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Preparatory Material for NISM-

Mutual Fund Distributors’ Examination

This material is a summary of the classroom training content of CIEL’s training program for NISM-MFD
Examination. c) 2015, Centre for Investment Education and Learning Pvt. Ltd. www.ciel.co.in 1
CHAPTER 1 - CONCEPT AND ROLE OF A MUTUAL FUND (6 Marks)

1.1 Introduction
 A mutual fund is a collective investment vehicle, which pools investors’ money and
invests it.
 Those who contribute to the pool are the ones who get the benefit (mutuality
principle).
 Benefits accrue in the proportion to the investors’ share in the pool.
 A mutual fund product is described by its investment objective that defines the risk
return profile of the fund.
 Before investing, investors match their objectives with the funds’ investment
objectives.
 Mutual funds offer different “schemes” with different investment objectives for
investors.
 Every mutual fund scheme holds an investment portfolio. A portfolio is a collection
of securities.
 Mutual funds can invest only in marketable securities.
 The mutual fund portfolio has to be marked to market. ‘Marking to market’ is a
process of using market price to value the investment portfolio.
 Value of the investment portfolio changes with a change in market price of the
securities.
 Mutual funds are first offered to an investor in a NFO (New Fund Offer).
 Unit capital is the corpus of the fund and is calculated as number of units * face
value.
 Assets Under Management (AUM) of a mutual fund is calculated as Market value of
portfolio + current assets
 A mutual fund does not hold any long-term assets or liabilities.
 Net assets are calculated as Market value of portfolio + current assets – Current
liabilities – Accrued expenses.
 Net Asset Value (NAV) is the value per unit at current market prices and is
calculated as net assets divided by units outstanding.
 The net assets of a mutual fund may go up or down due to various reasons. Some of
them are:
 entry or exit of investors
 income from dividends or interest
 expenses
 realised gains or losses
 unrealised gains or losses.
 Following are the advantages of mutual funds:
 Portfolio diversification
 Low transaction cost
 Professional fund management
 Higher flexibility
 Protection of investor interest

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 Tax advantages
 Liquidity
 Systematic investments
 Following are limitations of mutual funds:
 Portfolios are not customised or personalised to each investor
 Too many product variants
 No control over costs.

1.2 Mutual Fund Products


 Open ended funds do not have a fixed maturity date. These funds accept continuous
sale and re-purchase requests at fund offices and ISCs.
 Transactions of open ended funds are NAV-based. Unit capital of this kind of fund is
not fixed.
 Closed end funds run for a specific period and are offered in an NFO but are closed
for further purchases after the NFO.
 Closed end funds are required to be compulsorily listed on a stock exchange, in
order to provide liquidity. Unit capital if a closed end fund is kept constant.
 Interval fund is a variant of closed-ended funds. These are primarily closed-ended
but become open-ended at specific intervals. Minimum duration of interval is 15
days.
 Specified Transaction Period (STP) is the duration when they become open-ended.
The minimum STP is 2 days, no redemption allowed except during STP.
 Interval schemes also have to be mandatorily listed.
 Debt funds invest in short and long term debt instruments with an objective of
earning regular income.
 Equity invest in equity securities for capital appreciation.
 Hybrid funds invest in a combination of equity and debt for both income and capital
appreciation.
 Equity funds have a greater degree of risk as compared to a debt funds
 Liquid funds are the least risky, as they invest in very short-term securities
 Active funds seek to invest in securities and sectors that may offer a better return
than the index.
 Active funds manage the allocation to market securities and cash and may perform
better or worse than the market index. Active funds incur a higher cost than passive
funds.
 Passive funds replicate a market index. They invest in the same securities and in the
same proportion as that of the index. An index fund replicates the index.
 Investment management of a passive fund does not involve active stock or sector
selection. Hence, expenses of a passive fund are lower than that of an active fund.
 Portfolio of a passive fund is modified each time the index composition changes.
Index fund is an example of a passive fund.
 Performance of passive funds with their peers is measured with the help of tracking
error.

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 Equity funds are recommended for the long term (five years and above)
 Balanced funds are recommended for three years and above
 Income funds are recommended for medium term (one year and above)
 Short term debt funds are recommended for the short term (up to one year)
 Liquid funds are recommended for ultra-short periods (up to a month)
 Equity funds invest in equity shares; Debt funds invest in debt securities;
 Money market funds invest in money market securities; Commodity funds invest in
commodity-linked securities;
 Real estate funds invest in property-linked securities; Gold funds invest in gold-
linked securities
 Money market or liquid funds invest very short term maturity debt securities with
less than 91 days to maturity.
 Primary source of income for money market or liquid funds is interest. Marking to
market is not followed for securities less than 91 days to maturity.
 Money market or liquid funds ensure safety of principal and offer superior liquidity.
These funds are used primarily by large corporate investors and institutional
investors.
 Floating rate funds invest largely in floating rate debt securities. Primary source of
income for these funds is interest income which is in line with the market interest
rates.
 Because of their nature, these floating rate funds have lower mark to market risk.
Floating rate funds are attractive when the interest rates are rising.
 Cash or Treasury Management Funds are similar to liquid funds. These funds
choose securities with slightly longer tenor of up to 364 days.
 Gilt funds invest in government securities of medium and long-term maturities.
Since investment is made in government securities, there is no risk of default.
 Gilt funds are exposed to interest rate risk, depending upon maturity profile.
 Income funds invest in medium-term and long-term securities issued by the
government, banks and corporate.
 Income funds enjoy the benefit of higher coupon. These funds are exposed to higher
credit risk. Due to long term orientation these funds are also exposed to high
interest rate risk.
 Maturity profile of a dynamic bond fund varies according to the interest rate view.
 High-yield debt funds seek higher interest income by investing in debt instruments
that have lower credit ratings. These funds are also known as ‘junk bond funds’ and
are not permitted in India.
 Fixed Maturity Plans (FMPs) are closed-end funds that invest in debt instruments
with maturities that match the term of the scheme. On maturity the debt securities
are redeemed and paid to investors. FMPs carry no interest rate risk. These
schemes are ideal for investors looking for predictable return.
 Short term plans combine long and short term debt securities. These funds earn
interest from short term securities and capital gains from long term securities.
 Diversified equity funds invest in equity shares across various sectors, sizes and
industries and are less risky compared to other equity funds.

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 Thematic equity funds funds follow a particular theme and invest in multiple sectors
and stocks falling within that theme. These funds are less diversified than a
diversified equity fund.
 Sector equity funds invest in a given sector. Sector funds are concentrated funds
and feature high risk because sector performances tend to be cyclical.
 Focused funds are equity funds that restrict portfolio to a particular number of
selected securities. These funds have selection risk.
 Growth funds invest in companies whose earnings are expected to grow at an
above-average rate.
 Value funds identify stocks of good quality companies whose real worth has not
been realised yet.
 Mid-cap and Small-cap funds focus on smaller and emerging companies for their
higher growth potential.
 Dividend Yield Funds/Equity Income Funds: These funds invest in companies that
have a high dividend yield.
 Dividend yield funds are attractive in bearish and over-valued markets due to less
volatility and regular dividend income.
 Index funds are passive funds based on equity indices.
 Equity-Linked Savings Scheme (ELSS) offers tax benefits u/s 80C of the Income Tax
Act. Investment up to Rs. 150,000 in a year in such funds can be deducted from
taxable income of individual investors.
 An ELSS scheme must hold at least 80% of the portfolio in equity securities. ELSS
schemes have a lock-in period of 3 years from the date of investment.
 Rajiv Gandhi Equity Savings Scheme provides 50% deduction for investments in
RGESS compliant schemes upto Rs. 50000 over a period of 3 consecutive years to
new retail investors with income not more than Rs. 12 lakh per annum.
 Monthly Income Plans (MIPs) are debt oriented schemes with smaller allocation to
equity (5% to 25%). These funds offer periodic distribution of dividends, though
there is no assurance of such payout.
 Balanced funds are equity-oriented hybrids that invest up to 65% in equity.
Balanced funds are aimed at investors who seek growth from equity but want
protection from volatility.
 Asset Allocation Funds are dynamic funds that can change proportion between debt
and equity depending upon market outlook.
 Capital Protection-Oriented Funds invest in debt securities with a derivative
instrument or equity shares. These funds structure a portfolio such that ‘Amount
invested + Interest = Investor’s principal’.
 Fund of Funds (FOFs) invest in funds of same fund house or various fund houses
(Multi-manager).
 An FoF scheme chooses funds according to its investment objective. Fund of fund
schemes have two levels of expenses - underlying fund level and FoF level.
 International Funds invest in foreign securities or foreign funds. A ‘Feeder‘fund ties
up with the ‘Host’ fund in a FoF structure. An investor who has invested in an

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Examination. ©2015, Centre for Investment Education and Learning Pvt. Ltd. www.ciel.co.in
international fund investing in US securities will benefit when the dollar depreciates.
NAV of an international fund is affected by changes in forex rates.
 In an international fund, weakness in the foreign currency can adversely impact the
total return to the investor. Appreciation in the foreign currency will boost portfolio
performance.
 Arbitrage funds take equal and opposite exposure in the spot and future markets.
These funds earn a return due to difference in price in the two markets. Arbitrage
funds carry low risk and return similar to debt funds.
 Exchange Traded Funds (ETF)are open-ended funds that track a market index. Units
of ETFs are listed like shares on the stock exchange.
 Sale and re-purchase transactions of ETFs are executed on stock exchange using
demat. accounts. Transactions are executed at market prices, which may be
different from the NAV.
 In India, direct investment in commodity futures is not allowed. Indian commodity
funds usually invest in stocks of commodity companies or commodity ETFs.
 Gold Funds are structured as ETFs.
 A REIT is a fund investing directly in real estate through properties or mortgages.
Regulations for launching REITs in India are yet to be passed.
 Infrastructure debt funds invest 90% of their assets in debt securities or securitised
debt instruments of infrastructure companies.
 InvITs are trusts registered with SEBI that invest in the infrastructure secto

1.3 Role of Mutual Funds


 Mutual funds offer products that enable access to various markets to investors.
 With respect to the issuers of various securities, mutual funds are institutional
investors seeking better return, lower risk.
 The mutual fund industry is competitive and well-regulated.
 Mutual funds have grown from a single player (UTI) in 1964 to 43 players.
 There are about 1985 mutual products in the market.
 Public sector mutual funds came in 1980s and the private/foreign funds came in
1990s.
 About 60% of assets are in short term debt funds, favoured by institutional
investors.
 Regulators and the mutual fund industry have taken various measures to increase
retail participation.
CHAPTER 2 - FUND STRUCTURE AND CONSTITUENTS (4 Marks)

2.1 Structure of Mutual Funds


 Mutual funds have a three-tier structure of Sponsor-Trust-Asset Management
Company.
 Sponsor promotes the mutual fund and sets up the AMC. Sponsor’s role is similar to
that of a promoter of a company.
 Sponsor appoints the Board of Trustees and Board of Directors of the AMC. Sponsor
seeks regulatory approval for launch of mutual fund.

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 In order to be a sponsor, SEBI has laid down eligibility criteria as follows:
a. At least 5 years experience in the financial services industry
b. Positive net worth over the last 5 financial years
c. Profits over the last 3 out of 5 years
d. At least 40% contribution to the capital of the AMC.
 Mutual fund is structured as a trust, overseen by a Board of Trustees. Trustees are
appointed by the sponsor with SEBI approval.
 Trust deed is executed by the Sponsor in favour of the trustees. Trustees can be a
Board of Trustees or Trustee Company. Working of a Trustee company is handled by
its Board of Directors.
 Investors in the mutual fund are beneficiaries of the trust. Trustees must act on
behalf of the investors.
 Sponsor must appoint at least 4 trustees. At least 2/3rds of the members have to
be independent.
 Trustees appoint the AMC to manage the affairs of the fund. The Board of Trustees
oversee the working of the AMC and management of the mutual fund.
 Key decisions of the AMC require trustee approval. Trustees meet at least 6 times in
a year.
 Asset Management Company (AMC) is the investment manager of the mutual fund.
AMC is appointed by the Trustees, with SEBI approval.
 Investment Management Agreement is executed between the trustees and the AMC.
 An AMC should have a net worth of at least Rs.50 crore at all times.
 AMCs in existence before May 2014 have to comply with the net worth requirement
of Rs. 50 crores within 3 years of the date of the SEBI circular.
 At least 50% of members of the board of an AMC have to be independent.
 The AMC of one mutual fund cannot be an AMC or trustee of another fund.
 AMCs cannot engage in any business other than that of financial advisory and
investment management.
 An AMC must invest seed capital of 1% of the amount raised subject to maximum of
Rs.50 lakh in all open-ended schemes through the lifetime of the scheme.

2.2 Mutual Fund Constituents


 AMCs appoint other external agencies to support the functions of the mutual fund.
These are called constituents. The following table shows the summary of the role of
each constituent:
Constituent Role
Custodian Hold funds and securities
R&T Agent Keep and service investors’ records
Banks Enable collection and payment
Auditor Audit scheme accounts
Distributors Distribute fund products to investors
Brokers Execute transactions in securities
Fund Accountants NAV calculation

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 Mutual fund constituents (except custodians) are appointed by the AMC with the
approval of the trustees.
 All mutual fund constituents have to be registered with SEBI. They are usually paid
fees for their services.
 An R&T Agent is responsible for issue and redeeming units and updating the unit
capital account.
 R&T Agent accept and process investor transactions such as purchase, redemption
and switches. They create, maintain and update investor records.
 R&T Agents are responsible for bank the payment instruments given by investors
and notifying the AMC.
 R&T Agents process payouts to investors in the form of dividends and redemptions
and send statutory and periodic information to investors.
 A custodian holds cash and securities of the mutual fund.
 Custodian is appointed by the Trustees and is the only constituent NOT directly
appointed by the AMC.
 A custodian must be independent of the sponsor and its associates.
 Functions of the custodian include delivering and accepting securities and cash,
tracking and completing corporate actions and payouts on the securities, and
coordinating with the depository participants(DPs).
 Custodial functions cannot be done in-house by the AMC.
 Distributors are appointed by the AMC in order to sell mutual fund units to investors.
 Distributors enable the reach of mutual fund products across geographical
locations.
 Commission is paid to distributors on sale of mutual fund units. There’s no
exclusivity in mutual fund distribution.
 Sponsor and its associates may act as the distributors of the fund.
 Brokers execute buy and sell transactions of the fund managers.
 Banks provide collection and payment services. Payment instruments are collected
in mutual fund scheme accounts.
 Banks carry out redemption and dividend payments.
 Auditors audit the books of the mutual fund.
 Account of each mutual fund scheme is kept separately.
 Auditors of mutual fund are different from auditors of the AMC.
 To avoid duplication of KYC formalities by the client every time they open an account
with a Sebi-registered intermediary, Sebi has introduced the system of KYC
Registration Agencies (KRA).
 Intermediaries include mutual funds, DPs, stock brokers, portfolio managers,
venture capital funds and collective investment schemes.
 The KRA is a centralized agency which will maintain and make available the
information provided by a client to an intermediary to comply with the KYC norms.
 The intermediary has to upload the information onto the KRA system and dispatch
the supporting documents. The KRA will send a letter to the investor within 10 days
of receipt of the same confirming the details. Subsequent account opening by the

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client with any other intermediary will just require the information to be downloaded
from the KRA system and verified.
 Sebi has also mandated an In Person Verification (IPV) of the client by the
intermediary with whom the client conducts the KYC formalities. The name,
designation, organisation and signature of the person doing the IPV should be
recorded on the KYC form.
 The AMC and distributors who are KYD compliant are authorised to conduct IPV of
mutual fund investors. In case of direct applicants, IPV conducted by a scheduled
commercial bank can be relied upon.

CHAPTER 3 - LEGAL AND REGULATORY FRAMEWORK (10 MARKS)

3.1 Key Agencies in Regulation


 SEBI is primarily responsible for safeguarding the interests of the investors.
 Indian mutual funds are supervised and regulated by SEBI (Mutual Funds)
Regulations, 1996.
 SEBI issues amendments and circulars to the regulations from time to time.
 SEBI was set up by the SEBI Act, 1992 and is supervised by the Ministry of Finance.
 All the mutual fund constituents such as registrars, custodians, brokers, collecting
banks must be registered with SEBI.
 Distributors have to clear the mandatory certification prescribed by SEBI.
 AMC and Trustee company are also governed by the Companies Act and Indian
Trusts Act respectively.
 RBI regulates banks in India. Banks can act as sponsors, custodians, bankers and
distributors of mutual funds.
 Mutual funds also invest in money market instruments and g-secs.
 Money and debt markets are regulated by RBI and to that extent, mutual funds are
subject to regulations laid down by RBI.
 Mutual funds enter into listing agreement with stock exchanges for closed-ended
funds/ETFs that are listed on stock exchanges.
 They are subject to regulatory and disclosure requirements laid down in the listing
agreement.
 AMFI is an industry association. It is not a Self Regulating Organisation (SRO). It
cannot form rules of its own. An SRO is set up by a statutory body which sets out
policy framework, leaving micro regulation to SRO.
 AMFI is responsible for recommending best business practices and code of conduct
for members. It represent the industry to regulators and policy makers.
 AMFI conducts conduct investor awareness programmes and disseminates
information on mutual funds.
 AMFI Code of Ethics (ACE) sets out guidelines for mutual fund’s relationship with
investors, intermediaries and the public. It has been adopted by SEBI as a part of
the mutual fund regulation.

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 AMFI Guidelines and Norms for Intermediaries (AGNI) is a code of conduct for
mutual fund intermediaries.
 Distributors have to pass the NISM exam and get register with AMFI in order to get
the AMFI Registration Number (ARN).
 AMFI can issue notice, impose penalties and cancel the registration of distributors.

3.2 Guidelines on Unauthenticated News

 Market intermediaries to have internal code of conduct and controls to not


encourage or circulate rumours or unverified information obtained from client,
industry, any trade or any other sources without verification.
 Access to Blogs/Chat forums/Messenger sites etc. should either be restricted under
supervision or access should not be allowed.
 Logs for any usage of such Blogs/Chat forums/Messenger sites shall be treated as
records and the same should be preserved.
 Employees can forward any market related news received by them either in their
official mail/personal mail/blog or in any other manner, only after the same has
been seen and approved by the Compliance Officer.

3.3 Distributor Due Diligence

 AMCs are required to put in place a due diligence process to evaluate distributors at
the time of empanelment and subsequent review
 The due diligence initially will be applicable to those distributors satisfying one or
more of the following conditions :
a) Multiple point presence in more than 20 locations.
b) AUM raised over Rs.100 crore across industry in the non-institutional category
but including high net worth individuals (HNIs).
c) Over one crore p.a. received as commission across industry.
d) Over Rs 50 lakh received as commission from a single mutual fund.
 The distributors will be evaluated on the following aspects:
a) Experience and proficiency in the business.
b) History of regulatory compliance and conduct
c) Checks and balances to delink sales and client relationship from the process of
customer risk and mutual fund scheme evaluation processes.
d) Process for periodic review and categorization of products and risk profile of the
investors.
 Customer relationship and transaction to be categorised as “Advisory” and
“Execution only”.
 Advisory: Where a distributor offers advice while distributing a product based on
its suitability for the investor’s risk appetite and need.
 Execution only: Where transactions are conducted despite the unsuitability of
the product to the investor’s requirements being communicated to the investor.

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No fee to be charged on such transactions except transactions charges as
applicable.
 Compliance and Risk Management process of distributor should have processes for:
a) Criteria used for review of products, periodicity of review.
b) Factors for determining risk appetite of customer.
c) Review of transactions, exceptions, escalation and resolution process by
internal audit.
d) Recruitment, training, certification and performance review of all personnel
engaged.
e) Customer on-boarding, relationship management process, service standards,
grievance handling mechanism.
f) Internal/external audit process, their comments and observation relating to the
MF distribution business.
g) Findings of ongoing review from sample survey of investors.

3.4 Rights of Investors


 NAV and Sale and Purchase prices should be disclosed on AMFI website by 9pm
every business day. FoFs can publish their NAV by 10 am of the next business day.
 NAV should be published in at least 2 newspapers with nationwide circulation.
 Detailed portfolio disclosure in the prescribed format should be made every 6
months within one month of the close of half-year.
 Closed-end debt funds and interval funds have to publish their portfolios on website
within 3 working days of every month-end.
 It is a voluntary industry practice to disclose summarised portfolio to unit holders
every month through the factsheet
 Key documents of mutual fund and AMC may be inspected by investors such as
Trust deed, Investment management agreement, Custodial services agreement,
R&T agreement, Memorandum of Association (MOA) & Articles of Association (AOA)
of the AMC.
 Mutual funds have to report annually the number of investor complaints under
specific heads and extent of redressal of complaints received.
 AMCs to provide investors the option of receiving scheme annual accounts or
abridged summary through email. If email-ID is not available, physical copies to be
sent to investors. Investors can ask for physical copies even if the email-ID is
registered with the mutual fund.
 In case of delay in dispatching dividend warrants or redemption proceeds, the AMC
has to pay the unit-holder interest at the rate of 15% p.a.
 Investors in whose folios transactions have taken place during a calendar month
should receive Consolidated Account Statement (CAS) by the 10th of the next month.
 CAS to be sent every half yearly (September/ March)by the 10 th of the next month
giving holding at the end of the six months, across all schemes of all mutual funds,
to all such investors in whose folios no transaction has taken place during that
period.

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 Soft copy of the Statement of Accounts shall be emailed to the unit holders instead
of a physical statement if mandated by investor.
 In case of open-ended funds, statement of accounts (SOA) to be dispatched within
5 working days (15 days in case of RGESS Schemes)from the date of closure of the
initial subscription list and/or from the date of receipt of the request from the
unitholders.
 In case of closed-end funds, the mutual fund should give an option to investors
either to receive the statement of accounts or to hold units in dematerialised form.
 AMC shall Issue SOA or issue units in demat within 5 working days of closure of
initial subscription of closed-end funds. On request of unitholder, AMC shall issue
units in demat form within 2 working days for a closed end scheme listed on a stock
exchange.

Summary of Service Standards imposed by Sebi

Transaction Turnaround Time

Allotment of units in a NFO (other than


5 days from NFO closing date
ELSS and RGESS)

Allotment of units in a ELSS and RGESS


30 days from NFO closing date
NFO

5 business days from NFO closing date (15


Refund of money
days for RGESS)

5 working days from closure of


Dispatch of Statement of account -
subscription list / request (15 days for
NFO or request by unitholder
RGESS)

10 days from end of each calendar month


Dispatch of Consolidated Account
if transaction has taken place during the
Statement (CAS)
month.

Dispatch of dividend warrants 30 days from date of dividend declaration

Dispatch of redemption proceeds 10 working days from transaction request

3.5 Redressal of Investor Complaints

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 Investor must first approach the Investor Service Centre (ISC). If not resolved, then
approach the personnel at senior levels in the AMC. If not resolved, then the
investor may approach Sebi.
 If the investor is not satisfied with the Sebi ruling, the investor may approach
Securities Appellate Tribunal (SAT)
 Mutual funds should annually disclose details of complaints received from all
sources on their website, AMFI website and in annual report.
 Compliant can also be initiated through SCORES (SEBI Complaint Redress System).
 SCORES is the Centralized web based system for lodging and tracking investor
complaints.
 Anyone who has a grievance against a listed company or against any market
intermediaries, can file a complaint using SCORES.
 The registered complaint is scrutinized by Sebi to determine if the subject matter
falls under their purview. If yes, it forwards the complaint to the concerned entity
with an advice to send a written reply to the investor and file an action taken report
in SCORES.
 The entity is required to submit action taken report within a reasonable period, not
later than 30 days.

3.6 Other Rights


 The mutual fund has to deploy unclaimed dividend and redemption amounts in the
money market.
 AMC can recover investment management and advisory fees on management of
these unclaimed amounts, at a maximum rate of 0.50% p.a.
 AMC is expected to make a continuous effort to remind the investors through letters
to claim their dues.
 The annual report has to mention the unclaimed amount and the number of such
investors for each scheme.
 If the investor claims the money within 3 years, then payment is based on prevailing
NAV i.e. after adding the income earned on the unclaimed money
 If the investor claims the money after 3 years, then payment is based on the NAV at
the end of 3 years.
 If an investor wishes to change his broker, a letter to the mutual fund indicating
change of ARN needs to be submitted by the investor. No NoC is required.
 Proceeds of the folio in the event of death will go to the nominee appointed by the
unitholder.
 Unit certificate is like a balance confirmation certificate and may be provided upon
request within 30 working days.
 Unit certificate is not transferable and only specifies number of units held by the
investor. It does not serve any operational purpose.
 Units shall be freely transferable either by act of parties (sale or gift of units) or by
operation of law (Transmission of units). Exception : ELSS Schemes during lock- in
period.
 Unitholders have an option to receive allotment of units in demat form is available in
all schemes. An option is provided to the investor in the subscription form for
providing demat account details.

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 Mutual funds co-ordinate with DP to provide demat statement to unit holders. Units
in demat form are also freely transferable.
 Mutual funds need to send a written communication to ALL unit holders about the
proposed change. An option to exit without exit load should be given to the unit
holders.
 A scheme can be wound up by a resolution by unit holders holding at least 75% of
assets in the scheme. Trustees can wind up the scheme by seeking consent of the
unitholders.
 If there is a change in sponsor or the AMC, an option to redeem without exit load
needs to be provided to the investors.
 The AMC or the sponsor do not directly hold the funds or securities belonging to the
investors. The Custodian is independent of the Sponsor.
 A unit holder cannot sue the Trust as the Trust is only a notional entity.
 Unit holders do not have recourse for ignorance. They are expected to have read
and understood the offer document before investing.
 A prospective investor has no rights with respect to the fund, the AMC or
intermediaries.
 Investors also have limited rights for redressal as they are neither shareholders nor
depositors. Investments cannot be protected and redressal of complaints is not
obligatory.

CHAPTER 4 - OFFER DOCUMENT (OD) (6 Marks)

4.1 Format and Content


 An offer document is a legal representation of the offer of the mutual fund scheme
to the investors. It is prepared before a new fund offer (NFO) and is approved by
Sebi.
 Sebi only vets the OD to ensure that all required information is provided. SEBI does
not approve or disapprove the offer document.
 It defines the contractual relationship between investor and the mutual fund.
 It is a vital source of information about the mutual fund and the scheme and
investors are expected to read and understand OD before investing.
 Format of the offer document is prescribed by SEBI. There are two components of
the offer document: Statement of Additional Information(SAI) and Scheme
Information Document(SID)
 SEBI has prescribed that the NFO period must be limited to 15 days, except in case
of ELSS and RGESS schemes the NFO can be upto 30 days.
 After NFO, open-ended scheme opens for re-purchase and sale after allotment.
Closed-ended scheme gets listed on stock exchange.
 Allotment must be completed within 5 days of NFO closure. Scheme must open for
transactions within 5 working days of allotment.
 Offer document of a new fund needs to be approved by the trustee and draft needs
to be filed with SEBI.

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 SEBI usually takes 21 days to clear offer document, subject to changes, if any. NFO
must be made within 6 months of SEBI clearance.

4.2 Statement of Additional Information (SAI) and Scheme Information Document (SID)
 The SAI contains generic information about the mutual fund and is common to all
schemes.
 SAI contains details of the sponsor and financial history, names and addresses of
the Board of Trustees, details of AMC, key personnel and Board of Directors of AMC.
 SAI also contains details of various fund constituents and investor service officer’s
details.
 SAI contains financial information of the mutual fund including performance of
existing schemes on yearly basis, scheme expenses and loads applicable.
 AI lays down the rights of investor. It is filed only once with SEBI in the prescribed
format.
 Material changes to the SAI need to be updated immediately. If there are no
material changes, SAI to be updated every year, with 3 months at the end of
Financial Year.
 SID is filed with SEBI for approval before launch of a new scheme. It contains
information specific to a scheme.
 SID contains information on scheme type (open or closed end), investment
objective, asset allocation, investment strategies, terms with regard to liquidity, fees
and expenses, benchmark for the scheme, and investment restrictions, if any.
 Projected returns cannot be shown in SID.
 SID contains mandatory disclosures and disclaimers, fundamental attributes and
risk factors pertaining to the scheme.
 SID includes borrowing policy of the fund, policy on inter-scheme transfers,
methodology of calculation of NAV, sale and purchase price.
 Operational details such as NFO period, plans, options and loads, NFO price and
basis for subsequent pricing are in the SID.
 SID also contains application process, minimum investment amount, investment
facilities such as SIPs, SWPs and switches, and eligibility of investors who can
invest.
 The date of commencing ongoing sale and re-purchase, maturity date, if scheme is
closed-ended, list of Official Points of Acceptance (OPAT) are details found in the
SID.
 An open-ended scheme’s SID must be valid at all times and updated version of the
SID must be available on the mutual fund’s website.
 Material changes to the SID need to be updated immediately.
 If there are no material changes, SID needs to be updated every year, within 3
months of the end of the financial year.
 Schemes launched after September 30 must update SID after next financial year
end.
 Mutual Funds issue an addendum to notify any change in the information provided
till such time they are incorporated in the SID or SAI every year.

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 Addendums have to be approved by trustees and notified to SEBI.
 Addendum must be published in two newspapers.
 Addendum needs to be prominently displayed on the notice board at the official
points of acceptance of application forms.

4.3 Fundamental Attributes and KIM


 Fundamental attributes are essential features of the scheme. Risk and return
parameters are defined by the fundamental attributes.
 Whenever a change is proposed to the fundamental attributes, it requires the
approval of the trustees and SEBI.
 Information about the change in fundamental sttributes should to be given to
investors with an option to exit the scheme without paying an exit load.
 Merger or consolidation of schemes shall not be seen as change in fundamental
attribute of the surviving scheme if the fundamental attributes of the scheme that
remains in existence after merger (surviving scheme) do not change.
 Mutual funds should be able to demonstrate that the circumstances merit merger or
consolidation of schemes and the interest of the unitholders of surviving scheme is
not adversely affected.
 Risk factors may be standard or scheme-specific.
 Standard risk factors apply across mutual fund schemes. For example “Mutual
funds are subject to market risk” is a standard risk factor.
 Scheme-specific risk factors apply to the specific scheme. For example risk factors
such as a scheme being the first scheme of a mutual fund or risk of concentration in
a sector fund are specific to a fund.
 Application forms contain abridged and concise version of the OD, known as Key
Information Memorandum (KIM).
 A KIM must accompany every application form. Format for KIM is prescribed by
SEBI.
 KIM must be updated at least once a year.
 KIM contains information such as NFO open and close date, investment objective
and asset allocation pattern of the scheme and scheme-specific operational details,
 The names of the AMC and trustee company, performance history of the scheme
and the benchmark for one, three and five years and since inception are in the KIM.
 Expenses and loads applicable to the scheme and investor services and rights are
also found in the KIM.

4.4 Additional Disclosures for Debt Schemes


 Closed-end debt oriented mutual funds to make the following disclosures:
a) Credit evaluation policy for investments in debt instruments
b) List of sectors in which the scheme will not invest
c) Type of instruments that the scheme would be investing in CDs, CPs, NCDs,
Treasury bills, Securitized debt etc.
d) Floors and ceilings within a 5% range of the allocation intended against each
sub-asset class and credit rating
e) Variations between disclosure list and final portfolio will not be permissible

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 Sebi circular dated September 13, 2012 has mandated mutual funds to make
following disclosures for debt schemes:
a) Total exposure in a particular sector not to exceed 30% of the net assets of the
scheme. This excludes investments in Bank CDs, CBLO, G-Secs, T-Bills and AAA
rated securities issued by Public Financial Institutions and Public Sector Banks.
b) Schemes were the above condition is not being met, must meet the same
within a year’s time from the issue of the circular.
c) Disclosures regarding the same should be made in both SID and KIM

4.5 Product Labeling of Mutual funds


 Mutual funds are required to ‘Label’ their schemes on the following parameters:
a) Nature of scheme in an indicative time horizon (short/medium/long term)
b) A brief about the investment objective (in a single line sentence) followed by
kind of product in which investor is investing (Equity/Debt).
c) Level of risk, depicted by ‘Riskometer’ as under:
o Low - principal at low risk
o Moderately Low - principal at moderately low risk
o Moderate - principal at moderate risk
o Moderately High -- principal at moderately high risk
o High - principal at high risk
d) A disclaimer saying: “Investors should consult their financial advisers if they are
not clear about the suitability of the product.
e) Product labels are to be disclosed in scheme advertisements and on the Front
page of initial offering application forms, KIM and SID.

CHAPTER 5 - FUND DISTRIBUTION AND CHANNEL MANAGEMENT PRACTICES (8 Marks)

5.1 Who can invest?


 Following types of investors are eligible to invest in Mutual funds:
 Companies & partnership firms
 Individuals & Hindu undivided families (HUFs)
 Trusts & charitable institutions
 Banks & financial institutions
 Non-banking finance companies (NBFCs)
 Insurance companies, Provident funds, Mutual funds
 Foreign institutional investors (FIIs), Non resident Indians (NRIs), Persons of
Indian origin (PIOs)
 HUFs can invest through Karta. Minors can invest through a guardian.
 Overseas Corporate Bodies (OCBs) and foreign citizens (except PIOs and QFIs) are
not eligible to invest.
 The ‘Who Can Invest’ section of the offer document of a scheme specifies the
categories of investors eligible to invest in a mutual fund scheme.
 The individual investor category includes retail investors, HNIs, minors and NRIs.
 Retail investors may depend upon the distributor to provide the information and
analysis. HNIs may demand a better quality of service.
 In case of institutional investors, investment in mutual fund must be approved by
the management committees and board of directors as the case may be.

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 Copy of Board’s resolution and charter of the institution are required to be
submitted to the fund house. Application needs to be signed by authorised
signatories.

5.2 Distribution Channels


 Independent Financial Advisors (IFAs) are Individual distributors. They establish
personal long-term contacts across investment products.
 Institutional Distributors can be distribution houses, banks, or non-banking finance
companies. They mobilise investments through their employees and network of sub-
brokers.
 Institutional distributors have a wide branch network and large client base and
greater geographical reach. They have standardised processes.
 AMC’s channel managers service the institutional distributors. Institutional
distributors provide in-house research and product recommendations to investors.
 Online Mutual Fund Distribution happens directly to investors through internet.
Investors are able to view current holdings at latest NAV and conduct sale/re-
purchase transactions online.
 Investor creates an account which is password protected and thus ensures
convenient and paper-less transactions. No cheque writing is required.
 Distribution through Stock Exchanges has been enabled through trading platforms
of brokers.
 Mutual funds tie up with PSU banks to reach out to the non urban locations for
distribution of their products.
 In order to be eligible, brokers must clear NISM MFD Certification, obtain ARN and
empanel as distributor with AMC.
 Transactions can be executed on NSE’s NEAT MFSS and BSE’s STAR Mutual Fund
Platform which is open from 9am to 3 pm. Mutual funds can choose to tie up with
any stock exchange.
 AMCs appoint distributors by entering into Distribution agreements which spell out
the terms and conditions of their appointment.
 Distributor empanelment form must be filled up while seeking empanelment with an
AMC. The form includes details such as personal details, names of key people
handling sales and operations, business details.
 AMC has the power to terminate agreement at any time, after due notice.
 In order to be appointed as a distributor, Individual distributors and employees of
institutional distributors have to clear the NISM MFD certification examination.
 After clearing the examination, they need to obtain the ARN. Institutions in the
distribution business also need to get registered with AMFI.
 Validity of certification examination is three years after which distributors can take
continuing professional education (CPE) training in order to revalidate the
certification.
 SEBI has allowed postal agents, retired government and semi-government officials
(class III and above or equivalent), retired teachers and retired bank officers with a
service of at least 10 years to distribute simple performing mutual fund schemes.

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 These distributors can be empanelled with minimal registration requirements and a
simplified certification process as compared to standard requirements for
empanelment of mutual fund distributors.
 Such distributors can only sell diversified equity schemes, fixed maturity plans
(FMPs) and index schemes that have returns equal to or better than their scheme
benchmark returns during each of the last three years.

5.3 Distributor Commission


 SEBI does not prescribe rules on the minimum or maximum rate of commission.
However, Distributors are not allowed to charge commissions on their own
investment.
 Initial commission is paid up-front. Entry load has been banned since Aug 1, 2009.
 Investors have the power to decide the payment to advisors for their services.
 Distributors have to disclose the commissions they earn on comparable schemes
when they recommend a scheme to the investor.
 The commissions paid to distributors in respect of its non-institutional retail and HNI
investors should be disclosed on the mutual fund’s website. This is applicable to
distributors satisfying one of more of the conditions specified earlier for due
diligence.
 Trail commission is paid as long as the investor remains invested in the fund. It is
calculated on the current market value (units brought in by the distributor x current
NAV of the units).
 AMFI has banned trail commission for transferred assets from one distributor to
another.
 Sebi circular dated September 13, 2012 - in addition to the total commission and
expenses paid to distributors, AMC shall make annual disclosures on its website on:
a) distributor-wise gross inflows (indicating whether the distributor is an associate
or group company of the sponsor(s) of the mutual fund),
b) net inflows,
c) average assets under management and
d) ratio of AUM to gross inflows
e) If the data shows that a distributor has excessive portfolio turnover ratio, i.e.
more than two times the industry average, AMC shall conduct additional due-
diligence of such distributors.
 Mutual Funds / AMCs shall also submit the above data to AMFI. AMFI shall disclose
the consolidated data in this regard on its website.

5.4 Know Your Distributor (KYD)


 AMFI has introduced the KYD process in order to verify the details of the distributor.
KYD Process is handled by the CAMS Point of Service (PoS). KYD is a pre requisite
for appointment as a distributor.
 KYD involves verification of documents such as PAN card and proof of address.
Biometric impression of the index finger of the right hand of the ARN holder is
captured.

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 In case of institutional distributors, bio-metric process is undertaken for its
authorised personnel. Acknowledgement is given OTC and must be submitted at the
time of empanelment with the AMC.

5.5 Sales Practices


 Distributor actions must be in the interest of the unit holders. Distributors have to
follow AMFI's code of ethics (ACE) as well as those prescribed by the concerned
AMC, AMFI and SEBI.
 AMFI and fund houses have put in place a set of guidelines to be followed by the
distributors. These include the following:
 Distributor is accountable for the activities of the sub-brokers
 Distributors must have complete knowledge of the product on offer.
 Distributors must know their clients’ needs and profile.
 The product chosen must meet the clients’ requirements
 Distributors must encourage good investment habits such as long-term and
regular investment.
 Distributors must provide good and efficient after-sales service.

5.6 Advertisement Guidelines


 Returns to be presented as point to point return on a standard investment of Rs
10,000, in addition to the CAGR:
 For schemes in existence for more than 3 years, performance to be provided:
 since inception: and
 for as many 12 month periods as possible for the last 3 years.
 For schemes which have been in existence for less than 3 years, returns to be
provided:
 since inception: and
 for as many 12 month periods as possible
 Benchmark indices for the same periods have to be shown to enable comparison.
 A scheme’s performance has to also be compared with additional benchmarks:
a) The Sensex or Nifty (equity funds)
b) 10 year GOI paper (debt funds)
c) 1 year treasury bill (short term funds)
 Performance to be shown in rupees as well as CAGR.
 The performance of all schemes managed by the fund manager of the scheme being
advertised has to be disclosed.
 In case the number of schemes managed by a fund manager is greater than six:
 the AMC to disclose the total number of schemes managed
 the performance data of the top 3 and bottom 3 schemes.

CHAPTER 6: ACCOUNTING, VALUATION AND TAXATION (10 Marks)

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6.1 Definitions
 Unit capital or corpus of the fund is calculated as:
Unit Capital (Corpus) = Total outstanding units * face value per unit
 Purchase of units increases unit capital; redemption reduces unit capital.
 Unit capital is shown on the liabilities side of the balance sheet. Mutual fund has
only current liabilities, and no long term liabilities.
 The portfolio + any accrued income and receivables = Assets of the scheme
 Net assets = Assets - Liabilities
 NAV per unit = Net assets of a scheme / number of outstanding units.
 Valuation day is every business day when NAV is calculated.
 Net assets of can go up when there is a realized income or an appreciation in the
market value of the scheme’s assets.
 Net assets will go down when there is a realized loss or depreciation in the market
value.
 Expenses and income are accrued every day.
 NAV is rounded off to two decimal places for all schemes and to four decimal places
for liquid schemes.
 Example:
 The net assets of a fund are Rs.200cr.
 The current liabilities are Rs.20 cr.
 The unit capital is Rs.50 cr and the face value per unit is Rs.10. What is the NAV
of the fund?
 Total outstanding units = 50cr/ Rs. 10
 NAV = (Current assets – Current liabilities) = (200cr – 20 cr)/ 5 crore = Rs. 175
Total outstanding units

6.2 Sale and Repurchase Price


 If an entry load is imposed, the investor pays a price that is more than the NAV. SEBI
has banned entry loads, so no entry loads can be charged to investors.
 Sale Price needs to be the same as NAV (subject to deduction of applicable
transaction charges, if any).
 Upfront commission is to be paid by investor directly to the distributor, based on his
assessment of various factors including the service rendered by the distributor.
 Exit load is imposed on NAV to arrive at the re-purchase price. NAV less NAV x % exit
load = repurchase (redemption)price.
 Exit load reduces the repurchase price by the amount of load. Exit load cannot be
varied based on the type of investor.
 CDSC (Contingent Deferred Sales Charge) is a variable exit load applied on the basis
of the period for which the investor stays invested.
 All exit loads or CDSC charged to investors shall be entirely credited back to the
scheme.
 SEBI has allowed a transaction charge of Rs. 100 for mutual fund subscriptions
above Rs. 10,000.
 An additional amount of Rs. 50 can be charged from a first time mutual fund
investor.

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 Charges are restricted to purchase transactions only.
 The transaction charges are deducted by the AMC from the subscription amount
and paid to the distributor and the balance will be invested.
 In case of SIPs, the transaction charge shall be applicable only if the total
commitment through the SIP amounts to Rs 10,000 and above. The charge can be
recovered over 3-4 instalments.
 There can be an “opt-out” of charging the transactions charge at a distributor level
though not at investor level.
 Distributor cannot choose to charge one investor and not charge another.
 Distributor shall have option to opt-in or opt out of levying transaction charge based
on type of the product.
 Transaction Charge(s) will not be deducted if:
a) Purchase/Subscription is not routed through any distributor
b) Purchase/ Subscription through a distributor for less than Rs. 10,000;
c) Transactions such as Switches, STP i.e. all such transactions wherein there is
no additional cash flow at a Mutual Fund level similar to Purchase/Subscription.
d) Purchase/Subscriptions through any stock exchange.
 The account statement must reflect the net investment as the gross subscription
less transaction charge and provide the units allotted against net investment.
 The AMC will ensure that the distributor does not engage in mal-practices to
enhance commissions.

6.3 Applicable NAV


 NAV is computed on business days for all schemes. Except liquid funds, for which
NAV is computed every calendar day.
 Mutual fund transaction documents have to be submitted at designated Official
points of acceptance (OPoA).
 All financial transactions received at OPoAs have to be time stamped. Time stamp
determines the applicable NAV according to Sebi’s cut-off time regulations.
 For all non-liquid funds, the applicable NAV is prospective (NAV is not known at the
time of investment).
 Same day NAV will apply for all redemption transactions received before 3pm on a
business day. Transactions received after cut-off will get the NAV of the next
business day.
 Applicable NAV for purchase transactions is different depending on scheme type.
a) For all funds except liquid funds, cut-off time is 3pm.
b) For liquid funds the cut-off time is 2pm.
 In case of purchase transaction in equity and debt-oriented funds, where the value
of the transaction is more than Rs.2 lacs:
a) The NAV of the same day will apply only if funds have been realised and
credited to the scheme account before cut-off.
b) If not, the NAV of the day in which funds were credited will apply.
 The allotment of units at the applicable NAV for a day will therefore depend upon:
a) Receiving application before cut-off time
b) Funds credited to the scheme’s account before cut-off time
c) Funds available for utilization without using any credit facilities

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 Liquid funds purchase transactions are subject to a different treatment. The NAV is
computed every calendar day. Also, the funds are utilised on the same day, if
credited to the scheme, since cut off is earlier.
 Applicable NAV for a liquid fund is NAV of the day previous to the day on which funds
were credited and available for use by the scheme.
 The applicable NAV for liquid fund purchases depends upon
a) Receiving application before cut-off time
b) Funds credited to the scheme’s account before cut-off time
c) If both conditions are met, previous calendar day’s NAV is applied
 Review these rules to be able to answer questions regarding applicable NAV:

Type of Scheme Transaction Cut off time Applicable NAV

Equity oriented funds • Purchases 3.00 pm • Same day NAV if received


and debt funds (except before cut off time.
• Switch in
liquid funds) in respect
• Next business day NAV for
of purchases less than
applications received after
Rs. 2 lacs
cut off time.

Liquid fund • Purchases 2.00 pm • Previous day NAV if received


before cut off time and funds
• Switch ins
are realised.

• If received after cut off time,


NAV of the day previous to
funds realisation.

Equity Oriented Funds, • Redemptions 3.00pm • Same day NAV if received


Debt funds, Liquid funds before cut off time.
• Switch out
• Next business day NAV for
applications received after
cut off time.

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Equity oriented funds • Purchases 3.00pm NAV of the business day on which
and debt funds (except funds for the entire amount of
• Switch- in
liquid funds) in respect subscription / purchase as per the
of transaction of Rs. Rs. application are available for utilization
2 lacs or more before the cut-off time will apply.

 Time stamping is done in order to record the time at which a transaction was
received at an official point of acceptance.
 Electronic time stamp is mandatory to determine the applicable NAV for a financial
transaction.
 The location code, machine identifier, date, time (hh:mm) and running serial number
are generated in every time stamp.
 The time stamping machine records three impressions for purchase:
 the application form or transaction slip,
 the back of the payment instrument, and
 the acknowledgement.
 For redemption transactions all three impressions are on the redemption request.
 In case of online and stock exchange transactions the time stamp is as per
server/trading system time.
 The time of transaction done through various online facilities / electronic modes
offered by the AMC, for the purpose of determining the applicability of NAV, would be
the time when the request for purchase / sale / switch of units is received in the
servers of AMC/RTA.

6.4 Scheme Expenses


 Expenses that can be borne by the mutual fund scheme are regulated by SEBI.
 Any expense that is not chargeable, or exceeding the limits, has to be borne by the
AMC.
 Initial issue expenses are expenses on advertisement, commissions, and launch of
the scheme during an NFO. Expenses related to an NFO cannot be charged to the
scheme/investor.
 Fund Recurring Expenses are expenses incurred to manage the money mobilised
from the investor.
 SEBI specifies heads of expenses that can be charged to the scheme and the
maximum expense, as percentage of net assets, that can be so charged.
 Recurring expenses are charged on an accrual basis, and reduced from the assets
of the scheme, before computing NAV.
 Expenses, identified as being direct expenses incurred to manage the fund, can be
charged to the scheme. These expenses include:
 Investment management fees
 Marketing and selling expenses

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 Fees of custodians
 Fees of registrar and transfer agents
 Audit fees
 Trustee fees
 Costs relating to investor communication
 Costs of statutory disclosure and advertisements

 Expenses other than those listed above, cannot be charged to the scheme. Fines
and penalties also cannot be charged to the scheme.
 The limits for expenses charged to the fund are as per the following slabs:
 2.5% on the first Rs 100 crore of net assets
 2.25% on the next Rs 300 crore of net assets
 2% on the next Rs 300 crore of net assets
 1.75% on the balance net assets
 The net assets in the above slabs are taken as weekly average net assets.
 Debt funds are required to charge 0.25% lower in each of the above slabs.
 Index funds cannot charge more than 1.5% as recurring expense.
 Liquid funds and debt funds cannot charge any investment management fees for
funds parked in short-term bank deposits.
 Fund of funds invest in other funds, therefore there may be two layers of expenses,
one for the FoF and the other for the schemes in which the FoF invests.
 FoFs can charge Management fees + Scheme recurring expenses + expenses levied
by underlying schemes not more than 2.50% of net assets.
 Any expense incurred over and above the maximum prescribed limits has to be
borne by the AMC.
 Exceptions are as follows:
a) Additional TER for mobilisation from non- top 15 cities upto 30 bps
b) Additional TER upto 20 bps incurred towards permissible expense heads
c) Brokerage and transaction costs for execution of trades (if included in the
transaction cost) not exceeding 0.12% for cash market transactions and 0.05%
for derivative transactions.
d) Service tax on Investment Management Fees
 Additional TER can be charged up to 30 basis points on daily net assets of the
scheme if new inflows from beyond top-15 cities (top 15 based on AMFI data) is at
least:
a) 30% of gross new inflows in the scheme or
b) 15% of the average AUM (year to date) of the scheme, whichever is higher.
 If such inflows are less than higher of above, additional TER:
= Daily net assets X 30 basis points X New inflows from beyond top 15 cities
365 (or 366 w.e. applicable) X Higher of (a) or (b) above
 Additional charged as above shall be clawed back in case the same is redeemed
within a period of 1 year from the date of investment.
 Investment management fee can be decided by the AMC and chargeable within the
TER limits (upto 2.25% for debt schemes and upto 2.5% for equity schemes on
average net assets).
 Service tax payable on investment management fees can be charged over and above
TER.

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 Service tax on other services such as R&T, Custody, fund accounting shall be charged
within TER limits, i.e. within the limit of upto 2.5% of average net assets for equity
schemes and 2.25% of average net assets for debt schemes as the case may be.
 Service tax on exit load shall be paid out of the exit load proceeds and exit load net of
service tax shall be credited to the scheme.
 Service tax on brokerage and transaction cost paid for asset purchases shall be within
the TER limits.
 All new schemes shall have single plan with single expense structure.
 In case of existing schemes, only one plan will continue for fresh subscriptions.
 Existing investors to continue to remain invested in their respective plan.
 All schemes shall have separate plan for direct investments. This plan will feature a
lower expense ratio as it will exclude distribution expenses, commission. No
commission shall be paid from Direct Plan.

6.5 Accounting Policies


 Accounts of each mutual fund scheme have to be maintained separately.
 SEBI Regulations have laid down accounting treatment of various items.
 Average cost should be used to determine the holding cost of the securities
 Investments should be accounted on the transaction date, not on the settlement
date.
 Dividends, bonus and rights received by a mutual fund scheme should be
recognized on the ex-date.
 Distributable surplus is the amount available for paying dividends. This includes
realized gains, accrued income and unrealized losses but does not include
unrealized gains.
 Unrealised losses must be reduced from the distributable surplus. Unit Premium
Reserve is not available for dividend distribution.
 Valuation of the mutual fund portfolio is done on every business day.
 Equity shares are valued at the last traded price on the valuation day.
 If no traded price is available for an equity share, the closing price of the previous
trading day (not more than 30 days before) shall be taken for valuation.
 If it is a thinly traded share, fair value as per Sebi-approved valuation formula shall
be followed.
 In case of debt securities, those with residual maturity < 60 days shall be valued at
weighted average price if traded on the valuation date. Non-traded debt securities
will be valued on amortization basis.
 In case of Debt Securities with residual maturity > 60 days, if they are traded
securities, they will be valued at weighted average price. Non-traded valuation shall
be based on Crisil yield matrix.
 In case of holding of gold by a gold ETF, the same is valued at the AM fixing price of
London Bullion Market Association (LBMA) in US dollars per troy ounce for gold
having a fineness of 995.0 per thousand.
 Valuation policy should follow SEBI investment valuation norms and AMC shall
publish the same.
 AMC & sponsor will be liable to compensate for unfair treatment to any investor due
to inappropriate valuation.

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6.6 Taxation
 A mutual fund is a pass-through structure and is exempted from income tax
 The fund itself pays no tax on the investment income it earns
 In the hands of the investors:
 Dividends are exempt from tax
 Capital gains are taxable depending on their nature
 Short term capital gain or loss (STCG)/(STCL): Capital gain or loss realised by sale of
units within a period of 12 months in case of equity funds and 36 months in case of
non equity funds.
 Long term capital gain or loss (LTCG)/(LTCL): Gain or loss from sale after a
holding period of one year in case of equity funds, 36 months in case of non
equity funds.
 Indexation benefits are available for long term capital gains in case of debt
funds.
 Indexed cost of an asset = Cost of purchase X ( Index in year of sale/index in
year of purchase)
 Mutual funds are not subject to Wealth Tax in the hands of the investor
 Dividend Distribution Tax: Dividend Distribution Tax (DDT) applies if a scheme
is not equity-oriented
 Funds with at least 65% of assets in equity are equity-oriented
 Dividend Distribution Tax (DDT) to be paid by the fund, before distribution of
the dividend
 Liquid funds - 25% for individuals/HUFs/NRIs, 30% for others
 Non-equity oriented, non-liquid funds – 25% for individuals / HUFs/NRIs,
30% for others
 Surcharge and cess as applicable
 For the purpose of determining the tax payable, the amount of distributed
income be increased to such amount as would, after reduction of tax from
such increased amount, be equal to the income distributed by the Mutual
Fund. This will result in higher rate of effective DDT.
 Capital Gains Taxation
Individuals/HUF# Domestic Company# NRI# (tax deducted at
the time of
redemption)
Equity oriented schemes
LTCG (units held for Nil Nil Nil
more than 12 months)
STCG (units held for 12 15% 15% 15%
months or less)

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Other than Equity Oriented Schemes
LTCG (units held for 20% with indexation 20% with indexation Listed: 20% with
more than 36 months) indexation
Unlisted: 10% without
indexation
STCG(units held for 36 30%* 30% 30%*
months or less)
* assuming investor falls in highest tax bracket; # surcharge and cess as applicable

 STT is applicable only for equity-oriented funds and equity and derivative securities.
STT is payable by the mutual fund on purchase and sale transactions on the stock
exchanges, at 0.1% for equity shares.
 Investors have to pay STT at 0.001% on mutual fund purchase and sale transactions
that they conduct on listed equity-oriented schemes in the stock exchanges.
 If they transact with the fund directly, STT is payable at 0.001% by investors on
redeeming units of an equity oriented fund.
 Set off is a facility to reduce the capital gains by deducting the capital loss incurred
or carried forward.
 Rules for Set-off are as under:
 STCL can be set off against long/short-term capital gains.
 LTCL can be set off only against long-term capital gains
 STCL/LTCL can be set off only against capital gains.
 No set-off benefit for LTCL from equity-oriented funds
 LTCL from a non-equity oriented fund, can set it off only against LTCG from
non-equity oriented funds
 Buying into a mutual fund prior to declaration of dividend, and selling the units after
dividends at the ex-dividend price is called dividend stripping.
 The investor earns tax-free dividends and capital loss for set-off. Section 94(7) of
Income Tax Act has plugged this loophole.
 If an investor acquires a unit any time in the period of 3 months before the ex-
dividend date, and sells it within a period of 9 months from the ex-dividend date,
such capital gain will not available for set-off.
 Section 94(8) plugged loophole for dividend distribution in the form of bonus units.
Loss in the value of units will be deemed to be the purchase price of the bonus
units.

CHAPTER 7 - INVESTOR SERVICES (12 Marks)

7.1 Investor Information in the Application form


 An application can have 3 joint holders. Investments can be made jointly or on either or
survivor basis.

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 Signature is the identity of the investor. All joint holders have to sign the application
form as per holding pattern.
 Address of the investor is to enable physical identification of the investor’s location. No
post box numbers accepted
 Bank account detail is a mandatory detail. Mutual funds send dividends and redemption
proceeds to the bank account mentioned in the application form.
 Folio number is allotted on the first purchase. Investors can hold units of multiple
schemes of a fund house, under one folio.
 Subsequent investments can be made by quoting the existing folio number.
 To check flow of illegal money into the financial system, Prevention of Money
Laundering Act (PMLA) was promulgated.
 As per PMLA, identity of the customer in a financial transaction has to be verified.
 KYC (Know your customer) norm is part of this process.
 Proof of identity of the customer, proof of residence, Permanent Account Number and
photograph are verified to comply with KYC norms.
 KYC acknowledgement captures PAN of the investor.
 KYC once completed, is valid across mutual funds. Investors have to submit a
photocopy of the KYC acknowledgement along with application forms.
 KYC is mandatory for all joint investors in a folio, irrespective of the purchase amount.
 In case of investment by a minor, KYC compliance of guardian is required.
 For investments under power of attorney, KYC compliance of the investor as well as the
power of attorney holder is required.
 E-KYC is a Aadhaar based KYC verification service launched by UIDAI. SEBI has declared
that e-kyc shall be valid process for KYC verification.
 PAN is mandatory for all investors in a mutual fund, irrespective of invested amount
(Exception: Micro SIP)
 Micro-SIP is exempted from requirement of PAN card only in case of investments by
individuals, NRIs, minors and sole-proprietary firms if the annual investment does not
exceed Rs.50,000.
 Micro-SIP exemption is not available for HUFs and PIOs or non-individual investors.
 In place of PAN, alternate valid photo identification documents must be provided by
micro-SIP investors.
 Investor is also required to provide an undertaking that their total micro-SIP investments
across all mutual funds in a year do not exceed Rs.50,000 on a 12 month rolling period
or April-March financial year.
 SEBI has mandated a uniform KYC format and supporting documents for compliance by
clients.
 Applicable for transactions with mutual funds, DPs, stock brokers, portfolio managers,
venture capital funds and collective investment schemes.
 Part I will have information required by and common to all the above intermediaries.
Additional information as required by each category of intermediaries can be obtained in
part II of the form.
 Proof of identity , proof of address and self-attested supporting documents have to be
provided in part I.
 The exemption available for investors in micro-SIPs of mutual funds from providing PAN
card details will continue to apply.

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 Investments on behalf of the state/central governments, UN entities/multi-lateral
agencies exempt from paying tax in India, investors residing in Sikkim are also exempt
from the PAN requirement.

7.2 Purchase Transactions


 Fresh purchases are made by investors by submitting an application form complete in
all respects.
 Purchase transactions are denominated in amount, not units.
 Once a valid application is received, a new folio is opened.
 The application should be supported by a payment instrument of at least the minimum
investment amount mentioned in the SID/KIM.
 Additional Purchases are subsequent purchases after fresh purchase and can be made
under the existing folio using a transaction slip.
 Transaction slip is used by an existing investor for making redemptions, additional
purchases, switches and non-financial transactions.
 Folio number of the investor needs to be quoted on the transaction slip in order to
identify the investor. It has to be signed according to the mode of holding.

7.3 Payment Instruments


 Payment instruments accepted for mutual fund transactions are as under:
a) Local cheques, Outstation cheques, At-par cheques, Cash upto Rs.50,000
b) Demand drafts are accepted from locations where an ISC is not available
c) Electronic payment instruments
 Mutual funds do not accept money orders, stale cheques or post dated cheques (except
for SIPs).
 Third-Party cheques are not allowed, except for the following:
a) grandparents/parents making payments not exceeding Rs.50,000 on behalf of a
minor
b) employer making payments on behalf of employee through payroll deductions
c) custodian on behalf of FIIs
 Electronic payment can be made through EFT, RTGS, ECS, Direct transfer and SWIFT.
 The quickest method of transferring funds is RTGS.
 Electronic payment instruments are widely used for making liquid fund purchases by
institutional investors.
 In order to use electronic payment instruments for effecting mutual fund transactions,
the scheme’s account details are essential. Proof of transfer must be appended along
with the application.
 Cash investments in mutual funds to the extent of 20,000/- per investor, per mutual
fund, per financial year shall be allowed.
 It has been introduced as a move to enhance reach of mutual fund products amongst
small investors.
 Conditions for investment in cash:
a) compliance with Prevention of Money Laundering Act, 2002, Rules, Circulars issued
by SEBI

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b) AMC should have sufficient systems and procedures in place for accepting cash
transactions.
 Repayment with regard to dividends and redemptions can be made only through
banking channel.
 SEBI has permitted applications under ASBA for mutual fund NFO applications. Under
ASBA, the money goes out of the investor’s bank account only on allotment.

7.4 Investments by NRIs


 In case of NRI investments, source of funds determines repatriability of funds on re-
purchase.
 NRI investors can make mutual fund investments using the following accounts:
a) Non-resident external (NRE) is a foreign currency account. If subscription is
made using an NRE account, funds received on redemption can be fully
repatriated.
b) Non-resident ordinary (NRO) is an Indian rupee account, funds cannot be
repatriated on re-purchase.
c) Foreign currency non-resident (FCNR) is used when payment is remitted from
abroad.
d) Foreign Inward Remittance Certificate (FIRC) is a proof that an individual has
made a payment in foreign currency from outside the country.
 Re-purchase to NRIs is subject to TDS on the capital gains made in the transaction.
 Redemption proceeds to NRIs are in Indian rupees.
 FIIs use non-resident rupee accounts for investments in India so that funds are fully
repatriable on re-purchase.

7.5 Investment by QFIs


 QFIs can invest in:
a) Equity Schemes of mutual funds
b) Debt schemes which invest in Infrastructure
c) Listed units of mutual fund debt schemes
 QFIs must fulfil the following conditions:
a) Should be KYC compliant
b) Should also be a resident of a country compliant with Financial Action Task
Force (FATF) standards besides being a signatory to IOSCO’s (International
Organization of Securities Commission) Multilateral Memorandum of
Understanding
 The investments held by QFIs are non-tradable, non-transferable and cannot be
pledged.
 QFIs are only permitted to subscribe and redeem; SIPs/SWP/STP/Switches are not
permitted.
 Limits on investments by QFIs in domestic mutual funds.
a) Equity schemes : US$ 10 billion
b) Infrastructure debt schemes: US$ 3 billion.
c) Listed debt schemes: Included in limits for corporate debt USD 1 billion.

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 Allotment of units to QFIs on subscription will be based on the NAV of the day on
which funds are realized and available in the scheme’s account.
 Units will be redeemed on the day on which the redemption request is received and
time-stamped, as per applicable cut-off timings.
 The Scheme Information Document (SID) will mention the cut-off times and other
applicable requirements for QFI transactions.
 Investments by QFIs can be made through two routes:
a) Direct route: Units issued by the mutual fund are held by the QFI in a demat
account with a SEBI registered depository participant (DP)
b) Indirect route: QFI is issued UCRs (Unit Confirmation Receipt) by issuers
appointed by the mutual fund abroad against units issued by the mutual fund
and held by the custodian in India

7.6 Re-purchase Transactions


 Re-purchase may be specified in terms of units or rupees.
 The repurchase price is the applicable NAV minus exit load.
 Re-purchase request has to be filed by joint holders as per mode of holding.
 If a re-purchase request reduces the balance to below minimum limit, then all the
units standing to the credit of the folio will be redeemed and the folio closed.
 Repurchase proceeds are sent by direct credit or cheques with the registered bank
account number of the investor.
 Repurchase requests need to be processed within 10 working days. Failing this,
AMCs have to pay a penal interest of 15% per annum to the unit holders.

7.7 SOA and CAS


 SOA acts as a proof of investment in mutual funds. SoAs are dispatched by the R&T
agent, after every transaction within 10 business days of the transaction.
 In case of NFO, SoA must be dispatched within 5 business days of allotment. In case
of SIP, SoA is sent every quarter.
 When a fresh purchase is made, the amount invested, price, and units are
mentioned in the SOA.
 For subsequent transactions, the SoA mentions the amount invested, price, balance
units and current market value.
 SOA can be received through post, courier or email.
 Within 5 business days of any financial transactions, a email and/or SMS shall be
sent confirming the transaction with basic details like allotment date, Units allotted
and NAV.
 A Consolidated Account Statement (CAS) for each calendar month will be sent by
post/email on or before 10th of the succeeding month.
 If an email id is registered with the AMC, only a CAS via email will be sent. For the
purpose of sending CAS, investors will be identified across mutual funds by their
Permanent Account Number (PAN). Where PAN is not available, the account
statement shall be sent to the Unit holder

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 Further, where there are no transactions in a folio during any six month period, a
CAS detailing holding across all schemes of all mutual funds at the end of every
such six month period (i.e. September/March), shall be sent by post/e-mail by the
10th day of the month following that half year, to all such Unit holders.
 SoA to be sent to investors who have not transacted during the last 6 months prior
to the date of generation of account statements.
 SoA for such dormant folios must reflect the latest closing balance and value of the
Units prior to the date of generation of the account statement.
 SoA may be generated and issued along with the Portfolio Statement or Annual
Report of the Scheme for dormant investors.
 Alternately, soft copy of the account statements shall be mailed to the investors’ e-
mail address, instead of physical statement, if so mandated.

7.8 Transactions Through Stock Exchanges and Brokers


 In case of transactions through the stock exchange, transactions are placed like
orders to the brokers.
 Contract note generated with an electronic time stamp and sale /re-purchase
requests are handled by brokers.
 Allotment of units on sale and release of funds on re-purchase is handled by R&T
agents.
 Folio details are sent to R&T agents by brokers and responsibility of settlement lies
with the AMC and R&T agents.
 Transactions through the stock exchange may be in physical form or through demat
account. Demat statement is considered as the SoA to the investor.
 Demat transactions are settled through depository; physical transactions are settled
through R&T Agent.

7.9 Investment Options and Plans


 Mutual fund schemes offer various options and plans.
 The underlying portfolios for all options are the same, only post-tax returns are
different.
 In a growth option, gains made in the portfolio are retained and reflected in NAV.
Only when redemption is made, profit/loss is realized and is treated as capital gains
or loss. Tax deferral is possible by investing in growth option.
 In a dividend pay-out option, the fund declares dividend from realised profits after
trustee approval.
 Amount and frequency of dividend payout varies and depends upon distributable
surplus.
 NAV falls after dividend payout to the extent of dividend paid and dividend
distribution tax (if applicable).
 The NAV before dividend payout is called as cum dividend NAV, and the NAV after
dividend payout is the Ex-dividend NAV.

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 In the dividend re-investment option, dividend declared is not paid out but is re-
invested in the same scheme by buying additional units at the ex-dividend NAV.
 See the following table to compare the three options:
Growth Dividend Payout Dividend Re-
investment
NAV at the beginning Rs.10 Rs.10 Rs.10
Number of Units 100 100 100
NAV after 1 year Rs.12 Rs.12 Rs.12
Dividend of 10% No Yes Yes
declared
Dividend Amount Nil Rs.100 Rs.100
NAV post dividend Rs.12 1100/100 = Rs.11 1100/100 = Rs.11
Number of units held 100 100 100+(100/11)
=109.09
Value of investment 100x12=1200 100x11=1100 109.09 x 11=1200
Pre-tax return on Rs.200 capital Rs.100 dividend+ Rs.100 dividend+
investment gain Rs.100 capital gain Rs.100 capital gain*

7.10 Systematic Transactions


 In a Systematic Investment Plan (SIP) investment of a predetermined amount is
periodically invested into a mutual fund scheme.
 Applicable NAV is the NAV on the date of the installment.
 Period of commitment of SIP can vary e.g. 6 months, 1 year, 3 years, 5 years.
 The investor needs to specify certain intervals at which investment must be made
e.g. monthly, quarterly, half-yearly.
 Investment is made on standard dates e.g. 1st, 5th, 10th, 15th of every month as
provided by the AMC.
 Since a fixed amount is invested on given dates, more units are bought if NAV is low;
lesser units if NAV is high. This is called rupee cost averaging.
 SIP can be initiated along with NFO.
 SIP can be made through various payment modes such as post dated cheques,
electronic clearing service and standing instruction for direct transfer.
 Systematic Withdrawal Plan (SWP) refers to periodic redemptions made from the
scheme at the prevailing NAV (less exit load as applicable).
 Investor must specify the date of withdrawal and the period of withdrawal. SWP may
be specified in terms of number of units or amount.
 SWP is ideal for an investor who wants to have regular income but avoid bearing
dividend distribution tax.
 Systematic Transfer Plan (STP) is a transfer of a specified sum from one scheme to
another within the same fund house.
 STP helps in re-balancing portfolio. Re-purchase is made from the source scheme
and investment of re-purchase proceeds is made into the destination scheme.

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 In effect, STP amounts to SWP from source scheme and SIP into destination
scheme.
 As STP involves repurchase from source scheme, capital gains (STCG/LTCG) shall
apply.
 A switch is a redemption and purchase transaction rolled into one.
 The source scheme/option is the switch out leg and the target scheme /option is
the switch in leg. The R&T carries out the transactions in the investor’s records.
 Exit loads are not charged for switch within options of the same scheme. However,
exit loads are charged, as applicable, for inter-scheme switches.
 Triggers are automated purchase, redemption, switch or dividend decisions based
on pre-defined events. Pre-defined event may be Sensex levels, return targets etc.

7.11 Non-Financial Transactions


 Change in personal information such as name, bank account details, joint holder
details, signatories, status etc are non financial transactions.
 These transactions are based on documents provided as proof.
 Mutual fund units can be pledged to borrow funds.
 The amount of loan depends on the value of units on the date of borrowing and the
margin.
 Units pledged are marked under lien in the folio and cannot be redeemed.
 Individual unit holders can make nominations of upto 3 persons for mutual fund
investments they hold.
 Nominations can be changed.
 The nomination form has to be signed by all joint holders.
 A minor can be appointed as a nominee.
 Nominee rights are subservient to that of the joint holders.

Chapter 8 - Risk, Return and Performance of Funds (10 Marks)


8.1 Equity Securities
 Equity is issued by companies to investors when they contribute to the capital.
 Equity shareholders enjoy ownership privileges such as dividends and voting rights.
 There is no guarantee of income or principal, however, there is potential for capital
appreciation.
 The drivers of risk and return in an equity portfolio depend on the style used by the
fund manager to create the portfolio.
 Market cap = Outstanding shares of the company * current share price
 Large cap shares are shares of big companies which have characteristics such as
high liquidity, stability and a large size.
 Small and mid-cap shares are shares of smaller companies that are not very liquid
and have a growth potential.
 The drivers of risk and return in an equity portfolio depend on the style used by the
fund manager to create the portfolio.
 Style refers to the factors that may lead to the choice of stocks to be held in the
fund, such as growth or value.

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 Value style focuses on picking up the stock only if the price is right; a growth style
focuses on earning potential, and may reckon that a good stock may not be
available cheap.
 Active management endeavours to outperform the index by altering weighting to
sectors, stock selection and market timing.
 Passive management simply replicates the index.
 In an active management style, stocks are selected based on research and
analysis.
 Fundamental Analysis refers to evaluation of the earning capability of a stock,
leading to the determination of its fair value.
 This analysis judges whether the stock is undervalued or overvalued.
 In a fundamental analysis, a stock evaluated in the context of industry and macro
factors.
 An actively managed equity portfolio is created after considering the overall
situation for the economy, industry and company. This is called the economy-
industry-company (EIC) analysis framework.
 Stock selection may be top-down, starting with identifying macro-economic factors
first, then identifying industries, and then evaluating and selecting companies.
 If the fund manager first identifies the stock for investment first and then validates
this decision by evaluating the industry and overall economic prospects, it is a
bottom-up style of stock selection.
 Top-down is for sector selection; Bottom up is for stock selection
 Technical analysis involves study of stock prices and volumes, plotted as charts, to
identify patterns that may indicate buying or selling interest in stocks.
 EPS is profit after tax per share. It indicates how much the market is willing to pay
per rupee of earning of a stock.
 EPS is computed as: Profit after tax(PAT) / No. of shares issued
 Price earnings ratio (PE Ratio) is arrived by dividing Market price with Earnings per
share.
 Historical PE is computed using past earnings. Forward PE computed using future
earnings.
 Low PE means the stock is undervalued and high PE means the stock is
overvalued.
 Book value per share is calculated as net worth (share capital plus reserves and
surpluses) of the company divided by the number of shares.
 Market price/book value per share to arrive at Price-Book Value (PBV) ratio.
 A PBV less than one, indicates that the share is selling at a price lower than its book
value, and may therefore be undervalued.
 Dividend yield is the dividend per share divided by the current market price of the
stock. 


8.2 Debt Securities


 Debt securities represent an underlying loan. Borrower is the issuer; Lender is the
buyer.

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 Debt instruments have a face or par value, are issued for a specific period.
 Debt instruments mature on a specific date called the maturity date. Tenor is the
distance in time to maturity.
 Coupon rate is the annual rate of interest paid on the par value of the bond.
 Government securities are also called gilts and have no credit risk. Gilts are issued
for maturity of 2 to 30 years.
 Money market securities are issued for a tenor of less than 1 year.
 In case of floating rate securities, interest payable periodically is reset with
reference to the benchmark or base rate. A spread is added to the benchmark rate
to arrive at the coupon
 Zero coupon bonds are issued at a discount and redeemed at par. (Coupon for a
floating rate security is Base + Spread)
 Return of a debt portfolio is made up of accrual income that comes from interest
received and capital gains (losses) from changes in the value of the portfolio.
 Price of a bond responds to changes in market interest rates in an inverse
relationship. A debt portfolio may therefore hold both components.
 The debt portfolio would show a mark-to-market gain if interest rates fall.The debt
portfolio would show a mark-to-market loss is interest rates gain.
 The change in price of floating rate bond is limited due to interest rate changes
since changes in interest rates are reflected in the coupon itself.
 The effect of change in interest rate varies due to tenor and cash flow structure.
 Modified Duration is a technical measure of bond’s sensitivity to interest rates.
 Higher the modified duration of a bond, higher the interest rate sensitivity of a bond.
 Average maturity and modified duration are directly related.
 Yield curve shows the relationship between the interest rates and the tenor, on a
given day.
 The yield curve usually slopes upward indicating that the interest rate for a longer
tenor is higher than that of the shorter tenor.
 Yield spread is the difference in yield across tenors, for the same credit quality.
 Difference between the rate for a bond with credit risk and the government bond for
the same tenor is called credit spread.
 Interest rates of all non-govt bonds are higher and depend on their credit rating.
 Higher the credit rating of a bond, higher is the perceived safety and lower the credit
spread. Bonds with higher credit rating are issued at lower rates; and vice versa.

8.3 Gold and Real Estate


 Investors prefer to hold gold when their risk aversion goes up.
 Gold is a growth asset and generates no income.
 In rupee terms, the return from gold tends to increase when the rupee depreciates
and decrease when the rupee appreciates.
 Return from real estate is cyclical. It is a long-term investment and oriented towards
capital appreciation.
 Rent is a source of income but the yield may be low.
 Liquidity of real estate is very low.

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8.4 Measures of Return
 Absolute return = (NAV at the end) - (NAV at the start) X 100
(NAV at the start)
 SEBI prescribes simple absolute returns as the return representation for periods
less than one year for all funds except liquid funds.
 Simple Absolute return is calculated for period less than 1 year because it captures
accurate return only for a short period.
 Example:
 The NAV of a fund was Rs 23.45 on January 31, 2012 and Rs 27.65 on
March 31, 2012.
 The absolute return earned by the investor who invested at the start of the
period and is evaluating his investment at the end of the period, would be:
= ((27.65 – 23.45)/23.45) x 100
= 17.91%
 Simple Annualised Return is absolute return multiplied by annualising factor ‘365/n’
or ‘12/n’.
 Annualization of returns from Liquid funds, for periods less than a year, is allowed by
SEBI.
 Example:
o An investor bought a unit at Rs 10.50 on Jan 1, 2012 and sold it for Rs
11.50 on April 30, 2012.
o The absolute return to the investor is:
o (11.50 -10.50)/10.50 = 1/10.50 = 9.52%
o This is the return earned over the period Jan 1, 2012 to 30 April, 2012.
o If we were to ask, what would be the return per annum, we would annualise
the return as follows:
o = 9.52% x 365/120
o = 28.96% p.a
 Compounded Annual Growth Rate (CAGR) is the rate of return arrived at after
allowing for returns to be reinvested
 r = (V1/V0)1/n - 1, where: V0 is the value at the start; V1 is the value at the end; n is
the holding period in years; and r is the CAGR.
 Performance published by mutual funds use the CAGR method for periods greater
than one year.
 Example:
 An investor purchased mutual fund units at Rs.12 each and redeemed them
after three years for Rs.26 each. What is his CAGR?
 CAGR = ((26/12)^(1/3)) – 1 = 29.4%
 In the case of a dividend option, the CAGR is computed by assuming that the
dividends were reinvested at the ex-dividend NAV.
 Example:
 An investor bought 100 units of a fund at Rs 10.50 each. He received a dividend
of Rs 2 per unit, which he reinvested at the ex-dividend NAV of Rs 10 each.

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 If he sold his holdings at Rs 11 per unit, what is the total return?
Begin value = 100 units x Rs 10.50 = Rs 1050
Dividends = 100 units x Rs 2 = Rs 200
No of units reinvested = 200/10 = 20 units
End value = 120 units x Rs 11 = Rs 1320
Total return = ((1320-1050)/1050) x 100 = 25.71%
 Holding period returns (HPR) calculate the return on an investment for the period it
is held. If the investment is held for over 1 year, CAGR is used and absolute returns
is calculated for holding periods less than one year.
8.5 Measures of Risk
 Market (Portfolio) risk is a standard risk in mutual fund products.
 Market risk in equity arises from changes in prices due to changes in underlying
fundamental and technical factors.
 In debt instruments, changes in macro economic factors, those change the market
expectations for interest rates.
 Interest rate risk depends on average maturity and duration of the portfolio.
 The average maturity of liquid and very short term debt funds is too low for market
risks to be significant.
 Mutual funds manage market risks through diversification
 Liquidity risks refers to inability to buy or sell securities at fair price.
 Small and mid-cap funds, closed end funds may find it difficult to exit illiquid stocks
without impacting the price.
 Secondary markets in corporate bonds of lower credit quality are not very liquid.
 Money market securities help in ensuring sufficient liquidity.
 Mutual funds have a right to temporarily stop redemptions if they perceive higher
illiquidity in the markets.
 Mutual funds are not permitted to borrow in order to invest. There is no risk of
leverage in a mutual fund.
 Mutual funds can borrow for 6 months (maximum) to meet short term liquidity
requirements.
 Total borrowings must not exceeding 20% of net assets.
 Credit risk refers to risk of default in payment of interest or principal, or both, by an
issuer of debt securities.
 Deterioration of the credit quality will result in falling prices and net asset values.
 Credit risk is assessed from the credit rating. A high credit rating indicates a low
degree of default risk.
 It is therefore safe to invest in instruments that are credit rated by agencies
registered with SEBI. Mutual funds carry out their own internal credit research as
well.
 Risk is defined as the variance of actual returns from expected returns.
o MS Excel function = var(range containing the return time series)
o Standard deviation is the square root of variance
o MS Excel function =stdev(range containing the return time series)
 A higher standard deviation means greater volatility in return and greater risk.

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 Modified duration measures risk in a debt fund with respect to market factors.
 Higher the modified duration/average maturity greater the market risk of the fund
and vice versa.
 Market risk may be systematic or unsystematic.
 Systematic risk is not diversifiable.
 Unsystematic risk is company specific and can be reduced by diversification.
 Beta is a measure of the systematic risk in an equity portfolio.
 Beta measures the sensitivity of the fund's returns to changes in the market index.
 A beta of 1 means the fund is likely to move along with the market.
 Funds with beta > 1 are likely be more risky than the market and are aggressive
funds.
 Funds with beta < 1 tend to be less risky compared to the market and are defensive
funds.

8.6 Performance Evaluation


 Benchmark is a portfolio that generates an independent level of return, representing
an asset class or investment style.
 Choice of a benchmark for a fund depends on its objectives and the asset classes in
which it invests.
 Mutual funds have to indicate market benchmarks while filing the SID.
 Benchmark return has to be presented when they advertise the scheme’s
performance.
 Commonly used benchmarks:
 Market indices
 Idependently computed index benchmarks (crisl benchmarks)
 Peer group return
 Return on other comparable financial products
 Equity and Debt Fund Benchmarks:
Fund Type Benchmark
Large cap fund BSE Sensex/S&P CNX Nifty
Diversified equity fund BSE 100
Small/Mid cap fund BSE 500
Liquid fund Crisil Liquid Fund Index (Crisil LiquiFEX)
Short term bond fund Crisil Short Term Bond Fund Index (Crisil
STBEX)
Gilt fund i-Sec Si-Bex, Mi-Bex, Li-Bex (Short term,
medium term and long term respectively)
MIP Crisil MIP Blended Index (Crisil Mipex)
Balanced Fund Crisil Balanced Fund Index (Crisil Balancex)
Income Fund Crisil Composite Bond Fund Index (Crisil
CompBEX)
Banking Fund/Pharma BSE Bankex/BSE Healthcare/BSE Auto Index
Fund/Auto Fund
Gold ETFs Price of Gold
Real Estate Mutual funds Real estate indices

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 Return generated relative to the risk taken by the fund to generate the return is
called risk adjusted return.
 Sharpe ratio compares the return of a fund with its risk. Sharpe ratio = Excess return
/ Standard Deviation
 Return is measured as the excess return over a risk free rate (Return of the fund –
risk free rate).
 For the Sharpe ratio to be high, a fund needs to post a higher return for the same
risk, or lower risk for the same return.
 Example:
 An equity fund posted a return of 25% with a standard deviation of 16%.
 The benchmark posted a return of 22% with a standard deviation of 12%.
 If the risk free rate was 6%, the risk adjusted return measured by the Sharpe
ratio would be as follows:
 For the fund: (25-6)/16 = 1.1875
 For the benchmark: (22-6)/18 = 1.3333
 Though the fund has higher absolute return, it has a higher risk comapred to the
benchmark, so its Sharpe rario is lower.
 Treynor ratio compares the excess return over the risk free rate of a fund with its
risk, measured by beta.
 Treynor Ratio = Excess return/Beta. Higher the Treynor ratio, better the fund
performance.
 Beta measures only systematic risk, Standard deviation measures total risk
 Example:
 An equity fund posted a return of 25% with a beta 1.2.
 The benchmark posted a return of 22% with a beta of 1.
 If the risk free rate was 6%, the risk adjusted return measured by the Treynor
ratio would be as follows:
 For the fund: (25-6)/1.2 = 15.83
 For the benchmark: (22-6)/1 = 16
 Manager’s Alpha means the excess return after adjusting for beta
 Example:
 An equity fund posted a return of 30% with a beta 1.2.
 The benchmark posted a return of 22% with a beta of 1.
 If the risk free rate was 6%, the risk adjusted return measured by the Manager’s
alpha would be as follows:
 Excess return of the fund: 30% – 6% (risk free rate) = 24%.
 Given its beta of 1.2 and benchmark return of 22%, its excess return should
have been 19.2%.
 Therefore the alpha of the fund is 4.8%.
 A consistent performer is a fund which is able to give better returns than the
benchmark across time periods on a risk-adjusted basis.
 Tracking error measures the consistency in returns.
 The standard deviation of excess return is called the tracking error.
 Lower the tracking error, higher the consistency in performance.

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 If the excess returns come with higher risk, they may not be consistent.
 If the standard deviation is high, the returns may not be consistent.
 Since index funds replicate the index, their performance is amongst peer group is
compared using tracking error. Tracking error for index fund should to be zero.

Chapter 9 - Scheme Selection (10 Marks)


9.1 Selection of Equity Funds
 Equity funds that have consistently generated better returns than the benchmark
over different market situations are preferred for their consistent performance.
 Investors are also interested in the ability of the fund to protect downside risk in
time of market downturn.
 Longer term performance over 3, 5, 7 or 10 should be used to select equity funds
rather than short term returns.
 Ideally, cash levels should not be over 10% of the net assets.
 Holding cash is a defensive stance, hoping to protect the portfolio from a steep fall
in stock prices.
 The fund manager’s cash call may turn out to be right or wrong, implying a risk for
the investor.
 Different equity funds have different levels of diversification in the portfolio based
on the investment objective. Eg. a sector fund is less diversified than a thematic
fund.
 If the top 10 stocks in the portfolio account for more than 40% of the net assets, the
portfolio is said to be concentrated.
 If the top 3 sectors in a diversified equity fund account for over 40% of the net
assets, the equity fund is termed to be concentrated.
 Thematic/sector fund will have a higher sector concentration and hence chosen
tactically.
 The market cap of the stocks in the portfolio should be in line with the portfolio
objectives.
 Large cap fund should be predominantly have large cap stocks. Large cap fund has
lower risk of liquidity and earning shocks. In a difficult industry scenario,
investments should largely be made in funds investing in frontline stocks.
 A diversified fund that has too much exposure to small cap stocks is risky.
Small/mid cap funds are suited for aggressive investors.
 Portfolio turnover ratio = total sales or purchases of a fund (whichever is lower)
divided by the average net assets of the fund.
 Higher the ratio, greater the frequency of trading, and lower the average holding
period.
 Average holding period = 365/Portfolio Turnover Ratio.
 Low turnover indicates that the fund manager has high conviction in the stocks
selected. Frequent trading increases transaction costs of the scheme.
 Liquidity refers to the option to exit the fund. An open-ended fund enables investors
to exit the fund, when they choose to.

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 Closed end funds or ELSS should be chosen only if the investor is sure of a longer
holding period. However, in order to ensure liquidity, closed end funds are now
required to be listed.
 Size of the equity fund influences the performance. Funds with a large size may be
difficult to liquidate and rebalance.
 Finding suitable stocks becomes tougher as the size increases in case of mid-cap
and small cap funds and sector funds.
 Longer age of the fund presents a longer track record for evaluation. In case of an
old fund, the investor will have the ability to judge performance over a longer period
of time.
 Style of fund performance defines risk-return profile. An actively managed fund is
riskier than a passive fund.
 Dividend yield funds are less risky, compared to growth-oriented funds.
 Large cap funds may be larger in size and less volatile; small cap funds may be
smaller in size and more volatile.
 In a bullish market, growth funds outperform; in a bearish market, value funds
outperform.
 Value funds tend to perform better over a period of time.

9.2 Selection of Debt funds


 Debt funds are differentiated by the segment of the debt market they invest in.
 Fund managers construct portfolios including securities whose tenor is linked to the
objectives.
 Investing horizon of the investor may be matched to the average maturity.
 Average maturity indicates the extent of interest rate risk in the portfolio.
 Higher the average maturity of a debt fund, greater the interest rate risk of the fund.
 Yield indicates the return on the portfolio. Funds with shorter tenors may feature a
lower yield.
 Higher the proportion of securities to be valued every day on mark-to-market basis,
and higher the average maturity, higher the interest rate risk in the portfolio
 Expense ratio is very important in debt funds. A debt fund with lower expense ratio
should be preferred to those with higher expense ratios.
 Institutional plans are offered with lower expense ratios for large investors.
 Credit rating of instruments in the portfolio indicates the extent of credit risk.
 Extent of papers with low credit quality in the portfolio indicates the extent of risk.
 Funds may compromise credit quality for a higher yield than peer group average.
 Floating rate funds are preferred in rising interest rate scenario
 FMPs are not affected by interest rate risk
 Liquid funds have lowest interest rate risk
 Performance of debt funds is typically evaluated for periods from three months to
one year.
 Funds with stable returns and regular dividends are preferred.
 Debt fund performances, within a given peer group does not vary too much.
 Large holding of cash and equivalents will reduce the returns.

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 Funds with low credit quality may be giving a high return.
 Portfolio with a large number of securities is more liquid.
 Large-sized debt funds can manage inflows and outflows, expenses and liquidity,
better than smaller funds.

9.3 Selection of Hybrid and Other funds


 Hybrid funds can have an equity or debt-orientation.
 Hybrid funds provide an indicative allocation to equity and debt, usually within a
range.
 Performance of a hybrid fund depends on the allocation to asset classes and
changes to this allocation.
 It is difficult to compare hybrid funds with varying allocations. The securities held
within the portfolio, under each asset class, impact performance.
 The regularity of the dividend and the predictability of the amount of dividend are
important.
 Value of gold ETFs will be in line with the price of gold.
 Funds that invest in gold-linked company stocks may behave more like equity funds.
 Performance of arbitrage funds should be comparable to that of short term debt
funds. These funds may offer limited liquidity, and may be exposed to volatility from
basis risks.
 A multi-manager fund of funds may be a better choice. FoFs should be chosen
based on investment objective of the fund.
 Fund of funds are evaluated based on their ability to select and manage a portfolio
of funds.
 In an International fund risk and return depends on strategy they adopt to invest in
international markets.
 International funds carry both liquidity and currency risks.

9.4 Source of Information on Mutual funds


 Monthly factsheets of fund houses provide information on fund performance, and
portfolio composition.
 Information about funds is also found on investment-oriented websites and
websites of Amfi and Sebi and respective mutual funds
 Agencies that use mutual fund data to create comparisons and reports for product
comparison and selection provide fund performance information.
 Rankings and ratings of funds are widely available, after classification of funds into
a peer group.
 Information providers for mutual funds:
 Value Research at www.valueresearchonline.com
 Icra online at www.mutualfundsindia.com
 CRISIL at www.crisilfundservices.com
 Morning Star at www.morningstar.co.in
 Lipper at www.lipperweb.com

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CHAPTER 10 - SELECTING THE RIGHT INVESTMENT PRODUCTS FOR INVESTORS (9 Marks)

 Physical assets have a physical and material form. For example: gold and real
estate.
 Return on physical assets is in the form of appreciation over time.
 Physical assets are preferred by investors due their tangible nature. However,
physical assets are exposed to hazards such as fire, theft or floods.
 Financial assets involve investing money for some cash flows in the future.
 Financial assets do not have a tangible form. For example: Bank deposits, company
deposits, equity shares, government saving instruments, bonds and debentures.
 Financial assets because of their nature, are protected from physical harm.
Financial assets help in financing the economic activity and are encouraged by the
government over physical assets.
 Investment in gold acts as a hedge against inflation.
 One can hold gold in physical form in the form of Gold bonds, Gold coins and bars.
 Gold can be held in a financial form in 3 ways:
 Buying gold in the commodity futures market
 Buying gold-linked funds
 Buying gold exchange traded funds (ETFs)
 Mutual funds in India have launched gold-linked schemes that may invest in
physical gold, international gold funds, or in securities of gold mining companies.
 Some funds also offer hybrid products that combine gold with other assets such as
bonds, commodities and equity.
 There are many advantages of holding gold in the form of mutual funds.
 Gold-linked funds are exempt from wealth tax.
 Since they are in the form of a mutual fund unit, they become long-term capital
assets after a holding period of one year.
 Investors have nomination facility which is not available to investors in physical gold.
 Real Estate as an investment is preferred by investors but is beyond the means of
small investors.
 It is not easy to quickly liquidate investments in real estate at an appropriate price.
There is a high concentration risk attached to real estate investments.
 Real estate mutual funds (REMFs) enable investors to receive benefits of investing
in real estate with a small investment through a mutual fund product.
 The portfolio of REMFs can be made up of direct investment in real estate, debt
instruments issued by developers, or securitised loans.
 Bank deposit is a preferred form of investment with small investors.
 Bank deposits offer the facility to access funds anytime.
 Investors find it easy to invest in bank deposits due to their familiarity with their
bank and are considered as a safe investment option.
 However, term deposits usually impose a penalty for premature withdrawal.

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 Yield on bank deposits is quite low and investors cannot benefit from changes in
interest rates.
 Interest income from bank deposits is taxable.
 NPS, launched in May 2009, is regulated by PFRDA and has an objective of saving
for a retirement corpus.
 Contributions made by the individual are managed by professional portfolio
managers.
 NPS does not offer guarantee of returns.
 The minimum investment is Rs.500 a month or Rs.6000 annually. There is no upper
limit on investment.
 Investment mix in NPS is selected by the contributor.
 An NPS account can be opened through identified Points of Presence.
 Permanent Retirement Account Number (PRAN) will be allotted.
 Tier I (Pension account): The amount invested in this account cannot be
withdrawn before the end of the term.
 Tier-II (Savings account). The amount invested can be withdrawn.
 One needs to have a running Tier I account in order to be eligible to open a Tier
II account.
 Investment mix under Tier II can be selected by the contributor.
 The funds contributed will be managed according to the investment mix selected by
the contributor.
 The options available are equity (E), credit risk bearing debt instruments (C) and
government securities (G).
 While an investor can choose to invest the entire corpus in C or G, investment in E is
capped at 50%.
 There is also an auto choice option where the exposure to equity keeps reducing as
the age of the contributor increases.
 NPS subscribers are allotted a unique identification number known as Permanent
Retirement Account Number (PRAN) which is applicable across employers or
Pension Fund Managers.

CHAPTER 11 - FINANCIAL PLANNING (7 Marks)


 Financial needs occur at various stages in one’s life to meet ’life goals’.
 Financial needs can be classified as investment needs and protection needs.
 Financial need that can be described in terms of the amount of money that may be
required to fulfil the need and the time when the money would be required is called
a financial goal.
 Future value of goals can be estimated based on current cost, time to goal and the
expected rate of inflation.
 [FV=current cost*{1+rate of inflation}^time]. Use the FV function in MS Excel
 Example:
 It costs Rs.8 lakh to put a child through formal college education today.

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 If a family likes to estimate what this cost will be when their child, who is now 6
years old, is ready for college education at 16 years of age?
 = 8 x (1.07)^ 10 = 15.7 lakh
 Example:
 Suppose the investor indicates that an amount of Rs.5 lakh has been saved
already for this goal, and he likes to know what is the rate at which it should be
invested to meet the goal:
 ((Estimated future value/invested amount)^investment horizon ) – 1
 ((15.7/5)^(1/10)) -1 = 12.12%
 Use the RATE function in MS Excel
 Example:
 For an estimated expense of Rs.15.7 lakh after 10 years, the investor chooses
to invest in a diversified equity portfolio, expected to earn an average return of
14% p.a. The amount to be invested today can be computed as:
 Future value of goal/(1+expected return)^investment horizon
 15.7/((1+14%)^10) = 4.23 lakh
 Use the PV function in MS Excel
 Example:
 Instead of investing Rs.15.7 lakh in a lumpsum as mentioned in the earlier
example, the investor may choose SIP.
 Use the PMT function in MS Excel
 The amount to be invested today in SIP:
 PMT(rate of return, number of periods, PV (blank), FV)
 PMT(14/12, 10*12, , 15.7 lakh)=Rs.6060

11.2 Financial Planning


 Financial planning considers the overall situation of the investor.
 A financial plan proposes an asset allocation to match the investor’s risk profile.
 Financial planning involves creating an investment plan and asset allocation
strategy to meet financial goals.
 It also calls for periodic review of the plan and portfolio and taking corrective
measures.
 The objective of financial planning is to ensure that the financial goals are met
through proper planning and management of finances.
 It creates a road map in terms what has to be done to achieve the goals.
 It also ensures the right combination of savings and investment.
 It reviews current and expected income and expenses and the ability to save and
invest.
 Financial planners advise investors on managing their finances such that goals are
achieved.
 They have a good understanding of investment options available and their
suitability.
 They work with clients on their overall financial situation and not just one or two
aspects.
 They review the financial plan periodically so that it continues to be relevant to the
investor’s needs and situation.

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Examination. ©2015, Centre for Investment Education and Learning Pvt. Ltd. www.ciel.co.in
 Steps in financial planning:
 Establish the client relationship.
 Ascertain the clients’ needs and define with them, their financial goals
 Gather data about the clients’ financial status. Analyse the data to prepare a
current financial position statement.
 Understand how much of loss clients can withstand and for what period
 Understand and explain the tax situation to the clients.
 Suggest allocation to asset classes and specific schemes
 Execute the plan by making the specified investments
 Review and suggest changes in asset allocation
 Investor needs and preferences vary depending upon their situation.
 A commonsense approach to understanding these differences in preferences is to
look at which stage of life they are in.
 Childhood Stage: This stage represents dependence on parents to meet expenses.
Any gifts received can be invested for the long-term as there is no immediate
requirement for funds.
 Young Adult Stage: This is the start of the earning phase. Investing in equity must
begin in this stage preferably through Equity SIPs. Life insurance may be necessary
to protect income from disability or illness. In this stage of life, an individual is
partially dependent.
 Young married stage: In this stage, there is a need to provide for emergencies and
protect income from death, injuries or loss is high. A couple has joint responsibility
to create and adhere to budgets and to control expenses. The need for term
insurance is high.
 Married with Children Stage: In this stage, less money is available for investment.
Health and life insurance is important as protection needs are more important than
investment needs at this stage.
 Married with Older Children Stage: In this stage, there is higher ability to save and
invest. Investment needs take precedence over protection needs. Focus is on
repayment of loans and saving for retirement.
 Pre-retirement Stage: In this stage, people start setting aside increased amounts to
protect their life style, post-retirement. Pension products and health insurance are
preferred choices for investors.
 Retirement Stage: Persons in this stage of life require at least 2/3rd of their last
income. They focus on income generation and protect wealth from the effects of
inflation.
 The wealth stage approach assumes that the accumulation of wealth goes through
various phases. There are three wealth cycle stages as follows:
 Accumulation Phase: Investors in this stage are able to accumulate and save for the
long-term and choose growth-oriented investments. They have a long-term investing
horizon and can allocate savings to equity. e.g. saving for child’s education.
 Transition Phase: This phase is characterized by middle-aged investors. They have
both equity and debt in their portfolio, as they have a medium-term horizon. e.g.

This material is a summary of the classroom training content of CIEL’s training program for NISM-MFD 48
Examination. ©2015, Centre for Investment Education and Learning Pvt. Ltd. www.ciel.co.in
withdraw from savings to meet the immediate education expenses of a child while
at the same time saving for retirement.
 Distribution Phase /Reaping stage: Investors in this stage depend on investment
income and are usually retired investors. These investors are income-oriented,
preferring debt to equity.
 Inter-generational Wealth Transfer stage: In this stage, investors pass on their
wealth to the next generation or to organisations and trusts. They focus on the goals
of the beneficiaries and require advice on creating trusts and wills and estate
planning.
 Sudden Wealth Surge: Sudden wealth surge is a wealth stage where the investor
experiences a sudden surge in wealth from unexpected flow of funds.e.g. lottery,
sudden appreciation in shares, inheritance of wealth. In this stage, it is important
that the investor evaluate tax implications. Investments can be made in low-risk
products like a liquid fund till such time a proper financial plan is drawn.

CHAPTER 12: RECOMMENDING MODEL PORTFOLIOS AND FINANCIAL PLANS (8


Marks)
12.1 Model Portfolios and Risk Profiling
 A model portfolio is created for a given combination of risk, return and investing
horizon.
 Risk profile is influenced by investor’s personal and financial situation.
 Risk Profiling Tools are used to generate risk appetite scores for investors. These
can be in the form of surveys, questionnaires and proprietary risk profiling tools.
 Scenario analysis may also be used to carry out risk profiling. Past history of the
actual transactions of the investors may also be a good risk profiling tool.
 Asset allocation involves making the decision about the proportions in which
investments would be divided between asset classes.
 It takes into account correlation between asset classes.
 The asset allocation for an investor would have to be tweaked based upon the ability
and willingness of the investor to assume risk.
Factor Relationship with Risk Appetite
Age Older investors may have lower risk appetite
than younger investors
Accumulated capital Higher the accumulated capital, higher is the
risk appetite
Stability of Income Individuals with stable income tend to have
higher risk appetite
Job Security Individuals with higher job security may be
willing to assume higher risk
Dependents Risk appetite decreases as number of
dependents increases
Earning members Risk appetite increases as number of earning
members increases
Attitude Individuals willing to experiment may have a

This material is a summary of the classroom training content of CIEL’s training program for NISM-MFD 49
Examination. ©2015, Centre for Investment Education and Learning Pvt. Ltd. www.ciel.co.in
higher risk appetite

12.2 Types of Asset Allocation

 Strategic asset allocation (SAA) is driven completely by his need for return and risk
profile.
 Model portfolio is an example of SAA. For example, an investor desiring a return of
14% over 10 years, with a moderate appetite for risk, may choose to have 60% of
his investments in equity (expected return of 18%) and 40% in debt (expected return
of 8%).
 Tactical Asset Allocation (TAA) involves active management of the proportions in
various asset classes based on the expectation of the performance of different
asset classes.
 For example, if the advisor expects the equity markets to correct and he may
tactically reducing the allocation to equity and increasing the allocation to debt.
 TAA is carried out by fund managers, expert advisors and experienced investors.
 In Fixed Asset Allocation, investor chooses a strategic asset allocation and decides
to rebalance periodically to the same ratio.
 For example, imagine a portfolio has an allocation of 60% in equity and 40% in debt
and that equity markets are doing well. Value of equity portfolio goes upto 70%. The
investor will sell part of the equity holdings and bring it down to 60% of the portfolio
value and invest in debt and restore the proportion to 40%.
 Flexible Asset Allocation involves choosing an asset allocation and letting it move
along with the market without rebalancing.
 If equity does well and the allocation increases, they allow it to run, without
rebalancing to a fixed ratio.
 Model portfolios are indicative and asset allocations may have to be revised and
rebalanced based on investor needs.
 Examples:
a) Proportion to equity for an investor may change as he moves away from
accumulation phase into transition phase
b) Allocation to riskier assets reduces as life stage changes from young adult to
married with children stage
c) Allocation to income-oriented assets increases are investor approaches
retirement
d) A retired investor whose retirement income is well taken care of and is looking
to generate a corpus for a grandchild may be willing to take a greater exposure
to equity as he ages

This material is a summary of the classroom training content of CIEL’s training program for NISM-MFD 50
Examination. ©2015, Centre for Investment Education and Learning Pvt. Ltd. www.ciel.co.in