Inside of Mutual Fund Investments

A mutual fund is typically fashioned by an investment firm. The whole thing is publicized and the share holders are then encouraged to put their money in this mutual fund. And most investment funds come with a theme – this is a kind of standard practice. The cash invested in the business is then utilized by the investment firm for buying an assortment of financial investments. Such purchasing is usually carried out in a way that makes it relevant to the theme of the mutual fund.

The assets in a mutual fund's portfolio are managed by a professional Fund Manager(s) who decides which securities to buy and sell based on the fund's investment objective, mentioned in the fund's prospectus. The job of the manager is to keep an eye on how the fund is growing. The mutual fund manager conducts various types of research on the area of investment with help from other financial analysts. The info gathered via such research is used in future decision-making pertaining to the buying or selling of bonds or stocks so as to get the best returns on the investment.

Mutual Funds are right way to invest into because it provides affordability, liquidity, tax benefits, and professional management and most importantly it helps in maximizing returns by effectively utilizing hard earned money. It also allows investor to systematically invest in equities and debt markets through Systematic Investment Plan. Through this mode investor can take exposure with as little as Rs. Five hundred and by investing regularly for a longer period can benefit from cost averaging and can built a large corpus to meet future commitments.

Why prefer mutual fund route over stock market?

Mutual fund is required to be registered with Securities and Exchange Board of India (SEBI), which regulates securities markets, before it can collect funds from the public. It acts like a company that pools money from investors and invests the same in stocks, bonds, short-term money-market instruments, other securities or assets and some combination of these investments. It offers an opportunity to invest in a diversified, professionally managed basket of securities. These securities are often referred to as holdings and all of the fund's holdings make up the portfolio. When one invest in a mutual fund, the investor is actually buying shares in the fund, which means investors own a percentage of the fund's entire portfolio in ratio of its holding.

If any new investor is looking to invest for the future in equities will usually face two options - mutual funds or individual stocks. However understanding the differences between them is essential as both carry inherent advantages and risks. Any individual investing in common stock of a company has to bear the responsibility of managing his portfolio on his own and also bear the price risk. In this active form of investment an individual must have sound knowledge, experience and adequate time, lack of which may increase his risk exposure. However Mutual Funds help to reduce risk through diversification and professional management. The experience and expertise of Fund managers in selecting securities and timing their purchases and sales help them to build a diversified portfolio that minimizes risk and maximizes returns.

Parameters for selecting right mutual fund scheme

Lastly, after understanding the basics of mutual fund and its various schemes, an individual as per his investment objective needs to know the various criteria to choose the fund, which can be:

• Performance analysis of the scheme for a considerable long period taking into account historical returns and portfolio.
• Analysis of the Fund House and the experience of the Fund Manger.
• Analysis of the fund corpus and how it has changed across the time period.
• Comparison of charges deducted by Asset Management Companies across the category where an investor wishes to make investment.
• The price at which one can exit (i.e. exit load) the scheme and its impact on overall return.
• Comparison of scheme with its benchmark and how has the scheme performed especially in a volatile environment.
• Last but not the least an investor can refer to certain investment ratios such as Sharpe, Sortino, Treynor, Alpha etc. to judge the risk-return analysis of the scheme.

Before Investing in 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. 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 one of the best available investments being very cost efficient and also easy to invest in as compare to others. 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.

Mutual funds are set up to buy many stocks as they automatically diversify in a predetermined category of investments, i.e. growth companies, emerging or mid size companies, low-grade corporate bonds, etc. The most basic level of diversification is to buy multiple stocks rather than just one stock.

Regulatory Authorities

To protect the interest of the investors, SEBI formulates policies and regulates the mutual funds. It notified regulations and issues guidelines from time to time. MF either promoted by public or by private sector entities including one promoted by foreign entities is governed by these Regulations.

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.

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.

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.

Advantages of Investing Mutual Funds:

• Professional Management: The basic advantage of funds is that, they are professionally 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: By purchasing units in a mutual fund instead of buying individual stocks or bonds, 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 AMCs have automatic purchase plans popularly known as SIP where investor can reap the benefit of mutual fund by investing as little as Rs. 50 per month basis.

Disadvantages of Investing Mutual Funds:

• 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.
• 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.
• Taxes: When making decisions about your money, fund managers don’t consider your personal tax situation. For example, when a fund manager sells a security, a capital-gain tax is triggered, which affects how profitable the individual is from the sale. It might have been more advantageous for the individual to defer the capital gains liability.

Types of Mutual Fund Schemes in India

Mutual funds have wide variety of schemes to cater the needs such as financial position, risk tolerance and return expectations etc. Availability of plethora of schemes and each scheme being a collection of many investment options, an investor can be easily confused in picking a right mutual fund as per his/her needs. There are over hundreds of mutual funds schemes to choose from & to select the appropriate one it would be easier to first categorize mutual funds in below mentioned framework:

A: BY STRUCTURE

1. Open - Ended Schemes

An open-ended 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-ended schemes is liquidity.

2. Close - Ended Schemes

These schemes have a pre-specified maturity period. One can invest directly in the scheme at the time of the initial issue. Depending on the structure of the scheme there are two exit options available to an investor after the initial offer period closes. Investors can transact (buy or sell) the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchanges could vary from the net asset value (NAV) of the scheme on account of demand and supply situation, expectations of unit holder and other market factors. Alternatively some close-ended schemes provide an additional option of selling the units directly to the Mutual Fund through periodic repurchase at the schemes NAV; however one cannot buy units and can only sell units during the liquidity window. SEBI Regulations ensure that at least one of the two exit routes is provided to the investor.

3. 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.

B: BY NATURE

1. Equity fund

These funds invest a maximum part of their corpus into equities holdings. The structure of the fund may vary 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.

·         MIPs: 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 with investment horizon of 1 day 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 objectives 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 market.

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. 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.

History of Indian Mutual Fund Industry

The idea of Mutual Fund had its formal origin in Belgium as investments in national industries associated with high risks. In 1860s this movement started in England. In 1868, the foreign and Colonial Government Trust was established to spread risks for investors over a large number of securities. In USA the idea took root in the beginning of the 20^th century. In Canada, during 1920, many close ended investment companies were organized. The first mutual fund in Canada to issue its share to general public was the Canadian Investment Fund (1932). Large number of mutual funds emerged and expanded their wings in the many countries in Europe, the Far East countries and Latin America. Countries in Pacific area like Hong Kong, Thailand, Singapore and Korea have also entered this field in a long way.

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 of India. The history of mutual funds in India can be broadly divided into four distinct phases

First Phase – 1964-87 (Establishment & Growth of UTI)

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. 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, which attracted the largest number of investors in any single investment scheme over the years. UTI launched more innovative schemes in 1970s and 80s to suit the needs of different investors. It launched ULIP in 1971, six more schemes during 1981-84, Children's Gift Growth Fund and India Fund (India's first offshore fund) in 1986, Mastershare (India’s first equity diversified scheme) in 1987 and Monthly Income Schemes (offering assured returns) during 1990s. Since establishment UTI enjoyed complete monopoly and by the end of 1987, UTI's assets under management grew ten times to Rs. 6700 crores.

Second Phase – 1987-1993 (Entry of Public Sector Funds)

The Indian mutual fund industry witnessed a number of public sector players entering the market in 1987 including 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 increased by seven times to Rs. 47,004 crores. However, UTI remained to be the leader with about 80% market share.

Third Phase – 1993-2003 (Entry of Private Sector Funds)

With the 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.

The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of ` 1,21,805 crores. The Unit Trust of India with ` 44,541 crores of assets under management was way ahead of other mutual funds.

Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of ` 29,835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India, functioning under an administrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTI which had in March 2000 more than ` 76,000 crores of assets under management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place among different private sector funds, the mutual fund industry has entered its current phase of consolidation and growth.

In this phase, the mutual fund industry witnessed several merger & acquisitions and simultaneous entry of international mutual fund players like Franklin Templeton, Fidelity, DSP BlackRock, HSBC, JP Morgan, Mirae Asset, AIG Global etc.

The industry witnessed a compounded annual growth rate of 31.25% from March 2003 to March 2011. The graph indicates the growth of assets over the years.