Basics on Mutual Fund

What is a Mutual Fund?

A Mutual Fund is a professionally-managed investment scheme, usually run by an AMC (Asset Management Company) pooling the savings of a number of investors sharing a common financial goal. The collected money is invested in stocks, bonds or other capital market instruments and the profits or losses are shared by investors in proportion to their investments. Thus, it is one of the most suitable investments for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. However, MF is required to be registered with the Securities and Exchange Board of India (SEBI) before it can collect funds from the public.

What are the various types of MFs?

Broadly, there are three types of mutual funds based on structure – a) Open-Ended Funds: Usually they do not have a fixed maturity period and can be bought and sold on demand at their NAV (Net Asset Value). b) Closed-Ended Funds: They can’t issue new units except in case of bonus or rights issue. Hence, they have a fixed number of shares and are traded among investors on an exchange. c) Interval Funds: It has the features of both open-ended and close-ended funds and they are opened for the repurchase of shares at different intervals during the fund tenure. The AMC offers to repurchase units from existing unitholders during these intervals. If they wish, the units can be offloaded in favor of the fund.

Another classification is based on the asset class – Equity mutual funds invest primarily in shares, B invests primarily in bonds and money market mutual funds invest mainly in the short-term debt instruments such as treasury bills, certificate of deposits and inter-bank call money.

What are the different types of investment strategies?

Growth/value etc

Who can invest in a Mutual Fund? 
Anybody with an investible surplus of as little as a few hundred rupees can invest in mutual funds and buy units of a fund that best suits their investment objectives and future needs. NRIs (Non Resident Indian), PIO (Persons of Indian Origin), OCI (Overseas Citizen of India) and FIIs (Foreign Institutional investors) can invest in the Indian MFs based on the relevant provisions of the Income-tax Act, 1961, regulations issued under the FEMA, 1999 and the Wealth-tax Act, 1957. However, only a select few mutual funds are accepting investments from US and Canadian citizens at the moment.

What are the advantages of investing in a Mutual Fund? 
There are several advantages of investing in a Mutual Fund.

  • Professional Management: It offers investors the opportunity to earn an income or build their wealth through the professional management of their investible funds.
  • Portfolio diversification: Even with a small investment, the MF scheme can provide investors a diversified portfolio which helps reduce the risk in investment.
  • Economies of scale: The pooling of large sum of money through several investors provides economies of scale in costs related to investment research, office rental, better negotiation terms with the broker, banker or any other service provider.
  • Liquidity: Investors in a MF scheme can recover the value of the money invested, from the mutual fund itself. Depending on the structure of the scheme, this would be possible, either at any time, or during specific intervals, or only on the closure of the scheme.
  • Tax deferral/benefits: The investor can defer the tax liability by letting the money grow in the scheme for several years. This helps investors to legally build their wealth faster than would have been the case if they were to pay tax on the income each year.
  • Convenience: Investors can structure their investments in line with their liquidity preference and tax position.
  • Regulatory comfort: All the mutual funds are registered with SEBI and they function within the provisions of strict regulation designed to protect the interests of the investor.

What are the limitations of investing in a mutual fund?

There could be several disadvantages of investing in a mutual fund.

  • Lack of portfolio customization: Once you buy a mutual fund, investment management is left to the fund manager and you can’t influence what securities or investments the scheme would buy. However, this may not be a serious limitation as large sections of investors lack the time or knowledge to be able to make portfolio choices.
  • Choice overload: There are more than 1800 mutual fund schemes offered by around 40 odd MFs. Multiple options within these schemes make it difficult for investors to choose between them. However, the availability of competent advisors and greater dissemination of industry information can help investors in handling the choice overload.
  • No control over costs: an individual investor has any control over the costs in a scheme which is shared by all the unit-holders in proportion to their holding. However, SEBI has imposed certain limits on the expenses that can be charged to any scheme depending on the size of the assets & nature of the scheme.

What is the NAV (Net Asset Value) of a scheme?

The performance of a particular scheme of a mutual fund is reflected in its NAV which is disclosed on a daily basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. As the market value of securities changes every day, the NAV of a scheme also varies on day to day basis. The NAV per unit of all mutual fund schemes has to be updated on AMFI’s website and the Mutual Funds’ website by 9 PM. of the same day. Fund of Funds is allowed time till 10 AM the following business day to update the information.

What is the expense ratio?

Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund’s daily net assets. Operating expenses of a scheme are administration, management, advertising related expenses, etc. An expense ratio of 1% per annum means that each year 1% of the fund’s total assets will be used to cover expenses. Information on expense ratio that may be applicable to a scheme is mentioned in the offer document. Currently, in India, the expense ratio is fungible, i.e., there is no limit on any particular type of allowed expense as long as the total expense ratio is within the prescribed limit.

What is a load or no-load fund?

A load fund is one that charges a percentage of NAV for entry or exit and the load structure in a scheme has to be disclosed in its offer documents. Suppose the NAV per unit is Rs.10. If the entry, as well as exit load charged, is 1%, then the investors who buy would be required to pay Rs.10.10 (10 + 1% of 10) per unit and those who offer their units for repurchase to the mutual fund will get only Rs.9.90 (10 – 1% of 10) per unit. Currently, as per the SEBI guidelines, no entry load can be charged for any mutual fund scheme while the exit load charged is credited to the scheme.

What should an investor look into an offer document?

KIM (Key Information Memorandum), an abridged offer document containing very useful information is required to be given to the prospective investor by the MFs. The application form for subscription to a scheme is an integral part of this offer document. SEBI has prescribed minimum disclosures in the offer document. Mutual fund investments are subject to market risks. An investor should carefully read all the scheme related documents. Due care must be given to portions relating to main features of the scheme, risk factors, and recurring expenses to be charged to the scheme, loads, sponsor’s track record, educational qualification and work experience of key personnel including fund managers, performance of other schemes launched by the mutual fund in the past, pending litigations and penalties imposed, etc.

What is a Consolidated Account Statement?

A CAS (Consolidated Account Statement) details all the transactions and investor’s holding at the end of the month including transaction charges paid to the distributor, across all schemes of all mutual funds, by an investor. A CAS for each calendar month is issued to the investors in whose folios transactions have taken place during that month. A CAS every half-yearly (September/ March) is issued, detailing holding at the end of the six months, across all schemes of all mutual funds, to all such investors in whose folios no transaction has taken place during that period.