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| MUTUAL FUND |
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| What is Mutual Fund ? |
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Mutual Fund is a vehicle that enables a collective group of individuals to:
a.) Pool their investible surplus funds and collectively invest in instruments / assets for a common investment objective.
b.) Optimize the knowledge and experience of a fund manager, a capacity that individually they may not have
c.) Benefit from the economies of scale which size enables and is not available on an individual basis
Typical classification of mutual fund schemes on various basis: |
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Investing in a mutual fund is like an investment made by a collective. An individual as a single
investor is likely to have lesser amount of money at disposal than say, a group of friends put
together.
Now, let's assume that this group of individuals is a novice in investing and so the group turns over
the pooled funds to an expert to make their money work for them. This is what a professional Asset
Management Company does for mutual funds. The AMC invests the investors' money on their
behalf into various assets towards a common investment objective. |
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Hence, technically speaking, a mutual fund is an investment vehicle which pools investors' money
and invests the same for and on behalf of investors, into stocks, bonds, money market instruments
and other assets. The money is received by the AMC with a promise that it will be invested in a
particular manner by a professional manager (commonly known as fund managers). The fund
managers are expected to honour this promise. The SEBI and the Board of Trustees ensure that this
actually happens. |
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Tenor refers to the 'time'. Mutual funds can be classified on the basis of time as under:
1.Open ended funds
These funds are available for subscription throughout the year. These funds do not have a fixed
maturity. Investors have the flexibility to buy or sell any part of their investment at any time, at
the prevailing price (Net Asset Value - NAV) at that time.
2.Close Ended funds
These funds begin with a fixed corpus and operate for a fixed duration. These funds are open for
subscription only during a specified period. When the period terminates, investors can redeem
their units at the prevailing NAV.
Asset classes
1.Equity funds
These funds invest in shares. These funds may invest money in growth stocks, momentum
stocks, value stocks or income stocks depending on the investment objective of the fund.
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2.Debt funds or Income funds
These funds invest money in bonds and money market instruments. These funds may invest into
long-term and/or short-term maturity bonds.
3.Hybrid funds
These funds invest in a mix of both equity and debt. In order to retain their equity status for tax
purposes, they generally invest at least 65% of their assets in equities and roughly 35% in debt
instruments, failing which they will be classified as debt oriented schemes and be taxed
accordingly. (Please see our Tax Section on Page 39 for more information.) Monthly Income
Plans (MIPs) fall within the category of hybrid funds. MIPs invest up to 25% into equities and the
balance into debt.
4.Real asset funds
These funds invest in physical assets such as gold, platinum, silver, oil, commodities and real
estate. Gold Exchange Traded Funds (ETFs) and Real Estate Investment Trusts (REITs) fall within
the category of real asset funds.
Investment Philosophy
1.Diversified Equity Funds
These funds diversify the equity component of their Asset Under Management (AUM), across
various sectors. Such funds avoid taking sectoral bets i.e. investing more of their assets towards
a particular sector such as oil & gas, construction, metals etc. Thus, they use the diversification
strategy to reduce their overall portfolio risk.
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2.Sector Funds
These funds are expected to invest predominantly in a specific sector. For instance, a banking
fund will invest only in banking stocks. Generally, such funds invest 65% of their total assets in a
respective sector.
3.Index Funds
These funds seek to have a position which replicates the index, say BSE Sensex or NSE Nifty.
They maintain an investment portfolio that replicates the composition of the chosen index, thus
following a passive style of investing.
4.Exchange Traded Funds (ETFs)
These funds are open-ended funds which are traded on the exchange (BSE / NSE). These funds
are benchmarked against the stock exchange index. For example, funds traded on the NSE are
benchmarked against the Nifty. The Benchmark Nifty BeES is an example of an ETF which links to
the stocks in the Nifty. Unlike an index fund where the units are traded at the day's NAV, in ETFs
(since they are traded on the exchange) the price keeps on changing during the trading hours of
the exchange. If you as an investor want to buy or sell ETF units, you can do so by placing orders
with your broker, who will in-turn offer a two-way real time quote at all times. The AMC does
not offer sale and re-purchase for the units. Today, ETFs are available for pre-specified indices.
We also have Gold ETFs. Silver ETFs are not yet available.
5.Fund of Funds (FOF)
These funds invest their money in other funds of the same mutual fund house or other mutual
fund houses. They are not allowed to invest in any other FOF and they are not entitled to invest
their assets other than in mutual fund schemes/funds, except to such an extent where the fund
requires liquidity to meet its redemption requirements, as disclosed in the offer document of
the FOF scheme.
6.Fixed Maturity Plan (FMP)
These funds are basically income/debt schemes like Bonds, Debentures and Money market
instruments. They give a fixed return over a period of time. FMPs are similar to close ended
schemes which are open only for a fixed period of time during the initial offer. However, unlike
closed ended schemes where your money is locked for a particular period, FMPs give you an
option to exit. Remember though, that this is subject to an exit load as per the funds regulations.
FMPs, if listed on the exchange, provide you with an opportunity to liquidate by selling your
units at the prevailing price on the exchange. FMPs are launched in the form of series, having
different maturity profiles. The maturity period varies from 3 months to one year.
Geographic Regions
1.Country or Region Funds
These funds invest in securities (equity and/or debt) of a specific country or region with an
underlying belief that the chosen country or region is expected to deliver superior performance,
which in turn will be favourable for the securities of that country. The returns on country fund
are affected not only by the performance of the market where they are invested, but also by
changes in the currency exchange rates.
2.Offshore Funds
These funds mobilise money from investors for the purpose of investment within as well as
outside their home country.
so we have seen that funds can be categorised based on tenor, investment philosophy, asset
class, or geographic region. Now, let's get down to simplifying some jargon with the help of a
few definitions, before getting into understanding the nitty-gritty of investing in mutual funds.
DEFINITIONS
Net Asset Value (NAV)
NAV is the sum total of all the assets of the mutual fund (at market price) less the liabilities (fund
manager fees, audit fees, registration fees among others); divide this by the number of units and
you get the NAV per unit of the mutual fund.
Standard Deviation (SD)
SD is the measure of risk taken by, or volatility borne by, the mutual fund. Mathematically
speaking, SD tells us how much the values have deviated from the mean (average) of the values.
SD measures by how much the investor could diverge from the average return either upwards or
downwards. It highlights the element of risk associated with the fund.
Sharpe Ratio (SR)
SR is a measure developed to calculate risk-adjusted returns. It measures how much return you
can expect over and above a certain risk-free rate (for example, the bank deposit rate), for every
unit of risk (i.e. Standard Deviation) of the scheme. Statistically, the Sharpe Ratio is the
difference between the annualised return (Ri) and the risk-free return (Rf) divided by the
Standard Deviation (SD) during the specified period. Sharpe Ratio = (Ri-Rf)/SD. Higher the
magnitude of the Sharpe Ratio, higher is the performance rating of the scheme.
Compounded Annual Growth Rate (CAGR)
These funds invest in physical assets such as gold, platinum, silver, oil, commodities and real
estate. Gold Exchange Traded Funds (ETFs) and Real Estate Investment Trusts (REITs) fall within
the category of real asset funds.
Absolute Returns
These are the simple returns, i.e. the returns that an asset achieves, from the day of its purchase
to the day of its sale, regardless of how much time has elapsed in between. This measure looks
at the appreciation or depreciation that an asset - usually a stock or a mutual fund - achieves
over the given period of time. Mathematically it is calculated as under:
Ending Value - Beginning Value x 100
Beginning Value
Generally returns for a period less than 1 year are expressed in an absolute form. |
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