Professional Documents
Culture Documents
Investor Perspective
Basics of Investments:
Risk Aversion Risk Management
(Reference: amfiindia.com)
History of Mutual Funds
Phase I – 1964 – 87: In 1963, UTI was set up by Parliament
under UTI act and given a monopoly. The first scheme
launched by UTI was Unit Scheme-64. Later in ’70’s and
’80’s, UTI started offering some special purpose schemes
like ULIP and Children’s Gift Growth Fund. Master share, the
first equity fund was launched in 1986. These were launched
to suit the needs of different class of investors.
• Wide Choice to suit risk-return profile: Investors can chose the fund
based on their risk tolerance and expected returns.
Advantages of Mutual Funds
• Liquidity: Investors may be unable to sell shares directly, easily and
quickly. When they invest in mutual funds, they can cash their investment
any time by selling the units to the fund if it is open-ended and get the
intrinsic value. Investors can sell the units in the market if it is closed-
ended fund.
Closed-end Fund
• One time sale of fixed number of units.
• Investors are not allowed to buy or redeem the units directly from the
funds. Some funds offer repurchase after a fixed period. For example,
UTI MIP offers a repurchase after 3 years.
• Listed on stock exchange and investors can buy or sell units through
the exchange.
• Units maybe traded at a discount or premium to NAV based on
investor’s perception about the funds future performance and other
market factors.
Load Vs. No-load Funds
Marketing a new mutual fund scheme involves initial expenses.
These expenses are charged to the investors through loads and are
recovered from the investors in different ways:
• Front-end or entry load is charged to the investor at the time of
his entry into the scheme.
• Back-end or exit load is charged to the investor at the time of his
exit from the scheme.
• Deferred load is charged to the investor over a period of time.
• Contingent deferred sales charge: Different amount of loads are
charged to the investor depending upon the time period the investor
has stayed with the fund. The longer he stays with the fund, lesser
the amount of exit fund he is charged.
Very often, AMC’s do not charge any initial expenses to the investor
in the IPO. These are hence are no-load funds. In no-load funds,
the investors get units for the complete amount invested.
Mutual Fund Types
Money Market Funds/Cash Funds
• Invest in securities of short term nature I.e. less than one year
maturity.
• Invest in Treasury bills issued by government, Certificates of
deposit issued by banks, Commercial Paper issued companies and
inter-bank call money.
• Aim to provide easy liquidity, preservation of capital and
moderate income.
Gilt Funds
• Invest in Gilts which are government securities with medium to
long term maturities, typically over one year.
• Gilt funds invest in government paper called dated securities.
• Virtually zero risk of default as it is backed by the Government.
• It is most sensitive to market interest rates. The price falls when
the interest rates goes up and vice-versa.
Debt Funds
Debt Funds/Income Funds
• Invest in debt instruments issued not only by government, but
also by private companies, banks and financial institutions and
other entities such as infrastructure companies/utilities.
• Target low risk and stable income for the investor.
• Have higher price fluctuation as compared to money market
funds due to interest rate fluctuation.
• Have a higher risk of default by borrowers as compared to Gilt
funds.
• Debt funds can be categorized further based on their risk profiles.
• Carry both credit risk and interest rate risks.
Equity Funds
Equity Funds:
• Invest a major portion of their corpus in equity shares issued by
companies, acquired directly in initial public offering or through
secondary market and keep a part in cash to take care of
redemptions.
• Risk is higher than debt funds but offer very high growth potential
for the capital.
• Equity funds can be further categorized based on their investment
strategy.
• Equity funds must have a long-term objective.
Hybrid Funds
Balanced Funds:
• Has a portfolio comprising of debt instruments, convertible
securities, preference and equity shares.
• Almost equal proportion of debt/money market securities and
equities. Normally funds maintain a Equity-Debt ratio of 55:45 or
60:40.
• Objective is to gain income, moderate capital appreciation and
preservation of capital.
• Ideal for investors with a conservative and long-term orientation.
Options Available to the Investor
Mutual Funds Vs. Other Investments
Product Return Safety Liquidity Tax Conven-
Benefit ience
Bank Low High High No High
Deposit
Equity High Low High or No Moderate
Instruments Low
Debentures Moderate Moderate Low No Low
• Bank deposits are not totally free from risk and generally give lower
returns. A conservative debt fund can give higher returns than a bank
deposit, even though there is no contractual guarantee as in a
deposit.
Mutual Funds Prove Best!
While instruments like shares give high returns at the cost of
high risk, instruments like NSC and bank deposits give lower
returns and higher safety to the investor.
Trustees
Asset Management
Company
Depository Agent
Custodian
Fund Sponsor
The Fund Sponsor
• Any person or corporate body that establishes the Fund
and registers it with SEBI.
• Form a Trust and appoint a Board of Trustees.
• Appoints Custodian and Asset Management Company
either directly or through Trust, in accordance with SEBI
regulations.
Depositories
• Indian capital markets are moving away from physical
certificates for securities to ‘dematerialized’ form with a
Depository.
• Will hold the dematerialized security holdings of the Mutual
Fund.
Distribution Channels
Distribution Channels
Mutual Funds are primary vehicles for large collective investments,
working on the principle of pooling funds.
A substantial portion of the investments happen at the retail level.
Agents and distributors are a vital link between the mutual funds and
investors.
Agents
- Is a broker between the fund and the investor and acts on behalf of the
principal.
- He is not exclusive to the fund and also sells other financial services.
This in a way helps him to act as a financial advisor.
Distribution Companies
- Is a company which sells mutual funds on behalf of the fund.
- It has several employees or sub-broker under it.
- It manages distribution for several funds and receives commission for its
services.
Distribution Channels
Banks and NBFCs
- Several banks, particularly private and foreign banks are
involved in a fund distribution by providing similar services like
that of distribution companies.
- They work on commission basis.
Direct Marketing
- Mutual funds sell their own products through their sales
officers and employees of the AMC.
- This channel is normally used to mobilise funds from high
net worth individuals and institutional investors.
Sales Practices
Agent Commissions
- No rules prescribed for governing the maximum or
minimum commissions payable by a fund to its agents.
- As per SEBI regulations, 1996 all initial expenses
including brokerage charges paid to agents cannot
exceed 6% of resources raised under the scheme.
- Excess distribution charges have to be borne by the AMC.
- A no-load fund is authorised to charge the schemes with the
commissions paid to agents as part of the regular
management and marketing expenses allowed by SEBI.
Accounting and Taxation
Accounting
Calculating Net Asset Value
Unit Capital is the investor’s subscriptions. In mutual funds it
is not treated as a liability.
Investments made on behalf of the investors are reflected on
the assets side of the balance sheet.
There are liabilities of short-term nature.
Fund’s Net Asset = Asset – Liabilities
Net Asset Value = Net Assets of the scheme / No. of
Outstanding Units
i.e
NAV = (Market value of investments + Receivables + Other
Accrued Income + Other assets – Accrued Expenses – Other
Payables – Other liabilities) / ( No. of Units Outstanding as at
the NAV date)
Accounting
The factors affecting the NAV are as following:
Capital Gains or Losses on the sale or purchase of the
Investment securities.
Dividend and income earned on the assets.
Capital Appreciation in the underlying value of the stocks
held in the portfolio.
Other assets and liabilities.
Number of units sold or purchased.
Accounting
Tax of 10.2% is deducted from the NAV by the fund in the following
cases:
- All closed end funds including equity.
- All open end funds with less than 50% allocation in equity.
Taxation
Taxation in the Hands of the Investor
Capital Gains on Sale of Units: Capital Gains tax is charged when
something is sold at profit. If the investor sells his units and earns “Capital
Gains”, the investor is subject to the Capital Gains Tax.
If the units are held for less than 12 months, they will be treated as short
term capital gain. Otherwise,t hey are called long term capital gains.
For long term capital gains, the investor gets the benefit of ‘Indexation’
by which his purchase price is marked up by an inflation index.
Cost of acquisition or improvement = actual cost of acquisition or
improvement * cost of inflation index for year of transfer/cost of inflation
index for year of acquisition or improvement.
The tax charged is either 10% or (20% - rate of inflation).
In-dept classification of Mutual Funds
Mutual Fund Types
• Broad fund types by Nature of Investments: Mutual funds may
invest in equities, bonds or fixed income securities, or short-term
money market securities. So, we have Equity, Bond and Money
Market Funds.
Growth Funds:
• Objective is capital appreciation over a long time, 7 - 10 years
span.
• Invest in companies whose earnings are expected to rise at an
above average rate.
• These companies will be considered to have growth potential, but
not entirely unproven and speculative.
• Less volatile than aggressive growth funds.
Equity Funds
Specialty Funds
• Thematic funds that have a theme for investments.
• Narrow portfolio orientation and invest only in companies that meet
pre-defined criteria.
• Diversification is limited to one type of investment.
• More volatile than diversified funds.
• Specialty funds are further sub-categorized based on their
investments.
Offshore Funds:
• Invest in equities in one or more foreign countries.
• Sensitive to foreign exchange rate risk and economic conditions of the
countries they invest in.
Value Funds:
• Invest in fundamentally sound companies whose shares are currently
under-priced in the market.
• Have lower risk as compared to Growth Funds and take a long term
approach.
• Often invested in cyclical industries.
• Example: Templeton India Growth fund that has shares of
Cement/Aluminum and other cyclical industries.
Hybrid Funds
Growth & Income Funds:
• Strike a balance between capital appreciation and income for the
investor.
• Portfolio is a mix between companies with good dividend paying
records and those with potential for capital appreciation.
• Less risky than growth funds but more risky than income funds.
Cash Holdings
-A large cash holding allows the fund to strengthen its
position in preferred securities without liquidating others.
- Allows cushion against decline in market prices of shares or
bonds.
Benchmarking
Importance of Benchmarking
- A funds performance can be judged in relation to investor’s
expectations.
- However, it is important for the investor to define his expectations in
relation to certain “guideposts”.
- These guideposts or indicators of performance can be thought of as
benchmarks against which a fund’s performance ought to be measured.
- For instance, BSE-30 will be a benchmark for diversified equity fund and
BSE IT index for tech funds.
Example:
If MR. Kapoor invests Rs. 1000 @ 10% interest rate for 10 years and the
amount is compounded annually, this is how the money grows:
Interest generated in the first year would be Rs. 80 (1,000*.08)
Interest generated in the second year would be 86.4 [(1,000+ 80)*.08]
instead of 80
Interest in the third year would be 93[(1000 + 80+ 86.4) * .08)
And so on till the interest keeps growing each year, resulting in a total
of Rs. 2,600 at the end of 10
Strategy to Maximize Returns
a) Buy and Hold
- Most common strategy adopted by investors and the most common
mistake.
- Long term investments does not necessarily mean buy and hold
without adjusting the portfolio.
- Continuous tracking needs to be for keeping the right funds.
b) Rupee Cost Averaging
- It is advisable to invest regularly in small amounts rather than
investing a lump sum at one go.
- A regular investor is always a winner.
- The disadvantage of this method is that it does not tell the investor
when to buy and sell a fund.
i) Value Averaging
- Investor keeps the target value of investment constant.
- He accordingly keeps changing the investment amount either by
increasing or decreasing the same.
Rupee Cost Averaging
Scenario 24.
Mrs. Sudhakar is investing Rs. 1000 every month for 3
months in ABC mutual fund. Following are the details:
Date Amount NAV
Invested
January 1000 R. 10/-
February 1000 Rs. 8/-
Average cost per unit under the plan = 3000/305 = Rs. 9.84
Average NAV = (10 + 8 + 12.50)/3 = Rs. 10.17
Average of the three NAV’s is higher than the figure achieved
through rupee-cost averaging.
So, we can say that rupee-cost-averaging is beneficial to
Investors.
Thank You!