What is a Mutual Fund?
Normally, an investor directly invests in various market securities like Shares, Bonds, Warrants, money market instruments etc. However, a Mutual Fund (MF) is a pool of money gathered from several small retail investors, which in turn is invested in various financial securities. These Funds are managed by ‘Money Managers’ or ‘Fund Managers’ who invest this pool of money collected in numerous investment avenues for producing capital gain and returns for investors.
A small investor may not be able to invest in multiple blue chip companies or make multiple investments with limited resources. But by investing in a Mutual Fund, the investor will be able to partake in wide range of investments made by such a fund, thereby broad basing the rewards and the risks to the proportional share in the fund’s gain or losses.
What are the types of Mutual Funds?
The type of Mutual Funds is determined in the underlying securities it invests in, namely
- Equity Funds: One of the largest category of funds, it primarily invests in stocks. Depending on the size of the company invested in and the investment style of the Fund Manager, there are various combinations of Funds invested. For eg. If the investment is focused on companies with high quality and good brand acceptance in the market, it refers to value investing style. If the funds invest in fast-growing companies, it is known as ‘Growth Funds’.
- Speciality Funds: Investment is focused in a particular sector like Infra, technology, Healthcare, Financial etc. These could also refer to Funds focused on a particular region like Asia, Latin America etc, which makes it accessible in foreign land as an investment opportunity.
- Index Funds: It replicates the performance of the Index by investing in prime stock which forms a part of the Index on BSE, NSE etc.
- Fixed-Income Funds: Focuses on investment in Bond and Fixed income securities like government bonds etc, with an objective to create a steady flow of returns for the investor. The returns are usually higher than the money market investments or deposits with relatively lower risk.
- Balanced Funds: Invests in different securities to balance growth, capital appreciation along with security of income. Generally the investment is proportioned in a ratio of 60% Equity and 40% fixed income.
- Money Market Funds: Generally considered a good option for liquidity as it gives lesser returns compared to deposits but is relatively safer option since it invests in short-term debt instruments like treasury bills.
What are Open Ended and Close Ended Scheme?
Open ended Mutual Funds are most popular and are with the largest volume of assets managed. An investor can directly purchase or sell the shares with the fund, hence there is no limit on number of shared issued by them. The value of share does not depend on number of shares outstanding in the market as it is determined by net asset value arrived at with daily adjustments of portfolio value done by marking the securities to market price.
Close Ended Schemes on other hand refers to the funds issue only a limited number of shares in the market through initial public offering known as New Fund Offer – NFO. The share value depends on the demand of the fund by investor, who purchase it at either a discount or premium.
What are the benefits of investing in a Mutual Fund?
- Diversity: First and foremost, it allows you to diversify your investment as the Fund itself invests in multiple types of securities to manage risk and rewards. One can also choose sector specific funds to invest in a growing sector
- Easy Access: It allows easy access to invest in major league stocks and markets which otherwise may not be accessible to individual investor. It allows one to invest in smaller numbers however, if they are planning to buy the stock of a premium company, they may require huge sums of money to buy the odd lot of shares.
- Reduced Costs: Enjoy reduced transaction costs which come with buying and selling huge number of securities by the Mutual Fund, even while churning the portfolio.
- Liquidity: Mutual Funds are easily tradable in the market, making it one of the most liquid investment options. The sale price is the net asset value which is calculated only once a day.
- Expert Handling: Mutual Funds are managed by expert professionals as Fund Managers who understand risks and returns of the investment made at both micro and macro level. Save enough time from researching each stock to make a sound investment.
- Tax Benefits: Most funds are held for more than one year accruing the tax benefit for an investor
What is the role of SEBI in Mutual Fund?
SEBI issued a code of conduct and set of regulations in 1996 for smooth functioning of the Mutual Funds, laying out the guidelines for investing, accountability, disclosures and distribution of returns to investors. It acts as a regulator protecting the interest of an investor by laying out policies overseeing Mutual Funds.
What is Net Asset Value (NAV)?
Net Asset Value (NAV) refers to the market price of each mutual fund share, at which the buyers would bid the shares, and the sellers would redeem them in the market. NAV for open-ended schemes is arrived at by dividing all the current assets in the fund’s portfolio net of all liabilities and divided by the total number of outstanding shares.
The current value of stock in the portfolio is calculated at the end of each trading day by aggregating the value of each stock based on closing market prices.
What is Systematic Investment Plan?
Systematic Investment Plan (SIP) is a mechanism offered by mutual funds by which an investor can invest small amount of money (a pre-determined value of as less as 1000 Rs) regularly at pre-determined time, i.e. monthly, in the securities through the fund. It creates an opportunity to build a portfolio and better returns over time through planned investment strategy.
Does an Investor need a demat account to invest in MF?
No, a Demat account is not required to invest in Mutual Fund. However if one holds a Demat account, he can access or trade his Mutual funds through Demat Account.
Who are Fund Managers?
A Fund manager is a person who manages a mutual fund. Generally a fund is managed by a team of three of more people who are expert in the financial markets. They work for a fee to manage funds which is generally a percentage of the average assets under management.
What is Fund of Funds Scheme?
As a mutual fund invests in securities, a Fund of Funds also known as ‘Multi-manager Investment’, invests in other investment funds rather than directly investing in bonds, shares or other market securities
Can a mutual fund change the nature of the scheme from the one specified in the offer document?
Yes, A mutual fund can change the scheme from one specified in the document, but other attributes like structure of fund investment its schedule etc can be changed only when each shareholder is duly notified with a written communication. In case a mutual fund share holder do not wish to continue with the changed scheme, he has a right to exit the fund without any exit load.
How will an investor come to know about the changes, if any, which may occur in the mutual fund?
There are quarterly newsletters sent to each investor as an update. The mutual fund is required to communicate the changes in between to each shareholder through an addendum to offer document as it is refreshed only once in every two years.
How can an investor evaluate the performance of a mutual fund?
The performance can be gauged in both absolute and relative terms in one of the three ways below
- Peer-Group Comparison – Benchmarking the fund performance vis-à-vis industry peers
- Historical Data – Check the performance of the fund over past , in comparison to the environment
- Returns Analysis – Check the costs involved like fee structure and expenses. Tactical management of funds by churning results in heavy trading costs that can eat away the profits.
What are Tax-Saving Schemes?
Tax-saving mutual funds are most popularly known as Equity Linked Saving Schemes (ELSS) which has a minimum lock-in period of three years from the date of investment and yields tax benefit under Sec 80C for the amount invested.