What is a Mutual Fund?
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Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document. Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with the quantum of money invested by them. Investors of mutual funds are known as unit holders.
The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally bring out a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI), which regulates securities markets, before it can collect funds from the public.
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What is the history of Mutual Funds in India and role of SEBI in mutual funds industry?
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Unit Trust of India was the first mutual fund set up in India in the year 1963.
In early 1990s, Government allowed public sector banks and institutions to set up
mutual funds.
In the year 1992, Securities and Exchange Board of India (SEBI) Act was passed. The objectives of SEBI are to protect the interest of investors in securities and to promote the development and regulation of the securities market.
As far as mutual funds are concerned, SEBI formulates policies and regulates the
mutual funds to protect the interest of the investors. SEBI notified regulations
for the mutual funds in 1993. Thereafter, mutual funds sponsored by private sector
entities were allowed to enter the capital market. The regulations were fully revised
in 1996 and have been amended thereafter from time to time. SEBI has also issued
guidelines to the mutual funds from time to time to protect the interests of investors.
All mutual funds whether promoted by public sector or private sector entities, including those promoted by foreign entities, are governed by the same set of Regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes launched by the mutual funds sponsored by these entities are of similar type.
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How is a mutual fund set up?
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A mutual fund is set up in the form of a trust, which has Sponsor(s), Trustees, Asset Management Company (AMC) and Custodian. The trust is established by a sponsor or more than one sponsor who acts like the promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unit holders. 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 their 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.
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Cash investments in mutual funds
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As per SEBI Circular Number CIR/IMD/DF/21/2012 dated September 13, 2012,
In partial modification to SEBI Circular no. MFD/CIR/15/19133/2002 dated September 30, 2002 and in order to help enhance the reach of mutual fund products amongst small investors who may not be tax payers and may not have PAN/bank accounts, such as farmers, small traders/businessmen/workers, cash transactions in mutual funds to the extent of 20,000/- per investor, per mutual fund, per financial year shall be allowed subject to (i) compliance with Prevention of Money Laundering Act, 2002, and Rules framed thereunder; the SEBI Circular(s) on Anti Money Laundering (AML) and other applicable AML rules, regulations and guidelines and (ii) sufficient systems and procedures in place.
Repayment in the form of redemptions, dividend, etc. with respect to aforementioned
investments shall be paid only through banking channel.
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What is Net Asset Value (NAV) of a scheme?
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The performance of a particular scheme of a mutual fund is denoted by Net Asset
Value (NAV). Mutual funds invest the money collected from the investors in securities
markets. In simple words,
Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on a day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs. 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs. 20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme.
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Computation of NAV:
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NAV = Net assets of the scheme/Number of units outstanding
Where;
Net assets of the scheme = Market value of investments + receivables + other accrued
income + other assets – Accrued expenses – other payables – other
liabilities
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What is Applicable NAV?
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For the purpose of purchase, redemption & switches, the applicable NAV is the Net Asset Value per unit at the close of the working day on which a request, complete in all respects, is accepted and received before the cut-off time for the particular scheme. Otherwise, the applicable NAV would be the one for the next business day.
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What are the different types of mutual fund schemes?
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Schemes according to Maturity Period:
A mutual fund scheme can be classified into open-ended scheme or close-ended scheme
depending on its maturity period.
Open-ended Fund/Scheme
An Open-ended fund or scheme is one that is available for subscription and repurchase
on a continuous basis. These schemes do not have a fixed maturity period. Investors
can conveniently buy and sell units at Net Asset Value (NAV) related prices which
are declared on a daily basis. The key feature of Open-ended schemes is liquidity.
Close-ended Fund/Scheme
Close-ended mutual funds are those which have restrictions on time of entry and exit. There is some particular time duration for buying the units and then it is locked for some pre-decided period. For e.g. ABC mutual fund, a 3-years Close Ended Fund
Schemes according to Investment Objective:
A scheme can also be classified as growth scheme, income scheme, or balanced scheme
considering its investment objective. Such schemes may be open-ended or close-ended
schemes as described earlier. Such schemes may be classified mainly as follows:
Growth/Equity Oriented Scheme
The aim of growth funds is to provide capital appreciation over the medium to long term. Such schemes normally invest a major part of their corpus in equities. Such
funds have comparatively high risks. These schemes provide different options to
the investors like dividend option, capital appreciation, etc. and the investors
may choose an option depending on their preferences. The investors must indicate
the option in the application form. The mutual funds also allow the investors to
change the options at a later date. Growth schemes are good for investors having
a long-term outlook and seeking appreciation over a period of time.
Income/Debt Oriented Scheme
The aim of income funds is to provide regular and steady income to investors. Such
schemes generally invest in fixed income securities such as bonds, corporate debentures,
Government securities and money market instruments. Such funds are less risky compared
to equity schemes.
These funds are not affected because of fluctuations in equity markets. However,
opportunities of capital appreciation are also limited in such funds. The NAVs of
such funds are affected by change in interest rates in the country. If the
interest rates fall, NAVs of such funds are likely to increase in the short run
and vice versa. However, long-term investors may not bother about these fluctuations.
Balanced Fund
The aim of balanced funds is to provide both growth and regular income as such schemes
invest both in equities and fixed income securities in the proportion indicated
in their offer documents.
These are appropriate for investors looking for moderate growth. They generally
invest 40-60% in equity and debt instruments. These funds are also affected because
of fluctuations in share prices in the stock markets. However, NAVs of such funds
are likely to be less volatile compared to pure equity funds.
Money Market or Liquid Fund
These funds are also income funds and their aim is to provide easy liquidity, preservation
of capital and moderate income. These schemes invest exclusively in safer short-term
instruments such as treasury bills, certificates of deposit, commercial paper and
inter-bank call money, government securities, etc. Returns on these schemes fluctuate
much less compared to other funds. These funds are appropriate for corporate and
individual investors as a means to park their surplus funds for short periods.
Gilt Fund
These funds invest exclusively in government securities. Government securities have
no default risk. NAVs of these schemes also fluctuate due to change in interest
rates and other economic factors as is the case with income or debt oriented schemes.
Index Funds
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive
index, S&P NSE 50 index (Nifty), etc. These schemes invest in the securities in
the same weightage that comprises an index. NAVs of such schemes would rise or fall
in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors which are collectively called "tracking error" in technical terms. Necessary
disclosures in this regard are made in the offer document of the mutual fund scheme.
There are also exchange traded index funds launched by the mutual funds which are
traded on the stock exchanges.
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What are sector specific funds/schemes?
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These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents, e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek the advice of an expert.
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What are Tax Saving Schemes?
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These schemes offer tax rebates to the investors under Section 80C of the Income Tax Act, 1961, as the Government offers tax incentives for investment in specified avenues, e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth-oriented and invest predominantly in equities. Their growth opportunities and associated risks are like those of any other equity-oriented scheme.
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What is Section 80C of Income Tax Act, 1961?
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In order to encourage savings, the government gives tax breaks on certain financial
products under Section 80C of the Income Tax Act. Investments made under such schemes
are referred to as 80C investments. Under this section, you can invest a maximum
of Rs 1,00,000 and if you are in the highest tax bracket of 30%, you save a tax
of Rs 30,000.
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What is a Fund of Funds (FoF) scheme?
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A scheme that invests primarily in other schemes of the same mutual fund or other
mutual funds is known as an FoF scheme. An FoF scheme enables the investors to achieve
greater diversification through one scheme. It spreads risks across a greater universe.
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What is a Load or No-Load Fund?
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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. Suppose the NAV per unit is Rs.10. If the entry as well as exit load charged is 1%, then the investors who buy would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund will get only Rs.9.90 per unit. 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.
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Can a mutual fund impose fresh load or increase the load beyond the level mentioned
in the offer documents?
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Mutual funds cannot increase the load beyond the level mentioned in the offer document.
Any change in the load will be applicable only to prospective investments and not
to the original investments. In case of imposition of fresh loads or increase in
existing loads, the mutual funds are required to amend their offer documents so
that the new investors are aware of loads at the time of investments.
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What is a sales or repurchase/redemption price?
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The price or NAV that 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.
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What is an assured return scheme?
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Assured return schemes are those schemes that assure a specific return to the unitholders
irrespective of performance of the scheme.
A scheme cannot promise returns unless such returns are fully guaranteed by the
sponsor or AMC and this is required to be disclosed in the offer document.
Investors should carefully read the offer document to check whether return is assured for
the entire period of the scheme or only for a certain period. Some schemes assure
returns one year at a time and they review and change it at the beginning of the
next year.
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What is a load and types thereof?
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Load is the charge paid by the Investor to the Mutual Fund.
There are 3 types of load, 1) Entry load – abolished, 2) Exit load – this is paid when redemption is carried out from a scheme and 3) CDSC (Contingent Deferred Sales Charge) - this is an Exit charge payable by the Investor for a No-Load scheme. As per the SEBI (Mutual Fund) Regulations, 1996, CDSC may only be charged for the first four years after purchase of the units. The regulations also provide for the maximum CDSC that can be charged in a particular year. The front end and back end loads cannot be in excess of 7%.
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Can a mutual fund change the asset allocation while deploying funds of investors?
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Considering the market trends, any prudent fund manager can change the asset allocation i.e. he can invest higher or lower percentage of the fund in equity or debt instruments compared to what is disclosed in the offer document. It can be done on a short-term basis on defensive considerations, i.e. to protect the NAV. Hence, the fund managers are allowed certain flexibility in altering the asset allocation considering the interest of the investors. In case the mutual fund wants to change the asset allocation on a permanent basis, they are required to inform the unitholders and give them the option to exit the scheme at prevailing NAV without any load.
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How to invest in a scheme of a mutual fund?
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Mutual funds normally come out with an advertisement in newspapers, publishing the date of launch of the new schemes. Investors can also contact the agents and distributors of mutual funds, who are spread all over the country, for necessary information and application forms. Forms can be deposited with mutual funds through the agents and distributors who provide such services. Nowadays, the post offices and banks also distribute the units of mutual funds.
However, the investors may please note that the mutual funds schemes being marketed by banks and post offices should not be taken as their own schemes and that no assurance of returns is given by them. The only role of banks and post offices is to help in distribution of mutual funds schemes to the investors.
Investors should not be carried away by commission/gifts given by agents/distributors for investing in a particular scheme. Instead, they must consider the track record of the mutual fund and should take objective decisions.
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Can non-resident Indians (NRIs) invest in mutual funds?
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Yes, non-resident Indians can also invest in mutual funds. Necessary details in
this respect are given in the offer documents of the schemes.
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How much should one invest in debt or equity oriented schemes?
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An investor should take into account his risk-taking capacity, age factor, financial
position, etc. As already mentioned, the schemes invest in different types of securities
as disclosed in the offer documents and offer different returns and risks. Investors
may also consult financial experts before taking decisions. Agents and distributors
may also help in this regard.
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How should an investor fill up the application form of a mutual fund scheme?
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An investor must mention clearly his name, address, number of units applied for
and such other information as required in the application form. He must give his
bank account number so as to avoid any fraudulent encashment of any cheque/draft
issued by the mutual fund at a later date for the purpose of dividend or repurchase.
Any changes in the address, bank account number, etc at a later date should be informed
to the mutual fund immediately.
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What should an investor look for while going through an offer document?
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An abridged offer document, which contains very useful information, is required
to be given to the prospective investor by the mutual fund. The application form
for subscription to a scheme is an integral part of the offer document. SEBI has
prescribed minimum disclosures in the offer document. An 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.
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What is an Account Statement?
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It is a statement summarising all the transactions and other details like unit balance, value of units etc. of the investor. It also records all his/her registration attributes and records changes therein as and when they occur. It is a conclusive proof of their investments and shows the financial standing on a given date.
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When will the investor get certificate or statement of account after investing in
a mutual fund?
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Mutual funds are required to despatch certificates or statements of accounts within
six weeks from the date of closure of the initial subscription of the scheme. In
case of close-ended schemes, the investors would get either a demat account statement
or unit certificates as these are traded in the stock exchanges. In case of open-ended
schemes, a statement of account is issued by the mutual fund within 30 days from
the date of closure of initial public offer of the scheme. The procedure of repurchase
is mentioned in the offer document.
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How long will it take for transfer of units after purchase from stock markets in
case of close-ended schemes?
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According to SEBI Regulations, transfer of units is required to be done within thirty
days from the date of lodgment of certificates with the mutual fund.
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As a unitholder, how much time will it take to receive dividends/repurchase proceeds?
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A mutual fund is required to despatch to the unitholders the dividend warrants within
30 days of the declaration of the dividend and the redemption or repurchase proceeds
within 10 working days from the date of redemption or repurchase request made by
the unitholder.
In case of failure to despatch the redemption/repurchase proceeds within the stipulated
time period, the Asset Management Company is liable to pay interest as specified by
SEBI from time to time (15% at present).
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Can a mutual fund change the nature of the scheme from the one specified in the offer
document?
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Yes. However, no change in the nature or terms of the scheme, known as fundamental
attributes of the scheme e.g. structure, investment pattern, etc. can be carried
out unless a written communication is sent to each unitholder and an advertisement
is given in one English daily having nationwide circulation and in a newspaper published
in the language of the region where the head office of the mutual fund is situated.
The unitholders have the right to exit the scheme at the prevailing NAV without
any exit load if they do not want to continue with the scheme. The mutual funds
are also required to follow similar procedure while converting the scheme from close-ended
to open-ended scheme and in case of change in sponsor.
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How will an investor come to know about the changes, if any, which may occur in the
mutual fund?
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There may be changes from time to time in a mutual fund. The mutual funds are required
to inform any material changes to their unitholders. Apart from it, many mutual
funds send quarterly newsletters to their investors.
At present, offer documents are required to be revised and updated at least once
in two years. In the meantime, new investors are informed about the material changes
by way of addendum to the offer document until the offer document is revised
and reprinted.
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How to know the performance of a mutual fund scheme?
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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 websites of mutual funds. All mutual funds are also required to put their NAVs on the website 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 effect on the yield, and other useful information in the same half-yearly format.
The mutual funds are also required to send annual report or abridged annual report to the unitholders at the end of the year. Various studies on mutual fund schemes, including yields of different schemes, are being published by the financial newspapers on a weekly basis. Apart from these, many research agencies also publish research reports on performance of mutual funds including the ranking of various schemes in terms of their performance. Investors should study these reports and keep themselves informed about the performance of various schemes of different mutual funds.
Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity oriented schemes with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc.
On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme.
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How to know where the mutual fund scheme has invested money mobilised from the investors?
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The mutual funds are required to disclose full portfolios of all of their schemes
on half-yearly basis which are published in the newspapers. Some mutual funds send
the portfolios to their unitholders.
The scheme portfolio shows investment made in each security i.e. equity, debentures,
money market instruments, government securities, etc. and their quantity, market
value and % to NAV.
These portfolio statements also required to disclose illiquid securities in the
portfolio, investment made in rated and unrated debt securities, non-performing
assets (NPAs), etc.
Some of the mutual funds send newsletters to the unitholders on quarterly basis
which also contain portfolios of the schemes.
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Is there any difference between investing in a mutual fund and in an initial public
offering (IPO) of a company?
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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.
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If schemes in the same category of different mutual funds are available, should one
choose a scheme with lower NAV?
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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. Sometimes, they prefer a new scheme which is issuing units at Rs. 10 whereas the existing schemes in the same category are available at much higher NAVs. Investors may please note that in case of mutual funds schemes, lower or higher NAVs of similar 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. This is explained in an example given below.
Suppose scheme A is available at an NAV of Rs.15 and another scheme B is available at Rs.90. Both schemes are diversified equity oriented schemes. Investor has put Rs. 9,000 in each of the two schemes.
He would get 600 units (9000/15) in scheme A and 100 units (9000/90) in scheme B. Assuming that the markets go up by 10 per cent and both the schemes perform equally well and it is reflected in their NAVs, the NAV of scheme A would go up to Rs. 16.50 and that of scheme B to Rs. 99. Thus, the market value of investments would be Rs. 9,900 (600* 16.50) in scheme A and it would be the same amount of Rs. 9,900 in scheme B (100*99). The investor would get the same return of 10% on his investment in each of the schemes. Thus, lower or higher NAV of the schemes and allotment of higher or lower number of units within the amount an investor is willing to invest should not be the factors for making investment decision. Likewise, if a new equity oriented scheme is being offered at Rs.10 and an existing scheme is available for Rs. 90, it should not be a factor for decision making by the investor. Similar is the case with income or debt-oriented schemes.
On the other hand, 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.
Similar is the case of fall in NAVs. An efficiently managed scheme at higher NAV may not fall as much as an inefficiently managed scheme with lower NAV. Therefore, the investor should give more weightage to the professional management of a scheme instead of lower NAV of any scheme. He may get much higher number of units at lower NAV, but the scheme may not give higher returns if it is not managed efficiently.
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How to choose a scheme for investment from a number of schemes available?
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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.
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Are the companies with names like mutual benefit the same as mutual funds schemes?
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Investors should not assume that some company bearing the name "mutual benefit" is a proper mutual fund.
These companies do not come under the purview of SEBI. In fact, mutual funds can mobilise funds from the investors by launching schemes only after getting registered with SEBI as mutual funds.
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Is the higher net worth of the sponsor a guarantee for better returns?
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In the offer document of any mutual fund scheme, financial performance including
the net worth of the sponsor for a period of three years is required to be given.
The only purpose is that the investors should know the track record of the company
which has sponsored the mutual fund.
However, higher net worth of the sponsor does not mean that the scheme would give
better returns or that the sponsor would compensate in case the NAV falls.
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Where can an investor look out for information on mutual funds?
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Almost all the mutual funds have their own websites. Investors can also access the NAVs, half yearly results and portfolios of all mutual funds at the web site of Association of Mutual Funds in India (AMFI): www.amfiindia.com. AMFI has also published useful literature for the investors.
Investors can log on to the website of SEBI (www.sebi.gov.in) and go to "Mutual Funds" section for information on SEBI regulations and guidelines, data on mutual funds, draft offer documents filed by mutual funds, addresses of mutual funds, etc. Also, in the annual reports of SEBI available on the website, a lot of information on mutual funds is given.
There are a number of other websites which give a lot of information regarding various schemes of mutual funds including yields over a period of time. Many newspapers also publish useful information on mutual funds on daily and weekly basis. Investors may approach their agents and distributors to guide them in this regard.
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Can an investor appoint a nominee for his investment in units of a mutual fund?
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Yes. The nomination can be made by individuals applying for/holding units on their
own behalf singly or jointly. Non-individuals including society, trust, body corporate,
partnership firm, Karta of Hindu Undivided Family, holder of Power of Attorney cannot
nominate.
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What happens to the invested money when a mutual fund scheme is wound up?
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In case of winding up of a scheme, the mutual funds pay a sum based on prevailing
NAV after adjustment of expenses. Unitholders are entitled to receive a report on
winding up from the mutual funds which gives all necessary details.
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