Brief summary on Mutual Funds

Mutual Funds

Mutual funds are financial investment vehicles that is made of the capital of different investors who share a common financial goal. A fund manager manages the pool of money which is collected from various investors and invests the money into a variety of investment options such as company stocks, bonds, and shares. Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI), and investing in mutual funds is considered to be the easiest way through which you can increase your wealth.

Types of Mutual Funds in India

Mutual funds in India are classified into different categories based on certain characteristics such as asset class, structure, investment objectives, and risk. Here, we will help you understand in detail the various categories and the kinds of funds under each category.

Based on Asset Class

  1. Equity Funds
  2. Debt Funds
  3. Money Market Funds
  4. Hybrid or Balanced Funds

Based on Structure

  1. Open-ended Mutual Funds
  2. Closed-ended Mutual Funds
  3. Interval Funds

Based on Investment Objectives

  1. Growth Funds
  2. Income Funds
  3. Liquid Funds
  4. Tax-saving Funds
  5. Aggressive Growth Funds
  6. Capital Protection Funds
  7. Pension Funds
  8. Fixed Maturity Funds

Based on Risk Profile

  1. High-risk Funds
  2. Medium-risk Funds
  3. Low-risk Funds
  4. Very Low-risk Funds

Specialised Mutual Funds

  1. Index Funds
  2. Sector Funds
  3. Fund of Funds
  4. Foreign/International Funds
  5. Global Funds
  6. Emerging Market Funds
  7. Real Estate Funds
  8. Market Neutral Funds
  9. Asset Allocation Funds
  10. Gift Funds
  11. Exchange-traded Funds

Features of Mutual Funds

Investors can accumulate huge amount of wealth through investment in a diversified portfolio that is made of high-performing schemes. But, there are so many different fund houses and schemes to choose from which can be overwhelming to select the right portfolio. This is when a professional fund manager can come to your help and ensure that your money is invested in the funds that will offer maximum returns. Here are some of the key features of mutual funds:

  • Smart, practical, and strategic investment instrument
  • Professionally managed by qualified and experienced fund managers
  • Risk mitigation via investments done in a diverse portfolio of securities
  • More liquid than other investment options in deposits, shares, and bonds
  • Relatively lower expenses and fees regardless of the fund’s performance
  • Consistent in performance over a short, medium to long term period
  • Highly flexible in terms of financial objectives, liquidity, and tenures
  • Ample choice of investment catering to varied investor needs
  • Ease of trading and transacting the units on all the working days
  • Tax exemption/deduction benefits under Section 80C of the Income Tax Act

Mutual Fund Eligibility

Investments in mutual funds can be made by a variety of investors such as individuals, partnership firms, Qualified Foreign Investors (QFIs), registered Foreign Institutional Investors (FIIs), Persons of Indian Origin (PIOs), Non-Resident Indians (NRIs), cooperative societies, Hindu Undivided Families (HUFs), etc. To invest in mutual funds, applicants are required to be KYC compliant.

How to Invest in a Mutual Fund in India?

An increasing number of individuals in India have taken to investing in mutual funds, but a huge percentage of the investors have no idea how to go about it. Here are some tips to help you kick-start your investment in mutual funds:

  • Identification of Goals
  • Understanding the Various Schemes
  • Approaching Advisors
  • Keeping your Documents Handy
  • Considering the Risk Factor
  • Plans and Options
  • Considering your Age
  • Past Performance of Funds

Mutual Fund Fees, Charges, and Expenses

Mutual funds are managed by Asset Management Companies that employ fund managers to handle each scheme. Fund managers are assisted by a team of market experts and financial analysts. Managing the expenses of these professionals and working towards overcoming market risks can be a difficult task. It is for this reason that mutual fund houses charge fees to investors.

Asset Management Companies and fund managers grow in terms of reputation based on the fees or expense ratios charged by fund houses to investors. The better the performance of schemes managed by Asset Management Companies and fund managers, the better their reputation.

The final = goal of Asset Management Companies and fund managers is to maximise returns and satisfy investors as achieving so will help them acquire steady investments in the future. At the same time, their performance can attract new investors, thus increasing the company’s Assets Under Management. However, to achieve these feats, operational costs are incurred by fund houses, and to cover these costs, fees and charges are levied to investors. The following are the different mutual fund fees and charges in India:

  • Entry Load
  • Exit Load
  • Management Fees
  • Account Fees
  • Service Fees and Distribution Fees
  • Switch Fee

Mutual Funds – Modes of Investment

There are three primary ways through which investment is made in mutual funds, they are as follows:

  • Direct Investment
  • Online
  • Agents

Objectives of Mutual Funds

The objectives of mutual funds vary based on their type. Different funds have different objectives. Here, we will look at some of the common kinds of mutual funds and their objectives.

  • Growth Funds
  • Income Funds
  • Value Funds

Common Approaches to Investing in Mutual Funds

There are four common approaches to invest in mutual funds. They are as follows:

  • Bottom-up approach: This approach focusses on choosing the stocks of certain companies that are performing well regardless of the prospects for the economy or the industry under which the companies fall.
  • Top-down approach: This approach look at the big economic picture and finds countries or industries that are forecast to perform well in the future. Investments are then made in companies that fall under the sectors or countries that are expected to perform well.
  • Technical analysis: This approach studies past market data to predict the direction of investment prices.
  • Combination of Bottom-up and Top-down approach: This approach combines the two most common approaches of investing in mutual funds. The fund manager usually uses the top-down analysis to figure out the countries in which to invest, and then uses the bottom-up analysis to build the portfolio.

Benefits of Investing in Mutual Funds in India

Here are the benefits of investing in mutual funds:

  1. Liquidity: Open-ended mutual funds are quiet liquid. Units in these funds are easy to purchase and it is very easy to exit from the scheme. But, most funds charge an exit load at the time you sell the units of your scheme. Just look out for the same to ensure that you will not be paying too much when exiting from the mutual fund scheme.
  2. Managed by experts: One of the main reasons why mutual funds have become the preferred investment choice among a large number of investors in India is the fact that they are managed by experts. Investors require minimal knowledge about mutual funds to invest in them. Professional fund managers do all the work on behalf of investors, and make decisions regarding the kind of funds to invest in, how long to hold them, etc.
  3. Diversification: Market movements determine the performance of mutual funds and the risks associated with them. Therefore, investments are almost usually made in multiple asset classes such as equities, money market securities, debt instruments, etc. so that the risk is spread out. Doing this ensures that when one of the asset classes performs poorly, returns can be generated from the other classes and compensate for the losses.
  4. Meeting your financial targets: Investors have access to a wide variety of mutual funds and can therefore, find schemes that are ideal to meet their financial targets, be it in the long run or in the short term. Regardless of how much income you earn, or how low your finances are, you can find funds to invest in on a monthly basis through SIPs and therefore, raise funds for future use.
  5. Low cost for bulk purchases: When you purchase a 1-litre Bisleri water bottle, you pay Rs.20. If you purchase a 2-litre Bisleri water bottle, you pay Rs.30. However, a 20-litre can of Bisleri water costs Rs.80. Similarly, the higher the number of mutual fund units purchased, the lower the cost as there will be lower commission charges and processing fees.
  6. Systematic Investment Plans: The average transactional costs that you incur are lower if you choose the SIP route to make investments in mutual funds. SIPs are also a great option because most people may not have a lump sum amount to invest in mutual funds. However, if you earn a monthly salary, you can set aside a certain amount each month and the same will be invested in mutual funds, thereby giving you exposure to the whole stock. SIPs can also help you benefit from market highs and lows.
  7. Easy investment process: Investment in mutual funds is a very easy process. All you have to do is identify your financial goals and decide how much money you want to invest in order to achieve them and the fund manager will take care of the rest.
  8. Tax-efficiency: Investment in tax-saving mutual funds such as Equity-Linked Savings Scheme can help you avail tax benefits to the extent of Rs.1.5 lakh. Although you will have to pay tax on Long Term Capital Gains if the investment is held for more than a year, you can still save a lot of money on tax under Section 80C of the Income Tax Act.
  9. Safety: One of the most common things you hear about mutual funds is that they are unsafe in comparison with bank products. However, if you assess the fund house from which you purchase units of mutual funds in addition to an assessment of the fund manager, your capital will be safe.
  10. Automated payments: Sometimes, you may forget to pay your SIP amount on time, and this would mean that you will have to pay two instalments in the following month. However, fund houses encourage automated payments and you can have the SIP amount paid directly on a certain date each month, thereby avoiding the failure to make timely payments.

Glossary of Mutual Funds Terms

  • Asset class: Asset class refers to a group of investments or securities whose characters are rather similar. The most common kinds of asset classes include fixed income securities, equities, and cash equivalents.
  • Benchmark: It refers to the standard of performance against which a mutual fund’s performance is measured.
  • Bonds: Bonds are debt instruments issued by governments, government agencies, municipalities, or companies.
  • Broker: A broker is a middleman or a firm that is involved in the business of effecting securities transactions for others’ accounts. Brokers work for commission.
  • Distribution of Capital Gains: When the mutual fund sells the securities in its portfolio for a profit, it distributes these profits to the shareholders. This is called the distribution of capital gains.
  • Commercial Paper: Commercial papers are basically short-term unsecured notes that are issued by corporation for the purpose of meeting immediate short-term cash needs like the financing of short-term liabilities or inventories. The maturity period of a commercial paper usually ranges from one day to 270 days.
  • Dividend: It is the money paid by a company or a fund house to its shareholders usually from its investment income. It is a form of distribution.
  • Equity: They are investments or securities that represent ownership in a firm or company.
  • Expense Ratio: It is a measure of the amount required for the operation of a fund, and is expressed as a percentage of its assets.
  • Fund Manager: The individual responsible for handling the corpus of a fund and investing in the securities to generate returns for investors.
  • Government Bond: They are debt securities issued by governments or their agencies.
  • Investment Objective: It is the goal of the fund, and how it intends to raise money or returns for the investors.
  • Liquidity: It is the ability of an investment to gain instant access to invested money.
  • Money Market: It is the worldwide financial market for the purchase and sale of short-term securities like commercial paper, treasury bills, and repurchase agreements. It is basically a market for borrowing and lending in the short term.
  • Net Asset Value: It is an investment company’s per-share value and is computed by deducting the liabilities of the fund from its assets’ current market value and dividing the figure by the number of outstanding shares.
  • Redemption: Redemption refers to the resale of the units of a fund back to the fund house.
  • Total Net Assets: It is the overall amount of assets held by a fund minus any liabilities.
  • Trustee: A trustee basically oversees the operations and management of the mutual fund. Trustees also have the fiduciary responsibility to represent the shareholders’ interests.

Case Study on Mutual Fund Investment

Suppose Richa Sharma of 24 years having a secured job with one dependant and monthly take-home salary of Rs.40,000 – Rs.50,000 with no knowledge of financial planning/investment wants to invest in a mutual fund. Before taking the final investment decision she has to know her investment objective, estimate her risk-taking capacity and understand her level of risk tolerance. The risk-assessment and asset allocation tools available online will help her in this process.

  1. Risk profiling
  2. Risk analysing
  3. Asset allocation

Related Terms

Some of the common terms related to mutual funds are as follows:

  • Fund Units or Shares – The investors of a mutual fund make investments by buying the units or shares of the particular fund in which they are willing to invest. The more the number of units bought by the investors, the higher the investment is for them.
  • Net Asset Value – This is the value/price of a unit or price per share of the fund. It is actually the prime indicator of the performance of a mutual fund. Based on the performance of the fund, its NAV changes from time to time. During the purchase or sale of the fund units, the prevailing NAV is considered and the units are bought/sold/redeemed at the current value per unit.
  • Entry Load- This is the total amount that an investor has to pay at the time of purchasing the units of a mutual fund scheme. This is basically the entry fee that is charged by the fund management company when a person makes investments in a mutual fund.
  • Exit Load- The exit load is the penalty fee charged by the company for making an untimely exit from a mutual fund scheme. In other words, it is the amount that an investor is required to pay before selling the units or assets prior to the pre-decided time frame.
  • Offer document – The official document that formally summarises all the basic features and rules and regulations of a mutual fund is the offer document. The investment objective of a particular fund along with all the details of investments made in securities and asset classes are elaborated in the offer document. Apart from the terms and conditions, it contains information about its managing authority, the associated risks, performance history, and other financial matters. It is very important for an investor to go through the offer document carefully prior to the investment.
  • Assets Under Management (AUM): AUM is the overall market value of funds that are managed and handled by a particular mutual fund company.
  • Expense Ratio: As the word suggests, the expense ratio of a mutual fund is the total expense incurred by the fund when compared to the total assets that it acquires.
  • New Fund Offer (NFO): NFOs are the latest fund offers and schemes that are introduced in the market by the AMC. Since these new funds are launched at a special offer price, the investors can purchase these units at a relatively low price compared to that of the usual market price.
  • Redemption: When the fund units are sold or transferred or cancelled, it is known as redemption.
  • SIP Investment- SIP or Systematic Investment Planning is a method of investing money in mutual funds in a small amount in periodic instalments. By opting for this recurring investment vehicle, people can invest small amounts instead of a lump sum in the mutual fund on a weekly, quarterly, and monthly basis. This investment method is particularly beneficial for investors who want to invest small amounts on a regular basis for a long term.
  • Lump sum Investment: Lump sum mutual fund investment is the method of contributing a fixed amount of one-time money in a mutual fund. This type of investment is specially opted by people having huge money to invest. Retired persons or business entrepreneurs with massive capital usually choose such investments.
  • Equity Funds- Equity funds are growth funds which invest in the shares and stocks of companies particularly. Also known as stock funds, these funds have a mix of stocks and shares of diverse companies in their portfolio.
  • Debt Funds- This type of fund invest in a combination of fixed income securities such as government securities, treasury bills, money market instruments, corporate bonds and other types of debt securities. Such securities have a fixed date of maturity and pay a fixed interest rate. These are mostly opted by investors who don’t want to take much risk and are satisfied with a steady income.
  • Lock-in period- This is the period during which an investor is not allowed to sell a particular investment. In other words, during the lock-in-period, the investment of a person remains locked.
  • Index fund- An index fund specifically focuses on the purchase of securities matching or representing a particular index. The portfolio of such fund is designed in order to mimic or track the components of a specific market index.
  • Liquid Fund- This category of a liquid mutual fund is similar to the money market funds but doesn’t have any lock-in-periods. It predominantly invests in money market instruments such as a certificate of deposits, commercial papers, treasury bills, and term deposits.
  • Income fund- Income fund is a type of mutual fund which essentially aims at providing current income instead of capital growth. The tendency of income fund is to contribute to stocks and bonds which collect high interest and dividends.
  • Floating rate debt- Type of bond or debt whose coupon rate undergoes changes based on the change in the market conditions.
  • Holding period- This is the duration or period for which an investor holds an asset. In other words, it is the time between the initial date of purchase of a security and the date of its sale.
  • Long-term capital gain- Profits derived from the sale of assets such as shares and securities which are kept on hold for a period of more than 12 months.
  • Short-term capital gain- Profits that an investor earns from the sale of assets like shares, stocks, and securities which were owned for less than a year.
  • Portfolio turnover rate- It is the rate levied on the change of the mutual fund portfolio every year.
  • Money Market fund- Mutual funds which capitalise especially in money markets like commercial bills, commercial papers, treasury bills certificate of deposit, and other RBI instruments. The lock-in period for this type of funds is a minimum of 15 days.
  • Switch- Certain mutual funds allow the investors to shift or switch from one investment scheme to another within that particular fund. However, the mutual fund companies charge a switching fee for making a switch within funds. An investor can either shift his whole investment from one scheme to another or can transfer it partially depending on his investment goals, risk profile, and other circumstances.
  • Interval Schemes- Interval schemes combine the features of both open-ended and closed-ended mutual funds. The units of these schemes can be traded either on the stock exchange or can be kept open for sale or redemption during the prefixed intervals at the NAV (Net Asset Value) related prices.
  • Offshore funds- These funds focus in making investments in offshore.foreign companies or corporations. The investors of such funds are NRIs and these are regulated as per the provisions of the offshore countries where these funds are registered. Such funds are regulated as per the directives of the Reserve Bank of India (RBI).
  • Systematic Withdrawal Plan- Systematic Withdrawal Plan or SWP in funds permit the investor to take out a fixed/variable amount from his/her fund scheme monthly, quarterly, semi-annually, or annually on a predetermined date. Such funds not only offer consistent income to the investors but these also provide good returns on the remaining amount.