Introduction

Mutual Funds

What is a Mutual Fund?

A Mutual Fund is a trust that pools together the savings of a number of investors who share a common financial goal. The money collected is then invested in capital market instruments such as shares, debentures and other securities based on their objective. 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 the investors.

Advantages of mutual fund

  • Professional Management – Money is being managed by a team of qualified professionals.Since they continuously analyse the performance and prospects of various sectors and companies, they are in a better position to manage investments and generate better returns.The investments will be made depending on the objectives of the scheme.
  • Flexibility -A variety of scheme options are available depending on the risk profile, needs and goals of the client.Further, as and when the needs change, the portfolio can be redesigned and reallocated with ease.
  • Liquidity–Client has the option to withdraw money at current NAV at any point of time, in case of open ended schemes.
  • Diversification –Since money is invested in multiple stocks spread across sectors, the risk is reduced and the portfolio is not exposed to higher volatility.
  • Affordability –One can start with a amount as low as Rs.500 per month.
  • Low Costs – The economy of scale result in low cost.
  • Regulations – All mutual funds are regulated by SEBI
  • Transparency – As an investor, regular updates, NAVs and holdings are available keeping the investor updated.

Types of funds/ schemes

There are 2 types of classifications:

  • Constitution
  • Investment objective

Open-ended scheme

An open-end scheme is one that is available for subscription all through the year. Majority of mutual fund schemes are open-ended. Investors have the flexibility to buy or sell any part of their investment at any time at scheme’s Net Asset Value.

Close-ended scheme

A closed ended scheme operates for a fix duration (generally ranging from 3 to 15 years). The fund would be open for subscription only during a specified period and there is an even balance of buyers and sellers, so someone would have to be selling in order for you to be able to buy it. Closed-end funds are also listed on the stock exchange so it is traded just like other stocks on an exchange or over the counter. Usually the redemption is also specified which means that they terminate on specified dates when the investors can redeem their units.

Interval schemes

These schemes combine the features of open-ended and closed-ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV based prices.

Equity Oriented Schemes

These schemes invest a major part of their corpus into equities. The aim of these schemes is to provide capital appreciation over the medium to long- term. Since they are into equities, theycarry relatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date.

There are further options depending on the market cap of companies such as large cap schemes, mid cap schemes, small cap schemes, multi-cap, etc.

Debt Oriented Scheme?

These schemes invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. The aim of these schemes is to provide regular and steady income to investors. They are less risky compared to equity schemes. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

Balanced Schemes/Fund

These schemes invest, both, in equities and fixed income securities in the proportion indicated in their offer documents. The aim of these schemes is to provide, both, growth and regular income.These are appropriate for investors with moderate risk profile looking for moderate growth. They generally invest 40-60% in equity and debt instruments. NAVs of these schemes are affected by, both, movement in equity market as well as change in interest rates in the economy. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.

Liquid Schemes / Fund

These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Their aim is to provide easy liquidity, preservation of capital and moderate income. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.

Equity Linked Saving Schemes (ELSS)

These schemes are open-ended growth schemes with a mandatory 3-year lock- in. These schemes offer the benefit of section 80(C) of IT Act, up to a maximum of Rs 100,000.

Index Funds

Index Funds replicate the portfolio of a particular index such as the BSE Sensex, NSE Nifty, etc. These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the respective index.

Sector specific funds

These schemes invest only in the equity of companies existing in a specific sector, as laid down in the fund’s offer document. For example, an FMCG sectoral fund shall invest in companies like HLL, Britania, Nestle etc., and not in a software company like Infosys. The various sectoral funds available are IT, Pharma, Infra, etc.

Fund of Funds (FoF) scheme

A scheme that invests primarily in other schemes of the same mutual fund or other mutual funds is known as a FoF scheme. A FoF scheme enables the investors to achieve greater diversification through one scheme. It spreads risks across a greater universe.

Industry Journey So Far

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank. The history of mutual funds in India can be broadly divided into four distinct phases

Phase – 1964-87

Unit Trust of India (UTI) was established in 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and Industrial Development Bank of India (IDBI) took over the regulatory and administrative control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of assets under management.

Second Phase – 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks,  Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India Mutual Fund (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC set up its mutual fund in December 1990. At the end of 1993, the mutual fund industry had assets under management of Rs.47,004 crores.

Third Phase – 1993-2003 (Entry of Private Sector Funds)

With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996.

The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets under management was way ahead of other mutual funds.

Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963, UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs.29,835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India functioning under an administrator and under the rules framed by Government of India does not come under the purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund Ltd sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs.76,000 crores of assets under management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place among different private sector funds, the mutual fund industry has entered its current phase of consolidation and growth. As at the end of September, 2004, there were 29 funds, which manage assets of Rs.153108 crores under 421 schemes.