MUTUAL FUNDS

Investors investing in securities market desires to earn maximum return for a given level of
risk. But they do not have expertise or they are not professionally qualified to undertake
investment analysis. Also sometimes there investment amount is so small that the investment
analysis is not worthwhile. In such a case investors can go for indirect investment instead of
investing directly. An indirect form of investing in securities market is mutual fund.

Meaning of mutual fund

Mutual fund is a single, large, and professionally managed investment organization that pools
the savings of individual investors and after making proper study of the market and the
companies invest it in corporate securities. The returns generated out of such investments
after charging the fees of portfolio managers are distributed among the investors. The
securities and exchange board of India defines a mutual fund as “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.
A mutual fund serves as a link between the investors and the securities market by mobilizing
the savings from the investors and investing them in the securities market to generate returns.
Mutual funds offers an opportunity to invest in a diversified portfolio in spite of having less
funds, service of good research team along with transparency therefore it is a most suitable
form of investment for a common man.

Open ended mutual fund schemes

An open ended mutual fund is one that continuously offers to sell and repurchase its units at
net assets value. The maturity period of these schemes are not specified. An investor can buy
or sell units at NAV which are declared on a daily basis. Thus these funds provide investors a
freedom to enter and exit from the scheme at any time during the life of the fund. Since these
schemes have perpetual succession and flexible corpus, these schemes provide instant
liquidity to the investors. Unlike close ended schemes, these schemes do not have to be listed
on the stock exchange rather they are transacted by the mutual fund themselves.

The fluctuation in stock price causes the purchase price and sales price of these funds to
change daily. Therefore when there is bearish in the stock market, the NAV of these schemes
decreases and the transactions of buying and selling can be done at low price and vice a
versa. The corpus of these schemes are not fixed and goes on increasing or decreasing
depending upon the redemption and purchase of the units by the investors.

Close ended mutual fund schemes

Close ended mutual fund schemes have a fixed corpus, stipulated maturity period and a
specified subscription period. They are like any other company operating in an industry. The
investors are allowed to investor in close ended schemes, when it is launched and that too up
to the specified date. Once the initial subscription is over, the units of these schemes are listed
on the stock exchange. As the units are listed on the stock exchange it provides liquidity to
the investors. The shares of close ended schemes are often sells at discount because from the
point of view of the investor’s close ended schemes are more risky as compared to the open
ended schemes. It is worthwhile for an investor to make investment in close ended scheme
only when the discount is very high.

STRUCRURE OF MUTUAL FUND

Regulation 2 (d) asset management company‖ means a company formed and registered
under the Companies Act, 2013 and approved as such by the Board under sub- regulation (2)
of regulation 21

2 (q) mutual fund means a fund established in the form of a trust to raise monies
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 or gold or
gold related instruments or real estate assets.

Regulation 2 (x) sponsor means any person who, acting alone or in combination with
another body corporate, establishes a mutual fund;

2 (y) trustees mean the Board of Trustees or the Trustee Company who hold the
property of the Mutual Fund in trust for the benefit of the unit holders;

Mutual Funds in India follow a 3-tier structure. There is a sponsor (the First tier), who thinks
of starting a mutual fund. The Sponsor approaches to the Securities & Exchange Board of
India (SEBI), which grants its permission for establishing mutual funds. As per SEBI
regulation everyone cannot start a mutual fund. “SEBI checks whether the person is of
integrity, whether he has enough experience in the financial sector, his net worth etc. Once
SEBI is convinced, the sponsor creates a public trust (the Second tier) as per the Indian
Trusts Act, 1882. Trusts have no legal identity in India and cannot enter into contracts, hence
the Trustees are the people authorized to act on behalf of the Trust. Contracts are entered into
in the name of the Trustees. Once the Trust is created, it is registered with SEBI after which
this trust is known as the mutual fund. It is important to understand the difference between
the Sponsor and the Trust. They are two separate entities. Sponsor is not the Trust; i.e.
Sponsor is not the Mutual Fund. It is the Trust which is the Mutual Fund. The Trustees role is
not to manage the money.” The job trustee is only to see, whether the investor’s money is
being managed as per stated objectives. So we can say that the Trustees are the internal
regulators of a mutual fund company.

Section 7 of the SEBI (Mutual Funds) Regulations, 1996

Eligibility criteria

As the mutual funds involve in managing small investor’s money, therefore it becomes
important to ensure that it is carried by the entities and person which have capabilities and
professional merits. SEBI (Mutual fund) Regulations, 1996 specifies the following eligibility
criteria in this regard: (i) Sponsor is required to have financial services business experience of
at least 5 years and a positive net worth in all the preceding five years. (ii) Sponsor’s Net
worth in the immediately preceding year is required to be more than the capital contribution
to AMC. (iii) Sponsor is required to be profit making in at least three out of the last five years
including the last year. (iv)Sponsor must contribute at least 40% of the Net worth of the Asset
Management Company. Any entity, which contributes at least 40% to the Net worth of an
AMC, is deemed sponsor and therefore is required to fulfil all the requirements given in 1 to
4.

Regulation 11 - Rejection of application

Where the sponsor does not satisfy the eligibility criteria mentioned in regulation 7, the
Board may reject the application and inform the applicant of the same.

Regulation 14- Trust deed to be registered under the Registration Act

A mutual fund shall be constituted in the form of a trust and the instrument of trust shall be in
the form of a deed, duly registered under the provisions of the Indian Registration Act, 1908
(16 of 1908), executed by the sponsor in favour of the trustees named in such an instrument.

Regulation 16- Disqualification from being appointed as trustees (1) A mutual fund shall
appoint trustees in accordance with these regulations. (2) No person shall be eligible to be
appointed as a trustee unless— (a) he is a person of ability, integrity and standing; and
(b) has not been found guilty of moral turpitude; and (c) has not been convicted of any
economic offence or violation of any securities laws; and
Regulation 18

RESPONSIBILITIES OF TRUSTEES

The Trustees have to fulfil several obligations and duties in accordance with the Regulation
and the Trust Deed which constitute the Mutual Fund. “These obligations and duties include
1.The Trustee and the Asset Management Company enter into an Investment Management
Agreement (IMA) with the approval from SEBI. 2. The Investment Management Agreement
shall contain such clauses as are mentioned in the Fourth Schedule of the SEBI (MFs)
Regulations, 1996 and other such clauses as are necessary for making investments.
3. The Trustees shall have a right to obtain from the Asset Management Company such
information as is considered necessary by the Trustees.1 4. The Trustee shall ensure before
the” launch of any scheme that the Asset Management Company possesses/has done the
following:2
a. Systems in place for its back office, dealing room and accounting;

b. Appointment of all key personnel including fund managers must be done for the Schemes
to be launched and submitted their bio-data which shall contain the educational
qualifications, past experience in the securities market to SEBI, within 15 days of their
appointment;

c. Appointed Auditors to audit its accounts;

d. Appointed a Compliance Officer to comply with regulatory requirement and to redress

investor grievances;

e. Appointed Registrars and laid down parameters for their supervision;

f. Prepared a compliance manual and designed internal control mechanisms including internal
audit systems; and

g. Specified norms for empanelment of brokers and marketing agents.

1
Id Regulation 18.
2
Id. Regulation 18(4).
ASSET MANAGEMENT COMPANY

Regulation 20 - Appointment of an asset management company

(1) The sponsor or, if so authorised by the trust deed, the trustee, shall appoint an asset
management company, which has been approved by the Board under sub-regulation (2) of
regulation 21.

Regulation 21 - Eligibility criteria for appointment of asset management company .

(1) For grant of approval of the asset management company the applicant has to fulfill
the following :—

(a) in case the asset management company is an existing asset management company it
has a sound track record, general reputation and fairness in transactions.

(aa) the asset management company is a fit and proper person;

(b) the directors of the asset management company are persons having adequate
professional experience in finance and financial services related field and not found
guilty of moral turpitude or convicted of any economic offence or violation of any
securities laws;

(c) the key personnel of the asset management company [have not been found guilty
of moral turpitude or convicted of economic offence or violation of securities laws]
[or worked] for any asset management company or mutual fund or any intermediary [during
the period when its] registration has been suspended or cancelled at any time by the Board;

(d) the board of directors of such asset management company has at least fifty per cent
directors, who are not associate of, or associated in any manner with, the sponsor or
any of its subsidiaries or the trustees;

(e) the Chairman of the asset management company is not a trustee of any mutual fund;
(f) the asset management company has a net-worth of not less than rupees fifty crore.

The Asset Management Company (AMC) is the investment Manager of the Trust. The
sponsor, or the trustees is so authorized by the trust deed, appoints the AMC as the
Investment Manager of the trust (Mutual Fund) via an agreement called as Investment
Management Agreement. An asset management company is a company registered under the
Companies Act, 2013. Sponsor creates the asset management company and this is the entity,
which manages the funds of the mutual fund (trust). The mutual fund pays a small fee to the
AMC for management of its fund. The AMC acts under the supervision of Trustees and is
subject to the regulations of SEBI too. The AMC is a working body of the mutual fund. AMC
is responsible for the management of the assets of the trust. It structures various schemes,
launches the scheme and mobilizes initial amount, manages the funds and give services to the
investors.

Regulation 24 -Restrictions on business activities of the asset management company

In India, regulator has ensured that an AMC focuses just on its core business and that the
activities of AMCs are not in conflict of each other. For preventing such conflicts some
restrictions and obligations are imposed by the Regulation which are as following-

a. An AMC shall not undertake any business activity except in the nature of portfolio
management services, management and advisory services to offshore funds etc., provided
these activities are not in conflict with the activities of the mutual fund.

b. An AMC cannot invest in any of its own schemes unless full disclosure of its intention to
invest has been made in the offer document

c. An AMC shall not act as a trustee of any mutual fund.

Regulation 25- Obligation on AMC

1) The asset management company shall take all reasonable steps and exercise due
diligence to ensure that the investment of funds pertaining to any scheme is not contrary
to the provisions of these regulations and the trust deed.

(2) The asset management company shall exercise due diligence and care in all its investment
decisions as would be exercised by other persons engaged in the same business.
(2A) The asset management company shall obtain, wherever required under these
regulations, prior in-principle approval from the recognized tock exchange(s) where units
are proposed to be listed.
(3) The asset management company shall be responsible for the acts of commission or
omission by its employees or the persons whose services have been procured by the asset
management company.

(4) The asset management company shall submit to the trustees quarterly reports of each
year on its activities and the compliance with these regulations.

(5) The trustees at the request of the asset management company may terminate the
assignment of the asset management company at any time:

CUSTODIAN
Regulation 26 and 27

Though the securities are bought and held in the name of trustees, they are not kept with
them. The responsibility of safe keeping the securities is on the custodian. Custodians keep
the investment account of the mutual fund.3

Following are the responsibilities of a custodian: (i) Provide post-trading and custodial
services to the Mutual Fund; (ii) Keep securities and other instruments belonging to the
Scheme in safe custody; (iii) Ensure smooth inflow/outflow of securities and such other
instruments as and when necessary, in the best interests of the unit holders; (iv) Ensure that
the benefits due to the holdings of the Mutual Fund are recovered; and (v) Be
responsible for loss of or damage to the securities due to negligence on its part or on the part
of its approved agents. The Custodian normally charge portfolio fee, transaction fee and out-
of -pocket expenses in accordance with the terms of the Custody Agreement and as per any
modification made thereof from time to time.

CHAPTER V of Regulation 1996

SCHEMES OF MUTUAL FUND

 All the schemes to be launched by the AMC needs to be approved by the Board of Trustees
and copies of offer documents of such schemes are to be filed with SEBI.

 The offer documents shall contain adequate disclosures to enable the investors to make
informed decisions.

3
Id. Regulation 7(g).
 The listing of close-ended schemes is mandatory and they should be listed on a recognised
stock exchange within six months from the closure of subscription. However, the listing is
not mandatory in case (i) the scheme provides for monthly income or caters to senior citizens,
women, children and physically handicapped; (ii) if the scheme discloses details of
repurchase in the offer document; or (iii) if the scheme opens for repurchase within six
months of closure of subscription.

 Units of a close-ended scheme can be opened for sale or redemption at a predetermined

fixed interval if the minimum and maximum amount of sale, redemption and periodicity is
disclosed in the offer document.

 Units of a close-ended scheme can be converted into an open-ended scheme with the
consent of a majority of the unit-holders and disclosure is made in the offer document about
the option and period of conversion.

 The AMC is required to refund the application money if minimum subscription is not
received, and also the excess over subscription within six weeks of closure of subscription.