How do Mutual Funds Work

A mutual fund is managed by the asset management company (AMC). The activities of the AMC are supervised by its own board of directors and by the board of trustees of the mutual fund. All major decisions are taken with approval of trustees who meet 6 times a year to review and monitor its activities.

A mutual fund scheme is first offered to investors in a new fund offer (NFO). This is the primary market issue for a fund product. Investors can assess the fund through offer document and key information memorandum that contains details of the scheme.

Mutual fund schemes are distributed through a large network of institutional distributors such as banks, brokers and independent financial advisors. They receive commission on such transaction. They also receive “trail commission” which is paid periodically as a percentage of net assets brought in by the distributor and remaining invested in the fund. Investors can also choose to invest directly in a fund without involving a distributor.

Investors fill prescribed application form to apply for mutual fund units and pay for the units through banking channels. The NFO price is usually the face value, typically Rs 10 per unit, thereon any purchases in open ended scheme are at NAV linked prices. Minimum investment amount for scheme varies from Rs 500 to Rs 100000.

Investors are allotted units at the price applicable on the date of transaction. Investors are allotted unique folio number. Details of the investor’s holding and transactions are maintained under unique folio numbers. Registrar and transfer agents (R&T agents) facilitate investor services for most funds.

AMC appoints a custodian bank to hold the funds and securities on behalf of investors. The treasury and operations teams of the fund work with R&T agents and custodians to invest and maintain the funds and investor records.

The fund managers are specialists who create and manage the portfolio. They are responsible for the returns and performance of the scheme. They work with brokers, research teams, and issuers to identify the securities to invest in.

The brokers execute the trades resulting from the investment decisions taken by the fund managers. The custodian bank settles these transactions by making and receiving delivery of funds and securities.

The valuation of the investment portfolio of a fund is done every business day, by evaluating the portfolio income and expenses, bringing it to market terms (MTM) and declaring the NAV at end of day on published newspapers and websites. Mutual funds are required to disclose the complete investment portfolio and accounts (balance sheet and profit and loss accounts) of each scheme to investors periodically.

Some specialist agencies do non-core functions other than investment management for an AMC. They are called constituents. They must be registered with SEBI and appointed only with the approval of the trustees. Mutual Funds pay them a fee for their services. Constituent Role

• • Custodian – Hold and settle funds and securities
  • R&T Agent – Keep and service investor records
  • Banks – Enable collection and payment
  • Auditor – Audit scheme accounts
  • Distributors – Distribute fund products to investors
  • Brokers – Execute transactions in securities