Mutual Funds

An Overview Shaleen Prakash

Agenda

The Concept History Structure of Mutual Funds Types of MF Important Terms Advantages of investing in a MF Drawbacks of investing in a MF Fund Comparison

The Concept

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realized are shared by its unit holders in proportion to the number of units owned by them.

MF Operation Flowchart
Investors
passed back to

pool their money with

Returns

Mutual Fund
invests the money in

generates

Securities

Origins of MF Investing

The idea of pooling money together for investing purposes started in Europe in the mid-1800s. The first pooled fund in the U.S. was created in 1893 for the faculty and staff of Harvard University. On March 21st, 1924 three Boston securities executives pooled their money together and the first official mutual fund was born. It was called the Massachusetts Investors Trust.

History.Today

After one year, the Massachusetts Investors Trust grew from $50,000 in assets in 1924 to $392,000 in assets (with around 200 shareholders). There are over 10,000 mutual funds in the U.S. today totaling around $7 trillion (with approximately 83 million individual investors)

Worldwide Market for MF

Mutual fund assets worldwide reached $14.0 trillion by year-end 2003. This figure includes $7.4 trillion in the U.S. fund market, and $6.5 trillion in 38 other reporting nations

History of Indian Mutual Fund Industry

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and the Reserve Bank. The history of mutual funds in India can be broadly divided into four distinct phases.

First Phase 1964-87

UTI established in 1963 by an Act of Parliament Set up by RBI - under Regulatory & Admin. Control of RBI The first scheme launched by UTI was Unit Scheme 1964 1978: UTI de-linked from RBI. Reins handed to IDBI At the end of 1988 UTI had Rs.6,700 crores of assets under management

Indian MF: Second Phase

Second Phase 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and LIC and GIC SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92) LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990 At the end of 1993, the mutual fund industry had assets under management of Rs.47,004 crores

Indian MF: Third phase

Third Phase 1993-2003 (Entry of Private Sector Funds) Beginning of a new era ! The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993. 1993: First mutual fund regulations came into being Industry now functions under SEBI (Mutual Fund) Regulations 1996

As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores

Indian MF: Fourth phase

Fourth Phase since February 2003

Repeal of UTI Act 1963.UTI Bifurcated into:

Specified Undertaking of UTI with assets under management of Rs.29,835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. Does not come under the purview of MF Regulations. UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations.

Phase of consolidation and growth begins As at the end of September, 2004, there were 29 funds, which managed assets of Rs.1,53,108 crores under 421 schemes

Indian MF Industry

Mutual Fund Structure - US

Shareholders

Board of Directors Mutual Fund

Investment Advisor / Management Co.

Distributor

Custodian

Independent Public Accountants

Transfer Agent

Mutual Fund Structure - India

SEBI Trustee Operations AMC Fund Manager Schemes Marketing/Sales Sponsor

Distributor

Investors

MF Constituents

Sponsor:

Sponsor is the person who establishes a mutual fund. Must meet the eligibility criteria prescribed under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996. Is not responsible or liable for any loss or shortfall resulting from the operation of the Schemes beyond the initial contribution made by it towards setting up of the Mutual Fund. The Mutual Fund is constituted as a trust in accordance with the provisions of the Indian Trusts Act, 1882 by the Sponsor.

Trust :

MF Constituents

Trustee:

Trustee is usually a company (corporate body) or a Board of Trustees (body of individuals) Main responsibility of the Trustee is to safeguard the interest of the unit holders and inter alia ensure that the AMC functions in the interest of investors and in accordance with the SEBI (Mutual Funds) Regulations, 1996, the provisions of the Trust Deed and the Offer Documents of the respective Schemes At least 2/3rd directors of the Trustee are independent directors who are not associated with the Sponsor in any manner

Asset Management Company (AMC):

The AMC is appointed by the Trustee as the Investment Manager of the Mutual Fund The AMC is required to be approved by the SEBI to act as an asset management company of the Mutual Fund. At least 50% of the directors of the AMC are independent directors who are not associated with the Sponsor in any manner. The AMC must have a net worth of at least 10 crore at all times

MF Constituents

Registrar and Transfer Agent:

The AMC if so authorized by the Trust Deed appoints the Registrar and Transfer Agent to the Mutual Fund. The Registrar processes the application form, redemption requests and dispatches account statements to the unit holders. The Registrar and Transfer agent also handles communications with investors and updates investor records.

Custodian:

The safe custody of assets of the Trust is entrusted to one or more custodians.

Types of MF Schemes
Investment Objective Types of Schemes Constitution

Equity Based

Debt Based

Hybrid

Open Ended

Close Ended

Interval

MF Schemes by Investment Objective

Equity Oriented (Growth):

Seek to invest a majority of their funds in equities and a small portion in money market instruments. Potential to deliver superior returns over the long term. High Risk and High reward Not suitable for investors seeking regular income or needing to use their investments in the short-term. The NAV prices of equity fund fluctuates with market value of the underlying stock which are influenced by external factors such as social, political as well as economic.

Types of Equity Funds

Index Funds :

Buys and holds a portfolio of stocks (or bonds) equivalent to those in a specific market index Investments are restricted to a particular segment of the market Investments are restricted to companies within a particular market capitalization range.

Sector Funds:

Market Cap Funds:

MF Schemes by Investment objective

Debt Based (Income): Invest in debt securities such as corporate bonds, debentures and government securities. Prices of these schemes tend to be more stable compared to equity schemes and most of the returns to the investors are generated through dividends or steady capital appreciation. Ideal for conservative investors or those not in a position to take higher equity risks, such as retired individuals. As compared to the money market schemes they do have a higher price fluctuation risk and compared to a Gilt fund they have a higher credit risk.

Types of Debt Funds

Bond Funds:

Invest in various kinds and grades of bonds, with income as primary objective Invest in short-term securities with maturities of less than 90 days

Money Market Funds:

MF Schemes by Investment Objective

Hybrid ( Balanced) schemes:

Invest in both equities as well as debt. By investing in a mix of this nature, balanced schemes seek to attain the objective of income and moderate capital appreciation. Ideal for investors with a conservative, long-term orientation.

Risk & Returns

Equity Based Schemes Debt Based Schemes

MF schemes by Constitution

Open Ended :

The fund does not have a set number of shares. Instead, the fund will issue new shares to an investor based upon the current net asset value and redeem the shares when the investor decides to sell. Open-end funds always reflect the net asset value of the fund's underlying investments because shares are created and destroyed as necessary.

Close Ended :

The fund has a set number of shares issued to the public through an initial public offering with a stated maturity period after which the units are fully redeemed at NAV linked prices. These shares trade on the open market. The closed-end fund does not redeem or issue new shares like a normal mutual fund. These schemes combine the features of open-ended and closed-ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV based prices.

Interval Schemes:

Loads

d ge ar ch l fee utua n A m e y s wh b d e fun its ar ed un eem red

Entry/ Front End Load

Mutual Fund

Exit / Back End Load

Th ch e sa pu arge les rch o as n M es F

Share Class- US Specific

Known as "multi-class funds," some mutual funds offer investors different types of shares, known as "classes." Each class will invest in the same "pool" (or investment portfolio) of securities and will have the same investment objectives and policies. But each class will have different shareholder services and/or distribution arrangements with different fees and expenses and therefore different performance results. A multi-class structure offers investors the ability to select a fee and expense structure that is most appropriate for their investment goals (including the time that they expect to remain invested in the fund). For example, you might find a multi-class fund with three classes of shares that are sold to the general publicClass A, Class B, and Class Cand a class that is sold only to institutional investorsClass I.

Share Class

Class A shares might have a front-end sales load. Class B shares might not have any front-end sales load, but might have a contingent deferred sales load (CDSL) and a 12b-1 fee (an annual fee paid by the fund for distribution and/or shareholder services). Class B shares also might convert automatically to a class of shares with a lower 12b-1 fee if held by investors long enough. Class C shares might have a 12b-1 fee and a CDSL or frontend sales load, but the CDSL or sales load would be lower than Class Bs CDSL or Class As front-end sales load, and the Class would not convert to another class. Class I would be sold only to institutional investors and might have different fees and expenses.

Share Class

Class A shares may be appropriate for:

Investors who would qualify for volume discounts referred to as breakpoints. Those who expect to be long-term investors, because the longer you hold these shares, the greater the potential benefit when compared to B or C shares. Investors who want all of their money invested immediately. Investors who do not qualify for volume discounts. Investors who intend to hold their investment for longer time periods. Investors who want all of their money invested immediately. Investors who do not qualify for volume discounts. Investors who intend to hold their investment for a short time period

Class B shares may be appropriate for:

Class C shares may be appropriate for:

Important Terms

Assets Under Management:

Market Value of Assets that the Asset Management company manages on behalf of its investors.

NAV: Net Asset Value:

Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date.

Net Asset Value (NAV)

Market Value in Dollars of a Funds Assets (including income and other earnings) ($6,000,000) Funds Liabilities (including fees and expenses) ($60,000) Number of Investor Shares Outstanding = (500,000)

Fund Share Price or Net Asset Value (NAV) $11.88

Important Terms

Expense Ratio: The percentage of total fund assets that is

used to cover expenses associated with the operation of a mutual fund. This amount is taken out of the fund's assets and lowers the return that fund holders achieve. These expenses include management fees and operating expenses.

The management fee is the fee that is charged to the fund by the portfolio manager, and it is often a fixed percentage. The operating expenses are the expenses that the fund incurs through operation and this can include brokerage fees, taxes, investor services, and interest expenses.

Important Terms

Benchmark: A standard against which the performance of a security, index, or investor can be measured. Dollar Cost Averaging:

Investment of a set dollar amount at regular intervals, regardless of the fund's share price. More fund shares are bought when prices are low than at high prices, usually bringing down an investor's average cost per share over time. Dollar cost averaging does not, however, guarantee a profit or protect against a loss.

Dollar Cost Averaging

Let's say, for example, that an investor puts $100 a month into the same mutual fund for six months in a row. The share price is up in some months, down in other months. The table below shows how the hypothetical investor might have made out.

Month 1 2 3 4 5 6

Investment $100 $100 $100 $100 $100 $100

Share Price 10 8 5 10 16 10

Shares Bought 10 12.5 20 10 6.25 10

Results: Total Amount Invested: $ 600 No. of shares owned : 68.75 Average Cost/ Share: $8.72 Current Market Price :$10

Important Terms

Fund of Funds: A mutual fund which invests in other mutual

funds. Just as a mutual fund invests in a number of different securities, a fund of funds holds shares of many different mutual funds.

These funds were designed to achieve even greater diversification than traditional mutual funds. On the downside, expense fees on fund of funds are typically higher than those on regular funds because they include part of the expense fees charged by the underlying funds. In addition, since a fund of funds buys many different funds which themselves invest in many different stocks, it is possible for the fund of funds to own the same stock through several different funds and it can be difficult to keep track of the overall holdings.

Advantages of investing in MF

Professional Management Diversification Convenient Administration Return Potential Low Costs Liquidity Transparency Flexibility Choice of schemes Tax benefits Well regulated

Drawbacks of investing in MF

Substantial transaction costs

Management fee Commission fees on load funds Consistently beating the market is difficult Many mutual funds just keep even with overall stock market index

Lower-than-market performance

MF comparison parameters

expense ratio the number of years needed to reach an investment goal, the type of stocks, bonds, or other securities that the fund buys, the risk of the fund, the fit between the fund and the investor's portfolio (diversification), the fund company or portfolio manager who runs the fund, the fund's track record or performance over time, and the types of services offered by the fund company

MF Schemes

Franklin Templeton http://www.franklintempletonindia.com/Ge ICICI Prudential http://www.pruiciciamc.com/pruicicin/h tdocs/home1/funds1.html

Thank You...

Important Terms

Call money : Money that is loaned in the call market, which can be demanded for repayment on call. The term call money is also known as money at short notice as it is repayable in 24 hours. It is also traded in the money market.

Certificate of Deposit (CD) :Short-term debt instrument issued by scheduled commercial banks excluding regional rural banks. They are unsecured instruments that mature between three months to one year Commercial Paper: An unsecured, short-term loan issued by a corporation, typically for financing accounts receivable and inventories. It is usually issued at a discount reflecting prevailing market interest rates