INTRODUCTION

ABOUT SBI MUTUAL FUND

SBI Funds Management is a joint venture between State Bank of India, the
country’s largest bank and Societe Generale Asset Management (France), one
of the world’s leading fund management companies. With over 20 years of rich
experience in fund management, SBI Funds Management Pvt. Ltd. Is one of the
largest investment management firms in India managing investment mandates
of over 46 Lakh investors. With a network of over 130 points of acceptance
spread across India our vast family of investors in expanding faster and further.
SBI Mutual Fund has won the prestigious CNBC TV 18 Crisil Mutual Fund of
the year Award 2007, apart from winning five awards for scheme performance.
SB Mutual Fund has also won the Most Preferred Brand of Mutual Fund at the
CNBC Awaaz Consumer Awards in 2006 and 2007. But above all, it is the trust
of over 46 Lakh investors that eggs us on deliver innovative and stable
investment services, day after day. It is the driving force for our team of
investment experts to develop arid deliver products that help investors like you
achieve their financial objectives.

1
 CHAPTER-I

THE CONCEPT
AND
ROLE OF MUTUAL FUNDS

2
MUTUAL FUNDS OPPORTUNITY

 Most appropriate investment opportunity for small un estors.

 Birth of Mutual Funds U. S. A.

 Good Alternative to Direct Investing.

 Size in USA> Bank Deposits.

 Financial Intermediary.

 UTI only player between 1964 — 87.

 Helps in the wowth of Capital Markets.

CONCEPT OF MUTUAL FUND

 A common pool of money into which investors place their contributions to be

invested in accordance with a stated objective

 The ownership of the fund is joint or mutual.

 The fund belongs to all investors.

 Ownership is proportionate to contribution made by one.

ADVANTAGES OF INVESTING THROUGH MUTUAL FUNDS OVER DIRECT

INVESTMENTS

 Portfolio Diversification

 Professional Management

 Reduction / Diversification of Risk

 Liquidity

 Flexibility & Convenience

 Reduction in Transaction cost

 Safety of regulated environment

3
DISADV&NTAUES OF INVESTING THROUGH MUTUAL FUNDS OVER DIRECT
INVESTMENTS

 No control over cost

 No Tailor made portfolios

 Managing a Portfolio funds.

INDUSTRY PROFILE

ASSETS UNDER MANAGEMENT (Rs. In Crs)

TYPES OF MUTUAL FUND

Mutual fluids can be classified as:

 Close ended / Open ended funds

 Load fund I No-load funds

 Tax-exempt / Non-tax exempt funds

4
CLOSE ENDED FUNDS

 Close ended fund:

o Initial public offer

o Investor cannot buy units later on from NW

o Get listed on the stock exchange

o Traded on stock exchange at a discount / premium to NAy

o Redemption of units on expiry date

o Unit capital constant

o Close ended funds may allow buy back of units option

OPEN ENDED FUNDS

 OPEN ENDED FUND:

o Units available for sale / purchase at all times at NAV based prices

o Units capital variable

o Fresh subscriptions may be discontinued

o Any time redemptions always allowed, except .when there is

lock in period.

LOAD FUNDS

 Load is one time fee payable by the investor when they enter / exit an

open-eiided scheme.

 Loads are charged to recover initial issue expenses including

5
 marketing & selling expenses, brokerage, advertising costs. Such expenses not to
exceed 6%

 SEBI prescribes ceiling on Recurring Expenses.

 There can be entry load or exit load or both

 Entity load is also called front-end load

 Exit load is also called Back-end load or Deferred load

NO LOAD FUNDS & IMPACT OF LOADS

 In a no load fund, marketing and selling expenses are absorbed by the AMC and the
investor buys and sells units at NAy price.

 Return on investment to the investor is reduced because of the loads

o When the investor buys a unit from the MFs, he pays more than NAy (NAY +
Entry load)

o When the investor sells the unit to the MF, he gets less than NAY (NAY - Exit
load)

EXAMPLE ON LOADS AND RETURNS

ROI with Loads

Amount invested = 11+0.22 = Rs.11.22

Amount received = 12- 0.12 = Rs.11.88

Gain = Rs.0.66

ROI = (0.66 x 100)/11.22 = 5.88%

6
EXAMPLE ON LOADS AND RETURNS

ROI without loads

Amount invested = Rs. 11

Amount received = Rs. 12

Gain = Rs.1

ROI =(1 x 100)/11 = 9.09%

CONTINGENT DEFERRED SALES CHARGE (CDSC)

 Exit Charge may vary depending upon the holding period.

 if Exit Charge varies with the holding period it is called contingent

 deferred sales charge (CDSC) and it may vary as shown under.

 Redemption during the first five years from the date of purchase

First Year Maximum CDSC 4%

Second Year Maximum CDSC 3%
Third Year Maximum CDSC 2%
Fourth Year Maximum CDSC 1%
Fifth Year Nil

MUTUAL FUNDS CLASSIFIED ASP CLASS (NATURE) OF

INVESTMENTS

 Equity Funds

7
  Bond Funds

 Money Market Funds

MUTUAL FUNDS CLASSIFIED AS PER INVESTMENT OBJECTIVES

 Growth Funds

 Income Funds

 Value Funds

MUTUAL FUNDS CLASSIFIED AS PER RISK PROFILES

 High Risk Funds

 Moderate Risk Funds

 Low Risk Funds

RISK RETURN HEIRARCHY OF DIFFERENT FUNDS

Risk High

Sector Funds

Diversified Equity Funds

Index Funds

Balanced Funds

Debt Funds

8
 Gilt Funds

Risk Low MMMF

Low Return High Return

MONEY MARKET FUNDS

 Invest in securities of less than I year maturity

 High liquidity & safety of principal

 Low risk and low returns

GILT FUNDS

 Invest only in Government Securities of over 1 year maturity

 Risk and return low but higher than that of MMF

 No default risk but carry interest rate risk

 C Fund values drop when interest rates go up & rise when interest rates go down

DEBT FUNDS & TYPES

 Invest in corporate bonds and government securities

 Risk higher than that of gilt funds

 Aims at regular income distribution and not at capital appreciation

 Types of Debt Funds:

o Diversified Debt Funds

9
 o Focused Debt Funds

o High yield Debt Funds

o Assured return Debt Funds

o Fixed Term Plan Series

EQUITY FUNDS & TYPES

 Invest in equity and equity related instruments

 High risk and aim at capital appreciation

 Types of equity funds

o Aggressive growth funds

o Growth funds

o Value funds

o Specialty funds:

 Sector funds

 Foreign securities funds

 Mid-Cap or Small-Cap equity funds

EQUITY FUNDS & TYPES

 Diversified equity finds

 ELSS funds

 Equity index funds

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  Equity income or dividend yield fund

TYPES OF HYBRID FUNDS

 Balanced Funds :Seek to provide regular income &

capital appreciation

 Growth & Income Funds :Seek to provide high dividend and

Capital appreciation

 Asset Allocation Funds :Flexible asset allocation between

debt, equity & MM.

OTHER FUNDS

 Commodity Funds : Invest in commodity stocks

 Real Estate Funds : Invest th stocks of real estate

 Exchange Traded Funds : Trade like a single stock on the stock

exchange

 Fund of Funds : Invest in other Mutual Fund schemes

EXCHANGE TRADED FUNDS

 It tracks the market index & trades like a single stock.

11
  Unlike Index Funds, unit price varies during the day as per market movements.

 FTP’S are bought & sold through market makers who give a two way quote.

(Ask & Bid).

 Benefit of holding a single share & diversification & cost efficiency of an index.

 Market makers allow exchange of units for the underlying shares.

FUND OF FUNDS

 Fund of f invest in other mutual fund schemes of the same AMC/other AMC’S.

 It does not invest directly in capital markets.

 Greater diversification

 Higher expenses.

12
 CHAPTER-II

FUND STRUCTURE
AND

CONSTITUENTS

13
MUTUAL FUND STRUCTURE

 Mutual funds in U.S. are setup as investment companies

 Mutual funds in UK. are either Unit Trusts (Trust) or Investment Trust (Companies)

 Mutual funds are public trusts under the Indian Trusts Act, 1882

 Mutual fund is a 3 tier structure:

o Sponsor

o Trustee and

o AMC

 Mutual funds invest

o In capital market instruments

o On behalf of investors

All gains and losses of funds are shared by the unit holders

MF is a pass-through structure and it has tax implications

CONSTITUENTS OF A MUTUAL FUND

1. Sponsor

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 2. Trustees

3. Asset Management Company

4. Custodian / Depository Participant

5, R&T Agent

6. Distributors

7. Banker

ROLE OF SPONSOR

 Sponsor is a person who sets up a Mutual Fund

 Sponsor settles the Trust and executes Trust Deed

 Sponsor contributes to the initial capital of the Trust

 Sponsor appoints the Board of Trustees

 Sponsor appoints Asset Management Company

 Sponsor contributes minimum 40% of net worth of AMC

WHO CAN BE A SPONSOR?

 Criteria of a Sponsor are

o Positive net worth

o Minimum 5 years’ track record

o History of positive after tax profit for 3 out of 5 years including fifth year

o Net worth more than contribution for AMC

o ‘Fit and Proper’ person

15
BOARD OF TRUSTEES & ROLE

 Trustees appointed by the Sponsor with SEBI approval

 At least two third trustees must be independent

 The trustees have a fiduciary responsibility towards unit holders

 Trustees not liable for acts done in good faith and if they have exercised adequate due
diligence

 Trustees oversee the functioning of AMC

 Trustees approve each MF scheme floated by AMC

 The investments in MF’s are held by the trustees

 Trustees receive fees for their services.

 Obligation to undertake general & specific due diligence.

WHO CAN BE A TRUSTEE?

Eligibility Conditions

 Person of high repute and integrity

 Not guilty of moral turpitude

 Not convicted for economic offence under securities laws

 Not a part of AMC e.g. Director, Employee or Officer of AMC

16
  One can be trustee of two MF’s if approved by Board of Trustees of both the mutual
funds.

ASSET MANAGEMENT COMPANY

 Constituted as a company under the Indian companies Act

 Minimum Net worth of Rs.l0 crores for AMC

 Minimum contribution of sponsor: 40% of share capital of AMC

 At lest 50% of directors of AMC to be independent

 AMC can do only the following businesses.

o Asset management services

o Portfolio management services

o Portfolio Advisory services

 AMC can be terminated/changed with the consent of

o Majority of Trustees or

o At least 75% majority of unit holders

ROLE OF AMC

 AMC is the fund Manager for managing Mutual fund Assets

 AMC floats different MF schemes

 AMC accountable to the Trustees

 AMC charges Asset Management Fees subject to ceiling prescribed by

SEBI.

17
  Asset management Agreement between AMC and Trustee

OBLIGATIONS OF AMC

 Limit of 5% of aggregate purchase and sales of securities under all its scheme per
broker per quarter

 As far as possible AMC to avoid services of its sponsor.

 All security transactions with a sponsor and his associates to be disclosed.

 Disclosure of transactions with a company which has invested more than 5% of NAV
in any scheme.

CUSTODIAN / DEPOSITORY / PARTICIPANT

 Custodian /DP:

o Appointedby Board of Trustees

o Keep record & account of securities I Investments

o Collects benefits tinder securities

o Sponsor & custodian I DP cannot be the same entity

o Registered with RBI

REGISTRAR & TRANSFER AGENT

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 o Registrar & Transfer Agent:

o Issues, redeems, transfers units of MF schemes

o Keeps unit holders accounts up to date

o Registered with RB!

MERGER OF TWO AMC’S

 Merger of 2AMC’S:

o Approval of Trustees of both AMC’S required

o SEBI approval required

o Approval of High Court also required

o Unit holders are informed and given option to exit without load

TAKE OVER OF AMC / SCHEME OF AMC

 Take over of AMC by new sponsor

o Trustees approval required

o SEBI clearance required

o Unit holder to be informed

 Merger of two schemes of different AMC’S

o Scheme of one mutual fund taken over by another mutual fund

 Trustees approval required

 SEBI approval required

 Unit holders to be informed

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CHAPTER-III

LEGAL

20
 &
REGULATORY
FRAME WORKS

REGULATORS IN INDIA

 SEBI is capital market regulator with legal powers

o SEBI regulates Mutual Funds.

o All Mutual Fund’s to be registered with SEBI

 RBI is money market regulator

 SEBI is regulator for liquid funds investing in MM instruments

 MOF supervisory body for RBI & SEBI

 Security appellate tribunal setup in 2003 to hear appeal against SEBI decisions

 Registrar of companies (ROC) ensures compliance by AMC & by trustee company

with the Indian Companies Act 1956

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  ROC supervised by department of company affairs (DCA)

 DCA frames and modifies regulations relating to the companies

 DCA is a part of company law board

 CLB is a part of ministry of law and justice

 Company law board carries out judicial proceedings for offences under companies
act

 Mutual fund trustees accountable to public trustees

 Public trustee reports to charity commissioner

 UTI set up under L act 1963

SELF REGULATORY ORGANISATIONS

 SROs are second tier in the regulatory structure

 SRO is an association of market participants

 Approval of SRO given by MOF

 All stock exchanges are SROs and are supervised by SEBI

 Close ended funds listed on SE observe listing agreement requirements of SE’s

 AMFI was incorporated in 1995 and is not an SRO

 Role of AMFI

o To promote interest of MF ’s & unit holders

22
 o To set ethical, commercial & professional standards

o To increase public awareness of MF industry

ROLE OF AMFI

 To promote interest of ME’s & unit holders

 Interact with the regulator

 To create public awareness

 To set ethical, commercial & business standards

 To promote best business practices and formulate code of conduct for persons
engaged in the activities of MF and for the AMC ’s

 To implement the certification programme.

INVESTORS RIGHTS & OBLIGATIONS

 Right of proportionate ‘beneficial’ ownership

 Right to timely service

 Right to information e.g. NAV calculation, unit pricing

 Right to approve changes in fundamental attributes of the scheme

 Right to wind up a close ended scheme with 75% majority of unit holders

 Right to terminate the AMC with 75% majority of unit holders

INVESTOR RIGHTS TO SERVICES

23
  Investor to be informed about change in fundamental attributes of the scheme eg.
from no load fund to load fund or change in pricing norms for purchase / sale of units

 Open ended fund must reopen within 30 days after the offer period

 Nomination facility allowed

 Redemption proceeds to be sent to investor within 10 working days otherwise penal

interest at the rate specified by SEBI for the fill period

 Annual holding statements and transaction statements to be sent to investors

 Dividend warrants to be dispatched within 30 days of dividend declaration by MF

 1 Mandatory portfolio disclosure for half-year period to unit holders within I month

 Investor’s right to inspect documents such as

o Trust deed,

o AMC agreement

o Balance sheets of MF schemes and

o Balance sheet of AMC

LEGAL LIMITATION TO INVESTOR RIGHTS

 Investors can’t sue the trust

 Investor can sue the trustee

 Sponsor of fund not responsible for shortfall in non assured scheme

 Prospective investors can’t sue the trustees/AMC/Custodians

INVESTOR’S OBLIGATIONS & COMPLAINT REDRESSAL

 Investor should:

24
 o Read offer documents

o Understand risk factors

o Monitor performance of investments

o To submit PAN details

 Complaint Redressal

o Through SEBI intervention. Complaints can be made to

AMC /Trustees / SEBI

 Investors cannot seek redressal under companies act since fund

investor are neither share holders nor depositors in AMC

CHAPTER-IV

25
 FUND DISTRIBUTION

&

SALES PRACTICE

WHO CAN INVEST IN A MUTUAL FUND SCHEME

 Residents

o Resident Individuals / HUF

o Indian companies

o Partnership firms

26
 o Indian trusts/ Charitable institutions

o Insurance companies

o Banks

o Financial Institutions

o NBFC s

o Provident funds

o Mutual funds

 Non residents

o NRI’ s & Persons of Indian origin

o Overseas corporate bodies (OCB s)

 Foreign Entities

o FII ’s registered with SEBI

 Foreign nationals cannot invest in MF

DIFFERENT DISTRIBUTION CHANNELS

1. Direct marketing by sales officers through

a. Mailers

b. Call centers

c. Branch networks

DISTRIBUTION CHANNELS TYPES

2. Individual agents as distributors and advisors

27
3. Institutional intermediaries

o Fund distribution companies

o Finance companies

Investment Advisory companies

o Banks and institutions

o Post offices

o Brokers and sub-brokers

o Private sector MF prefer established fund distribution COS as fund distributors.

AMFI REGISTERED DISTRIBUTORS

 AMFI Registration no.(ARN) card necessa before selling

 As on 3l/3/2005,

o 49837 candidates passed AMFI certification test

o out of which 30028 candidates registered with AMFI

 Out of 30038 AMFI registered candidates,

o Individuals are 24850

o Corporate are 1946

o Corporate employees are 3232

AGENT’S COMMISSION

 Commission can be paid upfront or trail commission

 Market practice

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 o 1.5 to 25% for Equity funds

o 0.25 to 1.25% for Debt funds

o Still lower for liquid funds

o Higher commission for ELSS

 AMFI has prohibited parting / sharing of commission (see AMFI

Guidelines & Norms for Intermediaries [AGNI]. SEBI CIR of 2002.

 SEBI does not prescribe any ceiling on commission

PROCESS OF EFFECTIVE SELLING OF M F SCHEMES PRESCRIBED

FOR DISTRIBUTORS

 Know the important characteristics of scheme

 Know your client profile (age, risk tolerance, income level, etc.)

 Understand client’s needs (investment objective, return expectation,

o cash flow requirement, etc.)

 Assist in making the right choice

 Encourage regular investment & commitment to invest

 Personalized post sales service

AMFI CODE OF ETHICS FOR MF’S

 Funds to be managed in the interest of unit holders

 Unit holders to be treated equally & fairly

 Ensure meaningful disclosures

 Avoid conflict of interest

 Ensure segregate accounting

29
  Stick to ethical standards and fairness in dealings

 High standards of care, diligence, services and disclosure

 announcements

SEBI ADVERTISEMENT CODE FOR MF’S

 No promises in the future without resources hacked guarantee

 Standard measures to compare such as Annual Yield, CAGR etc.

 Annualized yields for at least one, three, five years & since launch

 For less than I year performance, Absolute return without

 Annualisation

 Past gains may not repeat in future

 Risk factors prominently stated

 No celebrities

 No add-ons during offer period

 Appropriate benchmark to be chosen

 Any ranking of thud to be explained

CHAPTER-V

30
 ACCOUNTING

 VALUATION

 TAXATION

31
 ACCOUNTING

MUTUAL FUND ACCOUNTING

 Knowledge of MF accounting vital

 Separate Balance Sheet for each scheme of ME

32
  MFs to follow Accounting Policies laid down by SEBI (Mutual Funds) Regulations,
1996

 Unit holder’s subscriptions accounted

o not as liabilities or deposits

o but as unit capital at face value

 Investments made by the fund appear on asset side in the balance sheet

 All assets of the scheme belong to investors

NAV CALCULATIONS

 Net Assets = Assets Liabilities

o Assets = Market value of investments + Receivables + Accrued

Incomes + Other Assets

o Liabilities = Accrued expenses + Payablcs + Liabilities

 NAV of a Unit = Net Assets of the Scheme

Number of units outstanding

DISCLOSING NET ASSET VALUE OF A UNIT

 Data on which NAv is calculated is called valuation date

 Open ended funds are required to compute and disclose NAy daily

 Close ended Funds can compute NAV’s every week NAV calculation has to consider
up to date transactions

DISCLOSING NET ASSET VALUE OF A UNIT

 All income, expenditure to be accounted up to date of valuation

33
  Non accrual of small amounts not affecting NAV by more than 1% permitted

 Non-recorded transactions should not affect NAV calculation by more than 1%

 If NAV is more than 1% AMC to

o Pay excess difference.

o Recover excess paid.

ALLOCATION / DE-ALLOCATION OF UNITS

 For all valid applications received before the cut-off time, units are allotted / cancelled
based on NAV at the end of the same day

 For valid application received after the cut-off time, units are allotted I cancelled
based upon NAV of the next business day.

 The above rule does not apply to liquid fund schemes

CUT-OFF TIME

 The cut-off time for all mutual fund schemes except liquid fund schemes is 3 pm

 For liquid fund schemes valid application received up o I p.m. are allotted units based
on NAV of the previous day

 For liquid fund schemes valid application received up to 1 p.m. are allotted units
based on NAV of the same day

 For repurchases under liquid funds the cut-off time is 10a.m. instead

Of 1pm.

 NAV’s are required to be rounded off up to 4 decimal places for liquid funds & up to
2 decimal places for other finds

FACTORS AFFECTING NET ASSET VALUE OF A UNIT

34
  NAV is affected by 4 set of factors:

o Purchase & sale of investment securities

o Valuation of all investment securities held

o Other assets and liabilities

o Units sold or redeemed

PRICING OF A FUND UNIT

 SEBI regulations on pricing of mutual fund units

o For open ended funds

• Repurchase price not lower than 93% of NAV

• Sale price cannot be more than 107% of NAV

• Difference between the repurchase and sale price of a unit

cannot be more than 7%

CHARGES IN A MF

 Mutual funds can recover two types of expenses

o Initial issue expenses

o Recurring expenses

 Initial issue expenses

o Effective April 04’ 2006 allowed up to 6% for close ended finds only

o Close ended funds cannot charge entity loads

o Open ended Rinds can recover initial expenses through entry load

MAXIMUM RECURRING EXPENSES

35
  Recurring expenses cannot exceed the following regulatory limits

Average Weekly Assets For equity funds For Bond Funds

2.50% 2.25%
For first Rs.100crs.

2.25% 2.00%
For next Rs300crs

2.00% 1.75%
For next Rs.300crs.
On the balance average weekly 1.75% 1.50%
assets
Fund of Funds Max-0.75%

ASSET MANAGEMENT FEES

 AMC changes asset management fees

o Limits on AMC fees as per SEBI regulations:

• 125% of the 1st Rs.100 crs of weekly average net assets

• 1.00% of the weekly average net assets in excess of Rs.l00 crs

• AMC may change additional 1% of weekly average net assets

for ‘ Load’ funds

 Assets management fees are not in addition to but a part of recurring expenses

 Assets management fees are usually lower for debt funds as compared to equity funds
and are disclosed in OD

AMORTIZATION OF INITIAL EXPENSES

36
  Close ended funds do not charge initial expenses of fund but amortize the same over a
period of years

 Initial expenses amortized on a weekly basis over the period of the scheme. e.g. for a
yr scheme, amortized over 260 weeks

 Investor exiting before expiry of period of scheme will be charged unrecovered initial
issue expenses

 Conversion of close ended hinds into open ended funds allowed only after recovery of
unrecovered initial expenses

 Un-amortized portion added for NAV calculation as other asset but no AMC fee on
this amount

AMORTISATION AN EXAMPLE

 Assume close ended fund of five years collects Rs.100 cores and

incurs initial issue expenses of Rs.5 cores.

Units issued = 10 corers

Investment = 95 corers

Initial NAV = 95 + ((260/260)*5 ) 10

10

After 4 weeks let the market value of investments 98 crs

NAV = 98 + ((256/260)*5)

10 =10.29

INITIAL ISSUE EXPENSES IMPACT ON NAV

 Open ended fund collects Rs,100crores

37
  Entry load 2.25%

 Initial issue expenses Rs,5 Corers

 Impact on NAV

Initial NAV 10

As No. of Units allotted would be 9.775 corers

DISCLOSURE AND REPORTING REOLIREMENTS

 AMC to prepare annual report and annual statement of account for each scheme

 Annual statement of account to be audited by an auditor independent of the auditor of

AMC

 Within 6 months of accounting year, fund shall

o Publish scheme wise abridged summary of reports in newspapers

o Mail summary of report to all unit holders

o Forward to SEBI annual audited accounts, half yearly unaudited accounts,

quarterly portfolio statement

o Display the scheme wise annual reports on their website & on AMFI website

o Mail annual reports to all unit holders

ACCOUNTING POLICIES

 Investments to be marked to market

38
  Unrealized appreciation can’t be distributed

 Dividend / Bonus recognized on the date share is quoted ex-dividend / ex-bonus

 Average cost considered for determining gain / loss on sale of shares

 Purchase / sale of investments recognized

o on the trade date,

o not on settlement date

 Debt investments to be taken as NPA

o if interest or principal amount remains unpaid for more than 3 months.

o e.g. if interest due 3 June 2000 remains unpaid on 1/10/2000 it becomes NPA
in 1/10/2000

PROVISIONING OF NPA - DEBT SECURITIES

If interest remain unpaid for 6 months 10% of Book Value

If interest remain unpaid for 9 months 20% of Book Value
If interest remain unpaid for 12 months Another 20% of Book Value

If interest remain unpaid for 15 months Another 25% of Book Value

If interest remain unpaid for 18 months Balance 25% of Book Value

39
VALUATION NORMS
FOR
MUTUAL FUNDS

40
VALUATION NORMS FOR MUTUAL FLNDS

 Valuation norms prescribed by SEBI to protect investor’s interests

 Valuation norms

o Based upon fair portfolio valuation

o Uniform across al funds

 SEBI

o Prescribes detailed valuation methodologies in its fund regulations

o Mandates disclosure of valuation methods used for investors’ information

VALUATION NORMS FOR SHARES

 Va1uation of traded shares

o done on the basis of traded price

o if not more than 30 days old

 Valuation of thinly traded shares

o less than 50,000 shares or Rs.5 lacs or less amount and

o done as per SEBI approved norms

 Valuation of not traded shares

o done as per SEBI approved valuation norms

 If thinly traded & non traded equity securities exceed 5% of the total assets of the
scheme.

41
 o independent valuer should be appointed for valuation

 If illiquid securities exceed

o 15% of net assets for open ended finds

o 20% of net assets for close ended funds

o value is taken zero for securities in excess of 15% 20%

LIMIT ON ILLIOUID SHARES

 Illiquid share (Non traded, thinly traded & Unlisted equity shares)

o not to exceed 15% for open ended find assets

o not to exceed 20% for close ended fund assets

VALUATION NORMS FOR THINLY-TRADED AND_NON-TRADE

SHARES

Equity Instruments

 Calculate book value per share

 Calculate earning value per share based upon average capitalization rate of industry
P/E and discount it by 75% (Latest audited EPS be taken for this purpose)

 Calculate fair value per share taking 90% of average of book value and earning value
per share

 If EPS is negative or not available for within previous nine months, it should be taken
as zero

42
CAPITALISATION OF EARNINGS—AN EXAMPLE

 Assume net worth / share Rs.8

 Audited EPS Rs.2

 Industry PIE 12

 Discounted P/E for comp (25% of 12)-3

 Value of share (2*3) -6

 Average value (8+6)/2 -7

 Value to be taken discounted by 10%

 90% of Average value (7) - Rs.6.30

VALUATION OF TRADED DEBT SECURITIES

 A debt security. is treated as traded if traded any day during the last 15 days

 Trading ca be on a stock exchange or between institutions

 Publicly traded price or private placement price if private placement is within last 15
days is taken as valuation price

 Market lot for trading in debt securities is 5 Crores

 A debt security if not traded in last 15 days in called not traded or thinly traded debt
security

43
VALUATION OF THINLY - TRADED AND NON - TRADED DEBT
SECURITIES

Debt Instruments

 Less than 182 days maturity

o Valued at cost plus accrued interest and

o Difference between redemption value and cost uniformly spread over

remaining life of instrument

 More than 182 days maturity

o Government securities valued at prices released by CRISIL

o Investment grade debt securities valued on the basis of YTM derived

from CRISIL valuation matrix

o Non investment grade

 Performing asset valued at 25% discount to their face value

 NPA valued as per valuation norms for NPA ’s

 Calculating yields for pricing debt securities

o A risk free benchmark yields curve is built on GOl securities as the base.

44
 o A matrix of spreads (based on the credit risk) are built for marking up the benchmark
yields

o Marked yields are adjusted for liquidity risk

o The yields so arrived are used to price debt portfolios

GROSS REDEMPTION YIELD (GRY)

 Gross redemption yield (GRY) is also called Yield to Maturity (YTM)

 YTM is the Internal Rate of Return on investment in Bond.

 Internal rate of return is computed based on:

I. Coupon Rate

II. Purchase Price

III. Period to Maturity

 If purchase price is the same as face value of bond,

o YTM will be the same as coupon rate.

 If purchase price is more than the face value,

o YTM will be lower than the coupon rate.

 If purchase price is less than the face value,

o YTM will be more than the coupon rate.

45
CALCULATING PRICE BOND WITH GIVEN YTM - AN EXAMPLE

Given data:

Face value : R& 1000

Coupon : 10%

Tenure : 5 Years

Interest payment : Yearly

Yield : 8. 72%

Calculate price of the bond

Cash flows under the bond and their present values are as under

100 + 100 + 100 + 100 +(100+1000)

(1+8.72%) (1+872%)2 (l+872%)3 (1+8.72%)4 (1+8.72%)5

Price of the bond = Rs.1050 (By solving the above equation)

46
 TAXATION
OF
MUTUAL FUNDS

47
TAXATION_OF MF’S AND INVESTORS

 Finance act 1999 radically changed taxation of dividends received by investors in

Mutual Funds

 Mutual fund as an entity is not taxed since it is a Pass through entity. Section 10 (23d)
of the IT Act.

 Finance Act 1999 made income (dividends) from UNITS totally EXEMPT from tax
u/s 10(33) in the hands of all investors

 Income (dividends) distributed by a debt fund was made liable to dividend

distribution tax at applicable rate

 Open ended funds with more than 50% invested in equity do not pay any DDT (since
changed to 65% in FY 06— 07)

 Security transaction tax (STT) is charged as applicable (01% on Net Sales

Consideration

 80 C benefit under ELSS up to Rs. I lac

 Restriction on dividend stripping (Sec 94(7))

o Within 3 months prior to record date of dividend distribution and

o Within 9 months after record date for dividend distribution

48
IMPACT OF DIVIDEND TAX

 Investor pays the tax indirectly. since NAV comes down to the extent of tax paid by
the fund.

 DD tax bears no relationship to the investor’s tax bracket.

 Dividend reinvested in also subject to dividend distribution tax.

 In growth plans, dividend distribution tax not applied, since no dividend is distributed.

SHORT / LONG TERM CAPITAL GAINS TAX

 Short term capital gain

 If units held for less than 12 months

 Long term capital gain

 If units held for more than 12 months

 Short term capital gains at normal tax rates as applicable to investor

 Long term capital gains taxed at 20% with indexation or at 10% without indexation of
cost + Applicable surcharge & Educational cess

 Under section 111(a) of IT Act

o No long term gains tax on equity oriented schemes if STT charged.

o Short term gains tax at Government specified rate if STT is charged for equity
oriented schemes currently the rate is 10%.

49
CAPITAL GAINS TAX

 Option to pay 20% or 10% lies with investor for each and every security.

 10% surcharge also payable

 Indexation benefit on unlisted bonds not available

 No capital gain tax payable if entire capital gain invested in capital gain bonds of
NABARD, NHAI, REC under sec 54 EC with a lock in of 3 years.

 Long term capital gains exempt u/s 54 ED if invested within 6 months in shares of
companies formed and registered in India with a lock in of I year.

CALCULATE CAPITAL GAIN TAX - AN EXAMPLE

Mr. H Invests Rs.2 lacs in MF units during FY 97 — 98

 After 2 years, he sells units and gets Rs.2.4 lacs

 His tax liability will be: C 99-00:389, CU 97-98:331, Ratio: 389/331 = 1.18

 Indexed cost (2,00,000 x 1.18) Rs.2,36,000

 Capital gain — Rs.4,000

 Long term capital gain tax of Mr. H: Rs.4,000* 20% = Rs.800 or 10% of Rs.40,000/-
i.e. Rs.4,000/-

Obviously he will select the option of paying Rs.800/-

WEALTH TAX

 Ownership of units not included in ‘Net Wealth’

50
 Hence no wealth tax payable on mutual ifind units

CHAPTER-VI

INVESTOR
SERVICES

51
INVESTOR SERVICES

 Application procedure — as per offer document

o Wide distribution of application forms

o downloadable application forms

o Application through internet

 The procedure for NRIs / OCB provided in the OD/ KIM

 Bank details to be given in the application form

 PAN no. to be given if investment is Rs. 50,000/- or more

 Joint account can be operated jointly by all

APPLICATION PROCEDURE FOR PURCHASE OF MF UNITS

 The application form is an important agreement on the part of the investor of having
read and understood the OD

 The various modes of payment specified in the OD

 NRI s can pay

o From FCNRINRE accounts by demand drafts or Cheques in case of

repatriation benefits.

o For non repatriation bel1efits payment can be made from NRO /

NRNR A/c.

 FIls can remit directly from abroad or pay from their NRE A/c.

 Offer documents contains procedure purchasing and redeeming of units

 Introduction of Multi purpose application form

52
 o dispenses with the need for existing investors to fill up full application form

o for making further investments

INVESTMENT PLANS AND SERVICES

Investment Plans

 Systematic In plan (SIP)

o Regular investment of fixed amount periodically (Rupee cost averaging

advantage)

 Automatic Reinvestment plan (ARP)

o Reinvestment of dividend at ex dividend NAY

 Systematic Withdrawal plans (SWP)

o Regular withdrawals at periodical intervals

 Systematic Transfer plans (STP)

o Selling units of one scheme & buying units of another scheme at regular
periodical intervals of the same AMC

OTHER SERVICES AVAILABLE L UNDER MUTUAL FUNDS

 Phone Transactions

 Internet / Email transactions

 Cheque writing facility for Liquid Funds

 Periodic statements of holdings

53
 Periodic statements of Investment portfolio disclosures

 Mutual Funds cannot give loan against units

 Banks can give loan against MF units

 Nomination facility allowed

 Units of close end schemes can be transferred to another person

 Transfer in open ended fund happens upon

o death of unit — holder or

o when units are pledged or

o by operation of law i.e. insolvency or

o winding up of the corporate investor

54
 PART—VII

INVESTMENT POLICY AND

RESTRICTIONS

55
INVESTMENT POLICY OF A FUND

 Investment policy of a fund scheme is stated in OD

 For equity tuna

o See kind of Sectoral allocation & companies to invest

 For debt find

o See types of instruments.

o Credit rating,

o Proposed average maturity,

o Minimum & maximum miii instruments percentage

 For balanced fund

o See equity &debt proportions

 For money market fund

o See types of instruments preferred & their rating profile

REGULATORY RESTRICTIONS ON INVESTMENTS BY FUNDS

 Minimum no. Investors in scheme

o 20 &no single investors to hold over 25% of the corpus

56
  Minimum portfolio diversification

o investment in equity of a single company — max 10% of the NAV (Except

index funds, sector finds)

o Al! non government debt to be mandatory rated by at least one rating company

o Investment in rated debt instrument of a company

• Max 15% of net assets

• Max 20% of net assets with approval of board of trustees

REGULATORY RESTRICTIONS ON IN VESTMENTS BY FUNDS

 Investment in unrated/below investment grade securities

o Not exceeding 10% of net assets iii a single company

o Not exceeding 25% of net assets of the fluid in all the companies

 Prior approval of Unrated mandatory for investments in unrated debt

Instruments.

REGULATORY RESTRICTIONS ON IN VESTMENTS BY FUNDS

 Investment in unlisted shares of companies

o Close ended fund: not more than 10% of net assets

o Open ended fund: not more than 5% of net assets

 Investments in equity shares under all schemes of a mf

o Not more than 10% of paid up capital of a company

 Investment by a mutual fund in ADRs / GDRs allowed

57
  Investment by a MR in equities of listed overseas companies having share holding of
at least 10%allowed

 Overall limit of u.s $l billion for such overseas investment for entire MY. industry

 Overall limit per M.F

o Not exceeding 10% of net assets subject to maximum 50 million

REGULATORY RESTRICTIONS ON INVESTMENTS BY FUNDS

 A mutual fund can invest

o Maximum 5%of net assets under all its schemes

o Into different fund schemes of the same AMC or of any other AMC except
fund of funds schemes

 The above limit doses not apply to fund of funds

 Securities are to be bought or sold only on delivery basis no short selling allowed

 Securities to be bought and sold for a relevant scheme

 Purchases! sales cannot be aggregated and allocated later

 MFs can lend securities under the SEBT approved stock lending scheme

 A mutual fund can invest only iii marketable securities

 A mutual fund cannot invest in unlisted securities of sponsor or sponsor group

companies

58
 A mutual fund can invest in listed securities of the sponsor / sponsor group companies
up to 25% of net assets of the funds

 A mutual fund can transfer securities from one scheme to another scheme at market
prices and on spot delivery basis

 Inter-scheme transfers allowed if objectives of both the schemes are same

 A mutual fund can park its money in deposits of scheduled commercial banks pending
deployment into regular investments

 Borrowing by MFs restricted up to 20% of net assets for maximum 6 months for
paying dividends/ redeeming units

 Record of investment decisions to be maintained.

 A FOP cannot invest in other FOF scheme

 A liquid fund can not have mark to market Components> 10%. Maximum re pricing
tenure 1 year

59
CHAPTER-VIII

MEASURING

60
 &
EVALUATION
MUTUAL FUND
PERFORMANCE

MEASURING MF PERFORMANCE

 Major sources of return to investors are dividends and capital.

 Investor should track the value of his investments in terms of

o Returns on such investments

o Decide whether he needs to switch to another hind.

METHODS OF MEASURlNG/EVALUAT1NG MF PERFORMANCE

 Absolute return method

61
  Simple annual return method

 Total return method

 Total return method when dividend is reinvested

 Compounded annual average rate method (CAGR)

 Expense ratio method

 Income ratio method

 Portfolio turn over ratio method

 Transaction cost method

 Fund size

 Cash holding percentage

ABSOLUTE RETURN METHOD

 Absolute returns for a specific period

 Absolute return are calculated for less than l year period

 If NAV changes from 20 to22 in 6 months, absolute return is 2/20*100=1

SIMPLE ANNUAL RETURN METHOD

 Simple annual return method computes returns as follows

 Lets take the previous examples

62
 o NAV changed from 20 to 22 in 6 months period

o Annual return is

( 22 - 20) x 12 x 100 = 20%

20 6

TOTAL RETURN METHOD

 Formula for total return when dividend is received but not reinvested:

Dividend distributed -- changes in NAV X 100

NAV at the start

 Total return when dividend is not received but reinvested

 This method is used to calculate return on investments when dividends are declared
and reinvested at ex dividend NAV price

 See example as given below for calculating total returns

TOTAL RETURN METHOD WHEN DIVIDEND NOT REINVESTED AT

NAV- AN EXAMPLE

 Assume units are purchased when NAV is 20

 Assume that dividend of Rs 4/- is distributed when NAV ex dividend is 21

 Assume NAV at the end of the year is rs.22/-

 Simple total returns for the year will be as under

(22-20)+4 x 100 = 30%

20

63
TOTAL RETURN or ROl or CAGR METHOD

Compounded average annual return method

Formula

A=P x (1 + R/100)N

P = Principal invested

A =Maturity value

N = Period of investment in years

R = Annualized compound interest in %

R =[(Nth Root of A/P) — 1] x 100

COMPOUNDED AVERAGE ANNUAL RETURN METHOD AN EXAMPLE

 Begin NAV - 100

 End NAV-200

 Period of investment - 10 years

 Average annual compounded return — is it 10% or lower

 2O0=100 x (1+R /100 )10

 Solving fort gives annualized compounded rate of 7.1773% or 7.2%

 Apply thumb rule of 72

64
  SEBI prescribes average annual compounded return method to be followed for
advertising returns for over 1 year period.

RETURNS EMPACTED BY LOADS

 The above example assumes a no load fund

 If there is an entry load, you will be allotted lesser number of units since you will pay
more than NAV

 If there is exit load, you will get lesser amount per unit than NAV

EXPENSES RATIO! INCOME RATIO (METHOD OF EVALUATION)

 Funds can be evaluated based on expenses ratio and income ratio

 Expenses Ratio: it is the ratio of total expenses to average net assets of the funds.

o This ratio is important for evaluating bond fund

o Expenses do not include brokerage paid since it is capitalized and therefore

expenses may be understated

 Income Ratio = Net Investment Income

Net Assets

65
 o Income ratio is important for evaluating bond Rinds

PORTFOLIO TURN OVER RATE METHOD OF FUND EVALUATION

 Another measure of fund evaluation is portfolio turn over rate

 Portfolio turnover rate = Total Sales & Purchases Net Assets of the Fund

 Higher turnover rate indicates

More churning of portfolio

More transaction costs

 Portfolio turn over ratio relevant for actively managed funds

IMPORTANCE OF BENCH MARKING IN EVALUATING FUND

PERFORMANCE

 Three methods of evaluating fund performance

o Evaluating fund performance against bench marks

o Evaluating fund performance against other peer group mutual fund schemes

o Evaluating fund performance against other financial products

FUND EVALUATION AGAINST BENCHMARKS

66
  Funds performances can be evaluated against some performance indicators called
benchmarks

 Mutual funds are required by regulations to state the benchmark in the OD against
which scheme performance will be compared

 Investors expect fund performance better than the benchmark

BENCHMARKS FOR EQUITY FUNDS

BENCHMARKS FOR DEBT FUNDS & MONEY MARKET FUNDS

Bo
nd Funds with over 60% in Bonds to use Bond Market Index

67
Balanced Funds should use Tailor Made Index

BENCHMARKS FOR DEBTS FUNDS & MONEY MARKET FUNDS

 There are various Indices for benchmarking of debt funds

 Bex index of I-SEC is used for tracking govt. Security performances

 Crisil has 8 debt indices for tracking performances of corporate bond market &
money rnarket

 NSE has govt. Security index & treasury bill index -

BENCHMARKING AGAINST OTHER MUTUAL FUNDS

Peer group comparisons:

 Performance of fund can be compared with similar schemes of other mutual funds.

 Criteria for peer group comparison would be similarity in

o Investment objectives and rating profile of portfolios

o Average maturity of debt portfolios

o Size of fund big or small

 Higher expenses ratio of a debt fund hurts long term debt investors

BENCHMARKINQ WITH OTHER FINAN PRODUCTS

68
 Comparison with other comparable financial products

 Risk return relationship to be considered

 Liquidity factors to be considered

 Average annualized compounded returns to e compared

FUND PERFORMANCE RANKING

 Fund performance evaluation & ranking done by Crisil

 Fund house rating done by Crisil

SOURCES FOR TRACKING MUTUAL FUND PERFORMANCE

69
Following sources of information can be used to track performances of mutual fund schemes

 Mutual funds annual periodic reports

 Mania! funds website

 AMFI website

 Daily financia] news papers

 Fund tracking agencies - Credence, Value Research & Lipper India

 Newsletters from brokers.

 Offer document of the fund

 Analytical articles

CHAPTER-IX

70
 RECOMMENDING FINANCIAL

PLANNING STRATEGIES

TO

INVESTORS

INVESTMENT STRATEGIES FOR INVESTORS

 Start planning & investing early and regularly. Use SIP

 Invest for long term.

 Have realistic expectation of returns on investments

 Harness the power of compounding by choosing growth option.

71
  Choose an-investment strategy to maximize returns on investments

o Buy and hold strategy

 Can be adopted for good mutual fund schemes but not for individual
stocks

o Rupee cost averaging strategy for investment

o Value averaging strategy for investments

UPEE COST AVERAGING STRATEGY OF IN VESTMENT

 Rupee cost averaging RCA involves the following

o A fixed amount is invested at regular intervals

o More units are bought when NAY is low

o Fewer units are bought when NAY is high

o Over a period, average purchase price per unit is lower than average NAY

o This strategy does not tell you when to sell am! switch

o Investor use SIP to implement RCA

VALUE AVERAGING STRATEGY OF INVESTMENT

 Value Averaging Strategy involves the following

o A fixed amount is targeted as a desired value of the portfolio at regular

intervals

o If market values go up

 Units are so to restore target value

72
 o If market values go down -

 More investments are made to maintain target value

o Over a period,

 Average purchase price per units is lower than

 If one tries to guess the highs and of market

VALUE AVERAGING STRATEGY

 Value averaging strategy is superior to RCA

 It enables you to book profits and rebalance portfolios

 Investors can use SWP to implement value averaging strategy

 Investors can use mm funds and equity finds to implement value averaging strategy

SET ALLOCATION PRINCIPLES

 Asset allocation is basic tool to translate financial plans into action.

 Asset allocation is determining the percentages of investments to

 beheld in equities, bonds and money market instruments

 Over 95% of returns on managed portfolio come from the right

 Level of asset allocation amongst stock, bonds & cash.

 Asset allocation differs for investors depending upon

o Their personal situation,

o Financial goals and

o Risk appetite

MODEL PORTFOLIO FOR INVESTORS BENJAMIN GRAHAM’S 5O5 BALANCE

STRATEGY FOR ASSET ALLOCATION

73
  50/50 split between equities and bonds-

o A common sense approach

o Conservative investments approach

o When value of equity goes up ,balance restored by liquidity part of equity

portfolio or

o vice versa.

o Good to get half the returns of a rising market and avoid the fbll losses of a
falling market.

MODEL PORTFOLIO FOR IN\ SUGGEST BY BOGLE

Bogle suggests the following combinations:

1. A basis managed portfolio

o 50% in diversified equity & ‘value’ finds

o 25% in a Govt. Securities Funds

o 25% in High Grade Corporate Bond Funds.

2. A Basic Indexed Portfolio

o 50% in Total Stock Market Index Fund

o 50% in Total Bond Market Portfolio

3. A Simple Managed Portfolio

o 85% in a Balanced 60/40 Fund.

o 15% in Medium TenTi Bond Fund 4, A Complex ManaQed Portfolio

o 20% in Diversified Equity Fund

o 20% in Aggressive Growth Fund

o 10% in Specialty Funds

74
 o 30% in Long Teim Bond Funds

o 20% in Short Term Bond Funds

5. A Readymade Portfolio

Single Index Fund with 60/40 Equity / Bond Holdings

Bogle’s Rule of Thumb for Asset Allocation

Debt Portion of an investor’s portfolio to be equal to his age.

30 year old investor — 70/30 (Equity I Debt Allocation)

BOGLE’S STRATEGIC ASSET ALLOCATION STRATEGY FOR INVESTORS

Bogle recommends the following factors to be considered in strategic asset allocation strategy
for investors:

o Age

o Financial Circumstances

o Objectives

Equity / Debt

Lounger Investors in Accumulation Phase 80 / 20

Older Investors in Accumulation Phase 70 / 30

Younger Investors in Distribution Phase 60 / 40

Older Investors in Distribution Phase 50 / 50

FIXED v/s FLEXIBLE ASSET ALLOCATION STRATEGY

75
  Asset Allocation percentages can be on Fixed or Flexible Basis

 Fixed Ratio of Asset Allocation:

o Balance maintained by liquidating a part of the position in the Asset class with
higher return and

o reinvesting in the other assets with lower returns

 Flexible Ratio of Asset Allocation:

o Not doing any rebalancing and

o letting the profits run

 Fixed ratio approach works better in bull markets

INVESTICAL ASSET ALLOCATION STRATEGY

 Change in Asset Allocation percentages based on Fund Manager’s views on the future
movements in asset prices.

 May invest more in shares of small companies than large companies.

 May change the equity debt mix where they expect greater returns.

76
 CHAPTER-X

SELECTING THE RIGHT

INVESTMENT PRODUCTS
FOR
INVESTORS

ASSET TYPES — PHYSICAL & FINANCIAL ASSETS

 Physical Assets

77
 o Real Estate

o Gold

 Financial Assets

o Bank Deposits - Bond I Debentures

o Company Deposits - Commercial Papers

o NSC, KVP, PPF - Certificate of Deposits

o RBI Relief Bonds - Life Insurance Policies

o Equity / Preference Shares - Mutual Funds

GUARANTEED AND NON GUARANTEED INVESTMENTS

 Guaranteed Investments: Capital protection and interest rates are guaranteed by the
borrower.

Bank Deposits

Government Savings Instruments

 Non — Guaranteed Investments: Capital protection and interest rates are Not
guaranteed

Mutual Funds

Equity Investments

PHYSICAL ASSETS

 Individuals can invest physical assets e.g. Gold & Real Estate

 Govt. has permitted issue of Gold Bonds by Banks

 Gold Bonds represent securitization of Gold Where they earn some returns and avoid
risks associated with storage of gold

 Investors are likely to be allowed to invest in gold linked units schemes

78
  Real Estate M.F. are also in the offing Which Will offer the investors the twin
benefits of

o Real Estate Investing &

o Mutual Fund Investing

FINANCIAL PRODUCTS & ISSUERS

ISSUER PRODUCT AVAILBLE TO

Banks Fixed Deposits Investors.MFs.
Corporates Shares Investors.MFs.
Bonds, Debentures Investors.MFs.
Fixed Deposits Investors.MFs.
Government Govt. Securities Investors.MFs.
PPF Investor
Bonds Investors.MFs.
Insurance Policies Investor

EVALUATING FINANCIAL PRODUCTS

PRODUCT SAFETY/ LIQUIDITY RETURNS VOLATILITY

CONVINENCE
Equity Low High/Low High- High

mod
F1 Bonds High Moderate Mod.- Moderate

High
Debentures Moderate Low Mod-Low Moderate
Corp. FD Low Low Moderate Low
Bank Dep. High High Low-High Low
PPF High Moderate Moderate Low
Life Ins. High Low Low-Mod. Low
Gold High Moderate Mod.-Low Modarate

79
Real Estate Moderate Low High-Low High
Mutual High High High Modarate

Fund

WHY MF IS BEST OPTION?

 MF combine the advantage of each of the investment product choices

 It reduces the short comings of other options

 Returns in mutual funds get adjusted for market changes/movements

INVESTING THROUGH MF’S Vs DIRECT EOUITY INVESTMENT

 Identifi’ing stocks without detailed research is difficult in direct equity rnvestment

 Diversification easily achieved in MF

 Professional management employed in ME

 Investment activities based on investment objective in MFs

 MFs offers more liquidity

 Transactions costs are Lower of MFs

 More convenience in mutual funds

INVESTOR’S PERPECTI YES: MF’S V/s OTHER PRODUCTS

80
81
 CHAPTER-XI

HELPING INVESTORS

UNDERSTAND RISKS
IN FUND INVESTORS

CLASSIFICATION OF INVESTORS

 Risk Tolerance Levels of Investors

82
 o Low Risk Tolerance

o Moderate Risk Tolerance

o High Risk Tolerance

CLASSIFICATION OF FUNDS BASED ON RISK LEVELS

LOW RISK FUNDS

 Money Market Fund

 Government Securities Fund

Moderate Risk Funds

 Income Fund

 Balance Fund

 Growth & Income Fund

 Growth Fund

 Short Term Bond Fund

 Intermediate Bond Fund

 Index Fund

High Risk Funds:

 Aggressive growth fund

 International fund

 Sector fund

 Specialized fund

 Precious Metal find

83
  High Yield fund

 Commodity fund

 Index find

JACOBS RECOMMENDATIONS FOR PORTFOLIO ALLOCATION

WITHIN EACH CATEGORY

Low Risk (Conservative) Portfolio:

 50% - Gilt Fund + 50% Money Market Fund Moderate Risk (Cautiously A Portfolio

 40% - Growth and Income Funds

 30% - Gilt Funds

 20% - Growth Funds

 10% - Index Funds

High Risk (Aggressive) Portfolio:

 25% - Aggressive Growth Funds

 25% - International Funds

 25% - Sector Funds

 15% - High Yield Funds

 10% - Gold Funds

RISKS IN MUTUAL FUND INVESTING

 Risk in a generic sense means the possibility of financial loss

 In the investment world possibility of financial loss arises from variability of earnings
from time to time.

 A fund with stable, positive earnings is less risky

84
  Than a fund with fluctuating total return.

 Risk is thus equated with volatility of earnings — a statistically measurable concept.

RISK IN EOUITY FUNDS

 Volatility of earnings of an equity fund conies from

o Kinds of stocks

o Degree of diversification

o Fund manager’s success at market timings

 Equity funds are exposed to equity price risks arising out of

o Company specific risk

o Sector specific risk

o Market level risk

 Market level risk

o Not diversiflable, not controllable because of changes due to broad economic,

political and other factors.

o Can be controlled to some extent through equity index fund or futures and
options.

RISK MEASURES OF AN EQUITY FUND

 Beta Co-efficient Measure of Risk

 EX Marks or ‘R Squared’ Measure of Risk

 Standard Deviation Measure of Risk

RISK MEASURES

 Beta Coefficient Measure of Risk:

o Beta relates a fund’s return with a market index.

85
 o Measures the sensitivity of the fund’s returns to changes in the Market Index.

o Beta of 1 — Fund moves with the Market i.e. Passive Fund

o Beta of less than 1 — Fund less volatile than the market i.e. Defensive Fund

o Beta of more than 1 — Higher Beta — greater returns in rising markets and
higher losses in falling markets i.e. Aggressive Fund.

 Ex — Marks or ‘R-squared’ Measure of Risk

o Ex-Marks represents co relation with markets

o Higher the ex-Marks, Lower the risk of the fund

o A fund with higher ex-marks is better diversified than a fund with a lower ex-
mark.

 Standard Deviation Measure of Risk

o A statistical concept, which measures volatility.

o Measures the fluctuations of Fund’s returns around a mean le

o Basically gives you an idea of how volatile your earnings are

o Broader concepts than Beta.

o Measures total risk and not just the market risk of the portfolio.

RISK ADJUSTED PERFORMANCE MEASURES

 Risk and Returns have co-relation.

 Risk adjusted return is measured by using Sharpe ratio or Treynor ratio

SHARPE RATIO = Risk Premium

Fund’s Standard Deviation

TREYNOR RATIO = Risk Premium

Fund’s Beta

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  Risk Premium

o Difference between the fund’s average return and risk free return on
Government securities or Treasury Bills over a given period

PRICE EARNING MULTIPLES:

o Higher the Fund’s P/F, Higher the probability of its fall in thud values in future.

RISK MEASUREMENT OF DEBT FUNDS

 Beta or P/E ratio not relevant to Debt Funds.

 Debt Funds exposed to Risk of loss through

o Default (Non Performing Assets) and

o Interest Rate Changes.

Look at the average maturity (duration) of a debt portfolio

Greater the loss if interest rates go up.

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 CHAPTER-XII

RECOMMENDING MODEL
PORTFOLIOS

AND
SELECTING

THE RIGHR FUNS

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JACOBS’ FOUR STEPS TO DEVELOP A MODEL PORTFOLIO FOR A CLIENT

1. Work with investor to develop long term goals.

2. Determine the asset allocation of the investment portfolio.

3. Deterrniiie the sector distribution.

4. Select the specific fund manager and their schemes.

MODEL PORTFOLIOS FOR CLIENT’S RECOMMENDED BY JACOBS

 For Young Unmarried Professional -

o 50% in Aggressive equity funds

o 25% in High yield bond funds and growth & income funds.

o 25% in Conservative money market funds.

 For Young Couple with 2 incomes & 2 children

o 10% in Money Market Funds

o 30% in Aggressive Equity Funds

o 25% in High Yield Bond Funds and Long Term Growth Funds.

o 35% in Municipal Bond Funds.

 For Older Couple, Single Income

o 30% in Short Term Municipal Funds.

o 35% in Long Term Municipal Funds

o 25% in Moderately Aggressive equity funds.

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 o 10% in Emerging growth equity funds

 For Recently Retired Couple

35% in Conservative equity funds for capital preservation.

25% in Moderately Aggressive equity for modest capital

growth

o 40% in Money market funds.

JACOB’S MODEL PORTFOLIO FOR INVESTORS

 Investors in accumulation phase:

Asset Allocation %

Diversified Equity, Sector & Balanced Funds 65 to 80

Income & Gilt Funds 15 to 30

Liquid Funds & Bank Deposits 5

 Investors in Transition Phase:

o Mid-forties when children are approaching the age of higher education or marriage.

o Start Converting

• Some of your equity investment into income and cash funds

• To prepare for these financial commitments.

 Investors in Distribution or Reaping Phase: -

Assets Class Allocation %

Diversified Equity & Balance Funds 15 to 30

Income Funds 65 to 80

Cash Funds 5

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 MODEL PORTFOLIO OF INDIAN INVESTORS BASED ON MUTUAL FUNDS
AVAILABLE IN INDIA

 Investors in Intergenerational Transfer Phase

Young Investor up to age 50 years

o Life Insurance Policy

o To take care of next generation in the event of death.

Older Investors

o For grown up children

• Balanced Corithination of Income & Growth Funds

For grand children

Growth funds

For charitable institutions

Income funds to provide current income.

Investors in Sudden Wealth Stage

Keep money in Liquid Funds.

o Take time to decide what to do

with the money.

Affluent Investors

o Wealth Creating Individuals — 70% to 80% in Diversified Equity and

Sector Funds.

o Wealth Preserving Individuals — 70% to 80% in Income, Gilt & Liquid

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 Funds.

EQUITY FUND SELECTION FOR A CLIENT

 Select Specified Fund I Schemes For Inclusion in The Model Portfolio.

Bogle Approach:

 Selecting equity funds

o Classify the available equity schemes into growth, value, equity income,

broad based specialty etc.

o Either Select main stream growth or value fund providing broad

diversification.

o Select differentiated growth or value fund or specialty fund where risk and
return vary from market.

o Evaluate past returns records of avai funds

Review Salient Feature Of A Scheme

o Fund size

o Fund age

o Portfolio managers experience

o Cost of investing

o Portfolio characteristics cash position, portfolio concentration, market

capitalization

o Portfolio turnover

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 o Portfolio statistics

o Ex Marks, Beta, Gross Dividend Yield.

DEBT FUND SELECTION FOR A CLIENT

Selecting Debt Funds

 Narrow down the choice

 Know your investors’ objectives

o For young investors- long term bond funas

o For retired investors- monthly income funds

 Determine the right selection criteria

o Fund age

o Fund size

o Relative yields

o Relative costs

o Portfolio characteristics

o Average maturity

o Tax implication

o Bonds vs bond fund

o Post returns and

o Expense performance

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SELECTING MM / BALANCE FUNDS FOR A CLIENT

 Selecting Money M Funds

o Costs, quality, yields.
 Selecting Balance Funds

o Rarely- 50/50
o Equity oriented balanced funds or income oriented balanced funds.
o Selection criteria (Portfolio Balances, Debt Portfolio
o Characteristics , Costs, Portfolio Statistics, Returns)

Chapter-XIII

Business Ethics
For
Mutual Funds

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WHAT IS MEANT BY BUSINESS ETHICS?

 Business ethics means rules of acceptable & good conduct

 Every person engaged in any business must comply with a set of mies of good
conduct

 Rules may be set by those who own and manage business or by agencies regulating
such business

 In addition to laws, rules of ethics are adopted by the business practitioners

themselves

 Ethics go beyond the laws

 Laws are enforced by regulators. Ethical codes are self enforced.

WHAT IS THE NEED FOR BUSLNESS ETHICS

 The need for business ethics arises from the need to protect the consumer

 Ethical practices means practices in the interest of the consumer of a product or user
of a service

 A consumer who feels cheated once will not buy the product again.

 Mutual funds and their sales person are required to adopt ethical and good business
practices

 Consumer of goods and services expect the goods and services meets the promises.

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  A sales persons is expected to know the product thoroughly

 Not promising more than what the product gives is an ethical business practice.

 AMFI’s code sets a common set of rules for all the funds.

OBJECTIVES OF BUSINESS ETHICS

 One major objective of business ethics is being honest, open and transparent with
your potential clients.

 another objectives of business ethics is to protect the consumer of goods &services

from being cheated or exploited

 In mutual fund industry the product is described in detail in the

 offer documents.

 AMF sets rules of goods conduct by fund distributed

SOME KEY TERMS OF BUSINESS ETHICS

 Fair business practice Ensure that business is cqnducted both hi the

 interest of the seller and consumer! investors.

 Ethical standards are bench marks set for acceptable level of performance

 Ethical norms or guidelines: these norms may be voluntary or compulsory

 A code of conduct: it is voluntarily adopted set of good conduct,

 acceptable to the business participants, the regulators & SRO’s

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  Ethical business practices: they ensure with compliance with rules &code of good
conduct.

 Conflict of interest: in mutual fund business there are situations where the interest of
the investors runs counter to the interest of the agent

BUSINESS ETHICS & MUTUAL FUND REGULATIONS IN INDIA

 The main role of SEW is to protect the interest of the investors.

 SEBI encourages development of ethical standards among the mutual thnds

 SEBI guidelines require mutual funds and AMFI to develop code of

 conduct for

o Distributors

o Fund managers all employees

o Associate persons

 SEBI also lays down its own rule of ethics for certain matters incorporated in the
Mutual Fund regulations

 SEBI mandates that all activities are done in the best interest of the regulators mid it
monitors 3 areas

o Fund structure and governance

o Exercise of voting right’s by finds

o Fund operations

 The Mutual Fund structure in India is

o A 3 tier structure

o With sponsor, trustees & AMC as independent bodies

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  AMC’s are supervised by independent trustees

o Who have fiduciary responsibility towards the Investors.

 There is a separation of functions,

o AMC charged with investment of funds and they don’t hold

asset of the fund.

o The Trust holds investment assets in fiduciary capacity since

beneficial owners are investors.

o Trustees actually don’t hold the trusts assets — investment assets

are held by the custodians.

 By separating ownership, management & custody of assets

 fraudulent use of assets is prevented.

 Board of trustees have at least 2 I independent directors

o Thus ensuring independence of organization.

 AMC board has at least 50% independent directors

Thus reducing the influence of the promoter.

 The Mutual Funds have to exercise voting rights in the companies

o In the interest of fund investors and

o Not in the interest of fund managers or promoters or employees.

 It is an Ethical but not a legal requirement

 SEBI expects day to day find operations to be free from unethical business practices.

o Insider trading regulations

o No preferential treatment to selected investors

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 o Control over personal trading by find managers and employees

o Uniform cut Off Time for accepting subscription application & for

determining applicability of uniform NAVs to all customers.

o Personal trades to be disclosed by the fund managers and the directors.

o All forms of advertisements to be as per SEBI regulations. To ensure that they

don’t mislead the investor

o Regulations require the trustees of the mutual fund to certify that the persons
of the AMC do not indulge in front running or self dealing.

o There are regulations on hind advertisements.

 SEBI has made it mandatory for the AMC to appoint a compliance

officer to ensure implementation of laws and mutual find regulation & voluntary code
of conduct.

 SEBI requires all distributors to follow a code of conduct.

 AMFI has put in place amore detailed code of conduct called AGNI

 Mutual funds have to report any violation of all these regulations.

BUSINESS ETHICS & FUND REGULATIONS IN THE U.S.

 The U.S Regulator (Security Exchanges Commission) Require at least 75% of the
funds board to be independent directors including the Chairman.

 Independent directors are required meet separately every quarter and make self
assessment of their effectiveness

 SEC requires registered investment advisors to adopt and enforce codes of ethics
applicable to their supervised persons, including personal trading

 Supervised persons have to acknowledge in writing receipt of copy of the code of

Ethics.

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 An advisor’s code will require the advisor’s supervised persons to comply with
applicable federal securities laws.

o There is requirement of reporting of personal securities holding &

transactions, including transactions in Mutual Funds advised

o by the advisor.

o The code requires access persons to pre clear any personal investments in
IPOs

o Prevention of disclosure of material non public information about the advisors

Buy and sell recommendations.

o Reporting of code violations to the compliance officer

 The law requires intuitional investors to invest as a prudent man would invest.

 The mutual fund managers have also to follow ‘Prudent Man’

 Approach’ & ‘Responsible Investing Approach’ even though there is no law.

 Responsible Investing means

o Ethical criteria may preclude investing in companies manufacturing cigarettes

or alcohol

o Voting in share holders meeting in the interest of the investors.

o Community investing to help the tinder privileged communities.

 New Regulations & Fair Business Practices Require

o AMCs to avoid making special payments to distributors and brokcrs

o Uniform cut off time for all finds for NAV calculations

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 OBSERVATION AND FINDINGS
If we analyze all the above findings from the survey, it gives a very clear picture regarding
the awareness investment avenues available in India and it gives an idea on the financial
planning done by people of Bhubaneswar to make their future more safe. The finding,
visualizes the perception of the population regarding Mutual funds.

From the analysis we can say, that People are more ever aware of investment avenues like
Bank FD, Postal FD, and Insurance, while more than 60% of people know there exists an
investment avenue called Mutual fund.

But unfortunately they have very little idea about the percentage of returns delivered by some
of the performing Mutual funds (where the average return was 26.3%). That is one of the
vital points, why they never took an interest in Mutual h In we can also see that people who
have some idea are only aware of the Returns provided by mutual finds. they are hardly
aware other attributes like moderate risk and tax benefits etc.

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We can conclude that if some strong steps are taken in creating an awareness of Mutual finds,
with its entire technicality, vyhich will certainly help in the growth of Mutual fund market in
Bhubaneshwar.

Due to unawareness and less knowledge regarding mutual hinds people still don’t believe
investing a chunk of their money into it. It has only been able to penetrate a small portion of
the population. People th Bhubaneshwar are still unaware of the benefits of SIP, which can
attract a larger part of the rural areas population to invest in Mutual funds. This is because
most of the populations belong to the middle class category and are now in the process of
growth in their economic standards.

Very few people have now chosen Mutual fund as an investment option and this is mostly
due to the past experience with UTI. So, now they are not interested in putting money into
mutual funds.

So there is a strong requirement of educating these people about the regulatory body that now
are actively working as watch dogs that are keeping track of this industry and ensuring it as a
safe investment avenue.

Bank & postal Fixed Deposits and Insurance were more preferred avenues five yeas back.

In the recent times, the Insurance has become a more preferred avenue in comparison to
others. And simultaneously mutual funds, equity market investments and real estate are
getting included th the investment portfolio.

One forth of the populations still don’t believe in new investment avenues, and these mostly
include the old people, who have witnessed the era before late nineties.

In Bhubaneswar people still don’t believe in taking professionals help for managing their
investment portfolio, which makes them unaware new in avenues in market and they miss the
opportunity.

In India Mutual fund Industry has seen Dramatic improvements in Quality as well as quality
Qf products and services offering over the past decade, but the industmy has witnessed
growth in the last 10 years considerably below

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Potential.

The Asset under Management have grown from about Rs. 470 billion in march 1993 to Rs.
1,540 billion in April 2004(CAGR of 11.4 percent) & now it grown to Rs. 1,679 billion till
June 2005. This has mainly achieved due to collection through mutual tund IPO’s that has
been increasing due to the investors feeling that it is cheaper in its IPO stage on account of its
Rs. 10 NAy.

There has been a strong appreciation in equities in comparison to the debt market which has
shown a downward trend last year. Aiid in turn Mid-cap and diversified funds have delivered
the highest in comparison to other funds. As the Indian economy is showing a growing trend
with GDP more than 6% and expected to show 8% and Indian household saving being 24%
of the entire GDP. There is a strong growth potential of Mutual fund.

CONCLUSION
Despite its crucial importance, the Mutual Funds are the least understood and most
misunderstood phenomenon, particularly by the retail investor. All economists, all over the
world, recognize him as the main artery supplying blood to the heart of the economy of the
nation. It is necessary to try and impart the much-needed insight into the system and clear his
cobwebs, in an Endeavour to help him understand this phenomenon. -

There has been a perceptible change In sweeping across the mutual fund landscape in India.
Factors such as changing investors’ needs and their appetite for risk, emergence of Internet as
a powerful servicing platform, and above all the growing commodization of mutual fund
products are acting as a major catalysts putting pressure on industry players to formulate
strategies to stay die course.

In the changed scenario today, product innovation is increasingly becoming one of the key
determinants of success, Building and sustaining a powerful brand is also becoming an issue
of paramount importance. Increased deregulation of the financial markets in the country

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coupled with the introduction of derivative products offers tremendous scope for the industry
to design the sell innovative schemes to suit individual customer needs.

Distribution has taken a whole new meaning with the introduction of automated trading,
clearing and settlement system. Factors such as cross- selling through modes like financial
institution, banks, post-offices and co branded credit cards are bound to play a decisive role
in the success of the industry players. Mutual funds still after 40 years of its presence doesn’t
have a strong foothold. The main reasons behind this are past experience faced by most of the
old people with lt. S 64 crisis, and the awareness level on all the benefits provided by this
Industry.

As we can see a steady growth in the economy of India where, the BSE sensex has crossed
the magic around 12000 points mark and the GDP which is growing at present percentage of
9 and above, along with the flow of FIIs which are playing vital role in the growth of the
economy. The market is showing strong increase in the midcap companies that are in
growing stage. Until now, any change in FII investment strategies would rock the market and
have a severe impact on valuations. But, if mutual fluids and domestic financial institutions
have a larger stake in the market, it is more likely to remain stable. So more initiatives needs
to taken for creating the awareness of mutual funds among the retail investors, which is the
larger section of the entire Indian population. So we can say that, Mutual funds in India, as an
investment vehicle, still have a miniscule penetration level compared to that in develop
countries. This certainly portends plenty of opportunity.

Orissa as a market was not that efficient few years back, but now with lot of multinational
companies and other reputed companies coming down, the Orissa market is slowly picking
up. For mutual funds it is one of the emerging markets that can be trapped form its
developing stage and though people of rural areas prefer Moderate risk they can easily accept
mutual funds. So, Mutual Fund industries can use these market conditions and the
opportunities coming up for creating more awareness, It should try to capture the retail
investors along with the HNI’s those are going to put a substantial effect on the mutual fund
market. And help its customers to properly manage their disposable fluids and generate

104
returns from their investments. Which in turn will give a strong stability to the market if not
entirely, but certainly to a great extent. And in turn the Mutual fund industry will flourish in
Orissa / Bhubaneswar and India at large.

BIBLOGRAPHY

 SBI :SBI Mutual Fund Handbook

 Magazine :Business Today

: Business World

 News Papers :Economics Times

: Financial Express

 Website :www.sebigov.in

: www.arnfiindia.com

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