Mechanism of Mutual Funds

EMERGENCE OF MUTUAL FUNDS:

Mutual Funds now represent perhaps the most appropriate investment opportunity for most small investors. As financial markets become more sophisticated and complex, investor need a financial intermediary who provides the required knowledge and professional expertise on successful investing. It is no wonder then that in the birthplace of mutual funds-the U.S.A.-the fund industry has already overtaken the banking industry, with more money under Mutual Fund management than deposited with banks. The Indian Mutual Fund industry has already opened up many exciting investment opportunities to Indian investors. Despite the expected continuing growth in the industry, Mutual Fund is a still new financial intermediary in India.1

WHAT IS MUTUAL FUND?

A mutual fund is just the connecting bridge or a financial intermediary that allows a group of investors to pool their money together with a predetermined investment objective. The mutual fund will have a fund manager who is responsible for investing the gathered money into specific securities (stocks or bonds). When you invest in a mutual fund, you are buying units or portions of the mutual fund and thus on investing becomes a shareholder or unit holder of the fund. The income earned through these investments and the capital appreciations realized are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

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Working of Mutual Funds

REGULATORY AUTHORITIES:
To protect the interest of the investors, SEBI formulates policies and regulates the mutual funds. It notified regulations in 1993 (fully revised in 1996) and issues guidelines from time to time. MF either promoted by public or by private sector entities including one promoted by foreign entities is governed by these Regulations.

SEBI approved Asset Management Company (AMC) manages the funds by making investments in various types of securities. Custodian, registered with SEBI, holds the securities of various schemes of the fund in its custody.

The Association of Mutual Funds in India (AMFI) reassures the investors in units of mutual funds that the mutual funds function within the strict regulatory framework. Its objective is to increase public awareness of the mutual fund industry.2

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WHO ALL ARE INVOLVED IN MUTUAL FUND?

1. Investors: Investors are the people who put their money or invest in the Mutual Fund. Every investor, given his/her financial position and personal disposition, has a certain inclination to take risk. The more risk one is capable of taking, the more return one can expect to get, and vice versa. However, most people have neither the time nor the knowledge to directly invest in the market. Mutual Fund is a solution for investors who lack either the time or the inclination or the necessary skills to actively manage their investments in individual securities. In the scheme of a Mutual Fund, the investor may have invested in a bank or any other safe option, thus depriving them of the possibility of getting a better return.

2. Trustees: Trustees are the people who are responsible for ensuring the proper care of the investors interest in a scheme. In return, they are paid the trustees fees.

3. Asset Management Company (AMC): Asset Management Companies are those companies who manage the investment portfolios of the schemes. Its income comes from the management fee that it charges for its services. The management fee is calculated as a percentage of the net asset that is managed. In some countries, the management fee is based on performance.

An AMC has to employ people in order to bear all the establishment costs related to its activities such as premises, furniture, etc. These costs are paid from the management fee earned by it. Expenses such as trustee fees, marketing costs, etc are borne by the Mutual Fund scheme. Sometimes, due to competition, the AMC is forced to bear these costs. As long as the income is more than the expenditure, the AMC is viable. All AMCs have certain Asset Under Management (AUM), below which it is not viable. In Indian context, it is difficult for an AMC to achieve Break-Even if its AUM is below Rs. 2,000 crores. Within an AMC, the fund manager ensures that the schemes funds are invested in such a way that the objectives of the scheme in the interest of its investors are achieved. The CEO, in turn, sees that the fund manager performs his duty in a correct way.

4. Distributors: Distributors are the people who attract or bring in the investors into the schemes of a mutual fund. They earn a commission for this. The commission is an expense for the AMC and it may choose to bear the cost wholly or partially. Depending upon the financial and physical resources at their disposal, the distributors can be classified into 3 tiers: Tier-1 Distributor: These distributors have their own or franchise network reaching out to investors all across the country. Tier-2 Distributor: These distributors are mostly regional players. Tier-3 Distributor: These are the small distributors marginal players and have limited reach.

Distributors bring in investors for the AMC, for which they earn commission from them. But they also safeguard the financial health of the investors who dont pay them in return. Karvy the finapolis belongs to the tier-1 distributors with the wide-spread channels all across the India for distribution of mutual funds.

5. Registrars: Registrars and Transfer Agents (R&T) keeps track of the Mutual Fund scheme on account of the investors investments and disinvestments from the scheme. The R&T of the Mutual Fund maintains the database of investors. As a result, interest based transactions of the existing investors in the schemes of an AMC are affected through its database server.

6. Custodial Depository: The Custodial Depository maintains custody of the securities in which the scheme invests. This ensures an ongoing independent record of the investment of the scheme. It also follows various corporate actions such as bonus and dividends declared by the invested companies. Its importance is growing as securities are increasingly being dematerialized.

Types of Mutual Funds:3

Types of Mutual Fund

By Strucuture

By Nature

By Investment

Other Schemes

OpenEnded Schemes CloseEnded Schemes

Equity fund

Growth Schemes

Tax Saving Schemes

Debt fund

Income Schemes

Index Schemes

Interval Schemes

Balanced funds

Balanced schemes

Sector specific schemes

Money Market schemes

http://www.mutualfundsindia.com/mfbasic.asp

A. By Structure:

1. Open - Ended Schemes: An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity.

2. Close - Ended Schemes: These schemes have a pre-specified maturity period. One can invest directly in the scheme at the time of the initial issue. Depending on the structure of the scheme there are two exit options available to an investor after the initial offer period closes. Investors can transact (buy or sell) the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchanges could vary from the net asset value (NAV) of the scheme on account of demand and supply situation, expectations of unit holder and other market factors. Alternatively some closeended schemes provide an additional option of selling the units directly to the Mutual Fund through periodic repurchase at the schemes NAV; however one cannot buy units and can only sell units during the liquidity window. SEBI Regulations ensure that at least one of the two exit routes is provided to the investor.

3. Interval Schemes: Interval Schemes are that scheme, which combines the features of open-ended and close-ended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.

B. By Nature: