AMFI(NISM)

Beta MMS,by Shivani Dani contact 9860133860 and [email protected]

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NATIONAL INSTITUTE OF

SECURITIES MARKETS

WWW.NISM.AC.IN

Established by the Securities and Exchange Board of India


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NISM-SERIES-V-A MUTUAL FUND DISTRIBUTORS CERTIFICATION EXAMINATION


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National Institute of Securities Markets (NISM) Certification

Examination forMutual Fund Distributors.

All rights reserved. Reproduction of this publication in any form without prior permission of the publishers is strictly prohibited

NISM brings out various publications on securities markets with a view to enhance knowledge levels of participants in the securities industry.

The announcement made by the Finance Minister in his Budget Speech in February 2005, Securities and Exchange Board of India (SEBI) has established the National Institute of Securities Markets (NISM) in Mumbai.


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TRAINING ON MUTUAL FUNDS

FOR AMFI CERTIFICATION

BYBETA MONEY MANAGEMENT SERVICES,

EDUCATION [email protected] & +91-9579322224

mailto:[email protected]

mailto:[email protected]

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ABOUT THE NCFM-AMFI EXAMINATION

All agents and distributors should take the MF Advisor’s module.

Computerised multiple choice examination Example:

The NAV of an open-ended fund has to be disclosed° Every Friday° Every Monday° Every Day° None of the above

All questions are multiple choice with four options.



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MARKS

The paper has 70-75 questions, with 1 and 2 mark questions adding up to 100 marks.

Candidates have to score a minimum of 50% to pass.

A wrong answer will lead to negative marking of 25%. If you get a 2 mark question wrong, you loose 2.5

marks. The marks for each question is given along with

the question.


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QUESTION PAPER DESIGN

Each chapter has a weightage: not disclosed. Read the

whole book.

The question bank has questions stored for each chapter.

The question paper for each candidate is different.

The paper is generated by the computer, by randomly

choosing from the bank.


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ATTEMPTING THE PAPER There is a practice exam to help first timers.

Detailed instructions are given. Click the blank button of the chosen answer. It

will turn black. Clicking another answer for the same question

will automatically change the answer to the new one.

Clicking on the black button of the chosen answer, will make it blank.

You can scroll up and down and change your answers.


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TIME AND SUBMISSION

There are 90 minutes to do the paper. There is a clock on the screen. At the end of the 90 mins, paper will be

automatically submitted. There is a back-up sheet on which answers can

be written. Once you click on finish, a summary of attempted

and unattempted questions appears. You can go back to the paper.

If you say”submit” at this stage, your marks will be displayed. Exam over


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Today’s AMFI Training Program - The Agenda• Session 1 Concept & Product• Session 2 Regulatory Framework• Session 3 The Investment Process• Session 4 Investor Services• Session 5 Markets & Portfolio Management• Session 6 Accounting & Valuation• Session 7 Risk, Return & Performance• Session 8 Financial Planning•Session 9 Business Ethics


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Session 1

Mutual Funds - Concept & Product


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Introduction Mutual fund products Sponsor-Trustee-AMC Other constituents Regulatory framework Merger and acquisitions

Contents - Session 1


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WHAT IS A MUTUAL FUND?

Terms to know Mutual Pool Investment objectives

A mutual fund is a pool of money collected from investors and is invested according to stated investment objectives.


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CHARACTERISTICS OF A MUTUAL FUND

Investors own the mutual fund.

Professional managers manage the affairs for a fee.

The funds are invested in a portfolio of marketable

securities, reflecting the investment objective.

Value of the portfolio and investors’ holdings, alters

with change in market value of investments.


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PROS AND CONES OF MUTUAL FUNDS

Advantages of Mutual Funds 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


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MUTUAL FUND PRODUCTS Open ended funds

Initial issue for a limited periodContinuous sale and repurchaseSize of the fund changes as investors enter and

exitNAV-based pricing

Closed ended fundsSale of units by fund only during IPOListing on exchange and liquidity for investorsSize of fund is kept constantPrice in the market is usually at a discount


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EQUITY FUNDS Pre-dominantly invest in equity markets

Diversified portfolio of equity shares Select set based on some criterion

Diversified equity fundsELSS as a special case

Primary market funds Small stock funds Index funds Sectoral funds


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DEBT FUNDS Predominantly invest in the debt markets

Diversified debt fundsSelect set based on some criterion

Income funds or diversified debt funds Gilt funds Liquid and money market funds Serial plans or fixed term plans


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BALANCED FUNDS Investment in more than one asset class

Debt and equity in comparable proportionsPre-dominantly debt with some exposure to

equityPre-dominantly equity with some exposure to

debt Education plans and children’s plans


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INVESTMENT OPTIONS Investors can achieve income and growth

objectives in all fundsDividend option

Regular dividend Ad-hoc dividend

Growth optionRe-investment option

Most funds provide multiple options and the facility to switch between options


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BASIS FOR CLASSIFICATION

RiskSectoral 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 objectiveEquity funds suit growth objectives; debt

funds suit income objectives


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RISK AND RETURN

Liquid funds

ST debt funds

Gilt funds

Debt Funds

Index funds

Equity funds

Sectoral funds

Balanced funds

Risk

Retu

rn


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Session 2

Mutual Funds - Regulatory Framework


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CONTENTS - SESSION 2

3-tier structure Sponsor Trustee AMC

The regulatory Framework UTI - The lessons learnt Self regulatory Organisations Mergers & Acquisitions


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SPONSOR

Promoter of the the mutual fund

Creates AMC and appoints trustees

Criteria Financial services business

5-year track record

3-year profit making record

At least 40% contribution to AMC capital


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TRUSTEES 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 At least 4 trustees

2/3 should be independent Trustees of one mutual fund cannot be trustee of

another mutual fund Right to seek regular information and remedial action All major decisions need trustee approval


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ASSET MANAGEMENT COMPANY

Responsible for operational aspects of the MF 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 Appoints other constituents Cannot have any other business interest 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


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OTHER CONSTITUENTS Custodian

Investment back-office

Registrar and Transfer agent Investor records and transactions

Broker Purchase and sale of securities 5% limit per broker

Auditor Separate auditor for AMC and mutual fund


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REGULATORY FRAMEWORK SEBI (Mutual Fund) Regulations, 1996 RBI as regulator

Guarantees of sponsors in bank-sponsored mutual funds Regulator of G-Secs and money markets

Stock exchanges (for listed Mutual Funds) Companies Act

AMCs and Trustee Company RoC for Compliance CLB for prosecution and penalties

Office of the public trustee Registration Complaints against trustees


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UTI: DIFFERENCES Formed as a trust under UTI Act, 1963

Voluntary submission to SEBI regulation

No separate sponsor or AMC

Major Differences Assured return schemes

Different accounting norms

Ability to take and make loans


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SELF-REGULATORY ORGANISATIONS

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


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MERGERS AND ACQUISITIONS Scheme takeover

One AMC buys schemes of another AMC Organic growth in assets No change in AMC stakes

AMC merger Two AMCs merge Similar to merger of companies Sponsor stakes change

AMC take-over Stake of one sponsor in a AMC bought out by another sponsor Change in AMC and sponsor

Investor rights No prior approval needed Option to exit at NAV Right to be informed


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Session 3

Mutual Funds - The Investment Process


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Scheme Information Document Key Information Memorandum Application and form of holding Distribution channels Investors rights Taxation of Income and capital gain NAV and Load


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Scheme Information Document

• Legal offer from AMC to investor

• Contains vital information about Fund and schemes

• SEBI approved format

• KIM is a mandatorily enclosed to application forms

• Investor has no recourse for not having read the OD/KIM


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PERIOD OF VALIDITY

Updated every 2 years for OEFs

Regular Addendum for results

Updated for every major change· Change in the AMC or Sponsor of the mutual fund.

· Change in the load structures.

· Changes in the fundamental attributes of the schemes.

· Changes in the investment options to investors; inclusion or deletion of options.


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FUNDAMENTAL ATTRIBUTES

· Scheme type

· Investment objective

· Investment pattern

· Terms of the scheme with regard to liquidity

· Fees and expenses

· Valuation norms and accounting policies

· Investment restrictions


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CHANGES IN FUNDAMENTAL ATTRIBUTES

· Investors have right to be informed

· Public announcement by AMC

· Option to exit without load

· SEBI and Trustee approval

· New offer document


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CONTENTS OF OFFER DOCUMENT

Preliminary information· Summary information about the mutual fund, the scheme and

the terms of offer.· Mandatory disclaimer clauses as required by SEBI. · Glossary of terms in the offer document, which defines the terms

used.· Standard and scheme specific risk factors pertaining to the

scheme being offered· Fund specific information

· Constitution of fund, details of sponsor, trustees and AMC.· Financial history of sponsor(s) for 3 years, in summary form.· Director of Boards of the trustees and the AMC.· Details of key personnel of the AMC.· Details of Fund constituents


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CONTENTS OF SCHEME INFORMATION DOCUMENT CONTD..

· Scheme Specific Information· Details regarding IPO, sale and Repurchase· Minimum subscription and face value· Initial issue expenses· current scheme and the past schemes· Special facilities to investors · Eligibility for investing · documentation required.· Procedure for applying, and subsequent operations relating to

transfer, redemption, nomination, pledge and mode of holding· Loads and the annual recurring expenses

· Proposed as well as other schemes for last 3 years· Comparison with OD numbers· Condensed Financial information for last 3 years


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UNIT HOLDER RIGHTS· Rights of unit holders

· services & information· protection of rights and problem resolution.

· Details of information disclosure and their periodicity.· Documents available for inspection· Details of pending litigation and penalties· Cannot sue the mutual fund· 75% unit holders can

· wind up a scheme· seek AMC termination

· Prospective investor has no rights· Right to redeem for fundamental changes


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ASSOCIATE TRANSACTIONS

· Summary information on associate companies being used as

constituents.

· Summary information of associates investing in schemes of

the mutual fund.

· Summary information on investment made by mutual fund

schemes in associate company securities.


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VERIFICATION AND DUE DILIGENCE

· SEBI: Format and Content· Trustee Approval· Compliance Office certifies that

information contained therein is true and fair is in accordance with SEBI regulations constituents of the fund are all SEBI registered entities

The AMC is responsible for the contents and the accuracy of information


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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


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DISTRIBUTION CHANNELS Individual agents Distribution companies

NBFCs and Broking Houses Service and Collection Advisory

Banks Private / HNI Banking Branch Banking Corporate Banking Special Investment Advisory Desks

Direct marketing channels


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PROCEDURE Proof of purchase

Certificate Account statement

Application Joint holding Minor Nomination PAN number Tax status Folio number Bank details


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NAV AND LOAD Sale and repurchase price are NAV-based

Cut-off time for NAV 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 CDSC is variable exit load, charged depending

on duration of stay in the fund Loads are subject to SEBI Regulation and vary

depending on industry practice


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ENTRY LOAD : EXAMPLEIf the entry load (sales load) for a scheme is 1.5% and the NAV of the scheme is Rs. 10.00, the investor who wants to buy the units will not be able to buy at Rs. 10.00. He will pay:

= 10.00 + (10.00*1.5/100) = 10.00 + 0.15 = 10.15

Exit Load : ExampleIf a fund imposes an exit load of 1.25%, the investor who repurchases his units, will get a price that is:= 10.00 –(10.00*1.25/100)=10.00-0.125 = 9.875


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SEBI REGULATIONS : LOADThere are 2 regulatory requirements:

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%.

The repurchase price cannot be less than 93% of the sale price.

For a close ended fund, the limits are set at 5% of NAV


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EXAMPLEIf 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.10 (9.3/0.93).


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TAXATION

Mutual fund is exempt from paying taxes (Section 10 (23D))

Income for investors Dividend Capital gain

Present position (AMFI examination) Dividend exempt from tax Fund pays dividend distribution tax at 12.5% Open end funds with >65% in equity, fully exempt. Tax arbitrage for investors


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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 marginal rate of taxation.

• Investor buys on March 31, 1999 and sells on April 1, 2000. What is the indexation adjustment factor?– (1998-99 - 351, 1999-2000 - 386, 2000-01 - 406)

• Investor buys on April 1, 1998 and sells on March 31, 2001. What is the indexation adjustment factor?

Indexation - An Example


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Session 4

Investor Services


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Importance of Services for Investors Source of Information on Fund Services Applying for and Redeeming MF Units Investment Plans/ Options and Services


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IMPORTANCE OF SERVICES FOR INVESTORS

The most important factor is the package of overall services provided by the the fund

‘Convenience’ is an important advantage of a mutual fund

Selected fund should be examined to see if they offer the investor the desired level of service

While choosing the right fund to invest, an investor and his advisor need to consider the following factors:


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SOURCE OF INFORMATION ON FUND SERVICES

Most comprehensive source is the Scheme Information Document of the scheme in question

The ‘Scheme Information Document’ details the procedure for purchase and redemption of units and specifies other investor services


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APPLYING FOR AND REDEEMING MF UNITS

Who can Apply Indian citizens, Indian entities, NRIs and foreign entities

Procedure for Purchase of Units: Appointing Registrars, Investor Service Centres to carry out the following: Ensuring the completion and collection of the required

application form Acceptable mode of payment Permissible places of payment Minimum subscription required

Procedure for Redemption of Units : Details are contained in the Scheme Information Document


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INVESTMENT PLANS/OPTIONS AND SERVICES

Automatic Reinvestment Plan (ARP) : Allows the investor to reinvest amount of dividends or other distributions made back into the same fund and receive additional units

Systematic Investment Plan (SIP) : These require the investor to invest a fixed sum periodically

Systematic Withdrawal Plan (SWP) : Allows the investor to make periodic withdrawals from his funds


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Session 5

Markets & Portfolio Management


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What is Investment/ Portfolio Management? Equity Portfolio Management Debt Portfolio Management Investment restrictions


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WHAT IS INVESTMENT MANAGEMENT ?

Investment or Portfolio Management is a “specialist” function. After

collecting and investing an investor’s money effective portfolio

management will have to give acceptable returns to the investor, in

order to keep him satisfied and prevent him from moving to any

other competitor fund


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EQUITY PORTFOLIO MANAGEMENT

Constructing a portfolio of equity shares or equity-linked instruments consistent with the investment objective

Managing or constantly rebalancing the portfolio

An equity portfolio manager’s task consists of two major steps :


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Ordinary Shares Preference Shares Equity Warrants Convertible Debentures Equity Classes

Types of Equity Instruments


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EQUITY PORTFOLIO MANAGEMENTMarket CapitalisationMarket Capitalisation is equivalent to the current value of a company. There are Large Capitalisation companies, Mid-Cap companies and Small-Cap companies

Classification in Terms of Anticipated Earnings• Price Earning Ratio

• Cyclical Stocks

• Growth Stocks

• Value Stocks


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Investment Strategies:

Growth and value Active and passive Large and small cap Cyclical stock Stock selection

P/E ratio Dividend yield Undervalued companies

Fundamental analysis Technical analysis Quantitative analysis


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Fund Managers, each assigned to a specific scheme or set of schemes

Security Analysts and Researchers Security Dealers

Portfolio Management Organization Structure

Three types of skilled employees :


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Risk Management Portfolio Balancing

Use of Equity derivativesIn India, SEBI permitted the use of futures and options by mutual funds only for two purposes :


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DEBT PORTFOLIO MANAGEMENT

Tenor short and long put and call options

Interest payment Fixed and floating Periodic v/s Discounted

Credit quality Gilt, guaranteed, and others

Traded and non-traded


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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.


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YIELD TO MATURITY

Rate at which present value of future cash flows equals the current market price.

Given price, YTM can be calculated through iteration.

Given YTM, price can be computed, using the YTM rate to discount the future cash flows

• Coupon as a percentage of current market price• If we bought a 8% bond at Rs. 110, the current yield =

(8/110)*100 = 7.27%

Current Yield and YTM


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INTEREST RATE SENSITIVITY

Measured by a number called duration. If duration is 3 years, and interest changes by 1%,

price of the bond will change in the opposite direction, by 3%.

Example

• Example: Duration of a bond is 4 years. Yield spreads increases by 1.5%. what is the change in price?

• Change in the Price = 1.5 *4 = -6%


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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


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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.


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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

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


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INVESTMENT RESTRICTIONS CONTD…...

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 unlisted shares cannot exceed 5% of net assets for an open-ended scheme, 10% of net assets for a close-ended scheme

Mutual funds can invest in ADRs/GDRs up to a maximum limit of 10% of net assets or $50 million, whichever is

lower. The limit for the mutual fund industry as a whole is $500 million

Mutual funds can also invest in a limited manner in treasury bonds and AAA rated corporate debt issued outside India.


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INTER-SCHEME TRANSFER

• Such transfers happen on a delivery basis, at market prices.

• Such transfers should not result in significantly altering the investment objectives of the schemes involved.

• Such transfer should not be of illiquid securities, as defined in the valuation norms.

• One scheme can invest in another scheme, up to 5% of net assets. No fee is payable on these investments.


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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


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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.


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Session 7

Mutual Funds - Accounting & Valuation


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Net assets Accounting policy Initial issue expenses Operating expenses: Limits AMC fees Disclosure and reporting norms Valuation norms


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NET ASSETS VALUE - CALCULATION

+ Market value of investments

+ Current assets and other assets

+ Accrued income

- Current liabilities and other liabilities

- Accrued expenses

NAV = Net assets/Number of units


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FACTORS IMPACTING NAV Sale and purchase of securities

• Cannot impact NAV by more than 2% Sale and repurchase of units

• Cannot impact NAV by more than 2% Valuation of assets Accrual of income and expenses

• Cannot impact NAV by more than 1%

Frequency of NAV Calculation• Everyday by 8.00 p.m on AMFI website• Open ended funds: Daily, Close ended funds: Weekly• Exempt funds: CEFs which are not listed (UTI’s Monthly income

schemes)


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HISTORIC AND PROSPECTIVE NAV

Business day definition and applicable NAV are stated in the offer document

Cut off time for each scheme is also announced.

Prospective NAV applies to applications made before the cut-off time.


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ACCOUNTING POLICIES Investments to be marked to market according to SEBI

Guidelines. Unrealised appreciation cannot be distributed. Profit or loss on average cost basis. Dividend on ex-dividend date. Sale and purchase accounted on trade date. Brokerage and stamp duties are capitalised and added to

cost of acquisition or sale proceeds


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SOURCES OF INCOME

Interest Dividend Profit from sale of investments Other income Extra-ordinary income


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INITIAL ISSUE EXPENSES Expenses incurred in floating schemes

Limit of 6%; excess expenses to be borne by

AMC/sponsor

CEF : Amortise on weekly basis until maturity

OEF : Amortise over period not exceeding 5 years

No-load fund: additional fees


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OPERATING EXPENSES Investment management fees Custodian’s fees Trustee Fees Registrar and transfer agent fees Marketing and distribution expenses Operating expenses Audit fees Legal expenses Costs of mandatory advertisements and communications to

investors


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LIMITS ON EXPENSES 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%.


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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.


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INVESTMENT MANAGEMENT FEES

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 Balance of DRE not included in net assets for

computing investment management fee and expense limits.


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REPORTING REQUIREMENTS

Audited accounts within 6 months of closure of accounts.

Publish within 30 days of the closure of the half-year, unaudited abridged accounts.

Summary of the accounts has to be mailed to all unit holders.

File with SEBI: A copy of the annual report Six monthly unaudited reports Quarterly movement in net assets of the fund Quarterly portfolio statements


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SPECIFIC DISCLOSURES

Complete portfolio to be disclosed every six months. Industry practice: monthly disclosure.

Any item of expenditure which is more than 10% of total expenses

NPAs, provisioning, NPAs as % of total assets.

Number of unit holders holding more than 25% of unit capital.


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NON PERFORMING ASSETAn asset shall be classified as an NPA, if the interest and/or principal amount have not been received or have remained outstanding for one quarter, from the day such income/installment has fallen due.

Such assets will be classified as NPAs, soon after the lapse of a quarter from the date on which payments were due.

Treatment of NPAs• Accrual to be stopped.• Income accrued until date of classification to be provided for.• Provisioning for principal due

– In graded manner after 3 months of classification.– Complete write off in 15 months from classification


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VALUATION

Market price for all frequently traded securities

Illiquid and thinly traded equity Valuation procedure

Debt: < 182 days accrual principal.

> 182 days common valuation methodology

Illiquid securities to not exceed 15% of net assets.


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VALUATION: EQUITY Market price for Liquid shares

Price should not be more than 30 days old Fair valuation for Illiquid shares

Earnings based SEBI approved model Fair Valuation for Thinly traded shares

Less than Rs. 5 lakh value and Less than 50,000 shares

• YTM based for Gilt and Corporate securities with investment grade rating

• 25% discount for speculative grade performing assets• NPA norms for NPAs• Accrual for money market securities

Valuation: Debt


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LIQUID SECURITIES Last traded price in the exchange where the

security is principally traded. Previous traded date as long as such date is not

over 30 days ago.

Thinly Traded Securities• Equity shares– Traded value in a month is less than Rs. 5 lakhs; and – Total volume of shares traded is less than 50,000 shares a

month• Debt security– Traded value of less than Rs. 15 crore in the 30 days prior

to the valuation date.


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VALUATION OF THINLY TRADED EQUITY Book value of the share Earnings capitalisation value

Discount the industry P/E by 75%

Average of the two methods 10% discount for illiquidity

Earning capitalisation is zero if EPS if negative Accounts not available for 9 months after closing date.

If illiquid securities are more than 5% of the portfolio, independent valuation to be done


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VALUATION OF A THINLY TRADED SECURITY (<182 DAYS)

For example, if a security was issued at Rs. 90 and redeemable at Rs. 100, after 364 days, the accrued interest for each day is

= 10/364= 0.02747The value of the security is increased by 2.747

paise every day, so that the security is worth Rs. 100 on the date of maturity.

If it has to be valued 200 days after issuance, its value is

90+(0.02747*200)= 95.494


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VALUATION OF OTHER SECURITIES(>182D)

G-Secs are valued at market prices or using the CRISIL Gilt valuer.

Corporate bonds are valued at market prices or using the CRISIL Bond valuer.

Both these methods use duration to classify bonds and assign a rate for each duration bucket.


100

Session 8

Risk, Return and Performance


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CONTENTS : SESSION 8 Return Methods

Change in NAV Total Return Total Return with dividend re-investment CAGR

Risk Standard deviation Beta and Ex-Marks

Benchmark and comparison


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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 Computing return

Percentage change in NAV.Simple total returnROI or Total return with dividend re-investmentCompounded rate of growth


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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.

%age change in NAV = (27.65 – 23.45)/23.45 *100 = 17.91% Annualizing the Rate of

ReturnIf NAV on Jan 1, 2001 was Rs. 12.75 and the NAV on June 30, 2001 was

Rs. 14.35,

% age change in NAV = (14.35 – 12.75)/12.75 x 100 = 12.55%

Annualised return = 12.55 x 12/6 = 25.10%


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TOTAL RETURNInvestor

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 70%.

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%


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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.


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ROI METHOD: EXAMPLEAn 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 =10.5x100= 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 ROI =(1344.51-1050)/1050 x 100 = 28.05%


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COMPOUNDED AVERAGE GROWTH RATE

CAGR is the rate at which investment has grown frombegin 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.


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CAGR: EXAMPLE 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 initial value of the investment= 10.5 x 100 = Rs. 1050

Number of units reinvested = 100/10.25 = 9.756 units

Final 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%


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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 reinvestment of dividend at ex-dividend NAV.

Less then 1 year, simple return without compounding or annualisation.

Some funds use simple annualised return, without compounding.


110

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.


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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.


112

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.


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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.


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OTHER MEASURES OF PERFORMANCE

Tracking errorTracking error for index funds should be nil.

Credit qualityRating profile of portfolio should be studied

Expense ratioHigher expense ratios hurt long term investors

Portfolio turnoverHigher for short term funds and lower for long term

funds Size and portfolio composition


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Session 9

Mutual Funds & Financial Planning


116


Concept of financial planning Mapping life cycles and wealth cycles Financial products Asset allocation Model portfolios Fund selection


117

CONCEPT OF FINANCIAL PLANNING

Financial planning identifies all the financial needs of an investor and translates the needs into monetarily measurable goals. These goals can be short term, medium term and long term. A Financial Planner plans the financial investments that will allow these goals to be met.

Financial Planning provides direction and meaning to financial decisions. It helps to understand how each financial decision effects other areas of one’s financesBy viewing each financial decision as part of a whole one can consider its short and long term effects on one’s life goals


118

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


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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


120

CLASSIFICATION OF INVESTORS

Wealth cycle based classification Life cycle based classification


121

PROCESS OF FP IN PRACTICE

Step I: Establish and define the relationship with the client Step II: Define the client’s goals Step III: Analyse and evaluate client’s financial status Step IV: Determine and shape the client’s risk tolerance level Step V: Ascertain client’s tax situation Step VI: Recommend the appropriate asset allocation and specific

investments Step VII: Executing the plan Step VIII: Periodic Review


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PRODUCTS AVAILABLE

Physical Assets – Gold & Real Estate Bank Deposits Corporate –Shares, Bonds, Debentures & Fixed

Deposits Government – G. Secs, PPF, RBI Relief Bonds and

other personal Investments Financial Institutions – Bonds, Shares Insurance Companies – Insurance Policies


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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


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PUBLIC PROVIDENT FUND 15 years deposit product made available through banks. 9% p.a. interest payable on monthly balances Minimum Rs. 100 & maximum Rs. 70,000 p.a investment

allowed. Tax benefits u/s 88 under IT Act. Limited by taxable income

slabs. Interest receipt and withdrawal of principal exempt from

tax. Limited liquidity available.


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RBI RELIEF BONDS Issued by banks on behalf of the RBI Tenure of five years 6.5% p.a. interest payable s.a. Proposed to be converted to floating rate

instrument linked to government yields Option to receive or reinvest interest Interest income exempt from tax Limit of Rs.2 lakh per annum, except for severance

benefits.


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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 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


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INSTRUMENTS ISSUED BY CORPORATES

Commercial Paper Debentures Equity Shares Preference Shares Fixed Deposits Bonds of FI


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HOW TO COMPARE PRODUCTS

Compare options by nature of investments – Characteristics, benefits and risks.

Current performance and suitability– Taxability, age, risk profile.

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


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STRATEGIES FOR INVESTORS

Harness the power of compounding Start early Have realistic expectations Invest regularly

Useful Strategies• Rupee Cost Averaging• Value Averaging• Jacob’s rebalancing strategy• Graham’s 50:50 rebalancing strategy


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RUPEE COST AVERAGING° Invest regularly a predetermined amount

° Invests in more units when the market is low; less when the markets are high.

° Reduces the average cost of purchase

Invest regularly to achieve a predetermined value

Book profits at a high, and adds units at the low, and enables meeting financial goals.

Reduces the average cost of purchase

Value Averaging


131

RUPEE COST AVERAGING

AmountInvested

(Rs)

NAV perunit

Number ofunits bought

Cumulativenumber of

units

Value ofholding

1000 12.5 80.00 80.00 1000.00

1000 11.25 88.89 168.89 1900.00

1000 10.75 93.02 261.91 2815.56

1000 11 90.91 352.82 3881.03

1000 12.75 78.43 431.25 5498.47

1000 13.35 74.91 506.16 6757.22

1000 13.85 72.20 578.36 8010.30

1000 14.45 69.20 647.57 9357.32

1000 13.85 72.20 719.77 9968.78

1000 13.5 74.07 793.84 10716.86

Average cost 12.60


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VALUE AVERAGING

TargetValue

NAV PerUnit

Value OfHolding

UnitsToInvest

CumulativeBalance

1000 12.5 0.00 80 802000 11.25 900.00 97.78 177.783000 10.75 1911.11 101.29 279.074000 11 3069.77 84.57 363.645000 12.75 4636.36 28.52 392.166000 13.35 5235.29 57.28 449.447000 13.85 6224.72 55.98 505.428000 14.45 7303.25 48.22 553.639000 13.85 7667.82 96.19 649.8210000 13.5 8772.56 90.92 740.74


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ASSET ALLOCATION AND MODEL PORTFOLIOS

Deciding the allocation of funds amongst equity, debt and money market.

Incorporating product, investor profile and preferences in the portfolio

Equity, debt and money market products are called asset classes. Allocating resources to each of these is called asset allocation.


134

GRAHAM’S MODEL PORTFOLIO

Based on the 50:50 rule. Basic managed portfolio. Basic indexed portfolio. Simple managed portfolio. Complex managed portfolio. Readymade portfolio.


135

BOGLE’S STRATEGIC ASSET ALLOCATION

Combine age, risk profile and preferences 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


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FIXED AND FLEXIBLE ASSET ALLOCATION

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


137

DEVELOPING A MODEL PORTFOLIO

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


138

JACOB’S MODEL PORTFOLIOS

Accumulation phase Diversified equity: 65 - 80% Income and gilt funds: 15 - 30% Liquid funds: 5%

Distribution phase Diversified equity: 15 - 30% Income and gilt funds: 65 - 80% Liquid funds: 5%


139

FUND SELECTION Equity funds: Characteristics

Fund category Suitability to investor objective

Investment style Growth vs Value

Age of the fund Experience preferred to new fund

Fund management experience Size of the fund

Larger funds have lower costs Performance and risk


140

EQUITY FUNDS: SELECTION CRITERIA

Percentage holding in cash. Concentration in portfolio. Market capitalisation of the fund. Portfolio turnover. Risk Statistics

Beta Ex-Marks Gross dividend yield Funds with low beta, high ex-marks and high gross dividend

yield is preferable


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DEBT FUNDS: SELECTION CRITERIA

A smaller or new debt fund may not necessarily be riskyTotal return rather than YTM is importantExpense very important

High expense ratios lead to yield sacrificeCredit quality

Better the rating of the holdings, safer the fundAverage maturity

Higher average maturity means higher duration and interest rate risk


142

MONEY MARKET FUNDS

Liquidity and high turnover rate Shorter term instruments are turned over more frequently.

Protection of principal invested NAV fluctuation limited due to low duration and low levels

of interest rate risk.Credit quality of portfolioLow expense ratio


143

Session 9

Business Ethics for Mutual Funds


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CONTENTS - SESSION 9 What is meant by Business Ethics ? Need for Business Ethics Objectives Key Terms Fund Regulators and Business Ethics

Responsibilities Objectives Requirements Operations Publicity

Ethical Issues and Responsible Investing


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WHAT IS MEANT BY BUSINESS ETHICS ?It means rules of acceptable and good conduct Rules may be set my those who own and run a business or by an agency

Need for Business EthicsIn a civilised society business must be conducted in an ethical, disciplined, organized and fair manner. Good ethics is good business. Ethical practices ensure that the customer remains a long term and satisfied buyer

“Honesty is the Best Policy”


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OBJECTIVES

Simply be honest, open and transparent with all your current and potential clients

Protect customers from being cheated and exploited

Ensure a level field playing among all categories of business participants


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KEY TERMS OF BUSINESS ETHICS Fair Business Practices Ethical Standards Ethical norms or guidelines A Code of Conduct Ethical Business Practices Conflict of interest in a mutual fund

business


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FUND REGULATORS AND BUSINESS ETHICS

Primarily concerned with the protection of investors

Develop code of conduct for fund distributors, fund managers, all employees and associated persons of AMCs

May lay down its own rules of ethics

Investigates any practices that run counter to the interest of fund investor

Responsibilities


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FUND REGULATORS AND BUSINESS ETHICS

Fund Structure and Governance Exercise of Voting Rights by Funds Fund Operations

Requirements Separation of Functions Independence of Organisations Independence of Personnel

Objectives


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FUND REGULATORS AND BUSINESS ETHICSFund Operations Insider Trading Preferential treatment to selected investors Personal training by fund managers and

employees

Fund PublicityPublicity and advertisements provide the investors correct, complete and relevant information needed to make the investments in mutual funds


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ETHICAL ISSUES AND RESPONSIBLE INVESTING

Fully protect the best interests of the investor

‘Prudent Investing’ which refers to the quality and safety of investments

‘Responsible Investing’ means that fund managers must invest with a sense of responsibility Screening Investments Shareholder Activism by fund advisors/ managers Community Investing


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THANK YOU AND ALL THE VERY BEST!!

AMFI(NISM)

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