Class Discussion : Financial Services..

MBA-BM-2015

Financial Services: MBA-BM-2014-16

Session 1

• Financial Services defined

• Financial services can be defined as
– The services offered by financial institutions for the facilitation and management of various financial
and money related transactions and issues.

• Institutions providing Financial Services

• Institutions providing Fee Based ( Advisory) services:
– Portfolio Management services ( like mutual funds, pension funds, hedge funds)
– Depository services
– Brokerage services
– Credit rating services
– Investment banking services( issue management, M&A, corporate restructuring etc.).

• Fund Based Services :

– Leasing
– Factoring
– Forfaiting
– Credit card companies
– Bill discounting and rediscounting
– Hire Purchase and installment credit
– Financial and Performance guarantees
– Venture capital / PE funds

Mutual funds
• What is a mutual fund ?
A common pool of fund or capital mobilized from a large number of investors, and invested on their
behalf in several securities in the market.

– All the returns from such investments, both in terms of dividends and capital appreciation, net of
various expenses and fees of the fund house, accrue to the investors.

Advantage of investing through a mutual fund

1) Provide continuous professional portfolio management services

2) Diversification

3) Reduction in transaction cost:

4) Regulatory Protection :

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• Evolution of Indian Mutual fund Industry

The Indian mutual fund industry has witnessed the following interrelated stages of development in terms
of entry of players :

Phase I – July 1964 – November 1987..

– Only UTI
– First scheme : Unit scheme 1964 or US-64

Phase –II – November 1987 – October 1993 :

– 6 PSU banks and 2 Insurance cos allowed to launch their MFs.

Phase –III – October 1993-2003:

– Two important milestones in Indian MF industry
– Introduction of Regulations.. SEBI Mutual Funds Regulation Act , 1993 ( though the first set of
regulations were not applicable for UTI)
– Entry of Private MF players ( Kothari Pioneer the first ever Private MF to enter India… later merged
with Franklin Templeton.)
– By the end of 2003, India had 33 Mutual Funds with the total assets under management of US$ 22.2
billion.

Phase-IV - 2003 onwards

– Bifurcation of UTI and consolidation of Indian MF industry.

Current Status of Mutual Fund industry in India

• No of Funds ( Fund Houses ) : 43
• A) BANK SPONSORED : 7
– JOINT VENTURES - PREDOMINANTLY INDIAN : 4
– JOINT VENTURES - PREDOMINANTLY FOREIGN : 1
– OTHERS : 2
• B) INSTITUTIONS – 2
– JOINT VENTURES - PREDOMINANTLY INDIAN : 1 ( LIC –NOMURA)
– INDIAN: IIFCL ASSET MGT CO. LTD.
• C) PRIVATE SECTOR : 34
– INDIAN : 19
– FOREIGN : 5
– JOINT VENTURES - PREDOMINANTLY INDIAN : 7
– JOINT VENTURES - PREDOMINANTLY FOREIGN: 3

• Total number of schemes existing= 1900 ( apporx)

• AUM: INR 11,89,000 Crores (approx)= $ 0.19 trillion (close to 10% of last year’s GDP).
• as on Mar-2015 : (http://portal.amfiindia.com/spages/ammar2015repo.pdf

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• Big Six of the Indian MF industry :

70%
60%
50%
40%
30%
20%
10%
0%

Global Scenario

Worldwide Total Net Assets of Mutual Funds

Millions of U.S. dollars, year-end
2006 2007 2008 2009 2010 2011 2012 2013
World $21,808,826 $26,129,767 $18,918,982 $22,945,327 $24,709,854 $23,795,808 $26,835,850 $30,049,934
Americas 11,470,431 13,421,360 10,580,914 12,578,297 13,597,527 13,529,258 15,138,443 17,156,409
United States 10,397,877 11,999,734 9,602,574 11,112,674 11,831,334 11,626,493 13,043,666 15,017,682
US ( % of
world ) 48% 46% 51% 48% 48% 49% 49% 50%
Europe 7,803,877 8,934,861 6,231,115 7,545,535 7,903,389 7,220,298 8,230,059 9,374,830
Europe (% of
world) 36% 34% 33% 33% 32% 30% 31% 31%
France 1,769,258 1,989,690 1,591,082 1,805,641 1,617,176 1,382,068 1,473,085 1,531,500
Germany 340,325 372,072 237,986 317,543 333,713 293,011 327,640 382,976
Ireland 855,011 951,371 720,486 860,515 1,014,104 1,061,051 1,276,601 1,439,867
Italy 452,798 419,687 263,588 279,474 234,313 180,754 181,720 215,553
Luxembourg 2,188,278 2,685,065 1,860,763 2,293,973 2,512,874 2,277,465 2,641,964 3,030,665
Netherlands 108,560 113,759 77,379 95,512 85,924 69,156 76,145 85,304
Switzerland 159,517 176,282 135,052 168,260 261,893 273,061 310,686 397,080
United
Kingdom 755,163 897,460 504,681 729,141 854,413 816,537 985,517 1,166,834
UK ( % of
world ) 3% 3% 3% 3% 3% 3% 4% 4%
Asia and
Pacific 2,456,492 3,678,325 2,037,536 2,715,234 3,067,323 2,921,276 3,322,198 3,375,828

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Asia Pacific (
% of world) 11% 14% 11% 12% 12% 12% 12% 11%
Australia 864,234 1,192,988 841,133 1,198,838 1,455,850 1,440,128 1,667,128 1,624,081
China N/A 434,063 276,303 381,207 364,985 339,037 437,449 479,957
China ( % of
world ) - 2% 1% 2% 1% 1% 2% 2%
India 58,219 108,582 62,805 130,284 111,421 87,519 114,489 107,895

India ( % of
world ) 0.3% 0.4% 0.3% 0.6% 0.5% 0.4% 0.4% 0.4%
Japan 578,883 713,998 575,327 660,666 785,504 745,383 738,488 774,126

Structure of a typical mutual fund organization in India

Sponsor

Trustee AMC

Custodian & Transfer Registrar Auditor

depository Agent

A mutual fund in India is primarily comprised of a three tire structure as indicated in the figure below:
•
• a) Sponsor or Settler:
The sponsor for a mutual fund can be a registered company, a scheduled bank or a financial institution
which establishes the mutual fund and gets it registered with SEBI. For instance, Prudential Plc
and ICICI Bank are the sponsors for the Prudential ICICI mutual fund.
The sponsor is required to contribute at least 40% of the minimum net worth (Rs 10 crore) of the
AMC.
A sponsor must have a sound track record means at least five years experience in financial
services industry,
A sponsor must have a positive net worth in all the immediately preceding five years.

The sponsor should have a reputation for fairness and integrity in all his business transactions and
should not have been found guilty of fraud or convicted of an offence involving moral turpitude.

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For forming a trust the sponsor has to execute a trust deed in favour of the trustee.
The promoters or sponsors intending to set up or float a mutual fund appoint the trustees and set up an
AMC who in turn appoints the custodian/depository, registrar and transfer agents and auditors.

B) Trustee:
The trustee is a person or group of persons who ‘hold in trust’ the investments of the unit
holders/investors of the mutual fund. They monitor the activities of the mutual fund and see to it
that the schemes floated by the fund are managed in accordance with the announced objectives and
SEBI guidelines.

C) Asset Management Company (AMC):

means a company formed and registered under the Companies Act, 1956 appointed by the board
of trustees, to manage the day to day affairs of the MF and operate the schemes of such funds.
The AMC functions under the supervision of its own board of directors and on the instructions
of the trustees and SEBI.

The AMC is accountable to provide relevant information and periodic reports of its activities to the
trustee.

d) Custodian:
Often, an independent organisation, such as a bank, takes the custody of securities and other assets
of a mutual fund.

The custodian is appointed by the trustees for safekeeping the physical securities. The dematerialised
securities holdings are held in a depository through a depository participant.

The custodian and depositories work under the instructions of the AMC and the direction of the
trustees.

e) Other entities :

Apart from these four main parties, there are some independent administrative entities like the
bankers,( provide banking services), registrars and transfer Agents(responsible for issuing and
redeeming units of the mutual fund and providing other related services, such as preparing the transfer
documents and updating the investor records)

Types of Mutual Fund Schemes

Mutual fund schemes can be categorized based on :
ü Tenor/structure
ü Asset class /Investment Objective or
ü Geography

Types of schemes by Tenor/Structure

Based on structure mutual fund schemes may be classified into three broad categories :
– Open ended
– Closed ended
– ETFs

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Open ended Schemes :

– These are the schemes that do not have a fixed maturity. The mutual fund sells and repurchases
units of such a scheme on an ongoing basis at announced prices.

– Investors can exit from a scheme or enter a scheme by directly transacting with the mutual fund.
– Key feature of such a scheme is liquidity.

Every repurchase or Sale results in a change in capital of the scheme.

– The unit capital increases when additional units are sold and decreases if existing units are
repurchased.

Closed Ended Schemes :

A closed-ended fund or scheme has a stipulated maturity period .
– The fund is open for subscription only during a specified period at the time of launch of the scheme.
Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy
or sell the units of the scheme on the stock exchanges where the units are listed. Prices at
which transactions happen may NOT be closely related to the NAV: depends on demand and
supply.

Types of schemes by Asset Classes/Investment Objectives

• Mutual fund schemes can be offered with any of a range of investment objectives, each corresponding to a
certain point on the risk- return ‘investment frontier’.

Classified by Asset classes, mutual fund schemes can be as follows :

– Equity Oriented Funds ( more than 65% equity )
– Debt Oriented funds ( mostly debt )
– Balanced / Hybrid funds ( combination of stocks and bonds)
– Money Market mutual funds
– Index Funds
– Fund of Funds

Equity Oriented Funds

An equity fund may be further classified along two dimensions:

– (1) market capitalization or size of the companies in which a fund invests, based on the value of
the company's stock and
– (2) investment style (i.e., growth vs. blend/core vs. value). The two dimensions are often displayed
in a grid known as a "style box".
– Growth funds seek to invest in stocks of fast-growing companies.
– Value funds seek to invest in stocks that appear cheaply priced. Blend funds are not biased toward
either growth or value.

Accordingly several names are used for various schemes like :

– Aggressive Growth funds
– Growth funds
– Growth and Income

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– Mid cap fund

– Small cap fund
– Income fund

Some more categories of equity funds

Some more categories of equity funds are as follows :

Sector/Specialty Funds :
– Invests in common shares of companies in a single industry or sector which is expected to
provide high growth particularly over an intermediate term.

Diversified Equity Funds

– Invests in a diversified equity portfolio comprising 40 or more stocks , with not more than 5%
invested in any particular stock

Commodity Funds :
– Investing predominantly in a portfolio of stocks of companies engaged in the commodity business
within specified sectors like Oil& Gas, Metals, and Materials & Agriculture.
– Example: SBI Magnum COMMA fund.

Contra Funds :
– Invests in stocks that are currently out of favour but expected to turnaround.
– Example: SBI MSFU -Contra Fund. (MSFU :Magnum Sector Fund Umbrella) -

Debt/Bond Oriented Funds

These funds invest primarily in bonds or debt securities ( > 80% typically.)
– The principal source of their return is the interest payments from the fixed income securities (i.e
bonds, notes etc) held in the portfolio.
– There are also potential profits from capital gains arising out of changes in interest rates These are
however usually quite small.

Types of debt funds

Debt funds are again typically classified along the following dimensions :
– Issuer of the bonds /debt securities
– Maturity ( or duration or interest rate sensitivity)
– Credit quality

Accordingly different varieties may be as follows :

– Govt . Bond funds
– Municipal Bond funds
– International bond funds
– Corporate bond funds
• General Corporate Bond Fund
• High Quality Corporate Bond Fund
• High Yield Corporate Bond Fund ( Or Junk Bond Fund): In India, SEBI guidelines limit
investments in unrated securities that are below investment grade to 25% of the net assets of
any scheme. Hence it is not possible to have a full fledged junk bond scheme in India.

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• Hybrid or Balanced Funds

• Hybrid funds invest in both stocks and bonds. Can also invest in convertible bonds or preferred stocks.

– Generally they are thought to be less risky than stock funds, while providing a better return than
the bond funds.

• Types of hybrid/balanced funds

• Depending on the flexibility the fund manager has, to alter the proportions of stock and debt in the portfolio
these funds can be :
– Fixed hybrid fund : The proportions are pre specified and are strictly adhered to. One of the
common allocation used in these types of funds is known as the “robot mix’( 55 % equity-35%
debt-10% cash or cash equivalent). It may be 60-30-10 or 60-40 also. In order to maintain these
percentages periodic adjustments or re balancing is required as the bonds and stocks change in value.

– Flexible hybrid fund: Fund manager has the flexibility to alter the proportions (within a broad
range) in response to changing market conditions and investment opportunities.

• Capital Protected Funds :

– A capital protected fund or scheme is a kind of balanced scheme , where a part of the initial issue
proceeds is invested in gilts that would mature to a value equivalent to the unit capital of the
scheme. Thus the investor’s capital is protected.
The remaining issue proceeds is invested in equity securities.

– Example : Suppose an investment in gilts for 5 years yields 7% return. In that case, a 5 yrs Capital
Protected scheme can collect Rs100 from investors and invest Rs 71.30 in gilt of 5 yrs maturity and
balance Rs. 18.70 in equity securities.
– At the end of 5 yrs the investment in gilt would grow to Rs100 which would be adequate to cover the
amount collected from investors. Thus even if the investment in shares is completely wiped out( a
very remote possibility), the investor’s capital is still protected.
– Under SEBI guidelines, a capital protected scheme can only be structured as a closed ended
scheme and repurchase of schemes before maturity is not allowed.

Money Market Mutual Funds

• Invests in high quality, low risk , short term “ money market “ securities like T-bills, CDs, Commercial
papers etc.

• The short term nature of money market instruments and the fact that most of the issuers of securities in the
money market are reputed institutions or the govt or reputed corporates, provides the following advantages
to the money market funds :
– Low risk of default
– High liquidity
– The return provided is often higher than that provided through a traditional savings account.

Index Funds
• Also called tracker fund ( in Europe) or unmanaged fund, index funds seek to replicate the performance
of a designated index( eg. S&P CNX Nifty, or BSE 100 or BSE Sensex etc. ) .

– Example: SBI Magnum index fund which invest in stocks comprising the S&P CNX Nifty index in
the same proportion as in the index with the objective of achieving returns equivalent to the
Total Returns Index of S&P CNX Nifty index. The Total Returns Index is an index that reflects the
returns on the index from index gain/loss plus dividend payments by the constituent stocks.

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• The fund accomplishes this by investing in virtually the same securities or a representative sample of the
same securities that make up the index.

• Fund of funds
• As the name suggests a ‘fund of funds’ is a mutual fund that invests in a group of top performing mutual
funds. These may be managed or unmanaged funds.

• The idea is appealing --- instead of having to research and select the few funds in which you want to
invest from among the many types and investment objectives available, the manager chooses “the best of
the best” for the investor.

• Not only is this one stop shopping, but the fund of funds usually provides instant diversification and
asset allocation among different industries, different countries, and different classes of assets.

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