CHAPTER – I

MUTUAL FUNDS IN INDIA

INTRODUCTION

Mutual Funds play a vital role in resource mobilization and

efficient allocation of these financial resources to the productive

channels of an economy. Throughout the world, Mutual funds are

considered as a reliable instrument in bringing changes in the financial

intermediation, development of capital markets and growth of the

corporate and industrial sectors. Globalization, liberalization,

deregulation and restructuring of the Indian economy have created

necessity for efficient allocation of financial resources. Mutual Funds

are playing an important role in bringing stability in the financial

system and efficiency to the resource allocation process. Capital

market reforms have increased reliance of the corporate sector on

equity financing thus entailing even greater scope for the Mutual Funds

to expand and grow.

The Indian mutual fund industry is one of the fastest growing

sectors in the Indian capital and financial markets. The mutual fund

industry in India has seen dramatic improvements in quantity as well

as quality of product and service offerings in recent [Link]

Funds Industry has shown approximately 100% growth in last 6 years

which is impeccable for any Industry. The total Assets under

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Management of the Mutual Fund Industry as on 31 December, 2007

stood at Rs.5,18,123 Crores 1.

There is a lot of difference between an investor of today and the one of

yesterday in many respects. Today’s investor is Rational and analyzes

in detail all the information available regarding various investment

avenues. This can be attributed to Information Technology boom that

has created awareness among investors to invest their hard earned

money in best available alternatives according to their respective

investment objectives. With the growth of capital markets and the

emergence of alternative savings instruments, investors tend to move

towards more liquid short-term instruments as the units of the Mutual

[Link] market complications and investment risk in the stock

market have pushed households further towards Mutual Funds.

Mutual funds provide various benefits like diversification, professional

management etc. and simplicity of investment process that have

proven to be major favorable factors for these funds. With the

introduction of diverse options, an investor needs to choose a mutual

fund that meets his risk acceptance and his risk capacity levels and

has similar investment objectives as those of the investor’s. With

plethora of schemes available in the Indian markets, an investor needs

to evaluate and consider various factors before making an investment

decision. As we all know that the environment under which

Investments are made is very dynamic and unpredictable in nature.

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These uncertainties can be tackled

1. The Tribune, (4January, 2008, Page 16, Stock Market)

through diversification of investment and forecasting changes in the

crucial economic variables and their impact on investment returns.

Every investor doesn’t have the time or knowledge to scan this

ever-changing environment and its micro and macro variables

affecting the Investments. But if an investor is going for Mutual Fund,

this task is left to a professional. i.e. a Fund Manager who applies his

market knowledge and experience and further invests the funds of

investors keeping in mind their objectives and of the fund itself.

As we all know that Indian economy has started integrating with

the international markets; external factors too affect our economy.

Factors such as a change in international interest rates, hike in crude

prices, or any major happening in International market like a recent

recession in U.S Economy have a deep impact on the Indian stock

market. It may not be possible for an investor to have such minute

knowledge and understanding of all variables. Investing in such an

environment is a tough task and this process can become fairly time

consuming. Mutual Funds provide an option of investing without

getting lost in these complexities. Fund managers are paid to

understand these issues and the Asset Management Company invests

in further research in this field. Mutual Funds in India receive an

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unparalleled array and level of services. This has resulted due to entry

of Private players. With the following of Foreign fund Management

Companies through Joint Venture route, a new dimension in the

Industry has emerged. These fund houses brought in with them the

latest product innovations, Investment Management techniques and

investor servicing technology. In India, Savings Rate is over 23% which

is one of the highest in the [Link], efforts are required from

the players in the Industry to attract and channelize these savings

towards this Sector.

CONCEPT OF MUTUAL FUNDS

Mutual Funds mobilize the savings, particularly from the small &

household sectors, for investment in securities and stocks. These

institutions are professional fund managers, managing funds of

individuals and institutions that may not have such a high degree of

expertise or sufficient time to cope with the complexities of different

investment avenues, legal provisions associated therewith and the

unpredictability of capital markets. Mutual Fund is considered as an

institutional arrangement wherein savings of millions of investors are

pooled together for investment in a diversified portfolio of securities to

spread risk and to ensure steady return. It receives money from the

unit holders, invests it, earns on it, attempts to make it grow and

agrees to share prosperity with the unit holders. The income earned

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through these investments and the capital appreciation realized is

shared by its unit holders in proportion to the number of units owned

by them.

Mutual Fund is a collective investment scheme designed to

provide benefits of diversified investment portfolio and expert

investment management. It ensures a reasonable return, liquidity,

safety and security to the investment besides providing growth

prospects and other advantages. It gathers and processes information,

identifies investment opportunities, formulate investment strategies,

invest funds and monitor progress. To add value to the investment

Mutual Funds undertake research. Thus, a Mutual Fund is the most

suitable investment for the common man as it offers an opportunity to

invest in a diversified, professionally managed basket of securities at a

relatively low cost.

CLASSIFICATION OF MUTUAL FUNDS

Mutual funds may be classified as under-

1. EQUITY FUNDS

Equity Funds invest most of their funds in equity shares of

companies and undertake the risk associated with the investment in

Equity shares. The strength of these funds is the expected capital

appreciation. Equity funds are considered to be more risky as

compared to other types of funds. There are different types of equity

funds and each one of them falls in different risk bracket. Types of

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Equity Funds are listed below according to descending risk levels-

(a)Aggressive Growth Funds - In Aggressive Growth Funds, fund

managers aim for maximum capital appreciation and invest in shares

of speculative nature. Due to this reason these funds become more

mercurial.

(b)Growth Funds – Under this category, Fund Managers aim for

capital appreciation but within the time frame of 3 to 5 years. Funds

are invested in those companies that are expected to outperform the

market in the future. Such funds invest in growth oriented securities

which can appreciate to the expansion of production facilities in long

run. Growth Funds are also called 'Nest Eggs' investments. An investor

who selects such funds should be able to assume higher than normal

degree of risk.

(c) Equity Income or Dividend Yield Funds - The objective of

Equity Income or Dividend Yield Equity Funds is to generate high

recurring income and steady capital appreciation for investors by

investing in those companies which issue high dividends such as Utility

companies whose share prices fluctuate comparatively lesser than

other companies' share prices.

(d). Diversified Equity Funds - Diversified equity funds invest

mainly in equities without any concentration on a particular sector(s).

These funds are well diversified and reduce sector-specific or

company-specific risk.

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(e) Equity Index Funds - Equity Index Funds match the performance

of a specific stock market index. The portfolio of these funds comprises

of the same companies that form the index and is constituted in the

same proportion as the index. Equity index funds that follow broad

indices (like S&P CNX Nifty, SENSEX) are less risky than equity index

funds that follow narrow sectoral indices (like BSEBANKEX or CNX Bank

Index etc) as Narrow indices are less diversified and are more risky.

(f) Value Funds - Value Funds invest in those companies that have

sound fundamentals and whose share prices are currently under-

valued. The portfolio of these funds comprises of shares that are

trading at a low Price to Earning Ratio (Market Price per Share /

Earning per Share) and a low Market to Book Value (Fundamental

Value) Ratio. Value Funds may select companies from diversified

sectors and are exposed to lower risk level as compared to growth

funds or specialty funds. Value stocks are generally from cyclical

industries (such as cement, steel, sugar etc.), which make them

volatile in the short-term. Therefore, it is advisable to invest in Value

funds with a long-term time horizon as risk in the long term, to a large

extent, is reduced

(g) Specialty Funds - Specialty Funds state criteria for investments

and their portfolio comprises of only those companies that meet their

criteria. Criteria for some specialty funds could be to invest or not to

invest in particular regions, sectors or companies. Specialty funds are

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concentrated and are comparatively riskier than diversified funds.

There are following types of specialty funds:

g(1)Sector Funds: Equity funds that invest in a particular sector or

industry are known as Sector Funds. Their exposure is limited to a

particular sector (say Information Technology, Auto, Banking,

Pharmaceuticals or Fast Moving Consumer Goods).

g(1.1)Foreign Securities Funds: Foreign Securities Equity Funds

have the option to invest in one or more foreign companies. Foreign

securities funds achieve international diversification and are less risky

than sector funds. These funds are exposed to foreign exchange rate

risk and country risk.

g(1.2)Mid-Cap or Small-Cap Funds: Funds that invest in companies

having lower market capitalization are called Mid-Cap or Small-Cap

Funds. Market capitalization of Mid-Cap companies is less than that of

big, blue chip companies. Small-Cap companies have market

capitalization of less than Rs. 500 crores. Market Capitalization of a

company can be calculated by multiplying the market price of the

company's share by the total number of its outstanding shares in the

market.

g(1.3)Option Income Funds: Option Income Funds write options on

a large fraction of their portfolio. Proper use of options can help to

reduce volatility. These funds invest in big, high dividend yielding

companies, and then sell options against their stock positions, which

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generate stable income for investors. These funds are not available in

India.

2. Money Market / Liquid Funds

Money market / liquid funds invest in short-term (maturing within

one year) interest bearing debt instruments. These securities are

highly liquid and provide safety of investment. But money market /

liquid funds are exposed to the interest rate risk. Investment options

for liquid funds include Treasury Bills, Commercial papers (issued by

companies) and Certificates of Deposit (issued by banks).

[Link]

Hybrid funds are those funds whose portfolio includes a blend of

equities, debts and money market securities. Hybrid funds have an

equal proportion of debt and equity in their portfolio. There are

following types of hybrid funds in India:-

3a Balanced Funds - The portfolio of balanced funds include debt

securities, convertible securities, equity and preference shares held in

a relatively equal proportion. The objectives of balanced funds are

regular income, moderate capital appreciation and at the same time

minimizing the risk of capital erosion. Balanced funds are appropriate

for conservative investors having a long-term investment horizon.

3b Growth-and-Income Funds - Funds that combine features of

growth funds and income funds are known as Growth-and-Income

Funds. These funds invest in companies having potential for capital

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appreciation and issuing high dividends. The level of risks involved in

these funds is lower than growth funds and higher than income funds.

3c Asset Allocation Funds - Mutual funds may invest in financial

assets like equity, debt, money market or non-financial (physical)

assets like real estate, commodities etc. Asset allocation funds adopt a

variable asset allocation strategy that allows fund managers to switch

over from one asset class to another at any time depending upon their

outlook for specific markets. Fund managers may switch over to equity

if they expect equity market to provide good returns and switch over

to debt if they expect debt market to provide better returns. Switching

over from one asset class to another is a decision by the fund manager

on the basis of his own judgment and understanding of specific

markets and the success of these funds depends upon the skill of a

fund manager in anticipating market trends.

4. Debt / Income Funds

Funds that are invested in medium to long-term debt instruments

issued by banks, private companies, government, financial institutions

and other entities belonging to various sectors are known as Debt /

Income Funds. Debt funds are low risk profile funds that seek to

generate fixed current income and not capital appreciation to

investors. Debt securities are comparatively less risky than equities but

they are subjected to credit risk. i.e. risk of default by the issuer at the

time of interest or principal payment. To minimize this risk, debt funds

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generally invest in securities from those issuers, which are rated by

credit rating agencies and are considered to be of "Investment Grade".

There can be following types of debt funds depending on different

investment objectives:

4a Diversified Debt Funds - Debt funds that invest in securities

issued by entities belonging to different sectors of the market are

known as diversified debt funds. The best feature of diversified debt

funds is that investments are properly diversified into various sectors,

which results in reduction of risk. All investors share any loss incurred,

on account of default by a debt issuer.

4b High Yield Debt funds -High Yield Debt Funds prefer securities

issued by issuers considered to be of "below investment grade". The

motive behind adopting this sort of risky strategy is to earn higher

interest returns from these issuers.

4c Assured Return Funds -It is not necessary that a fund will meet

its objectives or provide assured returns to investors, but there can be

funds that come with a lock-in period and offer assurance of annual

returns to investors during the lock-in period. Any shortfall in returns is

suffered by the sponsors or the Asset Management Companies (AMC’

s).The security of investments depends upon the net worth of the

guarantor (whose name is specified in advance on the offer

document).To safeguard the interests of investors, SEBI permits only

those funds to offer assured return schemes whose sponsors have

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adequate net-worth to guarantee returns in the [Link] the past, UTI

had offered assured return schemes like Monthly Income Plans that

assured specified returns to investors in the future. UTI was not able to

fulfill its promises and faced large shortfalls in returns. Eventually,

government had to intervene and took over UTI's payment obligations

on itself. Currently, no AMC in India offers assured return schemes to

investors.

4d Fixed Term Plan Series - Fixed Term Plan Series usually are

closed-end schemes having short term maturity period (of less than

one year) that offer a series of plans and issue units to investors at

regular

2. [Link]

intervals. Fixed term plans are not listed on the exchanges. Fixed term

plan series usually invest in debt / income schemes and target short-

term investors. The objective of these schemes is to generate

expected returns in a short period.

5. GiltFunds

Gilt Funds invest in government securities having medium to long-term

maturity period. Issued by the Government of India, these investments

have very less risk of default and provide safety of principal to the

investors. Gilt funds are also exposed to interest rate risk. Interest

rates and prices of debt securities are inversely related and any

change in the interest rates results in a change in the NAV of debt/gilt

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funds in an opposite direction.

6. OTHERS-

6a -Commodity Funds

Those funds that focus on investing in different commodities (like

metals, food grains, crude oil etc.) or commodity companies or

commodity futures contracts are termed as Commodity Funds. A

commodity fund that invests in a single commodity or a group of

commodities is a specialized commodity fund and a commodity fund

that invests in all available commodities is a diversified commodity

fund and bears less risk than a specialized commodity fund. "Precious

Metals Fund" and Gold Funds that invest in gold, gold futures or shares

of gold mines are common examples of commodity funds.

6b-Exchange Traded Funds (ETF) Exchange Traded Funds provide

combined benefits of a closed-end and an open-end mutual fund.

These Funds follow stock market indices and are traded on stock

exchanges like a single stock at index-linked prices.

6c- Fund of Funds These Funds invests in other mutual fund

schemes offered by different AMC’s. Fund of Funds maintain a portfolio

comprising of units of other mutual fund schemes. Fund of Funds

provide investors with an advantage of diversifying into different

mutual fund schemes with even a small amount of investment, which

further helps in diversification of risks. But the expenses of Fund of

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Funds are quite high on account of compounding expenses of

investments into different mutual fund schemes.

STRUCTURE OF A MUTUAL FUND

A mutual fund is set up in the form of a trust, having sponsor(s),

trustee(s), Asset management company (“AMC”) and a custodian. The

trust is established by sponsor(s) who acts like a promoter of a

company. The trustees of the mutual fund hold its property for the

benefit of the unit-holders. The AMC manages the funds by making

investments in various types of securities. The custodian 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.

REGULATORY REGIME

A mutual fund is a fund established in the form of a trust to raise

money through the sale of mutual fund units to the public. The

regulation of mutual funds operating in India falls under the purview of

the Securities and Exchange Board of India (“SEBI”). Any person

proposing to set up a mutual fund in India is required, under the

Securities and Exchange Board of India Mutual Funds Regulations,

1996 to be registered with the SEBI.

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(a) Mutual Fund

The Mutual Fund Regulations lay down several criteria that need to be

fulfilled in order to be granted registration as a mutual fund. Every

mutual fund must be registered with SEBI and must be constituted in

the form of a trust in accordance with the provisions of the Indian

Trusts Act, 1882. The instrument of trust must be in the form of a deed

between the sponsor and the trustees of the mutual fund duly

registered under the provisions of the Indian Registration Act, 1908.

(b) Sponsor

The sponsor is required, under the provisions of the Mutual Fund

Regulations, to have a sound track record, a reputation of fairness and

integrity in all its business transactions. The sponsor should contribute

at least 40% to the net worth of the AMC. However, if any person holds

40% or more of the net worth of an AMC shall be deemed to be a

sponsor and will be required to fulfill the eligibility criteria specified in

the Mutual Fund Regulations. The sponsor or any of its directors or the

principal officer employed by the mutual fund should not be guilty of

fraud, not be convicted of an offence involving moral turpitude or

should have not been found guilty of any economic offence.

(c) Trustees

The mutual fund is required to have an independent Board of Trustees,

i.e. two thirds of the trustees should be independent persons who are

not associated with the sponsors in any manner whatsoever. An AMC

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or any of its officer(s) or employee(s) is not eligible to act as a trustee

of any mutual fund. In case a company is appointed as a trustee, then

its directors can act as trustees of any other trust provided that the

object of such other trust is not in conflict with the object of the mutual

fund. Additionally, no person who is appointed as a trustee of a mutual

fund can be appointed as a trustee of any other mutual fund unless he

is an independent trustee and prior approval of the mutual fund of

which he is a trustee has been obtained for such an appointment.

The trustees are responsible for ensuring that the AMC has all its

systems in place, all key personnel, auditors, registrars etc. have been

appointed prior to the launch of any scheme. It is also the

responsibility of the trustees to ensure that the AMC does not act in a

manner that is favorable to its associates such that it has a detrimental

impact on the unit holders. The trustees are also required to ensure

that an AMC has been diligent in monitoring any securities transactions

with brokers, so as to avoid any undue concentration of business with

any broker. The Mutual Fund Regulations further mandates that the

trustees should prevent any conflicts of interest between the AMC and

the unit holders in terms of deployment of net worth. The trustees are

also responsible for ensuring that there is no change carried out in the

fundamental attributes of any scheme or the trust or fees and

expenses payable or any other change that would modify the scheme

and affect the interest of unit holders, unless each unit holder is

16
provided with written communication thereof.

(d) Asset Management Company

The sponsor or the trustees are required to appoint an AMC to manage

the assets of the mutual fund. Under the Mutual Fund Regulations, the

applicant must satisfy certain eligibility criteria in order to qualify to

register with SEBI as an AMC.

1the sponsor must have at least 40% stake in the AMC;

2the directors of the AMC should be persons having adequate

professional experience in finance and financial services related field

and not found guilty of moral turpitude or convicted of any economic

offence or violation of any securities laws;

3the AMC must maintain at all times, a minimum net worth of Rs. 100

million;

4the board of directors of such AMC has at least 50% directors, who

are not associate of, or associated in any manner with, the sponsor or

any of its subsidiaries or the trustees;

5the Chairman of the AMC is not a trustee of any mutual fund.

In addition to the above eligibility criteria and other on going

compliance requirements laid down in the Mutual Fund Regulations,

the AMC is required to observe the following restrictions in its normal

course of business:

1any director of the AMC cannot hold office of a director in another

AMC unless such person is an independent director and the approval of

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the board of the AMC of which such person is a director, has been

obtained;

2the AMC shall not act as a trustee of any mutual fund;

3the AMC cannot undertake any other business activities except

activities in the nature of portfolio management services, management

and advisory services to offshore funds, pension funds, provident

funds, venture capital funds, management of insurance funds, financial

consultancy and exchange of research on commercial basis if any of

such activities are not in conflict with the activities of the mutual fund;.

However, the AMC may, itself or through its subsidiaries, undertake

such activities if it satisfies the Board that the key personnel of the

asset management company, the systems, back office, bank and

securities accounts are segregated activity wise and there exist

systems to prohibit access to inside information of various activities.

The AMC is required to take all reasonable steps and exercise due

diligence to ensure that the investment of funds pertaining to any

scheme are not contrary to the provisions of the Mutual Fund

Regulations and the trust deed.

(e) Custodian

The mutual fund is required to appoint a custodian to carry out the

custodial services for the schemes of the fund. Only institutions with

substantial organizational strength, service capability in terms of

computerization, and other infrastructure facilities are approved to act

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as custodians. The custodian must be totally de-linked from the AMC

and must be registered with SEBI. Under the Securities and Exchange

Board of India (Custodian of Securities) Guidelines, 1996, any person

proposing to carry on the business as a custodian of securities must

register with the SEBI and is required to fulfill specified eligibility

criteria. Additionally, a custodian in which the sponsor or its associates

holds 50% or more of the voting rights of the share capital of the

custodian or where 50% or more of the directors of the custodian

represent the interest of the sponsor or its associates cannot act as

custodian for a mutual fund constituted by the same sponsor or any of

its associate or subsidiary company.

(f) Schemes

Under the Mutual Fund Regulations, a mutual fund is allowed to float

different schemes. Each scheme has to be approved by the trustees

and the offer document is required to be filed with the SEBI. The offer

document should contain disclosures which are adequate and enough

to enable the investors to make informed investment decision,

including the disclosure on maximum investments proposed to be

made by the scheme in the listed securities of the group companies of

the sponsor. If the SEBI does not comment on the contents of the

offering documents within 21 days from the date of filing, the AMC

would be free to issue the offer documents to public. There are

19
obligations on the AMC and the trustee to ensure that the statements

made in the offer documents are true and correct. The AMC is also

required to provide an option to the unit-holder to nominate a person

in whom the units held by him shall vest in the event of his death. SEBI

has also prescribed an Advertising Code that has to be observed while

launching a new scheme. Close-ended schemes are required to be

listed on a recognized stock exchange within six months from the

closure of the subscription. However, this requirement is not

mandatory if the scheme provides for periodic repurchase facility to all

the unit-holders or monthly income or caters to special classes of

persons, if the details of such repurchase facility are clearly disclosed

in the offer document or if the scheme opens for repurchase within a

period of six months from the closure of subscription. The units of

close-ended scheme may be converted into open-ended scheme if the

offer document of such scheme discloses the option and the period of

such conversion or if the unit-holders are provided with an option to

redeem their units in full. A close-ended scheme is required to be fully

redeemed at the end of the maturity period. The SEBI has restricted a

mutual fund from giving guaranteed returns in a scheme unless such

returns are fully guaranteed by the sponsor or the AMC or a statement

indicating the name of the person who will guarantee the return is

made in the offer document or the manner in which the guarantee to

be met has been stated in the offer document.

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(g) Investment Criteria

The Mutual Fund Regulations lay down certain investment criteria that

the mutual funds need to observe. There are certain restrictions on the

investments made by a mutual fund. The money collected under any

scheme of a mutual fund shall be invested only in transferable

securities in the money market or in the capital market or in privately

placed debentures or securitized debts. However, in the case of

securitized debts, such fund may invest in asset backed securities and

mortgaged backed securities.

In addition to the above, mutual funds are not permitted to borrow

money from the market except to meet temporary liquidity needs of

the mutual funds for the purpose of repurchase, redemption of units or

payment of interest or dividend to the unit holders. Even such

borrowing cannot exceed 20% of the net asset of a scheme and the

duration of such a borrowing cannot exceed a period of six months.

Similarly, a mutual fund is not permitted to advance any loans for any

purpose. A mutual fund is permitted to lend securities in accordance

with the Stock Lending Scheme of SEBI. However, SEBI has permitted

mutual funds to enter into derivative transactions on a recognized

stock exchange for the purpose of hedging and portfolio balancing and

such investments in derivative instruments have to be made in

accordance with SEBI Guidelines issued in this regard.

In addition to the above provisions, the Mutual Fund Regulations lay

21
down several compliance or filing requirements pertaining to reporting

to the SEBI, guidelines for calculation of Net Asset Value, disclosure

requirements, accounting norms, etc.3

ADVANTAGES OF MUTUAL FUNDS

Mutual Funds have been a popular investment avenue for investors.

Their simplicity along with other attributes provides great benefit to

investors with limited knowledge, time or money. A small investor

faces many handicaps in the share market. He has limited resources

because of this reason he cannot afford the professional advice of

professional investment consultants. He cannot buy the shares of

certain blue-chip companies by sitting at home if he is not having any

knowledge about Online Trading. He has limited access to price

sensitive information on

3Mutual Funds in India-An Overview-Nishith Desai Associates Pages6-9

the stock exchanges. He may not know the developments taking place

in

the share market. Mutual funds have come as a boom to the small

investors and they have emerged as the popular media through which

small and medium investors can reap all the benefits of good

investments. Investors derive a number of advantages by investing

their money in mutual funds. Some of these advantages are as under:-

1. Reduced Risk: - Mutual funds invest in a number of reputed and

well-managed companies. Because of such diversification and

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economies of scale in transaction cost, the risk of lose due to a fall in

the value of few scrip’s is minimized. Therefore, investor’s risk is

reduced to the minimum.

2. Expertise of professional management: - The investors get the

expertise of professional fund managers who watch the funds portfolio

and take necessary decisions on what scrip’s are to be purchased, why

scrip’s are to be sold and when they should be bought and sold. The

Fund Managers with their market knowledge and research tend to

maximize the income of the fund.

3. Portfolio Diversification: - When a person invests in a mutual

fund, he participates in a large basket of shares of many different

companies in number of different industries which are included in the

fund’s portfolio. By investing in many companies the Mutual Funds can

protect themselves from unexpected drop in value of some shares. The

small investor cannot achieve wide diversification on his own.

4. Automatic Re-investment:-In a mutual fund it is possible to

reinvest the dividends and capital gains. An individual investor may not

always find it easy to re-invest his dividends. The automatic re-

investment feature of a mutual fund is a form of forced saving and can

make a big difference in the long run.

5. Selection and timings of investment: - A distinct advantage of a

mutual fund over other investments is that there is always a market for

its units. Mutual funds are required by the SEBI to provide liquidity to

23
investors. Mutual funds are ready on any day (after the initial lock –in-

period is over) to buy back the units from the investors at the Net

Asset value (NAV) of the investment. They announce through daily

newspaper their repurchase price of the Units issued under different

schemes.

6. Saving habits: - Mutual funds encourage saving and investment

habit among the public at large.

7. Tax shelter: - Depending on the schemes of Mutual funds, tax

shelter is also available, the provisions for which vary from country to

country.

8. Safety of funds:-Mutual funds are governed by the guidelines

issued by the ministry of finance on 14.2.1992. They are controlled and

regulated by the SEBI. The SEBI acts as a watchdog and tries to protect

the interest of investors. So the funds invested in mutual funds are

generally regarded as safe as compared to any other direct

investments made by an investor

9. Minimize operating cost: - Mutual funds having large investable

funds at their disposal avail economies of scale. The brokerage fees or

trading commission may be reduced substantially. The reduced

operating cost increases the income available for investors.

DISADVANTAGES OF MUTUAL FUNDS

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1. Fluctuating Returns:-Mutual funds are like many other

investments without a guaranteed return. Unlike fixed-income

products, such as bonds and Treasury bills, mutual funds experience

price fluctuations along with the stocks that make up the fund. When

deciding on a particular fund to buy, one needs to research the risks

involved.

2. Diversification:-Diversification is one of the keys to successful

investing, but many mutual fund investors tend to over diversify. The

idea of diversification is to reduce the risks associated with holding a

single security. Over diversification occurs when investors acquire

many funds that are highly related so they don't get the risk reducing

benefits of diversification. Just because one possesses mutual funds

doesn't mean that they are automatically diversified. For example, a

fund that invests only in a particular industry or region is still relatively

risky.

3. Costs:-Mutual funds provide investors with professional

management which comes at a cost. Funds have a range of different

fees that reduce the overall payout. In mutual funds the fees are

classified into two categories: shareholder fees and annual fund-

operating fees.

The shareholder fees, in the forms of loads and redemption fees are

paid directly by shareholders purchasing or selling the funds. The

annual fund operating fees are charged as an annual percentage -

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usually ranging from 1-3%. These fees are assessed to mutual fund

investors regardless of the performance of the fund.

4. Misleading Advertisements:-The misleading advertisements of

different funds can guide investors down the wrong path. Some funds

may be incorrectly labeled as growth funds, while others are classified

as small-cap or income. A fund can manipulate prospective investors

by using names that are attractive and misleading. Instead of labeling

itself a small cap, a fund may be sold under the heading growth fund.

5. Evaluating Funds:-Another disadvantage of mutual funds is the

difficulty they pose for investors interested in researching and

evaluating the different funds. Unlike stocks, mutual funds do not offer

investors the opportunity to compare the P/E ratio, sales growth,

earnings per share, etc. A mutual fund's net asset value gives investors

the total value of the fund's portfolio less liabilities, but how an

investor can know if one fund is better than another. Furthermore,

advertisements, rankings and ratings issued by fund companies only

describe past performance. Though a tagline “past results are not

indicative of future returns".

is mentioned in the Mutual fund descriptions/advertisements but

investors tend to ignore it.

HOW FUNDS ARE COLLECTED BY MUTUAL FUNDS?

Mutual Funds offer units or shares to the public by issuing an offer

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document or prospectus. The offer document/prospectus contains:-

(i) The face value of each unit in terms of rupees;

(ii) Objective of the scheme;

(iii) How the funds collected will be invested and in what securities or

in what money market instruments;

(iv) Minimum amount of subscription per application;

(v) Duration of the scheme;

(vi) Who can apply for units?

(vii) Date of launching the scheme and the date up to which the

application will be received; and

(viii) Repurchase facility (if available) or arrangements proposed to be

made for listing the units on Stock-Exchanges.

Each scheme of the Mutual Fund should be registered with SEBI. The

draft of the offer document (i.e. prospectus or letter or offer and text of

advertisement) should be got approved by SEBI. The funds give wide

publicity through news-papers, television, Internet etc. about their

schemes and make arrangements for collecting the application money

in important centers in one or more banks. After the last date for

receiving the application is over, mutual funds collect all the

applications, scrutinize them and allot units to the applicants and issue

them unit certificates, which are the evidence for owning the units.

Investors are very much aware of the aspects such as returns and

benefits from Mutual Funds Investments, but are not fully aware of the

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risks and problems involved in the Mutual Fund investments. Mutual

Fund investments are prone to almost all sorts of risk.

The most important thing is that the investors must read the offer

document completely and carefully before deciding to make their

investment. That is why the under-mentioned statements are

inevitably found in every Disclaimer Clause of the Mutual

Funds-"Mutual Funds are subject to Market Risks. Please read the offer

document carefully before investing. There is no assurance or

guarantee that all the objectives of the fund will be achieved. Past

performance of the Sponsors/Mutual Fund/Schemes/Asset Management

Company is not necessarily an indicative of future results. The name of

the fund/scheme does not, in any manner indicate either the quality of

the fund, its future prospects or returns’.

Mutual Funds are permitted to operate both open-ended and closed-

ended schemes. The subscription list for any scheme cannot be kept

open for more than 45 days. The initial lock-in-period is to be specified

in the offer document/prospectus. For open –ended schemes mutual

fund should sell and repurchase units at predetermined price based on

the NAV of its securities.

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