ALL ABOUT

MUTUAL FUNDS

By - Dr. Y. P. Singh
Lucknow (India)
Session 1: Concept,
Structure and Regulatory
Framework
• Introduction
• Sponsor-Trustee-AMC
• Other constituents
• Regulatory framework
• Mutual fund products
• Merger and acquisitions
What Is a Mutual Fund?
A mutual fund is a pool of money
collected from investors and is
invested according to stated
investment objectives

Terms to know

Mutual: the ownership of the fund is
joint or mutual

Pool

Investment objectives
 Functioning of Mutual
fund

MF org.

Launches

Set of Investments (Portfolio)

Investors MF Scheme (Fund
Mgr) Market

Unit holders

Return pass
on to
investors*

•* Fund mgr charges fees as per SEBI

regulation against its services.
•The role of MF org. is like financial
intermediary
Mutual Fund: Back ground
•Most appropriate investment
opportunity for small investors
•Birth of mutual funds – USA
•Good alternative to direct investing
•Size (AUM) in USA > Bank deposits
•Financial intermediary
•UTI only player between 1964-87
•Helps in the growth of capital markets
Characteristics of a Mutual
Fund
• Investors own the mutual fund.
• Professional managers manage the
fund for a fee.
• The funds are invested in a portfolio of
marketable securities, reflecting the
investment objective.
• Value of the portfolio and the value of
investors’ holdings, alters with change
in market value of investments.
Advantages of Mutual
Funds to Investors
• Portfolio diversification
• Professional management
• Reduction in risk
• Reduction in transaction cost
• Liquidity
• Convenience and flexibility
Disadvantages of Mutual
Funds
• No control over costs
• No tailor-made portfolios
• Issues relating to management of
a portfolio of mutual funds
Fund Structure &
Constituents
• Mutual funds in US are setup as
investment companies
• Mutual funds in UK are either unit trusts
(trust) or investment trust (companies)
• Mutual funds in India are public trusts
under the Indian trust Act, 1882
• Mutual funds in India is a 3-tier structure

Sponsor

Trustee

AMC
 Sponsor

• Promoter of the the mutual fund

• Appoints AMC and also appoints
the trustees
• Criteria

Financial services business

5-year track record

3-year profit making record

At least 40% contribution to AMC
capital
Trustees
• Trustees represent the trust i.e. MF org. Trust has no
physical identity
• Fiduciary responsibility for investor funds
• Appointed by sponsor with SEBI approval
• Registered ownership of investments is with Trust
• Board of trustees or Trustee Company
appoints all other constituents
• Trustees oversee the functioning of AMC
• Trustees approve each MF schemes floated by AMC
• Trustees receive fees for their services
Trustees

• At least 4 trustees

2/3 should be independent
• Trustees of one mutual fund cannot
be trustee of another mutual fund
except in case of Independent trustee
after Board approval of Both the MFs
• Right to seek regular information and
remedial action
• All major decisions need trustee
approval
Asset Management
Company
• Responsible for operational aspects of
the mutual fund & can undertake
following businesses

Asset mgt services

Portfolio Management Services

Portfolio advisory services
• Investment management agreement
with trustees
• Registered with SEBI
• Rs. 10 crore of net worth to be
maintained at all times
• At least 1/2 of the board members to be
independent
Asset Management
Company
• Appoints other constituents with
trustees approval
• Cannot have any other business
interest & can be changed /terminated

Majority of trustees or

At least 75% majority of unit holders
• Structured as a private limited
company

Sponsor and associates hold capital
• AMC of one MF cannot be trustee of
another MF
• Quarterly reporting to Trustees
Other Constituents
• Custodian

Investment back-office: Safekeeping of
records & documents

Registered with SEBI
• Registrar and Transfer agent

Keeps Investors A/c’s & record of transactions:
purchase, redemption tranfer of units etc.

Registered with SEBI
• Broker

Purchase and sale of securities

5% limit per broker
• Banker

Assist funds pay in & pay out obligations
• Auditor

Separate auditor for AMC and mutual fund
Regulatory Framework
• SEBI:

Apex regulator of capital markets. It is the
primary regulator of mutual funds in India.

SEBI has enacted SEBI (Mutual Fund)
Regulations 1996 to regulate MF industry.

Mutual funds mandatorily required registering
with SEBI.

Mutual funds have to send half-yearly
compliance report.

Inspects and regulates other constituents of
mutual fund.
• RBI:

Monetary authority of the country and also
the regulator of the banking system.

It is involved only with bank-sponsored
mutual funds.
• MoF:

Supervisor of RBI and SEBI

Appellate authority under SEBI regulations.
Regulatory Framework
• COMPANIES ACT:

The AMC and the Trustee Company may be
structured as limited companies, which come
under the regulatory purview of Company Law
Board (C L B),

Registrar of Companies (ROC) oversees the
compliance.

Department of Company Affairs (DCA) is
responsible for the formulation and
amendments in laws relating to companies,
including the Indian Companies Act. It has the
power to prosecute the directors.
• STOCK EXCHANGES:

Regulatory role if the mutual fund is registered
with it.
• PUBLIC TRUSTEE:

Since the mutual funds are registered under
Indian Trusts Act, they come under regulatory
purview of the office of public trustee, which in
turn reports to the commissioner.
Regulatory Framework
• UTI:

UTI was governed by provisions of the UTI Act, 1963.

UTI has, however, subjected itself voluntarily to the
provisions of the SEBI regulations in 1996.

All the UTI schemes, except the US 64, are under dual
regulation of both SEBI and UTI Act.

The Board of Trustees operates it.

The Board has nominees from MoF, RBI and other
institutions who subscribed to the initial corpus.

The Chairman is appointed by MoF, in consultation with
IDBI, the principal investor in the corpus.

UTI does not have a three-tier structure. Hence no AMC.

All expenses borne by the schemes. UTI has powers to
take loans, other mutual funds can’t.

Major Differences
• Assured return schemes
• Different accounting norms
• Ability to take and make loans
Regulatory Framework
Self-regulatory Organisations
(SROs)
• Derive powers from regulator
• Ability to make bye-laws
• Example : Stock exchanges
• Industry Associations

Collective industry opinion

Guidelines and recommendation

Example: Association of Mutual Funds in
India
• AMFI is not yet a SEBI registered SRO
Mutual Fund Products -
classification:
Mutual fund products can be classified on
various parameters:

On the basis of maturity:
– Open ended funds - no maturity
– Close ended funds – having maturity

On the basis of Investment
– Equity or growth fund
– Debt or income fund
– Balanced or hybrid fund

On the basis of investment objective
– Equity diversified fund
– ELSS / index funds
– Sectoral fund
– Money market fund / gilt-edge fund
– Gold fund
– Exchange traded fund
– Funds of fund etc.
Mutual Fund Products

• Open ended funds


Initial issue for a limited period

Continuous sale and repurchase

Size of the fund i.e. Unit capital
changes as investors enter and
exit

NAV-based pricing
Mutual Fund Products

• Closed end funds


Sale of units by fund only during
Initial Public Offer

Listing on exchange and liquidity for
investors

Size of fund i.e. Unit capital remains
constant

Price in the market is usually at a
discount
 Equity Funds
• Pre-dominantly invest in equity markets

Diversified portfolio of equity shares

Select set based on some criterion
• Diversified equity funds that invest in the broad markets

ELSS as a special case have the following features:
– 3 year lock in
– Minimum investment of 90% in equity markets
at all times
– Open or close ended
– Deduction u/s 80c for investments up to Rs.
10000.
• Primary market funds
• Small Cap funds
• Index funds which replicate an index
• Sectoral funds which focus on a sector
Debt Funds
• Predominantly invest in the debt markets

Diversified debt funds

Select set based on some criterion
• Income funds or diversified debt funds-
Diversified debt funds which invest in the
broad debt market
• Gilt funds that invest only in Government
securities
• Liquid and money market funds which
invest only in short term securities
• Short term funds which invest in debt of
tenor higher than the money market funds.
• Fixed term plans that invest in securities
and hold them to maturity, for a fixed
period.
Balanced Funds
• Investment in more than one
asset class

Debt and equity in comparable
proportions

Pre-dominantly debt with some
exposure to equity

Pre-dominantly equity with some
exposure to debt
• Education plans and children’s
plans are examples of balanced
funds
Investment Options

• Investors can achieve income

and growth objectives in all funds

Dividend option

Growth option

Re-investment option
• Most funds provide multiple
options and the facility to switch
between options
 Basis for Classification
Investors choose funds based on their
objective, risk appetite, time horizon and
return expectations.

• Risk

Sectoral funds are most risky; money
market funds are least risky
• Tenor

Equity funds require a long investment
horizon; liquid funds are for the short term
liquidity needs
• Investment objective

Equity funds suit growth objectives; debt
funds suit income objectives
Risk and Return

Sectora
l funds
Return Equity
funds
Index
funds
Balance
d funds
Debt
Funds
Gilt
funds
ST debt
funds Risk
Liquid
funds
Mergers and Acquisitions
• Scheme take over : If the schemes of one fund are
taken over by another fund, it is called as scheme
take over. This requires SEBI and trustee approval.
• AMCs merger: If two AMCs merge, the stakes of
sponsors changes and the schemes of both funds
come together. High court, SEBI and Trustee
approval needed.
• AMC take-over : If one AMC or sponsor buys out the
entire stake of another sponsor in an AMC, there is a
take over of AMC. The sponsor who has sold out,
exits the AMC. This needs high court approval as
well as SEBI and Trustee approval.
• Investors can choose to exit at NAV if they do not
approve of the transfer. They have a right to be
informed. No approval is required, in the case of
open-ended funds.
• For close-ended funds investor approval is required
for all cases of merger and take-over.
Session 2: Investing in
Mutual Funds:
Understanding the
Process
• Offer Document
• Investors/ unit holders rights
• Verification and Due Diligence
• Investing in a Fund Scheme
 Offer Document/ KIM
• Legal offer from AMC to investor
• Offer Document (OD) is the most important source
of information for investors.
• Abridged version is called as Key Information
Memorandum (KIM).
• Investors are required to read and understand the
offer document.
• No recourse is available to investors for not reading
the OD or KIM
• A glossary of important terms is included in the offer
document.
• The cover page contains the details of the scheme
being offered and the names of sponsor, trustee and
AMC.
• Mandatory disclaimer clause of SEBI should also be
on the cover page.
• The borrowing restrictions on the mutual fund
should be disclosed. This includes the purposes and
the limits on borrowing.
Offer Document/ KIM
Continue……
• OD is issued by the AMC on behalf of the
trustees.
• KIM has to be compulsorily made available
along with the application form.
• Close ended funds issue an offer document
at the time of the IPO.
• Open ended funds have to update OD atleast
once in 2 years.
• Any change in scheme attributes calls for
updating the OD.
• Addendums for financial data should be
submitted to SEBI and made available to
investors.
• Trustees approve the contents of the OD and
KIM.
• The format and content of the OD has to be
as per SEBI Guidelines
• The AMC prepares the OD and is responsible
for the information contained in the OD.
 Offer Document/ KIM
Continue……
• A scheme cannot make any guarantee of return,
without stating the name of the guarantor, and
disclosing the networth of the guarantor.
• Information on existing schemes and financial
summary of existing schemes to be given for 3
years.
• Information on transactions with associate
companies to be provided for the past 3 years.
• If any expense incurred is higher than what was
stated in the OD, for past schemes, explanations
should be given.
• There is no information on other mutual funds,
their product or performance in the OD.
• 3 years track record of investors’ complaints and
redressal should be disclosed in the OD.
• Any pending cases or penalties against sponsors
or AMC should be disclosed in the OD.
• Investors’ rights are stated in the OD.
Contents of Offer
Document
•OD has to be submitted to SEBI prior to the launch of
the scheme.
• The OD contains

Preliminary information on the fund and scheme

Information on fund structure and constitution

Fundamental attributes of the scheme

Details of the offer

Fee structure and expenses

Investor rights

Information on income and expenses of existing
schemes
• Risk factors, both standard and scheme-specific,
have to be disclosed
• Factors common to all funds are called as standard
risk factors. These include market risk, no
assurances of return, etc.
• Factors specific to a scheme are scheme-specific,
risk factors in the Offer Document. These include
restrictions on liquidity such as lock-in period, risks
of investing in the first scheme of a fund, etc.
Fundamental Attributes
Fundamental attributes of a
scheme include:


Scheme type

Objectives

Investment pattern

Fees and expenses

Liquidity conditions

Accounting and valuation

Investment restrictions, if any
Changes in Fundamental
Attributes

• Investors approval is not needed

but Investors have right to be
informed
• Public announcement by AMC
• Option to exit without load
• SEBI and Trustee approval
• New offer document
Unit Holder Rights
/Investors
Investors have the right to inspect
a number of documents. These
are:


Trust deed

Investment management agreement

SEBI (MF) Regulations

AMC Annual reports

Unabridged offer document

Annual reports of existing schemes
Unit Holder Rights

• Cannot sue the mutual fund

•
Complaints against AMC, sponsor
and BoT
• 75% unit holders can
•
wind up a scheme
•
seek AMC termination
• Prospective investor has no
rights
• Right to redeem for fundamental
changes without exit load
Verification and Due
Diligence
• Compliance Officer has to sign the due
diligence certificate. He is usually an
AMC employee.
• The due diligence certificate states that

Information in the OD is according to
SEBI formats

Information is verified and is true and fair
representation of facts

All constituents of the fund are SEBI
registered.
• SEBI does not approve or certify the
contents of the OD.
Investing in a Fund
Scheme
• Units or amount
• Certificates and account statement
• Minimum amount
• Initial offer and subsequent buying
• List of eligible investors

Check eligibility with offer document

Foreign investors not eligible (FII
Regulations)
• Documents for classes of investors
Distribution Channels

• Individual agents
• Institutional Distributors


Banks

Distribution companies
• NBFCs

Direct marketing channels
Individual Agents
• Wide network
• Certification

AMFI registration No. (ARN) card
necessary before selling
• Commission structure

Initial and Trail
• Loyalty and volume incentives
Institutional Distributors
• Banks

HNIs and personal banking
• Distribution companies

NBFCs
• Service and collection
• Advisory
• Direct Marketing

Direct Service Agents

Investor Service Centres e.g CAMS
Procedure
• Proof of purchase

Certificate

Account statement

• Application form- contents


Single

Joint holding

Minor

Nomination

PAN number

Tax status

Folio number

Bank details
Session 3: Accounting,
Valuation & Taxation

• Accounting
• NAV & Pricing
• Accounting policies
• Valuation norms for mutual funds
• Taxation of mutual funds
 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 Fund) Regulations, 1996
• Unit holdes’ 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 belongs to investors
 NAV and Load
• 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 NAV’s every week NAV
calculation has to consider up to date transactions
• Sale and repurchase price are NAV-based

Cut-off time for NAV: The cut –off time for all mutual
fund schemes except liquid fund schemes is 3 pm

For all valid applications received before the cut-off
time, units are allotted /cancelled based on NAV at the
end of the same day & after the cut-off time , NAV of
the next business day.

The above rule does not apply to liquid fund schemes
 NAV and Load
• Load is a charge on the NAV

Entry load is charged on NAV and increases
the sale price

Exit load is charged on NAV and reduces the
repurchase price
• Load is defined as a percentage
• Load is primarily used to meet the expenses related
to sale and distribution of units.
• An exit load that varies with the holding period of an
investor is called as CDSC (Contingent deferred sales
charge).
• Loads are subject to SEBI Regulation and vary
depending on industry practice
 Entry Load : Example
If the entry load (sales load) for a scheme is
1.5% and the NAV of the scheme is Rs.
24.50, the investor who wants to buy the
units will not be able to buy at Rs. 24.50.
He will pay

= 24.5 + (24.5*1.5/100)

= 24.5 + 0.3675

= 24.8675
Exit Load : Example

If a fund imposes an exit load of

1.25%, the investor who repurchases
his units, will get a price that is:

= 24.5 – (24.5*1.25/100)

= 24.5 - 0.30625

= 24.19375
SEBI Regulations : Load
For opened end funds :


The sale price cannot be more than 107% of
the NAV and

The repurchase price cannot be less than 93%
of the NAV.

That is, the maximum load can be only 7%.

For closed end funds


The maximum entry or exit load cannot be
higher than 5%. The repurchase price cannot
be less than 95% of the sale price.
Example
If the NAV is Rs. 10,
• Sale price cannot be higher than Rs. 10.7.
• Repurchase price cannot be lower than Rs.
9.3.
• However, the mutual fund cannot charge
both these prices.
• If the sale price is Rs. 10.7, the repurchase
price cannot be lower than Rs. 9.95
(10.7*0.93).
• If the repurchase price is Rs. 9.3, the sale
price cannot be higher than Rs.9.95
(9.3*1.07).
Industry Practice

Load is not imposed on NAV, but

on the price.
NAV = Sale price - sale price x load
= Sale price (1-load)
Sale price = NAV/(1-load).
NAV = Rep. price + Rep.price x load
= Rep. Price(1+load)
Repurchase price = NAV/(1+load)
Example
If the NAV is Rs. 10,
• Sale price cannot be higher than 10/0.93 =
Rs. 10.753.
• Repurchase price cannot be lower than
10/1.07 = Rs. 9.346.
• However, the mutual fund cannot charge
both these prices.
• If the sale price is Rs. 10.753, the
repurchase price cannot be lower than Rs.
10 (10.753*0.93).
• If the repurchase price is Rs. 9.346, the sale
price cannot be higher than Rs.10
(9.346*1.07).
NAV Calculations

• Market value of investments

• Plus Receivables and other assets
• Plus accrued income
• Less Payables and other liabilities
• Less accrued expenses
• NAV = Net assets/Number of units
Disclosing NAV of a Unit
• All income, expenditure to be accounted up to
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 affected by more than 1% , AMC to:
•
Pay excess difference
•
Recover excess paid
Factors affecting NAV

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
Sources of Income
• Interest
• Dividend
• Profit from sale of investments
• Other income
• Extra-ordinary income
 Charges in MF
Mutual funds can recover two types of
expenses:
• Initial issue expenses
• Recurring expenses

• Initial issue expenses: Expenses incurred

in floating schemes

Effective April 04,2006 allowed up to 6% for
close ended funds only

Close ended funds can not charge entry loads

Open ended funds can recover initial expenses
through entry load
 Initial issue expenses
• Limit of 6% of initial resources raised under the scheme;
excess expenses to be borne by AMC/sponsor
• CEF : Amortise on weekly basis until maturity
• OEF : For an open-ended scheme, the initial issue
expenses are carried in the balance sheet of the fund as
“deferred revenue expenses.” They are written off over a
period not exceeding 5 years.
• A fund that does not charge any of the initial issue
expenses is called a no-load fund. AMCs can charge 1%
higher investment management fee in this case.
• Open-ended fund should meet the expenses related to
sales and distribution of schemes from the entry load and
not through initial issue expenses.
• In case of CEF, Investors exiting before expiry of period of
scheme will be charged unrecovered initial expenses
• Conversion of CEF into OEF allowed only after recovery of
un-recovered initial expenses
Amortisation – An example

Assume close ended fund of five years, collects

Rs. 100 Cr. and incurs initial issue expenses of
Rs 5 Cr.
Units issued = 10 cr
Investment = 95 cr
Initial NAV = [{95+((260/260)*5)} / 10 ]=10
After 4 weeks let the market value of
investments = 98 cr
Therefore,
NAV = [{98+((256/260)*5)} / 10 ]=10.29
Impact of initial issue expenses on
NAV
Assume open ended fund collects Rs. 100 cr

Entry load = 2.25%

Initial issue expenses = 5 cr
Impact on NAV
Initial NAV = Rs. 10 per unit
As no. of units allotted would be:
[{100 - (100*2.25%)} / 10 ]=9.775 cr
Recurring / Operating
Expenses
• Investment management fees
• Custodian’s fees
• Trustee Fees
• Registrar and transfer agent fees
• Marketing and distribution expenses
• Other Operating expenses
• Audit fees
• Legal expenses
• Costs of mandatory advertisements
and communications to investors
Limits on recurring
expenses
Recurring expenses can not exceed
the following regulatory limits:

For net assets up to Rs. 100 crore: 2.5%

For the next Rs. 300 crore of net assets:
2.25%

For the next Rs. 300 crore of net assets: 2%

For the remaining net assets: 1.75%

Applied on the weekly average net assets of
the mutual fund scheme.

On debt funds the limits on expenses are
lower by 0.25%.

For fund of funds the limit on expenses is
0.75%
Investment (Asset) Management
Fees
AMC charges Asset management fees: the
limits as per SEBI regulations are as follows:

For the first Rs. 100 crore of net assets: 1.25%

For net assets exceeding Rs. 100 crore: 1.00%

1% higher fee 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

Balance of Deferred Revenue Expenses not included in
net assets for computing investment management fee
In other words un-amortized portion added for NAV
calculation as other asset but no AMC fee on this
amount
Expenses that cannot be
charged
• Penalties and fines for infraction of laws.
• Interest on delayed payments to unit holders.
• Legal, marketing and publication expenses not
attributable to any scheme.
• Expenses on investment and general
management.
• Expenses on general administration, corporate
advertising and infrastructure costs.
• Expenses on fixed assets and software
development expenses.
• Such other costs as may be prohibited by SEBI.
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
Accounting Policies
• Investments to be marked to market
• Unrealized appreciation can’t be distributed
• Dividend/bonus recognized on the date share
is quoted ex-dividend/ex-bonus
• Average cost considered for determining
gain/loss on sale of shares
• Purchase / Sale of investments recognized: 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
Provisioning of NPA – Debt
securities
If interest remain unpaid for 10% of BV
6 months
If interest remain unpaid for 20% of BV
9 months
If interest remain unpaid for Another 20% of BV
12 months
If interest remain unpaid for Another 250% of BV
15 months

If interest remain unpaid for Balance 25% of BV

18 months
Valuation norms
for mutual funds
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

Prescribed detailed valuation methodologies
in its fund regulations

Mandates disclosure of valuation methods
used for investors’ information
Valuation of 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
50000 shares or Rs. 5 lacs or less amount) is
done as per SEBI approved norms
• Valuation of non traded shares is done as per
SEBI approved norms
• If thinly traded & Non traded equity securities
exceed 5% of the total assets of the scheme,
then independent valuer should be appointed for
valuation
Valuation of Shares
• If illiquid securities (non traded, thinly traded & unlisted
equity shares) exceed
• 15% of net assets for open ended funds
• 20% of net assets for close ended funds
Then Value is taken zero for securities in excess of
15% / 20%
The above mentioned is also limit for valuation of illiquid
shares
• Valuation mechanism for illiquid equity instruments is as
follows:
o Calculate book value per share
o Calculate earning value per share based upon industry
P/E and discount it by 75%. (latest audited EPS be taken
for this purpose) as,
o Earning value per share=discounted P/E x audited EPS
o Calculate fair value per share taking 90% of average of
book value and earning value per share
Valuation – An example
Assume net worth / share = Rs. 8
Audited EPS = Rs 2
Industry P/E = 12
Discounted P/E for company = 25% of 12 = 3
(discounted up to 75%)
Value of share (2*3) = 6
Average value (8+6) = 7
Value to be taken = 90% of average value = 90%
of 7=Rs. 6.30

Remark:
 If EPS is negative or not available for within
previous nine months, it should be taken as
zero
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 cr.
• A debt security if not traded in last 15 days is
called not traded or thinly traded debt security
Valuation of thinly traded and non-
traded debt securities
Debt instruments:
• Less than 182 days maturity
• 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
Yield to Maturity (YTM)
• YTM is the internal rate of return on investment in
bond also called Gross Redemption Yield (GRY)
• Internal rate of return is computed based on:
• Coupon rate
• Purchase price
• Period to maturity
• 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 the lower than the coupon rate
• If purchase price is less than the face value, YTM will
be the more than the coupon rate
Calculating price of bond with given
YTM – An example
Given data:

Face value : Rs. 1000

Coupon rate : 10%
Tenure : 5 Yrs
Interest payment : yearly
Yield (YTM) : 8.72%

Calculate price of the bond:

Cash flows under the bond and their present
values are as under
= [{100/(1+8.72)}+ [{100/(1+8.72)2}+ [{100/
(1+8.72)3}+ [{100/(1+8.72)4}+ [{(100+1000)/
(1+8.72)5}]
Thus Price of Bond = Rs. 1050
Taxation of mutual
funds

• Income for investors

–Dividend
–Capital gain
 Taxation of MFs and
Investors
• Finance Act 1999 radically changed taxation of
dividends received by investors in MFs.
• MF as an entity is not taxed since it is a Pass
Through Entity. (defined under 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 the investors.
• Income (dividends) distributed by a debt fund was
made liable dividend distribution tax (DDT) at
applicable rate of 10%
• Open ended funds with more than 50% invested in
equity do not pay any DDT (since changed to 65%
in FY 06-07)
 Taxation of MFs and
Investors
• Impact of DDT:

Investor pays the tax indirectly, since NAV comes down to
the extend of tax paid by the fund

DDT bears no relationship to the investor’s tax bracket.

Dividend reinvested is also subject to DDT

In growth plans, DDT not applied, since no dividend is
distributed.
• Securities transaction tax (STT) is charged as applicable
• 80 C benefit for 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
 Treatment of Capital Gains
• Long term: > 12 months
• Short term: < 12 months
• Long term capital gains subject to indexation
benefit

20% +surcharge after indexation

10% + surcharge without indexation
• Short term capital gains taxed at normal tax rates
as applicable to investors.
• U/s 111(a) of IT Act:

No long term gains tax on equity oriented schemes if STT
charged

Short term capital gains tax at 10% on equity oriented
schemes if STT charged
• Indexation benefit on unlisted bonds not available
 Treatment of Capital Gains

• 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.
Session 4: Capital Markets and
Mutual Funds – Investment
management
• Managing Equity portfolios

Equity investment options

Equity markets: issue of concern

Investment strategies

Successful equity portfolio management

Risk hedging techniques: use of equity derivatives
• Managing Debt portfolios

Debt market securities- types and characteristics

Risks of investing in debt securities /bonds

Yield and duration

Investment styles
• Investment restrictions
Managing Equity portfolios
Equity Investment

• Investment Options

Equity shares

Preference shares

Convertibles: Debentures or
preference shares

Equity Warrants: give holders option
to purchase specified number of
shares at predetermined rate.
Equity Markets: Issue of
concern
• Concentration of market
capitalization and liquidity (shares at
BSE: Grp A-140, B1-1100, B2- 4500)
• High levels of volatility
• Information inadequacies:

Disclosure of information

Insider trading
• Lack of depth for large volumes
Investment Strategies: is aimed at
to produce capital appreciation & earnings
and rewarding investors with superior
returns

• Large cap, Mid cap and small cap

• P/E ratios & Dividend yield
• Cyclical , Growth and value stocks
• Active fund management style and
passive fund management style
• Fundamental analysis, Technical
analysis and quantitative analysis
• Use of equity derivatives
Large cap, Mid cap and small
cap
• Large cap companies:
• High liquidity
• Low transaction costs
• Mid cap companies:
• Moderate liquidity
• More transaction cost
• Small cap companies:
• High profit potential
• High transaction costs
• High volatility
• There are different indices & benchmarks
for Large/ Mid / Small Cap
P/E ratios & Dividend yield and
Cyclical, Growth and value stocks
• P/E ratios :
• Higher the P/E, greater the growth potential
• Dividend yield :
• Lower the dividend yield, Higher the growth potential
• Cyclical stocks:
• Earnings linked with market cycles i.e. macro economic
factors
• Growth stocks:
• Low asset base
• High growth potential
• High P/E – Low dividend yield
• Value stocks:
• Large Asset base
• Long term good track records
• Moderate P/E & Moderate dividend yield
Passive fund management style and
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
• Stock selection and timing:
– Growth investment strategy: Fund manager
selects stocks of cos. Having potential of
above average rate of growth in earnings.
– Value investment strategy: Fund manager
selects stocks of cos. With good track record,
stability of earnings and are undervalued
Fundamental analysis, Technical
analysis and quantitative analysis
• Fundamental analysis :
• Seeks where to invest
• Research inputs based upon fundamentals of the
company and its profit potential
• Technical analysis :
• Seeks when to invest
• Analysis of market price and volumes based
upon demand and supply position & past trend
charts
• Quantitative analysis :
• Helps in choosing asset class
• Analysis of sectors and industries based upon
macroeconomic factors
Equity portfolio management
organization structure

• Fund manager:
– focuses on a certain location
– select stocks &
– fixes price range for purchase & sale
• Analysts:
– researches companies and
– recommends buy & sell
• Dealers:
– collects market intelligence
– Places bye and sell orders with brokers
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
• Ensure risk hedging techniques
Risk hedging techniques: 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
What are equity derivatives?
• Equity derivatives instruments are specially designed contracts
• They derive their value from an underlying assets
• They are traded separately in F&O segment of exchange
• Main derivative instruments are:
• Futures,
• options
• 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 (call)
or right to sell (put)
• The underlying equity
• At agreed price
• On a future date
• Only if he exercises the option &
• For the right he pays a price called premium.
• Option contracts are of two types viz: call option & put option
Equity derivatives as risk hedging tools
• If fund manager expects the equity market to decline:

He may not sell the equity in cash market rather

He 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 with the use of future
contracts.
• If market rise, instead of declining, the fund will not gain
out of rise in the market prices as future contract will show
corresponding loss since fund manager has sold future
contract at lower price.
• Other method of hedging investment portfolio 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.
Managing Debt portfolios
Debt securities: Types
Debt securities:

• Central government securities

• State government securities
• Government guaranteed bonds
• PSU bonds
• FI bonds
• Bank deposits
• Corporate debentures
Debt securities: Other
types
Features based:

• Fixed rate / floating rate debt

securities
• Coupon bonds / cumulative bonds
• Listed bonds / un-listed bonds
• Rated bonds / un-rated bonds
• Secured / unsecured bonds
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
Debt Markets
• Tenor

short and long

put and call options
• Interest payment

Fixed and floating

Periodic vs discounted
• Credit quality

Gilt, guaranteed, and others
• Traded and non-traded
Price and Yield
• Increase in rates reduces value of
existing bonds.
• Decrease in rates increases value of
existing bonds
• Price and yield are inversely related
• The relationship between yield and
tenor can be plotted as the yield
curve.
Current Yield and YTM
• Coupon as a percentage of current
market price
• If we bought a 8% bond at Rs. 110,
the current yield is:

= (8/110)*100
= 7.27%
Credit Risk
• Probability of default by the
borrower

• Change in credit rating:


downgrade increases the yield
and decreases the price

upgrade decreases the yield and
increases the price.
Debt Portfolio
Management Styles
• Buy and hold

Portfolio exposed to interest rate risk.
• Duration management

increase duration if rates are expected to fall

decrease duration if rates are expected to
rise
• Credit selection

invest in low grade bonds that are likely to
be upgraded.
Investment Restrictions
• Invest only in marketable
securities.
• Investment only on delivery basis
• A mutual fund under all its
schemes, cannot hold more than
10% of the paid-up capital of a
company.
Investment Restrictions
• Not more than 10% of its NAV in a single
company.

Exceptions: Index Funds and Sectoral funds
• Rated investment grade issues of a single
issuer cannot exceed 15% of the net assets

Can be extended to 20%, with the approval of
the trustees.
• Investment in unrated securities of one
company cannot exceed 10% of the net
assets of a scheme and not more than 25%
of net assets of a scheme can be in such
securities.
Investment in Sponsor
Company

A mutual fund scheme cannot invest
in unlisted securities of the sponsor
or an associate or group company of
the sponsor.

A mutual fund scheme cannot invest
in privately placed securities of the
sponsor or its associates.

Investment by a scheme in listed
securities of the sponsor or associate
companies cannot exceed 25% of the
net assets of the scheme
Other Limits
• Mutual funds cannot make loans
• Mutual funds can borrow upto 20% of net
assets for a period not exceeding 6 months.
• Derivatives can be used only after informing
investors
• Any change in investment objectives requires
information to investor, and provision of option
to exit at NAV, without exit load.
Session 5: Risk and
Return
• Return Methods

Change in NAV

Total Return

Total Return with dividend re-investment

CAGR
• Risk

Standard deviation

Beta and Ex-Marks
• Benchmark and comparison
Computing Returns
• Sources of return

Dividend

Change in NAV
• Return = Income earned for
amount invested over a given
period of time
• Standardise as % per annum
Alternate Methodologies

• Computing return

Percentage change in NAV.

Simple total return

ROI or Total return with
dividend re-investment

Compounded rate of growth
Percentage Change in
NAV
• Assume that change in NAV is the
only source of return.
• Example:

NAV of a fund was Rs. 23.45 at



the beginning of a year

Rs. 27.65 at the end of the year.


• Percentage change in NAV

= (27.65 – 23.45)/23.45 *100

= 17.91%
Annualising the Rate of
Return
If NAV on Jan 1, 2001 was Rs. 12.75 and the
NAV on June 30, 2001 was Rs. 14.35,

Percentage change in NAV

= (14.35 – 12.75)/12.75 x 100
= 12.55%

Annualised return:
= 12.55 x 12/6
= 25.10%
Total Return

Investor bought units of a mutual fund

scheme at a price of Rs.12.45 per unit.
He redeems the investment a year later,
at Rs. 15.475 per unit.
During the year, he also receives dividend
at 7%.
The rate of return on his investment can
be computed as
=((15.475 – 12.45) + 0.70)/12.45 x 100
= (3.725/12.45) x 100
= 29.92%
 Total Return or ROI
Method
• (Value of holdings at the end of the period - value of
holdings at the beginning of the period)/ value of
holdings at the beginning of the period x 100
• Value of holdings at the beginning of the period =
number of units at the beginning x begin NAV.
• Value of holdings end of the period = (number of
units held at the beginning + number of units re-
invested) x end NAV.
• Number of units re-invested = dividends/ex dividend
NAV.
ROI Method: Example

An investor buys 100 units of a fund

at Rs. 10.5 on January 1, 2001. On
June 30, 2001 he receives dividends
at the rate of 10%. The ex-dividend
NAV was Rs. 10.25. On December
31, 2001, the fund’s NAV was Rs.
12.25.

What is the total return on

investment with dividends re-
invested?
ROI Method: Solution
• The begin period value of the investment
is
= 10.5 x 100 = Rs. 1050
• Number of units reinvested
= 100/10.25 = 9.756 units
• End period value of investment
= 109.756 x 12.25 = Rs. 1344.51
• The return on investment is
=(1344.51-1050)/1050 x 100
= 28.05%
Compounded Average Growth
Rate
• CAGR is the rate at which investment
has grown from begin point to the end
point, on an annual compounding basis.

V0(1+r)n = V1

r =((V1/V0)1/n )-1

Where n is the holding period in years.

CAGR: Example 1

An investor buys 100 units of a fund

at Rs. 10.5 on January 6, 2001. On
June 30, 2001 he receives dividends
at the rate of 10%. The ex-dividend
NAV was Rs. 10.25. On March 12,
2002, the fund’s NAV was Rs.
12.25.

Compute the CAGR.

CAGR: Solution

• The begin period value of the investment is

= 10.5 x 100 = Rs. 1050

• Number of units reinvested
= 100/10.25 = 9.756 units
• End period value of investment
= 109.756 x 12.25 = Rs. 1344.51
• Holding period = 6/01/01 - 12/3/02
= 431 days
• The CAGR is
=(1344.51/1050)365/431 - 1 x 100
= 23.29%
Returns: Industry Practice
• Growth Option: CAGR implicit in the
change in holding period NAVs.
• Dividend Option: CAGR implicit in
the change in value over the holding
period, assuming re-investment of
dividend at ex-dividend NAV.
• Less then 1 year, simple return
without compounding or
annualisation.
• Some funds use simple annualised
return, without compounding.
SEBI Regulations

• Standard measurements and

computation
• Compounded annual growth rate
for funds over 1 year old.
• Return for 1,3 and 5 years, or since
inception, which ever is later.
• No annualisation for periods less
than a year.
Risk in Mutual Fund
Returns
• Risk arises when actual returns are
different from expected returns.
• Historical average is a good proxy
for expected return.
• Standard deviation is an important
measure of total risk.
• Beta co-efficient is a measure of
market risk.
• Ex-marks is an indication of extent of
correlation with market index.
Benchmarks
• Relative returns are important than
absolute returns for mutual funds.
• Comparable passive portfolio is used as
benchmark.
• Usually a market index is used.
• Compare both risk and return, over the
same period for the fund and the
benchmark.
• Risk-adjusted return, is the return per
unit of risk.
SEBI Guidelines
• Benchmark should reflect the asset
allocation
• Same as stated in the offer document
• Growth fund with more than 60% in equity
to use a broad based index.
• Bond fund with more than 60% in bonds to
use a bond market index.
• Balanced funds to use tailor-made index
• Liquid funds to use money market
instruments.
Other Measures of
Performance
• Tracking error

Tracking error for index funds should be nil.
• Credit quality

Rating profile of portfolio should be studied
• Expense ratio

Higher expense ratios hurt long term investors
• Portfolio turnover

Higher for short term funds and lower for longer
term funds.
• Size and portfolio composition
Session 6: Financial
Planning and Mutual
Funds
• Concept of financial planning
• Mapping life cycles and wealth
cycles of investors
• Financial products
• Investment Strategies for Investors
• Asset allocation
 Concept of Financial Planning
Financial planning process involves following
steps:

• Study client’s profile

• Identifies all the financial needs of client
• Translates the needs into monetarily
measurable goals e.g. Need of Rs. 30 lakh
after 5 yrs for purchase of house property
• These goals can be short term, medium term
and long term
• Recommend Asset mix (asset allocation) /
Portfolio under the framework of client's profile
• Implement recommendations and review the
performance time to time and suggest
changes in changed circumstances to
accomplish desired goals in time.
 Assessing client’s profile
Parameters to assess:
• Age, gender, physical status
• Source of income & nature of income : steady or
fluctuating & Level of income
• Details of recurring expenses and life style (habits of
spending) to assess all time liquidity need.
• Risk tolerance level or risk appetite
• Tax status
• Current savings & Investments
• Details of Assets & Liabilities
• Family details & number of dependents

Note: Structured questionnaire should be used to

assess client’s profile and risk tolerance level
Objective of Financial Planning
The ultimate objective of financial
planning is to ensure that the right amount
is available at right time to meet defined
financial goal.

Thus financial planning comprises of :

• Defining financial goals
• Recommending and implementing
appropriate assets mix
• Reviewing performances and make
suitable changes to achieve defined
financial goals.
Who is a Financial Planner
(FP)?
• Is a person who uses the financial
planning process to help another
person determine how to meet his
or her financial goals
• Key functions of a FP is to help
people identify their financial
needs, priorities and the products
that are most suitable to meet
their needs
 Role of a Financial
Planner?

Consult Mkt experts**

Financial
Assets
Client Financial planner Assets mix
Physical
Assets

** Market experts are those having knowledge about market

& products. E.g. Brokers/PMS provider/Mf advisor, insurance
advisor, property dealer, bullion mkt dealer etc,
 Benefits of Financial
Planning

• Financial planning provides direction

and meaning to financial decisions
• Financial decisions comprises of
financing and investment decisions to
attain financial goals
Importance of Financial
Planning
• Financial goals are meant to fulfill human needs
which comprises of physical, social and spiritual
needs.
• Physical need to remain fit and fine, social need to
fulfill family responsibility and spiritual need to
attain peace & happiness which comes through
love, affection, freedom and space which in turn
comes from power/influence (intangible attribute)
and authority (tangible attribute) in society
• The above mentioned needs involve cost viz.
survival cost (for basic need & reasonable std of
living), social cost (for education, marriage,
settlement etc. of family members) and protection
cost (for post retirement life and health care etc.)
which in turn require sufficient liquidity,
Investments, and variety of insurance.
• Financial planning helps in realizing above
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 is required only when clients get older
• FP is considered same as retirement
planning and estate planning
• FP is primarily tax planning
• Only after a crisis FP is started
• Expectation of unrealistic returns on
investments
MFs in Financial Planning
• Forms the core foundation and
building block for any type of FP
• Variety of products available to
suit any need or combination of
needs
• Barring life and property
insurance, rest of the product
portfolio can be created out of
bouquet of MFs
Why should a Fund
distributor become an FP
• Strong potential demand for such
services

• Limited supply of financial planners

• Ability to establish Long term

relationships

• Ability to build a profitable business

Attributes of a Good
Financial Planner
Understands:
• The universe of investment products
• Risk-return attributes
• Tax and estate Planning

• Has the ability to convert life cycles of

investors into need and preference
based financial products
• Organised approach to work
• Excellent communication and
interpersonal skills
Process of FP in Practice

• Step I: Establish and define the

relationship with the client

• Step II: Gathering client’s data,

Define the client’s goals

• Step III: Analyze and evaluate

client’s financial status

• Step IV: Determine and shape

the client’s risk tolerance level
Process of FP in practice
• Step V: Ascertain client’s tax situation

• Step VI: Recommend the appropriate

asset allocation and specific
investments

• Step VII: Executing the plan & making

the client invest

• Step VIII: Review the progress &

portfolio rebalancing
Mapping life cycles and wealth cycles of
investors

The life cycle stages of an investor can be

classified as follows:
– Childhood stage
– Young unmarried stage
– Young married with children stage
– Married with older children stage
– Post-family/Pre-retirement stage
– Retirement stage

The income level of investors, the saving potential,
the time horizon and the risk appetite of an investor
depend on his life cycle.

Younger investors have higher income and saving
potential, take longer-term view and may be willing to
take risks.

Older investors may have limited income and saving,
shorter time horizon, and unwilling to risk their
savings.
 Life Cycle Stages

I
N Child’s
C marriage

O Child’s
education
M EXPENSES
Child’s birth
E
Marriage
(0-22) Yrs (23-60) Yrs (61-90)Yrs

Birth & Earning Years Retirement

Education
Mapping life cycles and wealth cycles of
investors
Continue…….
There are 3 wealth cycle stages for investors:
• Accumulation stage is when investors are earning and have
limited need for investment income. They focus on saving
and accumulating wealth for the long term. Equity
investments are preferred in this stage.
• Transition stage is when financial goals are approaching.
Investors still earn incomes, but have also draw on their
earnings. Investors choose balanced portfolios that have
both debt and equity.
• Reaping stage or distribution stage in when investors need
the income from their investment, and cannot save further.
They reap the benefits of their savings. They prefer debt
investments and preserving of capital at this stage.
Mapping life cycles and wealth cycles of
investors
Continue…….
• Inter generational fund transfer refers to
transfer of wealth to an investor. The
preferred investment avenue will
depend on the life cycle and wealth
cycle stage of the beneficiaries.
• Sudden wealth surge refers to winnings
in games and lotteries. Investors should
be advised to temporarily park their
funds in money market investments and
create a long-term plan after thinking
through the plan.
Mapping life cycles and wealth cycles of
investors
Continue…….
Affluent investors are of two types:

» Wealth preserving investors who

are risk-averse and like to invest
in debt.
» Wealth creating investors who
prefer growth and are willing to
take the risk of equity
investments.
Investment Products:
There are two broad
categories of products
available:
Physical Assets:
Gold ,Real Estate, Fine Arts, Commodities
Financial Assets:
• Bank Deposits, CPs, CDs
• Corporate –Shares, Bonds, Debentures & Fixed
Deposits
• Government – G. Secs, PPF, RBI Relief Bonds
and other post office savings-KVP,NSC etc.
• Financial Institutions – Bonds, Shares
• Insurance Companies – Insurance Policies
 Physical Assets:

• Individuals can invest in physical assets e.g. Gold and

Real estate
• Govt. has permitted issue of gold bonds by banks
• Gold bonds represent securitization of gold where they
earn some returns and avoid risks associated with
storage of gold
• Investors are likely to be allowed to invest in gold
linked unit schemes
• Real estate MF are also in the offing which will offer the
investors the twin benefits of

Real estate investing &

Mutual fund investing
 Investment Products:
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
 Evaluating Financial products
Product Risk Liquidity Return Volatility

Equity High High/Low High-Mod. High

FI Bonds Low Moderate Mod-high Moderate
Debentures Medium Low Mod.-Low Moderate
Corp. FD Medium Low Moderate Low
Bank Deposit Low High Low-High Low

PPF Low Moderate Moderate Low

Life ins. Low Low Low-Mod Low
Gold Low Moderate Mod-Low High
Real estate Medium Low High-Low High
MF H-M-LOW High High Moderate
Investor’s perspectives : MF’s v/s Other
products
Product Investment Risk Time
objective tolerance horizon
Equity Capital appre. High Long term
FI Bonds Income Low Med-Long
Debentures Income Medium Med-Long
Corp. FD Income Medium Medium
Bank Deposit Income Low Flex-All terms
PPF Income Low Long
Life ins. Risk cover Low Long
Gold Inflation hedge Low Long
Real estate Inflation hedge Medium Long
MF Cap.,gwth,incme H-M-LOW Flex-All terms
Bank Deposits
• Available since a long period of time
• Large geographical network –
transactions made easy & convenient
• Fund transfer mechanism available
• Perception of bank deposits being free of
default; Deposits guaranteed up to Rs 1
lakh per depositor
• Electronic facilities make it liquid and
easy to use
PPF
• 15 years deposit product made
available through banks.
• 9% p.a. interest payable on
monthly balances
• Minimum Rs. 100 & maximum Rs.
60,000 p.a investment allowed.
• Tax benefits u/s 80C under IT Act.
Limited by taxable income slabs.
• Interest receipt and withdrawal of
principal exempt from tax.
• Limited liquidity available.
RBI Relief Bonds

• Issued by banks on behalf of the

RBI
• Tenure of five years
• 8% p.a. interest payable
• Proposed to be converted to
floating rate instrument linked to
government yields
• Option to receive or reinvest
interest
• Interest income exempt from tax
Other Government
Schemes
• IVP & KVP issued by central
government & sold by post offices
• Interest is taxable
• Investor identity is protected and
investment in cash is possible
Other Government
Schemes
• Post office savings and RD – gives
fixed rate of interest but are not
liquid.
• These are government
guaranteed deposits
• Attractive for their safety and
cash investment options
Instruments issued by
Companies

• Commercial Paper
• Debentures
• Equity Shares
• Preference Shares
• Fixed Deposits
• Bonds of FI
How to Compare Products
• Compare products by nature of
investments – Characteristics,
benefits and risks.
• Current performance and
suitability
on the basis of Taxability, age &
risk profile of Investors.
Why MF is the Best Option
• Mutual funds combine the
advantages of each of the
investment products
• Dispense the short comings of the
other options
• Returns get adjusted for the
market movements
Investment Strategies for
Investors
Basic strategy:

• Harness the power of

compounding by choosing growth
option for long term
• Start early
• Have realistic expectations
• Invest regularly
 Investment Strategies for
Investors
Continue…….
• Buy and hold strategy which is preferred by many investors,
may not be beneficial because investors may not weed out
poor performing companies and invest in better performing
companies , it is the fund manager who takes the decision
but this strategy can be adopted for good mutual fund
schemes
• Rupee-cost averaging (RCA) involves the following:

A fixed amount is invested at regular intervals

More units are bought when price is low and fewer units
are bought when price is high.

Over a period of time, the average purchase price of the
investor’s holdings will be lower than if one tries to guess
the market highs and lows
• RCA does not tell indicate when to sell or switch from one
scheme to another. This is a disadvantage.
• Investors use the Systematic investment plan to implement
RCA.
 Investment Strategies for
Investors
Continue…….
• Value averaging involves the following:

A fixed amount is targeted as the desired value of the
portfolio at regular intervals.

If markets have moved up, the units are sold and the target
value is restored.

If markets move down, additional units are bought at the
lower prices.

Over a period of time, the average purchase price of the
investors holdings will be lower than if one tries to guess the
market highs and lows
• Value averaging is superior to RCA, because it enables
the investor to book profits and rebalance the portfolio.
• Investors can use the systematic withdrawal and
automatic withdrawal plans to implement value investing.
• Investors can also use a money market fund and an
equity fund to implement value averaging.
Asset Allocation
• Asset allocation is basic tool to translate financial
plans into action.
• Asset allocation is about allocating money between
equity, debt and money market segments.
• Asset allocation varies from investor to investor
depending on their situation, financial goals and risk
appetite.
• Equity, debt and money market products are called
asset classes. Allocating resources to each of these
is called asset allocation.
• The asset allocation for an investor will depend on
his life cycle and wealth cycle.
Asset Allocation Strategies:

• Asset allocation strategy differ for

investors depending upon:

Their financial situation

Financial goals and,

Risk appetite
• Investors can have following strategies:
• Fixed v/s flexible asset allocation strategy
• Tactical asset allocation strategy
• Benjamin Graham’s 50/50 balance strategy for
Asset Allocation
• Bogle’s strategic asset allocation strategy
Fixed and Flexible Asset Allocation
strategy
• Fixed ratio between asset classes

Portfolio has to be periodically re-balanced

Disciplined approach

Enables investor to book profits in a rising
market and invest more in a falling market.
• Flexible allocation

No re-balancing; asset class proportions can
vary when prices change.

If equity returns are higher than debt returns,
equity allocation will go up at a faster rate.
• Fixed ratio approach works better in bull
markets
Tactical asset allocation strategy

• Change in asset allocation percentages

based on fund manager’s views on the
future movements in asset prices.
• May invest more in shares of small
companies than large companies
• Fixed ratio approach works better in
bull markets
Benjamin Graham’s 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
 Bogle’s strategic asset allocation
strategy
• Bogle recommends the following factors to be considered in strategic asset
allocation strategy for investors:
– Age
– Financial circumstances
– Objectives


Older investors in distribution phase - 50% equity; 50% debt

Younger investors in distribution phase - 60% equity; 40% debt

Older investors in accumulation phase - 70% equity; 30% debt

Younger investors in accumulation phase - 80% equity; 20% debt

• Bogle’s rule of thumb for asset allocation:


Debt portion of an investor’s portfolio to be equal to his age.

E.g. 30 Yrs old investor - 70/30 (Equity/ Debt Allocation)
Session 7: Recommending
model portfolios and
selecting the right funds

• Model portfolios
• Fund selection
 Developing a Model Portfolio
A model portfolio creates an ideal approach for the
investors’ situation and is a sensible way to invest.

Steps in developing a model portfolio for the investors:

• Develop long term goals
– Investment avenues, time horizon, return and risk
• Determine asset allocation
– Allocation to broad asset classes
• Determine sector distribution
– Allocation of sectors of the mutual fund industry
• Select specific fund schemes for investment
– Compare products and choose actual funds to invest in
 Developing a Model Portfolio
continue…..

Bogle recommends that age, risk profile and preferences

have to be
combined in asset allocation

• Older investors in distribution phase - 50% equity;

50% debt
• Younger investors in distribution phase - 60% equity;
40% debt
• Older investors in accumulation phase - 70% equity;
30% debt
• Younger investors in accumulation phase - 80%
equity; 20% debt
 Developing a Model Portfolio
continue…..
Model portfolios according to life cycle stage:

• Young unmarried professional: 50% in aggressive equity

funds,25% in high yield bond funds, growth and income
funds,25% in conservative money market funds
• Young couple with 2 incomes and 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
• Older couple in single income:30% in short term municipal
funds,35% in long term municipal funds,25% in moderately
aggressive equity,10% in emerging growth equity.
• Recently retired couple:35% in conservative equity funds
for capital preservation/income,25% in moderately
aggressive equity for modest capital growth,40% in money
market funds
 Developing a Model Portfolio
continue…..
Jacob’s Model Portfolios
• Accumulation phase
– Diversified equity: 65 - 80%
– Income and gilt funds: 15 - 30%
– Liquid funds: 5%
• transition phase:
– They will benefit from the income component of
their asset allocation.
• Distribution phase
– Diversified equity: 15 - 30%
– Income and gilt funds: 65 - 80%
– Liquid funds: 5%
 Developing a Model Portfolio
continue…..
Recommended portfolio for investors in inter-
generational transition phase

Investors who plan to leave behind wealth for their
heirs, tend to create portfolios that serve the needs of
the heirs:
• Growth and income funds in a balanced manner for
grown up heirs
• Higher percentage of growth funds could be appropriate
if the heirs are young.
• In case of trusts and charities, income funds would be
more appropriate.
• In case of wealth surge, it is advisable to keep the money
in liquid avenues, while deciding a long term plan.
 Developing a Model Portfolio
continue…..
Recommended portfolio for investors for
affluent investors:

In case of wealth creating affluent investors, who
are focused on setting aside a good part of their
wealth in savings, 70-80% allocation to sectoral
and growth funds should be recommended. These
investors do not have immediate income
requirements, and can bear higher risks.

Incase of wealth preserving affluent investors, who
do not like to take risks, and want to conserve their
funds, 70-80% exposure to income, gild and liquid
funds would be appropriate. The remaining funds
can be invested in diversified equity or balanced
funds. These investors are risk-averse.
 Fund Selection

Fund selection refers to the

actual choice of funds
according to the chosen
model portfolio for the
investor.
Fund Selection
Equity funds: Characteristics

Fund category – the fund chosen should be
suitable to investor objective

Investment style – Choose between growth
and value depending on investor’s risk
perception

Age of the fund – Experienced funds are
preferred to new funds

Fund management experience –Track record
of the fund managers is important

Size of the fund – Larger funds have lower
costs

Performance and risk – risk adjusted
performance matters
Equity Funds: Selection
Criteria

Percentage holding in cash should be low –
Funds can always sell liquid stocks for
liquidity requirements.

Concentration in portfolio should be low – An
equity fund should be well diversified.

Market capitalization of the fund – High
capitalization means better liquidity

Portfolio turnover – Higher turnover means
more transactions and costs, but exploitation
of opportunities. Low turnover represents
patience and stable investments.
Equity Funds: Selection
Criteria
Risk Statistics
• Beta – represents market risk, higher
the beta higher the risk.
• Ex-Marks – represents correlation with
markets – higher the ex-marks, lower
the risk. A fund with higher ex-marks is
better diversified than a fund with
lower ex-marks.
• Gross dividend yield represents return.
Funds with higher gross dividend yield
should be preferred.
• Funds with low beta, high ex-marks and
high gross dividend yield are preferable
Debt Funds: Selection
Criteria
• A smaller or new debt fund may not
necessarily be risky.
• Total return rather than yield to maturity
(YTM) is important.
• Expenses are very important, because high
expense ratios lead to yield sacrifice.
• Credit quality - Better the rating of the
holdings, safer the fund.
• Average maturity - Higher average
maturity means higher duration and
interest rate risk. Funds with higher
average maturity are more risky than funds
with lower average maturity.
Money Market Funds: Selection
Criteria

• Liquidity and high turnover rate is high.

• Shorter-term instruments are turned
over more frequently.
• Protection of principal invested is
important.
• NAV fluctuation limited due to low
duration and lack of interest rate risk.
• Credit quality of portfolio should be
high.
• Low expense ratio is important.
Thank you and all the very
best!!