Thursday, 7 October 2010

All About Mutual Fund

Mutual Fund is the most suitable investment for common man. It gives an opportunity to invest in diversified financial instruments managed by professionally experienced fund managers. It is a trust which accumulated the deposits of many investors with a common financial goal. The pooled money is invested in shares, debentures and securities and the income derived from these investments will be distributed among the investors according to number of units they have taken.

This mutual fund offers the best possible return with flexibility and liquidity.  This mutual fund industry is controlled by some regulating authorities in each country. In India these authorities are Securities and exchange Board of India (SEBI) and Association of Mutual Funds (AMFI). So it is safe and convenient to invest in mutual funds. In India Mutual Fund industry is the best disciplined Institutional investors who play an important role in Indian Market. Mutual fund offers tax benefits also under the Equity Linked Tax Saving Plans (ELSS).

History of Mutual Funds in India

The first mutual fund set up in India by Unit trust of India in 1963 and In 1990s The Government of India allowed public sector banks and institutions to set up mutual funds. In 1992, SEBI act was passed and its objectives includes

1.      To formulate policies and regulates the mutual funds

2.      Protect the interest of investors in securities

3.      Promote the development

4.      Regulate the securities market.

SEBI notified regulations for the mutual funds in 1993. Soon after the mutual funds sponsored by private sector entities were allowed to enter the capital market and the regulations are revised in 1996 and making timely amendments.  They are issuing timely guidelines to the mutual funds to protect the interests of investors. The same set regulations are controlled all mutual funds promoted by public sector or private sector or promoted by foreign entities. So all mutual funds are monitoring and inspecting by SEBI. So the risks associated with the all mutual funds schemes are of similar type.

Net Asset Value (NAV)

Net Asset Value is the market value of the securities held by the scheme. Market value of securities changes every day and the NAV also changes every day. NAV per unit is the market value of securities of a particular scheme divided by the total number of units of the scheme on any particular date.

If the Market value of all securities of a mutual fund is $ 500 Million and the total number of units of the mutual fund is 10 Million, then the NAV of a unit of the mutual fund is $ 50, even if the purchase price of one unit is $10 at the beginning. This NAV should be disclosed every day or every week according to the terms of the Mutual Fund.

Types of mutual fund schemes

According to Maturity period a mutual fund scheme can be classified into Open-ended Fund or close-ended fund.

Open-ended mutual fund

An open-ended fund can be subscribe and repurchase on a continuous basis. There is not fixed maturity period for such schemes. Investors can buy and sell units whenever they wish to do so at Net Asset Value (NAV) which is declared on a daily basis. The key feature of open-end schemes is liquidity.

Close-ended mutual fund

A close-ended fund has a fixed maturity period and the investor can subscribe only on a specified period of time when it is launched. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units on the stock exchanges where the units are listed. Some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices.

As per SEBI Regulations one can exit from the mutual fund through repurchase facility or through listing on stock exchanges. These mutual funds normally disclose NAV on weekly basis.

Growth / Equity Oriented Scheme

Mutual funds also can be classified as growth scheme, income scheme, or balanced scheme such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows.

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.

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