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3.1
4.1
5.1
5.2
5.3
5.4
5.5
STOCK EXCHANGES
I-13
6.5 Trading mechanism on exchanges
CONTENTS
DERIVATIVES MARKET
7.1 Introduction to derivatives
7.2 Classification of derivatives
7.3 Participants (or traders) in derivatives market
7.4 Forwards
7.5 Futures
TRADING IN SECURITIES
8.1
8.2
8.3 Price quotations
8.4 Types of orders
8.5 Order conditions
8.6 How to place an order
8.7 How to view/modify/cancel an order?
9.1 Mutual funds
9.2 Evolution of mutual funds in India
9.3 Establishment of mutual funds
9.4 Advantages of investing in mutual funds
9.5 Limitations of investing in mutual fund
INTRODUCTION TO MUTUAL FUNDS
LEARNING OUTCOMES
After reading this chapter you will be able to:
Understand the meaning of mutual fund
Know evolution of mutual funds in India
Understand the establishment of a mutual fund
Analyse the benefits or advantages of mutual funds
Know various types of mutual funds
9.1 MUTUAL FUNDS
A Mutual fund is a financial intermediary that collects funds from individual investors and invests those funds in a wide range of assets or securities. The individual investor has a claim to the assets established by the mutual fund in the proportion of the amount invested, thereby becoming a part owner of the assets of mutual funds. The fund employs professional experts and investment consultants who invest the money so collected in different stocks, bonds or other securities so as to meet the objective of fund. The net income earned on these investments together with the capital appreciation, if any are shared with the unit holders in the proportion of units held by them. The mutual fund manager charges fee from the unit holders for administering the fund and managing the mutual fund of investment. In India Mutual Funds are required to get registered with the Securities and Exchange Board of India (SEBI).
Mutual Funds are an Indirect Mode of Investment:
Mutual funds as explained above pools the money from investors and invest it across a wide range of securities. Hence from an investor’s point of view, mutual funds is an indirect of investment in financial and other assets and securities. Direct mode of investment is one in which an investor invests directly in securities or assets by himself purchasing them. In case of mutual funds, the investor invests in a particular scheme of a mutual fund and hence buys or invests in the units of mutual funds. The mutual fund in turn invests the amount given by the investor, in assets and securities and creates a mutual fund. The value of this mutual fund represents the value of the units sold by the mutual funds. To be precise, the net asset value (NAV) of the mutual fund reflects the value of the Unit held by the investor.
For example, Mr. X wants to invest ` 10000 in equity shares. He can do so using two modes in investment. (i) Direct investment - in this case Mr. X will first of all decide about the equity shares in which investment is to be made, then he will allocate ` 10,000 among these equity shares and finally buy equity shares. He has to manage this mutual fund of equity shares on his own and revise it periodically. (ii) Indirect Mode of Investment- in this case, Mr. X will buy the units of an Equity mutual fund scheme which invests in a diversified mutual fund of equity shares. By buying the units of mutual fund, Mr. X supplies his ` 10,000 to the mutual fund which in turn invests it in equity shares. The task of shares selection, mutual fund construction and revision is not done by Mr. X now. It is done by the fund manager, for which the mutual fund charges some nominal fee.
FIG. 9.1: WORKING OF MUTUAL FUNDS
Hence Indirect mode of investment i.e. mutual funds represent a convenient mode of investment for a small investor who has small savings and does not possess requisite skills for investment.
9.2 EVOLUTION OF MUTUAL FUNDS IN INDIA
The mutual fund industry in India began in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank of India. It can mainly be divided into four phases:-
First Phase - 1964-1987
Unit Trust of India (UTI) was established in 1963. UTI launched its first scheme named as Unit Scheme 1964. For a quite long period of time UTI was the only mutual fund operating in India. UTI enjoyed monopoly till the year 1987.
Second Phase - 1987-1993
The Government allowed entry of public sector banks, Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC) into the mutual fund industry. SBI Mutual Fund established India’s first non-UTI Mutual Fund in 1987. The same year witnessed the entry of Canbank Mutual Fund. Others bank following the suit were Punjab National Bank Mutual Fund (1989), Indian Bank Mutual Fund (1989), Bank of India (1990), and Bank of Baroda Mutual Fund (1992). LIC and GIC established their mutual funds in 1989 and 1990 respectively.
Third Phase - 1993-2003
This phase marked the entry of private sector into mutual fund industry in India. Moreover, the phase witnessed the first Mutual Fund Regulations (1993), according to which all mutual funds, except UTI were needed to be registered. The first private sector mutual fund registered in 1993 was Kothari Pioneer which has now merged with Franklin Templeton. In the year 1996, market regulator SEBI came up with SEBI (Mutual Fund) Regulations, 1996 replacing the old regulations of 1993. This phase had been a prosperous phase where number of mutual fund houses set up in India was on rise, with many foreign mutual funds setting up funds in India and also several mergers and acquisitions were witnessed by industry. In the year 1994 the first foreign mutual fund Morgan Stanley entered Indian Mutual fund industry.
Fourth Phase - since February 2003
UTI was divided into two separate entities. First is the Specified Undertaking of the UTI which functions under an administrator and the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations. Second is UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC, registered with SEBI and functions under the Mutual Fund
Para 9.3
Regulations. With tremendous growth potential as evident by mergers taking place among different private sector funds, the mutual fund industry can be said to have entered into its current phase of consolidation and growth. Presently there are around 45 mutual fund organizations in India handling assets worth nearly ` 10 lakh crore. Today, the Indian mutual fund industry has opened up many exciting investment opportunities for investors. As a result, we have started witnessing the phenomenon of savings now being entrusted to the funds rather than in banks alone. Mutual Funds are now perhaps one of the most sought-after investment options for most investor.
9.3 ESTABLISHMENT OF MUTUAL FUNDS
SEBI (Mutual Fund) Regulations,1996 defines mutual fund as under:
“‘Mutual fund’ means 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 related instruments or real estate assets.” Thus, a mutual fund is set up in the form of a trust and this trust has following major constituents:
1. Sponsor: Sponsor means any person who, acting alone or in combination with another body corporate, establishes a mutual fund. Sponsor is similar to promoter of a company.
2. Board of trustees: The board of trustees of the mutual fund hold its property for the benefit of the unit holders. The board is vested with the general power of superintendence and direction over Asset Management Company. They are required to monitor the performance of mutual fund and ensure compliance of SEBI Regulations by them. 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.
3. Asset Management Company (AMC): AMC is a Company established under Companies Act, 2013 and it is required to take approval of SEBI to be AMC of a mutual fund. It manages the funds of the mutual fund scheme by making investments in various types of securities. SEBI regulations require that 50% of the directors of AMC must be independent.
4. Custodian: Custodian is required to be registered with SEBI. Custodian is appointed to keep custody of the securities or gold and gold related instrument or other assets of the mutual fund and provide such other custodial services as may be authorised by the board of trustees.
9.4 ADVANTAGES OF INVESTING IN MUTUAL FUNDS
Mutual funds offer a number of benefits or advantages to the investors. The basic idea behind mutual funds is diversification and risk reduction. A small investor may not have such a large amount of savings to buy a diversified mutual fund. Hence mutual funds provide an option to such a small investor so as to reap the gains of diversification. The advantages of mutual funds are discussed below:
(
i) Professional Management:
The services of highly experienced and skilled professionals are availed under mutual funds. These professionals are backed up by a dedicated investment research team which first analyses the performance and prospects of companies and then invest accordingly.
(
(
ii) Diversification:
MFs invest in a wide range of companies of different industries and sectors. Thus, investors enjoy the benefit of diversification with less money and less risk. However it must be noted that sectoral funds such as IT funds, Pharma funds etc. may not provide the benefit of diversification as all the stocks in the mutual fund of sectoral schemes belong to a particular sector.
iii) Convenient Administration:
Investing in a Mutual Fund reduces a huge amount of paper work. Further, it helps investors to avoid many problems like bad deliveries, delayed payments and unnecessary follow up with brokers and companies.
(
iv) Return Potential:
Mutual Funds may provide higher returns in medium to long term as they invest in wide range of securities which is not possible to attain by a small investor.
(
(
v) Low Costs:
Mutual Funds are less expensive way of investing in comparison with direct investing. Indirect investing via mutual funds offers the benefits of scale in brokerage, custodial & other fees. All these benefits translate into lower costs for investors.
vi) Liquidity:
In open ended schemes, investors can get their money back instantly at the prevailing NAV. Also in close-ended schemes, investors can sell their units on a stock exchange at the prevailing market price, or can go for direct repurchase at NAV related prices.
(vii) Transparency:
Investors get regular information about the value of their investment. The disclosure on the investments made by the particular scheme along with the proportion invested in each class of assets and details regarding future investment strategy are also provided.
9.5 LIMITATIONS OF INVESTING IN MUTUAL FUND
Although mutual funds offer a number of advantages as discussed above, they are also subject to certain limitations. These limitations are provided below:
1. No direct Choice of Securities:
Mutual funds is an indirect mode of investment. Hence Investors do not have a say in the securities selection. They cannot choose securities in which they want to invest in. The mutual fund of mutual fund scheme is built by the fund manager and unit holders cannot ask for any alteration or modification.
2. Relying on Fund Manager’s Competence:
Investors have to rely on the competence of Fund Manager for receiving any earning made by the fund. Further, if Manager’s pay is linked with the fund’s performance, then in the zest of earning more, he will go for short term goals ignoring the long term ones. There is always a possibility that the mutual fund deviates from its investment objective and serves the interest of its management.
3. High Management Fee and other expenses:
All mutual funds may not run efficiently. Mutual funds at times may charge high management fee so as to pay higher compensation to the fund managers. The Management Fees, related expenses and loads charged by the fund reduce the return available to the investors.
4. Lock-in Period:
Many Mutual Funds schemes especially tax savings schemes have strict lock-in period. The mutual fund units cannot be redeemed during the lock-in period. Hence during lock-in period the units of mutual funds become illiquid.
9.6 TYPES OF MUTUAL FUND SCHEMES
Mutual funds offer various schemes to attract the investors and to meet up their investment objectives. These schemes are of different types as the fund invests in a wide range of securities keeping in mind their investor’s preference and the fund goals. Some schemes offer a steady flow of income while Para
others offer tax advantage. These schemes can be classified in a number of ways detailed as under:
OPEN-ENDED SCHEMES
STRUCTURE
MUTUAL FUNDS
INVESTMENT OBJECTIVES
CLOSE-ENDED SCHEMES
INTERVAL SCHEMES
INCOME SCHEMES
GROWTH SCHEMES
BALANCED SCHEMES
MONEY MARKET SCHEMES
TAX SAVING SCHEMES
OTHERS
SECTOR SCHEMES
INDEX SCHEMES
9.2: SCHEMES OF MUTUAL FUND
The following paragraphs discuss these schemes in detail:
1. Open-ended, Close-ended and Interval funds:
An open-ended scheme allows the investor to make entry and exit at any point in time. The capital of the fund in unlimited and there is no fixed maturity date. On the other hand, close-ended scheme has a fixed maturity period and investors can invest only during the initial launch period known as the IPO period. The investor can make an exit from the scheme by selling his units in the secondary market
FIG.
Para 9.6
or at the end of maturity period or during repurchase period. The points of distinction between open-ended and close-ended schemes are tabulated as under:
BasisOpen-ended SchemeClose-ended Scheme
Initial Subscription
Available for subscription throughout the year
Available for subscription during a speci ed period only
MaturityNo xed maturity periodStipulated maturity period
Subsequent Transactions
Investors can buy or sell units at net asset value (NAV) declared by the fund anytime, directly from the fund
Number of outstanding units Increases when the fund house sells more units in the market and decreases when the fund house repurchases the existing units
Size of fundThe fund expands in size when the fund house sells more units than it repurchases and the fund’s size reduces when the fund house repurchases more units than it sells.
Investors can buy or sell units at stock exchange where the fund is listed. The units may trade at a premium or discount to the NAV. The demand and supply of fund units and other market factors also affect their price.
The number does not change as a result of trading on the stock exchange.
No change in fund size as no sudden redemption of units takes place.
Interval funds are hybrid funds and combine the features of open-ended and close ended schemes. These schemes are open for purchase and redemption during pre-specified intervals (monthly, quarterly, annually, etc.) at NAV related prices.
2. Domestic Funds and Off-Shore funds :
Domestic mutual funds are open for investment by the investors within the country where the fund is registered. Most of the mutual funds in India are domestic funds. Off shore mutual funds are open for subscription by foreign investors only. These funds channelize foreign investment if mutual funds in a country. At present a number of off shore funds have been launched by Mutual funds in India.
3. Growth funds, Income funds and Balanced funds:
A growth fund scheme is one which offers capital appreciation and dividend opportunity to the investor. Such schemes invest majority of their funds in equities. The main idea behind a growth scheme is to
provide capital gains rather than regular income to the unit holders. Capital appreciation is in the form of increased NAVs over long period. This is ideal for investors who are in their prime earning stage and are looking for long term investment. A growth fund invests about 90% or more in equity shares. As Growth schemes invest primarily in equity shares they are exposed to high risk.
On the other hand, income funds promise a regular income to its investors. Majority of funds are channelized towards fixed income securities such as debentures, government securities, and other debt instruments. Although capital appreciation is low as compared to the growth funds, this is a relatively low risk-low return investment avenue. This scheme is ideal for investors seeking capital stability and regular income. Income funds invest about 90% of their total funds into fixed income securities so as to provide regular income to the unit holders.
A balanced fund (or Hybrid Fund) - is a combination of growth fund and income fund. They invest in shares for growth and invest in bonds for regular income. These are ideal for investors who are looking for a regular income source and moderate growth over a period of time.
4. Equity Fund schemes:
These types of mutual fund schemes are similar to growth schemes. Under equity fund schemes, the funds are invested primarily in equity shares. Hence the return from these schemes is primarily in the form of change in prices or NAVs rather than regular dividend. Equity fund schemes are growth schemes. There are a variety of equity schemes available which include- Sector specific schemes, Equity Linked Savings Schemes, Diversified equity schemes etc.
5. Debt fund schemes :
These schemes are similar to income funds. In case of debt funds the collected funds are invested in debt securities such as bonds, debentures, govt. Securities etc. These schemes offer low return at low risk as compared to Equity schemes. Debt schemes are ideal for investors who are not willing to undertake high risk and want regular income.
6. Gilt Funds :
Gilt funds are those funds which invest exclusively in government securities. Therefore, these funds provide low return at a very low risk. They are preferred by risk averse and conservative investors who wish to invest in the shadow of secure government bonds. Since gilt funds invest only in government bonds, investors are protected from credit
risk. Almost every mutual fund operating in India has launched a Gilt fund. SBI Magnum Gilt is a Gilt fund operating in India.
7. Money market funds:
Money market funds provide the opportunity of easy liquidity and moderate income. These schemes invest in short-term debt, i.e. money market instruments and seek to provide reasonable returns for the investors. The funds collected are exclusively invested in money market instruments such as Treasury Bills, Certificates of Deposit, Commercial Paper and Inter-Bank Call Money. The average maturity of such schemes is 90 days or less to help protect against interest rate risk. The income from these funds is generally determined by shortterm interest rates. These schemes are mainly used by corporate and institutional investors who wish to invest their surplus funds for short period of time.
8. Tax saving schemes [or Equity Linked Savings Scheme (ELSS)]
As the name suggests, these schemes offer tax benefits to its investors under specific provisions (Section 80C) of Indian Income-tax Act, 1961. These funds (also called Equity Linked Savings Schemes) invest in equities, thus offer long-term growth opportunities. Investment in these schemes is deductible from total income under section 80C within the limit of ` 1,50,000. This helps the investor in reducing tax liability. However these schemes have a 3-year lock-in period. These schemes are ideal for persons who seek to reduce their tax liability.
9. Index Schemes:
Index Funds attempt to replicate the performance of a benchmark market index such as the BSE Nifty or the NSE 50. The funds are allocated on the basis of proportionate weight of different securities as stated on the benchmark index and earn the same returns as earned by the market. A number of index schemes have been launched in India. Index funds are ideal for Passive management. An investor may invest in an index fund and can earn return at commensurate risk.
10. Sectoral Funds:
These funds invest exclusively in the stocks of companies belonging to a specified sector or industry. The idea is to reap the benefit of the sector or industry cycles. If an industry is going through good times, these schemes offer good returns to the investors. However, the investor can’t limit his risk exposure as available in case of diversified funds.
