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Introduction to Mutual Funds:
Concept
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. The flow chart below describes broadly the
working of a mutual fund.
Mutual fund is a mechanism for pooling the resources by issuing units to the investors and
investing funds in securities in accordance with objectives as disclosed in offer document.
Investments in securities are spread across a wide cross-section of industries and sectors and
thus the risk is reduced. Diversification reduces the risk because all stocks may not move in
the same direction in the same proportion at the same time. Mutual fund issues units to the
investors in accordance with quantum of money invested by them. Investors of mutual funds
are known as unit holders.
The investors in proportion to their investments share the profits or losses. The mutual funds
normally come out with a number of schemes with different investment objectives that are
launched from time to time. A mutual fund is required to be registered with Securities and
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Exchange Board of India (SEBI), which regulates securities markets before it can collect
funds from the public.
Different investment avenues are available to investors. Mutual funds also offer good
investment opportunities to the investors. Like all investments, they also carry certain risks.
The investors should compare the risks and expected yields after adjustment of tax on
various instruments while taking investment decisions
Organisation of a Mutual Fund:
A mutual fund is set up in the form of a trust, which has sponsor, trustees, Asset
Management Company (AMC) and custodian. The trust is established by a sponsor or more
than one sponsor who is like promoter of a company. The trustees of the mutual fund hold its
property for the benefit of the unitholders. Asset Management Company (AMC) approved by
SEBI manages the funds by making investments in various types of securities. Custodian,
who is registered with SEBI, holds the securities of various schemes of the fund in its
custody. The trustees are vested with the general power of superintendence and direction
over AMC. They monitor the performance and compliance of SEBI Regulations by the
mutual fund SEBI Regulations require that at least two thirds of the directors of trustee
company or board of trustees must be independent i.e. they should not be associated with the
sponsors. Also, 50% of the directors of AMC must be independent. All mutual funds are
required to be registered with SEBI before they launch any scheme
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Mutual fund structure:
The structure consists of:
Sponsor: Sponsor is the person who acting alone or in combination with another
body corporate establishes a mutual fund. Sponsor must contribute at least 40% of the
net worth of the Investment Managed and meet the eligibility criteria prescribed
under the Securities and Exchange Board of India (Mutual Funds) Regulations,
1996.The Sponsor is not responsible or liable for any loss or shortfall resulting from
the operation of the Schemes beyond the initial contribution made by it towards
setting up of the Mutual Fund
Trust: The Mutual Fund is constituted as a trust in accordance with the provisions of
the Indian Trusts Act, 1882 by the Sponsor. The trust deed is registered under the
Indian Registration Act, 1908
Trustee: Trustee is usually a company (corporate body) or a Board of Trustees (body
of individuals). The main responsibility of the Trustee is to safeguard the interest of
the unit holders and inter alia ensure that the AMC functions in the interest of
investors and in accordance with the Securities and Exchange Board of India (Mutual
Funds) Regulations, 1996, the provisions of the Trust Deed and the Offer Documents
of the respective Schemes. At least 2/3rd directors of the Trustee are independent
directors who are not associated with the Sponsor in any manner
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Asset Management Company: The Trustee as the Investment Manager of the
Mutual Fund appoints the AMC. The AMC is required to be approved by the
Securities and Exchange Board of India (SEBI) to act as an asset management
company of the Mutual Fund. Atleast 50% of the directors of the AMC are
independent directors who are not associated with the Sponsor in any manner. TheAMC must have a net worth of atleast 10 crore at all times
Registrar or Transfer agent: The AMC if so authorized by the Trust Deed appoints
the Registrar and Transfer Agent to the Mutual Fund. The Registrar processes the
application form; redemption requests and dispatches account statements to the unit
holders. The Registrar and Transfer agent also handles communications with
investors and updates investor records
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Need and Importance of the Study
People always would be in a perception to save the surplus money that they earn.
There are many modes of saving the money. While making an investment people have to
clearly and carefully think as to how well their money can be distributed among various
means of investing, so that they can earn the maximum benefits from what they have
invested. 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. Mutual fund organizations serve
the investors purpose by making a portfolio of where all to invest their money so as to get
maximum returns. Here again arises a confusion of choosing whether to buy mutual funds
from public sector companies or private sector companies. The need of the present study is to
analyze and compare Mutual funds sold by Public sector and private sector companies and
give a feasible solution to the investors.
Objective of the study
The study totally attempts to know the performance of public and private sector mutual
funds.
Primary Objective:
Measuring the performance of the following.
ICICI Pru emerging star fund
Reliance equity opp fund- retail plan (G)
SBI magnum emerging fund (G)
Birla Sun life yield plus (G)
Secondary objective:
Measuring the Five Year quarterly returns of different schemes taken and comparing
it with the benchmark performance.
To measure return and risk of investing in mutual funds.
To measure the fund performance.
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Scope of the study
The historical performance of the fund is compared with the performance of the market
(Nifty). Both the historical data of the fund and the Market is used for analysis. The internal
factors contributing for the performance of this specific fund is not included in the scope of
the study. The scope of the study is confined to the performance of this specific fund in
comparison to the prevailing market conditions. The market being a major factor affecting
the mutual funds performance, the market conditions play a critical role despite the
precautions taken by the fund managers. The care taken by the fund managers does not fall in
the scope of the study. The scope of the study is limited to the performance of the fund in the
existing market conditions. The scope is confined only to two public companies namely UTI
and two private sector companies TATA and Reliance.
Research methodology:
The data for the study is collected from two main sources.
1. primary source
2. secondary source
Primary source:
The data is collected through interaction with the official in the company.
Secondary source:
The secondary source has been collected through the following sources.
Web sites
Mutual fund books
News papers and magazines.
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Limitations of the Study:
The study is conducted in short period i.e. for 2005 - 2009 due to which it may not
be detailed in all the aspects.
The study is limited only to the analysis of different schemes and its suitability to
different investors according to their risk taking ability.
Different people may interpret the same analysis in different ways.
The analysis done only on basis of returns.
Mutual funds are restricted to Equity- diversified schemes only.
Mutual funds are restricted to Growth plan only
Performance evaluation is done to four mutual funds by taking quarterly returns
only.
As the study is based on five years data only entire findings cannot be generalized.
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Company Profile
India InfolineLimited a one-stop financial services shop, most respected for quality of its
advice, personalized service and cutting-edge technology.
The India Infoline group, comprising the holding company, India infoline limited and its
wholly-owned subsidiaries, straddle the entire financial services space with offerings ranging
from equity research, equities and derivatives trading, commodities trading, portfolio
management services, mutual funds, life insurance, fixed deposits, goi bonds and other small
savings instruments to loan products and investment banking.
India Infoline also owns and manages the websites www.indiainfoline.com and
www.5paisa.com the company has a network of over 2100 business locations (branches andsub-brokers) spread across more than 450 cities and towns. The group caters to
approximately a million customers.
Vision Statement:
Our vision is to be the most respected company in the financial services space.
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Board of Directors
1 Mr.Nirmal Jain
Chairman and managing director
India infoline securities Pvt.Ltd.
India infoline Insurance services Ltd.
India infoline Commodities Pvt.Ltd.
2 Mr.R.Venkataraman
Executive Director
India infoline Insurance services Ltd.
India infoline.com
Distribution company Ltd.
3 Mr. Sat Pal Khattar
Non-Executive Director
AB Hotels Ltd.
GTL Ltd.
Prime vetcare Pvt.Ltd.
4 Mr.Sanjiv Ahuja
Non-Executive Independent Director
Pagro Foods Ltd.
India infoline insurance services Ltd.
5 Mr. Kranti Sinha
Non-Executive Independent Director
Hindustan Motors Ltd.
Larsen and Toubro Ltd.
6 Mr. Nilesh ShivjiVikamsey
Non-Executive Independent Director
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Alpha Garments Pvt. Ltd.
History:
We were founded in 1995 by Mr. Normal Jain (Chairman and Managing Director) as an
independent business research and information provider. We gradually evolved into a one-
stop financial services solutions provider. Our strong management team comprises competent
and dedicated professionals
We are a pan-India financial services organization across 1,361 business locations and a
presence in 428 cities. Our global footprint extends across geographies with offices in New
York, Singapore and Dubai. We are listed on the Bombay Stock Exchange (BSE) and the
National Stock Exchange (NSE).
We offer a wide range of services and products comprising broking (retail and institutionalequities and commodities), wealth management, credit and finance, insurance, asset
management and investment banking.
We are registered with the BSE and the NSE for securities trading, MCX, NCDEX and
DGCX for commodities trading, CDSL and NSDL as depository participants. We are
registered as a Category I merchant banker and are a SEBI registered portfolio manager. We
also received the FII license in IIFL Inc. IIFL Securities Pte Ltd received approval from the
Monetary Authority of Singapore to carry out corporate advisory and dealing in securities
operations. Two subsidiaries India Infoline Investment Services and Moneyline Credit
Limited are registered with RBI as non-deposit taking non-banking financial services
companies. India infoline Housing Finance Ltd, the housing finance arm, is registered with
the National Housing Bank.
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Products and Services
Equities:
Indiainfoline provided the prospect of researched investing to its clients, which was
hitherto restricted only to the institutions. Research for the retail investor did not exist prior
to Indiainfoline. Indiainfoline leveraged technology to bring the convenience of trading to the
investors location of preference (residence or office) through computerized access.
Indiainfoline made it possible for clients to view transaction costs and ledger updates in real
time.
PMS:
Our Portfolio Management Service is a product wherein an equity investment portfolio is
created to suit the investment objectives of a client. We at Indiainfoline invest your resources
into stocks from different sectors, depending on your risk-return profile. This service is
particularly advisable for investors who cannot afford to give time or don't have that
expertise for day-to-day management of their equity portfolio.
Research:
Sound investment decisions depend upon reliable fundamental data and stock selection
techniques. Indiainfoline Equity Research is proud of its reputation for, and we want you to
find the facts that you need. Equity investment professionals routinely use our research and
models as integral tools in their work. They choose Ford Equity Research when they can
clear your doubts.
Commodities:
Indiainfolines extension into commodities trading reconciles its strategic intent to emerge
as a one-stop solutions financial intermediary. Its experience in securities broking has
empowered it with requisite skills and technologies. The Companys commodities business
provides a contra-cyclical alternative to equities broking. The Company was among the first
to offer the facility of commodities trading in Indias young commodities market (the MCX
commenced operations only in 2003). Average monthly turnover on the commodity
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exchanges increased from Rs 0.34 bn to Rs 20.02 bn. The commodities market has several
products with different and non-correlated cycles. On the whole, the business is fairly
insulated against cyclical gyrations in the business.
Mortgages
During the year under review, Indiainfoline acquired a 75% stake in Moneytree
Consultancy Services to mark its foray into the business of mortgages and other loan
products distribution. The business is still in the investing phase and at the time of the
acquisition was present only in the cities of Mumbai and Pune. The Company brings on
board expertise in the loans business coupled with existing relationships across a number of
principals in the mortgage and personal loans businesses. Indiainfoline now has plans to roll
the business out across its pan-Indian network to provide it with a truly national scale in
operations.
Home & Personal Loans
Loan against residential and commercial property, Expert recommendations,Easy
documentation, Quick processing and disbursal, No guarantor requirement
Invest Online
Indiainfoline has made investing in Mutual funds and primary market so effortless. All you
have to do is register with us and thats all. No paperwork no queues and No registration
charges.
Invest In Mf
Indiainfoline offers you a host of mutual fund choices under one roof, backed by in-depth
research and advice from research house and tools configured as investor friendly.
SMS
Stay connected to the market. The trader of today, you are constantly on the move. But how
do you stay connected to the market while on the move? Simple, subscribe to Indiainfoline's
Stock Messaging Service and get Market on your Mobile!
There are three products under SMS Service:
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Market on the move.
Best of the lot.
VAS (Value Added Service)
Insurance
An entry into this segment helped complete the clients product basket; concurrently, it
graduated the Company into a one-stop retail financial solutions provider. To ensure
maximum reach to customers across India, we have employed a multi pronged approach and
reach out to customers via our Network, Direct and Affiliate channels. Following the opening
of the sector in 1999-2000, a number of private sector insurance service providers
commenced operations aggressively and helped grow the market.
The Companys entry into the insurance sector derisked the Company from a predominant
dependence on broking and equity-linked revenues. The annuity based income generated
from insurance intermediation result in solid core revenues across the tenure of the policy.
Wealth Management Service
Imagine a financial firm with the heart and soul of a two-person organization. A world-
leading wealth management company that sits down with you to understand your your needs
and goals. We offer you a dedicated group for giving you the most personal attention at every
level.
Newsletters
The Daily Market Strategy is your morning dose on the health of the markets. Five intra-day
ideas, unless the markets are really choppy coupled with a brief on the global markets and
any other cues, which could impact the market. Occasionally an investment idea from the
research team and a crisp round up of the previous day's top stories. That's not all. As asubscriber to the Daily Market Strategy, you even get research reports of Indiainfoline
research team on a priority basis.
The Indiainfoline Weekly Newsletter is your flashback for the week gone by. A weekly
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outlook coupled with the best of the web stories from Indiainfoline and links to important
investment ideas, Leader Speak and features is delivered in your inbox every Friday evening.
Company structure:
India Infoline Limited is listed on both the leading stock exchanges in India, viz. the Stock
Exchange, Mumbai (BSE) and the National Stock Exchange (NSE) and is also a member of
both the exchanges. It is engaged in the businesses of Equities broking, Wealth Advisory
Services and Portfolio Management Services. It offers broking services in the Cash and
Derivatives segments of the NSE as well as the Cash segment of the BSE. It is registered
with NSDL as well as CDSL as a depository participant, providing a one-stop solution for
clients trading in the equities market. It has recently launched its Investment banking and
Institutional Broking business
.
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A SEBI authorized Portfolio Manager; it offers Portfolio Management Services to clients.
These services are offered to clients as different schemes, which are based on differing
investment strategies made to reflect the varied risk-return preferences of clients.
The content services represent a strong support that drives the broking, commodities, mutual
fund and portfolio management services businesses. Revenue generation is through the sale
of content to financial and media houses, Indian as well as global.
It undertakes equities research which is acknowledged by none other than Forbes as 'Best of
the Web' and 'a must read for investors in Asia'. India Infoline's research is available not
just over the internet but also on international wire services like Bloomberg (Code: IILL),
Thomson First Call and Internet Securities where India Infoline is amongst the most read
Indian brokers.
India Infoline Commodities Limited
India Infoline Commodities Pvt Limited is engaged in the business of commodities broking.
Our experience in securities broking empowered us with the requisite skills and technologies
to allow us offer commodities broking as a contra-cyclical alternative to equities broking. We
enjoy memberships with the MCX and NCDEX, two leading Indian commodities exchanges,
and recently acquired membership of DGCX. We have a multi-channel delivery model,
making it among the select few to offer online as well as offline trading facilities
India Infoline Marketing & Services
India Infoline Marketing and Services Limited is the holding company of India Infoline
Insurance Services Limited and India Infoline Insurance Brokers Limited.
(a) India Infoline Insurance Services Limited is a registered Corporate Agent with the
Insurance Regulatory and Development Authority (IRDA). It is the largest Corporate
Agent for ICICI Prudential Life Insurance Co Limited, which is India's largest privateLife Insurance Company. India Infoline was the first corporate agent to get licensed
by IRDA in early 2001
(b) India Infoline Insurance Brokers Limited is a newly formed subsidiary which will
carry out the business of Insurance broking. We have applied to IRDA for the
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insurance broking licence and the clearance for the same is awaited. Post the grant of
license, we propose to also commence the general insurance distribution business.
India Infoline Investment Services Limited
Consolidated shareholdings of all the subsidiary companies engaged in loans and
financing activities under one subsidiary. Recently, Orient Global, a Singapore-based
investment institution invested USD 76.7 million for a 22.5% stake in India Infoline
Investment Services. This will help focused expansion and capital raising in the said
subsidiaries for various lending businesses like loans against securities, SME financing,
distribution of retail loan products, consumer finance business and housing finance
business. India Infoline Investment Services Private Limited consists of the following
step-down subsidiaries.
a) India Infoline Distribution Company Limited (distribution of retail loan products)
b) Moneyline Credit Limited (consumer finance)
c) India Infoline Housing Finance Limited (housing finance)
IIFL (Asia) Pte Limited
IIFL (Asia) Pte Limited is wholly owned subsidiary which has been incorporated in
Singapore to pursue financial sector activities in other Asian markets. Further to
obtaining the necessary regulatory approvals, the company has been initially capitalized
at 1 million Singapore dollars.
Milestones:
In the year 1995:
Incorporated as an equity research and consulting firm with a client base that included
leading FIIs, banks, consulting firms and corporates.
In the year 1999:
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Restructured the business model to embrace the Internet; launched
archives.indiainfoline.com
Mobilized capital from reputed private equity investors.
In the year 2000:
Commenced the distribution of personal financial products; launched online equity
trading.
In the year 2004:
Acquired commodities broking license; launched Portfolio Management Service.
In the year 2005:
Listed on the Indian stock markets
In the year 2006:
Acquired membership of DGCX; launched investment banking services.
In the year 2007:
Launched a proprietary trading platform; inducted an institutional equities team; formed a
Singapore subsidiary; raised over USD 300 mn in the group; launched consumer finance
business under the Moneyline brand.
In the year 2008:
Launched wealth management services under the IIFL Wealth brand; set up India Infoline
Private Equity fund; received the Insurance broking license from IRDA; received the venture
capital license; received in principle approval to sponsor a mutual fund; received Best
broker- India award from Finance Asia; Most Improved Brokerage- India award
from Asiamoney.
In the year 2009:
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Received registration for a housing finance company from the National Housing Bank;
received Fastest growing Equity Broking House - Large firms in India by Dun &
Bradstreet.
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Concepts
Types of Mutual Funds Schemes in India
Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial
position, risk tolerance and return expectations etc. thus mutual funds has Variety of
flavors, Being a collection of many stocks, an investors can go for picking a mutual fund
might be easy. There are over hundreds of mutual funds scheme to choose from. It iseasier to think of mutual funds in categories, mentioned below.
Overview of existing schemes existed in mutual fund category: By Structure
1. 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.
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2. 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 fundsgive 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
Key Differences between close and open ended schemes
3. Interval Schemes: Interval Schemes are that scheme, which combines the features of
open-ended the and close-ended 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.
The risk return trade-off indicates that if investor is willing to take higher risk then
correspondingly he can expect higher returns and vise versa if he pertains to lower risk
instruments, which would be satisfied by lower returns. For example, if an investors opt
for bank FD, which provide moderate return with minimal risk. But as he moves ahead to
invest in capital protected funds and the profit-bonds that give out more return which is
slightly higher as compared to the bank deposits but the risk involved also increases in the
same proportion.
Thus investors choose mutual funds as their primary means of investing, as Mutual funds
provide professional management, diversification, convenience and liquidity. That doesnt
S.No Feature Open end Close end
1 Capitalization Unlimited Limited
2 Any time entry Yes No
3 Any time exit Yes No
4 Tax advantages Yes No
5 Listed on exchange Generally no Yes
6 Available for a
fixed mutual fund
No Yes
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mean mutual fund investments risk free. This is because the money that is pooled in are
not invested only in debts funds which are less riskier but are also invested in the stock
markets which involves a higher risk but can expect higher returns. Hedge fund involves a
very high risk since it is mostly traded in the derivatives market which is considered very
volatile.
Overview of existing schemes existed in mutual fund category: BY NATURE
Equity fund :
These funds invest a maximum part of their corpus into equities holdings. The structure of
the fund may vary different for different schemes and the fund managers outlook on
different stocks. There are however, many different types of equity funds because there are
many different types of equities. A great way to understand the universe of equity funds is touse a style box, an example of which is below.
The idea is to classify funds based on both the size of the companies invested in and the
investment style of the manager. The term value refers to a style of investing that looks for
high quality companies that are out of favor with the market. These companies are
characterized by low P/E andprice-to-book ratios and high dividend yields. The opposite of
value is growth, which refers to companies that have had (and are expected to continue to
have) strong growth in earnings, sales and cash flow. A compromise between value andgrowth is blend, which simply refers to companies that are neither value nor growth stocks
and are classified as being somewhere in the middle.
For example, a mutual fund that invests in large-cap companies that are in strong financial
shape but have recently seen their share prices fall would be placed in the upper left quadrant
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of the style box (large and value). The opposite of this would be a fund that invests in startup
technology companies with excellent growth prospects. Such a mutual fund would reside in
the bottom right quadrant (small and growth).
The Equity Funds are sub-classified depending upon their investment objective, as
follows:
Diversified Equity Funds
Mid-Cap Funds
Sector Specific Funds
Tax Savings Funds (ELSS)
Equity investments are meant for a longer time horizon, thus Equity funds rank high on the
risk-return matrix.
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: Invest their corpus in securities issued by Government, popularly known as
Government of India debt papers. These Funds carry zero Default risk but are associated with
Interest Rate risk. These schemes are safer as they invest in papers backed by Government.
Income Funds: Invest a major portion into various debt instruments such as bonds, corporate
debentures and Government securities.
MIPs: Invests maximum of their total corpus in debt instruments while they take minimum
exposure in equities. It gets benefit of both equity and debt market. These scheme ranks
slightly high on the risk-return matrix when compared with other debt schemes.
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Short Term Plans (STPs): Meant for investment horizon for three to six months. These
funds primarily invest in short term papers like Certificate of Deposits (CDs) and
Commercial Papers (CPs). Some portion of the corpus is also invested in corporate
debentures.
Liquid Funds: Also known as Money Market Schemes, These funds provides easy liquidity
and preservation of capital. These schemes invest in short-term instruments like Treasury
Bills, inter-bank call money market, CPs and CDs. These funds are meant for short-term cash
management of corporate houses and are meant for an investment horizon of 1day to 3
months. These schemes rank low on risk-return matrix and are considered to be the safest
amongst all categories of mutual funds
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.
Further the mutual funds can be broadly classified on the basis of investment
parameter:
Each category of funds is backed by an investment philosophy, which is pre-defined in the
objectives of the fund. The investor can align his own investment needs with the funds
objective and invest accordingly.
By investment objective.
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 schem
es normally invest a major part of their fund in equities and are willing to bear short-term
decline in value for possible future appreciation.
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.
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the investors to achieve greater diversification through one scheme. It spreads risks across a
greater universe.
Load or no-load fund: A Load Fund is one that charges a percentage of NAV for entry or
exit. That is, each time one buys or sells units in the fund, a charge will be payable. This
charge is used by the mutual fund for marketing and distribution expenses. Suppose the NAV
per unit is Rs.10. If the entry as well as exit load charged is 1%, then the investors who buy
would be required to pay Rs.10.10 and those who offer their units for repurchase to the
mutual fund will get only Rs.9.90 per unit. The investors should take the loads into
consideration while making investment as these affect their yields/returns. However, the
investors should also consider the performance track record and service standards of the
mutual fund, which are more important. Efficient funds may give higher returns in spite of
loads.
A no-load fund is one that does not charge for entry or exit. It means the investors can enter
the fund/scheme at NAV and no additional charges are payable on purchase or sale of units.
Mutual funds cannot increase the load beyond the level mentioned in the offer document.
Any change in the load will be applicable only to prospective investments and not to the
original investments. In case of imposition of fresh loads or increase in existing loads, the
mutual funds are required to amend their offer documents so that the new investors are aware
of loads at the time of investments.
Assured return scheme: Assured return schemes are those schemes that assure a specific
return to the unit holders irrespective of performance of the scheme.A scheme cannot
promise returns unless such returns are fully guaranteed by the sponsor or AMC and this is
required to be disclosed in the offer document.
Investors should carefully read the offer document whether return is assured for the entire
period of the scheme or only for a certain period. Some schemes assure returns one year at a
time and they review and change it at the beginning of the next year.
Asset allocation funds: These funds invest in various asset classes including, but not limited
to, equities, fixed income securities, and money market instruments. They seek high total
return by maintaining precise weightings in asset classes. Global asset allocation funds invest
in a mix of equity & debt securities issued worldwide
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Flexible portfolio funds: These funds invest in common stocks, bonds, other debt securities,
and money market securities to provide high total return. These funds may invest up to100
percent in any one type of security and may easily change weightings depending upon
market conditions
High yield funds: These funds invest two-thirds or more of their in lower rated U.S.
corporate bonds.
World bond funds invest in debt securities offered by foreign companies and governments.
They seek the highest level of current income available worldwide.
Advantages Of Investing In Mutual Funds
There are several that can be attributed to the growing popularities and suitability of
mutual funds as an investment vehicle especially for retail investors.
Professional management: Mutual funds provide the services of experienced and skilled
professionals, backed by a dedicated investment research team that analysis the
performance and prospects of companies and selects suitable investments to achieve the
objectives of the scheme.
Diversification: Mutual funds invest in a number of companies across a broad cross-
section of industries and sectors. This diversification reduces the risk because seldom do
all stocks decline at the sane time and in the same proportion. You achieve this
diversification through a mutual fund with far less money than you can do on your own.
Convenient administration: Investing in a mutual fund reduces paperwork and help you
avoid many problems such as bad deliveries, delayed payment and follow up with brokers
and companies. Mutual funds save your time and make investing easy and convenient.
Return potential: Over a medium to long term, mutual funds have the potential to provide
a higher return as they invest in a diversified basket of selected securities.
Low costs: Mutual funds are a relatively less expensive way to invest compared to directly
investing in the capital markets because the benefits of scale in brokerage, custodial and
other fees translate into lower costs for investors.
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Liquidity : In open ended schemes, the investors get the money back promptly at net asset
value related prices from the mutual fund. In closed end schemes, the units can be sold on
a stock exchange at the prevailing market price or the investor can avail of the facility of
direct repurchase at NAV related prices by mutual fund.
Transparency: You get regular information on the value of your investment in addition to
disclosure on the specific investments made by your scheme, the proportion invested in
each class of assets and the fund managers investment strategy and outlook.
Flexibility: Through features such as regular investment plans, regular withdrawal plans
and dividend reinvestment plans, you can systematically invest or withdraw funds
according to your needs and convenience.
Affordability :Investors individually may lack sufficient funds to invest in high-gradestocks. A mutual fund because of its large corpus allows even a small investor to take the
benefit of its investment strategy.
Choice of schemes: Mutual funds offer a family of schemes to suit your varying needs
over a lifetime
The power of compounding:Compounding is the financial equivalent of a snowball
rolling downhill. With each revolution, the snowball gets bigger because it picks up even
more snow every time around. Compounding produces a snowball effect with money
because the earnings each year contribute a little more to earnings the following year. As
time passes, the earnings contribute more and more to the total value of an investment.
The longer the period of an investment, the more one can accumulate, because of the
power of compounding which is why it makes sense to start investing early.
The secret is to start early For example:
Take Suresh and manoj. Suresh invests Rs. 5000 while manoj invests twice as much. As
illustrated in the table below, even though the amount invested by suresh is half of what
manoj puts, his investment final amount is becomes twice as much as manojs simply
because he started earlier a clear instance of the benefits of compounding. This is the
power of compounding.
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Compounding favors the early starter
Suresh Manoj
Investment amount Rs 5,000 Rs 10,000
Investment duration 20 years 10 years
Final amount Rs 81,833 Rs 40456
(Assumed annual rate of return 15% with dividends and capital gains reinvested. For
illustrative purposes only)
The key therefore lies in staring earlier, and giving ones investments a longer time to
grow.
Reinvest earnings and put money to work
You may have noticed that this example assumes that dividends and capital gains arent
taken in cash. Reinvesting distributions increases the value of a portfolio which, in turn,
increases the amount of interest earned each year.
Just like our snowfall growing larger with each roll, the value of the investment increases
by a greater amount each year as the earnings are put back in. as the time passes, earnings
generated by the reinvested interest can rival or surpass the earnings that come from the
initial investment alone. The longer, the better compounding works. Money starts
multiplying, more towards the end.
Growth on top of compounding
The basic principles of compounding apply to any mutual fund. Namely, reinvesting
earnings (dividend and capital gains for non-money market funds) over time can lead to
potentially large increases in value.
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If a funds share rises, initial investment grows independently of the effects of
compounding. Although theres no guarantee that a funds share price will increase,
coupling this kind of growth potential with compounding has been an effective strategy for
many long term investors.
Well regulated
All mutual funds are registered with SEBI and they function within the provisions of strict
regulations designed to protect the interest of investors. The operations of mutual funds are
regularly monitored by SEBI.
Disadvantages of Mutual Funds
Professional Management: Did you notice how we qualified the advantage of professional
management with the word "theoretically"? Many investors debate whether or not the so-
called professionals are any better than you or I at picking stocks. Management is by no
means infallible, and, even if the fund loses money, the manager still takes his/her cut..
Costs: Mutual funds don't exist solely to make your life easier - all funds are in it for a profit.
The mutual fund industry is masterful at burying costs under layers of jargon. These costs are
so complicated that in this tutorial we have devoted an entire section to the subject.
Dilution: It's possible to have too much diversification. 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.
Taxes: When making decisions about your money, fund managers don't consider your
personal tax situation. For example, when a fund manager sells a security, a capital-gains tax
is triggered, which affects how profitable the individual is from the sale. It might have been
more advantageous for the individual to defer the capital gains liability.
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Costs Involved In Mutual funds
An investor must know that there are certain costs involved while investing in mutual
funds. Mutual funds costs can be classified into 2 broad categories.
Operating expenses which are paid out of the funds earnings and
Sales charges : that are directly deducted from your investment. It is not compulsory that
every Mutual funds levy sales charges but they certainly have operating expenses. No
doubt they influence returns on investment in a fund.
Operating Expenses:These referred to cost incurred to operate a Mutual fund. Advisory
fees paid to investment managers, Audit fees to chartered accountant, custodial fees,
register and transfer agent fees, trustee fee, agent commission. Operating expenses also
known as expenses ratio, which is annual expenses, expressed as a percentage of the funds
average daily net assets mutual funds. The break up of these expenses is required to be
reported in the schemes offer document or prospectus.
Operating expenses
Expenses Ratio = ------------------------
Average Net Assets
For instance, if funds Rs. 100 crores and expenses 20 lakhs. Then the expenses ratio is
2%, expenses ratio is available in the offer document and from historical per unit statistics
included in the financial results of the fund, which are published by annually. Un-audited
for the half year ending September 30 and audited for the physically year end I march 30.
Depending upon scheme and net asset, operating expense are determined by limits
mandated by SEBI Mutual funds regulation Act. Any excess over specified limits as to be
born by Asset Management Company, the trustees or sponsors.
Sale Charges:
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There are known commonly sales loads, these are charged directly to investor. Sales loads
are used by mutual fund for the payment of agents commission, distribution and
marketing expenses. These charges have no effect on the performance of the scheme.
Sales loads are usually expression percentage and or of two types front-end and back-end.
Front-End Load:
It is a one time fixed fee paid by an investor when buying a Mutual funds scheme. It
determines public offer price which intern decides how much of your initial investment
actually get invested the standard practice of arriving a public offer price is as follows.
Net Asset Value
Public offer price = ------------------------
(1 front-end load)
Let us assume, An investor invests Rs. 10,000 in a scheme that charges a 2% front end
load at a NAV per unit Rs. 10 using the formula public offer price = 10/(1-0.02) is Rs.
10.20. So only 980 units are allotted to the investor
Amount invested
Number of units allotted = -------------------------
Public Offer Price
10,000/10.20 = 980 units at a NAV of Rs. 10
This means units worth 980 are allotted to him an initial investment of Rs. 10,000. Front-
end loads tend to decrease as initial investment amount increase.
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Exit Load:
May be a fixed fee redemption or a contingent deferred sales charges A redemption load
continues so long as the redeeming or selling of the units of the units of a fund does not
take place in the event of a back end load is applied. The redemption price is arrive are
using following formula.
Net Asset Value
Redemption price = --------------------------
(1 + back end load)
Let us assume an investor redeems units valued at Rs. 10,000 in a scheme that charges a
2% back end load at a NAV per units of Rs. 10 using the formula redemption price 10/(1 +
0.02) = Rs. 9.80. So, what the investor gets in hand is 9800 (9.8 x 1000).
For a subscription
NAV of a scheme X : Rs. 10
Entry load : 2%
POP : Rs. 10.20 [10*(1 +0.02}]
Amount invested : Rs. 10,000
Units allotted : 980.392 [10,000 /10.20]
For a Redemption
NAV of a scheme X : Rs 10
Entry load : 2%POP : Rs.9.8 [10*(1-0.02)]
Amount invested : Rs. 10,000
Units allotted : 1020.408 [10000 / 9.8]
Units are computed and denoted with a decimal precision.
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In addition to the standard load structure mentioned above, some schemes can have more
complex load structures often based on investment slabs, duration of investment etc. As a
general rule, as the investment value goes up, the load percentage tends to zero.
Contingent Deferred Sales Charges (CDSC):
Contingent deferred sales charges are a structured back end load. It is paid when the units
are redeemed during the initial years of ownership. It is for a pre-determined period only
and reduced over the time you invested for a fund. The longer the investor remains in a
fund the lower the CDSC.
The SEBI (Mutual fund regulation 1996) stipulate that a CDSC may be charge only for
first 4 years after purchase of units and also stipulate the maximum CDSC that can we
charge every year. The SEBI mutual funds regulation 1996 do not allow either the front
end load or back end load to any combination is higher than 7%.
Transaction Cost:
Some funds may also impose a switch over fee which is a charge on transfer of investment
from one scheme to another with in a same mutual funds family and also to switch from
one plan (short term) to another (long term) within same scheme.
Service Standard
Checks at the bank are compelled to compete the transaction in the timeliness mentioned.
This compulsion to compete transactions within timeliness is called service standard.
Similarly mutual funds also have service standards too.
It is usually measured as T + n
List of general service standards
Transaction Service standard
New purchases T+1
Additional purchases T+1
Redemptions in a liquid plan T day
Redemptions in non-liquid plan T+1
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Switches T+1
Non commercial transactions T+2
Dividends T+5
Role Of A Registrar
Primary role of a registrar in a mutual fund is to provide back office functions and provide a
accurate and timely service to investors, distributors and asset management companies.
Processing the following transactions is the main job of a registrar.
Commercial transactions
1. Noncommercial transactions
2. Special products
3. Special product features
4. Dividends
5. Brokerage
6. Banking reconciliation
7. Daily reporting to AMC
8. Various data feeds to banks, distributors.
9. Noncommercial transactions
10. Special products
11. Special product features
12. Dividends
13. Brokerage
14. Banking reconciliation
15. Daily reporting to AMC
16. Various data feeds to banks, distributors.
Objectives Of Equity Funds
Capital appreciation funds seek capital appreciation: dividends are not a primary
consideration
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Aggressive growth funds invest primarily in common stocks of small, growth
companies.
Growth funds invest primarily in common stock of well-established companies.
Sector funds investment primarily in companies in related fields.
Total return funds seek a combination of current income and capital appreciation.
Growth and income funds invest primarily in common stocks of established
companies with a potential for growth and a consistent record of dividend payments.
Income equity funds incest primarily in equity securities of companies with consistent
record of dividend payment they seek income more than capital appreciation.
World equity funds invest primarily in stocks of foreign companies. Emerging market funds invest primarily in companies based in developing regions of
the world.
Global equity funds invest primarily in equity securities traded worldwide, including
those of U.S.companies.
International equity funds invest primarily in equity securities of companies located
outside the United States.
Regional equity funds invest in companies based in a specific part of the world.
Asset Allocation: Considering the market trends, any prudent fund managers can change the
asset allocation i.e. he can invest higher or lower percentage of the fund in equity or debt
instruments compared to what is disclosed in the offer document. It can be done on a short
term basis on defensive considerations i.e. to protect the NAV. Hence the fund managers are
allowed certain flexibility in altering the asset allocation considering the interest of the
investors. In case the mutual fund wants to change the asset allocation on a permanent basis,
they are required to inform the unit holders and giving them option to exit the scheme at
prevailing NAV without any load.
Risk factors
Mutual Funds and securities investments are subject to market risks and there can be
no assurance that the objectives of the Mutual Fund will be achieved.
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As with any investment in securities, the NAV of the Units issued under the Scheme
can go up or down depending on the factors and forces affecting capital markets.
Past performance of the Sponsor / Investment Manager / Mutual Fund does not
indicate the future performance of the Scheme and may not necessarily provide a
basis of comparison with other investments.
The name of the Scheme do not in any manner, indicate either the quality of the
Scheme or its future prospects or returns.
The Sponsors are not responsible for any loss resulting from the operation of the
Scheme beyond the initial contribution of Rs.1, 00,000 towards setting up the Mutual
Fund.
The Mutual Fund is not guaranteeing or assuring any monthly/Quarterly dividend or
returns. The Mutual fund is also not assuring that it will make monthly/Quarterly
dividend distributions, though it has every intention of doing so. All dividend
distributions are subject to the investment performance of the scheme.
Trading volumes and settlement periods inherently restricts the liquidity of the
Schemes investments. In the event of an inordinately large number of redemptions or
of a restructuring of the Scheme's investment portfolio, there may be delays in the
redemption of units. Please refer section "Extraordinary Circumstances" and "Risk
Factors and Special Considerations".
Changes in Government Policy in general and changes in tax benefits applicable to
mutual funds may impact the returns to investors in the Scheme.
The NAVs may be affected by changes in the general market conditions, factors and
forces affecting capital market in particular, level of interest rates, various market
related factors, settlement periods and transfer procedures.
The Scheme may also invest in ADRs / GDRs as permitted by Reserve Bank of India
and Securities and Exchange Board of India. To the extent that some part of the assets of the
Scheme may be invested in securities denominated in foreign currencies, the Indian Rupee
equivalent of the net assets, distributions and income may be adversely affected by the
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changes in the value of certain foreign currencies relative to the Indian Rupee. The
repatriation of capital also may be hampered by changes in regulations concerning exchange
controls or political circumstances as well as the application to it of other restrictions on
investment.
A Unit holder may invest in the scheme and acquire a substantial portion of the scheme units.
The repurchase of units by the Unit holder may have an adverse impact on the units of the
scheme, because the timing of such repurchase may impact the ability of other Unit holders
to repurchase their units
Various types of benchmarks
Equity-oriented funds are usually benchmarked against the CNX Nifty, CNX Nifty Junior,
CNX 100, CNX 500 and CNX Midcap indices maintained by the NSE or against the
Sensex, BSE Midcap, BSE 100 or 200 maintained by the BSE.
Debt funds, Balanced funds and Monthly Income Plans are usually measured against either
benchmarks created by CRISIL or against blended (combinations of existing indices)
indices constructed by the fund house.
Are benchmarks best standards?
However, the stated benchmarks are not always the best standard for performance
evaluation as many a time funds take liberties while managing the fund. There are times
when the fund managers invest actively in stocks outside the benchmark, in order to
maximise their returns. At times, the fund may also invest in a class of stocks that are not
correctly reflected in the benchmark.
A fund supposed to invest in large-cap stocks (stocks with high market capitalisation)
may dabble in mid-cap or small-cap stocks, to improve returns. These investments entail
taking higher risk as mid-cap and small-cap stocks are subject to greater volatility
compared to large caps.
As the number of schemes in the market increases, fund houses have been coming out
with thematic schemes to attract investors. For example, if infrastructure stocks are the
flavour of the season, you see fund houses launching infrastructure funds. When you
compare their returns with the large-cap indices, they often deliver superlative returns. But
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the returns may not appear in such good light compared to a sector index such as the BSE
Capital Goods.
Benchmark comparisons also have to factor in how challenging the year has been for the
peer group. A fund may have outperformed the benchmark by a small margin when all its
peers have comfortably trounced the index. In such a case, out performance against thebenchmark may not be of much comfort to the investor.
Measuring Mutual Fund Performance
The investor would be interested in tracking the value of his investments, whether investing
directly in the markets or indirectly through mutual funds The investor would have to make
intelligent decisions whether to get an acceptable return on the investments in the funds
selected or to switch to another fund. The investor therefore needs to understand the basis of
performance measurement for the fund and acquire the basic knowledge of the different
measures of evaluating the performance of a fund. Only then investor would be in a position
to judge correctly whether the fund is performing well or not, and make right decisions.
Different Performance Measures
There are many measures of fund performance depending on the type of fund, the stated
investment objective of the fund and depending on the current financial conditions.
Change In NAV:
Purpose: If an investor wants to compute the return on investment between the two dates,
use the Per Unit Asset Value at the beginning and the end periods, and the change in the
value of the NAV between the two dates in the absolute ands percentage terms.
Formula: For NAV change in absolute terms
(NAV at the end of the period) (NAV at the beginning of the period).
For NAV Change in percentage terms
(Absolute change in NAV / NAV at the beginning) * 100
If period covered is less /more than one year
For annualized NAV change
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{[(Absolute change in NAV at the beginning)/months covered] * 12}* 100
Suitability: Investors to evaluate fund performance mostly use NAV change, and the
advantage of this measure is that it is easily understood and applies to virtually any type of
fund.Interpretation: Whether the return in terms of NAV growth is sufficient or not should be
interpreted in light of the investment objective of the fund, current market conditions and
alternative investment returns. Thus, a long-term growth fund or infrastructure fund will give
low returns in the initial years. All equity funds may give lower returns when the markets are
in a bearish phase. Debt funds may give lower returns when interest rates are rising.
Limitations: This measure does not always give the correct picture, in cases where the fund
has distributed to investors a significant amount of dividend in the interim period. Therefore
it is suitable for evaluating growth funds and accumulation plans of debt and equity funds,
but should be avoided for income funds and funds with withdrawal plans..
Total Return:
Purpose: This measure corrects the shortcoming of the NAV change, by taking account of
the dividends distributed by the fund between the two NAV dates, and adding them to NAV
change to arrive at the total return.
Formula:
Total return = [(Distributions + change in NAV) / NAV at the beginning of the period] * 100
Suitability: Total return is a measure suitable for all type of funds. Performance of different
types of funds can be compared on the basis of total return. Thus, during a given period, find
out whether a debt fund gave better returns than an equity fund. It is also more accurate than
simple NAV change, because it takes in to account distributions during the period. While
using total return, performance must be interpreted in the light of market conditions and
investment objective of the fund.
Limitations: Although more accurate than NAV change, simple total return as calculated is
still inadequate as a performance measure, because it ignores the fact that distributed
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dividends also get reinvested if received during the year. The investors total return should
take account of reinvestment of interim dividends.
Return On Investment Or Total Return With Dividends Reinvested At NavPurpose: The shortcoming of the simple total return is overcome by computing the total
return with reinvestment of dividends in the fund itself at the NAV on the date of distribution
(ex-dividend date). The appropriate measure of the growth of an investors mutual fund
holdings is, therefore the return on investment on accumulative basis over a certain time
period. Total return with reinvestment is such a measure of cumulative wealth accumulation,
and the same as ROI.
Formula: Total return on investment:
[{(Units held + div/ex-divNAV)*endNAV} begin NAV] /begin NAV * 100
Suitability: Total return with distributions reinvested at NAV is a measure accepted by
mutual fund tracking agencies such as Credence in Mumbai and Value research in New
Delhi. It is appropriate for measuring performance of accumulation plans, monthly/quarterly
income schemes and debt funds that distribute interim dividends.
Cumulative Aggregate Vs Average Annualized Returns
Purpose: While deploying any of the measures described above, it must be remembered that
absolute NAVs do not give a complete picture and that consistent performance with respect
to total return and compounded annual return is of paramount importance.
Many mutual fund schemes, notably from Unit Trust of India, are based on cumulative
returns over a long time period, e.g. Childrens Gift Growth Fund or Rajalaxmi Fund. When
an investor receives a cumulative figure at the end of a long period, care should be taken to
compute an annualized average compounded rate of return from the cumulative. Many
mutual funds present schemes with cumulative growth option or with dividend option.
Comparison between two such schemes is possible only after the cumulative returns are into
average annualized returns.
Formula: To convert cumulative return to average annualized return:
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The maturity value of an original investment will be
A=P*(1+R/100),
P = principal, A = maturity value of investment, N = period of investment in years,
R = annualized compounded rate in %
The growth in maturity value can be converted to average annualized return as follows:R = [(Nth root of A/P}]* 100
Effect Of Loads
The principal amount invested will be lower if there is an entry load charged by the fund.
Therefore investors return on amount invested has to be reduced by the initial load paid.
There would be two ways of accounting for the load.
One would be to reduce the compound rate of return by load % number of years.
A second and more accurate approach would be to reduce the % cumulative NAV
growth figure by the entry load paid.
a) Compare the same time periods
While computing these total returns, it is imperative to use the performance data over the
same time periods for two different funds being compared, as returns over different periods
vary due to market conditions prevalent then. This means only those funds for which
performance data are available during a given period for both of the funds being compared.
For less than one-year periods, it should not be annualized, except for money market mutual
funds, which have a short investment horizon.
b) Returns since inception
SEBI requires return to be computed since the inception of a scheme, using Rs. 10 as the
base amount. This method is correct as it is applied to no-loads funds. Otherwise an
adjustment for the loads paid has to be made as described above.
Expense Ratio
Purpose: The expense ratio is an indicator of the funds efficiency and cost effectiveness.
Formula: It is defined as the ratio of total expenses to average net assets of the fund.
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Suitability: SEBI Regulations regulate this aspect for funds in India, and it is important that
brokerage commissions on the funds transactions are not included in the fund expenses figure
while computing this ratio. The Expense ratio is most important in case of Bond Fund or
Debt Funds performance can be adversely affected if a larger proportion of it as income is
spent on expenses.
Limitations: though an important yardstick, fluctuations in the ratio across periods require
that an average over three to five years be used to judge a funds performance. Also, the
expense ratio must be evaluated in the light of fund size, average account size and portfolio
composition equity or fixed income.
Income Ratio
Formula: A funds income ratio is defined as its net investment income divided by its net
assets for the period.
Purpose/Suitability: This ratio is a useful measure for evaluating income-oriented funds
particularly debt-oriented funds. It is not recommended for funds that concentrate primarily
on capital appreciation.
Limitation: the income ration cannot be considered in isolation; it should be used only to
supplement the analysis based on the expense ratio and total return.
Portfolios Turn Over Rate
Purpose: the ratio measures how many times the fund manager turns over his port folio by
buying or selling of securities in the market. A 100%turnover implies that the manager
replaced his entire portfolio during the period in question
Formula: portfolio turn over rate measures the amount of buying and selling of securities
done by a fund. It defined as the lesser of assets purchased or sold divided by the funds net
assets.
Suitability: Turnover ratios would be most relevant to analyze in case of equity and
balanced funds, particularly those that derive a large part of their income from active trading.
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However, it would not be appropriate for equity funds with a value based, long term
investment philosophy, or even a growth fund.
Interpretation: This percentage is a good indicator of the extent to which the fund is active
in terms of its dealing on the market. However, high turn over ratio also indicates hightransaction costs charged to the fund. The net return to the investor can be lower with high
transaction costs.
Limitation: However, as a performance measure, this ratio is meaningful only when
evaluated against the backdrop of the funds investment objectives, and in terms of its ability
to perform well on a consistent basis. High turn over rate does not necessarily indicate
greater efficiency, and must be seen in relation to the total return of the investor. It is not
meaningful to use the turn over rate for newly launched schemes that are not fully invested.
In the Indian context, only the securities market turnover should be considered, excluding the
call money operations.
Transaction Costs
Definition: Transaction costs include all expenses related to trading such as the brokerage
commissions paid, stamp duty on transfers, registrars fees and custodians fees. Brokerage
commissions are an important component of transaction costs. These are quantified in the
prospectus. In addition, transaction costs include the so called dealer spreads. All securities
usually have a bid and an offer price. The fund sells securities at the bid price and buys them
at the offer price. The offer price is usually higher than the bid price and the difference is the
dealer spread, representing a cost to the fund investors. This spread may be further magnified
if a security is thinly traded and the fund wants to buy/sell a large quantity quickly.
Suitability: Transaction has a significant bearing on fund performance and its total return.
Funds with small size, or small returns, have to be judged on their expense ratios and
transaction costs, given their impact on total return.
Limitation: While other costs are detailed in the fund prospectus or annual reports, dealer
spreads are difficult to quantify or document.
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Fund SizeFund size can affect performance. Small funds are easier to maneuver and can achieve their
objectives in a focused manner with limited holdings. Large funds benefit from economies of
scale with lower expense ratios and superior fund management skills. They also gain through
greater risk bearing and management capacity. There can be no definition of what a small
fund and what a big fund, as small and big are relative terms. But, simply comparing the
corpus of two or more funds helps get a good fix on size.
Cash Holdings:
Definition: Mutual funds allocate their assets among equity shares, debt securities and
cash/bank deposits. The percentage of a funds portfolio held in cash equivalents can be
important element in its successful performance.
Interpretation: A large cash holdings allows the fund to strength its position in preferred
securities without liquidating its other portfolios. Cash also allows the fund a cushion against
decline in the market prices or bonds. The fund must also guard against large, consistent net
redemptions, because these not only indicate dissatisfaction on the part of investors, but also
force the fund to maintain large cash reserves lowering the return on the portfolio. It becomes
difficult for the fund to attain its objectives in such a situation
Borrowing By Mutual funds:
There are hedge funds that seek to enhance per unit earnings by borrowing, thereby
enhancing their fund size or corpus. The strategy holds well when interest costs is not very
high and fund performance is good. However if interest rates rise unexpectedly, or the value
of the portfolio declines significantly, the fund must reduce its dependence on debt quickly.
In general, in India, mutual funds are not allowed to borrow to increase their corpus. SEBI
Regulations allow mutual funds to borrow only for the purpose of meeting temporary needs
for a period not exceeding six months, and to the extent of 20% of its net assets. Hence it
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would be uncommon to see fund schemes with borrowings on their balance sheets, and if
borrowings are seen, caution may need to exercise in evaluating the fund performance.
EVALUATING FUND PERFORMANCE
Importance of Benching In Evaluating Performance:
The measures described earlier are absolute, meaning that none of the measures should be
used to evaluate the fund performance in isolation. A funds performance can only be judged
in relation to investors expectations. However, it is important for the investor to define his
expectations in relation to certain guide posts on what is possible to achieve, or moderate
his expectations with realistic investment alternatives available to him in the financial
markets. These guide posts or indicators of performance can be thought of as benchmarks
against which a funds performance ought to be judged. For example, an investors
expectations of returns from an equity fund should be judged against how the overall stock
market performed, in other words how much the stock market index itself moved up or
down, and whether the fund gave a return that was better or worse than the index movement.
In this example, we can use a market index like S&P CNX Nifty or BSE SENSEX as
benchmarks to evaluate our investors mutual fund performance.
While an advisor needs to look at the absolute measures of performance, he needs to select
the right benchmark to evaluate a funds performance, so that he can compare the measured
performance figures against the selected benchmark. How do we select the right benchmark
to evaluate a given funds performance?
Historically in India, investors only options were UTI schemes or bank deposits. UTI itself
tended to benchmark its returns against what interest rates were available on bank deposits
of 3/5-year maturity. Thus, for long period, US 64 scheme dividends were compared to bank
interest rate and investors would be happy if the dividend yield on US 64 units was greater
than comparable deposit interest rate. Thus, investors in Indian mutual funds tend to
routinely compare bank interest rates with returns on mutual fund schemes. However, with
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increasing investment options in the market, bank interest rates should not be used to judge a
mutual funds performance in all cases. Let us therefore take a look at how to choose the
correct benchmarks of mutual fund performance.
Basis of choosing an appropriate performance benchmark:
Appropriate benchmark for any fund has to be selected by reference to:1. The asset class it invests in.
thus, an equity fund has to be judged by an appropriate benchmark from the equity markets,
a debt fund performance against a debt market benchmark and so on; and
2. The funds stated investment objective:
for example, if a fund invests in long-term growth stocks, its performance ought to be
evaluated against a benchmark that captures growth stocks performance.
There are in fact three types of benchmarks that can be used to evaluate a funds
performance, relative to the market as a whole, relative to other mutual funds, and relative to
other comparable financial products or investment options open to the investor.
Benchmarking Relative To The Market-Equity Index
Index funds-a base index: If an investor to choose an equity index fund, now being offered
in India, he can expect to get the same return on his investment as the return on the equity
index used by the fund as its benchmark, called the base index. this is a passive investment
style. The fund would invest in the index stocks. And expect its NAV changes to mirror the
changes in the index itself. The fund and therefore the investor would not expect to beat the
benchmark, but merely earn the same return as the index.
In the case of index funds, then, the benchmark is clear and pre-specified by the fund
manager in advance. For example, IDBI mutual funds index fund is based on and will track
the S&P CNX Nifty index, while UTIS fund is based on BSE SENSEX Index
Tracking error: In order to obtain the same returns as the index, an index fund invests in all
of the stocks include in the index calculation, in the same proportion as the stocks weightage
in the index .an index funds actual return may, however, be better or worse by what is called
tracking error the tracking error arises from the practical difficulties faced by the fund
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manager in trying to always buy or sell stocks to remain in line with the weightage that the
stocks enjoy in the index.
Active equity funds: An Index Fund is passively managed, to track a given index. However,
the fund managers actively manage most of the other equity funds/schemes. If an investorholds such an actively managed equity fund, the fund manager would not specify in advance
the benchmark to evaluate his expected performance as in case of an index fund. However,
the investor still needs to know whether the fund performance is good or bad. To evaluate the
performance of an equity fund, therefore we still need to select an appropriate benchmark
and compare its returns to the returns on benchmark: usually this means using the appropriate
market index. The appropriate index to be used to evaluate a broad-based equity fund should
be decided on the basis of the size and the composition of the funds portfolio.
If the fund in question has a large portfolio, a broader market index like BSE 100 OR 200
OR NSE 100 may have to be used as the benchmark rather than S&P CNX NIFTY OR
BSE30 .An actively managed fund expects to be able to beat the index, in other words give
higher returns than the index itself.
Somewhat like the index funds, the choice of the benchmarks in case of sector funds is
easier. Clearly, for example, an investor in InfoTech or Pharma sector funds can only expect
the same return as the relative sectoral indices. In such case he should expect the same or
higher returns than an InfoTech or Pharma sector index if such an index exists. In other
words, the choice of the correct equity indexes as a benchmark also depends upon the
investment objective of the fund. the performance of a small cap fund has to be compared
with a small cap index. A growth fund investing in new growth sectors but is diversified in
many sectors can only be judged against the appropriate growth index if available. If not, the
returns can only be compared to either a broad-based index or a combined set of sectoral
indices
Choosing market benchmarks in practice: The best alternative in practice for the investor
and his advisor is to rely on the expert performance tracking agency reports and analyses,
since the choice of appropriate benchmark can become a difficult technical exercise.
In India, benchmarking for retail investors is done using a menu of indices in combination.
Agencies such as credence prefer the BSE200 because of its broad-based nature. For sector
funds, the S&P CNX Sectoral indices have been preferred. Choice of an appropriate index
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from the ones available is critical. The investor or his advisor would do well to refer to India
Index Services Limited for more details of the indices available and the past performance
data, similar information can be obtained from the Index Services Divisions of the BSE or
other exchanges.
Debt Funds: As we have seen, historically investors have used bank deposit interest rates as
benchmarks to judge the performance of debt funds. However, a debt funds performance
ought to be judged against a debt market index, just as an equity funds benchmark would be
judged against the equity market index. Further, for debt funds, the kind of debt that
comprises the portfolio will also decide the index to be used. If the bond fund in question is
abroad based one, and then a broad-based debt index has to be used for this purpose. If the
debt fund is a narrowerGovernment Securities Fund, for example, then only the govt. sec.
sub segment of the broad based index has to be used as the appropriate benchmark. Investors
in India commonly do performance of closed end debt funds with a clear period of maturity
however may be compared with bank deposits of comparable maturity, as.
In practice, no appropriate debt index is available in India, to be used for benchmarking debt
funds. Some analysts often use I-SECS I-BEX index, and its govt.securities sub segment can
be used as benchmark to judge govt.sec.funds. in any case, any benchmark for a debt must
have the same portfolio composition and the same maturity profile as the fund itself, to be
comparable.
Risk Of The Mutual Fund Portfolio
Pursuing greater than average return generally means assuming high risk. Since investment
risk is defined as variability of investment return, portfolios with above-average return
potential are subject to above average swing in value relating to stock market as a whole.
These portfolios beat the market, far behind when rising, but drop faster than the market fall.
The risk taking investors tend to re-structure their portfolio in a manner that the constituent
of growth securities is increased to un proportionate level, forgetting that market would dip
suddenly.
Risks in mutual funds holdings
For diversified portfolios, such as common stock mutual funds, beta provides a useful index
of investment risk. Simply stated, beta measures portfolio risk in relation to the
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riskiness of the market risk. The trade off between investment risk and investment return
is known as the capital market line. The upward sloping of this line represents the
combinations of risk and return found in well-diversified portfolios of common stocks.
The return potential of a diversified common stock portfolio can be obtained by applying the
following mathematical statement of the capital line,Portfolio Return = Risk Free Return + Beta (Market Return Risk Free Return}
The risk free rate of return is approximated by the yield on short-term treasury bills while the
market return (MR) is usually taken as the total rate of return on the market index.
Beta measures how one security, or group of stocks, would likely to fare relatively to the
stock market as a whole. A mutual fund where beta = 1.0 is most likely to go up or down as
much as stock market as whole i.e. with the market movement, the portfolio of a mutual fund
is perfectly co-related. One with a beta more than 1.0 the portfolio price would be more
volatile and likely to go up and down more e.g. if beta =1.6, the movement of portfolio
would go up and down by 60% more than the corresponding movement of the stock market.
A beta lowers than 1.0 tends to react less than the market reaction. A negative beta is the
symbol of movement in opposite direction. If market grows upwards, then the portfolio
movement would be downwards and vice-versa. Although beta cannot predict direction of
the marketgoing upward or downward, stable, it is an excellent indicator of the
responsiveness of a portfolio value, given changes in stock market as a whole.
Risk Exposure
Many individual inventors define investment success as beating the market, or in other
word, earning above- average returns. But these investors often forget that they are pursuing
greater-than-average risk also. Since investment risk is defined as variability of investment
return, portfolio with above average return potential are subject to above average swings in
value relative to the stock market as a whole.
These portfolios far-out pace the market when the market is rising but drop faster than the
market when the market falls. However, when stock prices are rising, investors tend to forget
about the negative aspects of holding a high-risk portfolio because they are beating the
market. In fact it has been found that as long as stock prices continue t rise, investors tend to
increase the risk of their portfolios in pursuit of grater and greater investment rewards. These
investors are generally shaken by the size of their losses when the stock market takes a
sudden dip.
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An astute investment management requires that individuals continually monitor the riskiness
of their investment portfolios. They must periodically ask themselves if the current level of
portfolio risk is consis