Mutual fund is a pool of money managed by a professional Fund Manager. It is a trust that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities.
The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds. Each share represents an investor’s part ownership in the fund and the income it generates.
And the income / gains generated from this collective investment is distributed proportionately amongst the investors after deducting applicable expenses and levies, by calculating a scheme’s “Net Asset Value” or NAV.
What is “Net Asset Value” or NAV. Just like an equity share has a traded price, a mutual fund unit has Net Asset Value per Unit. The NAV is the combined market value of the shares, bonds and securities held by a fund on any particular day (as reduced by permitted expenses and charges). NAV per Unit represents the market value of all the Units in a mutual fund scheme on a given day, net of all expenses and liabilities plus income accrued, divided by the outstanding number of Units in the scheme.
Mutual funds are ideal for investors who either lack large sums for investment, or for those who neither have the inclination nor the time to research the market, yet want to grow their wealth. The money collected in mutual funds is invested by professional fund managers in line with the scheme’s stated objective. In return, the fund house charges a small fee which is deducted from the investment. The fees charged by mutual funds are regulated and are subject to certain limits specified by the Securities and Exchange Board of India (SEBI).
Mutual funds offer multiple product choices for investment across the financial spectrum. As investment goals vary – post-retirement expenses, money for children’s education or marriage, house purchase, etc. – the products required to achieve these goals vary too. The Indian mutual fund industry offers a plethora of schemes and caters to all types of investor needs.
Mutual funds offer an excellent avenue for retail investors to participate and benefit from the uptrends in capital markets. While investing in mutual funds can be beneficial, selecting the right fund can be challenging. Hence, investors should do proper due diligence of the fund and take into consideration the risk-return trade-off and time horizon or consult a professional investment adviser. Further, in order to reap maximum benefit from mutual fund investments, it is important for investors to diversify across different categories of funds.
While investors of all categories can invest in securities market on their own, a mutual fund is a better choice for the only reason that all benefits come in a package.
TYPE OF MUTUAL FUND SCHEMES
Mutual Fund schemes could be ‘open ended’ or close-ended’ and actively managed or passively managed.
OPEN-ENDED AND CLOSED-END FUNDS
An open-end fund is a mutual fund scheme that is available for subscription and redemption on every business throughout the year, (akin to a savings bank account, wherein one may deposit and withdraw money every day). An open-ended scheme is perpetual and does not have any maturity date.
A closed-end fund is open for subscription only during the initial offer period and has a specified tenor and fixed maturity date (akin to a fixed term deposit). Units of Closed-end funds can be redeemed only on maturity (i.e., pre-mature redemption is not permitted). Hence, the Units of a closed-end fund are compulsorily listed on a stock exchange after the new fund offer, and are traded on the stock exchange just like other stocks, so that investors seeking to exit the scheme before maturity may sell their Units on the exchange.
ACTIVELY MANAGED AND PASSIVELY MANAGED FUNDS
An actively managed fund is a mutual fund scheme in which the fund manager “actively” manages the portfolio and continuously monitors the fund's portfolio, deciding on which stocks to buy/sell/hold and when, using his professional judgement, backed by analytical research. In an active fund, the fund manager’s aim is to generate maximum returns and out-perform the scheme’s bench mark.
A passively managed fund, contrast, simply follows a market index, i.e., in a passive fund, the fund manager remains inactive or passive inasmuch as, she does not use her judgement or discretion to decide as to which stocks to buy/sell/hold, but simply replicates / tracks the scheme’s benchmark index in exactly the same proportion. Examples of Index funds are an Index Fund and all Exchange Traded Funds. In a passive fund, the fund manager’s task is to simply replicate the scheme’s benchmark index i.e., generate the same returns as the index, and not to out-perform the schemes benchmark.
Mutual funds can be further classified as ;
1.money market funds, have relatively low risks. By law, they can invest only in certain high-quality, short-term investments issued by U.S. corporations, and federal, state and local governments.
2.Bond funds, have higher risks than money market funds because they typically aim to produce higher returns. Because there are many different types of bonds, the risks and rewards of bond funds can vary dramatically.
3.Stock funds, invest in corporate stocks. Not all stock funds are the same.
4. Target date funds hold a mix of stocks, bonds, and other investments. Over time, the mix gradually shifts according to the fund’s strategy. Target date funds, sometimes known as lifecycle funds, are designed for individuals with particular retirement dates in mind.
Mutual Funds are then further categorised depending on the investment goal the fund is trying to fulfil. While some investors seek capital protection and safe returns, others have a strong risk appetite and look for high returns.
Growth funds or capital protection funds
Income funds - These schemes aim to provide income for the investors.
Liquid funds - These funds invest in fixed-income securities such as bonds and government securities.
Balanced funds - These funds invest both in equity as well as fixed-income securities to provide returns while trying to keep the risks to a minimum.
Mutual Funds based on geography
Domestic funds - These invest in securities traded within the country.
International or foreign funds
Global funds Examples: Emerging market funds, regional funds
These funds are further classified based on the investments made.
1 Equity funds
2 Large-cap / Mid-cap / Small-cap funds
3 Aggressive / growth funds
4 Value funds
5 Dividend-yield funds
6 Index funds
7 Diversified equity funds
8 Sectoral funds
9 Debt funds / Fixed-income funds
10 Income funds
11 Gilt funds
12 Dynamic bond funds
Money market funds or liquid funds
Ultra-short-term funds or treasury management funds
Floating-rate funds Short-term / Medium-term income funds corporate bond funds Fixed Maturity Plans (FMPs) (they are close-ended) Hybrid funds / Balanced funds Monthly Income Plans (MIPs)Capital Protection Funds (these are close-ended)
Other categories include
Tax-saving funds Pension funds Fund of funds Exchange Traded Funds (ETFs)Leverage funds
Why do people buy mutual funds?
Mutual funds are a popular choice among investors because they generally offer the following features:
1 Professional Management. The fund managers do the research for you. They select the securities and monitor the performance.
2 Diversification or “Don’t put all your eggs in one basket.” Mutual funds typically invest in a range of companies and industries. This helps to lower your risk if one company fails.
3 Affordability. Most mutual funds set a relatively low dollar amount for initial investment and subsequent purchases.
4 Liquidity. Mutual fund investors can easily redeem their shares at any time, for the current net asset value (NAV) plus any redemption fees.
What are the benefits of mutual funds?
Mutual funds offer professional investment management and potential diversification. They also offer three ways to earn money:
Dividend Payments. A fund may earn income from dividends on stock or interest on bonds. The fund then pays the shareholders nearly all the income, less expenses.
Capital Gains Distributions. The price of the securities in a fund may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, the fund distributes these capital gains, minus any capital losses, to investors.
Increased NAV. If the market value of a fund’s portfolio increases, after deducting expenses, then the value of the fund and its shares increases. The higher NAV reflects the higher value of your investment.
Risk involved with Mutual Funds
All funds carry some level of risk. With mutual funds, you may lose some or all of the money you invest because the securities held by a fund can go down in value. Dividends or interest payments may also change as market conditions change.
A fund’s past performance is not as important as you might think because past performance does not predict future returns. But past performance can tell you how volatile or stable a fund has been over a period of time. The more volatile the fund, the higher the investment risk.
Structure of a Mutual Fund
Mutual Funds in India are created as trusts. The parties involved are:
Sponsor - This is the one who sets up the Mutual Fund or trust. A sponsor is similar to a promoter of a company. The sponsor of a Mutual Fund appoints / sets up the board of trustees, the asset management company or fund house and appoints the custodian.
Board of trustees - The role of the trustees is to ensure that the interests of Mutual Fund holders are protected. The board of trustees also needs to ensure that the fund house complies with all the rules laid down by the Securities Exchange Board of India (SEBI). The board needs to have at least four independent directors. The trustees act according to the Trust Deed executed by the sponsor. The board sees to it that the fund house has established the required infrastructure and ensures that processes are in place to operate and manage the fund effectively. The board appoints the main members of the fund house including the board of directors and fund managers (scheme-wise). They also devise the fund house's internal control and audit processes including the rules for enrolling and dealing with brokers / agents.
Asset Management Company (AMC)/Fund house - An AMC or fund house will act as the investment manager for the trust. It will be responsible for the day-to-day operations. This means that it is be taking care of all the money put in by investors. The AMC or fund house is appointed by the sponsor or the board of trustees. SEBI approval is required for setting up the AMC. 40% of its net worth should be contributed by the sponsor.
Custodian - A custodian is one who has custody of all the shares and securities invested in by the AMC. The custodian is responsible for the investment account of a fund house.
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