Concept of mutual fund

CONCEPT OF MUTUAL FUNDS
By:-
Dr. Ashish Kumar Suri
(Ph.D, MBA, B.E.)

• A Mutual Fund is a collective investment plan that pools the
savings of a number of investors who share a common
financial goal.
• Every mutual fund scheme has a defined investment objective
and strategy according to which the fund manager construct
the portfolio.
• Every mutual fund scheme is managed by a fund manager
who invests the collected money on behalf of investors by
using his investment skills in different types of securities such
as shares, bonds, money market instruments and other
securities as per the scheme’s stated objectives.
• The income earned through these investments and the capital
appreciation realized is distributed among the unit holders in
proportion to the number of units owned by them after
deducting applicable expenses, load and taxes.

Operation of a Mutual Fund Scheme

• Any investor with a surplus fund of as little as a few hundred
rupees can invest in Mutual Funds.
• Investors can buy units of a particular Mutual Fund scheme at
the prevailing market price known as Net Asset Value (NAV).
• In comparison to investing directly in bonds and stocks,
mutual funds have an advantage in terms of diversity and
liquidity at lower cost.

• Professional Investment Management
• Diversification of Investment
• Low Transaction Cost
• Convenience and Flexibility
• Convenient Administration
• Liquidity
• Transparency
• Choice of Various Schemes to Invest
• Well Regulated Industry

Why Should We Invest in Mutual Funds?

• To invest directly in securities an investor must have
Knowledge, Time and Money.
• Knowledge is the most important parameter required to invest
in securities directly. Investment without knowledge may result
in losses.
• To identify the securities and to track their performance an
investor must devote time without which identification of
potential securities for investment will not be possible.
• To invest in securities an investor must have sufficient amount
of money. Some of the securities like there in money market
has a minimum investment amount which may be out of the
reach of most of the retail investors.
• In lack of any of these three criteria an investor may not be
able to invest directly in securities.
• Mutual funds are the best options for such investors to park
their money in securities.

• Mutual Funds qualify in all the three criteria. Every mutual fund
scheme is managed by a fund manager who is a qualified
professional and has knowledge of investment.
• The fund manager along with the research team devote their
time to identify potential securities to invest money.
• As mutual fund pools money from large number of investors
so it is possible for the fund manager to invest in securities as
per the objective of the scheme.

The selection of scheme for investment must be based on the
following process:
1. Identify the investment needs:
• An investor must identify the investment objectives and need.
• Level of risk which the investor is willing to take
• Cash flow requirements based on investment objective.
2. Choose the right mutual fund:
• Choose the category of mutual fund based on investment objective and risk
profile.
• Based on past performance select the best performing schemes in the category
and compare their performance with the benchmark index.
• Look for the reputation of the fund house and the performance and experience of
the fund manager.
3. Select the idle mix of schemes:
• Investment in one scheme may not fulfill the investment objectives. Select a
combination of schemes for investment.
• Decide the proportion of investment in each scheme.

Determining the Net Asset Value (NAV)

• Net Asset Value is the market value of the assets of the
scheme minus its liabilities. Net assets represent the unit-
holders’ funds in the scheme.
• If all the scheme’s assets are realized, and the scheme’s dues
other than to unit-holders are paid out, what remains is the net
assets of the scheme. This amount divided by the number of
units is the Net Asset Value (NAV) per unit of the scheme.
• The total asset value of a fund includes its stocks, cash and
bonds at market value. Dividends and interest accrued and
liquid assets are also included in total assets.
• Liabilities like money owed to creditors and other expenses
accrued are included in the liabilities.
Net Asset Value (NAV) = (Assets – Liabilities)
Number of Outstanding Units

• NAV can also be treated as the purchase or the redemption
price of the scheme for the investor.
• As per the guidelines of SEBI the asset management
company shall disclose the basis of calculating the repurchase
price and NAV of the various schemes of the fund in the
scheme particulars and disclose the same to the investors at
such intervals as may be specified by the trustees and Board.
• At the end of each trading day asset management companies
update the NAV of various schemes on daily basis. It is
mandatory for all AMC’s to update the latest NAV on their
website.

Classification of Mutual Fund Schemes

Based on Structure
• Based on structure mutual fund schemes can be
categorize as follows:
• Open Ended Schemes
• Close Ended Schemes

• An open-end(ed) fund is a collective investment plan in which
an investor can buy or redeem shares at any time from the
fund house.
• These schemes do not have a fixed maturity period. An
investor can purchase shares in such funds directly from the
mutual fund company, or through any other distribution
channel.
• An open-ended fund is equitably divided into shares (or units)
which vary in price in direct proportion to the variation in
value of the funds net asset value.
• Each time money is invested in the fund, new shares or units
are created to match the prevailing share price; each time
units are redeemed the assets are sold to match the
prevailing share price.

• In a close-ended fund, investments can be made only during
the launch of fund or NFO period i.e. New Fund Offer period.
• During this time only investors can purchase units from the
AMC. After this stage, no fresh investors can enter the fund.
Thereafter investor can buy or sell the units of the scheme on
the stock exchanges where the fund is listed.
• The market price at the stock exchange could vary from the
scheme’s NAV on account of demand and supply situation,
unit holders’ expectations and other market factors.
• Close ended fund also has a fixed tenure and investors can
liquidate their investments only on maturity; premature
withdrawals are permitted as per conditions laid out by the
fund house at the time of launch.
• Investors are granted an exit option by listing the fund on the
stock markets. The fund has a trading price which is distinct
from its net asset value (NAV).

Based on Asset Class
• Based on Asset Class mutual fund schemes can be
categorize as:
• Equity Schemes
• Debt Schemes
• Balanced/Hybrid Schemes
• Money Market Schemes

• Funds that invest large part of their assets in equity shares are
called equity funds.
• As per Indian Income Tax Act, an equity oriented fund refers to
a fund in which the funds invested in equity shares in domestic
companies exceed 65% of the total proceeds of such fund and
which has been set up under a scheme of a mutual fund
specified under Section 10(23D) of the Act.
• Equity shares carry expectations to generate high returns.
These funds carry the principal objective of capital appreciation
of the investment over a medium to long-term investment
horizon.
• Equity Funds also carry high risk due to large exposure to
equity shares and their returns are linked to the movement of
stock markets.
• These schemes are best suited for risk taker investors who are
seeking long term growth.

• Debt funds are also known as Fixed Income Funds or Bond
Funds and they invest only in debt securities like corporate
bonds, debentures, government securities etc.
• The main advantage of investing money in debt funds is that
they are designed primarily to protect the capital invested and
provide stable returns by investing in debt securities.
• They are considered safe investments as compared to equity
schemes and provide fixed returns.

• Hybrid or Balanced schemes provide an investment option
between equity and debt schemes.
• These schemes are characterized by a portfolio that is made
up of a mix of equity stocks and bonds which suit investors
looking for safety plus returns with higher levels of risk than
fixed income schemes.
• These funds invest both in equity shares and debt (fixed
income) instruments and strive to provide both growth and
regular income. Risk and returns are balanced out this way.
• They are ideal for investors who are willing to take moderate
risks.

• These funds invest exclusively in safer and short-term Money
Market instruments like treasury bills, commercial papers,
certificate of deposits etc.
• Their aim is to provide easy liquidity, preservation of capital
along with moderate income.
• Returns on these schemes does not fluctuate too much as
compared to other funds and are most appropriate for
corporate and individual investors as an option to park their
surplus funds for short periods.

Based on Investment Objective
• Based on Investment Objective mutual fund schemes can
be categorize as:
• Growth Schemes
• Income Schemes
• Liquid Schemes
• Tax Saving Schemes (ELSS)
• Capital Protection Schemes
• Fixed Maturity Schemes
• Pension Schemes

• Growth Schemes: Under these schemes, money is invested
primarily in equity stocks with the purpose of providing capital
appreciation. These schemes are risky and are ideal for
investors who are looking for higher returns on their
investment with a long-term investment timeline.
• Income Schemes: These schemes invest primarily in fixed-
income instruments e.g. bonds, debentures etc. with the
purpose of providing capital protection and regular income to
investors.
• Liquid Schemes: Under these schemes, money is invested
primarily in short-term or very short-term instruments e.g. T-
Bills, Commercial Papers etc. with the purpose of providing
liquidity. They are considered to be low on risk with moderate
returns and are ideal for investors with short-term investment
timelines.

• Tax-Saving Schemes (ELSS): These schemes are variant of
equity schemes. Investments made in these funds qualify for
deductions under section 80(c) of Income Tax Act. They are
considered high on risk but also offer high returns if fund
performs well. These are close ended schemes with a lock-in
period of 3 years.
• Capital Protection Schemes: These schemes invest
meticulously in fixed income options and equity. These are
closed-ended hybrid mutual fund schemes with a clear focus on
debt to achieve capital protection. The primary objective of
capital protection funds is to safeguard the interest of the
investors during economic downturns and at the same time,
preserve their capital. A major portion of the fund is invested in
debt securities and a small fraction is invested in equities.
• Fixed Maturity Schemes: These schemes invest in debt and
money market instruments where the maturity date is either the
same as that of the fund or earlier than it.

• Pension Funds: These schemes invest with a long term goal
in mind. These schemes are primarily meant to provide a
regular return around the time when the investor is ready to
retire. The investments in such a fund may be split between
equities and debt markets where equities act as the risky part
of the investment providing higher return and debt markets
balance the risk and provide lower but steady returns. The
returns from these funds can be taken in lump sums, as a
pension or a combination of the two.

Based on Specialty
• Based on specialty mutual fund schemes can be
categorized as:
• Sector Specific Schemes
• Index Schemes
• Fund of Funds
• Emerging Market Schemes
• Global Schemes
• Gilt Schemes
• Exchange Traded Schemes

• Sector Specific Schemes invests solely in the shares of
companies which belongs to a particular industry or sector of
the economy. Example Pharma Funds, Banking Funds, IT
Funds etc.
• As per SEBI norms a sector specific fund has to invest at least
80 per cent of total assets in stocks of chosen sector.
• Benefits of diversification are not available in sector specific
schemes because the stock holdings of this type of schemes
are in the same industry.
• Sectorial schemes outperform the market when there is an
increase in demand of products or services of a particular
sector, while these schemes may face heavy losses if there is
a decrease in the demand of products offered by the
companies of the specific sector in which scheme invest.

• An index fund is a type of mutual fund with a portfolio which
replicates the composition of a market index, such as the
Nifty-50 or Sensex.
• An index mutual fund provides a broad market exposure and
has low operating expenses and low portfolio turnover due to
passive investment strategy.
• By investing money in an index fund, an investor is purchasing
a share of a portfolio that contains the securities in an
underlying index.
• The portfolio of an index fund holds the securities in the same
proportion as they occur in the actual index. Due to this the
performance of the index fund also replicates the performance
of the underlying index.
• When the index decreases in value the fund's value also
decrease as well and vice versa.

• A "Fund of Funds" is a mutual fund scheme that invests in
other schemes of the same mutual fund company or other
mutual fund companies.
• A fund of funds allows investors to get exposure in a variety
of fund categories that are all combined up into one fund.
• Thus a fund of funds scheme provide its investors a broad
diversification.
• However, if the fund of funds carries an operating expense,
investors are essentially paying double for an expense that is
already included in the expense figures of the underlying
funds.

• Emerging market schemes invests the majority of its assets in
securities from countries with economies that are considered
to be emerging.
• These countries are in an emerging growth phase and offer
high potential return with higher risks than developed market
countries.
• An emerging market fund invest heavily in securities of
varying asset classes—stocks, bonds, and other securities
from developing or emerging market economies.
• The most common places where these funds invest in include
India, China, Russia, and Brazil.

• Global Mutual Fund schemes invest in companies which are
spread around the globe. They allow investors to invest
in international markets.
• Usually, investors opt for these funds to further diversify their
investment portfolios. Since global funds invest in a wide
range of securities in several countries, the investment is
truly diversified and does not carry concentration risk.
• Global funds gives the opportunity to invest in the fastest-
growing markets in the world which otherwise are out of the
reach of retail investors.

• Gilt funds are debt funds that invest primarily in fixed interest
generating government securities of varying maturity periods.
• These funds have no risk of non-payment of interest or
principal amount but get affected by interest rate movements
as the Government borrowing typically happens to be for a
longer duration.
• These funds are ideal for an investment horizon of at least 3-5
years.
• Gilt funds ensures the preservation of capital along with
moderate returns. So they ensures the capital protection of the
investors.
• Gilt funds do not invest in corporate bonds which can be risky.
• These funds are considered an ideal investment haven for
those investors who are risk-averse and want to invest in
government securities.

• An ETF, or exchange traded fund is a marketable security that
tracks an index, a commodity, bonds or a basket of assets like
an index fund.
• Unlike mutual funds, exchange traded funds trades like
a common stock on a stock exchange and experience price
changes throughout the day as they are bought and sold like
other stocks listed on the exchange.
• Due to higher daily liquidity and less fees as compared to
other mutual fund schemes, ETF’s have become an attractive
alternative for individual investors.
• An ETF does not have any net asset value (NAV), as it trades
like a stock.

How to Invest in Mutual Funds
• Investment in mutual funds can be made in any of the
following ways:
• Lump Sum Investment
• Systematic Investment Plan (SIP)
• Systematic Withdrawal Plan (SWP)
• Systematic Transfer Plan (STP)

• In this option an investor can invest lump sum money at a time
in a mutual fund scheme.
• This type of investment is beneficial when the market is down.
The money invested will appreciate as the market will move
up.
• On the other hand such type of investment will be highly risky
if made at a time when market is at high level. Any downfall in
the market will result in losses. The investor has to wait for the
returns until the market will again move up.

Systematic Investment Plan (SIP)

• A systematic investment plan or SIP is a way to invest in
mutual funds on regular basis. It is very similar to regular
saving schemes like a recurring deposit in banks or post office.
• The aim behind SIP is to set apart a sum of money every
month or quarter on regular basis, and use that to buy units of
a particular mutual fund regardless of its price.
• People like such a system because it helps them to save
regularly and build up a corpus over a long period of time.
• Investment through SIP enables an investor to take part in the
stock markets without actively timing them.
• Investors are benefited by buying more units when the price
falls and less units when the price rises thus taking the benefit
of Rupee Cost Averaging which reduces the average cost of
investment.

• SIP is a good investment option for those investors who can
save small amount of money every month like a salaried
employee.

Systematic Withdrawal Plan (SWP)

• A Systematic Withdrawal Plan (SWP) is a facility in which an
investor can invest lump sum money in a mutual fund scheme
and can withdraw money at predetermined intervals.
• The money withdrawn through a systematic withdrawal plan
can be reinvested in another fund or retained by the investor in
cash.
• Systematic withdrawal plans are used by investors to create a
regular flow of income from their investments.
• Systematic Withdrawal Plans are suitable for investors who
have large sum of money from which they look for a regular
income. It is a good investment option for retired people also
who have received lump sum money after retirement.
• SWP can be set up to withdraw only the appreciation made on
a particular investment. In this way the capital stays invested
while the investor continues to enjoy the gains periodically.

Systematic Transfer Plan (STP)

• In Systematic Transfer Plan an investor invests a lump sum
amount in one scheme and regularly transfers (i.e. switches) a
pre-defined amount into another scheme.
• Every month on a specified date an amount chosen by the
investor is transferred from one mutual fund scheme to
another as selected by the investor.
• STP will make sense from DEBT => EQUITY scheme. As debt
schemes are not risky as compared to equity schemes the
money invested initially will remain safe and the return
generated by debt scheme will also be enjoyed by the
investor.
• As a pre decided amount will be transferred from debt to
equity scheme on regular time intervals the investor need not
to time the market and he/she will also enjoy the benefit of
Rupee Cost Averaging.

Working of Systematic Transfer Plan (STP)

• Fund A represents a debt scheme in which the investor has
initially invested the money and Fund B represents the equity
scheme chosen for systematic transfer of fund. During the
period of time the value of Fund A decreases due to regular
withdrawals and value of Fund B increases due to regular flow
of money.

Concept of mutual fund

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