CHAPTER 1: INVESTMENT LANDSCAPE

Factors to evaluate investments

 Safety
 Liquidity
 Returns
 Convenience
 Ticket size - the minimum amount required for investment
 Taxability of income
 Tax deduction

Different Asset Classes

 Real Estate
 Commodities
 Fixed Income
 Equity

Investment Risk
1. Inflation Risk - Inflation, or price inflation is the general rise in the prices of
various commodities, products, and services that we consume
2. Liquidity Risk
3. Credit Risk

Market Risk and Price Risk

There are two types of risks to a security—market risk and price risk
 The risk specific to the security can be reduced through diversification across
unrelated securities, but the one that is market-wide cannot be reduced through
diversification

Interest Rate Risk: The risk that an investment's value will change as a result of a
change in interest rates. This risk affects the value of bonds/debt instruments more
directly than stocks. Any reduction in interest rates will increase the value of the
instrument and vice versa.

Risk Profiling - The ability to take risk refers to the financial ability, and the
investment horizon, whereas the willingness is linked to the psychological capacity to
handle risk

Understanding Asset Allocation

Asset Allocation is a process of allocating money across various asset categories in
line with a stated objective

There are two popular approaches to asset allocation

Strategic asset allocation is allocation aligned to the financial goals of the individual
 It is an approach to maintain a target allocation across various asset categories
 A target asset allocation across the asset categories is decided based on the
analysis of the needs and risk appetite of the investor
Tactical asset allocation is also referred as dynamic asset allocation.
 Tactical asset allocation is typically suitable for seasoned investors operating
with large investible surplus
 One may choose to dynamically change the allocation between the asset
categories

CHAPTER 2: CONCEPT AND ROLE OF A MUTUAL FUND

Concept of a Mutual fund -

 A mutual fund is a professionally managed investment vehicle.
 Mutual fund is a vehicle (in the form of a “trust”) to mobilize money from
investors, to invest in different markets and securities, in line with stated
investment objectives.
 An investor can get access to equities, bonds, money market instruments and/or
other securities, that may otherwise be unavailable to them and avail of the
professional fund management services offered by an asset management
company.

Important Concepts in Mutual Funds

1. Units - The investment that an investor makes in a scheme is translated into a

certain number of ‘Units’ in the scheme. Thus, an investor in a scheme is issued units
of the scheme
2. Face Value - Typically, every unit has a face value of Rs. 10. The face value is
relevant from an accounting perspective.
3. Unit Capital- The number of units issued by a scheme multiplied by its face value
(Rs. 10) is the capital of the scheme–its Unit Capital.
4. Recurring Expenses- The fees or commissions paid to various mutual fund
constituents come out of the expenses charged to the mutual fund scheme. These
are known as recurring expenses.
5. Net Asset Value- The true worth of a unit of the mutual fund scheme is otherwise
called Net Asset Value (NAV) of the scheme
6. Assets Under Management- The sum of all investments made by investors’ in the
mutual fund scheme is the entire mutual fund scheme’s size, which is also known as
the scheme’s Assets Under Management (AUM).
7. Mark to Market-The process of valuing each security in the investment portfolio
of the scheme at its current market value is called Mark to Market (MTM).

Advantages of Mutual Funds for Investors

1. Professional Management - Mutual funds offer investors the opportunity to earn

an income or build their wealth through professional management of their investible
funds.
2. Affordable Portfolio Diversification - Investing in the units of a scheme provide
investors the exposure to a range of securities held in the investment portfolio of the
scheme in proportion to their holding in the scheme.With diversification, an investor
ensures that “all the eggs are not in the same basket”.
3. Economies of Scale - Mutual funds offer the same benefits at a much lower
investment value since it pools small investments by multiple investors to create a
large fund.
4. Transparency - The structure of the mutual funds and the regulations by SEBI have
ensured that investors get such transparency about their investments.
5. Liquidity - Investors in a mutual fund scheme can recover the market value of
their investments, from the mutual fund itself.

6. Tax Deferral - Mutual funds are not liable to pay tax on the income they earn. If
the same income were to be earned by the investor directly, then tax may have to be
paid in the same financial year.

7. Tax benefits - Specific schemes of mutual funds (Equity Linked Savings Schemes)
give investors the benefit of deduction of the amount subscribed (upto Rs. 150,000
in a financial year), from their income that is liable to tax. This reduces their taxable
income, and therefore the tax liability.

8. Convenient Options - The options offered under a scheme allow investors to

structure their investments in line with their liquidity preference and tax position.

9. Investment Comfort - Once an investment is made with a mutual fund, they make
it convenient for the investor to make further purchases with very little
documentation.

10. Regulatory Comfort - The regulator, Securities and Exchange Board of India
(SEBI), has mandated strict checks and balances in the structure of mutual funds and
their activities. Mutual fund investors benefit from such protection.

11. Systematic Approach to Investments - Systematic approaches promote

investment discipline, which is useful in long-term wealth creation and protection

By the structure of the fund

1. Open-ended funds allow the investors to enter or exit at any time, after the NFO
2. Close-ended funds have a fixed maturity. Investors can buy units of a close-ended
scheme, from the fund, only during its NFO.
3. Interval funds combine features of both open-ended and close-ended schemes.

By the management of the portfolio

1. Actively managed funds are funds where the fund manager has the flexibility to
choose the investment portfolio.
2. Passive funds invest on the basis of a specified index; whose performance it seeks
to track.
A. Equity schemes

1. Multi Cap Fund: An open-ended equity scheme investing across large cap, mid cap,
small cap stocks.
3. Large Cap Fund: An open-ended equity scheme predominantly investing in large
cap stocks. .
4. Large and Mid-Cap Fund: An open-ended equity scheme investing in both large
cap and mid cap stocks. The minimum investment in equity and equity related
instruments of large cap companies shall be 35 percent of total assets. The minimum
investment in equity and equity related instruments of mid cap stocks shall be 35
percent of total assets.
5. Mid Cap Fund: An open-ended equity scheme predominantly investing in mid cap
stocks. The minimum investment in equity and equity related instruments of mid cap
companies shall be 65 percent of total assets.
6. Small cap Fund: An open-ended equity scheme predominantly investing in small
cap stocks. Minimum investment in equity and equity related instruments of small
cap companies shall be 65 percent of total assets. 6. Dividend Yield Fund: An
open-ended equity scheme predominantly investing in dividend yielding stocks.
Scheme should predominantly invest in dividend yielding stocks. The minimum
investment in equity shall be 65 percent of total assets.
7. Value Fund or Contra Fund: A value fund is an open-ended equity scheme
following a value investment strategy.
8. Focused Fund: An open-ended equity scheme investing in maximum 30 stocks
(the scheme needs to mention where it intends to focus, viz., multi cap, large cap,
mid cap, small cap).
9. Sectoral/Thematic: An open-ended equity scheme investing in a specific sector
such as bank, power is a sectoral fund.
10. Equity Linked Savings Scheme: An open-ended equity linked saving scheme with
a statutory lock-in of 3 years and tax benefit. The minimum investment in equity and
equity related instruments shall be 80 percent of total assets (in accordance with
Equity Linked Saving Scheme, 2005 notified by the Ministry of Finance).

Debt schemes

1. Overnight Fund: An open-ended debt scheme investing in overnight securities.

The investment is in overnight securities having maturity of 1 day.
2. Liquid Fund: An open-ended liquid scheme whose investment is into debt and
money market securities with maturity of upto 91 days only.
3. Ultra-Short Duration Fund: An open ended ultra-short-term debt scheme
investing in debt and money market instruments with Macaulay duration between 3
months and 6 months.
4. Low Duration Fund: An open ended low duration debt scheme investing in debt
and money market instruments with Macaulay duration between 6 months and 12
months.
5. Money Market Fund: An open-ended debt scheme investing in money market
instruments having maturity upto 1 year.
6. Short Duration Fund: An open ended short-term debt scheme investing in debt
and money market instruments with Macaulay duration between 1 year and 3 years.
7. Medium Duration Fund: An open ended medium-term debt scheme investing in
debt and money market instruments with Macaulay duration of the portfolio being
between 3 years to 4 years.
8. Medium to Long Duration Fund: An open ended medium-term debt scheme
investing in debt and money market instruments with Macaulay duration between 4
years and 7 years.
9. Long Duration Fund: An open-ended debt scheme investing in debt and money
market instruments with Macaulay duration greater than 7 years.
10. Dynamic Bond: An open ended dynamic debt scheme investing across duration.
11. Corporate Bond Fund: An open-ended debt scheme predominantly investing in
AA+ and above rated corporate bonds. The minimum investment in corporate bonds
shall be 80 percent of total assets (only in AA+ and above rated corporate bonds).
12. Credit Risk Fund: An open-ended debt scheme investing in below highest rated
corporate bonds. The minimum investment in corporate bonds shall be 65 percent
of total assets (only in AA (excludes AA+ rated corporate bonds) and below rated
corporate bonds).
13. Banking and PSU Fund: An open-ended debt scheme predominantly investing in
debt instruments of banks, Public Sector Undertakings, Public Financial Institutions
and Municipal Bonds. The minimum investment in such instruments should be 80
percent of total assets.
14. Gilt Fund: An open-ended debt scheme investing in government securities across
maturity.
15. Gilt Fund with 10-year constant duration: An open-ended debt scheme investing
in government securities having a constant maturity of 10 years.
16. Floater Fund: An open-ended debt scheme predominantly investing in floating
rate instruments (including fixed rate instruments converted to floating rate
exposures using swaps/derivatives).

Hybrid Schemes

1. Conservative Hybrid Fund: An open-ended hybrid scheme investing

predominantly in debt instruments.

Balanced Hybrid or Aggressive Hybrid Fund

1. Balanced Hybrid Fund: An open-ended balanced scheme investing in equity and

debt instruments.
The investment in equity and equity related instruments shall be between 40
percent and 60 percent of total assets while investment in debt instruments shall be
between 40 percent and 60 percent. No arbitrage is permitted in this scheme.
2. Aggressive Hybrid Fund: An open-ended hybrid scheme investing predominantly
in equity and equity related instruments. Investment in equity and equity related
instruments shall be between 65 percent and 80 percent of total assets while
investment in debt instruments shall be between 20 percent and 35 percent of total
assets.
3. Dynamic Asset Allocation or Balanced Advantage: It is an open-ended dynamic
asset allocation fund with investment in equity/debt that is managed dynamically.
4. Multi Asset Allocation: An open-ended scheme investing in at least three asset
classes with a minimum allocation of at least 10 percent each in all three asset
classes. Foreign securities are not treated as a separate asset class in this kind of
scheme.
5. Arbitrage Fund: An open-ended scheme investing in arbitrage opportunities. The
minimum investment in equity and equity related instruments shall be 65 percent of
total assets.
6. Equity Savings: An open-ended scheme investing in equity, arbitrage and debt.
The minimum investment in equity and equity related instruments shall be 65
percent of total assets and minimum investment in debt shall be 10 percent of total
assets.
Asset Allocation under defensive considerations may also be stated in the SID.
Solution Oriented Schemes
1. Retirement Fund: An open-ended retirement solution-oriented scheme having a
lock-in of 5 years or till retirement age (whichever is earlier). Scheme having a lock-in
for at least 5 years or till retirement age whichever is earlier.
2. Children’s Fund: An open-ended fund for investment for children having a lock-in
for at least 5 years or till the child attains age of majority (whichever is earlier).
Scheme having a lock-in for at least 5 years or till the child attains age of majority
whichever is earlier.
Other Schemes
1. Index Funds/Exchange Traded Fund: An open-ended scheme replicating/tracking
a specific index. This minimum investment in securities of a particular index (which is
being replicated/ tracked) shall be 95 percent of total assets.
2. Fund of Funds (Overseas/Domestic): An open-ended fund of fund scheme
investing in an underlying fund. The minimum investment in the underlying fund
shall be 95 percent of total assets.

Fixed Maturity Plans are a kind of close-ended debt fund where the duration of the
investment portfolio is closely aligned to the maturity of the scheme. AMCs tend to
structure the scheme around pre-identified investments.
Further, being close-ended schemes, they do not accept money post-NFO.

CHAPTER 3: LEGAL STRUCTURE OF MUTUAL FUNDS IN INDIA

Structure of Mutual Funds in India

Key features of a mutual fund that flows from the definition above are:
• It is established as a trust
• It raises money through sale of units to the public or a section of the public
• The units are sold under one or more schemes
• The schemes invest in securities (including money market instruments) or gold or
gold-related instruments or real estate assets.
SEBI has stipulated the legal structure under which mutual funds in India need to be
constituted.

 Mutual funds are constituted as Trusts. Therefore, they are governed by the
Indian Trusts Act, 1882
 The mutual fund trust is created by one or more Sponsors, who are the main
persons behind the mutual fund business.
 The beneficiaries, in the case of a mutual fund trust, are the investors.
 The operations of the mutual fund trust are governed by Trust Deed, executed
between the sponsors and the trustees
 The Trust acts through its trustees.
 Individuals are appointed as trustees jointly referred as ‘Board of
Trustees’.Trustee company functions through its Board of Directors.
 Day to day management of the schemes is handled by an Asset Management
Company (AMC).
 AMC is appointed by the sponsor or the Trustees.

Sponsors
 Application to SEBI for registration of mutual fund is made by sponsor(s)
 Sponsor should be carry on business in financial services for not less than 5
years.
 Should have positive net worth (share capital plus reserves minus accumulated
losses) in all the immediately preceding 5 years
 Net worth in the immediately preceding year should be more than the amount
that sponsor contributes to the capital of the AMC
 The sponsor should have earned profits, after providing for depreciation and
interest and tax, in three of the previous five years, including the fifth (latest)
year.
 Needs to contribute a minimum 40 percent of the net worth of the AMC
 Have to contribute a minimum of Rs.50,00,000 or 1 percent of the corpus raised
in the NFO, whichever is lower, as initial contribution to the corpus of the
mutual fund

Trustees
 Every trustee must be a person of ability, integrity and standing
 A person who is guilty of moral turpitude cannot be appointed as a trustee
 A person convicted of any economic offence or violation of any securities law
cannot be appointed as trustee.
 No AMC and no director (including independent director), officer, employee of
an AMC shall be eligible to be appointed as a trustee of a mutual fund.
 No person who is appointed as a trustee of a mutual fund shall be eligible to be
appointed as trustee of any other mutual fund.
 Prior approval of SEBI needs to be taken, before a person is appointed as
Trustee
 The sponsor will have to appoint at least 4 trustees
 If a trustee company has been appointed, then company need to have at least 4
directors on the Board
Asset Management Company
 Day to day operations of mutual fund is handled by the AMC
 Prior approval of the trustees is required, before a person is appointed as
director on the board of the AMC
 At least 50 percent of the directors should be independent directors i.e. not
associate of or associated with the sponsor or any of its subsidiaries or the
trustees
 The AMC needs to have a minimum net worth of Rs. 50 crore

Custodian
 The custodian has custody of the assets of the fund
 Custodian settles all the transactions on behalf of the mutual fund schemes
 All custodians need to register with SEBI under the SEBI (Custodian) Regulations
1996

Custodian is appointed by the trustees

 A custodial agreement is entered into between the trustees and the custodian
 The custodian also tracks corporate actions such as dividends, bonus and rights
in companies where the fund has invested

Compliance Function
 Compliance Officer needs to ensure all the legal compliances
 Reports directly to the head of the AMC
 The responsibility of the compliance officer to report any issue of
non-compliance directly and immediately to the trustees

Fund management main function of this team is to invest the investors’ money in
line with the stated objective of the scheme

Fund Accountant
 Performs the role of calculating the NAV, by collecting information about the
assets and liabilities of each scheme
 AMC can either handle this activity in-house or engage a service provider
 No need for a registration with SEBI

Registrars and Transfer Agents

 The Registrars and Transfer Agents (RTAs) maintain investor records
 Not compulsory to appoint a RTA, the AMC can choose to handle this activity
in-house
 All RTAs need to register with SEBI

Auditors
 Auditors are responsible for the audit of accounts.
 Auditor appointed to audit the MF scheme accounts needs to be different from
the auditor of the AMC
 Scheme auditor is appointed by the Trustees & AMC auditor is appointed by the
AMC

Distributors
 A distributor can be empanelled with more than one AMCs
 Distributors need to pass the NISM certification Examination (NISM-Series- V-A:
Mutual Fund Distributors (MFD) Certification Examination) and register with
AMFI

Collecting Bankers/Payment Aggregators

 Investors’ money goes into the bank account of the scheme they have invested
 Bank accounts are maintained with collection bankers who are appointed by the
AMC
 Banks enable collection and payment of funds for the schemes

KYC Registration Agencies

 SEBI issued regulations for registration of central KYC Registry Agencies (KRAs) in
2011
 KYC registration firms are registered with SEBI

Valuation agencies
 SEBI has issued guidelines for the purpose of arriving fair valuation of debt
securities
 AMFI has appointed CRISIL Ltd. and ICRA Ltd

Credit Rating Agencies

 Credit rating agencies rate debt securities issued by various issuers
 debt funds such as corporate bond funds, credit risk funds are defined on the
basis of credit rating

Depositories and the Depository Participants

 A depository is an institution, which holds the securities in dematerialised or
electronic form on behalf of the investors
 Investors have the option of holding their mutual fund units in dematerialised
form through a depository participant
 There are two depositories in India, viz., National Securities Depository Limited
(NSDL), and Central Depository Services Limited (CDSL)

Stock exchanges and the transaction platforms

 Investors can now transact in mutual fund units through the stock exchanges
 units of close-ended funds and ETFs are listed on stock exchange
 Bombay Stock Exchange (BSE), this segment is known as BSE-StarMF
 National Stock Exchange of India (NSE)

Association of Mutual Funds in India (AMFI) is the association of all the registered
Asset Management Companies
 To define and maintain high professional and ethical standards in all areas of
operation of mutual fund industry
 To recommend and promote best business practices and code of conduct to be
followed by members
 To interact with SEBI and to represent to SEBI on all matters concerning the
mutual fund industry
 To represent to the Government, Reserve Bank of India and other bodies on all
matters relating to the mutual fund Industry
 To undertake nationwide investor awareness programme to promote proper
understanding of the concept and working of mutual funds
 To regulate conduct of distributors including disciplinary actions (cancellation of
ARN) for violations of Code of Conduct
 To protect the interest of investors/unit holders
 AMFI involves the registration of mutual fund distributors, by allotting them
AMFI Registration Number (ARN), which is mandatory for becoming a mutual
fund distributor
 AMFI is neither a regulatory body nor a Self-Regulatory Organisation (SRO)

CHPTER 4: LEGAL AND REGULATORY FRAMEWORK

Role of Regulators in India

 Reserve Bank of India (RBI) that regulates the banking system, as well as money
markets
 Securities and Exchange Board of India (SEBI) that regulates the securities
markets
 Insurance Regulatory and Development Authority of India (IRDAI) that regulates
the insurance market
 Pension Fund Regulatory and Development Authority of India (PFRDA) that
regulates the pension market

Role of Securities and Exchange Board of India

SEBI protects the interests of investors in securities and to promote the
development of, and to regulate the securities market and for matters connected
therewith or incidental thereto

 Securities markets in India are regulated by the Securities and Exchange Board of
India (SEBI)
 It regulates, among other entities, mutual funds, depositories, custodians and
registrars and transfer agents (RTAs) in the country
 Deliberate speculation in stock markets
 Insider trading
 Excessive risks taken by mutual fund
 Inadequate collateral by issuers of debt securities
Mutual Funds Regulations

Mutual funds need to comply with RBIs regulations regarding investment in the
money market, investments outside the country, investments from people other
than Indians resident in India, remittances (inward and outward) of foreign currency
etc
 Mutual funds need to comply with regulations issued by other regulators also
 Stock Exchanges are regulated by SEBI

General Restrictions
 The Mutual Fund will buy and sell securities on delivery basis
 Mutual Fund shall not advance any loans
 The scheme will not invest in the unlisted or privately placed securities of any
associate or group company of the sponsor
 Scheme may invest in other schemes of the same Mutual Fund or other Mutual
Funds

Restrictions pertaining to investment in Debt Securities:

 A mutual fund scheme shall not invest more than 10 percent of its NAV in debt
instruments comprising money market instruments and non-money market
instruments issued by a single issuer which are rated not below investment
grade by a credit rating agency
 A mutual fund scheme shall not invest in unlisted debt instruments including
commercial papers, except Government Securities and other money market
instruments

Restrictions pertaining to investment in Equity:

 All investments by a MF scheme in equity shares and equity related instruments
shall only be made provided such securities are listed or to be listed
 The ELSS notification requires that atleast 80 percent of the ELSS funds should
be invested in equity and equity-linked securities

Restrictions pertaining to investment in REITs and InvITs:

No mutual fund under all its schemes shall own more than 10 percent of units issued
by a single issuer of REIT (Real estate investment trust) and InvIT (Infrastructure
investment trusts)

SEBI Advertisement Code for Mutual Funds

1. Advertisements shall be accurate, true, fair, clear, complete, unambiguous and
concise
2. Advertisements shall not contain statements which are false, misleading, biased
or deceptive, based on assumption/projections
3. Advertisements shall not contain statements which directly or by implication or by
omission may mislead the investor
4. No celebrities shall form part of the advertisement
5. Advertisements shall not be so framed as to exploit the lack of experience or
knowledge of the investors
6. Advertisements shall be accompanied by a standard warning in legible fonts which
states ‘Mutual Fund investments are subject to market risks, read all scheme
related documents carefully.’ No addition or deletion of words shall be made to
the standard warning’
7. The dividends declared or paid shall also be mentioned in Rupees per unit along
with the face value of each unit of that scheme and the prevailing NAV at the time of
declaration of the dividend

Advertisement Guidelines for Mutual Funds

Disclosing performance related information of mutual fund schemes
 When the mutual fund scheme has been in existence for more than three
years
 Performance advertisement of mutual fund schemes shall be provided in
terms of CAGR for the past 1 year, 3 years, 5 years and since inception
 Where the scheme has been in existence for less than one-year, past
performance shall not be provided
 In the case of money market schemes or cash and liquid schemes,
performance can be advertised by simple annualization of yields if a performance
figure is available for at least 7 days, 15 days and 30 days

Celebrity endorsements of Mutual Funds at industry level

SEBI has permitted celebrity endorsements at industry level for the purpose of
increasing awareness of Mutual Funds as a financial product category

 The celebrity endorsements shall not promote a scheme of a particular

Mutual Fund or be used as a branding exercise of a Mutual Fund house/AMC
 Expenses towards such celebrity endorsements shall be limited to the
amounts that are aggregated by Mutual Funds at industry level
 Prior approval of SEBI shall be required for issuance of any endorsement of
Mutual Funds as a financial product

Investors’ Rights & Obligations

1. Right to beneficial ownership
 Investor can ask for a Unit Certificate for his Unit-holding
 Investors have the option to receive allotment of MF units of open ended
and closed end schemes in their demat account
2. Right to change the distributor
 Investors can choose to change their distributor or opt for direct investing
3. Right to Inspect documents
 Unit-holders have the right to inspect key documents such as the Trust Deed,
Investment Management Agreement, Custodial Services Agreement, RTA agreement
and Memorandum & Articles of Association of the AMC\
4. Right to appoint nominees
 The investors can appoint upto 3 nominees
  Investor can also specify the percentage distribution between the nominees
 If no distribution is indicated, then an equal distribution between the
nominees will be presumed
5. Right to pledge mutual fund units
 Investors can pledge their mutual fund units
6. Right to grievance redressal
 SEBI has mandated that the status of complaints redressed should be
published by each AMC in their annual report. The same should be available on the
website of the mutual fund and on AMFI’s website
7. Rights of investors in context of change in Fundamental Attributes
 If there is a change in the fundamental attributes of a mutual fund scheme,
then the unitholders are provided the option to exit at the prevailing NAV without
any exit load
8. Rights to terminate appointment of an AMC
 75 percent of unit holders can terminate the appointment of an AMC
 75 percent of the unitholders (unitholding) can pass a resolution to wind up
a scheme
 If an investor feels that the trustees have not fulfilled their obligations, then
he can file a suit against the trustees for breach of trust
 Under the law, a trust is a notional entity, therefore investors cannot sue
the trust but they can file suits against trustees
9. Right to unclaimed amounts
 AMC is expected to make a continuous effort to remind the investors
through letters to claim their dues

Due Diligence Process by AMCs for Distributors of Mutual Funds

 AMCs are required to conduct a due diligence of their distributors

Investor Grievance Redress Mechanism

 In the event of any issue with the AMC or mutual fund scheme, the investor
can first approach the investor service centre
 If the issue is not redressed, even after taking it up at senior levels in the
AMC, then the investor can write to SEBI with the complaint details

SEBI Complaint Redress System

 SEBI Complaint Redress System (SCORES) is a web based centralized
grievance redress system of SEBI

AMFI Code of Conduct for Intermediaries

1. AMFI Code of Ethics (ACE)

The AMFI Code of Ethics (ACE) sets out the standards of good practices to be
followed by the Asset Management Companies in their operations and in their
dealings with investors, intermediaries and the public

 This code of conduct is applicable for all AMC’s

  SEBI has mandate AMFI to have ACE for all AMC as specified in the Fifth Schedule of
rule book

2. AMFI’s Code of Conduct for Intermediaries of Mutual Funds

AMFI has also framed a set of guidelines and code of conduct for intermediaries.
AMFI has framed a set of guidelines and code of conduct for intermediaries (known
as AMFI Guidelines & Norms for Intermediaries (AGNI))

In the event of breach of the Code of Conduct by an intermediary, the following++

sequence of steps is initiated by AMFI:
• Write to the intermediary (enclosing copies of the complaint and other
documentary evidence) and ask for an explanation within 3 weeks.
• In case explanation is not received within 3 weeks, or if the explanation is not
satisfactory, AMFI will issue a warning letter indicating that any subsequent violation
will result in cancellation of AMFI registration.
• If there is a proved second violation by the intermediary, the registration will be
cancelled, and intimation sent to all AMCs.

The intermediary has a right of appeal to AMFI

CHAPTER 5: SCHEME RELATED INFORMATION

Mandatory Documents

The legal documents that provide the information that the investor requires is
available in the scheme related documents (Scheme Information Document,
Statement of Additional Information) and the Key Information Memorandum
There are primarily two important documents -
1. Scheme Information Document (SID), which has details of the particular scheme
2. Statement of Additional Information (SAI), which has statutory information about
the mutual fund or AMC, that is offering the scheme.

SAI is part of the SID

 Both documents are prepared in the format prescribed by SEBI and submitted to
SEBI
 SEBI does not approve or disapprove the Scheme Related Documents, it gives its
observations
 The mutual fund needs to incorporate these observations in these documents.
 The Documents in the market are “vetted” by SEBI, and not approved by SEBI
 Draft SID and SAI are public documents, available for viewing on SEBI’s website
(www.sebi.gov.in)
 The final documents (after incorporating SEBI’s observations) have to be hosted
on AMFI’s website (www.amfiindia.com) two days before the issue opens
 Every mutual fund, on its website, provides for download of these documents
for all its current schemes
Statement of Additional Information
 Statement of Additional Information (SAI), has statutory information about the
mutual fund or AMC, that is offering the scheme

Key Information Memorandum

 Key Information Memorandum (KIM) is mandatorily circulated along with the
application form
 KIM is essentially a summary of the SID and SAI

Addendum interim changes are updated through the issuance of such addendum

Updation of SID
 If a scheme is launched in the first 6 months of the financial year (say, May 2019),
then the first update of the SID is due within 3 months of the end of the financial
year
 If a scheme is launched in the second 6 months of the financial year (say,
December 2019), then the first update of the SID is due within 3 months of the
end of the next financial year (i.e. by June 2021)
 Thereafter, SID is to be updated every year

Updation of SAI
 Regular update has to be done by the end of 3 months of every financial year.
 Material changes have to be updated on an ongoing basis and uploaded on the
websites of the mutual fund and AMFI.

Updation of KIM
KIM is to be updated at least once a year. As in the case of SID, KIM is to be revised
in the case of change in fundamental attributes

Disclosure of Total Expense Ratio

Important factors that impacts the scheme’s NAV is the Total Expense Ratio (TER),
charged to the scheme

Fund Factsheet
The fund factsheet contains the basic information of each scheme such as the
inception date, corpus size (AUM), current NAV, benchmark and a pictorial depiction
of the fund’s style of managing the fund

CHAPTER 6: FUND DISTRIBUTION AND CHANNEL MANAGEMENT PRACTICES

Different kinds of mutual fund distributors

1. Individual players
2. Non-individual entities
3. Banks
Modes of distribution
1. Online Channel Partners
2. Stock Exchange Platforms
3. MF Utilities
Pre-requisites to become Distributor of a Mutual Fund
1. Obtaining NISM Certification
2. Know Your Distributor Requirements
3. Obtaining AMFI Registration Number
4. Empanelment with AMCs

Revenue for a mutual fund distributor

 The mutual fund distributor earns revenue in the form of commission income for
distribution of the mutual fund products/schemes
 The commission may be linked to either the transaction or to the assets under
management.
 Transaction-based commission accrues at the time of a transaction, whereas the
AUM-linked commission is payable on an on-going basis, so long as the investor
remains invested.
 The only way a distributor can earn commission income is in the form of trail
commission
 The upfront trail commission to be paid from AMC’s books
 The said commission will be charged to the scheme as ‘commissions’ and should
also account for computing the TER differential between regular and direct plans
in each scheme
 The commission paid to be recovered on pro-rata basis from the distributors, if
the SIP is not continued for the period for which the commission is paid
 Trail commission payable is calculated on the daily balances and paid out
periodically to the distributor as per the agreement entered into with AMC
 Distributors benefit from increase in net assets arising out of valuation gains in
the market
 Trail commission for the day = AUM X trail commission rate p.a./365
 Since the trail commission rate is mentioned as percent per annum, the same
needs to be divided by 365 to arrive at the daily trail commission amount
 No commission is payable to the distributor for their own investments
(self-business)
 Distributors have the option of opting out of charging transaction charges
 This means that the distributor cannot choose to charge transaction charge from
one investor and not from another

Transaction Charges
 SEBI has allowed a transaction charge per subscription of Rs. 10,000/- and above
to be paid to distributors of the mutual fund products
 There shall be no transaction charges on direct investments
 The transaction charge is deducted from the gross investments of the investor
and paid to the distributor and the balance shall be invested
Provision of opt-in and opt-out
 Distributors have the option of opting out of charging transaction charges
 Distributor cannot choose to charge transaction charge from one investor and
not from another

Due Diligence Process by AMCs for Distributors of Mutual Funds

 SEBI has mandated AMCs to put in place a due diligence process to regulate
distributors who qualify any one of the following criteria
A. Multiple point presence (More than 20 locations)
B. AUM raised over Rs. 100 crore across industry in the non-institutional category
but including high networth individuals (HNIs)
C. Commission received of over Rs. 1 Crore p.a. across industry
D. Commission received of over Rs. 50 Lakhs from a single mutual fund

Change of distributor
 Mutual fund industry allows the investor to change the distributor, without
specifying any reason

CHAPTER 7: NET ASSET VALUE, TOTAL EXPENSE RATIO AND PRICING OF UNITS
 The asset management companies are required to compute and carry out
valuation of investments made by its scheme(s) in accordance with the
investment valuation norms specified in the Eighth Schedule of SEBI (Mutual
Funds) Regulations, 1996

Valuation
 A mutual fund scheme invests the investors’ money in a portfolio of securities
created and managed based on the investment objective and strategy of the
scheme
 The NAV of the scheme will depend upon the value of this portfolio, which in
turn, depends upon the value of the securities held in it
 The valuation of these 129 securities to determine the net asset value has to be
done in accordance with the valuation guidelines laid down by SEBI and AMFI
https://nextime.startek.com/NexTimeIndia/Tracker/MyActivites.aspx
Computation of Net Assets of Mutual Fund Scheme and NAV
Net Assets of Scheme
 Value of each unit of the scheme
 Unit-holders’ Funds in the Scheme (Net Assets) ÷ No. of outstanding Units
 Higher the interest, dividend and capital gains earned by the scheme, higher
would be the NAV
 Higher the appreciation in the investment portfolio, higher would be the NAV
 Lower the expenses, higher would be the NAV
Mark to Market
 The process of valuing each security in the investment portfolio of the scheme at
its current market value is called ‘mark to market’ i.e. marking the securities to
their market value
 Marking to market helps investors buy and sell units of a scheme at fair prices
 mark-to-market based NAV also helps in assessing the performance of the
scheme/fund manager

Total Expenses in Mutual Fund Scheme

 Investment and Advisory Fees are charged to the scheme by the AMC. The
details of such fees are fully disclosed in the Scheme Information Document
 Recurring Expenses in addition to the investment and advisory fee, the AMC
may charge the mutual fund scheme with recurring expenses
 Any expense other than investment advisory fee and recurring expenses
shall be borne by the asset management company or trustee or sponsors

1. In case of fund of fund scheme (An open-ended fund of fund scheme investing in
an underlying fund)
 Investing in liquid schemes, index fund scheme and exchange traded funds, the
total expense ratio of the scheme shall not exceed 1.00 per cent of the daily net
assets of the scheme
 In equity oriented schemes as per scheme information document, the total
expense ratio of the scheme including weighted average of the total expense
ratio levied by the underlying scheme(s) shall not exceed 2.25 percent of the
daily net assets of the scheme
 Investing in schemes other than as specified above, the total expense ratio of
the scheme shall not exceed 2 per cent of the daily net assets of the scheme

2. In case of an index fund scheme or exchange traded fund, the total expense ratio
of the scheme including the investment and advisory fees shall not exceed 1.00 per
cent of the daily net assets

3. In case of open ended schemes other than as specified for fund-of-fund and index
fund schemes, the total expense ratio of the scheme shall not exceed the following
limits:
In case of close ended and interval schemes

(i) the total expense ratio of equity oriented scheme(s) shall not exceed 1.25 per
cent of the daily net assets of the scheme

(ii) the total expense ratio of close ended and interval scheme(s) other than schemes
specified in clause d (i) above shall not exceed 1.00 per cent of the daily net assets of
the scheme

Expenditure in excess of the said prescribed total expense ratio limit has to be
borne by the AMC

Dividends & Distributable Reserves

 SEBI guidelines stipulate that dividends can be paid out of distributable reserves
 The trustees shall decide the quantum of dividend and the record date.
 The record date is the date used as cut-off to determine the eligibility to receive
the dividend by investors based on the register of unit holders
 There is no assurance or guarantee to Unit holders as to the rate or quantum of
dividend distribution that it will be paid regularly

Concept of Entry and Exit Load and its impact on NAV

 SEBI has banned entry loads
 Sale Price needs to be the same as NAV (subject to deduction of applicable
transaction charges, if any
 No exit load will be charged on bonus units and units allotted on reinvestment of
dividend
 Exit loads have to be credited back to the scheme immediately i.e. they are not
available for the AMC to bear selling expenses
 Upfront commission to distributors will be paid by the investor directly to the
distributor

Key Accounting and Reporting Requirements

 The accounts of the schemes need to be maintained distinct from the accounts
of the AMC. The auditor for the AMC has to be different from that of the
schemes
 NAV is to be calculated upto 4 decimal places in the case of index funds, liquid
funds and other debt funds
 NAV for equity and balanced funds is to be calculated upto at least 2 decimal
places
 Investors can hold their units even in a fraction of 1 unit. However, current stock
exchange trading systems may restrict transacting on the exchange to whole
units

NAV, Total expense ratio and pricing of units for the Segregated Portfolio

 The key provision with respect to the NAV, TER and pricing of units are
 AMC shall not charge investment and advisory fees on the segregated portfolio
 The Net Asset Value (NAV) of the segregated portfolio shall be declared on a
daily basis

Segregated portfolio is discussed in details in Chapter 10

CHAPTER :8 TAXATION

Investments or income from investments may be subject to tax. The investor would
get the income after payment of taxes

Capital Gains
 The difference between the purchase price of the units and the selling price of
the units would be treated as capital gain (or loss)
 The capital gains are subject to tax.
 Capital gains tax is classified depending on the period of holding and the type of
funds invested in
 Long-term is defined as holding period of more than three years in case of
non-equity oriented funds, whereas the same more than 1 year in case of
equity-oriented funds
 Capital gains booked before completion of this period would be treated as short
term capital gains
 Equity mutual funds were exempt from long term capital gains tax earlier. In the
Union Budget of the year 2018, this was changed. Starting April 2018, long term
capital gains became taxable at the rate of 10 percent

Grandfathering of capital gains:

 The capital gains earned till January 31, 2018 would not be taxable, which means
that for all the equity mutual funds that one has invested in, the valuation as on
January 31, 2018 becomes the base point

 Exemption upto Rs. 1 lakh: In case of long term capital gains arising out of
equity shares and equity-oriented mutual funds, the tax is applicable only on the
capital gains above Rs. 1 lakh
 The first Rs. 1 lakh worth of long term capital gain from this category is
tax-exempt.

Dividend income

 Dividend income from mutual funds used to be tax-free in the hands of the
investor
 The dividend would be paid to the investor after deduction of dividend
distribution tax from the scheme itself
 The dividend was tax-free, the NAV reduced to the extent of the dividend as
well as the dividend distribution tax
 This tax had an impact on the investor’s after-tax returns
 In the Union Budget presented by the Finance Minister in February 2020, the
dividend distribution tax has been done away with, the dividend would
henceforth be added to the taxable income of the assessee for the year.
 The dividends would be taxable in the hands of the recipient at the applicable
tax rate

What is the change for those who opted for dividend option in mutual funds?

 Tax on dividends can be reduced through various exemptions and adjustments,

as applicable
 In the earlier regime: Drop in NAV = Dividend paid to the investor + dividend
distribution tax
 Under the new regime: Post-tax dividend received by the investor = Dividend
paid out by the scheme – Tax payable thereon, as per the applicable tax slab
 Growth option works out to be more tax-efficient

Setting off of Capital Gains and Losses under Income Tax Act

 The Income Tax Act provides for taxation under various heads of income viz.
salaries, income from house property, profits & gains of business or profession,
capital gains, and income from other sources
Limitations to such set-off

 Capital loss, short term or long term, cannot be set off against any other head of
income (e.g. salaries)
 Short term capital loss is to be set off against short term capital gain or long
term capital gain
 Long term capital loss can only be set off against long term capital gain

Bonus Stripping

 When a dividend is paid, the NAV (ex-dividend NAV) goes down.

 Investor buys units within 3 months prior to the record date for a dividend/
Bonus.
 Investor sells units within 9 months after dividend/ Bonus
 Capital loss is not available for setting off against capital gains, if the original
units were bought within a period of 3 months prior to the record date for the
bonus issue and sold off within a period of 9 months after the record date
 The capital loss will be treated as the cost of acquisition of the bonus units

Securities Transaction Tax

 Investor sells units of an equity fund in the stock exchange, or offers them for
repurchase to the fund, STT is applicable only on redemption/switch to other
schemes/sale of units of equity oriented mutual funds whether sold on stock
exchange or otherwise
 STT is not applicable on purchase of units of an equity scheme
 It is not applicable to transactions in debt securities or debt mutual fund
schemes

Tax benefit under Section 80C of the Income Tax Act

 The benefit is available upto Rs. 1.50 lacs per year per taxpayer in case of
individuals and HUFs
 The scheme has a lock-in period of three years from the date of investment
 If one is investing in this scheme through SIP, each investment would be
locked-in from the date of the respective investment.
 The lock-in for the entire amount would not get over on completion of 3 years
from the date of the first SIP instalment
 If one opts for dividend reinvestment plan, each time a dividend is reinvested,
the same would also attract a 3-year lock-in

Tax Deducted at Source

 There is no TDS on re-purchase proceeds to resident investors

 In case of dividends from mutual fund schemes, even for resident Indians, TDS is
applicable
 The tax is required to be deducted at 10 percent on the dividend amount if it
exceeds Rs. 5,000
 Government of India has entered into Double Taxation Avoidance Agreements
(DTAA) with several countries

Applicability of GST AMC(s) can charge GST, as per applicable Taxation Laws, to the
schemes within the limits prescribed under SEBI (Mutual Fund) Regulations

CHAPTER 9: INVESTOR SERVICES

 New Fund Offer

 Units in a mutual fund scheme are offered to investors for the first time through
a New Fund Offer (NFO)
 AMC decides on a scheme to take to the market
 AMC prepares the Scheme Information Document for the NFO. This needs to be
approved by the Trustees and the Board of Directors (BoD) of the AMC
 The documents are then filed with SEBI. The observations that SEBI makes on
the SID need to be incorporated
 After approval by the trustees, the same can be issued in the market
 The AMC launches its advertising and public relations campaigns to make
investors aware of the NFO. These need to comply with SEBI’s advertising code
 The Scheme Documents and Application Forms are distributed to market
intermediaries, and circulated in the market, so that investors can apply in the
NFO

Three dates are relevant for the NFO of an open-ended scheme:

NFO Open Date – This is the date from which investors can invest in the NFO NFO
Close Date – This is the date upto which investors can invest in the NFO
Scheme Re-Opening Date – This is the date from which the investors can offer their
units for re-purchase to the scheme (at the re-purchase price); or buy new units of
the scheme (at the sale price).
 The AMC announces Sale and Re-purchase prices from the Scheme Re-Opening
Date
 Close-ended Schemes have an NFO Open Date and NFO Close Date
 Under the SEBI guidelines, NFOs other than ELSS can remain open for a
maximum of 15 days
 Allotment of units or refund of moneys, as the case may be, should be done
within 5 business days of closure of the scheme
 Open-ended schemes have to re-open for sale/repurchase within 5 business
days of the allotment

New Fund Offer Price/On-going Offer Price for subscription

 New Fund Offer (NFO) Price is the price per unit that the investors have to pay
to invest during the NFO
 Ongoing price for purchase, redemption (sale) /switch outs (to other
schemes/plans of the Mutual Fund) by investors is the price at which the
investor purchases or receives redemptions/switch outs

Investment Plans and Services

 Direct and Regular Plans
 Investors have a choice of going through the distributors or invest directly
through the AMC
 The direct plan shall have a lower expense ratio excluding distribution expenses,
commission, etc., and no commission shall be paid from such plans
 The TER is different in both cases, the plans will have separate NAVs

 Dividend Pay-out, Dividend Re-Investment and Growth Options

 Mutual fund schemes offer two options – Dividend and Growth
In a dividend pay-out option, the fund declares a dividend from time to time
 When a dividend is paid, the NAV of the units falls to that extent
 The reduced NAV, after a dividend pay-out is called ex-Dividend NAV
 After a dividend is announced, and until it is paid out, it is referred to as
cum-Dividend NAV
 In a dividend pay-out option, the investor receives the dividend in his bank
account
 In a dividend re-investment option, additional units are allotted to the investor.
The reinvestment happens at the ex-dividend NAV

 In a growth option, dividend is not declared. The NAV would therefore capture
the full value of the portfolio gains. The NAV of those units will however be
higher, to reflect the gain in the portfolio
Allotment of Units to the Investor

NFO: Since entry load is banned, units in an NFO are sold at the face value i.e. Rs. 10
 Allotment is completed within 5 business days after the closure of the New Fund
Offer
 In case of applicant who have quoted their demat account, the units are
credited within 2 working days to the demat account as per the depository
account details
 For applicants applying through the ASBA mode, on intimation of allotment by
CAMS to the banker the investors account is debited to the extent of the
amount due thereon

Account statements for investments

 Monthly Statement of Account

 Annual Account Statement
 Consolidated Account Statement - (CAS) for each calendar month is sent by
post/email on or before 10th of the succeeding month provided there has been
a financial transaction in the folio in the previous month

Filling the Application Form for Mutual Funds

 Direct Plan and Regular Plan

 Unit Holder Information - A mutual fund investment can have upto three
holders
 Minor as a unit holder - An investment made for a minor (less than 18 years)
is done through a guardian who complies with the KYC and PAN requirements and all
other formalities
 The guardian is typically a natural parent or court appointed legal
guardian
 POA as a unit holder-A folio operated under a Power of Attorney (PoA),
requires the PoA holder and issuer to comply with the KYC and PAN requirements
and a certified copy of the PoA to be submitted to the mutual fund before the holder
can operate the folio
 Status of the Holder and Mode of Holding - the status of the first holder as
an individual or non-individual and mode of holding and operating the account as
single/joint/either or survivor
 Once a mutual fund folio is created as a jointly held account there can
be no change in the joint holders.
 A joint holder cannot be deleted or a new one added, except in the
event of death can a name be deleted
 KYC Details
 FATCA and CRS Details - For applicants, including guardians, whose country
of birth/citizenship/nationality/tax residency is other than India, the application
requires additional information under Foreign Account Tax Compliance Act (FATCA)
and Common Reporting Standards (CRS)
  Unit Holding Option - Investors have the option to hold the units in physical
mode or demat mode
 Nomination - The applicant can make a nomination in favour of a maximum
of three nominees and indicate the percentage to each nominee

Application Supported by Blocked Amount

 Is a facility where the investment application in a New Fund Offer (NFO) is
accompanied by an authorization to the bank to block the amount of the
application money in the investor’s bank account
 The benefit of ASBA is that the money goes out of the investor’s bank account
only on allotment

Cash Payments Mutual funds usually do not accept cash.

Cut-off Time and Time Stamping

 The above cut-off timing is not applicable for NFOs and International Schemes
Purchase/ Sale Cut Off
Scheme Amount Mode of Txn Cutt Off Request Submitted Nav - Applicability
Subject to Application
Application submitted befor 3 Same Working Day NAV
Submission PM
Less Than 2 Lacs 3PM
Subject to Application
Application submitted After 3 Next Working Days NAV
Non- Liquid (Equity & Submission PM
Debt)
Subject to Fund Funds realisation
Save Working Day NAV
Realisation befor 3 PM
2 Lacs & Above 3PM
Subject to Fund Funds realisation
Next Working Days NAV
Realisation after 3 PM

Subject to Fund Funds realisation

Transaction Day - 1 day
Realisation After cut off
Irrespective of any
Liquid Fund
amount
1:30PM
Subject to Fund Funds realisation (Transaction Day) next working
Realisation befor cut off day - 1day

Re-Purchase/ Redemption Cut Off

Scheme Amount Mode of Txn Cutt Off Request Submitted Nav - Applicability
Subject to Application
Application submitted befor 3 Same Working Day NAV
Equity Oriented Funds, Submission PM
Irrespective of any
Debt funds & liquid
amount
3PM
Fund Subject to Application
Application submitted befor 3 Next Working Days NAV
Submission PM
Time Stamping - The time stamping on the transaction requests is done at the
official points of acceptance
 Applications for non-financial transactions like change of address, and investor’s
acknowledgement are stamped
 For online transactions, the time as per the web server to which the instruction
goes, is used in determining the NAV for sale/re-purchase transactions

KYC Documents

 Permanent Account Number (PAN) Card with photograph is mandatory for all
applicants except those who are specifically exempt from obtaining PAN
 Proof of Address
 The copies of the documents produced have to be self-attested and the originals
have to be provided for verification purpose

PAN Exempt Investments in Mutual Funds

 PAN Exempt KYC Reference Number (PEKRN) issued by the KRA and submit a
copy of the letter with the application form

KYC Registration Agencies

1. Centralised KYC Registration Agencies
2. KYC through e-KYC service of UIDAI - e-KYC service launched by UIDAI has also
been accepted as a valid process for KYC verification
3. KYC through Intermediaries - Mutual funds, depositories, registrars and transfer
agents, KYD compliant mutual fund distributors and brokers are authorised to
facilitate the KYC documentation of investors

Foreign Account Tax Compliance Act and Common Reporting Standards

 Identify foreign reportable accounts and collect such information as required
under the said provisions and report the same to the US Internal Revenue
Service/any other foreign government or to the Indian Tax Authorities for
onward transmission to the concerned foreign authorities
 If there is a change in the status of the investor after the information is first
provided, then the same has to be reported to the mutual fund within 30 days

Systematic Transactions
1. Systematic Investment Plan - SIP is an approach where the investor invests
constant amounts at regular intervals
2. Systematic Withdrawal Plan re-purchase a constant value of units over a period
of time
3. Systematic Transfer Plan the amount that is withdrawn from a scheme (called the
source scheme) is re-invested in some other scheme (called the target scheme) of
the same mutual fund

Switch - A switch is a redemption from one scheme and a purchase into another
combined into one transaction
Dividend Transfer Plan - allows investors to invest the dividend earned in a mutual
fund investment into another scheme of the same mutual fund

Non-Financial Transactions in Mutual Funds

1. Nomination - Nomination can be made in favour of a maximum of three nominees.

If the percentages are not clearly indicated, then the nomination will be made
equally among the nominees
2. Pledge/Lien of Units - Banks, NBFCs and other financiers often lend money
against pledge of Units by the Unitholder
a) Pledge Form executed by the unit-holder (pledger)
b) In whose favour the units are pledged (pledgee)
3. Demat Account - Dematerialisation is a process whereby an investor’s holding of
investments in physical form (paper), is converted into a digital record
4. Transmission of Units - Transmission is the process of transferring units to the
person entitled to receive it in the event of the death of the unit holder

CHAPTER 10: RISK, RETURN AND PERFORMANCE OF FUNDS

The Scheme Information Document (SID) contains a list of all these risks. The SID also
contains a discussion on various risk mitigation strategies

Fundamental and Technical analysis

 Fundamental analysis normally ties in well with the security selection strategy
and mostly used for identifying long term investment avenues
 Fundamental analysis-based decision has been taken on a stock, technical
analysis might help decide when to implement the decision i.e. the timing
 Technical Analysts believe that price behaviour of a share over a period of time
throws up trends for the future direction of the price
 Technical Analysts therefore study price-volume charts (a reason for their
frequently used description as “chartists”) of the company’s shares to decide
support
 Longer term investment decisions are best taken through a fundamental
analysis approach, while technical analysis comes in handy for shorter term
speculative decisions
 Earnings per Share (EPS): Net profit after tax ÷ No. of equity shares outstanding
 This tells investors how much profit the company earned for each equity share
that they own.
 Price to Earnings Ratio (P/E Ratio): Market Price per share ÷ Earnings Per Share
(EPS)
 P/E ratio indicates how much investors in the share market are prepared to pay
(to become owners of the company), in relation to the company’s earnings
 Book Value per Share: Net Worth ÷ No. of equity shares outstanding
 This is an indicator of how much each share is worth, as per the company’s own
books of accounts
 Dividend Yield: Dividend per share ÷ Market price per share
 This is used as a measure of the payouts received from the company, in
percentage, for each rupee of investment in the share

Investment Styles – Growth and Value

 Growth investment style entails investing in high growth stocks i.e. stocks of
companies that are likely to grow much faster than the market
 Valuation of these stocks tends to be on the higher side. Further, in the event of
a market correction, these stocks tend to decline more
 Value investment style is an approach of picking up stocks, which are priced
lower than their intrinsic value, based on fundamental analysis

Portfolio building approach – Top down and Bottom up

 In a top down approach, the portfolio manager evaluates the impact of
economic factors first and narrows down on the industries that are suitable for
investment
 Thereafter, the companies are analysed and the good stocks within the
identified sectors are selected for investment.
 A bottom-up approach on the other hand analyses the company-specific factors
first and then evaluates the industry factors and finally the macro-economic
scenario and its impact on the companies that are being considered for
investment
 Stock selection is the key decision in this approach; sector allocation is a result of
the stock selection decisions

Factors affecting performance of Debt Schemes

 Debt securities that are to mature within a year are called money market
securities
 The total return that an investor earns or is likely to earn on a debt security is
called its yield
 Securities issued by the Government are called Government Securities or G-Sec
or Gilt
 Treasury Bills are short term debt instruments issued by the Reserve Bank of
India on behalf of the Government of India
 Certificates of Deposit are issued by Banks (for 7 days to 1 year) or Financial
Institutions (for 1 to 3 years)
 Commercial Papers are short term securities (upto 1 year) issued by companies.
 Gilts are viewed as safe as there is no credit risk associated with them

Factors Affecting Performance of Gold Funds

 Investor in gold makes money is when one is able to sell the gold at prices higher
than one’s cost of purchase. The gold prices move on account of the
demand-supply balance or imbalance
 Gold is a truly international asset
 The value of gold in India depends on the international price of gold

Measures of Returns
1. Simple Return
 Simple return is simply the change in the value of an investment over a period of
time
(Later NAV - Initial NAV) * 100/Initial Value
2. Annualized Return
 Annualisation helps us compare the returns of two different time periods.
Simple Return * 12/Period of Simple return(in months)

3. Compounded Return
(Later Value / Initial Value)^(1/n) - 1… Where: ‘n’ is the period in years

4. Compounded Annual Growth Rate

The CAGR calculation is based on an assumption that the dividend would be
re-invested in the same scheme at the ex-dividend NAV

Measures of Risk
Fluctuation in returns is used as a measure of risk
1. Variance - Variance measures the fluctuation in periodic returns of a scheme, as
compared to its own average return
2. Standard Deviation - standard deviation is equal to the square root of variance.
Standard deviation is a measure of total risk in an investment
 A high standard deviation indicates greater volatility in the returns and greater
risk
3. Beta measures the fluctuation in periodic returns in a scheme, as compared to
fluctuation in periodic returns of a diversified stock index (representing the market)
over the same period
 The diversified stock index, by definition, has a Beta of 1.
 Companies or schemes, whose beta is more than 1, are seen as more risky than
the market
 Beta less than 1 is indicative of a company or scheme that is less risky than the
market
 Beta as a measure of risk is relevant only for equity schemes

Segregated portfolio or side pocketing

 Segregated portfolio” means a portfolio, comprising of debt or money market
instrument affected by a credit event, that has been segregated in a mutual fund
scheme
 Segregated portfolio of such unrated debt or money market instruments may be
created only in case of actual default of either the interest or principal amount
 No redemption or subscription is allowed in the segregated portfolio

TER for Segregated Portfolio

 AMC will not charge investment and advisory fees on the segregated portfolio

CHAPTER 11: MUTUAL FUND SCHEME PERFORMANCE

Benchmarks
An approach to assess the performance is to pre-define a comparable—a
benchmark—against which the scheme can be compared

 Choice of benchmark is simplest for an index fund

 For other schemes, choice of benchmark is subjective. The benchmark for a
scheme is decided by the AMC in consultation with the trustees

Price Return Index or Total Return Index

 The performance of a Price Return Index (PRI) captures only the capital gain or
loss and not the coupon or dividend received from the security, whereas a
Total Return Index (TRI) captures both
 Mutual Fund schemes were benchmarked to the Price Return variant of an Index
(PRI)
 The scheme performance would be calculated after adding the dividends that
the scheme has earned
 The gap between the returns between PRI and TRI is the amount of dividend
PRI - Gains
TRI - Gains + Dividend Amount

Basis of Choosing an appropriate performance benchmark

Selection of a benchmark for the scheme of a mutual fund to be in alignment with
the investment objective, asset allocation pattern and investment strategy of the
scheme

Benchmarks for equity schemes

Scheme Type funds investing in different sectors need to have a diversified index as
a benchmark index, like S&P BSE Sensex or Nifty 50 or S&P BSE 200 or S&P BSE 500
or Nifty 100 or Nifty 500 as a benchmark

Benchmarks for Debt Schemes

As per the SEBI guidelines, the benchmark for debt (and balanced schemes)
developed by research and rating agencies recommended by AMFI

Scheme Type -Liquid schemes invest in securities of upto 91 days’ maturity.

Therefore, a short term money market benchmark such as NSE’s MIBOR or CRISIL
Liquid Fund Index is suitable.
Choice of Investment Universe - Gilt funds invest only in Government securities.
Therefore, indices based on Government Securities are appropriate

Benchmarks for Other Schemes

Hybrid Funds - Hybrid funds invest in a mix of debt and equity. Therefore, the
benchmark for a hybrid fund is a blend of an equity and debt index
Gold ETF - Gold price would be the benchmark for such funds
International Funds The benchmark would depend on where the scheme proposes
to invest

Quantitative Measures of Fund Manager Performance

Scheme perform vis-à-vis its benchmark or peer group, such comparisons are called
relative return comparisons

Sharpe Ratio
 The Sharpe Ratio assesses the returns generated by a portfolio against each unit
of risk undertaken
 Sharpe ratio is used measure of risk-adjusted returns
 An investor can invest with the government and earn a risk-free rate of return
(Rf). T-Bill index is a good measure of this risk-free return
 Higher the Sharpe Ratio, better the scheme is considered to be
 Investment in a scheme, a risk is taken, and a return is earned (Rs).

Sharpe Ratio = (Rs minus Rf) ÷ Standard Deviation

Rs- Risk earned Rf- Risk free return

Treynor Ratio
 Treynor Ratio too is a risk premium per unit of risk
 It indicates how much return an investment, such as a portfolio of stocks,
a mutual fund, or exchange-traded fund, earned for the amount of risk the
investment assumed
 Higher the Treynor Ratio, better the scheme is considered to be

Treynor Ratio = (Rs minus Rf) ÷ Beta

 The Treynor ratio considers the return (excess return generated over risk free
return) of a fund in relation to the portfolio risk that the fund manager has taken
(beta) in order to achieve that incremental return
 The Sharpe ratio and the Treynor ratio are two ratios used to measure the
risk-adjusted rate of return.
 The Sharpe ratio helps investors understand an investment's return compared
to its risk while the Treynor ratio explores the excess return generated for each
unit of risk in a portfolio

Alpha
 The difference between a scheme’s actual return and its optimal return is its
Alpha—a measure of the fund manager’s performance
 Measures the performance of the investment in comparison to a suitable
market index
 Positive alpha is indicative of outperformance by the fund manager; negative
alpha might indicate under-performance

Tracking Error
 An index fund mirrors the index, it would have a Beta of 1, and it ought to earn
the same return as the market. The difference between an index fund’s return
and the market return is the tracking error
 Tracking error is expected to be zero
 The tracking error has to be low for a consistently out-performing fund

CHAPTER 12: MUTUAL FUND SCHEME SELECTION

Investor Need
 The selection of a mutual fund scheme for an investor will depend upon the
need that the investor has from the investment

Risk Profile of the investor

 The investor’s risk appetite is a function of three things—the need to take risks,
the ability to take risks, and the willingness to take risks

Asset allocation
 The investor’s asset allocation is a decision regarding how much money should
be allocated to which scheme category (asset class)

Age of the investor

 Younger investors have the potential for taking higher risks compared to old
people

The depiction of risk using colour codes was replaced by pictoral-meter named
"Riskometer" which categorises the risk in the scheme

Scheme Selection based on investment strategy of mutual funds

1. Active Fund v/s Passive Funds -
 Passive funds are suitable for investors looking for exposure to an asset class
without the risks associated with fund manager selection and strategies
 Index funds are passive funds and they are not traded on exchanges
 The costs that an index fund is allowed to charge is also lower since there are no
research or other fund management expenses
 If the benchmark index goes down, then the NAV of the index fund too will go
down
2. Open-ended funds v/s close-ended funds
 An open-ended scheme, the unit will be bought back by the scheme at the NAV
less exit load
 Open-end schemes are also subject to the risk of large fluctuations in net assets,
on account of heavy sales or re-purchases
 close-ended scheme offers liquidity through its listing on a stock exchange
3. Growth or Value funds
 Equity fund managers adopt various different styles of selection of stocks. The
most popular among these are the growth style and the value style
 Growth strategy seek to identify companies that are expected to grow at rates
higher than the average economic growth rate. Stocks of such companies tend
to do well in a bull phase in the markets
 Value strategy seeks to identify stocks that are available at a price that is seen as
cheap relative to the value that could be unlocked in the future
 A growth fund outperforms in a bull market, while the value orientations helps
a value fund outperform in a falling market
4. International Equity funds
 Invest in stocks of companies listed in stock exchanges located outside of India
5. Fixed Maturity Plans
 Investment in FMPs cannot be redeemed before the maturity of the scheme,
except through the stock exchanges
6. Short Duration Fund
 Short Duration Funds invest in securities with maturities between 1 year and 3
years
7. Liquid Funds
 An investor seeking the lowest risk ought to go for a liquid scheme
 These schemes are suitable for investors looking for a product to park their
funds for very short periods (upto 91 days)
8. Floater Funds
 Floater funds, invest in floating rate instruments
9. Hybrid Schemes
 An investor desirous of having a mix of debt and equity exposures has two
options—invest in a mix of equity schemes and debt schemes
10. Gold Funds
 Investors need to differentiate between Gold ETF and Gold Sector Funds
 The performance of these gold sector funds is linked to the profitability of these
gold companies
 Gold ETFs whose performance would track the price of gold

Selection of Mutual Fund scheme offered by different AMCs or within the scheme
category
 Matching fund’s portfolio with its investment objective
 Fund Manager
 Fund Performance
 Fund Portfolio
 Fund Age
 Fund Size
 Portfolio Turnover
 Scheme Running Expenses

Selecting options in mutual fund schemes

 Dividend payout, dividend re-investment and growth options
 Dividend payout option has the benefit of money flow to the investor
 Re-purchase transactions are treated as a sale of units by the investor