Mutual fund basics
MUTUAL FUND BASICS
Compiled by – Aparna Machawe
A mutual fund is a portfolio, or collection, of individual
securities (some combination of
stocks, bonds, or money market instruments) managed according
to a specific objective spelled out
in the fund’s prospectus. A mutual fund allows investors to
pool their money,
then the fund invests it on their behalf.
Unlike individual stocks, whose value fluctuates minute by
minute, mutual funds are priced at
the end of each day the market is open, based on what the
securities in the portfolio are
worth. The price per share, or net asset value (NAV).
What is NAV?
Basically, this is the investment company’s best assessment of
the value of a portfolio holdings in
their fund, and is what you see listed in the paper. They use
the daily closing price of all
securities held by the fund, subtract some amount for
liabilities, divide the result by
the number of outstanding units in the fund and Poof! you have
the NAV. The fund company will sell
you units at that price (don’t forget about any sales charge)
or will buy back your units at that
price (possibly less some fee).
Net Asset Value (NAV) =
(Value Of All Sec urities Held By The Fund -
Expenses And Liabilites Of The Fund) % Value Of Outstanding
Units In The Fund
What are different types of Mutual Funds?
Mutual funds can be classified based on the structure and
investment objective
By
Structure
-Closed-End Fund
A closed-end fund looks muc h like a stock of a publicly
traded
company: it’s traded on some stock
exchange, you buy or sell shares in the fund through a broker
just like a stock (including paying
a commission), the price fluctuates in response to the fund’s
performance and (very important) what people are
willing to pay for it. Also like a publicly
traded company, only a fixed number of shares are
available.
These funds have a stipulated maturity period generally
ranging from 3 to 15 years. The fund
is open for subsc ription only during a spec ified period.
Investors c an invest in the scheme
at the time of the initial public issue and thereafter they
can buy or sell the units of
the scheme on the stock exchanges where they are listed.
The market price of closed-end funds is determined by supply
and demand and not by net-asset
value (NAV), as is the case in open-end funds. Usually closed
mutual funds trade at discounts to
their underlying asset value.
-Open-End Fund
An open-end fund is the most common variety of mutual fund.
Both existing and new investors may
add any amount of money they want to the fund. In other words,
there is no limit to the number of
shares in the fund. Investors buy and sell shares usually by
dealing directly with the fund
company, not with any exchange. The price fluctuates in
response to the value of the
investments made by the fund, but the fund company values the
shares on its own; investor
sentiment about the fund is not considered.
Open-end funds keep some portion of their assets in short-term
and money market sec urities to
provide available funds for redemptions. A large portion of
most open mutual funds is invested
in highly liquid securities, which enables the fund to raise
money by selling securities at
prices very close to those used for valuations.
By Investment Objective
Growth Funds
The aim of growth funds is to provide capital apprec iation
over the medium to long term.
Such schemes normally invest a majority of their corpus in
equities. Growth schemes are
ideal for investors who have a long-term outlook and are
seeking growth over a period of
time.
Income Funds
The aim of Income Funds is to provide regular and steady
income to investors. Such schemes
generally invest in fixed income
securities such as bonds, corporate debentures
and Government securities.
Income Funds are ideal for capital stability and regular
income. Capital appreciation in such
funds may be limited, though risks are typically lower than
that in a growth fund.
Balanced Funds
The aim of Balanced Funds is to provide both growth and
regular income. Such schemes periodically distribute a part of their earning and invest
both in equities and fixed income securities in the proportion indicated in their offer documents. This proportion affects the
risks and the returns associated with the balanced fund - in
case equities are allocated a higher proportion, investors would be exposed to risks similar
to that of the equity market.
Balanced funds with equal allocation to equities and fixed
income securities are ideal forinvestors looking for a combination of
income and moderate
growth.
Money Market Funds
The aim of Money Market Funds is to provide easy liquidity,
preservation of capital and moderate
income. These schemes generally invest in safer
short-term instruments such as Treasury Bills, Certificates of Deposit, Commercial Paper
and Inter-Bank Call Money. Returns on these
schemes may fluc tuate depending upon the interest
rates prevailing in the market.
These are ideal for corporate and individual investors as a
means to park their surplus funds for short periods.
Tax Saving Schemes
These schemes offer tax rebates to the investors under specific provisions of the Indian
income Tax laws, as the Government offers tax incentives for
investment in specified avenues.
Investments made in Equity Linked Savings schemes (ELSS) and
Pension schemes are allowed as deduc tion under Sec tion 88 of the Indian
income
Tax Act, 1961.
Index Schemes
Index Funds attempt to replic ate the performanc e of a particular index such as the BSE
Sensex or the NSE S&P CNX 50.
Sectoral Schemes
Sec toral Funds are those whic h invest exc lusively in spec
ified sec tor(s) such as FMCG, Information Technology, Pharmaceuticals, etc . These
schemes carry higher risk as compared to general equity schemes as the portfolio is less
diversified, i.e. restricted to
specific sector(s) / industry(ies).
What are the different plans that mutual funds offer?
To cater to different investment needs, Mutual Funds offer
various investment options. Some of the important investment options include:
Growth Option
Dividend is not paid-out under a Growth Option and the
investor realises only the capital appreciation on the investment (by an increase in NAV).
Dividend Payout Option
Dividends are paid-out to investors under the Dividend Payout
Option. However, the NAV of the mutual fund scheme falls to the extent of the dividend
payout.
Dividend Re-investment Option
Here the dividend accrued on mutual funds is automatic ally
re invested in purchasing
additional units in open-ended funds. In most cases mutual
funds offer the investor an option of collecting dividends or re-investing the same.
Retirement Pension Option
Some schemes are linked with retirement pension. Individuals
participate in these options for themselves, and corporates participate for their
employees.
Insurance Option
Certain Mutual Funds offer schemes that provide insurance cover to investors as an added
benefit.
Systematic Investment Plan (SIP)
Here the investor is given the option of preparing a
pre-determined number of post-dated cheques in favour of the fund. The investor is allotted units
on a predetermined date specified in the offer document at the applicable NAV.
Systematic Withdrawal Plan (SWP)
As opposed to the Systematic Investment Plan, the Systematic
Withdrawal Plan allows the investor the facility to withdraw a predetermined amount /
units from his fund at a predetermined
interval. The investor’s units will be redeemed at the applic
able NAV as on that day.
Are returns from mutual funds guaranteed?
Generally, Mutual Funds do not offer guaranteed returns to
investors. Although, SEBI regulations allow Mutual Funds to offer guaranteed returns
subject to the Fund meeting certain conditions, most Funds do not offer
such
guarantees. In case of a guaranteed return scheme, the sponsor or the AMC, guarantees a minimum
level of return and makes good the difference if the actual returns are less than the
guaranteed minimum. The name of the guarantor and the manner in which the guarantee shall
be met must be disclosed in the offer document by the Mutual Fund. Investments in mutual
funds are not guaranteed by the Government of India, the Reserve Bank of India or any
other government body.
Aparna Machawe,
Financial Planner & Consultant
One Stop Solutions, 9822289916, 988110056.