Mutual Funds

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Mutual Funds
            The concept of mutual fund is originated in Belgium in 1882. A trust that pools that pools the savings of investors who share a common financial goal is known as a ‘Mutual Fund.’ The money thus collected then invested in financial market instruments such as shares, debenture and other securities like government paper etc. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Investments in securities are spread over a wide cross-section of industries and sectors, thus allowing risk reduction to take place. Diversification reduces risks because all stock/debt instruments may not move in the same direction and in the same proportion at the same time.

Features / Benefits
(1)       Mobilising Small Savings: Mutual funds mobilize the funds by selling their own shares known as units.
(2)       Investment Avenue: Mutual funds provide an ideal avenue for investments for persons of small means and enable them to earn a reasonable return with better liquidity.
(3)       Professional Management: Benefit of professional and expert management of funds of investors provides ideal portfolio management
(4)       Diversified Investment: Diversified investment of funds spread over various industrial segments across the country is possible.
(5)       Better Liquidity: There is always a ready market available for the mutual fund units.
(6)       Reduced Risk: Because of expert supervision, diversification and liquidity of the units, there is only minimum risk attached to the principal amount and return.
(7)       Investment Protection: Mutual funds are largely regulated by guidelines and legislative provisions like SEBI regulatory services, security Exchange Commission etc., providing provision of safety of investments.
(8)       Flexibility to Shift from one income scheme to growth scheme, closed scheme to open-ended scheme etc.     
(9)       Tax Benefits: Mutual funds provide tax shelter to the investor under the provision of Income Tax Act.
(10)   Low Transaction Cost: Cost of purchase and sale of mutual fund is relatively lower. Similarly, brokerage fee, trading commission etc. are lower, which increases the quantum of distributable income available for investors.
(11)   Economic Development: Mutual funds pave way for the efficient allocation of financial resources of the country and thus contributing to the economic development.
    Moreover, mutual funds help in strong possibility of capital appreciation, regular returns and options to reinvest dividends.


Schemes of Mutual Fund

1.      Open ended Scheme
           When a fund is accepted and liquidated on continuous basis by a mutual fund manager, it is called ‘open ended scheme’. The fund manager buys and sells units constantly on demand by the investors. Thus, capitalization of funds constantly changes as it is always open for the investors to sell/buy their share units. Thus it provides excellent liquidity provision for the investors.

2.      Close ended Scheme
           When the units of a scheme are liquidated (repurchased) only after the expiry of a specified period. Such funds have fixed capitalisation. Units of close ended schemes are to be quoted and therefore traded on the floors of stock exchange in the secondary market. The price will be determined on the basis of demand and supply.


Differences between Open Ended and Close Ended Scheme

BASIS
OPEN ENDED
CLOSE ENDED
Subscription


Exit


Liquidation


Maturity

Listing


Trading and liquidity
   Open for public subscription throughout the scheme.

   Easy and convenient exit at any time.

   Units can be liquidized at any time.

No maturity period

   No listing, hence not listed in stock exchange

   Traded through repurchase by mutual fund at net asset value or at any other price as may be determined
   Open for subscription only for a limited period.

   No exit is possible till the closure of the scheme.

   Units can be liquidized only at the end of specified period.

Fixed maturity period

   Listed in stock exchange and traded.

   Through trading in the stock exchange at current market price.


Interval Scheme: -   It is a type of close ended scheme with a peculiar feature that it remains open during a particular period for the benefit of the investors either to offload their holdings or to undertake purchase of units at the NAV.
            Under the SEBI (MF) Regulations, every mutual fund is free to launch any or both types of schemes, including interval scheme.

Return based Classification

  1. Income Fund Scheme
                  This scheme offers maximum current income which will be regular either providing target constant income at relatively low risk or maximum possible income distributed periodically.

  1. Growth Scheme
                  These are nest eggs or long haul investments, where investments will be made in growth oriented securities that are capable for capital appreciation in the long run, which usually amount to higher risk.

  1. Conservative Fund Scheme
                  It provides reasonable rate of return protecting the value of investment, achieving capital appreciation.

Investment Based Classification

  1. Equity Fund Scheme: - which is derived from equity based investments.
  1. Bond Fund Scheme: - which is derived from bond based investments.

3.                                                                            Balanced Fund Scheme: - which is derived from the mix of debt and equity in the portfolio of investments.
4.                                                                              Sectored Fund Scheme: - which is derived from the specialised sectors like gold, silver, real estate, oil industry, offshore investment etc.
5.                                                                              Fund-of-Fund Scheme: - where one mutual fund is invested in the units of other mutual funds.
6.                                                                              Leverage Fund Scheme: - consists of both ‘mobilised funds from small investors’ and ‘fund borrowed from the capital market’.
7.                                                                              Gilt Funds: - funds invested in Government (central/state) securities and not in equity or corporate debt securities.
8.                                                                              Index Funds: - funds linked to specific index of share prices where the scrips constitute to the BSE – 30 or 100 shares National Index
9.                                                                              Tax Savings Scheme: - which offers tax rebate in equity shares under Sec.88 of the IT Act 1961.

Mechanism of Mutual Fund Operations
Depositing Public
                                                                   Mutual Fund Company





Deposit / Savings
Deployment of Savings
Collection of small                                                                                                                                                                                                  Payment of                                        savings                                     return/income

 








Open ended    Close ended        Income              Growth         Bond             Sectoral        Guilt
 



Income and Capital Gain Generation




Four-tier System of Managing Mutual Funds

  • Sponsor: - Any corporate body which initiates the launching of mutual funds. (Should have sound track record of financial services for at least 5 years.)
  • Trustees: - Person who hold the property of the mutual fund in trust for the benefit of the unit holders.
  • Custodians: - an agency that keeps custody of the securities that are bought by the mutual fund managers under the various schemes.
  • Investment Manager or AMC: - Appointed by the sponsor or trustees which manages the affairs of the mutual fund

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