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MUTUAL FUNDS

THEORY

Mutual Fund
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 invested by the
fund manager in different types of
securities depending upon the objective
of the scheme. These could range from
shares to debentures to money market
instruments. The income earned through
these investments and the capital
appreciation realized by the scheme is
shared by its unit holders in proportion to
the number of units owned by them.

Anybody with an investible surplus of

as little as a few hundred rupees can invest in Mutual Funds. Each Mutual Fund
scheme has a defined investment objective and strategy. Mutual fund operations are
overseen by Board of Trustees and regulated by SEBI and therefore offers comfort
and protection to investors.

Stocks or Mutual Funds

Disadvantages of investing in a stock as compared to investing in a mutual fund are
many:
1. Money may not be sufficient to invest in many stocks, especially if you are
interested in creating a diversified portfolio.

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2. Many investors prefer several less value stocks to create a diversified portfolio,
but they may not satisfy the investment criteria at all.
3. One must consider the fact that several hours must be spent in identifying a
good stock for investment. One must understand the financials, browse lot of
data, gather variety of information about the business, sector, industry,
management etc. Such a time is usually not available.
4. After buying stocks, regular monitoring is required like tracking results, news
about the product, company etc., which may not be available. Therefore, stocks
may not be sold at the right time after investing, that can result in losses.
5. Most importantly, all investors may not possess the required knowledge to
study financials etc.
6. The appetite to take risk and face the ups and downs of a single stock in the
market is not everyone’s forte.

Benefits of investing through Mutual Funds

1. Professional Management
Mutual Funds provide the services of experienced and skilled professionals, backed by
a dedicated investment research team that analyses the performance and prospects of
companies and selects suitable investments to achieve the objectives of the scheme.

2. Diversification
Mutual Funds invest in a number of companies across a broad cross-section of
industries and sectors. This diversification reduces the risk with far less money than one
can do on their own.

3. Convenient Administration
Investing in a Mutual Fund reduces paperwork and helps avoid many problems such as
bad deliveries, delayed payments and follow up with brokers and companies. Mutual
Funds save time and make investing easy and convenient.

4. Low Costs
Mutual Funds are a relatively less expensive way to invest compared to directly
investing in the capital markets because the benefits of scale in brokerage, custodial
and other fees translate into lower costs for investors.

5. Liquidity
In open-end schemes, the investor gets the money back promptly at net asset value
related prices from the Mutual Fund. In closed-end schemes, the units can be sold on a
stock exchange at the prevailing market price or the investor can avail of the facility of
direct repurchase at NAV related prices by the Mutual Fund.

6. Transparency

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You get regular information on the value of your investment in addition to disclosure on
the specific investments made by your scheme, the proportion invested in each class of
assets and the fund manager's investment strategy and outlook.

7. Flexibility
Through features such as regular investment plans, regular withdrawal plans and
dividend reinvestment plans, you can systematically invest or withdraw funds according
to your needs and convenience.

8. Affordability
Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual
fund because of its large corpus allows even a small investor to take the benefit of its
investment strategy, by paying just few hundred rupees.

9. Choice of Schemes
Mutual Funds offer a family of schemes to suit your varying needs over a lifetime.

10. Well Regulated

Mutual Fund operations are overseen by Board of Trustees and regulated by SEBI.

Drawbacks of investing in a Mutual Fund

1. Even mutual funds face the risk of losing the amount invested, owing to market risk, poor
performance of the fund manager, poor policies of the fund house etc.
2. Investors cannot choose the securities which they want to invest in.
3. Investors face the risk of Fund Manager not performing well
4. Diversified mutual fund portfolios may provide less returns than the investor expects; as
investor may earn more by selecting few good stocks for investment
5. It is unfortunate that investor can rely only on past performance to select a good fund and
it may not guarantee good returns for future
6. Many mutual funds may provide positive returns, but may provide returns less than the
benchmark
7. If fund manager’s pay is linked to performance of the fund, he may be tempted to perform
only on short term and neglect long term performance of the fund.
8. The management fees charged by the fund reduce the return available to the investors.
9. Investors in Mutual Fund have to rely on the fund manager for receiving any earning made
by the fund, i.e. they are not automatic.

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Establishment of a Mutual Fund

The SEBI (MF) Regulations 1993 define a mutual fund (MF) as a fund established in the form
of a trust by a sponsor to raise monies by the Trustees through the sale of units to the public
under one or more schemes for investing in securities in accordance with these regulations.
These regulations have since been replaced by the SEBI (MF) Regulations, 1996.
A MF comprises four separate entities, namely sponsor, mutual fund trust, AMC and custodian.
The sponsor establishes the MF and gets it registered with SEBI. The MF needs to be
constituted in the form of a trust and the instrument of the trust should be in the form of a deed
registered under the provisions of the Indian Registration Act, 1908. The sponsor is required
to contribute at least 40% of the minimum net worth (₹ 10 crore) of the asset management
company. The board of trustees manages the MF and the sponsor executes the trust deeds
in favour of the trustees. It is the job of the MF trustees to see that schemes floated and
managed by the AMC appointed by the trustees are in accordance with the trust deed and
SEBI guidelines. MF appoints custodian, approved by SEBI, to take care of delivering and
accepting delivering of securities on sale and purchase of securities. MF also appoints
registrars to service investors and address on queries and grievances of non-receipt of units,
dividend etc.

Types of Mutual Funds by function

Open-end Funds
An open-end fund is one that is available for subscription (sale and repurchase) all through
the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at
Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity.

Closed-end Funds
A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years.
The fund is open for subscription only during a specified period. Investors can invest in the
scheme at the time of the new fund offer (NFO) and thereafter they can buy or sell the units
of the scheme on the stock exchanges where they are listed. In order to provide an exit route
to the investors, some close-ended funds give an option of selling back the units to the Mutual
Fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at
least one of the two exit routes be provided to the investor.

Interval Funds
Interval funds combine the features of open-ended and close-ended schemes. They are open
for sale or redemption during pre-determined intervals at NAV related prices. For example, a
scheme may be open for subscription and redemption only from 1st to 5th of every month. This
may suit certain class of investors to prefer this product as also facilitate fund manager to
manage the liquidity of the funds managed.

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Classification of Mutual Funds

The mutual fund can be classified based on several parameters. The following figure detail
their classification.

Type of Equity Funds

1. Growth Funds: These funds invest predominantly or fully in equities and aim at long term
growth i.e., capital appreciation.
2. Aggressive Funds: These funds also invests fully in equities, but prefers high beta stocks,
IPOs, and aim at earning frequent speculative gains. Such portfolios have high 'portfolio
turnover', meaning churning of stocks will be more frequent.
3. Income Funds: These funds cater to the needs of those investors who want to invest in
equity but desire regular income. Such funds invest in high dividend yield stocks, and
prefers less speculative stable & less volatile stocks in the portfolio.

Type of Debt Funds

There are two broad type of debt funds:

1. Bonds Funds:
Bond funds are funds that invest in short- and long-term bonds from a variety of issuers, such
as high rated corporate bonds, government securities etc. They tend to be less volatile in most
periods, unlike equity funds. They provide advantages such as diversification, liquidity, and
convenience, provide income stream and have a potential for tax-free income.

2. Gilt Funds:

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These funds predominantly invests in T-bills and dated securities issued by state and central
governments. Such funds generate steady and consistent return from a basket of
government securities across various maturities through proactive fund management aimed
at controlling interest rate risk.

Risks of Bond Funds

Bond Funds carry risks, such as Interest rate risk, credit risk, call risks, reinvestment risk etc.
[Refer Bond Market chapter for details about risks]

Index Funds
Index Funds are passive mutual funds that mimic popular market indices. The Fund Manager
doesn’t play an active role in selecting industries and stocks to build the fund’s portfolio but
simply invests in all the stocks that make up the index to be followed. The weightage of the
stocks in the fund closely matches the weightage of each of the stocks in the index. This is
passive investment i.e., the fund manager simply copies the Index while building the fund’s
portfolio and tries to maintain the portfolio in sync with its index at all times.
If the weight of a stock within the index changes, the fund manager must buy or sell units of
the stock to have its weight in the portfolio aligned to that of the index. While passive
management is easier to follow, the fund doesn’t always produce the same returns as that of
the index due to tracking error.
Tracking error occurs because it is always not easy to hold the securities of the index in the
same proportion and transaction costs are incurred by the fund in doing so. Despite tracking
error, index funds are ideal for those who don’t want to take the risk of investing in mutual
funds or individual stocks but would like to gain from exposure to the broader market.

Offshore Funds Vs International Funds

Offshore funds
Offshore mutual funds are professionally managed funds that are established and registered
outside India and are only available to non-Indian residents. In other words, these funds collect
money overseas but invest in India.
Offshore mutual funds are registered under the laws of overseas jurisdictions. Clients investing
in these funds invest for tax benefits. Because of their potential tax benefits, offshore mutual
funds can be a great option for non-Indian investors wanting a diverse portfolio with
professionally managed funds.

International funds
International funds are Indian registered funds but invest in global markets. Therefore, it is an
avenue for Indian investors to have exposure to global portfolio. An Indian investor desirous

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of having diversification which includes stocks invested in overseas markets should prefer
International Funds investment.
The biggest advantage of investing in international mutual funds is geographical
diversification. This ensures that all investments are not tied to a single region, thus enabling
an investor to benefit from the growth of diverse economies.

Money Market Funds

Money market funds are mutual funds that invest in money market instruments or securities
that have maturity period of one year or less. These securities are one of the safest and could
include T-Bills, commercial paper, certificates of deposits etc. Such securities are
characterized by short maturities and minimal credit risk. Money market mutual funds are
among the lowest-volatility types of investments. Income generated by a money market fund
could be either taxable or tax-exempt, depending on the types of securities the fund invests
in. These funds are less volatile, aim to provide stable income and are preferred by risk averse
investors who do not want to invest in comparatively more volatile bond funds.

Capital Protection Oriented Funds

These are closed ended funds that are hybrid in nature. They allocate money to debt and
equity securities. The allocation to debt securities is done in such a way that at the end of the
term of the product, the value of debt investment is equal to the original investment in the fund.
The equity portion aims to add to the returns of the product at maturity. These funds are
oriented towards protection of capital and do not offer guaranteed returns.
Say, for example, AAA bonds are quoting at interest rate of 10% p.a. for a 5-year term. This
means that at the end of 5 years, the investment of ₹100 in such bonds would be worth
₹161.05, assuming reinvestment of the interest. On the other hand, if one invests ₹62.09 in
such bonds, the value of the bonds at the end of 5 years would be ₹100. In such a case, the
allocation between equity and debt would be 37.91: 62.09 respectively. So, if the equity value
reduces to zero, the investor gets back the original amount invested.
The asset allocation is a function of prevailing interest rates on high quality (AAA rated) bonds.
It is mandatory for the fund to be rated by at least one rating agency in order to be called a
capital protection-oriented fund. Debt securities held in the portfolio must be of highest rating.

Gold Funds
Gold mutual funds are an investment option that allows investors to invest in gold without
buying physical gold. A gold fund is a type of mutual fund scheme that invests in units of ETFs
(Exchange Traded Funds) of gold. It is an open-ended investment option that does not require
an investor to open a demat account, as the investment is made in units of gold ETFs.

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These funds invest in gold-related securities such as exchange-traded funds (ETFs), mining
stocks, and futures contracts of Gold.
Gold mutual funds in India are subject to taxation, just like any other investment. The
taxation on gold mutual funds depends on the duration of the investment and the type of
gains made.

Advantages
1. Convenience : Investors can invest in gold mutual funds through online platforms, making
it a hassle-free investment option.
2. Diversification : Gold has historically had a low correlation to stocks and bonds, so
investing in gold mutual funds can reduce the overall risk of a portfolio.
3. Hedging against inflation : Gold has historically been a hedge against inflation, and gold
mutual funds can help investors protect their investments from the effects of inflation.
4. Transparency : Gold mutual funds in India are regulated by the Securities and Exchange
Board of India (SEBI) and provide transparency to investors. These funds have to disclose
their holdings, expense ratio, and performance regularly, which helps investors make
informed investment decisions.

Key differences between investing in physical gold, gold mutual funds, and sovereign gold
bonds:

Sovereign Gold
Features Physical Gold Gold Mutual Fund
Bond
Form of Physical asset Digital asset Digital asset
investment
Liquidity Medium to low High High
Security and Requires secure No storage No storage
storage storage and required required
insurance
Sovereign No No Yes
guarantee
Cost of investment High transaction Low management No transaction fee,
and storage fees fees small annual
charges of demat
account
Returns Market dependent, Market dependent, 2.5% per year
no fixed returns no fixed returns Fixed interest rate
+ market returns

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Quant Funds
A quant fund is an investment fund whose securities are selected based on numerical data
compiled through quantitative analysis. They are so called because they use quantitative
analysis rather than fundamental analysis. These funds are considered modern and passive.
They are built with customized models using software programs to determine investments.
Quant funds choose investments using inputs and computer programs. They believe in cutting
down on the risks and losses associated with management by human fund managers.
However, there exists human intervention in the form of monitoring the performance and
tweaking the quantitative model in times of need.

ELSS Funds
An ELSS is an Equity Linked Savings Scheme, that allows an individual or HUF a deduction
from total income of up to Rs. 1.5 lacs under Sec 80C of Income Tax Act 1961.
These schemes have a lock-in period of three years from date of units allotment. After the
lock-in period is over, the units are free to be redeemed or switched. ELSS offer both growth
and dividend options. Investors can also invest through Systematic Investment Plans (SIP),
and investments up to ₹ 1.5 lakhs, made in a financial year are eligible for tax deduction. One
must be careful when choosing Dividend Reinvestment Plan. This is because every
reinvestment will have a lock in of three years.

Exchange Traded Funds (ETF)

An ETF is created with a theme of investment. Then, it is the duty of the sponsor to create
enough interest in the new ETF so that investors will buy it. A sponsor then begins the creation
process by selecting an index that’s available to license and collaborates with an index
provider on the creation of a new ETF. It’s also the sponsor’s responsibility to get approval
from the regulator to create and market the fund.
The sponsor then identifies the select authorized participants who will provide the underlying
shares forming the index. A sponsor and a select number of authorized participants create an
ETF, though in some situations, a sponsor can himself be an authorized participant. An
authorized participant is a market maker, specialist, or institutional investor, who wanted to
invest in securities underlying the index for a very long-term period. Original ETF units, called
creation units, are created and issued to these authorized participants in lieu of the basket of
the securities tendered by these authorized participants.
If a new security is added to the index, the sponsor asks the authorized participant to deliver
shares of the new security and returns any securities dropped from the index. Similarly, when
the weights of underlying securities change within an index, then too securities are exchanged
with the authorized participant so as to ensure that the weights get aligned with the weights in
the original index. These exchanges don’t affect the value of the ETF shares an investor holds.

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A sponsor also has a responsibility to appoint a custodian who would upkeep the underlying
shares of the creation units issued to the authorized participants. A custodian’s primary
responsibility is relatively simple — keeping the securities underlying the ETF safe and acting
as a guarantor against fraud. In the case of stocks or bonds, the custodian holds the electronic
record of the securities. With a gold or silver ETF, the custodian has possession of the actual
commodity.
The custodian's other primary task is collecting dividends or interest on securities the ETF
holds and paying them out in the way that’s appropriate to the particular fund. Some ETFs
reinvest these earnings in the fund, others distribute them to the shareholders, and still others
offer investors the opportunity to reinvest the money in additional shares.

Advantages of ETFs
1. Simplicity and ease of the product to buy and sell
2. Lower expense ratio compared to almost any alternative investments
3. No income tax and only capital gains tax on sale
4. Tax Free on sale beyond one year
5. Easy liquidity permits an investor to buy or sell at will
6. Easy to track as they are listed and quotes are easily available
7. Price transparency since it is quoted in an exchange
8. Almost zero maintenance cost

ETF Vs. Open Ended Funds Vs. Close Ended Funds

Parameter Open Ended Fund Closed Ended Exchange Traded
Fund
Fund Size Flexible Fixed Flexible

NAV Daily Daily Real Time

Liquidity Provider Fund itself Stock Market Stock Market/ Fund

it

Sale Price At NAV plus load, if Significant Premium/ Very close to actual
any Discount to NAV New Scheme

Availability Fund itself Through Exchange Through Exchange

where listed with Fund itself.

Portfolio Disclosure Monthly Monthly Daily/ Real- time

Intra-Day Trading Not Possible Expensive Possible at low cost

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Advantages/Disadvantages of ETFs over mutual funds:

Advantages of ETFs over mutual funds:
• ETFs are traded on exchanges so can be sold or purchased at any time at the prevailing
price in the exchange. Open-end mutual funds can only be bought or sold at one specified
price (NAV) depending on the time of purchase or sale.
• The portfolio underlying ETF’s are always same and available for investor monitoring,
unlike in a mutual fund, where the portfolio movements are not immediately available for
investor monitoring. Mutual funds disclose portfolio at specified intervals as per regulator
norms.
• Transacting ETF’s are as simple as transacting equity shares. One has to just place an
order and his/her depository account gets credited / debited. Buying or selling a mutual
fund is not as simple as ETF.

Disadvantages of ETFs over mutual funds:

• There is a brokerage commission charged when buying and selling ETF shares. However,
in a mutual fund, nowadays an investor can choose “Direct option” and enter a mutual fund
with zero cost.
• A mutual fund investor can choose actively managed funds or passively managed index
funds. ETF’s are by their structure a reflection of prices of basket of stocks (mostly indices)
originally created. An investor has no choice.

Diversified Equity Funds

Diversified Equity Mutual Funds aim at diversifying investments in companies across a wide
range of sectors, irrespective of their size or whether they are large-caps, mid-caps or small-
caps. The primary aim of Diversified Equity Mutual Funds is to achieve long-term capital
appreciation through diversified investments across the stock market. Besides, investing in
different sectors also minimise risks, proving to be a smart long-term investment option that
accrues good returns even during challenging economic scenarios. Diversified equity funds
help investors meet long-term financial goals like children’s education, marriage, retirement
plans, etc.

Multi Cap Funds

Multi-cap funds are types of equity funds that diversify their investment in different market
capitalizations which are large cap, midcap, and small-cap companies. Multi cap funds usually
allocate their investment in different market cap stocks with an equal proportion of 25%. Thus,
they have to allocate 75% in equities.

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Flexi-cap Funds
Flexi cap funds are types of mutual funds that diversify their investment in companies
belonging from different market capitalization and sectors. There are no restrictions of fixed
allocation in each market cap or sector stocks. They have a minimum allocation in equities of
65%. Fund managers of Flexi-cap funds have no restriction while choosing stocks hence, they
can choose stocks from different market capitalizations and sectors.

Contra Fund
Contra fund is basically an equity mutual fund which invest in stocks which are currently not
in focus in the market, and they are underperforming. It is believed that a turnaround in
performance is around the corner. Therefore, the investment goes against the conventional
wisdom. It is believed that when the current problem of performance or perception is resolved
soon, the stock is expected to be an outperformer. It is a contrarian approach or out-of-the-
box approach to investing in equities.

Dividend Yield Fund

A dividend yield fund is a diversified type of equity fund where investment is made in the stocks
of companies that regularly declare dividends. The main aim of dividend yield fund is not
capital appreciation but to identify and invest in stocks that offer regular dividends to the
investors. As a company can declare dividends only if it is making healthy profits, dividend
yield mutual funds usually invest in companies with strong financials, excellent cash flow and
has good dividend policy.

Arbitrage Funds
Arbitrage refers to simultaneous purchase and sale of equivalent positions in two markets to
exploit mispricing. Arbitrage funds exploit mispricing in futures prices i.e. the price difference
between theoretical and actual futures price. The funds take futures and stock positions in the
process. Two trades are done simultaneously in the two markets irrespective of market trend.
Positions are held till expiry and closed to realize the profit.
The four most important features of arbitrage funds are as follows:

1. Volatility leads to lot of opportunities. As the profits are identified and pre-determined,
arbitrage funds have minimal risks. In fact, these funds are one of the few low-risk
investment instruments which perform well in volatile markets.
2. Arbitrage funds enjoy better taxation benefit of equity funds as against debt funds and
profits arising from these schemes are exempt from tax if held for more than one year.
Prior to the budget announcement in 2014, an investor would have earned similar returns
in debt funds and arbitrage funds and so could invest in either of them, but with the new
taxation policy, arbitrage funds have an edge over debt funds which suffer from the
disadvantage of long term capital gain tax of 20% with indexation and minimum 3 years of
holding period. Post tax returns are the biggest advantage of arbitrage funds.
3. Pre-determined profit estimations of arbitrage funds help investors to forecast their returns.
Realistic post tax returns from these funds range from 6% to 7%.

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4. Arbitrage funds are essentially a proxy to liquid funds. To be able to capitalize on the
benefits of these funds, one would have to stay invested for one full expiry cycle which is
can just one month in most cases.

Sector Funds and Thematic Funds

Sector funds invest money only in the specific sector/industry. A banking sector fund would
invest only in banking stocks. A Power and Natural resources sector fund would invest only in
stocks belonging to the power and natural resources sector only. It provides diversification
within a sector. It is better than single stock investing. Investment in sector funds is all about
the right timing. The main idea is to tap-in on the growth of a particular sector/industry. An
investor who held IT sector funds during the year 2000 would have reaped huge rewards while
the one who held it during the year 2008 would have lost substantially. The disadvantage
around sector fund investment is the higher rate of volatility. Investing in such funds, requires
greater risk-taking capability.
Thematic Funds are almost similar to sector funds. But instead of strictly focusing on specific
sectors, invests surrounds a theme say ‘manufacturing’. A ‘manufacturing’ thematic funds
would concentrate on investing in various sectors connected with manufacturing. Thematic
funds are more diversified than sector funds as far as sector diversification is concerned but
could be big failure if the invested theme fails.
Investors who know the sector/ theme well and know when to invest and exit should be the
ones taking bets on sector/thematic funds. These funds are also for investors who would like
to take concentrated bets on a particular sector or theme but are unable to decide which stocks
to invest in. By buying such a fund, they buy the entire basket of stocks in that sector. In all,
sector and thematic funds are meant for seasoned investors who have domain knowledge
regarding a sector or theme and know when to enter or exit. Such funds should not be large
percentage of one’s overall holdings.

Fund of Funds (FoF)

Fund of Funds is 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.
The advantage of FoF is that, when we do not want to invest in a particular equity fund of any
mutual fund, then FOF equity fund would be better choice. The disadvantages are:

1. There is no guarantee that the fund manager who manages FOF will be efficient
2. High Expense ratios

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3. Taxation Disadvantages

Side-Pocketing in Mutual Funds – Nov 2020

The term side-pocketing in mutual fund (MF) parlance, refers to a practice where fund houses
isolate risky assets from the rest of their holdings and cap redemption. After side-pocketing,
investments will contain of two parts – one containing all risky or troubled securities and the
other – remaining investments and cash holdings.
Once the fund manager comes to know of a security that is likely to be degraded or degraded
to junk status or 'default' grade which is likely to result in a sharp drop in the scheme's net
asset value (NAV), he will side-pocket (separate it) the bad asset. Subsequent to the split, the
segregated portion with the bad investment gets closed for subscriptions as well as
redemptions. The 'good' portion of the scheme will be open for subscription and redemption
as usual. If and when the fund house recovers the money from the bad assets, it pays off the
money to unit holders whose investments were stuck in the fund before the default.
Previously, SEBI was not in favour of allowing funds to side-pocket or segregate their bad
units. Now after the IL & FS fiasco, the board met and accepted the recommendations to allow
side-pocketing made the SEBI's mutual fund advisory committee.
Side-pocketing achieves three benefits. With the separation of bad asset, the investor has
three other choices besides selling both units: One, retain both units till maturity. Two, sell the
good unit and retain the bad one. Three, sell the bad unit and retain the good one.
The second benefit of side pocketing ensures that new investors are not faced with the loss
that can arise from bad asset. Even the mutual fund can market the good part separately.
The third benefit is that it can open doors for risky investors to subscribe for bad asset part of
the portfolio, who may be betting on the recovery process and expecting that amount more
than the expected loss is likely to be recovered.
The only downside of a side pocket in theory is that it may encourage fund managers to buy
riskier securities because they can always chop off the bad part when things get
tough. Alternatively, will this encourage the fund managers to proactively buy risky securities
to offer a separate layer of investment to risky investors?

Fixed Maturity Plans (FMP)

A Fixed Maturity Plan (FMP) is a kind of debt-based mutual fund which is closed-ended in
nature. It has a fixed tenure. This fund invests majorly in fixed income instruments whose
maturity period is in sync with the maturity of the fund.
FMPs invest in fixed income instruments like Commercial Papers (CP), Corporate Bonds,
Certificate of Deposits (CD), Non-Convertible Debentures (NCDs) of reputed and high rated
businesses, G-secs, money market instruments and more.
The maturity date of an FMP is closely aligned with the maturity period of these instruments.
Therefore, FMPs can yield a relatively fixed rate of return on maturity. One big advantage is

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one gets to know approximate returns (on maturity), in advance, at the NFO (New Fund Offer)
stage itself. Thus, for investors, who are looking for investments with relatively predictable
returns on maturity, FMPs are a suitable option. Looking at the nearly predictable returns
offered by the FMPs, it can be said that they have a lesser exposure to interest rate risk. Also,
these funds generally invest in high rated instruments. This can lower the risk of default or
credit risk.

Hedge Funds
There is no exact definition to the term "Hedge Fund"; it is perhaps undefined in any securities
laws. There is neither an industry wide definition nor a universal meaning for "Hedge Fund".
Hedge funds are unregistered private investment partnerships, funds or pools that may invest
and trade in many different markets, strategies and instruments (including securities, non-
securities and derivatives) and are not subject to the same regulatory requirements as mutual
funds, including mutual fund requirements to provide certain periodic and standardized pricing
and valuation information to investors.
In order to mitigate a particular type of risk, a hedge fund manager employs a particular risk
management or hedging technique. For example, the market risk can be hedged against by
selling a broad collection of securities short in equal proportion to one’s long exposure or by
buying put options on an index. One may hedge against factors like interest rate, inflation,
currency, and the tools and techniques of hedging include raising cash, selling short, buying
or selling options, futures, and commodity and/or currency futures. Hedge funds also tend to
be skill-based investment strategies that attempt to obtain returns based on a unique skill or
strategy. It can take both long and short positions, use arbitrage, buy and sell undervalued
securities, trade options or bonds, and invest in any opportunity in any market where it
foresees impressive gains at reduced risk. The primary aim of most hedge funds is to reduce
volatility and risk while attempting to preserve capital and deliver positive returns under all
market conditions.

Differences between a mutual fund and hedge fund

Mutual Fund Hedge Fund

Strategy Broadly directional Could be directional,

arbitrage and spread

Asset classes Usually single or two Uses all four major assets
assets viz. Equity and – Equity, Debt, Currency
Debt and Commodity

Return correlation High Low

with Market returns

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Mutual Fund Hedge Fund

Investor mentality Buy & Hold or pre-defined Trading or opportunistic

strategy

Target Outperform benchmark Generate return with low

volatility

Risk management level Low High

Fees Low High

Type of fees Management fees Performance fees

Regulation Well regulated Not as regulated as

mutual fund

Disclosures Good Poor

Options of Mutual Funds

Indian mutual funds offer three broad options within a scheme to Indian investors. They are:

• Growth option
• Dividend option
• Dividend Re-investment option

Growth Option:
The Growth option reinvests the profits back into the scheme and it is the ideal option for
investors who are looking to create a corpus for long-term goals.

Dividend pay-out option:

Under the Dividend pay-out option, the scheme distributes realised profits to investors as
dividends. This option is useful to investors looking for periodic income from their mutual
fund investments.

Dividend reinvestment option:

Dividend reinvestment option does not distribute the dividends to investors, the dividend is
declared, but not physically paid out. Instead, it is reinvested back into the scheme. And the
additional units are issued. These additional units are treated like a fresh purchase.
Same fund manager manages the different options. The investment portfolio that will be
handled by the fund manager is same, irrespective of which option one chooses. So,
the choice of option will not modify the performance of Mutual Funds. The choices are

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accounting entries that the fund makes to suit the needs of investors who may require dividend
pay-outs.

Differences between mutual fund plan options

Description Growth Dividend Re-investment Dividend Pay-

Option out Option

Dividend No No Yes
Received

Additional units No Yes No

issued

NAV Change No Declines to the extent of Declines to the

dividend extent of dividend

Value before No Change No Change Decreases

and after
dividend

Class of One who is One who does not desire One who is
investors looking at income, but desires tax looking to create
regular tax- benefits and at the same time wealth over the
free income interested in building wealth long run
over long-term

Systematic Withdrawal Plan & Systematic Investment Plan

A systematic withdrawal plan (SWP) allows investors to receive a regular income while still
maintaining their investments’ growth potential. Investors can use a SWP to supplement the
income they are receiving from any other source. A SWP includes convenient pay-out options
and has several tax advantages. An investor can choose to withdraw from the capital
appreciation in the NAV without affecting the principal amount a fixed amount every month or
quarter and any amount thereafter.
Systematic Investment Plan (SIP) is a feature specifically designed for those who are
interested in building wealth over a long-term and plan out a better future for themselves and
their family. The Systematic Investment Plan allows investors to save a fixed amount of rupees

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every month or quarter for the purchase of additional units. Anyone can enrol for this facility
by starting an account with (minimum investment amount) and giving post-dated cheques or
providing debit instructions through Electronic Clearing Service (ECS) of periodic investment
every month for a specified period based on one’s convenience. This disciplined approach to
investing gives advantages like, benefit of compounding, rupee cost averaging, convenience,
and help build wealth over the long-term and avoiding the risk of timing the market.

Expenses of a Mutual Fund

An AMC incurs various expenses and as expenses increase the return on a mutual fund
reduces. The following are two major expense heads:

1. Initial expenses – This is attributable to establishment of a scheme under a mutual fund

– this is similar to preliminary expenses of a corporate. Earlier, these initial expenses were
booked in the respective scheme accounts as a ‘load’. Now the mutual fund sponsor bears
them.
2. Recurring expenses – This is day to day expenses which are spent in running a mutual
fund scheme. The total annual recurring expenses of the Scheme, excluding deferred
revenue expenditure written off, issue or redemption expenses, but including the
investment management and advisory fee are classified as recurring expenses that can
be charged to the scheme shall be within the limits specified in Regulation 52 of SEBI
(Mutual Funds) Regulations.
3. Total Expense Ratio (TER): Investors generally look for the total quantum of expenses
through a measure called expense ratio which is given by:
Expenses per unit
Average Net Value of Assets

Maximum total expense ratio (TER) permissible under Regulation 52 (4) and (6) (c) is up
to 2.50% of average daily net assets of the scheme. It is to be noted that expenses
exclude brokerage incurred while doing sales and purchases of securities, as sales and
purchases are recorded on net basis.

Valuing Non Traded Securities

When a security is not traded on any stock exchange for a period of sixty days prior to the
valuation date, the scrip must be valued as a non-traded scrip. They should be valued “in good
faith” by the AMC on the basis of appropriate valuation methods based. Such method must be
approved by the Board of the AMC. The auditors should also report it as fair and reasonable
in their report. The following principles should be adopted:

1. Equity instruments shall generally be valued on the basis of capitalization of earnings

solely or in combination with the net asset value. The price or earnings ratios of

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comparable traded securities, with an appropriate discount for lower liquidity, should be
used for the purposes of capitalization.
2. Debt instruments should be valued on YTM (yield to maturity) basis. The capitalization
factor being determined for comparable traded securities with an appropriate discount for
lower liquidity.
3. Government securities will be valued at YTM based on the prevailing market rate.
4. Call money, bills purchased under rediscounting and short-term deposits with banks are
to be valued at cost + accrual; other money market instruments are traded at the yield at
which they are currently traded.
5. For Convertible debentures and bonds, non-convertible component should be valued as
a debt instrument, and convertibles as any equity instrument. If after conversion, the
resultant equity instrument would be traded pari-passu with an existing instrument which
is traded, the value of the latter instrument can be adopted after an appropriate discount
for the non-tradability of the instrument.

Selecting a mutual fund for investment

1. Past Performance – Though NAV is the yardstick for measuring monetary returns, the
real performance should be gauged with respect to the benchmark and the overall market
returns during the period under evaluation.

2. Timing – Generally mutual collect more money during bullish times and shies away from
market during bearish times. It should be other way round for growth in investments.
Novice investors should not attempt to time the markets.

3. Size of Funds – Preferring a large sized mutual fund may not be advisable as it may find
it difficult to build an attractive portfolio easily owing to its sheer demand for stocks. Time
may run out or market liquidity may forbid construction of quality portfolio. In the case of
small funds a big redemption may tilt the performance in a big way. Therefore medium
sized funds should be preferred.

4. Age of Fund – Longevity of the fund in business needs to be determined and its
performance in rising, falling and steady markets have to be checked. Pedigree does not
always matter.

5. Largest Holding – A look at the portfolio would reveal large stakes of entire mutual fund
house in a particular company or group. Cognizance should be given to this fact.

6. Fund Manager – Fund manager experience during good and bad times should be the
criteria than mere reputation

7. One should have an idea of the person handling the fund management. A person of repute
Expense Ratio – SEBI has laid down the upper ceiling for Expense Ratio. A lower
Expense Ratio will give a higher return which is better for an investor.

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8. PE Ratio – P/E ratio of securities in the mutual fund portfolio should be studied to identify
the risk levels in which the mutual fund operates.

9. Portfolio Turnover – Portfolio turnover which indicates the frequency at which the fund
manager buys and sells stocks should be studied. High number would indicate frequent
trading and high costs and low number would indicate an inactive fund manager and
possible loss of attractive opportunities.

Rights & obligations of investor investing in a Mutual Fund

Investors’ Rights:
1. Unit holders have proportionated right in the beneficial ownership of the schemes assets
as well as any dividend or income declared under the scheme.
2. Receive dividend warrant within 42 days.
3. AMC can be terminated by 75% of the unit holders.
4. Right to inspect major documents i.e. material contracts, Memorandum of Association
and Articles of Association (M.A. & A.A) of the AMC, Offer document etc.
5. 75% of the unit holders have the right to approve any changes in the close ended scheme.
6. Every unit holder have right to receive copy of the annual statement.

Investors’ Obligations:
1. An investor should carefully study the risk factors and other information provided in the
offer document. Failure to study will not entitle him for any rights thereafter.
2. It is the responsibility of the investor to monitor the NAV declared by the fund regularly
and take appropriate decisions if required.

Signals for exiting a mutual fund scheme

1. Consistent under - performance vis-à-vis benchmark
2. Consistent under-performance vis-à-vis peer group
3. Change in scheme objective
4. Change in the fund manager or the fund management style
5. Change in the composition of the portfolio
6. Investors’ change of strategy
7. Change in sponsor
8. Change in Mutual fund regulations

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Quantitative & Qualitative measures of Performance

Quantitative Measures of Performance
1. Risk Adjusted Returns - Sharpe Ratio, Treynor Ration, Jensen's Alpha
2. Benchmark Return - Comparison with benchmark against which portfolio has been
constructed or stated in the objective
3. Comparison with Peers - Compare performance with peers having similar objective
4. Comparison during different economic and market cycles - Say every 6 months, 1 year
etc.
5. Comparison of financial costs incurred - expense ratio

Qualitative Measures of Performance

1. Quality of portfolio - allocation to blue chips, diversification, beta of portfolio etc.
2. Track record of fund manager - Assessment of his knowledge, competence etc.
3. Credibility of fund house

Performance measures of a Mutual Fund

Sharpe Ratio
The Sharpe Ratio measures a fund's excess return relative to its total risk, as measured by
the standard deviation.
(Fund 's Re turn − Risk Free Rate) Excess Re turn
= =
Stan dard Deviation Stan dard Deviation

It determines the amount of "reward" (excess return) per unit of volatility (standard deviation)
investors’ bear. The Sharpe ratio is an appropriate measure of performance for an overall
portfolio particularly when it is compared to another portfolio, or another index such as the
S&P CNX Nifty, Mid Cap index, etc. While a high and positive Sharpe Ratio shows a superior
risk-adjusted performance of a fund, a low and negative Sharpe Ratio is an indication of
unfavourable performance.

Treynor Ratio
The Treynor ratio, similar to the Sharpe Ratio, measures a fund's excess return relative to the
systematic risk. Instead of using standard deviation the Treynor ratio uses beta (the fund's
volatility that is attributable to the market) as a risk measurement. The Treynor ratio is
computed as follows:

(Fund' s Re turn − Risk − Free Rate) Excess Re turn

Treynor Ratio = =
Beta Beta

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Thus, the Treynor Ratio focuses on the reward relative to market risk (measured by beta),
whereas the Sharpe ratio concerns the total risk (measured by standard deviation). It implicitly
assumes a completely diversified portfolio, which means that systematic risk is the relevant
risk measure. Treynor ratio of different funds can be compared to determine which fund to
include in already held well-diversified portfolio. The ratio should not be used to decide
regarding whether to buy only fund A or only fund B. Higher the Treynor ratio better is the
performance.
Sharpe and Treynor ratios are useful tools to measure performance of a mutual fund. Most
diversified funds give identical ranking when ranked under both measures. If portfolios are
less diversified, we obviously have conflict in rankings under Sharpe and Treynor.

Jensen’s Alpha
This measure controls for the level of the fund's susceptibility to market risk (beta), and asks:
given this level of market risk and the level of return expected from such risk, what are the
returns brought about in excess of the risk? As such, alpha examines the difference between
the return suggested by the fund's beta, and the return a fund actually delivers. Alpha is the
difference between actual return posted by the fund and the return posted by a benchmark
portfolio with the same risk- i.e. beta.
E(R) = Rf + β (Rm-Rf) … (as per CAPM)
Alpha = Rp – E(R)
An alpha of 0 means the fund performed as expected given the risks it undertook as reflected
in the beta. A fund with a positive alpha, in contrast, would return more than predicted by the
beta. A negative alpha would mean it returned less.
Jensen's alpha represents the ability of the fund manager to achieve a return that is above
what could be expected given the risk in the fund. It is an absolute measure as opposed to
Sharpe and Treynor measures, which are relative ones. Positive alphas represent good
performance by the fund manager. Negative alphas reflect poorly on the performance of the
fund manager. Superior risk-adjusted returns indicate that the manager is good at either
predicting market turns, or selecting undervalued securities for the portfolio, or both. Limitation
of this model is that it considers only systematic risk not the entire risk associated with the
fund and an ordinary investor cannot mitigate unsystematic risk, as his knowledge of market
is primitive.

Tracking Error [JUL 2021]

Tracking error can be defined as the divergence or deviation of a fund’s return from the
benchmarks return.
The passive fund managers closely follow or track the benchmark index. Although they design
their investment strategy on the same index but often it may not exactly replicate the index
return. In such situation, there is possibility of deviation between the returns.
The tracking error can be calculated on the basis of corresponding benchmark return vis a vis
quarterly or monthly average NAVs. The formula that is generally used is:

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̅̅̅̅𝑥 )2
∑(𝐷𝑥 − 𝐷
√
𝑛−1
̅𝑥 is the average differential return and n is the number of
Where 𝐷𝑥 Differential return is 𝐷
data.

Reasons of Tracking Error:

Higher the tracking error higher is the risk profile of the fund. Whether the funds outperform or
underperform their benchmark indices; it clearly indicates that fund managers are not following
the benchmark indices properly. In addition to the same other reasons for tracking error are
as follows:

1. Transaction cost
2. Fees charged by AMCs
3. Fund expenses
4. Cash holdings
5. Sampling biasness
Thus, from above it can be said that to replicate the return to any benchmark index the
tracking error should be near to zero.

Role of Fund Managers of a Mutual Fund

1. Manage funds as per objective. If it is an Index fund, then passively track the performance
of the fund with the benchmark. If it not an Index fund, then do active management.
2. Compliance to all regulatory authorities
3. Constantly monitor the performance, do adjustments in portfolio if required and try to
outperform the benchmark
4. Wealth creation and protection
5. Control over the work of third parties in case any work is outsourced.

Role of FIIs of a Mutual Fund

Foreign Institutional Investors represent institutional entities operating across international
borders, investing significant financial resources into foreign financial markets. These
entities, predominantly composed of organizations like pension funds, mutual funds, and
insurance companies, oversee substantial pools of capital on behalf of their clients. The
features of FII investments are:
A. They specialize in manging substantial funds.
B. They directly invest in Indian equities, bonds, government securities etc.

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C. Their primary objective is to earn returns rather than acquire controlling interest.
D. They prefer diversification while investing.
E. They employ a cadre of finance professionals and analysts for superior performance.
F. They adhere to the regulatory rules set.
In India, FIIs play a crucial role in nurturing capital markets by providing global expertise,
capital, and improving market efficiency, depth, and liquidity, thus boosting confidence, and
attracting more investments.
The advantages and disadvantages of FII investments in a country are:
Advantages of FIIs:

1. Capital Inflows: FIIs bring substantial foreign capital into host countries, which serves
as a catalyst for economic growth by providing businesses with the necessary
resources for expansion and innovation.
2. Strengthened Corporate Governance: FIIs frequently advocate for improved corporate
governance practices in the companies they invest in. Their presence encourages
transparency and accountability, elevating corporate governance standards.
3. Foreign Exchange Reserves: The foreign currency brought in by FIIs adds to the host
country’s foreign exchange reserves, which play a vital role in maintaining exchange
rate stability.
4. Economic Development: FIIs’ investments can lead to job creation and infrastructure
development, yielding positive spillover effects for the broader economy.
Disadvantages of FIIs:

1. Overreliance on FII capital inflow leads to huge volatility in the markets as the FII
inflows/outflows are highly sensitive to economic news.
2. In certain cases, heavy FII investments may lead to undue foreign control / influence
over local companies.
3. At times when FIIs engage in speculative behaviour in the market, the market
fluctuations contribute to asset bubbles.
4. Most often FIIs have shorter investment horizons, and their trading activity destabilizes
the markets.
5. FII inflows/outflows cause large activities in exchange market too and potentially lead
to large currency fluctuations that affect international trade and financial stability.

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PROBLEMS

1. Cindrella Mutual Fund has the following assets in Scheme Rudolf at the close of business
on 31st March, 2014.
Company No. of Shares Market Price Per Share
Nairobi Ltd. 25000 ₹ 20
Dakar Ltd. 35000 ₹ 300
Senegal Ltd. 29000 ₹ 380
Cairo Ltd. 40000 ₹ 500
The toal number of units of Scheme Rudolf are 10 lacs. The scheme Rudolf has
accrued expenses of ₹ 2,50,000 and other liabilities of ₹ 2,00,000. Calculate the NAV
per unit of Scheme Rudolf. [NOV 2014]

2. The unit price of Equity Linked Saving Scheme (ELSS) of a mutual fund is ₹10/-. The
public offer price (POP) of the unit is ₹10.204 and the redemption price is ₹9.80. [MAY
2018]
Calculate:
a) Front-end Load
b) Back-end Load

3. A Mutual Fund Co. has the following assets under it: [MAY 2012] [MAY 2018]
Company No. of Shares 1st February, 2012 2nd February, 2012
Market Price per share Market Price per share

L Ltd] 20,000 20.00 20.50

M Ltd 30,000 312.40 360.00

N Ltd 20,000 361.20 383.10

P Ltd 60,000 505.10 503.90

Total No. of Units 6,00,000

a. Calculate Net Assets Value (NAV) of the Fund as per above information as on
February 1, 2012.
b. Assuming one Mr. A, submits a cheque of ₹30,00,000 to the Mutual Fund on
February 1, 2012 before the cut off time and the Fund manager of this company
purchases 8,000 shares of M Ltd; and the balance amount is held in Bank. In such
a case, what would be the new NAV of the Fund as on 2nd February, 2012

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4. A mutual fund made an issue of 10,00,000 units of ₹10 each on January 01, 2008. No
entry load was charged. It made the following investments. [NOV 2009][MAY 2022]
₹
50,000 Equity shares of ₹ 100 each @ ₹ 160 80,00,000

7% Government Securities 8,00,000

9% Debentures (Unlisted) 5,00,000

10% Debentures (Listed) 5,00,000

98,00,000

During the year, dividends of ₹ 12,00,000 were received on equity shares. Interest on all
types of debts securities was received as and when due. At the end of the year equity
shares and 10% debentures were quoted at 9.375% premium and 10% discount
respectively. Other investments are at par.
Find out the Net Asset Value (NAV) per unit given that operating expenses paid during
the year amounted to ₹ 5,00,000. Also find out the NAV, if the Mutual fund had
distributed a dividend of ₹ 0.80 per unit during the year to the unit holders.

5. Calculate the NAV of a regular income scheme on per unit basis from the following
information : [NOV 2009]* [MAY 2010]* [MAY 2014] [MAY 2016]
₹ Crores
Listed shares at Cost (ex-dividend) 20
Cash in hand 1.23
Bonds and debentures at cost 4.3
Of these, bonds are not listed and quoted 1
Other fixed interest securities at cost 4.5
Dividend accrued 0.8
Amount payable on shares 6.32
Expenditure accrued 0.75
Number of units (₹ 10 face value) 20 lacs
The listed share was purchased when Index was 1,000
Present index is 2,300
Value of listed bonds and debentures at NAV date 8
There has been a diminution of 20% in unlisted bonds and debentures. Other fixed
income securities are at cost

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6. Mr. A has invested in two mutual fund schemes as per details given below:
[MAY 2013] [MAY 2015] [NOV 2016][JUL 2021]

Scheme A Scheme B Scheme C

Date on investment 1-10-2014 1-1-2015 1-3-2015

Amount of investment 15 lakhs 7.5 lakhs 2.5 lakhs

NAV at entry date 12.50 36.25 27.75

Dividend received up to 31.3.15 Amount = 45,000 Per unit = 0.60 Nil

NAV as on 31.3.2015 12.25 36.45 27.55

Calculate effective yield on p.a. basis up to 31-3-2015? 1 Year = 365 days

7. Mr. D had invested in three mutual funds (MF) as per the following details: [MAY 2022]

Particulars MF 'A' MF 'B' MF 'C'

Amount of Investment 2,00,000 5,00,000 4,00,000
NAV at the time of purchase 10.00 25.00 20.00
Dividend Yield up to 31-03-2022 3% 5% 4%
NAV as on 31-03-2022 10.50 22.80 20.80
Annualized Yield as on 31-03-2022 9.733% -11.185% 15%
Assume 1 Year = 365 Days.
Mr. D has misplaced the documents of his investments.
You are required to help Mr. D to find out the following:

a) Number of units allotted in each scheme.

b) Value of his investments as on 31-03-2022
c) Holding period of his investments in number of days as on 31-03-2022

(𝑁𝐴𝑉𝑒 − 𝑁𝐴𝑉𝑏 )+𝐶𝐺+𝐷𝑖𝑣

[Hint: Total Yield on MF % = 𝑁𝐴𝑉𝑏
× 100

𝑀𝐹 𝑌𝑖𝑒𝑙𝑑%
Number of Days (d) = 𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝑌𝑖𝑒𝑙𝑑 % × 365

[Refer:

(𝑁𝐴𝑉𝑒 − 𝑁𝐴𝑉𝑏 )+𝐶𝐺+𝐷𝑖𝑣 365 365

Annualized Yield = 𝑁𝐴𝑉𝑏
× 𝑑
× 100 = 𝑀𝐹 𝑌𝑖𝑒𝑙𝑑% × 𝑑
]

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d) Dates of original investments

e) Total Return on investments.
f) Assuming past performance of all three schemes will continue for next one year,
what action the investor should take? What will be the expected return for the next
one year after the above action?
g) Will your answer as above point no. (f) changes if the Mutual fund charges exit load
of 5% if the investment is redeemed within one year? If so, advise the investor what
and when the action to be taken to optimize the return.

8. During the year 2017 an investor invested in a mutual fund. The capital gain and dividend
for the year was ₹3.00 per unit, which were re-invested at the year end NAV of ₹23.75.
The investor had total units of 26,750 as at the end of the year. The NAV had appreciated
by 18.75% during the year and there was an entry load of ₹0.05 at the time when the
investment was made. The investor lost his records and wants to find out the amount of
investment made and the entry load in the mutual fund. [Nov 2018 – Old]

9. The following information is extracted from Steady Mutual Fund’s Scheme [NOV 2012]
• Asset Value at the beginning of the month - ₹ 65.78
• Annualised return – 15%
• Distributions made in the nature of Income and Capital gain (per unit respectively)
- ₹ 0.50 and ₹ 0.32
1. Calculate the month end net asset value of the mutual fund scheme (limit your
answer to two decimals).
2. Provide a brief comment on the month end NAV.

10. On 1-4-2012 ABC Mutual Fund issued 20 lakh units at ₹10 per unit. Relevent initial
expenses involved were ₹12 lakhs. It invested the fund so raised in capital market
instrument to build a portfolio of ₹185 lakhs. During the month of April 2012 it disposed
off some of the instruments costing ₹60 lakhs for ₹63 lakhs and used the proceeds in
purchaing securities for ₹56 lakhs. Fund management expenses for the month of April
2012 was ₹8 lakhs of which 10% was in arrears. In April 2012 the fund earned dividends
amounting to ₹2 lakhs and it distributed 80% of the realized earnings. On 30-4-2012 the
market value of the portfolio was ₹198 lakhs.
Mr. Akash, an investor, suscribed to 100 units on 1-4-2012 and disposed off the same
at closing NAV on 30-4-2012. What was his annual rate of earning? [MAY 2013]

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11. On 01-07-2010, Mr. X invested ₹50,000/- at initial offer in Mutual Funds at a face value
of ₹10 each per unit. On 31-03-2011, a dividend was paid @10% and annualized yield
was 120%. On 31-03-2012, 20% dividend was given. Mr. X redeemed all his 6271.98
units on 31-03-2013 when his annualized yield was 71.50% over the period of
holding/year.
Calculate NAV as on 31-03-2011, 31-03-2012 and 31-03-2013.
For calculations consider a year of 12 months [NOV 2013] [NOV 2015]

12. A mutual fund has a NAV of ₹8.50 at the beginning of the year. At the end of the year
NAV increases to ₹9.10. Meanwhile fund distributes ₹0.90 as dividend and ₹0.75 as
capital gains.
a. What is the fund’s return during the year?
b. Assuming that the investor had 200 units and also assuming that the distributions
been re-invested at an average NAV of ₹8.75, what is the return? [MAY 2011] [NOV
2011] [NOV 2018]
13. A Mutual Fund Company introduces two schemes – Dividend Plan and Bonus Plan. The
face value of the Unit is ₹10 on 1-4-2014. Mr. R Invested ₹5 lakh in Dividend plan and
₹10 lakh in Bonus Plan. The NAV of Dividend Plan is ₹46, and NAV of Bonus Plan is
₹42. Both the plans matured on 31-03-2019. The particulars of Dividend and Bonus
Declared over the period are as follows: [MAY 2019]

Date Dividend Bonus NAV of Dividend NAV of Bonus

(%) Ratio Plan Plan
(₹) (₹)
31-12-2014 12% - 47.0 42.0
30-09-3015 - 1:4 48.0 43.0
31-03-2016 15% - 49.5 41.5
30-09-2017 - 1:6 50.0 44.0
31-03-2018 10% - 48.0 43.5
31-03-2019 - - 49.0 44.0
You are required to calculate the effective yield per annum in respect of the above
two plans.
Solution:

In the following table, we calculate the effective yield (simple average yield)
over five years under both the plans for Mr. R.
Dividend Plan:
Invested amount = ₹5,00,000
NAV on investment date = ₹46.00

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Units allotted = ₹5,00,000/₹46 = 10869.565

Dividend amounts are calculated on outstanding units based on FV of ₹10
NAV on
Dividend Dividend Units Outstanding
Date Dividend
Declared Amount Allotted Units
Date

01-04-2014 Opening Units AS ON 1-4-2014 10869.565

31-12-2014 12% ₹ 13,043.48 ₹ 47.00 277.521 11147.086

31-03-2016 15% ₹ 16,720.63 ₹ 49.50 337.791 11484.877

31-03-2018 10% ₹ 11,484.88 ₹ 48.00 239.268 11724.145

31-03-2019 Closing Units as on 31-03-2019 (After 5 years) 11724.145

Valuation of 11724.145 units as on 31-03-2019 at the rate of ₹49 per unit =

₹5,74,483.11. Effective (simple average) yield over 5 years:
₹5,74,483.11 − ₹5,00,000 1
× × 100 = 2.98%
₹5,00,000 5
Bonus Plan:

Invested amount = ₹10,00,000; NAV on investment date = ₹42.00

Units allotted = ₹10,00,000/₹42 = 23809.524
Date Bonus Declared Bonus Units Allotted Outstanding Units
01-04-2014 OPENING UNITS 23809.524
30-09-2015 1:4 5952.381 29761.905
30-09-2017 1:6 4960.318 34722.223
31-03-2019 CLOSING UNITS 34722.223

Valuation of 34722.223 units as on 31-03-2019 at the rate of ₹44 per units

= ₹15,27,777.79. Effective (simple average) yield over 5 years:
₹15,27,777.79 − ₹10,00,000 1
× × 100 = 10.56%
₹10,00,000 5

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14. M/s. Corpus an AMC, on 1.04.2015 has floated two schemes viz. Dividend Plan and Bonus
Plan. Mr. X, an investor has invested in both the schemes. The following details (except
the issue price) are available :

Date Dividend Bonus NAV

(%) Ratio
Dividend Bonus Plan
Plan
1.04.2015 ? ?
31.12.2016 1:4 (One unit 47 40
on 4 units
held)
31.03.2017 12 48 42
31.03.2018 10 50 39
31.12.2018 1:5 (One unit 46 43
on 5 units
held)
31.03.2019 15 45 42
31.03.2020 - - 49 44

Additional Details :

Investment (₹) ₹9,20,000 ₹10,00,000

Average Profit ₹27,74,860
(₹)
Average Yield 6.40
(%)
You are required to calculate the issue price of both the schemes as on
1.04.2015
15. On 1st January 2020, an open-ended scheme of mutual fund had outstanding units of 300
lakhs with a NAV of ₹20.25. At the end of January 2020, it had issued 5 lakhs units at an
opening NAV plus a load of 2%, adjusted for dividend equalization. At the end of February
2020, it had repurchased 2.5 lakhs units at an opening NAV less 2% exit load adjusted for
dividend equalization. At the end of March 2020, it had distributed 70 per cent of its
available income. In respect of January – March quarter, the following additional
information is available : [JAN 2021]

Value appreciation of the portfolio ₹460 lakhs

Income for January ₹24 lakhs
Income for February ₹36 lakhs
Income for March ₹47 lakhs

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You are required to calculate :

a) Income available for distribution

b) Issue price at the end of January
c) Repurchase price at the end of February.
d) Closing value of Net Assets at the end of March

Solution:
Whenever an investor enters a mutual fund, i.e., purchases fresh units, he is not eligible
to the earnings already earned for the existing unitholders by the mutual fund scheme. It
solely belongs to the existing investors. In order to equalize the situation, the new
investors should bring in additional money, over and above the NAV, an amount equal to
earnings already earned by the fund. On the same lines, when an investor leaves the
scheme, he has to be given his part of earnings. This helps the mutual fund to distribute
same dividend to all the investors, existing as well as new.
The above concept is demonstrated in this problem.

A. Income available for distribution:

Total Outstanding Per Unit Calculations
(Rs in Units (lakhs)
lakhs)
Income from 24.00 300 =24/300 = 0.08
January (given) This is the earning solely
belonging to the 300 lakh
investors.
New Units Issued 0.40 5 =0.08 x 4 = 0.40
in January - New investors, i.e., 5
Dividend lakhs, would have to bring
Equalization in 0.08 per unit as
collected additional amount.
Sub-Total 24.40 305 =24.4/305 = 0.08
Add: Income 36.00 305 =36/305 = 0.1180
from February This is the earning solely
(given) belonging to the 306 lakh
investors.
Sub-Total 60.40 305 =60.4/305 = 0.1980
Less: Units 0.4950 2.50 =0.1980 x 2.5 = 0.4950
repurchased - When investors leave a
Dividend mutual fund scheme, they
Equalization will take their share of
distributed earnings, calculated on
per unit basis.
Sub-Total 59.9050 302.50 =59.905/302.5 = 0.1980

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Total Outstanding Per Unit Calculations

(Rs in Units (lakhs)
lakhs)
Add: Income 47.00 302.5
from March
(given)
Amount available 106.9050 302.5 =106.905/302.5 = 0.3534
for distribution
Dividend Paid 74.8335 302.5 =74.8335/302.5 = 0.2474
(70%)
Outstanding at 32.0715 302.5
end of March

B. Issue price at the end of January: -

DER for the month of January= ₹ 24 lakhs/ 300 lakhs units = ₹ 0.08/unit
Issue Price = NAV + 2% load + DER = ₹ 20.25 + ₹ 0.405 + ₹ 0.08 = ₹ 20.7350

1. Repurchase price at the end of February: -

DER for the month of February= ₹ 60.4 lakhs/ 305 lakhs units = ₹ 0.1980/unit
Repurchase price = NAV - 2% load + DER = ₹ 20.25 – ₹ 0.405 + ₹ 0.1980 =
₹20.0430

2. Net asset value (NAV) as of March

NAV on 1st January = ₹ 20.25 x 300 lakhs units = ₹ 6075 lakhs
+ Income Jan, Feb and March = ₹ 107 lakhs
+ Appreciation in portfolio = ₹ 460 lakhs
(-) Dividend = ₹ 74.8335
lakhs
(+) Proceeds from issue (Jan End) = 20.735 x 5 = ₹ 103.675
lakhs units lacs lakhs
(-) Proceeds through repurchase (Feb) = 20.0430 = ₹ 50.1075
x 2.5 lakhs units lakhs
NAV – End of March = ₹ 6620.7340
lakhs
NAV per unit (end of March) = Total Net Asset = ₹ 21.8867 per
Value/ units unit
= ₹ 6620.7340/302.5 lakhs

16. There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. Each having
close ended equity schemes. NAV as on 31-12-2014 of equity schemes of D Mutual
Fund Ltd., is ₹70.71 (consisting 99% equity and remaining cash balance) and that of K

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Mutual Fund Ltd. is ₹62.50 (consisting 96% equity and balance in cash). Following is the
other information : [MAY 2015]
Particulars Equity Schemes
D Mututal Fund Ltd K Mutual Fund Ltd
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Standard Deviation 11.25 5
There is no change in portfolios during the next month and annual average cost is ₹ 3
per unit for the schemes of both the Mutual Funds. If Share market goes down by 5%
within a month, calculate expected NAV after a month for the schemes of both the
Mutual Funds. For calculation, consider 12 months in a year and ignore number of
days for particular month.

17. The following are the data on five mutual funds : [MAY 2016]
Funds Return % Standard Deviation % Beta
A 16.5 25.6 1.250
B 15.3 20.5 0.95
C 9.5 15.8 0.85
D 22.5 16.5 1.15
E 18.5 18.5 1.05
Sensex 14.0 13.5 1.00
You are required to compute Reward to Volatility Ratio and rank these portfolio using :

• Sharpe method and

• Treynor’s method
• Jensen’s Alpha method
Assuming the risk free rate as 7%. Do your working strictly with two decimals.

18. The following are the details of three mutual funds of MFL: [NOV 2020]
Growth Balanced Regular Market
Fund Fund Fund
Average Return (%) 7 6 5 9
Variance 92.16 54.76 40.96 57.76
Coefficient of 0.3025 0.6561 0.9604
Determination
The yield on 182 days Treasury Bill is 9 per cent per annum.
You are required to :

a) Rank the funds as per Sharpe’s measure.

b) Rank the funds as per Treynor’s measure.
c) Compare the performance with the market.

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19. The five portfolios of a mutual fund experienced following result during last 10 years
periods: [MAY 2017]
Average annual Standard Correlation with the market
Portfolio
return % deviation return

A 20.0 2.3 0.8869

B 17.0 1.8 0.6667

C 18.0 1.6 0.600

D 16.0 1.8 0.867

E 13.5 1.9 0.5437

Market Risk 1.2

Market rate of return 14.3%
Risk free rate 10.1%
Beta may be calculated only up to two decimals. Rank the portfolio using JENSEN’S
ALPHA method.

20. Following is the information related to three mutual funds: [NOV 2022]

Year MF-A MF-B MF-C

2020 10% 5% 14%
2021 8% 10% 10%
2022 12% 8% 18%
Correlation between market and mutual fund:

MF-A MF-B MF-C

Correlation with
0.45 0.25 0.65
Market
Variance of the market is 9 and the rate of return on government bond is 7%

You are required to rank the Mutual Fund using Sharpe Ration and Treynor Ratio.

21. Mr. Potential has made investments in two mutual funds. The following information is
available: [MAY 2023]

Mutual Fund Smart Growth

Jensen Alpha 1.10% 1.50%
Treynor's Ratio 0.0714 0.0775
Actual Return 8.50% 9.10%

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Risk Premium 4%
You are required to calculate:

(i) Beta (β) for both the funds

(ii) Risk free Rate

(iii) Security Market Line

22. A ₹50 Crores hedge fund is operated and the fees payable to the fund manager are as
follows: 0.1% flat fee is payable on the managed corpus every year. An incentive fee of
2% is payable on the excess earned over cut off value. For this year, the year end fund
value has to be a minimum of ₹60 Crores, and any excess will provide an incentive to
the fund manager.
a. If the fund has earned 30% during the year, what is the total fee payable to the fund
manager?
b. If the fund has lost 5% during the year, what is the total fee payable to the fund
manager?

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NOTES

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MUTUAL FUNDS
MULTIPLE CHOICE QUESTIONS

1. The type of entity of a mutual fund is:

A ○ A private Limited Company

B ○ A public limited company

C ○ A partnership firm or LLP

D ○ None of the above

2. The investments by a mutual fund are controlled by

A ○ RBI

B ○ SEBI

C ○ Registrar of Companies

D ○ Both (A) and (B)

The following is not true in the context of a mutual fund’s

3.
payment to its unit – holders:
A ○ a scheme that invests in equity pays dividends

B ○ an exchange traded fund pays dividends

C ○ a bond fund pays interest

D ○ a G-sec. fund pays dividends

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Under a Systematic Investment Plan, the following is NOT

4.
TRUE :
Unit holders can invest on a monthly basis whatever amount
A ○ they can save.
Investors can invest only a pre-specified amount every period,
B ○ say monthly, quarterly or half yearly.
If an investor has subscribed ~3,000 in quarterly payments for a
C ○ 3 year SIP, he can choose to step up this amount to ~4,000
from the second year.
Even where the SIP amount in a financial year does not exceed
D ○ ~50,000 an investor cannot invest in cash.

This scheme is open for purchase and redemption during

5.
pre-specified periods only.
A ○ Close Ended Scheme

B ○ Interval Scheme

C ○ Open Ended Scheme

D ○ Period Scheme

6. Gilt funds have ____________ risk.

A ○ High

B ○ Moderate

C ○ Low

D ○ No

____________ is the preferable standard measure of

7. performance for investors in mutual funds for one year or more
time periods.
Jensen’s Alpha
A ○
B ○ Treynor Measure

C ○ Sharpe Measure

D ○ None of these

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8. An Exchange Traded Fund is a product

A ○ Hybrid in nature

B ○ Like equity share

C ○ Like Index fund

D ○ None of these

Which of the following Fund focuses on trends that are

9. likely to result in the out-performance' by certain sectoral
funds.
A ○ Contra Fund

B ○ Index Fund

C ○ Thematic Fund

D ○ Hedge Fund

For any investor the biggest advantage of investing in a

10.
Mutual Fund over direct investment is
A ○ Tax advantage

B ○ Cost

C ○ Diversification

D ○ Choice of stocks to invest

11. Gilt Funds mainly invest in ............

A ○ Government Securities

B ○ Only in Debt Securities

C ○ Only in shares

D ○ Mix of debt and equity

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While Sharpe ratio measures ____________, the Treynor

12.
Ratio measures only the _______________
A ○ Total Risk; Systematic Risk

B ○ Unsystematic Risk; Systematic Risk

C ○ Systematic Risk; Unsystematic Risk

D ○ Systematic Risk; Total Risk

For an investor managing his own portfolio as against

13. investing in a mutual fund, which of the following could be
the reason:
A ○ Want to buy select stocks

B ○ Want to decide timing of sales and purchases

C ○ Do not believe in professional management of a fund manager

D ○ All of these

Investing in a Mutual Fund provides the following but

14.
cannot be achieved in direct investment.
One can achieve diversification of even up to 50 or even 200
A ○ stocks using a small sum
B ○ One can get professional management of portfolio
One need not worry about news and events of companies
C ○ affecting the portfolio
D ○ All of these

15. Which is not an advantage of investing in a Mutual Fund?

A ○ Transparency of information

B ○ Guaranteed Return

C ○ Professional Fund Management

D ○ All the above

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Which of the following indicate that the fund is close

16.
ended?
One can buy units from a MF only during the initial offer period
A ○ of a scheme
One can sell units from a MF only during the initial offer period
B ○ of a scheme
One can buy units from a MF only during the initial offer period
C ○ of a scheme and one can sell units from a MF only at the end of
tenure of the scheme
D ○ None of these

17. The main objective of a Money Market Mutual Fund is

A ○ Preservation of capital

B ○ Easy liquidity

C ○ Moderate income

D ○ All of these

Gold ETFs have the following advantage which are absent

18.
in a Sovereign Gold Bond of the government because of
A ○ Ease of selling when required

B ○ Trading like a stock

C ○ Both the above

D ○ None of these

If an investor is investing in a Contra Fund, then his belief

19.
is that
The stocks of the fund which are not current flavour of the
A ○ market will be the flavour of market in future
B ○ The fund predominantly invests in undervalued stocks

C ○ The fund is investing against the trend of the market

D ○ All of these

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If an investor is investing in an Index Fund instead of a

20.
diversified equity fund, then it is possible that
A ○ He does not have belief in the fund manager
He believes that, with or without the fund management,
B ○ earnings cannot exceed average market return
He does not like the extent of diversification of the diversified
C ○ equity fund
D ○ All of these

Sector funds carry more risk than diversified equity funds

21.
because

A ○ They lack diversification

B ○ They bet on a single / few sector

C ○ Only with proper timing one can earn good returns

D ○ All of these

22. Which is not a Thematic Fund?

A ○ Birla Sun Life MNC Fund

B ○ Sundaram Rural India Fund

C ○ HDFC Equity Fund

D ○ ICICI Prudential Exports and Other Services Fund

Hedge Fund and a Mutual Fund differ in which of the

23.
following?

A ○ Hedge Funds are not well-regulated like Mutual Funds

Hedge Fund takes its share of profit on outperformance while

B ○ Mutual Fund does not
Hedge funds are managed much more aggressively than their
C ○ mutual fund counterparts

D ○ All the above

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24. ETFs have the following advantages?

We can trade like a stock – easy to buy and sell

A ○
With a very small investment we can get significant
B ○ diversification

C ○ Cheaper than a MF investment

D ○ All the above

Which of the following is not a valid reason for exiting a

25.
MF?

A ○ Mutual fund consistently under performs the broad-based index

B ○ Mutual fund changed its objectives

When the fund manager, handling the mutual fund schemes,

C ○ has been replaced by a star fund manager and you do not like
him personally

D ○ Mutual Fund has changed the style of managing the portfolio

Which of the following is a valid reason for choosing a

26.
MF?

A ○ A strong sponsor backs it

B ○ MF has varieties of schemes under its belt

The funds managed by mutual funds have shown consistent

C ○ performance

D ○ All the these

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NOTES

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