MUTUAL FUND

BY: RONAK JAIN

SANJAY SAXENA

RAVI PRAKASH

An old Axiom :

“It is not wise to put all eggs into one basket”

……… was probably in the minds of those who formed the first mutual fund.

MUTUAL FUND

A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors to buy stocks, bonds, short-term money market instruments, and/or other securities.

• Currently, the worldwide value of all mutual funds totals more than $US 26 trillion. The United States leads with the number of mutual fund schemes. There are more than 8000 mutual fund schemes in the U.S.A.

• Comparatively, India has around 1000 mutual fund schemes, but this number has grown exponentially in the last few years.

WHY MUTUAL FUND FAMOUS

Indians have been traditionally savers and invested money in traditional savings instruments such as bank deposits. Against this background, if we look at approximately Rs. 5 lakh crores which Indian Mutual Funds are managing, then it is no mean an achievement. A country traditionally putting money in safe, risk-free investments like Bank FDs, Post Office and Life Insurance, has started to invest in stocks, bonds and shares – thanks to the mutual fund industry.

Mutual Funds defined….a flow cycle

STRUCTURE OF MUTUAL FUND

Mutual Funds in India follow a 3-tier structure. There is a Sponsor (the First tier), who thinks of starting a mutual fund. The Sponsor approaches the Securities & Exchange Board of India (SEBI), which is the market regulator and also the regulator for mutual funds. Not everyone can start a mutual fund. SEBI checks whether the person is of integrity, whether he has enough experience in the financial sector, his networth etc.

Once SEBI is convinced, the sponsor creates a Public Trust (the Second tier) as per the Indian Trusts Act, 1882. Trusts have no legal identity in India and cannot enter into contracts, hence the Trustees are the people authorized to act on behalf of the Trust. Contracts are entered into in the name of the Trustees. Once the Trust is created, it is registered with SEBI after which this trust is known as the mutual fund.

WHO MANAGES MUTUAL FUND

This is the role of the Asset Management Company (the Third tier). Trustees appoint the Asset Management Company (AMC), to manage investor’s money.

The AMC in return charges a fee for the services provided and this fee is borne by the investors as it is deducted from the money collected from them.

The AMC’s Board of Directors must have at least 50% of Directors who are independent directors. The AMC has to be approved by SEBI.

The AMC functions under the supervision of it’s Board of Directors, and also under the direction of the Trustees and SEBI.

Organizational Structure of Mutual Fund

Sponsor• Akin to the Promoter of the company,• Contribution of minimum 40% of net worth of AMC,• Posses sound financial record over five years period,• Establishes the Fund,• Gets it registered with the SEBI,• Forms a trust, & appoints Board of trustee.

Trustees• Holds assets on behalf of unit holders in trust,• Trustees are caretaker of unit holders money,• Two third of the trustees shall be independent persons (not

associated with the sponsor),• Trustees ensure that the system, processes & personnel are in place,• Resolves unit holders GRIEVANCES,• Appoint AMC & Custodian, & ensure that all activities are accordance

with the SEBI regulation.

Custodian • Holds the fund’s securities in safekeeping,• Settles securities transaction for the fund,• Collects interest & dividends paid on securities,• Records information on corporate actions.

Asset Management Company• Floats schemes & manages according to SEBI,• Can not undertake any other business activity, other than portfolio

mgmt services,• 75% of unit holders can jointly terminate appointment of AMC,• At least 50% of independent directors,• Chairman of AMC can not be a trustee of any MF.

Distributor / Agents• Sell units on the behalf of the fund,• It can be bank, NBFCs, individuals.

REGULATION ASPECT

REGULATION• Governed by SEBI (Mutual Fund) Regulation 1996

– All MFs registered with it, constituted as trusts ( under Indian Trusts Act, 1882)

• Bank operated MFs supervised by RBI too• AMC registered as Companies registered under Companies Act, 1956• SEBI- Very detailed guidelines for disclosures in offer document, offer

period, investment guidelines etc.– NAV to be declared everyday for open-ended, every week for closed

ended– Disclose on website, AMFI, newspapers– Half-yearly results, annual reports– Select Benchmark depending on scheme and compare

ADVANTAGES OF MUTUAL FUND

Mutual funds have advantages compared to direct investing in individual securities. These include:

• Increased diversification• Daily liquidity• Professional investment management• Ability to participate in investments that may be

available only to larger investors• Service and convenience• Government oversight• Ease of comparison

DISADVANTAGES OF MUTUAL FUND

Mutual funds have disadvantages as well, which include :

• Fees• Less control over timing of recognition of

gains.• Less predictable income.• No opportunity to customizezees.

TYPES OF MUTUAL FUND BY STRUCTURE

Open - Ended Schemes:

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

Close - Ended Schemes:

These schemes have a pre-specified maturity period. One can invest directly in the scheme at the time of the initial issue. Depending on the structure of the scheme there are two exit options available to an investor after the initial offer period closes. Investors can transact (buy or sell) the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchanges could vary from the net asset value (NAV) of the scheme on account of demand and supply situation, expectations of unitholder and other market factors.

Other classification of MF schemes

• By Structure– Open-Ended – anytime enter/exit

– Close-Ended Schemes – listed on exchange, redemption after period of scheme is over.

• By Investment Objective– Equity (Growth) – only in Stocks – Long Term (3 years or more)

– Debt (Income) – only in Fixed Income Securities

– Liquid/Money Market – Short-term Money Market (CPs, CDs, Treasury Bills)

– Balanced/Hybrid – Stocks + Fixed Income Securities (1-3 years)

– Gilt Funds – primarily in G-Sec

• Other Schemes– Tax Saving Schemes such as ELSS

– Special Schemes (ETFs, foreign funds)

AMFI Classification of MF Schemes

Fund schemes Portfolio objectives

Growth & Income High Risk & High Return

Balanced Moderate Risk & Return

Liquid & Money Market Fixed Return

Gilt Zero Risk

ELSS Tax Saving

Fund of funds Additional diversification

ETFs Market Driven

Risk –Return of different schemes

Phases of Mutual Fund Industry in India

Formation of UTI 1964

Entry of Public Sector Funds

1987

Entry of Private Sector Funds

1993

A phase dedicated to Retail Investors

2009

Indian Asset Management Industry - Growth in Assets

Computing Net Asset Value

• For investors, the performance of their investment depends on what happens to the fund’s per share value, or net asset value (NAV).

NAV= Market Value of Assets – Liabilities Number of Shares Outstanding

NAV1=NAV0+All Incomes-All Distributed

Example: NAV0=Rs.100, Distributed 1) Net Realized Gains=Rs.2 and 2) Net Investment Income=Re.1.

NAV1= Rs.100-Rs.2-Re.1=Rs.97

Mutual Fund Returns

Three sources of return:• Income distributions (ID)

– Bond interest, stock dividends• Capital gain distributions (CGD)

– Realized gains/losses from selling assets• Changes in NAV (DNAV)

– From unrealized gains/losses from assets

Return = (ID + CGD –Payments + DNAV)/Beg.NAV

• Ex. NAV0=Rs.35,NAV1=Rs.35.2, Net Realized Gain Rs.2, Net Investment Income =Rs..5. Return= (2+.5+35.2-35)/35=7.714%

• Most mutual funds allow investors to either receive distributions in cash or to reinvest in additional shares.

Mutual Fund Expenses and Considerations

• Loads– Commission to the broker to financial advisor who sold the fund to the

investor– For load funds, the offer price is the fund’s NAV plus the load (while no-load

funds are sold at their NAV)– Ex. 4% load with NAV Rs.96, buy at Rs.100– Load range from around 3% (low-load) to 8.5%

• 12b-1 Fees: pay to the distributor (.25%-.75% )+ .25% servicing charge in some cases)

• 12b-1 fees A mutual fund may charge an annual fee, known as a 12b-1 fee, for marketing and distribution services. This fee is computed as a percentage of a fund's assets, subject to a maximum of 1% of assets. The 12b-1 fee is included in the expense ratio.

– Fees deducted from the asset value of the fund to cover marketing expenses

• Offering Price= NAV*(1-load %).– Investing Rs.1,000 in a load MF with 7% and

expected return of 10%,– Rs.value=1000(1-.07)(1.10)=1023 (2.3%

growth)– Investing Rs.1,000 no load MF with 8% return

and 2% redemption fee,– Rs.value=1000(1-0)(1.08)(1-.02)= 1058.4

(5.84% growth)– Rs.35.4 Difference

When should you sell a mutual fund?

• Personal considerations– Portfolio rebalancing points due to life cycle

considerations• Be aware of the quick trigger, selling on the first dip in NAV;

think long-term• Be aware of capital gains with selling fund shares

• Fund considerations– Change in portfolio manager– Change in investment style– Fund is growing “too large” or “too fast”– Persistent bad performance.

Tax Benefits

Tax Laws governing investments in mutual funds Under Income Tax Act, 1961

• I) To Unit-holders(Resident)• Section 94(6) of the Income Tax Act, 1961• Section 94(6) of the Income Tax Act 1961 now provides that any

person who buys or acquires any securities or unit within a period of three months prior to the record date and such person sells or transfers such securities or unit within a period of three months after such date and the dividend or income on such securities or unit received or receivable by such person is exempt, then, the loss, if any, arising to him on account of such purchase and sale of securities or unit, to the extent such loss does not exceed the amount of dividend or income received or receivable on such securities or unit, shall be ignored for the purposes of computing his income chargeable to tax.

• Section 10(33) of the Income Tax Act, 1961• The dividend received by the investors from

the scheme will be exempt from income tax for all categories of investors under Section 10(33) of the Income Tax Act, 1961. The scheme will pay a distribution tax currently @10% plus surcharge if the portfolio holds less than 50 percent debt securities on an average during the last one year period.

Section 80 C of the Income Tax Act, 1961

• Specified units of mutual fund schemes qualify for rebate under Section 80 C of the Income Tax Act, 1961, subscription to the Units of the Scheme by Individuals and Hindu Undivided Families, not exceeding Rupees ten thousand would be eligible to a deduction, from income-tax, of an amount equal to 20% of the amount so subscribed. In the case of subscription by an individual, whose income is derived from the exercise of his profession as an author, playwright, artist, musician, actor or sportsman (including an athlete), the deduction admissible would be at the rate of 25%.

• Tax Deducted at Source (TDS)

There will not be any Tax Deduction at Source on payment to resident unit-holders towards redemption or dividends.

• Capital Gains benefit under Section 112 of the Income Tax Act, 1961

Long-term capital gains in respect of Units held for a period of more than 12 months will be chargeable under Section 112 of the Income Tax Act, 1961, at a concessional rate of tax @ 20% (excluding surcharge)

• From the full value of consideration, the following amounts would be deductible to arrive at the amount of capital gains:

· Cost of acquisition as adjusted by Cost Inflation Index notified by the Central Government and

· Expenditure incurred wholly and exclusively in connection with such transfer

• Investors can also opt to pay tax @10% (excluding surcharge) on such Long Term Capital Gains, but without the cost inflation indexation benefit.

• Wealth Tax Benefits

Mutual Fund units are exempt from Wealth Tax.

• To Non-Residents/OCBs

a) Capital Gains under Section 112 of the Income Tax Act, 1961

• Long-term capital gains in respect of Units held for a period of more than 12 months will be chargeable under Sec 112 of the Income Tax Act, 1961 at a concessional rate of tax of 20%. The capital gains would be calculated after indexation of the cost of acquisition.

• Investors can also opt to pay tax @10% (excluding surcharge) on Long Term Capital Gains, but without the cost inflation indexation benefit.

• b) Tax Deduction at Source (TDS)

Redemptions/Exchanges/Switches by non- residents/OCBs/FIIs will be subjected to tax deduction at source at the rates in force and certificates for tax deducted will be issued.

• To Charitable Trusts

Investment in the units of the scheme is an eligible mode of investment under Section 11(5) of the Income Tax Act read with Income Tax Rule 17 C.

• II. To the Fund

Open Ended Mutual Funds are exempt from income tax under Section 10 [23D] of the Act.

FAQ’S

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