Mutual Funds

The investment companies collect the money from different investor and invest that money in different securities.
The investment in those securities collections is called mutual funds investment.

A mutual fund is a financial intermediary that pools the savings of investors for collective investment in a diversified
portfolio of securities. A fund is “mutual” as all of its returns, minus its expenses, are shared by the fund’s investors.

The Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 defines a mutual fund as a ‘a fund
established in the form of a trust to raise money through the sale of units to the public or a section of the public under
one or more schemes for investing in securities, including money market instruments’. According to the above
definition, a mutual fund in India can raise resources through sale of units to the public. It can be set up in the form
of a Trust under the Indian Trust Act.

Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in
securities in accordance with objectives as disclosed in offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced.
Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the
same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them.
Investors of mutual funds are known as unitholders.

The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come
out with a number of schemes with different investment objectives which are launched from time to time. A mutual
fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities
markets before it can collect funds from the public.
History of Mutual Funds
The origin of pooled investing concept dates back to the late 1700s in Europe, when "a Dutch merchant and broker
invited subscriptions from investors to form a trust to provide an opportunity to diversify for small investors with
limited means."

Unit Trust of India was the first mutual fund set up in India in the year 1963. In early 1990s, Government allowed
public sector banks and institutions to set up mutual funds.

In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of SEBI are - to
protect the interest of investors in securities and to promote the development of and to regulate the securities
market.
As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the interest
of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by
private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have
been amended thereafter from time to time. SEBI has also issued guidelines to the mutual funds from time to time to
protect the interests of investors.

All mutual funds whether promoted by public sector or private sector entities including those promoted by foreign
entities are governed by the same set of Regulations. There is no distinction in regulatory requirements for these
mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes
launched by the mutual funds sponsored by these entities are of similar type. It may be mentioned here that Unit
Trust of India (UTI) is not registered with SEBI as a mutual fund (as on January 15, 2002).

The objective then was to attract small investors and introduce them to market investments. Since then, the history
of mutual funds in India can be broadly divided into six distinct phases.

Phase I (1964-87): Growth Of UTI:

In 1963, UTI was established by an Act of Parliament. As it was the only entity offering mutual funds in India, it had a
monopoly. Operationally, UTI was set up by the Reserve Bank of India (RBI), but was later delinked from the RBI.
The first scheme, and for long one of the largest launched by UTI, was Unit Scheme 1964.

Later in the 1970s and 80s, UTI started innovating and offering different schemes to suit the needs of different
classes of investors. Unit Linked Insurance Plan (ULIP) was launched in 1971. The first Indian offshore fund, India
Fund was launched in August 1986. In absolute terms, the investible funds corpus of UTI was about Rs 600 crores in
1984. By 1987-88, the assets under management (AUM) of UTI had grown 10 times to Rs 6,700 crores.

Phase II (1987-93): Entry of Public Sector Funds:

The year 1987 marked the entry of other public sector mutual funds. With the opening up of the economy, many
public sector banks and institutions were allowed to establish mutual funds. The State Bank of India established the
first non-UTI Mutual Fund, SBI Mutual Fund in November 1987.

This was followed by Canbank Mutual Fund,LIC Mutual Fund, Indian Bank Mutual Fund, Bank of India Mutual
Fund, GIC Mutual Fund and PNB Mutual Fund. From 1987-88 to 1992-93, the AUM increased from Rs 6,700 crores
to Rs 47,004 crores, nearly seven times. During this period, investors showed a marked interest in mutual funds,
allocating a larger part of their savings to investments in the funds.

Phase III (1993-96): Emergence of Private Funds:

A new era in the mutual fund industry began in 1993 with the permission granted for the entry of private sector
funds. This gave the Indian investors a broader choice of 'fund families' and increasing competition to the existing
public sector funds. Quite significantly foreign fund management companies were also allowed to operate mutual
funds, most of them coming into India through their joint ventures with Indian promoters.

The private funds have brought in with them latest product innovations, investment management techniques and
investor-servicing technologies. During the year 1993-94, five private sector fund houses launched their schemes
followed by six others in 1994-95.

Phase IV (1996-99): Growth And SEBI Regulation:

Since 1996, the mutual fund industry scaled newer heights in terms of mobilization of funds and number of players.
Deregulation and liberalization of the Indian economy had introduced competition and provided impetus to the
growth of the industry.

A comprehensive set of regulations for all mutual funds operating in India was introduced with SEBI (Mutual Fund)
Regulations, 1996. These regulations set uniform standards for all funds. Erstwhile UTI voluntarily adopted SEBI
guidelines for its new schemes. Similarly, the budget of the Union government in 1999 took a big step in exempting
all mutual fund dividends from income tax in the hands of the investors. During this phase, both SEBI and
Association of Mutual Funds of India (AMFI) launched Investor Awareness Programme aimed at educating the
investors about investing through MFs.

Phase V (1999-2004): Emergence of a Large and Uniform Industry:

The year 1999 marked the beginning of a new phase in the history of the mutual fund industry in India, a phase of
significant growth in terms of both amount mobilized from investors and assets under management. In February
2003, the UTI Act was repealed. UTI no longer has a special legal status as a trust established by an act of
Parliament. Instead it has adopted the same structure as any other fund in India - a trust and an AMC.

UTI Mutual Fund is the present name of the erstwhile Unit Trust of India (UTI). While UTI functioned under a
separate law of the Indian Parliament earlier, UTI Mutual Fund is now under the SEBI's (Mutual Funds) Regulations,
1996 like all other mutual funds in India.

The emergence of a uniform industry with the same structure, operations and regulations make it easier for
distributors and investors to deal with any fund house. Between 1999 and 2005 the size of the industry has doubled
in terms of AUM which have gone from above Rs 68,000 crores to over Rs 1,50,000 crores.

Phase VI (From 2004 Onwards): Consolidation and Growth:

The industry has lately witnessed a spate of mergers and acquisitions, most recent ones being the acquisition of
schemes of Allianz Mutual Fund by Birla Sun Life, PNB Mutual Fund by Principal, among others. At the same time,
more international players continue to enter India including Fidelity, one of the largest funds in the world.

Types Of Mutual Funds

By Structure

 Open Ended

These are schemes that do not have a fixed maturity. The mutual fund ensures liquidity by announcing sale and
repurchase price for the unit of an open-ended fund.

These funds buy and sell units on a continuous basis and, hence, allow investors to enter and exit as per their
convenience. The units can be purchased and sold even after the initial offering (NFO) period (in case of new funds).
The units are bought and sold at the net asset value (NAV) declared by the fund.

 Closed Ended

These are schemes that have a fixed maturity. The money of the investor is locked in for the period. Occasionally,
closed-end schemes provide a re-purchase option to the investors, either for a specified period or after a specified
period. Liquidity in these schemes is provided through listing in a stock market; however this option is not yet
available in India.

The unit capital of closed-ended funds is fixed and they sell a specific number of units. Unlike in open-ended funds,
investors cannot buy the units of a closed-ended fund after its NFO period is over. This means that new investors
cannot enter, nor can existing investors exit till the term of the scheme ends. However, to provide a platform for
investors to exit before the term, the fund houses list their closed-ended schemes on a stock exchange.

 Interval Schemes
These combine the features of open-ended and close-ended schemes. They may be traded on the stock exchange or
may be open for sale or redemption during predetermined intervals at NAV related prices.

Schemes according to Investment Objective:

A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its investment
objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be
classified mainly as follows:

Growth / Equity Oriented Scheme

The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally
invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide
different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an
option depending on their preferences. The investors must indicate the option in the application form. The mutual
funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a
long-term outlook seeking appreciation over a period of time.

Income / Debt Oriented Scheme

The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed
income securities such as bonds, corporate debentures, Government securities and money market instruments. Such
funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity
markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are
affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to
increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

Balanced Fund
The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and
fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors
looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also
affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be
less volatile compared to pure equity funds.

Different Constituents of Mutual Funds in

India
Sponsor: The sponsor is akin to a promoter of a company as he gets the mutual fund registered with Sebi. The
sponsor is defined under Sebi regulations as a person who, acting alone or in combination with another body
corporate, establishes a mutual fund. The sponsor forms a trust, appoints the board of trustees, and has the right to
appoint the asset management companyNSE 0.00 % (AMC) or fund manager.

In accordance with SEBI Regulations, the sponsor forms a trust and appoints a Board of Trustees, and also generally
appoints an AMC as fund manager. In addition, the sponsor also appoints a custodian to hold the fund assets. The
sponsor must contribute at least 40% of the net worth of the AMC and possess a sound financial track record over
five years prior to registration.

For example ICICI Bank and Purdential Plc are sponsors for ICICI Mutual Fund. For Birla Sun Life Mutual Fund,
Aditya Birla Financial Services and Sun Life (India) AMC Investments Inc. are sponsors.

The Sponsor:

 Sponsor is defined under the SEBI regulations as any person who, acting alone or in combination with
another body corporate, establishes a mutual fund.
 Sponsor is the promoter of the fund.
 Sponsor could be a bank, a corporate or a financial institution.
 Sponsors then form Trust and appoint Board of Trustees.
 The sponsor also appoints Custodian.
 As per SEBI regulations, sponsor must contribute at least 40% of the net worth of the AMC and possess a
sound financial track record over five years prior to registration.
 Sponsor signs the trust deed with the trustees.
 Sponsor creates the AMC and the trustee company and appoints the board of directors of companies, with
SEBI approval.
 Sponsor should have at least a 5 year track record in the financial services business and should have made
profit in at least 3 out of the 5 years.
 The AMC’s capital is contributed by the sponsor.
 Sponsor should contribute at least 40% of the capital of the AMC.

Trustee – The main role of a trustee is to ensure that the interest of the unit holders is protected while making sure
that the mutual fund complies with all the regulations of SEBI. Either, the sponsor should appoint four trustees or
establish a trustee company with at least four independent directors. Additionally, at least two thirds of the trustees
or the directors should be independent not associated with the sponsor in any way.
The Trustees:

 A mutual fund in India is form as Trust under Indian Trust Act, 1882.
 The trust-mf is managed by Board of Trustees.
 The board of Directors i.e. Trustees do not manage the portfolio of securities directly rather they appoint
as AMC (Asset Management Company)
 Trustees ensure that fund is managed by stated objective and as per SEBI regulations.
 Trusts always work for the interest of unit holders.
 The trust is created through a document called Trust Deed that is executed by sponsor in favors of
Trustees.
 The Trustees being the primary guardians of unit holder’s funds and assets.
 Trustees must ensure that the investor’s interests are safeguarded and that the AMC operations are as per
regulation laid down by SEBI.
 SEBI mandates a minimum of 2/3rd independent directors on the board of the trustee company.
 Trustees are appointed by the sponsor with SEBI approval.
 Trustees are required to meet at least 4 times a yea to review the AMC.
 The trustees make sure that the funds are managed according to the investor’s mandate.

The trustees being the primary guardians of the unit holder’s funds and assets, a trustee has to be a person of high
repute and integrity. The trustees, however, do not directly manage the portfolio of securities. The portfolio is
managed by the AMC as per the defined objectives, in accordance with Trust Deed and SEBI (Mutual Funds)
Regulations.

Asset Management Company: The AMC is appointed by trustees for managing fund schemes and corpus. An AMC
functions under the supervision of its own board of directors and also under the directions of trustees and Sebi.

The market regulator has mandated the limit of independent directors to ensure independence in AMC
workings. The major obligations of AMC include: ensuring investments in accordance with the trust deed, providing
information to unit holders on matters that substantially affect their interests, adhering to risk management
guidelines as given by the Association of Mutual Funds in India and Sebi, timely disclosures to unit holders on sale
and repurchase, NAV, portfolio details, etc.

For example; HDFC AMC is the Asset Management Company for HDFC Mutual Fund.

Custodian – The custodian has the custody of the all the shares and various other securities bought by the AMC.
The custodian is responsible for the safe keeping of all the securities. The custodian is liable for keeping the
investment account of the mutual fund.

The fund management includes buying and selling of securities in large volumes. Therefore, keeping a track of such
transactions is a specialist function. The custodian is appointed by trustees for safekeeping of physical securities
while dematerialised securities holdings are held in a depository through a depository participant. The custodian and
depositories work under the instructions of the AMC, although under the overall direction of trustees.

Advantages of Mutual Funds

Let us first look at the advantages of mutual funds:

1. Diversification
To diversify is to reduce risk. For example, let’s say you buy milk from one milkman. If someday he falls ill, you won’t
have any milk to drink! On the other hand, let’s say you buy milk from two milkmen. If one milkman falls ill, you’ll
still have milk from the other milkman. The chance of both the milkmen falling ill at the same time is very low. This is
why diversification is so important in investing.
Investing requires in depth research and analysis which usually takes a long period of time. Often, people do not have
so much time. Mutual funds are managed by fund managers who invest money in a manner that allows
diversification.
The advantage of mutual funds is that diversification is automatically done. Instead of buying shares, bonds, and
other investments on your own, you outsource the task to an expert. Thus, your investments are diversified without
you having spent too much time and effort.

2. Professional Management
Investing is obviously not an easy task. Investing, be it in shares, real estate, gold, bonds, and so on depends on a
multitude of factors that constantly need to be studied and understood. Many people often think they can understand
the markets. A great percentage of these people end up making losses.
The advantage of mutual funds is that they are managed by qualified and professional experts. Thus, to ensure your
money is invested in the right places, you only have to choose the right mutual fund. That is much easier than
constantly monitoring investments.
Once invested in a mutual fund, you can relax with the knowledge that an expert will make necessary changes to the
portfolio whenever required.
This isn’t to say that you shouldn’t review your investments in mutual funds. You definitely should, but not too often.
If you’ve chosen your mutual fund carefully, reviewing it once a year is usually enough.

3. Simplicity
When investing, the availability of information and data is particularly time-consuming. If all information would be
easily available, investing would be much simpler.
Investing in mutual funds is much easier and simpler. The research and information collection is done by the mutual
funds themselves. All you have to do then is analyse the performance of mutual funds.
Mutual fund dealers allow you to compare the funds based on metrics such as level of risk, return, and price. Because
the information is easily accessible, you, the investor, is able to make wise decisions.

4. Liquidity
Of all others, one of the advantages of mutual funds that is often overlooked is liquidity. In financial jargon, liquidity
basically refers to the ability of being able to convert your assets to cash with relative ease.
Consider this: if you own a house and need cash, how long would it take for you to sell the house and get cash in
hand? It could take anywhere from a few weeks to a few months.
Mutual funds are considered liquid assets since there is high demand for many of the funds in the marketplace. Since
this is the case, you can retrieve money from a mutual fund very quickly. Usually, in about two days.

5. Costs
Mutual funds are one of the best investment options considering the costs involved. If you hire a portfolio
management service, you’ll typically be charged 2% to 3% of your total investments per year. They will also take a
share from your profits.
Mutual funds are relatively cheaper with 1% to 2% of expense ratios. Debts funds have an even lesser expense.

6. Tax Efficiency
Mutual funds are relatively more tax-efficient than other types of investments. Long-term capital gain tax on equity
mutual funds is zero. That means if you sell your investments one year after purchase, you pay no tax.
For debt funds, long-term capital gains apply when you hold them for 3 years. Apart from this, there are a certain
class of funds, called ELSS funds, that are exempt under section 80c up to a limit of Rs 1.5L. Some important
features of tax saving funds:
1. Surrogate route to direct stock markets
2. Minimum investment is Rs 500 per month
3. Only 3-year lock-in period
 4. Tax benefits under 80C up to 1.5 lac
5. The returns are tax-free too
6. Highest expected returns.

7. Selection of Mutual Funds

Mutual Funds come with different types – this allows investors to invest in particular type depending on your goals.
Depending on you goals, you can choose the appropriate category to invest in. Here are some examples
1. For parking money for very short term, you can invest in liquid funds like Kotak Floater Short Term
2. For investing for short-term duration like 1 to 3 years, you can invest in Ultra Short Term Funds (example –
Franklin India Low Duration Fund) or Short Term Funds (example – HDFC Short Term Opportunities Fund)
3. For Tax saving, there are tax saving funds as we discussed in the previous section.
4. For Long-term investing there are equity funds. In equity funds also, one can choose from high-risk funds like
mid cap and small cap funds to relatively less risky funds like large cap and diversified funds
5. For people who want to take a middle approach, there are balanced funds. Example – HDFC Balanced Fund.

8. You can start with very small amounts

Unlike other investments like real estate or investing directly in stocks, mutual funds allow you to start as small as Rs
500. One can start with mutual funds with as low as Rs 500 or Rs 1000. Some funds, like Reliance Small Cap Fund
allow you to start with just Rs 100.

9. Automated investments
Because of our human behavior, we can easily fall prey to our laziness or emotions (fear and greed). Mutual funds
allow us to set automated investing to make way. One can start automated investments in mutual funds with any
paperwork.

10. Safe and transparent

Investing in mutual funds is very transparent. All mutual funds companies come under the purview of SEBI and they
need to make necessary disclosures. All the stocks they hold are known to you. The historical performance is all out
in public. Fund managers qualification and track record are known. The NAV (net asset value) of the fund is updated
every day. On any mutual fund page on Groww – you can look at all the details about the mutual fund.
Mutual funds investments are also very safe as the transaction happens in a very transparent way. Also when you
redeem, money goes directly into your bank account, hence no chance of someone hacking into your account.

11. Option to choose SIP or Lumpsum

Mutual funds also give you the flexibility to invest through SIP (systematic investment plan) or through lump sum.

12. Match Your Style

If you have more knowledge about certain industries or sectors, but don’t have enough expertise to know which
companies to invest in, you can make use of sector mutual funds. By doing so, you are ensuring your money gets
invested in a certain industry without having to research which companies to invest in.
Sector mutual funds stick to investing primarily in a certain sector only. Some common types of sector mutual funds
are mining funds, energy funds, automobile funds, etc.

Disadvantages of Mutual Funds

 Management Fees. Mutual fund companies have to pay salaries and marketing expenses and they always
get paid FIRST before the investors/owners get paid! Management fees are one of the key metrics to watch out for as
an investor because they can quickly and devilishly eat into your profits over time. Do higher management fees
correlate to higher returns and better performance? As it turns out, the answer is NO. In fact, many studies have been
done that show higher fees generally correlate to lower performance.
The fees that are charged will depend on the type of mutual fund purchased. If a fund is riskier and more aggressive,
the management fee will tend to be higher. In addition, the investor will also be required to pay taxes, transaction
fees as well as other costs related to maintaining the fund.

2. Dilution
This is one of the most prominent of all disadvantages of mutual funds. Diversification has an averaging effect on
your investments. While diversification saves you from suffering any major losses, it also prevents you from making
any major gains! Thus, major gains get diluted.
This is exactly why it is recommended that you do not invest in too many mutual funds. Mutual funds are themselves
diversifying investments. Therefore buying many mutual funds in the name of diversifying only further dilutes your
gains.

Locked in Clause. There are two different mutual fund structures - one allows you to go in and
out at any time. The other one is locked in for 5-7 years. With this one, if you try to take your money
out earlier, you’ll get charged for it. Make sure to ask your financial advisor which type you are
investing in.

Mutual Fund Charges.

Mutual funds charge fees when you redeem your money. There are also “operating expense” fees. This is a percentage
of what it costs to run the fund. Let’s say you invested $10,000, and the operating fees are 2%. This means that you
are effectively paying $200 every year in operating charges.

Unpredictable
Although expected returns will be quoted, it is impossible to find a mutual fund with a guaranteed return. This is
because all assets carry some degree of risk. However, some mutual funds will carry a higher level of risk than others
depending on how well it is diversified.

Wasted Cash. Because people occasionally want to withdraw their mutual funds, there must always be funds
available - in cash - for payouts. When money’s in cash, it’s not collecting interest. Since this comes from a portion of
the investment funds, it means it doesn’t collect any interest for you. That amount of cash is better off sitting in your
bank account.

Tax Inefficiency
Like it or not, investors do not have a choice when it comes to capital gain payouts in mutual funds. Due to the
turnover, redemptions, gains and losses in security holdings throughout the year, investors typically receive
distributions from the fund that are an uncontrollable tax event.