Term Paper on

Mutual FundsSub: (ABM-621) Financial Services (1+0)

Presented By:

Hareesh .M

2014600120

Mutual Funds

What are Mutual Funds?

• A Mutual Fund is a trust that pools the savings of a number of investors who share a

common financial goal.

• The money thus collected is then invested in capital market instruments such as shares,

debentures and other securities.

• The income earned through these investments and the capital appreciation realized are

shared by its unit holders in proportion to the number of units owned by them.

Concept of Mutual Funds

Mutual funds are institutions that collect money from several sources - individuals or

institutions by issuing 'units', invest them on their behalf with predetermined investment

objectives and manage the same all for a fee. They invest the money across a range of

financial instruments falling into two broad categories – equity and debt. Individual people

and institutions no doubt, can and do invest in equity and debt instruments by themselves

but this requires time and skill on both of which there are constraints. Mutual funds

emerged as professional financial intermediaries bridging the time and skill constraint.

They have a team of skilled people who identify the right stocks and debt instruments and

construct a portfolio that promises to deliver the best possible 'constrained' returns at the

minimum possible cost. In effect, it involves outsourcing the management of money. More

explicitly, the benefits of investing in equities and debt instruments are supposedly much

better if done through mutual funds. This is because of the following reasons: Firstly, fund

managers are more skilled. They are trained to identify the best investment options and to

assess the portfolio on a continual basis; secondly, they are able to invest in a diversified

portfolio consisting of 15-20 different stocks or bonds or a combination of them. For an

individual such diversification reduces the risk but can demand a lot of effort and cost.

Each purchase or sale invites a cost in terms of brokerage or transactional charges such as

demat account fees in India. The need to possibly sell 'poor' stocks/bonds and buy 'good'

stocks/bonds demands constant tracking of news and performance of each company they

have invested in. Mutual funds are able to maintain and track a diversified portfolio on a

constant basis with lesser costs. This is because of the pecuniary economies that they enjoy

when it comes to trading and other transaction costs; thirdly, funds also provide good

liquidity. An investor can sell her/his mutual fund investments and 17

• receive payment on the same day with minimal transaction costs as compared to dealing

with individual securities, this totals to superior portfolio returns with minimal cost and

better liquidity.

•

• In India one can gain additional benefit by investing through mutual funds tax savings.

Investment in certain types of funds such as Equity Linked Tax Savings Schemes (ELSS)

allows for certain amount of income tax benefits.

How do I make money from a mutual fund?

1. Capital appreciation:

As the value of securities in the fund increases, the fund's unit price will also increase. You can

make a profit by selling the units at a price higher than at which you bought

2. Coupon / Dividend Income:

Fund will earn interest income from the bonds it holds or will have dividend income from the

shares

3. Income Distribution:

The fund passes on the profits it has earned in the form of dividends

Disclaimer

As the value of securities in the fund increases, the fund's unit price will also increase. You can

make a profit by selling the units at a price higher than at which you bought. Although Mutual

Fund does not guarantee the same. 

Mutual Funds Schemes

Mutual Funds Schemes-By Structure

1. Open-ended Fund/ Scheme - An open-ended fund or scheme is one that is available for

subscription and repurchase on a continuous basis. These schemes do not have a fixed

maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV)

related prices which are declared on a daily basis. The key feature of open-end schemes is

liquidity.

2. Close-ended Fund/ Scheme: A close-ended fund or scheme has a stipulated maturity

period e.g. 5-7 years. The fund is open for subscription only during a specified period at

the time of launch of the scheme. Investors can invest in the scheme at the time of the

initial public issue and thereafter they can buy or sell the units of the scheme on the stock

exchanges where the units are listed.

3. Interval Schemes : Interval Schemes are that scheme, which combines the features of

open-ended and close-ended schemes. The units may be traded on the stock exchange or

may be open for sale or redemption during pre-determined intervals at NAV related prices

Mutual Funds- By Investment Objectives

1) Growth Schemes are also known as equity schemes. The aim of these schemes is to provide

capital appreciation over medium to long term. These schemes normally invest a major part of

their fund in equities and are willing to bear short-term decline in value for possible future

appreciation.

2) Income Schemes are also known as debt schemes. The aim of these schemes is to provide

regular and steady income to investors. These schemes generally invest in fixed income securities

such as bonds and corporate debentures. Capital appreciation in such schemes may be limited.

3) Balanced Schemes aim to provide both growth and income by periodically distributing a part of

the income and capital gains they earn. These schemes invest in both shares and fixed income

securities, in the proportion indicated in their offer documents (normally 50:50).

4) Money Market Schemes aim to provide easy liquidity, preservation of capital and moderate

income. These schemes generally invest in safer, short-term instruments, such as treasury bills,

certificates of deposit, commercial paper and inter-bank call money.

By Investment based classification

• Equity fund: such fund invest in equity shares they carry a high degree of risk such fund

do well in favorable market conditions. Investments are made in equity shares in diverse

industries and sectors.

• Debt funds: Such fund invest in debt instruments like bonds and debentures. These funds

carry the advantage of secure and steady income there is little chance of capital

appreciation. Such funds carry no risk. A variant of this type of fund is called liquid fund

which specializes in investing in short term money market instruments.

• Balanced funds: such scheme have a mix of debt and equity in their portfolio of

investments. The portfolio is often shifted between debt and equity depending upon the

prevailing market conditions.

By Investment based classification

• Sectoral fund: Such fund invest in specific sectors of the economy. The specialized sectors

may include real estate infrastructure, oil and gas etc, offshore investments, commodities

like gold and silver.

• Fund of Funds: such funds invest in units of other mutual funds there are a number of

funds that direct investments into specified sectors of economy. This makes diversified

and intensive investments possible.

• Leverage funds: the funds that are created out of investments with not only the amount

mobilized from investors but also from borrowed money from the capital markets are

known as leveraged funds. Fund managers pass on the benefit of leverage to the mutual

fund investors. Additional provisions must be made for such funds to operate. Leveraged

funds use short sale to take advantage of declining markets in order to realize gains.

Derivative instruments like options are used by such funds.

• Gilt fund : These funds seek to generate returns through investment in govt. securities.

Such funds invest only in central and state govt. securities and REPO/ reverse REPO

securities. A portion of the corpus may be invested in call money markets to meet liquidity

requirements. Such funds carry very less risk. Their prices are influenced only by moment

in interest rates.

• Indexed funds: these funds are linked to specific index. Funds mobilized under such

schemes are invested in securities of companies included in the index of any exchange.

The fund performance is linked to the growth in concerned index.

• Tax saving schemes: The amount invested in tax-saving funds (ELSS) is eligible for

deduction under Section 80C, However the aggregate amount deductible under the said

section cannot exceed Rs 100,000 (in a financial year).

Rating Agencies

Role of Rating Agencies

1. Facilitate informed investment decision making

2. Provide independent and reliable opinion of schemes

3. The quality of the Fund’s management and operations

4. Help meet specific investment objective

5. CRISIL~CPR Rankings and Value Research Star Rating are prominent ones

Advantages Of Mutual Fund

Diversification - It can help an investor diversify their portfolio with a minimum investment.

Spreading investments across a range of securities can help to reduce risk. A stock mutual fund,

for example, invests in many stocks . This minimizes the risk attributed to a concentrated position.

If a few securities in the mutual fund lose value or become worthless, the loss may be offset by

other securities that appreciate in value. Further diversification can be achieved by investing in

multiple funds which invest in different sectors.

Professional Management - Mutual funds are managed and supervised by investment professional.

These managers decide what securities the fund will buy and sell. This eliminates the investor of

the difficult task of trying to time the market.

Well regulated - Mutual funds are subject to many government regulations that protect investors

from fraud.

Liquidity - It's easy to get money out of a mutual fund.

Convenience - we can buy mutual fund shares by mail, phone, or over the Internet.

Low cost - Mutual fund expenses are often no more than 1.5 percent of our investment. Expenses

for Index Funds are less than that, because index funds are not actively managed. Instead, they

automatically buy stock in companies that are listed on a specific index

Transparency - The mutual fund offer document provides all the information about the fund and

the scheme. This document is also called as the prospectus or the fund offer document, and is very

detailed and contains most of the relevant information that an investor would need.

Choice of schemes - there are different schemes which an investor can choose from according to

his investment goals and risk appetite.

Tax benefits - An investor can get a tax benefit in schemes like ELSS (equity linked saving

scheme)

Types of risks associated with Mutual Fund Investment

Risk is an inherent aspect of every form of investment. For Mutual Fund investments, risks would

include variability, or period-by-period fluctuations in total return.

Market risk: At times the prices or yields of all the securities in a particular market rise or fall due

to broad outside influences. This change in price is due to 'market risk'.

Inflation risk: Sometimes referred to as 'loss of purchasing power'. Whenever the rate of inflation

exceeds the earnings on your investment, you run the risk that you'll actually be able to buy less,

not more.

Credit risk: In short, how stable is the company or entity to which you lend your money when you

invest? How certain are you that it will be able to pay the interest you are promised, or repay your

principal when the investment matures?

Interest rate risk: Interest rate movements in the Indian debt markets can be volatile leading to the

possibility of large price movements up or down in debt and money market securities and thereby

to possibly large movements in the NAV.

Other risks associated are:

Investment risks Liquidity risk Changes in the government policy

Systematic Investment Planning (SIP)

SIP is similar to a Recurring Deposit. Every month on a specified date an amount you choose is

invested in a mutual fund scheme of your choice. The dates currently available for SIPs are the

5th, 10th, 15th, 20th and the 25th of a month. There are many benefits of investing through SIP.

Advantages of SIP

•Encourages Regular and Disciplined Investments

•A Convenient way to invest regularly

•Long term perspective

•Rupee Cost Averaging Benefit to counter volatility

•Compounding Benefits

•Simple & convenient

•A larger target segment due to lower initial investment

SIP – Easy Pay Facility

•Opt for the SIP EASY PAY Auto debit Facility

•Choose the Amount (minimum Rs 500/- p.m.)

•Choose one Day of the month (5th / 10th /15th / 20th / 25th/ 30th )

•Make First Investment by Cheque drawn in favor of the scheme.

E.g. SBIMF -Magnum Tax Gain Scheme

And Relax…….. Every month the said amount will be debited from your bank account and units

will allocated to you.

Register for Statement Of Account (SOA) by mail.

How to invest in mutual funds?

Step One - Identify your investment needs.

Your financial goals will vary, based on your age, lifestyle, financial independence, family

commitments, level of income and expenses among many other factors. Therefore, the first step is

to assess your needs. Begin by asking yourself these questions:

1. What are my investment objectives and needs?

Probable Answers: I need regular income or need to buy a home or finance a wedding or educate

my children or a combination of all these needs.

2. How much risk am I willing to take?

Probable Answers: I can only take a minimum amount of risk or I am willing to accept the fact

that my investment value may fluctuate or that there may be a short term loss in order to achieve a

long term potential gain.

3. What are my cash flow requirements?

Probable Answers: I need a regular cash flow or I need a lump sum amount to meet a specific

need after a certain period or I don‟t require a current cash flow but I want to build my assets for

the future.

By going through such an exercise, you will know what you want out of your investment and can

set the foundation for a sound Mutual Fund Investment strategy.

Step Two - Choose the right Mutual Fund.

Once you have a clear strategy in mind, you now have to choose which Mutual Fund and scheme

you want to invest in. The offer document of the scheme tells you its objectives and provides

supplementary details like the track record of other schemes managed by the same Fund Manager.

Some factors to evaluate before choosing a particular Mutual Fund are:

The track record of performance over the last few years in relation to the appropriate yardstick

and similar funds in the same category.

How well the Mutual Fund is organized to provide efficient, prompt and personalized service.

Degree of transparency as reflected in frequency and quality of their communications.

Step Three - Select the ideal mix of Schemes.

Investing in just one Mutual Fund scheme may not meet all your investment needs. You may

consider investing in a combination of schemes to achieve your specific goals.

The following charts could prove useful in selecting a combination of schemes that satisfy your

needs.

Step Four - Invest regularly

For most of us, the approach that works best is to invest a fixed amount at specific intervals, say

every month. By investing a fixed sum each month, you get fewer units when the price is high and

more units when the price is low, thus bringing down your average cost per unit. This is called

rupee cost averaging and is a disciplined investment strategy followed by investors all over the

world. With many open-ended schemes offering systematic investment plans, this regular

investing habit is made easy for you.

Step Five - Keep your taxes in mind

As per the current tax laws, Dividend/Income Distribution made by mutual funds is exempt from

Income Tax in the hands of investor. However, in case of debt schemes Dividend/Income

Distribution is subject to Dividend Distribution Tax. Further, there are other benefits available for

investment in Mutual Funds under the provisions of the prevailing tax laws. You may therefore

consult your tax advisor or Chartered Accountant for specific advice to achieve maximum tax

efficiency by investing in mutual funds.

Step Six - Start early

It is desirable to start investing early and stick to a regular investment plan. If you start now, you

will make more than if you wait and invest later. The power of compounding lets you earn income

on income and your money multiplies at a compounded rate of return.

Step Seven - The final step

All you need to do now is to get in touch with a Mutual Fund or your advisor and start investing.

Reap the rewards in the years to come. Mutual Funds are suitable for every kind of investor

whether starting a career or retiring, conservative or risk taking, growth oriented or income

seeking.

Various Mutual Funds in India

State Bank of India mutual fund

ICICI prudential mutual fund

TATA mutual fund

HDFC mutual fund

Birla sun life mutual fund

Reliance mutual fund

Kotak Mahindra mutual fund etc..

REFERENCES

• moneycontrol.com

• wikipedia.co.in