NISM Mutual Fund Distributors Certification Exam PDF/NISM_MFD_ch1n2.pdf · NISM Mutual Fund...
Transcript of NISM Mutual Fund Distributors Certification Exam PDF/NISM_MFD_ch1n2.pdf · NISM Mutual Fund...
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CENTRE FOR INVESTMENT EDUCATION AND LEARNING
NISM Mutual Fund Distributors Certification Exam
Module 1
Chapters 1 and 2
Basic Mutual Fund Concepts
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Collective Investment Vehicle
‘Mutuality’ in contribution and benefit
Benefits accrue in the proportion to the share in the pool
Product is described by its ‘Investment Objective’
Investors match their objectives with the funds’ investment objectives
Investment objective defines the risk return profile of the fund
Mutual funds are first offered to an investor in NFO (New Fund Offer)
Unit Capital is the corpus of the fund
Number of Units * Face Value
Changes depending upon the nature of the fund
Net Assets
Assets Under Management (AUM) = Total Assets + Current Assets
Mutual Fund does not hold any long term liabilities
Net Assets = Total assets + Accrued income – Current liabilities – Accrued expenses
Net Asset Value = Net assets divided by units outstanding
Value per unit at current market prices
The net assets of a mutual fund may go up/down due to the following reasons:
Entry /exit of investors
Income from dividends or interest/ Expenses
Realised gains/losses
Unrealised gains/losses
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Investment Portfolio
Portfolio is a collection of securities
Mutual funds can invest only in marketable securities
Value of the investment portfolio changes with a change in market price of the
securities
‘Marking to market’ - Process of using market price to value investment portfolio
Unrealised gains or Unrealised losses
Total Assets - Market Value of all the securities held in the portfolio
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Advantages and Limitations of a Mutual Fund
Advantages
Portfolio diversification
Low transaction cost
Professional fund management
Higher flexibility
Protection of investor interest
Tax advantages
Liquidity
Limitations
Not customised portfolios
Offer several product variants
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Mutual Fund Products - Structure
Open-ended Funds
No fixed maturity date
Accept continuous sale and re-purchase requests at fund offices and ISCs
Transactions are NAV-based
Unit capital is not fixed
Closed-ended Funds
Run for a specific period
Offered in an NFO but are closed for further purchases after the NFO
Compulsorily listed on a stock exchange to provide liquidity
Unit capital is kept constant
Interval Funds
Variant of closed-ended funds
Primarily closed-ended but become open-ended at specific intervals
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Fund Classification
Based on investment objective
Debt funds investing in short and long term debt instruments for regular income
Equity funds investing in equity securities for capital appreciation
Hybrid funds investing in a combination of equity and debt for both income and capital
appreciation
Based on investment risk
Equity funds have a greater degree of risk as compared to a debt funds
Liquid funds are the least risky, as they invest in very short-term securities
Based on investment style
Active funds
Passive funds
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Fund Classification-2
Based on investment horizon
Equity funds are recommended for the long term (five years and above)
Balanced funds are recommended for three years and above
Income funds are recommended for medium term (one year and above)
Short term debt funds are recommended for the short term (up to one year)
Liquid funds are recommended for ultra-short periods (up to a month)
Based on investment categories
Equity funds invest in equity shares; Debt funds invest in debt securities;
Money market funds invest in money market securities; Commodity funds invest in
commodity-linked securities;
Real estate funds invest in property-linked securities; Gold funds invest in gold-linked
securities
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Funds Based on Investment Style
Passive Funds
Replicate a market index
Invest in the same securities and in the same proportion
No active stock or sector selection
Expenses are lower
Portfolio is modified everytime the index composition changes
Active Funds
Seek to invest in securities and sectors that may offer a better return than the index
Actively manage the allocation to market securities and cash
May perform better or worse than the market index
Incurs a higher cost than passive funds
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Debt Funds - 1
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Money Market or Liquid Funds
Very short term maturity
Debt securities with less than 91 days to maturity
Primary source of income is interest
No mark to market for securities less than 91 days to maturity
Safety of principal and superior liquidity
Used primarily by large corporate investors and institutional investors
Floating Rate Funds
Invest largely in floating rate debt securities
Interest income in line with the market interest rates
Lower mark to market risk
Attractive when the interest rates are rising
Cash or Treasury Management Funds
Risk and return profile similar to liquid funds
Choose securities with slightly longer tenor of up to 364 days
Debt Funds - 2
Gilt Funds
Invest in government securities of medium and long-term maturities
No risk of default
Presence of interest rate risk, depending upon maturity profile
Income Funds
Invest in medium-term and long-term securities issued by the government, banks and
corporates
Benefit of higher coupon
Higher credit risk
High interest rate risk due to long term orientation
Dynamic Bond Funds
Maturity profile varies according to the interest rate view
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Debt Funds - 3
High-yield Debt Funds
Seek higher interest income by investing in debt instruments that have lower credit ratings
Also known as ‘junk bond funds’
Not permitted in India
Fixed Maturity Plans
Closed-end funds that invest in debt instruments with maturities that match the term of the
scheme
Debt securities are redeemed on maturity and paid to investors
No interest rate risk
Short Term Plan
Combine long and short term debt securities
Earn interest from short term securities
Capital gains from long term securities
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Equity Funds
Diversified Equity Funds
Invest in equity shares across various sectors, sizes and industries
Less risky
Thematic Equity Funds
Multiple sectors and stocks falling within a theme
Less diversified than a diversified equity fund
Sector Equity Funds
Invest in a given sector
Concentrated funds and feature high risk
Sector performances tend to be cyclical
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Strategy-Based Equity Funds
Growth Funds
Invest in companies whose earnings are expected to grow at an above-average rate
Value Funds
Identify stocks of good quality companies whose real worth has not been realised yet
Mid-cap and Small-cap funds
Focus on smaller and emerging companies for their higher growth potential
Dividend Yield Funds/Equity Income Funds
Invest in companies that have a high dividend yield
Attractive in bear and over-valued markets due to less volatility and regular dividend
income
Index Funds
Passive funds based on equity indices
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Equity-Linked Savings Scheme
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Some equity schemes are designated as ELSS at the time of launch
Offer tax benefits u/s 80C
Investment up to Rs. 100,000 in a year in such funds can be deducted from taxable income
of individual investors
ELSS must hold atleast 80% of the portfolio in equity securities
Lock-in period of 3 years from the date of investment
Hybrid Funds
Monthly Income Plans
• Smaller allocation to equity (5% to 25%) , Debt-oriented
• Periodic distribution of dividends, though there is no assurance
• Balanced Funds
• Equity-oriented hybrids that invest up to 65% in equity
• For investors who seek growth from equity but want protection from volatility
• Asset Allocation Funds
• Dynamic Funds that can change proportion between debt and equity depending upon market
outlook
• Capital Protection-Oriented Funds
• Debt securities with a derivative instrument or equity shares
• Structured portfolio such that ‘Amount invested + Interest = Investor’s principal’
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Other Types of Funds-1
Fund of Funds (FoF)
Invests in funds of same fund house or various fund houses (Multi-manager)
Choice of funds according to investment objective
Two levels of expenses- underlying level and FoF level
International Funds
Invests in foreign securities or foreign funds
‘Feeder‘ fund ties up with the ‘Host’ fund in an FoF structure
Arbitrage Funds
Take equal and opposite exposure in different markets
Earn a return due to difference in price in the two markets
Low risk, return similar to the debt funds
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Other Types of Funds - 2
Exchange Traded Funds (ETF)
Open-ended funds that track a market index
Units are listed like shares on the stock exchange
Sale and re-purchase transactions are executed on stock exchange
Demat accounts are used
Transactions at market prices, which may be different from the NAV
Commodity Funds
In India, direct investment in commodity futures is not allowed
Indian commodity funds usually invest in stocks of commodity companies or commodity ETFs
Gold Funds are structured as ETFs
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Role of Mutual Funds
To the investor
they offer products that enable access to various markets
a diversified investment opportunity at a low cost
To the issuers of various securities,
they are institutional investors seeking better return, lower risk
Industry competitive and well-regulated
Mutual funds have grown from a single player (UTI) in 1964 to 40 players in 2010
There are about 850 mutual products in the market
Public sector mutual funds came in 1980s and the private/foreign funds came in 1990s
60% of assets are in short term debt funds, favoured by institutional investors
Measures by regulators and the industry to increase retail participation
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Summary
Investment objective defines the risk-return profile of the mutual fund
Unit Capital = No. of units * Face value
Value of the investment portfolio changes with a change in market price of the securities
Assets Under Management (AUM) = Total Assets + Current Assets
Net Assets = Total assets + Accrued income – Current liabilities – Accrued expenses
Net Asset Value = Net assets/total outstanding units
Mutual funds offer benefits of diversification, professional management, low costs and liquidity
Choice overload and non-customization are limitations of investing in mutual funds
Open-ended funds accept continuous transactions while closed-ended funds are listed on stock
exchange. Interval funds are closed-ended but become open-ended at specific intervals
Active funds seek to better the return on the benchmark
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Summary
Liquid funds have the lowest risk of NAV volatility
Floating rate funds offer low mark to market risk
Gilt funds have no credit risk
Income funds have a higher credit risk and provide benefit of higher coupon
High yield bond funds invest in debt instruments that have lower credit ratings
FMPs have no market/portfolio risk
Diversified equity funds are less riskier than thematic funds. Sector funds are riskiest.
ELSS have 3 year lock-in and provide tax benefits upto Rs.1lakh u/s 80C
MIP is debt-oriented while Balanced fund is equity-oriented
Balanced fund may have fixed or flexible asset allocation
International funds may invest in foreign securities or foreign funds
ETF transactions are executed on stock exchange
Indian commodity funds invest in stocks of commodity companies or commodity ETFs
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Structure of a Mutual Fund
The structure of a mutual fund in India is governed by the Sebi (Mutual Fund )
Regulations, 1996.
A mutual fund is set up as a trust
It raises money through sale of units of various schemes
Money raised is invested in securities
Investors in the fund are the beneficiaries of the trust
The three key entities in the structure of a mutual fund are:
The sponsor who sets up the fund
The trustees who supervise the fund on behalf of the investors
The asset management company which carries out the activities of the fund
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Sponsor
Sponsor is the main business entity that sets up the mutual fund.
There can be more than one sponsor for a fund
Role of the sponsor
Is the promoter of the mutual fund
Sets up the trust and the AMC
Appoints the Board of Trustees and Board of Directors of the AMC
Seeks regulatory approval for the fund from Sebi
Eligibility criteria
At least 5 years experience in the financial services industry
Positive net worth over the last 5 financial years
Profits over the last 3 out of 5 years
At least 40% contribution to the capital of the AMC
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Trust and Trustees
The mutual fund is the trust, and is managed by trustees
Trustees can be individuals or a trustee company with a board of trustees
Investors in the mutual fund are beneficiaries of the trust
Trustees must act on behalf of the investors
Trustees are appointed by the Sponsor with Sebi approval
Trust deed is executed by the Sponsor in favour of the trustees
Trustees oversee the working of the AMC and management of the mutual fund
Points to note
Sponsor must appoint at least 4 trustees
Key decisions of the AMC require trustee approval
Trustees must meet at least 6 times in a year
At least 2/3rds of the trustees/members of the board of trustees have to be independent
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Asset Management Company (AMC)
AMC is the investment manager of the mutual fund
They manage the day to day affairs of a mutual fund
The compliance officer of the AMC reports regularly to the trustees of the fund
AMC is appointed by the trustees, with Sebi approval
Trustees appoint AMCs through an investment management agreement
Appointment to the board of an AMC has to be approved by trustees
AMC should have a net worth of at least Rs10 crore at all times
At least 50% of members of the board of an AMC board have to be independent.
The AMC of one mutual fund cannot be an AMC or trustee of another fund.
AMCs cannot engage in any business other than that of financial advisory and investment
management
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Other Fund Constituents
Mutual funds may outsource several functions to external constituents
Mutual fund constituents (except custodians) are appointed by the AMC with the
approval of the trustees.
All mutual fund constituents have to be registered with Sebi. They are usually paid fees
for their services
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Constituent Role
Custodian Hold funds and securities
R&T Agent Keep and service investors’ records
Banks Enable collection and payment
Auditor Audit scheme accounts
Distributors Distribute fund products to investors
Brokers Execute transactions in securities
Fund Accountants NAV calculation
Custodian
Banks usually function as custodians
Custodians hold the custody of the assets of a mutual fund
They hold cash and securities of the mutual fund
Are appointed by the Sponsor
Only constituent NOT directly appointed by the AMC
Must be independent of the Sponsor and its associates
Sponsor cannot hold 50% or more of the capital of the custodian
Independence of custodian critical for investor protection
Functions of the Custodian
Delivering and accepting securities and cash for transactions in the investment portfolio
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Registrars and Transfer Agents
R&T agents maintain investor records. They
Operate investor service centres for mutual funds
Accept and process investor transactions such as purchase, redemption and switches.
Create, maintain and update investor records.
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Distributors
Distributors are appointed by the AMC in order to sell mutual fund units to investors
Enable the reach of mutual fund products across geographical locations
Commission is paid to distributors on sale of mutual fund units
There’s no exclusivity in mutual fund distribution
Sponsor and its associates may act as the distributors
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Brokers, Banks, Accountants and Auditors
Brokers execute buy and sell transactions of the fund managers
Banks provide collection and payment services
Payment instruments are collected in mutual fund scheme accounts
Redemption and dividend payments are funded from these accounts
Fund accountants compute the NAV of the mutual fund
This service is sometimes outsourced
Auditors audit the books of the mutual fund
Account of each mutual fund scheme is kept separately
Auditors of mutual fund are different from auditors of the AMC
Mutual fund auditors are appointed by trustees; AMC auditors by the AMC
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Summary
Three-tier structure of Sponsor-Trust-AMC
Sponsor is the promoter who creates the trust and AMC
Investors in the mutual fund are beneficiaries of the trust
Board of trustees oversee the working of the mutual fund
AMC is the investment manager of the mutual fund
AMC should have a net worth of at least Rs10 crore at all times
Custodian holds assets of the fund and is independent of the Sponsor
R&T agent runs ISCs and maintains investor records
Distributors enable the reach of mutual fund products across geographical locations
Fund accountant calculates NAV
Auditors of the AMC must be different from the auditors of the mutual fund schemes
Mutual fund constituents (except custodians) are appointed by the AMC with the approval of
the trustees.
All mutual fund constituents have to be registered with Sebi
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