THE VERSATILITY OF MUTUAL FUNDS

Introduction :
Today, one of the best savings instrument cum investment vehicle in India is the Mutual
Funds. This is mainly because of the continuous refinement it has been subjected to over
the years, particularly the last twelve years, ever since it was launched in 1963. Mutual
Funds are for everyone. Around the world millions of investors invest in mutual funds
because of their safety, simplicity, ease of investing and the many advantages they
offer. This article will cover some of its unique features dealing with subjective,
emotional and psychological aspects that make it a versatile one.

Concept :
A Mutual Fund is a trust that pools the savings of a number of investors who share a
common financial goal. The money thus collected is then invested in capital market
instruments such as shares, debentures and other securities. The income earned through
these investments and the capital appreciation realised are shared by its unit holders in
proportion to the number of units owned by them. Thus a Mutual Fund is the most
suitable investment for the common man as it offers an opportunity to invest in a
diversified, professionally managed basket of securities at a relatively low cost. The flow
chart below describes broadly the working of a mutual fund:

Mutual Fund Operation Flow Chart

INVESTORS  (Pool their Money with)  FUND MANAGER  (Invest in) 
 SECURITIES  (Generates)  RETURNS  (Passed back to)  INVESTORS.

ORGANISATION OF A MUTUAL FUND

There are many entities involved and the diagram below illustrates the organisational set
up of a mutual fund. They are given below :
1. SEBI
2. AMC
3. Sponsors
4. Trustees
5. The Fund
6. Custodians
7. Registrars

Mutual Fund Structure :

The structure consists of :
1. SPONSOR : The sponsor is the person who acting alone or in combination with
another body corporate establishes a mutual fund. Sponsor must contribute at least
40% of the net worth of the Investment Managed and meet the eligibility criteria
prescribed under the Securities and Exchange Board of India (Mutual Funds)
Regulations, 1996.The Sponsor is not responsible or liable for any loss or shortfall
resulting from the operation of the Schemes beyond the initial contribution made by
it towards setting up of the Mutual Fund.

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2. TRUST : The Mutual Fund is constituted as a trust in accordance with the provisions
of the Indian Trusts Act, 1882 by the Sponsor. The trust deed is registered under the
Indian Registration Act, 1908.
3. TRUSTEE : Trustee is usually a company (corporate body) or a Board of Trustees
(body of individuals). The main responsibility of the Trustee is to safeguard the
interest of the unit holders and inter-alia ensure that the AMC functions in the
interest of investors and in accordance with the Securities and Exchange Board of
India (Mutual Funds) Regulations, 1996, the provisions of the Trust Deed and the
Offer Documents of the respective Schemes. At least 2/3rd directors of the Trustee
are independent directors who are not associated with the Sponsor in any manner.
4. ASSET MANAGEMENT COMPANY (AMC) : The AMC is appointed by the Trustee as the
Investment Manager of the Mutual Fund. The AMC is required to be approved by the
Securities and Exchange Board of India (SEBI) to act as an asset management
company of the Mutual Fund. At least 50% of the directors of the AMC are
independent directors who are not associated with the Sponsor in any manner. The
AMC must have a net worth of at least 10 Crores at all times.
5. REGISTRAR AND TRANSFER AGENT : The AMC if so authorised by the Trust Deed
appoints the Registrar and Transfer Agent to the Mutual Fund. The Registrar
processes the application form, redemption requests and dispatches account
statements to the unit holders. The Registrar and Transfer agent also handles
communications with investors and updates investor records.

ADVANTAGES OF MUTUAL FUNDS

1. The advantages of investing in a Mutual Fund are:
2. Professional Management
3. Diversification
4. Convenient Administration
5. Return Potential
6. Low Costs
7. Liquidity
8. Transparency
9. Flexibility
10. Choice of schemes
11. Tax benefits
12. Well regulated

Benefits of Mutual Funds :

There are numerous benefits of investing in mutual funds and one of the key reasons for
its phenomenal success in the developed markets like US and UK is the range of benefits
they offer, which are unmatched by most other investment avenues. The benefits have
been broadly split into universal benefits, applicable to all schemes, and benefits
applicable specifically to open-ended schemes.
1. UNIVERSAL BENEFITS :
a. Affordability : A mutual fund invests in a portfolio of assets, i.e. bonds, shares,
etc. depending upon the investment objective of the scheme. An investor can buy

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 in to a portfolio of equities, which would otherwise be extremely expensive. Each
unit holder thus gets an exposure to such portfolios with an investment as
modest as Rs.500/-. This amount today would get you less than quarter of an
Infosys share! Thus it would be affordable for an investor to build a portfolio of
investments through a mutual fund rather than investing directly in the stock
market.
b. Diversification : The nuclear weapon in your arsenal for your fight against Risk. It
simply means that you must spread your investment across different securities
(stocks, bonds, money market instruments, real estate, fixed deposits etc.) and
different sectors (auto, textile, information technology etc.). This kind of a
diversification may add to the stability of your returns, for example during one
period of time equities might under perform but bonds and money market
instruments might do well enough to offset the effect of a slump in the equity
markets. Similarly the information technology sector might be faring poorly but
the auto and textile sectors might do well and may protect your principal
investment as well as help you meet your return objectives.
c. Variety : Mutual funds offer a tremendous variety of schemes. This variety is
beneficial in two ways: first, it offers different types of schemes to investors with
different needs and risk appetites; secondly, it offers an opportunity to an
investor to invest sums across a variety of schemes, both debt and equity. For
example, an investor can invest his money in a Growth Fund (equity scheme) and
Income Fund (debt scheme) depending on his risk appetite and thus create a
balanced portfolio easily or simply just buy a Balanced Scheme.
d. Professional Management : Qualified investment professionals who seek to
maximise returns and minimise risk monitor investor's money. When you buy in
to a mutual fund, you are handing your money to an investment professional that
has experience in making investment decisions. It is the Fund Manager's job to
(a) find the best securities for the fund, given the fund's stated investment
objectives; and (b) keep track of investments and changes in market conditions
and adjust the mix of the portfolio, as and when required.
e. Tax Benefits : Any income distributed after March 31, 2002 will be subject to tax
in the assessment of all Unit holders. However, as a measure of concession to
Unit holders of open-ended equity-oriented funds, income distributions for the
year ending March 31, 2003, will be taxed at a concessional rate of 10.5%. In
case of Individuals and Hindu Undivided Families a deduction up to Rs. 9,000
from the Total Income will be admissible in respect of income from investments
specified in Section 80L, including income from Units of the Mutual Fund. Units of
the schemes are not subject to Wealth-Tax and Gift-Tax.
f. Regulations : Securities Exchange Board of India (“SEBI”), the mutual funds
regulator has clearly defined rules, which govern mutual funds. These rules relate
to the formation, administration and management of mutual funds and also
prescribe disclosure and accounting requirements. Such a high level of regulation
seeks to protect the interest of investors.
2. BENEFITS OF OPEN-ENDED SCHEMES :
a. Liquidity : In open-ended mutual funds, you can redeem all or part of your units
any time you wish. Some schemes do have a lock-in period where an investor
cannot return the units until the completion of such a lock-in period.
b. Convenience : An investor can purchase or sell fund units directly from a fund,
through a broker or a financial planner. The investor may opt for a Systematic

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 Investment Plan (“SIP”) or a Systematic Withdrawal Advantage Plan (“SWAP”). In
addition to this an investor receives account statements and portfolios of the
schemes.
c. Flexibility : Mutual Funds offering multiple schemes allow investors to switch
easily between various schemes. This flexibility gives the investor a convenient
way to change the mix of his portfolio over time.
d. Transparency : Open-ended mutual funds disclose their Net Asset Value (“NAV”)
daily and the entire portfolio monthly. This level of transparency, where the
investor himself sees the underlying assets bought with his money, is unmatched
by any other financial instrument. Thus the investor is in the know of the quality
of the portfolio and can invest further or redeem depending on the kind of the
portfolio that has been constructed by the investment manager.

TYPES OF MUTUAL FUND SCHEMES

Wide varieties of Mutual Fund Schemes exist to cater to the needs such as financial
position, risk tolerance and return expectations etc. The table below gives an overview
into the existing types of schemes in the Industry. The following are the major types :
1. By Structure :
a. Open Ended Schemes
b. Closed Ended Schemes
c. Interval Schemes
2. By Investment Objectives :
a. Growth Schemes
b. Income Schemes
c. Balanced Schemes
d. Money Market Schemes
3. Other Schemes :
a. Tax Saving Schemes
b. Special Schemes :
i. Sector Specific Schemes
ii. Index Schemes

What are the different types of mutual fund schemes?

1. SCHEMES ACCORDING TO MATURITY PERIOD : A mutual fund scheme can be
classified into open-ended scheme or close-ended scheme depending on its maturity
period.
a. Open-ended Fund/ Scheme : An open-ended fund or scheme is one that is
available for subscription and repurchase on a continuous basis. These schemes
do not have a fixed maturity period. Investors can conveniently buy and sell units
at Net Asset Value (NAV) related prices which are declared on a daily basis. The
key feature of open-end schemes is liquidity.
b. Close-ended Fund/ Scheme : A close-ended fund or scheme has a stipulated
maturity period e.g. 5-7 years. The fund is open for subscription only during a
specified period at the time of launch of the scheme. Investors can invest in the

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 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 the units are listed. In
order to provide an exit route to the investors, some close-ended funds give an
option of selling back the units to the mutual fund through periodic repurchase at
NAV related prices. SEBI Regulations stipulate that at least one of the two exit
routes is provided to the investor i.e. either repurchase facility or through listing
on stock exchanges. These mutual funds schemes disclose NAV generally on
weekly basis.
2. SCHEMES ACCORDING TO INVESTMENT OBJECTIVE : A scheme can also be classified
as growth scheme, income scheme, or balanced scheme considering its investment
objective. Such schemes may be open-ended or close-ended schemes as described
earlier. Such schemes may be classified mainly as follows:
a. Growth / Equity Oriented Scheme : The aim of growth funds is to provide capital
appreciation over the medium to long- term. Such schemes normally invest a
major part of their corpus in equities. Such funds have comparatively high risks.
These schemes provide different options to the investors like dividend option,
capital appreciation, etc. and the investors may choose an option depending on
their preferences. The investors must indicate the option in the application form.
The mutual funds also allow the investors to change the options at a later date.
Growth schemes are good for investors having a long-term outlook seeking
appreciation over a period of time.
b. Income / Debt Oriented Scheme : 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, Government securities and
money market instruments. Such funds are less risky compared to equity
schemes. These funds are not affected because of fluctuations in equity markets.
However, opportunities of capital appreciation are also limited in such funds. The
NAVs of such funds are affected because of change in interest rates in the
country. If the interest rates fall, NAVs of such funds are likely to increase in the
short run and vice versa. However, long term investors may not bother about
these fluctuations.
c. Balanced Fund : The aim of balanced funds is to provide both growth and regular
income as such schemes invest both in equities and fixed income securities in the
proportion indicated in their offer documents. These are appropriate for investors
looking for moderate growth. They generally invest 40-60% in equity and debt
instruments. These funds are also affected because of fluctuations in share prices
in the stock markets. However, NAVs of such funds are likely to be less volatile
compared to pure equity funds.
d. Money Market or Liquid Fund : These funds are also income funds and their aim is
to provide easy liquidity, preservation of capital and moderate income. These
schemes invest exclusively in safer short-term instruments such as treasury bills,
certificates of deposit, commercial paper and inter-bank call money, government
securities, etc. Returns on these schemes fluctuate much less compared to other
funds. These funds are appropriate for corporate and individual investors as a
means to park their surplus funds for short periods.
e. Gilt Fund : These funds invest exclusively in government securities. Government
securities have no default risk. 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.

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 f. Index Funds : Index Funds replicate the portfolio of a particular index such as the
BSE Sensitive index, S&P NSE 50 index (Nifty), etc. These schemes invest in the
securities in the same weightage comprising of an index. NAVs of such schemes
would rise or fall in accordance with the rise or fall in the index, though not
exactly by the same percentage due to some factors known as "tracking error" in
technical terms. Necessary disclosures in this regard are made in the offer
document of the mutual fund scheme. There are also exchange traded index
funds launched by the mutual funds which are traded on the stock exchanges.
g. Sector specific funds/schemes : These are the funds/schemes which invest in the
securities of only those sectors or industries as specified in the offer documents.
E.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum
stocks, etc. The returns in these funds are dependent on the performance of the
respective sectors/industries. While these funds may give higher returns, they are
more risky compared to diversified funds. Investors need to keep a watch on the
performance of those sectors/industries and must exit at an appropriate time.
They may also seek advice of an expert.
h. Tax Saving Schemes : These schemes offer tax rebates to the investors under
specific provisions of the Income Tax Act, 1961 as the Government offers tax
incentives for investment in specified avenues. E.g. Equity Linked Savings
Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax
benefits. These schemes are growth oriented and invest pre-dominantly in
equities. Their growth opportunities and risks associated are like any equity-
oriented scheme.

History of the Indian Mutual Fund Industry :

The mutual fund industry in India started in 1963 with the formation of Unit Trust of
India, at the initiative of the Government of India and Reserve Bank the. The history of
mutual funds in India can be broadly divided into four distinct phases.

First Phase – 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up
by the Reserve Bank of India and functioned under the Regulatory and administrative
control of the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the
Industrial Development Bank of India (IDBI) took over the regulatory and administrative
control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the
end of 1988 UTI had Rs.6,700 Crores of assets under management.

Second Phase – 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non- UTI, public sector mutual funds set up by public sector
banks and Life Insurance Corporation of India (LICI) and General Insurance Corporation of
India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987
followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89),
Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund
(Oct 92). LICI established its mutual fund in June 1989 while GIC had set up its mutual
fund in December 1990. At the end of 1993, the mutual fund industry had assets under
management of Rs.47,004 Crores.

Third Phase – 1993-2003 (Entry of Private Sector Funds)

With the entry of private sector funds in 1993, a new era started in the Indian mutual
fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was
the year in which the first Mutual Fund Regulations came into being, under which all
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mutual funds, except UTI were to be registered and governed. The erstwhile Kothari
Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund
registered in July 1993.
The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive
and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI
(Mutual Fund) Regulations 1996.
The number of mutual fund houses went on increasing, with many foreign mutual funds
setting up funds in India and also the industry has witnessed several mergers and
acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets
of Rs. 1,21,805 Crores. The Unit Trust of India with Rs.44,541 Crores of assets under
management was way ahead of other mutual funds.

Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was
bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust
of India with assets under management of Rs.29,835 Crores as at the end of January
2003, representing broadly, the assets of US 64 scheme, assured return and certain
other schemes. The Specified Undertaking of Unit Trust of India, functioning under an
administrator and under the rules framed by Government of India and does not come
under the purview of the Mutual Fund Regulations.
The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is
registered with SEBI and functions under the Mutual Fund Regulations. With the
bifurcation of the erstwhile UTI which had in March 2000 more than Rs.76,000 Crores of
assets under management and with the setting up of a UTI Mutual Fund, conforming to
the SEBI Mutual Fund Regulations, and with recent mergers taking place among different
private sector funds, the mutual fund industry has entered its current phase of
consolidation and growth. As at the end of September, 2004, there were 29 funds, which
manage assets of Rs.1,53,108 Crores under 421 schemes. As at November, 2009 the
number of AMCs is 37 and they command a total AUM of Rs. 8.085 Lakh Crores
(=Trillions). The Two biggest AMCs of Reliance and HDFC have each more than a Trillion
Rupees AUM.

GROWTH IN ASSETS UNDER MANAGEMENT

Note: Erstwhile UTI was bifurcated into UTI Mutual Fund and the Specified Undertaking of
the Unit Trust of India effective from February 2003. The Assets under management of
the Specified Undertaking of the Unit Trust of India has therefore been excluded from the
total assets of the industry as a whole from February 2003 onwards.

The Mind of the Investor :

Behavioural finance is a fascinating subject to study in relation to the markets. As they
say, if you loose on the markets, it is not the markets that are loosing, it’s your behaviour
that makes you loose. The ancient Greek saying, “Know thyself”, was the most important
piece of education and advice that was handed out to young men. For, knowing yourself
means understanding how you are likely to behave under various circumstances. And
from there emerges preparedness. Because as behavioural finance theorists have told us
often enough, half the battle lies in knowing your pitfalls. Once you know the traps you
are likely to fall into, you can avoid them or at least allay them. What are the lessons
from these in managing your finances?

Personality issues :

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We react in different ways risk averseness. And decision making under stress. But we
don’t have the same pattern for risk behaviour; we exhibit anomalies or contrariness in
our behaviour to risk.
Some of the problems of interpreting human behaviour in the face of risk have to do with
the problems of people making decisions on the basis of suggestive assessments of
probabilities which may be quite different from objective or true probabilities.
Events of small probability that have never occurred before may be assessed as having a
zero probability in decision making, but this leads to tragedies.
Some of the problems of interpreting human behaviour in the face of risk have to do with
the problem of people making decisions on the basis of subjective assessments of these
probabilities which may be quite different from the objective or true probabilities. To the
educated trader, personal psychology is the real difference between winning and loosing.
One of the many issues to examine within your personal psychology is your particular
personality.
Every time you loose money, think : your personality is loosing you the money, not the
market. If every time you mis-time the market in your irrational exuberance or cutback
just when you are on threshold of making a killing, it is your self sabotaging personality
that is causing it. While it is perfectly respectable and normal to make mistakes initially,
till you get a feel for trends, you need to watch out id you are making same mistakes.
How far ahead have you got in your learning curve? But what isn’t so obvious is that your
personality also determines what investing mistakes he or she is most likely to make.

Where does one fit in?

These investors are least likely to say they waited too long to start investing or that they
haven’t invested enough. Moreover, they are least likely to be plagued by emotions such
as fear and anxiety that commonly cause investment mistakes.
Reluctant investors don’t particularly enjoy investing and prefer to spend as little time as
possible managing their holdings. Not surprisingly that group was the most likely to have
financial advisor. They are least likely to become overly attached to an investment or to
put too much money into a single holding.
Competitive investors enjoy investing are informed and try to beat the market. They are
most likely to have started investing early, to put enough money into their investments
and to invest regularly. On the down side, their enthusiasm for investing can be their
undoing. They have a hard time letting go of loosing investments, often dedicate too
much of their portfolio to one stock and tend to be greedy logging on frequently to hot
stocks.
Last, there are the unprepared investors, who have no control over their investment
strategy. Lacking confidence they are the kinds who push the accelerator when they
should be breaking.

Common errors :
Some mistakes in investing commonly seen and those that need to be avoided are :
1. Over confidence : Researchers have found that people consistently overrate their
abilities, knowledge, and skill - especially in areas outside their expertise. So look for
good advice from an objective source.
2. Anchoring and adjusting : Did you know that in considering a decision we often give
disproportionate weight to the first information we receive, hence anchoring our

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 subsequent thoughts? Imagine the wrong information and its consequences. Multiple
information sources often mitigate this flaw.
3. Framing : The decisions of investors are effected by how a problem, or a set of
circumstances, is presented. Even the same problem framed in different, and
objectively equal, ways can cause people to make different choices. Framing, too,
plays central role in assessing probabilities.
4. Irrational escalation of a commitment : Investors tend to make choices that justify
past decisions even when circumstances change. So only consider future cost and
benefits.
5. Confirmation trap : We all fall into the trap of seeking out information that supports
our existing points of view while avoiding information that contradicts our opinion.
6. One must also understand how one tends to react under stress. People with different
personality profiles behave in dissimilar ways when stressed. Here again self
awareness and some basic techniques to offset sub-optimal behaviour go a long way.
Here’s what you can take away from here : some probabilities add up when chances
are taken repeatedly. So one can take a test. Self introspection and seeking
professional guidance will go a long way in managing one’s wealth better.

Emotional involvement :
A third disturbing error that emotionally charged investors make is falling in love with
their investments. Undoubtedly, long-term equity investment is handsomely rewarding.
Maybe someone has owned a fund or stocks for many years. Perhaps the fund was a
winner for five years, but in the last three, it doesn't even keep pace with its peers. Or
possibly, one can't stand the thought of taking a loss, determined to break even.
Despite the obvious need to sell one’s lemon, cut bait and get those proceeds in a higher
value alternative, the average investor buys-n-holds at his/her own peril. On the other
hand, smart investors set their objectives from individual investments and understand
under what conditions they will sell.
There's nothing wrong with expressing feelings about investing, so long as they don't
interfere with the decision-making process. Celebrate, mourn, fear, and get greedy. But
these things are best avoided until after the decision to buy, sell, or hold has been made.
All the best minds seem to come to the same, simple conclusion when it comes to the
best way to invest - pick an allocation, invest money with clearly stated objective, track it
periodically and over the long haul & one can do better than 90% of the money
managers. Do the jobs, open a business, or use the time any way one wants. Just invest
the money, leave it alone, add to it regularly and let it compound. This is vital stuff we
should be taught in our schools, as we are too soon old and smart too late!

THE RISK FACTOR :

We all know that any MF Scheme can’t be judged by its past returns or performance
alone. A particular scheme may perform well in one quarter or a year but may falter in
another. So, what really matters is the consistency of returns (which indicates the risk
level). The higher the fluctuation, the higher is the risk level. Therefore, to assess this
risk level, and to ensure that there’s no mismatch between the investors’ risk appetite
and inherent investment risk involved, one can make use of several financial tools such
as discussed in the following :
1. BETA : Beta is a statistical tool, which can give an idea of how a scheme will move in
tandem with the market. If the Sensex moves by 20%, a scheme’s beta number will
tell if the scheme’s returns will be more than this or less. The beta value for an index
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 is taken as a reference which is 1. This shows that a scheme with a beta more than 1
will rise more than the market, and also fall more than the market meaning that it is
more volatile than a scheme with a beta of less than 1. Beta can be a useful tool for
creation and management of the portfolio of an investor. A person with low risk
appetite should be advised schemes with a low beta as it will reduce his risk
exposure. Whereas for an investor looking at returns above market should be
advised scheme with a higher beta.
2. R-SQUARED : The R-squared value is a statistical figure, which indicates how reliable
the beta of a scheme is. It varies between 0 and 1. An R-squared value of 1 indicates
complete correlation with the index. Thus, an index scheme investing in the Sensex
should ideally have an R-squared value of 1 when compared to the Sensex. For
equity diversified schemes, an R-squared value of more than 0.8 is generally
expected to mean that the underlying beta value is reliable and can be used for the
scheme. Beta and R-squared should thus be used together when examining a
scheme’s risk profile.
3. STANDARD DEVIATION : Standard deviation measures the total risk associated with a
MF Scheme. It measures to what extent the actual returns offered by the scheme
varies from average values and the extent of variations. Here also a fund with a low
Std Dev. Can be offered to risk averse investors whereas those with a higher std dev.
can be recommended to investors to higher risk capacity.
4. SHARPE` RATIO : mathematically the Sharpe` ratio is the return generated over the
risk free rate of return (return offered by the Govt. security which carries zero-risk).
To calculate Sharpe` ratio, one has to take a scheme’s returns in excess of the risk
free return and divide by the std dev. of those returns. As std dev represents the
total risk experienced by a scheme, the Sharpe` ratio reflects the returns generated
by undertaking all possible risks. It is thus one single number, which represents
trade-off between risks and returns. A higher Sharpe` ratio is therefore, better as it
represents a higher return generated per unit risk.
5. TREYNOR RATIO : The aim of the Treynor ratio is to analyse the returns generated in
relation to the market risk of the fund. It’s also known as the “reward to volatility”
ratio. It’s similar to the Sharpe` ratio except that it uses beta to measure the
quantum of risk. Higher the Treynor ratio, the better is the scheme’s performance.
Sharpe` and Treynor ratio will enable you to decide which scheme in a position to out
perform the market but at the same time adopts relatively good risk management
practices.
6. CONCLUSION : A clear understanding of the scheme type, its investment objective
and assessing the risk inherent in the scheme will help towards a sound investment
decision.

The Versatility of Mutual Funds :

Simplicity Of The Mutual Funds

This means that financial products must be simple, straightforward and easy to
understand as far as possible. For example, just about the only 'investment' that is
suitable as the way for a small child to save pocket money till the next month is to keep
it in a box. The money is there, and when the kid needs it, it can take it out. This is as
simple as that.
This need for simplicity can actually be extended much further. All investments are of
two types-debt or equity. By themselves, debt or equity is very straightforward. Debt is
the simpler of the two. If one gives a loan to somebody who can put it to some use, like a

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bank or some other business, for example. After sometime, this money, plus a little
extra, is returned to him. Equity is almost as simple. Someone wants to run a business
but doesn't have enough money. So another contributes some money and becomes a
business partner, in proportion to the money he has contributed. So if one per cent of the
money is his then one per cent of the profit is his and so on.
In practice, debt and a equity (specially equity) are slightly more complex but if one
keeps a clear-head there's nothing that can't easily be boiled down to the basics. There
could be different ways of actually investing but it all comes down to debt or equity. For
instance, the provident fund is just a loan given to the government. And mutual funds
are really not an investment at all but and entity to whom the investors give the task of
investing for them.

Managing own funds :

In reality, investment management is an activity that can be as simple as one wants it to
be. At the most the investment needs of most of us would be served by choosing two or
three mutual funds, investing regularly in them and then just taking an annual look at
them. And how is an investor to learn enough to do this much? There's plenty of
information available on the Internet and in books and magazines, if only one goes out
and looks for it.
The key to getting quality information is not to rely on those who are selling you the
funds. Just like buying anything from TVs to cars to vacations, one must seek out
independent, uninterested sources of information, rather than swallow salesmen's hype
disguised as advice. While there are many sincere individuals who are running a small,
honest fund sales business in their neighbourhoods, it's wiser to be sceptical of the hype
that emanates from larger branded players in the 'organised' sector.
And as for management of investments that one has already made, what needs to be
done is even simpler. Twice a year, it’s to be checked whether the mutual funds one
owns are doing roughly as well as most of their peers (the same kind of funds). It’s not
necessary to have to have funds whose past performance is absolutely the best (in fact it
is dangerous to do so). As long as they are better than perhaps two thirds of other funds
(that is, they are in the top third), it's fine. Funds that don't make this grade for a year or
two should be sold off and replaced with similar funds. The information that one needs to
make these decisions is easily available in many newspapers, magazines and websites.

Monitoring one’s own investments :

Most people think that once they invest in a fund, the job of taking care of their
investments has been successfully passed on to the fund manager. Conceptually nothing
wrong but a dangerous strategy to adopt.
The performance of a fund, especially equity-oriented funds, is to quite an extent
dependant on the calls of the fund manager. Hence, if your fund manager quits, the
investment style may change, and the fund's performance could suffer. Hence, you
should carefully monitor the fund's performance any time such changes occur, and exit
the fund if its performance dips drastically.
How does one keep track of your fund's performance? All AMCs provide the investors
with their annual report, a half-yearly report (unaudited results) and a quarterly fact
sheet/newsletter. Over and above this, public disclosure of the NAV of a scheme happens
on the AMFI website, on the AMCs own website, as well as in the financial dailies. While
NAV information tells you very little other than how well your investments are doing, it is
basically the portfolio disclosure that happens through the newsletters and AMC reports

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that one should be interested in. Also, the fund's performance vis-à-vis its benchmark
and its peers (at least to the extent possible) can be easy to gauge.
The fund manager will not tell the investors when to exit the fund. This is something the
investors will have to decide, based on the information available. So, keeping track of the
fund's performance is a prudent job. After all, it's the investors’ money and they should
know what the fund is doing with it.

Zero Risk
One can classify two major sources of problems: One, investing without thinking enough,
and two, thinking too much about investments. We all know at least a few
hypochondriacs who continuously suspect themselves to be suffering from dangerous
illnesses and require frequent visits to specialists and get exotic medical tests done to
allay their fears.
By this process, deciding on an asset allocation starts by figuring out how risk-averse one
is and how much risk he is willing to take to get the returns he wants. This sounds so
logical and systematic but is actually completely useless. Professional investors who are
investing other people's money may be able to find out their location on a risk-vs.-return
continuum, but at the back of their mind, everyone else wants zero risk. And guess what,
zero risk is effectively possible if one does asset allocation the right way.
The key to really figuring out asset allocation is simply to make a rough time table of the
future, one where the investor can try and lay down when he will need how much money.
Now, what one needs to understand is that over some time horizon, most asset types
turn zero risk, or as least as close to it as humanly possible. What you need to do is to
match your investment time horizon (and not some theoretical risk level) to the asset
type. Assets like bank FDs and cash mutual funds are always zero risk, short-term
income funds are zero risk after six months, and a good stock portfolio like a well-chosen
set of diversified equity funds are close to zero risk after maybe seven years.

Advice of an investment guru :

Every year, some of those interested in absorbing some unusually astute common sense
about business and investing eagerly await the release of Warren Buffett's annual
address to his company's shareholders. Buffett is often regarded as the greatest
investors in the world. Buffett's importance lies in the way he invests, and in what he
says and writes about business, investing and even life. These are the words of the
world’s biggest investor.
Buffett's annual address to his shareholders and the answers he gives to their questions
at Berkshire's annual meetings contain a great deal of common sense that adds up to an
uncommon amount of investing wisdom. This year, in response to an investors' question
he repeated something he first said during the tech boom, that he does not invest in
businesses he does not understand. Think carefully about what the old man is implying.
He is saying that even if there is a great investment, he will not invest in it unless he
personally understands it. Otherwise, one will just end up proving what Buffett once
said : The stock market is designed to transfer money from the active to the patient.

Conclusion :
The flexibility of investing is so vast, one can only feel and experience. Several of these
are explained in the foregoing paragraphs. We can summarise safely that whatever the
kinds of investors there are, there always is an MF scheme most suitable for them. Some
of these are given in the following :

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1. The Returns : The MF is suitable for both savings and investment. They are similar in
all respects except that for investment the returns are more than 25% p.a. (This is a
thumb rule and supported by most financial experts. Since the expected returns from
an MF Scheme varies between 3% to over 30% p.a., it affords different returns to
different kinds of investors.
2. The Risks : The MFs have different risk profiles that can match individuals’ personal
risk appetite. Any investor can choose one according to one’s own preferences and
requirements. This is because risks are associated with retunes - more the return, the
more the risk involved.
3. Flexibility : The savings or investments are done with ease and at one’s own sweet
will. The entry is only restricted to a small fees, and so is the exit. In India we have
around thirty MF Fund Houses (AMCs) who have close to eight hundred schemes to
choose from, out of which there are around a hundred good ones. An investor can
change (switch) at any point of time from any scheme to another.
4. Tenure : The options for tenure or the period of investment varies from virtually one
day to the life time of the investor.
5. Procedure : These are very simplified ones. With the advent of modern day gadgets
and communications and networking systems, transaction of money has become
virtually effortless and fast. These include ECS clearing, direct credit/debit, SIP, STP,
SWAP etc.
6. The Life Cycle and Wealth Cycle Stages : There are always schemes that are suitable
for various stages of life cycle wealth cycle.
7. Speculation and Safety : One can go to any length to opt for higher returns without
getting into the complexities of stock markets, and of course with some amount of
safety.
Thus the versatility of the Mutual Funds is proved beyond doubt.
References :
The following sources of information were used as direct inspiration while writing this
article :
1. Articles by Mr Dhirendra Kumar, CEO, Value Research Online,
2. HDFC MF News Letter, Sep-2006 issue, Article by S Luthra,
3. Kotak MF News Letter, Sep-2006 issue,
4. Kotak MF Presentation,
5. Mutual Fund Fundamental Concepts by SEBI,
6. Value Research Online Website,
7. Websites of AMFI, SEBI,
8. Websites of BSL MF, HDFC MF, Franklin Templeton MF, etc.,

Acknowledgement :
The author expresses his heartfelt gratitude to the respective authors of these
information sources.

Compiled by Himansu S M / Written Jan-2007, Published Feb-2010

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