BroadSpectrumofFS&MF-Lec1

8/8/2019 BroadSpectrumofFS&MF-Lec1

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Management of Financial Services


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Broad Spectrum of Financial

Services What is Financial Service?


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Mutual Fund


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Basics of Investments:

Risk Aversion Risk Management

Bank Deposits, PPF,

NSC, Insurance,

Kisan Vikas Patra etc.

Mutual Funds

Low Risk/Low Return Managed Risk/High Return


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1. Mutual Funds invest only in shares.

2. Mutual Funds are prone to very high risks/actively traded.3. Mutual Funds are very new in the financial market.

4. Mutual Funds are not reliable and people rarely invest in them.

5. The good thing about Mutual Funds is that you dont have to pay

attention to them.


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1. Equity Instruments like shares form only a part of

the securities held by mutual funds. Mutual funds

also invest in debt securities which are relatively

much safer.

2. The biggest advantage of Mutual Funds is their

ability to diversify the risk.

3. Mutual Funds are their in India since 1964. Mutual

Funds market is very evolved in U.S.A and is therefor the last 60 years.

4. Mutual Funds are the best solution for people who

want to manage risks and get good returns.


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5. The truth is as an investor you should always pay

attention to your mutual funds and continuouslymonitor them. There are various funds to suit

investor needs, both as a long term investment

vehicle or as a very short term cash management

vehicle.6. US-64 is very much a part of the market and is not

immune to its vagaries. The crisis has risen due to

mismanagement of the fund.


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A mutual fund is a common pool of money into which investors place

their contributions that are to be invested in different types of

securities in accordance with the stated objective.

An equity fund would buy equity assets ordinary shares, preference

shares, warrants etc.

A bond fund would buy debt instruments such as debenture bonds,

or government securities/money market securities.

A balanced fund will have a mix of equity assets and debt

instruments.

Mutual Fund shareholder or a unit holder is a part owner of the funds

asset.


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Operations Flow Chart

(Reference: amfiindia.com)


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Phase I 1964 87: In 1963, UTI was set up by Parliament under UTI

act and given a monopoly. The first scheme launched by UTI was Unit

Scheme-64. Later in 70s and 80s, UTI started offering some special

purpose schemes like ULIP and Childrens Gift Growth Fund. Master

share, the first equity fund was launched in 1986. These were launched to

suit the needs of different class of investors.

Phase II 1987 93: 1987 marked the entry ofnon-UTI, Public Sector

mutual funds. Some of the mutual funds launched during this period are

SBI Mutual Fund, Canbank Mutual Fund, LIC Mutual Fund, Indian Bank

Mutual Fund, GIC Mutual Fund and PNB Mutual Fund.

Also marked a spurt in launch of assured funds like


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Cantriple, Magnum Triple, BOI Double Square Plus. Equity funds with

assured returns were launched which later ended in disaster.Phase III 1993 96: Permission was granted for entry ofprivate sector

funds. It gave greater choice to the Indian Investors. These private funds

have brought in with them the latest product innovations, investment

management techniques and investor servicing technology that makes

the Indian mutual fund industry vibrant and growing. This phase also

marked the launch of an open-end funds.

Phase IV 1996: Investor friendly regulatory measures have been taken

both by SEBI to protect the investor, and by the government to enhance

investors returns through tax benefits.


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Portfolio diversification: It enables him to hold a diversified investment

portfolio even with a small amount of investment like Rs. 2000/-.

Professional management: The investment management skills, along

with the needed research into available investment options, ensure a

much better return as compared to what an investor can manage on his

own.

Reduction/Diversification of Risks: The potential losses are also

shared with other investors.

Reduction of transaction costs: The investor has the benefit of

economies of scale; the funds pay lesser costs because of larger volumesand it is passed on to the investors.

Wide Choice to suit risk-return profile: Investors can chose the fund

based on their risk tolerance and expected returns.


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Liquidity: Investors may be unable to sell shares directly, easily and

quickly. When they invest in mutual funds, they can cash their investmentany time by selling the units to the fund if it is open-ended and get the

intrinsic value. Investors can sell the units in the market if it is closed-

ended fund.

Convenience and Flexibility: Investors can easily transfer their holdings

from one scheme to other, get updated market information and so on.

Funds also offer additional benefits like regular investment and regular

withdrawal options.

Transparency: Fund gives regular information to its investors on the

value of the investments in addition to disclosure of portfolio held by their

scheme, the proportion invested in each class of assets and the fund

manager's investment strategy and outlook


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No control over costs: The investor pays investment

management fees as long as he remains with the fund, even while

the value of his investments are declining. He also pays for funds

distribution charges which he would not incur in direct investments.

No tailor-made portfolios: The very high net-worth individuals or

large corporate investors may find this to be a constraint as they will

not be able to build their own portfolio of shares, bonds and othersecurities.

Managing a portfolio of funds: Availability of a large number of

funds can actually mean too much choice for the investor. So, he

may again need advice on how to select a fund to achieve hisobjectives.

Delay in redemption: It takes 3-6 days for redemption of the units

and the money to flow back into the investors account.


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Broad Types of Mutual Funds


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Open-end Fund

Available for sale and repurchase at all times based on the net assetvalue (NAV) per unit.

Unit capital of the fund is not fixed but variable.

Fund size and its total investment go up if more new subscriptions

come in than redemptions and vice-versa.

Closed-end Fund

One time sale of fixed numberof units.

Investors are not allowed to buy or redeem the units directly from the

funds. Some funds offer repurchase after a fixed period. For example,

UTI MIP offers a repurchase after 3 years. Listed on stock exchange and investors can buy or sell units through

the exchange.

Units maybe traded at a discount or premium to NAV based on

investors perception about the funds future performance and other

market factors.


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Marketing a new mutual fund scheme involves initial expenses.These expenses are charged to the investors through loads and are

recovered from the investors in different ways:

Front-end or entry loadis charged to the investor at the time ofhis

entry into the scheme.

Back-end or exit loadis charged to the investor at the time of hisexit from the scheme.

Deferred loadis charged to the investor over a period of time.

Contingent deferred sales charge: Different amount of loads are

charged to the investor depending upon the time period the investor

has stayed with the fund. The longer he stays with the fund, lesserthe amount of exit fund he is charged.

Very often, AMCs do not charge any initial expenses to the investor

in the IPO. These are hence are no-load funds. In no-load funds,

the investors get units for the complete amount invested.


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Money Market Funds/Cash Funds

Invest in securities of short term nature I.e. less than one year

maturity.

Invest in Treasury bills issued by government, Certificates of

deposit issued by banks, Commercial Paper issued companies andinter-bank call money.

Aim to provide easy liquidity, preservation of capital and moderate

income.

Gilt Funds

Invest in Gilts which are government securities with medium tolong term maturities, typically over one year.

Gilt funds invest in government paper called dated securities.

Virtually zero risk of default as it is backed by the Government.

It is most sensitive to market interest rates. The price falls when

the interest rates goes up and vice-versa.


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Debt Funds/Income Funds

Invest in debt instruments issued not only by government, but also

by private companies, banks and financial institutions and otherentities such as infrastructure companies/utilities.

Target low risk and stable income for the investor.

Have higher price fluctuation as compared to money market funds

due to interest rate fluctuation.

Have a higher risk of default by borrowers as compared to Giltfunds.

Debt funds can be categorized further based on their risk profiles.

Carry both credit risk and interest rate risks.


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Equity Funds:

Invest a major portion of their corpus in equity shares issued by

companies, acquired directly in initial public offering or through

secondary market and keep a part in cash to take care of

redemptions. Risk is higher than debt funds but offer very high growth potential

for the capital.

Equity funds can be further categorized based on their investment

strategy.

Equity funds must have a long-term objective.


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Balanced Funds:

Has a portfolio comprising of debt instruments, convertible

securities, preference and equity shares.

Almost equal proportion of debt/money market securities and

equities. Normally funds maintain a Equity-Debt ratio of55:45 or

60:40. Objective is to gain income, moderate capital appreciation and

preservation of capital.

Ideal for investors with a conservative and long-term orientation.


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Options Available to theInvestor


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Product Return Safety Liquidity Tax

Benefit

Conven-

ienceBank

Deposit

Low High High No High

Equity

Instruments

High Low High or

Low

No Moderate

Debentures Moderate Moderate Low No Low

Fixed

Deposits by

Companies

Moderate Low Low No Moderate

Bonds Moderate Moderate Moderate Yes Moderate


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Benefit

Conven-

ienceRBI Relief

Bonds

Moderate High Low Yes Moderate

PPF Moderate High Low Yes Moderate

National

Saving

Certificate


National

SavingScheme


Monthly

Income

Scheme



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Benefit

Conven-

ienceLife

Insurance


Mutual

Funds

(Open-end)

Moderate Moderate High No High

Mutual

Funds

(Closed-

end)

Moderate Moderate High Yes High


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Bank Deposits cater to investor class that look for safety and

accepts a relatively low return. They cannot be compared with equity

funds but with debt funds.

A bank deposit is guaranteed by the bank for repayment of principal

and interest whereas a debt fund has no contractual guarantee for

repayment of principal or interest.

In bank deposits, the investor has to assess the risk in terms of

credit ratings of the bank which gives an indication of the financial

soundness of the bank. However, a debt fund is not rated by any

agency. The investor has to assess the risk on the portfolio held by

the fund.

Bank deposits are not totally free from risk and generally give lower

returns. A conservative debt fund can give higher returns than a bank

deposit, even though there is no contractual guarantee as in a

deposit.


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While instruments like shares give high returns at the cost of high risk,

instruments like NSC and bank deposits give lower returns and higher

safety to the investor.

Mutual Funds aim to strike a balance between risk and return and give

the best of both to the investor.


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Fund Structure and its

Constituents


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Fund Sponsor

Trustees

Asset Management

Company

Depository

Custodian

Agent


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The Fund Sponsor

Any person or corporate body that establishes the Fund and registers

it with SEBI.

Form a Trust and appoint a Board of Trustees.

Appoints Custodian and Asset Management Company either directly

or through Trust, in accordance with SEBI regulations.

SEBI regulations also define that a sponsor must contribute

at least 40% to the net worth of the asset management

company.


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Trustees

Created through a document called the Trust Deed that is executed by

the Fund Sponsor and registered with SEBI.

The Trust-the mutual fund may be managed by a Board of Trustees- a

body of individuals or a Trust Company- a corporate body. Protector of unit holders interests.

2/3 of the trustees shall be independent persons and shall not be

associated with the sponsors.


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Rights of Trustees:

Approve each of the schemes floated by the AMC.

The right to request any necessary information from the AMC.

May take corrective action if they believe that the conduct of thefund's business is not in accordance with SEBI Regulations.

Have the right to dismiss the AMC,

Ensure that, any shortfall in net worth of the AMC is made up.


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Obligations of the Trustees:

Enter into an investment management agreement with the AMC. Ensure that the fund's transactions are in accordance with the Trust

Deed.

Furnish to SEBI on a half-yearly basis, a report on the fund's

activities

Ensure that no change in the fundamental attributes of any scheme orthe trust or any other change which would affect the interest of unit

holders is happens without informing the unit holders.

Review the investor complaints received and the redressal of the same

by the AMC.


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Acts as an invest manager of the Trust under the Board Supervision

and direction of the Trustees.

Has to be approved and registered with SEBI.

Will float and manage the different investment schemes in the name of

Trust and in accordance with SEBI regulations.

Acts in interest of the unit-holders and reports to the trustees. At least 50% of directors on the board are independent of the

sponsor or the trustees.


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Obligation of

Asset

Management Company:

Float investment schemes only after receiving priorapproval from the

Trustees and SEBI.

Send quarterly reports to Trustees.

Make the required disclosures to the investors in areas such ascalculation ofNAV and repurchase price.

Must maintain a net worth of at least Rs.10 crores at all times.

Will not purchase or sell securities through any broker, which is

average of5% or more of the aggregate purchases and sale of

securities made by the mutual fund in all its schemes. AMC cannot act as a trustee of any other mutual fund.

Do not undertake any other activity conflicting with managing the

fund.


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Custodian

Has the responsibility of physical handling and safe keeping of the

securities.

Should be independent of the sponsors and registered with SEBI.

Depositories

Indian capital markets are moving away from physical certificates for

securities to dematerialized form with a Depository.

Will hold the dematerialized security holdings of the Mutual Fund.


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Distribution Channels


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Mutual Funds are primary vehicles for large collective investments, working

on the principle of pooling funds.A substantial portion of the investments happen at the retail level.

Agents and distributors are a vital link between the mutual funds and

investors.

Agents

- Is a broker between the fund and the investor and acts on behalf of theprincipal.

- He is not exclusive to the fund and also sells other financial services. This

in a way helps him to act as a financial advisor.

Distribution Companies

- Is a company which sells mutual funds on behalf of the fund.

- It has several employees or sub-broker under it.

- It manages distribution for several funds and receives commission for its

services.


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Banks and NBFCs

- Several banks, particularly private and foreign banks are involved in a

fund distribution by providing similar services like that of distributioncompanies.

- They work on commission basis.

Direct Marketing

- Mutual funds sell their own products through their sales officers and

employees of the AMC.

- This channel is normally used to mobilise funds from high net worth

individuals and institutional investors.


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Agent Commissions

- No rules prescribed for governing the maximum or minimum

commissions payable by a fund to its agents.-As per SEBI regulations, 1996 all initial expenses including brokerage

charges paid to agents cannot exceed 6% of resources raised under

the scheme.

- Excess distribution charges have to be borne by the AMC.

-A no-load fund is authorised to charge the schemes with the commissionspaid to agents as part of the regular management and marketing expenses

allowed by SEBI.


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Accounting and Taxation


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Calculating Net Asset Value

Unit Capital is the investors subscriptions. In mutual funds it is nottreated as a liability.

Investments made on behalf of the investors are reflected on the assets

side of the balance sheet.

There are liabilities of short-term nature.

FundsNet Asset =Asset LiabilitiesNet Asset Value = Net Assets of the scheme / No. ofOutstanding Units

i.e

NAV = (Market value of investments + Receivables + Other Accrued

Income + Other assets Accrued Expenses Other Payables Other

liabilities) / ( No. of Units Outstanding as at the NAV date)


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The factors affecting theNAVare as following:

Capital Gains or Losses on the sale or purchase of the Investment

securities.

Dividend and income earned on the assets.

Capital Appreciation in the underlying value of the stocks held in the

portfolio.

Other assets and liabilities.

Number of units sold or purchased.


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SEBI regulations forNAV

The day on which NAV is calculated by a fund is called valuation date.

NAVof all schemes must be calculated and published at leastweekly.

This is applicable to both open-end and closed-end fund.

Some closed end funds (Monthly Income Schemes) that are not listed

on stock exchange may publish it monthly-quarterly.


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SEBI Guidelines forPricing of Units:

The mutual fund shall ensure that the re-purchase price is not

lower than 93% of the NAV.

The sale price is not higher than 107% of theNAV. Repurchase

price ofclosed end scheme shall not be lower than 95% of the

NAV.

The difference between the repurchase price and the sale price

of the units shall not exceed 7% of the sale price.


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Since investments held by a mutual fund in its portfolio are tobe marked to the market, the NAV includes two components:

a) Realized gains or losses.

b) Unrealized gains or losses.

As per SEBI guidelines, unrealized appreciation cannot be

distributed by a fund, whereas the realized gain can be

distributed.


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Investment Management Fees and Advisory Fees:

1.25% of the firstRs.100 crores of weekly average net assets

outstanding in the accounting year.

1% weekly average net assets in excess ofRs. 100 crores.

A no load scheme can charge an additional management fee up to1% of weekly average net assets outstanding in the accounting year.


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Total expenses charged by the AMC to a scheme,

excluding issue or redemption expenses but includinginvestment management and advisory fees have

following limits:

2.5% -On the firstRs. 100 crores of average weekly net assets

2.25% -On the nextRs. 300 crores of average weekly net assets

2% -On the nextRs. 300 crores of average weekly net assets

75% -On the balance of average weekly net assets

For bond funds, the above percentages are required to be lower by

0.25%


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Taxation in the Hands of the Fund

Income earned by any mutual fund registered with SEBI or set up by a

public sector bank/Financial Institution or authorised by RBI is exempt

from tax.

Income distributed to unit holders by a closed-end or debt fund has to

pay a distribution tax of 10% plus surcharge of 1% I.e. a tax of 11%.

This tax is also applicable to distributions made by open-end fundswhich have less than 50% allocation to equity.

The Impact on the Fund and the Investor

Due to the tax payment by the fund, the NAV and the value of the

investors investment will come down.

The tax bears no relationship to the investors tax bracket.

This tax makes the income schemes less attractive than growth

schemes.

The fund cannot avoid tax even if the investor chooses to reinvest the

distribution back into the fund.


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Taxation in the Hands of the InvestorTax Rebate available on Subscriptions to Mutual Funds (In accordance with

Section 88 of Income Tax Act)

Investments up to Rs. 60,000 in units of any specified mutual fund

qualifies for tax rebate to the extent of 20% of such investment.

In case of Infrastructure Bonds, investments up to Rs. 70,000 is eligiblefor 20% tax rebate.

Total investment eligible for tax rebate cannot exceed Rs. 60,000.

Investment up to Rs. 10,000 in an equity linked saving scheme (ELSS)

qualifies for tax rebate of 20%.


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Taxation in the Hands of the Investor

Dividend Tax : The tax paid by the investor on receiving dividends from a

mutual fund. There is no dividend tax to be paid at the investors end.

There is no dividend tax deduction from NAV in all funds which are open-

end and with over50% allocation of investment to equities.

Tax of 10.2% is deducted from the NAVby the fundin the following

cases:

- All closed end funds including equity.

-All open end funds with less than 50% allocation in equity.


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Taxation in the Hands of the Investor

Capital Gains on Sale of Units: Capital Gains tax is charged whensomething is sold at profit. If the investor sells his units and earns Capital

Gains, the investor is subject to the Capital Gains Tax.

If the units are held for less than 12 months, they will be treated as short

term capital gain. Otherwise,t hey are called long term capital gains.

For short term, capital gains = Sale consideration (Cost of Acquisition +

Cost of Improvements + Cost of Transfer)

The tax charged depends on the income bracket of the investor.

For long term capital gains, the investor gets the benefit of Indexation bywhich his purchase price is marked up by an inflation index.

Cost of acquisition or improvement = actual cost of acquisition or

improvement * cost of inflation index for year of transfer/cost of inflation

index for year of acquisition or improvement.

The tax charged is either 10% or (20% - rate of inflation).


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In-dept classification of Mutual

Funds


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Broad fund types byNature of Investments: Mutual funds may

invest in equities, bonds or fixed income securities, or short-termmoney market securities. So, we have Equity, Bond and Money

Market Funds.

Broad fund types by InvestmentObjective: Investors and hence

mutual funds pursue different objectives while investing.- Growth funds invest for medium to long term capital appreciation.

- Income funds invest to generate regular income and preservation

of capital with little emphasis on capital appreciation.

-Value funds invest in equities that are considered under-valued

today, whose value will be unlocked in future.

Broad fund types byRisk Profile: Funds portfolio and its

investment objective imply different risk levels. Equity funds have a

greater risk of capital loss than a debt fund. Money Market funds are

exposed to lesser risk than Bond funds.


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Diversified Debt Funds:

Invests in all available types of debt securities, issued by entitiesacross all industries and sectors.

Derives benefit of risk reduction through risk diversification.

Focused Debt Funds:

Have a narrow focus with less diversification in its investments. Include Sector, Specialized and Offshore debt funds.

Have a higher risk as compared to diversified debt funds.

High Yield Debt Funds:

Invest in debt instruments that are not backed by tangible assets

and considered below investment grade.

May earn higher returns though at the cost of higher risk.


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Assured Return Funds- An Indian Variant:

Assured Return or Guaranteed Monthly Income Plans areessentially Debt/Income funds.

Returns are indicated in advance for all the future years of the

closed-end funds.

Any shortfall is borne by the sponsors or managers.

Market regulator, SEBI has been discouraging fund managersfrom offering assured return schemes. If offered, explicit guarantee

is required from a guarantor whose name is specified in advance in

the offer document of the scheme.


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Aggressive Growth Funds

Objective is to earn very high returns for the investor. Target is maximum capital appreciation.

Invest in less researched or speculative shares and may adopt

speculative investment strategies.

High volatility and risk as compared to other funds.

Growth Funds:

Objective is capital appreciation over a long time, 7 - 10 years span.

Invest in companies whose earnings are expected to rise at an

above average rate.

These companies will be considered to have growth potential, but

not entirely unproven and speculative.

Less volatile than aggressive growth funds.


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Specialty Funds

Thematic funds that have a theme for investments. Narrow portfolio orientation and invest only in companies that meet

pre-defined criteria.

Diversification is limited to one type of investment.

More volatile than diversified funds.

Specialty funds are further sub-categorized based on theirinvestments.

Diversified Equity Funds:

Invest only in equities except for a very small portion in liquid money

market securities.

It is not focused on any one or few sectors or shares.

Reduce the sector or stock specific risks through diversification.

Lower risks than growth funds.


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Sector Funds:

Portfolios consists of investments in only in one industry or sector of themarket such as IT, Pharmaceuticals or FMCG.

Higher level of company or sector specific risk than diversified funds.

Offshore Funds:

Invest in equities in one or more foreign countries.

Sensitive to foreign exchange rate risk and economic conditions of the

countries they invest in.

Small-CapE

quity Funds: Invest in shares of companies with relatively low market capitalization

that that of big blue chip companies.

More volatile than other funds as smaller companies are not very liquid.

In terms of investment style, it may be aggressive-growth orgrowth type

or even value fund.


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Equity Linked Savings Schemes - an Indian Variant:

Investment in these schemes entitles the investor to claim an income tax

rebate.

Usually has a lock-in period of 3 years before the end of which funds

cannot be withdrawn.

There are no specific restrictions on the investment objectives for the

fund managers.

Generally, such funds would be Diversified Equity Funds.

Equity Income Funds:

Objective is to give high level of current income along with some steadycapital appreciation.

Invest in shares of companies with high dividend yields and do not

fluctuate as much as other shares. Ex - Power/Utility sector.

Less volatile and risky than other equity funds.


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Equity Index Funds:

The objective is to match the performance of the stock market by

tracking an index that represents the overall market.

Invests in shares that constitute the index and in the same proportion.

Sensitive to overall market risk.

Example: UTI Nifty Fund

Value Funds:

Invest in fundamentally sound companies whose shares are currently

under-priced in the market.

Have lower risk as compared to Growth Funds and take a long termapproach.

Often invested in cyclical industries.

Example: Templeton India Growth fund that has shares of

Cement/Aluminum and other cyclical industries.


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Growth & Income Funds:

Strike a balance between capital appreciation and income for the

investor.

Portfolio is a mix between companies with good dividend paying

records and those with potential for capital appreciation.

Less risky than growth funds but more risky than income funds.

Asset Allocation Funds:

Follow variable asset allocation policy.

Move in an out of an asset class (equity, debt, money market oreven non-financial assets)

Asset allocation funds that follow more stable allocation policies are

like balanced funds.

Asset allocation funds that follow more flexible allocation policies are

like aggressive growth or speculative funds.


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Automatic Re-investmentPlans

Allows the investor to re-invest in additional units the amount of dividends

or other distributions made by the fund instead of receiving it in cash.

Investment takes place at ex-dividend NAV.

The investors reap the benefit of compounding his investments.

Automatic Investment Plans

Allows the investor to invest a fixed sum periodically. Enables him to save

in a disciplined and phased manner.

Such funds help in rupee cost averaging. Mode of investment could be through direct debit to investors salary or

bank account.

Voluntary Accumulation Plan, a modified version of AIP allows the

investor flexibility in terms of amount and frequency of investment.


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Systematic Withdrawal Plans

Allow systematic withdrawals from his fund investment on a periodic

basis. The investor must withdraw a specific minimum amount and also maintain

a minimum balance in his fund account.

The amount withdrawn is treated as redemption of units at the applicable

NAV as specified in the Offer Document.

SWPs are different from MIPs. SWPs allows investors to get back theprincipal amount invested while MIPs will only pay the income part on

regular basis.

Systematic TransferPlans

Allow the investor to transfer on a periodic basis from one scheme to

another within the same fund family.A transfer will be treated as redemption of units from one scheme and

investment of units in another scheme.

Such redemption and investment will be at applicable NAV as mentioned

in the Offer Document.


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Measuring and Evaluating

Mutual Fund Performance


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The InvestorPerspective

-To make intelligent decisions on whether he should continue with the

investment or not.

- He needs the basic knowledge of fund evaluation to judge the

performance of the fund.

The Advisors Perspective

-The potential investors would expect the advisor to give them a proper

advise on which funds have good performance.

- In order to compare different funds, the advisor must have the correct

knowledge and appropriate measures of evaluating the fund performance.


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Change in NAV

- most commonly used by investors to evaluate fund performance and

most commonly published by fund managers.- Easily understood and applied to any type of fund.

- Should be interpreted in light of the investment objective of the fund,

current market conditions and alternative investment returns.

- Long term growth fund or infrastructure fund will give low returns in the

initial years.NAVChange in absolute terms:

(NAV at the end of period) (NAV at the beginning of period)

NAVChange in percentage terms:

(Absolute change in NAV/NAV at the beginning of period) * 100

AnnualisedNAVChange:

{[(Absolute Change in NAV/NAV at the beginning)/months

covered]*12}*100


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No, percentage NAV change cannot give a correct picture as it does not

take into account the interim dividends paid. The correct measure here is

Total Return Method.

Total Return Method

- It takes into account the dividends paid in the interim period and is

suitable for all types of funds.

- It must be interpreted in the light of market conditions and investment

objective of the fund.

-Its limitation is that it ignores the fact that distributed dividends also getreinvested if received during the year.

Total Return is:

[(Distributions + Change in NAV)/NAV at the beginning of the period]* 100


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Return on Investment or Total Return with Dividends Reinvested at

NAV

-The shortcoming of Total return is overcome by computing the TotalReturn with reinvestment of dividends in the fund at the NAV on the date of

distribution.

- Is a measure of cumulative wealth accumulation and is the same as ROI.

-Appropriate for measuring performance of accumulation plans,

monthly/quarterly income income schemes debt funds that distributeinterim dividends.

ROI or Total Return with Reinvestment is:

{(Units Held + div/ex-dNAV) * endNAV begin NAV} /begin NAV * 100


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Cumulative Aggregate vs. Average Annualised Returns

-Absolute NAVs do not give a complete picture. Consistent performancewith respect to Total Return and compounded annual return is of

importance.

- Childrens Gift Fund and Rajalakshmi of UTI are based on cumulative

returns.

- When Cumulative Returns are received at the end of a long period,Annualised Average Compound Rate of Return must be calculated from

the cumulative figure.

- Comparisons between two such schemes is possible only after the

Cumulative Returns are converted into Average Annualised Returns.

Formula for conversion:

A = P*(1+R/100)N where P = principal invested, A = Maturity value of the

investment, N = Period of investment in years, R = annualised compound

rate in percentage.


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Following things should also be considered while comparing fund

performance:

Use long-term performance data

The longer the period covered by fund performance data, the more

reliable would be the conclusions about the funds record.

Compare the Same Time Periods- it is imperative to use the performance data over the same periods of

time as returns over different periods vary due to different market

conditions.


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The Expense Ratio

- Indicator of funds efficiency and cost effectiveness.

- It is defined as the ratio of total expenses to average net assets of the

fund.

- Past and estimated expense figures and ratios are disclosed in the Offer

Document.

- Fluctuations in the ratio across periods require that an average over three

to five years be used to judge a funds performance. Also it should be

evaluated in the light of the fund size, average account size and portfolio

composition.

- Funds with small corpus size will have higher expense ratio.

- If a funds income levels or returns are small say a debt fund with 10%

return, expense ratio becomes important and difference of even 0.5%

between two funds can make lot of difference.


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The Income Ratio

- Defined as its net investment income divided by its net assets for theperiod.

- Useful for measuring income oriented funds, particularly debt funds and

not suitable for funds looking for capital appreciation.

- Cannot be used in isolation, but only with expense ratio and total return.


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Portfolio Turnover Rate

- Measures the buying and selling done by a fund.-A 100% turnover implies that the manager replaced his entire portfolio

during the period in question, lets say one year.

-A 50% turnover implies that the manager replaced his entire portfolio in 2

years.

- Most useful while evaluating equity and balance funds, but notappropriate for equity funds with a value-based long term investment

philosophy.

- Higher T/o does not necessarily mean greater efficiency and must be

seen in relation to the total return to the investor.


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Fund Size

- Small fund are easier to manoeuvre and can achieve their objectiveseasily.

- Large funds benefit from economies of scale.

Cash Holdings

-A large cash holding allows the fund to strengthen its position in preferred

securities without liquidating others.

-Allows cushion against decline in market prices of shares or bonds.


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Importance ofBenchmarking

-A funds performance can be judged in relation to investors expectations.

- However, it is important for the investor to define his expectations in

relation to certain guideposts.- These guideposts or indicators of performance can be thought of as

benchmarks against which a funds performance ought to be measured.

- For instance, BSE-30 will be a benchmark for diversified equity fund and

BSE IT index for tech funds.

While an advisor needs to look at the absolute measures of

performance, he needs to select the right benchmark to evaluate a

funds performance, so that he can compare the measured

performance figures against the selected benchmark.


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Basis for choosing an AppropriatePerformanceBenchmark

The appropriate benchmark has to be selected by reference to:

1. The Asset Class it invests in. Thus, an equity fund has to be judged by

from an appropriate benchmark from the equity market and so on.

2. The funds stated Investment Objective.

There are three types of benchmarks that can be used to evaluate a funds

performance:

1. Relative to the market as a whole.

2. Relative to other mutual funds.

3. Relative to other comparable financial products or investments optionsopen to the investor.


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Equity Funds

Index Funds- a base index:- If an investor were to chose an equity index fund, he can expect toget the same return as on the Index, called the Base Index.

- For index funds, the benchmark is clear and pre-specified by the fund

manager in advance.

Tracking Error:- an Index Fund invests in all of the stocks included in the indexcalculation, in the same proportion as the stocks weight in the index.

- An index funds actual return may be better or worse by what is called

the tracking error.

- The tracking error arises from the practical difficulties faced by thefund manager in trying to remain in line with the weight that the stocks

enjoy in the index.


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Active Equity Funds:

- Using appropriate market index.

- The appropriate index to be used to evaluate a broad-based equity

fund should be decided on the basis of the size and the composition of

the funds portfolio.

- If the fund has a large portfolio, a broader market index like BSE 100

or 200 or NSE 100 may be used to benchmark rather than S&P NIFTY

orBSE 30.- An actively managed fund expects to beat the index.

Sector Funds:

- Benchmark will be the relative Sectoral Index.

- An investor in Infotech or Pharma Sector funds can expect the same

return as the relative sectoral indices.

In other words, the choice of a correct equity index as a benchmark

also depends upon the investment objective of the fund. For example,

a small cap fund has to be compared with a small cap index.


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Debt Funds:

- Using appropriate debt market index.- A broad based bond fund or debt fund should be benchmarked with

broad based debt index whereas a narrower Government Securities

Fund, only the Government Sector sub-segment of the broad based

index has to be used.

- Closed-end funds with clear maturity can be compared with bankdeposits.

- I-SECs I-BEX is most commonly used by some analysts.

Money Market Funds:

- Money market funds due to their short term nature are benchmarkedagainst the government funds of appropriate maturities.

- J.P.Morgans T-Bill index is used by analysts.

- NSEs mibid/mibor rates that reflect interbank call money money

market interest rates can also be used as a benchmark.


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While comparing two funds, it is extremely important to ensure that the

comparisons are meaningful and meet the following criteria:

The InvestmentObjectives and Risk Profiles

- Of two funds being compared must be same.

- For example an equity fund cannot be compared with a debt fund.

Portfolio Compositions- Of the funds compared must be similar.

- High returns fund investing in high risk-prone securities cannot be

compared with a scheme that invests in low risk securities.

Credit Quality and Average Maturity

- The credit ratings of the investments have to be comparable, forexample a security with investments in AAA is not same as AA-.

- A fund with maturity of 3 yrs is not same as the fund with 6yrs.

Fund Size

- Funds of equal size should be compared.


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Expense Ratio

- Expense ratios effect funds performance.

Even when two funds of similar characteristics are compared, their

returns must be calculated on the following comparable basis:

Compare the returns over the same period only.

Only annualised compound returns are comparable, I.e. data must be

available for long enough periods.

Only after-tax returns of two different schemes should be compared.


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An investor will compare the mutual fund performance with other -

investment products like bank deposits, NSCs Indira Vikas Patra etc.

Only instruments of similar investment characteristics and with returns

and calculated over the same periods should be used for meaningful

comparisons.


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While every fund is exposed to market risks, good funds should at least

match major market indices. An AMC or the fund managers must be

evaluated on the following criteria:

Operate with long-term perspective.

Do not indulge in excessive trading that generates high transaction costs

and in turn reduce the NAV/risk of loss.

Turns out a more consistent performance rather than a one time high

and otherwise volatile performance record.

Team of managers with successful records as against fund that are

managed by one individual.

The reliability and track record of the sponsors.

Performance record against competing managers running similar funds.


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To track fund performance, the first step is to find the relevant information

on NAV, expenses, cash flow, appropriate indices etc. The common

sources of information are:

Mutual Funds Annual and Periodic Reports include data on thefunds financial performance which are indicators forexpense ratios and

total return. It also includes a listing of the funds portfolio holdings at

market value, statement of revenue and expenses, unrealizedappreciation/depreciation at year end and changes in net assets.

Financial Press: Daily newspapers like Economic Times provide dailyNAV figures for open-end schemes and share prices of closed-end

schemes. There are also weekly supplements like Smart Investor ofBusiness Standard and Investor Guide of Economic Times also give

enough information for evaluation.


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Fund Tracking agencies like Credence and Value Research are

sources for MF performance data and evaluation. Newsletters: Many MFs, banks and non-banking firms catering to retailinvestors publish their own newsletters.

Prospectus: SEBI regulations requires sponsors to discloseperformance data relating to schemes being managed by them.


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Investing forLong Term the power of compounding

- Invest for the long term and let your money grow on a compound basis.- Higher the frequency of compounding, greater the growth of capital.- An advisor must enable the investor to understand the benefits of

compounding.

Example:

If MR. Kapoor invests Rs. 1000 @ 10% interest rate for10 years and the

amount is compounded annually, this is how the money grows:

Interest generated in the first year would be Rs. 80 (1,000*.08)

Interest generated in the second year would be 86.4 [(1,000+ 80)*.08]instead of 80 Interest in the third year would be 93[(1000+ 80+ 86.4) * .08)

And so on till the interest keeps growing each year, resulting in a total ofRs.2,600 at the end of10


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a) Buy and Hold

- Most common strategy adopted by investors and the most common

mistake.- Long term investments does not necessarily mean buy and hold

without adjusting the portfolio.

- Continuous tracking needs to be for keeping the right funds.

b) Rupee Cost Averaging

- It is advisable to invest regularly in small amounts rather thaninvesting a lump sum at one go.

- A regular investor is always a winner.

- The disadvantage of this method is that it does not tell the investor

when to buy and sell a fund.

c) Value Averaging

- Investor keeps the target value of investment constant.

- He accordingly keeps changing the investment amount either by

increasing or decreasing the same.


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Scenario 24.

Mrs. Sudhakar is investing Rs. 1000 every month for 3 months in ABC

mutual fund. Following are the details:

Check whether rupee cost averaging method will prove beneficial to Mrs.

Sudhakar.

Date Amount

Invested

NAV

January 1000 R. 10/-

February 1000 Rs. 8/-

March 1000 Rs. 12.50


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Solution 24.

Average cost per unit under the plan = 3000/305 = Rs. 9.84

Average NAV = (10 + 8 + 12.50)/3 = Rs. 10.17

Average of the three NAVs is higher than the figure achieved through

rupee-cost averaging.

So, we can say that rupee-cost-averaging is beneficial to Investors.

Date Amount

Invested

NAV Units

Purchased

January 1000 R. 10/- 100

February 1000 Rs. 8/- 125

March 1000 Rs. 12.50 80


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Thank You!

Documents

BroadSpectrumofFS&MF-Lec1