CHAPTER 7: MUTUAL F`UNDS

Regulatory Body for Mutual Funds: Securities Exchange Board of India (SEBI)

Benefits of investing in Mutual Funds:

1. Small investments: Even with small investments the investor can get benefit of returns by a portfolio spread
across a wide spectrum of companies.
2. Professional Fund Management: Professionals having considerable expertise, experience and resources
manage the pool of money collected by a mutual fund. They thoroughly analyse the markets and economy
to pick good investment opportunities.
3. Spreading Risk: The risk is diversified in a mutual fund as the manager will spread the risk by investing a
number of sound stocks or bonds which is not possible by single investors’ money.
4. Transparency: Mutual Funds also provide complete portfolio disclosure of the investments made by various
schemes and also the proportion invested in each asset type. This makes this form of investments quite
reliable.
5. Choice: The large amount of Mutual Funds offers the investor a wide variety to choose from. An investor can
pick up a scheme depending upon his risk/return profile.
6. Regulations: All the mutual funds are registered with SEBI and they function within the provisions of strict
regulation designed to protect the interests of the investor.

NAV (NET ASSET VALUE):

1. It is the cumulative market value of the assets of the fund net of its liabilities.
2. NAV= net value of assets/ the number of units outstanding
3. Buying and selling of the units of the funds is done based on NAV-related prices.
4. The NAV of an open-end scheme is disclosed on a daily basis and the NAV of a close end scheme should be
disclosed at least on a weekly basis.

Risks involved in investing in Mutual Funds:

1. Returns of mutual funds are expected not assured, so there an element of risk.
2. Mutual fund derives its value from the performance of the company, if the company defaults any payment
related to bonds/ debentures, it affects the fund.
3. Other factors could be – unfavourable government policy

Different types of risks mutual funds are exposed to are:

Market risk: When the stock or bond markets fall due to some economic factors, the value of stock or bond holdings
in the fund’s portfolio can drop, thereby impacting the fund performance.

Non-market risk: Bad news about an individual company can pull down its stock price, which can negatively affect
fund holdings. This risk can be reduced by having a diversified portfolio that consists of a wide variety of stocks
drawn from different industries.

Interest rate risk: Bond prices and interest rates move in opposite directions. When interest rates rise, bond prices
fall and this decline in underlying securities affects the fund negatively.

Credit risk: Bonds are debt obligations. So, when the funds invest in corporate bonds, they run the risk of the
corporate defaulting on their interest and principal payment obligations which can lead to a fall in the value of the
bond causing the NAV of the fund to fall.

Different types of Mutual funds:

Mutual funds are classified in the following manner:

(a) On the basis of Objective

Equity Funds/ Growth Funds:

Funds that invest in equity shares are called equity funds.
Objective- capital appreciation of the investment over the medium to long-term.
Suitability for- investors who are seeking capital appreciation.
There are different types of equity funds such as
1. Diversified funds
2. Sector specific funds
3. Index based funds.

Diversified Funds: These funds invest in companies spread across sectors. These funds are generally meant for risk-
averse investors who want a diversified portfolio across sectors.
Sector Funds: These funds invest primarily in equity shares of companies in a particular business sector or industry.
These funds are targeted at investors who feel that a particular sector/ industry is going to develop fast.

Index Funds: These funds invest in the same pattern as popular market indices like S&P CNX Nifty or S&P CNX 500.
The money collected from the investors is invested only in the stocks, which represent the index. The objective is to
give a return equivalent to the market returns.

Tax Saving Funds: These funds offer tax benefits such as tax rebates to investors under the Income Tax Act.

Debt/Income Funds: These funds invest in high-rated fixed-income-bearing instruments like bonds, debentures,
government securities, commercial paper and other money market instruments. They are best suited for the
medium to long-term investors who are averse to risk and seek capital preservation. They provide a regular income
to the investor.

Liquid Funds/Money Market Funds: These funds invest in highly liquid money market instruments. The period of
investment could be as short as a day. They provide easy liquidity. They have emerged as an alternative for savings
and short-term fixed deposit accounts with comparatively higher returns. These funds are ideal for corporate,
institutional investors and business houses that invest their funds for very short periods.

Gilt Funds: These funds invest in Central and State Government securities so, they give a secured return and also
ensure safety of the principal amount. They are best suited for the medium to long-term investors who are averse to
risk.

Balanced Funds: These funds invest both in equity shares and fixed-income-bearing instruments (debt) in some
proportion. They provide a regular return and reduce the volatility (NAV going up and down) of the fund while
providing some upside for capital appreciation. They are ideal for medium to long-term investors who are willing to
take moderate risks.

b) On the basis of Flexibility

Open- ended funds Close-ended funds

Such funds are open for subscription and redemption These funds are open initially for entry during the Initial
throughout the year Public Offering (IPO) and thereafter closed for entry as
well as exit.
These funds have no fixed date of redemption. These funds have a fixed date of redemption.
more liquid than closed-ended less liquid than open-ended
Their prices are linked to the daily net asset value One of the characteristics of the close-ended schemes
(NAV). is that they are generally traded at a discount to NAV;
but the discount narrows as maturity nears.
These are not traded on stock exchange These are listed and traded on stock exchange.
Different investment plans that Mutual Funds offer:

1. Growth Plan: A growth plan is a plan under a scheme wherein the returns from investments are reinvested and
very few income distributions, if any, are made. The investor thus only realizes capital appreciation on the
investment.
2. Dividend Plan: Under the dividend plan, income is distributed from time to time. This plan is ideal to those
investors requiring regular income.
3. Dividend Reinvestment Plan: Dividend plans of schemes carry an additional option for reinvestment of income
distribution. This is referred to as the dividend reinvestment plan. Under this plan, dividends declared by a fund
are reinvested in the scheme on behalf of the investor, thus increasing the number of units held by the
investors.

As per SEBI Regulations on Mutual Funds, an investor is entitled to: (read from the text book)

Fund Offer Document is a document that offers you all the information about a particular scheme and the fund
management company It gives information of the risks involved. This must be designed in accordance with the
guidelines given by SEBI. It should have the following:

1. Investment objectives
2. Risk factors and special considerations
3. Summary of expenses
4. Constitution of the fund
5. Guidelines on how to invest
6. Organization and capital structure
7. Tax provisions related to transactions
8. Financial information

Investment plan:
 It refers to the services that the funds provide to investors offering different ways to invest or reinvest.
 It determines the flexibility available to the investors.

Rights available to a Mutual Fund holder in India

As per SEBI Regulations on Mutual Funds, an investor is entitled to:

1. Receive Unit certificates or statements of accounts confirming your title within 6 weeks from the date your
request for a unit certificate is received by the Mutual Fund.

2. Receive information about the investment policies, investment objectives, financial position and general affairs of
the scheme.

3. Receive dividend within 30 days of their declaration and receive the redemption or repurchase proceeds within
10 days from the date of redemption or repurchase.

4. The trustees shall be bound to make such disclosures to the unit holders as are essential in order to keep them
informed about any information which may have an adverse bearing on their investments.

5. 75% of the unit holders can pass a resolution to wind up the scheme.

6. An investor can send complaints to SEBI, who will take up the matter with the concerned. Mutual Funds and
follow up with them till they are resolved.
Fund Offer Document: It is a document that offers all the information about a particular scheme and the fund
launching that scheme. That way, before you put in –

A. MUTIPLE CHOICE QUESTIONS:

1 It’s a special kind of mutual fund whose prices fluctuate with the demand and supply in the stock market. Identify.
a) Debt funds
b) close-ended funds
c) Diversified funds
d) All of the above

2. These funds invest in Central and State Government securities. These are backed by Government bonds. What
kind of investors like ton invest here.
a) Investors looking for capital appreciation
b) Investors looking for handsome return on mutual funds
c) Those who want regular income only
d) Medium to long-term investors who are averse to risk

3. Which of the following is not true?

a) Receive Unit certificates confirming title within 6 weeks from the date your request for a unit certificate is
received by the Mutual Fund.
b) Receive information about the investment policies, investment objectives, financial position and general affairs of
the scheme.
c) Receive dividend within 10 days of their declaration
d) 75% of the unit holders can pass a resolution to wind-up the scheme.

4. Risk to which Mutual Funds are exposed is

a) falling bond prices
b) Default in the redemption of debentures by Company
c) Bad news about an individual company
d) All of the above

5. Buying and selling into funds is done on the basis of ------------of mutual funds.
a) NAV
b) listed price
c) issue price
d) traded price

B Very Short Answer Questions VSA (1 Mark) Level

1 What is diversification? U

2 How do mutual funds spread risks? MD

3 What is an ETF? U

4 What is Net Asset Value? H

5 Who regulates Mutual Funds in India? C

C Short Answer Questions SA (2/3 Marks) Level

1 Explain the market and non-market risks involved in mutual funds. U

2 Write a brief note on balanced funds, tax funds, liquid funds. MD

3 Differentiate between active fund management and passive fund management. H

4 Differentiate between growth investing style and value investing style. U

5 Classify and explain the types of mutual funds on the basis of flexibility. MD

6 Differentiate between diversified funds and sector funds.

7 Explain the different types of equity funds.

D Long Answer Questions LSA (5 Marks) Level

1 Explain the features of passive fund management. MD

2 Describe the benefits of investing in mutual funds. C

“Mutual Fund is subject to market risk; read all documents carefully before invest”. You
3 U
must aware about debt market mutual fund investment risks describe each in brief.

4 What are the rights that are available to a Mutual Fund holder in India? MD

This has to be designed in accordance with the guidelines stipulated by SEBI and the
5 prospectus must disclose details important information about the mutual fund. To
what do these lines refer to? Name it. Also, write about its significance.