level of non-market risk, even if the fund has close to 1000 companies represented. Therefore it makes little sense for the investor to pay the high management fees of an industry specific fund, because in order to be properly diversified the investor must pick nine other industry funds from other industries.

True Diversification
To achieve true diversification that you need to buy funds that are different from each other whether by company size, industry, sector, country, etc. This means you are buying funds that are uncorrelated – funds that move in different directions during different times. A person's overall portfolio should also diversify among different asset classes, meaning allocating a certain percentage to bonds, commodities, real estate, alternative assets and so on.
Owning a mutual fund that invests in 100 companies doesn't necessarily mean that you are at optimum diversification. Many mutual funds are sector specific, so owning a telecom or health care mutual fund means you are diversified within that industry, but because of the high correlation between movements in stocks prices within an industry, you are not diversified to the extent you could be by investing across various industries and sectors. Balanced funds offer better risk protection than a sector-specific mutual fund because they own 100 or more stocks across the entire market.
Many mutual fund holders also suffer from being over-diversified. Some funds, especially the larger ones, have so many assets (i.e. cash to invest) that they have to hold literally hundreds of stocks. In some cases this makes it nearly impossible for the fund to outperform indexes.


Over diversification

Many mutual funds hold close to a thousand securities in their portfolio, which reduces nonmarket risk a small fraction more than a portfolio of 10 securities. But the question must be raised as to whether the costs of holding a thousand securities are worth the small reduction in risk. The personnel, equipment, and administrative costs associated with analyzing, following band holding large numbers of securities are passed on to the mutual fund investor and for what? Basically, for attaining the same returns as the market in general minus the extra expenses mentioned.

Drawbacks of Over Diversification:

• Unforeseen taxes and turnover costs.
• Mediocre performance due to broad-based exposure.
• Lack of adequate supervision over each asset class.

How can over diversification hurt returns?

Unfortunately, many investors overdo diversification because there is a tendency to believe that if more is good, even more is better. Taken to an extreme, diversification can diminish returns simply because, if you have too many investments, the positive contribution of one won't be big enough to make a difference. For example, if a fund or security only makes up 1 percent or 2 percent of your portfolio, even a significant gain in that investment won't have a material difference in the overall portfolio.

How much is enough?

• Generally 10 to 15 funds
• Or funds in four to five asset classes (essentially top fund in each asset class). Small cap, Mid cap and Large cap domestic stocks, and some international exposure.










Pros & cons of investing in mutual funds:
For investments in mutual fund, one must keep in mind about the Pros and cons of investments in mutual fund.
Advantages of Investing Mutual Funds:
• Professional Management - The basic advantage of funds is that, they are professional managed, by well qualified professional. Investors purchase funds because they do not have the time or the expertise to manage their own portfolio. A mutual fund is considered to be relatively less expensive way to make and monitor their investments.
• Diversification - Purchasing units in a mutual fund instead of buying individual stocks or bonds, the investors risk is spread out and minimized up to certain extent. The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains in others.
• Economies of Scale - Mutual fund buy and sell large amounts of securities at a time, thus help to reducing transaction costs, and help to bring down the average cost of the unit for their investors.
• Liquidity - Just like an individual stock, mutual fund also allows investors to liquidate their holdings as and when they want.
• Simplicity - Investments in mutual fund is considered to be easy, compare to other available instruments in the market, and the minimum investment is small. Most AMC also have automatic purchase plans whereby as little as Rs. 2000, where SIP start with just Rs.50 per month basis.





Disadvantages of Investing Mutual Funds:
• No Guarantees- No investment is risk free. If the entire stock market declines in value, the value of mutual fund shares will go down as well, no matter how balanced the portfolio. Investors encounter fewer risks when they invest in mutual funds than when they buy and sell stocks on their own. However, anyone who invests through a mutual fund runs the risk of losing money.
• Costs – The biggest source of AMC income is generally from the entry & exit load which they charge from investors, at the time of purchase. The mutual fund industries are thus charging extra cost under layers of jargon. However it is subjected to change with effect from 1’st August 2009 as per the new SEBI Guidelines.
• Taxes-During a typical year, most actively managed mutual funds sell anywhere from 20 to 70 percent of the securities in their portfolios. If your fund makes a profit on its sales, you will pay taxes on the income you receive, even if you reinvest the money you made.
• Management risk-When one invests in a mutual fund, they depend on the fund's manager to make the right decisions regarding the fund's portfolio. If the manager does not perform as well as they had hoped, one might not make as much money on their investment as they have expected. Of course, if he invests in Index Funds, he’ll forego management risk, because these funds do not employ managers.
• Dilution - Because funds have small holdings across different companies, high returns from a few investments often don't make much difference on the overall return. Dilution is also the result of a successful fund getting too big. When money pours into funds that have had strong success, the manager often has trouble finding a good investment for all the new money.





Guidelines of the SEBI for Mutual Fund Companies:
1. Market regulator, the Securities and Exchange Board of India (SEBI), has decided to scrap entry load on all mutual fund schemes from August 1 onwards. The entry load is the amount paid by AMCs - from total paid amount in the scheme - as marketing and distribution expenses. The Indian market watchdog, through its June 30 circular, has also directed AMCs to pay upfront commission directly to the distributors. According to new norms, SEBI said AMCs are required to have a maximum of 1% of the exit load in a different account. The AMCs are free to pay commissions to the distributor from the prescribed amount. The SEBI has also asked all distributors to disclose all the commission payable to them by fund houses.
2. To protect the interest of the investors, SEBI formulates policies and regulates the mutual funds. It notified regulations in 1993 (fully revised in 1996) and issues guidelines from time to time.
3. SEBI approved Asset Management Company (AMC) manages the funds by making investments in various types of securities. Custodian, registered with SEBI, holds the securities of various schemes of the fund in its custody.
4. According to SEBI Regulations, two thirds of the directors of Trustee Company or board of trustees must be independent.
5. The Association of Mutual Funds in India (AMFI) reassures the investors in units of mutual funds that the mutual funds function within the strict regulatory framework. Its objective is to increase public awareness of the mutual fund industry. AMFI also is engaged in upgrading professional standards and in promoting best industry practices in diverse areas such as valuation, disclosure, transparency etc.



Documents required (PAN mandatory):
1. Proof of identity :
a. Photo PAN card
b. In case of non-photo PAN card in addition to copy of PAN card any one of the following: driving license/passport copy/ voter id/ bank photo pass book. Proof of address (any of the following) :latest telephone bill, latest electricity bill, Passport, latest bank passbook/bank account statement, latest Demat account statement, voter id, driving license, ration card, rent agreement.
2. Offer document: An offer document is issued when the AMCs make New Fund Offer (NFO). It’s advisable to every investor to ask for the offer document and read it before investing. An offer document consists of the following:
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.





Key Information Memorandum: a key information memorandum, popularly known as KIM, is attached along with the mutual fund form. And thus every investor gets to read it. Its contents are:
1. Name of the fund
2. Investment objective
3. Asset allocation pattern of the scheme
4. Risk profile of the scheme
5. Plans & options
6. Minimum application amount/ no. of units
7. Benchmark index
8. Dividend policy
9. Name of the fund manager(s)
10. Expenses of the scheme: load structure, recurring expenses
11. Performance of the scheme (scheme return v/s. benchmark return)
12. Year- wise return for the last 5 financial years

Distribution channels:
Mutual funds posses a very strong distribution channel so that the ultimate customers doesn’t face any difficulty in the final procurement. The various parties involved in distribution of mutual funds are:
1. Direct marketing by the AMCs: the forms could be obtained from the AMCs directly. The investors can approach to the AMCs for the forms. some of the top AMCs of India are; Reliance ,Birla Sunlife, Tata, SBI magnum, Kotak Mahindra, HDFC, Sundaram, ICICI, Mirae Assets, Canara Robeco, Lotus India, LIC, UTI etc. whereas foreign AMCs include: Standard Chartered, Franklin Templeton, Fidelity, JP Morgan, HSBC, DSP Merill Lynch, etc.
2 .Broker/ sub broker arrangements: the AMCs can simultaneously go for broker/sub-broker to popularize their funds. AMCs can enjoy the advantage of large network of these brokers and sub brokers.eg: SBI being the top financial intermediary of India has the greatest network. So the AMCs dealing through SBI has access to most of the investors.
3. Individual agents, Banks, NBFC: investors can procure the funds through individual agents, independent brokers, banks and several non- banking financial corporation’s too, whichever he finds convenient for him.
Costs associated:
1. Expenses: AMCs charge an annual fee, or expense ratio that covers administrative expenses, salaries, advertising expenses, brokerage fee, etc. A 1.5% expense ratio means the AMC charges Rs1.50 for every Rs100 in assets under management. A fund's expense ratio is typically to the size of the funds under management and not to the returns earned. Normally, the costs of running a fund grow slower than the growth in the fund size - so, the more assets in the fund, the lower should be its expense ratio
2. Loads:
a) Entry Load/Front-End Load (0-2.25%) - it’s the commission charged at the time of buying the fund to cover the cost of selling, processing etc.
b) Exit Load/Back- End Load (0.25-2.25%) - it is the commission or charged paid when an investor exits from a mutual fund, it is imposed to discourage withdrawals. It may reduce to zero with increase in holding period.









HOW TO INVEST IN MUTUALFUNDS
Step One- Identify your investment needs.

Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, level of income and expenses among many other factors. Therefore, the first step is to assess your needs. Begin by asking yourself these questions:

1. What are my investment objectives and needs?

Probable Answers: I need regular income or need to buy a home or finance a wedding or educate my children or a combination of all these needs.

2. How much risk am I willing to take?

Probable Answers: I can only take a minimum amount of risk or I am willing to accept the fact that my investment value may fluctuate or that there may be a short term loss in order to achieve a long term potential gain.

3. What are my cash flow requirements?

Probable Answers: I need a regular cash flow or I need a lump sum amount to meet a specific need after a certain period or I don’t require a current cash flow but I want to build my assets for the future.
By going through such an exercise, you will know what you want out of your investment and can set the foundation for a sound Mutual Fund Investment strategy.

Step Two: Choose the right Mutual Fund.
Once you have a clear strategy in mind, you now have to choose which Mutual Fund and scheme you want to invest in. 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 performance over the last few years in relation to the appropriate yardstick and similar funds in the same category.
• How well the Mutual Fund is organized to provide efficient, prompt and personalized service.
• Degree of transparency as reflected in frequency and quality of their communications.
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.
The following charts could prove useful in selecting a combination of schemes that satisfy your needs.


This plan may suit:
• Investors in their prime earning years and willing to take more risk.
• Investors seeking growth over a long term.


This plan may suit:
• Investors seeking income and moderate growth.
• Investors looking for growth and stability with moderate risk.


This plan may suit:
• Retired and other investors who need to
• Preserve capital and earn regular income.

Step Four: Invest regularly
For most of us, the approach that works best is to invest a fixed amount at specific intervals, say every month. By investing a fixed sum each month, you get fewer units when the price is high 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. With many open-ended schemes offering systematic investment plans, this regular investing habit is made easy for you.

Step Five: Keep your taxes in mind

As per the current tax laws, Dividend/Income Distribution made by mutual funds is exempt from Income Tax in the hands of investor. However, in case of debt schemes Dividend/ Income Distribution is subject to Dividend Distribution Tax. Further, there are other benefits available for investment in Mutual Funds under the provisions of the prevailing tax laws. You may therefore consult your tax advisor or Chartered Accountant for specific advice to achieve maximum tax efficiency by investing in mutual funds.

Step Six: 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 Seven: The final step

All you need to do now is to get in touch with a Mutual Fund or your advisor and start investing. 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.



YOUR RIGHTS AS A MUTUAL FUND UNITHOLDER

As a unit holder in a Mutual Fund scheme coming under the SEBI (Mutual Funds) Regulations, you are entitled to:

1. Receive unit certificates or statements of accounts confirming your title within 30 days from the date of closure of the subscription under open-ended schemes or within 6 weeks from the date your 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 30 days of their declaration and receive the redemption or repurchase proceeds within 10 working days from the date of redemption or repurchase.

4. Vote in accordance with the Regulations to:
a. change the Asset Management Company;
b. Wind up the schemes.

5. Receive communication from the Trustees about change in the fundamental attributes of any scheme or any other changes which would modify the scheme and affect the interest of the unit holders and to have option to exit at prevailing Net Asset Value without any exit load in such cases.

6. Inspect the documents of the Mutual Funds specified in the scheme’s offer document.

In addition to your rights, you can expect the following from Mutual Funds:

• To publish their NAV, in accordance with the regulations: daily, in case of open-ended schemes and once a week, in case of close ended schemes.


• To disclose your schemes’ entire portfolio twice a year, unaudited financial results half yearly and audited annual accounts once a year. In addition many mutual funds send out newsletters periodically.
• To adhere to a Code of Ethics which require that investment decisions are taken in the best

Measuring and evaluating mutual funds performance:
Every investor investing in the mutual funds is driven by the motto of either wealth creation or wealth increment or both. Therefore it’s very necessary to continuously evaluate the fund’s performance with the help of factsheets and newsletters, websites, newspapers and professional advisors like SBI mutual fund services. If the investors ignore the evaluation of funds performance then he can lose hold of it any time. In this ever-changing industry, he can face any of the following problems:
1. Variation in the funds’ performance due to change in its management/ objective.
2. The funds’ performance can slip in comparison to similar funds.
3. There may be an increase in the various costs associated with the fund.
4. Beta, a technical measure of the risk associated may also surge.
5. The funds’ ratings may go down in the various lists published by independent rating agencies.
6. It can merge into another fund or could be acquired by another fund house.





Funds Performance measures:
Equity funds: the performance of equity funds can be measured on the basis of: NAV Growth, Total Return; Total Return with Reinvestment at NAV, Annualized 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: likewise the performance of debt funds can be measured on the basis of: Peer Group Comparisons, The Income Ratio, Industry Exposures and Concentrations, NPAs, besides NAV Growth, Total Return and Expense Ratio.
Liquid funds: the performance of the highly volatile liquid funds can be measured on the basis of: Fund Yield, besides NAV Growth, Total Return and Expense Ratio.
Concept of benchmarking for performance evaluation:
Every fund sets its benchmark according to its investment objective. The fund’s performance is measured in comparison with the benchmark. If the fund generates a greater return than the benchmark then it is said that the fund has outperformed benchmark , if it is equal to benchmark then the correlation between them is exactly 1, and if in case the return is lower than the benchmark then the fund is said to be underperformed.
Some of the benchmarks are:
1. Equity funds: market indices such as S&P CNX nifty, BSE100, BSE200, BSE-PSU, BSE 500 index, BSE banker, and other sectorial indices.
2. Debt funds: Interest Rates on Alternative Investments as Benchmarks, I-Bex Total Return Index, JPM T-Bill Index Post-Tax Returns on Bank Deposits versus Debt Funds.
3. Liquid funds: Short Term Government Instruments’ Interest Rates as Benchmarks, JPM T-Bill Index


To measure the fund’s performance, the comparisons are usually done with:
i) With a market index.
ii) Funds from the same peer group.
iii) Other similar products in which investors invest their funds.
Financial planning for investors:
Investors are required to go for financial planning before making investments in any mutual fund. The objective of financial planning is to ensure that the right amount of money is available at the right time to the investor to be able to meet his financial goals. It is more than mere tax planning. Steps in financial planning are:
 Asset allocation.
 Selection of fund.
 Studying the features of a scheme.
In case of mutual funds, financial planning is concerned only with broad asset allocation, leaving the actual allocation of securities and their management to fund managers. A fund manager has to closely follow the objectives stated in the offer document, because financial plans of users are chosen using these objectives.
Why has it become one of the largest financial instruments?
If we take a look at the recent scenario in the Indian financial market then we can find the market flooded with a variety of investment options which includes mutual funds, equities, fixed income bonds, corporate debentures, company fixed deposits, bank deposits, PPF, life insurance, gold, real estate etc. all these investment options could be judged on the basis of various parameters such as- return, safety convenience, volatility and liquidity.


Measuring these investment options on the basis of the mentioned parameters, we get this in a tabular form

We can very well see that mutual funds outperform every other investment option. On three parameters it scores high whereas it’s moderate at one. comparing it with the other options, we find that equities gives us high returns with high liquidity but its volatility too is high with low safety which doesn’t makes it favorite among persons who have low risk- appetite. Even the convenience involved with investing in equities is just moderate.
Now looking at bank deposits, it scores better than equities at all fronts but lags badly in the parameter of utmost important i.e.; it scores low on return , so it’s not an happening option for person who can afford to take risks for higher return. The other option offering high return is real estate but that even comes with high volatility and moderate safety level, even the liquidity and convenience involved are too low. Gold have always been a favorite among Indians but when we look at it as an investment option then it definitely doesn’t gives a very bright picture. Although it ensures high safety but the returns generated and liquidity are moderate. Similarly the other investment options are not at par with mutual funds and serve the needs of only a specific customer group. Straightforward, we can say that mutual fund emerges as a clear winner among all the options available. The reasons for this being:
I) Mutual funds combine the advantage of each of the investment products: mutual fund is one such option which can invest in all other investment options. Its principle of diversification allows the investors to taste all the fruits in one plate. Just by investing in it, the investor can enjoy the best investment option as per the investment objective.
II) Dispense the shortcomings of the other options: every other investment option has more or less some shortcomings. Such as if some are good at return then they are not safe, if some are safe then either they have low liquidity or low safety or both….likewise, there exists no single option which can fit to the need of everybody. But mutual funds have definitely sorted out this problem. Now everybody can choose their fund according to their investment objectives.
III) Returns get adjusted for the market movements: as the mutual funds are managed by experts so they are ready to switch to the profitable option along with the market movement. Suppose they predict that market is going to fall then they can sell some of their shares and book profit and can reinvest the amount again in money market instruments.
IV) Flexibility of invested amount: Other then the above mentioned reasons, there exists one more reason which has established mutual funds as one of the largest financial intermediary and that is the

flexibility that mutual funds offer regarding the investment amount. One can start investing in mutual funds with amount as low as Rs. 500 through SIPs and even Rs. 100 in some cases.
How do investors choose between funds?
When the market is flooded with mutual funds, it’s a very tough job for the investors to choose the best fund for them. Whenever an investor thinks of investing in mutual funds, he must look at the investment objective of the fund. Then the investors sort out the funds whose investment objective matches with that of the investor’s. Now the tough task for investors start, they may carry on the further process themselves or can go for advisors like SBI. Of course the investors can save their money by going the direct route i.e. through the AMCs directly but it will only save 1-2.25% (entry load) but could cost the investors in terms of returns if the investor is not an expert. So it is always advisable to go for MF advisors. The MF advisors thoughts go beyond just investment objectives and rate of return. Some of the basic tools which an investor may ignore but an mf advisor will always look for are as follow:
1. Rupee cost averaging:
The investors going for Systematic Investment Plans (SIP) and Systematic Transfer Plans (STP) may enjoy the benefits of RCA (Rupee Cost Averaging). Rupee cost averaging allows an investor to bring down the average cost of buying a scheme by making a fixed investment periodically, like Rs 5,000 a month and nowadays even as low as Rs. 500 or Rs. 100. In this case, the investor is always at a profit, even if the market falls. In case if the NAV of fund falls, the investors can get more number of units and vice-versa. This results in the average cost per unit for the investor being lower than the average price per unit over time. The investor needs to decide on the investment amount and the frequency. More frequent the investment interval, greater the chances of benefiting from lower prices.
Investors can also benefit by increasing the SIP amount during market downturns, which will result in reducing the average cost and enhancing returns. Whereas STP allows investors who have lump sums to park the funds in a low-risk fund like liquid funds and make periodic transfers to another fund to take advantage of rupee cost averaging.
2. Rebalancing:
Rebalancing involves booking profit in the fund class that has gone up and investing in the asset class that is down. Trigger and switching are tools that can be used to rebalance a portfolio. Trigger facilities allow automatic redemption or switch if a specified event occurs. The trigger could be the value of the investment, the net asset value of the scheme, level of capital appreciation, level of the market indices or even a date. The funds redeemed can be switched to other specified schemes within the same fund house. Some fund houses allow such switches without charging an entry load. To use the trigger and switch facility, the investor needs to specify the event, the amount or the number of units to be redeemed and the scheme into which the switch has to be made. This ensures that the investor books some profits and maintains the asset allocation in the portfolio.
3. Diversification:
Diversification involves investing the amount into different options. In case of mutual funds, the investor may enjoy it afterwards also through dividend transfer option. Under this, the dividend is reinvested not into the same scheme but into another scheme of the investor's choice.
For example, the dividends from debt funds may be transferred to equity schemes. This gives the investor a small exposure to a new asset class without risk to the principal amount. Such transfers may be done with or without entry loads, depending on the MF's policy.
4. Tax efficiency:
Tax factor acts as the “x-factor” for mutual funds. Tax efficiency affects the final decision of any investor before investing. The investors gain through either dividends or capital appreciation but if they haven’t considered the tax factor then they may end loosing. Debt funds have to pay a dividend distribution tax of 12.50 per cent (plus surcharge and education cess) on dividends paid out. Investors who need a regular stream of income have to choose between the dividend option and a systematic withdrawal plan that allows them to redeem units periodically. SWP implies capital gains for the investor. If it is short-term, then the SWP is suitable only for investors in the 10-per-cent-tax bracket. Investors in higher tax brackets will end up paying a higher rate as short-term capital gains and should choose the dividend option.
If the capital gain is long-term (where the investment has been held for more than one year), the growth option is more tax efficient for all investors. This is because investors can redeem units using the SWP where they will have to pay 10 per cent as long-term capital gains tax against the 12.50 per cent DDT paid by the MF on dividends. All the tools discussed over here are used by all the advisors and have helped investors in reducing risk, simplicity and affordability. Even then an investor needs to examine costs, tax implications and minimum applicable investment amounts before committing to a service.
Does fund ranking persist?
Thus ratings are totally irrelevant for investors. Here is why they are totally irrelevant to investor:
1. Mutual fund ratings are based on the returns generated, that is, appreciation of net asset value, based on the historical performance. So they rely more on the past, rather than the current scenario.
2. As returns play a key role in deciding the ratings, any change in returns will lead to rerating of the mutual fund. If you choose your mutual fund only on the basis of rating, it will be a nuisance to keep realigning your investment in line with the revision of the ratings.
3. The ratings don’t value the investment processes followed by the mutual fund. As a result, a fund following a certain process may lose out to a fund that has given superior returns only because it has a star fund manager. But there is a higher risk associated with a star fund manager that the ratings don’t reflect. If the star fund manager quits, it can throw the working of a mutual fund out of gear and thus affect its performance.
4. The ratings don’t show the level of ethics followed by the fund. A fund or fund manager that is involved in a scam or financial irregularities won’t get poor ratings on the basis of ethics. As the star ratings look at just returns, any wrongdoing carried out by the fund or fund manager will be completely ignored.
5. Ratings also don’t consider two very important factors: transparency and keeping investors informed. There are no negative ratings awarded to the fund for being investor-unfriendly.
6. Ratings don’t match the investor’s risk-appetite with their portfolio. As a matter of fact, investments should be done only after considering the risk appetite of the investor. For example, equities may not be the best investment vehicle for a very conservative investor. However ratings fail to take that into account.
Ratings should be the starting point for making an investment decision. They are not the be all and end all of mutual fund investments. There are other important factors like portfolio management, age of funds and more, which should be taken into account before making an investment.