What do we know about mutual funds?
I think what everyone knows about mutual fund is that “Mutual funds are subjected to market risk. Please read your offer documents carefully before investing”.
What are the market risks mentioned here? Are mutual funds subjected only to market risks?
Market risks includes risk associated with equity investments, change in interest rates, foreign exchange risk, commodity risk etc. If mutual funds are subjected only to market risk, then how would different funds perform differently? Aren’t they all supposed to be performing same way for at least mutual funds in same sector? Here comes the role of fund manager and his approach. This is also one of the key aspects of performance of a mutual fund. The key to a mutual fund is how the fund manager mitigates the market risk without impacting the performance of the fund scheme. The role of a mutual fund manager includes selecting the stocks that will deliver, diversifying the schemes and everything possible to do the balancing of risk Vs return.
Importance of market research
Even if we want to invest in shares of only one company we need to do lot of research before taking a decision. It takes lots of time and effort. The concept of mutual fund has significance at this context.
Mutual Funds are kind of collective investment schemes, which are professionally managed by a Fund manager. The money for a mutual fund is pooled from many investors and is invested in stock, bonds short term money market instruments and other securities. Mutual funds are relatively less expensive as with minimum investment amount investor gets maximum diversification.
Net Asset Value (NAV) of Mutual Fund:
NAV is the per share market value of a mutual fund. While buying a mutual fund, the number of shares are allotted by dividing the invested money with NAV.
NAV of a mutual fund is calculated as below:
(Total value of all the cash + securities - liabilities if any)/Number of shares.
An NAV computation is undertaken at the end of each trading day based on the closing market prices of the portfolio's securities. Liabilities would include charges for fund manager and his team.
Setting Up a Mutual Fund
Mutual funds have got a 3 tier set up. First the sponsor who wants to set up a mutual fund approaches SEBI (Securities and exchange board of India). SEBI does a back ground check of personal integrity and financial sector experience etc and gives the approval. Sponsor then set up a public trust under Indian trust act 1882. According to this act it’s not a legal entity. So trustees act on behalf of them. Once after this trust is registered with SEBI it’s known as Mutual fund. The last level is AMC (Asset management company). Actual money management of investors are done by AMC.
When a new scheme is launched, it is known as new fund offer or NFO.
First the investor has to fill the NFO available with the distributor. He is supposed to read the offer document (OD) thoroughly. At least he should read the key information memorandum (KIM) available with the application. Investor has to give the cheque or draft (MF cannot collect cash). Mutual fund will give this cheque to the corresponding bank in which it has the account.
Different Type of Investment Plans:
Lump Sum Investment Plan or One Time Investment Plan: In this type of investment plan, the whole amount is invested as lump sum in a single go. This type of investment plan has got higher risk depending on the market performance from the time of buying the mutual fund.
Systematic Investment Plan (SIP): In this type of investment plan, the investment is done in instalments. There will be an effective averaging of NAV (Net Asset Value) of the mutual fund in this type of plans. So, the risk will be lesser in case of SIPs due to averaging of NAVs of various instalments. At the same time, you may be loosing on potentially higher returns of one time investment based on market performance.
Different Type of Mutual Fund Products:
Equity fund products are comparatively riskier one and the probability of higher return is also more in this case. This product can be either open ended or closed ended. Open ended products allow the investor to enter and exit the scheme at his convenience. But in case of closed ended product the investor can invest only during the NFO period. And even the redemption also happens only after the specific period mentioned in the scheme.
In equity funds, Index funds are considered as the safer one as it’s a diversified and large cap fund. It’s a passively managed one. But sector funds come under the risky category.
Again based on market capitalization equity funds are divided as
- Large cap-Stable and safe top 100/200 actively managed companies.
- Mid cap- more expense to do the market research.
- Small cap- relatively higher risk
The commonly knows equity fund linked schemes are growth scheme and value scheme. Growth schemes invest in the stocks of the companies where the growth is expected more than the average. But in case of value scheme the investment is done in relatively low profile companies and expecting the stock price to grow over years.
Exchange Traded Funds (ETFs)
These are the mutual fund units which investor buy or sell from the stock exchange. Here the AMC deal with the APs (Authorized Participant) few designated participants. This is comparatively less expensive and investor require one demat a/c for the trade. It can be on the basis of gold, silver, indices etc.
- Gold Exchange Traded Funds (ETFs): Here the investment is in gold or gold related securities. This is as good as buying gold where there is no treats as keeping gold. Upon maturity investor can realize this on the prevailing rate of gold ETFs. Here again we have a custodian who does the safe keeping of physical gold.
These are relatively safer funds. Debt market in
India is not an
easily accessible one. So mutual fund industry helps the investor to trade in
debt instruments. The two major risks in the debt securities trade are interest
rate risk and credit risk. The interest rate risk can be overcome by investing
in relatively short duration schemes. The credit risk arises mainly when the
borrower turns to bankrupt. To overcome this there are credit rating agencies
like CRISIL and ICRA which gives the rates from “AAA” to “D”(defaulter).
Price in a bond is calculated as the present value of future cash flow. YTM (“Yield to Maturity” denotes the rate applied to future cash flow.
Different schemes available are mentioned below:
Different schemes available are mentioned below:
- Fixed Maturity Plans- it’s a closed end scheme where the investor is assured of fixed income.
- Capital Protection scheme - Here a portion of the fund is invested in debt instruments and other portion in derivative instruments like options.
- Gilt funds- This scheme will invest only in the securities issued by government. It’s safer one.
- Balanced/hybrid funds - here 50% investment tin debt instruments and other 50% in equity schemes.
- Monthly Income Plans (MIP) - Here the dividends are payee monthly.
Liquid funds are the biggest contributor of mutual fund industry. All the schemes with less than one year maturity are called liquid funds. Few of the widely traded liquid funds are commercial papers, certificate of deposit treasury bills etc.