What is a Mutual Fund ?
A mutual fund, is a corporation (trust) that pools the savings, which are then invested in money market, debt market and capital market instruments such as shares, debentures and other securities. Thus the MF serves as a link between the public and the capital markets so as to mobilise savings from the investors and invest them in the capital markets to generate returns.
The following are some of the more popular definitions of a Mutual Fund
A Mutual Fund is an investment tool that allows small investors access to a well-diversified portfolio of equities, bonds and other securities. Each shareholder participates in the gain or loss of the fund. Units are issued and can be redeemed as needed. The fund's Net Asset Value (NAV) is determined each day.
Mutual Funds are financial intermediaries. They are companies set up to receive your money, and then having received it, make investments with the money Via an AMC. It is an ideal tool for people who want to invest but don't want to be bothered with deciphering the numbers and deciding whether the stock is a good buy or not. A mutual fund manager proceeds to buy a number of stocks from various markets and industries. Depending on the amount you invest, you own part of the overall fund.
The beauty of mutual funds is that anyone with an investible surplus of a few hundred rupees can invest and reap returns as high as those provided by the equity markets or have a steady and comparatively secure investment as offered by debt instruments.
What is an AMC ?
A company formed under the Companies Act and registered with the Securities and Exchange Board of India (SEBI) to manage investor's funds collected through different schemes The trustee delegates the task of floating schemes and managing the collected money to a company of professionals, usually experts who are known for smart stock picks. This is an asset management company (AMC). AMC charges a fee for the services it renders to the MF trust. Thus the AMC acts as the investment manager of the trust under the broad supervision and direction of the trustees.
What is an Unit ?
A unit in a mutual fund scheme means one share in the assets of a particular scheme. So, a person holding units in a scheme is referred to as a unit holder.
What is NAV ?
NAV means Net Asset Value. This is the main performance indicator of a fund, especially when viewed in terms of its appreciation over time. The NAV breaks down the performance of a scheme in terms of the market value of every outstanding unit of the scheme. A fund's NAV is calculated as total assets minus all expenses and divided by the number of its total outstanding units.
What is 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.
What is Repurchase Price ?
Redemption or Repurchase Price 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.
When an investor chooses to withdraw money from his investment in an open-ended fund at any point in time, the units are "sold" at NAV (after deduction of Exit Load, if any) to the Fund. When a closed-ended fund completes its tenure, it is redeemed at the prevailing NAV and investors are paid the proceeds thereof.
What is Load & what are the types of Load ?
Load is a charge collected by a mutual fund on units. It can be either entry load i.e., the charge is collected when an investor buys the units or exit load i.e., the charge collected when the investor sells back the units.
Types of Load:
1. Entry Load:
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. The entry load percentage is added to the NAV at the time of allotment of units.
2. Exit 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.
3.Contingent Deferred Sales Load (CDSL):
The load amounts charged to units when recovered at various period of time is called a "deferred load". This load reduces the redemption proceeds paid out to the outgoing investors. Depending on how many years the investor stays with the fund, some funds may charge different amount of loads to the investors- the longer the investor stays with the fund, lesser the amount of exit load charged to him. This is called the contingent deferred sales charge (CDSC) and contingent deferred sales load (CDSL).
Some schemes do not charge any load (i.e. Sell/repurchase at NAV) and are called No Load Schemes.
What is Statement of Account ?
A Statement of Account is a document that serves as a record of transactions between the fund and the investor. It contains details of the investor with the various transactions executed during the period, i.e., sales, repurchase, switch-over in, switch-over out. The Statement of Account is issued every time any transaction takes place.
What is a Fund Manager ?
An investment professional appointed by the AMC to invest money in accordance with the stated objectives of the scheme.
What are the advantages of investing in Mutual Fund ?
Following are the major advantages of investing in Mutual Fund :
Portfolio Diversification/Risk reduction: An investor holds a diversified portfolio even with a small amount of investment, which would otherwise require a big capital. Further, the fund invests in diverse portfolios, hence reducing the riskiness of the investments.
Reduction of transaction costs: -While investing through the funds, an investor has the benefit of economies of scale; the funds incur lesser costs because of larger volumes, a benefit passed on to its investors.
Professional Management: Mutual funds are managed by professional management who has requisite skills and resources to analyze the various investment options in this fast-moving, global and sophisticated markets.
Liquidity: Often, investors hold shares or bonds they cannot directly, easily and quickly sell. If they invest in the units of a fund, they can generally cash their investment any time, by selling their units to the fund if open-end, or selling them in the market if the fund is close-end.
Convenience and flexibility: - Investors have the option of transferring their holdings from one scheme to the other, get updated market information and so on.
Tax Benefits: Income tax benefits are granted to investors in mutual funds, making it more tax efficient as compared to other comparable investment avenues. There are various types of Tax incentives for the investors of mutual funds. There are various sections of the Income Tax Act that provide for the tax rebates and exemptions on investments in mutual funds and the income arising thereof.
What are Open ended & Close ended schemes ?
Open-ended schemes do not have a fixed maturity and are open for subscription the whole year. One can buy and sell units at the NAV related prices to the Mutual funds. These schemes are normally not listed on the stock exchanges and can be redeemed directly to the Mutual Fund.
Close-ended Schemes can be bought and sold on the stock exchange subsequent to the initial subscription through the public offer. One can stay invested in the scheme for a stipulated period ranging from 2 to 15 years. Generally, the close-ended schemes are traded at a discount to their NAV in the stock exchange.
What are the other classifications of mutual funds schemes?
Domestic funds: Fund houses launch domestic funds, which mobilize savings from a particular geographic locality, like a country or region. Majority of schemes launched by Indian MFs like UTI, GIC MF, LIC MF, SBI MF, Canbank MF, Bank of Baroda MF, Bank of India MF, Morgan Stanley, Templeton, Alliance etc, are the examples of such a fund.
Offshore Funds : The objective behind launching offshore funds is to attract foreign capital for investment in the country of the issuing company. These funds facilitate cross border fund flow, which is a direct route for getting foreign currency. From the investment point of view, offshore funds open up domestic capital markets to the international investors and global portfolio investments.
Growth Funds: Investment objectives of such funds are capital appreciation through investment in equity shares. They invest in the equity shares of companies with high growth potential. The examples are software, services, brand value, contra, FMCG etc.
Income Funds : Such funds have the objective of providing safety of investments with regular income. The funds predominantly invested in bonds, debentures and other debt related instruments and to some extent in equity shares of companies with high dividend payouts. E.g. Monthly income plans.
Value Funds: Such funds invest in the equities that are undervalued today in anticipation of unlocking its value in the near future. E.g. Master value unit fund.
Balanced Funds : Balanced Funds have an objective of providing modest risk of investments with reasonable rate of return. The funds are invested in a judicious mix of equity shares, preference shares as well as bonds, debentures and other debt related instruments E.g. US-95.
Money Market Mutual Funds (MMMFs): Such funds have an objective of taking advantage of the volatility in interest rates in the money market instruments. The funds are invested in certificate of deposits (CDs), interbank call money market, commercial papers, T-bills and short-term securities with a maturity horizon of less than one year. Investors can participate indirectly in the money market through MMMFs. E.g. Money Market Fund.
Index Funds:The investment Objective is to increase the value of the portfolio in line with the benchmark index (for e.g. BSE Sensex, SP CNX 50). These funds are invested in the shares of companies as included in the benchmark index in the same proportion.E.g. Nifty Index Fund, Master index fund etc.
Leveraged Funds: These funds have an objective of increasing the value of the portfolio and benefit the shareholders by gains exceeding the cost of borrowed funds. The funds are invested in speculative and risky investments like short sales to take advantage of declining market. Such funds are yet not common in India.
What are the different plans that Mutual fund offers ?
Dividend Plan: Under the Dividend Plan, the fund distributes a substantial part of the surplus to investors in the form of dividend (income distribution).
Growth Plan : Under the Growth Plan, an investor realises only the capital appreciation on the investment (by an increase in NAV) and normally does not get any income in the form of income distribution.
Re-investment Plan: Here the income distribution accrued on a mutual fund scheme is automatically re-invested in purchasing additional units under the scheme. In most cases mutual funds offer the investors an option of collecting income distribution or re-invest in the same scheme at scheme NAV/NAV based price.
Systematic Investment Plan (SIP): Here the investor is given the option of managing his investments on a periodic basis and thus inculcates a regular saving habit. He may issue a pre-determined number of post-dated cheques in favour of the fund. He will get units on the date of the cheque at the NAV of that date. For instance, if on 25th March, he has given a post-dated cheque for June 25th, he will get units on at NAV of 25th June.
Systematic Withdrawal Plan: As opposed to the Systematic Investment Plan, the Systematic Withdrawal Plan allows an investor the facility to withdraw a pre-determined amount/units from his fund at a pre-determined interval. The investor's units will be redeemed at the NAV as on that day. This would tantamount to a tax efficient mode of withdrawal, if planned well.
What is Equity Scheme ?
Equity schemes are those that invest predominantly in equity shares of companies. Although an equity scheme seeks to provide returns by way of capital appreciation, these schemes are exposed to higher risks and hence the returns may fluctuate. They invest only in stocks, and hence, are the riskiest among mutual fund schemes. However, these funds offer the possibility of superior returns since equities have historically outperformed all other asset classes. At present, there are four types of equity funds available in the market.
What is Debt Scheme ?
Debt schemes invest mainly in income-bearing instruments like bonds, debentures, government securities, commercial paper, etc. These instruments are much less volatile than equity schemes. Their volatility depends essentially on the health of the economy e.g., rupee depreciation, fiscal deficit, and inflationary pressure. Performance of such schemes also depends on bond ratings. These schemes provide returns generally between 7 to 12% per annum. These funds invest in fixed-income securities like bonds, Government of India securities, debentures, commercial paper, call money, etc. There are three types of debt funds.
What is Balanced Schemes ?
Balanced schemes invest both in equity shares and in income-bearing instruments in such a proportion that the portfolio is balanced. They aim to reduce the risks of investing in stocks by having a stake in the debt markets.Thus debt and balanced schemes offer a reasonable return with a moderate risk exposure.
What is Sector fund ?
They are the riskiest among equity funds, as they invest only in specific sectors or industries. The performance of sector funds is married to the fortunes of the specific sector or industry. This can work both ways for sector funds. One way to maximize your returns from sector funds is to get into the sector when it is expected to zoom and get out before it falls. However, it is easier said than done. Since you have managed a nodding acquaintance with various equity funds, how do you choose the right one for you? First, identify the category of equity funds you want to invest in. Next, evaluate the performance record of the fund. Find out how it has performed over the years compared to its competitors. Also, check out the reputation, transparency in operations, etc.
Make sure your fund has a diversified portfolio. Avoid funds that have exposure to a few sectors or stocks, as the performance of the fund will be tied to the performance of only these stocks and not to the entire market performance. Also make sure that the fund has a diversified investor base. A fund with a few large investors will be forced to take orders from them, which may not be in your interest.
What is Gilt fund ?
Funds that invest only in government securities and treasury bills. Such funds generally provide marginally higher returns than a money market fund, and are a good option for investors who seek protection of principal. Gilt funds can also be volatile due to increase or decrease in interest rates. Gilt schemes invest in government bonds, money market securities or some combination of these. They have medium to long-term maturities, typically of over one year and have moderate returns. Since the issuer is the central or state Governments, these funds have reduced risk of default and hence offer better protection of principal.
What is index fund ?
These funds track a key stock market index, like the Bombay Stock Exchange Sensex or the National Stock Exchange S & P CNX Nifty. They invest only in stocks that form the market index, as per the individual stock weightages. The idea is to replicate the performance of the benchmarked index to near accuracy. Index funds are considered a passive investment vehicle, as the performance of the fund will be almost the same as the index concerned, except for few minor points.
What is MIPs ?
MONTHLY INCOME PLANS are basically debt schemes, which make marginal investments in the range of 10-25 percent in equity to boost the scheme's returns. MIP schemes are ideal for investors who seek a slightly higher return than pure long-term debt scheme at a marginally higher risk. Declining returns from income funds and improved equity market performance are two main reasons, which have given an opportunity to launch these funds.
What is ELSS ?
According to the central government's Equity Linked Saving Schemes (ELSS) guideline, 1992 and the amendment in 1998, these schemes offer tax rebates to the investor under section 88 of the Income tax act, 1961. Under Section 88 of the I.T. Act, 1961, one gets a tax rebate of upto 20% of the amount contributed to ELSS schemes subject to a maximum investment of Rs. 10000/- within the allowable limit under section 88. Also these schemes generally diversify the equity risk by investing in a wider array of stocks across sectors.
How can one invest in Mutual Fund schemes ?
One can invest by approaching the Asset Management Companies/a Registrar of Mutual Funds or the respective offices of the Mutual funds in a particular town/city. An application form has to be filled in giving all the particulars along with the cheque or Demand Draft for the amount to be invested. The application form is accompanied with Key information Memorandum (which gives the highlights of the scheme), as per SEBI guidelines. An investor has the option to use brokers' or agents' services with respect to filling in the application form etc.
Investor should always know the risk factors before investing.
1. Mutual funds and securities investments are subject to market risks and there is
no assurance or guarantee that the objective of the Mutual fund will be achieved.
2. As with any investment in securities, the NAV of the units issued under the schemes can go up or down depending on the factors and forces affecting the securities markets.
3. Past performance of the Sponsor / AMC / Mutual Fund does not indicate the future performance of the schemes of the Mutual fund
What is Money Market Fund ?
Money Market Mutual Funds (MMMFs) : Such funds have an objective of taking advantage of the volatility in interest rates in the money market instruments. The funds are invested in certificate of deposits (CDs), interbank call money market, commercial papers, T-bills and short-term securities with a maturity horizon of less than one year. Investors can participate indirectly in the money market through MMMFs. E.g. Money Market Fund. Its objective is to preserve principal while yielding a moderate return. MMMF's are favoured by investors seeking low-risk investment avenues that offer instant liquidity.
What is SIP ?
Systematic Investment Plan (SIP) Here the investor is given the option of managing his investments on a periodic basis and thus inculcates a regular saving habit. He may issue a pre-determined number of post-dated cheques in favour of the fund. He will get units on the date of the cheque at the NAV of that date. For instance, if on 25th March, he has given a post-dated cheque for June 25th, he will get units on at NAV of 25th June.
Based on the concept of rupee cost averaging. SIP's allow an investor to invest a prefixed amount with a scheme at set intervals, and derive the benefit of fluctuating share prices and NAV's. So, when the share price drops, the investor get more units and when the share price moves up, he gets less. Finally, if the NAV is high, his entire investment is valued at the existing higher level, while his cost of purchase averages out.
What is SWP ?
Systematic Withdrawal Plan As opposed to the Systematic Investment Plan, the Systematic Withdrawal Plan allows an investor the facility to withdraw a pre-determined amount/units from his fund at a pre-determined interval. The investor's units will be redeemed at the NAV as on that day. This would tantamount to a tax efficient mode of withdrawal, if planned well.
A plan that allows you to withdraw pre-decided amounts from your investments in a scheme at periodic intervals. It is advisable to apply for SWP under Income Funds to save on TDS (Tax Deducted at Source).
The following example illustrates how the SWAP Option in the HDFC Income Fund - Growth Plan, is more tax efficient as compared to the Dividend Plan in the HDFC Income Fund.
What is Switch-over ?
Switching facility provides investors with an option to transfer the funds amongst different types of schemes or plans.
Investors can opt to switch units between Dividend Plan and Growth Plan at NAV based prices. 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.
While switching between Debt and Equity Schemes, one has to take care of exit and entry loads. Switching from a Debt Scheme to Equity scheme involves an entry load while the vice versa does not involve an entry load. Exiting a Debt scheme before 6 months involves an exit load. Switching within Debt and Equity schemes does not involve loads.
Switch requests are effected the day the request for switch is received. The Applicable NAV for the switch will be the NAV on the day that the request for switch is received.
What is a Mutual Fund ?