What is a Mutual Fund?

According to SEBI (Mutual Funds) Regulations, 1996 mutual fund “is a fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one or more schemes for investing in securities including money market instruments or gold or gold related instruments or real estate assets.”

A mutual fund is a trust that aggregates the savings and investments from a number of persons who have common investment goals. The mutual fund moves on to invest the pool of money in to various financial instruments such as stocks, debentures and certificates of deposits and manages these investments. Investors share the income and gains as well as losses in proportion to the money they have invested.

There are a number of stakeholders involved in the process of running a mutual fund.

Regulator

Mutual funds collect money from the public and they need to follow several rules and regulations. Securities Exchange Board of India (SEBI) is the prime regulator of mutual fund industry in India. SEBI, established in 1992 in accordance with Securities and Exchange Board of India Act, 1992, has the mandate to protect the interests of investors in securities and to promote the development of, and to regulate the securities market. SEBI provides the regulatory framework and oversees the functioning of mutual fund industry to ensure the protection of public interest.

Structure of a mutual fund.

A mutual fund is set up in the form of a trust, which has sponsor, trustees, Asset Management Company (AMC) and custodian. The sponsor should have a sound track record and general reputation of fairness and integrity in all its business transactions. The sponsor must be a fit and proper person. Further, the sponsor must make three more appointments, namely:

  • Trustees to act as trustees for the mutual fund
  • Asset Management Company (AMC) to manage the mutual fund and operate the schemes of such funds, and a
  • Custodian in order to keep custody of the securities or gold and gold related instrument or other assets of the mutual fund.

The trustees of the mutual fund hold its property for the benefit of the investors in the fund. The trustees oversee the Asset Management Company and give it the direction to meet the fund objectives.

Asset Management Company (AMC) approved by SEBI manages the funds by making investments in various approved securities and financial instruments, according to underlying objectives of specific schemes.

Custodian, who is registered with SEBI, holds the investments of the fund in its custody.

SEBI regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be independent. All mutual funds are required to be registered with SEBI before they launch any scheme.

Classification of Funds

There are 44 registered mutual funds or fund houses at the last count as on 07/02/2015according to Association of Mutual Funds in India (AMFI), Self-Regulatory Organisation (SRO) for mutual fund industry, and several hundreds of schemes floated by these funds. Mutual funds cater to the investment needs of almost all categories of investors; be it individual investor with a small amount to invest or a high net worth individual, be it a small business or a big industry house, everyone can find a product to meet their requirements. Such is the breadth and depth of mutual funds and the schemes in India.

Popular classifications of mutual funds:

Maturity based classification

Open ended schemes
Close ended schemes
Interval schemes
Fixed Maturity Plans

Investment Objective based classification

Income funds
Growth funds
Income and growth funds

Asset based classification

Equity funds
Debt Funds
Balanced Funds
Index Funds

Other classifications

Sector/Thematic Funds
Pharmaceutical sector funds
Banking sector funds
Infrastructure funds
Natural Resources Fund
International Fund

Special Funds

Equity Linked Saving Schemes (Tax Planning Funds)
Children Education funds
Pension Funds
Fund of Funds
Exchange Traded Funds
Structured funds

Advantages of mutual fund

Investing in mutual funds is growing in popularity with the investing public day by day. Following are some of the attributes for the growing popularity of mutual funds

  • Professional Management
  • Diversification
  • Convenient Administration
  • Return Potential
  • Low Costs
  • Liquidity
  • Transparency
  • Flexibility
  • Choice of Schemes
  • Well Regulated

What an investor should know before investing in a mutual fund?

Investor must go through the offer document before investing in a mutual fund. Offer document provides an investor with information such as objective of the fund and risk factors. Offer document would also provide information on sponsor, AMC, trustee and custodian.

All investments carry several risks. Investing in a mutual fund also is not an exception to this rule. The risk factors that affect the underlying assets of a fund also affect the performance of a mutual fund.

An investor must first find his needs by asking questions such as

  • What are his investment needs and goals?
  • How much risk he is willing to take?
  • When his investments need to generate cash flows?

Although mutual funds give a superior investment framework for an investor, he should be well aware of the factors such as entry and exit loads, management fee and other costs and fees.

Some key words explained

Asset Allocation

A term used to describe an investor’s approach for dividing the portfolio into stocks, bonds and cash and their sub-categories. This strategy is designed to minimise the danger of putting all eggs in one basket.

Asset management fee

The fee charged by the asset management company (AMC) for portfolio management. The fee charged on an annual basis is calculated as percentage of net assets under management.

Exit load

A sales charge paid when an investor sells a fund; also known as Back-end load.

Expense ratio

The annual expenses of a fund including the management fee, administrative costs, divided by the number of units on that day.

Net asset value (NAV)

The price or value of one unit of a fund. It is calculated by summing the current market values of all securities held by the fund, adding in cash and any accrued income, then subtracting liabilities and dividing the result by the number of units outstanding.

Systematic Investment Plan (SIP)

An investment technique enabled by mutual funds where an investor buys units of a mutual fund on a fixed date for a fixed sum. Idea behind SIP is to average the cost of acquisition (Rupee Cost Averaging) of units.

Disclaimer: This data above does not purport to be advice nor a complete guide on mutual fund or investing in mutual fund. An Investor must consult a licensed professional, on any of his investment decisions before investing.