Professional Management

Mutual Funds provide the services of experienced and skilled professionals, backed by a
dedicated investment research team that analyses the performance and prospects of companies
and selects suitable investments to achieve the objectives of the scheme.

Diversification

Mutual Funds invest in a number of companies across a broad cross-section of industries

and sectors. This diversification reduces the risk because seldom do all stocks decline at
the same time and in the same proportion. You achieve this diversification through a
Mutual Fund with far less money than you can do on your own.

Convenient Administration

Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad
deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your
time and make investing easy and convenient.

Return Potential

Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they
invest in a diversified basket of selected securities.

Low Costs

Mutual Funds are a relatively less expensive way to invest compared to directly investing in the
capital markets because the benefits of scale in brokerage, custodial and other fees translate into
lower costs for investors.

Liquidity

In open-end schemes, the investor gets the money back promptly at net asset value
related prices from the Mutual Fund. In closed-end schemes, the units can be sold on a
stock exchange at the prevailing market price or the investor can avail of the facility of
direct repurchase at NAV related prices by the Mutual Fund.

Transparency

You get regular information on the value of your investment in addition to disclosure on the
specific investments made by your scheme, the proportion invested in each class of assets and
the fund manager's investment strategy and outlook.

Flexibility

Through features such as regular investment plans, regular withdrawal plans and dividend
reinvestment plans, you can systematically invest or withdraw funds according to your
needs and convenience.

Affordability

Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual
fund because of its large corpus allows even a small investor to take the benefit of its
investment strategy.

Choice of Schemes

Mutual Funds offer a family of schemes to suit your varying needs over a lifetime.

Well Regulated

All Mutual Funds are registered with SEBI and they function within the provisions of strict
regulations designed to protect the interests of investors. The operations of Mutual Funds are
regularly monitored by SEBI. The net asset value of the fund is the cumulative market value of
the assets fund net of its liabilities. In other words, if the fund is dissolved or liquidated, by selling
off all the assets in the fund, this is the amount that the shareholders would collectively own. This
gives rise to the concept of net asset value per unit, which is the value, represented by the
ownership of one unit in the fund. It is calculated simply by dividing the net asset value of the fund
by the number of units. However, most people refer loosely to the NAV per unit as NAV, ignoring
the "per unit". We also abide by the same convention.

Calculation of NAV

The most important part of the calculation is the valuation of the assets owned by the fund. Once
it is calculated, the NAV is simply the net value of assets divided by the number of units
outstanding. The detailed methodology for the calculation of the asset value is given below.

Asset value is equal to

Sum of market value of shares/debentures

+ Liquid assets/cash held, if any

+ Dividends/interest accrued

Amount due on unpaid assets

Expenses accrued but not paid

Details on the above items

For liquid shares/debentures, valuation is done on the basis of the last or closing market price on
the principal exchange where the security is traded

For illiquid and unlisted and/or thinly traded shares/debentures, the value has to be estimated.
For shares, this could be the book value per share or an estimated market price if suitable
benchmarks are available. For debentures and bonds, value is estimated on the basis of yields of
comparable liquid securities after adjusting for illiquidity. The value of fixed interest bearing
securities moves in a direction opposite to interest rate changes Valuation of debentures and
bonds is a big problem since most of them are unlisted and thinly traded. This gives considerable
leeway to the AMCs on valuation and some of the AMCs are believed to take advantage of this
and adopt flexible valuation policies depending on the situation.

Interest is payable on debentures/bonds on a periodic basis say every 6 months. But, with every
passing day, interest is said to be accrued, at the daily interest rate, which is calculated by
dividing the periodic interest payment with the number of days in each period. Thus, accrued
interest on a particular day is equal to the daily interest rate multiplied by the number of days
since the last interest payment date.

Usually, dividends are proposed at the time of the Annual General meeting and become due on
the record date. There is a gap between the dates on which it becomes due and the actual
payment date. In the intermediate period, it is deemed to be "accrued".

Expenses including management fees, custody charges etc. are calculated on a daily basis.

The end of millennium marks 36 years of existence of mutual funds in this country. The ride
through these 36 years is not been smooth. Investor opinion is still divided. While some are for
mutual funds others are against it.

UTI commenced its operations from July 1964 .The impetus for establishing a formal institution
came from the desire to increase the propensity of the middle and lower groups to save and to
invest. UTI came into existence during a period marked by great political and economic
uncertainty in India. With war on the borders and economic turmoil that depressed the financial
market, entrepreneurs were hesitant to enter capital market.
The already existing companies found it difficult to raise fresh capital, as investors did not
respond adequately to new issues. Earnest efforts were required to canalize savings of the
community into productive uses in order to speed up the process of industrial growth.
The then Finance Minister, T.T. Krishnamachari set up the idea of a unit trust that would be "open
to any person or institution to purchase the units offered by the trust. However, this institution as
we see it, is intended to cater to the needs of individual investors, and even among them as far as
possible, to those whose means are small."

His ideas took the form of the Unit Trust of India, an intermediary that would help fulfill the twin
objectives of mobilizing retail savings and investing those savings in the capital market and
passing on the benefits so accrued to the small investors.

UTI commenced its operations from July 1964 "with a view to encouraging savings and
investment and participation in the income, profits and gains accruing to the Corporation from the
acquisition, holding, management and disposal of securities." Different provisions of the UTI Act
laid down the structure of management, scope of business, powers and functions of the Trust as
well as accounting, disclosures and regulatory requirements for the Trust.

One thing is certain the fund industry is here to stay. The industry was one-entity show
till 1986 when the UTI monopoly was broken when SBI and Canbank mutual fund entered
the arena. This was followed by the entry of others like BOI, LIC, GIC, etc. sponsored by
public sector banks. Starting with an asset base of Rs0.25bn in 1964 the industry has
grown at a compounded average growth rate of 26.34% to its current size of Rs1130bn.

The period 1986-1993 can be termed as the period of public sector mutual funds (PMFs). From
one player in 1985 the number increased to 8 in 1993. The party did not last long. When the
private sector made its debut in 1993-94, the stock market was booming.

The opening up of the asset management business to private sector in 1993 saw international
players like Morgan Stanley, Jardine Fleming, JP Morgan, George Soros and Capital
International along with the host of domestic players join the party. But for the equity funds, the
period of 1994-96 was one of the worst in the history of Indian Mutual Funds.
1999-2000 Year of the funds

Mutual funds have been around for a long period of time to be precise for 36 yrs but the year
1999 saw immense future potential and developments in this sector. This year signaled the year
of resurgence of mutual funds and the regaining of investor confidence in these MFs. This time
around all the participants are involved in the revival of the funds ----- the AMCs, the unit holders,
the other related parties. However the sole factor that gave lifr to the revival of the funds was the
Union Budget. The budget brought about a large number of changes in one stroke. An insight of
the Union Budget on mutual funds taxation benefits is provided later.

It provided centrestage to the mutual funds, made them more attractive and provides acceptability
among the investors. The Union Budget exempted mutual fund dividend given out by equity-
oriented schemes from tax, both at the hands of the investor as well as the mutual fund. No
longer were the mutual funds interested in selling the concept of mutual funds they wanted to talk
business which would mean to increase asset base, and to get asset base and investor base they
had to be fully armed with a whole lot of schemes for every investor .So new schemes for new
IPOs were inevitable. The quest to attract investors extended beyond just new schemes. The
funds started to regulate themselves and were all out on winning the trust and confidence of the
investors under the aegis of the Association of Mutual Funds of India (AMFI)

One cam say that the industry is moving from infancy to adolescence, the industry is maturing
and the investors and funds are frankly and openly discussing difficulties opportunities and
compulsions.

Future Scenario

Future Scenario

The asset base will continue to grow at an annual rate of about 30 to 35 % over the next few
years as investors shift their assets from banks and other traditional avenues. Some of the older
public and private sector players will either close shop or be taken over.

Out of ten public sector players five will sell out, close down or merge with stronger players in
three to four years. In the private sector this trend has already started with two mergers and one
takeover. Here too some of them will down their shutters in the near future to come.

But this does not mean there is no room for other players. The market will witness a flurry of new
players entering the arena. There will be a large number of offers from various asset
management companies in the time to come. Some big names like Fidelity, Principal, Old Mutual
etc. are looking at Indian market seriously. One important reason for it is that most major players
already have presence here and hence these big names would hardly like to get left behind.

The mutual fund industry is awaiting the introduction of derivatives in India as this would enable it
to hedge its risk and this in turn would be reflected in its Net Asset Value (NAV).

SEBI is working out the norms for enabling the existing mutual fund schemes to trade in
derivatives. Importantly, many market players have called on the Regulator to initiate the process
immediately, so that the mutual funds can implement the changes that are required to trade in
Derivatives.

May the Net Asset Values grow!!

 Market Trends

A lone UTI with just one scheme in 1964, now competes with as many as 400 odd products and
34 players in the market. In spite of the stiff competition and losing market share, UTI still remains
a formidable force to reckon with.

Last six years have been the most turbulent as well as exiting ones for the industry. New players
have come in, while others have decided to close shop by either selling off or merging with
others. Product innovation is now pass with the game shifting to performance delivery in fund
management as well as service. Those directly associated with the fund management industry
like distributors, registrars and transfer agents, and even the regulators have become more
mature and responsible.

The industry is also having a profound impact on financial markets. While UTI has always been a
dominant player on the bourses as well as the debt markets, the new generation of private funds
which have gained substantial mass are now seen flexing their muscles. Fund managers, by their
selection criteria for stocks have forced corporate governance on the industry. By rewarding
honest and transparent management with higher valuations, a system of risk-reward has been
created where the corporate sector is more transparent then before.

Funds have shifted their focus to the recession free sectors like pharmaceuticals, FMCG and
technology sector. Funds performances are improving. Funds collection, which averaged at less
than Rs100bn per annum over five-year period spanning 1993-98 doubled to Rs210bn in 1998-
99. In the current year mobilization till now have exceeded Rs300bn. Total collection for the
current financial year ending March 2000 is expected to reach Rs450bn.

What is particularly noteworthy is that bulk of the mobilization has been by the private sector
mutual funds rather than public sector mutual funds. Indeed private MFs saw a net inflow of Rs.
7819.34 crore during the first nine months of the year as against a net inflow of Rs.604.40 crore
in the case of public sector funds.

Mutual funds are now also competing with commercial banks in the race for retail investors
savings and corporate float money. The power shift towards mutual funds has become obvious.
The coming few years will show that the traditional saving avenues are losing out in the current
scenario. Many investors are realizing that investments in savings accounts are as good as
locking up their deposits in a closet. The fund mobilization trend by mutual funds in the current
year indicates that money is going to mutual funds in a big way. The collection in the first half of
the financial year 1999-2000 matches the whole of 1998-99.

India is at the first stage of a revolution that has already peaked in the U.S. The U.S. boasts of an
Asset base that is much higher than its bank deposits. In India, mutual fund assets are not even
10% of the bank deposits, but this trend is beginning to change. Recent figures indicate that in
the first quarter of the current fiscal year mutual fund assets went up by 115% whereas bank
deposits rose by only 17%. (Source: Thinktank, The Financial Express September, 99) This is
forcing a large number of banks to adopt the concept of narrow banking wherein the deposits are
kept in Gilts and some other assets which improves liquidity and reduces risk. The basic fact lies
that banks cannot be ignored and they will not close down completely. Their role as
intermediaries cannot be ignored. It is just that Mutual Funds are going to change the way banks
do business in the future.
Banks v/s Mutual Funds

BANKS MUTUAL FUNDS

Returns Low Better
Administrative exp. High Low
Risk Low Moderate
Investment options Less More
Network High penetration Low but improving
Liquidity At a cost Better
Quality of assets Not transparent Transparent
Interest calculation Minimum balance between 10th. & 30th. Of every month Everyday
Guarantee Maximum Rs.1 lakh on deposits None

Global Scenario

Some basic facts-

The money market mutual fund segment has a total corpus of $ 1.48 trillion in the U.S.
against a corpus of $ 100 million in India.

Out of the top 10 mutual funds worldwide, eight are bank- sponsored. Only Fidelity and
Capital are non-bank mutual funds in this group.

In the U.S. the total number of schemes is higher than that of the listed companies while
in India we have just 277 schemes

Internationally, mutual funds are allowed to go short. In India fund managers do not have
such leeway.

In the U.S. about 9.7 million households will manage their assets on-line by the year
2003, such a facility is not yet of avail in India.

On- line trading is a great idea to reduce management expenses from the current 2 % of
total assets to about 0.75 % of the total assets.

72% of the core customer base of mutual funds in the top 50-broking firms in the U.S. are
expected to trade on-line by 2003.

(Source: The Financial Express September, 99)

Internationally, on- line investing continues its meteoric rise. Many have debated about the
success of e- commerce and its breakthroughs, but it is true that this aspect of technology could
and will change the way financial sectors function. However, mutual funds cannot be left far
behind. They have realized the potential of the Internet and are equipping themselves to perform
better.

In fact in advanced countries like the U.S.A, mutual funds buy- sell transactions have already
begun on the Net, while in India the Net is used as a source of Information.
Such changes could facilitate easy access, lower intermediation costs and better services for all.
A research agency that specializes in internet technology estimates that over the next four years
Mutual Fund Assets traded on- line will grow ten folds from $ 128 billion to $ 1,227 billion ;
whereas equity assets traded on-line will increase during the period from $ 246 billion to $ 1,561
billion. This will increase the share of mutual funds from 34% to 40% during the period.

(Source: The Financial Express September ,99)

Such increases in volumes are expected to bring about large changes in the way Mutual Funds
conduct their business.

Here are some of the basic changes that have taken place since the advent of the Net.

Lower Costs: Distribution of funds will fall in the online trading regime by 2003 . Mutual funds could bring
down their administrative costs to 0.75% if trading is done on- line. As per SEBI regulations , bond funds can
charge a maximum of 2.25% and equity funds can charge 2.5% as administrative fees. Therefore if the
administrative costs are low , the benefits are passed down and hence Mutual Funds are able to attract mire
investors and increase their asset base.

Better advice: Mutual funds could provide better advice to their investors through
the Net rather than through the traditional investment routes where there is an
additional channel to deal with the Brokers. Direct dealing with the fund could help
the investor with their financial planning.
In India , brokers could get more Net savvy than investors and could help the investors
with the knowledge through get from the Net.

New investors would prefer online : Mutual funds can target investors who are
young individuals and who are Net savvy, since servicing them would be easier on
the Net.
India has around 1.6 million net users who are prime target for these funds and this could
just be the beginning. The Internet users are going to increase dramatically and mutual
funds are going to be the best beneficiary. With smaller administrative costs more funds
would be mobilized .A fund manager must be ready to tackle the volatility and will have to
maintain sufficient amount of investments which are high liquidity and low yielding
investments to honor redemption.

Net based advertisements: There will be more sites involved in ads and promotion of
mutual funds. In the U.S. sites like AOL offer detailed research and financial details about
the functioning of different funds and their performance statistics. a is witnessing a
genesis in this area . There are many sites such as indiainfoline.com and indiafn.com that
are doing something similar and providing advice to investors regarding their
investments.

In the U.S. most mutual funds concentrate only on financial funds like equity and debt. Some like
real estate funds and commodity funds also take an exposure to physical assets. The latter type
of funds are preferred by corporates who want to hedge their exposure to the commodities they
deal with.

For instance, a cable manufacturer who needs 100 tons of Copper in the month of January could
buy an equivalent amount of copper by investing in a copper fund. For Example, Permanent
Portfolio Fund, a conservative U.S. based fund invests a fixed percentage of its corpus in Gold,
Silver, Swiss francs, specific stocks on various bourses around the world, short term and long-
term U.S. treasuries etc.

In U.S.A. apart from bullion funds there are copper funds, precious metal funds and real estate
funds (investing in real estate and other related assets as well.).In India, the Canada based
Dundee mutual fund is planning to launch a gold and a real estate fund before the year-end.

In developed countries like the U.S.A there are funds to satisfy everybodys requirement, but in
India only the tip of the iceberg has been explored. In the near future India too will concentrate on
financial as well as physical funds.

Mutual funds and the Budget 2000-2001

Important measures

Deletion of sections 54 EA and 54 EB of the Income Tax Act, 1961.
The above two sections provided relief from capital gains tax if investments were made in
specified securities and locked in for a period of 3 years in the case of 54EA and 7 years
in the case of 54EB. Mutual fund units were one of the specified securities and this
resulted in a lot of money realised as profit from sale of securities being reinvested in the
market through mutual funds.

With the withdrawal of the exemption to mutual funds, investors have lost out on a very
viable alternative for tax saving and funds also would be faced with the problem of hot
money as there would no longer be any lock in period for investments. It is estimated
that 54EA investments formed approximately 15% of the corpus.

Increase in dividend tax from 10% to 20% for debt funds.

The existing dividend tax payable by debt schemes has been doubled to 20%. This would lead to
a reduction in returns available to investors by approximately 1.5% from the average of
approximately 14%. This is expected to hurt retail investment in debt schemes and could lead to
a pull out and reduced mobilisation. Two implications of this move could be:

Reinvestment of dividends by investors; since capital gains would be taxed at a lower

rate as compared to dividend, investors would prefer to reinvest dividend and earn long-
term capital appreciation.
Switch over from debt to equity schemes; since open ended equity schemes are free
from paying dividend tax, these schemes could attract some of the investment that is
pulled out from debt schemes.

Instead of taxing debt schemes so as to bring parity between the banks and mutual funds, it is
widely felt that the finance minister could have simply extended some of the benefits enjoyed by
mutual funds to banks and FIs. The experience with mutual funds has in any case shown that
turning dividends tax free in the hands of investors has simply improved collections, widened the
tax base and reduced procedural delays. Regulatory Aspects

Schemes of a Mutual Fund

The asset management company shall launch no scheme unless the trustees approve
such scheme and a copy of the offer document has been filed with the Board.
 Every mutual fund shall along with the offer document of each scheme pay filing fees.

The offer document shall contain disclosures which are adequate in order to enable the
investors to make informed investment decision including the disclosure on maximum
investments proposed to be made by the scheme in the listed securities of the group
companies of the sponsor A close-ended scheme shall be fully redeemed at the end of
the maturity period. "Unless a majority of the unit holders otherwise decide for its rollover
by passing a resolution".
The mutual fund and asset management company shall be liable to refund the application
money to the applicants,-

(i) If the mutual fund fails to receive the minimum subscription

amount referred to in clause (a) of sub-regulation (1);

(ii) If the moneys received from the applicants for units are in
excess of subscription as referred to in clause (b) of sub-
regulation (1).

The asset management company shall issue to the applicant whose application has been
accepted, unit certificates or a statement of accounts specifying the number of units
allotted to the applicant as soon as possible but not later than six weeks from the date of
closure of the initial subscription list and or from the date of receipt of the request from
the unit holders in any open ended scheme.

Rules Regarding Advertisement:

The offer document and advertisement materials shall not be misleading or contain any
statement or opinion, which are incorrect or false.

Investment Objectives And Valuation Policies:

The price at which the units may be subscribed or sold and the price at which such units
may at any time be repurchased by the mutual fund shall be made available to the
investors.

General Obligations:

Every asset management company for each scheme shall keep and maintain proper
books of accounts, records and documents, for each scheme so as to explain its
transactions and to disclose at any point of time the financial position of each scheme
and in particular give a true and fair view of the state of affairs of the fund and intimate to
the Board the place where such books of accounts, records and documents are
maintained.

The financial year for all the schemes shall end as of March 31 of each year. Every
mutual fund or the asset management company shall prepare in respect of each financial
year an annual report and annual statement of accounts of the schemes and the fund as
specified in Eleventh Schedule.
Every mutual fund shall have the annual statement of accounts audited by an auditor who
is not in any way associated with the auditor of the asset management company.

Procedure For Action In Case Of Default:

 On and from the date of the suspension of the certificate or the approval, as the case
may be, the mutual fund, trustees or asset management company, shall cease to carry
on any activity as a mutual fund, trustee or asset management company, during the
period of suspension, and shall be subject to the directions of the Board with regard to
any records, documents, or securities that may be in its custody or control, relating to its
activities as mutual fund, trustees or asset management company.

Restrictions On Investments:

A mutual fund scheme shall not invest more than 15% of its NAV in debt instruments
issued by a single issuer, which are rated not below investment grade by a credit rating
agency authorized to carry out such activity under the Act. Such investment limit may be
extended to 20% of the NAV of the scheme with the prior approval of the Board of
Trustees and the Board of asset management company.
A mutual fund scheme shall not invest more than 10% of its NAV in unrated debt
instruments issued by a single issuer and the total investment in such instruments shall
not exceed 25% of the NAV of the scheme. All such investments shall be made with the
prior approval of the Board of Trustees and the Board of asset management company.
No mutual fund under all its schemes should own more than ten per cent of any
company's paid up capital carrying voting rights.
Such transfers are done at the prevailing market price for quoted instruments on spot
basis.
The securities so transferred shall be in conformity with the investment objective of the
scheme to which such transfer has been made.
A scheme may invest in another scheme under the same asset management company or
any other mutual fund without charging any fees, provided that aggregate interscheme
investment made by all schemes under the same management or in schemes under the
management of any other asset management company shall not exceed 5% of the net
asset value of the mutual fund.
The initial issue expenses in respect of any scheme may not exceed six per cent of the
funds raised under that scheme.
Every mutual fund shall buy and sell securities on the basis of deliveries and shall in all
cases of purchases, take delivery of relative securities and in all cases of sale, deliver the
securities and shall in no case put itself in a position whereby it
has to make short sale or carry forward transaction or engage in badla finance.
Every mutual fund shall, get the securities purchased or transferred in the name of the
mutual fund on account of the concerned scheme, wherever investments are intended to
be of long-term nature.
Pending deployment of funds of a scheme in securities in terms of investment objectives
of the scheme a mutual fund can invest the funds of the scheme in short term deposits of
scheduled commercial banks.
No mutual fund scheme shall make any investment in;

i. Any unlisted security of an associate or group company of the

sponsor; or
ii. Any security issued by way of private placement by an
associate or group company of the sponsor; or

The listed securities of group companies of the sponsor

which is in excess of 30% of the net assets [of all the
schemes of a mutual fund]
 No mutual fund scheme shall invest more than 10 per cent of its NAV in the equity shares
or equity related instruments of any company. Provided that, the limit of 10 per cent shall
not be applicable for investments in index fund or sector or industry specific scheme.
A mutual fund scheme shall not invest more than 5% of its NAV in the equity shares or
equity related investments in case of open-ended scheme and 10% of its NAV in case of
close-ended scheme.

Frequently Asked Questions

Why had mutual funds in India performed so poorly in the past?

Most investors associate mutual funds with Mastergain, Monthly Equity Plans of SBI Mutual
Fund, UTI and Canbank Mutual Fund and of course Morgan Stanley Growth Fund. This is so
because these funds truly had participation from masses, with a fund like Morgan Stanley having
more than 1 million investors. Investors feel that after 5 years, Morgan Stanley Growth Fund units
still trade below the original IPO price of Rs 10.

It is incorrect to think that all mutual funds have performed poorly. If one looks at some income
funds, they have come with reasonable returns. It is only the performance of equity funds, which
has been poor. Their poor performance has been amplified by the closed end discounts ie units
of these funds quoting at sharp discounts to their NAV resulting in an even poorer return to the
investor.

One must remember that a Mutual Fund does not provide assured returns and neither can it
"manufacture" returns out of thin air. Returns provided by mutual funds are a function of the
returns in the underlying asset class in which the fund invests. Good funds can beat returns in
their asset class to some extent but thats all. Eg take the case of a sector specific fund like a
pharma fund which invests only in shares of pharmaceutical companies. If the Govt. comes with
new regulation that severely restricts the pricing freedom of these companies resulting in negative
outlook for the sector, the prices of all stocks in the sector could fall substantially resulting in a
severe erosion in the NAV of the fund. No one can do anything about it. A good fund manager
would probably sell part of the fund before prices fall too much and wait for an opportune time to
reinvest at lower levels once the dust has settled. In that case, the NAV of the fund would fall to a
lesser extent but fall it will. If the investor in the fund has invested in some stocks in the sector
on his own, in all probability, his personal investments may have depreciated to a larger extent.

Let us extend this example to an analysis of the investment climate in the last 7 years. The stock
markets have done very badly in the last seven years. The BSE Sensex crossed 3000 for the first
time in early 1992. Since then it has gone up and come down several times but has remained in
the same range. Effectively, for a seven-year investment period, the total return has been almost
zero. The prices of many leading stocks of yesteryear have fallen by more than 50% in these
seven years. If one considers the fact that the Sensex has been changed several times, with all
the weak stocks having been weeded out, the effective returns on the old Sensex, existing in
1992, have been substantially negative. The following table gives some of the prices of stocks
considered "blue chips" in 1992, in 1994 and the prices prevailing at present.

Price in Rs

Name of the Company 1992 high 1994 high Current price

Tata Steel 552 336 114

Grasim Industries 650 793 234
Century Textiles 490 550 40
Raymond 250 263 65
Arvind Mills 353 290 9
ICICI 290 197 109

It is quite obvious that if a fund had invested in any of these shares in 1992 or subsequently in the
1994 boom, and if it remained invested in the share, then it would be confronting a huge fall in
NAV. This is exactly what had happened.

A similar table for prices of shares of Public Sector Undertakings (PSUs) is given below.

Price in Rs

Name of the Company 1994 high Present price

MTNL 325 161

HPCL 550 130
SAIL 83 6

Most mutual fund managers took some time to realize the changed circumstances wherein the
open economy ushered in by the liberalization took the full impact of the global deflation in
commodity prices. This problem was compounded further by the Asian crisis after which cheap
imports from Asia caused severe pressure on profits.

To add to this, most funds had invested some part of their portfolio in medium sized "growth"
companies. Many of these companies have performed even worse than bigger ones and quite a
few have seen share prices dip more than 90% from their 1994 highs. More important, funds
could not sell these shares because of complete lack of liquidity with, at best, few hundred shares
being traded every day.

Meanwhile, shares of companies in sectors like consumer goods (FMCG) and software, were
showing good growth and they went up rapidly in price. Most fund managers were unwilling to sell
shares of erstwhile "blue chips" at low prices and buy shares of emerging "blue chips" at high
prices. This resulted in poor performance and negative returns.

One more issue is that the fund managers in many funds were not "professionally qualified and
experienced". This is especially true of some of the funds floated by nationalized banks. Some of
these individuals were transferred from the parent organization and did not really know much
about investment management.

Lastly, investors would do well to have a look at the investments, which they made on their own.
In most cases, they would have done much worse than the mutual funds. We have received
numerous requests for advice from individual investors on what to do about their own
investments. If that were any indicator, investors would have done really badly.

Is it true that globally mutual funds underperform benchmark indices? Why are smart
money managers unable to do as well as the market? Or is it that they are not smart at all?
What are the limitations of mutual funds?

It is 100% true that globally, most mutual fund managers underperform the asset class that they
are investing in, over the very long-term. It is not true that the fund managers are dumb; this
under performance is largely the result of limitations inherent in the concept of mutual funds.
These limitations are as follows:
Entry and exit costs: Mutual funds are a victim of their own success. When a large body
like a fund invests in shares, the concentrated buying or selling often results in adverse
price movements ie at the time of buying, the fund ends up paying a higher price and while
selling it realizes a lower price. This problem is especially severe in emerging markets like
India, where, excluding a few stocks, even the stocks in the Sensex are not liquid, let alone
stocks in the NSE 50 or the CRISIL 500. So, there is simply no way that a fund can beat the
Sensex or any other index, if it blindly invests in the same stocks as those in the Sensex
and in the same proportion. For obvious reasons, this problem is even more severe for
funds investing in small capitalization stocks. However, given the large size of the debt
market, excluding UTI, most debt funds do not face this problem

Wait time before investment: It takes time for a mutual fund to invest money.
Unfortunately, most mutual funds receive money when markets are in a boom phase and
investors are willing to try out mutual funds. Since it is difficult to invest all funds in one
day, there is some money waiting to be invested. Further, there may be a time lag before
investment opportunities are identified. This ensures that the fund underperforms the
index. For open-ended funds, there is the added problem of perpetually keeping some
money in liquid assets to meet redemptions. The problem of impracticability of quick
investments is likely to be reduced to some extent with the introduction of index futures.

Fund management costs: The costs of the fund management process are deducted from
the fund. This includes marketing and initial costs deducted at the time of entry itself,
called "load". Then there is the annual asset management fee and expenses, together
called the expense ratio. Usually, the former is not counted while measuring performance,
while the latter is. A standard 2% expense ratio means that, everything else being equal,
the fund manager underperforms the benchmark index by an equal amount.

Cost of churn: The portfolio of a fund does not remain constant. The extent to which the
portfolio changes is a function of the style of the individual fund manager ie whether he is
a buy and hold type of manager or one who aggressively churns the fund. It is also
dependent on the volatility of the fund size ie whether the fund constantly receives fresh
subscriptions and redemptions. Such portfolio changes have associated costs of
brokerage, custody fees, registration fees etc. which lowers the portfolio return
commensurately.

Change of index composition: World over, the indices keep changing to reflect changing
market conditions. There is an inherent survivorship bias in this process, with the bad
stocks weeded out and replaced by emerging blue chips. This is a severe problem in India
with the Sensex having been changed twice in the last 5 years, with each change being
quite substantial. Another reason for change index composition is Mergers &
Acquisitions. The weightage of the shares of a particular company in the index changes if
it acquires a large company not a part of the index.

Tendency to take conformist decisions: From the above points, it is quite clear that the
only way a fund can beat the index is through investment of some part of its portfolio in
some shares where it gets excellent returns, much more than the index. This will pull up
the overall average return. In order to obtain such exceptional returns, the fund manager
has to take a strong view and invest in some uncommon or unfancied investment options.
Most people are unwilling to do that. They follow the principle "No fund manager ever got
fired for investing in Hindustan Lever" ie if something goes wrong with an unusual
investment, the fund manager will be questioned but if anything goes wrong with the blue
chip, then you can always blame it on the "environment" or "uncontrollable factors"
knowing fully well that there are many other fund managers who have made the same
decision. Unfortunately, if the fund manager does the same thing as several others of his
class, chances are that he will produce average results. This does not mean that if a fund
manager takes "active" views and invests in heavily researched "uncommon" ideas, the
fund will necessarily outperform the index. If the idea does not work, it will result in poor
fund performance. But if no such view is taken, there is absolutely no chance that the fund
will outperform the index.

Should an investor invest in a mutual fund despite its limitations or no?

Yes. Investor should invest some part or their investment portfolio in mutual funds. In fact some
investors may be better off by putting their entire portfolio in mutual funds. This is on account of
the following reasons:

On their own, uninformed investors could perform much worse than mutual funds.
Diversification of risks which is difficult for an investor to achieve with the small amount of
funds at his disposal
Possibility of investing in small amounts as and when the investor has funds to invest
Unquestioned service of transaction processing, tracking of investments, collecting
dividends/interest warrants etc.
Debt funds in India offer exposure to a diversified portfolio of bonds/debentures, which is
possible, only if the investor is investing millions of rupees. Further, they offer easy
liquidity and tax benefits. Debt funds thus offer a great proposition that is impossible for
ordinary investors to replicate on their own. This proposition compares favorably against
competing investments like small savings.
Investors require analytical capability and access to research and information and need
to spend an enormous amount of time to make investment decisions and keep monitoring
them. Some people have the inclination and the time to make better decisions than fund
managers do, but the vast majority does not. Those who can are advised to invest some
part of their money into funds, especially debt funds, to diversify their risk. They may also
note that one of the objectives of this site is to help them improve the odds in their favor.

Are mutual funds safe? Are returns on mutual funds guaranteed by Government of India,
or Reserve Bank or any other government body?

Any mutual fund is as safe or unsafe as the assets that it invests in. There are two basic
categories of mutual funds with others being variations or mixtures of these. Firstly, there are
those that invest purely in equity shares (called equity funds or " growth funds") and secondly,
there are those that invest purely in bonds, debentures and other interest bearing instruments
called "income" or "debt" funds. The NAV of growth funds fluctuates in line with the fluctuation of
the shares held by them. They can also witness face substantial erosion in value, which could be
permanent in some cases. On the other hand, prices of debt instruments fluctuate to a much
lesser degree and an income fund is extremely unlikely to face erosion in value especially of the
permanent kind.

Most mutual funds have qualified and experienced personnel, who understand the risks of
investing. But, nobody is immune from making mistakes. However, funds diversify the investment
portfolio substantially so that default in any single investment (in the case of an income fund) will
not affect the overall performance of a fund in a significant manner. In the event of default of a
part of the portfolio, an income fund is extremely unlikely to face erosion in face value.

Generally, mutual funds are not guaranteed by anybody. However, in the Indian context, some of
the mutual funds have floated "guaranteed" or "assured" return schemes which guarantee a
certain annual return or guarantee a buyback at a specified price after some time. Examples of
these include funds floated by the UTI, Canbank Mutual Fund, SBI Mutual Fund, LIC Mutual Fund
etc. Many of these funds have not earned returns that they promised and the asset management
companies of the respective mutual funds or their sponsors have made good their promises. The
biggest case pertains to the US 64, which never guaranteed any returns but is being bailed out by
the Government due to the millions of individuals who have invested in it.

Can the foreign mutual funds operating in India take investors money outside the country?

A mutual fund and the company that manages it are 2 entirely different companies. Legally
speaking, a mutual fund is a trust formed and registered under the Indian Trust Act. The sponsor
asset management company is formally appointed by the trustees of the trust to manage money
on their behalf eg DSP Merrill Lynch equity fund is a mutual benefit trust registered under the
Indian Trust Act. The trustees have appointed DSP Merrill Lynch Asset Management Company
Pvt. Ltd. to manage the funds in the trust and the company cannot touch one rupee from the trust
except to the extent of the fees that it receives for managing the funds.

Repatriation of money outside India comes under the purview of the Foreign Exchange
Regulation Act, 1973 which specifies the situations in which money can be remitted outside India.
Under the act, banks that repatriate money on behalf of their clients have to ensure compliance
with various legal formalities and ensure that the entity, which remits money, is entitled to do so.
Any failure or violation leads to serious consequences for both the remitter and the bank. Money
collected by a mutual fund domestically is not allowed to be remitted outside India. However, with
the repeal of FERA, 1973, regulations are likely to be eased.

Is mutual funds outperformance always good?

Mutual fund performance of index may not always be a positive indicator. In several cases one
notices that the funds performance is very lop sided and is driven by few scrips. In other words
the fund manager has taken significantly higher risks and in the game of probability he would
have made more money. But it is very likely that if his call had not been right, he would have
under performed and lost badly. From an investors point of view, when he is looking at such out-
performances in the past, he cannot derive confidence and comfort in the fund managers' ability
to repeat the performance in future. As markets are not rational, there is no methodology in the
world to scientifically predict stock prices. Therefore it is not possible for anyone to beat the
market on a consistent basis and hence there is no guarantee that the fund manager would
perform well all the while.

How does one see through the marketing hype given out by mutual funds?

It is amazing how fund marketers can come up with statistics to show how their particular fund
has done extremely well. Standard techniques include the following:

Defined period returns: Some period is depicted in which the particular fund outperformed
others or some benchmark. One should look very carefully at start and end dates they
can always be chosen in a way that shows the fund in a favorable light

Outperformance vs performance: Sustained periods of low absolute performance are a

cause for concern. It is all right to look at relative returns with respect to benchmark
indices; but there is no sense if a particular fund produces absolute returns less than the
deposit interest rates, even after a few years of existence.

Promise of long term performance: Lack of performance is often explained away as

temporary with promises of good performance in the long term. Few define what this "long
term" is 1 or 2 or 5 or 10 years. Do not forget that the longer the period, the longer is the
uncertainty in between in other words, would you want to wait for 10 years to get an
uncertain 2% higher returns as compared to the certain returns that you get in say the
Public Provident Fund.
Rupee cost averaging: This is a term that has found its way into the marketing literature of
all mutual funds. What it means is that if you put in a fixed amount of money every month
in a fund, then, in months when the NAV is low, the investor gets more units which
benefits him when the NAV rises. Do not forget the implicit assumption behind this that
the NAV will rise eventually. If it does not, you are no better off than by not buying.

Equities are the best bet in the long run: Ask this to any investor who put money in the
Sensex in 1992. After a long run of 7 years, the investor is down on his investment by 50%.
He would have been better off by investing in other avenues.

What went wrong with US64?

Basically, for a period of 2-3 years, the UTI distributed more dividend to the unitholders of US 64
than the return earned from the investments in the scheme. This reduced the value of the residual
investments in the scheme. This problem was compounded by the persistent fall in the prices of
shares, especially the shares of companies in basic commodity industries like cement, steel,
manmade fibres etc. and shares of public sector units. Throughout this period, when the NAV of
US 64 was going down, UTI kept increasing the sale and repurchase prices of US 64 units. The
stock market collapse after the Pokhran II nuclear tests was the last straw, which resulted in the
erosion of the schemes book reserves and a wide difference between the actual NAV and the
sale/repurchase price.

When this became known, it set a panic amongst investors of US 64. Many people felt that if
there were large-scale redemptions, UTI would not be able to meet them without support of
outside bodies like the RBI. Further, theoretically, if all investors wanted to redeem their US 64
units on the same day, the US 64 simply did not have the money to meet the redemptions on its
own (due to the difference between NAV and the repurchase price).

What went wrong with Morgan Stanley?

Morgan Stanley raised large corpus (more than Rs10bn) in around early 1994. The entire
exercise in fund raising was centered on the hype of the fund being the first fund promoted by an
internationally acclaimed asset management company. It was marketed like any other public
issue and fund investors rushed to invest in the scheme hoping to get superior returns. No one
bothered to explain to them that Morgan Stanley AMC was a service provider - providing them the
service of investment advice and management. No one explained to them that they were not
investing in a share of a company in fact the artificial gray market premium served to perpetrate
this feeling.

The IPO was a great success. It ensured that the name "Morgan Stanley" was now a part of the
dreams of more than 1 million Indians.

The fund raising exercise, unfortunately, coincided with the peak of stock market boom. Indian
stock markets lack depth and are quite illiquid. The fund managers were compelled to invest in
equities in a big hurry as a number of Foreign Institutional Investors were investing huge sums of
money in the country resulting in a mad rush for equity stocks. The funds managers invested a
considerable amount of money in smaller companies with low floating stock and low market
capitalization, either through the secondary market or through private placements. These
companies had experienced the highest appreciation in prices in the immediate past.

The market position started changing from late 1994. The boom in the market made it possible for
many companies to raise equity capital and literally hundreds of public/rights issues opened for
subscriptions every week, many of them at high issue prices. There were also massive private
placements of equity shares and GDR issues at huge premiums. There were very few companies
which did not wash their hands in this great gravy train. This deluge of paper soaked up money
and reduced the amount available for fresh investment both from resident Indians, domestic
mutual funds and from foreign institutional investors.

At this time, the RBI commenced on its tight money policy in a bid to control inflation from raising
its head. Money supply tightened and bond yields started increasing dramatically. High industrial
growth and tight money created a shortage for credit and rates started going sky high. Many
corporates and banks started redeeming their holdings in the Unit Trust of India and other mutual
funds. This put major pressure on the market, which was already showing signs of weakness.
What followed was the great crash.

And in this crash, the biggest losers were the smaller capitalization stocks. Many of these stocks
lost more than 90% of their peak prices.

Morgan Stanley AMC restructured the funds portfolio at big losses.

As the NAV went below par, investors confidence was shattered. Being a closed-ended scheme
the Morgan Stanleys mutual fund unit is also listed on the stock markets. Crisis of confidence led
to its price on the stock exchange crashing and it started quoting at a steep discount to its NAV.
The fund started buying back units in order to reduce the discount and also to boost the NAV
(buying back units at prices below the NAV results in a profit, which will reduce the NAV). Given
its large corpus size no amount of buy back or otherwise support could help boost the investor
confidence.

Since then the equity markets have gone nowhere with the index still below the level at which the
fund was invested. Most of the stocks in the Sensex have performed poorly with markets
punishing commodity companies and companies with non-transparent Indian managements. To
top it, many erstwhile bluechips have reported disastrous financial performances.

Consequently, the NAV of MSGF mirrors this gory saga of the Indian markets. In fact, the fund
invested considerable amount of money in FMCG, pharmaceutical and software companies at the
right time which improved the NAV from 1998 onwards.

How important is an AMC (Asset Management Company) behind a mutual fund?

AMC controls the operations and functioning of a mutual fund. It is very critical to the performance
of a mutual fund as it decides on the style of functioning, people who are going to manage the
funds, the commitment to service quality and overall supervision.

The financial strength and the commitment of the AMC sponsors to the business are very key
issues. This is because most AMCs lose money in the first few years of operations. In most
cases, these losses are much more than the capital requirements stipulated by SEBI. Hence, a
sponsor which is financially weak or which cannot capital to the business either because of its
inability or unwillingness will result in an unhealthy operation. There will be a tendency to cut
corners and unwillingness to spend money to expand operations. This is the last place where
high quality persons would want to remain and work. The AMC then remains stunted and the
sponsors lose interest. The worst affected are the investors. This is exactly what has happened
with some AMCs promoted by Indian business houses.

This is also a problem that has afflicted some of the AMCs floated by nationalized banks. In these
organizations, the traditional thinking is prevalent which can be summarized as "money is power".
Since mutual fund business did not have access to too much money, a posting in the AMC
became punishment postings for some personnel who were not doing well in the parent
organization or who lost out in the organizational politics. The management of the banks also did
not allow these AMCs to become independent viable businesses. The CEOs of the AMCs did not
have any clue of the mutual fund business and neither were they interested in it the entire effort
was spent in getting a posting back in the parent. The fund managers had no experience in the
activity making a mockery of "professional management". The sad results are there to see. Some
of the parents had to provide funds to bridge the gap in "assured return schemes". It looks
extremely likely that some of these AMCs will no longer exist in a few years.

How and against what should you benchmark the performance of a mutual fund?

All mutual funds have different objectives and therefore their performance would vary. A mutual
funds performance should be benchmarked against mutual funds of similar type or India infoline
mutual fund index for a particular type. eg equity fund index, income fund index or balanced fund
index or liquid fund index. One can also benchmark the fund against the Sensex or any other
broadbased index for the particular asset class.

One has to be very careful about choosing the comparison period. Ideally, one should compare
the performance of equity or an index fund over a 1-2 year horizon. Any comparison over a
shorter period would be distorted by short term, volatile price movements. Comparisons over a
longer period need to be interpreted carefully by looking at other factors such as change in
individuals managing the fund, one time investment successes etc. Similarly, the ideal
comparison period for a debt fund would be 6-12 months while that for a liquid/money market
fund would be 1-3 months. Apart from the entire period, one should also compare the
performance in smaller intervals within the same period say intervals of one month duration.

To make comparison meaningful, one has to compare the average annual compounded rate of
return. This adjusts for comparisons of differing period and also facilitates comparison across
different classes. The return also incorporates dividend payouts. Thus, for example, one can say
that ABC income fund has given a compounded annual growth rate (CAGR) of 13% p.a. including
dividends in the last 2 years while XYZ income fund has given a CAGR of 13.2% p.a. over the
last 3 years.

Apart from NAV, what other parameters can be compared across different funds of the
same category?

Apart from plain numerical comparison of NAVs, several other things can be checked, eg
correlation of changes in NAV with changes in portfolio composition and
appreciation/depreciation in valuation of individual items, increase in the size of the corpus etc. In
debt funds, it is useful to compare the extent to which the growth in NAV comes from interest
income and from changes in valuation of illiquid assets like bonds and debentures. It is also
useful to compare expense ratios of funds eg Birla Income Plus has an expense ratio of 1.7%
which is one of the lowest expense ratios of all income funds in the industry this means that,
everything else being equal, the performance of that fund will be higher by 0.55% than other
funds, which have an expense ratio of 2.25%. Last, but not the least, one has to compare the risk
profile of two funds. For income funds, this could mean credit quality of the portfolio and the
fluctuations in the NAV with periodic changes in the interest rate environment. For equity funds, it
could mean the volatility of the NAV with the ups and downs in the market or the percentage
exposure to smaller company shares etc.

How different are styles of different mutual funds?

Different mutual funds have very different investing styles. These styles are a function of the
individuals managing the fund with the overall investment objectives and policies of the
organization acting as a constraint. These are manifest in things like
Portfolio turnover Buy and hold strategy versus frequent investment changes

Kind of investments made small versus large companies, multi baggers (investments
which yield high gains) versus percentage players (investing in shares which will give
small gains in line with the market), high quality low yield bonds versus low quality
high yield bonds

Asset allocations Varying percentage of cash depending on aggressive views on

markets

The following examples serve to illustrate a few styles of equity fund managers

Some fund managers are passive value seekers and some are value creators. The former type
buys undervalued assets and patiently waits for the market to discover the value. The latter
aggressively promote the undervalued stocks that they have bought.

Some fund managers restrict themselves to liquid stocks while some thrive on illiquid stocks
which offer themselves easily to large price changes.

Some fund managers are masters of the momentum game and seek to buy stocks that are in
market fancy. They attach lesser importance to fundamentals and believe that a rising stock price
and favorable momentum indicators imply that fundamentals are changing. In effect, they are
following the philosophy, " The trend is my friend". Other fund managers go more by deep
fundamental analysis completely ignoring price movements. They do not mind price going down
and are in fact happy to buy more.

Some fund managers are growth investors ie they buy stocks with a high P/E using the
forecasted growth to justify the high valuation. Others are value investors who buy shares with
low P/E or P/BV multiples - typically companies rich with undervalued assets.

When you buy a mutual fund unit what exactly do you buy?

When you buy a mutual fund unit you are buying a part of the equity or debt portfolio owned by
the mutual fund. In other words you are buying a part ownership of various companies and when
you buy a debt mutual fund you are buying a part right to title to debt securities. In other words
you step into the shoes of owners or lenders indirectly. The value of your part of the assets will
fluctuate in line with the value of the individual components of the portfolio on the stock or the
bond market.

In effect, you are buying a bundle of services as follows:

Investment management which means investment advice and execution rolled into one

Diversification of investment risk buying a larger basket of securities reduces the overall
risk of investment

Asset custody which means registration and physical custody of assets, ensuring
corporate actions like payment of dividend and interest, bonus, rights entitlements etc

Portfolio information which means calculating and disseminating ownership information

like NAV, assets owned, etc on a periodic basis

Liquidity Ability to speedily disinvest assets and obtain disinvestment proceeds

The mutual fund exploits economies of scale in research, execution and transaction processing to
provide the first three services at low costs. The pooling of money makes it possible to offer the
fourth service (since all investors are unlikely to exit at the same time). In addition, one also gets
benefits like special tax concessions.

What you do not get is a guaranteed way of making money. There is no way that a mutual fund
can insulate the investor from the vagaries of the market place and ensure that he always makes
money. In addition, one is implicitly taking the risk of bad service quality in any of the four
elements above including investment management.

What are load and no-load funds? Why are loads charged?

Some asset management companies (AMCs) levy service charges for allowing subscribers entry
into/exit from mutual fund schemes. The service charge is termed as entry/exit load and such
schemes are called "load" schemes. In contrast, funds for which no entry/exit charge is levied are
called no-load funds.

The load is levied to cover the up-front cost incurred by the AMC in the process of marketing and
selling the fund and other one-time transaction processing costs.

Why is the buy and sell price different for some mutual fund units and same for others?

Buying and selling prices are different for those mutual funds which have up front sales charges
or entry loads. Usually, the selling price is the NAV while the buying price incorporates the service
charge or the load. In case the fund is a no-load fund, there is no difference between the buying
and selling prices. We have a detailed section on the characteristics of all mutual fund schemes,
which tells you the exact load charged by respective funds.

Where can one obtain information on the market price of specific mutual fund units?

Buying and selling prices for units of open-ended mutual funds are declared every day. You can
obtain this information on our website. Check out the section on mutual funds.

Most closed-ended mutual funds are listed on the stock exchanges. The trading volume in some
of the widely held mutual fund units is considerable. The latest NAV and market price information
of closed-ended mutual funds is available on our website.

All the above information is also available on the stock market page of popular newspapers.

Why do returns from debt/income mutual funds fluctuate from period to period despite
them being invested in fixed interest instruments?

The returns differ from year to year on account of the following reasons:

An income fund invests in instruments from which it earns two kinds of returns The first comes
from interest income. The second comes from any increase in the market price of invested
instruments. The second component could also be negative when there is a fall in the market
value of the invested instruments. The rise and fall in market prices of debt instruments is a
function of the prevailing interest rates. Thus changes in interest rate environment cause
fluctuations in returns.

Secondly, income mutual funds invest in an array of instruments with different maturity.
Whenever any debt instrument in which the fund has invested is redeemed, the redemption
proceeds have to be reinvested in a fresh instrument(s). This fresh investment would earn a rate
of return depending on the prevailing interest rate which could be higher or lower than that
prevailing in the earlier period. Accordingly, the overall return of the portfolio will change.

A third reason can be active view taking by the fund manager eg a fund manager can take a view
that interest rates are expected to rise. Accordingly, he would disinvest a large part of his
holdings and convert them into cash so as to avoid loss in the value of his holdings. If this view is
wrong, he may end up having a low return on a large part of his portfolio, since cash is invested in
low yielding money market avenues. On the other hand, if the view is right, the cash can be
deployed in higher yielding instruments after interest rates rise, thus improving the overall return
and more important avoiding the loss.

There is a fourth reason, which is relevant only for open-ended income funds. Such funds have a
fluctuating level of idle cash (depending on the level of fresh collections) which is typically
invested in low yielding money market instruments. This causes change in the rate of return.

Lastly, there is always the possibility of a credit loss for any income mutual fund ie losses arising
out of default in any of the instruments in which the fund has invested. The fund will declare a low
return in the period in which such losses show up.

What are the risks associated in investing in income mutual funds and how should one
find out about these?

Income funds invest in a diversified portfolio of debt instruments which provide interest income.
There is a possibility that some of these instruments are of low credit quality and the issuers of
these instruments default in the payment of interest or principal. Such losses, called "credit
losses", constitute an area of risk for income funds. The process of diversification mitigates this
risk ie by the fund investing in a number of debt instruments. However, it should be noted that the
funds returns could be eroded considerably if even 10% of the investments have credit quality
problems. Also, the problem can be accentuated for investors who are investing for a short period
if the losses show up in a particular period resulting in a short term decline in NAV. Investors can
check the credit quality of the investment portfolio, which is published by most funds on a
quarterly basis.

The second area of risks comes from the fluctuations in the prices of the underlying instruments
in which the fund invests. Any rise in interest rates will result in a fall in the value of the
investments causing a dip in the NAV. The fall in value is maximum for longer dated instruments
and negligible for short dated instruments. Hence, the risk is higher in a fund that has an
investment portfolio with a higher average maturity. This can again be checked from the
investment portfolio, which is published by the funds.

Even if interest rates rise by 2-3%, the fall in NAV for most mutual funds is unlikely to exceed 5%.
Similarly, a portfolio with as high as 10% of poor quality instruments will result in a fall in NAV by
10%. Regular interest income will take care of the losses in a few months. Thus, there is unlikely
to be permanent erosion of capital in most reasonable circumstances. Hence, debt or income
funds have a much lower risk than equity funds, which can have permanent erosion in value.

Todays environment is characterized by a deep industrial recession and consequent high level of
defaults on loans provided by banking sector to industry. In such a scenario, it may be prudent to
look at the credit quality aspect very carefully before investing in an income mutual fund.

What are the tax benefits available for investing in mutual funds?

The tax benefits for investing in mutual funds are as follows:

Twenty percent of the amount invested in specified mutual funds (called equity linked savings
schemes or ELSS and loosely referred to as "tax savings schemes") is deductible from the tax
payable by the investor in a particular year subject to a maximum of Rs2000 per investor. This
benefit is available under section 88 of the I.T. Act.

Investment of the entire proceeds obtained from the sale of capital assets for a period of three
years or investment of only the profits for a period of 7 years, exempts the asset holder from
paying capital gains tax. This benefit is available under section 54EA and 54EB of the I.T. Act,
provided the capital asset has been sold prior to April 1, 2000 and the amount is invested before
September 30, 2000.

The mutual fund is completely exempt from paying taxes on dividends/interest/capital gains
earned by it. While this is a benefit to the fund, it is the indirect benefit of unitholders as well. This
benefit is available to the mutual fund under section 10 (23D) of the I.T. Act.

A mutual fund has to pay a withholding tax of 10% on the dividends distributed by it under the
revised provisions of the I.T. Act putting them on par with corporates. However, if a mutual fund
has invested more than 50% of its assets into equity shares, then it is exempt from paying any tax
on the dividend distributed by it, for a period of three years, by an overriding provision. This
benefit is available under section 115R of the I.T. Act.

The investor in a mutual fund is exempt from paying any tax on the dividend received by him from
the mutual fund, irrespective of the type of the mutual fund. This benefit is available under section
10(33) of the I.T. Act.

The units of mutual funds are treated as capital assets and the investor has to pay capital gains
tax on the sale proceeds of mutual fund units sold by him. For investments held for less than one
year the tax is equal to 30% of the capital gain. For investments held for more than one year, the
tax is equal to 10% of the capital gains. The investor is entitled to indexation benefit while
computing capital gains tax. Thus if a typical growth scheme of an income fund shows a rise of
12% in the NAV after one year and the investor sells it, he will pay a 10% tax on the selling price
less cost price and indexation component. This reduces the incidence of tax considerably. This
concession is available under section 48 of the I.T. Act. The following calculations show this in
more detail:

Purchase NAV = Rs 10

Sale NAV = Rs 11.2

Indexation component = 8%

Capital gains = 11.2 10(1.08)

= 11.2 10.8

= 0.4

Capital gains tax = 0.4*0.1 = 0.04.

If an investor buys a fresh unit in the closing days of March and sells it in the first week of April of
the following year, he is entitled to indexation benefit for two financial years which close in the two
March ending periods. This is termed as double indexation and lowers the tax even further
especially for income funds. In the above example, the calculation would be as follows:
Capital gains = 11.2 10(1.08)(1.08)

= 11.2 11.7

= -0.5

Thus there would be no capital gains tax.

Glossary

Advisor

The organization employed by a mutual fund to give professional advice on the fund's
investments and to supervise the management of its assets.

Asked or Offering Price

The price at which a mutual fund's shares can be purchased. The asked or offering price means
the current net asset value (NAV) per share plus sales charge, if any. For a no-load fund, the
asked price is the same as the NAV.

Asset Allocation Fund

A fund that spreads its portfolio among a wide variety of investments, including domestic and
foreign stocks and bonds, government securities, gold bullion and real estate stocks. This gives
small investors far more diversification than they could get allocating money on their own. Some
of these funds keep the proportions allocated between different sectors relatively constant, while
others alter the mix as market conditions change.

Automatic Reinvestment

A service offered by most mutual funds whereby income dividends and capital gain distributions
are automatically invested into the fund by buying additional shares and thus building up holdings
through the effects of compounding.

Balanced Fund

A mutual fund that maintains a balanced portfolio, generally 60% bonds or preferred stocks and
40% common stocks.

Bid or Sell Price

The price at which a mutual fund's shares are redeemed (bought back) by the fund. The bid or
redemption price means the current net asset value per share, less any redemption fee or back-
end load.

Bond Fund
A mutual fund whose portfolio consists primarily of corporate or Government bonds. These funds
generally emphasize income rather than growth.

Bond Rating

System of evaluating the probability of whether a bond issuer will default. Various firms analyze
the financial stability of both corporate and government bond issuers. Ratings range from AAA or
Aaa (extremely unlikely to default) to D (currently in default). Bonds rated BBB or below are not
considered to be of investment grade. Mutual funds generally restrict their bond purchases to
issues of certain quality ratings, which are specified in their prospectuses.

Capital Appreciation Fund

A mutual fund that seeks maximum capital appreciation through the use of investment techniques
involving greater than ordinary risk, such as borrowing money in order to provide leverage, short-
selling and high portfolio turnover.

Capital Gains Distributions

Payments (usually annually) to mutual fund shareholders of gains realized on the sale of portfolio
securities.

Capital Growth

A rise in market value of a mutual fund's securities, reflected in its net asset value per share. This
is a specific long-term objective of many mutual funds.

Certificate of Deposit

Interest-bearing, short-term debt instrument issued by banks and thrifts.

Closed-End Investment Company

An investment company that offers a limited number of shares. They are traded in the securities
markets, usually through brokers. Price is determined by supply and demand. Unlike open-end
investment companies (mutual funds), closed-end funds do not redeem their shares.

Commercial Paper

Short-term, unsecured promissory notes with maturities no longer than 270 days. They are issued
by corporations, to fund short-term credit needs.

Common Stock Fund

An open-end investment company whose holdings consist mainly of common stocks and usually
emphasize growth.

Confirm Date

The date the fund processed your transaction, typically the same day or the day after your trade
date.
Contingent Deferred Sales Charge (CDSC)

A fee (or back-end load) imposed by certain funds on shares redeemed within a specific period
following their purchase. These charges are usually assessed on a sliding scale, such as four
percent to one percent of the amounts redeemed, with the fee reduced each year the units are
held.

Custodian

The bank or trust company that maintains a mutual fund's assets, including its portfolio of
securities or some record of them. Provides safekeeping of securities but has no role in portfolio
management.

-------------------------

Daily Dividend Fund

This term applies to funds that declare their income dividends on a daily basis and reinvest or
distribute monthly.

Deferred Compensation Plan

A tax-sheltered investment plan to which employees of state and local governments can defer a
percentage of their salary.

Distributor

An individual or a corporation serving as principal underwriter of a mutual fund's shares, buying

shares directly from the fund, and reselling them to other investors.

Diversification

The policy of spreading investments among a range of different securities to reduce the risks
inherent in investing.

Rupee-Cost Averaging

The technique of investing a fixed sum at regular intervals regardless of stock market
movements. This reduces average share costs to the investor, who acquires more shares in
periods of lower securities prices and fewer shares in periods of high prices. In this way, investing
risk is spread over time.

------------

Exchange Privilege (Or switching privilege)

The right to transfer investments from one fund into another, generally within the same fund
group, at nominal cost.

Ex-Dividend Date
The date on which a fund's Net Asset Value (NAV) will fall by an amount equal to the dividend
and/or capital gains distribution (although market movements may alter the fund's closing NAV
somewhat). Most publications which list closing NAVs place an "X" after a fund name on its ex-
dividend date.

Expense Ratio

The ratio of total expenses to net assets of the fund. Expenses include management fees, the
cost of shareholder mailings and other administrative expenses. The ratio is listed in a fund's
prospectus. Expense ratios may be a function of a fund's size rather than of its success in
controlling expenses.

--------------------------

Fiscal Year

An accounting period consisting of 12 consecutive months.

-------------------

Global Fund

A fund that invests in both Indian. and foreign securities.

Growth Fund

A mutual fund whose primary investment objective is long-term growth of capital. It invests
principally in common stocks with significant growth potential.

Income Dividend

Payment of interest and dividends earned on the fund's portfolio securities after operating
expenses are deducted.

Income Fund

A mutual fund that primarily seeks current income rather than growth of capital. It will tend to
invest in stocks and bonds that normally pay high dividends and interest.

Index Fund

A mutual fund that seeks to mirror general stock-market performance by matching its portfolio to
a broad-based index, most often the S&P CNX Nifty index.

International Fund

A fund that invests in securities traded in markets outside India.

Investment Company
A corporation, partnership or trust that invests the pooled monies of many investors. It provides
greater professional management and diversification of investments than most investors can
obtain independently. Mutual funds, or "open-end" investment companies, are the most popular
form of investment company.

Investment Objective

The financial goal (long-term growth, current income, etc.) that an investor or a mutual fund
pursues.

---------------------------

Junk Bond

A speculative bond rated BB or below."Junk bonds" are generally issued by corporations of

questionable financial strength or without proven track records. They tend to be more volatile and
higher yielding than bonds with superior quality ratings. "Junk bond funds" emphasize diversified
investments in these low-rated, high-yielding debt issues.

-----------------------

Load
A sales charge or commission assessed by certain mutual funds ("load funds,") to cover
their selling costs. The commission is generally stated as a portion of the fund's offering
price, usually on a sliding scale from one to 8.5%.

Load Fund

A mutual fund that levies a sales charge up to 6%, which is included in the offering price of its
shares, and is sold by a broker or salesman. A front-end load is the fee charged when buying into
a fund; a back-end load is the fee charged when getting out of a fund.

Low-Load Fund

A mutual fund that charges a small sales commission, usually 3.5% or less, for the purchase of its
shares.

-------------------

Management Fee

The amount a mutual fund pays to its investment adviser for services rendered, including
management of the fund's portfolio. In general, this fee ranges from .5% to 1% of the fund's asset
value.

Money Market Fund

A mutual fund that aims to pay money market interest rates. This is accomplished by investing in
safe, highly liquid securities, including bank certificates of deposit, commercial paper, government
securities and repurchase agreements. Money Market funds make these high interest securities
available to the average investor seeking immediate income and high investment safety.

Mutual Fund
An open-end investment company that buys back or redeems its shares at current net asset
value. Most mutual funds continuously offer new shares to investors.

--------------------------

Net Asset Value Per Share

The current market worth of a mutual fund share. Calculated daily by taking the funds total assets
securities, cash and any accrued earnings deducting liabilities, and dividing the remainder by the
number of shares outstanding.

No-Load Fund

A commission-free mutual fund that sells its shares at net asset value, either directly to the public
or through an affiliated distributor, without the addition of a sales charge.

----------------------------

Payable Date

The date on which distributions are paid to shareholders who do not want to reinvest them. This
date can be anywhere from one week to one month after the Record Date.

Payroll Deduction Plan

An arrangement between an employer and a mutual fund, authorized by the employee, through
which a specified sum is deducted from an employee's salary to buy shares in the fund.

Portfolio Turnover Rate

The rate at which the fund's portfolio securities are changed each year. If a fund's assets total
Rs100mn and the fund bought and sold Rs100mn worth of securities that year, its portfolio
turnover rate would be 100%. Aggressively managed funds generally have higher portfolio
turnover rates than do conservative funds that invest for the long term. High portfolio turnover
rates generally add to the expenses of a fund.

Prospectus

An official document that each investment company must publish, describing the mutual fund and
offering its shares for sale. It contains information required by the Securities and Exchange
Commission.

-----------------------

Record Date

The date the fund determines who its shareholders are; "shareholders of record" who will receive
the fund's income dividend and/or net capital gains distribution. Frequently the business day
immediately prior to the Ex-Dividend Date.

Redemption Fee
A fee charged by a limited number of funds for redeeming, or buying back, fund shares.

Redemption Price

The price at which a mutual fund's shares are redeemed (bought back) by the less expensive
fund. The redemption price is usually equal to the current net asset value per share.

Regional Fund

A mutual fund that concentrates its investments within a specific geographic area, usually the
fund's local region. The objective is to take advantage of regional growth potential before the
national investment community does.

Reinvestment Date (Payable Date)

The date on which a share's dividend and/or capital gains will be reinvested (if requested) in
additional fund shares.

Reinvestment Privilege

A service that most mutual funds offer whereby a shareholder's income dividends and capital
gains distributions are automatically reinvested in additional shares.

----------------------------

Sector Fund

A fund that operates several specialized industry sector portfolios under one umbrella. Transfers
between the various portfolios can usually be executed by telephone at little or no cost.

Short Selling

The sale of a security which is not owned by the seller. The "short seller" borrows stock for
delivery to the buyer, and must eventually purchase the security for return to the lender.

Specialty Fund

A mutual fund specializing in the securities of a particular industry or group of industries or special
types of securities.

Systematic Investment Plans

In case of Systematic Investment Plans, instead of a lump sum amount, investor invests a pre-
specified amount in a scheme at pre-specified intervals at the then prevailing NAV.

Systematic Withdrawal Plans

Many mutual funds offer withdrawal programs whereby shareholders receive payments from their
investments. These payments are usually drawn from the funds dividend income and capital gain
distributions, if any, and from principal only when necessary.

Underwriter
The organization that acts as the distributor of a mutual fund's shares to broker/dealers and the
public.

--------------------------

Variable Annuity

A type of insurance contract that guarantees future payments to the holder, or annuitant, usually
at retirement. The annuity's value varies with that of the underlying portfolio securities, which may
include mutual fund shares. All monies held in the annuity accumulate tax-deferred.

Voluntary Plan

A flexible plan for capital accumulation, involving no specified time frame or total sum to be
invested.

Yield

Income or return received from an investment, usually expressed as a percentage of market

price, over a designated period. For a mutual fund, yield is interest or dividend before any gain or
loss in the price per share.

------------------------------

Zero Coupon Bond

Bond sold at a fraction of its face value. It appreciates gradually, but no periodic interest
payments are made. Earnings accumulate until maturity, when the bond is redeemable at full face
value. Nonetheless, interest is taxable as it accrues.

List Of Books:

Investment Policy and Performance of Mutual Funds

M.Jayadev

Mutual Funds Management and Working

Lalitb K. Bansal

Mutual Funds a Comprehensive Approach

Dr. Peeush Rajan Agrawal

Working at Mutual Fund Organization in India

P. Mohana Rao
 How Mutual Funds Work

A. J. Friedman & Russ Wiles

The Future of Fund Management in India

Tushar Waghmare

Mutual Funds in India

S. Krishnamurti

New provision introduced to prevent dividend stripping

A new provision has been introduced to bring into tax ambit the notional short term capital loss
booked by investors on mutual funds. As per this provision, any investor who acquires mutual
fund units before 3 months prior to the dividend record /distribution date and sells or transfers
these units within a period of three months after the record date and obtains dividend income that
is exempt from tax, then the capital loss arising from the such purchase and sale will be ignored
to the extent of the amount received as tax free dividend.

This will help the interests of the long term investors in mutual fund units as it is expected to
considerably reduce the sharp short term movement of funds into open ended equity oriented
st
mutual funds. However as the provisions are applicable with effect from 1 April 2001, this will
lead to large cases of dividend declaration by mutual funds in equity schemes in March 2001.
st
Investors have a last chance to undertake dividend stripping by 31 March 2001 to claim short
term capital loss tax benefits before the new provisions become applicable.

Decrease in dividend distribution tax to 10.2% from 22.4% for Debt/Income
st
schemes with effect from 1 June 2001

Dividend tax payable by Debt/Income mutual fund schemes has been reduced to an effective rate
st
of 10.2% from 22.4% inclusive of surcharge with effect from 1 June 2001.

This move is expected to lead to greater flows into dividend option of the income schemes. This
is because earlier long term capital gains tax rate was 11.2% (without indexation). This lead to
investors preferring growth option as effective tax was lower. However as the difference in the net
returns (adjusted for taxation) is now marginal, investors will now move to dividend option.

Reduction in capital gains tax

The budget has removed the surcharge chargeable to income tax. Thus,

- Short tem capital gains tax rate will now be 30.6% against 35.1% earlier.
- Long term capital gains tax rate (with indexation benefits) will now be 20.4% compared to
22.4% earlier.
- Long term capital gains tax rate (without indexation benefits) will now be 10.2% compared
to 11.2% earlier.

Exemption from long term capital gains tax for investment in primary market
issues

The long term capital gains made on sale of mutual funds will be exempt from capital gains
provided the capital gains are invested in primary market issues that are open for public
subscription and are not sold within one year from the date of acquisition.

Income arising on transfer of mutual fund or units of UTI in secondary market to be
taxable retrospectively

The Budget has amended Section 10(33) of the IT Act whereby any income arising from transfer
of units of UTI or mutual fund by unit holders to persons other than UTI or mutual fund will be
st
taxed. This provisions are applicable with retrospective effect from 1 April 1999.

This clarificatory amendment has been introduced to avoid misuse of the Income tax provisions
whereby capital gains on transfer of mutual fund and UTI units in secondary market was claimed
as exemption by investors.

Other provisions affecting the mutual fund industry

Cut in the small savings interest rate by 1.50%.

Deductions available for interest income under Section 80L maintained at Rs12000 of
which Rs3000 will be exclusively available for interest received from government
securities.
TDS limit for interest income exceeding Rs5000 will now be applicable for all categories
of deposits (including deposits made with financial institutions)
Measures for strengthening the debt market as under:

- Setting up of a clearing corporation for orderly development of money market

(including repo), government
securities market
- Setting up of an electronic Negotiated Dealing System to facilitate transparent
electronic bidding in auctions and
dealings in Government securities on a real time basis.
- Introduction of Electronic Fund Transfer and Real Time Gross Settlement
Systems by RBI.

This measures are expected to lead to shift in investor preference to debt/income based mutual
funds due to higher returns (net of taxes) available to the investors. Government Securities based
mutual funds will be major beneficiary by the reforms undertaken in the debt market.