Mutual Fund Basics

1. What is mutual fund?

A mutual fund is a form of collective investment that pools money from investors
and invests the money in stocks, bonds, short-term money-market instruments,
and/or other securities. The fund manager trades the fund's underlying securities,
realizing a gain or loss, and collects the dividend or interest income. The investment
proceeds are then passed on to the individual investors.
The rationale behind a mutual fund is that there are large numbers of investors who
lack the time and or the skills to manage their money. Hence professional fund
managers, acting on behalf of the Mutual Fund, manage the investments (investor's
money) for their benefit in return for a management fee. Thus a Mutual Fund is the
most suitable investment for the common man as it offers an opportunity to invest
in a diversified, professionally managed basket of securities at a relatively low cost.
2. Why it is better to invest through mutual funds rather than investing
individually?
Making investment requires a lot of knowledge and expertise on the area of
investment. Some of the basic requirements to invest in capital markets are as
follows:
a. Up to date financial data and other material information regarding the investment
b. Financial knowledge and expertise to analyze financial statements
c. Expertise to analyze other material information
d. Sufficient time to analyze financial statements and material information
e. Financial tools that is required for analysis of the data
f. Skill for interpretation of data and information and link it to value investment for
reaching fair pricing
g. Sufficient fund to make diversified investment
h. Continuous monitoring of investment performance and make changes in the
allocation of invested funds etc.
In most cases, individuals lack these basic requirements. A very small
mistake in analysis may cause heavy loss. Even those institutions that
provide financial market services but not the investment management
services may not be able to arrange for regular analysis and monitoring of
investment due to the priority towards their core business. Therefore,
mutual fund is the best alternative for individuals as well as for many
institutions to invest in capital markets.
3. What are the benefits of investing in mutual funds to investors?
Diversification: A mutual funds investment portfolio consists of stocks and/or
bonds from different companies, usually in many different industries or business
sectors. As a result, an investors money is somewhat shielded against a decline in
any company or depending on the fund, any one business sector.
Professional management: The major advantage of investing in a mutual fund to
the investors is that they get a professional money manager for a small fee. The
investor can leave the investment decisions to the fund manager and only has to
monitor the performance of the fund at regular intervals.
Low Transaction Costs: Compared with buying individual stocks and bonds to
build a diversified portfolio on your own, the costs associated with investing in
mutual fund which contains these financial instruments are lower. A funds

administrative; operations and trading expenses are spread over all of the
shareholders in the fund.
Affordability: Mutual funds allow the investors to start with small investments. For
example, if an investor wants to buy a portfolio of blue chips of modest
size, s/he should have at least one Lakh rupees. A mutual fund gives that
investor the same portfolio for a smaller sum of money. A mutual fund can
do that because it sells the units of the mutual fund schemes even for a very small
sum of money and creates large corpus (amount) from such small sums and invest
it to create the same portfolio.
Liquidity: In case of close end fund, since the units are generally listed on the
stock exchange, investors can sell their units there.
Tax exemption: Usually, in most countries, investors do not have to pay any taxes
on dividends issued by mutual funds. Also, the schemes are exempted from income
tax, which ultimately is a benefit to the unit holders. In case of Nepal, there are
initiatives taken by SEBON and MoF for giving tax incentives to the mutual fund
schemes in a manner similar to international practices. If this incentive is
announced, mutual fund investors also may have taxation advantage.
Transparency: Mutual funds offer daily NAVs of schemes, which help the investor
to monitor their investments on a regular basis. They also get periodic information
that gives details of the portfolio, performance of schemes against various
benchmarks, etc. They are also well regulated and SEBON monitors their actions
closely.