INTRODUCTION TO MUTUAL FUND AND ITS VARIOUS ASPECTS.

Mutual fund is a trust that pools the savings of a number of investors who share a common financial goal. This pool of money is invested in accordance with a stated objective. The joint ownership of the fund is thus Mutual, i.e. the fund belongs to all investors. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciations realized are shared by its unit holders in proportion the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. A Mutual Fund is an investment tool that allows small investors access to a well-diversified 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 funds Net Asset value (NAV) is determined each day.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unit holders.

When an investor subscribes for the units of a mutual fund, he becomes part owner of the assets of the fund in the same proportion as his contribution amount put up with the corpus (the total amount of the fund). Mutual Fund investor is also known as a mutual fund shareholder or a unit holder. Any change in the value of the investments made into capital market instruments (such as shares, debentures etc) is reflected in the Net Asset Value (NAV) of the scheme. NAV is defined as the market value of the Mutual Fund scheme's assets net of its liabilities. NAV of a scheme is calculated by dividing the market value of scheme's assets by the total number of units issued to the investors.

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. Though the growth was slow, but it accelerated from the year 1987 when non-UTI players entered the Industry.

In the past decade, Indian mutual fund industry had seen a dramatic improvement, both qualities wise as well as quantity wise. Before, the monopoly of the market had seen an ending phase; the Assets Under Management (AUM) was Rs67 billion. The private sector entry to the fund family raised the Aum to Rs. 470 billion in March 1993 and till April 2004; it reached the height if Rs. 1540 billion.

The Mutual Fund Industry is obviously growing at a tremendous space with the mutual fund industry can be broadly put into four phases according to the development of the sector. Each phase is briefly described as under. First Phase 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament 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 1993-2003 (Entry of Private Sector Funds)

1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. Fourth Phase since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs.29,835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes

The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. consolidation and growth. As at the end of September, 2004, there were 29 funds, which manage assets of Rs.153108 crores under 421 schemes.

WORKING OF MUTUAL FUND:A Mutual Fund is a collection of stocks, bonds, or other securities owned by a groupof investors and managed by a professional investment company . For an individualinvestor to have a diversified portfolio is difficult. But he can approach to such companyand can invest into shares. Mutual funds have become very popular since they makeindividual investors to invest in equity and debt securities easy. When investors invest a particular amount in mutual funds, he becomes the unit holder of corresponding units. Inturn, mutual funds invest unit holders money in stocks, bonds or other securities that earninterest or dividend. This money is distributed to unit holders. If the fund gets money byselling some stocks at higher price the unit holders also are liable to get capital gains.

CATEGORIES OF MUTUAL FUND:

Mutual funds can be classified as follow:

Based on their structure:

Open-ended funds: Investors can buy and sell the units from the fund, at any
point of time.

Close-ended funds: These funds raise money from investors only once.
Therefore, after the offer period, fresh investments can not be made into the fund. If the fund is listed on a stocks exchange the units can be traded like stocks (E.g., Morgan Stanley Growth Fund). Recently, most of the New Fund Offers of closeended funds provided liquidity window on a periodic basis such as monthly or weekly. Redemption of units can be made during specified intervals. Therefore, such funds have relatively low liquidity.

Based on their investment objective: Equity funds: These funds invest in equities and equity related instruments.
With fluctuating share prices, such funds show volatile performance, even losses. However, short term fluctuations in the market, generally smoothens out in the long term, thereby offering higher returns at relatively lower volatility. At the same time, such funds can yield great capital appreciation as, historically, equities have outperformed all asset classes in the long term. Hence, investment in equity funds should be considered for a period of at least 3-5 years. It can be further classified as:

i) Index funds- In this case a key stock market index, like BSE Sensex or Nifty is tracked. Their portfolio mirrors the benchmark index both in terms of

composition and individual stock weightages.

ii) Equity diversified funds- 100% of the capital is invested in equities spreading across different sectors and stocks.

iii|) Dividend yield funds- it is similar to the equity diversified funds except that they invest in companies offering high dividend yields.

iv) Thematic funds- Invest 100% of the assets in sectors which are related through some theme. e.g. -An infrastructure fund invests in power, construction, cements sectors etc.

v) Sector funds- Invest 100% of the capital in a specific sector. e.g. - A banking sector fund will invest in banking stocks.

vi) ELSS- Equity Linked Saving Scheme provides tax benefit to the investors.

Balanced fund:

Their investment portfolio includes both debt and equity. As a

result, on the risk-return ladder, they fall between equity and debt funds. Balanced funds are the ideal mutual funds vehicle for investors who prefer spreading their risk across various instruments. Following are balanced funds classes:

i) Debt-oriented funds -Investment below 65% in equities.

ii) Equity-oriented funds -Invest at least 65% in equities, remaining in debt.

Debt fund: They invest only in debt instruments, and are a good option for
investors averse to idea of taking risk associated with equities. Therefore, they invest exclusively in fixed-income instruments like bonds, debentures, Government of India securities; and money market instruments such as certificates of deposit (CD), commercial paper (CP) and call money. Put your money into any of these debt funds depending on your investment horizon and needs.

i) Liquid funds- These funds invest 100% in money market instruments, a large portion being invested in call money market.

ii) Gilt funds ST- They invest 100% of their portfolio in government securities of and T-bills.

iii) Floating rate funds - Invest in short-term debt papers. Floaters invest in debt instruments which have variable coupon rate.

iv) Arbitrage fund- They generate income through arbitrage opportunities due to mis-pricing between cash market and derivatives market. Funds are allocated to equities, derivatives and money markets. Higher proportion (around 75%) is put in money markets, in the absence of arbitrage opportunities.

v) Gilt funds LT- They invest 100% of their portfolio in long-term government securities.

vi) Income funds LT- Typically, such funds invest a major portion of the portfolio in long-term debt papers.

vii) MIPs- Monthly Income Plans have an exposure of 70%-90% to debt and an exposure of 10%-30% to equities.

viii) FMPs- fixed monthly plans invest in debt papers whose maturity is in line with that of the fund.

INVESTMENT STRATEGIES
1. Systematic Investment Plan: under this a fixed sum is invested each month on a fixed date of a month. Payment is made through post dated cheques or direct debit facilities. The investor gets fewer units when the NAV is high and more units when the NAV is low. This is called as the benefit of Rupee Cost Averaging (RCA)

2. Systematic Transfer Plan: under this an investor invest in debt oriented fund and give instructions to transfer a fixed sum, at a fixed interval, to an equity scheme of the same mutual fund.

3. Systematic Withdrawal Plan: if someone wishes to withdraw from a mutual fund then he can withdraw a fixed amount each month.

RISK V/S. RETURN:

similarly, a sector stock fund (which invests in a sin g l e i n d u s t r y , s u c h a s telecommunications) is at risk that its price will decline due to developments in itsindustry. A stock fund that invests across many industries is more sheltered from this risk defined as industry risk. Following is a glossary of some risks to consider when investing in mutual funds:CALL RISK:The possibility that falling interest rates will cause a bond issuer to redeem or call itshigh-yielding bond before the bond's maturity date. COUNTRY RISK:The possibility that political events (a war, national elections), financial problems (risinginflation, government default), or natural disasters (an earthquake, a poor harvest) willweaken a country's economy and cause investments in that country to decline. CREDIT RISK:The possibility that a bond issuer will fail to repay interest and principal in a timelymanner. Also called default risk. CURRENCY RISK:The possibility that return s could be reduced for Americans investi ng in foreignsecurities because of a rise in the value of the U.S. dollar against foreign currencies. Alsocalled exchange-rate risk. INCOME RISK:The possibility that a fixed-income fund's dividends will decline as a result of fallingoverall interest rates. INDUSTRY RISK:The possibility that a group of stocks in a single industry will decline in price due todevelopments in that industry. INFLATION RISK:The possibility that increases in the cost of living will reduce or eliminate a fund's realinflation-adjusted returns. INTEREST RATE RISK:The possibility that a bond fund will decline in value because of an increase in interestrates. MANAGER RISK:The possibility that an actively managed mutual fund's investment adviser will fail toexecute the fund's invest men t strategy effect ively resulting in the failure of stated objectives

Market risk The possibility that stock fund or bond fund prices overall will decline over short or evenextended periods. Stock and bond markets tend to move in cycles, with periods when prices rise and other periods when prices fall. PRINCIPAL RISK:The possibility that an investment will go down in value, or "lose money," from theoriginal or invested amount. HOW RISK IS MEASURED:There are two ways in which you can determine how risky a fund is. STANDARD DEVIATION:Standard Deviation is a measure of how much the actual performance of a fund over a period of time deviates from the average performance. Since Standard Deviation is a measure of risk, a low Standard Deviation is good. SHARPE RATIO:This ratio looks at both, returns and risk, and delivers a singl e m e a s u r e t h a t i s proportional to the risk adjusted returns. Since Sharpe Ratio is a measure of risk-adjusted returns, a high Sharpe Ratio is good." Advantages & Disadvantages of Mutual Funds 1.Professional Management Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme. This risk of default by any company that one has chosen to invest in, can be minimized by investing in mutual funds as the fund managers analyze the companies financials more minutely than an individual can do as they have the expertise to do so. They can manage the maturity of their portfolio by investing in instruments of varied maturity profiles. 2.Diversification Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same

time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own. 3.Convenient Administration Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient. 4.Return Potential Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities. Apart from liquidity, these funds have also provided very good post-tax returns on year to year basis. Even historically, we find that some of the debt funds have generated superior returns at relatively low level of risks. On an average debt funds have posted returns over 10 percent over one-year horizon. The best performing funds have given returns of around 14 percent in the last one-year period. In nutshell we can say that these funds have delivered more than what one expects of debt avenues such as post office schemes or bank fixed deposits. Though they are charged with a dividend distribution tax on dividend payout at 12.5 percent (plus a surcharge of 10 percent), the net income received is still tax free in the hands of investor and is generally much more than all other avenues, on a post tax basis. 5.Low Costs Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors. 6.Liquidity In open-end schemes, the investor gets the money back promptly at net asset value related prices

from the Mutual Fund. In closed-end schemes, the units can be sold on a stock exchange at the prevailing market price or the investor can avail of the facility of direct repurchase at NAV related prices by the Mutual Fund. Since there is no penalty on pre-mature withdrawal, as in the cases of fixed deposits, debt funds provide enough liquidity. Moreover, mutual funds are better placed to absorb the fluctuations in the prices of the securities as a result of interest rate variation and one can benefits from any such price movement. 7.Transparency Investors get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook. 8.Flexibility Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans; you can systematically invest or withdraw funds according to your needs and convenience. 9.Affordability A single person cannot invest in multiple high-priced stocks for the sole reason that his pockets are not likely to be deep enough. This limits him from diversifying his portfolio as well as benefiting from multiple investments. Here again, investing through MF route enables an investor to invest in many good stocks and reap benefits even through a small investment. Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy. 10.Choice of Schemes Mutual Funds offer a family of schemes to suit your varying needs over a lifetime. 11.Well Regulated

All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI. 12.Tax Benefits Last but not the least, mutual funds offer significant tax advantages. Dividends distributed by them are tax-free in the hands of the investor. They also give you the advantages of capital gains taxation. If you hold units beyond one year, you get the benefits of indexation. Simply put, indexation benefits increase your purchase cost by a certain portion, depending upon the yearly cost-inflation index (which is calculated to account for rising inflation), thereby reducing the gap between your actual purchase costs and selling price. This reduces your tax liability. Whats more, tax-saving schemes and pension schemes give you the added advantage of benefits under Section 88. You can avail of a 20 per cent tax exemption on an investment of up to Rs 100000 in the scheme in a year. Disadvantages of mutual funds Mutual funds are good investment vehicles to navigate the complex and unpredictable world of investments. However, even mutual funds have some inherent drawbacks. Understand these before you commit your money to a mutual fund. 1.No assured returns and no protection of capital If you are planning to go with a mutual fund, this must be your mantra: mutual funds do not offer assured returns and carry risk. For instance, unlike bank deposits, your investment in a mutual fund can fall in value. In addition, mutual funds are not insured or guaranteed by any government body (unlike a bank deposit, where up to Rs 1 lakh per bank is insured by the Deposit and Credit Insurance Corporation, a subsidiary of the Reserve Bank of India). There are strict norms for any

fund that assures returns and it is now compulsory for funds to establish that they have resources to back such assurances. This is because most closed-end funds that assured returns in the earlynineties failed to stick to their assurances made at the time of launch, resulting in losses to investors. A scheme cannot make any guarantee of return, without stating the name of the guarantor, and disclosing the net worth of the guarantor. The past performance of the assured return schemes should also be given. 2.Restrictive gains Diversification helps, if risk minimization is your objective. However, the lack of investment focus also means you gain less than if you had invested directly in a single security. Assume, Reliance appreciated 50 per cent. A direct investment in the stock would appreciate by 50 per cent. But your investment in the mutual fund, which had invested 10 per cent of its corpus in Reliance, will see only a 5 per cent appreciation. 3.Taxes During a typical year, most actively managed mutual funds sell anywhere from 20 to 70 percent of the securities in their portfolios. If your fund makes a profit on its sales, you will pay taxes on the income you receive, even if you reinvest the money you made. 4.Management risk When you invest in a mutual fund, you depend on the fund's manager to make the right decisions regarding the fund's portfolio. If the manager does not perform as well as you had hoped, you might not make as much money on your investment as you expected. Of course, if you invest in Index Funds, you forego management risk, because these funds do not employ managers. Fund Management Style & Structuring of Portfolio Factors affecting Management style of a scheme Its one thing to understand mutual funds and their working; its another to ride on this potent

investment vehicle to create wealth in tune with your risk profile and investment needs. Here are seven factors that go a long way in helping an AMC meet its investors investment objectives. The factors listed below evaluate factors affecting the management style of a mutual fund scheme. Knowing the profile Investors investments reflect his risk-taking capacity. Equity funds might lure when the market is rising and peers are making money, but if you are not cut out for the risk that accompanies it, dont bite the bait. So, check if the investors objective matches yours. Investors will invest only after they have found their match. If they are racked by uncertainty, they seek expert advice from a qualified financial advisor. Identifying the investment horizon How long on an average does the investor want to stay invested in a fund is as important as deciding upon your risk profile. Investors would invest in an equity fund only if they are willing to stay on for at least two years. For income and gilt funds, have a one-year perspective at least. Anything less than one year, the only option among mutual funds is liquid funds. Declare and Inform Watch what you commit. Investors look out for the Offer Document and Key Information Memorandum (KIM) before they commit their money to a fund. The offer document contains essential details pertaining to the fund, including the summary information (type of scheme, name of the Asset Management Company and price of units, among other things), investment objectives and investment procedure, financial information and risk factors. The fund fact sheet Fund fact sheets give investors valuable information of how the fund has performed in the past. It gives investors access to the funds portfolio, its diversification levels and its

performance in the past. The more fact sheets they examine, the better is their comfort level. Diversification across fund houses If Investors are routing a substantial sum through mutual funds, they would diversify across fund houses. That way, they spread their risk. Chasing incentives Some financial intermediaries give upfront incentives, in the form of a percentage of the investors initial investment, to invest in a particular fund. Many amateur investors get lured into such incentives and invest in such attractive schemes, which may not meet their future expectations. The ideal investors focus would be to find a fund that matches his investment needs and risk profile, and is a performer. Tracking investments The investors job doesnt end at the point of making the investment. They do track your investment on a regular basis, be it in an equity, debt or balanced fund. Portfolio management is an important foundation of mutual fund business. The performance of the fund measured by the risk adjusted returns produced by the investor arises largely by successful portfolio management function. After collecting the investors funds, effective portfolio management will have to give returns acceptable to the investor; else, the investor may move to better performing funds. From the investors perspective, the need for successful portfolio management function is obviously paramount. However, in the complex world of financial markets, portfolio management is a specialist function. Now how a fund manager manages the portfolio would depend on the type of the fund he is managing. The funds can be broadly classified as equity funds and debt funds. Equity Portfolio Management: When the fund contains more than 65% equity, it is called as an equity fund. Thus such type of a fund would need equity portfolio management.

An equity portfolio managers task consists of two major steps: a)Constructing a portfolio of equity shares or equity linked instruments that is consistent with the investment objective of the fund and b)Managing or constantly re-balancing the portfolio to produce capital appreciation and earnings that would reward the investors with superior returns. How To Identify Which Kind Of Stocks 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 their potential than shares of other companies. So how does the fund manager go about choosing the different types of stocks, in order to construct his portfolio? The general answer is that his choice of shares to be included in funds portfolio must reflect the investment objective of the fund. More specifically, the equity portfolio manager will choose from a universe of invisible shares in accordance with: a)The nature of the equity instrument, or a stocks unique characteristics, and b)A certain investment style or philosophy in the process of choosing. Thus, you may see a mutual funds equity portfolio include shares of diverse companies. 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. Indian economy is going through a period of both rapid growth and rapid transformation. Thus, the industries with the growth prospects or blue chip shares of yesterday are no longer certain to continue to be in that category tomorrow. New sectors like software or technology stocks have

matured and newer sectors such as biotechnology are now making an entry in the investment markets. In this process of rapid change, the stock selection task of an active fund manager in India is by no means simple or limited. We will therefore, review how different stocks are classified according to their characteristics. Ordinary shares: Ordinary shareholders are the owners if the company and each share entitles the holder to ownership privileges such as dividends declared by the company and voting rights at the meetings. Losses as well as the profits are shared by the equity shareholders. Without any guaranteed income or security, equity share are a risk investment, bringing with them the potential for capital appreciation in return for the additional risk that the investor undertakes. Preference Shares: Unlike equity shares, preference shares entitle the holder to dividends at the 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. Preference shares do not entitle the holder to ownership privileges such as voting rights at the meetings. Equity Warrants: These are long term rights that offer holders the right to purchase equity shares in a company at a fixed price (usually higher than the current market price) within specified period. Warrants are in the nature of options on stocks. Convertible Debentures: As the term suggests, these are fixed rate debt instruments that are converted into specified number of equity shares at the end of the specified period. Clearly, convertible debentures are debt instruments until converted; when converted, they become equity shares.

EQUITY CLASSES: Equity shares are generally classified on the basis of either the market capitalization or the anticipated movement of company earnings. it is imperative for the fund manager to understand these elements of the stocks before he selects them for inclusion in the portfolio. Classification in terms of Market Capitalization Market Capitalization is equivalent to the current value of a 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 the Large or mid or the Small Cap Companies shares. For example, the tax plan of ICICI Prudential AMC is essentially a midcap fund where as the tax plan of Reliance is large-cap fund. Large Cap shares are more liquid and hence easily tradable. Mid or Small Cap shares may be thought of as having greater growth potential. The stock markets generally have different indices available to track these different classes of shares. 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 relation to one of the following measures: Price/Earning Ratio is the price of the share divided by the earnings per share and indicated what the investors are willing to pay for the companys earning potential. Young and fast growing companies usually have high P/E ratios and the established companies in the mature industries may have lower P/E ratios. Dividend Yield for a stock is the ratio of dividend paid per share to the current market

price. In India, at least in the past, investors have indicated the preference for the high dividend paying shares. What matters to the fund managers is the potential dividend yields based on earning prospects. Cyclical Stocks are the shares of companies whose earnings are correlated with the state of the economy. Growth Stocks are shares of companies whose earnings are expected to increase at the rates that exceed the normal market levels. Value Stocks are share of companies in mature industries and are expected to yield low growth in earnings. These companies may, however, have assets whose values have not been recognized by investors in general. Funds manager may try to identify such currently undervalued stocks that in their opinion can yield superior returns later. Approaches to Portfolio Management (Fund Management Style): Mutual funds can be broadly classified into two categories in terms of the fund management style i.e. actively managed funds and passively managed funds (popularly referred to as index funds). Actively managed funds are the ones wherein the fund manager uses his skills and expertise to select invest-worthy stocks from across sectors and market segments. The sole intention of actively managed funds is to identify various investment opportunities in the market in order to clock superior returns, and in the process outperform the designated benchmark index. in active fund management two basic fund management styles that are prevalent are: ) Growth Investment Style: wherein the primary objective of equity investment is to obtain capital appreciation. This investment style would make the funds manager pick and choose those shares for investment whose earnings are expected to increase at the rates that exceed the normal market levels. They tend to reinvest their earnings and

generally have high P/E ratios and low Dividend Yield ratio. ) Value Investment Style: wherein the funds manager looks to buy shares of those companies which he believes are currently under valued in the market, but whose worth he estimates will be recognized in the market valuation eventually. On the contrary, passively managed funds/index funds are aligned to a particular benchmark index like the S&P CNX Nifty or the BSE Sensex. The endeavor of these funds is to mirror the performance of the designated benchmark index, by investing only in the stocks of the index with the corresponding allocation or weightage. Investing in index funds is less cumbersome as compared to investing in actively managed funds. Broadly speaking, investors need to consider two important aspects i.e. the expense ratio and the tracking error (i.e. the difference between the returns clocked by the designated index and index fund). Conversely, investing in actively managed funds demands a deeper review and understanding of the fund house's investment philosophy; also the investor needs to decide on the kind of funds he wishes to invest in - a large cap/mid cap/small cap fund among others Successful Equity Portfolio Management: Portfolio Management skills are innate in nature and strong intuitive traits from the portfolio manager. Nevertheless, there are certain principles of good equity management that any portfolio manager can follow to improve his performance. Set realistic target returns based on appropriate benchmarks. Be aware of the level of flexibility available while managing the portfolio. Decide on appropriate investment philosophy, i.e., whether to capitalize on economic cycles, or to focus on the growth sectors or finding the value stocks. Develop an investment strategy based on the investment objective, the time frame for the investment and economic expectations over this period. Avoid over diversification. Although diversification is a major strength of mutual

funds, the portfolio manager must avoid the temptation to invest into very large number of securities so as to maintain focus and facilitate sound tracking. Develop a flexible approach to investing. Markets are dynamic and it is impossible to buy stocks for all seasons Debt Portfolio Management: Debt portfolio management has to contend with the construction and management of portfolio of debt instruments, with the primary objective of generating income. Just as the equity fund manager has to identify suitable stocks from a larger universe of equity shares, a debt fund manager has to select from a whole universe of debt securities he wants to invest in. Debt schemes of a mutual fund have a short maturity period, generally up to one year. Nevertheless, some schemes regarded as debt schemes do have maturity period a little longer than a year, say, eighteen months. Thus in the context of debt mutual funds, depending upon the maturity period of the scheme, the funds managers invest more in markettraded instruments or the debt securities. The difference in market-traded instruments and debt securities is that the former matures before one year and the later after a year. Instruments in Indian Debt Market: The objective of a 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 the principal is secure. The debt market in India offers the following instruments for investment by mutual funds. Certificate of Deposit: Certificate of Deposits (CD) are issued by scheduled commercial banks excluding regional rural banks. These are unsecured negotiable promissory notes. Bank CDs have a maturity period of 91 days to one year, while those issued by financial institutions have maturities between one and

three years. Commercial Paper: Commercial Paper (CP) is a short term, unsecured instrument issued by corporate bodies (public and private) to meet short term working capital needs. Maturity varies between 3 months and 1 year. This instrument can be issued to the individuals, banks, companies and other corporate bodies registered or incorporated in India. CPs can be issued to NRIs on non repairable and non transferable basis. Corporate Debentures: Debentures are issued by manufacturing companies with physical assets, as secured instruments, in the form of certificates. They are assigned credit rating by the rating agencies. All publicly issued debentures are listed on the exchanges. Floating Rate Bond (FRB): These are short to medium term interest bearing instruments issued by financial intermediaries and corporations. The typical maturity is of these bonds is 3 to 5 years. FRBs issued by the financial institutions are generally unsecured while those form private corporations are secured. Government Securities: These are medium to long term interest bearing obligations issued through the RBI by the Government of India and state governments. Treasury Bills: T-bills are short term obligations issued through the RBI by the Government of India at a discount. The RBI issues T-bills for tenures: now 91 days and 364 days. These treasury bills are issued through an auction procedure. The yield is determined on the basis of bids tendered and accepted Public Sector Undertakings (PSU) Bonds: PSU are medium and long term obligations issued by public sector companies in which the government share holding is generally greater than 51%. Some PSU Bonds carry tax exemptions.

The minimum maturity is 5 years for taxable bonds and 7 years for tax-free bonds. PSU bonds are generally not guaranteed by the government and are in the form of promissory notes transferable by endorsement and delivery. Credit Selection: Some debt managers look to investing in a bond in anticipation of changes on OTS credit rating. An upgrade of a bonds credit rating would lend 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. Usually, debt funds will specify the proportion of assets they will hold in instruments of different credit quality/ratings, and hold these proportions. Active credit selection strategy would imply frequent trading of bonds in anticipation of changes in ratings. While being an active risk management strategy, it does not take away the interest rate, prepayment or credit risks that are faced by any debt fund. Prepayment Prediction: As noted earlier some bonds allow the issuers the option to call for redemption before maturity. a fund which holds bonds with this provision is exposed to the risk of high yielding bonds being called back before maturity when interest rates decline. The fund manager would therefore strive to hold bonds with low prepayment risk relative to yield spread. Or try to predict the course of the interest rates and decide what the prepayment is likely to be, and then increase or decrease his exposure. In any case, the risks faced by such fund managers are the same as any other. What matters at the end is the yield performance obtained by the fund manager. Interest Rates and Debt Portfolio Management: No matter which investment strategy is followed by a debt fund manager, debt securities are always exposed to interest rate risk, as their price is directly dependent on them. While they may

yield fixed rates of returns, their market values are dependent on interest rate movements, which in turn affect the performance of fund portfolio of which they are a part. Hence, it is essential to understand the factors that affect the interest rates. While this is an intricate subject in itself, we have summarized below some key elements that have a bearing on interest rate movements: Inflation: simply put, inflation is the percentage by which prices of goods and services in the economy increase over a period of time. This increase may be on account of factors arising within the country change in production levels, mechanisms for distribution of goods, etc, and/or on account of changes in the countrys external balance of payments position. In India, inflation is generally measured by the Wholesale Price Index although t he Consumer Price Index is also tracked. When the inflation rate rises, money becomes dearer, leading to an increase in the general level of interest rates. Exchange Rate: a key factor in determining exchange rates between any two currencies is their relative purchasing power. Over a period, the relative purchasing power between two currencies may change based on the performance of the respective economies. The consequent change in exchange rates can affect interest rate levels in the country. Policies of the Central Bank: the central bank is the apex authority for regulation of the monetary system in a country. In India, this role is played by the Reserve Bank. The RBIs policies have a strong bearing on interest rate levels in the economy. If the RBI wishes to curb excess liquidity in a monetary system, it could impose a higher liquidity ratio on banks and institutions. This would restrict credit leading to an increase in interest rates. Similarly, and increase in RBIs bank rate has the effect of increasing interest rate levels. RBI may also

undertake open operations in Treasury Bills and Government securities with the intention of restricting / relaxing liquidity, thereby impacting the interest rates. Use of Derivatives for Debt Portfolio Management: As explained above, a debt portfolio is always exposed to the interest rate risk. Hence, derivatives contracts can be used to reduce or alter the risk profile of the portfolios containing debt instruments. Interest rate derivatives contracts can be exchange traded or privately traded (on the OTC market). Thus, a portfolio manager can sell interest rate futures or buy interest rate put options, usually on an exchange, to protect the value of his debt portfolio. He can also buy or sell forward contracts or swaps bilaterally with other market players on OTC market. In India, interest rate swaps and forward rate agreements were introduced in 1999, though the market for these contracts has not yet fully developed. In 2004, the National Stock Exchange has introduced futures on Interest Rates. Interest rate options are not yet available for trading on exchange.