MUTUAL FUND INVESTMENT

Unit – III
 Mutual Funds Products – Concept and Salient Features;
 Equity Schemes; Debt Schemes; Diversified Schemes; Balanced Schemes; Tax Funds; Liquid Funds; Index
Funds; Fixed Maturity Plans; Exchange Traded Funds (ETFs), Gold ETFs;
 Risk Disclosures and Return Calculations by type of Mutual Fund;
 Fact Sheet of Mutual Funds and their uses;
 Identifying investor needs and choice of mutual fund products.

A. Introduction
i. What is investing?
An investment operation is one which, upon thorough analysis promises safety of principal and an adequate
return. Operations not meeting these requirements are Speculative.
- Benjamin Graham – The Intelligent Investor

Investing is the act of seeking value at least sufficient to justify the amount paid. Consciously paying more in the
hope that it can soon be sold for a still higher price should be labelled as speculation
- Warren Buffet – The Making of an American Capitalist

Investing is a method of purchasing assets to gain profit in the form of reasonably predictable income (dividend,
interest or rentals) and / or appreciation over the long term.
- Burton G Malkiel – A Random Walk Down Wall Street

Investing is an Act of faith, a willingness to postpone present consumption and save for the future. We entrust
our capital to corporate stewards in the faith –at least with the hope that their efforts will generate high rates of
return on our investments
- John C. Bogle – Common Sense on Mutual Funds

ii. Role of Financial Intermediaries

Financial intermediaries help to transfer the savings to the real sector of the economy through the formation of
financial assets. Institutional developments in the financial market influence the saving patterns, particularly in
the household sector.

The following (Figure 1) which is self-explanatory details the investment avenues.

Figure 1: Investment Avenues

[Source: https://www.thewealthwisher.com/investment-avenues-for-indian-investors/]

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 iii. Debt Vs Equity Instruments
The debt market is the market where debt instruments are traded. Debt instruments are assets that require a
fixed payment to the holder, usually with interest. Examples of debt instruments include bonds (government or
corporate) and mortgages.
The equity market (often referred to as the stock market) is the market for trading equity instruments. Stocks
are securities that are a claim on the earnings and assets of a corporation (Mishkin 1998). An example of an
equity instrument would be common stock shares, such as those traded on the New York Stock Exchange.

iv. Differences between Stocks and Bonds.

Equity financing allows a Company to acquire funds (often for investment) without incurring debt. On the other
hand, issuing a bond does increase the debt burden of the bond issuer because contractual interest payments
must be paid— unlike dividends, they cannot be reduced or suspended. Those who purchase equity instruments
(stocks) gain ownership of the business whose shares they hold (in other words, they gain the right to vote on
the issues important to the firm). In addition, equity holders have claims on the future earnings of the firm. In
contrast, bondholders do not gain ownership in the business or have any claims to the future profits of the
borrower. The borrower’s only obligation is to repay the loan with interest.
Bonds are considered to be less risky investments for at least two reasons. First, bond market returns are less
volatile than stock market returns. Second, should the company run into trouble, bondholders are paid first,
before other expenses are paid. Shareholders are less likely to receive any compensation in this scenario.

B. MUTUAL FUNDS PRODUCTS – CONCEPT AND SALIENT FEATURES

i. Introduction
Mutual funds are a synonym for an investment company in USA and an investment trust in UK and other
European countries. It is a financial intermediary, which pools the savings of several individuals and invests the
money thus raised in equity shares, debentures, bonds, government securities and other such instruments. An
investor can invest either directly in securities or can invest through mutual funds. By investing through a mutual
funds having professional expertise, the risk is reduced. Several authors have defined mutual funds in different
words but meaning the same i.e. it is a non-banking financial intermediary who acts as ―important vehicle for
bringing wealth holders and deficit units tighter indirectly (Pierce, 1984).

A Mutual Fund is a trust that collects money from investors who share a common financial goal, and invest the
proceeds in different asset classes, as defined by the investment objective.

Simply put, mutual fund is a financial intermediary, set up with an objective to professionally manage the money
pooled from the investors at large.
An investor in a mutual fund scheme receives units which are in accordance with the quantum of money invested
by him. These units represent an investor’s proportionate ownership into the assets of a scheme and his liability
in case of loss to the fund is limited to the extent of amount invested by him. The pooling of resources is the
biggest strength for mutual funds. The relatively lower amounts required for investing into a mutual fund scheme
enables small retail investors to enjoy the benefits of professional money management and lends access to
different markets, which they otherwise may not be able to access. The investment experts who invest the pooled
money on behalf of investors of the scheme are known as 'Fund Managers'. These fund managers take the
investment decisions pertaining to the selection of securities and the proportion of investments to be made into
them. However, these decisions are governed by certain guidelines which are decided by the investment
objective(s), investment pattern of the scheme and are subject to regulatory restrictions. It is this investment
objective and investment pattern which also guides the investor in choosing the right fund for his investment
purpose.

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 ii. How is a mutual fund set up?
A mutual fund is set up in the form of a trust, which has sponsor, trustees, asset management company (AMC) and
custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of a company.
The trustees of the mutual fund hold its property for the benefit of the unitholders. Asset Management Company
(AMC) approved by SEBI manages the funds by making investments in various types of securities. Custodian,
who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are
vested with the general power of superintendence and direction over AMC. They monitor the performance and
compliance of SEBI Regulations by the mutual fund.
SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be
independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be
independent. All mutual funds are required to be registered with SEBI before they launch any scheme.

iii. Role of Mutual Fund in Financial Market:

 Organized Investments: Due to participation of Mutual Funds in a large scale, it has transformed the
Financial Market Transactions into a much more organized. Individual investors may speculate to the
maximum, but under the collective investment scheme (i.e. Mutual Fund), the tendency to speculate
greatly reduced at an individual level.
 Evolution of Stock Markets: Large scale transactions entered into by Mutual Funds, headed by team
professionals, have helped in the evolution of stock markets and financial markets.
 Household Savings: They are the ideal route for many a household to invest their savings for a higher
returns, than normal term deposits with banks.

iv. The advantages of investing in Mutual Funds:

 Professional Management: Investors avail the services of experienced and skilled professionals who are
backed by a dedicated investment research team which analyses the performance and prospects of
companies and selects suitable investments to achieve the objectives of the scheme.
 Diversification: MFs invest in a number of companies across a broad cross-section of industries and
sectors. Investors achieve this diversification through a MF with less money and risk.
 Convenient Administration: Investing in a MF reduces paper work and helps investors to avoid many
problems such as bad deliveries, delayed payments and unnecessary follow up with brokers and
companies.
 Return Potential: Over a medium to long term, MF has the potential to provide a higher return as they
invest in a diversified basket of selected securities.
 Low Costs: MFs are a relatively less expensive way to invest compared to directly investing in the capital
markets because the benefits of scale in brokerage, custodial & other fees translate into lower costs for
investors.
 Liquidity: In open ended schemes, investors can get their money back promptly at Net Asset Value (NAV)
related prices from the Mutual Fund. With close-ended schemes, investors can sell their units on a stock
exchange at the prevailing market price, or avail of the facility of direct repurchase at NAV related prices
which some close ended and interval schemes offer periodically.
 Transparency: Investors get regular information on the value of their investment in addition to disclosure
on the specific investments made by scheme, the proportion invested in each class of assets and the Fund
Manager’s investment strategy and outlook.

v. Limitations of taking the Mutual Fund route for investment:

 No Choice of Securities: Investors cannot choose the securities which they want to invest in.
 Relying on Other’s Performance:
 Investors face the risk of Fund Manager not performing well. Investors in Mutual Fund have to rely
on the Fund Manager for receiving any earning made by the fund, i.e. they are not automatic.
 If Fund Manager’s pay is linked to performance of the fund, he may be tempted to perform only on
short-term and neglect long-term performance of the fund.

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  High Management Fee: The Management Fees charged by the fund reduces the return available to the
investors.
 Diversification: Diversification minimizes risk but does not guarantee higher return.
 Diversion of Funds: There may be unethical practices e.g. diversion of Mutual Fund amounts by Mutual
Fund/s to their sister concerns for making gains for them.
 Lock-In Period: Many MF schemes are subject to lock in period and therefore, deny the investors market
drawn benefits

vi. The Structure of the Mutual Fund

A mutual fund is set up in the form of a trust, which has sponsor, trustees, asset management company (AMC)
and a custodian. The trust is established by a sponsor or more than one sponsor who is like a promoter of a
company. The trustees of the mutual funds hold its property for the benefit of the unit-holders. The AMC,
approved by SEBI, manages the funds by making investments in various types of securities. The custodian, who
is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested
with the general power of superintendence and direction over AMC. They monitor the performance and
compliance of SEBI regulations by the mutual funds.

C. TYPOLOGY OF MUTUAL FUND PRODUCTS

Factors Affecting selection of Mutual Funds:
1. Past Performance: The Net Asset Value is the yardstick for evaluating a Mutual Fund. An increase in
NAV means a capital appreciation of the investor. While evaluating the performance of the fund, the
dividends distributed is to be considered as the same signifies income to the investor. Dividends
distributed during a period go on to reduce the Net Asset Value of the fund to the extent of such
distribution.
2. Timing: The timing when the mutual fund is raising money from the market is vital. In a bullish market,
investment in mutual fund falls significantly in value whereas in a bearish market, it is the other way
round where it registers growth.
3. Size of Fund: Managing a small sized fund and managing a large sized fund is not the same as it is not
dependent on the product of numbers. Purchase through large sized fund may by itself push prices up
while sale may push prices down. Medium sized funds are generally preferred.
4. Age of Fund: Longevity of the fund in business needs to be determined and its performance in rising,
falling and steady markets have to be checked for consistency.
5. Largest Holding: It is important to note where the largest holdings in mutual fund have been invested in
order to identify diversion of funds to Group Concerns.
6. Fund Manager: One should have an idea of the person handling the fund management. A person of
repute gives confidence to the investors. His performance across varying market scenarios should also
be evaluated.
7. Expense Ratio: SEBI has laid down the upper ceiling for Expense Ratio. A lower Expense Ratio will give a
higher return which is better for an investor.
8. PE Ratio: The ratio indicates the weighted average PE Ratio of the stocks that constitute the fund
portfolio with weights being given to the market value of holdings. It helps to identify the risk levels in
which the mutual fund operates.
9. Portfolio Turnover: The fund manager decides as to when he should enter or quit the market. A very
low portfolio turnover indicates that he is neither entering nor quitting the market very frequently. A
high ratio, on the other hand, may suggest that too frequent moves have lead the fund manager to miss
out on the next big wave of investments. A simple average of the portfolio turnover ratio of a peer group
updated by mutual fund tracking agencies may serve as a benchmark. The ratio is annual purchase plus
annual sale to average value of the portfolio.

Accordingly, there is a wide range of Mutual fund schemes/products to choose from which is such devised
to meet the varied need of the investor. Thus, Mutual funds can be classified in accordance with its
structure, type of investment and/or the objective with which the mutual fund is set up. A pictorial
representation of the types of mutual funds products in the Indian Mutual Fund Industry is provided in
Figure 2;

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 Figure 2: Classification of Mutual Funds
[source: https://arthikdisha.com/7-top-best-types-of-mutual-funds-in-india/]

Structural classification: Open Ended Vs Close Ended

Mutual fund schemes are classified as open ended or close ended on the basis of the period for which it is initially
available for sale, also known as the new fund offer. An open end fund is one that sells and repurchases units at
all times. When the fund sells units, the investor buys them from the fund. When the investor redeems the units,
the fund repurchases the units from the investor. An investor can buy units or redeem units from the fund itself
at a price based on the net asset value per unit. NAV per unit is obtained by dividing the amount of the market
value of the fund‘s assets by the number of units outstanding. The number of units outstanding goes up or down
every time the fund sells new units or repurchases existing units. In other words, the unit capital of an open end
mutual funds is not fixed but variable. When sale of units exceeds repurchase, the fund increase in size. When
repurchase exceeds sale, the fund shrinks.
In practice, an open end fund is not obliged to keep selling new units at all times, though it has the obligation to
repurchase units tendered by the investor. Many successful funds, if they think they cannot manage a large fund
without adversely affecting profitability, stop accepting further subscriptions from new investors after they
reach a certain size. As indicated earlier, an open end fund rarely denies its investors the facility to redeem
existing units.
Unlike an open end fund, the unit capital of a close end fund is fixed, as it makes a onetime sale of a fixed number
of units. After the offer closes, closed end funds do not allow investors to buy or redeem units directly from the
funds. However, to provide the much needed liquidity to investor closed end funds list on a stock exchange.
Trading through a stock exchange enables investor to buy or sell units of a closed end mutual funds from each
other, through a stockbroker, in the same fashion as buying or selling shares of a company. The fund‘s units may
be traded at discount or premium to NAV based on investors‘ perceptions about the funds future performance
and other market factors affecting the demand for or supply of the funds units. The number of outstanding units
of a closed end fund does not vary on account of trading in the funds units at the stock exchange. Sometimes,
close ended funds do offer buy back of funds, thus offering another avenue for liquidity to closed end fund
investors. In this case, mutual funds actually reduce the number of outstanding units. In India, SEBI regulations
ensure that the closed end scheme investors are given at least one of the two exit avenues. The difference
between the two; open ended and close ended scheme is well clarified in the following table.

Table 1

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Load Funds and NO load funds
Marketing of a new mutual funds scheme involves initial expenses. These expenses may be recovered from the
investors in different ways at different times. Three usual ways in which funds marketing expenses may be
recovered from the investors are:
 At the time of investor’s entry into the fund/scheme, by deducting a specific amount from his
contribution

 By charging the fund/scheme with a fixed amount each year, during a specified number of years

 At the time of investors’ exit from the fund/scheme, by deducting a specified amount from the
redemption proceeds payable to the investors.

These charges imposed on the investors to cover distribution/sales/marketing expenses are often called loads.
The load charged to the investor at the time of his entry into a scheme is called ―front-end load or entry load. The
load amount charged to the scheme over a period of time is called a ―deferred load. The load that the investor
pays at the time of his exit is called a ―back end load or exit load. Some funds may also charge different amount
of loads to the investors, depending upon how many years the investor has stayed with fund, the long the investor
stays with the fund, less the amount of exit load he is charged. This is called ―contingent deferred sales charge.
Funds that charge a front end load would be load funds as per SEBI definition. This is in line with the
internationally used definition. However, SEBI would consider a fund to be a no-load fund, if an AMC absorbs these
initial marketing expenses and does not charge the fund – a situation that is somewhat special to India and not
widely prevalent elsewhere. Internationally, a fund even when it does not make a front end load would still be
considered a load fund, if it charges an exit load or a deferred sales load.
From the investor’s perspective, it is important to note that loads are not charged only by open end funds; even
a close end fund can charge a load to cover the initial issue expenses. It is also important to note that there are
other expenses such as the fund manager’s fees, which are charged to the investors on an ongoing basis. Such
expenses reduce the NAV of the fund. If the investor’s objective is to get the benefit of compounding his initial
investment by reinvesting and holding his investment for a very long term, then a no-front load is preferable. The
number of units allotted to an investor is based on the purchase price offered to him. In a no front end load fund,
the NAV based purchase price offered to the investor is same as the fund NAV per unit, there being no deduction
from the amount paid by him.

Load Funds: MF can recover the initial marketing expenses (loads) in any of the following ways —
• Entry Load: Deducting these expenses at the joining time (suitably adding to the existing NAV, thus allotting less units).
• Deferred Load: By deducting deferred load, where the expenses are charged over a specified period.
• Exit Load: By deducting these expense when investors exit the scheme (suitable reducing from the existing NAV while
making payment)
No Load Funds: Investor in a No-Load fund enters and exits the fund at the NAV, i.e. they do not bear the initial marketing
expenses.
Note: Load / No—Load Funds are differentiated on the basis of initial marketing expenses and not on the basis of other running/
management expenses. [special case in case of the India MF Market]

Interval Funds: Interval funds combine the features of open-ended and close ended schemes. They are open for
sale or redemption during pre-determined intervals at NAV related prices.

By Investment Objectives:
1. Growth Funds:
(a) Object: To provide capital appreciation over the medium to long term.
(b) Investment Pattern: Such schemes invest a majority of their corpus in equities. It has been proved
that returns from stocks, have outperformed most other kind of investments held over the long term.

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 (c) For Whom? Growth Schemes are meant for investors who have a long-term outlook, and seek growth
over a period.

2. Income Funds:
(a) Object: To provide regular and steady income to investors.
(b) Investment Pattern: Fixed income securities such as Bond, Corporate Debentures and Government
Securities.
(c) For Whom? Income Funds are ideal for capital stability and regular income.
(d) Variants:
• Gilt Fund: Fund that invests its proceeds only in Government Securities and Treasury Bills.
• Bond Fund: Fund that invests its proceeds only in Bonds and Corporate Debt Instruments.

3. Balance Funds:
(a) Object: Provide both growth and regular income. Such schemes periodically distribute a part of their
earning.
(b) Investment Pattern: Both in Equities and Fixed Income Securities, in the proportion indicated in their
offer documents.
(c) For Whom? For investors looking for a combination of income and moderate growth.
(d) Less Sensitive to Market Movements: In a rising stock market, the NAV of these schemes may not
normally keep pace, or fall equally when the market falls.

4. Money Market Funds:

(a) Object: Provide easy liquidity, preservation of capital and moderate income.
(b) Investment Pattern: Safer Short-Term Instruments such as Treasury Bills, Certificates of Deposit,
Commercial Paper and Inter-Bank Call Money. Returns on these schemes may fluctuate depending upon the
interest rates prevailing in the market.
(c) For Whom? For corporate and individual investors, who wish to invest their surplus funds for short
period.

5. Tax Saving Schemes:

(a) Object: Provide tax rebates to the investors under specific provisions of the Indian Income Tax laws as
the Government offers tax incentives for investment in specified avenues.
(b) For Whom? For persons who seek to park their otherwise taxable income in funds for a moderate
income, to reduce their tax liability.

By Investment Types
(a) Industry Specific Schemes: Industry-Specific Schemes invest only in the industries specified in the
offer document. The investment of these fund is limited to specific industries like Infotech, FMCG,
Pharmaceuticals, etc.
(b) Index Schemes: Index Funds attempt to replicate the performance of a particular index such as the
BSE Sensex or the NSE 50
(c) Sectoral Schemes: Invest exclusively in a specified sector. This could be an industry or a group of
industries or various segments such as “A” Group shares or initial public offerings.

Some other Mutual fund schemes/products are also being prevalent in the Indian Mutual Fund Industry.
Exchange traded fund (ETF) and the Fund of Fund (FoF) are two very prevalent ones;

Exchange Traded Fund (ETF):

(i) Nature: An ETF is a hybrid product having features of both an Open-Ended Mutual Fund and an exchange-
listed security. It is a fund that tracks an index, but can be traded like a stock.
(ii) Scheme/Structure: In this type of fund, money is invested in the stocks of the index in the same
proportion. ETF are traded on stock exchanges, and hence can be traded any time during the day.

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 (iii) Features:
 Prices fluctuate from moment to moment. The difference in price is due to the forces of demand and
supply for ETF in the market at that point of time.
 Investor needs a broker to purchase units of ETF.
 They have very low operating and transaction costs, since there are no loads or investment minimums
required to purchase and ETF.
 ETFs can be traded any time during the day, as against conventional index funds which can be traded
only at the end of the day.
 ETF units can be traded at a premium or discount to the underlying Net Asset Value.

Fund of Funds:
(i) Nature: It is a Mutual Fund Scheme, where the subscription proceeds are invested in other Mutual
Funds, instead of investing in Equity or Debt Instruments.
(ii) Features:
 These funds offer and achieve a greater diversification than traditional mutual funds.
 Expense/Fees on such funds are higher than those on regular funds because they include part of the
expense fees charged by the underlying funds.
 Indirectly, the proceeds of Fund of Funds may be invested in its own funds, and can be difficult to
keep track of overall holdings.

In addition to the above discussion on the classification of funds the following terminology is of prime
importance as the issues provide some fine tuning to the mutual fund products and how the investors go about
in buying the mutual fund products;

Systematic Withdrawal Plan (SWP):

(i) Nature: SWP permits the investor to make an investment at one go and systematically withdraw at
periodic intervals, at the same time permitting the balance funds to be re-invested.
(ii) Features:
 Investors can receive regular income while still maintaining their investment’s growth potential.
 SWP includes convenient payout options and has several tax advantages.
 Withdrawal can be done either on a monthly basis or on a quarterly basis, based on needs and
investment goals of an investor.
 Tax is not deducted, & dividend distribution tax is not applicable. There are no entry or exit loads.

Systematic Investment Plan (SIP):

(i) Nature: Under a SIP, an investor can invest in the units of Mutual Funds at periodic intervals (monthly
or quarterly) prevailing unit price of that time. This fund is for those investors who do not want to
accumulate their savings and invest in one go. This fund permits them to accumulate their savings by
directly investing in the mutual fund.
(ii) Feature: Investors can save a fixed amount of rupees every month or quarter, for the purchase of
additional units.

Systematic Transfer Plan (STP): Investors can use Systematic Transfer Plan (STP) as a defence mechanism in
volatile market. This plan is used to transfer investment from one asset or asset type into another asset or
asset type. Before we understand STP, let's define SIP (Systematic Investment Plan) first. SIP is a
disciplined way of investing where investors invest a regular sum every month in mutual funds. SIP is also
known as rupee cost averaging and it is the best way to handle volatility in investment. For example, you
start to invest Rs 5,000 every month in a mutual fund. If you do it via SIP, this money will be taken from
your account every month and invested in the mutual fund that you have selected for SIP.
STP is a variant of SIP. STP is essentially transferring investment from one asset or asset type into another asset
or asset type. The transfer happens gradually over a period. Systematic Transfer Plan is of two types; fixed
STP, and capital appreciation STP. A fixed STP is where investors take out a fixed sum from one investment
to another. A capital appreciation STP is where investors take the profit part out of one investment and
invest in the other.

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D. IDENTIFYING INVESTOR NEEDS AND CHOICE OF MUTUAL FUND PRODUCTS
In identifying the investor needs financial planning is of the essence. The Investor has to not only clarify his
investment needs but also zero down on his risk tolerance. For this the risk questionnaire (discussed in
wealth management module) is of prime importance. On the basis of the risk preference of the investor and
the customization of the Mutual Fund products some strategies have evolved, a discussion of the strategies
follows;

1. The Wing-It Strategy

This is the most commonly seen mutual fund investment strategy, especially among new investors. How does
it work? If you're not following a specific plan or structure that helps guide you in making your investments
and maintaining your portfolio, you are likely employing a wing-it strategy.
Without a plan for investing, you might struggle to make decisions that accurately reflect your investing goals.
Most experts would agree that this strategy tends to be least successful because of its lack of consistency.
On the other hand, if you have a plan or structure in place that guides your investing, then managing your
portfolio should be much easier.

2. Market Timing Strategy

The market timing strategy implies the ability to get into and out of sectors, assets, or markets at the right
time. In an ideal world, the ability to time the market means that you would always buy low and sell high.
Unfortunately, few investors do this consistently because investor behaviour is typically driven by emotions
instead of logic. The reality is most investors tend to do exactly the opposite of what is optimal (i.e., buy high
and sell low). This leads many to believe that market timing does not work. No one can accurately predict the
future with any consistency, yet there are many market-timing indicators that some investors believe give
them an edge in predicting where the markets are headed.

3. Buy-and-Hold Strategy
This is by far the most widely preached investment strategy. This strategy means you'll buy your investments
and hold onto them for a long time regardless of whether the markets are going up or down. Conventional
wisdom says If you employ a buy-and-hold strategy and weather the ups and downs of the market, over time
your gains will outweigh your losses. Billionaire and legendary investor, Warren Buffett, is on record as
saying this strategy is ideal for the long-term investor.
The other reason this strategy is so popular is that it's easy to employ. This does not make it better or worse
than the other options; it's simply easy to buy and then to hold.

4. Performance Weighting Strategy

This is somewhat of a middle ground between market timing and buy-and-hold. With this mutual fund
investment strategy, you will revisit your portfolio mix from time to time and make some adjustments. Let's
walk through an oversimplified example using real performance figures.
Let's say you started with an equity portfolio of $100,000 across four mutual funds, split into equal
weightings of 25% each. After the first year of investing, the portfolio is no longer weighted equally at 25%
in each fund because some funds performed better than others.
The reality is that after the first year, most mutual fund investors are inclined to dump the loser (Fund D) and
buy more of the winner (Fund A). That, however, is not what performance weighting is about. Performance
weighting simply means that you would sell some of the funds that did the best to buy some of the funds that
did the worst.
Your heart will go against this logic, but it is the right thing to do because the one constant in investing is that
everything is cyclical. In year four, Fund A has become the loser and Fund D has become the winner.
Performance-weighting this portfolio year after year means you would have taken the profit when Fund A
was doing well to buy Fund D when it was down. If you had re-balanced this portfolio at the end of every year
for five years, you would be further ahead as a result of performance weighting. It's all about discipline.

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E. RISK DISCLOSURES AND RETURN CALCULATIONS BY TYPE OF MUTUAL FUND

Investor Returns
 If the investor invested at the NAV and redeemed his investments at the NAV, then the scheme returns for
any period will be equal to the investor’s returns for the same period.
 At the NFO stage, investors invest at the face value of Rs10, in the case of both open-end and closed-end
schemes.
 They invest in the post-NFO stage in closed-end schemes at the prevailing price in the stock exchange.
Investors can sell their units held in closed-end schemes, at the prevailing market price.

 post-NFO investment in open-end schemes is done at the Sale Price.

Earlier, open end schemes could fix the Sale Price higher than NAV. The difference was called entry load.
For example, if NAV was Rs 15, and the scheme declared Sale Price of Rs 15.30, the differential of Rs
0.30 was entry load. Under the current regulatory environment, entry load is not permitted. Therefore,
investors subscribe to units of open-end schemes at the NAV.

 They can redeem their units held in open-end schemes, at the Re-purchase Price, which can be lower
than NAV. The difference is called exit load. For example, if NAV is Rs 15 and the scheme declares Re-
purchase Price of Rs. 14.75, the differential of Rs 0.25 is exit load. SEBI regulations permit exit load
upto 7% of NAV.

Offer Document
1. AMC prepares the Offer Document for the NFO. This needs to be approved by the trustees and the Board
of Directors of the AMC.
2. The observations that SEBI makes on the Offer Document need to be incorporated. After approval by
the trustees, the Offer Document can be issued in the market.
3. Three dates are relevant for the NFO of an open-ended scheme:
i. NFO Open Date - This is the date from which investors can invest in the NFO
ii. NFO Close Date - This is the date upto which investors can invest in the NFO
iii. Scheme Re-Opening Date - This is the date from which the investors can offer their units for re-
purchase to the scheme (at the re-purchase price); or buy new units of the scheme (at the sale
price).
4. Information like the nature of the scheme, its investment objectives and term, are the core of the
scheme. Such vital aspects of the scheme are referred to as its fundamental attributes.
5. Investment in mutual funds is governed by the principle of caveat emptor i.e. let the buyer beware.
6. Mutual Fund Offer Documents have two parts:
i. Scheme Information Document (SID), which has details of the scheme, like.
a. Investment Objective defines the broad investment charter.
b. The investment policy gets into details of how the portfolio is proposed to be distributed
between different types of assets (also called asset allocation).
c. Investment strategy is decided regularly by the top management of the AMC based on
developments in the economy and market
ii. Statement of Additional Information (SAI), which has statutory information about the mutual
fund that is offering the scheme.
[In practice, SID and SAI are two separate documents, though the legal technicality is that SAI is part of
the SID].
 A single SAI is relevant for all the schemes offered by a mutual fund
 A single SAI is relevant for all the schemes offered by a mutual fund
7. Key Information Memorandum (KIM) is essentially a summary of the SID and SAI. It is more easily and
widely distributed in the market,
8. The Offer Documents in the market are “vetted” by SEBI, though SEBI does not formally “approve” them

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Problems on return computation

Calculation of NAV

Quantitative Indicators
Sharpe Ratio:
The Sharpe Ratio is a measure for calculating risk-adjusted return, Itis the average return earned in excess of
the risk-free rate per unit of volatility or total risk.

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Beta Ratio (Portfolio Beta):
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as
a whole.

Macaulay Duration:
The Macaulay duration is the weighted average term to maturity of the cash flows from a bond. The weight of
each cash flow is determined by dividing the present value of the cash flow by the price.

Modified Duration:
Modified Duration is the price sensitivity and the percentage change in price for a unit change in yield.

Standard Deviation:
Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the
data, the higher the deviation. It is applied to the annual rate of return of an investment to measure the
investment's volatility.

F. FACT SHEET OF MUTUAL FUNDS AND THEIR USES

A mutual fund fact sheet is a basic three-page document that gives an overview of a mutual fund. It helps the
investor to assess the risk and return of the mutual fund in accordance to the past performance. The fact sheet
will show how risky a fund is.
The factsheet provides all the general information on the fund – its objective or philosophy, options (growth or
dividend), plans (direct and regular), net asset value (NAV) of each plan, minimum investment amount,
systematic features (SIP, SWP, STP) and assets under management (AUM) data. It is important to know about the
fund's exit load, as it gets deducted from total gains if the investor exits during a specific period after investment.
It is a small penalty charged on prevailing NAV to discourage premature redemption. Different schemes have
different exit loads, while few such as liquid funds generally do not have exit load. Some funds have a fixed exit
load and some have a tiered structure. For instance, a fund may have nil exit load if the investor withdraws up to
10% of units per year. For units more than 10%, it charges 3% for exit before 12 months, 2% for exit before 24
months, 1% for exit before 36 months and nil after that.
Investors should look out for the fund's product labeling and riskometer. Product labeling underlines product
suitability for investors. It tells about ideal investment time frame required to benefit from the fund and where
it invests. Riskometer is a presentation that helps investors measure the risk associated with the fund. It presents
ve levels of risks - low, moderately low, moderate, moderately high and high. Since an equity fund typically has
high risk involved, needle of the scale points towards moderately high /high, suggesting the fund is meant for
investors with a high risk-taking appetite.
Please refer to Annexure 1 (how to read a Fact Sheet) and Annexure 2 (Fact sheet of ICICI Pru) for better
understanding of fact sheet and how to interpret it.

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Multiple Choice Questions
1. NAV of growth option of a scheme went up from Rs 10 to Rs 12. Simple return on the scheme is
a. 2%
b. 20%
c. 1.2%
d. 12%

2. Which of the following considers compounding?

a. Simple return
b. Annualised return
c. CAGR
d. None of the above

3. Investor’s return is different from scheme return to the extent of

a. Load
b. Scheme running expenses
c. MTM
d. AMC fees

4. __________ is a measure of risk-adjusted return

a. Simple return
b. Standard Deviation
c. Beta
d. Sharpe Ratio

5. Offer document of mutual fund scheme is prepared by

a. AMC
b. Trustees
c. RTA
d. SEBI

6. SEBI ________ offer documents of mutual fund schemes.

a. Vets
b. Approves
c. Approves or disapproves
d. Registers

7. Close-end schemes do not have

a. NFO open date
b. NFO close date
c. Scheme re-open date
d. All of the above

8. Which of the following is permitted to invest in mutual funds in India?

a. Individuals
b. HUF
c. Qualified Foreign Investors
d. All of the above

9. Where investment is by minor, KYC compliance is required from

a. The minor
b. The guardian
c. The minor and guardian
d. No KYC required

10. A greater portion of returns from equity asset class is generally through
a. Capital gain
b. Interest income
c. Dividend income
d. Inflation

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11. A greater portion of returns from conventional debt investments is generally through
a. Capital gain
b. Interest income
c. Dividend income
d. Inflation

12. SEBI regulations permit an exit load of __________ %

a. 10
b. 12
c. 7
d. 9

13. The arithmetic mean return is _________ geometric mean return

a. Equal to
b. Greater than
c. Less than
d. No relationship

14. Gilt funds invest in only treasury bills and government securities, which do not have a _______________
a. Credit risk
b. Market risk
c. Interest risk
d. Purchase power risk

15. The assets of the mutual fund are held by ______.

a. AMC
b. Trustees
c. Custodian
d. Registrar

16. If YTM increases

a. Future Value of Cash Flows goes down
b. Present Value of Cash Flows goes up
c. Present Value of Cash Flows goes down
d. Future Value of Cash Flows goes up

17. For a scheme to be defined as equity fund, it must have minimum

a. 65% in Indian equities
b. 65% in equities
c. 51% Indian equities
d. 35% in Indian equities

18. A scheme has 50 cr units issued with a face value of Rs. 10. Its NAV is Rs. 12.36. Its AUM in Rs. Cr is _______________. Given
that the Entry Load is 2%
a. 500
b. 618
c. 630.36
d. Insufficient Information

19. A group of securities, usually a market index, whose performance is used as a standard is called as a ____
a. Benchmark
b. Beta
c. Standard deviation
d. None of the above

20. A debt fund that aims to generate ___________________ by investing in a range of debt and money market instruments of
various maturities
a. Dividend
b. Income
c. Capital appreciation
d. None of the above

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ANSWER KEY

1 2 3 4 5 6 7 8 9 10
b c a d a a c d b a

11 12 13 14 15 16 17 18 19 20
b c b a c c a a a b

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