INTRODUCTION TO MUTUAL FUNDS AND ITS VARIOUS ASPECTS

A MUTUAL FUND is simply a financial intermediary that allows a group of investors to pool their money together with a predetermined investment objective.

The mutual fund will have a fund manager who is responsible for investing the pooled money into specific securities (usually stocks or bonds). When you invest in a mutual fund, you are buying shares (or portions) of the mutual fund and become a shareholder of the fund. Mutual funds are one of the best investments ever created because they are very cost efficient and very easy to invest in (you don't have to figure out which stocks or bonds to buy).

By pooling money together in a mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they tried to do it on their own. But the biggest advantage to mutual funds is diversification. Diversification is the idea of spreading out your money across many different types of investments. When one investment is down another might be up. Choosing to diversify your investment holdings reduces your risk tremendously.

A MUTUAL FUND is an investment company designed to pool the funds of smaller investors and place them under professional management. A mutual fund allows small investors to diversify their portfolios. When a mutual fund is formed, it issues a prospectus detailing its intended investment strategy, and it is not permitted to deviate

from that strategy without public disclosure. A mutual fund prospectus also details the fees investors will be charged, which can be substantial.

In the US, the SEC regulates a mutual fund. A mutual fund may invest in stocks, bonds, options, futures, currencies, and/or commodities. Although any specific mutual fund is required to follow a specific investing strategy, the range of strategies available is wide. A mutual fund such as an index fund may attempt to replicate market or sector index. A mutual fund may specialize in large-cap, small-cap or even micro-cap stocks. Investors seeking regular income can invest in a mutual fund that specializes in government bonds or, for the more aggressive, corporate debt.

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realized is shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

Mutual fund means a fund establish in the form of a trust to raise money through the sale of units to the public or a section of the public under one or more schemes for investing in securities, including money market instrument.

DEFINITION OF MUTUAL FUND:

A mutual fund is a company that brings together money from many people and invest in a stock, bonds, or other asset the funds owns are known as its portfolio. Each investor in the fund owns share, which represents a part of these holdings.

- The U.S. Securities and Exchange Commission.

Briefly,

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal.

The money thus collected is then invested in capital market instruments such as shares, debentures and other securities.

The income earned through these investments and the capital appreciation realized are shared by its unit holders in proportion to the number of units owned by them.

Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

HISTORY OF INDIAN MUTUAL FUND INDUSTRY

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and RBI. The history of mutual funds in India can be broadly divided into four distinct phases:

First Phase 1964-87:

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory and administrative control in place of RBI. At the end of 1988 UTI had Rs. 6,700 crores of assets under management.

Second Phase 1987-1993 (Entry of Public Sector Funds):

1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92).

At the end of 1993, the mutual fund industry had assets under management of Rs. 47,004 crores. Third Phase 1993-2003 (Entry of Private Sector Funds):

With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996.

The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets under management was way ahead of other mutual funds.

Fourth Phase since February 2003:

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was

bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs.29,835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India, functioning under an administrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs.76,000 crores of assets under management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place among different private sector funds, the mutual fund industry has entered its current phase of consolidation and growth.

Formation of UTI Entry of Public Sector Funds Entry of Private Sector Funds A phase dedicated to Retail Investors

GROWTH OF MUTUAL FUNDS OVER YEARS

DIFFERENT MUTUAL FUNDS SCHEMES

Mutual funds schemes are broadly classified into 3 categories:

Open Ended Schemes: An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity.

Close Ended Schemes: A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor.

Interval Schemes: Interval Schemes are that scheme, which combines the features of open-ended and closeended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.

Further the mutual fund schemes can be broadly classified following basis:

By Structure: Equity funds Debt funds Balanced Funds

By Investment Objective: Growth Schemes Income Schemes Balanced Schemes Money Market Schemes

Other Schemes: Tax Saving Schemes Special Schemes Index Schemes Sector Specific Schemes

BY STRUCTURE:

1. Equity Funds: Equity mutual funds invest pooled amounts of money in the stocks of public companies. Stocks represent part ownership, or equity, in companies, and the aim of stock ownership is to see the value of the companies increase over time. Equity Funds are further classified as follows:

Diversified Equity Funds Large-cap, Mid-cap or Small-cap funds Sector Specific Funds Tax Savings Funds (ELSS)

2. Debt funds: The objective of these Funds is to invest in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Debt funds are further classified as:

Gilt Funds Income Funds MIPs

Short Term Plans (STPs) Liquid Funds

3. Balanced funds: As the name suggest they, are a mix of both equity and debt funds. They invest in both equities and fixed income securities, which are in line with pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns.

BY INVESTMENT OBJECTIVE:

1. Growth Schemes: Growth Schemes are also known as equity schemes. The aim of these schemes is to provide capital appreciation over medium to long term. These schemes normally invest a major part of their fund in equities and are willing to bear short-term decline in value for possible future appreciation.

2. Income Schemes: Income Schemes are also known as debt schemes. The aim of these schemes is to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited.

3. Balanced Schemes: Balanced Schemes aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. These schemes invest in both shares and fixed income securities, in the proportion indicated in their offer documents (normally 50:50).

4. Money Market Schemes:

Money Market Schemes aim to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer, short-term instruments, such as treasury bills, certificates of deposit, commercial paper and inter-bank call money.

OTHER SCHEMES:

1. Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time to time. Under Sec.88 of the Income Tax Act, contributions made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate.

2. Index Schemes: Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks that constitute the index. The percentages of each stock to the total holding will be identical to the stocks index weightage. And hence, the returns from such schemes would be more or less equivalent to those of the Index.

3. Sector Specific Schemes: These are the funds/schemes, which invest in the securities of only those sectors or industries as specified in the offer documents. E.g. Pharmaceuticals, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are

dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time.

TYPES OF MUTUAL FUNDS

Mutual funds can be classified as follow: Based on their structure:

1. Open-ended funds: Investors can buy and sell the units from the fund, at any point of time.

2. Close-ended funds: These funds raise money from investors only once. Therefore, after the offer period, fresh investments cannot be made into the fund. If the fund is listed on a stocks exchange the units can be traded like stocks (E.g., Morgan Stanley Growth Fund). Redemption of units can be made during specified intervals. Therefore, such funds have relatively low liquidity.

OPEN ENDED Open for all the year Min subs amt. 50cr No duration Repurchased any time Redeemed at NAV & LOAD factor ranges (4% to 6%) As repurchased so not listed at stock exchange Dividend may / may not Switchover allowed

CLOSE ENDED Open for fixed period Min subs amt. 20cr Duration (3 to 7 year) May be repurchased after close ended period Redemption specified & done at NAV Service charge Listed at stock exchange Dividend may / may not be Switchover allowed

Based on their investment objective:

Equity funds:

These funds invest in equities and equity related instruments. With fluctuating share prices, such funds show volatile performance, even losses. However, short term fluctuations in the market, generally smoothens out in the long term, thereby offering higher returns at relatively lower volatility. At the same time, such funds can yield great capital appreciation as, historically; equities have outperformed all asset classes in the long term. Hence, investment in equity funds should be considered for a period of at least 3-5 years. It can be further classified as:

i) Index funds: In this case a key stock market index, like BSE Sensex or Nifty is tracked. Their portfolio mirrors the benchmark index both in terms of composition and individual stock weightages.

ii) Equity diversified funds: 100% of the capital is invested in equities spreading across different sectors and stocks. iii) Dividend yield funds: it is similar to the equity-diversified funds except that they invest in companies offering high dividend yields. iv) Thematic funds: Invest 100% of the assets in sectors, which are related through some theme. e.g. -An infrastructure fund invests in power, construction, cements sectors etc. v) Sector funds: Invest 100% of the capital in a specific sector. For an e.g.- A banking sector fund will invest in banking stocks. vi) ELSS: Equity Linked Saving Scheme provides tax benefit to the investors.

Balanced fund:

Their investment portfolio includes both debt and equity. As a result, on the risk-return ladder, they fall between equity and debt funds. Balanced funds are the ideal mutual funds vehicle for investors who prefer spreading their risk across various instruments.

Following are balanced funds classes: i) Debt-oriented funds: Investment below 65% in equities. ii) Equity-oriented funds: Invest at least 65% in equities, remaining in debt.

Debt fund:

They invest only in debt instruments, and are a good option for investors averse to idea of taking risk associated with equities. Therefore, they invest exclusively in fixed-income instruments like bonds, debentures, and money market instruments such as certificates of deposit (CD), commercial paper (CP) and call money. Following are debt fund classes:

i) Liquid funds: These funds invest 100% in money market instruments, a large portion being invested in call money market. ii) Gilt funds ST: They invest 100% of their portfolio in government securities of and Tbills. iii) Floating rate funds: Invest in short-term debt papers. Floaters invest in debt instruments, which have variable coupon rate. iv) Arbitrage fund: They generate income through arbitrage opportunities due to mispricing between cash market and derivatives market. Funds are allocated to equities, derivatives and money markets. Higher proportion (around 75%) is put in money markets, in the absence of arbitrage opportunities. v) Gilt funds LT: they invest 100% of their portfolio in long-term government securities. vi) Income funds LT: Typically, such funds invest a major portion of the portfolio in long-term debt papers. vii) MIPs: Monthly Income Plans have an exposure of 70%-90% to debt and an exposure of 10%-30% to equities.

viii) FMPs- fixed monthly plans invest in debt papers whose maturity is in line with that of the fund. . Mutual fund Money Market Objective Liquidity + Moderate Income+ Reservation of Capital Risk Negligible Investment Portfolio Treasury Bills, Certificate of Deposits, Commercial papers, Call Money Who should invest Those who park their funds in current accounts or short term bank deposits Investment 2 days- 3 weeks

Shortterm Funds (Floating shortterm)

Liquidity + Moderate Income

Little interest rate

Call Money, Those with Commercial surplus shortPapers, term funds Treasury Bills, CDs, Shortterm Government securities

3 weeks- 3 months

Bond Funds (Floating Longterm) Gilt fund

Regular Income

Credit Risk & Interest Rate Risk

Predominantly Salaried & More than 9 Debentures, conservative 12 months Government investors securities, Corporate Bonds Government Securities Government Securities Portfolio indices like BSE, NIFTY etc. Salaried & 12 months & conservative more investors Salaried & 12 months & conservative more Investors Aggressive investors 3 years plus

Security & Income Long- term Capital Appreciation

Interest Rate Risk Interest Rate Risk

Equity Funds Index Funds

To generate NAV varies returns that with index are performance commensurate with returns of respective indices

Balanced Funds

Growth & Regular Income

Capital Balanced ratio Moderate & Market Risk of equity and Aggressive and Interest debt funds to Risk ensure higher returns at lower risk RISK VS. RETURN

2 years plus

Money Market Funds and Capital Preservation Funds tend to be the lowest risk; however they also offer the lowest returns. Income Funds such as bond and mortgage funds tend to be more risky than Capital Preservation Funds, but less risky than Growth and

Income Funds. Aggressive Growth funds have the potential for the highest return, but are also the highest risk asset class.

ADVANTAGES OF MUTUAL FUNDS

1. Diversification: The best mutual funds design their portfolios so individual investments will react differently to the same economic conditions. For example, economic conditions like a rise in interest rates may cause certain securities in a diversified portfolio to decrease in value. Other securities in the portfolio will respond to the same economic conditions by increasing in value. When a portfolio is balanced the value of the overall portfolio should gradually increase over time, even if some securities lose value.

2. Professional Management: Most mutual funds pay topflight professionals to manage their investments. These managers decide what securities the fund will buy and sell.

3. Liquidity: It's easy to get your money out of a mutual fund. Write a check, make a call, and you've got the cash.

4. Convenience: You can usually buy mutual fund shares by mail, phone, or over the Internet.

5. Low cost: Mutual fund expenses are often no more than 1.5 percent of your investment.

6. Flexibility: Mutual funds provide different types of plans like growth, regular income plans or equity oriented plan, Gilt Funds or Systematic Investment Plan (SIP), Systematic Withdrawal Plan (SWP).

DISADVANTAGES OF MUTUAL FUNDS

1. Hidden costs: The mutual fund industry tactfully buries costs under layers of jargon. These costs come despite of negative returns. Examples of such costs include sales charges, annual fees, and other expenses.

2. Lack of control: Investors typically cannot ascertain the exact make-up of a fund's portfolio at any given time, nor can they directly influence which securities the fund manager buys and sells or the timing of those trades.

3. Dilution: Because funds have small holdings in so many different companies, high returns from a few investments often don't make much difference on the overall return. Dilution is also the result of a successful fund getting too big. When money pours into funds that have had strong success, the manager often has trouble finding a good investment for all the new money.

4. Price Uncertainty: In mutual funds, the price at which one purchases or redeems shares will typically depend on the fund's NAV, which the fund might not calculate until many hours after the order has been placed. In general, mutual funds must calculate their NAV at least once every business day, typically after the major U.S. exchanges close.

5. Taxes: Fund managers don't consider personal tax situation while making decisions regarding the fund.

WORKING OF MUTUAL FUNDS

Mutual Funds in India follow a 3-tier structure. There is a Sponsor (the First tier), who thinks of starting a mutual fund. The Sponsor approaches the Securities & Exchange Board of India (SEBI), which is the market regulator and also the regulator for mutual funds.

Not everyone can start a mutual fund. SEBI checks whether the person is of integrity, whether he has enough experience in the financial sector, his net worth etc. Once SEBI is convinced, the sponsor creates a Public Trust (the Second tier) as per the Indian Trusts Act, 1882. Trusts have no legal identity in India and cannot enter into contracts, hence the Trustees are the people authorized to act on behalf of the Trust. Contracts are entered into in the name of the Trustees. Once the Trust is created, it is registered with SEBI after which this trust is known as the mutual fund. The role of trustees is to see, whether the money is being managed as per stated objectives.

Trustees appoint the Asset Management Company (the Third tier) to manage investors money. The AMC in return charges a fee for the services provided and this fee is borne by the investor as it is deducted from the money collected from them. The AMCs Board of Directors must have at least 50% of Directors who are independent directors. The AMC has to be approved by SEBI.

The AMC functions under the supervision of its Board of Directors, and also under the direction of the Trustees and SEBI. It is the AMC, which in the name of the Trust, floats new schemes and manage these schemes by buying and selling securities. In order to do this the AMC needs to follow all rules and regulations prescribed by SEBI and as per the Investment Management Agreement it signs with the Trustees. In the working of mutual fund, there are following steps-

1. First of all, Asset Management Company issues new fund offer. 2. Interested investors invest the money with fund manager. 3. Then fund manager invests the money in different profitable securities. 4. Then securities generate returns. 5. These returns are passed back to investors.

FUND CONSTITUENTS

Sponsor Trustee Asset Management Company Distributors Custodian/ Depository Registrar & Transfer Agent

Organizational Structure Of Mutual Fund:

THE FUND SPONSER:

Sponsor means any person who, acting alone or in combination with another body corporate, establishes a mutual fund. Sponsor is the promoter of the mutual funds. Sponsor creates the AMC and the Trustee Company and appoints the directors to these companies with SEBI approval. Sponsor should have at least 5 years record in the financial services business and should have made profit after providing for depreciation, interest and tax in at least 3 out of the 5 years. Sponsor must contribute at least 40% of the net worth of the AMC. Sponsor could be a bank, a financial institution or a Corporate.

TRUSTEES:

Trustees mean the board of trustees or the trustee company who hold the property Mutual Funds are always appointed by prior approval of SEBI. The Board of trustees is accountable to the office of the Public Trustee, in turn reporting to Charity Commissioner. Trust created through a document called the Trust Deed, executed by the Fund Sponsor in favor of the Trustees. The board of trustees is required to meet at least 4 times in a year to review AMC.

ASSET MANAGEMENT COMPANY:

The sponsor or, if so authorized by the trust deed, the trustee shall, appoint an Asset Management Company, which has been appointed by the Board. AMC must be registered with SEBI. Responsible for operational aspects of the MF. An AMCs net worth (Share capital + Reserves & Surplus) should be at least Rs.10 crores at all times. At least 40% of the AMC capital must be contributed by the sponsor. At least half (50%) of the directors of the AMC must be independent. Appoints other constituents Custodian, Registrar & Transfer Agent. Quarterly reporting to Trustees regarding the transactions of dealing in securities. The responsibility of preparing the OD lies with the AMC.

The AMC charge the mutual funds with investment and advisory fees as a percentage of the schemes net asset. This fee is borne by the investor as the fee is charged to the scheme:

1.25% of the weekly average net assets outstanding in each accounting year for the scheme where net assets do not exceed Rs. 100 crores, and

1% of the excess amount over Rs. 100 crores, where net assets so calculated exceeds Rs 100 crores.

CUSTODIAN/ DEPOSITORY:

The Custodian is appointed by the Board of Trustees A custodians role is safe keeping of physical securities and also keeping a tab on the corporate actions like rights, bonus and dividends declared by the companies in which the fund has invested.

The custodian also participates in a clearing and settlement system through approved depository companies on behalf of mutual funds, in case of dematerialized securities.

The holdings are held in the Depository through Depository Participants (DPs). The deliveries and receipt of units of a mutual fund are done by the custodian or a depository participant at the instruction of the AMC and under the overall direction and responsibility of the Trustees.

REGISTRAR & TRANSFER AGENT:

Registrars and Transfer Agents (RTAs) perform the important role of maintaining investor records. All the New Fund Offer (NFO) forms, redemption forms (i.e. when an investor wants to exit from a scheme, it requests for redemption) go to the RTAs office where the information is converted from physical to electronic form. How many units will the investor get, at what price, what is the applicable NAV, how much money will he get in case of redemption, exit loads, folio number, etc. is all taken care of by the RTA.

sponsor

Distributors: 1. Unit distribution 2. Broker/ Dealer

Auditor & legal counsel: 1. Regulatory compliance 2. Advisory

Transfer agent: 1. transactions & accounts 2. Unitholder services

METHODS OF INVESTING IN A MUTUAL FUND

INVESMENT OBJECTIVE

DIRECT SIP STP SWP GROWTH OPTION DIVIDEND PAYOUT DIVIDEND REINVESTMENT

INCOME OPTIONS

TYPES

OPEN ENDED CLOSE ENDED

LOAD / CHARGES

LOAD NO LOAD