Introduction to Mutual Funds

What is Direct Investment?

When assets such as equity shares, debentures, etc are bought by investors and held directly in their name, it is called a direct investment. Investors selects and manages the investments. Investors will have to make following decisions.   

• Selection: Is it the right stock or bond or property to buy?
• Price: Is it the correct price given for the underlying stock?
• Timing: Is it the time right to buy the investment?
• Portfolio Construction: Which stock to buy? How much? How to construct a portfolio?
• Evaluation: Is there a reason to think that the value of the asset will increase or decrease?
• Exit: Is it the right time to sell the investment? Will it be possible to sell it easily?
• Operations: Management of operational requirements, such as trading and depository accounts,
• Regulatory: safe deposit facilities, legal and regulatory compliances in place?

As the process of direct investments can sometimes be tedious, appropriate skill set is not easily available with every individual. Not everyone has the time to monitor their investments. Mutual Funds enable common man to invest in the capital markets without any prior knowledge of above decision making parameters. Mutual funds invest and manage the investors’ money by selecting the investments after evaluating their prospects, price and performance.

Types of Mutual Funds India, Basics of Mutual Fund Investment

Structure, Management and Operation of Mutual Funds

Mutual fund managed pool of investor money by employing specialist investment fund managers.

Mutual funds offer products (also called funds, schemes, plans) to investors, stating upfront the objectives to invest pooled money of that product.

Investors who invest money in a fund are allotted mutual fund units which represent their proportional participation in the assets of the mutual fund scheme.

Fund manager creates portfolio of the product by investing pooled money in accordance with the product objectives. The portfolio is monitored and managed on behalf of investors by the mutual fund without the investors having to directly trade in securities.

Fund will periodically disclose portfolio composition and its performance with respect to industry benchmarks.

Investors can buy or sell mutual fund units from the fund or in the secondary markets if the schemes are listed.

Investors in a mutual fund are unit holders, similar to shareholders of the equity market. The risk of the portfolio of securities is directly borne by them, without any assurances or guarantees.

The activities of a mutual fund including collecting money from investors, creating and managing the portfolio, subject to SEBI regulations.

Features of Mutual Fund products

There are several mutual fund products in the market. The following features distinguish one mutual fund product from another:

Asset allocation: Proportions in which the fund will invest in securities such as equity, debt, gold, real estate exclusively or in a combination.

Investment objective: It details out focus in creating and managing the portfolio – growth and capital appreciation, generation of regular income or combination of both.

Costs and fees: Mutual fund charges management cost for managing of portfolios./ In some cases, there are entry and exit charges as well.

Operational details: The terms for subscription, redemption and ongoing transactions in the fund

Terms and concepts related to mutual funds

• Mutual Fund: The term mutual fund refers to the common pool of funds contributed by investors. Investors investing in mutual funds give their consent for investment management company to invest their funds as per investment objectives. The funds and investments of the mutual fund are held in a trust and investors alone are the joint beneficial owners of the trust. Trustees oversee the management of the investors’ money by the investment manager. The term “mutual fund” is also used for the fund house that manages several funds using the same investment manager.
• Mutual Fund scheme: A mutual fund may offer multiple products, called schemes, plans and funds to investors. For example the Franklin Templeton Mutual Fund offers the following schemes, among others, to investors:
• Franklin India Blue-chip Fund, which invests in equity shares;
• Templeton India Income Fund, which invests in debentures and other debt instruments;
• FT India Monthly Income Plan, which invests in both equity and debt instruments

• Asset management companies (AMC): The Asset Management Company (AMC) is the specialist investment manager that manages the mutual fund. For example, Franklin Templeton Asset Management (India) Pvt. Ltd  is an AMC that manages the Franklin Templeton Mutual Fund. The fund manager of the mutual fund are employees of the AMC. The AMC launches mutual fund schemes, collects money from investors and manages it. Investors of a mutual fund deal with AMC for their operational requirements.
• Pooling and Proportionate Representation: Mutual funds pools the money contributed by investors to a scheme and invests them in a portfolio of securities. The investments made by the fund belong to the investors, who will share the profits or losses made in proportion to their investment.
• For example: Three investors invest Rs. 10,000, Rs. 20,000 and Rs. 30,000 respectively in a mutual fund. The pooled sum is Rs. 60,000 and their proportionate holding is in the ratio 1:2:3. The money is invested in equity shares. With time, fund’s portfolio appreciate in value and is now worth Rs. 72,000. The value of the investors’ holding also goes up proportionately (ratio of 1:2:3) to Rs. 12,000, Rs. 24,000 and Rs. 36,000 respectively.

• Units and Unit capital: An investor’s investment in a fund is represented in units and a mutual fund investor is called a unit holder. Each unit has a face value, typically Rs.10. In above example, if the investors bought the units at the face value, the number of units that will be allotted to them is 1,000 units (Rs.10,000/Rs.10), 2000 units (Rs.20,000/Rs.10) and 3000 units (Rs.30,000/Rs.10) respectively.
  • Mark to Market (MTM): Fund Managers invest pooled money in a variety of securities such as different shares, debentures etc as per investment objectives. As the prices of portfolio securities change, the value of portfolio will also decrease/increase. Mutual funds have to monitor the securities prices and its effects on the portfolio market value. Mutual Funds inform investors about the current market value of portfolio based on securities current market prices. This process of valuing the securities at its current market price is called marking to market (MTM). In the above example, the cost of investment was Rs. 60,000 and its MTM value was Rs. 72,000.
  • Net Asset Value (NAV): The NAV is the current market value of a mutual fund unit. This will depend upon the current MTM value of the securities held in the portfolio of the fund and adding any income earned such as dividend and interest. The costs and expenses charged for managing the fund are deducted from above value. The remaining value is called the net assets of the fund. The NAV of a fund is calculated every business day so that investors know the value of their investments. Investors buy and sell units at a price based on NAV. Consider the example we used earlier:
  • There were 6000 units of Rs.10 each issued.
  • The current market value of the portfolio was Rs. 72,000.
  • Assume dividend income of Rs.3000 and expenses of Rs.600.
  • The net assets are calculated by adding income earned and reducing expenses from the current market value of the portfolio. The net asset is Rs.74, 400.
  • As total number of units is 6000, so the net asset value per unit is 74,400/6000 = Rs.12.40.
  • The NAV of the fund has moved up from Rs.10 per unit to Rs.12.40 per unit.
• Pricing of transactions- In “open – ended” Mutual Funds, there is no fixed maturity date of the funds, i.e investors can purchase(buy)/ redeem (sell),the units of mutual funds at any point. The units of mutual funds are bought/sold at the current NAV and not face value because this helps maintain equality between existing investors and new entrant investors. The fund in our earlier example had 6000 units, whose current market value is Rs. 74,400. The face value per unit is Rs.10; the NAV per unit is Rs.12.40.
• If a new investor buys 1000 units and pays the face value of Rs. 10 per unit.
  • Assets of the fund are now 74400+10000 = 84400
  • The NAV will be = 84400/7000 = Rs. 12.05

In above example, The NAV has dropped from 12.40 to 12.05, not because the portfolio lost in market value, but because a new investor came in. Existing unit holders face a loss in NAV due to the entry of the new investor at face value.

• If new investor buys 1000 units and pays the NAV of Rs.12.40 per unit.
  • Assets of the fund are now 74400+12400 = 86800.
  • The NAV will be = 86400/7000 = Rs.12.40.

The NAV has remained unchanged since the incoming investor paid the NAV not face value.

• Existing investor sells 1000 units and receives the face value of Rs.10 per unit.
  • Assets of the fund are now 74400 – 10000 = 64400.
  • The NAV will be = 64400/5000 = Rs.12.88.

The NAV has increased from 12.40 to 12.88, not because the portfolio gained in market value, but because an existing investor left. Existing unit holders face a gain in NAV due to the exit of investors at face value.

• Existing investor sells 1000 units and receives the face value of Rs.10 per unit.
  • Assets of the fund are now 74400 – 12400 = 60000.
  • The NAV will be = 60000/5000 = Rs.12.40

The NAV has remained unchanged since the outgoing investor received the NAV not face value.

Thus when units are bought/sold at NAV and not face value, equality between new and existing investors can be maintained.

• Fund Running Expenses: Direct expenses incurred in managing the investment portfolio are charged to investors. It is calculated as a percentage of the daily average net assets managed by the fund. These expenses are already deducted at the time of calculating NAV thus investors don’t have to pay these expenses separately.
• Loads: Mutual funds may impose a charge on the investors at the time of exiting from a fund called the exit load. It is linked to the period a fund is held by investors. It is calculated as a percentage of the NAV and reduced from the NAV to arrive at the price that the investor will get on exiting from the investment.

The picture alongside states that if a the particular mutual fund is exited within 1 year, 1% of NAV will be charged as exit load. If the NAV is Rs. 12, then the exit load will be Rs 0.12 (1% of Rs. 12). Investor will get Rs 11.88 (Rs.12-.12) on redemption.

• Open Ended Funds: An open ended mutual fund does not have a fixed maturity date. Investors can buy additional units or sell existing units from the fund anytime at NAV linked prices. It can be listed on stock exchange for trading.
• Close ended mutual funds: A close ended mutual fund issues units to the investors during its scheme launch. The scheme is closed for subscription after its launch and hence additional units are not issued. Mutual funds lists close ended scheme on stock exchanges thereby enabling investors to buy and sell units amongst themselves. These funds have a maturity date at which the fund buys back units from the investors at the then current NAV linked price and the fund is wound-up.
• Interval Funds: Units are allotted to investors when the scheme is launched. The fund specifies transaction periods, such as three days every quarter, when investors can buy units and sell units directly with the fund. The funds are listed on the stock exchange enabling investors to trade in such funds.
• Relative performance: Performance of mutual funds will depend on the performance of securities in the fund portfolio. A mutual fund therefore cannot assure or guarantee a rate of return. Broadly, mutual fund return will reflect the return generated by that asset/security. For example, equity mutual funds will generate returns in line with equity markets and fund returns will have volatility of the stock markets.
• Diversification: Mutual funds invest in a variety of stocks from different sectors. It is likely that some stocks in the fund might not perform as good as the others. If prices of banking stocks are moving up, the prices of technology stocks may move down, since these sectors are influenced by different factors. Even if the banking sector is appreciating, every banking stock may not appreciate to the same extent. Diversification means creating a well balanced portfolio of securities across multiple sectors and securities, so that the rise or fall in prices of the components is smoothened out. Most mutual fund portfolios are well diversified, unless investment objectives are designed to focus on a single sector.
• Dividend and Growth Options: Investors are offered two options to receive the returns that the fund has generated – growth and dividend. If investor chooses growth option, returns generated by the fund are reinvested. If investor chooses dividend option, fund announces regular dividend to provide payout to the investors.  

Working of mutual funds

• 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,( who are employees of the AMC) 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

Mutual funds are categorized on the basis of portfolio constituents. Major fund categories include:

Equity Funds: Equity funds invest in a portfolio of equity shares and equity related instruments. The return and risk of the fund will be similar to investing in equity. Therefore investors seeking long term growth and capital appreciation can invest in equity funds.

Diversified equity funds: Invest in companies across segments, sectors and sizes of companies. This investment strategy enables participation in growth across the economy. It is not tied down to a particular sector or industry.

• Large-cap equity funds: Invest in stocks of large and liquid blue-chip companies with stable performance and returns.
• Mid-cap funds: Invest in mid-cap companies that have the potential for greater growth and returns.

• Small-cap funds: Invest in companies with small market capitalization with intent of benefitting from the higher gains in the price of stocks of smaller companies they may benefit from newer business opportunities.
• Sector funds: Invest in companies that belong to a particular sector, say technology or banking. Risk in sector funds is high as it is not diversified. Fall in stocks of one sector can lead to significant fall in investments.
• Thematic funds: Invest in stocks of companies which may be defined by a unifying underlying theme. For example, infrastructure funds invest in stocks in the infrastructure sector, across construction, cement, banking and logistics. They are more diversified than sector funds because sector funds might choose to invest only in a single sector, e.g. construction. Equity funds may also feature specific investment strategies. Value funds invest in stocks of good companies selling at cheaper prices; dividend yield funds invest in stocks that pay a regular dividend; special situation funds invest in stocks that show the promise of a turnaround.

Debt Funds: Debt funds invest in fixed income securities like bonds and treasury bills. Debt funds are preferred by individuals not willing to invest in a highly volatile equity market. A debt fund is comparatively less volatile and provides a steady but low income in comparison to equity funds.

Hybrid Funds: A hybrid fund is a debt and an equity fund, rolled into one. It invests in stocks as well as bonds and hence these mutual funds are highly diversified. The risk associated depends upon the proportion of investments in equity and debt respectively. The higher the equity component in the portfolio, the greater will be the overall risk.

• Equity oriented hybrid fund: These funds have greater proportion of equity than debt in their portfolio. The fixed income derived from debt investments balances the fluctuating and risky returns from equity investments. However, the higher equity component in the portfolio means the fund’s overall returns will depend on the performance of the equity markets.
• Debt oriented hybrid funds: Debt-oriented hybrid funds have a higher proportion of their portfolio allotted to debt investments. The debt returns are fixed and low. However due to a small proportion allotted to equity in these types of funds, the returns from equity investments augment the returns from debt, which will not happen in case of a pure Debt fund.
• Asset allocation Fund: These funds invest in both equity and debt but without a pre-specified allocation (proportion) as in the case of other hybrid funds. The fund manager takes a view on the type of investment and will tilt the allocation towards either asset class. Such funds may also hold 100% in equity or debt. Such funds will have a higher allocation to equity in the initial years and reduce equity exposure and increase debt exposure as the time advances.
• Capital Protection Funds: Capital Protection Funds are closed-end hybrids funds. The objective of this fund is to protect the investment and let it grow as well as receive higher returns. The portfolio is structured such that a portion of the principal amount is invested in debt instruments so that it grows to the principal amount over the term of the fund. For example, Rs.90 may be invested for 3 years to grow into Rs.100 at maturity, thereby protecting capital invested. The remaining portion of the original amount is invested in equity derivatives to earn better return.

Exchange Traded Funds: Exchange traded funds (ETF) are a type of mutual fund that combines features of an open ended fund and a stock. Units are issued directly to investors when the scheme is launched. Units are listed and traded on a stock exchange like a stock. Transactions are done through brokers of the exchange. Investors need a broking account and a demat account to invest in ETFs since the units purchased are credited to the demat account of investor. The prices of the ETF units on the stock exchange will be linked to the NAV of the fund, but prices are available on a real-time basis depending on trading volume on stock exchanges.

International Funds: International funds invest in securities listed on markets outside India. SEBI regulated the type of securities that the fund can invest in. Securities may includes equity shares, debt, units of mutual funds and ETFs issued abroad.

Real Estate Mutual funds: Real estate mutual funds invest in real estate either in the form of physical property or in the form of securities of companies engaged in the real estate business. Real estate mutual funds are an alternative to purchasing investment property, especially if investor wants to limit investment, level of risk and involvement in management of real estate. Assets held by the fund will be valued every 90 days by two valuers accredited by a credit rating agency. The lower of the two values will be taken to calculate the NAV. These funds are closed-end funds and should be listed on a stock exchange.

Infrastructure Debt Funds: Infrastructure Debt Schemes are closed-ended schemes with a tenor of at least five years that invest in debt securities and securitised debt of infrastructure companies. 90% of the fund’s portfolio should be invested in the specified securities. The remaining can be invested in the equity shares of infrastructure companies and in the money market instruments. The NAV of these schemes will be disclosed every 6 months. As a closed-ended scheme the units of the scheme will be listed on a stock exchange.

Process for investing in mutual funds

PAN & KYC norms

• SEBI’s regulations prescribe various categories of investors who are eligible to invest in a mutual fund in India. It  includes resident individuals, NRIs, PIOs, Foreign nationals and Institutions.
• All investors in mutual funds must have a Permanent Account Number (PAN) that needs to be provided at the time of applying for units.
• Institutions and Eligible investors in a mutual fund have to undergo a ‘Know Your Customer’ procedure prescribed by SEBI to be eligible for investing in mutual funds.
• KYC is done once at the time of the first mutual fund transaction or any other capital market transaction. KYC is valid across mutual funds and other capital market intermediaries.
• The KYC procedure may be conducted by an AMC or any other authorized entity. It involves collecting information about the investor in the specified format and conducting an In-Person Verification (IPV) to verify identity, address and other personal information.

Purchase Transactions

• Investing in a New Fund Offer (NFO): Units of a mutual fund are first available for investing when the scheme is launched in a New Fund Offer (NFO). These units are issued for first time, hence they are at face value. The application form for the NFO is available along with a document called the Key Information Memorandum (KIM). KIM provides the important information about the scheme and procedures for investing. The NFO will be open for a period of 15 days during which the investor has to make the application. Payment for the units can be made only through cheque and online payment facilities like NEFT and RTGS. A folio is created for each investor under which the investor’s personal information such as name, status, address, PAN, bank account details and investment information is captured. The units will be allotted to investors within 5 days of the NFO period coming to an end. The account statement giving details of the units allotted will be sent to the investor.
• Investing in the Continuous Offer: In an open ended fund, units are sold after the NFO period. It is called continuous offer. Investors can buy units at any time and not just during a specific period. The price of units in the continuous offer depends on the NAV of the fund, and is declared for every business day. New investors use the application form to invest in a fund on continuous offer. Existing investors invest using a transaction slip which requires only the folio number to be provided to identify the investor, apart from the investment details. Investors submit the completed application form or transaction slip and the payment instrument at an Official Point of Acceptance (OPoA). This could be the office of the AMC or an Investor Service Centre (ISC). Information on units allotted is communicated to the investor through a Statement of Account (SoA).
• Stock exchange channel: Both purchase and redemption/sale of units can be done using the stock exchange through the stock brokers who have obtained an AMFI Registration Number (ARN) and certified mutual fund distributors who have obtained the necessary permission from the stock exchange. The units need to be held in dematerialised form to enable transactions through this channel. Units will be credited to the investor’s demat account for any purchase and funds will be credited to their bank account for any redemption.
• Payment Instruments: Investors can make payments for investments in mutual funds using cheques and electronic payment modes such as NEFT, REGSS. Payments must be made from a bank account whose account holder is the first holder of the mutual fund folio. Cash upto Rs. 50,000 per mutual fund house is permitted as payment for purchases. Demand draft is accepted as payment instrument only in specific situations.

Redemptions: Redemption refers to encashing or withdrawing the investment made in a mutual fund by selling the units back to the mutual fund. Investments made in an open-ended fund can be redeemed at any time at the current applicable NAV. Units of a closed-ended fund can be redeemed only when the fund matures. Investors need to specify either amount or units at the time of redemption. The applicable NAV is adjusted for any exit loads before calculating the redemption amount. For example:

• Units redeemed 500
• Applicable NAV: Rs. 24
• Exit load: 1% OF NAV = Rs. 24 x 1%= 0.24
• Adjusted Nav= Applicable Nav – Exit load= Rs. 24 – 0.24
• Thus Adjusted NAV= Rs. 23.76
• Redemption Amount: 500 x Rs. 23.76 = Rs. 11880

SEBI has made it mandatory for investors to provide their bank account details. Mutual funds acquire bank details at the time of purchase. Redemptions are either made directly into the bank account, or by cheque. To avoid fraudulent encashment of redemption cheque, bank account details are pre-printed on the cheque.

Proof of Investment and Transaction:

• Statement of Accounts: Statement of account (SoA) is the proof of the investment made by the investor in a mutual fund. On behalf of mutual funds, the R&T agents dispatch a SoA after every transaction. A consolidated SoA across mutual fund holdings is sent to the investor for each calendar month where there have been transactions in a folio. Folios where no transactions have taken place during a six-month period will receive a statement at the end of such six-month period. A SoA is sent when an investor makes a fresh purchase transaction. The amount, price, and units are shown in the statement. For subsequent transactions, apart from these details, the balance units in the folio and their current market value are also shown.
• Units in Demat form: Investors can also hold the units in demat form. Both new and existing(already issued) units will be credited to their account. Purchases and sale of units held in this form are done through a stock broker. The investor will have to bear the demat account cost and security transaction cost for such transactions through the broker.

Distributor commission: Mutual funds pay an upfront commission to distributors who source investments from investors. Mutual funds also pay a trail commission which is based on the period for which the investment brought in remains with the fund and is a percentage of the current value of the investments. This means as long as the investor remains in the fund, the distributors receive commission on these investment. It is paid periodically to distributors and represents a steady source of income. Investors can directly pay a commission to the distributor, known as advisory fees. SEBI’s regulations allow a transaction charge to be paid to the distributor out of the money invested by the investor.

Systematic transactions

Transactions with mutual funds can be automated by signing for the facility of systematic transactions offered by mutual funds. This way they don’t have to worry about the period of their investments, its redemption etc. The mutual fund will periodically execute the systematic transactions as directed by the investor. Following details are to be specified:

• Type of transaction: Purchases, redemptions, transfers.
• Period: Length of time for which the transactions will run, say one year.
• Periodicity of transactions: The frequency of transactions, say monthly, quarterly, half yearly.
• Day of transaction: the day of the month on which each transaction will be executed, say 15th of the month.
• Amount: For each transaction and the total amount intended to be invested over a defined period.

The types of systematic transactions include:

Systematic Investment Plans (SIPs): SIPs enable investors to invest a fixed sum periodically into a mutual fund scheme. Investing in SIP enables an investor to take part in the stock markets without actively timing them and investor can benefit by buying more units when the price falls and less units when the price rises. This scheme helps reduce the average cost per unit of investment through a method called Rupee Cost Averaging. A person invests Rs 1000 for ten months in SIP. We will find out that the actual average purchase cost of asset would be lower than the average NAV of his investment over 10 months, which is the key benefit of Rupee Cost Averaging.

Actual average purchase cost as per SIP = (1000X10)/ (100+200+67+71+67+50+45+40+37+34) = 14.06. which is lower than the average NAV i.e 18.2.

Since SIP investor is a regular investor, its investment fetches more units when the price is low and lesser when the price is high. During volatile period, it may allow one to achieve a lower average cost per unit.

Systematic Withdrawal plan: SWPs allow investors to make periodic redemptions from their existing mutual fund investments at the prevailing NAV related price. For Example: 

• Investor have 8,000 units in a MF scheme. Investor can give instructions to the fund house to withdraw Rs. 5,000 every month through SWP.
• On 1 January, the NAV of the scheme is Rs. 10.
• Equivalent number of MF units : Rs. 5,000/Rs. 10 = 500
• 500 units would be redeemed and Rs. 5,000 would be given to the investor.
• Remaining units : 7500
• Now, on 1 February, the NAV is Rs. 15. Thus, Equivalent number of units = Rs. 5000/Rs. 15 = 333
• 333 units would be redeemed from investor’s MF holdings, and Rs. 5,000 would be given to the investor.
• Investor’s remaining units = 7500 – 333 = 7167

And so this process continues till the time investor wishes to withdraw. A statement of accounts showing the details of the transactions done, the balance units and their value will be sent every quarter.

Systematic Transfer Plans (STP’s): STPs permit investors to periodically transfer a specified sum from one scheme to another within the same fund house. The transfer is considered as redemption from the scheme from which transfer is made (source scheme) and investment into the scheme in which the redemption proceeds are invested (destination scheme). This help investors save the effort and time by compressing multiple instructions required for redemption from one scheme to invest in the other, into a single instruction. For example:

• An investor starts a monthly STP from a liquid fund to an equity fund over a six month period starting from 5th September 2014 for an amount of Rs. 10,000.
• The source scheme is the liquid fund and the destination scheme is the equity fund.
• On the 5th of September, Rs. 10,000 worth of units will be redeemed from the liquid fund at the NAV prevailing on that date.
• NAV has to be adjusted for exit loads, if applicable.
• On the same date the amount will be invested in the equity fund at the NAV of the fund.
• The number of units redeemed from the liquid fund and the number of units bought in the equity fund will not be the same each month but will depend upon the NAV prevailing at the time in each scheme.
• The STP will stop at the end of six months.
• The holding in the liquid fund would have reduced over the period and the holding in the equity fund would have increased.
• A statement of account giving the details of the transactions done and the unit balances and value will be sent to the investor every quarter.

Switches: Switch is redemption and a purchase transaction rolled into one and can be done for any amount and on any date as required by the investor. Switch is a single transaction executed on a given date and is not a series of transactions. The destination or target scheme is the scheme into which money is switched in to purchase new units. Switch can also be done from one option to another. For example, an investor who has chosen a growth option can switch to a dividend option. On the date of the submission of the switch request, the amount will be redeemed from the existing scheme at the applicable NAV after considering loads. Redemption amount will be invested into the new scheme at the current NAV. A statement of account will be sent giving details of the transaction.

Reading Mutual Funds

Investing in a mutual fund requires information to assess the suitability and the performance of the fund. Mutual funds need to provide periodic information to the investors as per their regulations.

• The Offer Document and KIM are issued and updated periodically to provide latest information to the investors.
• Product brochures issued by the mutual fund provides information on the  performance, portfolio and strategies of a fund.
• Fund factsheets disclose the scheme portfolios and returns generated by the fund relative to the benchmark on a monthly basis.
• Other sources of information include SEBI and AMFI’s website and the publications by investment websites, magazines and other rating and ranking agencies.

Benefits & Features of Mutual Fund Investment

Mutual Funds Benefits

• Diversification: Investors can invest in a diversified portfolio with small amounts, sometimes as low as Rs.500. Investors cannot achieve meaningful diversification to a self-managed portfolio with such a small amount.
• Professional Management: Investment decisions in a mutual fund are made by fund managers who have the expertise, information and knowledge to make better decisions than what a typical individual investor may be able to make.
• Liquidity: Investors can withdraw their investments at any time by either redeeming units from the fund or selling the units on the stock exchange where it is listed at a price that reflects the current value of the portfolio.

• Flexibility: Mutual funds allow investors the flexibility to structure their investments in a way that suits them. They can choose to make lump-sum investments or periodic small investments. Similarly, they can choose to receive periodic returns in the form of dividends or to allow the returns to grow in value over time.
• Tax efficiency: Mutual funds provide tax-efficient returns since the income is earned and gains are made by the fund. The mutual fund itself is exempt from paying taxes. Taxes may apply on income earned by the investor, subject to prevalent tax laws.
• Accessibility: Mutual funds invest in securities that investors may otherwise not be able to access. Instruments such as wholesale debt instruments privately placed and unlisted securities may not be accessible to the retail investor. Mutual funds can invest in them on behalf of the investor.

Mutual Funds Costs

• Costs and Fees: The investor pays a fee for the benefit of holding a managed portfolio of securities. The expenses charged include the fee for fund management and the costs associated with the operations of the fund, such as transactions done and fees paid to the various constituents used by the fund.
• Limited Control: The investors of a mutual fund do not approve or authorize any investment decision made by the fund manager. The control the investors have in the way the fund is managed is limited.
• Indirect Ownership: The investments made by the mutual fund from the investors’ money are held in the name of the mutual fund trust and not directly in the name of the investors. The investors are only the beneficial owners of the investments.

Note* : This chapter is a part of Free online mutual fund course by Trading Campus

{ This free online mutual fund course by Trading Campus will provide the participants, a quick snapshot of the Concept, Structure, Benefits and Classification of Mutual Funds. This online mutual fund course will also act as step by step guide to get you started in investing in mutual funds. }