1.1. Evolution

1.1.1. What is a Mutual Fund?

  • It is essentially a Trust which has an agreed objective of investment of money mobilised from various investors. Through this vehicle of Mutual Fund, the investor is able to get professional fund management services. The Investor also has the access to securities market like equities, gilts and bonds.

1.1.2. What does a Mutual Fund do?

  • Mutual Fund, through various schemes, has access to a substantial corpus of fund collected from a large base of investors. It then invests such money into securities to generate returns for these investors. Investment is done as per the investment objective of the particular scheme of mutual fund.
  • Main function of a mutual fund is to help investors earn income or build wealth by participating in opportunities offered by securities markets.
  • Mutual Fund not only benefits the investor but also all constituents of society, directly or indirectly. It benefits private sector companies, Government and other entities for financing of their  various projects. It helps in creating direct and indirect employment in the society. It generates employment since large manpower is required for AMCs and for market intermediaries.
  • With enhanced investments, there is a rapid economic development in general which further increases employment.

1.1.3. Why various kinds of Mutual Fund Schemes?

  • Different investors have different investment requirement and objectives. Hence Mutual Funds mobilize different pools of money (Schemes) to accommodate these different requirements.
  • Investors subscribe to a particular scheme which matches with their own objective and need.

1.1.4. Operation of a Mutual Fund Scheme

  • If investors make investment in New Fund Offer (NFO), they are issued units in the scheme of NFO which generally have a face value of Rs. 10.
  • Interest or Dividend income is earned by the Mutual Fund Scheme on the investment it is holding. Also, when the investments are purchased/sold, it earns capital gains/incurs losses which are called realised gains/losses.
  • Investments held by scheme may be quoted and valued in market at a higher/lower price than the cost. Such gains/losses on valuation are called valuation gains/losses.
  • Certain expenses are incurred by the fund to run and operate the scheme like transaction cost, brokerage etc.
  • When the income earned by scheme added by realised gains and valuation gains and reduced by realised losses, valuation losses and  operating expenses is positive, the scheme is said to be profitable.
  • If scheme is profitable, the true worth of units increases. It decreases when scheme is not profitable. The true worth of the unit is called its Net Asset Value (NAV).
  • Investors can invest in units of a particular scheme at face value(At par) when a new scheme is launched which is called “New Fund Offer” (NFO). Post NFO, units can be bought at NAV only.
  • Mutual Funds invest the money mobilised in a particular scheme in a portfolio of securities as per defined objectives of the scheme and thus a scheme portfolio is created. All profits/losses in the portfolio belong to the investors of that scheme.
  • Investors are offered following options – growth option, dividend pay out option and dividend reinvestment option within a particular scheme.

1.1.5. Assets Under Management

  • The relative size of various mutual fund companies is assessed  by their  assets under management (AUM).
  • The AUM of any scheme and consequently of any Mutual Fund company may increase depending on further subscriptions in the scheme and/or increase in the market value of the portfolio. It may fall due to redemption, income pay-outs or decrease in market value of portfolio.
  • Therefore, AUM is the result of the impact of profitability metric and the infusion/withdrawal of investor money.

1.1.6. How Investors gain from Mutual Funds

  • Professional: By investing in mutual fund schemes, investors get opportunity to earn income or build wealth aided by professional management of their funds.
  • Simpler: It is simpler than the investor directly investing in the securities market since separate broking and demat account are not required.
  • Affordable: Even small investment in mutual fund gives access to a diversified portfolio which is not affordable otherwise.
  • Diversification: Because of diversified portfolio of mutual fund, the investor is less likely to lose money on all the investment.
  • Economy of scale: Due to the availability of large investment pool, it is possible for mutual funds to deploy professional fund managers which is not possible otherwise. The scale also results in lower costs.
  • Liquidity: An investor investing directly in any specific security may not be able to sell it off and realise money when in need. In a mutual fund, in open ended scheme, he can quickly redeem the units and realise required money. Even Close ended schemes are listed on stock exchanges and one may sell off such units on exchange to realise the required money.
  • Tax Advantages: Mutual funds are not liable to pay tax on their income as against the individual investor who is liable for it. The Investors can also defer the tax liability by opting for growth schemes. Moreover, some mutual fund schemes like Equity Linked Savings Scheme offer a deduction of income to the extent of Rs. 150000/- under the provisions of Income Tax Act.
  • Other benefits: It offers other benefits like convenient investment options, Investment comfort, regulatory comfort and Systematic approach to investment like SIP, STP and SWP.

1.1.7. Limitations of Mutual Funds

There are a few limitations of a mutual fund  which are  detailed below :

  • In Mutual Fund, the investment management is left to the competence of the fund manager hence, investor can not influence what securities should scheme invest in.
  • There are over 40 Mutual Funds each of which offer different options in different schemes and hence, there is an overload for investor to choose between the schemes. This difficulty has however reduced with the categorisation of schemes by SEBI.
  • Individual investor can not control the cost or the expense ratio of mutual fund scheme. However, SEBI has specified the limits of expense ratio of each scheme according to the nature and category of the scheme.

1.2. Classification of Funds

1.2.1. Open Ended Funds

  • Open ended funds are the funds which are open for entry or exit any time even after the NFO period. Existing investor may purchase additional units or new investor can acquire fresh units any time in an open ended fund at a price linked to NAV.
  • Similarly, any existing investors can redeem the units at a price linked to NAV and remaining investors will continue in the scheme.
  • There is no specified time frame for open ended scheme.

1.2.2. Close ended Funds

  • There is a maturity and time frame in case of Close ended funds.
  • Investors can purchase units only during NFO period. Units can be redeemed only at the end of maturity or tenure. However, Close ended funds are compulsorily listed on stock exchanges. Post NFO, units of close ended schemes can be bought or  sold  on stock exchanges, where the scheme is listed.
  • The sale/purchase price on stock exchanges may be different from the NAV of the scheme.

1.2.3. Interval Funds:

  • Interval funds are a combination of open ended and close ended schemes. They are largely closed ended when no sale and purchase of units are possible with Mutual Fund. During this close ended period, units could be transacted only in stock exchanges where the scheme is listed. The scheme becomes open ended at prespecified interval. Such period is known as transaction period. During transaction period, purchase and repurchase may be made from mutual fund. Period between the close of a transaction period and opening of the next transaction period is called Interval Period.
  • Minimum duration of transaction period is 2 days and minimum duration of interval period is 15 days.

1.2.4. Actively managed Funds, passive Funds and ETFs

  • In actively managed funds, fund manager chooses investment portfolio within the parameters of investment objectives. Fund Manager has got an important role to play. Hence, the fund running expenses tend to be higher. Better returns than the market are expected from actively managed funds.
  • Passive funds invest on the basis of a specified index like BSE Sensex and therefore buy only the shares that are part of the composition of BSE Sensex. The proportion of each share in the scheme portfolio is equal to the weightage given to such stock in BSE Sensex. These are mirror of the index. They are not designed to perform better than the market. Fund manager has therefore no role in investment decisions. This results in low scheme expense.
  • Exchange Traded Funds (ETFs) are also passive funds and the scheme portfolio is identical to the related Index or benchmark like an equity index or a commodity index. Investor has to keep such funds compulsorily in a Demat account. Post NFO transactions are done on stock exchanges.

1.2.5. Equity, Debt, Hybrid and Solution Oriented schemes

Equity Schemes

  • Investment objective of the equity  scheme is to seek capital appreciation and growth by investing in equity capital and equity related instruments.

Debt Schemes

  • Investment objective of Debt Scheme is to earn regular income by investing in Debt securities like Government Securities, Treasury Bills, Bonds, Debentures.

Hybrid Schemes

  • Investment objective of Hybrid Scheme is to make investment both in equity and debt instruments.

Solution Oriented

  • Schemes with an investment objective of achieving a particular goal aimed in future like Children’s education or retirement are called solution-oriented scheme.

1.3. How many types of Equity Schemes are there?

  • Equity Funds aim for long term appreciation in the value of portfolio from valuation and dividend gains. These funds can be classified based on the type and market capitalisation of equity shares included in portfolio as also based on the strategy adopted by fund manager. Various categories are as under:
  • Market Segment based Funds: Companies may be categorised according to the value of their market capitalisation. Categorisation have now been clearly defined by SEBI. It is as Large Cap, Mid Cap and Small Cap. These funds Invest in companies of a particular size of market capitalisation. SEBI has defined Large Cap companies which are among  1st to 100th in terms of market capitalisation. Similarly, Mid cap companies are the ones from 101st to 250th  and small caps are from 251st and  onwards in terms of market capitalisation.
  • Large Cap funds invest in equities of Large and blue chip companies with comparatively less volatile  performance and returns.
  • Mid Cap Funds invest in equities of mid cap companies with potential for quick growth and higher returns but these may not withstand the downfall and therefore the related risk is also higher.
  • Small Cap funds invest in equities of companies with small market capitalisation with potential of very high returns. The related risks are also very high.
  • Diversified Equity Funds: invest in a mix of securities across all the sectors and market capitalisation. Fund performance is not expected to get impacted due to poor performance of any particular sector or segment.
  • Sector or Thematic Funds:These funds invest in the equities of a particular sector, like Banking or Pharma for sector fund. Similarly, these funds could invest for a particular theme like Infrastructure-construction for a thematic fund. Such funds are entirely depending on the performance of that particular sector or theme.
  • Dividend Yield Schemes: Such schemes invest in equities of companies whose shares market price fluctuate less and the dividend is the larger proportion of returns. But opportunity for capital appreciation, growth or expansion is limited.
  • Value Funds: These funds invest in companies which are fundamentally strong but are undervalued currently. Here risk is less but time horizon may be large for strategy to play out.
  • Growth Funds: The investment is made is such companies where earning potential is higher. The capital appreciation is therefore expected along with good returns in bullish markets. The risk of volatility in returns is higher in such funds.
  • Focused Funds: The investment portfolio is concentrated in a limited number of companies hence selection risk is If any one company does not perform, the impact is substantial on the returns.
  • Equity Linked Savings Scheme (ELSS): These are diversified equity funds offering tax benefits to investor under Section 80C of IT Act up to an investment limit of Rs. 150000/- per year. Here a lock in of 3 years is applicable.

1.4. Classification and Categorisation of schemes:

  • SEBI has categorised open ended mutual fund schemes to ensure uniformity of similar type of schemes launched by different mutual funds. This has been done in order to enable investor to evaluate various schemes and take an informed decision.

1.4.1. Open ended Mutual Fund equity Schemes

Have been categorised as detailed in following table:

CategoryInvestment inMinimum Investment in Equity & Equity Related Instruments
Multi CapMinimum Investment of 25%
Each in Large, Mid and Small cap
75% of total assets
Large CapLarge Cap Co.80% of total assets
Large & Mid CapLarge & Mid Cap35% each in Large & Mid Cap
Mid CapMid Cap65% of total assets
Small CapSmall Cap65% of total assets
Dividend YieldDividend Yielding stocks65% of total assets
Value FundValue strategy65% of total assets
Contra FundContra Strategy65% of total assets
FocussedMaximum 30 stocks65% of total assets
Sector/Thematicsector/Theme80% of total assets
ELSSDiversified 80% of total assets

1.4.2. Classification of Debt Schemes

  • Debt Funds are classified on the basis of type of debt securities in which they invest. The main differentiation can be on the basis of Issuer of Securities, Duration of the security and investment strategy.

Classification on the basis of Issuer:

  • Issuer : Government — Gilt Funds invest only in Treasury Bills and Government Securities issued by the Government. These securities offer lower  Interest rates  but  they do not have any risk of credit default. In Long Term Gilt Funds also, there is no risk of default but price of security is quite  sensitive to interest rate changes.
  • Issuer : Private sector and Public sector  Corporates — Corporate Bond  Funds  invest in debt securities issued by Corporates including PSUs. The credit risk is reflected in credit ratings given to the securities but the interest rate is higher. The price is sensitive to  interest rate changes.

Classification on the basis of Duration

  • Liquid Schemes invest in short term debt securities of up to 91 days maturity. Securities over 60 days have to be valued based on Mark to Market (MTM) basis. Hence fund managers prefer to invest mostly in securities with less than 60 days maturity. These funds are ideal for high liquidity and safety of capital.
  • Short Term Debt Scheme invest in short duration debt securities where interest rate risk is low. Interest income and valuation gains will depend on the duration of each security in portfolio. These include Short term plans  and short term Gilt funds.
  • Ultra Short term funds invest in money market and short term securities. Their objective is to generate steady returns mostly from interest income with very less volatility.
  • Long Term Debt Securities invest in Longer term securities issued by Government and other corporate issuers. The returns from these schemes are impacted by valuation of securities and therefore there is greater volatility in returns.

Classification on the basis of Investment Strategy

  • Diversified debt funds or Income Funds invest in a diversified mix of government and non government debt securities like Debentures, corporate bonds and commercial paper. Bonds earn higher interest whereas Government securities are kept for high liquidity and valuation gains.
  • High yield bond schemes or Junk Bond Schemes invest in securities with low credit ratings but higher interest rates.
  • Dynamic Bond Funds look for opportunities to earn income and capital gains with flexibility in type of securities held. Duration of securities is not fixed. These funds are managed in a dynamic fashion. Fund manager may reduce the portfolio duration if he thinks that interest rates will move upwards and vice – versa.
  • Fixed maturity Plans (FMP) invest in securities where duration is aligned with the maturity of the scheme. There is hardly anything a fund manager may strategize in such schemes. Investors have better clarity of likely returns if they stay invested.
  • Floating rate Funds invest in debt securities with a floating rate of interest. The NAV in such schemes fluctuates lesser than other funds with fixed rate debt securities.

1.4.3. SEBI Categorisation of Debt Schemes

  • Like equity schemes, SEBI has categorised the open ended Debt mutual fund schemes as tabulated below:
  • Duration means Macaulay duration.
  • Where % of total assets is given, it refers to minimum percentage in the required securities.

Fund CategoryInvestment inDuration of Portfolio
Overnight FundOvernight SecuritiesMaturity of 1 day
Liquid FundDebt & Money market InstrumentsMaturity of Up to 91 Days
Ultra-Short-DurationDebt & Money market Instruments Macaulay duration between 3-6 months
Low DurationDebt & Money market InstrumentsMacaulay duration Between 6-12 months
Money MarketMoney Market InstrumentsMaturity of Up To 1 year
Short DurationDebt & Money market InstrumentsMacaulay duration Between 1-3 years
Medium DurationDebt & Money market InstrumentsMacaulay duration Between 3-4 years
Medium To longDebt & Money market InstrumentsMacaulay duration Between 4-7 years
Long DurationDebt & Money market InstrumentsMacaulay duration Over 7 years
Dynamic BondDebt & Money market InstrumentsAcross Durations
Corporate BondMinimum 80 % of total assets to be invested in AA+ and above rated corporate bonds
Credit Risk FundMinimum 65% of total assets to be invested in AA & below rated corporate bonds
Banking & PSUMinimum 80% of total assets to be invested in Debt Instruments of Banks/PSU/Public Financial Institutions & Municipal bond
Gilt Funds80% of total assets to be invested in Govt. Securities across duration
Floater Funds65% of total assets to be invested in Floating rate Instruments

1.4.4. Classification of Hybrid Funds

  • These invest in a mixed combination of asset classes like equity, debt and Gold. The proportion of each class will depend on investment objective of the fund. The risk and return will depend on the allocation of each asset class in the combination. Risk is higher if allocation to equity is higher. Also, if allocation to higher term debt security or lower rated security is high, the risk will be higher.
  • Debt oriented Hybrid Funds invest predominantly in debt securities with a small allocation to equity funds. The allocation is specified in the offer document. The Debt securities earn interest whereas small equity component is meant to enhance returns.
  • Monthly Income Funds seeks to declare monthly dividend although there is no guarantee.
  • Multiple Yield Fund seeks to generate returns in medium term with allocation to multiple asset classes like Debt and Equity.
  • Equity Oriented Hybrid Fund invests predominantly in equity with a small proportion of total assets being invested in Debt to seek stable returns. It is also called the Balanced Fund. The Fund seeks to generate growth as well as stability. The allocation to Equity or Debt could be fixed or flexible. This has to be specified in offer document.
  • Capital Protection Schemes are close ended schemes with an objective of protecting the capital irrespective of market fluctuations. The investment is generally made in Government securities and debt securities with maturity aligned with that of the scheme and returns to be paid on maturity. The investment is structured in such a fashion that principal invested together with accumulated interest will become equal to the value  of investment at start. The balance amount is invested in riskier securities like equity to boost returns. Actually more befitting nomenclature is capital protection oriented schemes.
  • Arbitrage Funds invest by taking opposite positions in different markets such that risk is nullified and some return is generated. For example buying a security on BSE and selling the same at NSE at higher price.

1.4.5. SEBI Categorisation of Hybrid Funds

  • SEBI has classified hybrid funds in the manner tabulated below:

CategoryInvests inProportion
ConservativePredominantly DebtDebt 75-90% of Total asset
Equity 10-25% of Total asset
BalancedEquity & DebtEquity 40-60% of total assets
Debt-40-60% of total assets
AggressivePredominantly EquityEquity- 65-80% of total assets
Debt -20-35% of total assets
Dynamic Asset AllocationEquity & DebtTo be managed dynamically
Multi Asset AllocationAt least 3 asset classesAt least 10% in each asset class
Arbitrage FundArbitrage opportunitiesMinimum 65% in equity and Equity related
Equity SavingsEquity, Debt & ArbitrageMinimum 65% in Equity and Equity related.
Minimum 10% of total asset In Debt.

1.4.6. What are Solution Oriented Schemes?

  • Schemes with an investment objective of achieving a particular goal aimed in future like Children’s education or retirement are called solution-oriented scheme.
  • SEBI has categorised Solution Oriented Schemes under the sub heads of Retirement Funds and Children’s fund as detailed below:
  • Retirement Fund is the scheme which is open ended with a lock in period of 5 years or till retirement age, whichever is earlier
  • Children’s Fund is the scheme which is open ended with a lock in period of at least 5 years or till the child attains the Majority, whichever is earlier.

1.4.7. Other Schemes

  • SEBI has categorised other mutual fund schemes in two sub heads i.e. Index Funds/ Exchange Traded Funds(ETF) and Fund of Funds (FoF) – Overseas or Domestic, as detailed below:
  • Index Funds/ETF are the fund schemes which are open ended. They track specific index. Minimum investment in securities of a particular index (which is being replicated/ tracked) should not be less than  95% of total assets.
  • Fund of Funds (Overseas/Domestic) are the fund schemes which are open ended. They invest in an underlying fund. Minimum investment in the underlying fund should not be less than 95% of the total assets.

1.5. Mutual Funds/ Investment Trusts related to Real Estate

  • Real Estate Mutual Fund schemes invest directly or indirectly in real estate assets or other permissible assets in accordance with SEBI ( Mutual Funds ) Regulations 1996. At least 35% of total assets should be held in physical assets. A minimum of 75% of net assets should be in Real Estate assets, Mortgage backed securities (but not directly in mortgages), Equity Shares or Debentures  of companies dealing in  Real Estate assets or in undertaking real estate development projects. These Schemes will be close ended schemes listed on stock exchange. Every 90 days, the assets of the fund will be valued by 2 valuers accredited by a credit Rating Agency. Lower of the two values  will be considered  for calculating  the NAV.
  • Real Estate Investment Trusts (REITs) are the trusts registered with SEBI. They invest in commercial Real Estate. REIT units are to be listed on stock exchanges. They will raise fund through Initial offer and subsequently through follow on offers, Rights Issue and Institutional placements. Minimum value of asset owned or proposed to be owned  should be Rs 500 crores. Minimum offer size should be Rs 250 crores. The minimum subscription will be Rs 2 lacs in initial offer.
  • Infrastructure Investment Trust are the trusts registered with SEBI. They invest in Infrastructure sector. They are listed on stock exchanges. They will raise fund  through Initial offer. Minimum value of asset owned or proposed to be owned  should be Rs 500 crores. Minimum offer size should be Rs 250 crores. The minimum subscription will be Rs 10  lacs in initial offer.

1.6. Growth Story of Mutual Fund Industry

  • There has been phenomenal growth of Mutual Funds Industry in India since the times the first mutual fund was launched.
  • Growth started when Public Sector Mutual Funds were launched in 80s and then again in 90s when private sector mutual funds started operations.
  • Various factors like Technological developments, higher financial awareness, enhanced channels of distribution are driving the growth of the industry.
  • AUM of MF Industry has increased from Rs. 6 Trillion in 2012 to Rs. 23 Trillion in 2018.
  • The number of Folios or accounts were 7 crores as of March’18.
  • However, there is still tremendous scope since the Indian Mutual Funds market is less than 1 % of global market AUM of around USD 40 Trillion.

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