Industry overview

The idea of pooling money together for investing purposes started in Europe in the mid-1800s. The first pooled fund in the U.S. was created in 1893 for the faculty and staff of Harvard University. On March 21st, 1924 the first official mutual fund was born. It was called the Massachusetts Investors Trust.

After one year, the Massachusetts Investors Trust grew from $50,000 in assets in 1924 to $392,000 in assets (with around 200 shareholders).

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Reserve Bank and the Government of India. The objective then was to attract the small investors and introduce them to market investments. Since then, the history of mutual funds in India can be broadly divided into three distinct phases.

Phase 1- 1964-87 (Unit Trust of India)

In 1963, UTI was established by an Act of Parliament and given a monopoly. Operationally, UTI was

set up by the Reserve Bank of India, but was later de-linked from the RBI. The first, and still one of the largest schemes, launched by UTI was Unit Scheme 1964.

Later in 1970s and 80s, UTI started innovating and offering different schemes to suit the needs of different classes of investors. Unit Linked Insurance Plan (ULIP) was launched in 1971. Six new

schemes were introduced between 1981 and 1984. During 1984-87, new schemes like Children's Gift Growth Fund (1986) and Mastershare (1987) were launched. Mastershare could be termed as the first diversified equity investment scheme in India. The first Indian offshore fund, India Fund, was launched in August 1986. During 1990s, UTI catered to the demand for income-oriented schemes by launching Monthly Income Schemes, a somewhat unusual mutual fund product offering "assured returns".

The mutual fund industry in India not only started with UTI, but still counts UTI as its largest player with the largest corpus of investible funds among all mutual funds currently operating in India. Until 1980s, UTI's operations in the stock market often determined the direction of market movements. Now, many Indian investors have taken to direct investing on the stock markets. Foreign and other institutional players have been brought in. So direct influence of UTI on the markets may be less than before, though it remains the largest player in the fund industry. In absolute terms, the investible funds corpus of even UTI was still relatively small at about Rs. 600 crores in 1984. But, at the end of this Phase One, UTI had grown large as evidenced by the following statistics:

1987-88 Amount Mobilised (Rs. Crores) UTI Total 2,175 2,175 Assets Under Management (Rs. Crores) 6,700 6,700

Phase 2 - 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non-UTI, Public Sector mutual funds, bringing in competition. With the opening up of the economy, many public sector banks and financial institutions were allowed to establish mutual funds. The State Bank of India established the first non-UTI mutual fund- SBI Mutual Fund - in November 1987. This was foI1owed by Canbank Mutual Fund (launched in December, 1987), LIC Mutual Fund (1989), and Indian Bank Mutual Fund (1990) followed by Bank of India Mutual Fund, OIC Mutual Fund

. and PNB Mutual Fund. These mutual funds helped enlarge the investor community and the investible funds. From 1987 toI992-93, the fund industry expanded nearly seven times in terms of Assets Under Management, as seen in the following figures:

1992-93 Amount Mobilised (Rs. Crores)

Assets Under Management (Rs. Crores) 38,247 8,757 47,004

UTI Public Sector Total

11,057 1,964 13,021

Phase 3 - 1993-1996 (Emergence of Private Funds)

A new era in the mutual fund industry began with the permission granted for the entry of private sector funds in 1993, giving the Indian investors a broader choice of 'fund families' and increasing competition for the existing public sector funds. Quite significantly, foreign fund management companies were also allowed to operate mutual funds, most of them coming into India through their joint ventures with Indian promoters. These private funds have brought in with them the latest product innovations, investment management techniques and investor servicing technology

that make the Indian mutual fund industry today a vibrant and growing financial intermediary.

During the year 1993-94, five private sector mutual funds launched their schemes followed by six others in 1994-95. Initially, the mobilisation of funds by the private m_tual funds was slow. But, this segment of the fund industry now has been witnessing much greater investor confidence in them. One influencing factor has been the development of a SEBI driven regulatory framework for mutual funds. But another important factor has been the steadily improving performance of several funds themselves. Investors in India now clearly see the benefits of investing through mutual funds and have started becoming selective.

Phase 4 - 1996 (SEBI Regulation for Mutual Funds)

The entire mutual fund industry in India, despite initial hiccups, has since scaled new heights in terms of mobilisation of funds and number of players. Deregulation and liberalisation of the Indian economy has introduced competition and provided impetus to the growth of the industry. Finally, most investors - small or large - have started shifting towards mutual funds as opposed to banks or direct market investments.

More investor friendly regulatory measures have been taken both by SEBI to protect the investor and by the Government to enhance investors' returns through tax benefits. A comprehensive set of regulations for all mutual funds operating in India was introduced with SEBI (Mutual Fund) Regulations, 1996. These regulations set uniform standards for all funds and will eventually be applied in full to Unit Trust of India as well, even though UTI is governed by its own UTI Act. In fact, UTI has been voluntarily dopting SEBI guidelines for most of its schemes. Similarly, the 1999 Union

Government Budget took a' big step in exempting all mutual fund dividends from income tax in the hands of investors. Both the 1996 regulations and the 1999 Budget must be considered of historic importance, given their far-reaching impact on the fund industry and investors.

1999 marks the beginning of a new phase in the history of the mutual fund industry in India, a phase of significant growth in terms of both amounts mobilised from investors and assets under management. Consider the growth in assets as seen in the figures below:

Gross Amount Mobilised

Assets Under Management (Rs. Crores)

(Rs. Crores) 1998-99 UTI Public Sector 11,679 1,732 1999-2000 13,536 4,039

1998-99 53,320 (77.87%) 8,292 (12.11 %)

1999-2000 76,547 (67.75%) 11,412 (10.09%) 25,046 (22.16%) 113,005

Private Sector Total

7,966 21,377

42,173 59,748

6,860 (10.02%) 68,4 72

The size of the industry is growing rapidly, as seen by the figure of assets under management which have gone from over Rs. 68,000 crores to Rs.113,005 crores, a growth of nearly 60% in just one year. Within the growing industry, by March 2000, the relative market shares of different players in terms of amount mobilized and assets under management have undergone a change.

Mutual fund A mutual fund is a common fool of money into which investors place their contributions that are to be invested in accordance with a stated objective. The ownership of the fund is thus joint or mutual; the fund belongs to all investors. A single investors ownership of the fund is in the same proportion as the amount of the contribution made by him or her bears to the total amount of the fund.

A mutual fund is the ideal investment vehicle for todays complex and modern financial scenario. Markets for equity shares, bonds and other fixed income instruments, real estate, derivatives and other assets have become mature

and information driven. Price changes in these assets are driven by global events occurring in faraway places. A typical individual is unlikely to have the knowledge, skills, inclination and time to keep track of events, understand their implications and act speedily. An individual also finds it difficult to keep track of ownership of his assets, investments, brokerage dues and bank transactions etc.

Market trends in mutual fund industry

The most important trend in the mutual fund industry is the aggressive expansion of the foreign owned mutual fund companies and the decline of the companies floated by nationalized banks and smaller private sector players.

Many nationalized banks got into the mutual fund business in the early nineties and got off to a good start due to the stock market boom prevailing then. These banks did not really understand the mutual fund business and they just viewed it as another kind of banking activity. Few hired specialized staff and generally chose to transfer staff from the parent organizations. The performance of most of the schemes floated by these funds was not good. Some schemes had offered guaranteed returns and their parent organizations had to bail out these AMCs by paying large amounts of money as the difference between the guaranteed and actual returns. The service levels were also very bad. Most of these AMCs have not been able to retain staff, float new schemes etc. and it is doubtful whether, barring a few exceptions, they have serious plans of continuing the activity in a major way.

The experience of some of the AMCs floated by private sector Indian companies was also very similar. They quickly realized that the AMC business is a business, which makes money in the long term and requires deep-pocketed support in the intermediate years. Some have sold out to foreign owned companies, some have merged with others and there is general restructuring going on.

The foreign owned companies have deep pockets and have come in here with the expectation of a long haul. They can be credited with introducing many new practices such as new product innovation, sharp improvement in service standards and disclosure, usage of technology, broker education and support etc. In fact, they have forced the industry to upgrade itself and service levels of organizations like UTI have improved dramatically in the last few years in response to the competition provided by these.

SECURITIES AND EXCHANGE BOARD OF INDIA INVESTMENT MANAGEMENT DEPARTMENT Trends in Transactions on Stock Exchanges by Mutual Funds (since January 2000)

Equity (Rs in Crores) Gross Purchase 11070.54 17375.78 12098.11 14520.89 36663.58 45045.25 4347.95 7000.72 4567.84 503.73 16420.24 Gross Sales 11492.19 20142.76 15893.99 16587.59 35355.67 44597.23 2883.04 3660.61 6384.63 754.18 13682.46 Net Purchase/ Sales -421.65 -2766.98 -3795.88 -2066.70 1307.91 448.02 1464.91 3340.11 -1816.79 -250.45 2737.78

Debt (Rs in Crores) Gross Purchase 2764.72 13512.17 33583.64 46663.83 63169.93 62186.46 9568.20 10687.90 10686.86 1667.89 32610.85 Gross Sales 1864.29 8488.68 22624.42 34059.41 40469.18 45199.17 4533.42 5982.47 7089.49 863.84 18469.22 Net Purchase/ Sales 900.43 5023.49 10959.22 12604.42 22700.75 16987.29 5034.78 4705.43 3597.37 804.05 14141.63

Jan 2000-March 2000. April 2000 -March 2001. April 2001-March 2002. April 2002-March 2003 April 2003-March 2004 April 2004-March 2005 April 2005. May 2005. June 2005. July 2005 (as on 5th) Total (April '05 - July '05)

About mutual fund industry

Mutual funds today manages near about RS 1.50 lac crore 2004-05 97 new schemes were launched mobilizing funds to the tune of RS 25000 Crore in that 36 schemes were equity schemes mobilizing RS 11756 Crore from investor. Equity mutual fund accounts for 25% of the total assets managed by the Indian mutual fund industry. In U.S it is more than 50% even when compared to US based retail investors. There are clear indications that the Indian mutual fund industry has tremendous potential in terms of investors exposure to it. as Nishid Shah. chief investment

officer, Birla sun life puts it ,a recent study reveals that not even 1% of Indian investors were found to be investing in funds. In contrast one out of every two house holds in US is a mutual fund investor

In US, second household is a mutual fund holder.

In US, the mutual fund industry size is about 67% of the US GDP, whereas the Indian mutual fund industry is just about 6% of our GDP

In US, mutual fund assets are around 1.5% times the bank deposits.

In India though, bank deposits are about 10.50 times the MF assets.

MF product range can suit the needs of almost each & every individual

NAME OF SEBI REGISTERED MUTUAL FUNDS

1 . ABN AMRO Mutual Fund Capital Mutual Fund 3 . Benchmark Mutual Fund Mutual Fund, 5 . Birla Mutual Fund Fund 7 . Canbank Mutual Fund Fund(suspended) 9 . Chola Mutual Fund, Mutual Fund 11. DSP Merrill Lynch Mutual Fund, Mutual Funds, 13. Escorts Mutual Fund, Mutual Fund 15 . GIC Mutual Fund Mutual Fund, 17 . HSBC Mutual Fund, 2. Alliance

4. BOB

6. BOI Mutual

8. CRB Mutual

10. Deutsche 12. Dundee 14. Fidelity

16. HDFC

18. ICICI

Securities Fund, 19. IL & FS Mutual Fund, Mutual Fund, 21. J M Financial Mutual Fund Mahindra Mutual Fund, 23 . KJMC Mutual Fund, Fund 25 . Morgan Stanley Mutual Fund Fund 27 . Principal Mutual Fund ICICI Mutual Fund 29. Reliance Mutual Fund Mutual Fund, 31 . SBI Mutual Fund Mutual Fund 33 . Sun F&C Mutual Fund Chartered Mutual Fund, 35 . Sundaram Mutual Fund, Mutual Fund 37 . Tata Mutual Fund, Templeton Mutual Fund 39 . UTI Mutual Fund

20. ING Vysya 22. Kotak

24. LIC Mutual

26. PNB Mutual

28. Prudential 30. Sahara

32. Shriram

34. Standard

36. Taurus

38. Franklin

Status of Mutual Funds for the period April 2005 - June 2005 Private Sector Mutual Funds A (Figs in Rs. Crore) Public Sector Mutual Funds Grand Total

UTI (i)

Others (ii)

Sub-total (i)+(ii) B

A+B

Mobilisation of Funds Repurchase / Redemption Amt.

181071.43 167783.10

13061.72 12557.72

14862.38 14381.43

27924.10 26939.15

208995.53 194722.25

Net Inflow/ Outflow (-ve) of funds Cumulative Position of net assets as on June 30, 2005 (%) 13288.34 504.00 480.94 984.94 14273.29

130584.74 (79.36%)

21975.57 (13.36%)

11986.03 (7.28%)

33961.60 (20.64%) 164546.35

Structure of mutual fund

Sponsor is the person who acting alone or in combination with another body corporate establishes a mutual fund. Sponsor must contribute atleast 40% of the networth of the Investment Manged and meet the eligibility criteria prescribed under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996.The Sponsor is not responsible or liable for any loss or shortfall resulting from the operation of the Schemes beyond the initial contribution made by it towards setting up of the Mutual Fund.

Trust

The Mutual Fund is constituted as a trust in accordance with the provisions of the Indian Trusts Act, 1882 by the Sponsor. The trust deed is registered under the Indian Registration Act, 1908.

Trustee

Trustee is usually a company (corporate body) or a Board of Trustees (body of individuals). The main responsibility of the Trustee is to safeguard the interest of the unit holders and inter alia ensure that the AMC functions in the interest of investors and in accordance with the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, the provisions of the Trust Deed and the Offer Documents of the respective Schemes. Atleast 2/3rd directors of the Trustee are independent directors who are not associated with the Sponsor in any manner.

Asset Management Company (AMC)

The AMC is appointed by the Trustee as the Investment Manager of the Mutual Fund. The AMC is required to be approved by the Securities and Exchange Board of India (SEBI) to act as an asset management company of the Mutual Fund. Atleast 50% of the directors of the AMC are independent directors who are not associated with the Sponsor in any manner. The AMC must have a networth of atleast 10 crore at all times.

TYPES OF FUNDS

Mutual fund can be classified into 3 types from the investors' perspective:

Firstly, funds are usually classified in terms of their constitution - as closed-end or open-end. The distinction depends upon whether they give the investors the option to

redeem and buy units at any time from the fund itself (open end) or whether the investors have to await a given maturity before they can redeem their units to the fund (closed end).

Secondly,Funds can also be grouped in terms of whether they collect from investors any charges at the time of entry or exit or both, thus reducing the investible amount or the redemption proceeds. Funds that make these charges are classified as load funds, and funds that do not make any of these charges are termed no-load funds.

Finally, funds can also be classified as being tax-exempt or

non-tax-exempt, depending on whether they invest in securities that give tax-exempt returns or not. Currently in India, this classification may be somewhat less important, given the recent tax exemptions given to investors receiving any dividends from all mutual funds.

Under each broad classification, we may then distinguish between several types of funds on the basis of the nature of their portfolios, meaning whether they invest in equities or fixed income securities or some combination of both. Every type of fund has a unique risk-profile that is determined by its portfolio, for which reason funds are often separated into more or less risk-bearing.

Mutual Fund Types

All mutual funds would be either closed-end or open-end, and either load or no-load. These classifications are general. For example all open-end funds operate the same way; or in case of a load fund a deduction is made from investors' subscription or redemption and only the net amount used to determine his number of shares purchased or sold.

Funds are generally distinguished from each other by their investment objectives and types of securities they invest in.

a) Broad Fund Types by Nature of Investments

Mutual funds may invest in equities, bonds or other fixed income securities, or shortterm money market securities. So we have Equity, Bond and Money Market Funds. All of them invest in financial assets. But there are funds that invest in physical assets. For example, we may have Gold or other Precious Metals Funds, or Real Estate Funds.

b) Broad Fund Types by Investment Objective

Investors and hence the mutual funds pursue different objectives while investing. Thus, Growth Funds invest for medium to long term capital appreciation. Income Funds invest to generate regular income, and less for capital appreciation. Value Funds invest in equities that are considered undervalued today, whose value will be unlocked in the future.

c) Broad Fund Types by Risk Profile

The nature of a fund's portfolio and its investment objective imply different levels of risk undertaken.

Funds are therefore often grouped in order of risk. Thus, Equity Funds have a greater risk of capital loss than a Debt Fund that seeks to protect the capital while looking for income. Money Market Funds are exposed to less risk than even the Bond Funds, since they invest in short-term fixed income securities, as compared to longer-term portfolios of Bond Funds.

1. Money Market Funds

Often considered to be at the lowest run in the order of risk level, Money Market Funds invest in

securities of a short-term nature, which generally means securities of less than one-year maturity. The typical, short-term, interest-bearing instruments these funds invest in include Treasury Bills issued by governments, Certificates of Deposit issued by banks and Commercial Paper issued by companies. In India, Money Market Mutual Funds also invest in the inter-bank call money market.

The major strengths of money market funds are the liquidity and safety of principal that the investors can normally expect from short-term investments. .

2. Gilt Funds

Gilts are government securities with medium to long-term maturities, typically of over one year (under one-year instruments being money market securities). In India, we have now seen the emergence of Government Securities or Gilt Funds that invest in government paper called dated securities (unlike Treasury Bills that mature in less than one year). Since the issuer is the Government/s of India/States,

These funds have little risk of default and hence offer better

protection of principal. However, investors have to recognize the potential changes in values of debt securities held by the funds that are caused by changes in the market price of debt securities quoted on the stock exchanges (just like the equities). Debt securities' prices fall when interest rate levels increase (and vice versa).

3. Debt Funds (or Income Funds)

Next in the order of risk level, investor has Debt Funds. Debt funds invest in debt instruments issued not only by governments, but also by private companies, banks and financial institutions and other entities such as infrastructure companies/utilities. By investing in debt, these funds target low

risk and stable income for the investor as their key objectives. However, as compared to the money market. funds, they do higher price fluctuation risk, since they invest in longer-term securities. Similarly, as compared to Gilt Funds, general debt funds do have a higher risk of default by their borrowers.

Debt Funds are largely considered as Income Funds as they do not target capital appreciation, look for high current income, and therefore distribute a substantial part of their surplus to investors. Income funds that target returns substantially above market levels can face more risks

a) Diversified Debt Funds

A debt fund that invests in all available types of debt securities, issued by entities across all industries and sectors is a properly diversified debt fund. While debt funds offer high income and less risk than equity funds, investors need to recognise that debt securities are subject to risk of default by the issuer on payment of interest or principal. A diversified debt fund has the benefit of risk reduction through diversification and sharing of any default-related losses by a large number of investors. Hence a diversified debt fund is less risky than a narrow-focus fund that invests in debt securities of a particular sector or industry.

b) Focused Debt Funds

Some debt funds have a narrower focus, with less diversification in its investments. Examples include sector, specialized debt funds.

One category of specialised funds that invests in the housing sector, but offers greater security and safety than other debt instruments, is the Mortgage Backed Bond Funds that invest in special securities created after securitisation of (and thus secured by) loan receivables of housing finance companies

c) High Yield Debt Funds

Usually, Debt Funds control the borrower default risk by investing in securities issued by borrowers who are rated by credit rating agencies and are considered to be of "investment grade". There are, however, High Yield Debt Funds that seek to obtain higher interest returns by investing in debt instruments that are considered "below investment grade". Clearly, these funds are exposed to higher risk. In the U.S.A., funds that invest in debt instruments that are not backed by tangible assets and rated below investment grade (popularly known as junk bonds) are called Junk Bond Funds. These funds tend to be more volatile than other debt funds, although they may earn higher returns as a result of the higher risks taken.

d) Assured Return Funds

UTI and other funds have offered "assured return" schemes to investors. The most popular variant of such schemes is the Monthly Income Plans of UTI. Returns are indicated in advance for all of the future years of these closed-end schemes. If there is a shortfall, it is borne by the sponsors. Assured Return or Guaranteed Monthly Income Plans are essentially Debt/Income Funds. Assured return debt funds certainly reduce the risk level considerably, as compared to all other debt or equity funds, but only to the extent that the guarantor has the required financial strength. Hence, the market regulator SEBI permits only those funds whose sponsors have adequate net-worth to offer assurance of returns. If offered, explicit guarantee is required from a guarantor whose name has to be specified in advance in the offer document of the scheme.

While Assured Return Funds may certainly be considered to be the lowest risk type within the debt funds category, they are still not entirely risk-free, as investors have to normally lock in their funds for the term of the scheme or at least a specified period such as three years. During this period, changes in the financial markets may result in the investor losing the opportunity to obtain higher returns later in other debt or equity funds. Besides, the investor does carry some credit risk on the guarantor who must remain solvent enough to honour his guarantee during the lock in period.

4 .Equity Funds

As investors move from Debt Fund category to Equity Funds, they face increased risk level. However, there is a large variety of Equity Funds and all of them are not equally risk-prone.

Equity funds invest a major portion of their corpus in equity shares issued by companies, acquired directly in initial public offerings or through the secondary market. Equity funds would be exposed to the equity price fluctuation risk at the market level, at the industry or sector level and at the company-specific level. Equity Funds' Net Asset Values fluctuate with all these price movements. These price movements are caused by all kinds of external factors, political and social as well as economic. The issuers of equity shares offer no guaranteed repayment as in case of debt instruments. Hence, Equity Funds are generally considered at the higher end of the risk spectrum among all funds available in the market. On the other hand, unlike debt instruments that offer fixed amounts of repayments, equities can appreciate in value in line with the issuer's earnings

Potential, and so offer the greatest potential for growth in capital.

Equity funds adopt different investment strategies resulting in different levels of risk. Hence, they are generally separated into different types in terms of their investment styles.

a) Aggressive Growth Funds

There are many types of stocks/shares available in the market; Blue Chips that are recognized market leaders, less researched stocks that are considered to have future growth potential, and even some speculative stocks of somewhat unknown or unproven issuers. Fund managers seek out and invest in different types of stocks in line with their own perception of potential returns and appetite for risk.

As the name suggests, aggressive growth funds target maximum capital appreciation, invest in less researched or speculative shares and may adopt speculative investment strategies to attain their