Welcome to

AMFI Mutual Fund Testing Program

Duration 2 days
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Chapter 1
THE CONCEPT AND ROLE OF MUTUAL FUNDS
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MUTUAL FUNDS OPPOTUNITY

Most Appropriate investment opportunity for small investors. Birth of Mutual Funds U.S.A. Good Alternative to Direct Investing. Size in USA > Bank Deposits. Financial Intermediary. UTI only player between 1964-87. Helps in the growth of Capital Markets.

Concept of a Mutual Fund

A common pool of money into which investors place their contributions to be invested in accordance with a stated objective.

The ownership of the fund is joint or mutual

The fund belongs to all investors Ownership is proportionate to contribution made by one
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Advantages of Investing through Mutual Funds over Direct Investments

Portfolio Diversification Professional Management Reduction / Diversification of Risk

Liquidity
Flexibility & Convenience Reduction in Transaction cost Safety of regulated environment
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Disadvantages of Investing through Mutual Funds over Direct Investments

No Control over Cost No Tailor-made Portfolios
Managing a Portfolio Funds

History of Mutual Funds

Phase 1 (1964-87) : Growth of UTI.AUM FROM Rs 600 Cr in 84 Grew To Rs6700 Cr in 88. Phase 2 (1987-93) : Entry of PSU Banks and Financial Institutions MFs. AUM RS 47004 CRS. Phase 3 (1993-96) : Emergence of Private Sector Mutual Funds. Joint Ventures between Foreign Funds & Indian Promoters resulting in innovations in - Investment Management Techniques, - Investor Servicing Techniques 7

History of Mutual Funds

Phase 4 (1996-99) : SEBI Regulations for Investors Protection UTI Act 1963 repealed in Feb 2003 UTI Mutual Fund becomes SEBI compliant Assured Return Schemes of UTI taken over by a special undertaking administered by GOI Emergence of large & uniform industry Consolidation & Growth 29 Mutual Funds as at 31-03-06 Phase 5 (1999-2004) :

Phase 6 (2004 onwards):

Industry Profile
Industry Structure Public Sector MFs

UTI

Private Sector MFs

Indian Private Sector Funds

JV with Foreign Funds

Foreign MFs

Assets under Management (Rs. in Crs)

As at 31/3/99 UTI 53,320 Public Sector 8,292 Private Sector 6,860 Total 68,472

31/3/01
31/3/04 31/3/06

58,017
-

6,840

25,730

90,587

34,624 1,04,992 1,39,616 50,348 1,81,514 2,31,862

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Types of Mutual Fund

Mutual Funds can be classified as: Close ended / Open-ended Funds Load Fund / No-Load Funds Tax-exempt / Non-Tax exempt Funds
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Close Ended Funds

Close Ended Fund:
Initial Public Offer Investor cannot buy units later on from MF Get listed on the Stock Exchange Traded on Stock exchange at a discount/premium to NAV Redemption of Units on expiry date Unit Capital Constant Close ended funds may allow buy back of units option

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Open Ended Funds

Open Ended Fund:
Units available for sale / purchase at all times at NAV based prices Unit Capital variable Fresh subscriptions may be discontinued Any time redemptions always allowed, except when there is lock in period.
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Load Funds
Load is one time fee payable by the investor when they enter / exit an open-ended scheme. Loads are charged to recover initial issue expenses including marketing & selling expenses, brokerage, advertising costs. Such Expenses not to exceed 6%. SEBI prescribes ceiling on Recurring Expenses. There can be Entry load or Exit load or both Entry load is also called Front-end load. Exit load is also called Back-end load or Deferred load

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No Load Funds & Impact of Loads

In a No load fund, marketing and selling expenses are absorbed by the AMC and the investor buys and sells units at NAV price Return on investment to the investor is reduced because of the loads When the investor buys a unit from the MFs, he pays more than NAV (NAV + entry load) When the investor sells the unit to the MF, he gets less than NAV (NAV exit load)
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Example on Loads and Returns

Date Action NAV (Rs) Entry Load Exit Load 11.00 12.00 2% 1% 1/1/1999 Entry 31/12/1999 Exit

ROI with Loads Amount invested = 11 + 0.22 = 11.22 Rs. Amount received = 12 0.12 = 11.88 Rs. Gain = 0.66 Rs. ROI = (0.66 x 100) /11.22 = 5.88%

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Example on Loads and Returns

ROI without loads Amount invested = 11 Rs. Amount received = 12 Rs. Gain = 1 Rs. ROI=(1 x 100) /11 = 9.09%

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Contingent Deferred Sales Charge (CDSC)

Exit Charge may vary depending upon the holding period.

If Exit Charge varies with the holding period it is called Contingent Deferred Sales Charge (CDSC) and it may vary as shown under.
Redemption during the first five years from the date of purchase First Year Maximum CDSC 4% Second Year Maximum CDSC 3% Third Year Maximum CDSC 2% Fourth Year Maximum CDSC 1% Fifth Year Nil

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Mutual Funds classified as per Class (Nature) of Investments

Equity Funds

Bond Funds

Money Market Funds

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Mutual Funds classified as per Investment Objectives

Growth Funds

Income Funds

Value Funds
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Mutual Funds classified as per Risk Profiles

High Risk Funds

Moderate Risk Funds

Low Risk Funds

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Risk Return Hierarchy of Different Funds

Risk High Sector Funds Diversified Equity Funds Index Funds

Balanced Funds
Debt Funds Gilt Funds

Risk Low

MMMF

Low return

High return

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Money Market Funds

Invest in securities of less than 1 year maturity

High liquidity & safety of principal

Low risk and low returns

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Gilt Funds
Invest only in Government Securities of over 1 year maturity Risk and return low but higher than that of MMF No default risk but carry interest rate risk Fund values drop when interest rates go up & rise when interest rates go down
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Debt Funds & Types

Invest in Corporate Bonds and Government Securities Risk higher than that of Gilt Funds Aims at regular income distribution and not at capital appreciation Types of Debt Funds:
- Diversified Debt Funds - Focused Debt Funds - High yield Debt Funds - Assured return Debt Funds - Fixed Term Plan Series

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Equity Funds & Types

Invest in Equity and Equity related instruments High risk and aim at Capital appreciation Types of Equity Funds

Aggressive Growth Funds Growth Funds Value Funds Specialty Funds:

Sector Funds, Foreign Securities Funds, Mid-Cap or Small-Cap Equity Funds,

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Equity Funds & Types

Diversified Equity Funds ELSS Funds Equity Index Funds Equity Income or Dividend Yield Fund

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Types of Hybrid Funds

Balanced Funds: Seek to provide regular income & Capital appreciation Seek to provide High dividend and Capital appreciation
Flexible asset allocation between Debt, Equity & MM
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Growth & Income Funds:

Asset Allocation Funds:

Other Funds
Commodity Funds : Real Estate Funds :
Exchange Traded Funds

Fund of Funds

Invest in commodity stocks Invest in stocks of real estate companies : Trade like a single stock on the stock exchange : Invest in other Mutual Fund Schemes

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EXCHANGE TRADED FUNDS

It tracks the market index & trades like a single stock. Unlike Index Funds, unit price varies during the day as per market movements. ETFS are bought & sold through market makers who give a two way quote. (Ask & Bid ). Benefit of holding a single share & diversification & cost efficiency of an index. Market makers allow exchange of units for the underlying shares.
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Fund of Funds.
Fund of Fund invest in other mutual fund schemes of the same AMC/other AMCS. It does not invest directly in Capital Markets. Greater Diversification. Higher Expenses.
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Chapter 2
FUND STRUCTURE AND CONSTITUTENTS

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Mutual Fund Structure

Mutual Funds in U.S are setup as investment companies Mutual Funds in U.K are either Unit Trusts (Trust) or Investment Trust (Companies) Mutual Funds are Public Trusts under the Indian Trusts Act, 1882 Mutual Fund is a 3 tier structure:
Sponsor, Trustee and AMC

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Mutual Fund Structure

Mutual Funds invest
in Capital market instruments on behalf of investors

All gains and losses of funds are shared by the unit holders MF is a pass-through structure and it has tax implications
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Constituents of a Mutual Fund

1. Sponsor

2. Trustees
3. Asset Management Company

4. Custodian / Depository Participant

5. R & T Agent

6. Distributors
7. Banker
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Role of Sponsor
Sponsor is a person who sets up a Mutual Fund Sponsor settles the Trust and executes Trust Deed Sponsor contributes to the initial capital of the Trust Sponsor appoints the Board of Trustees Sponsor appoints Asset Management Company Sponsor contributes minimum 40% of net worth of AMC

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Who can be a Sponsor?

Criteria of a Sponsor are
Positive net worth Minimum 5 years track record History of positive After Tax Profit for 3 out of 5 years including fifth year Net Worth more than Contribution for AMC Fit and Proper person
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Board of Trustees & Role

Trustees appointed by the Sponsor with SEBI approval At least two third Trustees must be Independent The Trustees have a FIDUCIARY responsibility towards unit holders Trustees not liable for acts done in good faith and if they have exercised adequate due diligence Trustees oversee the functioning of AMC Trustees approve each MF scheme floated by AMC The investments in MFs are held by the Trustees Trustees receive fees for their services. Obligation to undertake General & specific due diligence.
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Who can be a Trustee

Eligibility Conditions :

Person of high repute and integrity

Not guilty of moral turpitude Not convicted for economic offence under securities laws Not a part of AMC eg. Director, Employee or Officer of AMC One can be Trustee of two MFs if approved by Board of Trustees of both the Mutual Funds. 39

Asset Management Company

Constituted as a Company under the Indian Companies Act
Minimum Net worth of Rs. 10 crores for AMC

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

At least 50% of Directors of AMC to be independent

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Asset Management Company

AMC can do only the following businesses
Asset Management Services Portfolio Management Services Portfolio Advisory Services

AMC can be terminated/changed with the consent of

Majority of Trustees or At least 75% majority of Unit holders
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Role of AMC
AMC is the Fund Manager for managing Mutual Fund Assets AMC floats different MF schemes

AMC accountable to the Trustees

AMC charges Asset Management Fees subject to ceiling prescribed by SEBI. Asset Management Agreement between AMC and Trustee
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Obligations of AMC
Limit of 5% of aggregate purchase and sales of Securities under all its scheme per broker per quarter As far as possible AMC to avoid services of its sponsor. All Security transactions with a Sponsor and his associates to be disclosed Disclosure of transactions with a company which has invested more than 5% of NAV in any scheme

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Custodian / Depository Participant

Custodian / DP:
Appointed by Board of Trustees Keep record & account of Securities / Investments Collects benefits under Securities Sponsor & Custodian / DP cannot be the same entity Registered with SEBI

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Registrar & Transfer Agent

Registrar & Transfer Agent:
Issues, redeems, transfers units of MF

schemes
Keeps Unit Holders A/cs upto date

Registered with SEBI

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Merger of two AMCs

Merger of 2 AMCs:
Approval of Trustees of both AMCs required

SEBI approval required

Approval of High Court also required

Unit holders are informed and given option to exit without load

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Take Over of AMC / Scheme of AMC

Take over of AMC by new Sponsor
Trustees approval required SEBI clearance required Unit holder to be informed

Merger of two schemes of different AMCs

Scheme of one Mutual Fund taken over by another Mutual Fund Trustees approval required SEBIs approval required Unit holders to be informed
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Chapter 3
LEGAL & REGULATORY FRAMEWORKS

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Regulators in India
SEBI is Capital Market Regulator with legal powers SEBI regulates Mutual Funds. All Mutual Funds to be registered with SEBI RBI is Money Market Regulator SEBI is regulator for Liquid Funds Investing in MM instruments

MOF supervisory body for RBI & SEBI

Security Appellate Tribunal setup in 2003 to hear appeal against SEBI decisions Registrar of Companies(ROC) ensures compliance by AMC & by Trustee Company with the Indian Companies Act 1956 ROC supervised by Department of Company Affairs (DCA)
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Regulators in India
DCA frames and modifies regulations relating to the companies DCA is a part of Company Law Board CLB is a part of Ministry of Law and Justice

Company Law Board carries out judicial proceedings for offences under Companies Act
Mutual Fund Trustees accountable to Public Trustees

Public Trustee reports to Charity Commissioner

UTI set up under UTI Act 1963
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Self Regulatory Organisations

SROs are second tier in the regulatory structure SRO is an association of Market Participants Approval of SRO given by MOF All Stock Exchanges are SROs and are supervised by SEBI Close Ended Funds listed on SE observe listing Agreement Requirements of SEs AMFI was incorporated in 1995 and is not an SRO Role of AMFI To promote interest of MFs & Unit Holders To set ethical, commercial & professional standards To increase public awareness of MF industry

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Role of AMFI
To promote interest of MFS & unit holders. Interact with the Regulator. To create public awareness. To set ethical, commercial & business standards. To promote best business practices and formulate code of conduct for persons engaged in the activities of MF and for the AMCS. To implement the certification programme.

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Investors Rights & Obligations

Right of proportionate beneficial ownership

Right to timely service

Right to information eg. NAV Calculation, Unit Pricing Right to approve changes in fundamental attributes of the scheme Right to wind up a close ended scheme with 75% majority of unit holders

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

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Investor Rights to Services

Investor to be informed about change in fundamental attributes of the scheme eg. from No Load fund to Load fund or change in Pricing norms for purchase/sale of Units

Open ended Fund must reopen within 30 days after the Offer period Nomination facility allowed
Redemption proceeds to be sent to investor within 10 working days otherwise Penal interest at the 54 rate specified by SEBI for the full period

Investor Rights to Services

Annual Holding statements and Transaction statements to be sent to investors Dividend Warrants to be dispatched within 30 days of dividend declaration by MF

Mandatory portfolio disclosure for half-yearly period to unit holders within 1 month
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Investor Rights to Services

Investors right to inspect documents such as
Trust deed,

AMC Agreement,
Balance Sheets of MF Schemes and

Balance Sheet of AMC

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Legal limitation to Investor Rights

Investors cant sue the Trust Investor can sue the Trustee Sponsor of fund not responsible for shortfall in non assured scheme

Prospective investors cant sue the trustees/AMC/ Custodians

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Investors Obligations & Complaint Redressal

Investor should:
Read Offer Documents
Understand Risk factors Monitor performance of investments. To submit PAN/Bank details.

Complaint Redressal
Through SEBI intervention. Complaints can be made to AMC/Trustees/SEBI. Investors cannot seek redressal under Companies Act since fund investors are neither share holders nor depositors in AMC
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Chapter 4
OFFER DOCUMENT

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What is an Offer Document ?

Offer Document of a MF scheme is like a Prospectus issued by AMC inviting public to subscribe to units of MF scheme
Discloses adequate information for investors to take informed investment decisions

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Offer Document & KIM

Offer Document A Legal document Issued by AMC on behalf of Trustees Offer Document describes the Product/Scheme Very important document for prospective investor First time investors must read OD before deciding to invest For Close Ended Fund issued at the time of launching a scheme For Open Ended Fund revised every 2 years

KIM
A abridged version of Offer Document A part of the Application Form To be in the format as prescribed by SEBI
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Offer Document prepared and issued by AMC Offer Document to be approved by Trustees Offer Document filed with SEBI with fees of Rs. 25000/Modifications if any advised by SEBI within 21 days of its filing SEBI neither approves nor disapproves an OD Offer Document valid for 6 months for launching of scheme from the date of receipt of by AMC of SEBI letter containing observations. Thereafter fresh OD to be filled with SEBI
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Offer Document

Contents of Offer Document

Summary information on Cover page: Names of Trustees, AMC, Scheme, Period of Opening / Closing, Face value of unit , SEBI Disclaimer Risk factors: Standard & Scheme Specific Legal & Regulatory Compliance Certificate Financial information on Schemes & Expenses for last 3 years Constitution of MF its Sponsors, Trustees, AMC & their functions Investment objectives & policies Management of Funds: Names of Fund Manager Offer related information: Minimum Subscription amount 63

Financial Information in Offer Document Expenses

Sales load, Redemption load Contingent Deferred Sales Charge Initial Issue Expenses for the scheme and for schemes launched during last one year
Estimated annual recurring expenses

Condensed financial information about schemes launched during last 3 years and their performance

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Constitution of Mutual Fund in Offer Documentof Sponsor / AMC / Board of Name

Trustees Powers of Trustee Names & Background of Key Personnel Names of Custodian / Registrar Name, age, qualification & experience of Fund Managers Details of Investor Relation Officer

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Investment Objectives and Policies as per OD Short description of type of Securities for investment Asset Allocation percentages Policy of Diversification Portfolio Turnover Policy Investment Limitations If Name suggests predominance of investments in a particular asset class, the minimum exposure to be at least 65%.

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Borrowing Policy of the Scheme as per OD

Fund not to borrow for making investments Temporary borrowing allowed
For a maximum period of 6 months Amount not exceeding 20% of NAV of the scheme Borrowing for redemption of scheme only

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Other Contents in OD
Procedure for redemption Disclosure of Valuation of Securities norms and NAV calculation Description of Accounting Policies

Tax treatment of Investments as per existing laws

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Offer related Information in OD

Minimum subscription amount Offer period : Calendar of opening, closing, allotment etc. Name of SE where Close ended units will be listed

Procedure for transfer and transmission of units

Different plans under the scheme Dividends and Distribution Policy

Procedure for winding up of the scheme

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Standard Risk factors in MF investing as per OD

NAV can go up and down depending upon Capital market movements Past performance on AMC is not indicative of future performance Name of the scheme does not indicate its quality or prospects There is no guarantee that objectives of the scheme will be met
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Chapter 5
FUND DISTRIBUTION & SALES PRACTICES
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Who can invest in a Mutual Fund Scheme

Residents

Resident Individuals / HUF Indian companies Partnership Firms Indian Trusts / Charitable Institutions Insurance Companies Banks Financial Institutions NBFCs Provident Funds Mutual Funds
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Who can invest in a Mutual Fund Scheme

Non Residents

NRIs & Persons of Indian Origin Overseas Corporate Bodies (OCBs)

Foreign Entities

FIIs registered with SEBI

Foreign nationals cannot invest in MF

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Different Distribution Channels

1. Direct Marketing By Sales Officers through
Mailers Call Centers Branch networks

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Distribution Channels - Types

2. Individual Agents as Distributors and Advisors 3. Institutional Intermediaries
Fund distribution companies Finance Companies Investment Advisory Companies Banks and Institutions Post Offices Brokers and Sub-brokers Private Sector MF prefer established Fund distribution Cos as Fund Distributors
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AMFI Registered Distributors

AMFI Registration No. (ARN) card necessary before selling As on 31/3/2005,
49837 candidates passed AMFI Certification Test out of which 30028 candidates registered with AMFI

Out of 30028 AMFI registered candidates,

Individuals are 24850 Corporates are 1946 Corporate Employees are 3232

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Agents Commission

Commission can be paid upfront or trail commission Market practice

1.5 to 2.5 % for Equity funds 0.25 to 1.25% for Debt Funds Still lower for Liquid Funds Higher commission for ELSS

AMFI has prohibited parting / sharing of commission (see AMFI Guidelines & Norms for Intermediaries [AGNI] ).SEBI CIR of 2002. SEBI does not prescribe any ceiling on commission
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Process of Effective Selling of M F Schemes prescribed for Distributors

Know the important characteristics of scheme Know your client profile (age, risk tolerance, income level, etc.) Understand clients needs (investment objective, return expectation, cash flow requirement, etc.) Assist in making the right choice Encourage regular investment & commitment to invest Personalised post sales service
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AMFI Code of Ethics for MFs

Funds to be managed in the interest of unit holders

Unit holders to be treated equally & fairly

Ensure meaningful disclosures Avoid conflict of interest Ensure segregate accounting Stick to ethical standards and fairness in dealings High standards of care, diligence, services and disclosure announcements

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SEBI Advertisement Code for MFs

No promises in the future without resources backed guarantee Standard measures to compare such as Annual Yield, CAGR etc. Annualised yields for at least one, three, five years & since launch For less than 1 year performance, Absolute Return without annualisation Past gains may not repeat in future Risk factors prominently stated No Celebrities No add-ons during offer period Appropriate benchmark to be chosen 80 Any ranking of fund to be explained

Chapter 6
ACCOUNTING, VALUATION & TAXATION
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ACCOUNTING

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Mutual Fund Accounting

Knowledge of MF accounting vital Separate Balance Sheet for each scheme of a MF MFs to follow Accounting Policies laid down by SEBI (Mutual Funds) Regulations, 1996

Unit holders subscriptions accounted

not as liabilities or deposits but as Unit Capital at Face Value

Investments made by the fund appear on Asset side in the Balance Sheet
All assets of the scheme belong to Investors
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NAV Calculations
Net Assets = Assets - Liabilities

Assets

= Market value of Investments + Receivables + Accrued income + Other Assets

= Accrued expenses + Payables + Liabilities

Liabilities

NAV of a Unit

Net Assets of the Scheme Number of units outstanding

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Disclosing Net Asset Value of a Unit Date on which NAV is calculated is called Valuation Date Open ended Funds are required to compute and disclose NAV daily Close ended Funds can compute NAVs every week NAV Calculation has to consider up to date transactions

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Disclosing Net Asset Value of a Unit

All income, expenditure to be accounted upto date of valuation Non accrual of small amounts not affecting NAV by more than 1% permitted Non-recorded transactions should not affect NAV calculation by more than 1% If NAV is more than 1% AMC to:-Pay excess difference. - Recover excess paid.

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Allocation / De-Allocation of Units

For all valid applications received before the Cutoff time, units are allotted / cancelled based on NAV at the end of the same day For valid application received after the cut-off time, units are allotted / cancelled based upon NAV of the next business day. The above rule does not apply to liquid fund schemes

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Cut-off Time
The cut-off time for all Mutual Fund schemes except liquid fund schemes is 3 pm For liquid fund schemes valid application received upto 1 p.m. are allotted units based on NAV of the previous day For liquid fund schemes valid application received upto 1 p.m. are allotted units based on NAV of the same day For repurchases under liquid funds the cut-off time is 10 a.m instead of 1 p.m.

NAVs are required to be rounded off upto 4 decimal places for liquid funds & upto 2 decimal places for other funds

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Factors affecting Net Asset Value of a Unit

NAV is affected by 4 set of factors:
Purchase & sale of investment securities

Valuation of all investment securities held

Other assets and liabilities Units sold or redeemed

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Pricing of a Fund Unit

SEBI Regulations on pricing of Mutual Fund units
For Open Ended Funds
Repurchase price not lower than 93% of NAV Sale price cannot be more than 107% of NAV Difference between the repurchase and sale price of a Unit cannot be more than 7%

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Charges in a MF
Mutual Funds can recover two types of Expenses a. Initial issue expenses b. Recurring Expenses Initial Issue Expenses
effective April 04 2006 allowed up to 6% for Close Ended Funds only Close Ended Funds cannot charge Entry Loads Open Ended Funds can recover initial expenses through Entry Load
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Maximum Recurring Expenses

Recurring Expenses cannot exceed the following regulatory limits
Average Weekly Assets For first Rs.100 crs For next Rs.300 crs For next Rs.300 crs For Equity Funds 2.50% 2.25% 2.0% For Bond Funds 2.25% 2.00% 1.75%

On the Balance Average Weekly Assets

Fund of Funds

1.75%
Max-0.75%

1.50%

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Asset Management Fees

AMC charges Asset Management Fees
Limits on AMC Fees as per SEBI Regulations:
1.25% of the 1st Rs. 100 crs of weekly Average Net Assets 1.00% of the weekly Average Net Assets in excess of Rs. 100 crs AMC may charge additional 1% of weekly Average Net Assets for No Load Funds

Asset Management Fees are not in addition to but a part of Recurring Expenses Asset Management fees are usually lower for Debt Funds as compared to Equity Funds and are disclosed in OD
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Amortization of Initial Expenses

Close Ended Funds do not charge initial expenses of fund but amortize the same over a period of years Initial Expenses amortized on a weekly basis over the period of the scheme. e.g for a 5 yr scheme, amortized over 260 weeks Investor exiting before expiry of period of scheme will be charged unrecovered initial issue expenses Conversion of close ended funds into open ended funds allowed only after recovery of unrecovered initial expenses Un-amortized portion added for NAV calculation as Other Asset but no AMC fee on this amount
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Amortisation

An Example

Assume close ended fund of five years collects Rs 100 Crores and incurs initial issue expenses of Rs 5 Crores. Units issued = 10 Crores. Investment = 95 Crores Initial NAV= 95+((260/260)*5) 10 10 After 4 weeks let the market value of investments-98 Cr NAV = 98+((256/260)*5) 10 =10.29
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Initial Issue expenses impact on NAV

Open ended fund collects Rs 100 Crores Entry load 2.25% Initial issue expenses Rs 5 Crores Impact on NAV Initial NAV 10 As No of Units allotted would be 9.775 crores.
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Disclosure and Reporting Requirements

AMC to prepare Annual Report and Annual Statement of Account for each scheme Annual Statement of Account to be audited by an Auditor independent of the Auditor of AMC Within 6 months of Accounting year, Fund shall Publish scheme wise abridged summary of report in newspapers Mail summary of report to all unit holders Forward to SEBI Annual Audited Accounts, Half yearly Unaudited Accounts, Quarterly Portfolio Statement Display the scheme wise annual reports on their website & on AMFI website Mail Annual Reports to all unit holders
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Accounting Policies
Investments to be marked to market Unrealized appreciation cant be distributed

Dividend/Bonus recognized on the date share is quoted ex-dividend/ ex-bonus Average cost considered for determining gain/loss on sale of shares
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Accounting Policies
Purchase / sale of investments recognized
on the trade date, not on settlement date

Debt Investments to be taken as NPA

if interest or Principal amount remains unpaid for more than 3 months. e.g. If Interest due 30th June 2000 remains unpaid on 1/10/2000 it becomes NPA on 1/10/2000

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Provisioning of NPA Debt Securities

If interest remain unpaid for 6 months If interest remain unpaid for 9 months 10% of Book Value 20% of Book Value

If interest remain unpaid for 12 months If interest remain unpaid for 15 months If interest remain unpaid for 18 months

Another 20% of Book Value

Another 25% of Book Value Balance 25% of Book Value

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VALUATION NORMS FOR MUTUAL FUNDS

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Valuation Norms for Mutual Funds Valuation Norms prescribed by SEBI to protect investors interests Valuation Norms
Based upon fair portfolio valuation Uniform across all funds

SEBI
Prescribes detailed valuation methodologies in its fund regulations Mandates disclosure of valuation methods used for investors information

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Valuation Norms for Shares

Valuation of traded shares
done on the basis of traded price
if not more than 30 days old

Valuation of thinly traded shares

less than 50,000 shares or Rs. 5 lacs or less amount and
Done as per SEBI approved Norms

Valuation of not traded shares

done as per SEBI approved valuation norms
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Valuation Norms for Shares

If Thinly traded & Non traded Equity Securities exceed 5% of the total assets of the scheme,
independent valuer should be appointed for valuation

If Illiquid Securities exceed

15% of net assets for open ended funds 20% of net assets for close ended funds value is taken zero for Securities in excess of 15% 20%

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Limit on Illiquid Shares

Illiquid Share (Non traded, Thinly Traded & Unlisted Equity Shares)
not to exceed 15% for Open Ended Fund Assets
not to exceed 20% for Close Ended Fund Assets

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Valuation Norms for Thinly-traded and Non-traded Shares

Equity Instruments
Calculate book value per share
Calculate earning value per share based upon Average capitalization rate of industry P/E and discount it by 75%.( Latest audited EPS be taken for this purpose) Calculate Fair value per share taking 90% of average of book value and earning value per share If EPS is negative or not available for within previous nine months, it should be taken as zero
106

Capitalisation of Earnings

- An Example

Assume Net worth/share Rs 8 Audited EPS Rs 2 Industry P/E 12 Discounted P/E for comp (25%of 12)=3 Value of share (2*3) = 6 Average value (8+6)/2 = 7 Value to be taken discounted by 10% =90% of Average value(7)= Rs 6.30

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Valuation of Traded Debt Securities

A Debt Security is treated as traded if traded any day during the last 15 days Trading can be on a stock exchange or between institutions Publicly traded price or private placement price if private placement is within last 15 days is taken as valuation price Market lot for trading in debt securities is 5 Crores A Debt Security if not traded in last 15 days is called Not Traded or Thinly Traded Debt Security 108

Debt Instruments Less than 182 days maturity

Valuation of Thinly-traded and Non-traded Debt Securities

Valued at Cost plus accrued interest and Difference between redemption value and cost uniformly spread over remaining life of instrument

More than 182 days maturity

Government Securities valued at prices released by CRISIL Investment Grade debt securities valued on the basis of YTM derived from CRISIL Valuation Matrix Non Investment Grade

Performing Asset valued at 25% discount to their face value NPA valued as per valuation norms for NPAs
109

Valuation of Thinly and Nontraded Debt Securities

Calculating Yields for pricing Debt Securities

A risk free benchmark Yield curve is built on GOI securities as the base.

A Matrix of spreads (based on the credit risk) are built for marking up the benchmark Yields
Marked Yields are adjusted for liquidity risk The yields so arrived are used to price debt portfolios
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Gross Redemption Yield (GRY)

Gross Redemption Yield (GRY) is also called Yield to Maturity (YTM) YTM is the Internal Rate of Return on investment in Bond. Internal Rate of return is computed based on :
i. ii. iii.

Coupon Rate Purchase Price Period to Maturity

111

Gross Redemption Yield (GRY)

If purchase price is the same as Face Value of Bond,
YTM will be the same as Coupon Rate.

If purchase price is more than the Face Value,

YTM will be lower than the Coupon Rate.

If purchase price is less than the Face Value,

YTM will be more than the Coupon Rate.
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Calculating Price of Bond with given YTM An

Example
Given data:

Face Value Coupon Tenure Interest Payment Yield

: : : : :

Rs.1000 10% 5 Years Yearly 8.72%

Calculate price of the bond Cash flows under the bond and their present values are as under
100 (1+8.72%) + 100 + 100 + 2 3 (1+8.72%) (1+8.72%) 100 (1+8.72%)4 + (100+1000) (1+8.72)5

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

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TAXATION OF MUTUAL FUNDS

114

Taxation of MFs and Investors

Finance Act 1999 radically changed taxation of Dividends received by investors in Mutual Funds Mutual Fund as an entity is not taxed since it is a Pass Through Entity. Section 10(23d)of the IT Act. Finance Act 1999 made income (dividends) from UNITS totally EXEMPT from tax u/s 10(33) in the hands of all investors Income (dividends) distributed by a Debt Fund was made liable to Dividend Distribution Tax at applicable rate Open Ended Funds with more than 50% invested in Equity do not pay any DDT ( since changed to 65% in FY 06-07) Individuals 14.02%. Companies 22.44%.

115

Taxation of MFs and Investors

Security Transaction Tax (STT) is charged as applicable 80 C benefit under ELSS upto Rs. 1 Lac Restriction on dividend stripping (Sec 94(7))
Within 3 months prior to record date of dividend distribution and within 3 months after record date for dividend distribution

116

Impact of Dividend Distribution Tax

Investor pays the tax indirectly, since NAV comes down to the extent of tax paid by the Fund. DD Tax bears no relationship to the investors tax bracket. Dividend reinvested is also subject to Dividend Distribution Tax. In Growth Plans, Dividend Distribution Tax not applied, since no dividend is distributed.

117

Short / Long Term Capital Gains Tax

Short Term Capital Gain
If units held for less than 12 months

Long Term Capital Gain

If units held for more than 12 months

Short Term Capital Gains at normal tax rates as applicable to investor Long Term Capital Gains taxed at 20% with indexation or at 10% without indexation of cost + Applicable Surcharge & Educational Cess

118

Short/Long Term Capital Gains Tax

Under Section 111(a) of I.T.Act - No Long Term Gains Tax on Equity oriented schemes if STT charged. - Short Term Gains Tax at Government specified rate if STT is charged for equity oriented schemes currently the rate is 10%.
119

Capital Gains Tax

Option to pay 20% or 10% lies with investor for each and every security 2% surcharge also payable Indexation Benefit on Unlisted Bonds not available No Capital Gain tax payable if entire Capital gain invested in Capital Gain Bonds of NABARD, NHAI, REC under sec 54 EC with a lock in of 3 years. Long Term capital gains exempt u/s 54 ED if invested within 6 months in shares of companies formed and registered in india with a lock in of 1 year.
120

Calculating Capital Gain Tax - An Example

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

After 2 years, he sells units and gets Rs.2.4 lacs His tax liability will be: CII 99-00 : 389, CII 97-98 : 331 , Ratio : 389/331=1.18 Indexed Cost (2,00,000 x 1.18) = Rs.2,36,000 Capital Gains Rs.4,000

Long Term Capital Gain tax of Mr. H: Rs.4,000* 20%=Rs.800 or 10% of Rs. 40,000/- i.e. Rs. 4,000/Obviously he will select the option of paying Rs. 800/-

121

Wealth Tax
Ownership of Units not included in Net Wealth Hence no Wealth Tax Payable on Mutual Fund units

122

Chapter 7
INVESTOR SERVICES

123

Investor Services

Application Procedure as per Offer Document

Wide Distribution of Application Forms Downloadable Application Forms Application through Internet
The

Procedure for NRIs/ OCB provided in the OD/KIM Bank details to be given in the Application Form PAN no. to be given if investment is Rs. 50,000/- or more Joint Account can be operated jointly by all
124

Application Procedure for Purchase of MF Units

The Application Form is an important agreement on the part of the investor of having read and understood the OD The various modes of payment specified in the OD NRIs can pay
from FCNR/NRE accounts by demand drafts or cheques in case of repatriation benefits. for non repatriation benefits payment can be made from NRO/NRNR A/c.
125

Application Procedure for Purchase of MF Units

FIIs can remit directly from abroad or pay from their NRE A/c. Offer Documents contains procedure purchasing and redeeming of units Introduction of Multi purpose Application Form
dispenses with the need for existing Investors to fill up full Application Form for making further investments
126

Investment Plans and Services

Investment Plans
Systematic Investment plan (SIP)
Regular Investment of fixed amount periodically (Rupee Cost Averaging Advantage) Automatic Reinvestment Plan (ARP)

Reinvestment of Dividend at Ex dividend NAV

Systematic Withdrawal plans (SWP) Regular withdrawals at periodical intervals Systematic Transfer Plans (STP) Selling units of one scheme & buying units of another scheme at regular periodical intervals of the same AMC

127

Other Services available under Mutual Funds Phone Transactions Internet / Email transactions

Cheque writing facility for Liquid Funds

Periodic statements of holdings Periodic statement of Investment Portfolio disclosures
128

Other Services available under Mutual Funds Mutual Funds cannot give loan against units Banks can give loan against MF units Nomination facility allowed Units of Close End Schemes can be transferred to another person Transfer in Open Ended Fund happens upon
death of unit-holder or when units are pledged or by operation of law i.e insolvency or winding up of the corporate investor
129

Chapter 8
INVESTMENT MANAGEMENT: EQUITY AND DEBT PORTFOLIOS
130

Investment Management
Fund Management Style impacts investment performance Magnitude of returns vary across funds
Time horizon of investments impacts Investors Returns
131

Part I : Managing Equity Portfolios

132

Types of Equity Instruments

Equity Shares
Preference Shares Equity Warrants Convertible Debentures
133

2 Major Task of Equity Portfolio Manager

Construction of a portfolio of equity shares
consistent with the objectives of the fund

Constantly rebalance the portfolio

to produce Capital Appreciation & Earnings rewarding the Investors with superior returns

134

Management of Equity Portfolios

Asset Allocation Stock Selection Market timing Monitoring of performance Portfolio re-balancing

Evaluation of performance
Risk assessment and Risk management
135

Equity Markets : Positive Features Largest number of listed stocks (9400

companies listed on all stock exchanges as at 31/3/04 out of which 7200 listed at BSE with a market cap of over 13 Lac Crores) Industrial diversity> (50 Industries / Sectors represented
Electronic Trading and Settlement System

Growing number of Institutional Players

Lower Transactions Cost Lower Settlement Risks
136

Equity Markets : Issues of Concern

Concentration of market cap and liquidity (Group A shares at BSE 140, B1 1100, B2 4500)

High levels of volatility

Information inadequacies
Disclosure of information Insider trading

Lack of depth for large volumes

137

Market Capitalisation based Classification of Shares Large cap companies

High Liquidity Low Transaction costs Moderate Liquidity More transaction cost High Profit potential High Transactions costs High Volatility

Mid cap companies Small cap companies

Different Indices and Benchmarks for Large / Mid / Small Cap

138

Earning based Classification of Shares

Price/Earnings Ratios
Higher the P/E, greater the growth potential

Dividend yield
Lower the dividend yield, Higher the growth potential

139

Cyclical, Growth, Value Stocks

Cyclical Stocks Growth Stocks
Earnings linked with market cycles

Low Asset base High growth potential High P/E - low dividend yields

Value Stocks

Large Asset base Long term good track record Moderate P/E & Moderate Dividend Yield
140

Passive Fund Management Style v/s Active Fund Management Style

Passive Fund Management Style
Replicates a chosen Index Low fees Low costs Index linked returns

Active Fund Management Style

Aim for Out-performance Higher fees Higher costs Stocks Selection and timing
141

Active Fund Management Strategies

Growth Investment Strategy
Fund Manager selects stocks of companies having potential of above average rate of growth in earnings.

Value Investment Strategy Fund Manger selects stocks of companies with good track record, stability of earnings and are undervalued
142

Role of Security Research in Active Fund Management

Fundamental Analysis
Research inputs based upon Fundamentals of the company and its profit potential

Technical Analysis
Analysis of market price and volumes based upon demand and supply position & past trend charts

Quantitative Analysis
Analysis of Sectors and Industries based upon macroeconomic factors

143

Equity Portfolio Management Organisation Structure Fund Manager

Focuses on a certain location Selects stocks & Fixes price range for purchase & sale researches companies and recommends buy & sell
Collects market intelligence Places buy and sell orders with brokers

Analyst Dealer

144

For Successful Equity Portfolio Management

Set realistic returns based on a Benchmark Be aware of the flexibility in managing a portfolio Decide on investment philosophy Develop an investment strategy based upon objectives & time horizons Avoid over diversification of portfolio & have well diversified portfolio Develop a flexible approach to investing
145

Use of Equity Derivatives

Mutual Funds have been allowed to make use of Futures & Option contracts in Equities for
Portfolio risk management Portfolio Rebalancing

Since September 2005 SEBI has also allowed Mutual Funds to trade in Derivative Contracts.
To enhance portfolio returns To launch schemes which invest mainly in Futures & Options

146

What are Equity Derivatives?

Equity derivatives instruments are specially designed contracts They derive their value from an underlying asset They are traded separately in F & O segment of Exchange Main derivative instruments are
Futures, Options
147

What are Equity Derivatives?

In a future contract
you can buy & sell the underlying equity at a specified future date at agreed price

In option contract
the buyer of option contract gets the right to buy or sell the underlying equity at agreed price on a future date only if he exercises the option & for this right he pays a price called Premium.

Option contracts are of two types

148

Using Derivatives for Hedging Portfolio Risk If Fund manager expects the equity market to decline
he may not sell the equity in the Cash Market. But can sell the Index Future at the current future price for future delivery.

If markets fall the equity portfolio will decline,

but future contract will show a corresponding profit, since fund manager have sold future contract at a higher price. This is called Hedging Portfolio Risk
149

Using Derivatives for Hedging Portfolio Risk If markets rise, instead of declining, the fund will not gain out of rise in the market prices. Other method of hedging investment portfolio risk is by buying a Put Option (an option to sell the underlying equity at an agreed price) by paying premium.

A fund manager has to decide whether to sell a future contract or to buy a put option depending upon the relative merits of each.
150

Part II : Managing Debt Portfolios

151

Debt Securities: Types

Debt Securities
Central Government Securities
State Government Securities Government Guaranteed Bonds PSU Bonds FI Bonds

Bank Bonds
Corporate Debentures
152

Debt Securities: Features

Other Features
Fixed rate / Floating rate Debt Securities Coupon Bonds / Cumulative Bonds Listed / Un-listed Debt Securities

Rated / Un-rated Debt Securities

Secured / Unsecured Bonds
153

Money Market Securities

All Debt Securities maturing within one year are called Money Market Securities Money Market Securities (Instruments) are:
T-Bills CDs CPs Call Money Repos

154

Indian Debt Market Size as at 31/3/2004

Type of security Central Government Securities Treasury Bills State Government Securities Market Capitalisation (Rs. In Crores) 959301 32692 79340

PSU Bonds
Others (FI, Bank, Corporate Bonds, CD, CP)

56831
87697

Total

1215861
155

Basic Characteristics of a Debt Security / Bond

Face Value, Par Value
Coupon Maturity Date

Put/Call options
156

Risks of Investing in Debt Securities / Bonds Interest rate risk Re-investment risk Call risk Default risk Inflation risk Liquidity risk

157

Measures of Bond Yields, Yields Spreads & Credit Risk

Measures of Bond yields are Yield curve of GOI Securities of different Maturities is constructed Yield Spread is the premium over G-sec rate paid by borrowers according to their credit risk quality Credit risk is priced using the ratings of credit rating agencies. Higher the credit rating, lower the spread Debt portfolios have credit quality objectives stated in OD
158

Current Yield Yield to maturity (YTM)

Duration of a Bond A Measure of Interest Rate Risk

Duration of a Bond is the average maturity period of a Bond as distinguished from the term of the Bond Duration helps to measure the interest rate risk of a Bond Higher the duration of a Debt Portfolio,
higher the risk of loss of value of the Portfolio if the rates of interest go up & vice-versa

Duration of Bond is less than its term, except for zero coupon bonds
159

Debt Management Strategies

Passive Debt Management Style
Buy and Hold Strategy exposing the portfolio to
Interest rate risk Credit risk

Active Debt Management Style

Duration Management Strategy
Duration increased/reduced based upon interest rates expectations

Credit Selection Strategy

160

Factors affecting Interest Rate Movements

Inflation Rate Changes
Exchange Rate Changes Monitory Policy Changes by R.B.I

161

Using Derivatives for Debt Portfolio Management

Debt Portfolio Risk arising out of Interest Rate increase can be hedged through interest rate derivatives. Interest rate derivatives are either exchange traded or privately traded in OTC market A Debt Portfolio Manager can sell interest rate futures or buy interest rate put options on an exchange to protect Debt Portfolio Value He can also buy and sell Forward Contracts or Swaps bilaterally with other market players in OTC.

162

Using Derivatives for Debt Portfolio Management

In India interest rate futures are available at OTC since 2004 Interest rate options are not introduced in India in the Exchange Through Swaps fund managers can hedge interest rate risk to Debt Portfolios Since June 2003 SEBI has permitted Mutual Funds to trade in Exchange Traded Debt Derivatives
163

Organisation Structure of Debt Fund Management

Interest Rate Forecasting Unit Fund Manager Security Dealer

164

Risk Management System in a Mutual Fund

SEBI has prescribed guidelines for Risk Management in a M.F Risk Management system Covers
Risks in Fund Management Risks in Operations Risks in Marketing & Distribution Other Business Risk

Internal Report on its adequacy to be placed before AMC & Trustee Board
165

Part III : Investment Policy and Restrictions

166

Investment Policy of a Fund

Investment policy of a fund scheme is stated in O.D
For Equity Fund
See kind of Sectoral Allocation & companies to invest

For Debt Fund

See types of instruments, credit rating, proposed average maturity, minimum & maximum MM instruments percentage

167

Investment Policy of a Fund

For Balanced Fund
See equity & debt proportions

For Money Market Fund

See types of instruments preferred & their rating profile

168

Regulatory Restrictions on Investments investors in a scheme by Funds Minimum no. of

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

Minimum portfolio diversification

Investment in equity of a single company Max 10% of the NAV (Except index funds, sector funds) All non government debt to be mandatorily rated by at least one rating company Investment in rated debt instrument of a Company
Max 15% of Net Assets Max 20% of Net Assets with approval of Board of Trustees
169

Regulatory Restrictions on Investments by Funds

Investment in unrated/below investment grade securities

Not exceeding 10% of Net Assets in a single company Not exceeding 25% of Net Assets of the fund in all the companies

Prior approval of Trustees mandatory for investments in unrated debt instruments

170

Regulatory Restrictions on Investments by Funds

Investment in unlisted shares of companies Close Ended Fund : Not more than 10% of Net Assets Open Ended Fund: Not more than 5% of Net Assets Investments in Equity shares under all schemes of a MF Not more than 10% of Paid up capital of a company Investment by a Mutual Fund in ADRs / GDRs allowed Investment by a M.F. in Equities of listed overseas companies having share holding of at least 10% allowed Overall limit of U.S. $ 1 Billion for such overseas investment for entire M.F. industry Overall limit per M.F. Not exceeding 10% of Net Assets subject to maximum 50 Million

171

Regulatory Restrictions on Investments by Funds A Mutual fund can invest

maximum 5% of Net Assets under all its schemes into different fund schemes of the same AMC or of any other AMC except Fund of Funds Scheme

The above limit does not apply to Fund of Funds Securities are to be bought or sold only on delivery basis No short selling allowed Securities to be bought and sold for a relevant scheme. Purchases/Sales cannot be aggregated and allocated later
172

Regulatory Restrictions on Investments by Funds MFs can lend securities under the SEBI approved Stock Lending scheme A Mutual Fund can invest only in Marketable Securities A Mutual Fund cannot invest in unlisted securities of Sponsor or Sponsor Group Companies A Mutual Fund can invest in listed securities of the sponsor / Sponsor Group Companies upto 25% of Net Assets of the Fund

173

Regulatory Restrictions on Investments by Funds

A Mutual fund can transfer Securities from one scheme to another scheme at market prices and on spot delivery basis Inter-scheme transfers allowed if objectives of both the schemes are same A Mutual fund can park its money in deposits of Scheduled Commercial Banks pending deployment into regular investments Borrowing by MFs restricted upto 20% of Net Assets for maximum 6 months for paying dividend/redeeming units Record of investment decisions to be maintained. A FOF cant invest in other FOF scheme A liquid fund cannot have mark to market component>10% . Maximum Re pricing tenure 1year.
174

Chapter 9
MEASRUING AND EVALUATING MUTUAL FUND PERFORMANCE

175

Measuring MF Performance
Major sources of return to investors are Dividends and Capital Gains Investor should track the value of his investments in terms of
Return on such investments Decide whether he needs to switch to another fund.
176

Methods of Measuring / Evaluating MF Performance

Absolute Return Method Simple Annual Return Method Total Return Method Total Return Method when Dividend is Reinvested Compounded Annual Average Rate Method (CAGR) Expense Ratio Method Income Ratio Method Portfolio Turn over Ratio Method Transaction Cost Method Fund Size Cash Holding Percentage
177

Absolute Return Method

Absolute returns are returns for a specific period
Absolute returns are calculated for less than 1 year period If NAV Changes from 20 to 22 in 6 months, Absolute return is 2/20*100=10%

178

Simple Annual Return Method

Simple Annual Return Method computes returns as follows Lets take the previous example
NAV changed from 20 to 22 in 6 months period Annual return is

(22-20) 20

x 12 6

100

20%

179

Total Return Method

Formula for Total Return when dividend is received but not reinvested: Dividend distributed + Change in NAV X 100 NAV at the start Total Return when Dividend is not received but reinvested This method is used to calculate return on investments when Dividends are declared and reinvested at ex Dividend NAV price See Example as given below for calculating Total Returns
Contd.

180

Total Return Method when Dividend not reinvested at NAV - An Example

Assume Units are purchased when NAV is 20 Assume that Dividend of Rs. 4/- is distributed
when NAV Ex Dividend is 21 22/-

Assume NAV at the end of the year is Rs. Simple Total returns for the year will be as
under

(22-20) + 4
20

x 100 = 30%

181

Total Return or ROI or CAGR Method

Compounded Average Annual Return Method
Formula A = P x (1+R/100)
N

P = Principal invested
A = Maturity Value

N = Period of Investment in years

R = Annualised compound interest rate in % R = [ (Nth Root of A/P) 1] x 100
182

Compounded Average Annual Return Method An Example

Begin NAV 100 End NAV 200 Period of Investment 10 years Average Annual Compound Return - Is it 10% or lower ? 200 = 100 x (1+R/100)10 Solving for R gives Annualised compound rate of 7.1773% or 7.2% Apply thumb rule of 72 SEBI prescribes Average Annual Compound Return Method to be followed for advertising Returns for over 1 year Period.
183

Returns impacted by Loads

The above example assumes a No Load Fund.
If there is an Entry Load, you will be allotted lesser number of units since you will pay more than NAV.

If there is Exit Load, you will get lesser amount per unit than NAV.
184

Expense Ratio / Income Ratio Method of Fund Evaluation

Funds can be evaluated based on Expense ratio and Income ratio Expense Ratio: It is the ratio of total expenses to Average Net Assets of the fund. This ratio is important for evaluating Bond Funds Expenses do not include brokerage paid since it is capitalized and therefore expenses may be understated Income Ratio = Net Investment Income Net Assets

Income ratio is important for evaluating Bond Funds

185

Portfolio Turn Over Rate Method of Fund Evaluation

Another Measure of Fund Evaluation is Portfolio Turn Over Rate Portfolio Turnover Rate = Total Sales & Purchases Net Assets of the Fund.

Higher Turn Over Rate indicates

More churning of Portfolio More transaction costs Portfolio turn over ratio relevant for actively managed funds

186

Importance of Bench Marking in Evaluating Fund Performance

Three methods of evaluating Fund Performance
Evaluating Fund Performance against Bench Marks Evaluating Fund Performance against other Peer Group Mutual Fund Schemes

Evaluating Fund Performance against other Financial Products

187

Fund Evaluation against Benchmarks

Funds Performance can be evaluated against some Performance Indicators called Benchmarks Mutual Funds are required by regulations to state the benchmark in the OD against which scheme performance will be compared Investors expect Fund Performance better than the benchmark 3 Types of Benchmarks : Relative to Market as a whole. Relative to other Mutual Funds Relative to other comparable financial products.
188

Benchmarks for Equity Funds

Type of Equity Fund
Index Funds Diversified Equity Funds

Name of Benchmark
BSE Sensex Index or S&P CNX Nifty Index BSE 100/200 Index for Large portfolio. Otherwise Sensex /Nifty Sector Specific Index

Sector Funds

Growth Funds with over 60% in Equity should use Broad Equity Index ( BSE 200 Index)

189

Benchmarks For Debt Funds & Money Market Funds

Type of Debt Fund Name of Benchmark

Gilt Fund
Debt Fund

Government Security Index

Corporate Bond Index

Money Market Fund

Mibor reflecting inter bank call money market interest rates.

Bond Funds with over 60% in Bonds to use Bond Market Index Balanced Funds should use Tailor made Index

190

Benchmarks For Debt Funds & Money Market Funds

There are various Indicies for benchmarking of Debt Funds I-Bex Index of I-SEC is used for tracking Govt. Security performance CRISIL has 8 Debt Indices for tracking performance of Corporate Bond Market & Money Market NSE has Govt. Security Index & Treasury Bill 191 Index

Benchmarking against other Mutual Funds.

Peer Group Comparisons :
Performance of Fund can be compared with similar schemes of other Mutual funds. Criteria for Peer Group Comparison would be similarity in Investment objectives and rating profile of portfolios Average maturity of debt portfolios Size of fund ( big or small) Higher Expense Ratio of a Debt Fund hurts long term debt investors
192

Benchmarking with other Financial Products

Comparison with Financial Products other

comparable

Risk Return Relationship to be considered Liquidity factors to be considered

Average Annualised compound returns to be compared.

193

Fund Performance Ranking

Fund performance evaluation & ranking done by CRISIL

Fund house rating done by CRISIL

194

Sources for tracking Mutual Fund Performance

Following sources of information can be used to track performance of Mutual Fund Schemes Mutual Funds Annual periodic Reports. Mutual Funds website. AMFI website Daily Financial News Papers. Fund Tracking Agencies Credence, Value Research & Lipper India Newsletters from brokers. Offer Document of the Fund Analytical Articles
195

Chapter 10
HELPING INVESTORS WITH FINANCIAL PLANNING

196

What is Financial Planning ?

Financial Planning includes
Identifying all financial needs of an individual Translating the needs into monetary goals at different times in the future Planning the financial investments to provide and satisfy future financial needs to achieve goals

Objective of financial planning

Right amount of money Right hands Right time in future
197

Need of Professional Financial Planners

Professional Financial Planners are need in case the investor:
Lacks expertise to do financial planning Lacks time to do financial planning Does not know where to start Feels there will be an improvement in the present situation Has an immediate need Wants professional opinion on self developed plan

198

Who is a Financial Planner?

A Financial Planner
Uses the financial planning process Help in determining the goals of the investor Identify
Financial planning needs of the customer Present priorities Products that suit their needs

199

Advantages of a Distributor becoming a Financial Planner

Strong Potential for such services
High saving habit Low awareness of various investment options Complexity of various investments

Limited supply of financial planners in India Benefit of establishing long-term relationships with clients Benefit of building a profitable business
200

What makes a good Financial Planner?

Building Trust Good Knowledge of Financial products / options Familiarity with Taxation & Estate planning issues Understanding of various Life stages in a clients life Independent judgment and balanced thinking Organized way of working Regular contact with clients Clear focus on the overall financial well-being of client

201

Roles of Each Participant

Client Financial Planner Fund Manager Portfolio Investments

Discussion of goals & Asset allocation

Choice of Schemes & Fund Manager

Analysis of Markets & Choice of Individual Securities

202

Basic Terms used in Financial Planning

Financial Planning: Advising clients on how to achieve their financial goals Financial Goals and Objectives: Needs of clients which have a monetary aspect Asset Allocation: Allocation of clients investment across various asset classes

Risk Tolerance: Extent of loss a client can tolerate, psychologically and financially and for how long they can withstand such declines in value
203

Basic Terms used in Financial Planning

Financial Plan: Document that details clearly in writing
financial goals available resources time frame for investment asset allocation specific investments clear action plan towards implementation

Portfolio Rebalancing: Process of making changes to asset allocation and specific investment to ensure the clients investment strategy stays consistent
204

Financial Planning Process

Establishing & Defining the Client-Planner Relationship
Gathering Client Data, Defining Client Goals Analyzing and Evaluating a Clients Financial Status Developing & Presenting Financial Planning Recommendations Implementing the Financial Planning Recommendations Monitoring the Financial Planning Recommendations

205

Steps in Financial Planning Process

1. Establishing & defining relationship with client 2. Defining clients goals 3. Assessing current resources in future Income potential of the client 4. Determining & Shaping the risk tolerance level of the client 5. Ascertaining Tax situation of the client 6. Recommending appropriate asset allocation & specific investment 7. Executing the plan & making the client invest 8. Reveal the progress & portfolio rebalancing
206

Common Mistakes in Financial Planning(FP)

Measurable financial goals are not set Financial decisions made in isolation FP is confused with investing Financial plans are not re-evaluated periodically Considered relevant only for wealthy FP required only when clients get older FP is considered same as retirement planning Only after a crisis FP is started Expectation of unrealistic returns on investments Belief of loss of control when Financial Planner FP is primarily tax planning 207

Key Issues in Financial Planning

A Financial Planner should make the client understand the following key issues:
To set Measurable Financial Goals To understand the Effect of each Financial Decision

To re-evaluate Financial Situation Periodically

To start Planning As Soon As Possible To be Realistic in Expectations To realize that the Client is in Charge

208

Life Cycle Stages of an Individual

Childhood Stage Young Unmarried Stage Young Married Stage Young Married with Children Stage Married with Older Children Stage Post-family/ Pre-retirement Stage

Retirement Stage

209

Life Cycle Stages

I N C O M E
CHILDS MARRIAGE CHILDS EDUCATION

CHILDS BIRTH MARRIAGE

EXPENSES
Over 25-30 yrs Retirement

22 yrs
Birth & Education

38 yrs

Earning Years

210

Constraints to Financial Planning

Insufficient investible resources Dearth of financial planning products

Time factor and Risk factor of investments:

Time is important to benefit from the power of compounding by starting early Basic principle of investing is Greater the Risk, Greater the Reward

Assumptions of life cycle needs

211

Financial Planning & Mutual Funds

Individuals have 2 types of needs

Protection Needs Investment Needs

For protection needs,

Pure Risk Plan of a Life Insurance company is the recommended option

For investment needs,

Mutual Fund schemes are the recommended options

Unit Linked Insurance is a new option satisfying both protection & investment needs

212

Wealth Cycle Stages of Investors

Another method of classifying investors is Wealth Cycle Stage (as against Life Cycle Stage There are 3 Wealth Cycle Stages for Investors
Accumulation Stage : Transition Stage
Reaping Stage :

Choose Equity Funds : Choose Balanced Funds

Choose Debt Funds

Intergenerational Transfer Stage refers to transferring wealth. Investment avenue will be linked with life cycle stage of the beneficiary The Sudden Wealth Stage refers to winning lotteries. Park in MM 213 Funds

Categories of Affluent Investors

Affluent investors do not need financial planning for life goals. They can be classified into 2 categories Wealth-Creating Affluent Investors
Build further wealth Willing to take a risk of Equity Investments to make net worth grow

Wealth-Preserving Affluent Investors

Preserving the created wealth Risk averse, prefer to invest in Debt Funds
214

Chapter 11
RECOMMENDING FINANCIAL PLANNING STRATEGIES TO INVESTORS.
215

Investment Strategies for Investors

Start planning & investing early and regularly. Use SIP Invest for long term. Have realistic expectation of returns on Investments Harness the power of compounding by choosing Growth option. Choose an investment strategy to maximise returns on investments. Buy and Hold strategy can be adopted for good mutual fund schemes but not for individual stocks. Rupee Cost Averaging strategy for investment.

Value Averaging strategy for investment.

216

Rupee Cost Averaging strategy of Investment

Rupee Cost Averaging (RCA) involves the following
A fixed amount is invested at regular intervals More units are bought when NAV is low Fewer units are bought when NAV is high Over a period, average purchase price per unit is lower than average NAV This strategy does not tell you when to sell and switch

Investor use SIP to implement RCA

217

Value Averaging Strategy of Investment

Value Averaging Strategy involves the following
A fixed amount is targeted as a desired value of the portfolio at regular intervals If market values go up
units are sold to restore target value

If market values go down

More investments are made to maintain target value

Over a period,
Average Purchase Price per unit is lower than if one tries to guess the highs and lows of market

218

Value Averaging Strategy

Value Averaging Strategy is superior to RCA It enables you to book profits and rebalance portfolios Investors can use SWP to implement Value Averaging Strategy

Investors can use MM Funds and Equity Funds to implement Value Averaging Strategy

219

Asset Allocation Principles

Asset Allocation is Basic tool to translate financial plans into action. Asset Allocation is determining the percentages of investments to be held in Equities, Bonds and Money Market instruments. Over 95% of returns on Managed Portfolio come from the right level of Asset Allocation amongst stock, bonds & cash. Asset Allocation differs for Investors depending upon their personal situation, financial goals and risk appetite 220

Model Portfolio for Investors Benjamin Grahams 50/50 Balance Strategy for Asset Allocation
50/50 split between Equities and Bonds
A common sense approach

Conservative investment approach

When value of equity goes up, balance restored by liquidating part of equity portfolio or vice versa. Good to get half the returns of a rising market and avoid the full losses of a falling market.
221

Model Portfolio for Investors Suggested By Bogle

Bogle suggests the following combinations:

1. A Basic Managed Portfolio

50% in Diversified Equity & Value Funds. 25% in a Govt.Securities Funds. 25% in High Grade Corporate Bond Funds.

2. A Basic Indexed Portfolio

50% in Total Stock Market Index Fund 50% in Total Bond Market Portfolio

3. A Simple Managed Portfolio

85% in a Balanced 60/40 Fund. 15% in Medium Term Bond Fund
222

Model Portfolio for Investors Suggested By Bogle 4. A Complex Managed Portfolio

20% 20% 10% 30% 20% in in in in in Diversified Equity Fund. Aggressive Growth Funds Specialty Funds Long Term Bond Funds Short Term Bond Funds

5. A Readymade Portfolio
Single Index Fund with 60/40 Equity / Bond Holdings Bogles Rule of Thumb for Asset Allocation Debt Portion of an investors portfolio to be equal to his age. 30 year old investor 70/30 (Equity /Debt Allocation)

223

Bogles Strategic Asset Allocation Strategy For Investors

Bogle recommends the following factors to be considered in strategic asset allocation strategy for investors: Age Financial Circumstances Objectives Equity / Debt

For For For For

Younger Investors in Accumulation Phase Older Investors in Accumulation Phase Younger Investors in Distribution Phase Older Investors in Distribution Phase

80/20 70/30 60/40 50/50

224

Fixed v/s Flexible Asset Allocation Strategy

Asset Allocation percentages can be on Fixed or Flexible Basis Fixed Ratio of Asset Allocation:
Balance maintained by liquidating a part of the position in the Asset class with higher return and reinvesting in the other assets with lower returns

Flexible Ratio of Asset Allocation :

Not doing any rebalancing and letting the profits run

Fixed ratio approach works better in bull markets

225

Tactical Asset Allocation Strategy

Change in Asset Allocation percentages based on Fund Managers views on the future movements in asset prices.

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

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

226

Chapter 12
SELECTING THE RIGHT INVESTMENT PRODUCTS FOR INVESTORS
227

Asset Types - Physical & Financial Assets

Physical Assets
Real Estate Gold

Financial Assets
Bank Deposits Company Deposits NSC, KVP, PPF RBI Relief Bonds Equity/preference shares

Bond/Debentures Commercial Papers Certificate of Deposits Life Insurance Policies Mutual Funds
228

Guaranteed and Non-Guaranteed Investments

Guaranteed Investments: Capital protection and interest rates are guaranteed by the borrower
Bank Deposits Government Savings Instruments

Non-Guaranteed Investments: Capital protection and interest rates are NOT guaranteed
Mutual Funds Equity Investments
229

Physical Assets
Individuals can invest in physical assets e.g. Gold & Real Estate Govt. has permitted issue of Gold Bonds by Banks Gold Bonds represent securitisation of Gold where they earn some returns and avoid risks associated with storage of gold Investors are likely to be allowed to invest in gold linked unit schemes Real Estate M.F. are also in the offing which will offer the investors the twin benefits of Real Estate Investing & Mutual Fund Investing
230

Financial Products & Issuers

ISSUER
Banks Corporates

PRODUCT
Fixed Deposits Shares

AVAILABLE TO
Investors, MFs Investors, MFs

Bonds, Debentures Investors, MFs Fixed Deposits Government Govt. Securities PPF FIs Bonds Investors, MFs Investors, MFs Investor Investors, MFs Investor
231

Insurance Cos. Insurance Policies

Evaluating Financial Products

PRODUCT
Equity FI Bonds

SAFETY/CONVIN ENCE
Low High

LIQUIDIT Y
High/low Moderate

RETURN

VOLATILIT Y

High-Mod. High Mod.-High Moderate

Debentures
Corp. FD Bank Dep. PPF Life Ins. Gold Real Estate MF

Moderate
Low High High High High Moderate High

Low
Low High Moderate Low Moderate Low High

Mod.-Low
Moderate Low-High Moderate Low-Mod Mod.-Low High-Low High

Moderate
Low Low Low Low Moderate High Moderate
232

Why MF is the Best Option?

MF combines the advantage of each of the investment product choices It reduces the short comings of other options
Returns in mutual funds get adjusted for market changes / movements

233

Investing through MFs Vs Direct Equity Investment Identifying stocks without detailed research is difficult in direct equity investment Diversification easily achieved in MF Professional management employed in MF Investment activities based on investment objective in MFs MFs offers more liquidity Transactions costs are lower for MFs More convenience in mutual funds
234

Investors Perspectives: MFs v/s. Other Products

Product INVESTMENT OBJECTIVE RISK TOLERANCE. TIME HORIZON

Equity
FI Bonds Debentures Comp. FD Bank Deposits PPF Life Insurance Gold

Capital Appr.
Income Income Income Income Income Risk Cover Inflation Hedge

High
Low Income Income Low Low Low Low

Long Term
Med-Long Med-Long Medium Flex-All Terms Long Long Long

Real Estate
Mutual Funds

Inflation Hedge
Cap. Gwt, Inc.

Low
H-M-Low

Long
Flex-All Terms

235

Chapter 13
HELPING INVESTORS UNDERSTAND RISKS IN FUND INVESTING.

236

Classification of Investors
Risk Tolerance Levels of Investors
Low Risk Tolerance Moderate Risk Tolerance

High Risk Tolerance

237

Classification of Funds Based on Risk Levels

Low Risk Funds :
Money Market Fund Government Securities Fund
High Risk Funds : Aggressive Growth Fund International Fund Sector Fund Specialized Fund Precious Metal Fund High Yield Fund Commodity Fund Index Fund

Moderate Risk Funds :

Income Fund Balanced Fund Growth & Income Fund Growth Fund Short Term Bond Fund Intermediate Bond Fund Index Fund

238

Jacobs Recommendations for Portfolio Allocation Within Each Category

Low Risk (Conservative) Portfolio : 50% - Gilt Fund + 50% Money Market Fund Moderate Risk (Cautiously Aggressive) Portfolio : 40% - Growth and Income Funds 30% - Gilt Funds 20% - Growth Funds 10% - Index Funds High Risk (Aggressive) Portfolio : 25% - Aggressive Growth Funds 25% - International Funds 25% - Sector Funds 15% - High Yield Funds 10% - Gold Funds 239

Risks in Mutual Fund Investing

Risk in a generic sense means the possibility of financial loss In the investment world possibility of financial loss arises from variability of earnings from time to time. A fund with stable, positive earnings is less risky
than a fund with fluctuating total return.

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

240

Risks in Equity Funds

Volatility of earnings of an equity fund comes from
Kinds of stocks Degree of diversification Fund managers success at market timings

Equity funds are exposed to equity price risks arising out of

Company Specific Risk Sector Specific Risk Market Level Risk

Market Level Risk

Not diversifiable, not controllable because of changes due to broad economic, political and other factors. Can be controlled to some extent through Equity Index Fund or Futures and Options 241

Risk Measures of an Equity Fund

Beta Co-efficient Measure of Risk

EX Marks or R Squared Measure of Risk

Standard Deviation Measure of Risk

242

Risk Measures
Beta Coefficient Measure of Risk :
Beta relates a funds return with a market index. Measures the sensitivity of the Funds returns to changes in the Market Index. Beta of 1 Fund moves with the market i.e.Passive Fund Beta of less than 1 Fund less volatile than the market i.e Defensive Fund. Beta of More than 1 Higher Beta greater returns in rising markets and higher losses in falling markets i.e Aggressive Fund.

243

Risk Measures
Ex-Marks or R-squared Measure of Risk
Ex-Marks represents co relation with markets Higher the Ex-Marks, lower the risk of the Fund A Fund with higher Ex-marks is better diversified than a Fund with a lower Ex-Mark

STANDARD DEVIATION MEASURE OF RISK

A statistical concept, which measures volatility. Measures the fluctuations of Funds returns around a mean level. Basically gives you an idea of how volatile your earnings are Broader concept than Beta. Measures total risk and not just the market risk of the portfolio.
244

Risk and Returns have co-relation. Risk adjusted Return is measured by using Sharpe Ratio or Treynor Ratio SHARPE RATIO = _____Risk Premium___ Funds Standard Deviation TREYNOR RATIO = ______Risk Premium ______ Funds Beta

Risk Adjusted Performance Measures

Risk Premium Difference between the Funds Average return and Risk free return on Government Securities or Treasury Bills over a given period PRICE EARNING MULTIPLES : Higher the Funds P/E, Higher the probability of its fall in fund values in future.

245

Risk Measurement of Debt Funds

Beta or P/E Ratio not relevant to Debt Funds. Debt Funds exposed to Risk of loss through
Default (Non Performing Assets) and Interest Rate changes.

Look at the credit quality of the Fund.

Higher the rating safer the Fund

Longer the average maturity (duration) of a debt portfolio

greater the loss if interest rates go up.

246

Chapter 14
RECOMMENDING MODEL PORTFOLIOS AND SELECTING THE RIGHT FUND
247

Jacobs Four Steps to Develop a Model Portfolio for a Client

1. Work with investor to develop long term goals. 2. Determine the Asset Allocation of the Investment Portfolio. 3. Determine the Sector Distribution. 4. Select the specific Fund Manager and their schemes.
248

Model Portfolios for Clients Recommended by Jacobs

For Young Unmarried Professional

50% in Aggressive Equity Funds 25% in High Yield Bond Funds and Growth & Income Funds. 25% in Conservative Money Market Funds.
For Young Couple with 2 incomes & 2 children
10% in Money Market Funds. 30% in Aggressive Equity Funds. 25% in High Yield Bond Funds and Long Term Growth Funds. 35% in Municipal Bond Funds.
249

Model Portfolios for Clients Recommended by Jacobs

For Older Couple, Single Income

30% 35% 25% 10%

in in in in

Short Term Municipal Funds. Long Term Municipal Funds. Moderately Aggressive Equity Funds. Emerging Growth Equity Funds.

For Recently Retired Couple

35% in Conservative Equity Funds for Capital Preservation. 25% in Moderately Aggressive Equity for modest Capital Growth. 40% in Money Market Funds.
250

Jacobs Model Portfolio for Investors

Investors in Accumulation Phase : Asset Diversified Equity, Sector & Balanced Funds
Income & Gilt Funds Liquid Funds & Bank Deposits

Allocation % 65 to 80

15 to 30 5
251

Jacobs Model Portfolio for Investors Investors in Transition Phase :

Mid-forties when children are approaching the age of higher education or marriage. Start converting
some of your equity investment into Income and Cash Funds to prepare for these financial commitments.

252

Jacobs Model Portfolio for Investors

Asset Class Diversified Equity & Balanced Funds Income Funds

Investors in Distribution or Reaping Phase : Allocation % 15 to 30 65 to 80

Cash Funds

253

Model Portfolio for Indian Investors Based on Mutual Funds available in India

Investors in Intergenerational Transfer Phase :

Young Investor upto age 50 years Life Insurance Policy to take care of next generation in the event of death. Older Investors For grown up Children

Balanced combination of Income & Growth Funds. Growth Funds. Income Funds to provide current income.

For grand Children For Charitable Institutions

254

Model Portfolio for Indian Investors Based on Mutual Funds available in India
Investors in Sudden Wealth stage :
Keep money in Liquid Funds. Take time to decide what to do with the money.

Affluent Investors :
Wealth Creating Individuals 70% to 80% in Diversified Equity and Sector Funds.

Wealth Preserving Individuals - 70% to 80% in Income, Gilt & Liquid Funds.
255

Equity Fund Selection for a Client

Select Specific Fund / Schemes for inclusion in the Model portfolio. Bogle Approach : Selecting Equity Funds
Classify the available Equity Schemes into Growth, Value, Equity Income, Broad based Specialty etc. Either Select main stream Growth or Value Fund providing broad diversification.
Select differentiated Growth or Value Fund or Specialty Fund where risk and return vary from market. Evaluate past returns records of available funds
256

Equity Fund Selection for a Client salient feature of a scheme Review

Fund size
Fund age Portfolio Managers experience Cost of investing Portfolio characteristics (cash position, portfolio
concentration,Market Capitalization)

Portfolio Turnover Portfolio Statistics ExMarks, Beta, Gross Dividend yield.

257

Debt Fund Selection for a Client

Selecting Debt Funds Narrow down the choice Know your investor objectives
For young investor Long Term Bond Funds
For Retired Investors Monthly Income Funds

258

Debt Fund Selection for a Client

Determine the right selection criteria
Fund Age Fund Size Relative yields Relative Costs Portfolio Characteristics Average Maturity Tax implication Bonds Vs Bond Fund Past Returns and Expense performance
259

Selecting MM / Balance Funds for a Client

Selecting Money Market Funds
Costs, Quality, Yields.

Selecting Balance Funds

Rarely 50/50, Equity oriented balanced funds or Income oriented balanced funds. Selection Criteria : (Portfolio balances, Debt portfolio characteristics, Costs, Portfolio Statistics, Returns)
260

Chapter 15

Business Ethics for Mutual Funds

261

What is meant by Business Ethics?

Business Ethics means rules of acceptable & good conduct Every person engaged in any business must comply with a set of rules of good conduct Rules may be set by those who own and manage business or by agencies regulating such business In addition to laws, rules of ethics are adopted by the business practitioners themselves Ethics go beyond the laws Laws are enforced by regulator, ethical codes are self enforced.

262

What is the Need for Business Ethics?

The need for Business Ethics arises from the need to protect the Consumer Ethical practices means practices in the interest of the consumer of a product or user of a service

A consumer who feels cheated once will not buy the product again.
Mutual funds and their sales person are required to adopt ethical and good business practices.

263

What is the Need for Business Ethics?

Consumer of goods and services expect the goods and services meets the promises. A sales person is expected to know the product thoroughly. Not promising more than what the product gives is an ethical business practice. AMFIs code sets a common set of rules for all the funds.
264

Objectives of Business Ethics

One major objective of business ethics is being honest, open and transparent with your potential clients. Another objective of business ethics is to protect the consumer of goods & services from being cheated or exploited In Mutual Fund industry the product is described in detail in the Offer Document. AMFI sets rules of good conduct by fund distributors
265

Some Key Terms of Business Ethics

Fair Business practices ensure that business is conducted both in the interest of the seller and consumer / investor. Ethical standards are bench marks set for acceptable level of performance Ethical Norms or guidelines: These norms may be voluntary or compulsory A Code of Conduct: It is voluntarily adopted set of good conduct, acceptable to the business participants, the regulators & SROs
266

Some Key Terms of Business Ethics

Ethical business practices: They ensure with the compliance with rules & code of good conduct.

Conflict of Interest: In Mutual Fund business there are situations where the interest of the investor runs counter to the interest of the agent.

267

Business Ethics & Mutual Fund Regulations in India The main role of SEBI is to protect the interest of the investors. SEBI encourages development of ethical standards among the Mutual Funds SEBI guidelines require Mutual Funds and AMFI to develop Code of Conduct for
Distributors Fund Managers All employees Associate persons

268

Business Ethics & Mutual Fund Regulations in India SEBI also lays down its own rule of ethics for certain matters incorporated in the Mutual Fund regulations SEBI mandates that all activities are done in the best interest of the regulators and it monitors 3 areas
Fund structure and governance Exercise of Voting Rights by Funds Fund operations

The Mutual Fund structure in India is

a 3 tier structure with sponsor, trustees & AMC as independent bodies

269

Business Ethics & Mutual Fund Regulations in India AMCs are supervised by independent Trustees
who have fiduciary responsibility towards the investors.

There is a separation of functions,

AMC charged with investment of funds and they dont hold asset of the fund. The Trust holds investment assets in fiduciary capacity since beneficial owners are investors. Trustees actually dont hold the trusts assets investment assets are held by the custodians, By separating ownership, management & custody of assets fraudulent use of assets is prevented. 270

Business Ethics & Mutual Fund Regulations in India

Board of trustees have at least 2/3rd independent directors thus ensuring independence of organization. AMC board has at least 50% independent directors thus reducing the influence of the promoter. The Mutual Funds have to exercise voting rights in the companies in the interest of fund investors and not in the interest of fund managers or promoters or employees.

It is an ethical but not a legal requirement

271

Business Ethics & Mutual Fund Regulations in India SEBI expects day to day fund operations to be free from unethical business practices.
Insider trading regulations No preferential treatment to selected investors Control over Personal Trading by Fund Managers and employees Uniform cut off time for accepting subscription application & for determining applicability of uniform NAVs to all customers Personal trades to be disclosed by the Fund Managers and the Directors

272

Business Ethics & Mutual Fund Regulations in India

All forms of advertisements to be as per SEBI regulations. To ensure that they dont mislead the investors. Regulations require the trustees of the mutual fund to certify that the persons of the AMC do not indulge in Front running or self dealing. There are regulations on Fund advertisements. SEBI has made it mandatory for the AMC to appoint a Compliance Officer to ensure implementation of laws and mutual fund regulation & voluntary Code of Conduct.
273

Business Ethics & Mutual Fund Regulations in India

SEBI requires all distributors to follow a Code of Conduct. AMFI has put in place amore detailed Code of Conduct called AGNI Mutual funds have to report any violation of all these regulations
274

Business Ethics & Fund Regulations in the U.S

The U.S Regulator (Security Exchanges Commission) require at least 75% of the funds board to be independent directors including the Chairman. Independent directors are required meet separately every quarter and make self assessment of their effectiveness SEC requires registered investment advisors to adopt and enforce codes of ethics applicable to their supervised persons, including personal trading Supervised persons have to acknowledge in writing receipt of copy of the Code of Ethics.
275

Business Ethics & Fund Regulations in the U.S An advisors code will require the advisors supervised persons to comply with applicable Federal Securities Laws.
There is requirement of reporting of personal securities holding & transactions, including transactions in Mutual Funds advised by the advisor. The Code requires access persons to pre clear any personal investments in IPOs Prevention of Disclosure of material non public information about the advisors buy and sell recommendations. Reporting of code violations to the compliance officer
276

Business Ethics & Fund Regulations in the U.S The law requires intuitional investors to invest as a Prudent Man would invest. The Mutual Fund managers have also to follow Prudent Man Approach & Responsible Investing Approach even though there is no law. Responsible Investing means
Ethical criteria may preclude investing in companies manufacturing cigarettes or alcohol Voting in share holders meeting in the interest of the investors. Community investing to help the under privileged communities 277

Business Ethics & Fund Regulations in the U.S

New Regulations & Fair Business Practices require

AMCs to avoid making special payments to distributors and brokers Uniform cut off time for all funds for NAV calculations

278

Thank You & Best of Luck for AMFI Test

279