Mutual funds

Presented by:

Yogesh Chayal(13323)

Tejveer Ruhil(13305)

What are mutual funds.

• Mutual funds are a type of investment that takes money from many investors and uses it to make investments based on a stated investment objective.

or

• A mutual fund is a common pool of money into which investors place their contributions that are to be invested in different types of securities in accordance with the stated objective.

• Each shareholder in the mutual fund participates proportionally (based upon the number of shares owned) in the gain or loss of the fund.

(investment) (return)

4020

40

100 200

80 80 40A

A

B

B

C

C

History of Mutual funds

• The mutual fund industry in India began in 1963 with the formation of the Unit Trust of India (UTI) as an initiative of the Government of India and the Reserve Bank of India.

• Much later, in 1987, SBI Mutual Fund became the first non-UTI mutual fund in India.

• Subsequently, the year 1993 heralded a new era in the mutual fund industry. This was marked by the entry of private companies in the sector. After the Securities and Exchange Board of India (SEBI) Act was passed in 1992, the SEBI Mutual Fund Regulations came into being in 1996.

• As the industry expanded, a non-profit organization,

the Association of Mutual Funds in India (AMFI), was established on 1995.

• Its objective is to promote healthy and ethical marketing practices in the Indian mutual fund Industry.

• SEBI has made AMFI certification mandatoryfor all those engaged in selling or marketing mutual fund products.

Investors

Fund

Securities

Return

Mutual Fund Operation Flow Chart

Given back to Pool their money in

That generates Which is invested in

• After investing your money in a mutual fund, you can earn returns in two forms:

• Dividend Income :In the form of dividends declared by the scheme, Fund will earn interest income from the bonds it holds or will have dividend income from the shares

• Capital appreciation - meaning an increase in the value of your investments.

As the value of securities in the fund increases, the fund's unit price will also increase. You can make a profit by selling the units at a price higher than at which you bought

How does one earn returns in a mutual funds?

What the investor has to pay:

• The company that puts together a mutual fund is called an AMC(Asset management company)

• The AMC hires a professional money manager, who buys and sells securities in line with the fund's stated objective.

• In return for such services, Asset Management Companies charge small fees. AMCs charge an annual fee, or expense ratio that covers administrative expenses, salaries, advertising expenses, brokerage fee, etc.

• So along with the amount invested you have to just pay an annual fees to the AMC.

Advantages

• Professional management: The investment management skills, along with the needed research into available investment options, ensure a much better return as compared to what an investor can manage on his own.

• Reduction/Diversification of Risks: The potential losses are also shared with other investors.

• Liquidity: Investors may be unable to sell shares directly, easily and quickly. When they invest in mutual funds, they can cash their investment any time by selling the units to the fund if it is open-ended and get the intrinsic value. Investors can sell the units in the market if it is closed-ended fund.

• Convenience and Flexibility: Investors can easily transfer their holdings from one scheme to other, get updated market information and so on. Funds also offer additional benefits like regular investment and regular withdrawal options.

• Transparency: Fund gives regular information to its investors on the value of the investments in addition to disclosure of portfolio held by their scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook

• Affordability :The minimum initial investment for a mutual fund is fairly low for most funds (as low as Rs500 for some schemes).

DISADVANTAGES

• Delay in redemption: It takes 3-6 days for redemption of the units and the money to flow back into the investor’s account.

• No control over costs: The investor pays investment management fees as long as he remains with the fund, even while the value of his investments are declining. He also pays for funds distribution charges which he would not incur in direct investments.

• Managing a portfolio of funds: Availability of a large number of funds can actually mean too much choice for the investor. So, he may again need advice on how to select a fund to achieve his objectives.

CONFUSION BETWEEN

Mutual Fund Scheme & Portfolio Management Scheme

In case of Mutual Fund schemes, the funds of large number of investors is pooled to form a common investible corpus and the gains / losses are same for all the investors during that given period of time.

On the other hand, in case of Portfolio Management Scheme, the funds of a particular investor remain identifiable and gains and losses for that portfolio are attributable to him only. Each investor's funds are invested in a separate portfolio and there is no pooling of funds.

Organization of a Mutual Fund

•

Fund Sponsor

Trustees

Asset Management Company

Depository Agent

Custodian

• Mutual Funds in India follow a 3-tier structure.

• The first tier is the sponsor who thinks of starting the fund.

• The second tier is the trustee. The Trustees role is not to manage the money. Their job is only to see, whether the money is being managed as per stated objectives. Trustees may be seen as the internal regulators of a mutual fund.

• Trustees appoint the Asset Management Company (AMC) who form the third tier, 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

SPONSORS

• Any corporate body which initiates the launching of a mutual fund is referred to as “The sponsor”.

• The sponsor is expected to have a sound track record and experience in financial services for a minimum period of 5 years and should ensure various formalities required in establishing a mutual fund.

• According to SEBI, the sponsor should have professional competence, financial soundness and reputation for fairness and integrity. The sponsor contributes 40% of the net worth of the AMC. The sponsor appoints the trustee, The AMC and custodians in compliance with the regulations.

TRUSTEE

• Sponsor creates a public trust and appoints trustees. Trustees are the people authorized to act on behalf of the Trust. They hold the property of mutual fund.

• Once the Trust is created, it is registered with SEBI after which this trust is known as the mutual fund. The Trustees role is not to manage the money but their job is only to see, whether the money is being managed as per stated objectives. Trustees may be seen as the internal regulators of a mutual fund.

• Trustees appoint the Asset Management Company (AMC), to manage investor’s money.

Asset Management Company (AMC)• 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.

• It is the AMC, which in the name of the Trust, floats new schemes and manage these schemes by buying and selling securities. In order to do this the AMC needs to follow all rules and regulations prescribed by SEBI and as per the Investment Management Agreement it signs with the Trustees.

• The role of the AMC is to manage investor’s money on a day to day basis. Thus it is imperative that people with the highest integrity are involved with this activity.

• The AMC cannot deal with a single broker beyond a certain limit of transactions.

• The AMC cannot act as a Trustee for some other Mutual Fund.

• The responsibility of preparing the OD lies with the AMC.

• Appointments of intermediaries like independent financial advisors (IFAs), national and regional distributors, banks, etc. is also done by the AMC.

• Finally, it is the AMC which is responsible for the acts of its employees and service providers.

Custodian• A custodian’s role is keeping custody of the securities that are

bought by the fund manager and also keeping a tab on the corporate actions like rights, bonus and dividends declared by the companies in which the fund has invested.

• The Custodian is appointed by the Board of Trustees. The custodian also participates in a clearing and settlement system through approved depository companies on behalf of mutual funds, in case of dematerialized securities.

• Only the physical securities are held by the Custodian. The deliveries and receipt of units of a mutual fund are done by the custodian or a depository participant at the instruction of the AMC and under the overall direction and responsibility of the Trustees. Regulations provide that the Sponsor and the Custodian must be separate entities.

Registrar and transfer agents• The registrar and transfer agents are appointed by the AMC.

AMC pay compensation to these agents for their services. They carry out the following functions

• Receiving and processing the application forms of investors

• Issuing unit certificates

• Sending refund orders

• Giving approval for all transfers of units and maintaining records

• Repurchasing the units and redemption of units

• Issuing dividend or income warrents

Fund accountants

• Fund accountants are appointed by the AMC. The are in charge of maintaining proper books of accounts relating to the fund transactions and management. The perform the following functions

• Computing the net asset value per unit of the scheme on a daily basis

• Maintaining its books and records

• Monitoring compliance with the schemes, investment limitations as well as SEBI regulations

• Preparing and distributing reports of the schemes for the unit holders and SEBI and monitoring the performance of mutual funds custodians and other service providers.

Lead manager• Lead manager carry out the following functions:

• Selecting and coordinating the activities of intermediaries such as advertising agency, printers, collection centers.

• Carrying out extensive campaign about the scheme and acting as marketing associates to attract investors.

• Assisting the AMC to approach potential investors through meetings, exhibitions, contacts, advertising, publicity and sales promotion.

Investment advisors

• Investment advisors carry out market and security analysis.

• Advising the AMC to design its investment strategies on a continuous basis.

• They are paid for their professional advice regarding fund investment on the average weekly value of the fund’s net assets.

Legal advisors

• Legal advisors are appointed to offer legal guidance about planning and execution of different schemes.

•A group of advocates and solicitors may be appointed as legal advisors.

• Their fee is not associated with net assets of the fund.

TYPES OF MUTUAL FUNDS:

• Investors have the option of choosing from a wide variety of schemes in a mutual fund depending upon their requirements. MF’s are classified as follows:

• Operational classification:

• Open ended scheme: when a fund is accepted and liquidated on a continuous basis by a MF manager, it is called as open ended scheme. The fund manager buys and sells units constantly as demanded by the investors. The scheme provides excellent liquidity facility to the investors. The buying and selling of units takes place at a declared NAV(Net Asset Value)

• Close ended scheme: when a units of a scheme is liquidated only after the expiry of a specified period it is known as close ended fund. Managing a close ended scheme is comparatively easy for the fund Manager. The fund can be liquidated after a specified period.

• Interval scheme: it is kind of close ended scheme with a feature that it remains open during a particular part of the year for the benefit of investors, to either off load or to undertake purchase of units at a NAV.

Return based classification

• Income fund scheme: this scheme is customised to suit the needs of investors who are particular about regular returns. The scheme offers maximum current income where by the income earned by the units is distributed periodically there are 2 types of such schemes, one that earns a target constant income at relatively low risk while the other offers maximum possible income.

• Growth scheme: it is a MF scheme that offers the advantage of capital appreciation of the underlying investment such funds invest in growth oriented securities that are capable of appreciating in the long run. The risk attached with such funds is relatively higher.

• Conservative fund Scheme: a scheme that aims at providing a reasonable rate of return, protecting the value of investment and achieving capital appreciation is called a conservative fund scheme. It is also known as middle of road funds as it offers a blend of the above features. Such funds divide their portfolio in stocks and bonds in such a way that it achieves the desired objective.

Investment based classification

• Equity fund: such fund invest in equity shares they carry a high degree of risk such fund do well in favorable market conditions. Investments are made in equity shares in diverse industries and sectors.

• Debt funds: Such fund invest in debt instruments like bonds and debentures. These funds carry the advantage of secure and steady income there is little chance of capital appreciation. Such funds carry no risk. A variant of this type of fund is called liquid fund which specializes in investing in short term money market instruments.

• Balanced funds: such scheme have a mix of debt and equity in their portfolio of investments. The portfolio is often shifted between debt and equity depending upon the prevailing market conditions.

• Sectoral fund: Such fund invest in specific sectors of the economy. The specialized sectors may include real estate infrastructure, oil and gas etc, offshore investments, commodities like gold and silver.

• Leverage funds: the funds that are created out of investments with not only the amount mobilized from investors but also from borrowed money from the capital markets are known as leveraged funds. Fund managers pass on the benefit of leverage to the mutual fund investors. Additional provisions must be made for such funds to operate. Leveraged funds use short sale to take advantage of declining markets in order to realize gains. Derivative instruments like options are used by such funds.

• Gilt fund : These funds seek to generate returns through investment in govt. securities. Such funds invest only in central and state govt. securities and REPO/ reverse REPO securities. A portion of the corpus may be invested in call money markets to meet liquidity requirements. Such funds carry very less risk. Their prices are influenced only by moment in interest rates.

• Indexed funds: these funds are linked to specific index. Funds mobilized under such schemes are invested in securities of companies included in the index of any exchange. The fund performance is linked to the growth in concerned index.

Evaluation of Mutual Funds

• It is essential that the performance of Mutual fund is evaluated and appraised. Such appraisal helps the fund to compare itself with other funds besides being a potential source of information to the present and prospective investors.

• Evaluation includes simple evaluation tools to sophisticated models which take into consideration the risk and uncertainty associated with the returns. Some of the models used are Treynor’s Model and Sharpe’s Model

Sharpe’s model

• Sharpe’s Performance Index: It offers a single value for performance ranking of different funds or portfolio. It measures the risk premium of the portfolio in terms of its total risk.

• Sharpe’s Index = Average portfolio return – Risk free

rate of return

Standard Deviation of Portfolio

= Rp – Rf

σp

Treynor’s model

• Treynor’s Performance Index: Here the fund’s performance is measured against the market performance. It is used to calculate return per unit of market risk.

• Treynor’s Index = Average portfolio return –Risk free rate of return

Market risk of Portfolio

= Rp – Rf

βp

Operational Efficiency of Mutual funds• Net Returns: the operational efficiency of a mutual fund

is best judged by its ability to earn for the investors better and safe returns in the form of capital appreciation and the dividends or income received on such investment.

• Returns are calculated keeping in mind the expenses incurred while earning such returns which include trusteeship fee, management fee, administrative fee, fund accounting fee, initial charges, brokerage etc. SEBI has fixed an overall limit on expenses as per the regulations.

• Net Asset Value: It is another parameter to measure the operational efficiency of the fund. The intrinsic value of a unit under a specific scheme is referred to as the NAV of the scheme. The value gives an idea of the amount that may be obtained by the unit holder on sale of the unit to the mutual fund company

NAV (per unit) = Total Market Value – Fund liabilities

No. of outstanding Units

• Load : The initial expenses that are incurred by a mutual fund in relation to the scheme operated by it is referred to as the load of the scheme. According to SEBI guidelines a certain percentage of load must be borne by the expected scheme.

• Disclosures: A highly transparent nature of mutual fund is said to operate to benefit the investors and service their needs. MFs are supposed to follow certain norms and ample disclosures for their operation. Disclosures are made through half yearly and annual reports where all the information relating to the scheme is disclosed.