FMI - Module III - Mutual Funds

Mutual Funds
1
Objective
• To understand working of a MF
• Structure of MF in India
• Procedure for NFO
• Types of MF
• MF V/s Other investment options
• Features of Mutual Funds – SIP, STP, SWP
• AMFI – Role & Objective
2
India Investment Mind set
• India has one of the highest savings rate globally.

• This penchant for wealth creation makes it necessary for Indian investors to
look beyond the traditionally favoured bank FDs and gold towards mutual
funds. However, lack of awareness has made mutual funds a less preferred
investment avenue.
• Mutual funds offer multiple product choices for investment across the financial
spectrum.
• Mutual funds offer an excellent avenue for retail investors to participate and
benefit from the uptrends in capital markets. While investing in mutual funds
can be beneficial, selecting the right fund can be challenging.
• While investors of all categories can invest in securities market on their own, a
mutual fund is a better choice for the only reason that all benefits come in a
package. 3
What is a Mutual Fund?
4
Mutual Funds Explained
Videos explaining the concept and basics of Mutual Funds:
• DSP Blackrock MF -
https://www.youtube.com/watch?v=cCD8icUm9dA
• UTI MF - https://www.youtube.com/watch?v=deaU-eVM5xs
5
What is a Mutual Fund?
• A mutual fund is a pool of money managed by a professional Fund Manager.
• It is a trust that collects money from a number of investors who share a
common investment objective and invests the same in equities, bonds, money
market instruments and/or other securities.
• And the income / gains generated from this collective investment is
distributed proportionately amongst the investors after deducting applicable
expenses and levies, by calculating a scheme’s “Net Asset Value” or NAV.
Simply put, the money pooled in by a large number of investors is what makes up
a Mutual Fund.
• Mutual funds are ideal for investors who either lack large sums for investment,
or for those who neither have the inclination nor the time to research the
market, yet want to grow their wealth. The money collected in mutual funds is
invested by professional fund managers in line with the scheme’s stated
objective. In return, the fund house charges a small fee which is deducted
from the investment. The fees charged by mutual funds are regulated and are
subject to certain limits specified by the Securities and Exchange Board of
India (SEBI).
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Mutual Fund
Concept Simplified
Let’s say that there is a box of 12 chocolates costing ₹48. Four friends decide to
buy the same, but they have only ₹12 each and the shopkeeper only sells by the
box. So the friends then decide to pool in ₹12 each and buy the box of 12
chocolates.
Now based on their contribution, they each receive 3 chocolates or 3 units, if

equated with Mutual Funds.
And how do you calculate the cost of one unit? Simply divide the total amount
with the total number of chocolates: 48/12 = 4.
So if you were to multiply the number of units (3) with the cost per unit (4), you get
the initial investment of ₹12.
This results in each friend being a unit holder in the box of chocolates that is
collectively owned by all of them, with each person being a part owner of the
box.
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MF Concepts: Net Asset Value
• NAV is the measure of performance of an individual scheme of
a mutual fund.
• It is essentially, the market value of the securities held by the
scheme.
• The NAV is the combined market value of the shares, bonds and
securities held by a fund on any particular day (as reduced by
permitted expenses and charges).
NAV per Unit represents the market value of all the Units in a mutual fund
scheme on a given day, net of all expenses and liabilities plus income accrued,
divided by the outstanding number of Units in the scheme.
Example – a mutual fund has issued 10 lakh units at Rs. 10 each. NAV at the time
of allotment is Rs. 10. If the market value of securities jumps to INR 200 lakhs, the
NAV of each unit shall be INR 20 (Rs. 200 lakhs/ 10 lakh units). (current value of
the fund is Rs. 200 lakhs. At the time of allotment of unit, value of the fund is Rs.
100 lakhs).
Since the market value of securities changes every day, so does the NAV of
funds. Depending on the type of scheme, it is mandatory for the NAV to be
disclosed daily or weekly.
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MF Concepts: Net Asset Value
A fund’s NAV is affected by 4 sets of factors;
• Purchase & Sale of Investment Securities (Realised Profit):
Lets take an example of ITC, which is one of the top holding of one of the equity
mutual fund scheme. The fund manager of the scheme had bought the stock at
the price of Rs. 251.40 per share. Currently ITC is trading at Rs. 279.45 per share. If
the fund manager sells the stock today, the fund will realise the profit. But, if the
prices declines and corrects to Rs. 222.05 and the fund manager sells the security
at this price then it will result in the loss booked by the fund affecting the NAV of
the fund.
• Valuation of all investment securities held (Unrealised Profit):

As can be seen from the case mentioned in point 1, even if the fund manager
does not sell ITC stock, the up/down in the price of the stock will lead to change in
the NAV of the fund, as the fund accounts for the daily closing price of its securities
to compute its NAV.
• Other assets and liabilities:

Mutual funds invests the entire money collected in various instruments e.g. small
sized companies in growth funds or corporate bonds in income funds, etc.
Sometimes liquidity or volumes in these instruments are very low. At this time, if the
fund witnesses large scale redemption pressure from its investors, the fund will have
to borrow money from banks to satisfy such liquidity requirement. Such liability
comes at a cost (i.e. rate of interest) which may affect the NAV of the fund.
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MF Concepts: Net Asset
Value
• Units sold or redeemed:
As explained above, large scale redemption by unit holders of the mutual
fund may also mean that the fund will have to sell its stocks or securities at
whatever prevailing prices in the market to satisfy the redemption requests by
its investors. This kind of stress selling may lead to further lowering of prices
affecting the NAV of the fund.
NAVs are disclosed on daily basis for both Open Ended schemes and Close
Ended schemes.
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NAV Computation
Example 1 -
Let's assume at the close of trading yesterday that a
particular mutual fund held Rs. 10,500,000 worth of
securities, Rs. 2,000,000 of cash, and Rs. 500,000 of liabilities.
If the fund had 1,000,000 units outstanding, then yesterday's
NAV would be:
NAV = (Rs. 10,500,000 + Rs. 2,000,000 – Rs. 500,000) /

1,000,000 = Rs. 12.00
A fund's NAV will change daily as the value of a fund's

securities, cash held, liabilities, and the number of shares
outstanding fluctuate.
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NAV Computation
Example 2 -
ABC Asset Management started its ABC Balanced Fund on 1 January 2016 with Rs. 50
million in capital. Following are the details of the fund's assets and liabilities at the end
of first year.
Rs. in thousand
Local equity 9,000
Global equity 15,000
Local bonds 8,000
Global bonds 12,000
US Treasury 5,000
Preferred stock 10,000
Cash 2,000
Management fee payable 500
Accrued expenses 200
The fund initially had 2 million shares. It issued new shares and redeemed some old
ones during the year such that its outstanding shares as at the year end are 2.2 million.
Find the fund's net asset value.

(Assets – liabilities)/outstanding units = Rs. 27 approx.
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Example 3 -
NAV Computation
Smart Invest AMC started its Smart Hybrid Fund (a close ended mutual fund) on 1
January 2018 and made an issue of 10,00,000 units at Rs. 10 each. It made the
following investments:
Particulars Rs.
50,000 equity shares of Rs. 100 each @ Rs. 160 80,00,000
7% G-sec at par 8,00,000
9% Debentures (Unlisted) at par 5,00,000
10% Debentures (Listed) at par 5,00,000
Cash 2,00,000
During the year, dividends received were Rs. 12,00,000. Interest on all kinds of debt
securities was received as and when due. At the end of the year, equity shares and
10% Debentures were quoted at 175% and 90% respectively. Other investments are at
par.
Find out NAV per unit at the end of the year, if operating expenses paid during the
year amounted to Rs. 5,00,000 and the MF paid a dividend of Rs. 0.80 per unit at the
end of the year.
NAV=[(50,000x100x175%)+(5,00,000x90%)+8,00,000+5,00,000+2,00,000+12,00,000+(7%x8,
00,000)+(9%x5,00,000)+(10%x5,00,000)-5,00,000-(10,00,000x0.80)]/10,00,000 = Rs. 10.75
per unit approx. 13
NAV Computation
Example 4 -
Based on the following information, determine the NAV of a Regular Income MF.
Particulars Rs. in crores
Listed shares at cost (ex-dividend) 20.00
Cash in hand 1.23
Bonds and debentures at cost 4.30
- Of these, bonds not listed and quoted 1.00
Other fixed income securities at cost 4.50
Accrued dividend 0.80
Amt payable on shares 6.32
Expenditure accrued 0.75
No. of units (FV – Rs. 10) 20.00
Current realisable value of fixed income securities of FV 106.50
Rs. 100 (not covered above)
The listed shares were purchased when index was 1,000
Current index value 2,300
Value of bonds and debentures (listed) 8.00
There has been a diminution of 20% in the vale of unlisted bonds and debentures.
NAV = [(20x2,300/1,000)+1.23+8+(1x80%)+4.50+0.80+106.50-6.32-0.75]/20 = Rs. 8.04 approx.

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MF Concepts: Expense Ratio
''There is no free lunch.'‘
• This holds true for investing in a mutual fund too. Like a doctor who charges you for his
service, mutual funds too charge a fee for managing your money.
• This involves the fund management fee, agent commissions, registrar fees, and selling
and promoting expenses.
• All this falls under a single basket called Total Expense Ratio (TER) or annual recurring
expenses
• TER is expressed as a percentage of the fund's average weekly net assets.
• TER is to be prominently disclosed on a daily basis under a separate head “Total Expense
Ratio of Mutual Fund Schemes” on the websites of the AMC and AMFI in downloadable
spreadsheet format.
• Any change in the base TER in comparison to previous base TER charged to any
scheme/plan shall be communicated to investors of the scheme/plan through
notice via email or SMS at least three working days prior to effecting such change.
Expense ratio is the percentage of total assets that are spent to run a mutual fund. Expenses
become an important factor while comparing bond funds.
Expense ratio states how much you pay a fund in percentage term every year to manage
your money.
A lower expense ratio does not necessarily mean that it is a better-managed fund. A good
fund is one that delivers good return with minimal expenses.
SEBI circular on TER for MFs dated June 08, 2018 - https://www.sebi.gov.in/legal/circulars/jun-
2018/total-expense-ratio-for-mutual-funds_39187.html
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Understanding Expense
Ratio
For example, you invest Rs. 10,000 in a fund (allotment NAV – Rs.
10 p.u.) with an expense ratio of 1.5%. In the first year of
investment, the fund gains 10% and hence, the NAV (pre-
expense) jumps to Rs. 11 p.u. After charging the expense, the
NAV shall fall to Rs. 10.84 p.u. (Rs. 11x98.5%) thus, delivering a
8.35% absolute return to the investor.
NAVs are always reported net of fees and expenses, therefore, it
is necessary to know how much the fund is deducting as
expenses.
Since this is charged regularly (every day), a high expense ratio

over the long-term may eat into your returns massively through
power of compounding.
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Impact of Expense Ratio on Returns
Power of Compounding – works well for returns
Unfortunately for investors, expenses too can compound over time!
As an illustration, let us compare two mutual funds with the same gross return of
15 per cent per annum. The first has an expense ratio of 2.5 per cent per annum
while the second has an expense ratio of 0.1 per cent per annum. Let us now see
the impact of these expense ratios on the long-term returns generated from
investing Rs 1 lakh in each of these mutual funds.
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Impact of Expense Ratio on Returns
The second fund’s corpus exceeds that of the first fund by:
• 24 per cent after ten years;
• 53 per cent after twenty years;
• 89 per cent after thirty years; and
• 133 per cent after forty years.
A twenty-year-old who invests Rs 1 lakh when he/she starts working will get Rs 1.11
crore when they retire (at sixty) from the first fund which has a 2.5 per cent
expense ratio. From the second fund, which has a 0.1 per cent expense ratio,
he/she will get Rs 2.58 crore. That’s more than double the corpus from the first
fund!
These are not assumptions which we have plucked from thin air. Presently, most
equity mutual funds have an annual management fee of 2.5 per cent. In
contrast, in an ETF (Exchange Traded Fund), the fee is approximately 0.1 per cent.
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Expense Ratio
Different funds have different expense ratios. But the Securities &
Exchange Board of India has stipulated a limit that a fund can
charge.
• Equity funds can charge a maximum of 2.5%, whereas a debt
fund can charge 2.25% of the average weekly net assets.
• The largest component of the expense ratio is management
and advisory fees.
• From management fee an AMC generates profits.
• Then there are marketing and promotion expenses.
• All those involved in the operations of a fund like the
custodian and auditors also get a share of the pie.
• Interestingly, brokerage paid by a fund on the purchase and
sale of securities is not reflected in the expense ratio.
• Funds state their buying and selling price after taking the
transaction cost into account.
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Expense ratio
Recurring expenses that are charged directly to the scheme which affects NAV are;
• Marketing & Selling expenses (incld. Distributors fees)
• Brokerage charges ( in case the AMC is not adjusting the brokerage charges in
buying or selling price)
• Registration charges
• Audit fees
• Custodian fees
• Expenses on investors communication
• Insurance Premium paid by the fund
• Cost of Statutory advertisement
• Management fees
Expenses that are not charged to the scheme and hence do not affect the NAV are;
• Penalties and fines for violation of law
• Interest on late payment to unit holders
• Legal, Marketing, publication and General expenses not attributed to any schemes
• Depreciation on fixed assets and software development expenses
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Importance of expense ratio
• Expense ratio matters especially in case of debt funds.
• When bond funds were giving a whopping 14.5% return, nobody cared about
expenses. But the days of double-digit returns are over.
• With an all-round reduction in interest rates, bond funds are expected to give
a return of 7-9% this year.
• Thus, in a low yield universe, every penny will count. And as expenses are
deducted from the fund before calculating the NAV, it is likely to be a major
differentiating factor among bond funds where returns vary marginally.
• In case of actively managed equity funds, the issue of expenses is more
complicated.
• The wide divergence of returns between 'good' and 'bad' funds makes the
expense ratio secondary. But here too, if you find two similar funds, the
expense ratio can be a good differentiator. Perhaps, more important is the
fact that expenses are charged at all times. Whether a fund generates
positive or negative returns, expenses are always there. Overall, before
venturing into any fund just check out this important number.
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MF Concepts: Loads
Mutual funds charge load to investors in order to pay for the distributor's sales
expenses. A load does take away a part of your investment, but it's a price you have
to pay in order to participate in a fund.
Load can be charged in three different ways;

• At the time of the entry into the fund, by deducting the specified load amount
from the initial investment. Such a load is called an entry load. For example, if Rs
100 is invested in a fund which charges an entry load of 2 per cent, Rs 2 will be
deducted and Rs 98 will be the amount actually invested.
• Load can also be charged at the time of redemption - called exit load. In this case
the load amount is deducted from the redemption proceeds of the investor. For
instance, if the investment has grown to Rs 100 in a fund that charges exit load of 2
per cent, he will get redemption of Rs 98 (100-2).
• A third type of load is similar to the exit load. Here the load is charged depending
on the duration of stay in the fund. Thus for example, if units are redeemed before
six months an exit load of 0.5 per cent is levied. This time-based exit load is called
contingent deferred sales charge (CDSC).
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Regulations on Loads
• Most equity funds used to charge an entry load and no exit load. However,
SEBI has banned Mutual Funds currently to charge an entry load and as a
result Mutual Funds charge exit load on cases which redeems funds within a
stipulated time period.
• Across the category of equity schemes, loads can be greater in actively
managed equity schemes than in passively managed ones.
• Regulations allowed a fund to charge a maximum load of 6 per cent in the
past.
• Another way of looking at it is that a load imparts discipline to investing. The
CDSC of 0.5 per cent in debt funds exists to ensure that you stay in the fund
• While the load is an expense you have to bear to participate in a mutual fund,
it is not the only expense that you pay for the pleasure of investing in a mutual
fund. The expense ratio is the sum of all charges that you bear to invest in a
fund. This is in addition to the load. So along with the load, do check the
expense ratio of the fund you invest in too.
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MF Concepts: AUM
Assets under management (AUM) is the total
market value of assets that an investment
company or financial institution manages on
behalf of investors.
• Assets under management definitions and formulae vary by company. Some financial
institutions include bank deposits, cash and mutual funds in their calculations; others limit
it to funds under discretionary management, where the investor assigns responsibility to
the company.
• Assets under management describes how much of investor’s money an investment

company controls. Investments are held in a mutual fund or hedge fund and are
managed by a venture capital company, portfolio manager or brokerage company.
• AUM indicates the size of the fund and may refer to the total amount of assets managed
for all clients or the total assets managed for a specific client. It includes the funds the
manager can use to make transactions.
For example, if an investor has Rs. 50,000 in an investment portfolio, the fund manager can
buy and sell shares using the investor's funds without obtaining the investor’s permission.
Fluctuating daily, AUM depends on the flow of investor money in and out of a particular fund
and asset performance. It also fluctuates based on changes in the company investments or
the value of a fund.
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AUM
• Calculating AUM:
o Methods of calculating assets under management vary among companies. It may
increase when investment performance increases or when new customers and new
assets are acquired.
o It may decrease when investment performance decreases, and because of client
turnovers, fund closures, withdrawals or redemptions.
o Assets under management include investor capital and can include capital owned
by the investment company executives.
• Why AUM Matters

o Several investment companies charge management fees that are a fixed
percentage of assets under management and it is important for investors to
understand how companies calculate AUM.
o Investment companies use assets under management as a marketing tool to attract
investors.
o It helps investors get an indication of the size of the company's operations relative to
its competitors. However, it is only one aspect in evaluating a company and does not
offer full details about the investment potential of the company.
• How to Compare AUM

o Investors want to know how much money from other investors is flowing into a
company. Therefore, an investor should understand how to compare AUM.
o More assets under management are not always better. It may be helpful to search
for below-average to average net assets as a method to compare AUM. 25
MF investments are Investing in MF is
Mutual Funds are for only for the long
experts same as investing
term in Stock market
Schemes with lower One needs a large One needs to have a

NAV as better than amount of money to Demat account to
Schemes with higher invest in Mutual invest in Mutual
NAV Funds Funds
Buying a top-rated
A scheme with a
mutual fund scheme
higher NAV has
ensures better
reached its Peak!!
returns.
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Myths & Facts
Myth 1: Mutual Funds are for experts
Fact: In fact, Mutual funds are meant for of common investors who may lack the knowledge
or skill set to invest in securities market. Mutual Funds are professionally managed by expert
Fund Managers after extensive market research for the benefit of investors. A mutual fund is
an inexpensive way for investors to get a full-time professional fund manager to manage their
money.
Myth 2: MF investments are only for the long term

Fact: Mutual funds can be for the short term or for longer term based on one’s investment
horizon and objective.
There are different types of mutual fund schemes – which invest in different types of securities
– in equity as well as debt securities that are suitable for different investor needs.
In fact, there are various short-term schemes where you can invest for a few days to a few
weeks to a few years e.g., Liquid Funds are low duration funds, with portfolio maturity of less
than 91 days, while Ultra short-Term Bond Funds are low duration funds, with portfolio maturity
of less than a year. There are Short-Term Bond Funds which are medium duration funds where
the underlying portfolio maturity ranges from one year – three years. Then, there are Long-
Term Income Funds which are medium to long duration funds with portfolio maturity between
3 and 10 years. While Equity Schemes are most suitable for a longer term, debt mutual funds
are suitable for investors with short term (less than 5 years) investment horizon.
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Myths & Facts
Myth 3: Investing in MF is same as investing in Stock market
Fact: Mutual Funds invest in stock market (i.e., equities), bond market (corporate bonds as
well as govt. bonds) and Money Market instruments such as Treasury Bills, Commercial Papers,
Certificate of Deposit, Collateral Borrowing & Lending Obligation (CBLO) etc. Many of these
instruments are not available to retail investors due to large ticket size of minimum order
quantity (such as G-Secs) and hence, retail investors could participate in such investments
through mutual fund schemes
Myth 4: Schemes with lower NAV as better than Schemes with higher NAV
Fact: This is a common misconception. A mutual fund's NAV represents the market value of all
its underlying investments. NAV of a fund is irrelevant, because it represents the market value
of the fund’s investments and not the market price. Any capital appreciation will depend on
the price movement of its underlying securities. Let us understand this through an illustration.
Suppose, you invest ₹10,000 each in scheme A whose NAV is ₹20 and scheme B (whose NAV
is say, ₹100. You will be allotted 500 units of scheme A and 100 units of scheme B. Assuming
that both schemes have invested their entire corpus in exactly same stocks and in the same
proportions, if the underlying stocks collectively appreciate by 10%, the NAV of the two
schemes should also rise by 10%, to ₹22 and ₹110, respectively. Thus, in both the scenarios, the
value of your investment increases to ₹ 11,000.
Thus, the current NAV of a fund does not have any impact on the returns.
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Myths & Facts
Myth 5: One needs a large amount of money to invest in Mutual Funds
Fact: Absolutely incorrect. One could start investing mutual funds with just ₹5,000 for a lump-
sum / one-time investment with no upper limit and ₹1,000 towards subsequent / additional
subscription in most of the mutual fund schemes. And for Equity linked Savings Schemes (ELSS),
the minimum amount is as low as ₹ 500.
In fact, one could invest via Systematic Investment Plan ( SIP) with as little as ₹500 per month for
as long as one wishes to.
Myth 6: One needs to have a Demat account to invest in Mutual Funds

Fact: Holding mutual fund Units in Demat mode is absolutely optional, except in respect of
Exchange Traded Funds. For all other schemes, including the close-ended listed schemes like
Fixed Maturity Plans (FMPs), it is entirely upto the investor whether to hold the units in a Demat
mode or in conventional physical account statement mode.
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Myths & Facts
Myth 7: A scheme with a higher NAV has reached its Peak!
Fact: This is a very common misconception because of the general association of Mutual Funds
with shares. One needs to keep in mind that the NAV of a scheme is nothing but a reflection of
the market value of the underlying shares held by the fund on any day. Mutual Funds invest in
shares, which may be bought or sold whenever deemed appropriate by the Fund Manager
depending on the scheme’s investment strategy (Buy-Hold-Sell). If the Fund Manager feels that
a particular stock has peaked, he can choose to sell it.
A high NAV does not mean the fund is expensive. In fact, high NAV indicates a good
performance of the scheme over the years.
Myth 8: Buying a top-rated mutual fund scheme ensures better returns.

Fact: Mutual fund ratings are dynamic and based on performance of the scheme over time –
which in itself is subject to market fluctuations. So, a Mutual fund scheme that may be on top
of the rating chart currently, may not necessarily maintain the same rating month after month
or at a later date . However, a top rated fund is a good first step to short list a scheme to invest
in (although past performance does not necessarily guarantee better returns in future).
Investment in a mutual fund scheme needs to be tracked with respect to the scheme’s
benchmark to evaluate its performance periodically to decide whether to stay invested or to
exit.
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The 3 Tier Structure
The board that is in charge of running the mutual
funds in India is called the Securities and Exchange
Board of India or SEBI for short. All mutual fund
schemes are required to be registered with SEBI
before their launch. Mutual Fund is run heavily on
investor’s money so SEBI has a set of stringent rules
and regulations in place which will dictate how the
mutual fund is run. According to SEBI, the three main
structure and roles are played by
– A Sponsor, a Trustee and an Asset Management
Company.
31
With such a clearly defined structure present in a mutual fund, your money and
investment details are filtered through a number of different processes to
determine the best investment for you. With a good structure in place, the mutual
fund you select will have a consistent performance too.
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Structure of MF
A mutual fund is set up in the form of a trust, which has Sponsor,
Trustees, Asset Management Company (AMC) and custodian.
• The trust is established by a Sponsor or more than one Sponsor

who is like promoter of a company.
• The Trustees of the mutual fund hold its property for the benefit
of the unit holders.
• AMC approved by SEBI manages the funds by making
investments in various types of securities.
• Custodian, who is required to be registered with SEBI, holds the
securities of various schemes of the fund in its custody.
The trustees are vested with the general power of

superintendence and direction over AMC. They monitor the
performance and compliance of SEBI Regulations by the mutual
fund.
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Structure
Sponsor:
•The sponsor is the one who ends up choosing the trustees and sets up an AMC where
investors can submit their money in.
•Being a sponsor is a huge responsibility which is why SEBI has a set of guidelines to
determine if they are eligible enough.
•These include being in the financial services for at least five years, three of which should
have positive returns.
•Along with this, the sponsor should have a positive net worth which will also contribute to
the AMC.
•According to SEBI, the sponsor should have professional competence, financial
soundness and reputation for fairness and integrity.
•The sponsor contributes 40% of the networth of the AMC.
A Sponsor is any person or corporate body that establishes the Fund

and registers it with SEBI. It forms a Trust and appoints a Board of
Trustees. It also appoints Custodian and Asset Management Company
either directly or through Trust, in accordance with SEBI regulations.
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Structure
Trustee
• Trustee is created through a document called the Trust Deed that is executed by the Fund Sponsor and
registered with SEBI.
• The Trust-the mutual fund may be managed by a Board of Trustees- a body of individuals or a Trust
Company- a corporate body.
• Trustees are the protector of unit holders’ interests.
• A minimum of 75% of the trustees must be independent of the sponsor to ensure fair dealings.
Rights of Trustees
• Approve each of the schemes floated by the AMC.
• The right to request any necessary information from the AMC.
• May take corrective action if they believe that the conduct of the fund's business is not in accordance
with SEBI Regulations.
• Have the right to dismiss the AMC,
• Ensure that, any shortfall in net worth of the AMC is made up.
Obligations of the Trustees
• Enter into an investment management agreement with the AMC.

• Ensure that the fund's transactions are in accordance with the Trust Deed.
• Furnish to SEBI on a half-yearly basis, a report on the fund's activities
• Ensure that no change in the fundamental attributes of any scheme or the trust or any other change
which would affect the interest of unit holders is happens without informing the unit holders.
• Review the investor complaints received and the redressal of the same by the AMC.
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Structure
Asset Management Company (AMC)
• Acts as an investment manager of the Trust under the Board Supervision and direction of the Trustees.
• Has to be approved and registered with SEBI.
• Will float and manage the different investment schemes in the name of Trust and in accordance with
SEBI regulations.
• Acts in interest of the unit-holders and reports to the trustees.
• At least 50% of directors on the board are independent of the sponsor or the trustees.
Obligation of Asset Management Company:
• Float investment schemes only after receiving prior approval from the Trustees and SEBI.
• Send quarterly reports to Trustees.
• Make the required disclosures to the investors in areas such as calculation of NAV and repurchase price.
• Must maintain a net worth of at least Rs. 10 crores at all times.
• Will not purchase or sell securities through any broker, which is average of 5% or more of the aggregate
purchases and sale of securities made by the mutual fund in all its schemes.
• AMC cannot act as a trustee of any other mutual fund.
• Do not undertake any other activity conflicting with managing the fund.
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Structure
Custodians
•A custodian’s role is keeping custody of the securities that are bought by the fund manager and also keeping a
tab on the corporate actions like rights, bonus and dividends declared by the companies in which the fund has
invested.
•The Custodian is appointed by the Board of Trustees. The custodian also participates in a clearing and settlement
system through approved depository companies on behalf of mutual funds, in case of dematerialized securities.
•Only the physical securities are held by the Custodian. The deliveries and receipt of units of a mutual fund are done
by the custodian or a depository participant at the instruction of the AMC and under the overall direction and
responsibility of the Trustees. Regulations provide that the Sponsor and the Custodian must be separate entities.
Registrar & Transfer Agents
•The Register and Transfer Agent is in charge of updating the records of the investors, processing the applications,
purchasing transactions, redemption of transactions amongst other functions.
•The registrar and transfer agents are appointed by the AMC. AMC pay compensation to these agents for their
services. They carry out the following functions
•Receiving and processing the application forms of investors
•Issuing unit certificates
•Sending refund orders
•Giving approval for all transfers of units and maintaining records
•Repurchasing the units and redemption of units
•Issuing dividend or income warrants
37
Structure
Accountants
•The fund accountants present are responsible in keep a tab on the NAV or Net Asset Value of the different assets
and liabilities available.
•Fund accountants are appointed by the AMC. The are in charge of maintaining proper books of accounts relating
to the fund transactions and management. The perform the following functions
•Computing the net asset value per unit of the scheme on a daily basis
•Maintaining its books and records
•Monitoring compliance with the schemes, investment limitations as well as SEBI regulations
•Preparing and distributing reports of the schemes for the unit holders and SEBI and monitoring the performance of
mutual funds custodians and other service providers.
Auditors
•Since the accounts and the schemes of the AMC are kept separately, the auditor is present to audit and keep a
track on the various accounts of the AMC.
•An auditor is appointed by the AMC and must undertake independent inspection and verification of its accounting
activities.
38
New Fund Offer (NFO)
• People are quite familiar with the term IPO which is a direct offer by the
company to buy its share which can be later traded in the stock market.
• Likewise, NFO is the first time subscription offer for a new scheme launched by
the mutual fund companies.
• During the subscription period an investor can buy the units at the fixed rate of
Rs.10 per unit (except in case of ETFs and Index Funds).
• If it is a close ended fund then investor can buy the units only during the
subscription period and will have to hold the units for the said period, whereas
in the open ended fund, one can buy units even after the subscription period
is over and can redeem it at any time.
• After the NFO period, investors can take exposure in open ended funds only
at the prevailing NAV.
Before investing in a NFO, it is important to check if the NFO is offering something

new or if something similar already exists.
39
NFO
• No proven track record: Since NFO’s are launched with a new idea or a theme/sector it is
very difficult to analyze the future of the fund. One can always find a similar kind of fund
already running in the market which has a rating from the experts and where
qualitative/quantitative analysis can be done on the basis of its past record, which
cannot be done in case of NFO.
• It is not cheaper than its other peer funds: Many investor thinks that NFO’s are available at
cheap price compared to other ongoing schemes, which is totally wrong. Suppose an
investor invests Rs. 10,000 in an NFO at NAV of Rs.10 and invests the same amount into an
ongoing scheme whose NAV is Rs.20. Now the growth of the NAV in both the schemes
depends upon the kind of portfolio they hold. Here the percentage growth of the NAV is
important rather than the value of NAV. So, unlike in equity IPO, it is the underlying in case
of mutual funds which matters not the NAV.
• Comes with high initial expenses: The marketing charges and other initial expenses are
high in case of NFO’s. These expenses are capped to a certain percentage and are
managed out of the NAV over the period and hence are responsible for the lesser return.
So it’s better to avoid new funds as charges are high.
40
NFO
• Limited Diversification: Generally NFOs are sector specific (normally at the top of bull
market) or have focus on certain category like mid cap, small cap. People are advised
to invest with a proper diversification because if one sector does not perform the returns
are compensated by another sector and proper balance is maintained. So it is better to
read the investment objective of the scheme before investing and avoid those which
have limited scope of diversification. Your portfolio should be designed based on your
goals.
• NFO are not exactly like IPO’s: Many people are of the view that there is no difference
between NFO and IPO which is not true. In NFO the NAV is fixed/ pre-decided at Rs. 10
per unit and is not affected due to the demand or some other factors. While in IPO the
listing price depends on the demand and expectation of the market with the company.
So the price may fall or rise while listing. So please remember the growth of NAV in mutual
funds only depends upon the growth of the underlying securities.
41
New Fund Offer (NFO)
42
43
Types of Mutual Funds
Basis of classification of MF schemes:
1. By structure of the MF scheme –
a) Open ended
b) Close ended
c) Interval
2. By style of management –
a) Actively managed Schemes
b) Passively managed Schemes
2. By category of the MF scheme –

a) Equity Schemes
b) Debt Schemes
c) Hybrid Schemes
d) Solution oriented Schemes
e) Other Schemes
Source: SEBI circular SEBI/HO/IMD/DF3/CIR/P/2017/114 dated October, 2017 on Categorization and
Rationalization of Mutual Fund Schemes
44
MFs by Structure
• Open-Ended Schemes
o Open-ended schemes are mutual funds that can issue and redeem their shares
at any time.
o They offer units for sale without specifying any duration for redemption.
o Open-ended funds also buy back shares when investors wish to sell. Investors can
conveniently buy and sell units of open-ended funds directly from the fund house
at the prevalent Net Asset Value (NAV) prices.
o One of the key features of open-end schemes is the liquidity that these funds offer
to investors.
• Close-Ended Schemes
o Close-ended schemes are mutual funds with a fixed number of shares (or units).
o Close-ended funds raise a fixed amount of capital through a New Fund Offer
(NFO).
o Any premature selling needs to be done through Stock exchange. AMC is not
permitted to do the same. They do not provide any interim liquidity by
redemption of units.
o These mutual funds schemes disclose NAV generally on daily basis.
• Interval Schemes
o Interval schemes are those that combine the features of both open-ended and
close-ended schemes.
o The units may be traded on the stock exchange or may be open for sale or
redemption during pre-determined intervals at NAV-related prices. 45
MFs by structure
• Actively managed funds are those where the fund manager
actively manages these funds and buys or sells stocks of
companies as per the broad guidelines that have been
enumerated in the scheme information document. These
funds don’t mimic the index but buy and sell on basis of the
research of the fund manager.
E.g. – ICICI Prudential Multicap Fund, HDFC Midcap
Opportunities Fund, HDFC Liquid Fund, etc.
• Passive funds on the other hand look at offering returns by

mimicking an index like S&P BSE Sensex or Nifty 50. The whole
point of an index fund or ETF is to follow a certain benchmark,
and therefore they are called passively managed funds.
E.g. – IDFC Sensex ETF, ICICI Prudential Nifty 50 ETF, ICICI
Prudential Nifty Low Volatility ETF, ICICI Prudential Nifty Next 50
Index Fund, etc.
46
MFs by characteristics
A. Equity Schemes:
An equity scheme must invest min. 65% of its assets in equity or equity related
securities.
i. Large cap Funds – min 80% investment in large cap cos.
An open ended equity scheme predominantly investing in large cap stocks
This type of fund is known to offer stability and sustainable returns, over a period of
time.
Large Cap companies are generally very stable and dominate their industry.
Large-cap stocks tend to hold up better in recessions, but they also tend to
underperform small-cap stocks when the economy emerges from a recession.
Large-cap tend to be less volatile than mid-cap and small-cap stocks and are
therefore considered less risky.
E.g. – ICICI Prudential Bluechip Equity Fund
ii. Mid cap Funds – min 65% investment in mid cap cos.
An open ended equity scheme predominantly investing in mid cap stocks
Mid cap cos. are considered as developing companies.
Mid-cap stocks tend to be riskier than large-cap stocks but less risky than small-
cap stocks.
Mid-cap stocks, however, tend to offer more growth potential than large-cap
stocks.
E.g. – HDFC Midcap Opportunities Fund
47
A. Equity Schemes:
iii. Small cap Funds - min 65% investment in small cap cos.
An open ended equity scheme predominantly investing in small cap stocks
Small cap cos. are young cos. with significant growth potential.
The risk of failure is greater with small-cap stocks than with large-cap and
mid-cap stocks. As a result, small-cap stocks tend to be the more volatile
(and therefore riskier) than large-cap and mid-cap stocks.
Historically, small-cap stocks have typically underperformed large-cap stocks
during recessions but have outperformed large-cap stocks as the economy
has emerged from recessions.
The smallest stocks of the small caps are called micro-cap stocks. While the
opportunity for these companies to experience extreme growth is great, the
risk to lose a large amount of money is also possible
E.g. – ICICI Prudential Smallcap Fund
iv. Large and Mid cap Funds – min 35% in large cap cos. and mid cap cos.
each
An open ended equity scheme investing in both large cap and mid cap
stocks
48
E.g. – ICICI Prudential Large and Midcap Fund
A. Equity Schemes:
iv. Multi cap Funds – min 65% in equity
An open ended equity scheme investing across large cap, mid cap, small
cap stocks
These funds provide the benefit of diversification by investing in companies
spread across sectors and market capitalisation.
They are generally meant for investors who seek exposure across the market
and do not want to be restricted to any particular sector.
They invest in companies across different market caps and hence reduce
the amount of risk in the fund.
Diversification helps prevent events that could affect a single sector for
affecting the fund, and hence reduce risk.
E.g. – IDFC Multicap Fund
49
Market capitalisation
Market capitalization (commonly known as market cap) is calculated
by multiplying a company’s outstanding shares by its stock price per
share. A company’s stock price by itself does not tell much about the
total value or size of a company; a company whose stock price is say
₹500 is not necessarily worth more than a company whose stock price is
say, ₹250. For example, a company with a stock price of ₹500 and 10
million shares outstanding (a market cap of ₹5 billion) is actually smaller
in size than a company with a stock price of ₹250 and 50 million shares
outstanding (a market cap of ₹12.5 billion).
Based on the market cap, companies are ranked and classified by SEBI
as under –
a) Large cap - 1st -100th company in terms of full market capitalization
b) Mid cap - 101st -250th company in terms of full market capitalization
c) Small cap - 251st company onwards in terms of full market
capitalization
50
A. Equity Schemes:
v. Dividend Yield Funds – min 65% investment in dividend yielding cos.
An open ended equity scheme predominantly investing in dividend yielding
stocks
E.g. – ICICI Prudential Dividend Yield Fund
vi. Value Funds – min 65% investment in equity

An open ended equity scheme following a value investment strategy
E.g. – ICICI Prudential Value Discovery Fund
vii. Contra Funds - min 65% investment in equity

An open ended equity scheme following contrarian investment strategy
E.g. – Invesco India Contra Fund
viii. Focused Funds – min 65% investment in equity

An open ended equity scheme investing in maximum 30 stocks
E.g. – ICICI Prudential Select Large Cap Fund
51
A. Equity Schemes:
ix. Sectoral/ Thematic Funds – min. 80% investment in a particular sector or
theme
An open ended equity scheme investing in a particular theme/ sector
Since the portfolio of such mutual funds consists mainly of investment in one
particular type of sector, they offer less amount of diversification and are
considered to be risky.
Their performance is aligned with the performance of the sector in which
they are investing.
E.g. – Reliance Banking Fund
x. Equity Linked Savings Schemes (ELSS) – min. 80% investment in equity as

per ELSS Guidelines, 2005 notified by Ministry of Finance
An open ended equity linked saving scheme with a statutory lock in of 3
years and tax benefit up to Rs. 1.50 lakhs under section 80C of the Income
Tax Act, 1961.
E.g. – ICICI Prudential Long Term Equity Fund (Tax Saving)
52
B. Debt Schemes:
These schemes generally invest in fixed-income securities such as bonds,
corporate debentures, Government Securities and money-market
instruments and are less risky compared to equity schemes.
However, opportunities of capital appreciation are limited in such funds.
The NAVs of such funds are impacted because of change in interest rates in
the economy.
If the interest rates fall, NAVs of such funds are likely to increase in the short
run and vice versa. However, long-term investors do not bother about these
fluctuations.
Who should invest in a debt fund?

Debt funds are ideal for investors who want regular income, but are risk-
averse. Debt funds are less volatile and, hence, are less risky than equity
funds. If you have been saving in traditional fixed income products like Term
Deposits, and looking for steady returns with low volatility, debt mutual funds
could be a better option, as they help you achieve your financial goals in a
more tax efficient manner and therefore earn better returns.
53
B. Debt Schemes:
i. Overnight Fund - Investment in overnight securities having maturity of 1
day
An open ended debt scheme investing in overnight securities
E.g. – Invesco India Overnight Fund
ii. Liquid Fund - Investment in Debt and money market securities with
maturity of upto 91 days only
An open ended liquid scheme
E.g. – ICICI Prudential Liquid Plan
iii. Ultra Short Duration Fund - Investment in Debt & Money Market
instruments such that the Macaulay duration of the portfolio is between 3
months - 6 months
E.g. – ICICI Prudential Ultra Short Term Fund
iv. Low Duration Fund - Investment in Debt & Money Market instruments
such that the Macaulay duration of the portfolio is between 6 months- 12
months
E.g. - ICICI Prudential Savings Fund
54
B. Debt Schemes:
v. Money Market Fund - Investment in Money Market instruments having
maturity upto 1 year
E.g. – Aditya Birla Sun Life Money Manager Fund
vi. Short Duration Fund - Investment in Debt & Money Market instruments
such that the Macaulay duration of the portfolio is between 1 year – 3
years
E.g. – HDFC Short Term Debt Fund
vii. Medium Duration Fund - Investment in Debt & Money Market instruments
such that the Macaulay duration of the portfolio is between 3 years – 4
years
viii. E.g. – ICICI Prudential Medium Term Bond Fund
viii. Medium to Long Duration Fund - Investment in Debt & Money Market
instruments such that the Macaulay duration of the portfolio is between 4
years – 7 years
E.g. - IDFC Bond Fund – Long Term Plan
55
B. Debt Schemes:
ix. Long Duration Fund - Investment in Debt & Money Market Instruments
such that the Macaulay duration of the portfolio is greater than 7 years
E.g. –
x. Dynamic Bond Fund - Investment across duration

An open ended dynamic debt scheme investing across duration
E.g. –
xi. Corporate Bond Fund – min 80% investment in highest rated corporate
bonds
An open ended debt scheme predominantly investing in highest rated
corporate bonds
E.g. –
xii. Credit Risk Fund – min 65% investment in corporate bonds below highest
ratings
An open ended debt scheme investing in below highest rated corporate
bonds
E.g. - ICICI Prudential Long Term Bond Fund
56
B. Debt Schemes:
xiii. Banking and PSU Fund – min 80% investment in Debt instruments of banks,
Public Sector Undertakings, Public Financial Institutions
An open ended debt scheme predominantly investing in Debt instruments of
banks, Public Sector Undertakings, Public Financial Institutions
E.g. – ICICI Prudential Banking & PSU Debt Fund
xiv. Gilt Fund – min 80% investment in G-secs

An open ended debt scheme investing in government securities across maturity
These funds invest exclusively in Government Securities. NAVs of these schemes
also fluctuate due to change in interest rates and other economic factors as is the
case with income or debt-oriented schemes.
E.g. – HDFC Gilt Fund
xv. Gilt Fund with 10 year constant duration – min 80% investment in Gilts such
that the Macaulay duration of the portfolio is equal to 10 years
An open ended debt scheme investing in government securities having a
constant maturity of 10 years
E.g. – ICICI Prudential Constant Maturity Gilt Fund
xvi. Floater Fund – min 65% investment in floating rate instruments

An open ended debt scheme predominantly investing in floating rate instruments
E.g. – Reliance Floating Rate Fund
57
Working of a Debt Fund
• Debt funds invest in either listed or unlisted debt instruments, such as Corporate and
Government Bonds at a certain price and later sell them at a margin.
• The difference between the cost and sale price accounts for the appreciation or
depreciation in the fund’s net asset value (NAV).
• Debt funds also receive periodic interest from the underlying debt instruments in
which they invest.
• In terms of return, debt funds that earn regular interest from the fixed income
instruments during the fund’s tenure are similar to bank fixed deposits that earn
interest.
• This interest income gets added to a debt fund on a daily basis. If the interest
payment is received, say, once every year, it is divided by 365 and the debt fund’s
NAV goes up daily by this small amount. Thus, a debt scheme’s NAV also depends
on the interest rates of its underlying assets and also on any upgrade or downgrade
in the credit rating of its holdings.
• Market prices of debt securities change with movements in interest rates.
Let’s assume, your debt fund owns a security that yields 10 % interest. If the interest rate
in the economy falls, new instruments issued in the market would offer this lower rate.
To match this lower rate, there would be an increase in the prices your fund’s
underlying instruments as they have a higher coupon (interest) rate. As a result of the
increase in the debt instrument’s value, your fund’s NAV, too, would increase.
59
Debt Funds
HOW DEBT FUNDS ARE DIFFERENT FROM OTHER MUTUAL FUND SCHEMES?
o In terms of operation, debt funds are not entirely different from other mutual fund
schemes. However, in terms of safety, they score higher than equity mutual funds.
o For instance, when the market falls, the NAVs of your equity funds fall sharply, whereas in
case of debt funds, the fall is not as sharp. Having said that, debt funds can offer only
moderate returns, while equity funds, which are highly risky, offer high returns over longer
time horizon.
• WHY INVEST IN DEBT MUTUAL FUNDS?

o A few major advantages of investing in debt funds are low cost structure, stable
returns, high liquidity and reasonable safety.
o Debt funds also score on post-tax return.
o Dividends from debt funds are exempt from tax in the hands of investors.
o The mutual fund, however, has to pay a Dividend Distribution Tax, which is currently
28.325% in case of individuals or Hindu undivided families. While long-term capital
gains from debt funds are taxed at 10 per cent without indexation and 20 per cent
with indexation, short-term capital gains taxes are levied according to the income-
tax bracket one belongs to.
Thus, debt funds can be a good alternative to investors for achieving their financial goals if
they do not intend to bear risk involved in equity investments.
60
Debt Funds
Growth Option vs. Dividend Option : As mentioned earlier, dividend from mutual funds is tax free in
the hands of the investors, but the same is subject to Dividend Distribution Tax (currently 28.325 %),
which indirectly decreases the net returns. Hence, dividend payment or dividend reinvestment
option gives better post-tax returns, to those who are in the highest tax bracket. However, for those
in lower tax slabs, growth option could be more tax-efficient. In short, one should choose the
appropriate option depending on the tax bracket.
How to pick the right Debt fund?

• It is the asset allocation (government securities, corporate debt and marketable securities) that
largely determines how a debt fund’s NAV will move. A close look at a fund’s portfolio
composition will give you an idea of the expected returns, risks and liquidity. So, when picking a
fund, watch out for a few things.
• Check the duration of the fund’s portfolio as this has a bearing on your returns. The lower the
duration, the lower the fund’s volatility and your returns. On the other hand, a fund with a long
duration is likely to be more volatile, but the returns are likely to be better.
• Make sure the fund’s portfolio is reasonably liquid. A large percentage of corporate debt in the
portfolio does not bode well in the short term, as it is relatively less liquid. If the fund faces
redemption pressure, it would be forced to sell these securities at a discount, lowering the NAV.
Also, be wary of funds that hold a lot of unrated and unlisted debt.
• Avoid schemes with small corpuses. That’s because funds don’t disclose if there are any investor
who owns a substantial chunk of outstanding units. If there are such investors and they decide to
redeem their holdings, the fund could be forced to sell holdings below the market rates.
• Mutual funds give you access to all the information in their offer documents and other periodic
disclosures for you to make an informed decision. It is then up to you to take the investment
decision and sign the form, or channel the money to suit your financial needs.
61
Debt Funds
• One should understand how interest rate movements, credit ratings and liquidity affect a debt
fund’s performance.
• Theoretically, if interest rates rise, the NAV of a debt fund should fall. That’s because Bond prices
move in the opposite direction as interest rates.
• A fall in bond prices leads to a decline in a fund’s NAV. The opposite would happen if interest
rates fell.
• Moreover, if some bonds held by your debt fund are upgraded, their prices would rise, leading
to a drop in yields.
• That would, of course, increase your fund’s NAV. So, one should be prepared for fluctuations in
one’s fund’s NAV.
• Even Gilt Funds (which invest only in government securities) that are advertised as the safest
available investments, can witness sharp fluctuations in their NAVs. That’s because prices of
government securities are a function of various economic factors, including interest rates,
macroeconomic data and liquidity in the banking system. When these change, so do the Gilt
Fund’s NAV.
62
Debt Funds
Why is it essential to match the investment horizon with that of the scheme?
• Funds having a lower duration are ideal for short-term holdings as they
are well protected from the fluctuating interest rate movements.
However, holding them for more than their duration may not get you the
optimal results. There can be various types of debt funds based on the
duration of the instruments invested in. Although debt funds are less risky
than equity funds, they are still subject to market volatility. The level of
volatility therefore depends on the duration of the specific portfolio.
• The higher the duration, the greater the uncertainty in the short term,
which is what results in greater volatility. Conversely, the lower the
duration, the greater the certainty, which in turn lowers volatility.
• Liquid funds are the least volatile as their duration is in a few days and at
the other extreme there are income funds, where the duration is in
multiple of years.
• So in order to really get the most out of debt funds, it is essential that you
match your investment horizon with the duration of the scheme.
63
Liquid Funds
o Liquid Funds, as the name suggests, invest predominantly in highly liquid
money market instruments and debt securities of very short tenure and
hence provide high liquidity.
o They invest in very short-term instruments such as Treasury Bills (T-bills),
Commercial Paper (CP), Certificates Of Deposit (CD) and Collateralized
Lending & Borrowing Obligations (CBLO) that have residual maturities of up
to 91 days.
o Redemption requests in these Liquid funds are processed within one working
(T+1) day.
o The aim of the fund manager of a Liquid Fund is to invest only into liquid
investments with good credit rating with very low possibility of a default.
o The returns typically take the back seat as protection of capital remains of
utmost importance.
o Control over expenses in the form of low expense ratio, good overall credit
quality of the portfolio and a disciplined approach to investing are some of
the key ingredients of a good liquid fund.
o Most retail customers prefer to keep their surplus cash in Savings Bank
deposits as they consider the same to be safest and they could withdraw the
money at any time.
64
Liquid Funds
o Liquid Funds and Money Market Mutual Funds provide a more attractive
option.
o Surplus cash invested in money market mutual funds earns higher post-tax
returns with a reasonable degree of safety of the principal invested and
liquidity.
o Liquid funds are preferred by investors to park their money for short periods of
time typically 1 day to 3 months.
o Wealth managers suggest liquid funds as an ideal parking ground when you
have a sudden influx of cash, which could be a huge bonus, sale of real
estate and so on and you are undecided about where to deploy that
money.
o Investors looking out for opportunities in equities and long-term fixed income
instruments can also park their money in the liquid funds in the meantime.
o Many equity investors use liquid funds to stagger their investments into equity
mutual funds using the Systematic Transfer Plan (STP), as they believe this
method could yield higher returns.
o Liquid Funds typically do not charge any exit loads.
o Investors are offered growth and dividend options.
65
Liquid Funds
o Within dividend option, investors can choose daily, weekly or monthly
dividends depending on their investment horizon and investment amount.
Redemption payment is typically made within one working day of placing
the redemption request.
o With mutual funds going online, individual investors with small sums can look
at Liquid funds as an effective short-term investment option over their savings
bank account.
o Liquid Funds also offer Instant Redemption Facility / Instant Access Facility
(IAF). IAF facilitates credit of redemption proceeds in the bank account of
the investor on the same day of redemption request.
o The monetary limit under IAF is INR 50,000/- or 90% of latest value of
investment in the scheme, whichever is lower. This limit is applicable per day
per scheme per investor.
o MFs have in place a mechanism so that adequate balance is available in
the bank account of the scheme to meet liquidity/ redemption requirements
under IAF. MFs cannot borrow to meet the redemption requirements under
IAF.
66
C. Hybrid Schemes:
i. Conservative Hybrid Fund – 10% to 25% investment in equity and 75% to
90% investment in debt
An open ended hybrid scheme investing predominantly in debt instruments
E.g. – ICICI Prudential Regular Savings Fund
ii. Balanced Hybrid Fund – 40% to 60% in equity and debt each; no
arbitrage
An open ended balanced scheme investing in equity and debt instruments
E.g. –
iii. Aggressive Hybrid Fund – 65% to 80% in equity and 20% to 35% in debt
An open ended hybrid scheme investing predominantly in equity and equity
related instruments
E.g. – IDFC Hybrid Equity Fund
iv. Dynamic Asset Allocation Fund or Balanced Advantage Fund –

Investment in equity/ debt that is managed dynamically
E.g. - IDFC Dynamic Equity Fund 67
C. Hybrid Schemes:
v. Multi Asset Allocation Fund – Invests in at least three asset classes with a
minimum allocation of at least 10% each in all three asset classes
E.g. – ICICI Prudential Multi-Asset Fund
vi. Arbitrage Fund – arbitrage strategy; min 65% investment in equity

An open ended scheme investing in arbitrage opportunities
E.g. – ICICI Prudential Equity Arbitrage Fund
vii. Equity Savings Fund – min 65% in equity; min 10% in debt
An open ended scheme investing in equity, arbitrage and debt
E.g. – ICICI Prudential Equity Savings Fund
68
D. Solution Oriented Schemes:
v. Retirement Fund – lock-in for at least 5 years or till retirement age
whichever is earlier
E.g. –
vi. Children’s Fund – lock-in for at least 5 years or till the child attains age of
majority whichever is earlier
E.g. – ICICI Prudential Child Care Fund (Gift Plan)
69
E. Other Schemes:
i. Index Funds/ ETFs – min 95% investment in securities of underlying index
An open ended scheme replicating/ tracking a particular index
E.g. – HDFC Sensex ETF
ii. Fund of Funds (FoFs) (Domestic/ Overseas) – min 95% investment in units
of underlying funds
E.g. – HDFC Dynamic PE Ratio Fund of Funds
70
FoFs
o A ‘Fund Of Funds’ (FOF) is an investment strategy of holding a portfolio of other
investment funds rather than investing directly in stocks, bonds or other securities.
An FOF Scheme of a primarily invests in the units of another Mutual Fund
schemes. This type of investing is often referred to as multi-manager investment.
o These schemes offer the investor an opportunity to diversify risk by spreading
investments across multiple funds. The underlying investments for a FoF are the
units of other mutual fund schemes either from the same mutual fund or other
mutual fund houses.
o Experts believe fund of funds are generally better suited for smaller investors that
want to gain access to a range of different asset classes or for those whose
advisers do not have the expertise to make single manager recommendations.
o Under current Income Tax regime in India, a FOF investing in equity funds is
treated as a Equity Fund and consequently taxed accordingly.
71
MFs by Investment
Objective
• Hybrid Schemes
o A hybrid scheme combines equity stock component, a bond component and
sometimes a money market component in a single portfolio. Generally, these
hybrid funds stick to a relatively fixed mix of stocks and bonds that reflects
either a moderate, or higher equity, component, or conservative, or higher
fixed-income, component orientation.
o These funds invest in a mix of equities and debt, giving the investor the best of
both worlds. Balanced funds gain from a healthy dose of equities but the debt
portion fortifies them against any downturn.
o Balanced funds are suitable for a medium/ long -term horizon and are ideal
for investors who are looking for a mixture of safety, income and modest
capital appreciation. The amounts this type of mutual fund invests into each
asset class usually must remain within a set minimum and maximum.
o Although they are in the "asset allocation" family, balanced fund portfolios do
not materially change their asset mix. This is unlike life-cycle, target-date and
actively managed asset-allocation funds, which make changes in response to
an investor's changing risk-return appetite and age or overall investment
market conditions.
72
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Why invest in Hybrid Schemes?
• Equities and Inflation
o Investors who have dual investment objectives favour Hybrid Funds.
o Typically, retirees or investors with low risk tolerance prefer these funds for
growth that outpaces inflation and income that supplements current needs.
o While retirees generally scale back risk as age advances, many individuals
recognize the need for equity exposure as life expectancies increase.
o Equities prevent erosion of purchasing power and help ensure long-term
preservation of retirement corpus
• Taxation
o Equity-oriented Hybrid funds have a larger portion of their corpus (at least 65%)
invested in stocks and qualify for the same tax treatment as equity funds.
o Debt-oriented hybrid funds are less volatile and suit those with a lower risk
appetite. However, they offer lower returns and the gains are not eligible for
tax exemption. If the investment is held for less than three years, the capital
gains are treated as short term and taxed at the normal rates. But if the holding
period exceeds three years, the gains are considered as long term and are
taxed at 20% after indexation benefit, which can significantly reduce the tax.
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Why invest in Hybrid Schemes?
• Income Needs
o The bond component of a balanced fund serves two purposes: creating an
income stream and moderating portfolio volatility. Investment-grade bonds
such as AAA corporate bonds and Money market instruments interest income
from periodic payments, while large-company stocks offer dividend pay outs
to enhance yield.
o Retired investors may take distributions in cash to bolster income from pensions
and personal savings.
o Secondarily, bonds hold much less volatility than stocks. Bondholders have a
claim against assets of a company while stocks represent ownership, bearing
all inherent risk if bankruptcy occurs. Hence, debt security prices do not move
in lockstep with equities, and their stability prevents wild swings in the share
price of a balanced fund.
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Exchange Traded Funds
• An ETF, or exchange traded fund, is a marketable security that tracks an
index, a commodity, bonds, or a basket of assets like an index fund.
• In the simple terms, ETFs are funds that track indexes such as Nifty 50 or S&P
BSE Sensex, etc.
• When you buy shares/units of an ETF, you are buying shares/units of a portfolio
that tracks the yield and return of its native index.
• They don't try to beat the market, they try to be the market.
• Unlike regular mutual funds, an ETF trades like a common stock on a stock
exchange.
• The traded price of an ETF changes throughout the day like any other stock,
as it is bought and sold on the stock exchange. The trading value of an ETF is
based on the net asset value of the underlying stocks that an ETF represents.
• ETFs typically have higher daily liquidity and lower fees than mutual fund
schemes, making them an attractive alternative for individual investors.
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ETFs
ETFs are cost-efficient : Because an ETF tracks an index without trying to
outperform it, it incurs lower administrative costs than actively managed
portfolios. Typical ETF administrative costs are lower than an actively managed
fund. Because they have lower expense ratio, there are fewer recurring costs to
diminish ETF returns.
Difference between ETF and Index Fund?

While both are passively managed, the biggest difference is that Index Funds
operate in the way all mutual funds do, in that they are priced at the close of the
trading day based on the NAV of the underlying securities, whereas ETFs are
priced to the market throughout the trading day. That means they are easier to
buy and sell quickly, if need be. Secondly, ETFs are available only on stock
exchanges. Hence, you need a demat account to invest in an ETF, whereas for an
Index Fund, you don’t need a demat account and you may buy or sell the Units of
an Index Fund directly from the mutual fund in small amounts.
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Growth of Global ETFs
• Over the past 10 years, Assets under Management (AUM) of
ETFs across the globe has grown exponentially with assets of
US$ 4.3 trillion as on September 2017.
• AUM of Global ETFs is expected to touch US$ 7 trillion by 2021.
In the above chart, bars represent AUM and the line represents number of ETFs.
Data Source: www.etfgi.com. Data as on Sep 29, 2017.
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Growth of ETFs in India
• Indian ETF industry has seen rapid growth in last 3 years.
• Recent investments in ETFs:
EPFO’s apex decision making body has approved the proposal to increase
investments in equity ETFs to 15% of the investible deposits. This may translate
into an investment of around Rs. 22,500 crore in ETFs during 2017-18.
ETFs in India - AUM (Rs. in crores)
70,000
60,720
60,000
50,000
40,000
30,000
20,000
10,000
Data Source: MFI Explorer Data as on Sep 29, 2017. EPFO: Employee Provident Fund Organisation
79
• ETFs are an example of an investment idea imported from the US which is
finding rapid traction in India.
• As the Indian stock market matures, as it becomes better regulated, more
institutionalized and more competitive, it is but natural that large-cap mutual
fund managers will struggle to beat the market.
• Hence, for most investors, large-cap ETFs with low fees will become a cost-
efficient way to participate in the growth of India’s vibrant economy.
• Presently, most equity mutual funds have an annual management fee of 2.5 per
cent. In contrast, in an ETF (Exchange Traded Fund), the fee is approximately
0.1 per cent.
• ETFs as a rule have very minimal expense ratios since they do not offer
‘active’ fund management and hence do not have to employ highly paid fund
managers.
• There are ETFs which fully replicate a benchmark. For example, a Nifty ETF
is a fund that invests in all the fifty Nifty companies in the same proportion as
they are in the index. 80
• Passively managed funds come in two types: funds with brains and funds
without. In the former (also called ‘Smart Beta’ funds), the fund is run based on
a preset strategy or an algorithm.
• For example, there are mutual funds which invest in a mix of Nifty and
government bonds. The weightage of each asset class is determined by the
Price/Earnings (or P/E) of the Nifty. In other words, based on an allocation table,
the fund invests more in the Nifty when markets are cheap and less when markets
are expensive. Since the decision making is based on a predetermined formula,
there is little contribution from the fund manager except executing the trade.
• The second category of passively managed funds is index funds (just like Index
ETFs). They are simply built to replicate an index like the Nifty or the Sensex
and have minimal human input.
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Benefits of Investing in ETFs
ETFs combine the range of a diversified portfolio with the simplicity of trading a
single stock. Investors can purchase ETF shares on margin, short sell shares, or hold
for the long term. ETFs can be bought/ sold easily like any other stock on the
exchange through terminals across the country.
• Asset Allocation: Managing asset allocation can be difficult for individual
investors given the costs and assets required to achieve proper levels of
diversification. ETFs provide investors with exposure to broad segments of the
equity markets. They cover a range of style and size spectrums, enabling
investors to build customized investment portfolios consistent with their
financial needs, risk tolerance, and investment horizon. Both institutional and
individual investors use ETFs to conveniently, efficiently, and cost effectively
allocate their assets.
• Cash Equitisation: Investors typically seek exposure to equity markets, but
often need time to make investment decisions. ETFs provide a "Parking Place"
for cash that is designated for equity investment. Because ETFs are liquid,
investors can participate in the market while deciding where to invest the
funds for the longer-term, thus avoiding potential opportunity costs.
Historically, investors have relied heavily on derivatives to achieve temporary
exposure. However, derivatives are not always a practical solution. The large
denomination of most derivative contracts can preclude investors, both
institutional and individual, from using them to gain market exposure. In this
case and in those where derivative use may be restricted, ETFs are a practical
82
alternative.
Benefits of Investing in
ETFs
• Hedging Risks: ETFs are an excellent hedging vehicle because they can be
borrowed and sold short. The smaller denominations in which ETFs trade
relative to most derivative contracts provides a more accurate risk exposure
match, particularly for small investment portfolios.
• Arbitrage (cash vs futures) and covered option strategies: ETFs can be used to
arbitrage between the cash and futures market, as they are very easy to
trade. ETFs can also be used for cover option strategies on the index.
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Gold ETF
• A Gold ETF is an exchange-traded fund (ETF) that aims to track the domestic
physical gold price. They are passive investment instruments that are based
on gold prices and invest in gold bullion.
• In short, Gold ETFs are units representing physical gold which is in
dematerialised form. One Gold ETF unit is equal to 1 gram of gold and is
backed by physical gold of very high purity. Gold ETFs combine the flexibility
of stock investment and the simplicity of gold investments.
• Gold ETFs are listed and traded on the National Stock Exchange of India (NSE)
and Bombay Stock Exchange Ltd. (BSE) like a stock of any company. Gold
ETFs trade on the cash segment of BSE & NSE, like any other company stock,
and can be bought and sold continuously at market prices.
• Buying Gold ETFs means you are purchasing gold in an electronic form. You
can buy and sell gold ETFs just as you would trade in stocks. When you
actually redeem Gold ETF, you don’t get physical gold, but receive the cash
equivalent. Trading of gold ETFs takes place through a dematerialised
account (Demat) and a broker, which makes it an extremely convenient way
of electronically investing in gold.
• Because of its direct gold pricing, there is a complete transparency on the
holdings of a Gold ETF. Further due to its unique structure and creation
mechanism, the ETFs have much lower expenses as compared to physical
gold investments.
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Gold ETF
• Purity & Price: Gold ETFs are represented by 99.5%
pure physical gold bars. Gold ETF prices are listed
on the website of BSE/NSE and can be bought or
sold anytime through a stock broker. Unlike gold
jewellery, gold ETF can be bought and sold at the
same price Pan-India.
• Where to buy: Gold ETFs can be bought on BSE/NSE
through the broker using a demat account and
trading account. A brokerage fee and minor fund
management charges are applicable when buying
or selling gold ETFs
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Gold ETFs
Risks:
Gold ETFs are subject to market risks impacting the price of
gold. Gold ETFs are subject to SEBI (Mutual Funds)
Regulations. Regular audit of the physical gold bought by
fund houses by a statutory auditor is mandatory.
Who should invest in Gold ETF?

Gold ETFs are ideal for investors who wish to invest in gold
but do not want to invest in physical gold due to the
storage hassles / doubt about purity of gold and are also
looking to get tax benefits. There is no premium or making
charge, so investors stand to save money if their investment
is substantial. What’s more, one can purchase as low as
one unit (which is 1 gram).
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Advantages of buying
Gold ETF
• Purity of the gold is guaranteed and each unit is backed
by physical gold of high purity.
• Transparent and real time gold prices.
• Listed and traded on stock exchange.
• A tax efficient way to hold gold as the income earned
from them is treated as long term capital gain.
• No security transaction tax, no VAT and no sales tax.
• No fear of theft - Safe and secure as units held in Demat.
One also saves on safe deposit locker charges.
• ETFs are accepted as collateral for loans.
• No entry and exit load.
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How to Sell or redeem
Gold ETF
Gold ETFs can be sold at the stock exchange through
the broker using a demat account and trading
account. Since one is investing in an ETF that is
backed by physical gold, ETFs are best used as a tool
to benefit from the price of gold rather than to get
access to physical gold. So, when one liquidates Gold
ETF Units, one is paid as per domestic market price of
the gold. AMCs also permit redemption of Gold ETF
Units in the form of physical gold in ‘Creation Unit’ size,
if one holds equivalent of 1kg of gold in ETFs, or in
multiples thereof.
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Other Schemes
• Load or No-Load Funds: A load fund is one that charges a percentage of NAV
for exit. That is, each time one sells units in the fund, a charge will be payable.
This charge is used by the Mutual fund for marketing and distribution
expenses. A no-load fund is one that does not charge for exit. It means the
investors can exit the fund at no additional charges during sale of units.
• Dividend Payout Schemes: Mutual Fund companies as when they keep on

making profit, distribute a part of the money to the investors by way of
dividends. If one wants to keep on taking part of profit regularly, he may
select this option.
• Dividend Reinvestment Schemes: This option is similar to the first option except
that the dividend declared is re-invested in the same fund on the same day’s
NAV.
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What is Systematic
Investment Plan (SIP)
A Systematic Investment Plan (SIP) is a plan that lets
you invest specific amounts of money at regular
intervals to gradually build a large corpus. By investing
in a SIP, your investments get disciplined. Also, since
you are investing regularly, the setbacks to your
investments when markets are low get balanced by
your investments’ gains when the market is high. And
as you gain returns and keep investing higher amounts
during the investment tenure, your returns keep
multiplying and growing.
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What is Capital Protection
Scheme
A capital protection-oriented scheme is typically a hybrid close
ended scheme that invests significantly in fixed- income securities
and a part of its corpus in equities. These are close-ended schemes
that come in tenors of fixed maturity e.g. three to five years.
Structure of the scheme - Example

If the fund collects INR 100, it invests INR 80 in fixed-income securities
and INR 20 in equities or equity related instruments. The money is
invested in such a way that the INR 80 portion is expected to
grow to become INR 100 in three years (assuming that the scheme
has a maturity period of three years). Thus, the aim is to preserve the
INR 100 capital till maturity of the scheme.
Thus, the scheme is oriented towards protection of capital and
not with guaranteed returns. Further, the orientation towards
protection of capital originates from the portfolio structure of the
scheme and not from any bank guarantee or insurance cover.
Investors are not offered any guaranteed/indicated returns
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Types of Returns in MFs
Following are the ways by which returns can be
realized in a mutual fund:
• Dividends
Unit holders earn dividends on mutual funds. These
dividends are distributed from the income
generated through dividends on stocks and interest
on other instruments.
• Capital Gains
Investors get capital gains on mutual funds. If the
fund sells securities that have appreciated in value,
it earns capital gains. Most funds distribute these
capital gains also to investors.
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Calculating returns on
mutual fund units
There are many ways to calculate returns from mutual fund investments. Two
of the most popular methods are Absolute returns and Annualised returns.
• Absolute returns
Absolute return is the simple increase (or decrease) in your investment in
terms of percentage. It does not take into account the time taken for this
change.
So if an investment’s current market value is Rs. 5,25,000 and your invested

amount was Rs. 2,75,000 then your absolute return will be: [(5,25,000-
2,75,000)/2,75,000] = 90.9%
Ideally, you should use the absolute returns method if the tenure of your
investment is less than 1 year.
For periods of more than 1 year, you need to annualise returns; which means
you need to find out what the rate of return is per annum.
97
Calculating returns on
mutual fund units
• Annualised returns
A Compound Annual Growth Rate (CAGR)
measures the rate of return over an investment
period. It is a smoothened rate because it measures
the growth of an investment as if it had grown at a
steady rate, on an annually compounded basis.
CAGR = [(Current Value / Beginning Value) ^ (1/# of

Years)]-1
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Practice
1. Let us say Fund XYZ has NAV at 5 consecutive year ends as follows -
2011 – Rs. 1200
2012 – Rs. 1250
2013 – Rs. 1310
2014 – Rs. 1380
2015 – Rs. 1500
Calculate CAGR
Solution:
CAGR = {(1500/1200)^(1/4)-1} * 100
5.73%
2. If the NAV of a fund increases from 300 to 369 in 4 years. Calculate CAGR
Solution:
CAGR = {(369/300)^(1/4)-1} * 100
5.311%
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Practise
3. NAV of Fund ABCC grows from Rs. 60 to Rs. 82.50 in 5 years, what is the
CAGR?
Solution:
CAGR = 6.58%
4. NAV at Inception is 10 and Current NAV is 11.50. Fund has completed 1.5 years.
Calculate CAGR
Solution: 9.76%
5. NAV of a fund on 1st Jan, 2010 was Rs. 25. CAGR of the fund is 12%. What is the
NAV on 1st Jan, 2017?
Solution:
25*(1+12%)^7 = 55.26
6. The NAV of the fund was Rs. 23. Current NAV is Rs. 37. Calculate Absolute
return.
Solution:
{(37-23)/23} * 100
60.86%
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Practice
7. The Fund’s current NAV is Rs. 52. the absolute return generated
by the fund is 20%. Compute the Initial NAV?
Solution:
52/(1+ 20%) = 43.33
8. Lets assume that the absolute returns generated in the

example above is 15%. Compute Initial NAV?
Solution:
52/(1+15%) = 45.217
9. Lets assume that fund’s Initial NAV is 8.57. Absolute return

generated by the fund is 11.55%. What is the current NAV?
Solution:
8.57 * (1+11.55%) = 9.55
101
Practice
10. Following are the NAVs of ABC fund:
2011 – Rs. 12.00
2012 – Rs. 12.50
2013 – Rs. 13.10
2014 – Rs. 13.80
2015 – Rs. 15.00
Compute CAGR between 2013 and 2015
Also compute absolute return between 2011 to 2015
Solution:
CAGR = {(15/13.10)^(1/2)-1} * 100
= 7.006%
Absolute Return = (15-12)/12 * 100
= 25%
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Practice
11. Rajeshbhai invested Rs. 1 crore in an equity fund for a 10 year
period. The fund delivered a return of 18% on a compounded
basis over initial 5 years and at a rate of return of 12% p.a. on a
compounded basis for the last 5 years. What is the current value
of the investment?
Solution:
= 10000000*(1+18%)^5 = 22877578
= 22877578*(1+12%)^5 = 40318109
12. Now calculate the total compounded return over the period
for 10 years based on the previous example. Also calculate the
absolute returns?
Solution:
CAGR = {(40318109/10000000)^(1/10)-1}*100 = 14.96%
Absolute Return = (40318109 – 10000000)/10000000 * 100 =
303.18%
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Advantages of Investing
in MFs
116
Advantages of investing in
MFs
• Professional Management
Mutual funds employ experienced and skilled professionals who make investment
research and analyze the performance and prospects of various instruments before
selecting a particular investment. Thus, by investing in mutual funds, one can avail the
services of professional fund managers, which would otherwise be costly for an individual
investor.
• Diversification
Diversification involves holding a wide variety of investments in a portfolio so as to
mitigate risks. Mutual funds usually spread investments across various industries and asset
classes, constrained only by the stated investment objective. Thus, by investing in mutual
funds, one can avail the benefits of diversification and asset allocation without investing
a large amount of money that would be required to create an individual portfolio.
• Liquidity
In an open-ended scheme, unit holders can redeem their units from the fund house
anytime. Even with close-ended schemes, one can sell the units on a stock exchange at
the prevailing market price. Besides, some close-ended and interval schemes allow direct
repurchase of units at NAV related prices from time to time. Thus investors do not have to
worry about finding buyers for their investments.
• Flexibility
Mutual funds offer a variety of plans, such as regular investment, regular withdrawal and
dividend reinvestment plans. Depending upon one’s preferences and convenience, one
can invest or withdraw funds, accordingly.
117
Advantages of investing
•
in MFs
Cost Effective
Since Mutual funds have a number of investors, the fund’s transaction costs, commissions
and other fees get reduced to a considerable extent. Thus, owing to the benefits of
larger scale, mutual funds are comparatively less expensive than direct investment in the
capital markets.
• Well Regulated
Mutual funds in India are regulated and monitored by the Securities and Exchange Board
of India (SEBI), which strives to protect the interests of investors. Mutual funds are required
to provide investors with regular information about their investments, in addition to other
disclosures like specific investments made by the scheme and the proportion of
investment in each asset classes.
• Convenient Administration
The facility of making investments through service centers as well as through internet
ensures convenience.
• Return Potential
By allocating right asset mix, mutual funds offer a chance of higher potential of returns.
The high concentration of risky assets would lead to higher return and vice-versa.
• Transparency
Information available through fact sheets, offer documents, annual reports and
promotional materials help investors gather knowledge about their investments.
• Choice of Schemes
The investors can chose from various kinds of scheme available to them. The risk-seeker
investors can go for more aggressive schemes while risk-averse investors can go for
118
income schemes funds and so on.
MF V/s Other Investment
Options
A. Bank Fixed deposits v/s Mutual Fund
Bank FDs are safe and chances of default are very
less. Banks operate under stringent requirements
regarding Statutory Liquidity Ration (SLR) and Cash
Reserve Ratio (CRR). Further, Deposit Insurance and
Credit Guarantee Corporation (DICGC) protect bank
deposits of up to Rs. 1,00,000. There are mutual funds,
which invest in Bank Certificate of Deposits of various
Bank. Thus, mutual funds offers diversification by
investing in the CDs of various banks.
119
MF V/s Other Investment
Options
B. Bonds and Debentures v/s Mutual fund
• Credit rating of a bond is an indication of the inherent default risk in the
investment. However unlike fixed deposits, bonds and debentures are
transferable securities.
• If security does not get traded in the market, then the liquidity remains on
paper. In this respect an open-end mutual fund scheme offering
continuous sale / repurchase option is superior.
• There could be capital gain / capital loss to investor in case of an early
exit, because the investment is subject to market risk. This is normally less
in Mutual fund as the investment is made in basket of funds and hence
your investment gets diversified.
C. Equity v/s Mutual fund

• It is not possible for a common man to lay his hands on all that
information needed to make an equity investment. Mutual fund handled
by professionals make capital investment decisions.
• Mutual fund investment offers diversification irrespective of the size of
investment. Individual investor investing in equity scheme may not have
this advantage especially if he does not have that sort of investible funds.
120
Role & Objective of AMFI
• AMFI, the apex body of all the registered asset management
companies was incorporated on August 22, 1995 as a non-
profit organization.
• All the asset management companies that have launched
mutual fund schemes are its members.
• One of the objectives of AMFI is to promote investors' interest
by defining and maintaining high ethical and professional
standards in the mutual fund industry.
• The AMFI code of ethics sets out the standards of good
practices to be followed by the asset management
companies in their operations and in their dealings with
investors, intermediaries and public.
• AMFI code has been drawn up to encourage adherence to
standards higher than those prescribed by the regulation s for
the benefits of investors in the mutual fund industry.
122
Role & Objective of SEBI
• SEBI is the regulator for Mutual Funds in India and lays down the basic rules
and regulations for Mutual funds in India.
• SEBI (Mutual funds) Regulations, 1996 also lays down the provisions for the
appointment of trustees and their obligations.
• Every mutual fund must be registered with SEBI and registration is granted only
where SEBI is satisfied with the background of the fund.
• SEBI has the authority to inspect the books of accounts , records and
documents of a Mutual fund, its trustees, AMC and custodian where it deems
it necessary.
• Regulations are laid down regarding listing of funds, refund procedures,
transfer procedures, disclosures etc.
• SEBI has also laid down advertisement code to be followed by a mutual fund
in making any publicity regarding a scheme and its performance.
• SEBI has prescribed norms/ restrictions for investment management with a
view to minimize / reduce undue investment risks.
• SEBI also has the authority to initiate penal actions against an erring Mutual
Fund.
• In case of a change in the controlling interest of an asset management
company, investors should be given at least 30 days time to exercise their exit
option.
123
Learning Through Case
Studies
124
Case Profile of Ms. Meena Mane
Ms Meena Mane is a 22-Yr old single lady i.e. she has no
dependents. She is a salaried individual earning Rs 100,000 per
month (pm). Her investment portfolio comprised only of assured
return instruments i.e. fixed deposits, bonds and small savings
schemes.
From the above profile, what can we observe?

• The client seemed to be a risk-averse individual, hence the
'equity-free' investment portfolio.
• Her portfolio lacks proper asset allocation, as the portfolio
lacks the presence of equity component.
• And finally, Ms. Mane invests predominantly in a directionless
manner i.e. her investments lacks investment objective and
goals like buying a house, retirement planning, etc.
125
Surprise difference in her investment attitude and risk appetite…
• With the limited information from the case profile mentioned above,
the advisor will have to do a series of discussions with Ms. Mane to
understand her risk appetite.
• After some discussion with Ms. Mane, it appeared that Ms. Mane is
not risk-averse as what can be ascertained from her portfolio. How?
Upon asking if she would panic upon stock markets falling more than
20% in one single day, her reply was a clear ‘NO’ as she would like to
invest for long-term and to generate wealth for her post retirement
requirements.
• But because she did not understand Equity Mutual Funds and its
functioning, she opted to invest with what she was most conversant
with i.e. fixed deposits, bonds, small savings scheme, etc.
• Thus, the risk-appetite of Ms. Mane can be ascertained now as the
one who can take higher risks to generate higher returns.
Further discussions with Ms. Mane helped in understanding that with
falling interest rates she was incrementally worried on how she will
generate wealth for her post retirement financial needs and therefore,
she was looking for instruments which could yield her around 10% returns
every year with moderate risks.
126
Corrective measures needed here!
• Our first task will be to impress upon her the
importance of asset allocation i.e. investing in
various asset classes in different proportions,
depending on the investor's risk appetite, with the
underlying intention being to offset a downside in
one asset class, by the presence of another. In Ms.
Mane’s case, there was a need to incorporate
equities in the portfolio.
• Also other assets like gold and real estate needed

to enter the portfolio in suitable proportions over
time. The aim being to convert the portfolio from an
assured return-dominated one to one that was
aptly diversified across asset classes.
127
Corrective measures needed here!
Now, let’s understand the following return and risk
assumptions:
Asset Classes Expected Rate of Return Expected Volatility
(Standard Deviation)
Real estate 20.0% 30%
Equities 15.0% 25%
Debt 7.0% 3%
Gold 10.0% 20%
Now let’s design an investment portfolio for Ms. Mane basis the details
available.
128
• Expected Returns basis Asset Allocation
Case 1 Case 2 Current Portfolio
Expected
Rate of
Asset Weighted Asset Weighted Asset Weighted
Return
Allocation Return Allocation Return Allocation Return
Real estate 20.00% 25.00% 5.00% 10.00% 2.00% 0.00% 0.00%
Equities 15.00% 4.00% 0.60% 45.00% 6.75% 0.00% 0.00%
Debt 7.00% 31.00% 2.17% 35.00% 2.45% 100.00% 7.00%
Gold 10.00% 40.00% 4.00% 10.00% 1.00% 0.00% 0.00%
Total Portfolio 100.00% 11.77% 100.00% 12.20% 100.00% 7.00%
129
• Expected Portfolio Volatility basis Asset Allocation
Case 1 Case 2 Current Portfolio
Expected
Volatility Asset Weighted Asset Weighted Asset Weighted
Asset Classes
(Standard Allocation Volatility Allocation Volatility Allocation Volatility
Deviation)
Real estate 30% 25.00% 7.50% 10.00% 3.00% 0.00% 0.00%

Equities 25% 4.00% 1.00% 45.00% 11.25% 0.00% 0.00%
Debt 3% 31.00% 0.93% 35.00% 1.05% 100.00% 3.00%
Gold 20% 40.00% 8.00% 10.00% 2.00% 0.00% 0.00%
Total Portfolio 100.00% 17.43% 100.00% 17.3% 100.00% 3.00%
130
From the above portfolio allocations, case 2 provides a superior risk-return trade
off inline with her investment objective. Hence, the advisor will have to allocate
Ms. Mane’s investments as per Case 2.
The next step will be to allocate this money across instruments in these asset
classes.
• In Equities, one may opt to allocate money to Equity Diversified Mutual Funds,
Large Cap Mutual Funds, Mid Cap Mutual Funds or Thematic Mutual Funds
depending upon the risk appetite of the investor.
• Since, Ms. Mane is a starter in Equity mutual funds, the advisor may allocate
large portion of monies in Large Cap Mutual Funds as it carries lower degrees
of risks compared to other counterparts in the equity space and,
• a small portion in Equity Diversified Mutual Funds (which are market cap and
sector agnostic)
• For Debt, the advisor may look at a combination of Debt Mutual Funds, FDs
and social deposit schemes to achieve tax-efficient returns.
• In Gold, the advisor may recommend to invest in Gold ETFs or Gold Funds
instead of physical gold to achieve superior tax efficient returns.
131
Case Profile of Mr. Krishnamoorthy.
Mr. Satish Krishnamoorthy will be retiring soon (inless
than 3 years). He wants to know where to invest the
retirement funds so as to get steady optimum
average return.
Please Advise
132
Case Profile of Mr. Krishnamoorthy.
For individuals such as Mr. Krishnamoorthy who are close to retirement (less than 3 years
from retirement), it is not advisable to invest into equity (whether direct equity i.e. in
stocks, or indirect equities i.e. through mutual funds). At his age Debt instruments would
be a safer option and he may invest in the following debt instruments:
• Highly rated corporate Bonds.
• FMPs (fixed maturity plans, are pure debt mutual fund schemes).
• Bank Fixed deposits with your bank
Also keep in mind the taxation of the above options:

• FMPs give you the advantage of indexation, thus being a good option as they offer
a higher post tax yield.
• Interest earned from corporate bonds would be taxable as per the tax slab of the
individual.
For managing your liquidity needs, Satish should always have at least 6 months
expenses in a liquid mutual fund or in his savings bank.
133
Tracking Error
• Tracking error is defined as the annualised standard
deviation of the difference in returns between the
Index fund and its target Index.
• In simple terms, it is the difference between returns
from the Index fund to that of the Index.
• An Index fund manager needs to calculate his
tracking error on a daily basis especially if it is open-
ended fund. Lower the tracking error, closer are the
returns of the fund to that of the target Index.
134
Tracking Error
Reasons for tracking error are as under –
• Expenditure incurred by the fund: Ideally all the corpus of the
fund have to be invested in the securities of the benchmarked
Index as the objective of the scheme is to mimic the returns of
the underlying index. But it is not possible, as the Fund has to
incur expenses towards its day to day management,
transaction fees payable at the time of purchase or sale of
securities, etc. The expenditure of the fund has to be met out
of the corpus of the fund which means that the fund will invest
less funds than what it has collected. This in turns affects the
returns as the fund will receive returns only on the amount
which is invested. Hence, the lower the expenditure incurred
by the fund, the lower will be the tracking error.
135
Tracking Error
• Cash balance: The investment pattern of the fund provides for the asset
allocation pattern. Ideally, the full corpus of the fund has to be invested
in the underlying index. But this may not be possible due to the funds
obligation to meet requests for redemption, receipt of dividend, etc. The
fund has to set aside some amount of its corpus to meet the redemption
request. As the redemption has to be made within a few days, the fund
has to hold cash or other short terms assets which enable it to convert
such instrument in cash. To provide for this exigency the fund has to keep
aside some part of its corpus and therefore is not able to investment all its
corpus. Further, the fund may receive dividend on the shares held by it
which should again be invested in the constituents of the benchmarked
index as soon as possible. If the fund is not able to invest such dividend
then it holds more cash than required and hence its returns would be
affected. Similar is the cash of subscription for purchase of units of the
fund. So when the funds holds more cash, it has that much less to invest in
the underlying index and thus it leads to mismatch in the returns. It should
be the endeavour of the fund to keep the right amount of cash which at
the same time can provide for redemption request and should not be
ideal.
136
Tracking Error - calculation
The following is the information pertaining to the NAVs of SBI Magnum
Nifty based Fund and the values of Nifty for a particular period: (Refer to
excel document attached separately)
137
Tracking Error - calculation
138

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Mutual Funds

• India has one of the highest savings rate globally.

Now based on their contribution, they each receive 3 chocolates or 3 units, if

• Valuation of all investment securities held (Unrealised Profit):

• Other assets and liabilities:

NAV = (Rs. 10,500,000 + Rs. 2,000,000 – Rs. 500,000) /

A fund's NAV will change daily as the value of a fund's

Find the fund's net asset value.

NAV = [(20x2,300/1,000)+1.23+8+(1x80%)+4.50+0.80+106.50-6.32-0.75]/20 = Rs. 8.04 approx.

Since this is charged regularly (every day), a high expense ratio

Load can be charged in three different ways;

• Assets under management describes how much of investor’s money an investment

• Why AUM Matters

• How to Compare AUM

Schemes with lower One needs a large One needs to have a

Myth 2: MF investments are only for the long term

Myth 6: One needs to have a Demat account to invest in Mutual Funds

Myth 8: Buying a top-rated mutual fund scheme ensures better returns.

• The trust is established by a Sponsor or more than one Sponsor

The trustees are vested with the general power of

A Sponsor is any person or corporate body that establishes the Fund

Obligations of the Trustees

• Enter into an investment management agreement with the AMC.

Obligation of Asset Management Company:

Registrar & Transfer Agents

Before investing in a NFO, it is important to check if the NFO is offering something

2. By category of the MF scheme –

• Passive funds on the other hand look at offering returns by

vi. Value Funds – min 65% investment in equity

vii. Contra Funds - min 65% investment in equity

viii. Focused Funds – min 65% investment in equity

x. Equity Linked Savings Schemes (ELSS) – min. 80% investment in equity as

Who should invest in a debt fund?

x. Dynamic Bond Fund - Investment across duration

xiv. Gilt Fund – min 80% investment in G-secs

xvi. Floater Fund – min 65% investment in floating rate instruments

• WHY INVEST IN DEBT MUTUAL FUNDS?

How to pick the right Debt fund?

iv. Dynamic Asset Allocation Fund or Balanced Advantage Fund –

vi. Arbitrage Fund – arbitrage strategy; min 65% investment in equity

Difference between ETF and Index Fund?

Who should invest in Gold ETF?

• Dividend Payout Schemes: Mutual Fund companies as when they keep on

Structure of the scheme - Example

So if an investment’s current market value is Rs. 5,25,000 and your invested

CAGR = [(Current Value / Beginning Value) ^ (1/# of

8. Lets assume that the absolute returns generated in the

9. Lets assume that fund’s Initial NAV is 8.57. Absolute return

C. Equity v/s Mutual fund

From the above profile, what can we observe?

• Also other assets like gold and real estate needed

Real estate 20.00% 25.00% 5.00% 10.00% 2.00% 0.00% 0.00%

Equities 15.00% 4.00% 0.60% 45.00% 6.75% 0.00% 0.00%

Debt 7.00% 31.00% 2.17% 35.00% 2.45% 100.00% 7.00%

Gold 10.00% 40.00% 4.00% 10.00% 1.00% 0.00% 0.00%

Total Portfolio 100.00% 11.77% 100.00% 12.20% 100.00% 7.00%

Case 1 Case 2 Current Portfolio

Real estate 30% 25.00% 7.50% 10.00% 3.00% 0.00% 0.00%

Also keep in mind the taxation of the above options:

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