Mutual Funds : Introduction

A mutual Iund is a Iinancial intermediary that pools the savings oI investors Ior collective
Investment in a diversiIied portIolio oI securities. A Iund is 'mutual as all its returns, minus
its expenses, are shared by the Iund`s investors.
Mutual Iunds pool the Iunds Irom small investors and invest in shares and bonds oI
companies. The income earned through these investments and the capital appreciation
realized are shared by its unit holders in proportion to the number oI units owned by them.
Thus a Mutual Iund is the most suitable investment Ior the common man as its oIIers an
opportunity to invest in a diversiIied , proIessional managed basket oI securities at a
relatively low cost.
The Securities and Exchange Board oI India ( Mutual Funds) Regulations, 1996 deIines
a mutual Iund as a ' a Iund established in the Iorm oI a trust to raise money through the
Sale oI units to the public or a section oI the public under one or more schemes Ior
Investing in securities , including money market instruments.
Mutual Iund is akin to PortIolio management services (PMS).Although , both are
conceptually same , they are diIIerent Irom each other. PMS are oIIered to high net worth
Individuals ; taking into account their risk proIile ,their investments are managed
separately. In the case oI mutual Iunds, savings oI small investors are pooled under
a scheme and the returns are distributed in the same proportion in which the investments
are made.
0n01its o1 Mutual Funds:
By investing in various Mutual Fund Schemes, small investors or middle investors seek
the Iollowing advantages compared to other types oI investment.
1 Pro10ssional Manag020nt: An average investor lacks the knowledge oI capital
market operations and does not have large resources to reap the beneIits oI investment.
. Hence , he requires the help oI an expert. Mutual Iunds are managed by proIessional
managers who have the requisite skills and experience to analyse the perIormance
and prospects oI companies.
They make possible an organised investment strategy , which is hardly possible Ior
an individual investor.
2 ortfo||o d|vers|f|cat|on An lnvesLor underLakes rlsk lf he lnvesLs all hls funds ln a slngle
scrlp MuLual funds lnvesL ln a number of companles across varlous lndusLrles and
secLors 1hls dlverslflcaLlon reduces Lhe rlsklness of Lhe lnvesLmenLs
3 keduct|on |n transact|on costs Compared Lo dlrecL lnvesLlng ln Lhe caplLal markeL
lnvesLlng Lhrough Lhe funds ls relaLlvely less expenslve as Lhe beneflL of economles of
scale ls passed on Lo Lhe lnvesLor
4 L|qu|d|ty ln case of muLual funds Lhey can easlly encash Lhelr lnvesLmenL by selllng
Lhelr unlLs Lo Lhe fund lf lL ls openended scheme or selllng Lhem on a sLock
exchange lf lL ls a closeended scheme
S Conven|ence lnvesLlng ln muLual fund reduces paperwork saves Llme and makes
lnvesLmenL easy
6 I|ex|b|||ty MuLual funds offer a famlly of schemes and lnvesLors have Lhe opLlon of
Lransferrlng Lhelr holdlng s from one scheme or selllng Lhem on a sLock exchange
lf lL a closeended scheme
7 Cho|ce of Schemes
%ax b0n01its: Mutual Iund investors now enjoy income-tax beneIits.Dividends
received Irom mutual Iund`s debt schemes are tax exempt to the overall
limit oI Rs. 10,000 alllowed under section 80L oI the Income Tax Act.
9 %ranspar0ncy: Mutual Iunds transparently declare their portIolio every month.
Thus an investor knows where his/ her money is being deployed and in case
They are not happy with the portIolio they can withdraw at a short notice.
10 Stability to th0 Stock Mark0t: Mutual Iunds have a large amount oI Iunds which
provide them economies oI scale by which they can absorb losses in the stock
market and continue investing in the stock market.
11 Equity r0s0arch: Mutual Iunds can aIIord inIormation and data required Ior
investments as they have large amounts oI Iunds and equity research available
with them.
12 W0ll R0gulat0d.
%yp0s o1 Mutual Funds:
Mutual Iunds could be classiIied in many ways based on structure, objectives oI
Investment, pattern oI investments and returns, etc.
A Functional Classi1ication o1 Mutual Funds: 3 Types
1 Op0n-End0d Funds: Under open-ended scheme, the mutual Iund will
continuously oIIers to sell and repurchase its unit at net asset value(NAV) or we
can say daily purchase and sale price oI the units oI the scheme. II you want to
buy the units today, you can buy the same at the sale price. May be aIter, six months
, iI you decide to sell the units, you can sell at the purchase price announced by
the mutual Iund on that date.
The key Ieature oI open-ended Iunds is liquidity. They increase liquidity oI the
Investors as the units can be continuously bought and sold.
Unlike close-ended schemes, open-ended ones do not have to be listed on the
Stock exchange and can also oIIer repurchase soon aIter allotment.
There is no Iixed redemption period in open-ended schemes, which can be
terminated whenever the need arises at redemption price. Besides, an investors
can enter the Iund again by buying units Irom the Iund at its oIIer price.
Clos0 -0nd0d Sch020s: There is no repurchase Iacility and a Iixed maturity
period ranging between 2 to 10 years. Investors can invest in the scheme when
it is launched. Investors in close-ended schemes can buy units only Irom the
market, , once initial subscriptions are over and thereaIter the units are listed
on the stock exchanges where they can be bought and sold.
The Iund has no interaction with investors till redemption except Ior paying
Dividend/bonus. The close-ended scheme can be converted into an open-ended
one.
3. Int0rval Sch020: Interval scheme combines the Ieatures oI open-ended and
close-ended schemes. They are open Ior sale or redemption during predetermined
intervals at NAV-related prices.
Port1olio Classi1ication or basis o1 inv0st20nt obj0ctiv0:
1 Income Funds: The aim of income funds is to provide safety of investments
and regular income to investors. Such schemes invest predominantly in
income-bearing instruments like bonds, debentures, government securities
and commercial paper. The return as well as the risk are lower in income funds
as compared to growth funds.
7owth Funds: The main objective of growth funds is capital appreciation
over the medium-to-long-term. They invest most of the corpus in equity shares
with significant growth potential and they offer higher return to investors in the
Long-term.There is no guarantee or assurance of returns.
3 BaIanced Funds: The aim of balanced scheme is to provide both capital
Appreciation and regular income. They divide their investment between equity
Shares with significant growth potential and they offer higher return to investors
in the long-term.
oney ma7et mutuaI funds: They specialise in investing in short-term
money market instruments like treasury bills and certificates of deposits.
The objective of such funds is high liquidity with low rate of return.
Othe7s
1 Secto7aI: These funds invest in specific core sectors like energy, tele-commun
-ications , T, construction, transportation and financial services. These new sectors
Offer good investment potential.
%ax saving schemes: Tax-saving schemes are designed on the basis of tax
policy with special tax incentives to investors. These are close-ended schemes
And investments are made for 10 years,although can avail encashment facilities
after 3 years.The latest scheme is the Systematic Withdrawl Plan(SWP) which
enables investors to reduce their tax incidence on dividends from as high as
30 percent to as low as 3 to 4 per cent.
3 Equity-link0d savings sch020 (ELSS) : In order to encourage investors to invest
in equity market, the government has given tax-concessions through special
Schemes. Investment in these schemes entitles the investor to claim on income-
tax rebate , but these schemes carry a lock-in period beIore the end oI which
Iunds cannot be withdrawn.
4 Load 1unds: A load Iund is one that charges a commission Ior entry or exit.
That is , each time you buy or sell units in the Iund, a commission will be payable..
Load range Irom 1 to 2..Load means incur certain expenses such as
Brokerage, marketing expenses and communication expenses.