PAPER – 6B: FINANCIAL SERVICES AND CAPITAL MARKETS

Case Study 3

Recently SEBI has come out with a circular relating to categorization and rationalization of Mutual Fund Schemes.
(The Extract of some of the relevant portion is as per Exhibit – 1).
Description of some of the existing schemes is given as per Exhibits 2 to 6.

Questions

(A) As per the circular, the existing ‘type of scheme’ would be replaced with type of scheme as applicable to each
category of scheme. You are required to suggest the group in which each of the five existing schemes shall
be re-categorized with brief reasons in the following format.

Source Name of the Proposed Re-categorization Reasons for such

Scheme as per Re-categorization
the exhibit
Exhibit No. Scheme Category of Scheme
(4 marks for each of the five schemes)
(B) A mutual fund raised `150 lakhs on April 1, by issue of 15 lakh units at `10 per unit. The fund invested in
several capital market instruments to build a portfolio of `140 lakhs. Initial expense amounted to `8 lakhs.
During the month of April, the fund sold certain securities costing `45.75 lakhs for `48 lakhs and purchased
certain other securities for `42.4 lakhs. The fund management expenses for the month amounted to `6 lakhs
of which `50,000 was in arrears. The dividend earned was `2 lakhs. 80% of the realized earnings were
distributed. The market value of the portfolio on 30th April was `148.75 lakhs.

Suppose you as an investor subscribed to 1000 unit on April 1 and disposed it off at closing NAV on 30th April
then what will be your annual rate of earning. (10 Marks)

(C) Multiple Choice Questions

(i) In an open ended scheme, redemption period is ……….

a) Definite
b) Indefinite
c) 5 years
d) 10 years
(ii) Gilt Funds mainly invested in …………
a) Government Securities
b) Only in Debt Securities
c) Only in shares
d) Mix of debt and equity
(iii) ……… seeks to generate long term capital appreciation by investing in equity and equity related
instruments including equity derivatives as well as debt instruments.
a) Focused Fund

© The Institute of Chartered Accountants of India

 b) Arbitrage Fund
c) Index Funds
d) Dynamic Equity Funds
(iv) ………… is an offer document containing all the relevant details except that of price or number of shares
being offered.
a) Letter of Offer
b) Draft Offer Document
c) Abridged Prospectus
d) Red Herring Prospectus
(v) Index value on a particular date is calculated as
a) Index on previous day x Total market capitalization for current day/Total market capitalization of
the previous day
b) Index on current day x Total market capitalization for current day/Total market capitalization of
the previous day
c) Index on previous day x Total market capitalization for previous day/Total market capitalization of
the current day
d) Index on current day x Total market capitalization for previous day/Total market capitalization of
the current day
(vi) While Sharpe ratio measures ………., the Treynor Ratio measures only the …………
a) Total Risk; Systematic Risk
b) Unsystematic Risk; Systematic Risk
c) Systematic Risk; Unsystematic Risk
d) Systematic Risk; Total Risk
(vii) A bank rediscounted a commercial bill with a face of `100 @12% for 3 months. The sale value is `96.8.
The yield to the investor will be
a) 15.39%
b) 14.08%
c) 13.22%
d) 12.80
(viii) Market Makers comprises of
a) Commercial Banks
b) Mutual Funds
c) Insurance Companies
d) All of the above
(ix) The risk which arises due to possible change in spreads is called
a) Optionality Risk

© The Institute of Chartered Accountants of India

 b) Repricing Risk
c) Yield Curve Risk
d) Basis Risk
(x) The role of ………. is responsible for the delivery and settlement and consequent accounting entries for
all those transactions.
a) Front Office
b) Back Office
c) Mid-Office
d) Top Office
(10 x 2 = 20 Marks)

Exhibit 1

EXTRACTS FROM SEBI CIRCULAR

All Mutual Funds/Asset Management Companies (AMCs)/ Trustee Companies/Boards of Trustees of

Mutual Funds/ AMFI
Sir/ Madam,
Subject: Categorization and Rationalization of Mutual Fund Schemes
1. It is desirable that different schemes launched by a Mutual Fund are clearly distinct in terms of asset allocation,
investment strategy etc. Further, there is a need to bring in uniformity in the characteristics of similar type of
schemes launched by different Mutual Funds. This would ensure that an investor of Mutual Funds is able to
evaluate the different options available, before taking an informed decision to invest in a scheme.
2. In order to bring the desired uniformity in the practice, across Mutual Funds and to standardize the scheme
categories and characteristics of each category, the issue was discussed in Mutual Fund Advisory Committee
(MFAC). Accordingly, it has been decided to categorize the MF schemes as given below:
I. Categories of Schemes, Scheme Characteristics and Type of Scheme (Uniform Description of Schemes):
3. The Schemes would be broadly classified in the following groups:
a. Equity Schemes
b. Debt Schemes
c. Hybrid Schemes
d. Solution Oriented Schemes
e. Other Schemes
The details of the scheme categories under each of the aforesaid groups along with their characteristics and
uniform description are given in the Annexure.
4. As per the annexure, the existing ‘type of scheme’ (presently mentioned below the scheme name in the offer
documents/ advertisements/ marketing material/etc.) would be replaced with the type of scheme (given in the
third column of the tables in the Annexure) as applicable to each category of scheme. This will enhance the
existing disclosure. Hence, for the purpose of alignment of the existing schemes with the provisions of this

© The Institute of Chartered Accountants of India

 circular, change in “type of scheme” alone, would not be considered as a change in fundamental attribute.
5. In case of Solution oriented schemes, there will be specified period of lock in as stated in the Annexure.
However, the said lock- in period would not be applicable to any existing investment by an investor, registered
SIPs and incoming STPs in the existing solution oriented schemes as on the date on which such scheme is
getting realigned with the provisions of this circular.
6. The investment objective, investment strategy and benchmark of each scheme shall be suitably modified
(wherever applicable) to bring it in line with the categories of schemes listed above.
II. Definition of Large Cap, Mid Cap and Small Cap:
7. In order to ensure uniformity in respect of the investment universe for equity schemes, it has been decided
to define large cap, mid cap and small cap as follows:
a. Large Cap: 1st -100th company in terms of full market capitalization
b. Mid Cap: 101st -250th company in terms of full market capitalization
c. Small Cap: 251st company onwards in terms of full market capitalization
8. Mutual Funds would be required to adopt the list of stocks prepared by AMFI in this regard and AMFI would
adhere to the following points while preparing the list:
a. If a stock is listed on more than one recognized stock exchange, an average of full market capitalization of
the stock on all such stock exchanges, will be computed;
b. In case a stock is listed on only one of the recognized stock exchanges, the full market capitalization of
that stock on such an exchange will be considered.
c. This list would be uploaded on the AMFI website and the same would be updated every six months based
on the data as on the end of June and December of each year. The data shall be available on the AMFI
website within 5 calendar days from the end of the 6 months period.
9. Subsequent to any updation in the list, Mutual Funds would have to rebalance their portfolios (if required) in
line with updated list, within a period of one month.
Annexures to the SEBI Circular
A. Equity Schemes:

Category Scheme Characteristics Type of scheme (uniform description

of of scheme)
Schemes

Large & Mid Minimum investment in equity & equity related Large & Mid Cap Fund- An open ended
Cap Fund instruments of large cap companies- 35% of total equity scheme investing in both large cap
assets. Minimum investment in equity & equity and mid cap stocks
related instruments of mid cap stocks- 35% of total
assets.
Small cap Minimum investment in equity & equity related Small Cap Fund- An open ended equity
Fund instruments of small cap companies- 65% of total scheme predominantly investing in small
assets cap stocks
Dividend Scheme should predominantly invest in dividend An open ended equity scheme
Yield Fund yielding stocks. predominantly investing in dividend
yielding stocks
Minimum investment in equity- 65% of total assets
Focused A scheme focused on the number of stocks An open ended equity scheme investing
Fund (maximum 30) in maximum 30 stocks (mention where
Minimum investment in equity & equity related the scheme intends to focus, viz., multi

© The Institute of Chartered Accountants of India

 instruments - 65% of total assets cap, large cap, mid cap, small cap)
B. Debt Schemes
Category of Scheme Characteristics Type of scheme (uniform description of
Schemes scheme)
Ultra Short Investment in Debt & Money Market An open ended ultra-short term debt
Duration instruments such that the Macaulay duration of scheme investing in instruments with
Fund the portfolio is between 3 months - 6 months Macaulay duration between 3 months and 6
months.
Low Duration Investment in Debt & Money Market An open ended low duration debt scheme
Fund instruments such that the Macaulay duration of investing in instruments with Macaulay
the portfolio is between 6 months- 12 months duration between 6 months and 12 months.
Money Investment in Money Market instruments An open ended debt scheme investing in
Market Fund having maturity upto 1 year money market instruments

C. Hybrid Schemes

Category of Scheme Characteristics Type of scheme (uniform

Schemes description of scheme)
Dynamic Asset Investment in equity/ debt that is managed dynamically An open ended dynamic asset
Allocation or allocation fund
Balanced
Advantage
Arbitrage Fund Scheme following arbitrage strategy. Minimum An open ended scheme
investment in equity & equity related instruments- 65% investing in arbitrage
of total assets opportunities

D. Solution Oriented Schemes:

Category of Scheme Characteristics Type of scheme (uniform description of

Schemes scheme)
Retirement Scheme having a lock-in for at least 5 An open ended retirement solution oriented
Fund years or till retirement age whichever is scheme having a lock-in of 5 years or till
earlier retirement age (whichever is earlier)
Children’s Scheme having a lock-in for at least 5 An open ended fund for investment for children
Fund years or till the child attains age of having a lock-in for at least 5 years or till the child
majority whichever is earlier attains age of majority (whichever is earlier)
E. Other Schemes:

Category of Scheme Characteristics Type of scheme (uniform

Schemes description of scheme)
Index Funds/ Minimum investment in securities of a particular index An open-ended scheme
ETFs (which is being replicated/ tracked)- 95% of total assets replicating/ tracking index
FoFs (Overseas/ Minimum investment in the underlying fund- 95% of total An open ended fund of fund
Domestic) assets scheme investing in fund.

Exhibit 2

Dream Venue Focused 25 Fund Regular Plan

A newbie entrant, Dream Venue Focused 25 Fund Regular Plan has nevertheless managed an impressive show
for the last three years. Strong outperformance of the benchmark and category has allowed it to debut in the rating
scale with a four-star rating in 2016 and climb to five stars recently.

© The Institute of Chartered Accountants of India

Following the 'buy right, sit tight' philosophy of this fund house, this fund aims to own compact portfolios of quality
stocks with secular long-term growth prospects, with low portfolio churn. The fund prefers to restrict its holdings to
not more than 30 companies. It presently has 19 stocks in its portfolio. Furthermore, the fund has minimum
investment in equity and equity related instruments upto 65%
While it seldom takes cash calls, it has a slightly higher preference for mid-cap stocks than peers in this category.
In the last one year, its large-cap allocation has hovered at 80-90 per cent, while mid caps have accounted for 10-
20 per cent.
The fund's track record is as yet too limited to draw conclusions about performance. For one year, the returns are
a good 5 percentage points more than the benchmark returns and 3 percentage points more than the category
returns. On a three-year basis, the margins are 8 and 5 percentage points, respectively. However, the fund is yet
to encounter hostile markets like 2008 or even 2011 and hence its ability to manage choppy or falling markets is
as yet untested.
A fund worth watching in the large-cap space.

Exhibit 3

Dream Venue Ultra Short Term Bond Fund - Regular Plan

The Open Ended ultra-short Scheme seeks to generate optimal returns consistent with moderate levels of risk and
liquidity by investing in debt securities and money market securities such that the Macaulay Duration of the portfolio
is between 6 – 12 months. The Scheme seeks to generate optimal returns consistent with moderate levels of risk
and liquidity by investing in debt securities and money market securities
Exhibit 4

Dream Venue Dynamic Equity Fund - Regular Plan

The scheme seeks to generate long term capital appreciation by investing in equity and equity related instruments
including equity derivatives as well as debt instruments. The basic purpose of the scheme is to invest in equity/debt
that is managed dynamically. In other words, it is an open ended dynamic asset allocation fund.

The investment objective is to generate long term capital appreciation by investing in equity and equity related
instruments including equity derivatives, debt, money market instruments and units issued by REITs and InvITs.
However, there can be no assurance or guarantee that the investment objective of the Scheme would be achieved

Exhibit 5

CFDH RSF

Let’s take a look at the newest retirement fund, CFDH RSF. This fund’s equity plan, which comes with a five-year
lock-in period, is similar to an ELSS fund. “Since ELSS, with a lower lock-in period of three years, is available, why
go for a scheme with a higher lock-in period and also a 1% exit load, if redeemed before the age of 60,” asks
Jeewan Kumar, CEO, South Asia Capital. Such products are also costlier because of their small size—small
schemes charge a higher expense ratio. Except for ITU RBP, other schemes have much smaller assets under
management (AUM). FIPF’s AUM, for instance, is just Rs 339 crore. The expense ratio of these products will be
higher than the national pension scheme (NPS) but cheaper than insurance products.

The main advantage of mutual funds’ retirement products is that you don’t have to buy an annuity, as is the case
with the NPS or pension plans from insurance companies. Instead, you can opt for a systematic withdrawal plan
to meet your regular cash flow needs. Since a part of the withdrawal is your principal, it will be more tax-efficient
as well.

© The Institute of Chartered Accountants of India

Also, while the NPS restricts your equity exposure to 50%, with mutual fund products such as the CFDH RSF, you
can take a 100% equity exposure. However, these products do not come with the additional Rs 50,000 in deduction,
available to NPS. Mutual funds have asked for the extra tax benefit to be extended to their products, but whether
or not this happens, will be known only when the Budget is presented on 29 February.

Mutual funds’ pension products also offer greater liquidity, compared with the NPS or products from insurance
companies. You can withdraw your accumulated corpus after the lock-in period— 3-5 years—is over. You may
have to, however, pay a small exit load, if you want to withdraw your corpus but have not reached the retirement
age—58 or 60, depending on the product. Calculating the lock-in period also varies across funds. For instance, in
the case of HDFC RSF, the lock-in for each instalment is calculated from the date of investment. So, the money
you invest at the age of 59 can be withdrawn only at the age of 64.

Exhibit 6

ITU Nifty Index Funds

The principal investment objective of this scheme is to invest in stocks of companies comprising S&P CNX Nifty
Index and endeavour to achieve return equivalent to Nifty by passive investment The scheme is managed by
replicating the index in the same weightage as in the S&P CNX Nifty-Index with the intention of minimising the
performance differences between the scheme and the S&P CNX-Nifty Index in capital terms, subject to market
liquidity, costs of trading, management expenses and other factors which may cause tracking error. The scheme
alters the scrips/weights as and when the same are altered in the S&P CNX-Nifty Index.

© The Institute of Chartered Accountants of India