What is a Mutual Fund?

A Mutual Fund is a pool of money, collected from investors, and is invested according to certain investment objectives. A Mutual Fund is created when investors put their money together. It is therefore a pool of the investors' funds. The most important characteristic of a Mutual Fund is that the contributors and the beneficiaries of the Fund are the same class of people, namely the investors. The term mutual means that investors contribute to the pool, and also benefit from the pool. There are no other claimants to the funds. The pool of funds is held mutually by investors is the Mutual Fund

What are the benefits of investing in Mutual Funds?

Qualified and experienced professionals manage Mutual Funds. Generally, investors, by themselves, may have reasonable capability, but to assess a financial instrument, a professional analytical approach is required, in addition to access to research and information as well as time and methodology to make sound investment decisions and to keep monitoring them.

Since Mutual Funds make investments in a number of stocks, the resultant diversification reduces risk. They provide small investors with an opportunity to invest in a larger basket of securities.

The investor is spared the time and effort of tracking investments, collecting income, etc. from various issuers, etc.

It is possible to invest in small amounts as and when the investor has surplus funds to invest.
Mutual Funds are registered with SEBI. SEBI monitors the activities of Mutual Funds.
In case of open-ended Funds, the investment is very liquid as it can be redeemed at any time with the fund unlike direct investment in stocks / bonds.

What is an Asset Management Company?

An Asset Management Company (AMC) is a highly regulated organisation that pools money from investors and invests the same in a portfolio. They charge a small management fee, which is normally 1.5% of the total funds managed.

Are there any risks involved in investing in Mutual Funds?

Mutual Funds do not provide assured returns. Their returns are linked to their performance. They invest in shares, debentures and deposits. All these investments involve an element of risk. The unit value may vary depending upon the performance of the company and companies may default in payment of interest / principal on their debentures / bonds / deposits. Besides this, the government may come up with new regulations, which may affect a particular industry or class of industries. All these factors influence the performance of Mutual Funds.

What is an Offer document and why is it important to investors?

The Offer document is very detailed and can run into 100 pages or more. It usually contains all information about the scheme that is being sold, namely, the objective of the scheme, the asset allocation, the sale and repurchase procedures, the load and expense structure, and the accounting and valuation policies. Apart from this core information, the offer document also contains details regarding the structure of the Mutual Fund, how it is constituted, and the performance of existing schemes of the Mutual Fund. It also contains operational details about how to apply and what the investors’ rights and obligations are.

Offer document is very important to an investor for the following reasons:

Information about the product and its fundamental attributes are specified in the Offer document. Therefore, it forms the basis for the investor’s decision.

Offer document is a legal document that specifies the details of the offer made by the Mutual Fund, and before buying the Mutual Fund product, an investor must read and understand the terms of the offer.

What is the difference between bonds and debentures?

The two words can be used interchangeably. In the Indian market, we use the word bonds to refer to debt securities issued by government, semi-government bodies and public sector financial institutions and companies. We use the word debentures to refer to the debt securities issued by private sector companies.

What are the different plans that mutual funds offer?

Mutual Funds, in order to cater to a range of investor needs, have various investment plans.
Some of the important investment plans include:

Growth Plan

Dividend is not paid-out under a Growth Plan and the investor realises only the capital appreciation on the investment (by an increase in NAV).

Dividend Reinvestment Plan

Dividend plans of schemes carry an additional option for reinvestment of income distribution. This is referred to as the dividend reinvestment plan. Under this plan, dividends declared by a Fund are reinvested on behalf of the investor, thus increasing the number of units held by the investor

Income Plan

Dividends are paid-out to investors under an Income Plan to the investors. However, the NAV of the mutual fund scheme under an Income Plan falls to the extent of the dividend payout.

Retirement Pension Plan

Some schemes are linked with retirement pension. Individuals participate in these plans for themselves, and corporates participate for their employees.

Insurance Plan

UTI and LIC Mutual Funds have some schemes that offer insurance cover to investors.

Automatic / Systematic Withdrawal Plan

As opposed to the Systematic Investment Plan, the Systematic Withdrawal Plan allows the 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 applicable NAV as on that day.

Automatic/ Systematic Investment Plan

Under the Automatic Investment Plan (AIP) also called Systematic Investment Plan (SIP), the investor is given the option of investing at a specified frequency of months in a specified scheme of the Mutual Fund for a constant sum of investment. AIP allows the investors to plan their savings through a structured regular monthly savings program.

What are standard risks?

Standard risk factors are SEBI stipulated factors that apply to the Mutual Fund products as a category. These have to be stated in the first section of the Offer document. The standard risk factors are:
Mutual Fund and securities investments are subject to market risks and there is no assurance or guarantee that the objectives of the Mutual Fund will be achieved.

As with any investment in securities, the NAV of units issued under the scheme can go up or down, depending on factors and forces affecting capital markets.

Past performance of a sponsor/ AMC / Mutual Fund does not indicate the future performance of the scheme.

The name of the scheme does not in any manner indicate either the quality of the scheme or its future prospects and returns.

What are scheme specific risks?

Scheme specific risk factors pertain to the scheme being offered and include the following:
Risk arising from investment objective, investment strategy and asset allocation of a scheme:
For example, a scheme may decide to invest in small illiquid shares, as a strategy to earn higher returns. This strategy however, has the risk that the scheme’s liquidity and return volatility are impacted by the presence of illiquid shares in the portfolio. The Offer document has to state the specific risks that investors have to bear while investing in such a scheme.

Risk arising from non-diversification, if any:

If a scheme offers assured returns, the scheme must state that the assurance is on the basis of guarantees by sponsor/AMC. The net worth and liquidity position of such a guarantor should also be disclosed. If guarantees are for only a specified period, that should be explicitly stated.
If the AMC has no previous experience in managing a Mutual Fund, a disclosure to the effect that this is the first scheme being launched under its management should be made.

What are the different types of Mutual Funds

Mutual fund schemes may be classified on the basis of their structure and its investment objective

By Structure:

Open-ended Funds
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.

Close-ended Funds
A Close-ended Fund has a stipulated maturity period, which generally ranges 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, if they are 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.

By Investment Objective:

Growth Funds
The aim of growth funds is to provide capital appreciation over the medium to long term. Such schemes normally invest a majority of their corpus in equities. Growth schemes are ideal for investors who have a long-term outlook and are seeking growth over a period of time.

Income Funds
The aim of Income Funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and Government securities.

Income Funds are ideal for capital stability and regular income. Capital appreciation in such funds may be limited, though risks are typically lower than that in a growth fund.

Balanced Funds
The aim of Balanced Funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. This proportion affects the risks and the returns associated with the balanced fund - in case equities are allocated a higher proportion, investors would be exposed to risks similar to that of the equity market.

Balanced funds with equal allocation to equities and fixed income securities are ideal for investors looking for a combination of income and moderate growth.

Money Market Funds
The aim of Money Market Funds is 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. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market.

These are ideal for corporate and individual investors as a means to park their surplus funds for short periods.

Other Equity Related Schemes:

Tax Saving Schemes
These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws, as the Government offers tax incentives for investment in specified avenues.

Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction under Section 80 CCC of the Indian Income Tax Act, 1961.

Index Schemes
Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE S&P CNX 50.

Sectoral Schemes
Sectoral Funds are those which invest exclusively in specified sector(s) such as FMCG, Information Technology, Pharmaceuticals, etc. These schemes carry higher risk as compared to general equity schemes as the portfolio is less diversified, i.e. restricted to sector(s) / industry (ies).
Mutual fund schemes may be classified on the basis of their structure and its investment objective.

What is Net Asset Value (NAV)?

As per SEBI (Securities and Exchange Board of India), NAV of a scheme is determined by dividing the net assets of the scheme by the number of outstanding units on the valuation date.

Typically, NAV is calculated by summing the current market values of all securities held by the fund, adding in cash and any accrued income, then subtracting liabilities and dividing the result by the number of units outstanding.
For example :
Total Value of Securities (Equity, Bonds, Debentures etc.) Rs. 1000
Cash Rs. 1500
Liabilities Rs. 500
Total outstanding units 100
NAV [(1000+1500-500)/100] Rs. 20 per unit

Most funds compute NAVs daily based on closing market prices.

Mutual fund schemes may be classified on the basis of their structure and its investment objective.

What are loads?

Load is a charge collected by a mutual fund when it sells units. It can be levied as an entry load (i.e., the charge is collected when an investor buys the units) and as an exit load (i.e, the charge is collected when the investor sells back the units).

Schemes that do not charge any load and are called No Load Schemes.

Can the buy and sell price of units be different from the NAV?
The buy and sell price of schemes can be different from the NAV due to entry / exit loads. For example, if the current NAV of a scheme is Rs. 10 and the entry and exit load is 1.5% then the effective purchase price for the investor per unit will be Rs. 10.15, and the sale price will be Rs. 9.85.

What is Purchase price?

Purchase price is the price paid by a customer to purchase a unit of the fund. If the fund has no entry load, then the sales price is the same as the NAV. If the fund levies an entry load, then the sales price would be higher than the NAV, to the extent of the entry load levied.

What is redemption price?

Redemption price is the price received by the customer on selling units of an open-ended scheme to the fund. If the fund does not levy an exit load, the redemption price will be same as the NAV. The redemption price will be lower than the NAV in case the fund levies an exit load.

What is repurchase price?

Repurchase price is different from redemption price and refers to the price at which a close-ended scheme repurchases its units. Repurchase can either be at NAV or can have an exit load.

What is Switch?

Some Mutual Funds provide the investor with an option to shift his investment from one scheme to another within that fund. For this option the fund may levy a switching fee. Switching allows the Investor to alter the allocation of their investment among the schemes in order to meet their changed investment needs, risk profiles or changing circumstances during their lifetime.