Beginner's
Basics
SEBI INVESTOR EDUCATION PROGRAMME
Introduction
Different investment avenues are available to investors.
Mutual funds also offer good investment opportunities to
the investors. Like all investments, they also carry certain
risks. The investors should compare the risks and expected
yields after adjustment of tax on various instruments while
taking investment decisions. The investors may seek advice
from experts and consultants including agents and distributors
of mutual funds schemes while making investment decisions.
With an objective to make the investors aware of functioning
of mutual funds, an attempt has been made to provide information
in question-answer format which may help the investors in
taking investment decisions.
What is a Mutual Fund?
Mutual fund is a mechanism for pooling the resources by
issuing units to the investors and investing funds in securities
in accordance with objectives as disclosed in offer document.
Investments in securities are spread across a wide cross-section
of industries and sectors and thus the risk is reduced.
Diversification reduces the risk because all stocks may
not move in the same direction in the same proportion at
the same time. Mutual fund issues units to the investors
in accordance with quantum of money invested by them. Investors
of mutual funds are known as unitholders.
The profits or losses are shared by the investors in proportion
to their investments. The mutual funds normally come out
with a number of schemes with different investment objectives
which are launched from time to time. A mutual fund is required
to be registered with Securities and Exchange Board of India
(SEBI) which regulates securities markets before it can
collect funds from the public.
What is the history of Mutual Funds in India and role
of SEBI in mutual funds industry?
Unit Trust of India was the first mutual fund set up in
India in the year 1963. In early 1990s, Government allowed
public sector banks and institutions to set up mutual funds.
In the year 1992, Securities and exchange Board of India
(SEBI) Act was passed. The objectives of SEBI are –
to protect the interest of investors in securities and to
promote the development of and to regulate the securities
market.
As far as mutual funds are concerned, SEBI formulates policies
and regulates the mutual funds to protect the interest of
the investors. SEBI notified regulations for the mutual
funds in 1993. Thereafter, mutual funds sponsored by private
sector entities were allowed to enter the capital market.
The regulations were fully revised in 1996 and have been
amended thereafter from time to time. SEBI has also issued
guidelines to the mutual funds from time to time to protect
the interests of investors.
All mutual funds whether promoted by public sector or private
sector entities including those promoted by foreign entities
are governed by the same set of Regulations. There is no
distinction in regulatory requirements for these mutual
funds and all are subject to monitoring and inspections
by SEBI. The risks associated with the schemes launched
by the mutual funds sponsored by these entities are of similar
type. It may be mentioned here that Unit Trust of India
(UTI) is not registered with SEBI as a mutual fund (as on
January 15, 2002).
How is a mutual fund set up?
A mutual fund is set up in the form of a trust, which has
sponsor, trustees, asset management company (AMC) and custodian.
The trust is established by a sponsor or more than one sponsor
who is like promoter of a company. The trustees of the mutual
fund hold its property for the benefit of the unitholders.
Asset Management Company (AMC) approved by SEBI manages
the funds by making investments in various types of securities.
Custodian, who is registered with SEBI, holds the securities
of various schemes of the fund in its custody. The trustees
are vested with the general power of superintendence and
direction over AMC. They monitor the performance and compliance
of SEBI Regulations by the mutual fund.
SEBI Regulations require that at least two thirds of the
directors of trustee company or board of trustees must be
independent i.e. they should not be associated with the
sponsors. Also, 50% of the directors of AMC must be independent.
All mutual funds are required to be registered with SEBI
before they launch any scheme. However, Unit Trust of India
(UTI) is not registered with SEBI (as on January 15, 2002).
What is Net Asset Value (NAV) of a scheme?
The performance of a particular scheme of a mutual fund
is denoted by Net Asset Value (NAV).
Mutual funds invest the money collected from the investors
in securities markets. In simple words, Net Asset Value
is the market value of the securities held by the scheme.
Since market value of securities changes every day, NAV
of a scheme also varies on day to day basis. The NAV per
unit is the market value of securities of a scheme divided
by the total number of units of the scheme on any particular
date. For example, if the market value of securities of
a mutual fund scheme is Rs 200 lakhs and the mutual fund
has issued 10 lakhs units of Rs. 10 each to the investors,
then the NAV per unit of the fund is Rs.20. NAV is required
to be disclosed by the mutual funds on a regular basis -
daily or weekly - depending on the type of scheme.
What are the different types of mutual fund schemes?
Schemes according to Maturity Period
A mutual fund scheme can be classified into open-ended
scheme or close-ended scheme depending on its maturity period.
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.
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. In order to provide an exit route
to the investors, some close-ended funds give an option
of selling back the units to the mutual fund through periodic
repurchase at NAV related prices. SEBI Regulations stipulate
that at least one of the two exit routes is provided to
the investor i.e. either repurchase facility or through
listing on stock exchanges. These mutual funds schemes disclose
NAV generally on weekly basis.
Schemes according to Investment Objective
A scheme can also be classified as growth scheme, income
scheme, or balanced scheme considering its investment objective.
Such schemes may be open-ended or close-ended schemes as
described earlier. Such schemes may be classified mainly
as follows:
Growth / Equity Oriented Scheme
The aim of growth funds is to provide capital appreciation
over the medium to long- term. Such schemes normally invest
a major part of their corpus in equities. Such funds have
comparatively 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. Growth
schemes are good for investors having a long-term outlook
seeking appreciation over a period of time.
Income / Debt Oriented Scheme
The aim of income funds is to provide regular and steady
income to investors. Such schemes generally invest in fixed
income securities such as bonds, corporate debentures, Government
securities and money market instruments. Such funds are
less risky compared to equity schemes. These funds are not
affected because of fluctuations in equity markets. 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 Fund
The aim of balanced funds is to provide both growth and
regular income as such schemes invest both in equities and
fixed income securities in the proportion indicated in their
offer documents. These are appropriate for investors looking
for moderate growth. They generally invest 40-60% in equity
and debt instruments. These funds are also affected because
of fluctuations in share prices in the stock markets. However,
NAVs of such funds are likely to be less volatile compared
to pure equity funds.
Money Market or Liquid Fund
These funds are also income funds and their aim is to provide
easy liquidity, preservation of capital and moderate income.
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. 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.
Gilt Fund
These funds invest exclusively in government securities.
Government securities have no default risk. NAVs of these
schemes also fluctuate due to change in interest rates and
other economic factors as is the case with income or debt
oriented schemes.
Index Funds
Index Funds replicate the portfolio of a particular index
such as the BSE Sensitive index, S&P NSE 50 index (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 index,
though not exactly by the same percentage due to some factors
known as "tracking error" in technical terms.
Necessary disclosures in this regard are made in the offer
document of the mutual fund scheme.
There are also exchange traded index funds launched by the
mutual funds which are traded on the stock exchanges.
What are sector specific funds/schemes?
These are the funds/schemes which invest in the securities
of only those sectors or industries as specified in the
offer documents. e.g. Pharmaceuticals, Software, Fast Moving
Consumer Goods (FMCG), Petroleum stocks, etc. The returns
in these funds are dependent on the performance of the respective
sectors/industries. While these funds may give higher returns,
they are more risky compared to diversified funds. Investors
need to keep a watch on the performance of those sectors/industries
and must exit at an appropriate time. They may also seek
advice of an expert.
What are Tax Saving Schemes?
These schemes offer tax rebates to the investors under
specific provisions of the Income Tax Act, 1961 as the Government
offers tax incentives for investment in specified avenues.
e.g. Equity Linked Savings Schemes (ELSS). Pension schemes
launched by the mutual funds also offer tax benefits. These
schemes are growth oriented and invest pre-dominantly in
equities. Their growth opportunities and risks associated
are like any equity-oriented scheme.
What is a Load or no-load Fund?
A Load Fund is one that charges a percentage of NAV for
entry or exit. That is, each time one buys or sells units
in the fund, a charge will be payable. This charge is used
by the mutual fund for marketing and distribution expenses.
Suppose the NAV per unit is Rs.10. If the entry as well
as exit load charged is 1%, then the investors who buy would
be required to pay Rs.10.10 and those who offer their units
for repurchase to the mutual fund will get only Rs.9.90
per unit. The investors should take the loads into consideration
while making investment as these affect their yields/returns.
However, the investors should also consider the performance
track record and service standards of the mutual fund which
are more important. Efficient funds may give higher returns
in spite of loads.
A no-load fund is one that does not charge for entry or
exit. It means the investors can enter the fund/scheme at
NAV and no additional charges are payable on purchase or
sale of units.
Can a mutual fund impose fresh load or increase the load
beyond the level mentioned in the offer documents?
Mutual funds cannot increase the load beyond the level
mentioned in the offer document. Any change in the load
will be applicable only to prospective investments and not
to the original investments. In case of imposition of fresh
loads or increase in existing loads, the mutual funds are
required to amend their offer documents so that the new
investors are aware of loads at the time of investments.
What is a sales or repurchase/redemption price?
The price or NAV a unitholder is charged while investing
in an open-ended scheme is called sales price. It may include
sales load, if applicable.
Repurchase or redemption price is the price or NAV at which
an open-ended scheme purchases or redeems its units from
the unitholders. It may include exit load, if applicable.
What is an assured return scheme?
Assured return schemes are those schemes that assure a
specific return to the unitholders irrespective of performance
of the scheme.
A scheme cannot promise returns unless such returns are
fully guaranteed by the sponsor or AMC and this is required
to be disclosed in the offer document.
Investors should carefully read the offer document whether
return is assured for the entire period of the scheme or
only for a certain period. Some schemes assure returns one
year at a time and they review and change it at the beginning
of the next year.
Can a mutual fund change the asset allocation while
deploying funds of investors?
Considering the market trends, any prudent fund managers
can change the asset allocation i.e. he can invest higher
or lower percentage of the fund in equity or debt instruments
compared to what is disclosed in the offer document. It
can be done on a short term basis on defensive considerations
i.e. to protect the NAV. Hence the fund managers are allowed
certain flexibility in altering the asset allocation considering
the interest of the investors. In case the mutual fund wants
to change the asset allocation on a permanent basis, they
are required to inform the unitholders and giving them option
to exit the scheme at prevailing NAV without any load.
How to invest in a scheme of a mutual fund?
Mutual funds normally come out with an advertisement in
newspapers publishing the date of launch of the new schemes.
Investors can also contact the agents and distributors of
mutual funds who are spread all over the country for necessary
information and application forms. Forms can be deposited
with mutual funds through the agents and distributors who
provide such services. Now a days, the post offices and
banks also distribute the units of mutual funds. However,
the investors may please note that the mutual funds schemes
being marketed by banks and post offices should not be taken
as their own schemes and no assurance of returns is given
by them. The only role of banks and post offices is to help
in distribution of mutual funds schemes to the investors.
Investors should not be carried away by commission/gifts
given by agents/distributors for investing in a particular
scheme. On the other hand they must consider the track record
of the mutual fund and should take objective decisions.
Can non-resident Indians (NRIs) invest in mutual funds?
Yes, non-resident Indians can also invest in mutual funds.
Necessary details in this respect are given in the offer
documents of the schemes.
How much should one invest in debt or equity oriented
schemes?
An investor should take into account his risk taking capacity,
age factor, financial position, etc. As already mentioned,
the schemes invest in different type of securities as disclosed
in the offer documents and offer different returns and risks.
Investors may also consult financial experts before taking
decisions. Agents and distributors may also help in this
regard.
How to fill up the application form of a mutual fund
scheme?
An investor must mention clearly his name, address, number
of units applied for and such other information as required
in the application form. He must give his bank account number
so as to avoid any fraudulent encashment of any cheque/draft
issued by the mutual fund at a later date for the purpose
of dividend or repurchase. Any changes in the address, bank
account number, etc at a later date should be informed to
the mutual fund immediately.
What should an investor look into an offer document?
An abridged offer document, which contains very useful
information, is required to be given to the prospective
investor by the mutual fund. The application form for subscription
to a scheme is an integral part of the offer document. SEBI
has prescribed minimum disclosures in the offer document.
An investor, before investing in a scheme, should carefully
read the offer document. Due care must be given to portions
relating to main features of the scheme, risk factors, initial
issue expenses and recurring expenses to be charged to the
scheme, entry or exit loads, sponsor’s track record,
educational qualification and work experience of key personnel
including fund managers, performance of other schemes launched
by the mutual fund in the past, pending litigations and
penalties imposed, etc.
When will the investor get certificate or statement of
account after investing in a mutual fund?
Mutual funds are required to despatch certificates or statements
of accounts within six weeks from the date of closure of
the initial subscription of the scheme. In case of close-ended
schemes, the investors would get either a demat account
statement or unit certificates as these are traded in the
stock exchanges. In case of open-ended schemes, a statement
of account is issued by the mutual fund within 30 days from
the date of closure of initial public offer of the scheme.
The procedure of repurchase is mentioned in the offer document.
How long will it take for transfer of units after purchase
from stock markets in case of close-ended schemes?
According to SEBI Regulations, transfer of units is required
to be done within thirty days from the date of lodgment
of certificates with the mutual fund.
As a unitholder, how much time will it take to receive
dividends/repurchase proceeds?
A mutual fund is required to despatch to the unitholders
the dividend warrants within 30 days of the declaration
of the dividend and the redemption or repurchase proceeds
within 10 working days from the date of redemption or repurchase
request made by the unitholder.
In case of failures to despatch the redemption/repurchase
proceeds within the stipulated time period, Asset Management
Company is liable to pay interest as specified by SEBI from
time to time (15% at present).
Can a mutual fund change the nature of the scheme from
the one specified in the offer document?
Yes. However, no change in the nature or terms of the scheme,
known as fundamental attributes of the scheme e.g.structure,
investment pattern, etc. can be carried out unless a written
communication is sent to each unitholder and an advertisement
is given in one English daily having nationwide circulation
and in a newspaper published in the language of the region
where the head office of the mutual fund is situated. The
unitholders have the right to exit the scheme at the prevailing
NAV without any exit load if they do not want to continue
with the scheme. The mutual funds are also required to follow
similar procedure while converting the scheme form close-ended
to open-ended scheme and in case of change in sponsor.
How will an investor come to know about the changes,
if any, which may occur in the mutual fund?
There may be changes from time to time in a mutual fund.
The mutual funds are required to inform any material changes
to their unitholders. Apart from it, many mutual funds send
quarterly newsletters to their investors.
At present, offer documents are required to be revised and
updated at least once in two years. In the meantime, new
investors are informed about the material changes by way
of addendum to the offer document till the time offer document
is revised and reprinted.
How to know the performance of a mutual fund scheme?
The performance of a scheme is reflected in its net asset
value (NAV) which is disclosed on daily basis in case of
open-ended schemes and on weekly basis in case of close-ended
schemes. The NAVs of mutual funds are required to be published
in newspapers. The NAVs are also available on the web sites
of mutual funds. All mutual funds are also required to put
their NAVs on the web site of Association of Mutual Funds
in India (AMFI) http://www.amfiindia.com/ and thus the investors
can access NAVs of all mutual funds at one place
The mutual funds are also required to publish their performance
in the form of half-yearly results which also include their
returns/yields over a period of time i.e. last six months,
1 year, 3 years, 5 years and since inception of schemes.
Investors can also look into other details like percentage
of expenses of total assets as these have an affect on the
yield and other useful information in the same half-yearly
format.
The mutual funds are also required to send annual report
or abridged annual report to the unitholders at the end
of the year.
Various studies on mutual fund schemes including yields
of different schemes are being published by the financial
newspapers on a weekly basis. Apart from these, many research
agencies also publish research reports on performance of
mutual funds including the ranking of various schemes in
terms of their performance. Investors should study these
reports and keep themselves informed about the performance
of various schemes of different mutual funds.
Investors can compare the performance of their schemes
with those of other mutual funds under the same category.
They can also compare the performance of equity oriented
schemes with the benchmarks like BSE Sensitive Index, S&P
CNX Nifty, etc.
On the basis of performance of the mutual funds, the investors
should decide when to enter or exit from a mutual fund scheme.
How to know where the mutual fund scheme has invested
money mobilised from the investors?
The mutual funds are required to disclose full portfolios
of all of their schemes on half-yearly basis which are published
in the newspapers. Some mutual funds send the portfolios
to their unitholders.
The scheme portfolio shows investment made in each security
i.e. equity, debentures, money market instruments, government
securities, etc. and their quantity, market value and %
to NAV. These portfolio statements also required to disclose
illiquid securities in the portfolio, investment made in
rated and unrated debt securities, non-performing assets
(NPAs), etc.
Some of the mutual funds send newsletters to the unitholders
on quarterly basis which also contain portfolios of the
schemes.
Is there any difference between investing in a mutual
fund and in an initial public offering (IPO) of a company?
Yes, there is a difference. IPOs of companies may open
at lower or higher price than the issue price depending
on market sentiment and perception of investors. However,
in the case of mutual funds, the par value of the units
may not rise or fall immediately after allotment. A mutual
fund scheme takes some time to make investment in securities.
NAV of the scheme depends on the value of securities in
which the funds have been deployed.
If schemes in the same category of different mutual
funds are available, should one choose a scheme with lower
NAV?
Some of the investors have the tendency to prefer a scheme
that is available at lower NAV compared to the one available
at higher NAV. Sometimes, they prefer a new scheme which
is issuing units at Rs. 10 whereas the existing schemes
in the same category are available at much higher NAVs.
Investors may please note that in case of mutual funds schemes,
lower or higher NAVs of similar type schemes of different
mutual funds have no relevance. On the other hand, investors
should choose a scheme based on its merit considering performance
track record of the mutual fund, service standards, professional
management, etc. This is explained in an example given below.
Suppose scheme A is available at a NAV of Rs.15 and another
scheme B at Rs.90. Both schemes are diversified equity oriented
schemes. Investor has put Rs. 9,000 in each of the two schemes.
He would get 600 units (9000/15) in scheme A and 100 units
(9000/90) in scheme B. Assuming that the markets go up by
10 per cent and both the schemes perform equally good and
it is reflected in their NAVs. NAV of scheme A would go
up to Rs. 16.50 and that of scheme B to Rs. 99. Thus, the
market value of investments would be Rs. 9,900 (600* 16.50)
in scheme A and it would be the same amount of Rs. 9900
in scheme B (100*99). The investor would get the same return
of 10% on his investment in each of the schemes. Thus, lower
or higher NAV of the schemes and allotment of higher or
lower number of units within the amount an investor is willing
to invest, should not be the factors for making investment
decision. Likewise, if a new equity oriented scheme is being
offered at Rs.10 and an existing scheme is available for
Rs. 90, should not be a factor for decision making by the
investor. Similar is the case with income or debt-oriented
schemes.
On the other hand, it is likely that the better managed
scheme with higher NAV may give higher returns compared
to a scheme which is available at lower NAV but is not managed
efficiently. Similar is the case of fall in NAVs. Efficiently
managed scheme at higher NAV may not fall as much as inefficiently
managed scheme with lower NAV. Therefore, the investor should
give more weightage to the professional management of a
scheme instead of lower NAV of any scheme. He may get much
higher number of units at lower NAV, but the scheme may
not give higher returns if it is not managed efficiently.
How to choose a scheme for investment from a number of
schemes available?
As already mentioned, the investors must read the offer
document of the mutual fund scheme very carefully. They
may also look into the past track record of performance
of the scheme or other schemes of the same mutual fund.
They may also compare the performance with other schemes
having similar investment objectives. Though past performance
of a scheme is not an indicator of its future performance
and good performance in the past may or may not be sustained
in the future, this is one of the important factors for
making investment decision. In case of debt oriented schemes,
apart from looking into past returns, the investors should
also see the quality of debt instruments which is reflected
in their rating. A scheme with lower rate of return but
having investments in better rated instruments may be safer.
Similarly, in equities schemes also, investors may look
for quality of portfolio. They may also seek advice of experts.
Are the companies having names like mutual benefit the
same as mutual funds schemes?
Investors should not assume some companies having the name
"mutual benefit" as mutual funds. These companies
do not come under the purview of SEBI. On the other hand,
mutual funds can mobilise funds from the investors by launching
schemes only after getting registered with SEBI as mutual
funds.
Is the higher net worth of the sponsor a guarantee for
better returns?
In the offer document of any mutual fund scheme, financial
performance including the net worth of the sponsor for a
period of three years is required to be given. The only
purpose is that the investors should know the track record
of the company which has sponsored the mutual fund. However,
higher net worth of the sponsor does not mean that the scheme
would give better returns or the sponsor would compensate
in case the NAV falls.
Where can an investor look out for information on mutual
funds?
Almost all the mutual funds have their own web sites. Investors
can also access the NAVs, half-yearly results and portfolios
of all mutual funds at the web site of Association of mutual
funds in India (AMFI) www.amfiindia.com. AMFI has also published
useful literature for the investors.
Investors can log on to the web site of SEBI www.sebi.gov.in
and go to "Mutual Funds" section for information
on SEBI regulations and guidelines, data on mutual funds,
draft offer documents filed by mutual funds, addresses of
mutual funds, etc. Also, in the annual reports of SEBI available
on the web site, a lot of information on mutual funds is
given.
There are a number of other web sites which give a lot
of information of various schemes of mutual funds including
yields over a period of time. Many newspapers also publish
useful information on mutual funds on daily and weekly basis.
Investors may approach their agents and distributors to
guide them in this regard.
If mutual fund scheme is wound up, what happens to money
invested?
In case of winding up of a scheme, the mutual funds pay
a sum based on prevailing NAV after adjustment of expenses.
Unitholders are entitled to receive a report on winding
up from the mutual funds which gives all necessary details.
How can the investors redress their complaints?
Investors would find the name of contact person in the
offer document of the mutual fund scheme whom they may approach
in case of any query, complaints or grievances. Trustees
of a mutual fund monitor the activities of the mutual fund.
The names of the directors of asset management company and
trustees are also given in the offer documents. Investors
can also approach SEBI for redressal of their complaints.
On receipt of complaints, SEBI takes up the matter with
the concerned mutual fund and follows up with them till
the matter is resolved. Investors may send their complaints
to:
Securities and Exchange Board of India
Mutual Funds Department
Mittal Court ‘B’ wing, First Floor,
224, Nariman Point,
Mumbai – 400 021.
Phone: 2850451-56, 2880962-70
