Investing in Mutual Funds

Meaning: A financial intermediary that pools the savings of investors for collective investment in a diversified portfolio of securities.

Mutual Funds

18-*Benefits Professional management Portfolio diversification Reduction in transaction cost Liquidity ConvenienceTax benefits Transparency

Net Asset Value (NAV)

Net Asset Value is the market value of the assets of the scheme.

The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date.

NAVs are disclosed on daily basis in case of open ended schemes and on weekly basis in case of close-ended schemes

Expense Ratio- cost of running the fundRatio of expenses incurred by a mutual fund for managing a fund to net assets of the fund.Such as, salaries, bonus, administrative costs, marketing and selling expensesDisclosed once every six monthsSEBI regulations permit expense ratio maximum 2.5% for equity funds and 2.25% for debt funds

Mutual Fund Concepts

Load- sales charge or commission. Entry load and Exit load Asset Under Management(AUM)- Market value of the securities/assets in which the funds are deployed.AUM = NAV x number of units issued by the scheme

Sale Price- Is the price you pay when you invest in a scheme. Also called Offer Price.

Repurchase Price Is the price at which units under open-ended schemes are repurchased by the Mutual Fund. Such prices are NAV related.

Redemption Price Is the price at which close-ended schemes redeem their units on maturity. Such prices are NAV related.

Mutual Fund Concepts

Comparison of Open-ended and Close-ended SchemesOpen- ended schemeClose- ended scheme

Continuous offer to sell and repurchase Scheme having a stipulated units at NAV maturity period ranging between two to five yearsNot listed on the Listed on the stock stock exchange exchange

Do not have a fixed corpusHave a fixed corpus

Income funds: Invest predominantly in income bearing instruments such as bonds, debentures etc.

Growth funds: Invest predominantly in equity shares with growth potential

Balanced funds: Investment divided between equity shares and fixed interest bearing instruments

Money market or Liquid funds: Invest in short- term money market instruments

Types of Mutual Funds- on the basis of investment objective

Types of Mutual Funds Gilt funds: Invest in government securities

Index Funds: replicate the portfolio of a particular index on which it is based. Invest in the stocks in the same weightage Follows a passive investment strategy Mirrors the performance of its benchmark index

Sectoral funds: Invest in specific core sectors like energy, telecommunication, IT, construction

Tax Saving Schemes: Closed-ended schemes with minimum lock-in period of three yearsEquity- linked savings scheme(ELSS): open-ended, diversified schemes invest in blue-chip companies

Hybrid of open-ended mutual funds and listed individual stocks traded on stock exchanges Passively managed funds

Advantages Allow for intra-day tradingSimple to understandProvide benefits of diversificationLow operating expenses

First ETF in India Nifty Benchmark Exchange Traded Scheme (Nifty BeES) Exchange-traded Funds:Types of Mutual Funds

Types of Mutual FundsFund-of-Funds: Invests in other mutual fund schemes.

Floating rate fundsInvest in floating rate instruments Coupon rate linked to a benchmark rate.

Gold ETF: invest in Gold and Gold related instruments. NAV depends on price of Gold

Systematic Investment Plans (SIPs): A fixed sum of money is invested periodically in mutual fund scheme. This plan avoids the problem of market timing and usually gives higher returns if investor has a long term investment horizon.

Large cap funds: are those mutual funds, which seek capital appreciation by investing primarily in stocks of large blue chip companies with above-average prospects for earnings growth. Generally, companies with a market capitalization in excess of Rs 1000 crore are known large cap companies.

Mid cap funds: are those mutual funds, which invest in small / medium sized companies. Generally, companies with a market capitalization of up to Rs 500 crore are classified as small. Those companies that have a market capitalization between Rs 500 crore and Rs 1,000 crore are classified as medium sized. Types of Mutual Funds

Equity- oriented mutual fund more risky compared to a debt mutual fund.

Proportion of risk varies from scheme to schemeRisks in Mutual Funds

Returns from Mutual FundsEquity-oriented Schemes:DividendsTax free in the hands of investorsCapital AppreciationHolding period less than 12 months- short term capital gain tax of 15 per centHolding period more than 12 months no long term capital gain tax but STT applicableDebt- oriented Schemes:Dividends- Taxed in the hands of investorsCapital AppreciationShort term capital gain taxed as ordinary incomeLong term capital gain taxed at 10% without indexation and 20% with indexation

Deciding Among Mutual FundsDetermining your preferred characteristics of a mutual fundMinimum initial investmentInvestment objective (type of fund)Investment companyReviewing a mutual funds prospectusProspectus: a document that provides financial information about a mutual fund, including expenses and past performance

Deciding Among Mutual Funds (contd)Investment objective: in a prospectus, a brief statement about the general goal of the mutual fundInvestment strategy: in a prospectus, a summary of the types of securities that are purchased by the mutual fund in order to achieve its objectivePast performance1 year, 3 years, 5 years

Deciding Among Mutual Funds (contd)Fees and ExpensesRedemption fee or back-end loadExpenses, including management fees-Expense ratioDistribution of dividends and capital gains

Deciding Among Mutual Funds (contd)

Sheet1

Growth FundIndex Fund

Fund's portfolio return (exludes expenses)9.00%8.00%

Expense ratio1.50%0.20%

Your annual return7.50%7.80%

Sheet2

Large Stock FundSmall Stock Fund

Dividends$1,000$0

Capital gains$0$1,000

Total income$1,000$1,000

Tax on divs (40%)$400$0

Tax on cap gains (20%$0$200

Total taxes$400$200

After-tax income$600$800

Sheet3

With $1,000 to invest in a stock mutual fund:

Internet FundLoad StatusExpense RatioRecent Annual Performance

#1No-load1.50%13%

#2No-load0.80%12%

#3No-load2.00%14%

#43% load1.70%11%

With $1,000 to invest in a bond mutual fund:

High-YieldBond FundsLoad StatusExpense RatioTypicalTerms toMaturity

#14% load1.00%6 - 8 years

#2No-load0.90%15 - 20 years

#3No-load0.80%5 - 7 years

#4No-load1.20%5 - 7 years

Copyright 2007 Pearson Addison-Wesley. All rights reserved.18-*

Copyright 2007 Pearson Addison-Wesley. All rights reserved.

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