Mutual Fund

Definition of Mutual Fund

A mutual fund is a company that pools money from many investors and invests the money
in securities such as stocks, bonds, and short-term debt. The combined holdings of the
mutual fund are known as its portfolio. Investors buy shares in mutual funds. Each share
represents an investor’s part ownership in the fund and the income it generates.

Benefit and Drawback of Mutual Funds

Advanced Portfolio Management

When you buy a mutual fund, you pay a management fee as part of your expense ratio, which is
used to hire a professional portfolio manager who buys and sells stocks, bonds, etc.1 This is a
relatively small price to pay for getting professional help in the management of an investment
portfolio.

Dividend Reinvestment

As dividends and other interest income sources are declared for the fund, they can be used to
purchase additional shares in the mutual fund, therefore helping your investment grow.

Risk Reduction (Safety)

Reduced portfolio risk is achieved through the use of diversification, as most mutual funds will
invest in anywhere from 50 to 200 different securities—depending on the focus. Numerous
stock index mutual funds own 1,000 or more individual stock positions.

Convenience and Fair Pricing

Mutual funds are easy to buy and easy to understand. They typically have low minimum
investments and they are traded only once per day at the closing net asset value (NAV). 1 This
eliminates price fluctuation throughout the day and various arbitrage opportunities that day
traders practice.
Disadvantages of Mutual Funds
However, there are also disadvantages to being an investor in mutual funds. Here's a more
detailed look at some of those concerns.

High Expense Ratios and Sales Charges

If you're not paying attention to mutual fund expense ratios and sales charges, they can get out
of hand. Be very cautious when investing in funds with expense ratios higher than 1.50%, as
they are considered to be on the higher cost end. Be wary of 12b-1 advertising fees and sales
charges in general. There are several good fund companies out there that have no sales charges.
Fees reduce overall investment returns.1

Management Abuses

Churning, turnover, and window dressing may happen if your manager is abusing their
authority. This includes unnecessary trading, excessive replacement, and selling the losers prior
to quarter-end to fix the books.

Tax Inefficiency

Like it or not, investors do not have a choice when it comes to capital gains 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.1

Poor Trade Execution

If you place your mutual fund trade anytime before the cut-off time for same-day NAV, you'll
receive the same closing price NAV for your buy or sell on the mutual fund.2 For investors
looking for faster execution times, maybe because of short investment horizons, day trading, or
timing the market, mutual funds provide a weak execution strategy.
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Types of Mutual Funds

Mutual funds offer one of the most comprehensive, easy and flexible ways to create a diversified
portfolio of investments. There are different types of mutual funds that offer different options to
suit investors diverse risk appetites. Let us understand the different types of mutual funds
available currently in the market to help you make an informed investment decision.

Broadly, any mutual fund will either invest in equities, debt or a mix of both. Further, they
can be open-ended or close-ended mutual fund schemes.

A. Open-ended funds
In an open-ended mutual fund, an investor can invest or enter and redeem or exit at any point
of time. It does not have a fixed maturity period.
B. Close-ended funds
Close-ended mutual funds have a fixed maturity date. An investor can only invest or enter in
these type of schemes during the initial period known as the New Fund Offer or NFO period.
His/her investment will automatically be redeemed on the maturity date. They are listed on stock
exchange(s).

Equity funds
I. Sector-specific funds:
These are mutual funds that invest in a specific sector. These can be sectors like infrastructure,
banking, mining, etc. or specific segments like mid-cap, small-cap or large-cap segments. They
are suitable for investors having a high risk appetite and have the potential to give high returns.
II. Index funds:
Index funds are ideal for investors who want to invest in equity mutual funds but at the same
time don't want to depend on the fund manager. An index mutual fund follows the same strategy
as the index it is based on.
For example, if an index fund follows the BSE Index as the replicating index and if it has a
20% weightage in let's say Stock A, then the index fund will also invest 20% of its assets in
Stock A.
Index funds promise returns in line with the index they mirror. Further, they also limit the loss to
the proportional loss of the index they follows, making them suitable for investors with a
medium risk appetite.

III. Tax saving funds:

These funds offer tax benefits to investors. They invest in equities and are also called Equity
Linked Saving Schemes (ELSS). These type of schemes have a 3 year lock-in period. The
investments in the scheme are eligible for tax deduction u/s 80C of the Income-Tax Act, 1961.
 

IV. Money market funds or liquid funds:

These funds invest in short-term debt instruments, looking to give a reasonable return to
investors over a short period of time. These funds are suitable for investors with a low risk
appetite who are looking at parking their surplus funds over a short-term. These are an
alternative to putting money in a savings bank account.

V. Fixed income or debt mutual funds:

These funds invest a majority of the money in debt - fixed income i.e. fixed coupon bearing
instruments like government securities, bonds, debentures, etc. They have a low-risk-low-return
outlook and are ideal for investors with a low risk appetite looking at generating a steady
income. However, they are subject to credit risk.

VI. Balanced funds:

As the name suggests, these are mutual fund schemes that divide their investments between
equity and debt. The allocation may keep changing based on market risks. They are more
suitable for investors who are looking at a combination of moderate returns with comparatively
low risk.

VII. Hybrid / Monthly Income Plans (MIP):

These funds are similar to balanced funds but the proportion of equity assets is lesser compared
to balanced funds. Hence, they are also called marginal equity funds. They are especially suitable
for investors who are retired and want a regular income with comparatively low risk.
VIII. Gilt funds:
These funds invest only in government securities. They are preferred by investors who are risk
averse and want no credit risk associated with their investment. However, they are subject to
high interest rate risk

NET ASSET VALUE

Net asset value (NAV) represents a fund's per-share intrinsic value. It is similar in some
ways to the book value of a company. NAV is calculated by dividing the total value of all the
cash and securities in a fund's portfolio, minus any liabilities, by the number of outstanding
shares.

A NAV computation is undertaken once at the end of each trading day based on the
closing market prices of the portfolio's securities. The formula for a mutual fund's NAV
calculation is straightforward:

NAV = (Assets - Liabilities) / Total number of outstanding shares

For example, let's say a mutual fund has $45 million invested in securities and $5 million in
cash for total assets of $50 million. The fund has liabilities of $10 million. As a result, the
fund would have a total value of $40 million.

The total value figure is important to investors because it is from here that the price per unit
of a fund can be calculated. By dividing the total value of a fund by the number of
outstanding units, you are left with the price per unit—the form of measurement in which
NAV is usually quoted. As such, the price of a mutual fund is updated  around the same time
as the NAVPS.
 SPONSER,TRUSTEE AND ASSET MANAGEMENT COMPANY

The structure of Mutual Funds in India is a three-tier one that comes with other substantial
components. It is not only about varying AMCs or banks creating or floating a variety of mutual
fund schemes. However, there are a few other players that play a major role into the mutual fund
structure. There are three distinct entities involved in the process – the sponsor (who creates a
Mutual Fund), trustees and the asset management company (which oversees the fund
management). The structure of Mutual Funds has come into existence due to SEBI (Securities
and Exchange Board of India) Mutual Fund Regulations, 1996 that plays the role of a primary
watchdog in all of the transactions. Under these regulations, a Mutual Fund is created as a Public
Trust. We will look into the structure of Mutual Funds in a detailed manner.. Read more at:
https://www.fincash.com/l/structure-mutual-funds
The Fund Sponsor

The Fund Sponsor is the first layer in the three-tier structure of Mutual Funds in India. SEBI
regulations say that a fund sponsor is any person or any entity that can set up a Mutual Fund to
earn money by fund management. This fund management is done through an associate company
which manages the investment of the fund. A sponsor can be seen as the promoter of the
associate company. A sponsor has to approach SEBI to seek permission for a setting up a Mutual
Fund. However, a sponsor is not allowed to work alone. Once SEBI agrees to the inception, a
Public Trust is formed under the Indian Trust Act, 1882 and is registered with SEBI. After the
successful creation of the trust, trustees are registered with SEBI and appointed to manage the
trust, protect the unit holder’s interest and to comply by the mutual fund regulations of SEBI.
Subsequently, an asset management company is created by the sponsor that should be complying
with the Companies Act, 1956 to regulate the management of funds. Considering that sponsor is
the primary entity that promotes the mutual fund company and that the mutual funds are going to
regulate public money, there are eligibility criteria given by SEBI for the fund sponsor: The
sponsor must have experience in financial services for a minimum of five years with a positive
Net worth for all the previous five years. The net worth of the sponsor in the immediate last year
has to be greater than the Capital contribution of the AMC. The sponsor must show profits in at
least three out of five years which includes the last year as well. The sponsor must have at least
40% share in the net worth of the asset management company. As clear as it could be, the role of
a sponsor is quite vital and must carry highest amount of credibility. The strict and rigorous
norms define that the sponsor must have adequate liquidity as well as faithfulness to return the
money of investors in case there is any financial crisis or meltdown. Thus, any entity that fulfills
the above criteria can be termed as a sponsor of the Mutual Fund.. Read more at:
https://www.fincash.com/l/structure-mutual-funds

Trust and Trustees

Trust and trustees form the second layer of the structure of Mutual Funds in India. Also known
as the protectors of the fund, trustees are generally employed by the fund sponsor. Just as can be
comprehended with the name, they have a critical role to play as far as maintaining the investors’
trust and tracking the fund’s growth are concerned. A trust is created by the fund sponsor in
favour of the trustees, through a document called a trust Deed. The trust is managed by the
trustees and they are answerable to investors. They can be seen as primary guardians of fund and
assets. Trustees can be formed by two ways – a Trustee Company or a Board of Trustees. The
trustees work to monitor the activities of the Mutual Fund and check its compliance with SEBI
(Mutual Fund) regulations. They also monitor the systems, procedures, and overall working of
the asset management company. Without the trustees’ approval, AMC cannot Float any scheme
in the Market. The trustees have to report to SEBI every six months about the activities of the
AMC. Also, SEBI has established tightened transparency rules to avert any type of conflict of
interest between the AMC and the sponsor. Therefore, it is critical for trustees to behave
independently and take satisfactory measures to keep the hard-earned money of investors
protected. Even trustees have to get registered under SEBI. And furthermore, SEBI regulates
their registration by revoking or suspending the registry if any condition is found to be breached..
Read more at: https://www.fincash.com/l/structure-mutual-funds

Asset Management Companies

Asset Management Companies are the third layer in the structure of Mutual Funds. Registered
under SEBI, it is a type of company that is created under the Companies Act. An AMC is meant
to float a variety of mutual fund schemes that are in compliance with the requirements of
investors and the nature of a market. The asset management company acts as the fund manager
or as an investment manager for the trust. A small fee is paid to the AMC for managing the fund.
The AMC is responsible for all the fund-related activities. It initiates various schemes and
launches the same. Furthermore, it also creates mutual funds with the sponsor and the trustee and
regulate its development. The AMC is bound to manage funds and provide services to the
investor. It solicits these services with other elements like brokers, auditors, bankers, registrars,
lawyers, etc. and works with them by getting into an agreement together. To ensure that there is
no conflict between the AMCs, there are certain restrictions imposed on the business activities of
the companies.. Read more at: https://www.fincash.com/l/structure-mutual-funds