CHAPTER 1 OVERVIEW OF MUTUAL FUND 1.1 INTRODUCTIONshodhganga.inflibnet.ac.in/bitstream/10603/15976/8/08_chapter 1.pdf · Chapter - 1 : Overview of Mutual Fund 8 1.2.1 Merits of Mutual

Chapter - 1 : Overview of Mutual Fund

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CHAPTER 1

OVERVIEW OF MUTUAL FUND

1.1 INTRODUCTION

During the past decade, the Indian financial market has witnessed

remarkable development. The reason can be attributed to the Liberalization,

Privatization, Globalization (LPG) process launched in 1991 under the

guidance of Prime Minister Mr P.V. Narsimha Rao and the then finance

minister Dr. Man Mohan Singh.

It is a fact beyond doubt that every one wants to be secured against

future uncertain events. Financial security is considered to be the most

important factor in any individual‟s life. Investment is the sacrifice of certain

present value of the uncertain future reward. It involves the decisions like,

where to invest, when to invest and how much to invest. Even though the

capital market attracts people, there are a number of problems associated with

it. The reason is that while investing directly in the capital market an individual

investor has to be very careful to judge the valuation of the stocks and to be

able to understand clearly the complexities involved in the stock market

operations as well as fluctuations in stock prices.

In last few years, there has been a mixture of investment opportunities

that has been made accessible for an investor to choose from. Investors have a

basic choice either they can invest directly in individual securities, or they can

invest indirectly through a financial intermediary or collective investment

vehicles. Financial intermediary or collective investment vehicle collect savings

from small and scattered investors and invest these funds in a portfolio of


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financial assets. Mutual fund is one form of such financial intermediary. It is one

of those areas of financial services which have grown rapidly. Mutual funds are

playing a major part in channelising individual savings in productive areas.

A mutual fund is type of financial intermediary that pools the savings of

investors who seeks the same general investment objective and there by invest

such savings in a diversified portfolio of securities. The term “mutual” is used in

the sense that all its returns, minus its expenses, are shared by the particular

fund‟s unit holders.

Mutual fund, a financial innovation provides a novel way of mobilizing

savings from small investors thus permitting them to enjoy the participation in

the equity & other securities of leading company‟s with less amount of risk

involvement, which otherwise would had been impossible for them. In other

words, Mutual fund is a mechanism for pooling the resources by issuing units to

the investors & investing funds in securities as per the objective as disclosed in

offer document issued by the respective mutual fund company.

A MF represents a vehicle for collective investment. When an investor

participates in the scheme of a mutual fund, he automatically becomes part

owner of the investment held under that scheme. The investors get a

proportional share in the gain as well as losses of the fund. A mutual fund

companies invest in equity shares, debentures, bonds, money market

instruments, government securities. Originally, mutual funds were devised as

investment options for retail investors, but now corporate investors are also

forming an important part of the investors‟ base.


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While the mf industry in India has registered a healthy growth over the

last 15 years, it is still very small in relation to other intermediaries like banks

and insurance companies.

Table 1.1

Profiles of Mutual Fund investors among working age Indians with cash

income (in %).

How First Attracted to invest Frequent

Investor

One time

investor

Self motivated 39.5 30.6

Recommended by an agent 28.6 24.2

Recommended by social network 12.8 23.1

Recommended by family member 6 10.8

Recommended by financial advisor/accountant 7 6.8

Convinced by advertising 5.3 4.1

Others 0.8 0.4

Main Reason for Remaining Invested Frequent

Investor

One time

investor

Higher returns 55.4 37.8

Wealth creation 13.3 17.9

Appreciation of investment 9.6 14.3

Tax savings 5.8 5.3

Secure investment 4.2 6.1

Flexibility/Liquidity 3.9 5.8

Simpler than equities 2 4.9

Systematic nature of saving 3 3.3

Others 2.8 4.5 Source The Economic Times : 25/02/2008


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1.1.1 ECONOMICS OF MUTUAL FUND

The most important reason of under development of a country is the

poor capital formation as it is sine qua non for development. The famous

economist, Prof. Ragnar Nurkse‟s concept of vicious circle of poverty

undoubtedly established this fact. The mobilization of small saving is one of the

important aspects of introduction to capital formation in a country. Even though

the Nurksian theory takes a different route to make the circle virtuous, the spirit

of the theory hovers around the capital formation concept. Mutual funds are the

investment venues which constantly are engaged in mobilization of small

savings in the economy and perform the most crucial part in the capital

formation of the country as well as for the development of country.

A mutual fund serves as a link between the investor and securities

market by mobilizing savings from the investor and investing them in the

securities market to generate income. In case of mutual funds, savings of small

investors are pooled under a scheme and the returns are distributed in the

same percentage in which the investments are made by the unit-holders.

Through the chief objective of maximum return, it has been a money-

spinning avenue for investment particularly in the reforms era in the Indian sub

continent.

1.1.2 CONCEPT OF MUTUAL FUNDS.

Mutual Fund is investment product that operates on the principle of

“strength of numbers”. The concept of Mutual fund is based on “Drops

make an ocean”.


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Mutual Funds are association or trusts of public members who wish to

make investment in the financial assets or corporate sector for the mutual

benefit of its members.

The fund collects the moneys of these members from their savings and

invests them on the behalf of investors in a diversified portfolio of financial

assets with a view to reduce risks and to maximize their income and capital

appreciation for distribution to its members on a pro-rata basis. A portfolio of a

mutual fund scheme is the basket of financial assets held by that particular

scheme. It comprises of investment in a variety of securities and asset

category. This collecting or “pooling” permits a number of investors to

contribute to, according to their amount and capacity of investment, the

performance of the fund that is managed with what is acknowledged to be

expertise. Hence, the small investors enjoy collectively the benefits of expertise

in investment by specialist in the trust, which no single individual by himself

could enjoy. By means of the number of options in the form of stocks, bonds or

other financial securities available in the fund‟s portfolio the investors gain

access to wide range of securities, which otherwise would have been only a

dream. Managers of mutual funds along with diversification and risk reduction,

also endow with a variety of services not otherwise reachable to the small

investors.

Mutual Fund is thus a concept of mutual help of subscribers for portfolio

investment and management of these investments by specialist and expert in

the field. Mutual funds play an imperative role in mobilizing the savings of small

investors and then channelizing the same for productive ventures in the Indian


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economy. These funds are set up under the Indian Trusts Act (1882).UTI is

governed by its own Act. From time to time Securities Exchange Board of India

(SEBI) provides necessary guidelines to regulate mutual fund companies.

Mutual Funds diversify their activities in the following areas:

Portfolio management services

Management of offshore funds

Providing advice to offshore funds

Management of pension or provident funds

Management of venture capital funds

Management of money market funds

Management of real estate funds

Figure 1.1

Mutual Fund Operation Flow Chart

Source: www.amfiindia.com

1.2 CHARACTERISTICS OF MUTUAL FUNDS

Some noteworthy distinctiveness of mutual funds which are considered

to be universal in nature irrespective of the type of fund is summarized as

under.


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1. Mobilization of funds: Mutual fund helps to mobilize the savings

of small investor by launching schemes which are specially designed to meet

their investment preferences. In this way the scattered savings of small

investors are accumulated into a common fund of considerable amount and

then invested in a number of financial instruments available in the capital

market. Hence the retail investors get an opportunity to participate in the

prosperity of a large number of companies.

2. Diversification of risks: Mutual funds with the collected funds

from small investors can ensure diversification. The investment collected from

various investors of a mutual fund scheme are invested in the scrip of a number

of companies so as to make certain the diversification of the portfolio, which

results in the diminution of magnitude of risk.

3. Allocation of returns with fellow investors: Returns earned on

the plentiful of scrip of various companies, that constitute the portfolio of a

mutual fund scheme are distributed among the investors after the deduction of

administration expenditure. The degree of returns earned depends on the value

of the underlying portfolio and as well on the proceeds earned on the various

scrips that make up the portfolio of an individual investor.

4. Expert services: Mutual fund employs experts and professional

managers to take the investment decision and to efficiently manage the

portfolio of the individual investors. Thus the professional insight and the

dynamic approach towards the investment of the resources provide these

managers an edge over the individual investor in dealing with risk of capital

market securities.


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1.2.1 Merits of Mutual Funds

1. Diversification: Retail investors owing to financial constraints cannot

do diversification of portfolio, which is a necessity for risk minimization. Also an

investor undertakes risk if he invests all his funds in a particular scrip without

diversifying.

Mutual funds invest the „pool‟ of funds accumulated in number of

companies across a broad cross-section of industries and sectors available for

investments purpose. Thus, this well-diversified portfolio, which has the

features of debt as well as equity instruments, reduces the risk phenomenon

considerably because seldom do all stocks decline at the same time and in the

same proportion. In this way, even if a part of investor‟s portfolio were to go

through a down turn, profit from other performing stocks can check the erosion

in its value. Moreover, each investor in a fund is a part owner of all of the fund‟s

assets. This enables an investor to possess a basket of diversified investment

opportunities shaped in a well-managed portfolio even with a small amount of

money, which would otherwise call for a huge capital.


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Figure 1.2

Investment Pyramid

2. Professional Management: As soon as an investor invests in a

mutual fund scheme, he is relieved of the chores and tensions associated with

managing investments on their own as they cede all the control to heir expert

fund managers. Also many of the investors are ignorant of the financial market

operations and it is not only expensive to „hire the services‟ of an expert but it is

more difficult to identify a real expert, whose main concern will be to invest

fairly on behalf of the investor. The fund manager of a mutual fund is a

professional, performing the job to handle the investors‟ investment so that he

does not have to worry about where to invest, as very few people have the

required time, knowledge, experience and the inclination to understand and

analyze financial markets, on their own to succeed in today‟s fast moving,

global and sophisticated world. Even if the investor has a big amount of capital

available to him, he gets the much deserved benefits from the professional

Capital Preservation

Risk: Low to Medium

Period: Less than 1 year

Income Risk: Medium to Low

Period: 1 to 3 years

Capital Growth Risk: Medium to High

Period: 3 to 5 years

Investor Portfolio Composition

Growth

Funds

Stock

s

Income/Bond Funds Company Fixed Deposits

Bonds

Debentures

Money Market Funds

Short-term Deposits /Government Paper


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management skills brought in by the fund in the management of the investor‟s

portfolio. The investment management skills along with the needed research

into available investment options ensure a much better return than what an

investor can manage themselves.

The fund manager is concerned about following areas of managing an

investor‟s investment.

1. Protection of value of the original investment.

2. Generation of a stable return on the original investment.

3. Facilitation of capital appreciation.

The investors avail of the services of the experienced and skilled

professionals who are backed by a committed investment team which analyses

the performance and prospects of companies and select suitable investment to

achieve the objective of the scheme as specified in the offer document of the

scheme. The fund manager makes possible an organized investment strategy,

which is hardly possible for an individual investor at a small scale.

3. Convenient Administration: Mutual fund companies offer services

such as updated information on the status of the investment through the fund‟s

newsletter. Investing in a mutual fund company results in the reduction of

paperwork and also assist an investor to avoid many problems for example bad

deliveries, delayed payments of dividends and any unnecessary follow up with

the brokers and companies. Also investors can easily transfer their holdings

from one scheme to the other without any difficulty as well they don‟t have to

make payment for brokerage. Hence providing these important services,


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mutual fund save investor‟s time and make investing trouble-free and

convenient.

4. Liquidity: Generally investors cannot sell the securities held by them

easily and quickly, as selling of these securities can be a painful proposition.

Investment in a mutual fund scheme is fairly liquid as compared to many

corporate shares. In an open-ended scheme, an investor can get back his

money promptly at the net asset value related prices from the mutual fund

itself. On the other hand, in case of a close-ended scheme, an investor can sell

the units on a stock exchange at the existing market prices or can avail of the

facility of direct repurchase at NAV related prices which some close-ended and

interval schemes offer the investors occasionally. Thus when there is

requirement of immediate cash, the units of the mutual fund scheme can be

liquidated by the respective investor without any impediment.

5. Return Potential: Mutual fund have the potential to provide higher

return over a long term as they yield to diversification of securities according to

the objectives which are mentioned clearly and specifically in an offer

document. In a mutual fund, dividend and capital gains earned by the investor

can be repeatedly reinvested, thus compounding the reinvestments.

6. Assured Allotment: Mutual fund houses endow with assurance to

the potential investors of firm allotment (typically it is total, some time it is

partial) when an application has been made for the units of the mutual fund

schemes. Obviously, under the tax-savings schemes, there is limit on

investment.


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7. Low Cost: Investment in a mutual fund scheme proves to be

relatively less expensive as compared to directly investing in the capital market.

A direct investor bears all the costs of investing for example brokerage or

custody of securities. While, investing through a mutual fund, the investor has

the advantage of economies of scale; the funds pay lesser costs because of

larger volumes of funds available for investment. In this way even a small

investor will obtain the benefits of economies of scale, if resorts to mutual fund

investment option. Moreover, the entry and exit load are nominal as well as

administration expenses are also economical.

8. Transparency: Investment in a mutual fund is perhaps considered

the most transparent financial intermediary. When investors invests in a

scheme of a mutual fund house, the investor knows the investment objective,

the asset allocation pattern, net asset value, expenses, and any other

information which is important before investment is made. The investors

receives regular information on the value of investment in addition to disclosure

on specific investment made by the scheme, the proportion of money invested

in each category of assets and the fund manager‟s investment strategy and

outlook. In addition to this, mutual fund clearly declares their portfolio every

month. Thus an investor has the idea of where his money is being deployed

and in case they are not satisfied with their portfolio construction, they can

withdraw at a short notice. With the help of such transparency an investor can

track the performance of the mutual fund scheme periodically.

9. Flexibility: Investing in a mutual fund scheme provides elasticity to

the investors. Various investment options are offered to the investors which


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may cater to the individual requirements. Through features of regular

investment plans, regular withdrawal plan, reinvestment option, dividend option,

growth plans an investor can systematically invest according to the necessity

and convenience. Along with this, mutual fund offers a family of schemes or

investment patterns such as equity, debt, liquid or balanced funds and an

investor have the option of transferring their holdings from one scheme to the

other within the same fund house.

10. Tax Benefits: Some mutual fund schemes offer tax rebates to the

investors under specific provisions of the Income Tax Act, 1961 as the

Government offers tax incentives for investment in specified avenues, for

example, Equity Linked Savings Schemes (ELSS). Pension schemes launched

by the mutual funds also offer tax benefits. These schemes are growth oriented

and invest pre-dominantly in equities. Their growth opportunities and risks

associated are like any equity-oriented scheme.

11. Asset Allocation: Investment in a mutual funds helps in allocating

money into diverse investment options, keeping the risk aptitude and tolerance

in mind. If Rs10000 is invested in a fund, then the money can be allocated in

debt or equity instruments, as per the risk appetite of the individual investor.

12. Career Planning: Mutual fund offers the option of Systematic

Investment Plan (SIP) which proves to be an ideal way of investment for young

people who are on the threshold of commencing their career and require

building wealth over a long period of time. Through systematic investment plan

an investor can invest money at regular interval in a mutual fund scheme. This

will also help in escalating the habit of savings among younger generation.


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13. Retirement Planning: Besides the concern for younger people,

mutual fund also offers Systematic Withdrawal Plan (SWP), which is ideal for

retired or nearing retirement persons. Under these plans one can make

investments in a mutual fund scheme and can withdraw money at regular

interval to take care of the old age expenditure.

14. Stability To Stock Market: As mutual fund houses have a large

amount of pooled funds at their discretion, it provides those economies of scale

by which they can absorb any losses in the stock market and can continue

investing in the stock market. In addition, mutual fund increases liquidity in the

money and capital market.

15. Equity Research: Mutual fund houses are able to afford information

and data required for investment in performing companies and sectors as they

have availability of large amount of funds, resources, and dedicated equity

research teams.

16. Well Regulated: Registration of mutual fund houses are made

mandatory by Securities Exchange Board of India (SEBI). All the mutual fund

companies are required to function within provision of strict regulations

designed to protect the interest of investors. Moreover, the operations of mutual

fund are regularly monitored by SEBI.

17. Small Investments: Even a small investor can become a part of

mutual fund scheme without any difficulty. Most mutual fund schemes keep the

minimum investment between Rs 1000 to 5000. No other avenue of investment

offers such a wide array of choice for such an affordable sum by retail

investors.


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18. Simplicity: Investments in mutual fund is measured to be

straightforward, in contrast to other available instruments in the market. Most

Asset Management Company also has automatic purchase plans whereby

units of the mutual fund can be purchased from as little as Rs 2000, as also

where systematic investment plan starts with just Rs.50 per month basis.

19. Freedom from Tracking Investments: Investors are relieved from

tracking the performance of their investments on a regular basis. The important

task of checking the scheme‟s performance is done by experts appointed by

the mutual fund house, who buy and sell securities on the behalf of investor to

achieve the preset objectives for them. Investors are only required to track the

performance of the mutual fund house.

20. Essentials: Investors are required to match their wants with the

detailed benefits that are provided by mutual fund. This will make certain that

the investor makes a better choice and gets the maximum advantages of

various schemes.

1.2.2 Demerits of Mutual Funds

1. No Control Over Cost: Investors who invest in a mutual fund do

not have any control over the overall cost of investing. People who invest in mf

are subject to pay management fees as long as they are part of the fund. In

return, they get professional management and research. The fees is payable as

a percentage of the value invested by the investor irrespective of the fund‟s

performance. A mutual fund investor is also bound to pay distribution cost,

which he would not incur in direct investment. On the other hand, this

shortcoming only means that there is a cost to get hold of the expert services of


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a mutual fund house and this cost is often less compared to the cost incurred

by the investor in direct investment. Above and beyond Securities Exchange of

Board of India has prescribed a ceiling on the maximum expenses that the fund

managers of a mutual fund company can charge on the schemes, thereby

minimizing the investors‟ expenditure of making investment in a mutual fund

company.

2. No Tailor Made Portfolio: Mutual fund has no tailor made

schemes which will be able to suit an individual investor‟s objectives of

investment. The reason for the same is that accomplished and proficient

investors construct their own portfolio of shares, bonds and other securities

with an unambiguous objective. Whereas investing through mutual fund means

transfer of this function to the fund manager. Now the decision of designing a

portfolio vests in the hands of fund managers. It depends on the fund managers

that how and where they mobilize the investments of individual investors

collectively. High-net-worth individuals or large corporate investors may find it

to be a constraint in accomplishing their goals. However, majority of the mutual

fund companies overcome this limitation by offering a variety of schemes under

the same fund. Also each scheme provides several plans and options for the

convenience of the investors. A particular investor can select from different

investment schemes/options/plans and can devise an investment portfolio

according to his preferences and requirements.

3. Difficulty in Managing Portfolio of Fund’s: Due to availability of

large number of funds the selection of appropriate funds itself becomes a brain

storming situation, as this will provide varied opportunities to retail investor.


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One may need professional advice for making a decision of selecting the most

appropriate scheme. Some times it may be difficult for the investor to make a

right choice from the basket of funds, quite similar to a situation where he

selects individual shares and bonds when he opts for direct investment.

Fortunately, India now has a large number of Association of Mutual Fund in

India (AMFI) - registered fund distributors and financial planners who are

competent enough to provide right guidance at the right time for the right

investment opportunities to the investors.

4. No Guaranteed Returns: There is no assurance to unit holders

as to the returns on their investment in a mutual fund scheme because the Net

Asset Value of the scheme may go up or down depending upon the factors and

forces affecting the securities market. The mutual fund schemes are exposed

to usual risk associated with capital and money market such as price/interest

rate risk, credit risk etc.

5. Inadequacy of Professional Management: Due to limitation of

professional management, some funds don‟t perform in the capital market. The

reason following this situation may the management which is not dynamic

enough to explore the available opportunity in the market. Hence, the investor

ponders over the question of whether assigning their hard earned money to be

invested by a professional manager of a mutual fund scheme or to directly

invest in the capital market themselves. Also due to lack of practical approach

on the part of fund manager can also detain an investor from investing in a

mutual fund scheme.


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6. Dilution: As funds of a single investor have small holdings across

different companies, high returns from a few investments often don‟t make

much variation on the overall return. Dilution is also the consequence of a

successful fund getting too big to manage. Once money pours into funds that

have had strong success, the managers often have to face dilemma of finding a

good investment for all the fresh money.

7. Taxes: A fund manager of a mutual fund scheme does not reflect

on the personal tax situation of an individual investor. For instance, when a sale

of security is made by fund manager, the capital-gain tax is triggered, which

influences the profitability of an investor from such sales. It might have been

more beneficial for the investors to put off the capital gain liability.

8. Shifting Of Loyalty Of A Fund Manager: Performance of the

mutual fund schemes of a mutual fund company could be severely affected if a

fund manager shifts his loyalty for the particular mutual fund house. It can

prove to be a loss for the investors whose investments were managed by that

fund manager.

1.3 HISTORY OF MUTUAL FUND

The origin of today‟s Mutual funds can be found in the early nineteenth

century‟s English Investment Trust and Investment Companies. The investment

company concept dates back to Europe in the late 1700s, according to K. Geert

Rouwenhorst in The origin of mutual funds “a Dutch merchant and broker …

invited subscription from investors to form a trust … to provide an opportunity to

diversify for small investors with limited means”. A mutual fund is a type of


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Investment Company that gathers assets from investors and collectively invests

those assets in stocks, bonds, or money market instruments.

Historians are uncertain of the origins of investment funds; some cite the

closed-end investment companies launched in the Netherlands in 1822 by King

William I formed “Societe Generale de Belique”,at Brussels,which appears to

be the first mf, while others point to a Dutch merchant named Adriaan van

Ketwich whose investment trust created in 1774 may have given the king the

idea. Van Ketwich probably theorized that diversification would increase the

appeal of investments to smaller investors with minimal capital. The name of

van Ketwich's fund, Eendragt Maakt Magt, translates to "unity creates

strength". The next wave of near-mutual funds included an investment trust

launched in Switzerland in 1849, followed by similar vehicles created in

Scotland in the 1880s.

The idea of pooling resources and spreading risk using closed-end

investments soon took root in Great Britain and France, making its way to the

United States in the 1890s. The Boston Personal Property Trust, formed in

1893, was the first closed-end fund in the U.S. The creation of the Alexander

Fund in Philadelphia, Pennsylvania, in 1907 was an important step in the

evolution toward what we know as the modern mutual fund. The Alexander

Fund featured semi-annual issues and allowed investors to make withdrawals

on demand. While the mutual fund had its origin in Belgium, it did not take firm

root in continental soil but flourished when transplanted in UK and USA

surroundings.

http://www.investopedia.com/terms/c/closed-endinvestment.asp


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1.3.1 Collective Investment Vehicle

Historically, mf in UK and USA began as private enterprise, known as

investment trust. An investment trust would be founded by a single individual

who used his financial abilities and judgment for the benefit of a group and

who, in turn for his advice and allowed to retain a percentage of profits made

from the group‟s joint investment.

Over a period of time, mf industry has undergone numerous changes.

MF evolved in response to the market condition marking notable changes in

their organization structure and the economics of the industry.

1.3.2 Mutual Fund Industry in UK

The first investment trust, Foreign and Colonial, set out its investment

aims “to give investors of moderate means, the same advantage as the large

capitalist” in its prospectus of 1868. 1880s was the period of boom for this

innovative investment opportunity in UK. Though some investment trusts failed

during the British crash of 1890, most of them survived. By 1900there were

more 100 investment trusts, many of them are still around. These investment

trusts are close-ended funds.

The years from 1900 to 1914 were marked by an increasing tendency on

the part of British investment manager to invest their clients‟ funds in American

securities, especially in stocks and bonds of American railways. With advent of

the First World War, this situation changed drastically. From 1914-1918, British

mutual fund sold a large proportion of their American investment, and a large

part of the money obtained from the sale of American stocks and bonds was


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promptly invested in the war loans of the British government. Though less

remunerative, yet this strategy enabled the survival of the industry.

A. Emergence of Unit Trust

In US, many small investors lost their fortunes in the years following the

Wall street crash of 1929. But not even one investment trust failed during those

troubled years (1890s) in UK. However, some structural changes started taking

place in the industry. The most important one was the emergence of unit trust.

Unit trusts are created by trust deed. The first unit trust appeared in 1931,

shortly after the Wall Street crash. It was a period when income was more

important consideration than growth. Unit trusts conform to the basic pattern of

open-ended investment funds in UK.

Investment trusts continued to be popular with private investor‟s right up

until the middle of 1960s. The unit trust industry expended rapidly till October

1987 crash. By January, 1998 there were almost 1200 unit trust managed by

more than 160 groups. These trusts became popular mainly because of the

range of investment opportunities they made available to the investors. The

stock market crash at the end of 1987 brought significant changes in the unit

trust industry. The other main event affecting the unit trust industry during and

after post 1988 is the implementation of the financial services act. The

Financial services Act brought the investors greater protection and large

number of restriction on the industry.

By the end of 1997 there was $237 billion of asset managed by 1455

open-ended funds. In the last decade, a lot of changes have taken place in the

industry. Increased investor sophistication, wealth and power have led to


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significant influence on the growth of mf market. Investors are demanding

better levels of services, transparency in prices and more product variety. On

the political front there is a drive for lower costs and standardization to

encourage saving. The competition in UK fund industry has increased due to

low entry barriers encouraging new players. The increased level of competition

is putting pressures on prices. There has been a trend in the industry to focus

on core activities and outsource the rest.

The pace of change is very rapid, resulting in steep increase in volumes.

New products are launched, and newer distribution methods are explored. The

mf industry in UK is witnessing a restructuring wave and the outcome is

powerful brand leaders.

1.3.3 Mutual Fund Industry in USA

The origin of mf in the USA could be traced to the private trustee system

in Boston during the second half of 19th century. One of the first investment

trusts, the Boston Personal Property Trust, was organized in 1893.It advertised

that it “was organized for the purpose of giving persons of small means an

opportunity to invest in diversified lists of securities held by a trust which was

managed by professional trustees which is regular line of business in Boston".

It was the Alexander Fund established in Philadelphia in 1907 by W. Wallace

Alexander that seems to have originated many of the ideas adopted by mutual

funds. Like 1924s M.I.T. and State Street Investors mutual fund, the Alexander

fund began as an investment vehicle for a small circle of friends and eventually

expanded to include the general public. As the United States economy grew,


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investment companies were formed in Boston, New York and many other

states.

The creation of the Massachusetts Investors' Trust in Boston,

Massachusetts, heralded the arrival of the modern mutual fund in 1924. The

fund went public in 1928, eventually spawning the mutual fund firm known

today as MFS Investment Management. State Street Investors' Trust was

the custodian of the Massachusetts Investors' Trust. Later, State Street

Investors started its own fund in 1924 with Richard Paine, Richard Saltonstall

and Paul Cabot at the helm. Saltonstall was also affiliated with Scudder,

Stevens and Clark, an outfit that would launch the first no-load fund in 1928. A

momentous year in the history of the mutual fund, 1928 also saw the launch of

the Wellington Fund, which was the first mutual fund to include stocks and

bonds, as opposed to direct merchant bank style of investments in business

and trade.

A. Regulation and Expansion

By 1929, there were 19 open-end mutual funds challenging with nearly

700 closed-end funds. With the stock market crash of 1929, the dynamic began

to change as highly-leveraged closed-end funds were wiped out and small

open-end funds managed to survive.

Government regulators also began to take notice of the fledgling mutual

fund industry. The creation of the Securities and Exchange Commission (SEC),

the passage of the Securities Act of 1933 and the enactment of the Securities

Exchange Act of 1934 put in place safeguards to protect investors: mutual

funds were required to register with the SEC and to provide disclosure in the

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24

form of a prospectus. The Investment Company Act of 1940 put in place

additional regulations that required more disclosures and sought to minimize

conflicts of interest.

The mutual fund industry continued to expand. At the beginning of the

1950s, the number of open-end funds topped 100. In 1954, the financial

markets overcame their 1929 peak, and the mutual fund industry began to grow

in earnest, adding some 50 new funds over the course of the decade. The

1960s saw the increase of aggressive growth funds, with more than 100 new

funds established and billions of dollars in new asset inflows.

Hundreds of new funds were launched throughout the 1960s until the

bear market of 1969 cooled the public appetite for mutual funds. Money flowed

out of mutual funds as quickly as investors could redeem their shares, but the

industry's growth later resumed.

In the USA, mutual fund industry evolved in three phases.

1. Pre 1940,

2. 1940-1970,

3. 1970 to the present.

The first stage that is the period before 1940 was the stage of infancy of

the mutual fund industry. Mutual funds, in those days, were small and dissimilar

to the extent that these entities were not even given the status of a separate

industry. Close-ended funds were the dominant form of mutual funds to

mobilize money (1929 assets mobilized under close ended schemes accounted

for 95% of the total assets of the industry). However, by the end of 1940s the

share of close-ended funds started shrinking in favor of open-ended fund.

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In the second stage, assets managed by mutual funds witnessed rapid

and steady growth and mutual fund evolved into an established industry.

Assets under management were $450 million. In 1940, it rose to $47.6 billion

by the end of 1970. During this phase open-ended funds became the dominant

form of mutual funds.

The most striking feature of the phase (1970 to present) has been the

innovation in the investment objective. Till this phase most of the money was

mobilized under the objective of providing the benefit of diversification in equity

investing. While there were five type of funds offered in 1970, there were 22

different types in 1987. The money market mutual fund is considered the most

innovative launch of that time, as this product was quite different in contrast

with the then existing equity product and was, in many respect very close to the

products offered by banks. It widened the scope of competition for mf with

banks on account of similarity in the product.

Another important happening of that time was the innovative steps taken

by the fund to improve the quality of investor servicing. An example can be

given of the exchange privilege given to the investors to shift from one fund to

another. Another significant development post-1970 has been the reduction or

elimination of sales loads, thereby increasing the mobility of investors. In 1971,

William Fouse and John McQuown of Wells Fargo Bank established the first

index fund, a concept that John Bogle would use as a foundation on which to

build The Vanguard Group, a mutual fund powerhouse renowned for low-cost

index funds. The 1970s also saw the rise of the no-load fund. This new way of

doing business had an enormous impact on the way mutual funds were sold

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and would make a major contribution to the industry's success. The total assets

under management by the end of 1997 were $ 4465 billion managed by 6900

funds.

The decade 1990-2000 was particularly favorable to mutual fund

industry in USA as by the end of 2000 the asset managed by the industry

increased to $7 trillion. The increased demand for mutual funds in the 1990s

led to the creation of a large number of new mutual fund companies. The

number rose from 2900 at the beginning of the decade to about 8200 by the

end of 2000. As stocks and other financial assets earned relatively high returns

in 1990s, households shifted their asset allocation away from real estates and

other tangible assets to financial assets.

During this shift, households showed an increasing preference to

investment through mf than buying securities directly. The number of

households owing mf reached to 50.6 million in 2000 as against 23.4 million in

1990. World equity funds were also an important element in the growth of mf,

as investors increasingly sought to diversify their financial assets through

overseas investment. With the rising demand for mf in 1990s, fund companies

and distribution companies developed new outlets for selling mf and expanded

traditional sales channels. Many funds primarily marketed directly to investors

turned increasingly to third parties and intermediaries for distribution. Funds

that were traditionally sold through a sales force of brokers shifted increasingly

to non-traditional sources of sales such as employee-sponsored pension plans,

banks and life insurance companies in the 1990s.


27

With the 1980s and '90s came bull market mania and previously obscure

fund managers became superstars; Max Heine, Michael Price and Peter Lynch,

the mutual fund industry's top gunslingers, became household names and

money poured into the retail investment industry at a stunning pace. More

recently, the burst of the tech bubble and a spate of scandals involving big

names in the industry took much of the shine off of the industry's reputation.

Shady dealings at major fund companies demonstrated that mutual funds aren't

always benign investments managed by folks who have their shareholders'

best interests in mind and who treat all investors equally.

Despite the 2003 mutual fund scandals, the story of the mutual fund is

far from over. In fact, the industry is still growing, opening up new markets

around the world. The first Korean mutual fund, the Mirae Asset Park Hyun-joo

Fund, was launched in Dec 1998. Today there are 20 trillion Korean won (about

US$19.32 billion) invested in Korea's funds. In the U.S. alone there are more

than 10,000 mutual funds, and if one accounts for all share classes of similar

funds, fund holdings are measured in the trillions of dollars. Despite the launch

of separate accounts, exchange-traded funds and other competing products,

the mutual fund industry remains healthy and fund ownership continues to

grow.

1.3.4 Mutual Funds Industry in India

The mutual fund industry in India started in 1963 with the formation of

Unit Trust of India, at the initiative of the Government of India and Reserve

Bank India. The purpose of establishing the Unit Trust of India was to give a

fillip to equity market. In the wake of Indo-China war of 1961, there was

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shortage of savings going into industrial investment for economic development.

There was a need to mobilize adequate amount of risk capital for industrial

enterprises. The household savings were sought to be channelized into the

primary and secondary share market through units. However in the initial years,

the emphasis in UTI was on income products.

The Indian mutual fund industry has evolved over distinct stages. The

growth of mutual fund industry in India can be divided into four phases:

(1) Phase I (1964-87)

(2) Phase II (1987-92)

(3) Phase III (1992-97)

(4) Phase IV (beyond 1997)

1. Phase I: 1964 – 87

The mutual fund concept was introduced in India with setting up of UTI

Act in 1963. The Unit Trust of India (UTI) was the first mutual fund set up under

the UTI Act, 1963, a special act of the Parliament. Unit Trust of India (UTI) was

established on 1963 by an Act of Parliament. It was set up by the Reserve

Bank of India and functioned under the Regulatory and administrative control of

the Reserve Bank of India. It became operational in 1964 with a major objective

of mobilizing savings through the sale of units and investing them in corporate

securities for maximizing yield and capital appreciation. In 1978 UTI was de-

linked from the RBI and the Industrial Development Bank of India (IDBI) took

over the regulatory and administrative control in place of RBI. This phase

commenced with launch of unit scheme 1964 (US-64) the first open-ended and


29

the most popular scheme. UTI‟s investible funds, at market value (and including

the book value of fixed assets) grew as under:

Table 1.2

Growth of UTI’s Investible Funds

during Phase I : 1964 - 87

Year Investment

1965 49 Crore

1970 – 71 219 Crore

1980 – 81 1126 Crore

1987 5068 Crore

Its investor base had also grown to about 2 million investors. It launched

innovative schemes during this phase. Its fund family included five income-

oriented, open-ended schemes, which were sold largely through its gent

network built up over the years. Master shares were the real close-ended

scheme floated by UTI. It launched Indian fund in 1986-the first Indian offshore

fund for overseas investors, which was listed on the London Stock Exchange

(LSE). UTI maintained its monopoly and experienced a consistent growth till

1987.

2. Phase II: 1987-92 (Entry of Public sector)

The second phase witnessed the entry of Mutual Fund Company

sponsored by nationalized banks and insurance companies. In 1987, SBI

Mutual fund and Canbank Mutual fund were set up as trusts under the Indian

Trust Act, 1882. In 1988, UTI floated another offshore fund, namely T he Indian

Growth Fund which was listed on the New York Stock Exchange (NYSE). By


30

1990, the two nationalized insurance giants, LIC and GIC, and nationalized

banks, namely, Indian bank, Bank of India, and Punjab National Bank had

started operations of wholly-owned mutual fund subsidiaries. The assured

return type of schemes floated by the mutual funds during this phase was

perceived to be another banking product offered by the arms of sponsor banks.

In October 1989, the first regulatory guidelines were issued by the Reserve

Bank of India, but they were applicable only to the mutual funds sponsored by

banks. Subsequently, the Government of India issued comprehensive

guidelines in June 1990 covering all mutual funds. These guidelines

emphasized compulsory registration with SEBI and an arms length relationship

be maintained between the sponsor and asset management company (AMC).

With the entry of public sector funds, there was a tremendous growth in the

size of the mutual fund industry with investible funds, at market value,

increasing to Rs 53,462 crore and the number of investors increasing to over

23 million. The buoyant equity market in 1991-92 and tax benefits under equity-

linked saving schemes enhanced the attractiveness of equity funds.

3. Phase III: 1992-97 (Entry of Public Sector Funds)

The year 1993 marked a turning point in the history of mutual funds in

India. With the entry of private sector funds in 1993, a new era started in the

Indian mutual fund industry, giving the Indian investors a wider choice of fund

families. The Securities and Exchange Board of India (SEBI) issued the Mutual

Fund Regulations in January 1993. SEBI notified regulations in bringing all

mutual funds except UTI under a common regulatory framework. Private

domestic and foreign players were allowed entry in the mutual fund industry.


31

Kothari group of companies, in joint venture with Pioneer, a US fund company,

set up the first private mutual fund the Kothari Pioneer Mutual Fund, in 1993.

Kothari Pioneer introduced the first open-ended fund Prima in 1993. Several

other private sector mutual funds were set up during this phase. UTI launched

a new scheme, Master-gain, in May 1992, which was a phenomenal success

with subscription of RS 4,700 crore from 63 lakh applicants. The industry‟s

investible funds at market value increased to Rs 78,655 crore and the number

of investor accounts increased to 50 million. The 1993 SEBI (Mutual Fund)

Regulations were substituted by a more comprehensive and revised Mutual

Fund Regulations in 1996.

The industry now functions under the SEBI (Mutual Fund) Regulations

1996. However, the year 1995 was the beginning of the sluggish phase of the

mutual fund industry. During 1995 and 1996, unit holders saw an erosion in the

value of their investment due to a decline in the NAV‟s of the equity funds.

Moreover, the service quality of mutual funds declined due to a rapid growth in

the number of investor accounts, and the inadequacy of service infrastructure.

A lack of performance of the public sector funds and miserable failure of foreign

funds like Morgan Stanley eroded the confidence of investors in fund

managers. Investor‟s perception about mutual funds gradually turned negative.

Mutual funds found it increasingly difficult to raise money. The average sales

declined from about Rs 13,000 crore in 1991-94 to about Rs 9000 crore in 1995

and 1996.

The number of mutual fund houses went on increasing, with many

foreign mutual funds setting up funds in India and also the industry has


32

witnessed several mergers and acquisitions. As at the end of January 2003,

there were 33 mutual funds with total assets of Rs. 1, 21,805 crores. The Unit

Trust of India with Rs.44, 541 crores of assets under management was way

ahead of other mutual funds.

4. Phase IV: 1997 – 98

During this phase, the flow of funds into the kitty of mutual funds sharply

increased. This significant growth was aided by a more positive sentiment in

the capital market, significant tax benefits, and 2000 to over Rs 1,10,000 croe

with UTI having 68% of the market share. During 1999-2000 sales mobilization

reached a record level of Rs 73000 crore as against Rs 31,420 crore in the

preceding year. This trend was, however, sharply reversed in 2000-01. The UTI

dropped a bombshell on the investing public by disclosing the NAV of US-64-

its flagship scheme as on December 28, 2000, just at Rs 5.81 as against the

face value Rs 10 and the last sale price of Rs 14.50. The disclosure of NAV of

the country‟s largest mutual fund scheme was the biggest shock of the year to

investors. Crumbling global equity markets, a sluggish economy coupled with

bad investment decision made life tough for big funds across the world in 2001-

02. The effect of these problems was felt strongly in India also. Pioneer ITI, JP

Morgan and Newton Investment Management pulled out from the Indian

market. Bank of India MF liquidated all its schemes in 2002.

The Indian MF industry has stagnated at around Rs 1, 00,000 crore

assets since 2000-01. This stagnation is partly a result of stagnated equity

markets and the indifferent performance by players. As against this, the

aggregate deposit of Scheduled Commercial Banks (SCBs) as on May 3, 2002,


33

stood at Rs 11,86,468 crore. Mutual fund assets under management (AUM)

form just around 10 % of deposits of SCBs.

5. Phase V: 1999-2004 (Emergence of a large and uniform industry)

The other major development in the fund industry has been the creation

of a level playing field for all mutual funds operating in India. This happened in

February 2003, when the UTI Act was repealed. In February 2003, following

the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two

separate entities.

One is the Specified Undertaking of the Unit Trust of India with assets

under management of Rs.29, 835 crores as at the end of January 2003,

representing broadly, the assets of US 64 scheme, assured return and certain

other schemes. The Specified Undertaking of Unit Trust of India, functioning

under an administrator and under the rules framed by Government of India and

does not come under the purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB

and LIC. It is registered with SEBI and functions under the Mutual Fund

Regulations. With the bifurcation of the erstwhile UTI which had in March 2000

more than Rs.76, 000 crores of assets under management and with the setting

up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations,

and with recent mergers taking place among different private sector funds, the

mutual fund industry entered in the fourth phase of consolidation and growth.

As at the end of September, 2004, there were 29 funds, which manage assets

of Rs.153108 crores under 421 schemes.


34

Unit Trust of India no longer has a special legal status as a trust

established by an Act of Parliament. Instead, it has also adopted the same

structure as any other fund in India-a trust and an Asset Management

Company. UTI Mutual Fund is the present name of the erstwhile Unit Trust of

India. While UTI functioned under a separate law of Indian parliament earlier,

UTI Mutual Fund is now under the SEBI‟s (Mutual Funds) Regulations, 1996

like all other mutual funds in India. UTI Mutual Fund is still the largest player in

the Indian fund industry. All SEBI compliant schemes of the erstwhile UTI are

under its charge. All new schemes offered by UTI Mutual Fund are SEBI

approved. Other schemes (US 64, Assured Return Schemes) of erstwhile UTI

have been placed with a special undertaking administered by the Government

of India. These schemes are being gradually wound up.

The emergence of uniform industry with the same structure, operation

and regulations makes it easier for distributors and investors to deal with any

fund house in India.

1999 marked the beginning of a new phase in the history of the mutual

fund industry in India, a phase of significant growth in terms of both amounts

mobilized from investors and assets under management.

Between 1999 and 2005, the size of the industry has doubled in terms of

assets under management which has gone from about Rs 68,000 crores to

over Rs 150,000 crores. Within the growing industry, the relative market share

of different players in terms of amount mobilized and assets under

management have also undergone changes.


35

6. Phase 6 – 2004 onwards: Consolidation and Growth of Mutual

Fund Industry.

The industry has lately witnessed a spate of mergers and acquisitions,

most recent ones being the acquisition of schemes of Alliance Mutual Fund by

Birla Sun Life, Sun F&C Mutual Fund by Principal and PNB Mutual Fund by

principal. At the same time, more international players continue to enter India,

including Fidelity, one of the largest funds in the world. The stage is set now for

growth through consolidation and entry of new international and private sector

players. AS at the end of March 2006, there were 29 funds.

Figure -1.3

Growth In Assets Under Management

Source AMFI

1.4 ORGANISATION OF MF

Mutual fund industry has shown a remarkable growth in performance

over the last few years and is still enduring to do so. It is considered to be the

safest investment avenues because of its well-diversified portfolio and strict

follow up by SEBI. SEBI, the market regulator, has outlined clearly the role,


36

responsibilities and duties of each entity, which form a mutual fund. In India, the

entities which are involved in a mutual fund operation are specified as under.

Figure 1.4

Working Of Mutual Funds

source : amfi

1. Sponsor

2. Trust

3. Asset management company

4. Custodian and depositories

5. Bankers

6. Transfer agent

7. Distributors

8. Registrar

1.4.1 Sponsor

What a promoter is to a company, a sponsor is to a mutual fund. In clear

terms a sponsor is a person who initiates the idea of establishing a mutual fund

company. The sponsor could be a financial services company, a bank or a


37

financial institution. The sponsor will form a trust and appoint the board of

trustees. The sponsor will also generally appoint an Asset Management

Company as fund managers. The sponsor, either directly or through the

trustees, will appoint a Custodian to hold the fund assets. All these

appointments are made in accordance with SEBI Regulation. The sponsor

takes big- picture decision related to the mf. In order to establish a mf in India,

the sponsor is required to obtain a license from SEBI.

A. Eligibility norms for sponsor

1. The sponsor‟s contribution must be a minimum of 40% of the net

worth of AMC.

2. The sponsor is also required to have carried on business in

financial services for a period of not less than five years.

3. It is desirable that the sponsor should have positive net worth in

all the immediate preceding five years of functioning.

4. The net worth of the immediately preceding year should more

than the capital contribution of the sponsor in AMC and the sponsor should

show profit after providing depreciation, interest, and tax for the three out of the

immediate preceding five years.

5. The sponsor and any of the directors or principal officers to be

employed by the mutual fund, should not have been found guilty of fraud or

convicted of an offence involving moral turpitude or guilty of economic offences.

6. Those who qualify the above mentioned criteria are granted

permission by the SEBI to establish a mutual fund.


38

1.4.2 Mutual fund as Trust

Mutual Fund Company is to be formed under the Indian Trust Act of

1882, and is registered with SEBI. The sponsor contributes towards the initial

capital as well as appoints trustee to acquire the assets of the trust for the unit-

holders who are the beneficiaries of such trust. The instrument of trust is

executed by the sponsor in favor of trustees and is registered under the Indian

Registration Act, 1908. The fund thus established invites the prospective

investors to contribute money in the common pool, by subscribing to “units”

issued by various schemes established by the trust. The units acquired by the

investor provide the proof of their beneficial interest in the fund. Under the

Indian Trust Act, 1882 the fund has no independent legal capacity; it is the

trustees who have the legal capacity.

1.4.3 Trustees

The MF company should have board of trustees and trust deed. The

trustees of the mutual fund are appointed by the sponsor. The mutual fund is

managed by the Board of Trustees, who could be- a body of individuals, or a

trust company- a corporate body. The trust is shaped through a document

called the Trust Deed that is executed by the Fund Sponsor in favor of the

trustees. It should be kept in mind that the trustees do not manage the portfolio

of securities directly. This function is performed by the Asset Management

Company, appointed by the trustees or the sponsor, as per the authorization

specified by the Trust Deed.

The trustees are the primary guardian of the unit holders‟ funds and

assets, a trustee is required to be a person of high reputation and integrity. The


39

trustees can be compared as internal regulator in a MF. The responsibility

assigned to trustees is to protect the interests of unit holders. They ensure that

the fund is managed by the AMC according to the defined objectives and in

compilation with the Trust Deed and SEBI Regulation. It is made mandatory by

the SEBI that out of the total number of trustees two-third of the trustees should

be independent- that is, not have any association with the sponsor, to ensure

they are impartial and fair in their dealings.

A. Rights of Trustees

The trustees appoint the AMC with the prior approval of SEBI

They also approve each of the schemes floated by the AMC

They have the right to request any necessary information from the

AMC concerning the operations of various schemes managed by the AMC as

often as required, to ensure that the AMC is in compliance with the Trust Deed

and the regulations

The trustees may take remedial action if they believe that the

conduct of the fund‟s business is not in accordance with SEBI Regulations. In

certain specific events, the Trustees have the right to dismiss the AMC, with the

approval of SEBI and in accordance with the regulations

The trustees have the right to ensure that, based on their

quarterly review of the AMC‟s networth, any shortfall in the networth is made up

by the AMC.


40

B. Obligations of Trustees

The trustees must enter into an investment management

agreement with the AMC. This agreement must be in accordance with the

Fourth Schedule of SEBI (MF) Regulations, 1996.

They must ensure that the fund‟s transactions are in accordance

with the Trust Deed.

The trustees are responsible for ensuring that the AMC has

proper systems and procedures in place and has appointed key personnel

including Fund Managers and a Compliance officer, besides other constituents

such as the auditors and registrars.

The trustees must ensure due diligence on the part of the AMC

for empanelment of brokers.

The trustees must ensure that the AMC is managing schemes

independent of other activities and that the interests of unit-holders of one

scheme are not compromised with those of other schemes/activities. For

example, the trustees must ensure that A MC has not given any undue

advantage to any associates.

The trustees must furnish to SEBI on a half-yearly basis, a report

on the fund‟s activities and a certificate stating that the AMC has been

managing the schemes independently of other activities.

1.4.4 Asset Management Company

An AMC is registered under the Companies Act, 1956, thus giving it a

legal entity. The asset management company also known as Investment

Manager is appointed by the Sponsor, or the trustees, if so authorized by the


41

Trust Deed. To form an AMC the approval of SEBI is also required. It should

have a certificate from SEBI to act as a portfolio manager under SEBI (portfolio

managers) Rules and Regulations, 1993. It is the responsibility of AMC to

recruit fund managers and analysts and other personnel to implement the

decision taken by the sponsor. The AMC has to manage all operational matters

which includes from designing schemes to launching schemes to efficient

handling of investments to communicating with investors. AMC mobilizes the

investment of the investors by making investment in various types of securities.

It acts as the investment manager to the trust under the supervision and

guidance of the trustees.

Minimum required net worth for the AMC is Rs. 10 crores at all times

and this net worth should be in the form of cash. At least 50% of the directors of

the board should be independent, that is, they should not be associated with

the sponsor or its subsidiaries or the trustees. The AMC cannot act as an

AMC/Trustee to any other Mutual Fund. No person can be a director of more

than one AMC or Director of Trust company operated by same AMC.

In return for rendering services, the AMC charges investment

management fees and advisory fess, on an annual basis, according to the size

of the scheme launched by the mutual fund. At present the fees is having the

limit as prescribed by SEBI: on the first Rs 100 crores of the weekly average

net assets – 1.25%; On the balance of net assets – 1.00%.


42

Figure 1.5 Organizational Structure of AMC

Table 1.3 Table Showing Assets Under Management of Certain MF Companies

as on 1st May 2006

Sr. No. Asset Management Company AUM Rs.(in cr.) As on

May 1, 2006 %

1 Prudential ICICI 32151 12

2 UTI 30551 11

3 Reliance 27915 10

4 HDFC 23650 9

5 Franklin Templeton 22360 8

6 Birla Sun Life 16991 6

7 SBI 13670 5

8 DSP Meryll Linch 13308 5

9 Kotak Mahindra 11818 4

10 Tata 10464 4

11 Others 73122 26

Total 276000 100 Source : Investopedia.com

Chief Executive Officer Head of Asset Management Company

Chief Investment Officer Designs the fund’s investment philosophy

Fund Managers

Manages the schemes of the fund

Team of Analysts track market, sectors and companies


43

Figure 1.6

Asset Under Management

12%

11%

10%

9%

8%6%5%

5%

4%

4%

26%

Prudential ICICI UTI Reliance

HDFC Franklin Templeton Birla Sun Life

SBI DSP Meryll Linch Kotak Mahindra

Tata Others

1.4.5 Custodian

The custodian is appointed by the board of trustees. A custodian is

responsible for the maintenance of back office of a mf. The custodian should be

registered with SEBI, to be eligible to become a custodian of mf. The custodian

of the mutual fund company holds the physical securities of various schemes of

the fund in its custody. The duties performed by the custodian can be summed

as receipt and delivery of securities, collection of income, distribution of

dividends, and segregation of assets between schemes. It is important to note

here that the sponsor of a mf cannot act as a custodian to the fund, so as to

ensure that the assets of mutual fund is not in the hands of its sponsor.


44

Custodian

1. HDFC Bank

2. SHCIL

3. Citi Bank

4. Deutsche Bank

5. ABN AMRO

6. IIT Corporate Services

7. SBI India

8. Standard Chartered Bank

1.4.6 Bankers

Mutual funds activities involve dealing with money on a continuous basis

primarily with respect to buying and selling of units, paying for investment

made, receiving the proceeds on sale of investment and discharging its

obligation towards operating expenses. A fund‟s banker therefore plays a

crucial role with respect to its financial dealings by holding its bank accounts

and providing it with remittance services.

1.4.7 Distributor

Mutual fund operates on the principle of accumulating funds from a large

number of investors and then investing on a big scale. For a fund to sell units

across a wide retail base of individual investors, an established network of

distribution agents is essential. Distributors are given agency to sell the

products of mutual fund company in return of a commission.


45

1.4.8 Registrar / Transfer Agent

The registrar is assigned with task of maintaining the accounts of

investors for the purpose of investment as well as disinvestments. The

responsibility undertaken by the registrar includes issuing and redeeming units,

sending fact sheets and annual reports. It depend upon the respective fund

house to manage such purpose in house or outsource it to SEBI- approved

registrars and transfer agents for example Karvy, CAMS etc.

R & TA

1. CAMS

2. Karvy

3. MCS Limited

4. Datamatics

5. MN Dastoor & Co.

6. IIT Corporate Services‟

7. MN Dastoor & Co.

8. Computeronics

9. Tata Consultancy Services

10. CanBank Computer Services

11. ICICI Infotec

12. MCS software solution ltd.

13. PCS Industries ltd.

14. Tata Share Registry

15. UTI ISL.


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1.4.9 Investor

The people who invest in Mutual Fund Company are known as

investors. The following persons are eligible to buy mf units:

1. Residents including:

a. Adult individuals (or minors through their parents or

guardians) holding singly or jointly (not exceeding three in all);

b. Hindu Undivided Families through their respective Kartas;

c. Companies, corporate bodies, partnership, associations of

persons or bodies of individuals, religious and charitable trusts and other

societies registered under the Societies Registration Act, 1860 (so long

as the purchase of units is permitted under their respective constituent

documents);

d. Religious and charitable trust and private trusts, subject to

receipt of necessary approvals as “public Securities” wherever required

e. Association of persons or body of individuals.

f. Mutual funds registered with SEBI.

g. Army/Air Force/Navy other paramilitary units and bodies created

by such institution besides other eligible institution.

2. Foreign Institutional Investors registered with SEBI

3. Multilateral funding agencies/bodies corporate incorporated out-

side India with permission of Government of India/Reserve Bank of India.

4. Overseas financial organizations which have entered into an

arrangement for investment in India, inter-alia with a Mutual fund registered

with SEBI and which arrangements are approved by Central Government.


47

5. NRIs, OCBs, FIIs and persons of Indian origin residing abroad, on

a full repatriation basis/non-repatriation basis.

6. Other schemes of same mutual fund subject to the conditions and

limits prescribed by SEBI Regulations.

7. The Trustees/Trust, AMC or Sponsor or their affiliates, their

associate companies and subsidiaries.

8. Provident / pension / Gratuity / Superannuation and such other

retirement and employee benefit and other similar funds.

1.5 RISK/RETURN ASSOCIATED WITH MUTUAL FUND

Mutual funds in this era are considered to be less risky than the direct

investment in share market. Mutual Fund can diversify across asset class by

investing part of pooled money in equities, part in debt, and so on. That way

even if a part of investors‟ portfolio were to go through a downturn, profit from

other can check the erosion in its value. Mutual Fund are also relatively less

expensive way to invest compared to directly investing in the capital market

because benefit of scale in brokerage, custodial and other fees translate into

lower cost for investors. The following figure clearly presents the risk return

relationship between investment in Mutual Funds and other Direct investment.


48

Figure 1.7 Risk / Return Matrix

Source: Yahoo finance

1.5.1 Risk associated with Mutual Fund Investments

Every investment avenue comes with a certain degree of risk and

uncertainty. Even an insured bank account is subject to the possibility that

inflation will rise faster than the returns, leaving a person with less amount of

real purchasing power than when one started (Rs 100 now gets one lesser

than it got his/her grand-parents when they were of the same age). Mutual

Funds Investment is also prone to risks which influence the financial market.

There are following type of risk associated with the mutual funds investment.

1. Market risk: At times, the price of all the instruments in particular

market rise or fall due to broad outside influences. The result of such kind of

fluctuation will be that the stock prices of both an outstanding highly profitable

company and a fledging corporation may be affected. This change is due to

„market risk‟.


49

2. Inflation risk: Whenever inflation sprints forward faster than the

earnings on investments, an investor runs the risk that actually purchases less

and not more. Hence, sometimes the inflation risk is also referred as „loss of

purchasing power‟. Inflation risk can also occur when the prices rise faster than

the returns on investments.

3. Credit risk: This type of risk involves the analysis of how stable is

the company to which one lends money in the form of investment and the

certainty that it will be able to pay the interest promised, or repay the principal

amount when the investment gets matured.

1.6 CLASSIFICATION OF MUTUAL FUND SCHEMES.

Henry Ford, founder of Ford Motor Company, has once quoted,” The

customer can have any color he wants as long as it‟s black.” The Indian Mutual

Fund investors in 1990s must have felt a bit like the American car buyer in the

1930s, who had as much freedom of choice in terms of car colors as Ford

warranted. Previously, every mutual fund offering resembled the other in terms

of kinds of schemes.

Mutual funds schemes are allocated to a vast number of investors based

on their individual needs and objectives. The requirement and the risk

undertaking ability of a retired man will be certainly different from a young man

of thirty years old. Hence, various types of mutual funds try to cater to the

requirement and objective of investors. The selection of a fund will depend on

an investor according to his income and risk taking capacity.

Subject to SEBI regulations, a Mutual Fund Company is free to construct

to its schemes or products to be offered to the potential investors. These


50

schemes will cater to the vast requirements of the different types of investors.

Mutual Funds in India presently offer more than 400 products across various

categories.

There are many types of mutual funds available to the investor.

However, these different types of funds can be grouped into certain

classification as under: Figure 1.8

Mutual Fund Products / Schemes


51

1.6.1 Functional classification

a) Open-ended schemes

b) Close-ended schemes

c) Interval schemes

d) Load funds

e) No-Load funds

f) Tax-exempt funds

(a) Open-ended schemes

In open ended scheme, the mutual fund constantly offers to sell and

repurchase its units at net asset value (NAV) or NAV related prices.Net Asset

Value can obtained by dividing the amount of the market value of the fund‟s

assets (plus accrued income minus the fund‟s liabilities) by the number of units

outstanding. Investors have the opportunity to enter and exit the scheme any

time during the life of fund. Open- ended funds do not require to be listed on

the stock exchange and can also put forward repurchase soon after allotment.

The open-ended funds do not have a permanent „unit capital‟. The corpus of

fund is subject to increase or decrease, depending on the acquisition or

redemption of units by investors.

There is no fixed period for of units in case of open-ended schemes; the

period can be terminated at whatever time the need arises. The open-ended

fund offers a redemption price at which the unit holder can sell units to the fund

and exit. Moreover, the investor has the facility to enter the fund again by

buying the units from the fund at its offer price. The funds declare sale and

repurchase prices from time to time.


52

The key feature of open-ended funds is degree of liquidity provided by

such funds to the investors.

(b) Close-ended fund

The „unit capital‟ of a close-ended fund is fixed, the reason, as it makes

a one time sale of a fixed number of units. Close-ended funds have a

predetermined maturity period ranging between 2 to 5 years. After the offer

closes, these funds do not permit the investors to buy or redeem units directly

from the funds. However, to present the much required liquidity to investors,

close-ended funds are listed on a stock exchange. Investors are able to trade

through a stock exchange, in the similar style as buying or selling shares of a

company in direct investment. The fund‟s units may be traded at a discount or

premium to NAV based on investors‟ perceptions about the fund‟s future

performance and other market factors affecting the demand for or supply of the

fund‟s units.

The number of outstanding units of a close ended fund does not differ on

account of trading in the fund‟s units at the stock exchange. Now and then, a

close ended funds do offer „buy-back of fund units”, thus offering another

possibility for liquidity to close ended fund investors.

(c) Interval schemes

Interval schemes are combination of both the features of open-ended

and close-ended funds. Interval funds are available for sale or redemption

during prearranged intervals at NAV-related prices.


53

(d) Load funds

Promotion of mutual funds involves preliminary expenses. The mutual

fund company recovers such expenses from the investors in different ways at

different times. The usual ways in which the expense can be recovered from

the investors may be categorized as:

At the time of investor‟s entry into the fund, by deducting a

specific amount from his contribution – Entry load

By charging the fund with a fixed amount each year, during a

specified number of years – Deferred load

At the time of investor‟s exit from the fund, by deducting s

specified amount from the redemption proceeds payable to the investor – Exit

load

The fund that charges entry, exit, or deferred loads is called Load funds.

(e) No-Load funds

Mutual funds that make no entry, exit, or deferred charges for sale

expenses are known as no-load funds. It may be noted here that a no-load fund

only means a fund that does not charge marketing expenses. All funds still

charge the schemes for management fees and other recurring expenses; it is

only that an investor in a no-load fund enters or exits at the net NAV of the

fund, calculated after accounting for these expenses, but without paying any

further marketing expenses from the particular NAV.

Some funds charge only an entry load and some only an exit loads.

Such funds may be termed as Partial load funds.


54

(f) Tax-exempt funds

A mutual fund which invests in tax-exempt securities, are termed as a

tax-exempt funds. In India, any income received by the mutual fund is tax-free.

After the 1999 Union Government Budget, all the dividend income received

from any mutual fund is tax-free in the hands of investors. On the other hand,

funds other than open-ended equity oriented funds have to pay a distribution

tax, before distributing income to investor.

1.6.2 Nature / Objective of investment

1) Money market mutual funds

2) Debt funds

3) Hybrid Funds

4) Equity funds

5) Other Funds

1) Money market / Liquid funds

Liquid funds are characterized as the lowest stair in the order of risk

level as they invest in debt securities of short term nature. These investments

are mainly done in the securities of less than one-year maturity. MMMFs offer

diversification of short-term assets, in terms of issues, maturity, and size,

thereby spreading the risk for the investors.

Foundation of MMMF

In India, Reserve Bank of India outlined the extensive framework for

setting up MMMF in its credit policy in April 1991. The objective was “Providing

an additional short-term avenue to investors and to bring money market

instruments within the reach of individuals.” RBI allotted a task force to work


55

out the comprehensive effective guidelines and documentation for MMMFs with

Mr.D Basu (Deputy MD, State Bank of India) as the chairman. Based on the

recommendation presented by the task force under the chairmanship of Mr D

Basu, the Reserve Bank of India declared a detailed scheme for money market

mutual funds on April 1992.

Money market mutual funds invest in the following securities:

(a) Treasury bills issued by Government: Treasury bills are the

instruments which are issued by Reserve Bank of India at a discount to the

face value and form an essential part of money market. In India the treasury

bills are issued in four different maturities period viz. 14 days, 90 days, 182

days, and 364 days.

(b) Certificate of Deposits issued by banks: Certificates of deposits

are issued by banks in denomination of Rs 5 lakhs and have maturity period

ranging anywhere between 30 days to 3 years. Banks are allowed to issue

certificates of deposits with a maturity of less than one year whereas financial

institutions are allowed to issue certificate of deposits having maturity period of

at least one year.

(c) Commercial paper issued by companies: A Commercial Paper

(CP) is a Usance Promissory Note issued by companies to raise short-term

funds in the money market. Commercial Paper was introduced in the Indian

financial market by the Reserve Bank of India on January 1, 1990 as per the

recommendations of the Working Group on Money Market under the

chairmanship of Sri N. Vaghul. In India, corporate, primary dealers (PD),

satellite dealers (SD) and financial institutions are having the rights to issue


56

these notes. Companies having very good ratings are active in the commercial

paper market, though Reserve Bank of India has given permission of a

minimum credit rating of CRISIL-P2. The tenure of commercial paper can be

anything between 15 days to one year, though the most popular duration is of

90 days. Investment in Commercial Paper is used by the companies to save

interest cost.

(d) Call or Notice money: The call money market has registered a

tremendous growth in volume of activity since its inception in 1955-56. The call-

money market is a market for very short-term funds, repayable on demand and

with a maturity period varying from one day to fortnight. When money is

borrowed or lent for a day it is known as call or (overnight) money. Intervening

holidays and Sundays are excluded for this purpose.

When money is borrowed for more than a day and up to a period of 14

days, it is known as Notice money. No collateral security is required to cover

these transactions. The call money market is highly liquid market, with the

liquidity being exceeded only by cash. It is highly risky and extremely volatile as

well.

The key strength of liquid funds is liquidity and security of the principal

that the investors can normally anticipate from short-term investments. MMMfs

also offer the advantage of bulk purchases, access to short term markets,

expertise of a professional fund manager, lower transaction cost. Investors with

monthly income for example, salaried class, provident funds etc., also have the

benefit of parking their funds in money market instruments till a long term

investment avenue of their individual choice emerges. Retail investors do not


57

have ready access to either Treasury bills or call lending. MMMFs make it

possible for such retail investors to earn relatively higher yields offered by

money markets.

As also money market mutual funds are ideally suited for short-term

investments, especially, when the tenure is not indeterminate, as the

investments earns money market interest rates while at the same time,

assuring the investor of liquidity. Though interest rate risk is present the impact

is low as the investment instruments‟ maturities are short.

2) Debt funds

Debt funds invest in debt instruments issued by Government as well as

private companies, banks, financial institution and other entities such as

infrastructure companies. The main objective of investing in debt funds is low

risk and stable income for the investor. Though, these funds are more risky

than liquid funds as the do have higher price fluctuation risk, since they invest

in long term securities. Likewise, debt funds do have higher risk of default by

their borrowers as compared to Gilt funds.

Debt funds are basically considered as Income funds as they primarily

invest in fixed income generating debt instrument. They do not target capital

appreciation but look for current income, and therefore allocate a considerable

part of their surplus to investor.

Debt funds can be further classified according to the different investment

objective and risk profile.

1. Gilt funds: In India, we have Government Securities or Gilt Funds

that invest in government paper called dated securities. Gilt securities are the


58

securities which are meant for medium to long-term investments, typically of

over one year. Since the issuer is the Government/s of India/States, these

funds have little risk of default and consequently offer better safeguard of

principal. Gilt securities are issued by Reserve Bank of India on behalf of the

Government. These instruments form a part of the borrowing program

approved by Parliament in the Finance Bill each year (Union Budget). Gilt funds

have a maturity period of 1 year to 20 years. Gilts are issued through the

auction route but RBI can sell or purchase in its Open Market Operation

(OMO). OMO includes conducting repos as well and are used by RBI to

manipulate short-term liquidity and thereby the interest rates to desired levels.

The other types of Government securities are as:

Inflation linked securities

Zero coupon bonds

State Government Securities (State loans)

However, Gilt securities, like all debt securities, face interest rate risk.

Debt securities‟ prices fall when interest rate level increases and rises when

interest rate level decreases. It is the responsibility of investors to realize the

potential changes in NAV of guilt funds on account of changes in interest rates

in the economy.

2. Diversified Debt fund: Diversified Debt Fund can be explained as a

debt funds that invest in all accessible types of debt securities, issued by

entities across all industries and sectors. A diversified debt fund has the

advantage of risk reduction through diversification. In addition, all debt mutual


59

funds lead to risk reduction for the individual investor as any losses by a debt

issuer are shared by a huge number of investors in the fund.

3. Focused Debt Fund: Focused debt funds are funds with less

diversification in its investment. These funds invest in sector, specialized, and

off-shore funds. They have a major part of their portfolio invested in debt

instrument and are more income oriented and inherently less risky.

Other example of focused funds includes those that invest only in

Corporate Debentures and Bonds or only in Tax Free Infrastructure or

Municipal bonds. But these funds may take some time to materialize as a real

choice for the Indian investor.

One category of specialized funds that invest in the housing sector, but

offers greater security and safety than other debt instrument, is the Mortgage

Backed Bond Funds that invest in distinctive securities created after

securitization of (and thus secured by) loan receivables of housing finance

companies. As the Indian financial markets observe the escalation of

securitization, such funds may emerge on the mutual funds prospect soon.

4. High Yield Debt Funds: Usually, Debt funds control the default risk

by investing in securities issued by borrowers who are rated by credit rating

agencies and are considered to be of “investment grade”. High Yield Debt

Funds, however, seek to earn higher interest returns by investing in debt

instrument that are considered “below investment grade”. High Yield debt funds

invest in instruments with high yield, consistent with risk tolerance. In the

U.S.A., funds that invest in debt instrument that are not backed by tangible

assets and rated below investment grade (popularly known as junk bonds) are


60

called Junk Bond Funds. These funds tend to be more volatile than other debt

funds, although they may earn at times higher returns as a result of the higher

risks taken.

5. Assured Return Funds – an Indian Variant: In India, UTI and other

funds had offered “assured return” schemes to investors. The most accepted

variant of such schemes was the Monthly Income Plans (MIP) of UTI. Returns

were indicated in advance for all the future years of these close-ended

schemes. In assured return schemes the loss, if any, is borne by the sponsor or

Asset Management Company. Assured return debt funds undoubtedly diminish

the risk to the investor, but only to the degree that the guarantor has the

required financial strength. Hence, the market regulator SEBI permits only

those funds whose sponsors have sufficient net-worth to recommend

assurance of returns.

If Assured return scheme is offered, unambiguous guarantee is required

from a guarantor whose name has to be specified in advance in the offer

document of the scheme. The risk that the investor faces was clearly confirmed

when the assured return schemes of UTI faced large shortfall in their payment

obligations. In case of UTI, the Government bailed it out and took over the

scheme obligation on itself. Assured return schemes are no longer offered by

AMC‟s though possible.

Despite the fact that Assured Return Schemes offer lowest risk to the

investor, they are not to be termed as risk – free instrument, as the investors

have to usually lock their funds for specified time such as three years. Because

of such lock in, the investor may lose the chance to acquire higher returns in


61

other debt or equity securities, as changes in financial market may take place.

In addition, the investor is likely to face the credit risk of the guarantor who

must remain solvent enough to honor his guarantee throughout the lock in

period.

6. Fixed Term Plan Series – an Indian variant: A mutual fund scheme

would generally be either open-end or close-end. However, in Indian context,

mutual funds have developed an innovative middle option between the two, in

response to investor requirements. If a scheme is open-ended scheme, the

fund issues new units and redeems them at any time. The fund does not

provide a stated maturity or fixed term of investment as such. Fixed Term Plan

Series offer a combination of both these features to the respective investors, as

a series of plans are offered and units are issued by the fund at frequent

intervals for short plan duration.

Fixed Term Plan are essentially close-ended in nature, in that case the

AMC issues a fixed number of units for each series only once and closes the

issue after an initial offering period, like a close-ended scheme. Though. A

close-ended scheme would normally make a one-time initial offering of units,

for a fixed duration generally exceeding one year depending upon the policy of

the particular scheme. The individual investors have to hold the units until the

end of the stated time period, or sell them on a stock exchange if listed. Fixed

Term Plan is close-ended, but usually for shorter period, they are also not listed

on stock exchange. The scheme under which Fixed Term Plan Series are

offered are likely to be an Income Scheme, since the objective is clear for the


62

AMC to attempt to reward investors with an expected return within a short

period.

3) Hybrid Funds – Quasi Equity/Quasi Debt

Hybrid securities are classic example of capital management tools,

combining elements of debt and equity in a flexible and cost-effective manner.

Hybrid schemes invest in mix of equity and debt instruments. Hybrid funds do

not specialize in a particular security. These funds are designed to meet

individual objectives for example, rapid growth, matching a market index, or

investing in any area of the economy. Hybrid funds thus use combination of

securities to achieve their pre-determined goals.

Merits of Hybrid funds

Hybrid funds plays the role of a catalyst as a risk diversification tool

and fulfills the investor‟s dream of making money without taking too much risk

and provide a smooth sailing in the market that is low volatility.

Hybrid funds prove advantageous to the investors who don‟t have

sufficient money to diversify into several funds.

They prove beneficial in rupee-cost-averaging strategies where an

investor wants to get both stock and bond in one easy monthly purchase.

Investors who do not wish to take the trouble of allocating their

respective funds in different investments options, with the help of Hybrid funds

can avail the services of expert portfolio managers.

Hybrid funds are also desired by the retired investors who are looking

for income but still wish to have some stock market growth opportunities.


63

1. Balanced funds: A balanced fund comprises debt instruments,

convertible securities, preference shares and equity shares in its portfolio.

Balanced funds invest in more or less equal proportions between debt/money

market and equities. As a result of investing in combine nature, balanced funds

seek to achieve the objectives of income, moderate capital appreciation and

preservation of capital. These funds are more suitable for investors who are

conservative and long-term players. The remarkable feature of such funds is

that the investor is very much conscious of the need of diversification of their

portfolios and they generally do not keep “all the eggs in the same basket”.

That is why a combination of debt and equity have formed a major chunk of

their portfolio.

2. Growth-and-Income Funds: Growth-and-Income Funds endeavor to

strike equilibrium between capital appreciation and income for the respective

investor. The portfolios consist of a mix between companies with good dividend

paying records and those with potential for capital appreciation.

3. Asset allocation Funds: The percentage of money to be invested in

a particular category of asset is predefined. Many funds permit variable asset

allocation policies and move in and out of an asset class (equity, debt, money

market, or even non-financial assets) depending upon their outlook for specific

market. The fund manager is provided with the elasticity to transfer towards

equity when equity market is estimated to do well and shift towards debt when

the debt market is expected to do well.


64

Figure 1.9

Asset Allocation Suitability Graph

4) Equity Funds

Equity funds are characterized as funds involving high risk as well as

high returns. Equity funds invest a major portion of their corpus in equity shares

issued by companies, acquired directly in initial public offerings or through the

secondary market. Equity funds are exposed to the equity price fluctuation risk

at the market level, at the industry or sector level and at the company-specific

level. Equity funds‟ Net Asset Value fluctuates with all these price movements,

which are caused by a number of external factors such as political, social and

economic. Equity funds can appreciate in value in line with the issuer‟s earning

potential, and thus propose the greatest possibility for growth in capital.

However, an investor should not overlook that Equity funds are considered at

the higher end of the risk spectrum among all available funds in the financial

market. But whenever the question of higher returns turn up it is the equity

oriented Mutual fund which glitters more than debt investment. Whether look at

Investment

Horizon

Risk/Return

Short term debt

Days 1 Yr 3 Yrs

Deb

t

Equit

y


65

a 1, 3, 5, or 10- year time frame, debt mutual funds have given among the

lowest returns, while equity seems a much better option. (The Times of India

March 1, 2008). The following returns from various investment avenues are

represented in the figure:

Equity funds implement diverse investment strategies resulting in

different levels of risk. For this reason they are generally categorized into

different types in terms of their investment styles.

1. Aggressive Growth Funds: As the name suggests, aggressive

growth funds aim at obtaining maximum capital appreciation, invest in less

researched or speculative shares and may adopt speculative investment

strategies to accomplish their objective of high returns for the investor.

Accordingly, they tend to be more unpredictable and riskier than other funds.

2. Growth Funds: The key objective of Growth funds is capital

appreciation over a three to five year span. To achieve this target the growth

funds invest in companies whose earnings are estimated to rise at an above

average rate. These companies may be operating in sectors like technology

considered having a growth potential, but not completely unproven and

speculative.

3. Specialty Funds: Specialty Funds invest in only those companies

that meet pre-defined criteria. For example, at the height of the South African

apartheid regime, many funds in U.S. offered plans that promised not to invest

in South African companies. Also, funds which exclude tobacco companies

from their portfolios come under this category. Funds which invest in particular

area for example, Middle East or ASEAN countries are also examples of


66

specialty funds. Specialty funds have a propensity to be more volatile as

diversification is limited to one type of investment or they are more

concentrated funds. Following are the kinds of specialty funds:

Sector funds

Foreign securities funds

Mid-cap or Small-cap Equity funds

Option income funds

i) Sector funds

Portfolios of sector funds consist of investment in only one industry or

sector of the market for example Information Technology, Pharmaceuticals or

Fast Moving Consumer Goods. Sector funds carry a higher level of sector and

company specific risk as these funds do not diversify into multiple sectors so

that the risk could be spread out.

ii) Foreign Securities Fund

Foreign Securities Fund invests in foreign countries thereby achieving

diversification across the national borders. However, they also have additional

risks, for example, foreign exchange rate risk as well as their performance

depends on the economic circumstances of the countries they invest in.

Foreign Securities fund may invest in one foreign country than it becomes risky

due to concentration and if investment is made in more than one country the

funds becomes more diversified.

iii) Mid-Cap or Small-Cap Fund

Mid-Cap or Small-Cap Funds invest in the shares of the companies

which have relatively lower market capitalization. These funds, therefore, prove


67

to be more volatile, as mid-size or smaller companies‟ shares are not very

liquid in markets. While pointing about risk features, small company funds may

be aggressive-growth or just growth type. In terms of investment styles, some

of these funds may also be “value investors” (AMFI pg. 124)

iv) Option Income Fund

Option Income funds do not yet exist in India, but option Income Funds

write options on a significant part of their portfolio. Though these funds are risky

instruments, they may in fact help out to control the volatility, if appropriately

used. Conventional option funds invest in large, dividend paying companies,

and then sell options against their stock positions. This ensures steady income

stream in the form of premium through selling option and dividends. Now that

option on individual shares has become obtainable in India, such funds

possibly will be introduced.

4. Diversified Equity Funds: Diversified Equity Funds seeks to invest

only in equities, except for a very small portion in liquid money market

securities. These funds are not focused on any one particular sector or shares,

hence termed as diversified equity funds. Though these types of funds are

vulnerable to all equity price risk, these funds lessen the sector or stock specific

risks through diversification. Diversified Equity Funds are also exposed to the

equity market risk.

(a) Equity Linked Saving Schemes: (ELSS) an Indian Variant

In India, investors have been given tax concessions to encourage them

to invest in equity market through these special schemes. The key feature of

such schemes is that they entitles the holder to claim an income tax rebate, but


68

generally has a lock-in period. The ELSS has no specific constraint on the

investment objective for the fund managers.

5. Equity Index Funds: An index fund tracks the performance of

specific stock market index. The key feature of this fund is to match the

performance of the stock market by tracking an index that represents the

overall market. The Index funds invest in the shares that comprise the index

and in the same percentage as the index. Main advantage of these funds are

that they take only the overall market risk, while reducing the sector and stock

specific risks through diversification. Some index funds have a narrow

approach as they invest in sectoral index for example Pharma index or Bank

index.

6. Value Funds: Value funds may be characterized as those funds

which try to seek out basically sound companies whose shares are presently

under-priced in the market, but are considered to have growth potential in

future. Value funds will invest only in those shares to their portfolios that are

selling at low price-earning ratios, low market to book value ratios and are

assumed to be undervalued compared to their true potential.

Value funds are subject to equity market risk. Value funds frequently

come from cyclical industries, for example, Templeton fund, which includes

Cement or Aluminium company‟s shares and other cyclical industry in its

portfolio built-up. Prices of such shares may rise and fall more often than the

overall market. Yet, proponents of the Value Investment propose it as a long-

term approach.


69

7. Equity Income or Dividend Yield Funds: Equity funds that are

designed to give the investor a high level of current income along with some

stable capital appreciation, investing mainly in shares of companies with high

dividend yields, are categorized under equity funds. To accomplish the

objective of steady income and capital appreciation, the Equity income fund

would invest in Power or Utility companies‟ shares of established companies

that pay higher dividends and as well as the prices of such companies do not

fluctuate as much as other shares. Hence, these funds have the merits of

stability and safety.

8. Exchange Traded Funds: An Exchange Traded Fund is the hybrid of

open-end index fund and close-end index funds. They are listed on stock

exchanges, just like a close ended fund and trade like individual stocks on the

stock exchange. ETF‟s pricing is linked to the index and units can be

bought/sold on the Stock Exchange. ETFs do not sell their shares directly to

investors for cash. The shares are offered to investors over the stock

exchange. Since they are listed on stock exchanges, it is possible to buy and

sell them throughout the day and their price is determined by the demand-

supply forces in the market. The key features of an Exchange Traded fund can

be explained as under:

1. The open-end side of an ETF is restricted to a limited set of

participants known as Authorized Participants and a certain minimum size is

prescribed for the creation/redemption of units.

2. The creation/redemption of units happens in kind. Authorized

Participants who want new ETF units have to pay in the form of a basket of


70

stocks that mirrors the underling index. Likewise, when Authorized Participants

wants the ETF units to be redeemed they are paid in the form of basket of

stocks that mirrors the underlying index.

3. As ETF units are listed on the secondary market investors can buy

and sell ETF units in cash.

4. In the secondary market ETF units tend to trade very near to their fair

value (NAV). If the market price of ETF units can exceeds their NAV,

Authorized Participants would sell ETF units from their inventory, buy the

underlying basket of stocks from the exchange, and deliver the basket of stocks

to the ETF to replenish their inventory of ETF units and make an arbitrage

profit. Likewise, if the market price of ETF units is less than their NAV,

Authorized Participants would buy ETF units from the market , redeem the units

with the ETF, get the underlying basket of stocks, sell the same in the market

and make an arbitrage profit.

The first exchange traded fund was launched in USA in 1993 under the

name of Standard and Poor‟s Depository Receipt (SPDR – also called Spider).

ETFs were launched in Europe and Asia in 2001. The first ETF to be

introduced in India is Nifty Bench mark Exchange – Traded Scheme (Nifty

BeES). It is an open-ended ETF, launched towards the end of 2001 by

Benchmark Mutual Funds. The fund is listed in the capital market segment of

the NSE and trades the S&P CNX Nifty Index. The benc mark Asset

Management Company has become the first company in Asia (excluding

Japan) to introduce ETF.


71

ETF offers investors the benefit of flexibility of holding a single share as

well as the diversification and cost efficiency of an index. ETFs offer quite a lot

of distinct advantages which can be summed up as:

ETFs make possible the facility to trade intra-day at prices that are

usually close to the actual intra-day NAV of the scheme which makes it nearly

real-time trading.

As ETFs are simple to be understood by the investors, therefore

they have the potential to attract the small investors who are deterred to trade

in index futures because of necessity of minimum contract size. Small investor

can have the privilege of trading intra-day by buying minimum one unit of ETF,

and placing limit orders.

ETFs can be used to arbitrate successfully between index futures

and spot index.

Diversified index funds are another advantage provided by the

Exchange Traded Funds. The investors can gain from the elasticity of stock as

well as the diversification of index.

ETFs are basically passively managed funds and hence they have

somewhat higher NAV against an index fund of the same portfolio. The

operating expenses of ETFs are lesser than even those of parallel index funds

as they do not have to service investors who deal in shares through stock

exchange.

Financial institution can utilize ETF in employing idle cash,

managing redemptions, modifying sector allocations, hedging market exposure.


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1.6.3 Other Funds

1. Commodity Funds: A commodity fund specializes in investing in

different commodities directly or through shares of commodity companies or

through commodity future contracts.

A most familiar example of such funds is the Precious Metals Funds.

Gold funds invest in gold, gold futures or shares of gold mines. Platinum or

silver are also available in other countries for investment. In India, the Union

Finance Minister recently announced a Gold Linked Unit scheme- like a Gold

fund. A large number of commodity futures contracts are now available for

trading on commodity exchange, popularizing the commodity funds.

2. Real Estate Funds: The latest entrant in the field of mutual fund is

Real Estate Mutual Fund. Real estate funds invest in real estate directly, or

may fund real estate developers, or lend to them, or buy shares of housing

finance companies or may even buy their securitized assets. Real estate funds

may have the objective of growth orientation or regular income.

REIF (Real Estate Investment Fund) has three categories:

I. Equity REIT: own and operate real estate.

II. Mortgage REIT: lend money directly or indirectly to real estate

owners.

III. Hybrid REID: own both property and lend money to real estate

owners.

Securities and Exchange Board of India and Association of Mutual

Funds in India together has set up a committee to recommend on the

introduction of REMF so that such funds would be available for the investment


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purpose. After submission of the report prepared by SEBI and AMFI, on June

26, 2006 SEBI permitted the guidelines for dealing in REMF.

Real Estate can be explained as land including the air above it and the

ground below it and any piece of structure constructed on it. It includes

residential house, commercial offices, trading areas for example shopping

malls, hotels, etc. It also includes purchase, sale and development of land,

building and structures. The players are landlords, developers, builders,

tenants and buyers to name a few in this market.

According to market regulator, SEBI has defined REMF as a scheme of

mutual funds which has investment objective to invest directly or indirectly in

the real estate property.

The REMF will be governed by the guidelines under SEBI (Mutual funds)

Regulation. These have evolved greatly in USA where they are referred to as

Real Estate Investment Trust. To point out the basic difference between REIT

and REMF is that in case of REIT, tax liability is minimal as it is a trust, while in

the case of REMF; tax rules are applicable as per other mutual funds.

The REMF can invest in real estate properties within India, mortgage

backed securities, equity shares, bonds, debentures of listed or unlisted

companies, which deal in real estate and also undertake property development

in other securities. According to SEBI guide lines, the REMF should invest at

least 35% of it in property and 40% of it can be invested in shares and

securities of realty companies. These funds possess properties, commercial

space and earn income in the way of rent and also in the form of capital

appreciation. They acquire, Develop and sell the property and the benefit is

shared with investors.


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Segment in India.

The introduction of REMF is projected to set in motion land acquisition

by realty developers across the country, which had slowed down over the last

couple of months after the RBI norms have dejected banks from providing

funds to developers for purchasing land. Banks are permitted to loan funds only

after the property developers have taken all the compulsory approvals from the

state and local authorities.

The commencement of REMFs will not only direct to improve investment

options, but will also boost the starving housing sector. There are a number of

mutual fund scheme that offer a chance to invest in a specific sector, but the

appearance of REMF will give the retail investor a possibility to invest in real

estate and earn the prospective returns from the real estate market.

The setting of REMF can also present some support to the cash-starved

housing sector. Though the mutual fund industry in India has received a

remarkable boost, presently mutual funds are not allowed to hold real estate

assets. But there already are sector funds where the investor invests money

exclusively in companies belonging to one particular sector.

Prerequisites for REMF.

For introducing and dealing in REMF, certain conditions are to be

followed by the players which are mentioned below:

1. Primarily the structure of REMFs will be close-ended.

2. It has been made mandatory for REMF, by the SEBI guidelines to

be listed on the stock exchange.


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3. To make REMF and the respective developers accountable to the

investors, the disclosure of Net Assets Value (NAV) of the scheme has to be

made on a daily basis.

4. The REMF are compulsorily required to appoint a custodian

having a certificate of registration to carry on the business of custodian of

securities.

5. It is essential for the custodian to continue the title of real estate

properties held by REMFs.

3. Funds of Funds: A regular Mutual fund invests in stocks, bonds, and

fixed income securities depending upon the objectives as specified in offer

document. A fund of fund scheme, instead of investing in a portfolio of

securities such as debt, equity, invests in a portfolio of the units of other mutual

funds scheme. The concept of diversification is applicable to Fund of funds.

Fund of fund assist the respective investor to pick the right funds from a wide

variety of schemes presented by various Asset Management Companies. As

also investors in such funds have the benefit of diverse management styles.

For example, Prudential ICICI Advisor series, the first Indian Fund of Fund

scheme offers five plans:

1) Very cautious (no equity, 100% debt)

2) Cautious (up to 35% equity)

3) Moderate (40-60% equity)

4) Aggressive (50-80% equity)

5) Very aggressive (90-100% equity)


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Merits of Fund of Fund:

(a) Fund of Fund schemes provides a high degree of diversification

thereby reducing the risk factor.

(b) It is argued that fund of fund are more tax-efficient rather than

investing in mutual funds directly.

(c) As far as risk is concerned, there will be lower level of risk in such

holdings.

(d) The investor will benefit from the expertise and the skill of different

leading fund managers.

(e) Convenience is another plus point. In the times when the market is

performing well in one section and dull in the other one, the fund manager will

take complete care of portfolio of the investors.

However, these funds prove to be expensive as the expenses of AMC

that manages the fund of funds get added to the expenses of other schemes it

invests in. As also fund of fund schemes invests in solely in the schemes of the

same mutual fund. This may not be in the interest of the investors, if the sister

schemes are not the best of their kind.

4. Domestic Funds: A domestic fund mobilizes the resources only from

a particular geographical locality like a country or region. The market is limited

and confined to the national boundaries in which the fund operates. Hence,

domestic funds can invest only in securities which are issued and traded within

the market of national boundaries.

5. Offshore Funds: An offshore fund invests in securities of foreign

countries. These funds are known to facilitate cross-border fund flow which


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leads to an augment in foreign currency and foreign exchange reserve. They

open domestic capital market to international investors. In short, offshore funds

attract the foreign capital for investment in the country of the issuing company.

6. Ethical Funds: Ethical funds are an innovative product which is

introduced recently in mutual funds products. Ethical funds assimilate personal

values and social concern with that of investment decision making process and

performance. Investment management of ethical funds is popularly known as

„socially responsible investing‟. The Ethical funds take into account both the

investor‟s financial requirements and an investment‟s influence on society and

surroundings. The most important objective of ethical funds is to confine the

investment universe to such companies, which come under the purview of the

ethical criteria. These criteria essentially concentrate on social, environmental

and ethical concerns of the investors. Securities from companies that adhere to

social, moral, religious and/or environmental beliefs are a few examples.

Ethical funds generally do not invest in companies producing tobacco or

liquor; some of them do not invest in companies whose chief action involves

producing military products. In addition to basic quantitative analysis, a socially

responsible portfolio manager takes into account a company's community

investment, environmental responsibility, protection of human rights,

employment diversity, animal testing and product offering. Some of the Ethical

funds focus on environmental responsibilities such as non-polluting companies,

organic farming etc. Ethical investors include individuals and institutions such

as Trusts, Universities, Hospitals, Foundations, Non-profit organizations, Non-

government organizations, Religious establishments, temple, Churches. Ethical


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funds managers‟ Endeavour‟s to apply the above mentioned investment criteria

of investing in companies which fulfills the ethical norms, by adopting

appropriate financial screening methodology that will support the investment

decision with the intensely held values of this class of investors. Some might

include only equities or bonds, while others might hold a combination of the

two. Furthermore, some funds might specialize in being free of securities from

alcohol, casino and tobacco companies, while others might invest exclusively in

companies that are environmentally responsible. Securities that have been

screened for socially responsible criteria are then combined to achieve a

specific investing style and goal. A portfolio manager will decide whether the

fund will be made up of:

equity, fixed income or both (balanced)

domestic or international securities

small, mid, or large cap stocks

On average, their performance has been comparable to that of regular

mutual funds. According to KLD Indexes, the Domini 400 Social Index YTD

return as of September 30, 2007 was 7.19%, compared to the S&P 500 return

of 9.13%.

7. Gold Exchange Traded Funds: It was Benchmark Asset

Management Company in India, which conceptualized the idea of Gold

Exchange Traded Funds (GETFs), in May 2002 when they filed a proposal with

the Securities Exchange Board of India. The primary motive of Gold Bullion

securities was to give financial and private investors the capability to have

possession of gold and achieve exposure to price. With the launch of the

GETFs in India, the investors can buy gold-linked units that would be traded on

http://www.investopedia.com/terms/d/domini_400.asp


79

the stock exchange. One unit of GETFs is equal to the value of one gram of

gold. The daily price of each unit is linked to the prices of gold in the physical

market. The investor is able to purchase and redeem the units GETF from the

stock market.

A Mutual fund house introducing a Gold ETF appoints „Authorized

Participants‟ who at the outset buy the units of Gold ETF from the mutual fund

by exchanging pure gold for the units of Gold ETF. These „Authorized

Participants‟ facilitate secondary market trading of the Gold ETF units through

the stock exchange where investors can buy or sell gold units on payment. The

underlying asset is gold, which is held by Mutual fund house in a physical form

through a gold receipt which provides the right of ownership. Authorized

Participants are provided with the facility that they can go back to the mutual

fund house to redeem the GETF units and can also demand the equivalent

value of actual pure gold at any time.

Gold, over the past years, has demonstrated to be a good hedge against

inflation and has maintained a long term value. For this reason Gold ETF offer

a well diversified option and reduction of overall risk and unpredictability of

investments.

8. Leveraged Funds: Leveraged funds are the funds which increase the

value of the portfolio and provide benefit to the unit holders by gains exceeding

the cost of borrowed funds. The leveraged funds invest in speculative and risky

instruments, like short sales to take the advantage of declining market.

Leveraged funds are not common in India because of the risk associated with

it.


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9. Hedge Funds: The main objective of Hedge funds is to hedge risks in

order to increase the value of the investors‟ portfolio. Hedge funds employ

speculative trading principles while investing in financial instruments. These

funds provide hedge by purchasing shares whose prices are likely to rise and

selling those shares whose prices are likely to fall. Hedge funds are not

common in India.

1.7 INVESTMENT ORIENTATION OF MUTUAL FUND SCHEMES:

Mutual funds invest in three broad categories of financial assets which

are described as:

(a) Stocks: Equity and equity-related instrument.

(b) Bonds: Debt instrument that have a maturity period of more than

one year for example; treasury bonds, quasi-government bonds, corporate

debentures, and asset-based securities.

(c) Cash: Debt instrument that have a maturity period of less than

one year for example; treasury bills, commercial paper, certificates of deposits,

reverse repos, call money, and bank deposits.

1.8 ASSOCIATION OF MUTUAL FUNDS IN INDIA (AMFI)

Realizing the requirement for a common forum for addressing the issues

that were affecting the mutual fund industry as a whole, the association of

mutual funds in India (AMFI) was established in 1993, with a joint effort of all

the mutual funds, with the exception of UTI. AMFI is committed in developing

the Indian mutual fund industry on professional, health and ethical lines. As

also to augment and sustain standards in all areas with a vision to protect and

promote the interests of mutual funds and their unit-holders.


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1.8.1 Objectives of AMFI:

To recommend and promote best business practices and code of

conduct to be followed by members and others engaged in the activities of

mutual fund and asset management, including agencies connected and

involved in the field of capital market and financial services.

To identify and preserve high proficient and moral standards in all

areas of function of mutual fund industry.

To interact with the Securities and Exchange Board of India and

to represent to SEBI on all matters concerning mutual fund industry.

To represent to the Government, Reserve Bank of India and other

governing bodies on all matters relating to the mutual fund industry.

To develop a cadre of well trained agent distributors and to

implement a programme of training and certification for all intermediaries and

others engaged in the industry.

To undertake nationwide investor awareness programme so as to

promote proper understanding of the concept and workings of mutual funds.

To disseminate information on mutual fund industry and to

undertake studies and research directly and in association with other bodies.

AMFI continues to play a major part as a catalyst for setting new

standards and refining existing ones in many areas, specifically in the field of

valuation of securities.

During the year 2001-02 an important initiative was launched by AMFI in

the form of registration of AMFI Certified Intermediaries as well as providing

appreciation and status to the distributor agents.


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AMFI maintains a liaison with different regulators such as SEBI, IRDA,

and RBI to prevent any over-regulation that may stifle the growth of industry.

AMFI has set up a working group to devise draft guidelines for pension scheme

by mutual funds for submission to IRDA. It holds meetings and deliberations

with SEBI regarding matters relating to mutual fund industry. Moreover, it also

makes representations to the Government for elimination of constraints and

bottlenecks in the augmentation of mutual fund industry.

AMFI recently launched suitable market indices which will enable the

investors to appreciate and make meaningful comparison of the returns of their

investments in mutual fund schemes. While in the case of equity funds, a

number of benchmarks like the BSE sensex and the S&P CNX Nifty are

available, there was a lack of relevant benchmark for debt funds.

AMFI took the initiative of developing eight new indices jointly with

Crisil.com and ICICI securities. These indices have been constructed to

yardstick the presentation of different types of debt schemes such as liquid,

income, monthly income, balanced fund, and guilt fund schemes. These eight

new market indices are Liquid Fund Index (Liqui fex), Composite Bond Fund

Index (Compbex), Balanced Fund Index (Balance EX), MIP Index (MIPEX),

Short Maturity Gilt Index (Si-Bex), Medium Maturity Gilt Index (Mi-Bex), Long

Maturity Gilt Index (Li-Bex) and the Composite Gilt Index.

In the case of liquid funds, the index comprises a commercial paper (CP)

component with a 60% weightage and an inter-bank call money market

component with a 40% weightage. The CP component of the index is

computed using the weighted average issuance yield on new 91 days CPs


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issued by top rated manufacturing companies. In the case bond funds, the

index comprises a corporate bond component with 55% weightage, gilt

component with a 30% weightage call component with 10% weightage and

commercial paper with 5% weightage. The index‟s 55% bond component is

split based on 40 point share of AA rated bonds, and 15 points share of AA

rated bonds.

Mutual funds have to disclose also the performance of appropriate

market indices along with the performance of scheme both in the offer

document and in the half-yearly results. Further, the trustees‟ are required to

review the performance of the scheme on periodical basis with reference to

market indices. These indices will be useful to distribution companies, agents,

brokers, financial consultant, and investor. AMFI also conducts investor

awareness programme regularly. AMFI is in the process of becoming self-

regulatory organization (SRO).

1.8.2 Promoters of Association Of Mutual Funds in India.

A. Bank Sponsored

1. Joint Ventures - Predominantly Indian

Canara Robeco Asset Management Company Limited

SBI Funds Management Private Limited

2. Others

BOB Asset Management Company Limited

UTI Asset Management Company Ltd

Canbank Investment Management Services Ltd

B. Institutions


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LIC Mutual Fund Asset Management Company Limited

GIC Asset Management Company Ltd

Jeevan Bima Sahayog Asset Management Company Ltd

C. Private Sector

Indian

Benchmark Asset Management Company Pvt. Ltd.

DBS Cholamandalam Asset Management Ltd.

Deutsche Asset Management (India) Pvt. Ltd.

Escorts Asset Management Limited

JM Financial Asset Management Private Limited

Kotak Mahindra Asset Management Company Limited (KMAMCL)

Quantum Asset Management Co. Private Ltd.

Reliance Capital Asset Management Ltd.

Sahara Asset Management Company Private Limited

Tata Asset Management Limited

Taurus Asset Management Company Limited

Foreign

AIG Global Asset Management Company (India) Pvt. Ltd.

Franklin Templeton Asset Management (India) Private Limited

Mirae Asset Global Investment Management (India) Pvt. Ltd.

Joint Ventures - Predominantly Indian

Birla Sun Life Asset Management Company Limited

DSP Merrill Lynch Fund Managers Limited

HDFC Asset Management Company Limited


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ICICI Prudential Asset Mgmt.Company Limited

Sundaram BNP Paribas Asset Management Company Limited

Joint Ventures - Predominantly Foreign

ABN AMRO Asset Management (India) Ltd.

Bharti AXA Investment Managers Private Limited

Fidelity Fund Management Private Limited

HSBC Asset Management (India) Private Ltd.

ING Investment Management (India) Pvt. Ltd.

JPMorgan Asset Management India Pvt. Ltd.

Lotus India Asset Management Co. Private Ltd.

Morgan Stanley Investment Management Pvt.Ltd.

Principal Pnb Asset Management Co. Pvt. Ltd.

Standard Chartered Asset Management Company Private Limited

1.9 GROWTH AND PERFORMANCE OF MUTUAL FUNDS IN INDIA

As per the study conducted by Associated Chambers of Commerce

and Industry of India (ASSCH), mutual fund industry is growing rapidly and is

expected to grow to Rs 4 lakh crore by 2010.

The Indian Mutual Fund industry has grown tremendously in the last

decade. There are mutual funds with assets under management of around Rs 1

lakh crore (Table 17.3). Assets under Management (AUM) crossed Rs.

1,00,000 crore during the year 1999-2000 recording a growth rate of 65 per

cent. Beside, vast majority of equity schemes out-performed the market.

However, in the subsequent year, that is, 2000-01, AUM sharply declined by

about 20 per cent to Rs 90,587 crore due to extreme volatility in the market and


86

depressed equity market conditions. The mutual fund industry witnessed such

a sharp decline for the first time in the last two decades. There was a

turnaround in the year 2001-02. The AUM grew by 11 per cent to Rs 1,00,594

crore. During the year 2001-02 while there was an increase in AUM by around

11 percent, UTI lost more than 11 per cent in AUM. It is evident that UTI is

losing out to other private sector players. The AUM of more than 11 sector

mutual funds rose by around 60 per cent during year 2001-02 (Table 17.4).

During the year 2001-02, 90 new schemes were launched-74 of which

were open ended and 16 close ended. Income schemes predominated with 53

schemes collecting Rs 2,744 crore which accounted for 82 per cent of total

collection of Rs 3,355 crore from new schemes. Almost 96 per cent of the

money raised from new scheme launches were invested in the debt/money

market. Sales under Growth, Balanced, and ELSS schemes declined during

the year (Table 17.6).

The gross mobilization from the sale of 417 schemes increased by 77

per cent to Rs 1,64,523 crore but on a net basis, the mobilization was down by

27 per cent to Rs 7,175 crore. Redemption during the year were Rs 1,57,348

crore-88 per cent higher than the previous year.

The asset allocation showed a marked shift towards debt and

government securities. Debt schemes made extraordinary return on account of

cut-in bank rate and by the RBI. Equity schemes remained generally depressed

in line with the conditions (Table 17.5)

Out of a total of 3.08 crore investors in the mutual fund industry, 2.44

crore or 79.15 per cent of the total investors are in UTI (Table 17.8). The


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percentage of total investors in private sector mutual funds, is 13.50per cent

(0.41 crore) and public sector mutual funds is 7.35 per cent (0.23 crore). Thus,

UTI has the largest number of small individual investors who contribute 72.61

per cent to UTI‟s total net assets. However, corporates and institutions are the

largest contributors to the net assets of private and public sector mutual funds.

The mutual fund industry has been remarkably resilient over the last

decade in spite of varying economic conditions, capital market scams, and

increasing competition. At present, 417 schemes are offered but this number is

a miniscule fraction of the 13,000 odd schemes offered by the mutual funds in

the US. Moreover, in the US, there is more money in mutual funds that in bank

deposits. Mutual funds in India have tapped only one per cent of the urban

population and rural penetration is negligible. In urban areas, the mutual fund

activity is more concentrated in the eight metros. Debt funds can have an edge

over banks as banks cannot offer attractive rates on deposits due to statutory

reserves and priority sector lending.

According to AMFI data, the total value of equity fund investments

depreciated by over Rs 6,200 crore over a three-and-a-half year period

between April 99 and September 2002. Hence, debt funds are emerging as the

most preferred investment option. Debt funds are characterized as low-risk and

high liquidity investments. Mutual funds worldwide have mobilized savings

more through income funds than equity funds. This is so because mutual funds

are able to offer diverse products based on the investors‟ risk return appetite.

For example, there are liquid funds, government securities funds, AAA rated

bond funds, and so on. The Government Securities Funds have no credit risk


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but interest rate risk element comported to bond funds with both credit and

interest rate risk. It is expected that returns from debt funds will increase in the

future in view of the Reserve Banks medium-term objective of reducing the

Cash Reserve Ratio (CRR) to 3 per cent.

1.10 ROLE OF MUTUAL FUNDS IN THE STOCK MARKET.

Mutual funds are proved to be an ideal investment vehicle by small and

scattered investors in the stock market may be for the following reasons:

Mutual Funds provide an investment opportunity to small investors

collectively thereby increasing their participation.

As Mutual Funds are institutional investors, they can invest in market

analysis usually not available to individual investor, providing thereby informed

decisions to small investors.

Portfolio Diversification can be made possible in a better way

because of expertise knowledge and availability of funds.

Mutual funds in India, because of their small size and slower

development in the recent past, have tended to play only a restricted part in the

stock market. In January 2000, the share of mutual funds in total turnover of the

stock market (BSE and NSE), was 4.9% which later on declined to 3.6% in

January 2003. The reason for such decline may be attributed to portfolio

composition of mutual funds companies which directed from equity to debt due

to passive equity market situation.


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1.11 RATING OF MUTUAL FUNDS SCHEMES.

Benchmark is a standard against which the performance of a security,

mutual fund or investment manager can be measured. Generally, broad market

and market-segment stock and bond indexes are used for this purpose.

When evaluating the performance of any investment, it's important to

compare it against an appropriate benchmark. In the financial field, there are

dozens of indexes that analysts use to gauge the performance of any given

investment including the S&P 500, the Dow Jones Industrial Average, the

Russell 2000 Index and the Lehman Brothers Aggregate Bond Index.

In India, rating of fixed income securities such as bonds and money

market instruments is in practice, though limited to only a few credit rating

agencies.

Rating of mutual funds schemes has assumed an essential place in the

contemporary and developed financial market. It is like a boon to mutual fund

companies and investors. It facilitates the companies in collecting fund from

small investors and assists the investors to decide their risk-return trade off.

Mutual fund schemes are occasionally evaluated by independent

institutions. The prominent credit rating agencies are the Credit Rating

Information and Services of India Limited (CRISIL) and India Credit Rating

Agencies Limited (ICRA).

Rating of mutual funds performed by CRISIL the Composite

Performance Ranking- tracking (CPR) is relative performance ranking.


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1.11.1 CRISIL

A credit rating and information service of India Limited (CRISIL) was

jointly promoted, in 1988, by India‟s leading financial institutions, ICICI and UTI.

CRISIL went public in 1992. In 1995, CRISIL entered into a strategic alliance

with Standard & Poor‟s to extend its credit rating services to borrowers from the

overseas market. CRISIL undertakes Composite Performance Rankings that

cover up all open-ended schemes that discloses their complete portfolio

composition and have NAV information for at least two years. The rankings of

CRISIL are based on the following criteria, which are; risk-adjusted return of the

scheme‟s NAV, diversification of the portfolio, liquidity, size of the asset, asset

quality (debt schemes). The weights allocated to these criteria differ from

category to category. Within each category, the top 10% are considered very

good, the next 20% are considered good, the next 40% are considered

average, the next 20% below average, and the last 10% poor. CRISIL currently

ranks schemes in five categories, which are, Equity scheme, Debt scheme, Gilt

scheme, Balanced scheme, and Liquid schemes.

a) CRISIL METHODOLOGY

For a comprehensive evaluation of the credit risk associated with each

debt instrument, CRISIL considers all factors which affect the credit worthiness

of borrowing companies. On receipt of request for credit rating by a company,

CRISIL assigns an analytical team of professionally qualified persons. This

team obtains data, analyses information, meets key personnel in the company

to discuss strategies, plans and other relevant issues, and interacts with a


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back-up team which would have also collected industry information. The key

areas which are considered for analysis are:

1. Business Analysis: This analysis includes industry risk, market

position of the company within the industry, operating efficiency of the

company, and legal position (terms of prospectus, trustees and their

responsibilities: systems for timely payment and for protection against

forgery/fraud etc.).

2. Financial Analysis: This analysis probes into accounting quality,

earnings protection, adequacy of cash flows, and financial flexibility.

3. Management Evaluation: Track record of management, planning

and control systems, depth of managerial talent, succession plans, goals,

philosophy and strategies, and evaluation of the capacity to overcome adverse

situation are some of the factors considered for evaluating the competence of

management.

4. Regulatory and Competitive Environment: The factors considered

for analyzing this are structure and regulatory framework of financial system,

trends in regulation/deregulation and their impact on the company. These

factors are especially important for a finance company.

5. Fundamental Analysis: The team considers liquidity management,

asset quality, profitability and financial position, and interest and tax sensitivity

in this analysis.

After evaluating both qualitative and quantitative factors, the team

presents its findings to rating committee which comprises of some directors not

connected with any CRISIL shareholders. This committee finally decides the


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ratings. The rating is them communicated to the company. If the company

wishes to furnish any additional information at this share, CRISIL welcomes it.

The whole process takes four to six weeks.

b) CRISIL RATINGS

CRISIL ratings indicate the current assessment of credit risk associated

with specific instruments like debentures, preference shares and fixed deposits

of company. The rating symbols and their meanings are given below:

Debenture Rating Symbols

The grades for safety and timely repayment of principal and interest in

the descending order are:

1. High Investment Grades: This grade consists of two ratings:

(i) AAA : Which indicates highest safety.

(ii) AA : Which indicates high safety.

2. Investment Grade: It comprises of two ratings:

(i) A : This indicates adequate safety.

(ii) BBB : This indicates moderate safety.

3. Speculative Grades: The speculative grade indicates that there is risk

associated with payment of interest and principal. This grade consists of four

ratings:

(i) BB : This indicates inadequate safety.

(ii) B : This indicates that there is high risk.

(iii) C : This indicates that there is substantial risk.

(iv) D : This indicates that either there is already default of

interest and/or principal as per terms or expected to

default on maturity.


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CRISIL has also the policy of assigning „+‟ or „-„sings for ratings from

„AA‟ to „D‟ to reflect comparative standing within the category.

Preference Share Rating Symbols

The rating symbols for preference share are identical to debenture rating

symbols described above except that the letters „pf‟ are prefixed to the rating

symbols. For example, „pfAAA‟ „PFAA” etc. are the rating symbols used for

preference shares.

Fixed Deposit Rating Symbols

The ratings for fixed deposits which indicate the degree of safety

regarding timely payment of interest and principal are:

(i) FAAA : Highest Safety.

(ii) FAA : High Safety.

(iii) FA : Adequate Safety.

(iv) FB : Inadequate Safety.

(v) FC : High risk.

(vi) FD : Default.

CRISIL applies „+‟ or „-„sings to indicates the relative degree of safety for

symbols „FAA‟ to „FC‟.

Ratings for Short-term Instruments

The ratings for short-term instruments like Commercial Paper indicate

the degree of safety regarding timely payment on instrument. These ratings are

indicated below:

(i) P1 : Very Strong.

(ii) P2 : Strong.


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(iii) P3 : Adequate.

(iv) P4 : Minimal.

(v) P5 : In Default.

CRISIL may apply „+‟ or „-„signs for grades P1 to P3 to indicate the

relative degree of safety within the grades.

The above ratings of CRISIL are only the indicators of the relative

degree of safety of investments in a specific instrument. These are surely not

the recommendations/discouragement to investors. Investors have to make

ultimate investment decisions based on risk-return trade-offs. It is very

important to note that different instruments of a company may carry different

CRISIL ratings. This is because CRISIL assigns ratings to a specific debt

instrument and not to a company as a whole.

Apart from CRISIL, these are two main rating agencies which are

involved in credit rating in India. The ratings assigned by these two are

discussed below.

1.11.2 Value Research India Ratings

Value research India rates schemes in dissimilar categories. Each

scheme is assigned a risk grade and return grade and a composite measure of

performance is calculated by subtracting the risk grade from the return grade.

Within each category, the top 10% are considered five stars, the next 22.5%

four star, the next 35% three star, the next 22.5% two star, and the last 10%

one star.


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1.11.3 Economic Times Lipper

The Economic Times, powered by Lipper, evaluates mutual funds

scheme using a return-risk ratio which is defined as average return divided by

standard deviation of return. The Economic Times from time to time reports the

return-risk ratio for top performing mutual fund schemes along with a few other

parameters.

1.12 OPTIONS OFFERED BY MUTUAL FUND SCHEMES.

No single gun is suitable for all types of hunting. Nor is one fishing rod

appropriate for all types of fishing. Due to the growing competition in the mutual

fund industry, mutual funds offer various options which cater according to the

requirements and capacity of investors.

1.12.1 Dividend option

Dividend option offers the gains of the particular scheme to be paid out

at regular intervals in the form of dividends. Dividend distribution depends on

the funds policy to offer daily, weekly, monthly, quarterly, half-early, or annual

dividend option.

1.12.2 Growth option

Under growth option, investments gains are subject to be ploughed back

into the scheme and announcement of dividend is not done.

1.12.3 Systematic Investment Plan (SIP)

Systematic investment Plan is an option offered by the mutual funds to

assist one save regularly. It resembles the recurring deposit with small money.

The investor is provided the facility of investing regular sums of money every

month to buy units of a mutual fund scheme. The minimum amount of


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investment in Mutual fund SIP is Rs 500 either monthly or quarterly depending

on the policies of the fund house. As the investment is made on a regular

basis, the investor buys more units when the prices are low and fewer units

when the prices are high. Basically it means the respective investor resorts to

Rupee Cost Averaging. SIP helps the investor to make money over the long

time.

1.12.4 Systematic Withdrawal Plan (SWP)

The systematic withdrawal plan allows the investor to extract a fixed

amount every month. The investor can select the withdrawal of a fixed sum

every month or a certain percentage of the capital appreciation in the NAV of

the scheme.

1.12.5 Retirement Pension Plan

Some schemes offered by he mutual fund houses are linked with

retirement pensions. Individual investors participate in these plans to safeguard

their retired lives and corporates for their employees‟ benefit.

1.12.6 Insurance Plan

Some schemes launched by Unit Trust of India and Life Insurance

Corporation provide insurance cover up to the respective investors.

1.13 VALUE-ADDED SERVICES OFFERED BY MUTUAL FUNDS

Time was when mutual funds in India took several weeks to send

redemption cheques. When they revealed precious little of where the money of

investor‟s was invested. But today the tables have turned. Mutual Funds are

paying greater attention to investors servicing, putting a place system to make

investing experience a breeze. And what is a visible trend, fund houses, having


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the basic investor servicing foundation in place, are looking to offer an investor

handy value-added services – at no additional cost. The emphasis is on helping

an investor to save money and time. Mutual fund offers value-added services to

the investors in the following way;

1.13.1 Redemption over phone

Some mutual funds offer investors the facility of making a redemption

demand or switch among the available schemes of a particular mutual fund

over the phone. All fund houses allow easy access – walk-in, phone or over the

Net – to investors. A few fund houses even have toll-free numbers, where

investors can call in for inquiry and update information.

1.13.2 Triggers

A trigger is an actionable facility that lets the investors pre-specify exit

targets for his mutual fund investment. Usually, triggers are based on value or

time duration of a mutual fund scheme. When the target is reached, the fund

house will automatically redeem the units of the investor.

1.13.3 Alerts

Under the alerts services, the fund house intimates to the investors – by

phone, post, or e-mail – when a certain trigger point has been reached. It

depends upon the investor to take the decision of redeeming the units or to

remain invested.

1.13.4 Cheque Book facility

Some fund houses provide investors in certain schemes generally a debt

scheme, the option to take a redemption cheque worth 75% of the investment

value subject to some limit, at the time of investment itself. Encashment of the


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cheque is deemed as withdrawal by the investor, at the scheme‟s NAV on the

day the cheque is deposited. Of course, the investor has to contact the fund

house to get the balance amount.

1.13.5 New point of purchase

Technology is a greater enabler, and fund houses are constantly finding

ways to use it to their benefit. Providing convenience to the investors, fund

houses are supplementing conventional channels of distribution with more

points-of-purchase. For example, HDFC Mutual fund permits its investors to

buy and sell through ATMs. As also Prudential ICICI and Templeton Mutual

fund sell units of their schemes On line to the potential investors who possess a

Net banking account with an of the banks these mutual funds have tied up.

1.13.6 Switching facility between schemes

Switching facility provides investors with an option to transfer the funds

amongst different types of schemes or plans. Investors can take the decision to

switch units between Dividend plans or Reinvestment plan at Net Asset Value

based prices. One has to take care when switching between Debt and Equity

schemes about the exit and entry loads. As switching between debt and equity

schemes involves an entry load while switching between equity and debt

schemes does not involve an entry load.

1.14 NEW FUND OFFERING (NFO)

New fund offering is the first issue of units of a mutual fund scheme to

investors. It resembles an Initial Public Offering (IPO) where the company

makes the first issue of its security to the public for subscription. In order to

make the NFO victorious, most of the mutual funds houses offer attractive


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commissions and incentives on the sale of units done by distributors and sub-

distributors.

Figure 1.10 Process of NFO

Earlier, mutual fund schemes which were offered to the investors for the

first time used the term “Initial Public Offering”. According to Securities

Exchange Board of India, because of this resemblance at the time of bull

markets of early 2003-04, led to misinformed decision-making by many

investors who were ignorant of the technical differences between an offer by a

mutual fund and that of a company. A lot of mutual funds benefited from this

gross negligence on the part of investors. Due to this misguidance created by

such IPO term, Securities exchange board of India made it mandatory for all

new schemes offered to investors to use the term “New Fund offering”.

1.14.1 Rules framed by SEBI for governing NFOs.

1. SEBI has made it compulsory that any new fund offering of a mutual

fund scheme should not exceed 30 days of subscription.

AMC SEBI

(1) Files Offer Documents

(2) Receives Clearance

(3) Pre-NFO activities like

marketing and advertisement

(4) NFO period – Subscription by

the public and institutions

(5) Screening for valid

applications and subsequent

allotment of units


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2. It has also been made mandatory for the fund house to allot the units

for all valid applications within the time frame of 30 days after the closure of the

NFO.

3. In case of failure of the scheme to collect the minimum subscription

amount, the fund house refunds the money to the applicants. In addition to this

rule, refund of subscription money on account of invalid application has to be

made within six weeks after the close of the NFO period.

4. If the refund money is not made within six weeks limit, interest @

15% per annum shall be paid by the Asset Management Company.

5. In recent times, SEBI has also considered an array of similar funds

being launched and has made it compulsory for the trustees of mutual fund to

personally certify that their new scheme which are launched are different from

earlier schemes.

1.14.2 Important Points to be considered before Investing in NFO

1. An investor should evaluate his current portfolio and then decide

whether any new funds will be an add-on and will help in diversifying and

increasing returns.

2. In rising market it is pretty easy for almost all funds to beat the

benchmarks, but the real test for any fund is how it performs during the bearish

phase of the market. A regular evaluation of the fund house and its various

schemes launched during the previous years can give the investors a fair idea

on how the new offering would fare.


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3. It is important for an investor to be aware of the objectives of the

scheme launched, asset allocation and risk factors along with reputation of the

fund house and credibility of the fund manager.

4. A vigilant observation of the fund house will assist the investor know

about the number of NFOs it is coming up with. If the frequency is too high

without any innovative addition to its range of offerings, the investors can

consider skipping the scheme.

5. NAV should not be criteria for investment in NFOs. Investments in

NFOs should be made if the fund is offering some innovative product which

matches the investment objectives of a particular investor.

1.15 BUILDING AND MANAGING PORTFOLIO WITH MUTUAL FUNDS

While building an investment portfolio there are three main

considerations – Liquidity, Income and Growth. It is very important that you

build a portfolio of assets that meet your individual needs and help you to

achieve your investments goals. Investing is about ensuring financial growth

and security in the long term. These goals could include: availability of cash for

emergencies, education for children, maintaining family lifestyle, retirement,

acquiring or selling a business, estate planning, financial independence or

personal objectives such as a special vacation or second home (Chart 1). To

achieve these goals in life, it is necessary to take steps at every income and

age level to make a more efficient use of assets and to make a more efficient

use of assets and ensure a secure financial future. Financial Planning is thus a

process of developing strategies for using financial resources to achieve short,

intermediate and long-term goals.


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The objective of Financial Planning is to achieve the highest potential

rate of return in keeping with the investors‟ risk tolerance. The right allocation of

investments depends on investors‟ objectives, risk profile, time horizon over

which investors want to achieve the financial and personal goals. The investor‟s

attitude towards risk is key element in customizing the portfolio and analyzing

the risk is the next important step in order to determine the appropriate mix of

assets. Another key factor to understand is where you can invest your money.

There are many ways to make money in today‟s market, but the one strategy

that has truly proven itself over the long term is investments thorough Mutual

Funds. Mutual funds have become one of the largest investment vehicles in the

world, currently controlling over 7trn dollars in assets in the US and over 3trn

euros in assets in Europe (Table 1).

Indian financial scene too presents multiple avenues to the investors.

With Indian long-term story firmly in place, mutual funds are going to be an

important vehicle of savings and capital market intermediation. It is going to be

a boon to the uninformed retail investors. The Barclays capital Wealth

Management Survey, involving the world‟s leading wealth mangers, has

predicted Asia‟s top three wealth markets of China, India and Korea to grow by

an much as 17% a year for the next three years. After nearly 40 years, the

industry has finally moved from infancy to adolescence particularly in the past

five years. The industry has made a leap to become an important and dynamic

sector of the capital markets and is expected to grow annually at 20% in the

coming years. It is going to stay as the main driver of wealth creation. India,

though certainly not the best or deepest of markets in the world, has ignited the

growth rate in mutual fund industry to provide reasonable options for a layman

to invest.


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Investments in stocks, bonds and other financial instruments require

considerable expertise and constant supervision to take such financial

decisions. Small investors usually do not have the necessary expertise and the

time to undertake any such monitoring that can facilitate informed decision-

making. By investing in mutual funds, investors can gain the expert assistance

of professional fund mangers who often specialize in selecting specific types of

investments to reflect a particular objective or strategy. Investing in mutual fund

is actually buying an interest in the many different investments that the fund

holds. This diversification reduces your overall investment risk, as a decline in

one investment in the mutual fund may be offset by the strength of other

investments in the fund. Most individual investors cannot readily match the

level of diversification available through a mutual fund.

Table 1.4 Table showing comparison of Life Insurance, Registered Pensions and

Mutual Funds as percentage of GDP

Penetration as % of GDP in Different Countries

Country Life Insurance

Registered Pensions

Mutual Funds

France 60.3 3.5 61.2

US 33.1 66 69.9

Korea 22.8 3.9 25.3

Chile 18.7 59.4 11.1

Thailand 6.2 8 10

Mexico 3.8 0.2 6.1

Poland 4.6 9.5 4.6

Brazil 1.2 20.4 39.6

India 13.3 4.2 4.6 Source : Economic Times


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1.15.1 Playing Safe with Mutual Funds and Managing Return

Expectations

Indian MF industry offers a plethora of schemes and serves broadly all

type of investors. It is important to understand that each mutual fund has

different risks and rewards. In general, the higher the potential returns, the

higher the risk of loss. Although some funds are less risky than others, all funds

have some level of risk. Each fund has a predetermined investment objective

that tailors the fund‟s assets, investment process and investment strategies. At

the fundamental level, there are three categories of mutual funds. Index funds

try to replicate broad market indices such as S&P Nifty and BSE Sensex in an

effort to returns, close to benchmark indexes. Others differentiate according to

perceived investment criteria such as size (large, medium, or small firms), and

style (value, growth, or blend). Moreover, some funds specialize in sectors of

the economy, such s information technology, pharma, banking, while others

may invest in international portfolios. When held over long periods of time,

broad portfolios of stocks and bonds have produced returns that substantially

exceed the interest rate paid on less risky.

1.15.2 Investment through Mutual Fund

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.

Now a days, the post offices and banks also distribute the units of mutual


105

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 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. On the other hand they

must consider the track record of the mutual fund and should take objective

decisions.

1.15.3 Returns from Mutual Funds

Investors who invest in a mutual fund are subject to following returns.

1. Dividends: The dividend income of a mutual fund company from

its investment in shares, both equity and preference, are passed on to the unit

holders. All income received by investors from mutual fund is exempt from tax.

A mutual fund can receive dividends from the stocks that it owns. Dividends are

shares of corporate profits paid to the stockholders of public companies. The

fund might have money in the bank that earns interest, or it might receive

interest payments from bonds that it owns. These are all sources of income for

the fund. Mutual funds are required to distribute this income to shareholders.

Generally they do this twice a year; in a move that's called an income

distribution.

2. Capital gains: At the end of the year, a fund makes another kind

of distribution, this time from the profits they might make by selling stocks or

bonds that have gone up in price. These profits are known as capital gains, and


106

the act of passing them out is called a capital gains distribution. Mutual fund

unit holders, thus gets the benefits of capital gain also which are realized and

distributed to them in cash or kind.

3. Appreciation in Net Asset Value (NAV): Although mutual funds do

not earn high rates of returns, they possess the capability of reducing risk to the

systematic level of market fluctuations. The increase or decrease in the Net

Asset Value of a mutual fund scheme is the unrealized gains or losses on the

portfolio holdings owned by a particular mutual fund. As the value of individual

securities in the fund increases, the fund‟s unit price increases. An investor can

book a profit by selling the units at price which is higher than the price at which

the units were purchased by the investor. The majority of mutual fund schemes

earn in a long run, an average rate of return that exceeds the return on bank

term deposits.

1.15.4 Costs of Investing in a Mutual Fund

Whenever an investor has to invest in any type of investment avenue

he/she has to incur some expenditure. Mutual Funds are no exception. There

are four types of costs associated with mutual fund investing: initial issue

expenses, entry load, exit load, and annual recurring expenses.

1. Initial issue expenses: Initial issue expense include items for

example brokerage fees and commission, marketing and advertising expenses,

printing and distribution costs, and so on which are incurred by the fund house

when the scheme is launched. Initial expenses upto 6 percent of the amount

mobilized can be charged to the scheme. What is incurred in excess of 6


107

percent has to be borne by the respective Asset Management Company

(AMC). Generally AMCs bear all the initial expenses.

2. Entry load: Entry load or sales load is the load imposed when the

units are purchase by the investors to become a part of Mutual Fund Scheme.

It may be upto 2% - of course for many schemes No entry load is charge from

the investors. If the entry load is 2 percent, it means that when an investor buy

the units of a mutual fund scheme which has a net asset value per unit of say

Rs 12 the investor have to pay Rs 12.24 (Rs 12 plus 2 percent thereof).

Schemes that have an entry load are called load schemes and schemes that

have no entry load are called no-load schemes.

3. Exit load: Exit load or redemption load is the load imposed when the

units are sold back to the mutual fund. In practice it varies from 0 percent to 3

percent. This load is imposed to deter investors from withdrawing from the

scheme. In some cases a contingent deferred sales charge of 0.5 percent to

1.0 percent is levied when the investor redeems the units before a certain

holding period (say 6 months). Normally exit load or contingent deferred sales

charge is not applicable when there is an entry load.

4. Annual recurring expenses: Annual recurring expenses refer to the

investment management and advisory fees charged by the AMC and costs,

trustee fees, custodian fees, audit fees, costs of investor communications,

costs of providing account statement and dividend/redemption cheques and

warrants, and costs of statutory advertisements.

The investment management and advisory fees chargeable by the AMC

is subject to the following restrictions: 1.25 percent of net assets upto Rs 100


108

crore and 1.00 percent of net assets above Rs. 100 crore. For schemes

launched on a no load basis, the AMC shall be entitled to collect an additional

management fees not exceeding 1 percent of weekly average net assets

outstanding in each financial year.

The annual recurring expenses shall be subject to the following limits:

On the first Rs 100 crore of the average weekly net assets : 2.50 %

On the next Rs 300 crore of the average weekly net assets : 2.25%

On the next Rs 300 crore of the average weekly net assets : 2.00%

On the balance of net assets : 1.75%

In respect of a debt scheme, the ceiling mentioned above has to be

lowered by 0.25%. In case of a fund of funds scheme, the total recurring

expenses of the scheme shall not exceed 0.75% of the daily or weekly average

net assets, depending on whether the NAV of the scheme is calculated on daily

or weekly basis.

There is one large cost, which is invisible and therefore is often ignored.

It is the cost incurred in executing portfolio transactions. When a mutual fund

buys and sells securities it incurs commissions as well as market impact costs.

Transaction costs depend on the rate of portfolio turnover and the degree of

liquidity and marketability of the securities included in the portfolio. These costs

may range between 0.5% to 2% of the assets of the fund.

When the costs (visible and invisible) of mutual fund investing are high,

they impose a significant haul on fund returns. The haul will be quite

burdensome if the gross returns are low. For example, when the costs are 3

percent and gross returns are 12 percent, the costs will absorb 25 percent of


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the returns. The lesson in simple: costs matter. Hence an investor should be

aware of their potential impact on investment returns.

1.16 STRATEGIC CHOICES IN MUTUAL FUND BUSINESS

Mutual fund industry is one industry which has undergone the most

dramatic transformation in the post-liberalization period of the nineties, in the

field of financial service sector. There has been a paradigm change in the

quality and quantity of product and services offered by mutual fund companies.

After being serviced by the monopoly players in the country for decades with

hardly any choice in product offerings, the Indian customer in the present time

is being wooed by virtually who‟s who of global as well as Indian players and

that also with a choice that was unbelievable a decade back. Based on this

background the strategic marketing choices which the mutual fund companies

implement for their respective products to survive and thrive in this extremely

promising industry in the face of cut throat competition.

1.16.1 Trends in the marketing of mutual fund in India

The changing marketing trends in the mutual fund industry can be easily

linked and traced to its history of growth. The changes in marketing strategies

can be characterized by four stages which have evolved along with the growth

and evolution of the industry. (The four stage model was first proposed by

freeman and co, a consulting company providing advisory services to

financial services industry.)

a. Product focus

b. Distribution focus

c. Client ownership focus

d. Specialized product and service sector


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a) Product Focus

For the first three decades of the industry, from the setting up of UTI till

the entry of private sector players, the only focus of the marketing strategy was

different product offering. UTI and various other public sector mutual funds

focused on introducing an array of products falling in different categories. The

categorization was primarily based on two factors: one was the way the

scheme were traded and the other through different composition of debt and

equity securities in the schemes.

Schemes according to trading:

Open-ended schemes

Close-ended schemes

In an open ended scheme there were no limits on the total size of the

corpus. Investors are permitted to enter and exit the open-ended scheme at

any point of time at a price that is linked to the net asset value (NAV). In case

of close-ended scheme, the total size of the corpus is limited by the size of the

initial public offer. The entry and exit of investor is possible only by trading on

the stock exchange. Due to liquidity constraints posed by close-ended funs,

they were soon rendered obsolete and most of the prevailing schemes are

today open-ended schemes.

Schemes according to composition of debt and equity

Growth schemes

Income schemes

Balanced schemes

Money market schemes


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The products were also differentiated by the composition of equity and

debt in various schemes. Growth schemes invest predominantly in equities

whereas Income schemes invest only n fixed income debt securities. Balanced

schemes try to derive the benefits of both equity and debt by investing in both.

Money market schemes invest in short term liquid securities like money market

instruments for example, treasury bills, commercial papers, government

securities, commercial bills, certificates of deposits etc so that they serve as

appropriate products for investing in short term funds.

There were other niche schemes to fulfill specific needs, such as Tax

saving schemes, Sector specific schemes, Index schemes and so on.

In the Product focus stage, the main aim of the mutual fund companies

was to introduce a wide variety of products and due to oligopolistic competition;

there was no dearth of subscribers. The only parameter on which the selling

was based was the relative performance of the products.

b) Distribution Focus

Product focus continued for two to three years even after the entry o

private sector players in 1993. Initially, the private sector players introduced the

same products available from the public sector and promised superior

performance. When they realized that they needed to differentiate on some

other parameter as well, they focused on distribution. As it was difficult and

time consuming to replicate the wide spread distribution structure of agents set

up by UTI, they encouraged third-party distribution companies to distribute their

products all over India. Specialist distribution companies such as Karvy, Bajaj

Capital, Integrated Enterprises etc. had emerged. Special focus was given to


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investor so that investors could experience superior servicing standards from

private players. Some groups such as Birla Mutual Fund even set up their own

distribution companies such as Birla Distribution.

While the focus on improved distribution and investors servicing did help

the private players establish themselves against large players like UTI, it had

also resulted in a lot of problems. In the rush to gain volumes and thereby

commission incomes, the distribution companies many a time sold the wrong

product to the wrong customer. A growth product, which invests primarily in

risky instruments like equities, was sold to old, retired people looking for

regular, steady income as pension. The ensuing dissatisfaction has thus paved

the way at last or the most critical area for marketing, the Customer ownership

focus.

c) Customer Ownership Focus

Mutual fund companies began to segment their target customer and

position their various products based on the target segment they proposed to

address. The target segment was broadly divided into institutional segment and

individual investor segment. The institutional segment consisted of treasury

departments of corporate, trusts etc and suitable products such as Institutional

Income schemes and Money Market schemes were targeted at them. The

individual investors were in turn divided into various segments such as Young

families with small or no children, Middle-aged people saving for retirement and

Retired people looking for steady income. Suitable products such as Growth

and Balanced schemes for young families and Income schemes for retired

people were marketed.


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By proper segmentation and by targeting the right product to the right

customer, mutual fund companies hoped to win the confidence of their

customer and „own‟ them for life time.

d) Specialized Product & Service Focus

If one observes the trends in the recent past, companies have been

taking the above customer focus further by designing and launching specialized

products and services. As awareness levels of individual investors go up, focus

is on identifying one‟s investment needs depending on one‟s financial goals,

risk taking ability and time horizon. Investor chose companies, which help them

in the above through specialized products and services.

For example, a common financial goal is to save and invest for meeting

the education needs of the children. A number of mutual fund companies such

as Prudential ICICI mutual fund and UTI mutual fund have launched products

that are designed to serve this specific need. The scheme is aimed at helping

investors plan for the education needs of their children. There are two sub-

parts: Gift plan- If the child is in the age group of 1-13 years and one is looking

to save over a long horizon. Gift plan invests between 51-60 percent in equities

and 40-49 percent in debt instruments.

Study plan: If the child is between 13-17 years and one is looking to

meet education expenses in a short time frame. Study plan invests between

85-100 percent in debt and 0-15 percent in equity. A similar need is planning

for a comfortable retirement.

In addition there is a need for specialized services that help investors

assess their risk taking ability and chose product accordingly. Some mutual


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fund companies are launching a new product called „fund of funds‟ which

invests in a combination of other mutual fund schemes (growth, income

schemes etc.), based on the investment objective and risk profile of the

investor.

1.17 SYSTEMATIC INVESTMENT PLAN (SIP) – WAY TO WEALTH

CREATION

A number of facilities are offered by mutual fund schemes so that the

investors can cater these services as per their convenience. Systematic

Investment Plan is straightforward and time-honored mutual fund scheme

constructed to help the low earning investors to accumulate wealth in a

systematic manner over a long period thereby plan a more estimable future for

them.

SIP are regular investment plan available on almost all kinds of mutual

fund schemes, though they are the most effective in equity schemes, as equity

is more volatile asset class than debt. SIP helps an investor to profit from

volatility by automatically buying more units when prices are falling and fewer

units when prices are rising, thus lowering the average purchase price, while

inculcating some much-required discipline into an investor‟s saving and

investing habits. SIP is a disciplined way of investing, where an investor can

invest fixed amounts at regular intervals trough a mutual fund scheme and

includes the following technical benefits:


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1.17.1 Benefit of SIP

a. Rupee cost averaging

b. Power of compounding

c. Low investment

d. Disciplined investment habit

e. Convenience

f. Commensurate returns

g. No entry load

a) Rupee Cost Averaging: Different investors have different objectives

of investing in a mutual fund scheme as majority of them want to

obtain maximum returns on their investments. Investment will be

simple and smooth if one can identify the right time to purchase units

or sell them. However, it proves to be a tiring and complex task of

keeping a track of the market consistently as it is not everybody‟s

„cup of tea‟. One has to face the loss in near future. An automatic

market-timing mechanism like Rupee cost Averaging is required to

track the investment and to save the time efficiency with a minimal

gain if not loss, if the circumstances are unfavorable.

With Rupee Cost Averaging there is no need to be concerned

about the rise and fall in prices shares of companies in which the

mutual fund has invested. An investor can merely invest a fixed

amount at regular intervals, irrespective of the Net Asset Value of the

scheme. The concept is that one has to purchase fewer units when

the NAV is high and more units when the NAV is low. This is in line

with the natural desire to “buy low and sell high”.


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Table 1.5

Benefits of Rupee Cost Averaging

Thus we see that the average unit cost under Systematic

Investment Plan will always be less than the unit cost when you make a one-

time investment.

However, rupee cost averaging does not guarantee a profit.

But with a sensible and long-term investment approach, rupee

cost averaging can smooth out the market's ups and downs and considerably

reduce the risks of investing in volatile markets.

b) Power of Compounding: The power of compounding stresses the

importance of starting the procedure of investment at young age. The

power of compounding involves “Future value of Annuity”, a series of

equal payments that occur at evenly spaced intervals. Hence under

the Systematic Investment Plan an investor can invest in a fixed

amount every month, for a pre-decided period of time, usually 6

months to 1 year, through post-dated cheques, at the applicable

NAV-related prices.

Rupee Cost Averaging - The power of disciplined investment

Month

Investment Rs.

NAV Rs.

No. of units

1

2

3

4

5

TOTAL

1000

1000

1000

1000

1000

5000

10

12

10

8

10

50

100.00

83.333

100.00

125

100

508.333

The average NAV = 50/5=Rs.10

Average price= Total investment/total no. of units

=5000/508.33= Rs.9.84


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Table 1.6

Power of Compounding (An Illustration)

Year Invest/Year Total Inv. Accumulation Int. % Interest Value

1 12000 12000 12000 18% 2160 14160

2 12000 24000 26160 18% 4709 30869

3 12000 36000 42869 18% 7716 50585

4 12000 48000 62585 18% 11265 73851

5 12000 60000 85851 18% 15453 101304

6 12000 72000 113304 18% 20395 133698

7 12000 84000 145698 18% 26226 171924

8 12000 96000 183924 18% 33106 217030

9 12000 108000 229030 18% 41225 270256

10 12000 120000 282256 18% 50806 333062

11 12000 132000 345062 18% 62111 407173

12 12000 144000 419173 18% 75451 494624

13 12000 156000 506624 18% 91192 597816

14 12000 168000 609816 18% 109767 719583

15 12000 180000 731583 18% 131685 863268

16 12000 192000 875268 18% 157548 1032816

17 12000 204000 1044816 18% 188067 1232883

18 12000 216000 1244883 18% 224079 1468962

19 12000 228000 1480962 18% 266573 1747536

20 12000 240000 1759536 18% 316716 2076252

21 12000 252000 2088252 18% 375885 2464137

22 12000 264000 2476137 18% 445705 2921842

23 12000 276000 2933842 18% 528092 3461934

24 12000 288000 3473934 18% 625308 4099242

25 12000 300000 4111242 18% 740024 4851265

26 12000 312000 4863265 18% 875388 5738653

27 12000 324000 5750653 18% 1035118 6785771

28 12000 336000 6797771 18% 1223599 8021369

29 12000 348000 8033369 18% 1446006 9479376

30 12000 360000 9491376 18% 1708448 11199824


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Figure 1.11

Power of Compounding

0

2000000

4000000

6000000

8000000

10000000

12000000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

year

Year

Total Inv.

Value

c) Low investment: In the SIP method, huge investment are not

required, even an investment as low as Rs 50 can be made. It is

suitable for small investors who don‟t have fixed and regular income.

d) Disciplined investment habit: Through Systematic Plan an

individual can cultivate the practice of saving and disciplined

investment habit. This will ultimately result in creation of capital in an

economy for better future. As also through disciplined and steady

investment, the investor can cease to worry about when and how

much to invest.

e) Convenience: An investor is relieved of all the cumbersome work of

tracking the fund‟s performance in the busy hectic schedule. By

starting an account with the mutual fund house and providing post-

dated cheques of periodic investments (monthly, quarterly, etc.),


119

based on the individual investor will provide the necessity of

investment. Also while buying, one can adopt the installment

method, but selling can be done as and when required. Withdrawals

can also be done through installments known as Systematic

Withdrawal Plan (SWP).

f) Commensurate returns: Systematic Investment Plan offer adequate

returns to an investor as rupee average costing and power of

compounding can be experienced. A one time huge amount of

investment leads to a major impact through the ups and downs of the

sensex. Investment through the SIP in the way of installments gives

an average rate of gain, though fluctuations in market prevail.

g) No Entry load: Mutual Fund Schemes do not charge entry load for

SIP schemes, thereby providing a decline in the cost of investing in a

mutual fund.

1.17.2 Beneficiaries of SIP

1. SIP enables the retail people to invest in mutual funds with low

investments as the monthly SIP installments start as low as Rs 50.

2. SIP method of investing proves beneficial to low income groups

as risk is very low and Rupee Average Cost is available.

3. For a common retailer who is risk averse and prefers to gain more

by investing at the right time, the SIP proves to be hassles free investment

option with risk free unlike open share market.

4. SIP is suitable to the investors who lack sufficient time to track the

performance of their portfolio.


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1.17.3 How to get best out of SIP

1 Investment objective: An objective assigns investment an indicative

time horizon and provides a better and clearer idea of how much to invest. For

example money assigned for retirement will obviously have a longer term than

the money earmarked for a car.

2) Fixed periodic investment amount: An investor should allocate

a fixed amount of money which he can set aside periodically to realize the

objectives. Conservatism should be followed while investing through SIP.

3) Decide on the periodicity: Most mutual funds offer two options

on SIP: monthly and quarterly. Between the two, the monthly option is the

smarter alternative. The more frequently investment is made and the longer the

investment is continued the smoother the average cost graph will become.

4) Selection of scheme category: The selection of the scheme to

invest as SIP depends much upon the risk profile and investment objective of

the investor. Hence the risk averse investor should stick to either debt funds

only.

5) Selection of a reliable fund house: An investor should select a

fund house which has proven its worth in the market and has gained reputation

as well.

6) Avoid the market trends: A falling market might make investor to

reconsider the method of SIP whether to continue or to take step back. An

investor has not to consider the volatility of the market because the investor

gets an opportunity to buy greater number of units, which brings down the

average cost price. And when the market recovers, gains are magnified.


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7) Review: Eventually, the success of SIP will depend on its

corresponding scheme‟s performance. Hence a review should be kept of the

scheme and if a scheme is underperforming consistently, an investor should

consider switching to another scheme.

1.17.4 SIP- Indian Context

In a country like India, where a majority of the people is either poor or

from lower middle class, the small saving from their hard earned is the only

reserve for their future needs. These investors generally prefer protection to

wealth creation while deciding about their investment choices. Though mutual

funds are also subject to market risks and fluctuations yet the SIPs are a very

convenient and useful savings method without any specific loss incurred to the

investor, with a minimum average gain in unfavorable situation.

In Indian context, Unit Trust of India is the first to offer Systematic

Investment Plan in mutual funds. Reliance mutual fund launched SIP with

minimum monthly installment of Rs. 100 for the rural investors. Stepping a little

further, ICICI Prudential Mutual Fund launched the Micro Systematic

Investment Plan (MSIP) in association with Konrad-Adenauer-Stiftung (KAS)

Foundation, a microfinance institution and reduced the minimum investment to

Rs. 50. Majority of other mutual companies are also introducing SIP in their

mutual funds. SIP facility is available in the following mutual fund schemes:

1. Income fund

2. Monthly Income Plan

3. Child Benefit Fund (Career, Building Plan only)

4. Balanced Fund


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5. Index Fund

6. Growth Fund

7. Equity fund

8. Tax Saving Fund

Table 1.7

Some of the Mutual Fund Houses with their Minimal SIP Installment

Name of the Mutual Fund House Minimal SIP installment for a month

(in Rs)

Prudential ICICI 50

Reliance Mutual Fund 100

SBI Mutual Fund 500

Franklin Templeton Fund 500

Unit trust of India 100

HDFC Mutual Fund 500

Source : ValueResearchOnline

1.18 SYSTEMATIC TRANSFER PLAN.

Small investors usually fancy a safe method to create wealth while

making investment selection. Investment requirement of person differ from one

individual to another individual and they need a more favorable and systematic

investment avenues. Investment made through Mutual Funds provides the

much needed safety of money as well diversification and liquidity. The

enormous growth of the equity market has induced the investor to reap the

benefits of high growth potentials of the Indian Money Market without taking the

inbuilt high risk, which can be possible only through Mutual Fund Investment.


123

No doubt Mutual Fund has rightly proved to be a right investment avenue for

the investors to enter the stock market indirectly. Earlier Mutual fund

companies were slow in sending redemption cheques and to reveal where the

money collected by a number of investors was invested. But today, the

scenario is completely changed. In the age of cut-throat competition the mutual

fund companies are providing a number of facilities to attract the attention of

the possible investors. Systematic Transfer Plan is one such facility provided by

most of the Fund Houses.

1.18.1 Meaning of Systematic Transfer Plan.

The Systematic Transfer Plan is a facility wherein the investor can

transfer a fixed amount or capital appreciation from one mutual fund scheme to

another scheme periodically. Investor can take the benefit of STP on a monthly

or quarterly basis from one plan to another in the same scheme or to another

scheme within the fund. STP facilitate an investor to invest a certain amount at

periodic intervals without decreasing his resources while simultaneously

building up a pool of assets to cater to the growing needs.

It is very similar to the Systematic Investment Plan (SIP), but differs in

source from which the amount is transferred. In the case of SIP, the amount is

transferred from the bank account of the investor whereas in STP, the sum is

transferred from another mutual fund scheme. The STP is often called as “Drip

Investment” as it helps to invest the capital appreciation in different small

installments.


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1.18.2 Categories of STPs.

Fixed option STP that allows the unit-holders to transfer a fixed

sum at periodic intervals into another fund.

Appreciation STP that is set in motion only when the capital

appreciation on the existing investment crosses a limit that has been set by the

investor.

1.18.3 Working Mechanism of STP

Systematic investment Plan provides the diversification within the

scheme as soon as the one scheme reaches a predestined goal. Among the

various strategies followed by Mutual Fund Houses Systematic Transfer Plan

provides an excellent opportunity to switch investment from one scheme to the

other scheme within the same fund.

Unit-holders may take the advantage of this plan by specifically applying

for it by filling up the relevant portion of the transaction form. In order to

illustrate how the STP works, let us assume that an investor has invested Rs.

1,00,000 either in debt instruments or in any other capital market related

scheme. Then he can have a STP with the existing scheme. As per that, the

investor can instruct the fund manger of the existing scheme to transfer Rs.

1,000 to another mutual fund scheme periodically. The other scheme can be

Equity Fund, a Balanced Fund or any other type of fund. In order to transfer the

amount to the new scheme, some of the units in the existing scheme will be

sold. The growth in the units of the existing scheme will neutralize the reduction

in the number of units. Table 1.8 provides the Net Asset Value (NAV) of the

funds at the beginning and the net amount at the end of each month.


125

Table 1.8 STP (An Illustration)

Month NAV No of Units to be Sold to

Transfer Rs. 1,000

Remaining Units

NAV at the End of the Month

0 10.00 - 10,000 1,00,000

1 10.40 97 9,903 1,02,992

2 10.80 93 9,810 1,05,948

3 10.20 98 9,718 99,062

4 9.80 102 9,616 94,237

5 10.580 96 9,520 99,260

6 11.00 91 9,429 1,03,719

7 11.30 89 9,340 1,05,542

8 11.50 87 9,253 1,06,409

9 11.40 88 9,165 1,04,481

10 12.00 84 9,081 1,08,972

The above Table 1.8 clearly shows that at the end of the first month, an

investor has to sell 97 units to transfer Rs. 1,000. However, at the end of the

tenth month, only 84 units should be transferring a sum Rs. 1,000. This is

possible due to the increase in the NAV of the existing units.

1.18.4 Beneficiaries of STP

STP can be effective for several classes of investor. Some are listed

below:

Investors who want to invest large amounts in schemes with

stable returns and ensure small exposure to equity schemes, in order to avail

themselves of the high growth potentials through equities.


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Investors who want to re-balance their portfolio or to phase out

investments in a particular fund over a period.

Investors who like to re-balance their equity investments and hold

them within a desirable limit by transferring from equity to debt.

1.18.5 Convenience of STP

An investor can easily enroll himself for a STP just by filling an

application form.

The fund manger transfers the amount on the requested date,

credits the units to the investor‟s account and sends a confirmation for the

basis.

In a STP, the investor has the option of transferring the sum

either on monthly or quarterly basis.

Most of the mutual funds do not charge any entry and exit load for

switches within the funds during the 365-day period.

1.18.6 Benefits of STP

It facilitates the investor to save as well as accumulate wealth at

the same time.

It permit the investor to enter at various market levels (averages

out the possible risk associated with the equity market).

Hassle-free mechanism (one-time arrangement-instructions are

given out the possible of initial transaction).

Uses the power of compounding to its advantages. Due to the

consistent savings over a period of time, the periodic installments aggregate to

a considerable amount.


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The initial amount invested is not kept idle. The unit-holder can

earn better returns on the initial amount than the bank return.

1.18.7 STP : Indian Scenario

In India, various fund houses such as Prudential ICICI, Kotak, Birla Sun

Life, UTI, HDFC Mutual, Franklin Templeton, etc., are offering the STPs in their

mutual fund schemes (Table 3). They usually offer monthly quarterly STPs, but,

a few funds such as Prudential ICICI, allow systematic transfers even at weekly

intervals.

The fund houses allow an investor to invest a lumpsum in a liquid or

floating rate fund and leave instructions to transfer Rs. 1,000 every month into

an equity fund. He can also transfer a fixed sum every month from a debt to an

equity fund. While many fund houses permit STPs from debt to equity funds,

only a few allow the reverse. Franklin Templeton, Prudential ICICI and Birla

Sun Life allow systematic transfers out o their debt schemes and into their

equity funds, but not the reverse. Kotak Mutual Fund permits two-way STP.

Though the STP has become a powerful tool to diversify risks and create

wealth over time, it also suffers from certain demerits:


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Table 1.9

STP Facilities Offered By Select Mutual Fund Houses

Fund Houses Facilities Offered On Which

Fund

Terms

Kotak Mutual STP-Weekly/ Monthly/

Quarterly

Equity/ Debt/

Hybrid

Min. Installment:

Rs. 1,000,6

months

Prudential ICICI

Mutual

STP-Weekly/ Monthly/

Quarterly

From Debt/

Liquid/ MIP

to

Equity/Hybrid

Min. Installment:

Rs. 1,000,6

months

Franklin

Templeton

STP-Monthly/ Quarterly From Debt/

MIP to

Equity/

Min. Balance: Rs.

25,000

Installment: Rs.

1,000,6 months

Birla Sun Mutual STP-Monthly/ Quarterly From Debt/

MIP to Equity

Min. Installment:

Rs. 500 , 12

months months;

Min. Balance: Rs.

6,000

HDFC Mutual STP-Monthly/ Quarterly Equity

/ Debt/Hybrid

Min. Installments:

Rs. 1,000, 6

months;

Min. Balance: Rs.

25,000

Source: coolavenues.com


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Firstly, the investor can transfer the amount from on scheme to

another only within that particular fund house.

Secondly the growth factor of the units within the scheme

depends upon the strength and weakness of the particular mutual fund.

Thirdly in downward market, a STP does not guarantee income,

but only safeguard one from incurring losses.

Mutual fund schemes have their own ups and downs as part of their

business. At the time of making choice, an investor should weigh the benefits

and downsides of each scheme. STP is an ideal investment option for risk-

averse small investors who are otherwise not able to enjoy the benefits of

investing in the equity market. It is more useful to investors who want to play for

high profit in the equity market without affecting the initial investment as the

saying goes. An ideal investor has to position in between both.

“Too many eggs in one basket is not good,

Putting eggs in too many baskets is also not good”

1.19 MUTUAL FUND WRAPS

The mutual fund industry is enormous. It offers to the investors a large

basket of schemes and options to choose from. An investor can select from the

available schemes any particular scheme which suits the requirements and

objectives of the respective investor. The Investment Company Institute (ICI), a

trade organization representing mutual fund providers, cites more than 8,300

U.S.-based mutual funds, with combined assets of about $8 trillion as of end-

March 2005. And worldwide, there are about 54,986 mutual funds, with assets

totaling about $16 trillion, according to the ICI. With so many funds to choose

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from, selecting one can be a real challenge. An investor can be under the

impression of a dilemma of what to choose and which fund to opt. Building and

monitoring a diversified portfolio can be an overwhelming burden. To ease this

burden, the industry has created the mutual fund advisory program, also known

as the mutual fund wrap.

1.19.1 Mutual Fund Wrap Working:

The mutual fund advisory program comes in two versions:

(a) Discretionary

(b) Non-discretionary.

(a) Discretionary: A discretionary mutual fund advisory program provides a

variety of portfolios that incorporate multiple mutual funds into pre-

selected asset allocation models. One model may offer an asset allocation of

80% equity and 20% fixed income while another may offer 80% fixed income

and 20% equity. Many of the portfolios divide the equity and fixed-income

portions among multiple mutual funds, each fund representing a specific

discipline

Investors work with a professional financial advisor to map out their

personal financial goals. Based on those goals, the advisor reviews the

offerings in the mutual fund advisory program and selects the asset allocation

model that matches the investor's goals. For example, a conservative investor

interested in income generation would be guided to select a portfolio that

allocates the majority of its assets to fixed-income investments. An aggressive

investor primarily interested in capital appreciation would be guided to select a

portfolio that allocates the majority of its assets to equity investments.

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The structure of a discretionary mutual fund advisory program is similar

to the structure of a multi-discipline account. Like a multi-discipline account, a

mutual fund advisory program offers a diversified portfolio, professional advice

and guidance, ongoing due diligence of the investments in the portfolio and

automatic rebalancing of the portfolio to maintain the desired asset allocation.

The discretionary mutual fund advisory program delegates authority to the

program sponsor (often the financial advisor's employer or a subsidiary of the

advisor's employer) to make changes to the asset allocation model and to add

or remove mutual funds from the portfolio without approval from the investor.

(b) Non-discretionary: In the non-discretionary program, the investor and the

financial advisor review a list of mutual funds that have been pre-screened and

selected for inclusion in the program, and choose funds from that list to create

a customized asset allocation model. The investor is responsible for providing

approval of the rebalancing of the portfolio and for the decision to replace any

of the mutual funds.

Both the discretionary and non-discretionary programs are considered to

be entry-level managed-money products because they offer professional

advice and guidance, no commissions for trading and a single fee based on

assets under management. Mutual fund advisory programs offer significantly

lower minimum investment requirements than other managed-money products.

Some mutual fund advisory programs are available at investment minimums as

low as $25,000, compared to $100,000 or more for other managed-money

offerings. Both discretionary and non-discretionary mutual fund advisory

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132

programs provide consolidated performance reporting, making it easy for

investors to review results at the portfolio level.

While mutual fund advisory programs offer many of the same benefits

provided by their more expensive managed-money cousins, there is also an

important difference. Assets in a mutual fund advisory program are not

separate and distinct from the accounts of other investors. Mutual funds, as the

name implies, are mutual investments. The basic premise of a mutual fund

involves a group of investors who pool their assets so that they can afford the

services of a professional money manager. The money manager then makes

portfolio management decisions on behalf of the collected pool of investors.

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