What are Mutual Funds?
Mutual Funds pool the savings of different investors together, invest them into specific securities (usually stocks or bonds) with a predetermined investment objective (mentioned in the offer document). Investors are issued ‘units’. Thus, for an investor, investments in Mutual Funds imply buying shares (or portions) of the MF and becoming shareholders of the fund.
How is a mutual fund set up?
A mutual fund is set up in the form of a trust, which has sponsor, trustees, asset management company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unitholders. Asset Management Company (AMC) approved by SEBI manages the funds by making investments in various types of securities. Custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI Regulations by the mutual fund. SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be independent. All mutual funds are required to be registered with SEBI before they launch any scheme.
What are the benefits of investing in mutual funds?
Mutual funds have many benefits. They offer an easy and inexpensive way for an individual to get returns from stocks and bonds without: incurring the risks involved in buying them directly; needing the capital to buy quality stocks; or having the expert knowledge to make the right buy/sell decisions.
What are the drawbacks with mutual funds?
The drawbacks with mutual funds are that you have no control on the investments of the fund; and, more importantly, the downside of diversification is that a fund can hold so many stocks that a tremendously great performance by a stock will make very little difference to a fund's overall performance.
What is Net Asset Value (NAV) of a scheme?
Mutual funds invest the money collected from the investors in securities markets. Net Asset Value is the market value of the securities held by the scheme. We arrive at the NAV after netting off liabilities from the asset value and dividing by the total number of units outstanding. Since market value of securities changes every day, NAV of a scheme also varies on day to day basis. The performance of a particular scheme of a mutual fund is denoted by Net Asset Value. This NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme.
When selling a scheme will I get paid for each unit equal to the NAV?
No, you may not actually get that much when you redeem your units. That is because of the charges levied by some mutual funds. Though NAV is a good enough figure to tell you what the price of each unit is, it is not an exact one. Funds charge fee for managing your money called the annual expense fee. Some funds also charge a fee when you buy or sell units called the entry and exit load.
Why does the NAV of equity schemes fluctuate very often?
As a class of assets, equities are subject to greater fluctuations. Hence, the NAVs of these schemes will also fluctuate frequently. Hence, equity schemes are more volatile, but offer better returns.
What are assets of a fund?
Asset, of course, is the investments of a mutual fund. And value is the market value of investments. What exactly is market value? Let’s say a fund has invested its money in stocks. Then, the price of those stocks on the stock market multiplied by the number of stocks owned gives you the value of all the investments made by that mutual fund. This value can change either when the market valuation changes or if people are joining or leaving the scheme.
What is the return that I earn from my investment in a Mutual Fund?
There are two ways of earning a return from a mutual fund - through dividend or through capital appreciation. Dividend is earned when the corpus of the MF grows (by way of investing the funds of the unitholders in various investment avenues) and the MF distributes this surplus among the unitholders in the form of Dividend. On the other hand, the surplus can remain in the fund, taking the net asset value (NAV) or the price of the unit, higher. Investors can now sell their units and realise a gain (by way of capital appreciation) or can hold on for future appreciation.
What are the expenses of a scheme?
Look for one thing in the fine print: the scheme's expenses. One such expense is the bomb of a salary paid to the investment experts who manage the fund. Apart from management fee there is also the money the fund spends on advertising and marketing a scheme. There is a host of operating expenses from buying stationery to maintaining the fund house's staff. Should it matter to you if the fund house purchases a new computer? It does. In whatever way the fund spends the money, the net expenses are all billed in one way or the other to the unitholder. The expenses of a scheme do not include brokerage commissions.
Which schemes generally have high expenses?
Schemes with smaller assets to manage and particularly those that are not part of a large fund house will generally have higher expenses relative to schemes with larger assets. Fresh schemes generally take some time to overcome their expense burden.
Is it always good that schemes change their portfolios often?
Higher the turnover, more the trades a fund does and hence greater are the transaction fees in the form of brokerage, custody fees, registration fees etc. that a fund has to pay. For a fund, such high transaction costs affect its performance and the NAV. And as an investor you get lower returns. Moreover, a fund with high turnover will also be making money more often as capital gains. These capital gains on distribution are open to taxes, which again would mean lower returns for a unitholder.
Do the dates on which funds declare returns matter?
Always look carefully at start and end dates - they can always be chosen in a way that shows the fund in a favorable light. A better approach would be to choose a reasonably longer period and compare the performance across the similar schemes of different players.
Is investing in Mutual Funds safe?
The mutual fund industry is well regulated in India. The market regulator, the Securities and Exchange Board of India (SEBI) has ensured that a repeat of the vanishing companies does not happen here. Therefore, mutual funds in India are in the form of a Trust. This means that the money belongs to the investors and is only held in the name of the Trust. The investment arm, the AMC, acts as a fee-for investment manager and does not own the money. This does not mean that the investments are risk-free. Investors need to take the risk of volatility or bad management and money can grow or lose value depending on the market and investment decisions. However, sensible mutual fund investing is a good way to include equity and debt in individual portfolios to see realistic growth.
How does one calculate risks?
Investors comfortable with numerical recipes, do a technical check of what the returns of a scheme would be in the worst case. This check is done with the Sharpe ratio. The higher the Sharpe ratio, the better is the fund's historical risk-adjusted performance.
What is a Load or no-load Fund?
A Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time one buys or sells units in the fund, a charge will be payable. This charge is used by the mutual fund for marketing and distribution expenses. The investors should take the loads into consideration while making investment as these affect their yields/returns. However, the investors should also consider the performance track record and service standards of the mutual fund which are more important. Efficient funds may give higher returns in spite of loads. A no-load fund is one that does not charge for entry or exit. It means the investors can enter the fund/scheme at NAV and no additional charges are payable on purchase or sale of units.
Can funds change the loads they charge?
Funds can change the load structure periodically. If you are a unitholder of a scheme that charges an exit load, and the scheme changes its exit load structure, then you will get a prior notice of the change. The new structure will be applicable to you rather than the load structure you were informed about when you joined the scheme.
The scheme I own has changed the exit load. Will the new load apply on me?
If you are a unitholder of a scheme that charges an exit load, and the scheme changes its exit load structure, then you will get a prior notice of the change. The new structure will be applicable to you rather than the load structure you were informed about when you joined the scheme.
Should I leave a scheme if it changes the exit load?
Now don't get too hassled about loads. Best thing to do when a scheme imposes a new load, is not to invest more money if the load charged is unreasonable.
What is sales price and repurchase/redemption price?
The price or NAV a unitholder is charged while investing in an open-ended scheme is called sales price. It may include sales load, if applicable. Repurchase or redemption price is the price or NAV at which an open-ended scheme purchases or redeems its units from the unitholders. It may include exit load, if applicable.
Can non-resident Indians (NRIs) invest in mutual funds?
Yes, non-resident Indians can also invest in mutual funds. Necessary details in this respect are given in the offer documents of the schemes.
What should the investor study in the offer document before investing in a MF?
Investor, before investing in a scheme, should carefully read the offer document. Due care must be given to portions relating to main features of the scheme, risk factors, initial issue expenses and recurring expenses to be charged to the scheme, entry or exit loads, sponsor’s track record, educational qualification and work experience of key personnel including fund managers, performance of other schemes launched by the mutual fund in the past, pending litigations and penalties imposed, etc.
How to know the performance of a mutual fund scheme?
The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on daily basis in case of open-ended schemes and on weekly basis in case of close-ended schemes. The NAVs of mutual funds are required to be published in newspapers. The NAVs are also available on the web sites of mutual funds. All mutual funds are also required to put their NAVs on the web site of Association of Mutual Funds in India (AMFI)www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place. The mutual funds are also required to publish their performance in the form of half-yearly results which also include their returns/yields over a period of time i.e. last six months, 1 year, 3 years, 5 years and since inception of schemes. Investors can also look into other details like percentage of expenses of total assets as these have an affect on the yield and other useful information in the same half-yearly format.
Do we a have benchmark performance for funds?
All mutual funds schemes have different objectives and therefore their performance would vary. But are there some standards for comparison? Schemes are usually benchmarked against commonly followed market indexes. The relevant index can be chosen after taking into consideration the asset class of the scheme. For example BSE Sensex can be used a benchmark for an equity scheme and I-Bex for an income fund. But if you switch the benchmarks, conclusions could be misleading. Benchmarking also requires a relevant time period of comparison. Ideally, one should compare the performance of equity or an index fund over a 1-2 year horizon. Short-term volatile price movements would distort any comparison over a shorter period. Similarly, the ideal comparison period for a debt fund would be 6-12 months while that for a liquid/money market fund would be 1-3 months. So if a comparison reveals a scheme to be out performing its index, does it mean it is going to deliver super returns? Not necessarily. In several cases it is noticed that the funds performance is volatile and driven by few scrips. In other words, the fund manager has taken significantly higher risks to achieve higher returns. That brings us back to the oft-repeated moral in the investment market: The funds that have the potential for the greatest returns also have the greatest potential for losses. From an investor's point of view, while looking at impressive returns in the past, he cannot derive confidence and comfort in the fund managers' ability to repeat the performance in future.
Can a sudden change in asset size affect performance?
Asset size also matters in case of small funds when they suddenly become big. For example, the excellent handling by the fund manager of a small fund may suddenly become popular and draw a lot new unitholders. The sudden flush of funds could lead to a change in the manager’s investment style that might record a drop in performance.
Does rupee depreciation affect scheme performance?
Rupee depreciation affects scheme performance in case of schemes that have invested in government instruments like debentures and government securities e.g., debt schemes and some balanced schemes. The volatility of debt schemes depends entirely on the health of the economy e.g., rupee depreciation, fiscal deficit, inflationary pressure.
Are high returns convincing enough to invest in a fund?
Great returns are not the only thing to look for in a scheme. If you feel while researching a scheme, which we will do later, that it’s returns are modest and steady and good enough for your needs, avoid other schemes that have recently delivered high returns. This is because great returns in the past are no guarantee for the fabulous performance to continue in the future. Never forget one of the commonplace morals of investment: The schemes that are expected to give the highest returns have the greatest probability to fall flat!
Are big funds with more unitholders always better?
Popularity has a flip-side which works against the funds many times. Consider this: If under some circumstances, a large number of untiholders decide to sell i.e. redeem, their units all at the same time, the fund will have to, at a short notice, generate enough cash to pay up the unitholders. The fund manager then faces what is called redemption pressure. He would have to sell off a significant portion of the scheme’s investments. If the markets are down the sell off could be at a throwaway price. Naturally then, more the investors in a scheme, greater are the chances of a sudden redemption pressure.
How often do funds announce their portfolio?
Most schemes periodically announce their current portfolio, though not all of them declare them as and when the fund manager makes a change. As specified by the Securities and Exchange Board of India (SEBI) funds are supposed to declare their portfolio at least once every year.
Is there any difference between investing in a mutual fund and in an initial public offering (IPO) of a company?
Yes, there is a difference. IPOs of companies may open at lower or higher price than the issue price depending on market sentiment and perception of investors. However, in the case of mutual funds, the par value of the units may not rise or fall immediately after allotment. A mutual fund scheme takes some time to make investment in securities. NAV of the scheme depends on the value of securities in which the funds have been deployed.
How do I find a scheme that suits my investment objective?
We are here to invest with some objective of our own. And we are looking for schemes that best fit our investment objective. So, now which are those schemes that suit our objectives best? Based on their objectives, schemes have been clubbed together in categories. These are broad market classifications and help investors narrow down their search for a scheme. After short listing schemes by their common objectives one can further look into each scheme for more specific differences in their objectives.
What if buying one scheme does not satisfy my investment needs?
Once again, back to the basic question. You came here looking for schemes that can suffice your investment needs. You might be like many others who actually have multiple needs. Consider going for a combination of schemes. Yet another recap of the basics: one of the things that made these mutual funds great was diversification. While you might have selected a scheme that has a diversified portfolio, you can also go for more than one scheme to further diversify your investments. It is well possible that just by picking more than one scheme from one fund house you can achieve enough diversification. In fact many investors who have tried out a fund house for long and developed a trust with the fund, prefer to pick another scheme from the fund's basket for their new investment needs. But convenience sometimes leads to venerable prejudices that might deprive you of trying something new and better. There could be a better-managed scheme in a different fund house that you are missing out on if you decide to stick to your old fund house for convenience sake.
How to choose a scheme for investment from a number of schemes available?
As already mentioned, the investors must read the offer document of the mutual fund scheme very carefully. They may also look into the past track record of performance of the scheme or other schemes of the same mutual fund. They may also compare the performance with other schemes having similar investment objectives. Though past performance of a scheme is not an indicator of its future performance and good performance in the past may or may not be sustained in the future, this is one of the important factors for making investment decision. In case of debt oriented schemes, apart from looking into past returns, the investors should also see the quality of debt instruments which is reflected in their rating. A scheme with lower rate of return but having investments in better rated instruments may be safer. Similarly, in equities schemes also, investors may look for quality of portfolio. They may also seek advice of experts.
If schemes in the same category of different mutual funds are available, should one choose a scheme with lower NAV?
Some of the investors have the tendency to prefer a scheme that is available at lower NAV compared to the one available at higher NAV. Investors should remember that in case of mutual funds schemes, lower or higher NAVs of similar type schemes of different mutual funds have no relevance. On the other hand, investors should choose a scheme based on its merit considering performance track record of the mutual fund, service standards, professional management, etc. It is likely that the better managed scheme with higher NAV may give higher returns compared to a scheme which is available at lower NAV but is not managed efficiently.
What makes Gilt schemes volatile?
Gilt schemes are slightly volatile because 95% of the traded volume of fixed income instruments in India comprises of gilt schemes and therefore pricing of such schemes is done daily.
Both money market and Gilt schemes promise high liquidity, then how do they differ?
Gilt schemes tend to give a higher return than a money market scheme at the same time retaining the qualities of a liquid fund. Gilt schemes generally give a return of 8.5-10% per annum whereas it is between 7-8% per annum for money market schemes.
While buying a debt fund what should I look for?
In debt funds, it is useful to compare the extent to which the growth in NAV comes from interest income and from changes in valuation of illiquid assets like bonds and debentures. This is important because as of today there is no standard method for evaluation of untraded securities. The valuation model used by the fund might have resulted in an appreciation of NAV.
What is the advantage of investing in ELSS?
Equity Linked Saving Schemes (ELSS) offer tax rebates to the investor under section 88 of the Income Tax law. These schemes generally diversify the equity risk by investing in a wider array of stocks across sectors. ELSS is usually considered a variant of diversified equity scheme but with a tax friendly offer. Typically returns for such schemes have been found to be between 15-20%.
Are sectoral equity schemes more volatile than diversified equity?
Yes. Sectoral equity schemes are more volatile than diversified equity because diversified schemes invest in equity shares of companies from a diverse array of industries and balances and prevent any adverse impact on returns due to a downturn in one or two sectors. Sectoral funds tend to have a very high risk-reward ratio and investors should be careful of putting all their eggs in one basket. Investors generally see such schemes to benefit them in the short term, usually one year.
For index funds, why doesn’t it matter much who the fund manager is?
Managing an index fund is usually called passive management because all a fund manger has to do is to follow the index. Hence, who the portfolio manager is or what his style is does not really matter in such funds.
Should I leave a scheme because it changed the fund manager?
There is not much reason to opt out of a fund just because it has a new manager. Managers usually work to the fund house's objective set for a scheme. However, do keep track what the new manager is upto. Is the manager handling the portfolio in a way that it reflects the fund's objectives?
How can the investors redress their complaints?
In the offer document of the mutual fund scheme, investors would find the name of contact person that they may approach in case of any query, complaints or grievances. The names of the directors of the asset management company and trustees are also given in the offer documents. Investors should approach the concerned Mutual Fund / Investor Service Centre of the Mutual Fund with their complaints. If the complaints remain unresolved, the investors may approach SEBI for facilitating redressal of their complaints. On receipt of complaints, SEBI takes up the matter with the concerned mutual fund and follows up with it regularly.