Mutual Funds

An Investors
Guide
(AIMT,AMBALA)

Submitted

to:

Submitted by :
Ashwani Gupta(B.M)

Gurmeet kaur

Chand Kapoor(T.M)

M.B.A 3rd

INDEX
1. Executive Summary
2. Introduction
2.1 ) Concept of Mutual Funds.
2.2 ) Organization of Mutual Fund
2.3) History of Indian Mutual Fund Industry
2.4) Types of Mutual Fund
2.5) Advantages of Mutual Fund.
2.6 )

The future Market Trends of Mutual Fund Industry.

3. Investment Management

3.1) Preface of Investment Management

3 .2) Types of Portfolio Management
3.2.1)Equity Portfolio Management
3.2.1 a ) Types of Equity Instruments
3.2.1b) Equity Classes
3.2.1c) Approaches to equity portfolio management
3.2.2) Debt Portfolio Management
3.2.2 a ) Types of Debt Instruments
3.2.2b) Debt Classes
3.2.2c) Approaches to Debt portfolio management
4. How to choose the right Mutual Fund scheme- An Investors Guide
4.1 ) What should be kept in mind before investing in Mutual Funds
4.1.1) 5 Things you must see before investing in a Mutual Fund
4.1.2) Common Investment Mistakes
4.2) Risk & Reward in Mutual Funds
4.2.1 ) Types of Risks
4.2.2) How Mutual Funds can help Reduce Risk
4.2.2. a) Strategies to Reduce Risks
4.3) Tax and Mutual Funds
5. Measuring and Evaluating Mutual Fund Performance
5.1) Different Performance Measures
5.1.1) Change in NAV
5.1.2) Total Return
5.1.3) Expense Ratio
5.1.4) Transaction Costs

5.1.5) Fund Size

5.2) Evaluating Funds Performance
5.2.1.) Benchmark Relative to Market
5.2.2) Benchmark Relative to Other Mutual Funds
5.2.3) Benchmark Relative to other Financial Products
6. Caselet on how Mutual Funds are Recommended
7. Bibliography

ACKNOWLEDGEMENT

Any work of this magnitude requires the inputs, efforts and encouragement of people
from all sides. In this project report I have been fortunate in having got the active cooperation of many people, whom I would like to thank.
I would like to thank Mr Ashwani Gupta, Mr. Chand Kpoor, and Mr.Sandeep Attray at
ShareKhan ltd.office for giving me an opportunity to work and enlightening my ways
whenever I need in completion of this project. Their able guidance and support helped
me a lot.

(Gurmeet kaur)

Executive Summary
Investment Planning involves identifying your financial goals throughout your life, and
prioritizing them. Investment Planning is important because it helps you to derive the
maximum benefit from your investments. Your success as an investor depends upon
your ability to choose the right investment options. This, in turn, depends on your
requirements, needs and goals. For most investors, however, the three prime criteria of
evaluating any investment option are liquidity, safety and return.
Investment Planning also helps you to decide upon the right investment strategy.
Besides your individual requirement, your investment strategy would also depend upon
your age, personal circumstances and your risk appetite. Investment planning is
necessary for every one who wishes to achieve any financial goal. You have to plan
your limited resources to avail the maximum benefit out of them. You should plan your
investments to fulfill major needs like:

Creating wealth over the long term

Acquiring assets like a dream house or a dream car

Fulfilling your need for financial security

Thus, Investment Planning is nothing but a holistic approach to meet your life's goals.
The investments avenues available to one are:
Apart from illiquid avenues like real estate, jewellery there is four major investment
avenues available to you, namely:

Debt Instruments

Equity

Money Market Instruments

Mutual Funds

In this project I would be focusing on investments through Mutual Funds. The projects
aims at giving a brief glimpse into the Mutual Fund Industry, what mutual funds are ,

some of the basic concepts of mutual funds, how it is better than other investment
instruments in the market . It gives an insight into the mutual funds , what it is made up
of , how to invest in it , how it is managed and what are the things one should see to
measure and evaluate performance of various mutual fund schemes in the market. This
project comprises of 6 chapters.
The first chapter deals with the introduction of mutual fund concept to give a clearer
picture to the investors. This chapter provides the basic knowledge about what mutual
funds are .It deals with the definitions of mutual funds, the advantage it has over other
instruments and the types of mutual funds available and the history and future trends of
Mutual Funds industry.
The second chapter deals with Investment Management. It is a specialist function and
forms the foundation of a mutual fund business. It talks about what is equity and debt
portfolio, what constitutes them, what are the strategies available to a fund manager to
select from a vast pool of equity and debt instruments. It is an important and demanding
function for a fund manager to maintain an ever profiting portfolios.
Investment decisions taken today directly affect our future wealth; it would make sense
that we utilize a plan to help guide our decisions. The mutual fund scheme you choose
should provide direction and meaning to your financial decisions which can vary from
saving for your child's education or planning for retirement . So it is very important to
choose the right mutual fund scheme. Our third chapter is about what investors should
keep in mind before choosing a mutual fund scheme. It

educate investors about the

common mistakes one makes while choosing a mutual fund scheme and the five things
one must see before investing in a mutual fund scheme. It would be foolish to say that
Mutual funds are risk free. As its portfolio comprises of market instruments, there is risk
involved in it .As higher the risk greater the returns/loss and lower the risk lesser the
returns/loss.

Thus it is necessary for an investor to understand the Risk- Return

Tradeoff, what are the different types of risk available in the market and how mutual
funds reduce these risks through there properties of diversification, asset allocation and
rupee cost averaging.

Mutual funds can be a tax efficient instrument for investing. The following sub part
details on the tax provisions and benefits that apply to Mutual funds. It highlights the
taxation aspect of mutual funds with respect to the fund investor.
The

next chapter deals with imperative measures used to measure and evaluate the

performance of a mutual fund scheme. The final task for the investor is to choose a
mutual fund scheme after deciding its objectives of investment, its risk profile and cash
flow requirements. Before doing the same its is important to measure and evaluate the
performance of various schemes available in the market. This chapter throws light on
the absolute (NAV, Total Return etc) and relative measures like benchmarking the
scheme against the markets or other mutual fund schemes available. In the last a case
study has been given describing how a fund manager recommends a Mutual Fund
scheme depending on the investment objectives of the investor
The volumes of Indian mutual fund industry will keep flourishing in future as investors
will have wider belief and faith in mutual funds units. It may be mentioned here that
since 1987, its size was Rs.10bn . Since than this figure has kept ballooning, revealing
the efficiency of growth in the mutual fund industry which at current level is estimated to
be over Rs2000bn.
The ASSOCHAM study highlights that mutual funds will be one of the major instruments
of wealth creation and wealth saving in the years to come. The consistency in the
performance of the Mutual Funds has been a major factor for attracting many investors.
It has been observed that investors have now changed their view about the stock
market. Unlike earlier, investors have now developed more confidence and trust in the
stock market functioning. A majority of investors has reported interest in Mutual Funds
as these Mutual funds provide a great variety of schemes where they can invest. It is
observed that these are formed according to the requirements of the investor, be it
open-ended, close-ended tax saving or index fund, all are formed according to the need
of investors.

INTRODUCTION
2.1) Concept of Mutual Funds
These days you are hearing more and more about mutual funds as a means of
investment. If you are like most people, you probably have most of your money in a
bank savings account and your biggest investment may be your home. Apart from that,

investing is probably something you simply do not have the time or knowledge to get
involved in. You are not the only one. This is why investing through mutual funds has
become such a popular way of investing.

What is a Mutual Fund?

Like most developed and developing countries the mutual fund cult has been catching
on in India. There are various reasons for this. Mutual funds make it easy and less
costly for investors to satisfy their need for capital growth, income and/or income
preservation.
And in addition to this a mutual fund brings the benefits of diversification and money
management to the individual investor, providing an opportunity for financial success
that

was

once

available

only

to

select

few.

Understanding Mutual funds is easy as it's such a simple concept: a mutual fund is a
company that pools the money of many investors -- its shareholders -- to invest in a
variety of different securities. Investments may be in stocks, bonds, money market
securities or some combination of these. Those securities are professionally managed
on behalf of the shareholders, and each investor holds a pro rata share of the portfolio -entitled to any profits when the securities are sold, but subject to any losses in value as
well.
For the individual investor, mutual funds provide the benefit of having someone else
manage your investments and diversify your money over many different securities that
may not be available or affordable to you otherwise. Today, minimum investment
requirements on many funds are low enough that even the smallest investor can get
started in mutual funds. A mutual fund, by its very nature, is diversified -- its assets are
invested in many different securities. Beyond that, there are many different types of
mutual funds with different objectives and levels of growth potential, furthering your
chances to diversify

Some of the definitions of Mutual Fund are:

1. A mutual fund is a common pool of money in to which investors with common
investment objective place their contributions that are to be invested in accordance with
the stated investment objective of the scheme. The investment manager would invest
the money collected from the investor in to assets that are defined/ permitted by the
stated objective of the scheme. For example, an equity fund would invest equity and
equity related instruments and a debt fund would invest in bonds, debentures, gilts etc.
2, A Mutual Fund is an investment tool that allows small investors access to a welldiversified portfolio of equities, bonds and other securities. Each shareholder
participates in the gain or loss of the fund. Units are issued and can be redeemed as
needed.

The

fund's

Net

Asset

Value

(NAV)

is

determinedeachday.

3. Mutual Funds are financial intermediaries. They are companies set up to receive
your money, and then having received it, make investments with the money Via an
AMC.

It is an ideal tool for people who want to invest but don't want to be bothered with
deciphering the numbers and deciding whether the stock is a good buy or not. A mutual
fund manager proceeds to buy a number of stocks from various markets and industries.
Depending on the amount you invest, you own part of the overall fund.
The beauty of mutual funds is that anyone with an investible surplus of a few hundred
rupees can invest and reap returns as high as those provided by the equity markets or
have a steady and comparatively secure investment as offered by debt instruments.

Mutual Fund Operation Flow Chart

2.2 ) Organization of a Mutual Fund

There are many entities involved and the diagram below illustrates the organizational
set up of a mutual fund:

The structure consists of

Sponsor
Sponsor is the person who acting alone or in combination with another body corporate
establishes a mutual fund. Sponsor must contribute at least 40% of the net worth of the
Investment Managed 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. At least 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. At least 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 net worth of at least 10 crore at all
times.

Registrar and Transfer Agent

The AMC if so authorized by the Trust Deed appoints the Registrar and Transfer Agent
to the Mutual Fund. The Registrar processes the application form, redemption requests
and dispatches account statements to the unit holders. The Registrar and Transfer
agent also handles communications with investors and updates investor records.

2.3) History of the Indian Mutual Fund Industry

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

First Phase 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up
by the Reserve Bank of India and functioned under the Regulatory and administrative
control of the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the
Industrial Development Bank of India (IDBI) took over the regulatory and administrative
control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the
end of 1988 UTI had Rs.6, 700 crores of assets under management.

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

1987 marked the entry of non- UTI, public sector mutual funds set up by public sector
banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation
of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June
1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund
(Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda
Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC had set
up its mutual fund in December 1990.At the end of 1993, the mutual fund industry had
assets under management of Rs.47, 004 crores.

Third Phase 1993- 1996 Emergence of Private Funds

Anew era in the Mutual Fund industry began in 1993 with the permission granted for the
entry of private sector funds. This gave the Indian investor a broader choice of fund
families and an increasing competition to the existing public sector funds. Quite
significantly, foreign fund management companies were also allowed to operate mutual

funds. These private funds have brought with them the latest product innovation,
investment management techniques and investor servicing technology that make the
Indian mutual fund industry today a vibrant and growing financial intermediary. The
factors that contributed to greater invertors confidence were:
1. The development of SEBI, s regulatory framework for the Indian mutual fund
industry.
2. The steadily improving performance of several fund houses.
Investors now clearly saw the benefits of investing through mutual funds and became
discerning and selective.

Fourth Phase 1996-1999: Growth and SEBI Regulation

Since 1996 the mutual fund industry in India saw tighter regulation and higher growth .It
scaled new heights in terms of mobilization of funds and number of players. Measures
were taken by SEBI to protect the investor and by the Government to enhance
investors returns through tax benefits. A comprehensive set of regulation for all mutual
funds operating in India was introduced with SEBI Regulation s, 1996. These
regulations set uniform standards for all funds. Similarly the Budget of Union
Government in 1996 took a big step in exempting all mutual funds dividends from
income tax in the hands of investors. .During this phase, both SEBI and AMFI launched
investor awareness programmed aimed at educating the investors in investing through
mutual funds.

Fifth Phase 1999-2004: Emergence of large and uniform industry

The other major development in the fund industry has been the creation of level playing
field for all mutual funds operating in India. This happened in February 2003 ,when the
UTI Act was repealed .UTI no longer had a special legal status and had to adopt the
same structure as any other fund in India a Trust and an Asset Management
Company. Between 1999 and 2005, the size of the industry has doubled in terms of
assets under management which have gone from about Rs. 6800 to over Rs. 150,000
crores. Within the growing industry relative market shares of different players in terms of
amount mobilized and assets under management have also undergone changes.

Sixth Phase 2004: Consolidation and Growth

The industry has lately witnessed a spate of mergers and acquisitions, most recent one
being the acquisition of schemes of Alliance Fund by Birla Sun Life etc. At the same
time, more international players continue to enter India .The mutual fund industry has
entered its current phase of consolidation and growth. As at the end of September,
2004, there were 29 funds, which manage assets of Rs.153108 crores under 421
schemes.

2.4 ) Types of Mutual Funds

Getting a handle on what's under the hood helps you become a better investor and put
together a more successful portfolio. To do this one must know the different types of
funds that cater to investor needs, whatever the age, financial position, risk tolerance
and return expectations. The mutual fund schemes can be classified according to both
their investment objective (like income, growth, tax saving) as well as the number of
units (if these are unlimited then the fund is an open-ended one while if there are limited
units then the fund is close-ended).

By Structure
1. Open-ended schemes

Open-ended schemes do not have a fixed maturity period. Investors can buy or sell
units at NAV-related prices from and to the mutual fund on any business day. These
schemes have unlimited capitalization, open-ended schemes do not have a fixed
maturity, there is no cap on the amount you can buy from the fund and the unit capital
can keep growing. These funds are not generally listed on any exchange.
Open-ended schemes are preferred for their liquidity. Such funds can issue and redeem
units any time during the life of a scheme. Hence, unit capital of open-ended funds can
fluctuate on a daily basis. EG: SBI Bluechip Fund-Growth, Reliance Vision Fund.
Benefits of Open-ended Schemes
Liquidity
In open-ended mutual funds, you can redeem all or part of your units any time you wish.
Some schemes do have a lock-in period where an investor cannot return the units until
the completion of such a lock-in period.
Convenience
An investor can purchase or sell fund units directly from a fund, through a broker or a
financial planner. The investor may opt for a Systematic Investment Plan (SIP) or a
Systematic Withdrawal Advantage Plan (SWAP). In addition to this an investor
receives account statements and portfolios of the schemes.
Flexibility
Mutual Funds offering multiple schemes allow investors to switch easily between
various schemes. This flexibility gives the investor a convenient way to change the mix
of his portfolio over time.
Transparency
Open-ended mutual funds disclose their Net Asset Value (NAV) daily and the entire
portfolio monthly. This level of transparency, where the investor himself sees the

underlying assets bought with his money, is unmatched by any other financial
instrument. Thus the investor is in the know of the quality of the portfolio and can invest
further or redeem depending on the kind of the portfolio that has been constructed by
the investment manager.
Close ended schemes
Close-ended schemes have fixed maturity periods (generally ranging from 3 to 15
years)... Investors can buy into these funds during the period when these funds are
open in the initial issue. These schemes are launched with an initial public offer (IPO)
with a stated maturity period after which the units are fully redeemed at NAV linked
prices. In the interim, investors can buy or sell units on the stock exchanges where they
are listed. Unlike open-ended schemes, the unit capital in closed-ended schemes
usually remains unchanged. After an initial closed period, the scheme may offer direct
repurchase facility to the investors. The market price of the units could vary from the
NAV of the scheme due to demand and supply factors, investors expectations and
other market factors. EG: Franklin India Tax shield 97 , & 98, Benchmark Split Capital
Fund Class A.
Interval funds
These funds combine the features of both openended and close-ended funds wherein
the fund is close-ended for the first couple of years and open-ended thereafter. Some
funds allow fresh subscriptions and redemption at fixed times every year (say every six
months) in order to reduce the administrative aspects of daily entry or exit, yet providing
reasonable liquidity.

Classification according to investment objectives

Mutual funds can be further classified based on their specific investment objective such
as growth of capital, safety of principal, current income or tax-exempt income.

Growth Funds
The aim of growth funds is to provide capital appreciation over the medium to longterm. Such schemes normally invest a majority of their corpus in equities. It has been
proven that returns from stocks, have outperformed most other kind of investments held
over the long term. Growth schemes are ideal for investors having a long-term outlook
seeking growth over a period of time.
Income Funds
The aim of income funds is to provide regular and steady income to investors. Such
schemes generally invest in fixed income securities such as bonds, corporate
debentures and Government securities. Income Funds are ideal for capital stability and
regular income.
Balanced Funds
The aim of balanced funds is to provide both growth and regular income. Such schemes
periodically distribute a part of their earning and invest both in equities and fixed income
securities in the proportion indicated in their offer documents. In a rising stock market,
the NAV of these schemes may not normally keep pace, or fall equally when the market
falls. These are ideal for investors looking for a combination of income and moderate
growth .For eg : DSP ML Balanced Fund , Kotak Balanced Fund

Money Market Funds

The aim of money market funds is to provide easy liquidity, preservation of capital and
moderate income. These schemes generally invest in safer short-term instruments such
as treasury bills, certificates of deposit, commercial paper and inter-bank call money.
Returns on these schemes may fluctuate depending upon the interest rates prevailing in
the market. These are ideal for Corporate and individual investors as a means to park
their surplus funds for short periods. Eg: DSP ML Lig(G), Llic MF Liquid.

Other Schemes:

Tax Saving Schemes

These schemes offer tax rebates to the investors under specific provisions of the Indian
Income Tax laws as the Government offers tax incentives for investment in specified
avenues. Investments made in Equity Linked Savings Schemes (ELSS) and Pension
Schemes are allowed as deduction u/s 80 C of the Income Tax Act, 1961. In a major
break through Section 88 under which the ELSS scheme qualified for rebate, with the
maximum amount to be invested in theses schemes was Rs 10000 has been replaced
by Section 80 C, which states that

investment up to Rs 1 lakh in ELSS Schemes by

individuals and HUFs are eligible for deduction under Section 80 C of the Income tax
Act, 1961. Investment is subject to a lock-in period of three years from the date of
allotment. EG :Prudential ICICI Tax Plan , HDFC Tax Saver

Special Schemes

Industry / Sectoral Specific Schemes

Sector mutual funds are those mutual funds that restrict their investments to a particular
segment or sector of the economy. These funds concentrate on one industry such as
infrastructure, heath care, utilities, pharmaceuticals etc. The idea is to allow investors to
place bets on specific industries or sectors, which have strong growth potential. The
investment of these funds is limited to specific industries like InfoTech, FMCG, and
Pharmaceuticals etc. For eg:

Index Schemes

Index Funds attempt to replicate the performance of a particular index such as the BSE
Sensex or the NSE 50.

By Risk Profile
The nature of a funds portfolio and its investment objective imply different levels of risks
undertaken. Funds are therefore often grouped in order of risk.
1. Equity Funds/ Growth Funds
Funds that invest in equity shares are called equity funds. They carry the principal
objective of capital appreciation of the investment over the medium to long-term. The
returns in such funds are volatile since they are directly linked to the stock markets.
They are best suited for investors who are seeking capital appreciation. There are
different types of equity funds such as Diversified funds, Sector specific funds and Index
based funds.

Diversified funds
These funds invest in companies spread across sectors. These funds are generally
meant for risk-taking investors who are not bullish about any particular sector. EG:
Magnum Global fund , HDFC Equity Fund-Growth .

Sector funds

These funds invest primarily in equity shares of companies in a particular business

sector or industry such as Pharmaceuticals, IT or FMCG. These funds are targeted at
investors who are extremely bullish about a particular sector. EG :Prudential ICICI
Technology Fund-Growth, Franklin Fast Moving Consumer Good Fund-Growth ETC.

Index funds

An index fund tracks the performance of a specific stock market index. These funds
invest in the same pattern as popular market indices like S&P 500 and BSE Index. The
value of the index fund varies in proportion to the benchmark index. The fund invests in
shares that constitute the index and in the same proportion as the index . EG: HDFC
Index Sensex Fund Growth, HDFC Index Nifty Fund Growth.

Tax Saving Funds

These schemes offer tax rebates to the investors under specific provisions of the Indian
Income Tax laws as the Government offers tax incentives for investment in specified
avenues. Opportunities provided under this scheme are in the form of tax rebates U/s 80
C as well saving in Capital Gains U/s 54EA and 54EB. They are best suited for
investors seeking tax concessions. EG: Prudential ICICI Tax Plan , HDFC Tax Saver

2. Debt / Income Fund

These Funds invest predominantly in high-rated fixed-income-bearing instruments like
bonds, debentures, government securities, commercial paper and other money market
instruments. They are best suited for the medium to long-term investors who are averse
to risk and seek capital preservation. They provide regular income and safety to the
investor. However compared to the money markets they do have higher price fluctuation
risk since they invest in long term securities. EG: Prudential ICICI LTP , Tata Income.
3. Liquid Funds / Money Market Funds
These funds invest in highly liquid money market instruments. The period of investment
could be as short as a day. They provide easy liquidity. They have emerged as an

alternative for savings and short-term fixed deposit accounts with comparatively higher
returns. These funds are ideal for Corporate, institutional investors and business houses
who invest their funds for very short periods. Eg: DSP ML Lig(G), Llic MF Liquid.
4. Gilt Funds
These funds invest in Central and State Government securities. Since they are
Government backed bonds they give a secured return and also ensure safety of the
principal amount. They are best suited for the medium to long-term investors who are
averse to risk. EG : ING VYSYA Gilt Portfolio, Reliance Gilt Securities.
5. Balanced Funds
These funds invest both in equity shares and fixed-income-bearing instruments (debt) in
some proportion. They provide a steady return and reduce the volatility of the fund while
providing some upside for capital appreciation. They are ideal for medium- to long-term
investors willing to take moderate risks. EG: DSP ML Balanced Fund , Kotak Balanced
Fund

Division Based on Capitalization

Large Cap Funds
Large cap funds are those mutual funds, which seek capital appreciation by investing
primarily in stocks of large blue chip companies with above-average prospects for
earnings growth.Different mutual funds have different criteria for classifying companies
as large cap. Generally, companies with a market capitalisation in excess of Rs 1800
crore are known large cap companies. Investing in large caps is a lower risk-lower
return proposition (vis--vis mid cap stocks), because such companies are usually
widely researched and information is widely available. EG: HDFC Equity Fund-Growth ,
Reliance Vision-Growth

Mid Cap Funds

Mid cap funds are those mutual funds, which invest in small / medium sized companies.
As there is no standard definition classifying companies as small or medium, each
mutual fund has its own classification for small and medium sized companies.
Generally, companies with a market capitalization of up to Rs 500 crore are classified as
small. Those companies that have a market capitalization between Rs 500 crore and Rs
1,800 crore are classified as medium sized.

Big investors like mutual funds and Foreign Institutional Investors are increasingly
investing in mid caps nowadays because the price of large caps has increased
substantially. Small / mid sized companies tend to be under researched thus they
present an opportunity to invest in a company that is yet to be identified by the market.
Such companies offer higher growth potential going forward and therefore an
opportunity to benefit from higher than average valuations.

But mid cap funds are very volatile and tend to fall like a pack of cards in bad times. So,
caution should be exercised while investing in mid cap mutual funds. EG: Franklin India
Prima Fund-Growth , Prudential ICICI Dynamic Plan-Growth
Small Cap
The small cap stocks are for the most part companies most are unfamiliar with and they
are usually not followed to a great extend by analysts or individual investors.
Caps typically have a capitalization of less than Rs. 500 to Rs 600

Small

crores..EG:

Prudential ICICI Emerging STAR Fund-Growth , ING Vysya Dividend Yield Fund-Growth

Snapshot of Mutual Fund Schemes

Mutual
Fund

Objective

Risk

Type

Investment

Who should Investment

Portfolio

invest
Those

Liquidity
Money
Market

Treasury Bills, park

Certificate

Moderate
Income

+ Negligible

Reservation of
Capital

horizon
who
their

of funds

in

Deposits,

current

Commercial

accounts or

Papers,

Call short-term

Money

bank

2 days 3 weeks

deposits
Call

Short-

Commercial

term
Funds

Liquidity

(Floating Moderate
-

Money,

short- Income

Papers,

Those

with

Little Interest Treasury Bills, surplus

Rate

3 months

CDs,

Short- short-term

term

term)

weeks

funds

Government
securities.
Predominantly

Bond
Funds
(Floating
-

Long-

Regular
Income

Credit
&

Risk

Interest

Rate Risk

term)

Debentures,
Government
securities,
Corporate

Salaried

&

conservative
investors

More than 9 - 12
months

Bonds

Gilt

Security

& Interest Rate Government

Funds

Income

Risk

securities

Equity

Long-term

High Risk

Stocks

Funds

Capital

Salaried

&

conservative 12 months & more

investors
Aggressive
investors

3 years plus

Appreciation

with

long

term

out

look.
To

generate

returns that are

Index
Funds

NAV

varies

commensurate with

index

with returns of performance

respective

Portfolio
indices
BSE,

like Aggressive
NIFTY investors.

3 years plus

etc

indices
Balanced ratio
Balanced
Funds

Growth
Regular
Income

&

Capital

of equity and

Market Risk debt funds to Moderate &

and Interest ensure higher Aggressive
Rate Risk

returns

2 years plus

at

lower risk

2.5 ) Why invest in Mutual Funds.

Investing in mutual has various benefits which makes it an ideal investment avenue.
Following are some of the primary benefits.

1. Professional investment management

One of the primary benefits of mutual funds is that an investor has access to
professional management. A good investment manager is certainly worth the fees you

will pay. Good mutual fund managers with an excellent research team can do a better
job of monitoring the companies they have chosen to invest in than you can, unless you
have time to spend on researching the companies you select for your portfolio. That is
because Mutual funds hire full-time, high-level investment professionals. Funds can
afford to do so as they manage large pools of money. The managers have real-time
access to crucial market information and are able to execute trades on the largest and
most cost-effective scale. When you buy a mutual fund, the primary asset you are
buying is the manager, who will be controlling which assets are chosen to meet the
funds' stated investment objectives.

2. Diversification
The clich, "don't put all your eggs in one basket" really applies to the concept of
intelligent investing. A crucial element in investing is asset allocation. It plays a very big
part in the success of any portfolio. However, small investors do not have enough
money to properly allocate their assets. By pooling your funds with others, you can
quickly benefit from greater diversification Mutual funds invest in a broad range of
securities. This limits investment risk by reducing the effect of a possible decline in the
value of any one security. Mutual fund unit-holders can benefit from diversification
techniques usually available only to investors wealthy enough to buy significant
positions in a wide variety of securities.

3. Affordability
A mutual fund invests in a portfolio of assets, i.e. bonds, shares, etc. depending upon
the investment objective of the scheme. An investor can buy in to a portfolio of equities,
which would otherwise be extremely expensive. Each unit holder thus gets an exposure
to such portfolios with an investment as modest as Rs.500/-. This amount today would
get you less than quarter of an Infosys share! Thus it would be affordable for an investor
to build a portfolio of investments through a mutual fund rather than investing directly in
the stock market...

4. Convenience and Flexibility

Investing in mutual funds has its own convenience. While you own just one security
rather than many, you still enjoy the benefits of a diversified portfolio and a wide range
of services. Fund managers decide what securities to trade collect the interest
payments and see that your dividends on portfolio securities are received and your
rights exercised. It also uses the services of a high quality custodian and registrar.
Another big advantage is that you can move your funds easily from one fund to another
within a mutual fund family. This allows you to easily rebalance your portfolio to respond
to significant fund management or economic changes.

5. Liquidity
With open-end funds, you can redeem all or part of your investment any time you wish
and receive the current value of the shares. Funds are more liquid than most
investments in shares, deposits and bonds. Moreover, the process is standardized,
making it quick and efficient so that you can get your cash in hand as soon as possible.

6. Transparency
Regulations for mutual funds have made the industry very transparent. You can track
the investments that have been made on you behalf and the specific investments made
by the mutual fund scheme to see where your money is going. In addition to this, you
get regular information on the value of your investment. As a unit holder, you are
provided with regular updates, for example daily NAVs, as well as information on the
fund's holdings and the fund manager's strategy.

7. Variety
There is no shortage of variety when investing in mutual funds. You can find a mutual
fund that matches just about any investing strategy you select. There are funds that

focus on blue-chip stocks, technology stocks, bonds or a mix of stocks and bonds. The
greatest challenge can be sorting through the variety and picking the best for you.

8. Regulations.
All mutual funds are required to register with SEBI (Securities Exchange Board of India).
They are obliged to follow strict regulations designed to protect investors. All operations
are also regularly monitored by the SEBI.

9. Tax Benefits
Any income distributed after March 31, 2002 will be subject to tax in the assessment of
all Unit holders. However, as a measure of concession to Unit holders of open-ended
equity-oriented funds, income distributions for the year ending March 31, 2003, will be
taxed at a concessional rate of 10.5%.
In case of Individuals and Hindu Undivided Families a deduction up to Rs. 9,000 from
the Total Income will be admissible in respect of income from investments specified in
Section 80L, including income from Units of the Mutual Fund. Units of the schemes are
not subject to Wealth-Tax and Gift-Tax.

2.6) The future Market Trends of Mutual Fund Industry

The size of mutual fund industry is expected to be worth Rs4000bn by 2010 from its
current level of over Rs2000bn as this industry will keep growing at a CAGR of around
17%, according to a Study conducted by The Associated Chambers of Commerce and
Industry of India (ASSOCHAM) on `Mutual Fund : Futures Wealth Creator and Wealth
Saviour.

Company Affairs Minister, Mr. P C Gupta, says that investors in future will prefer
mutual funds for their investment destination than choosing to park their
surpluses in stock markets because of safer returns and lower degree of risk as
compared to other markets.
The ASSOCHAM Study has the compilation of observations made by over 210
investors across the country in which over 80% have exuded confidence that the
volumes of Indian mutual fund industry will keep flourishing in future as investors will
have wider belief and faith in mutual funds units. It may be mentioned here that since
1987, its size was Rs.10bn which went up to Rs41bn in 1991 and subsequently touched
a figure of Rs720bn in 1998. Since than this figure has kept ballooning, revealing the
efficiency of growth in the mutual fund industry which at current level is estimated to be
over Rs2000bn.
Mutual funds will be one of the major instruments of wealth creation and wealth saving
in the years to come, giving positive results. The consistency in the performance of the
Mutual Funds has been a major factor for attracting many investors. The Indian mutual
funds industry has been growing at a healthy pace of 16.68% for the past eight years
and the trend will move northward. Changing scenario of the market, government and
related authorities will also add a lot to the uplift of the Mutual Funds industry.
The presence of intelligent investors has already made the investment market scenario
fiercely competitive, with in increased number of foolproof high-yielding investment
opportunities. The industry has also witnessed several mergers and acquisitions. Mutual
Funds will be available in a wide range of schemes, providing investment opportunities
to all categories of the investors such as shares of corporate firms, commodities and
debt instruments.
The ASSOCHAM Study has revealed the futuristic nature of investors; they invest for
future security and certainty (54%). However, there were some investors who invest in
order to meet their current requirements (38%). In addition, it has been clearly indicated
by the respondents that investments that are long-term are preferred more (54%) over
medium-term (23%) and short-term investments (23%). It has also been perceived

during the survey that complete information about the investment instrument and about
the company of related mutual funds is required by the investors in order to take their
investment decision. Investors are keen to remain updated regarding the latest trends
being followed in the market so as to take full benefits of the market conditions.
It also discloses that Mutual Funds are open to various kinds of risk: international risk,
national risk, policy related risk, etc. The major risk faced by the investors is of uncertain
market conditions that are hard to predict. The reasons could be attributed to the
volatility/fluctuations in the market. Another large risk observed is the change in
government policy, the changes could be either by government or RBI on Mutual Fund
related policies or the economy as a whole that affect the Mutual Funds market.
It has been observed that investors have now changed their view about the stock
market. Unlike earlier, investors have now developed more confidence and trust in the
stock market functioning. It is also observed that the investors who directly make
investments in stock market prefer cash/spot market to futures and options market. It
was also observed that investors now focus on a wider market rather than concentrating
on single area. Among all the different areas of investment it was found that investors
are attracted more towards IT sector, followed by Banking, Drugs & Pharma,
Automobiles, Petro & Gas, Infrastructure, Telecom, Engineering, Textile and Steel.

3.2 ) Investment Management

Portfolio management is an important foundation of mutual fund business. The

performance of the fund measured by the risk adjusted returns produced for the investor

arises largely by successful portfolio management function. From the investors

perspective the need for successful portfolio management function is obviously
paramount. However in the complex world of financial markets it is a specialist function.
This is an attempt be aware of what different portfolio management styles and
approaches exist and how different styles may affect the expected fund performance.

3.2.1 )Equity Portfolio Management

An equity portfolio managers tasks consist of two major tasks:

Constructing a portfolio of equity shares or equity linked instruments that is

consistent with the investment objective of the fund

Managing and constantly re-balancing the portfolio to produce capital

appreciation and earning that would reward the investor with superior returns.

How to identify what kind of stock to include?

The equity portfolio manager has available to him a whole universe of equity shares and
other instruments such as preference shares, warrants or convertible debentures issued
by many companies. Even within each category of equity instruments, shares of one
company may be very different in terms of potential than shares of other companies.
So, how does the fund manager go about choosing from the different types of stocks, in
order to construct his portfolio? The general answer is that his choice of shares to be
included in a fund portfolio must reflect the investment objective of the fund. More
specifically, the equity portfolio manager will choose from a universe of investible shares
in accordance with
1. The nature of the equity instrument or a stocks unique characteristics.
2. A certain investment style or philosophy in the process of choosing.

However in reality, the group of stocks selected will have certain unique characteristics,
chosen in accordance with the preferred investment style, such that the portfolio as a
whole is consistent with the schemes objectives.

3.2.1 a) Types of Equity Instruments.

1. Ordinary Shares
Ordinary shareholders are the owners of the company, and each share entitles the
holder to ownership privileges such as dividends declared by the company and voting
rights at the meetings. Looses as well profits are shared by the shareholders. Equity is
risk investment, bringing with them the potential for capital appreciation in return for the
additional risk the investors undertakes.
2. Preference Shares
Preference share entitle the holder to dividends at fixed rates subject to availability of
profits after tax. If preference shares are cumulative, unpaid dividends for years of
inadequate profits are paid in subsequent years. It does not entitle the holder to
ownership privileges as voting rights at meetings.
3. Equity Warrants
These are long term rights that offer the holders the right to purchase equity shares in a
company at a fixed price (usually higher than the current market price) within the
specified period.
4. Convertible Debentures
These are fixed rate debt instruments that are converted into specified number of equity
shares at the end of the specified period. For example, a company may issue 10%
convertible debentures for Rs 100 each that would be converted into 5 equity shares
after 2 years i.e. a holder of one debenture at that time would become a holder of 5

equity shares in 2 years time. Clearly, convertible debentures are debt instruments until
converted; when converted, they become equity shares.

3.2.1b) Equity Classes

Equity shares are generally classified on the basis of either the market capitalization or
the anticipated movement of company earnings.
a) Classification in terms of Market Capitalization
Market Capitalization is equivalent to the current value of the company i.e. current
market price per share times the number of outstanding shares . There are Large
Capitalization companies, Mid Cap companies and Small Cap companies. Different
schemes of a fund may define their fund objective as a preference for Large or mid or
Small Cap companies shares. Large Cap shares are more liquid and hence easily trade
able. Mid and Small Cap shares may be thought of as having greater growth potential.

b) Classification in terms of Anticipated Earnings

In terms of anticipated earnings of the companies, shares are generally classified on the
basis of their market price in relation to one of the following measures:

Price/Earning Ratio

It is the price of the share divided by the earnings per share and indicates what the
investors are willing to pay for the companys earning potential. Young and fast growing
companies usually have high P/E ratios. Established companies in mature industries
may have lower P/E ratio.
Dividend Yield

Dividend yield for a stock is the ratio of dividend paid per share to current market prices.
Low P/E stocks usually have high dividend yields. What matters to fund managers is the
potential dividend yields based on earning prospects.
Based on companies anticipated earnings and in the light of the investment
management experience the world over, stock as are classified in the following
groups:
Cyclical Stocks
These are shares of companies whose earnings are correlated with the state of
economy. Cement or Aluminum producers fall into this category

Growth Stocks
Theses are the shares of companies whose earnings are expected to increase at the
rates exceed the normal market levels. They tend to reinvest earnings and usually have
high P/E ratios and low dividend yields. Fund managers try to identify the sectors
/companies that have high growth potential.
Value Stocks
These are shares of companies in mature industries and are expected to yield low
growth in earnings .fund managers try to identify such currently under valued stocks that
in their opinion can yield superior returns late.

3.2.1 c) Approaches to portfolio management

There are two approaches to portfolio management:

Passive Fund Management

Active Fund Management

Passive Fund Management

These are mutual funds that offer Stock Index Funds whose objective is to track a
specified share index and offer returns equal to the return from that index .while the
style of investment may be called passive, even in this case, the fund manager has to
make certain decisions. for example he can purchase all the securities forming the part
of the index in the same proportion in the index .Alternatively if the index stocks are too
many, he can purchase a statistically repersentive sample of stocks whose combined
total return will closely approximate that of the index. The choice of the sample is
important and can require some amount of research into the behavior of index stocks
.Similarly , the fund manager has to also rebalance the portfolio to remain in line with
change in the index composition.
Active Fund Management
Two basic investment styles prevalent among the mutual funds are:

Growth Investment Style

Value Investment Style

Growth Investment Style

The primary objective of equity investment is to obtain capital appreciation .however;

the different types of shares would tend to give different returns. Growth shares will
appreciate over the longer term if the investment managers assessment of the sector
proves right. These are funds which avoid the cyclical stocks in their portfolio and funds
that prefer to invest only in growth stocks. Growth manager looks for companies that are

expected to give above average returns; the manager feels that the earnings prospect
and therefore the stock prices in future will be higher.
Identifying such growth stocks is the challenge before the investment manager. In India
the funds recently identified three sectors as likely to have the greatest earning growth
in future; IT, FMCG and pharmaceuticals.

Value Investment style

A value manager looks to buy companies that they believe are currently undervalued in
the market ,but whose worth they estimate will be recognized in the market valuation
eventually. The value manager seeks to cash in on the capital appreciation in future by
selling shares of companies as and when the unlocking of the value takes place. Thus,
an undervalued company may eventually be taken over or merged with another
company, or when PSU may be privatized or a company may be effect a buy back of its
shares.

Active management style requires detailed research of stocks traded in the

market. While the objective of research is to establish a view on future stock
prices, it usually takes any of the three alternate forms:

Fundamental Analysis

It involves research into the operations and finance of a company with the objective of
estimating its future earnings and risk profile the researcher considers many factors
such as the companys position relative to other industry players, impact of the
regulatory environment and quality of management.

Technical analysis

It involves the study of historical data on the companys share price movements and
trading

volume.therefore,

factors

such

as

market

sentiment

and

trends

in

supply/demand are of particular relevance in this form of research.

It is generally accepted that fundamental analysis form the basis of fund managers
decision on whether to buy a share , while technical analysis would guide the decision
on the right timing to make the investment.

Quantities Analysis

It uses mathematical models for equity valuation and may also use fundamental and
technical information in tandem. In todays environment computer based models form
the basis for such analysis.

Successful equity portfolio management

Robert Pozen suggests the following steps to create and manage a robust portfolio:

Set Realistic target returns based on appropriate benchmarks.

Be aware of the level of flexibility available while managing the portfolio.

Decide on an appropriate investment philosophy i.e. whether to capitalize on

economic cycles, or to focus on growth sectors or on finding value stocks.

Develop an investment strategy based on investment objective. the time frame

for investment and economic expectations over a span of time.

Avoid over diversification

Develop a flexible approach to investing. Markets are dynamic and it is

impossible to buy stocks for all seasons.

3.2.2 ) Debt Portfolio Management

Debt Portfolio Management has to contend with the construction and management of
portfolios of debt instruments, with the primary objective of generating income. In
context of debt mutual funds, managers invest only in market traded instruments (not in
loans as done by banks).

3.2.2b) Debt Classes

Debt instruments may be secured by the assets of the borrower as generally in the case
of Corporate Debenture or be it unsecured as in the case of with the Indian Financial
Institution Bonds.
Debt instruments are also distinguished by their maturity profile. The instruments issued
with short term maturities, typically under one year, are classified as Money Market
Securities. Instruments carrying longer than one year maturities are generally called
Debt Securities.
Most securities are interest bearing. However, there are securities that are discounted
or zero coupon bonds that do not pay regular interest at intervals but are bought at the
discount to their face value. a large part of the interest paying securities are generally
fixed income paying , while there are securities that pay interest on Floating Rate basis.

3.2.2 a ) Types of Debt Instruments

The objective of debt fund is to provide investors with a stable income stream. Hence, a
debt fund invests mainly in instruments that yield a fixed rate of return and where
principal is secure. The debt fund market in India offers the following instruments for
investment in mutual funds.

Certificate of Deposit

These are issued by banks in denominations of Rs 5 lakhs and have maturity ranging
from 30 days to 3 years. Banks are allowed to issue CDs with a maturity of less than
one year while financial institutions are allowed to issue CDs with a maturity of at least
one year

Commercial Paper

A Commercial Paper is a short term unsecured promissory note issued by the raiser of
debt to the investor. In India Corporate, Primary Dealers (PD), Satellite Dealers (SD)
and

Financial

Institutions

(FIs)

can

issue

these

notes.

It is generally companies with very good ratings which are active in the CP market,
though RBI permits a minimum credit rating of Crisil-P2. The tenure of CPs can be
anything between 15 days to one year, though the most popular duration is 90 days.
Companies use CPs to save interest costs

Corporate Debenture

Debentures are issued by the manufacturing companies with physical assets, as

secured instruments in the form of certificates. They are assigned a credit rating by
rating agencies.

Floating Rate Bonds

These are short to medium term interest bearing instruments issued by financial
intermediaries and corporations. The typical maturity of these bonds is 3 to 5 years
FRBs issued by financial institutions are generally unsecured while those from private
corporations are secured.

Government Securities

These are medium to long term interest bearing obligations issues through RBI by the
Govt. Of India and state governments. The RBI decides the cut off coupon on the basis

of bids received during auctions. There are issuers where the rate is pre-specified and
the investor only bids for the quantity.

Treasury Bills

Treasury Bills are instruments issued by RBI at a discount to the face value and form an
integral part of the money market. In India Treasury Bills are issued in four different
maturities

14

days,

90

days,

182

days

and

364

days.

Apart from the above money market instruments, certain other short-term instruments
are also in vogue with investors. These include short-term corporate debentures, bills of
exchange

and

promissory

notes.

Bank / FI Bonds

Theses are negotiable certificates, issued by the Financial Institutions such as

IDBI/ICICI/IFCI or commercial banks. These instruments have been issued both as
regular income bonds and as discounted long term instruments.

PSU Bonds

It is medium to long term obligations issued by PSU in which the government share
holding is generally greater than 51%. Some PSU bonds carry tax exemption. The
minimum maturity is 5 years for taxable bonds and 7 years for tax free bonds.

Measures of Bond Yield

Returns on fixed income security are generally computed in the form of
1. Current Yield

2. Yield to Maturity
1. Current Yield
This relates interest on a bond to its current market price by dividing annual coupon
interest by the current market price. For example , the yield of a bond with a par value of
Rs. 1000 , coupon rate 10% and market price of 1200 is 8.33% (10% *1000 / 1200).
The yield of bond bears an inverse relationship to the movements in interest rate. foe
example , if interest rate on the similar newly issued bonds rise to 12% the bond in the
above example will become less attractive. Current yield as a performance measure is
simple to use, but ignores issues such as interest and gain/loss over purchase price
upon maturity.
2. Yield to Maturity
This is more sophisticated technique of bond analysis. It is the annual rate of return an
investor would realize if he bought a bond at a particular price, received all coupon
payments, reinvest the coupons at the same YTM rate and received the principal at
maturity. The relationship between YTM and price of a bond is an inverse relationship.
The different yield on the entire available universe of debt securities is tracked by the
fund managers with the help of yield curve.
Yield Curve
This is a graph showing yields from bonds of various maturities, using benchmark group
of bonds, such as Government securities. This is also known as Term Structure of
Interest Rates. (TSIR). It is an important indicator of expected trends in interest rates.
A

yield

curve

can

be

positive,

neutral

or

flat.

A positive yield curve, which is most natural, is when the slope of the curve is
positive, i.e. the yield at the longer end is higher than that at the shorter end of
the time axis. This is as a result of people demanding higher compensation for
parting their money for a longer time into the future.

A neutral yield curve is that which has a zero slope, i.e. is flat across time. This
occurs when people are willing to accept more or less the same returns across
maturities.

The negative yield curve (also called an inverted yield curve) is one of which the
slope is negative, i.e. the long-term yield is lower than the short-term yield. It is
not often that this happens and has important economic ramifications when it
does. It generally represents an impending downturn in the economy, where
people are anticipating lower interest rates in the future.

3.2.2c) Approaches to Debt portfolio management

1. Buy and Hold
Historically, in India, UTI and many other mutual funds tended to invest in high yielding
debt securities that give adequate returns on the overall portfolio. The returns are
considered sufficient to reward the investors. Therefore the funds would just encase the
coupons and hold the bonds until maturity. It has to be understood that the strategy
holds good as long as the general interest levels are stable.
2. Duration management
It like Active Fund Management. This strategy involves altering the average duration of
bonds in a portfolio depending on the funds manager expectations regarding the
direction of interest rates. If bonds yield are expected to fall, the fund manager will buy
bonds with longer duration and sell bonds with shorter duration, until the funds average
duration becomes longer than the markets average duration

3. Credit selection
Some debt managers look to investing in a bond in anticipation of changes in its credit
ratings. An upgrade of a bond credit rating would lead to increase in its price, thereby
leading to a superior return. The fund would need to analyze the bonds credit quality so
as to implement this strategy. It would require frequent trading of bonds in anticipation of
changes in ratings.

Interest rates and Debt Portfolio Management

Debt securities are always exposed to interest rate risk, as there price is directly
dependent on them. Their market value is dependent on interest rate movements, which
in turn affect the performance of fund portfolios of which they are a part.
The

factors

are

largely

macro-economic

in

nature

1. Demand/Supply of money: When economic growth is high, demand for money

increases,

pushing

the

interest

rates

up

and

vice

versa.

2. Government Borrowing and Fiscal Deficit: Since the government is the biggest
borrower in the debt market, the level of borrowing also determines the interest rates.
On the other hand, supply of money is done by the Central Bank by either printing more
notes or through its Open Market Operations (OMO).

3.

RBI: RBI can change the key rates (CRR, SLR and bank rates) depending on the

state of the economy or to combat inflation. RBI fixes the bank rate which forms the
basis of the structure of interest rates and the Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR), which determines the availability of credit and the level of money
supply in the economy.

(CRR is the percentage of its total deposits a bank has to keep with RBI in cash or near
cash assets and SLR is the percentage of its total deposits a bank has to keep in
approved securities. The purpose of CRR and SLR is to keep a bank liquid at any point
of time. When banks have to keep low CRR or SLR, it increases the money available for
credit in the system. This eases the pressure on interest rates and interest rates move
down. Also when money is available and that too at lower interest rates, it is given on
credit

to

the

industrial

sector

that

pushes

the

economic

growth)

Inflation Rate: Typically a higher inflation rate means higher interest rates. The interest
rates prevailing in an economy at any point of time are nominal interest rates, i.e., real
interest rates plus a premium for expected inflation. Due to inflation, there is a decrease
in purchasing power of every rupee earned on account of interest in the future; therefore
the interest rates must include a premium for expected inflation. In the long run, other
things being equal, interest rates raise one for one with rise in inflation.

4 ) How to choose the right Mutual Fund scheme

Once you are comfortable with the basics, the next step is to understand your
investment choices, and draw up your investment plan relevant to your requirements.
Choosing your investment mix depends on factors such as your risk appetite, time
horizon of your investment, your investment objectives, age, etc.

What should be kept in mind before investing in Mutual Funds?

Mutual Fund investment decisions require consistent effort on the part of the investor.
Before investing in Mutual Funds, the following steps must be given due weight age to
decide on the right type of scheme:
1. identifying the Investment Objective
2. Selecting the right Scheme Category
3. Selecting the right Mutual Fund
4. Evaluating the Portfolio

A)

Identifying

the

Investment

Objective

your financial goals will vary, based on your age, lifestyle, financial independence,
family commitments, level of income and expenses, among many other factors. For
each goal, be sure to consider:

Your risk tolerance

Your time frame

Therefore, the first step is to assess you needs. Begin by asking yourself these simple
questions:

Why do I want to invest?

The probable answers could be:

"I need a regular income"

"I need to buy a house/finance a wedding"

"I need to educate my children," or

A combination of all the above

How much risk am I willing to take?

The risk-taking capacities of individuals vary depending on various factors. Based on
their risk bearing capacity, investors can be classified as:

Very conservative

Conservative

Moderate

Aggressive

Very Aggressive

What are my cash flow requirements?

For example, you may require:

A regular Cash Flow

A lump sum after a fixed period of time for some specific need in the future

Or, you may have no need for cash, but you may want to create fixed assets for
the future

B) Selecting the scheme category

The next step is to select a scheme category that matches your investment objectives:

For Capital Appreciation go for equity sectoral funds, equity diversified funds or
balanced funds.

For Regular Income and Stability you should opt for income funds/MIPS

For Short-Term Parking of Funds go for liquid funds, floating rate funds, shortterm funds.

For Growth and Tax Savings go for Equity-Linked Savings Schemes.

Investment

Investment

Ideal Instruments

Objective
Short-term
Investment
Capital
Appreciation

horizon
1- 6 months

Liquid/Short-term plans

Over 3 years

Diversified Equity/ Balanced Funds

Regular Income Flexible

Monthly Income Plans / Income Funds

Tax Saving

Equity-Linked Saving Schemes (ELSS)

3 yrs lock-in

C) Selecting the right Mutual fund

Once you have a clear strategy in mind, you now have to choose which Mutual fund and
scheme you want to invest in. The offer document of the scheme tells you its objectives
and provides supplementary details like the track record of other schemes managed by
the same Fund Manager. Some important factors to evaluate before choosing a
particular Mutual Fund are:

The track record of performance over that last few years in relation to the
appropriate yardstick and similar funds in the same category.

How well the Mutual Fund is organized to provide efficient, prompt and
personalized service.

The degree of transparency as reflected in frequency and quality of their

communications.

D) Evaluation of portfolio
Evaluation of equity fund involve analysis of risk and return, volatility, expense ratio,
fund managers style of investment, portfolio diversification, fund managers experience.
Good equity fund should provide consistent returns over a period of time. Also expense
ratio should be within the prescribed limits. These days fund house charge around
2.50% as management fees.

Evaluation of bond funds involve it's assets allocation analysis, return's consistency, its
rating profile, maturity profile, and its performance over a period of time. The bond fund
with ideal mix of corporate debt and gilt fund should be selected.

4.1.1 ) Five Things you must see before investing in a Mutual Fund
It helps if an investor follows this 5-point guide to select the right mutual fund:
1. Your risk profile
Investors must ascertain their own risk profile. As there are funds that cater to various
risk profiles in the market, ranging from very risky to very conservative, its important that
investors choose the fund that best suits his/her risk profile. For instance, it doesn't
make sense for a risk-taking investor to invest in debt funds because he would not be
satisfied by the kind of conservative returns debt funds give. Similarly, a conservative
investor should stay away from equity funds, as they are not suited to stomach the
accompanying volatility.
2. Your investment horizon
The amount of time investors are willing to stay invested in the fund also determines the
kind of fund suited for him. Equity funds are best suited for investors who have a longer
time horizon as equities give the best return amongst all other asset classes over the
long term. But for investors who want to invest for a shorter tenure, debt funds are the
best options.
3. Offer document
It is important to know your fund, as it is to know yourself. The best source of
information on a fund is its offer document. It has information on the nature of the
scheme, the kind of instruments the fund aims to invest in, its risk-profile, its investment
strategies, and so on. It also gives you an idea of how other schemes from the same
fund house have performed. It helps to check the potential of the fund and also the track
record of the fund house.

4. How good are its disclosures?

A mutual fund may promise you high returns and superior service, but how good are its
disclosure levels? Check if your fund house discloses its portfolios regularly. Although
Sebi rules require fund houses to disclose their portfolios only twice a year, many newage funds send portfolios and newsletter to their investors on a quarterly basis. Fund
houses send you quarterly newsletters by post or display their monthly portfolios on
their websites or do both. It helps if your fund regularly discloses such details as it tells
you exactly where your money is invested.
5. Past performance
If the fund is an existing one, check its past performance. Though past performance is
no guarantee of future returns, but it does give you an indication of how well a fund has
capitalized on upturns and weathered downturns. The fund's record also gives an
indication of the volatility of its returns.
Investors should invest in schemes that deliver high returns with low volatility. Then
again, see how well your fund house has performed in the particular class you are
planning to invest in. This is especially the case if an investor is putting money in new
launches where past performance is absent.

4.1.2 ) Common Investment Mistakes

Are you investing wisely? Knowing about some common investment mistakes, can help
prevent them from happening to you.
1. Investing without a clear plan of action. Many people neglect to take the time to
think about their needs and long-term financial goals before investing. Unfortunately,
this often results in their falling short of their expectations. You should decide whether
you are interested in price stability, growth, or a combination of these. Determine your
investment goals. Then, depending on your timeframe and your tolerance for risk, select
mutual funds with objectives similar to yours.

2. Meddling with your account too often. You should have a clear understanding of
your investments so that you are comfortable with their behavior. If you keep
transferring investments in response to downturns in prices, you may miss the upturns
as well. Even in the investment field, the "tortoise" who is more patient, may win over
the "hare". While past performance does not necessarily guarantee future performance,
your understanding of the behavior of various investments over time can help prevent
you from becoming short-sighted about your long-term goals.
3. Losing sight of inflation. While you may be aware of the fact that the cost of goods
and services is rising, people tend to forget the impact inflation will have on investments
in the long-term. You have to keep in mind that inflation will eat into your savings faster
than you can imagine.
4. Investing too little too late. People do not "pay themselves first". Most people these
days have too many monthly bills to pay, and planning for their future often takes a
backseat. Regardless of age or income, if you do not place long-term investing among
your top priorities, you may not be able to meet your financial goals. The sooner you
start, the less you have to save every month to reach your financial goals.
5. Putting all your eggs in one basket. When it comes to investing, most of us do not
appreciate the importance of diversification. While we know that we should not "put all
our eggs in one basket", we often do not relate this concept to stocks and bonds. Take
the time to discuss the importance of diversifying your investments among different
asset categories and industries with your financial advisor. When you diversify, you do
not have to rely on the success of just one investment.

6. Investing too conservatively. Because they are fearful of losing money, many
people tend to rely heavily on fixed-income investments such as bank fixed deposits
and company deposits. By doing this, however, you expose yourself to the risk of
inflation. Consider diversifying with a combination of investments. Include stock funds,

which may be more volatile, but have the potential to produce higher returns over the
long term.

4.2 ) Role of Risk vs. Reward in Mutual Fund

Having understood the basics of mutual funds the next step is to build a successful
investment portfolio. Before you can begin to build a portfolio, one should understand
some other elements of mutual fund investing and how they can affect the potential
value of your investments over the years. The first thing that has to be kept in mind is
that when you invest in mutual funds, there is no guarantee that you will end up with
more money when you withdraw your investment than what you started out with. That is
the potential of loss is always there. The loss of value in your investment is what is
considered risk in investing.
Even so, the opportunity for investment growth that is possible through investments in
mutual

funds

far

exceeds

that

concern

for

most

investors.

Heres

why.

At the cornerstone of investing is the basic principal that the greater the risk you take,
the greater the potential reward. Or stated in another way, you get what you pay for and
you get paid a higher return only when you're willing to accept more volatility.
Risk then, refers to the volatility -- the up and down activity in the markets and individual
issues that occurs constantly over time. This volatility can be caused by a number of
factors -- interest rate changes, inflation or general economic conditions. It is this
variability, uncertainty and potential for loss, that causes investors to worry. We all fear
the possibility that a stock we invest in will fall substantially. But it is this very volatility
that is the exact reason that you can expect to earn a higher long-term return from these
investments

than

from

savings

account.

Different types of mutual funds have different levels of volatility or potential price
change, and those with the greater chance of losing value are also the funds that can
produce the greater returns for you over time. So risk has two sides: it causes the value
of your investments to fluctuate, but it is precisely the reason you can expect to earn
higher

returns.

You might find it helpful to remember that all financial investments will fluctuate. There

are very few perfectly safe havens and those simply don't pay enough to beat inflation
over the long run.

4.2.1 )Types of Risks

All investments involve some form of risk. Consider these common types of risk and
evaluate them against potential rewards when you select an investment.
Market Risk
At times the prices or yields of all the securities in a particular market rise or fall due to
broad outside influences. When this happens, the stock prices of both an outstanding,
highly profitable company and a fledgling corporation may be affected. This change in
price is due to "market risk". Also known as systematic risk.

Inflation Risk

Sometimes referred to as "loss of purchasing power." Whenever inflation rises forward

faster than the earnings on your investment, you run the risk that you'll actually be able
to buy less, not more. Inflation risk also occurs when prices rise faster than your returns.
Credit Risk
In short, how stable is the company or entity to which you lend your money when you
invest? How certain are you that it will be able to pay the interest you are promised, or
repay your principal when the investment matures?
Interest Rate Risk
Changing interest rates affect both equities and bonds in many ways. Investors are
reminded that "predicting" which way rates will go is rarely successful. A diversified
portfolio can help in offsetting these changes.
Investment Risks
The sectoral fund schemes, investments will be predominantly in equities of select
companies in the particular sectors. Accordingly, the NAV of the schemes are linked to
the equity performance of such companies and may be more volatile than a more
diversified portfolio of equities.
Changes in the Government Policy
Changes in Government policy especially in regard to the tax benefits may impact the
business prospects of the companies leading to an impact on the investments made by
the fund
Effect of loss of key professionals and inability to adapt business to the rapid
technological change.
An industries' key asset is often the personnel who run the business i.e. intellectual
properties of the key employees of the respective companies. Given the ever-changing
complexion of few industries and the high obsolescence levels, availability of qualified,

trained and motivated personnel is very critical for the success of industries in few
sectors. It is, therefore, necessary to attract key personnel and also to retain them to
meet the changing environment and challenges the sector offers. Failure or inability to
attract/retain such qualified key personnel may impact the prospects of the companies
in the particular sector in which the fund invests

Why do people take investment risks?

Often called the risk-return tradeoff, investors accept greater investment risk because
they are seeking higher returns. If you wish to reduce risk, you must be willing to accept
lower returns. You just can't get a high return from a low-risk investment.

How much risk can you accept?

The amount of investment risk you can tolerate is a personal matter. If investment risk
worries won't let you get a good night's sleep, you may have taken on more risk than
you can live with.
Your investment advisor can help you develop realistic expectations of risk-adjusted
returns by discussing with you the risks and rewards of each of your investments while
matching your goals and objectives with appropriate mutual funds.

4.2.2 ) How Mutual Funds can help Reduce Risk

Mutual funds have experienced and skilled professionals who determine and monitor
risks on an ongoing basis. In addition, various bodies evaluate mutual fund returns by
the risks they carry.

4.2.2 a ) Strategies for reducing risk

Successful investors use several strategies to reduce their investment risk including:

Diversification

Asset allocation

Rupee-cost averaging

Diversification
Simply put, diversification means choosing several baskets for your investment eggs.
Sure, you could hit it big during good times by investing solely in one stock or sector.
But this strategy can be devastating if the market crashes and leaves you with a basket
of broken eggs.
Diversification is a little like buying insurance. By investing in multiple asset categoriesstocks, bonds, cash and real estate to name a few-you're less likely to get hurt if one
fares poorly.
Different ways to diversify
You can diversify within an asset category, across asset categories and investment
styles, and globally.
1. Diversifying within an asset category. By diversifying, you can reduce the impact
on your investments when a specific security does poorly. You could do this by
purchasing many bonds, for example, instead of one or two.

You're not really diversified, however, if all those bonds have short maturities.
Diversification means owning different types of bonds-long term, short term,
government, corporate and possibly high yield.
2. Diversifying among asset categories. Diversifying can also reduce the risk that an
entire asset category, such as stocks, will do poorly for an extended period of time. You
can select investments from several asset categories-stocks, bonds, cash and real
estate, for example.
3. Diversifying across investment styles. Value and growth stocks do not usually
move in tandem. In one year, one style typically outperforms the other. It's somewhat
like shopping, sometimes there's nothing better than a bargain and other times it's
better to spend a little more for something special.
Growth stocks tend to be more volatile than value stocks and are associated with higher
levels of risk and return.
4. Diversifying globally. Another advantage of diversifying is that you reduce the risk
that local financial markets will suffer an extended bear market. While global investing
includes some additional risks, such as currency fluctuations and political uncertainty,
diversifying globally can help offset overall portfolio volatility.

Mutual funds-the easiest way to diversify

Many people simply don't have enough money to invest in broad array of individual
stocks, bonds and other assets, much less the time and energy to research and monitor
them. For these investors, mutual funds may represent the most sensible option.
Mutual funds are, by definition, diversified. A single fund can hold securities from
hundreds of issuers. Funds are professionally managed providing an easy and costeffective way to invest within asset categories, across asset categories and investment
styles, and globally

 Asset Allocation
What is Asset Allocation?
Asset allocation means diversifying your money among different types of investment
categories, such as stocks, bonds and cash. The goal is to help reduce risk and
enhance returns.
This strategy can work because different categories behave differently, Stocks, for
instance, offer potential for both growth and income, while bonds typically offer stability
and income. The benefits of different asset categories can be combined into a portfolio
with a level of risk you find acceptable.
Establishing a well-diversified portfolio may allow you to avoid the risks associated with
putting all your eggs in one basket.

What allocation is right for you?

Asset allocation decisions involve tradeoffs among 3 important variables:

Your time frame

Your risk tolerance

Your personal circumstances

Depending on your age, lifestyle and family commitments, your financial goals will vary.
You need to define your investment objectivesbuying a house, financing a wedding,
paying for your children's education or retirement. Besides defining your objectives, you
also need to consider the amount of risk you can tolerate.
For example, when you retire and are no longer receiving a paycheck, you might want
to emphasize bonds and cash for income and stability. On the other hand, if you won't
need your money for 25 years and are comfortable with the ups and downs of the stock
market, a financial advisor might recommend an asset allocation of 100% stocks.

Sample Asset Allocations

Here are examples of 3 model portfolios that can give you a sense of how to approach
selecting your own asset mix. Remember, these are general suggestions only. When
reviewing the sample portfolios, consider your risk tolerance and your other assets,
income and investments.

Aggressive Portfolio
This portfolio emphasizes growth, suggesting 65% in stocks or equity funds, 25% in
bonds of fixed-income funds and 10% in short-term money market funds or cash
equivalents. Investment experts recommend this portfolio for people who have a long
investment time frame. The portfolio provides for short-term emergencies and a midterm goal such as building a home, but otherwise assumes the investor has long- term
goals such as retirement in mind.

Moderate
Portfolio
The portfolio seeks to balance growth and stability. It recommends 50% in stocks or
equity funds, 30% in bonds or fixed-income funds and 20% in short-term money market
funds or cash equivalents. This portfolio would seek to provide regular income with
moderate protection against inflation. The equity component provides the potential for
growth, whereas the component in bonds and short-term instruments helps balance out
fluctuations in the stock market.

Conservative Portfolio
This portfolio suggests 25% in stocks or equity funds, 50% in bonds or fixed-income
funds, and 25% in money market funds or cash equivalents. This portfolio appeals to
people who is very risk averse or who are retired. The 25% equity component is
intended to help investors stay ahead of inflation.

Asset allocation plans change with time

While an asset allocation plan eliminates a lot of the day-to-day decisions involved in
investing, it doesn't mean you should just "set it and forget it." Reviewing your portfolio
regularly with your financial advisor to monitor and rebalance your asset allocation can
help make sure you stay on track to meet your goals.

No matter what type of savings programme you choose, it's important to review your
portfolio every 6-12 months to assess your progress. Your financial advisor can provide
you with expert help in determining the best way to allocate your assets.

Rupee-cost averaging

Understanding rupee-cost averaging

Some investors like to speculate on the right moment to invest. But predicting whether
the market is going to move up, down or sideways is difficult even for professionals.
With rupee-cost averaging you can opt out of the guessing game of trying to buy low
and sell high.
With rupee-cost averaging, you invest a specific dollar amount at regular intervals
regardless of the investment's share (unit) price By investing on a regular schedule, you
can take advantage of market dips without worrying about when they'll occur. Your
money buys more shares when the price is low and fewer when the price is high, which
can mean a lower average cost per share over time.
The most important element of rupee-cost averaging is commitment. How frequently
you invest (monthly, quarterly or even annually) is less important than sticking to your
investment schedule.

Does it work when prices are rising and falling?

The purpose of rupee-cost averaging is to take the guesswork out of investing by
providing you with an average cost per share that's lower over the long term. Let's look
at 2 examples to see what your average price per share would be when prices are rising
and when prices are falling.
When unit price is rising. Rs.500 is invested in a mutual fund on the first of each
month. The investor is this example would methodically acquire 109.89 units at an

average cost of Rs.27.83 each. And there's no guesswork or worry about what the price
is about to do.

Rupee-Cost Averaging when Unit Prices Rise

No.
of
Units
Amount

Purchase

Month

Invested

Unit Price

01-Jan

Rs.500

Rs.22

22.73

01-Feb

Rs.500

Rs.26

19.23

01-Mar

Rs.500

Rs.26

19.23

01-Apr

Rs.500

Rs.28

17.86

01-May

Rs.500

Rs.31

16.13

01-Jun

Rs.500

Rs.34

14.71

Total:

Avg

Rs.3000

Rs.27.83

Cost: Total:
109.89

For illustrative purposes only. Not intended to represent any specific Franklin Templeton
fund.
When unit price is falling. Rupee-cost averaging in this scenario can reduce loss
compared to making a lump-sum investment. Rs.500 is invested in a mutual fund on the
first of each month. The investor in this scenario would have bought 98.63 units at an
average cost per unit of Rs.30.83. The investment's value at the end of the period would
be Rs.2 564.38.

By comparison, someone who invested the entire Rs.3 000 in January at Rs.38 per unit
would have owned only 78.94 units, and the investment would have been worth only
Rs.2 052.44 at the end of the period.

Rupee-Cost Averaging when Unit Prices Fall

No.
of
Units
Amount

Purchase

Month

Invested

Unit Price

01-Jan

Rs.500

Rs.38

13.16

01-Feb

Rs.500

Rs.31

16.13

01-Mar

Rs.500

Rs.29

17.24

01-Apr

Rs.500

Rs.32

15.63

01-May

Rs.500

Rs.29

17.24

01-Jun

Rs.500

Rs.26

19.23

Total:

Avg

Rs.3000

Rs.30.83

Cost: Total: 98.63

For illustrative purposes only. Not intended to represent any specific Franklin Templeton
fund.

Is rupee-cost averaging right for you?

Rupee-cost averaging is popular among people who invest in volatile funds. If a fund's
share price fluctuates a lot, rupee-cost averaging can help reduce the average cost per
share over time when you are investing, and increase your profit when you re
systematically withdrawing your money.

It's not for everyone, but many investors believe this systematic approach to investing
and withdrawing is an effective way to accumu1ate wealth over the long term.
Rupee-cost averaging doesn't guarantee a profit or eliminate risk, and it won't protect
you from a loss if you sell shares at a market low. Before adopting this strategy, you
shou1d consider your ability to continue investing through periods of low price levels.

How mutual funds fare on risk-reward

Category
Equity
Large Cap
Mid Cap
Flexi Cap
Index
Tax-saving
Sectoral
Debt
Long-term
Short-term
Gilt
Liquid
Hybrid
Balanced
MIPs

Risk-Return
Medium
High
Medium to High
Medium
Medium to High
High
Medium to High
Low
High
Low
Medium to High
Low to Medium

4.3) Tax and Mutual Funds

Taxation of mutual funds needs to be highlighted from two main angles. One angle
looks at taxation from the point of view of the fund itself and the other looks at the
taxation aspect with respect to the fund investor.
Income from units
Any income received from units of the schemes of a mutual fund specified under section
23 (D) is exempt under Section 10 (33) of the Act. While section 10(23D) exempts
income of specified mutual funds from tax (which currently includes all mutual funds

operating in India), Section 10(33) exempts income from funds in the hands of the unitholders. However, this does not mean that there is no tax at all on income distributions
by mutual funds.

Income received from Mutual Funds

Dividend Income from the Debt and Fund of Funds schemes only will attract the
dividend distribution tax @ 12.5% for Individuals and 20.00% for the non-individuals.
The dividends in the hands of the investor will be completely tax-free.
Capital Gains Tax
Capital gains can be defined as the difference between the sale consideration and the
cost of acquisition of the asset if the investor sells his units and earns capital gains he is
liable to pay capital gains tax.

Short Term Capital Gains

If the units are held for a period of less than one year, then the gains are short-term
capital gains. For Debt oriented and Fund of Funds scheme, it will be taxed at the
marginal income tax rate applicable to the investors. For Equity oriented schemes, the
Short Term Capital Gains will be taxed at 10% of the gain amount.

Long Term Capital Gains

Debt Scheme
The investor has to pay long-term capital gains on the units held by him for period of
more than 1 year. In this case, the investor will liable for the lower of the two:

Pay tax at a flat rate of 10 % on the capital gains without indexation or

Avail cost indexation on capital gains and pay 20 % tax,

Indexation means that the purchase price is marked up by an inflation index resulting in
lower capital gains and hence lower tax

Inflation index = Inflation index for the year of transfer

Inflation index for the year of acquisition
Equity Scheme:
In equity schemes Long Term Capital gains are Nil

Tax Payable with indexation

Purchase NAV = Rs.20. Sale NAV Rs.22. Let us assume that the period of holding is
Jan 2000 to Feb 2002. That is more than 1 year. In this case the investor can avail the
benefits of indexation. Indexation component = 426/406 = 1.037 (where 426 is the cost
inflation index for the year 2001-02 and 406 is the cost inflation index for the year 200001).Indexed cost of acquisition is Rs.20*(1.037) = Rs.20.739.Capital Gains = Rs.22Rs.20.739 = Rs.1.261Capital Gains Tax = Rs.1.261 * 0.20 = Rs.0.2522

Tax Payable without indexation

Purchase NAV = Rs 20 Sale NAV = Rs 22 Capital gains = 22-20= Rs 2 Capital Gains
Tax: 2*0.105=0.21 thus we see that the capital gains tax can be capped to 10% by
availing the benefits of indexation. If an investor buys a fresh unit in the closing days of
March and sells it in the first week of April of the following year, he is entitled to
indexation benefit for two financial years, which close in the two March ending periods.
This is termed as double indexation and lowers the tax even further.
Wealth Tax
Units held under the scheme of the fund are not treated as assets as defined by the
Wealth Tax Act, 1957 and therefore will not be liable for any wealth tax.
TDS on Redemptions

No TDS is required to be deducted from capital gains arising at the time of redemptions
for the resident investors.
Income

Distribution

Tax

As per prevailing tax laws, income distributed by schemes other than open-end equity
schemes is subject to tax at 20 % (plus surcharge of 10 %). For this purpose, equity
schemes have been defined to be those schemes that have more than 50 % of their
assets in the form of equity. Open-end equity schemes have been left out of the purview
of this distribution tax for a period of three years beginning from April 1999.
Section 80C
Section 80C as introduced by the Finance Act, 2005, provides that from the total income
of an individual & HUF, deduction for an amount paid or deposited in certain eligible
schemes or investments would be available, subject to a maximum amount of Rs 1
lakh. According to clause (xiii) and clause (xx) to sub-section 2, any subscription to any
units of Mutual Fund notified under Section 10(23D) would qualify for deduction under
the aforesaid Section provided, the plan formulated in accordance with a scheme
notified by the Central Government or approved by CBDT on an application made by
the Mutual Fund and an amount of subscription to such units is subscribed only in
eligible issue of capital of any company. Vide CBDT clarification dated 11th November,
2005 investment up to Rs 1 lakh in ELSS Scheme by individuals and HUFs are eligible
for deduction under Section 80 C of the Income tax Act, 1961. Investment is subject to a
lock-in period of three years from the date of allotment. This section replaced Section 88
under which the maximum amount that can be invested in the ELSS schemes was
Rs.10, 000; therefore the maximum tax benefit available works out to Rs.2000. It was a
major breakthrough for tax saving schemes as it marketed mutual fund as tax saving
instrument.

5.1 ) Measuring and Evaluating Mutual Fund Performance

The investor would naturally be interested in tracking the value of his investments,
whether he invests directly in the markets or indirectly through mutual funds. He would
have to make intelligent decisions on whether he gets an acceptable return on his
investments in the funds selected by him, or if he needs to switch to another fund. He
therefore needs to understand the basis of appropriate performance measurement of a
fund only then would be in a position to judge correctly whether his fund is performing
well or not and make the right decisions. SEBI requires mutual funds to specify
appropriate benchmarks foe each scheme in the Offer Document and Key Information
Memorandum.
The need to compare different funds performance requires the fund manager to have
the knowledge of the correct and appropriate measures of evaluating funds
performance.

Different Performance Measures

There are many measures of fund performance. One must find the most suitable
measure depending on the type of fund you are looking for at, the stated investment
objective of the fund and even depending on the current financial market conditions

5.1.1) Change in NAV

Purpose: If an investor wants to computer returns on investments between two dates,
he can simply use the Per Unit Net Asset Value at the beginning and at the end periods
and calculate the change in the value of the NAV between two dates in absolute and
percentage terms.
Formula: For NAV change in absolute terms:
(NAV at the end of the period) (NAV at the beginning of the period)

For NAV percentage terms:

(Absolute change in NAV / NAV at the beginning)* 100
Example: if a fund NAV was Rs. 20 at the beginning of the year and Rs 22 at the end of
the period. The absolute change is Rs. 2 and percentage terms was 10%
Suitability: NAV change is most commonly used by investors to evaluate fund
performance and so is also most commonly published by mutual fund managers. The
advantage of this measure is that it is easily understood and applies to virtually any type
of fund.
Interpretation: Whether in terms of NAV growth is sufficient or not, should be
interpreted in the light of investment objective of the fund, current market conditions and
alternate investment returns. Thus a long term growth fund or infrastructure fund will
give low returns in the initial years. All equity funds may give lower returns when the
markets are in bearish phase. Debt funds may give lower returns when interest rate is
rising.

5.1. 2) Total Return

Purpose: the measure corrects the shortcomings of the NAV change measure, by
taking account of the dividends distributed by the fund between two dates, adding them
to the NAV change to arrive at the4 total return.

Formula:
(Distributions + Change in NAV / NAV at the beginning of the period) * 100

Suitability: this measure is suitable for all kinds of funds. Performance of different types
of funds can be compared on the basis of total return. It is also more accurate as it
takes into account distributions during the period. It should, be interpreted in the light of
investments objective of the fund and current market conditions.
Limitations
Although more accurate than NAV change. It still ignores the fact that distributed
dividend also get reinvested if received during the year.

5.1.3) The Expense Ratio

Purpose; the expense ratio is an indicator of funds efficiency and cost effectiveness.
Formula: It is defined as the ratio of total expenses to average net assets of the fund.
Example; in the offer document, you will find the past and estimated fingers and ratios
as disclosed by the fund.
Suitability ; The expense ratio is most impotent in case of Bond Funds or Debt Funds ,
since such funds performance can be adversely affected if a larger proportion of its
income is spent on expenses. The fund expenses dose not include brokerage
commission.
Limitations; the fluctuations in the ratio across periods require that an average over
three to five years be used to judge a funds performance.

5.1.4 ) Transaction costs

Definition; It includes all expenses related to trading such as brokerage commissions

paid, stamp duty on transfers, registration fees and custodian fees.
Suitability; it therefore has a significance bearing on funds performance and its total
returns. Funds with small size or small returns have to be judged more on their expense
ratios and transaction costs given the impact on total return.

5.1.5 ) Fund Size

It can affect performance. Small funds are easier to a maneuver and can achieve their
objectives in focused manner with limited holdings. Large funds benefit from economies
of scale with lower expense ratios and superior fund management skills. Their can be
no definition of small fund and large fund as they are relative terms.

5.2 ) Evaluating Fund Performance

The measured described are absolute in nature. They see the fund in isolation. a funds
performance can only be judged in investors expectations .however it is important for
the investor to define his expectation in relation to certain guideposts on what is
possible to achieve or moderate his expectation with realistic comparable investment
alternatives available to him in the financial markets. These guideposts or indicators of
performance can be thought of as benchmarks against which a funds performance
ought to be judged. For example, an investors expectation of returns from a diversified
equity fund should be judged against how the overall stock market performed, in other

words, by how much the stock index itself moved up or down, and whether the fund
gave return that was better or worse than the index movement. . ion example of
diversified equity fund , we can use a market index like S& P CNX N ifty or BSE
SENSEX as benchmarks to evaluate the schemes performance.

Basis of Choosing an Appropriate Performance Benchmark

The appropriate benchmark foe any fund has to be selected by reference to;
1. The Asset Class it invest in. thus an equity fund has to be judged by an
appropriate benchmark from the equity markets, adept fund performance
against a debt market benchmark.
2. The funds stated Investment objective. For example, if a fund invests in
long term growth stocks, its performance ought to be evaluated against a
benchmark that captures a growth stocks performance.
There are three types of benchmarks that can be used to evaluate a funds
performance

Relative to the market as a whole.

Relative to other mutual funds.

Relative to other comparable financial products or investment options open to the

investor.

5.2.1 ) Benchmark relative to the Market

1. Equity Funds
a)

Index Funds

In this the fund would invest in index stocks and expect its NAV change mirror the
changes in the index itself. The fund and therefore the investor would not expect to beat
the benchmark but merely earn the same return as the index.
Many fund houses in India now offer index funds based on and tracking the S&P CNX
Nifty Index and BSE SENSEX Index.
b) Active Equity Funds
Most of the other equity funds are actively managed by the fund managers. To evaluate
the performance therefore we need an appropriate benchmark and compare its returns
to the returns on the benchmarks. usually this means using the appropriate market
index. The appropriate index to be used to evaluate a broad based equity fund should
be decided on the basis of size and the composition of funds portfolio. If the fund in
question has a large portfolio, a broader market index like BSE 200 or 100 or NSE 100
may have to be used as a benchmark rather than S&P CNX Nifty or BSE 30. An actively
managed fund expects to be able to beat the index, in other words give higher returns
than the index itself. Sector funds can be compared to sector index such as InfoTech
and pharma sector funds . Similarly the choice of correct equity index as a benchmark
also depends upon the investment objective of the fund.

2. Debt funds
A debt funds performance ought to be judged against a debt market index . Further , for
debt funds the kind of debt that comprises the portfolio will also decide the index to be
used. If the Bond Fund or Debt Fund in question is broad based one ; then a broad
based index has to be used for this purpose. Performance of close end debt funds
with a clear period maturity may be compared with the bank fixed deposits

of

comparable maturity as is commonly done by investors in India.

Different indices are now available to be used for benchmarking debt funds. Main
sources are ;

1. I-SEC : its I-Bex index is often used by some analyst as a benchmark to

track government securities performance. These are four indices Li-bex
that tracks the securities with maturities over 7 years , Mi Bex tracking
maturities between 3 and 7 years , Si Bex tracking short term maturities
of 1-3 years and a composite Index that is the average of all three
maturities.
2. CRISIL ; has 8 debt indices ,4 primary indices that track the prices of
underlying securities and 4 derived indices based on primary indices.
Primary indices cover AAA and AA rated securities and Call Market and
Commercial Paper . Among the derived indices , Liquid Index tracks the
return on Call Market and Commercial Paper : Balanced Fund Index
tracks the return on Nifty Index for equity and CRISIL Composite Bond
Index for debt .
3. NSE ; has designed a Government Securities and Treasury Bills Index .
these indices track either ;

Market

price

movements

that

is

mirror

image

of

yield

movements and are called Principal Return Index ; or

Both interest accruals and capital gains or losses the so

called

Total Return Index.

Any benchmark for a debt fund must have the same portfolio composition and the same
maturity profile as the fund itself , to be comparable.

Money Market / Liquid Funds

Liquid funds have portfolio of short term instruments . Hence, the performance of liquid
funds is usually benchmarked against the government securities of appropriate
maturity . Better benchmark for MM funds in India is either the Liquid Fund Index of
CRISIL or NSES G-Sec and T-Bills indices.

5.2.2.) Benchmarking relative to other similar mutual funds.

In addition to market based comparison , it is important to measure a fund or schemes
performance relative to other funds/schemes managed by other asset management
companies. In India at present , meaningful performance benchmarks in debt markets
are not available which makes such kind comparison more meaningful in debt funds?
Such comparison are called Peer Group Comparison
Criteria for Peer Group Comparison
It is extremely important to ensure that comparison is meaningful , that we compare
apples with apples only funds with similar characteristics can be compared . The
following are some of the important criteria for comparison of fund performance:

The investment objectives and risk profiles of two funds being compared must be
the same. For example it would not be appropriate to compare equity fund with
debt fund nor debt fund investing in government securities be compared with a
fund investing in corporate debt instruments.

Different equity funds among themselves can be compared or debt funds among
themselves can be compared however in the same equity and debt funds the
portfolio composition of two funds in question are similar . For example , a high
return fund

cannot be compared with a government security fund as their

portfolios are different. Similarly in debt funds investing in corporate and govt.
securities , the credit quality and the maturity profile of their assets are
important . The credit quality is indicated by the percentage of investment made
in instruments with different credit ratings . The average maturity of ones funds
investments may be 2 years , while that of other may be , say 6 years . In this
case if the interest rate go up the value of the second fund will drop more than
the first one.

Even when comparable on all other criteria two funds one big and one small
may not give comparable performance. Big funds have greater diversification
benefits such as risk sharing while the small one is easier to manage for quick
adjustments.

Even when two funds with similar characteristics

are otherwise comparable , their

returns may be calculated on comparable basis:

Compare returns of two funds over the same periods. Similarly , only average
annualized compound returns are comparable .

Only after tax returns of two different schemes should be compared

5.2.3 ) Benchmarking relative to other investment options or financial

products:
Since mutual funds are a vehicle for investments , it is essential for the investor to
compare its performance with other investment products. If the investor manages to
achieve a superior returns by investing in bank deposits or government securities , he
will not be willing to risk his capital with a mutual funding view of the higher inherent risk
to principal amount invested. The key point to remember in such competing investment
product comparison is that return is only comparable if the risks attached to this
investment are also comparable. Criteria described in the previous section also apply to
the comparisons

of two different investment options. Only instruments of similar

characteristics and with returns that are calculated over the same periods ought to be
used for meaningful comparison.

6. Case study

If a person wants to invest Rs 4 lakhs in a mutual fund scheme. His investment

objective is capital appreciation and has a high risk appetite. A fund manager has a
great deal of options available to him in the market to choose from. The above table is
an update on investment options and HDFC recommendations for various fund
categories as on April 30 the, 2006. As the investor profile is of an aggressive high risk
taker , so from the above table the manager can suggest him the various schemes
under Equity Funds (Aggressive funds) like Tata Pure Equity ,HDFC

Equity Fund

,Reliance vision fund etc. from the above short listed aggressive funds the fund
manager will compare the short listed schemes on the basis of :
1. Reputation of the AMC owning it: does the fund house that owns the fund holds a
good image in the market.
2. Time period / Inception date: how long the funds have been in operation. Longer
the time period better it is as we can compare the performance of the funds, whether
the fund has a stable or volatile performance.
3.Fund Size : A Large corpus is generally considered good because large funds have
lower costs, as expenses are spread over large assets and the portfolio can be easily
manipulated as compared to the restrictions faced by the scheme that have small fund
size.
4. Returns since the inception and after regular interval say 3 months, 1year so
on: this gives an idea about the returns a person will get since its inception and about
the performance of the scheme.
5.

Performance relative to the chosen benchmark index returns: Whether the

scheme has been constantly outperforming its index returns. If it is it means the scheme
is doing well.
On the basis of above mentioned criteria a fund manager can recommend to invest in
Equity or Vision Fund as both of them come from reputed fund houses. the funds have

been in years operation for the past 10 or 11 years, have a sound NAV, enjoy a good
returns.
Similarly we choose a fund in Balanced Schemes, Index funds etc.

FINDINGS
Like a traveler, who after completing his long and arduous journey reaches his destination and
looks back upon the area covered by him for recalling the important landmarks and experiences
he came across; similarly, it would be desirable to review the various aspects of the present
study. So prior to winding up this study, an attempt is made to summarize its major findings and
suggestions on the basis of forgoing chapters.
Findings:1. All the equity funds invested in high growth, current high importance sectors like
Energy, Infrastructure, IT, Telecom, Oil, Auto etc.

2. To maintain liquidity all the mutual funds have cash holdings of nearly 10% out of their
total asset. Maintaining cash also enables them to invest in any lucrative instrument as it
comes.
3. NAV of all the equity related funds fell down in June, July and August 2006 due to fall in
the Sensex. However those funds which invested in safer instruments like Bonds,
Government Securities there NAV were not much affected.
4. The main reasons for Sensex fall were found to be:
The interest rate hike in the US by the Federal Reserve Bank.
BSE Metal index lost 22%. This putted lot of impact as infrastructure
development is in Boom in INDIA.
Some people viewed that Sensex growth was valuated higher.
Markets in US and Japan were attracting liquidity and inflation scare was also
there, so a lot of emerging markets pulled back.
Industry feared more tax brackets.
Many reports were issued which criticized the growth shown by Sensex. It was
speculated by experts that Sensex may touch 9000 mark.
FIIs were net sellers in emerging markets to book profits.
The rise in the level of margin trading was very high.
International Crude Oil Prices were rising.
5. The one year equity related funds is higher than other funds. It proves the principal of
higher risk, high return.
6. DSP Merrill Lynch Mutual fund gave one year return of 36.4%. Total number of
instruments in its portfolio is 77. However HDFC Mutual Fund gave one year return of
nearly 34% with number of instruments in its portfolio close to 60. So its important what
instrument we include in portfolio rather than the number of securities. More number of
securities only complexes the portfolio management.
7. As the NAV increases, the number of units which an investor gets decreases and viceversa.

8. be less in one time investment than opting for SIP or Value Averaging (if available)
9. Average price which an investor has to pay to invest in a mutual fund was found to be
equal in SIP or Value Averaging .
10. Average cost associated with the mutual fund was found to be least in one time
investment than Value Averaging, whose average cost was further less than that
associated with SIP.
11. Average Price, average cost in one time investment was foundto be less in comparison to
other investing ways. This is one of the reasons why its one year returns are more.

12. To practically implement value averaging the minimum amount condition like in SIP has
to be eliminated. As we have seen in the calculations at one time investor was investing
Rs 1596/- and at other Rs 158/- only.
13. One year return in one time investment was found to be more than in Value Averaging
investment way, which was further high than one year return using SIP.
14. Growth fund option gives investors good returns as well as capital appreciation.

DAY TO DAY JOB EXPERIENCE

Reporting time : 9:30 am.

Fixing appointment with clients
Visit clients place
Demonstrate the product on internet to the client.
Completing the formalities like filling the application form and documentation .
Mailing research reports to prospective clients.
Cold calling

SUGGESTIONS
1. Best time to invest in stock market is when it is down because with same investment
money he will get more value.
2. Mutual fund is the best way to enter into market particularly for those investors who want
good returns with minimum risk as fund of mutual funds is handled by an expert.
3. To get good returns investor must invest considering the time horizon of at least two to
three years. This will help him in getting good returns.
4. Portfolio management is a difficult task. So fund managers must choose optimal number
of securities which meets the objectives of fund.
5. Mutual Fund companies must devise fund considering the end investor in mind.
6. Individual investors must also choose a basket of securities instead of making investment
in only one or two instruments, so that even if one instruments return is negative other
instruments return can compensate that.
7. Since there are large number of mutual funds in which an investor can invest, so he must
choose the fund in which investment is to be made by clearly understanding the little
aspects associated with it.
8. Those investors who are risk averse must invest in open ended funds because he can look
at the past performance of the fund under consideration.
9. Diversification of portfolio is must as it reduce the unsystematic risk and give the return
an edge.

LIMITATIONS

The researcher was inexperienced.

The scope of the study was very wide as there are hundreds of mutual funds of
different types but only few have been studied.
The portfolio published by the various Asset Management Companies might not be
the real one. As, if it would be so than any individual can invest in the manner similar
to portfolio of funds.
The objective of including a particular sector in the portfolio by the fund manager
couldnt be known.
The portfolio being maintained by different funds changes with market conditions.
The portfolio being actually maintained under different market conditions in last one
year couldnt be ascertained.
To develop a new way of investment lot of calculations needs to be done, but here
only few has been done.
The actual hurdles in making value averaging as an investment way in portfolio
couldnt be found.

CONCLUSION
Thus on the whole it can be concluded that there is no conclusive evidence which suggest
that performance of mutual funds scheme portfolio is superior to others. But it is for sure
performance of the most of the funds in better.
Each investment alternative has its own strengths and weakness. Equity related funds
give more returns, but the risk associated is also very high. It would be clearer from the fact
that when Sensex was down in the middle of 2006, the NAV of all the equity related funds
fell down. On the other hand investing in safer instruments like Bank Deposits, Government
Bonds.. gives investor the assured return with nearly no risk. But the returns are very less
in comparison to other instruments. So if an investor wants to get good returns with
minimum risk he must invest in basket of securities. Selecting a fund is not an easy task. So
he must do his homework very clearly. While choosing the fund it is also very necessary that
he chose funds investing in different sectors. Mutual funds are probably the best investment
tool for those persons who dont know the basics of Stock Market but wish to invest in it. As
mutual fund investment are taken, care by expert fund managers so chances of making a loss
in the investment are very less.
Right now practical application of investing in mutual fund by using Value Averaging
appears to be difficult. But if it is applied than by investing a small amount an investor will
be able to get good returns in comparison to SIP. A lot of research has to be done on to it. In
last we can conclude that those investors who wish to get good returns with minimum risk
they must invest in mutual funds. But while investing they must consider their investment
objectives, expected returns, risk taking capability. Depending upon these they must choose
the instrument in which they should invest. Further they should insure that they make
investment in basket of instruments as this will give those advantages of various sectors, at
the same time minimize the risk.

BIBLIOGRAPHY
Websites

www.reliancemutual.com
www.sbimf.com
www.franklintempletonindia.com
www.hdfcfund.com
www.dsmlmutualfund.com
www.kotakmutual.com
www.jmmutual.com
www.licmutual.com
www.utimf.com
www.valueresearcherindia.com
www.amfiindia.com
www.mutualfundindia.com
Books
Verna, Dr J.C., Mutual Funds & Investment Portfolio, Bharat Publications,
2nd Edition.
Pandian, punithavathy, Security Analysis and Portfolio Management, Vikas
Publications, 2nd Reprint.
Kothari, C.R., Research Methodology, New Age International Publishers,
2005.