Security Analysis Project

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Mutual Funds & Schemes

Submitted by:

Ritik Kirti (15BSP1010)

G U R G A O N

Introduction

A mutual fund is a pool of money from numerous investors who wish to save or make money just like you. Investing in a mutual fund can be a lot easier than buying and selling individual stocks and bonds on your own. Investors can sell their shares when they want.

The average mutual fund holds hundreds of different securities, which means mutual fund shareholders gain important diversification at a very low price. To see why this is important, consider an investor who just buys SBI stock before the company has a bad quarter. He stands to lose a great deal of value because all his money is tied to one company. On the other hand, a different investor may buy shares of a mutual fund that happens to own some SBI stock. When SBI has a bad quarter, she only loses a fraction as much because SBI is just a small part of the fund portfolio.

Investors pool

their money.

Fund managers pool money in

securities.

Income is distributed among

shareholders.

Income & dividend are generated.

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. Since then, the Mutual fund companies have continued to grow exponentially with foreign institutions setting shop in India, through joint ventures and acquisitions.

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 mandatory for all those engaged in selling or marketing mutual fund products.

Advantages of Mutual Funds:

When considering investment opportunities, every investor faces some challenges. From stocks, bonds, shares, money market securities, to the right combination of two or more of these, however, every option presents its own set of challenges and benefits.

So why should investors consider mutual funds over others to achieve their investment goals?

Mutual funds allow investors to pool in their money for a diversified selection of securities, managed by a professional fund manager. It offers an array of innovative products like fund of funds, exchange-traded funds, Fixed Maturity Plans, Sectoral Funds and many more.

Whether the objective is for financial gain or convenience, mutual funds offer many benefits to investors:-

• Portfolio diversification: It enables him to hold a diversified investment portfolio even with a small amount of investment like Rs. 2000/-.

• 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.

• Reduction of transaction costs: The investor has the benefit of economies of scale; the funds pay lesser costs because of larger volumes and it is passed on to the investors.

• Wide Choice to suit risk-return profile: Investors can chose the fund based on their risk tolerance and expected returns.

• 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

Disadvantages of Mutual Funds

• 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.

• No tailor-made portfolios: The very high net-worth individuals or large corporate investors may find this to be a constraint as they will not be able to build their own portfolio of shares, bonds and other securities.

• 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.

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

Fund Structure : Structure of Mutual Funds in India

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

Sponsor

Any corporate body which initiates the launching of a mutual fund is referred to as "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.

Fund Sponsor

Trustees

Asset Management Company

Depository Custodi

an

Agent

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. A minimum of 75% of the trustees must be independent of the sponsor to ensure fair dealings. Trustees appoint the Asset Management Company (AMC), to manage investor’s money.

Asset Management Company (AMC)

The investment manager of a mutual fund is technically known as ‘ASSET MANAGEMENT COMPANY’ and is appointed by sponsors and trustees. AMC manages affairs of mutual fund. 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 act as a Trustee for some other Mutual Fund. 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.

Other constituentsRegulation imposes responsibility on the trustees to ensure that the AMC has proper system and procedures in place and has appointed key personnel and other constituents like R&T agents, brokers etc.

Registrar and transfer agent

A registrar plays important role. The task of getting applications together, sorting them and arranging in an order is undertaken by registrar to issue. SEBI guidelines stipulate that a company offering public issue of shares should appoint merchant banker as registrar to issue. The registrar should be registered with SEBI.

Role of Registrar

A registrar should maintain proper books of accounts and records. He shall intimate SEBI the place where books are maintained He shall preserve books of accounts and other records for minimum period of 3 yrs He shall appoint compliance officer.

A mutual fund manages money of many unit-holders across cities and towns of the country. Investor servicing not only becomes important but challenging as well. This would typically include processing investors’ application, recording the details of investors, sending them account statements and other reports on periodical basis, processing dividend payouts, making changes in investor details and keeping investor records updated by adding details of new investors and by removing details of investors who withdraw their funds from the mutual funds. It is very impractical and expensive for any mutual fund to have adequate workforce all over India for this purpose. Instead, they use entities called as Registrars and transfer agents, which generally provide services to many mutual funds. This ensures quality services across all location and keeps the costs lower for the unit-holders.

Auditor

Investor money is held by the trustees in trust. Regulation has ensured proper accounting norms to ensure fair and responsible record keeping of investor’s money. Separate books of account are maintained for each scheme of the mutual fund and individual annual report is prepared. The books of accounts and the annual reports of the scheme are audited by auditors. The AMC is a company under companies act, 1956 and therefore is required to get its accounts audited as per the provisions of the companies act. In order to maintain high standards of integrity and transparency regulations stipulate that the auditor of the mutual fund schemes and the auditor of the AMC will have to be different.

Brokers

Brokers are registered members of the stock exchange whose services are utilized by AMCs to buy and sells securities on the stock exchanges. Many brokers also provide the Investment Manager (AMC) with research reports on the performance of various companies, sector and market outlook, investment recommendations etc. Regulations have imposes restrictions on

the involvement of brokers in the investment process of any mutual fund in the following ways- a. If a broker is related to the sponsor or its associate, then the AMC shall not purchase or sell securities through that broker in excess of 5% of the aggregate of purchase and sale of securities made by the mutual fund in all its schemes. b. For transactions through any other broker the AMC can exceed the limit of 5% provided it has recorded justification in writing and report of such exceeding has been sent to the trustee on a quarterly basis

Underwriter

A company or other entity that administers the public issuance and distribution of securities from a corporation or other issuing body. An underwriter works closely with the issuing body to determine the offering price of the securities, buys them from the issuer and sells them to investors via the underwriter's distribution network.

To act as an underwriter, a certificate of registration must be obtained from Securities and Exchange Board of India (SEBI). The certificate is granted by SEBI under the Securities and Exchanges Board of India (Underwriters) Regulations, 1993. These regulations deal primarily with issues such as registration, capital adequacy, obligation and responsibilities of the underwriters. Under it, an underwriter is required to enter into a valid agreement with the issuer entity and the said agreement among other things should define the allocation of duties and responsibilities between him and the issuer entity. These regulations have been further amended by the Securities and Exchange Board of India (Underwriters) (Amendment) Regulations, 2006.

TYPES OF MUTUAL FUNDS

EQUITY MUTUAL FUNDS

Equity Mutual Fund is a mutual fund that mainly invest in stocks. Investing in equity funds provides a simple way to buy a portfolio of stocks through a MF which pools the investors money into one fund that’s run by a manager. Instead of buying individual stocks at higher cost, one gets a diversified basket that offers the risk and objectives he/she wants. The investment does not have to be daunting and one can get a store of stock exposure one is seeking. An Equity Fund can be either actively managed or passively managed.

Why stock or Equity ?

Investing in equity funds is beneficial in various aspects:

It incorporates professional management. Investing in equity funds is transparent and cost efficient. It enhances diversification. It involves investments in small and staggered ways.

For companies– Offering stock or equity is a method of fund raising by companies.

– Companies can raise capital either through equity or through debt.

– Raising equity is cost efficient though certain amount of ownership changes.

For investors– Buying stock or equity is to participate in the growth of the companies in

anticipation of better ROI.

– Equity returns are expected to be better than that of returns from debt.

How investing in equity funds takes place ?

• Companies offer portion of stock or equity through the process of IPO (Initial Public Offering) at a pre-determined price band depending upon the requirement of capital for their business.

• Investors across categories such as retail, HNIs, FIIs, DIIs participate in the IPO and subscribe the required number of stocks which they want to own.

Simply put, an Equity Mutual Fund is a mutual fund that mainly invest in stocks. Most equity funds are categorized by :

Company size Firm’s investment style

Geographical location

Investing in equity funds provides a simple way to buy a portfolio of stocks through a MF which pools the investors money into one fund that’s run by a manager. Instead of buying individual stocks at higher cost, one gets a diversified basket that offers the risk and objectives he/she wants. The investment does not have to be daunting and one can get a store of stock exposure one is seeking. An Equity Fund can be actively managed, meaning that your benefits from the experience of a ‘Seasoned Stock Selector’ (fund manager) at a comparable lower price on day to day basis. Or the fund can be passively managed, which means that the performance is tracked alongside an Index which requires a change only in the index once and not daily.

Features of EMF

• It requires minimum 4-5 years of engagement.

• Minimum amount required to invest in equities is Rs. 500

• The best way to invest in equity funds is through Systematic Investment Planning (SIP)

• It gives the benefit from compounding, therefore no worries of market fluctuations.

Equity Linked Saving Scheme(ELSS)

It has been defined under Section 80C of Income Tax Act of 1961 to save more on taxes. ELSS helps saving all the amount of Income tax one pays. For example, if one invests Rs. 1.5 lakhs, he/she can save up to Rs. 46,350 in taxes.

ELSS is very similar to EMF. The only difference between the two is that in ELSS, there is a minimum locking period of 3 years, but it is a great deal considering your money is still being invested in Equity Asset class (EAC). Equity Asset Class have good potential of wealth creation over a long period. One cannot attempt to break the investment before 3 years which makes staying invested a habit. Icing on the cake is that one ends up saving up to Rs. 46,350 in taxes per year.

Types of Equity Mutual Funds :

There are many different types of equity funds, including international equity funds, which invest in stocks outside of your home country, global equity funds, which invest all over the world including your home country, sector equity funds, which invest in individual areas of the economy such as telecommunication firms or banks, and even market capitalization equity funds, that limit investments to micro cap, small cap, medium cap, large cap, or mega-cap companies.

When mutual funds invest maximum part of their corpus in the stock market, they are broadly called an equity mutual fund schemes. Remember, the structure of the fund may vary for different schemes and also on fund manager’s view on different stocks. The structure depends on the objective of the scheme. Equity Mutual Funds can be broadly classified under 4 categories :

1. Based on Geography

2. Based on Market Capitalization

3. Based on Investment style

Equity Funds Focused on Geographic Mandate

International Equity Funds are those that invest in stocks outside of the United States Global Equity Funds are those that invest in stocks around the world including those in

the United States but tend to favor foreign stocks by at least 80% of their overall portfolio weighting

Worldwide Equity Funds are those that invest in stocks around the world with no distinction between domestic or international assets, following wherever the portfolio managers or methodology dictate

Domestic Equity Funds are those that invest in stocks solely in the home country of the investor and issuer. For most readers, this will be the United States.

Equity Funds Focused on Market Capitalization

Mega Cap Equity Funds are those that invest in stocks of the biggest companies in the world; behemoths worth hundreds of billions of dollars like Walmart or Berkshire Hathaway.

Large Cap Equity Funds are those that invest in companies with a large market capitalization. For instance, funds which invest a large portion of their corpus in companies with large market capitalization are called large-cap funds. This type of fund is known to offer stability and sustainable returns, over a period of time.

Mid Cap Equity Funds are those that invest in companies with a medium market capitalization. Here the fund invests in stocks of mid-size companies, which are still considered developing companies.

Small Cap Equity Funds are those that invest in companies with a small market capitalization. Small cap funds are invested in small companies. Small companies are more likely to go bankrupt. So the risk associated with this category of equity mutual fund is very high as compared to large cap and mid cap funds. Small cap funds are exactly opposite to large cap funds. Even though the risk is high, there are equal chances of the company to make huge profits. This is because small companies have a scope of growing into a big coming in the near future. So small cap funds can be rewarding too.

Micro Cap Equity Funds are those that invest in tiny publicly traded companies worth a few million, or few tens of millions of dollars, in market capitalization.

Multi cap Equity Funds are those funds that invest in companies across different sectors and hence reduce the amount of risk in the fund. Diversification helps prevent events that could affect a single sector for affecting the fund, and hence reduce risk.”

Equity Funds Focused on Investing Style

Private Equity Funds are those that invest in privately held companies that don't trade on the stock market. They may setup a limited liability company, infuse millions, or even billions, of dollars into it, raise money by issuing bonds, and then acquire businesses management believes it can improve.

Equity Income Funds are those that invest in ownership of businesses that pay a significant dividend, often measured by a history of dividend increases, absolute and relative dividend yield, and conservative dividend coverage ratios.

Dividend Growth Funds are those that invest in ownership of businesses with a record of increasing dividends per share at a much faster rate than the stock market as a whole. There are many different ways to make money with a dividend growth strategy, they sometimes beat their higher-yielding counterparts, and, in many cases, can make wonderful buy-and-hold investments.

Index Equity Funds are those that mimic an index such as the Dow Jones Industrial Average or the S&P 500. Though not always true, index equity funds tend to have some of the lowest mutual fund expense ratios.

Sector or Industry Specific Equity Funds are those that track specific areas of the economy, such as industries or sectors; e.g., discount retailers or property and casualty insurance groups. This can be appealing for those who want to invest their money in certain types of businesses, which may not be a bad idea given that certain industries have disproportionately produced high returns for owners.In addition, equity funds can be bought as both traditional mutual funds and as exchange traded funds, or ETFs`. Some investors tend to favor one type over the other but there are advantages and disadvantages to both depending upon how the mutual fund is structured and the investor's goals, objectives, and preferences.

Why should one invest in equities ?One should always thing of investing in equities because of the multiple reasons. Equities have the potential to increase in value over time. Research studies have proved that the equity returns have outperformed the returns of most other forms of investments in the long term. Investors buy equity shares or equity based mutual funds because:-

• Equities are considered the most rewarding, when compared to other investment options if held over a long duration.

• Research studies have proved that investments in some shares with a longer tenure of investment have yielded far superior returns than any other investment. The average annual return of the stock market over the period of last fifteen years, if one takes the Nifty index as the benchmark to compute the returns, has been around 16%. However, this does not mean all equity investments would guarantee similar high returns.

• Equities are high risk investments. Though higher the risk, higher the potential returns, high risk also indicates that the investor stands to lose some or all his investment amount if prices move unfavorably.

Why SIP is a great Idea in equity funds ?

Systematic Investment Planning has been proved to be the best idea if one is willing to invest in equity funds. This is because with SIP,

One can easily invest in small amounts and make regular purchases SIP also manages volatility to a greater extent. It eliminates market timing as well. It has the power of compounding, that is, gives the best results in compounded form.

Risk associated with investing in Equity Funds

Investing in equity mutual funds comes at slightly higher risk as compared to debt mutual funds, but they also give your money a chance to earn higher returns. One could lose money investing in an equity fund. Only a few investments are risk free. An EF can be so diversified that growth in the value of one stock is enough to impact the whole fund. And the manager may make decisions that don’t benefit one’s interest.

Advantages of Equity Financing

• Less burden. With equity financing, there is no loan to repay. This offers relief in several ways. First, the business doesn’t have to make a monthly loan payment. This can be particularly important if the business doesn’t initially generate a profit. This also frees you to channel more money into growing the business.

• Credit issues gone. If you lack creditworthiness—through a poor credit history or lack of a financial track record—equity can be preferable or more suitable than debt financing.

• Learn, gain from partners. With equity financing, you might form partnerships—informal, perhaps—with more knowledgeable or experienced individuals. Some might be well connected. If so, your business could benefit from their knowledge and their business network.

Disadvantages of Equity Financing

• Share profit. Your investors will expect—and deserve—a piece of your profits. However, it could be a worthwhile trade-off if you are benefiting from the value they bring as financial backers and/or their business acumen and experience.

• Loss of control. The price to pay for equity financing and all of its potential advantages is that you need to share control of the company.

• Potential conflict. Sharing ownership and having to work with others could lead to some tension and even conflict if there are differences in vision, management style and ways of running the business. It can be an issue to consider carefully.

What has been the average return on equities in India ?

• If we take the Nifty index returns for the past fifteen years, Indian stock market has returned about 16% to investors on an average in terms of increase in share prices or capital appreciation annually.

• Besides that an average stock has paid 1.5% dividend annually.

• Dividend is a percentage of the face value of a share that a company returns to its shareholders from its annual profits.

• Compared with most of the other forms of investment, investing in equity shares offers the highest rate of return if invested over a longer duration.

DEBT MUTUAL FUNDS

Debt funds are mutual funds that invest in fixed income securities like bonds and treasury bills. These are called debt instruments because the issuers have borrowed money from the lender (investor) by issuing these securities. These “debts “mainly known as “bonds”, is income generating properties i.e. investors receive regular interest payments on them. These payments could be monthly, semi-annually or annually. These funds may invest in short term or long term plans. Debt funds are preferred by individuals who are not willing to invest in a highly volatile equity market. A debt fund provides a steady but low income relative to equity. The return of debt funds includes interest income and capital appreciation/depreciation in the value of security due to changes in market dynamics. The investment objectives of debt mutual funds are preservation of capital and generation of income. Such funds add stability to the investment portfolio. It aims for better post tax returns. Also they provide better liquidity as investor can withdraw his investment. One can go for partial withdrawal of funds instead of breaking entire investment. There is no existing penalty.

FACTORS AFFECTING DEBT FUNDS

1) INFLATION

All bonds are subject to inflation risk, which is also known as purchasing power risk. In periods of inflation, money in the future is not worth as much as money currently held. For example, if the inflation rate is 10 percent, goods will cost 10 percent more in one year. As a bond is a promise to return money to you in the future, the money you invested now will not purchase as much in the future when you receive it. Thus, periods of high inflation can greatly move the price of your bond and, consequently, its yield.

2) CREDIT RATING

Bond ratings reflect an outside agency’s opinion of the credit worthiness of a bond issuer. A bond with a lower credit rating carries a higher risk of default and a correspondingly higher risk to the investor. As a result, investors require lower-rated bonds to pay a higher rate of interest to compensate them for the additional risk. Occasionally, the credit rating of a bond issuer can be raised or lowered, usually due to a change in the financial fortunes of the underlying issuer. As result, the bond’s yield generally changes accordingly, as reflected in the rise or decline of the bond’s price

3) MARKET INTEREST RATES

Although a bond pays a stated, generally unchanging interest rate, the movement of interest rates in the bond marketplace as a whole affect the price of individual bonds. Usually, bond prices fall when market interest rates rise, and bond prices rise when market interest rates fall. The reason for this is simple. If you own a bond paying a 6 percent interest rate and market rates rise so that newly issued bonds pay 8 percent, your bond will not be as attractive to new investors. The price of your bond will be discounted, or go down, to the point where the net return of your bond now equals the market interest rate. Similarly, if rates in the marketplace fall to 4 percent, your 6 percent bond will become more attractive, and the price will rise.

RETURN ON DEBT FUNDS

1) Capital Appreciation2) Regular Income

CAPITAL APPRECIATION

Debt funds buy either listed or unlisted debt instruments at a certain price and then sell them. The difference between the cost and sale price accounts for the appreciation or depreciation in the funds value. A debt instruments market price depends on the interest rates of its underlying assets and also any up or downward movement in the credit ratings of its holdings. Market prices of debt securities swing with movements in the prevailing interest rates. Let us say our debt fund owns a security that yields a 10% interest. If the market interest rate falls, new instruments that hit the market would reflect the changed interest rates and offer lower returns. This would result in an increase in our funds price as the higher yield would raise our instruments value. As a result the NAV of our fund would increase which provides us with the capital appreciation.

REGULAR INCOME

Similar to the interest that banks offer us on our deposits, debt funds also earn a regular interest from the fixed income securities they are invested in.This income gets added to the debt fund on a regular basis. This income would be shared with us, thereby providing us with regular income.

TYPES OF DEBT MUTUAL FUND

GILT FUNDS

Also known as Government Securities in India, Gilt Funds invests in government papers (named dated securities) having medium to long term maturity period. These schemes are safer as they invest in papers backed by government. Issued by Government of India, these investments have little credit risk (risk of default) and provide safety of principal to the investors. However, like all debt funds, gilt funds too are exposed to interest rate risk. Interest rates and prices of debt securities are inversely related and any change in the interest rates results in a change in the NAV of debt/gilt funds in an opposite direction.MONEY MARKET FUNDSMoney market funds invests short-term (maturing within one year) interest bearing debt instruments. These securities are highly liquid and provide safety of investments, thus making money market the safest investment option when compared with other mutual fund types. However, even money market is exposed to the interest rate risk. The typical investment options for money market funds include Treasury Bills (issued by governments),Commercial papers(issued by companies) and Certificates of Deposit(issued by banks)INCOME FUNDSFunds that invest in medium to long term debt instruments issued by private companies, banks, financial institutions, governments and other entities belonging to various sectors(like infrastructure companies etc.) are known as Debt /Income Funds. These are low risk profile funds that seek to generate fixed current income to investors. In order to ensure regular income for investors, income funds distribute large fraction of their surplus to investors However, they are highly vulnerable to the changes in interest rates. Although debt securities are generally less risky than equities, they are subject to credit risk by the issuer at the time of interest or principle payment. To minimize the risk of default, debt funds usually invest in securities from issuers who are rated by credit rating agencies and are considered to be of “investment Grade”

MONTHLY INCOME PLANS (MIP)They invest 75-80% of their corpus in debt instruments and remaining in equities. They get the benefits of both equity and debt market. The debt investments ensure stability and consistency while the equity instruments in the portfolio boost the returns. These schemes rank slightly high on the risk-return matrix. These try to give you a monthly income in the form

of dividends, which is of course not guaranteed. These funds are for investors, who have a big corpus initially, and would like to generate a monthly income for themselves with low to moderate risk.MIPs are effected by interest rate changes in the economy (due to majority investment in debt instruments). When interest rates (in the economy) fall: NAV of MIPs rises (due to increase in bond prices).When interest rates rise, NAV of MIPs fall; this is when MIPs look to the equity portion in the portfolio to sustain returns.Tenure: MIPs are ideal for investment horizon of 2-3 yearsLIQUID FUNDS

Also known as money market schemes. These provide easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, inter-bank call money market, CPs and CDs and are meant for an investment horizon of one day to three months.

FIXED MATURITY PLAN

Fixed Maturity Plan (FMP) is fixed tenure, debt-based scheme, which terminate on a pre-determined date. FMPs are ideal for those investors who wish to park their funds for a specific period.

The return of these schemes is predictable as money is invested in fixed interest based securities maturing in the line with the maturity of the underline FMP

The portfolio comprises of bonds, which normally mature in line with the defined period of the FMP and are passively managed with an eye on interest income rather than the trading profits.

Tenure: FMPs are available for as short a 1 month to even more than 5 years

Difference between Equity and Debt

Equity DebtAlternate to stocks Alternate to FD's

Ownership ContractualNo fixed tenure (long term) Fixed tenure

High risk high reward Moderate risk moderate rewardLimited Unlimited

Transparent Opaque

Dependent on stock markets Dependent on interest rates

BALANCED MUTUAL FUND

A balanced mutual fund comprises of a stock component and bond component in a single portfolio. A Balanced Fund (or a Hybrid Fund as it is known sometimes), gives your capital an exposure to both equity and debt instruments in good measure. By combining these two classes of investment, a Balanced Fund combines the best facets- low risk and higher returns.

A Hybrid Fund can be primarily of two types:

Equity Balanced Fund

In this type of fund, the majority of the capital (generally 70-75%) is invested in equity instruments with the rest for debt instruments. The higher risk that the equity investment holds is balanced out by the percentage invested in debt instruments.

Monthly income plans (MIPs)

They are debt-oriented hybrid funds, with a marginal exposure to equity (upto 30%). They offer regular returns – on a monthly, quarterly, half-yearly or annual basis, as per the investors’ discretion. While these plans are relatively less risky than pure equity funds.

Advantages of Balanced Funds

A balanced mutual fund comes with many advantages of investment. This type of investment caters to most of the requirement of an amateur investor. Following are some of the benefits of holding funds in a balanced mutual fund.

Simplicity

A single balance fund investment provides investors with the option of investing in varied securities. It is a portfolio consisting of stock component, bond component and sometimes money market component. This type of mutual fund is simple and easy to manage.

Diversification of Investment

An investment in balanced funds allows the investor to diversify his investment into stocks, bonds and money market instruments. It does not compel the investor to hold funds in a single type of market.

Low risk

A balanced fund investment comes with an advantage of low risk. The securities comprising the portfolio is a blend of stocks and bonds which brings down the risk factor attached with this type of investment. The portfolio is less volatile in nature.

Steady Income

It is a steady income generating type of a mutual fund. It might not give you huge income, but yes, it will surely generate moderate income over a period of time. Balanced funds mostly focus on the value and growth factors of the securities rather than making huge profit overnight.

Disadvantages of Balanced Funds

Cost of Investment

Investors have to keep themselves updated with the stock market every time. This is because fund managers charge the same fees for a 60:40 and 40:60 ratio of stocks and bonds. If you forget to change the ratio of investment with market changes, then you may lose out on a lot of income.

Long-term Investment

A balanced fund investment is good for investors who are seeking long-term benefits. It is not a good option for people who wish to make huge income in a short duration.

Low Income

This type of mutual fund investment produces low income. So it is not a feasible option for investors who want to make more money in less time.

DSP BlackRock Balanced Fund

An Open Ended Balanced Scheme seeking to generate long term capital appreciation and current income from a portfolio constituted of equity and equity related securities as well as fixed income securities (debt and money market securities).The scheme was launched on May 27,1999.

Risk: Moderately High Risk

Age: 17 years 3 months since May 27, 1999

AUM: Rs. 1,359.41 crores as of Jul 31, 2016

Horizon: Long-term Horizon

Goal: Capital Growth & Income

Benchmark: CRISIL BALANCED FUND INDEX

History

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140

68.8957.22

72.26 72

104.41 109.43

125.3

15.66

-16.95

26.3

-0.37

45.02

4.8

14.5

NAV Total Return(%)

Portfolio Characteristics

Total Stocks 54Total Bonds 26Avg Mkt Cap (Rs.Cr) 40773Portfolio P/B Ratio 3.2Portfolio P/E Ratio 21.843Y Earnings Growth (%) 4.34

Top Equity Holdings

Company Sector PE% Assets

HDFC Bank Financial 25.43 4.35Yes Bank Financial 21.49 3.4State Bank of India Financial 23.07 3.14

Ultratech CementConstruction 45.32 3.09

Sun Pharmaceutical Inds. Healthcare 30.02 3.04BPCL Energy 11.05 3.04SRF Textiles 21.52 2.9IndusInd Bank Financial 29.3 2.72Tata Motors Automobile 15.13 2.39Asian Paints Chemicals 61.93 2.27

Top Debt Holdings

Company InstrumentCredit Rating

% Assets

7.88% GOI 2030 GOI Securities SOV 2.768.4% Power Finance Corp. 2020 Bonds AAA 2.037.59% GOI 2029 GOI Securities SOV 1.94

7.72% GOI 2025Central Government Loan SOV 1.92

9.15% Piramal Enterprises 2017 Debenture AA 1.46

Comparison Between different investment options

Principal invested: Rs. 1,000 x 121 installments = Rs. 121,000

DSP BlackRock Balanced

Fund

CRISIL BALANCED

FUND INDEXNIFTY 50 Gold PPF

Current value Rs. 251,292 Rs. 197,937Rs. 196,15

8Rs. 209,02

5Rs. 193,10

4Absolute growth 107.68% 63.58% 62.11% 72.75% 59.59%Annualized growth 14.06% 9.56% 9.39% 10.59% 9.09%Dividend paid - - - - -

PORTFOLIO COMPOSITION

Portfolio composition is a collection of different securities like Equity (shares), Debt securities, mutual funds, gold, derivatives etc. to make a portfolio for the investors in order to diverse the risk associated with the securities and to gain the maximum return over the portfolio.

In our project we have taken out the different mutual fund securities to make a portfolio and to know the return over them.

Some of the mutual funds securities are mentioned below:

Category FundsLaunch date

1-Year Return

3-Year Return

NAV (Cr.)

Return since launch

Min. Investment Type

Gold fundQuantum gold Fund

Feb 22, 2008 11.09 3.37 62.16 10.39 5000

Open ended

Equity: Mid cap

Tata euity PE Fund-Direct Plan

Jan 1, 2013 27.64 36.64 633 22.05 5000

Open ended

Debt: Gilt Short term

SBI Magnum gilt fund-short term

Dec 23, 2000 11.09 11.48 12.48 7.82 5000

Open ended

Debt: Gilt Medium & Large

Sundaram Gilt Fund - Direct Plan

Jan 1, 2013 9.8 11.61 39.63 12.14 5000

Open ended

Equity: Technology

Birla sunlife new millenium fund

Jan 1, 2013 0.42 15.13 18.27 20.19 1000

Open ended

Above are the necessary information related to the mutual funds and these are important while selecting the funds for the portfolio making.

While making a portfolio, investors should know about the composition of the different securities and their weightage in the portfolio. By selecting all these securities an investor is able to make his/her investment portfolio and then he/she can calculate the portfolio return over the time period.

RISK-RETURN CHARACTERISTICS

RISK

Every type of investment, including mutual funds involves risk. Risk refers to the possibility that you will lose money (Both principal and any earnings) or fail to make money on an investment. A fund’s investment objective and its holdings are influential factors in determining how risky a fund is. Generally, risk and potential return are related. This is the risk-return trade off. Higher risks are usually taken with the expectation of higher returns at the cost of increased volatility. While a fund with higher risk has the potential of higher return, it also has the greater potential for losses or negative returns. The evidence says that when the fund manager manages multiple funds simultaneously, the risk of one of the managed funds is significantly increased, minimizing the inherit benefits of mutual funds stock diversification. Thus, all else equals, the ore time that a manager devotes to an individual fund the more likely the fund will reduce the risk exposure. This has increased risk exposures of the multiple management structure results in fund misclassification.

RETURN

The annual return on an investment, expressed as a percentage of the total amount invested also called rate of return or the yield of a fixed security. The interaction of mutual funds flow and security returns in emerging markets. Phillippas Nikolas examined the hypothesis the mutual funds may act as instability factors in financial markets within a VAR framework. The empirical evidence suggested that mutual funds flow can be predicted by lagged flows and index returns. The analysis implied that mutual fund shareholders are unsophisticated, frequently wrong (noise traders) and often worse than the informed investors.

TYPES OF RISK ASSOCIATED WITH MUTUAL FUNDS

Risks that affect your investments come in many forms. Actively managed mutual funds and investment accounts attempt to minimize these risks.

Business Risk

Business Risk refers to the possibility that an issuer of a stock or a bond will go bankrupt, or in the case of a bond, be unable to pay the interest or principal repayment. Mutual funds hold securities of many different companies, which minimize this risk.

Credit Risk, Default Risk

Credit Risk, Default Risk refers to the possibility the issuer of a bond will be unable to make timely principal and interest payments.

Currency Risk

Currency Risk refers to the possibility changes in the price of one currency will affect another. If the value of the U.S. dollar is strong, the value of Non-U.S. securities may decline. If the dollar is weak, the value of a U.S. investor’s Non-U.S. assets may rise.

Interest Rate Risk

Interest Rate Risk refers to the possibility interest rates will rise and reduce the value of your investment. Fixed rate instruments decline in value when interest rates rise. Longer-term fixed-income securities such as bonds and preferred stocks have the greatest amount of interest rate risk, while shorter-term securities such as Treasury bills and money markets are affected less.

Market Risk

Market Risk or systematic risk, refers to risk that affects a certain industry, country or region, usually caused by some factor that impacts a whole segment of securities in the same manner. Diversification through mutual funds that invest in different markets can be an effective tool to manage this type of risk.

Inflation Risk

Inflation Risk refers to the possibility that the value of an asset or income will decline as inflation shrinks the value of a country's currency. Because inflation can cause the purchasing power of cash to decline, investors may want to consider investments that appreciate, such as growth stocks or bonds designed to stay ahead of inflation long-term.

Political Risk

Political Risk refers to the possibility that political unrest; government action, terrorism or other social changes can impact investments.

Performance assessment

Mutual fund’s performance assessment is viewed as a feedback and control mechanism that identifies superior performance and makes the investment management process successful. Superior performance of mutual funds may have been the result of good management decisions. Conversely, inferior performance of a mutual fund could also be attributed to costs associated with unscientific management.

There are various approaches to evaluate the performance of funds, these approaches tries to attribute the performance to the following:

Risk Timing: market or volatility Security selection– of industry or individual stocks

Therefore:

a) The focus of evaluation should be on excess returns

b) The portfolio performance must account for the difference in the risk

c) It should be able to distinguish the timing skills from the security selection skills.

The assessment of managed funds involves comparison with a benchmark. The benchmark could be based on the Capital Market Line (CML) or the Security Market Line (SML). When it is based on capital Market Line, the relevant measure of the portfolio risk is σ and when based on Security Market Line, the relevant measure is β. Various measures are devised to evaluate mutual fund performanceperformance, viz. Jensen Alpha, beta etc.

Jensen measure or (Alpha)

The Jensen measure, also called Jensen alpha is similar to the capital asset pricing model (CAPM). CAPM calculates the expected one-period return on any security or portfolio by the following expression.

Rp= Rf+βj[Rm-Rf]

Rj= return expected on fund p

Rf= Risk free interest rate

βj= Systematic risk (beta) for fund j

Rm= Expected return on market portfolio of risky assets

The above expression means that the realized rate of return on a security or portfolio during a given time period is a linear function of the risk free rate of return during a particular period, plus a risk premium that depends on the systematic risk of the security or portfolio during the period.

The Jensen measure (alpha), measures the average return on the portfolio over and above that predicted by the CAPM, given the portfolio’s beta and the average market returns. It is measured using the following formula:

αp= R͞p - [Rf+βj(Rm-Rf)]

The returns predicted from the CAPM model is taken as the benchmark returns and is indicated by the formula within the brackets. The excess return is attributed to the ability of the managers for market timing or stock picking or both. This measure investigates the performance of funds and especially the ability of the managers in stock selection in terms of these contributing aspects.

This measure is widely used in evaluating mutual fund performance. If αp is positive and significant, it implies that the fund managers are able to identify stocks with high potential for excess returns. Market timing would refer to the adjustment in the beta of the portfolio in tandem with market movements. Specifically, timing skills call for increasing the beta when the market is rising and reducing the beta, when the market declines, for example through futures position. If the fund manager has poor market timing ability, then the beta of the portfolio would not have been significantly different during a market decline compared to that during a market increase.

Beta(β)

Beta measures a fund's volatility compared to that of a benchmark. It tells you how much a fund's performance would swing compared to a benchmark.

It’s calculated as:

Beta (β)= (Standard deviation of fund/ Standard deviation of benchmark)* R-square

Its significance depicts how much a fund's performance would swing compared to a benchmark.

Let, if a fund has a beta of 1.5, it means that for every 10% upside or downside, the fund's NAV would be 15% in the respective direction.

The various aspects of beta is that if it’s equal to 1 fund’s movement is same as that of market.

If beta is less than 1 then fund’s movement is less than that of market i.e. conservative fund.

If beta is more than 1 then fund’s movement is less than that of market i.e. risky fund.

R-Squared

R-Squared measures the relationship between a portfolio and its benchmark. It can be thought of as a percentage from 1 to 100.

R-squared is not a measure of the performance of a portfolio. A great portfolio can have a very low R-squared. It is simply a measure of the correlation of the portfolio's returns to the benchmark's returns.

R-squared= (Correlation)2

For example, if R-squared is 0.71 or 71%, then it can be interpreted to mean that 71% of the returns in stock all related to the index. R-square below 0.5 would indicate that the relationship between share price and index is suspect, therefore the calculated beta isn’t reliable.

As R-squared derives its value from correlation between fund and index

Correlationxy= Covariance between index and fund/ (Standard deviation of fund * standard deviation of index)

The general for range for R-squared is

70-100% = good correlation between the portfolio's returns and the benchmark's returns

40-70% = average correlation between the portfolio's returns and the benchmark's returns

1-40% = low correlation between the portfolio's returns and the benchmark's returns

Index funds will have an R-squared very close to 100. R-squared can be used to ascertain the significance of a particular beta or alpha. Generally, a higher R-squared will indicate a more useful beta figure. If the R-squared is lower, then the beta is less relevant to the fund's performance. Values range from 1 (returns are explained 100% by the market) to 0 (returns bear no association with the market).

In respect of performance assessment of funds we have tried to evaluate a fund on the basis of it’s alpha and beta i.e. on basis of its volatility.

The fund taken by us is Franklin India Balanced Fund, which is a balanced fund and is mainly concentrated on large cap industries and its fund style i.e. the concentration of securities comprising of equity and debt is of growing behavior.

[Note: The above data has been retrieved from valueresesarch.com]

As we can see that Franklin India balanced fund is and open ended and balanced equity oriented fund whose risk grade is below average and return grade is of average only.

Its composition comprises of around 66.24 equities, 26.18 debt and around 7.59 cash.

[Note: The above data has been retrieved from valueresesarch.com]

Now if we look at the trailing returns of of Franklin India Balanced Fund and compares it with the risk analysis then:

As the fund has an average return of 11.27% and a standard deviation of 11.55%, it’s range will range from -0.28% to 22.82%. And as the beta of this fund is less than 1 then its less volatile

then market portfolio i.e. any change in market will have lesser effect over the change in fund, and this sentivity of the fund can be varified through the R-squared which is 89%, which means that 89% of the returns in fund are related to the index or market , therefore the calculated beta is reliable. And the alpha is of 9.32 which means that the average return given by this fund is over and above the expected return signified b CAPM model that this fund has been able to identify assets with high potential for excess returns.

Asset Under Management (AUM)

In simple terms Asset Under Management also known as Funds Under Management refers to total financial assets managed by various financial institutions such as Mutual Funds, Venture capital firm etc. on behalf of its clients and themselves.

In respect of AUMs, they have more than doubled since FY07.

• The asset management industry in India is among the fastest growing in the world

• Total AUM of the mutual fund industry clocked a CAGR of 12.8 per cent over FY07–16 to reach US$ 215.4 billion

• As of FY16 (Till September’15), 43 asset management companies were operating in the country, with total AUM US$ 215.4 billion

• SEBI has announced various measures aimed at increasing penetration and strengthening distribution network of MFs

Assets under management comprises both the capital raised from investors and capital belonging to the principals of the fund management firm.

For example, if fund managers contribute ₹20 lakh of their own capital to the fund and raise ₹1 crore additional from investors, their AUM is ₹1.2 crore.

Bibliography

https://www.sbimf.com/SBI_Fund_Guru/hybrid-Funds.aspx http://www.vitt.in/mutual-funds/balanced.html https://www.valueresearchonline.com/funds/newsnapshot.asp?schemecode=610 https://invest.dspblackrock.com/mutual-fund-products/details/dspbl-regular-growth/

balanced-fund http://www.slideshare.net/hariw7/t-hari-kumar-sip-final-report http://mfea.com/learn/investing_basics/content_tabbed/understanding_risk.fs