Contents:

i) Introduction ii) Objective of study iii) Literature Review iv) Study methodology v) Valuation Models vi) Data Analysis vii) Survey and the findings viii) Conclusion

Chapter: 1
Introduction
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 the scheme information document.

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 wide investible universe includes stocks, bonds, money market instruments and other types of securities which aid diversification.

Owner of a mutual fund unit gets a proportional share of thefunds gains, losses, income and expenses.

While mutual funds are major players in most established financial markets, they are relatively new to Indian investors. The first Indian mutual fund scheme (from Unit Trust of India) was offered in 1964, but it wasn't until the 1990s that the investor was provided with an array of fund choices of varying investment objectives and quality. Given the dearth of longer-term investment options in emerging markets such as India, one would expect mutual funds to become popular once made available. Yet, that has not happened. Investments in security related investments, including mutual funds, have hovered around 4 to 5% of household savings for more than a decade despite significant governmental concessions. Physical assets such as real estate and gold and the safer bank deposits continue to be the savings vehicle of choice for Indian investors. Why haven't mutual funds got the attention of the Indian investor?

SankaranNaren, CIO of Equities from ICICI Prudential Mutual Fund, observed that though the mutual fund industry has grown significantly since 2004, it is relatively small (for e.g., the Indian equity mutual funds account for only 3% of the total market capitalisation while the US equity funds account for 30%.) despite the investor-friendly taxation and regulatory framework in the country. He attributed this to the tendency of Indians to trade short-term in equities rather than invest in mutual funds with a long term view, and the fact that two other asset classes, gold and real estate, have managed to give much better returns with much lower volatility. However, despite the short-term uncertainty, he felt that with better awareness and investor education, investment in equity mutual funds was going to increase significantly over the next 10-20 years. Reiterating the issues of poor financial literacy of the Indian investor, and equity as an asset class being viewed in a short term manner, SandeshKirkire, CEO of Kotak Mahindra Asset Management Company, opined that the issue of financial literacy has to be addressed globally by bringing more investments into the capital markets through long term core savings. He observed that the "longest investment" that the Indian citizen makes, the provident fund, does not participate in the equity markets.

Putting forward the regulatory perspective, K. N. Vaidyanathan, currently Chief Risk Officer, Mahindra Group and formerly Executive Director, Securities and Exchange Board of India (SEBI), said that government policy to the mutual fund industry is more in the realm of tax arbitrage rather than providing a positive environment for growth. Further, he added, that our approach of developing regulators around products rather than functions have not aided the asset management industry.

Chapter: 2
Objective of Study
There are multiple objectives that we are seeking to address and fulfil through this project work on MUTUAL FUNDS. Mutual Funds are among those instruments which the Indian public is not much aware of. Through this project we will not only explain the fundamentals of Mutual Fund Investments but we will also try to find out the reasons of it are not performing well in the Indian context through an analysis report of their performance in the Indian markets in the last five years. We have also compared the performance of mutual funds in India with that of other developing countries. We have surveyed the awareness and knowledge of a general public regarding mutual funds and also their reasons of not choosing Mutual Funds as an Investment option. The first part of this article raises key issues relevant to the mutual funds and their related academic research, such as the ownership/affiliation of mutual funds, the performance of mutual funds in terms of the risk-adjusted returns they provide to investors, the fees that they charge, the type of investments they make, and the agency/moral hazard issues that arise in managing others' money, and so on. In its second part, this article records the views of important practitioners who have witnessed and participated in the evolution of the mutual fund industry in India as fund managers and regulators, as expressed in the round table discussion on mutual funds organized by IIMB Management Review.

The detailed objectives have been discussed below: i) Understanding the theoretical aspects of Mutual Funds which involves their structure, categories, types, and parties involved etc.
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ii)

History of Mutual Funds and their performance in India.

iii) iv)

Covering valuation of Mutual Funds. Analysis of performance of different types of mutual funds, comparison of their performance with their respective indices.

v)

Comparing good performers with bad performers and reasons for the same. Inter-nation comparison of overall mutual funds performance.

vi)

vii) viii)

Changes in AUM (Assets under Management) in the last 50 years. Understanding the reasons that de-motivate public from investing.

Chapter: 3
Literature Review
We will look to introduce the following theoretical aspects in this chapter: i) ii) iii) iv) v) Structure of Mutual funds Benefits of Mutual Funds Types of Mutual funds Categories of Mutual funds History of Mutual Funds in India

Structure of Mutual Funds

Structure of a Mutual Fund has been illustrated by the help of a suitable diagram followed by the write up:

Fig. Structure of Mutual funds

Parties Involved in a Mutual Fund

i)

S.E.B.I:
Formulates policies and regulates the mutual funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in 1993. SEBI has also issued guidelines to the mutual funds from time to time to protect the interests of investors.All mutual funds whether promoted by public sector or private sector entities including those promoted by foreign entities are governed by the same set of Regulations. All mutual funds are subject to monitoring and inspections by SEBI.

ii)

SPONSOR:
They act as promoters for the Mutual funds. They are given the charge to form a Trust and appoint Trustees. They are also responsible for appointing the custodian and AMC.

iii)

TRUSTEE COMPANY:

They have a sense of fiduciary responsibility towards the investors to mutual funds. The Trustee Company is appointed by the Sponsor after SEBI approval. The Trustee Company is responsible for the appointment of AMC to manage the portfolio of the Mutual Funds securities. Trustees hold the Unit Holders money in fiduciary trust. There is a requirement of minimum of 4 trustees out of which at least 2/3rd are required to be of independent nature.

iv)

ASSET MANAGEMENT COMPANY:

The AMC is responsible for the operational aspects of the Mutual Fund. It holds an Investment Management agreement with Trustees. It is a SEBI registered entity. There is a requirement of minimum 10 crores of net worth to be maintained at all times. And at least 1/2 of the board members are required to be independent and it cannot have any other business interest. They are usually structured as a private limited company (Sponsors and Associates hold capital). AMC of one Mutual Fund cannot be trustee of another Mutual Fund.75% of the Unit Holders jointly can terminate the AMC appointment.

v)

CUSTODIAN:
Custodian is responsible for safe keeping of the investments of the fund and receipt of all benefits due to the fund. They participate in the clearing system on behalf of the mutual fund.

vi)

REGISTRAR AND TRANSFER AGENT:

They are responsible for the unit holders record maintenance and servin g including purchase, repurchase and transfer of units. They are responsible for continuously updating the holders records and transactions performed by them.

Benefits of Mutual Funds

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Following are the benefits of mutual funds:

Diversification:
Diversification reduces risks involved as seldom do all securities fall at the same time in the same proportion. Mutual Funds are a cost effective way of investing in various asset classes in the lowest cost. Hence Diversification is regarded as one of the finest benefits of investing in the mutual funds.

Well Regulated:
In India all mutual funds are registered with SEBI, hence they all have to abide by the rules and regulations formulated by SEBI for the mutual funds. The regulations
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formulated by SEBI in any context are always to protect the investors wealth and interest.

High Return Potential & Low Cost:

Over Long term to short term all mutual funds aim at maximum profit by investing in diversified securities. It at the same time provides the investors to invest in various assets through diversification and minimal of the costs.

Liquidity:
Mutual funds are basically available as open end and closed end funds. Both these types are regarded as the most liquid assets. Open end funds can be redeemed directly from the issuer while the closed end funds can be traded in the secondary market.

Transparency:
Periodic statements are provided to the investors which ensure the transparency factor. Moreover the disclosure requirements as per the SEBI guidelines also require the funds to practice the culture of transparency.

Flexibility and Variety:

There are a variety of schemes available to investors. Investors have options available to choose funds that match their investment objectives.

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Professional Management:
Team of professionals, usually analysts are appointed for the asset management task. Before selection of any asset to the fund, these professionals make a thorough analysis of the fundamentals and the growth prospects. Technical analysis is also a mechanism practiced by them. This ensures Professionalism within the mutual fund.

Different types of mutual funds are as follows:

Types of Mutual Funds

There are basically three types of mutual funds as per the schemes available. The mutual funds can be constructed using only equity securities; those types of mutual funds are called Equity Related Mutual Funds. Mutual funds when constructed using the debt securities are then called Debt Related mutual funds. Similarly mutual funds present in the money market are called Money market Mutual Funds.Whatever may be the Schemes of mutual funds, they can be further categorised into Open End and Closed End Schemes.

In case of Open End Schemes, the investors can enter and exit the fund scheme at its NAV anytime as there is no specified maturity of this type of mutual funds. Usually a marginal exit load is charged in these. Continuous selling and purchase provide the investors a good investing vehicle option.In case of Closed End Schemes, the investors can purchase when the units are issued and can be sold by the investors in the exchange. These funds cannot charge any kind of entry load. There is tenure of maturity of about 3 to 5 years present in these kinds of instruments.

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Categories of Mutual Funds

There are altogether 9 categories in Mutual Funds: i) ii) iii) iv) v) vi) vii) viii) ix) Money Market/ Liquid Funds Debt Funds Gilt Funds Monthly Income Plans Balance funds Index Funds Diversified Equity Funds Tax planning Funds Sector/ Thematic Funds

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Summary of Categories and their different characteristics:

History of Mutual Funds

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank. The history of mutual funds in India can be broadly divided into four distinct phases:

Phase I
Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs. 6,700 crores of assets under management.

Phase II
1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987.

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Phase III
With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. In 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed.

Phase IV
In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was divided into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs. 29,835 crores as at the end of January 2003. The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations.

Other Issues in Mutual Funds:

Valuation:
Mutual Funds are valued using the concept of NAV. NAV or Net Asset Value of the fund is the cumulative market value of the assets of the fund net of its liabilities. The value of all the securities in the portfolio in calculated daily. From this, all expenses are deducted and the resultant value divided by the number of units in the fund is the funds NAV.

NAV=
Market Value of Funds Investments+Receivables+Accrued Income- Liabilities- Accrued Expense Number of outstanding units

Load:
Load is a charge, which the AMC may collect on entry/exit from a fund. A load is charged to cover the up-front cost incurred by the AMC for selling the fund.
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Load that is charged when investor buys units is the entry load or sale load. Entry load increases the price of the units for the investor

Load that is charged when investor redeems units is the exit load or repurchase load. Exit load reduces the proceeds to the investor.

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Chapter: 4
Study Methodology

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Chapter: 5
Data Analysis
Through this chapter we seek to answer all of the unanswered questions in relation to the Mutual Funds in India. We will look forward to answer the reasons behind the NOT-SO-SUCCESS STORY of Mutual Funds in India. To unveil the story of Mutual

Funds and their poor performance in India there is a list of questions to be answered. Are Mutual Funds performing poor? Are Schemes attractive? Do we have adequate exposure to them? Is Indian mind-set a hindrance?

We look to answer these unanswered questions quite critically and gradually conclude the reasons behind the failure of Mutual Funds in India. Firstly, we look to analyse the presence and growth of Asset under Management in India.

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Growth in Assets Under Management

The Indian mutual fund industry has grown significantly since the launch of economic reforms in the early 1990s. It took off in 2003/04, coinciding with the strong growth of the economy and capital markets. Total assets under management (AUM) have grown at a compound annual rate of 20 per cent. But growth peaked in 2009/10, and the AUM has since declined.

Assets Under management (Rs. Crore)

January 2003 112,307 December 2012 720,164 Change 607,857 % Change 84.41

These statistics are enough to satisfy ourselves that the returns and the growth in Mutual Funds have never been so demotivating. Returns generated have been fair and this seems even better than many other likely Investment opportunities. So, the problem lies in some other issue but not in the growth story. We move forward for the next issues We are now concerned with the Schemes, we doubt that growth is there but better schemes can be bring in more gains. So, there is a need to observe the different types of schemes in India.

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AUM distribution in India

AUM distribution in India shows a heavy skew (approximately 68 per cent) in favour of incomeand debt-oriented schemes, which are short-term investments. Growth and equity schemes account for 28 per cent of total AUM, and balanced and exchange traded funds, two per cent each. Despite tax benefits, equity-linked savings schemes have not generated sizable AUM. In March 2012, the AUM was approximately Rs 22,326 crore - about four per cent of total AUM. So product manufacturers focus on products for corporate investors rather than retail ones. Assets under management have been concentrated in short-term liquid or money market and assured returns schemes, which, because of tax arbitrages. Today, the bulk of the industry's assets under management are fixed income funds which are almost entirely used by corporates to store short- and medium-term surplus cash. This is a steady and profitablebusiness but doesn't serve any larger purpose - it's just asort of a quasibanking activity.

From the above Data we have been able to analyse the following: i) Indian Investments in Mutual Funds have been concentrating significantly on the Debt Oriented Schemes where the risk quotient is relatively less and the growth is also less. Whereas, In developed countries and even in few developing countries such as Brazil, the main focus of investments have been made on Equity
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ii)

iii)

Oriented Schemes, here returns are good enough but the risk quotient is relatively higher. This practice in the Mutual Funds especially in country like India has come into existence because of the risk averse attitude of Investors and also to cater to the conservative mind set of the Indian investors.

So, the schemes available are not so attractive. Since returns generated are relatively less, not much people turn up investing in these schemes of mutual funds.

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AUM by Geography
Concentration of mutual funds to a few major cities has been another concern for

the sector. Most AMCs and distributors have limited focus beyond the top 20 cities.

The top five cities contributed approximately 71.1 percent of the total AUM of the mutual fund sector, with Mumbai only accounting for about 42.1 percent in FY12. Hence it is evident that MF penetration is only in the metropolitan cities in India. Some of the reasons for this heavily skewed distribution are: Limited distribution channels and limited investor servicing available beyond cities. Distribution is skewed and shrinking. In March 2012, there were 84,793 mutual fund distributors certified by the Association of Mutual Funds in India. The number was 114,000 on June 30, 2010. About 77 per cent of distributors are in just 10 cities. There is a need to rationalise the incentive structure so that distribution can spread to smaller centres. Lack of incentives for distributors to expand in small cities has resulted in mutual funds becoming an investment product in the hands of urban Indians. Low public awareness (especially in smaller towns) about the investment opportunity in mutual funds is also an integral factor
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affecting their growth. It is thus very important to make investors aware about the benefits of mutual funds, viz., professional management, low costs, transparency, liquidity and a strong regulatory framework. A recent study - Visa's 2012 Financial Literacy Barometer, which assessed 28 markets - ranked India 23rd. Brazil fared the best, followed by Mexico, Australia, the US and Canada. The survey found that Indian families hold money management discussions infrequently, and that even educated people lack knowledge of investment products and investment plans. Major investments are by corporates- Assets under management have been concentrated to temporarily park corporate funds which are based in cities. So product manufacturers focus on products for corporate investors rather than retail ones.

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Mutual Funds and Wealth Creation

Mutual Funds have generated higher returns than traditional savings products over longer time frames. Category-wise returns generated by mutual funds across time frames are as follows Table 1 - Category-wise returns generated by mutual funds across time frames 3 Years (%) Equity Funds Balance Funds Income Funds GILT Funds 23.8 0 23.6 9 8.8 6 4.6 5 Years (%) 8.1 9 10.0 2 7.7 6 5.9 7 Years (%) 18.9 3 17.2 6 7.1 0 5.8 3 10 Years (%) 25.4 6 20.8 7 7.4 1 7.2 5

5 returns as of November 9 Returns are AUM weighted 11, 2012

Equity funds have given the highest returns followed by balance or hybrid funds. To enable optimal wealth creation, investors also need to look at asset allocation, i.e., investing across asset classes (equity, debt and gold) using principles of diversification to reduce the risk in the portfolio. The sample asset allocation below shows how Rs 1 lakh invested 10 years ago would have grown across different risk profiles across different asset classes for different customer profile. We look at four risk profiles conservative, moderately conservative, moderately aggressive and aggressive in relation to the returns using asset allocation and principles of diversification. The selection of funds is based on top ranked funds by CRISIL under each category. Table 2 - Sample asset allocation showing diversification benefits across risk profiles. Customer Profile Moderately Moderately Aggressive Aggressive Conservative 40 65 85 40 20 Rs.6.20 lakhs 20 15 Rs.8.60 lakhs 10 5 Rs.10.75 lakhs

asset Classes Equity Long term Debt

Conservative 15 50

Short term Debt 35 Initial Investment of Rs 1 lakh after 10 Rs.3.55 lakhs Years till Oct 31, 2011

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Annualised Returns

13.5%

20%

24%

27%

Understanding Taxation in Mutual Funds

While debt mutual funds offer varied advantages, very few are aware of the taxes levied by it. Debt Mutual Funds have a differential tax treatment as compared to equity. Taxation plays a key role in deciding what returns you will earn from your investment. For an individual in highest tax slab the return of 9% drops down to around 6% if the returns are taxable at maximum marginal rate. Considering inflation of 6%, the money may not be growing at all. Debt Mutual Funds have a differential tax treatment as compared to equity. While Dividends enjoy a tax free status in equity they are taxed in debt funds through Dividend Distribution Tax. Similarly, there is no tax on long term capital gains in equity while same is taxed in debt mutual funds. The tax rates also vary within various categories of this avenue. Hence, one needs to understand the taxations structure in debt mutual funds before making a decision to invest. Let's analyze how investment in debt mutual funds will be taxed for FY 2012-2013. Dividend: Dividend income is tax free in the hand of investors. However, the mutual fund company has to pay a dividend distribution tax (DDT) before distributing this income to its investors.
Tax rates for dividend income for FY 2012-2013

*5% surcharge Is applicable when total income exceed Rs 1 cr Capital Gains: Gains from debt mutual funds schemes are treated as capital gains. If you have held your investment for less than a year then you will have to pay short term capital gains tax while any investment which is held for more than a year is treated as long term.
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Following is the tax rates for long and short term capital gains:
Long Term Capital Gains

*5% surcharge is applicable when total income exceed Rs 1 cr Short Term Capital Gains

*5% surcharge is applicable when total income exceed Rs 1 cr Although NRIs have similar taxation rates as resident individual, they have to pay the tax during the redemption from mutual funds scheme in the form of TDS. For NRIs TDS on short term capital gains: 30.900% TDS on long term capital gains: 20.600% (With benefit of indexation) If the actual taxation is lower, NRIs can claim the refund through filing Income Tax Returns.

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Top 10 players control 80% of AUM

Among the 44 players, 56% of the AUM is controlled by the top 5 players while 80% of the AUM is controlled by 10 players. The bottom 10 players contribute less than 1% of the AUM. This significant tilt towards larger players has seen consolidation among asset management companies (AMCs) from time to time.

% of the Market Share of major AMCs

Mutual Funds HDFC Mutual Fund Reliance Mutual Fund ICICI Prudential Mutual Fund Birla Sun Life Mutual Fund

Total AUM 101,393 90,636 81,394 76,890

% of Market Share 12.89% 11.52% 10.35% 9.78%

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UTI Mutual Fund SBI Mutual Fund Franklin Templeton Mutual Fund Kotak Mahindra Mutual Fund DSP BlackRock Mutual Fund IDFC Mutual Fund Other Mutual Funds Total

70,638 53,311 40,869 31,773 30,838 30,002 178,800 786,544

8.98% 6.78% 5.20% 4.04% 3.92% 3.81% 22.73% 100%

The number of fund houses are increasing each year in the fast growing Indian economy but when it comes about the size, the top five players control over half of the country's mutual fund business. Some of the reasons for this skewed concentration of AUM are Inefficient or incapable fund managers in India Inability of the remaining Asset Management Companies to generate superior risk-adjusted returns. Tough business to be in: Fidelity, one of the biggest mutual fund manager in the world, sold its India business to L&T Finance Holdings recently.. Most of the foreign exits from India were due to global restructuring or M&A. Fidelitys exit from a loss-making India business highlights problems of doing business in India.

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