A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realized are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
(2) What is an organization structure of mutual fund?
In India mutual funds operate as a trust. Mutual funds in India are set up as three-tier structure. Sponsors, Trustees and AMC. Sponsors are the one who form or initiate the mutual fund business. They are similar to promoters of pvt ltd company. Sponsors appoint trust and board of trustees. Board of trustees work as internal watchdog and make sure that prudent business practice has been followed. Investorï's money at no time belong to AMC or Sponsors but held in trust by trustees in name of investors. The AMC is only fee for service provider and it does not own money. The board of trustees has to include independent trustees apart from representative of the sponsors. At least 2/3 of the trustees have to be independent. They are supposed to pay special attention to whether the AMC they have hired is charging higher fees than others in the market, whether the fees paid to the sponsors and other service providers like distributors are reasonable, whether the AMC is indulging in unethical business practices and whether they are sticking to their investment mandate as disclosed in the offer document. Sponsors and Board of Trustees together appoint AMC and Fund Manager who is the public face of mutual fund business. Fund manager remains responsible for managing investorï's money according the investment objective of the scheme.
Mutual Fund Operation Flow Chart
(3) What is a difference between open ended and close-ended scheme?
Open-ended schemes can be bought from or sold to fund house directly at daily NAV price. It allows investors to withdraw money at point of time, which provides liquidity to the investor. Close-ended schemes have fixed maturity period. For close-ended schemes subscription remains open only for limited period after which purchase or sell of units can be undertaken through stock exchange. Fund houses give an exit option to investors at regular interval and buy back units from investors but with heavy exit load. The basic difference between two is in close-ended schemes total number of issued units remain the same as issued during new offer period. Once offer closes it is the same number of units, which keep changing hands, which is not the case in open-ended schemes as number of units keep changing.
(4) What are different types of mutual fund schemes?
Based on investment objective mutual fund schemes can be classified into three broad categories: Equity Funds, Debt Funds and Balanced Funds.
Equity Funds invest in equity shares of companies available in stock market. Within equity funds there can be diversified equity funds, sector funds, ELSS funds, index funds etc. Debt Funds/Income Funds invest in fixed interest bearing instruments like bonds, debentures, government securities, treasury bill, certificate of deposits, commercial paper etc issued by corporates and government.
The combination of above two is Balanced Funds, which take minimum of 65% exposure to equity shares and remaining 35% in debt instrument.
(5) What are index funds?
Index funds are similar to equity funds but its passively managed funds. It means role of fund manager is minimal as the scheme follows particular index and mimic that particular index. Index funds replicate the portfolio of particular index.
e.g. if an index fund follows SENSEX then scheme will take the same 30 stocks which constitute SENSEX and it will be in the same proportion and weightage comprising of an index.
(6) What is Equity Linked Saving Scheme (ELSS)?
ELSS schemes are nothing but diversified equity funds which come with tax benefit. Investor can avail tax benefit under section 80 C by investing maximum Rs.100000 in the scheme. These types of equity schemes come with lock in period of 3 years.
(7) Does that mean ELSS is also close-ended scheme?
No, ELSS is not a close-ended scheme. In close ended scheme investor can invest in a scheme only during new fund offer period but ELSS is an open ended scheme in which buying can be done at any working day at that dayï's NAV. So ELSS is an open ended scheme but comes with lock in period of 3 years.
(8) What are sector funds?
Sector funds are one category of equity funds, which invest, only in a particular sector. The performance of the scheme is essentially depending on performance of that sector only. These type of funds are suitable only to high risk taking investors.
e.g. there are power sector funds, banking funds, media & entertainment fund etc.
(9) What is Net Asset Value of the scheme?
Net Asset Value is the price of one single unit of the scheme. It is derived at my deducting fundï's liabilities from market value of assets and dividing by number of units outstanding. i.e. (Market Value of investments ï' Liabilities) / Number of units outstanding.
(10) What are entry and exit loads?
This is a fee charged when you buy or sell the units of the scheme. Entry load is charged when you enter (purchase) units and exit load is charged when you exit (sell) units of the scheme.
When you buy units, you pay a certain percentage of NAV as fee which is known as entry load. When you sell units, similarly you get money after exit load getting deducting from your sell price. e.g. If you invest Rs. 10000 in a scheme with NAV of Rs.10 and entry load of 2.25% you will get 977.995 units (Rs. 10000/Rs.10.225) similarly when you sell the same number of units at Rs. 20 with exit load of 2% you will get Rs.19168.702 ( units 977.995 * Rs. 19.6 per unit) after excluding exit load of 2%.
(11) What is money market/liquid fund?
Money market/liquid fund is a part of income fund which invests in very short term debt instrument such as treasury bill, certificate of deposit, inter bank call money market etc. This can be viewed as a better alternative to saving/current account to generate better return. The basic objective of this type of fund is to provide easy liquidity and preservation of capital.
(12) What are gilt funds ?
Gilt funds invest exclusively in government securities. Government securities have no default risk. Return generated by gilt funds depend on interest rate scenario in the economy.
(13) In Fact Sheet of any fund house we find benchmark for all schemes. What is this benchmark?
To judge how a scheme is performing its performance has to be measured against some parameter. This parameter for any given scheme is benchmark. So benchmark return is taken as a standard against which performance of a scheme is compared. e.g. if BSE SENSEX is a benchmark for any given scheme, its performance will be compared against SENSEX return.
(14) What is a capital gain and how it is taxed in case of mutual fund ?
As per income tax act, any gain arising from sale of units of mutual funds is liable to income tax under the head capital gains. It can be of two types: Short Term Capital Gain and Long Term Capital Gain. Any gain made on units which are sold within one year of purchase is known as Short Term Capital Gain and any gain made on units which are sold after one year of purchase is known as Long Term Capital Gain. This differentiation is necessary as both types of gain are taxed differently in income tax.
For Equity Schemes: Short Term Capital Gain is taxed at 15% for all types of investors whereas there is no tax on Long Term Capital Gain for financial year 2008-09.
(15) How mutual funds share profit with investors ?
Profit is shared by way of giving dividend to unit holders. Dividend is a part of profit that a fund house distributes to its unit holders. Rate of dividend will be different for different schemes even for the same fund house. Dividend is always declared as a percentage which will be on a face value of Rs. 10 i.e. if a fund house declares a dividend of 50% in any of its scheme that means Rs. 5 per unit (50% on face value of Rs.10)
(16) What can be two different types of investment options in any scheme?
There can be dividend option and growth option. Under dividend option there can be dividend payout and dividend reinvestment options. Under growth option, profit remains within the scheme and gets reflected in terms of higher NAV.
(17) What is dividend reinvestment option?
In a dividend reinvestment option dividend gets reinvested within the scheme itself. So instead of getting cash dividend unit holder gets additional units depending on the amount of dividend declared. So in dividend reinvestment option, unit holder keeps accumulating additional units.
(18) What is record date?
Record date is nothing but a cut off date to consider a particular unit holder to give dividend or any other benefit.
(19) What is repurchase of a scheme?
Repurchase of a scheme is nothing but redemption of units by investor. Whenever an investor wants his/her money back he can give redemption request to fund house (for open ended scheme) which buys back units from investor and gives redemption proceeds based on that dayï's NAV after deducting applicable exit load. In case of close ended schemes redemption request can be given to fund house only on maturity of the scheme.
(20) How liquid mutual fund investment is?
One of the major advantages of investing in mutual fund is the liquidity. Money can be redeemed at any time in case of open ended scheme. After giving redemption request money gets credited within 3 working days in case of equity, balance and income funds and within 1 working day in case of liquid and money market mutual funds.
(21) What is Systematic Investment Plan (SIP)?
A Systematic Investment Plan allows an investor to buy units of a mutual fund scheme on a regular basis by means of periodic investments into that scheme in a manner similar to installments paid on purchase of normal goods. The investor is allotted units on a predetermined date specified in the application form of the scheme based on that dayï's NAV. Here the Plan allows the investor to take advantage of the Rupee Cost Averaging methodology.
(22) What is Systematic Withdrawal Plan?
A Systematic Withdrawal Plan permits the investor to receive a pre-determined amount / units from his investment in a mutual fund scheme on a periodic basis. Retirees in need of a regular income often opt for this.
(23) What is Systematic Transfer Plan?
An STP allows the investor to transfer a pre-determined amount from his investment in a mutual fund scheme to another mutual fund scheme (of the same company) on a periodic basis. This Plan is generally used to transfer sums from a Money Market / Liquid / Cash scheme to another scheme.
(24) It is said that investment in mutual fund gives diversification of portfolio. Please explain this advantage.
An investor can reduce risk by investing money across companies, sectors and asset class. You can reduce your risk by holding portfolio of securities than holding single security because in that case your profit or loss entirely depend on that one security. When you buy a particular equity scheme, indirectly you are diversifying the same amount across different securities as normally one scheme invests across 20-30 stocks of different sectors which is practically not possible for individual investor. So by investing in mutual fund, you are not putting all your eggs in one basket.
(25) On what basis mutual fund scheme should be selected?
While selecting mutual fund scheme basic thing to consider is oneï's investment horizon, objective and risk profile. If investor has risk appetite and horizon is long term (minimum three years) then equity schemes can be considered but investor is risk averse or investing only for few months then short term income funds can be a better option. To select a specific scheme from a particular type of fund, its performance can be compared against its benchmark as well as category average, consistency of return, long performance record and quality and image of the fund management team as well as fund house can also be considered.
(26) What is Systematic Investment Plan and how does it operate ?
Systematic Investment Plan (SIP) is one of the mode of investment in mutual fund scheme. Instead of investing lump sum, SIP gives an investor option to invest a particular amount every month at the prevailing NAV and units get alloted to investorï's folio.
(27) What are the advantages of SIP investment ?
Systematic Investment Plan offers following two major advantages:
- Rupee cost averaging. This means as you are investing a particular amount every month at prevailing NAV you accumulate more number of units when NAV is low and more number of units when NAV is high. So this automatically brings down your unit cost by way of rupee cost averaging.
- SIP is the best tool to accumulate long term wealth by taking advantage of rupee compounding in long term.
There are two broad investment styles followed by fund managers. Growth Investing and Value Investing.
In growth investing fund manager buys stocks which promise higher growth rate in future. If a stock is bought as a part of growth investing, its earnings should grow faster than overall market or sector earnings. Market normally pays premium price to these type of stocks. Value investing tries to find out stocks which are trading at price which is lower than their intrinsic value. Stocks may trade at a lower price for multiple reasons like that sector is out of favor in the market or there is some negative news for the sector in the market etc. These are stocks which are available at low price but have potential to give attractive return in future.
(29) What is expense ratio and how relevant it is ?
Expense Ratio = Total Expenses / Average Net Assets of the fund.
It indicates efficiency and cost effectiveness of the scheme. It is an indicator which shows how efficiently fund is managed by keeping cost and expenses under control. Particularly important for debt/money market schemes.
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