NISM SERIES VB

BOOK SUMMARY
BY NISMTOP500

NISMTOP500 – SERIES VB – MUTUA FUND FOUNDATION

EXAM

NISM BOOK SUMMARY

 FOR THE BENEFIT OF OUR VALUED STUDENTS, WE BRING TO YOU THE
SUMMARY OF THE NISM BOOK SO THAT YOU DO NOT HAVE TO READ THE
ENTIRE NISM BOOK.

I. Concept and Role of a Mutual Fund

A Mutual Fund pools the savings of a number of investors who share a common financial goal. The
money thus collected is then invested in capital market instruments such as shares, debentures and
other securities. The income earned through these investments and the capital appreciation realized is
shared by its unit holders in proportion to the number of units owned by them.

Operations of a Mutual Fund

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Mutual Funds: Multiple Roles

 Besides helping investors build their wealth through investment in financial markets, mutual
funds perform several other roles:
 The money mobilized from investors is translated into productive capital for various business
entities in which the schemes invest.
 As large investors, mutual funds are able to monitor the activities of the controlling
shareholders and management of the companies they invest in.
 The money that goes into new projects or expansion of existing projects, boosts overall
economic activity and employment in the country.
 The mutual fund industry itself provides employment or a source of livelihood to lakhs of
people who are associated with the industry. This includes mutual fund employees,
distributors and employees of various service providers.
 Some schemes invest in government securities, thus channeling money for the various
activities of the government.

Mutual Fund Operations

 Mutual funds announce the investment objective for every scheme they float, and seek
investments from the public. When a scheme is open for investment for a limited period,
initially, it is called a New Fund Offer (NFO).
 Depending on how it is structured, the scheme may be open to accept money from investors
only during the NFO (closed-end scheme), or it may accept money post-NFO too (open-end
scheme).
 The monetary investment that an investor makes in a scheme is translated into a certain
number of Units in the scheme.
 The purchase of units by the investor from the scheme is also called subscription. Refund of
money to the investor by the scheme is called redemption.
 The face value is relevant from an accounting perspective. The number of units multiplied by
its face value is the capital of the scheme – its Unit Capital.
 The scheme earns interest income or dividend income on the investments it holds. Further,
when it purchases and sells investments, it earns capital gains or incurs capital losses. These
are called realized capital gains or realized capital losses as the case may be.
 The practice of marking securities to their market value is called marked to market (MTM)
valuation. The true worth of each unit of every scheme i.e. its Net Asset Value (NAV)
 Running the scheme entails costs viz. scheme running expenses. The expenses pull down the
profits of the scheme and the NAV of the units.

Investors’ Transactions with Scheme

Various investors subscribing to an investment objective might have different expectations on how the
profits are to be handled. Some may like it to be paid off regularly as dividends. Others might like the
money to grow in the scheme. Mutual funds address such differential expectations between investors
within a scheme, by offering various options:
 In a growth option, the scheme does not declare a dividend. So the entire investment
performance is captured in its NAV.
 In a dividend option, the scheme declares a dividend from time to time. Since dividend comes
out of net assets of the scheme, the NAV of the dividend option goes down after a dividend.
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This reduced NAV is called ex-dividend NAV. The dividend option can have two sub-
options:
o Dividend pay-out, where dividend is paid to the investor.
o Dividend re-investment, where dividend is declared but retained in the scheme.
Instead of money, the investor is given new units against the dividend.

Some investors prefer to invest directly i.e. without the assistance of distributors. Mutual fund
schemes offer ‘Direct’ plans for the benefit of such investors. The NAV of the Direct plan is different
from the NAV of the Distributor plan.
Assets under Management: The relative size of mutual fund companies is evaluated by their assets
under management (AUM). The AUM of a mutual fund is the sum of the AUM of all its schemes.
Further, in an open-end scheme, new investments from investors will raise the AUM. Conversely, if
the scheme pays any money to the investors, either as dividend or as consideration for buying back
(redeeming) the units of investors, the AUM falls.
The aforementioned mutual funds should have returns equal to or better than their scheme benchmark
returns during each of the last three years. Such funds are called performing mutual funds.

Advantages of Mutual Funds for Investors

Professional Management: Mutual funds offer investors the opportunity to earn an income or build
their wealth through professional management of their investible funds. There are several aspects to
such professional management viz. investing in line with the investment objective, investing based on
adequate research, and ensuring that prudent investment processes are followed.

Affordable Portfolio Diversification: Units of a scheme give investors the exposure to a range of
securities held in the investment portfolio of the scheme. Thus, even a small investment of Rs.5000 in
a mutual fund scheme can give investors a diversified investment portfolio. With diversification, an
investor ensures that all his eggs are not in the same basket.

Economies of Scale: The pooling of large sums of money from so many investors makes it possible
for the mutual fund to engage professional managers to manage the investment operation and
underlying risks. Individual investors with small amounts to invest cannot, by themselves, afford to
engage such professional management. Large investment corpus leads to various other economies of
scale. For instance, costs related to investment research and office space get spread across investors.
Further, the higher transaction volume makes it possible to negotiate better terms with brokers,
bankers and other service providers.

Liquidity: At times, investors in financial markets are stuck with a security for which they can’t find
a buyer; worse, at times they can’t find the company they invested in. Such investments, whose value
the investor cannot easily realize in the market, are technically called illiquid investments and may
result in losses for the investor. Investors in a mutual fund scheme can recover the value of the
moneys invested, from the mutual fund itself.

Tax Deferral: Mutual funds are not liable to pay tax on the income they earn. If the same income
were to be earned by the investor directly, then tax may have to be paid in the same financial year.
Through the growth option in a scheme, the investor can let the moneys grow in the scheme for
several years without any incidence of taxation.

Tax Benefits: The dividend that the investor receives from any mutual fund scheme is tax-free in his
hands. Investment in specific schemes of mutual funds (Equity Linked Savings Schemes - ELSS) can
be reduced from the investor’s income that is liable to tax.
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Convenient Options: The options offered under a scheme viz. growth and dividend, allow investors
to structure their investments in line with their liquidity preference and tax position.

Investment Comfort: The Know-Your-Customer (KYC) requirements are centralized across the
capital markets, including mutual funds. Therefore, based on a single KYC process, investors can
invest across the capital market in shares, debentures, mutual funds etc.

Systematic Approaches to Investment: Mutual funds also offer facilities that help investor invest
regularly through a Systematic Investment Plan (SIP); or withdraw amounts regularly through a
Systematic Withdrawal Plan (SWP); or move moneys between different kinds of schemes through a
Systematic Transfer Plan (STP). Such systematic approaches promote an investment discipline, which
is useful in long term wealth creation and protection.

Regulatory Comfort: SEBI has mandated strict checks and balances in the structure of mutual funds
and their activities. Mutual fund investors benefit from such protection.

Limitations of Mutual Funds

Lack of Portfolio Customization: Some securities houses offer Portfolio Management Schemes
(PMS) to large investors. In a PMS, the investor has better control over what securities are bought and
sold on his behalf. On the other hand, a unit-holder is just one of several thousand investors in a
scheme. Once a unit-holder has bought into the scheme, investment management is left to the fund
manager (within the broad parameters of the investment objective). Thus, the unit-holder cannot
influence what securities or investments the scheme would buy.

Choice Overload: Over 1933 mutual fund schemes offered by 42 mutual funds – and multiple
options within those schemes – make it difficult for investors to choose between them. Greater
dissemination of industry information through various media and availability of professional advisors
in the market should help investors handle this overload. In order to overcome this choice overload,
SEBI introduced the categorization of mutual funds to ensure uniformity in characteristics of similar
type of schemes launched by different mutual funds. This will help investors to evaluate the different
options available before making informed decision to invest.

No Control over Costs for the investor: All the investor's moneys are pooled together in a scheme.
Costs incurred for managing the scheme are shared by all the Unit-holders in proportion to their
holding of Units in the scheme.
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II. Fund Structure and Constituents

Legal Structure of Mutual Funds

The SEBI Mutual Funds Regulations lay down the structure for mutual funds in India as follows:
 Any mutual fund in India needs to be constituted in the form of a Trust.
 The mutual fund trust is created by one or more Sponsors, who are the main persons behind
the mutual fund business.
 Every trust has beneficiaries. The beneficiaries, in the case of a mutual fund trust, are the
investors who invest in various schemes of the mutual fund.
 The operations of the mutual fund trust are governed by a Trust Deed, which is executed by
the sponsors. SEBI has laid down various clauses that need to be part of the Trust Deed.
 The Trust acts through its trustees. Therefore, the role of protecting the interests of the
beneficiaries (investors) is that of the trustees.
 Day to day management of the schemes is handled by an Asset Management Company
(AMC). The AMC is appointed by the sponsor or the Trustees.
 The trustees execute an investment management agreement with the AMC, setting out its
responsibilities.
 The AMC has to take all reasonable steps and exercise due diligence to ensure that the
investment of funds pertaining to any scheme is not contrary to the provisions of the SEBI
regulations and the trust deed. Further, it has to exercise due diligence and care in all its
investment decisions.
 Mutual funds schemes in India are permitted to invest in securities (including equity shares
and bonds / debentures), gold or gold related instruments and real estate assets.
 Although the AMC manages the schemes, custody of the assets of the scheme (securities,
gold, gold-related instruments & real estate assets) is with a Custodian, who is appointed by
the trustees.
 Investors invest in various schemes of the mutual fund. The record of investors and their unit-
holding may be maintained by the AMC itself, or it can appoint a Registrar & Transfer
Agent (RTA).

Other Service Providers

 The fund accountant performs the role of calculating the NAV, by collecting information
about the assets and liabilities of each scheme. The AMC can either handle this activity in-
house, or engage a service provider.
 Accounts of the schemes need to be maintained independent of the accounts of the AMC. The
scheme’s accounts are audited by an auditor, who needs to be different from the auditor of
the AMC.
 Distributors have a key role in selling suitable types of units to their clients i.e. the investors
in the schemes.
 The investors’ moneys go into the bank account of the scheme they have invested in. These
bank accounts are maintained with collection bankers who are appointed by the AMC.
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Organization of AMC
 Chief Investment Officer (CIO), who is responsible for overall investments of the fund.
Fund managers assist the CIO.
 As per SEBI regulations, every scheme requires a fund manager, though the same fund
manager may manage multiple schemes.
 Securities Analysts support the fund managers through their research inputs.
 Securities Dealers help in putting the transactions through in the market.
 Chief Marketing Officer (CMO) is responsible for mobilizing money under various schemes.
Direct Sales Team (generally focus on large investors), Channel Managers (manage the
distributors) and Advertising & Sales Promotion Team support the CMO.
 Chief Operations Officer (COO) handles all operational issues.
 Compliance Officer needs to ensure all the legal compliances.

III. Mutual Fund Products

Open-end, Closed-end and Interval Funds

AMCs launch NFOs (New Fund Offer) and collect investor’s money in a freshly launched mutual
fund scheme. After the NFO period is over, some schemes allow investors to put in fresh money while
other schemes do not.

Open-end schemes are open for investors to enter or exit at any time, even after the NFO. When
existing investors buy additional units or new investors buy units of the open-end scheme, it is called
a sale transaction. It happens at a sale price, which is equal to the NAV. When investors choose to
return any of their units to the scheme and get back their equivalent value, it is called a re-purchase
transaction. This happens at a re-purchase price that is linked to the NAV.
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Closed-end funds have a fixed maturity. Investors can buy units of a closed-end scheme, from the
fund, only during its NFO. The fund makes arrangements for the units to be traded, post-NFO in the
stock exchange/s. This is done through a listing of the scheme in one or more stock exchanges. Such
listing is compulsory for closed-end schemes.

Interval funds combine features of both open-end and closed-end funds. They are largely closed-end,
but become open-end during pre-specified time periods.

Actively Managed Funds and Passive Funds

Actively managed funds are funds where the fund manager has the flexibility to choose the
investment portfolio, within the broad parameters of the investment objective of the scheme. Since
this increases the role of the fund manager, the expenses for running the fund turn out to be higher.

Passive fund invests on the basis of a specified index, whose performance it seeks to track. Thus, a
passive fund, tracking the Nifty 506 or S&P BSE Sensex7, would buy only the shares that are part of
the composition of that index. The proportion of each share in the scheme’s portfolio would also be
the same as the weightage assigned to the share in the computation of the index.

Categorization of Mutual Funds according to SEBI

Equity Schemes
 Multi Cap Fund: An open ended equity scheme investing across large cap, mid cap, small
cap stocks. The minimum investment in equity and equity related instruments shall be 65
percent of total assets.
 Large Cap Fund: An open ended equity scheme predominantly investing in large cap stocks.
The minimum investment in equity and equity related instruments of large cap companies
shall be 80 percent of total assets.
 Large and Mid-Cap Fund: An open ended equity scheme investing in both large cap and
mid cap stocks. The minimum investment in equity and equity related instruments of large
cap companies shall be 35 percent of total assets. The minimum investment in equity and
equity related instruments of mid cap stocks shall be 35 percent of total assets.
 Mid Cap Fund: An open ended equity scheme predominantly investing in mid cap stocks.
The minimum investment in equity and equity related instruments of mid cap companies shall
be 65 percent of total assets.
 Small cap Fund: An open ended equity scheme predominantly investing in small cap stocks.
Minimum investment in equity and equity related instruments of small cap companies shall be
65 percent of total assets.
 Dividend Yield Fund: An open ended equity scheme predominantly investing in dividend
yielding stocks. Scheme should predominantly invest in dividend yielding stocks. The
minimum investment in equity shall be 65 percent of total assets.
 Value Fund or Contra Fund: A value fund is an open ended equity scheme following a
value investment strategy. Minimum investment in equity & equity related instruments shall
be 65 percent of total assets. A contra fund is an open ended equity scheme following
contrarian investment strategy. Mutual Funds will be permitted to offer either Value fund or
Contra fund.
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 Focused Fund: An open ended equity scheme investing in maximum 30 stocks (the scheme
needs to mention where it intends to focus. Minimum investment in equity & equity related
instrument shall be 65 percent of total assets.
 Sectorial/ Thematic: An open ended equity scheme investing in a specific sector such as
bank, power is a sectorial fund. While an open ended equity scheme investing in line with an
investment theme. The minimum investment in equity & equity related instruments of a
particular sector/ particular theme shall be 80 percent of total assets.
 Equity Linked Savings Scheme (ELSS): An open ended equity linked saving scheme with a
statutory lock in of 3 years and tax benefit. The minimum investment in equity and equity
related instruments shall be 80 percent of total assets.

Debt Schemes
 Overnight Fund: An open ended debt scheme investing in overnight securities. The
investment is in overnight securities having maturity of 1 day.9
 Liquid Fund: An open ended liquid scheme whose investment is into debt and money market
securities with maturity of up to 91 days only.10
 Ultra Short Duration Fund: An open ended ultra-short term debt scheme investing in debt
and money market instruments with Macaulay duration between 3 months and 6 months.
 Low Duration Fund: An open ended low duration debt scheme investing in debt and money
market instruments with Macaulay duration between 6 months and 12 months.
 Money Market Fund: An open ended debt scheme investing in money market instruments
having maturity up to 1 year.
 Short Duration Fund: An open ended short term debt scheme investing in debt and money
market instruments with Macaulay duration between 1-3 years.
 Medium Duration Fund: An open ended medium term debt scheme investing in debt and
money market instruments with Macaulay duration of the portfolio being between 3-4 years.
Portfolio Macaulay duration under anticipated adverse situation is 1-4 years.
 Medium to Long Duration Fund: An open ended medium term debt scheme investing in
debt and money market instruments with Macaulay duration between 4-7 years. Portfolio
Macaulay duration under anticipated adverse situation is 1-7 years.
 Long Duration Fund: An open ended debt scheme investing in debt and money market
instruments with Macaulay duration greater than 7 years
 Dynamic Bond: An open ended dynamic debt scheme investing across duration.
 Corporate Bond Fund: An open ended debt scheme predominantly investing in AA+ and
above rated corporate bonds. The minimum investment in corporate bonds shall be 80 percent
of total assets (only in AA+ and above rated corporate bonds)
 Credit Risk Fund: An open ended debt scheme investing in below highest rated corporate
bonds. The minimum investment in corporate bonds shall be 65 percent of total assets (only
in AA (excludes AA+ rated corporate bonds) and below rated corporate bonds).
 Banking and PSU Fund: An open ended debt scheme predominantly investing in debt
instruments of banks, Public Sector Undertakings, Public Financial Institutions and Municipal
Bonds. The minimum investment in such instruments should be 80 percent of total assets.
 Gilt Fund: An open ended debt scheme investing in government securities across maturity.
The minimum investment in G-secs is defined to be 80 percent of total assets (across
maturity).
 Floater Fund: An open ended debt scheme predominantly investing in floating rate
instruments Minimum investment in floating rate instruments shall be 65 percent of total
assets.
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Types of Hybrid Funds

Conservative Hybrid Fund: An open ended hybrid scheme investing predominantly in debt
instruments. Investment in debt instruments shall be between 75-90 percent of total assets while
investment in equity instruments shall be between 10-25 percent of total assets.

 Balanced Hybrid Fund: An open ended balanced scheme investing in equity and debt
instruments. The investment in equity and equity related instruments shall be between 40-60
percent of total assets while investment in debt instruments shall be between 40-60 percent.

 Aggressive Hybrid Fund: An open ended hybrid scheme investing predominantly in equity
instruments. Investment in equity related instruments shall be between 65-80 percent of total
assets while investment in debt instruments shall be between 20-35 percent of total assets.

 Dynamic Asset Allocation or Balanced Advantage: It is an open ended dynamic asset

allocation fund with investment in equity/debt that is managed dynamically.

 Multi Asset Allocation: An open ended scheme investing in at least three asset classes with a
minimum allocation of at least 10 percent each in all three asset classes.

 Arbitrage Fund: An open ended scheme investing in arbitrage opportunities. The minimum
investment in equity and equity related instruments shall be 65 percent of total assets.

 Equity Savings: An open ended scheme investing in equity, arbitrage and debt. The
minimum investment in equity and equity related instruments shall be 65 percent of total
assets and minimum investment in debt shall be 10 percent of total assets.

Solution Oriented Schemes:

 Retirement Fund: An open ended retirement solution oriented scheme having a lock-in of 5
years or till retirement age.
 Children’s Fund: An open ended fund for investment for children having a lock-in for at
least 5 years or till the child attains age of majority (whichever is earlier).

Other Schemes:

 Index Funds/ Exchange Traded Fund: An open ended scheme replicating/ tracking a
specific index. This minimum investment in securities of a particular index (which is being
replicated/ tracked) shall be 95 percent of total assets.
 Fund of Funds (Overseas/ Domestic): An open ended fund of fund scheme investing in an
underlying fund. The investment in the underlying fund shall be 95 percent of total assets.
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IV. Performance of Mutual Funds

Scheme Returns

Simple Return

The Simple Return can be calculated with the following formula:

Simple Return = (End Value- Begin Value)/ Begin Value *100

If the return related to a period not equal to 12 months, then the annualized return can be calculated
as:

Annualized Return = Simple Return * 12 / Period of Simple Return (In Months)

Total Returns

Mutual funds can offer returns in two forms; capital gains or losses and dividend. Total return can be
positive or negative.

Simple Return = [(End Value- Begin Value) + Dividend]/ Begin Value *100

Compound Returns

Total return is a comprehensive measure of returns because it takes into account all the benefits
earned from an investment. In case of CAGR method the interest / return earned during a period is
added back to the principal amount. As a result, interest is reinvested in the asset so that interest is
earned on interest. This is called the compounding effect.

Mutual funds declare Compounded Annual Growth Rate (CAGR) which provides for compounding
and dividend payments. CAGR is the SEBI-accepted method of declaring scheme returns, when the
investment period is more than a year.

Risks

Risk is defined as deviation from expectation i.e. what is actually earned as return could be different
from what is expected to be earned. Deviations from expected outcomes can be positive or negative;
both are considered as risky.
In the market, such risk is commonly quantified through two measures, Standard Deviation and Beta.

 Standard Deviation is the average deviation of observed returns from the average return over
a time period. It is a measure of dispersion, since it measures the extent to which observed
values are scattered away from the average.
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 Beta is a measure of volatility of a security or portfolio in comparison to the market as a

whole. The higher the value of these measures for a scheme, more risky the scheme is.

Debt securities trade in the market based on yields prevailing for similar securities. When yields rise
in the market, the values of debt securities fall and vice versa (although the issuer of the debt security
has to pay the same fixed rate of interest periodically).

Modified duration and weighted average maturity are two indicators of the price risk in a debt
security. Higher the number (value of modified duration and weighted average maturity), more is the
price risk in a debt portfolio.

Risk-adjusted Returns

Investments need to be made by balancing the risk and return. Measures of scheme performance that
consider both risk and return are called risk-adjusted returns. Two such measures that one often
encounters in the market are Sharpe Ratio and Treynor Ratio.

 Sharpe ratio relates the excess return generated over risk free return by an investment to the
standard deviation.
 Treynor ratio compares the excess return generated over risk free return by an investment to
the Beta.

The higher the value of these measures, the better is considered to be the scheme performance in
terms of risk-adjusted returns.

Scheme Comparison to Benchmark

Benchmark is some standard against which the scheme performance can be compared. A scheme that
has performed better than its benchmark is said to have out-performed. Some schemes do under-
perform i.e. demonstrate a performance that is weaker than the benchmark.
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V. Mutual Funds Taxation

 When a debt and equity scheme distributes dividend to its unit-holders, it has to pay an
Additional Tax on Income Distribution (in the market it is commonly referred to as Dividend
Distribution Tax. Since the tax payment reduces the NAV, scheme returns are affected. This
is an indirect cost for the unit holder.

Taxation of Investors in Schemes

 When an investor sells units of an equity fund in the stock exchange, or offers them for re-
purchase to the fund, he will have to incur STT based on the value of the transaction.
 Capital Gain is the difference between sale price and acquisition cost of the investment. If a
unit-holder buys a mutual fund unit (from the scheme or the market) at Rs.12 and sells it in
the market or offers it to the scheme for re-purchase at Rs.15, the difference of Rs.15 – Rs.12
i.e. Rs.3 is treated as capital gain.

(Readers are requested to read the taxation chapter from the Nism book)

VI. Offer Document

Units in a mutual fund scheme are offered to investors for the first time through a New Fund Offer
(NFO). The following are a few key steps leading to the NFO:

 The AMC decides on a scheme to launch in the market. This is decided on the basis of inputs
from CIO on investment objectives that would benefit investors, and inputs from the CMO on
the interest in the market for such investment objectives.
 AMC prepares the Offer Document for the NFO. This needs to be approved by the trustees
and the Board of Directors of the AMC.
 The documents are filed with SEBI. 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.
 The AMC decides on a suitable time-table for the issue, keeping in mind the market situation.
 The AMC launches its advertising and public relations campaigns to make investors aware of
the NFO. These need to comply with SEBI’s advertising code.
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 The AMC holds events for intermediaries, the press and electronic media to make them
familiar with the scheme, its unique features, benefits it offers for investors etc.
 The Offer Documents and Application Forms are distributed to market intermediaries, and
circulated in the market, so that investors can apply in the NFO.
 Three dates are relevant for the NFO of an open-end scheme:
 NFO Open Date – This is the date from which investors can invest in the NFO.
 NFO Close Date – This is the date up to which investors can invest in the NFO.
o Scheme Re-Opening Date – This is the date from which the investors can offer their
units for re-purchase to the scheme; or buy new units of the scheme. The AMC
announces Sale and Re-purchase prices from the Scheme Re-Opening Date.

Offer Document

Investors get to know the details of an NFO through the Offer Document. 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. These cannot be changed by the AMC without
going through specific legal processes, including permission of investors.

Investors need to note that their investment in mutual funds is governed by the principle of caveat
emptor i.e. let the buyer beware. An investor is presumed to have read the Offer Document, even if
he has not actually read it. Therefore, at a future date, the investor cannot claim that he was not aware
of something, which is appropriately disclosed in the Offer Document.

Mutual Fund Offer Documents have two parts:

 Scheme Information Document (SID), which has details of the scheme

 Statement of Additional Information (SAI), which has statutory information about the
mutual fund that is offering the scheme.

Contents of SID

The SID has information about the scheme name and type. It also mentions the face value of the Units
being offered, relevant NFO dates, date of SID, name of the mutual fund, and name & contact
information of the AMC and trustee company. Finally, the cover page has the standard clauses. It
provides information on Investment objective, Investment policy, Investment strategy, Risk factors,
Fees and expenses etc.

Contents of SAI

SAI provides information about Sponsors, AMC and Trustee Company (includes contact information,
shareholding pattern, responsibilities, names of directors and their contact information, profiles of key
personnel, and contact information of service providers like Custodian, Registrar & Transfer Agent,
Statutory Auditor, Fund Accountant) and Collecting Bankers.
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Key Information Memorandum

KIM is essentially a summary of the SID and SAI. It covers the Name of the AMC, mutual fund,
Trustee, Fund Manager and scheme, Dates of Issue Opening, Issue Closing & Re-opening for Sale
and Re-purchase, Plans and Options under the scheme, Risk Profile of Scheme, Price at which Units
are being issued and minimum amount / units for initial purchase, additional purchase and re-
purchase, Benchmark, Dividend Policy, Performance of scheme and benchmark over last 1 year, 3
years, 5 years and since inception.

VII. Fund distribution and Sales Practices

Distribution Channels

The following types of entities are involved in distributing mutual funds in India:

 Asset Management Companies: AMCs have a dedicated sales force that actively distributes
mutual fund schemes to large investors. Unlike the other entities that may sell schemes of
more than one mutual fund, AMCs distribute only their own mutual fund schemes.
 Independent Financial Advisers: These are individuals providing investment advice. Some
of the larger IFAs have support staff to cater to investor needs.
 Bank distributors: Investment advisers, relationship managers and wealth managers in banks
assist the bank’s customers with their investments, including mutual funds.
 Non-bank distributors include securities distribution companies and non-banking finance
companies. Many of them have offices all over the country.
 Members (brokers) of the stock exchange: They offer two kinds of mutual fund services:
o Purchase and sale of units of closed-end schemes and ETFs in the stock exchange.
This is done through the normal screen-based trading software that is used for
transactions in shares.
o Mutual fund transactions of investors in other situations, such as investment in NFOs
(both open-end and closed-end), sale / re-purchase of units of open-end schemes etc.
In order to facilitate such transactions by its members, both BSE and NSE have
developed mutual fund transaction engines.
 Post-offices, Self-help Groups etc., have emerged as alternate channels of mutual fund
distribution. Internet Channel: AMCs, large distribution houses and some mutual fund
information companies actively use the internet as a channel to reach out to investors and
handle their mutual fund transactions.

Pre-requisites for Selling Mutual Fund Schemes

 SEBI has prescribed a Certifying Examination, passing in which is compulsory for anyone
who is into selling of mutual funds, whether as IFA, or as an employee of a distributor or
AMC. Qualifying in the examination is also compulsory for anyone who interacts with
mutual fund investors, including investor relations teams and employees of call centers.
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 Know Your Distributor (KYD) Requirements: As part of SEBI’s drive to streamline the
distribution process of mutual fund products, AMFI has introduced KYD. It consists of
document verification and bio-metric process.
 After passing the examination and completing KYD requirements, the next stage is to register
with AMFI.
 Armed with the ARN No., the IFA/distributor/stock exchange broker can get empanelled with
any number of AMCs. Alternatively, they can become agents of a distributor who is already
empanelled with AMCs.

Conditions for Empanelment

Empanelment with an AMC is a simple process. There is a standard Request for Empanelment Form
to be filled in. This provides for basic details, such as
 Personal Information of the applicant
 Names and contact information of key people handling sales and operations
 Business details
 Bank details and preferences regarding Direct Credit of brokerage in the bank account
 Preferences regarding receiving information from the AMC
 Nominee

Commission Structures

There are no SEBI regulations regarding the minimum or maximum commission that distributors can
earn. However, SEBI has laid down limits on what the AMC can charge each type of scheme towards
total expense. The commission structures vary between AMCs. Even for the same AMC, different
commission structures are applicable for different kinds of schemes.

Trail commission is calculated as a percentage of the net assets attributable to the Units sold by the
distributor.

 Large distributors have agents / sub-brokers working under them. Being the principal, the
distributor is bound by the acts of agents / sub-brokers. The distributor therefore needs to
ensure that the agents comply with all the regulations.

ACE and AGNI

ACE sets out standards of good practices to be followed by AMCs in their operations and in their
dealings with investors, intermediaries and the public. It sets out standards with respect to integrity,
due diligence, disclosures, professional selling practices, investment practices, operations and
reporting practices.

AGNI is a set of guidelines and code of conduct for intermediaries, consisting of individual agents,
brokers, distribution houses and banks engaged in selling of mutual fund products.

SEBI has made it mandatory for intermediaries to follow the Code of Conduct.
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VIII. Investor Transactions

Who can invest in Mutual Funds?

Individual Investors
They invest for their personal benefit or the benefit of their family. Examples:
 Resident India Individuals
 Minors
 Hindu Undivided Families
 Non Resident Indian
 Foreign Investors

Non-individual investors include:

 Companies/corporate bodies, registered in India
 Registered societies and co-operative societies
 Religious and charitable trusts
 Trustees of private trusts
 Partner(s) of partnership firms
 Association of Persons or Body of Individuals, whether incorporated or not
 Banks and Financial Institutions and Investment Institutions
 Other Mutual Funds registered with SEBI
 Foreign Portfolio Investors registered with SEBI
 International Multilateral Agencies approved by the Government of India
 Army/Navy/Air Force, Para-Military Units and other eligible institutions
 Scientific and Industrial Research Organizations
 Universities and educational institutions

KYC Requirements for Mutual Fund Investors

SEBI has instituted a centralized KYC process for the capital market, including mutual funds. This is
a significant benefit for the investor. Based on completion of KYC process with one capital market
intermediary, the investor can invest across the capital market. KYC Registration Agencies (KRAs)
facilitate this centralized KYC process. So far, SEBI has approved 5 KRAs.

Foreign Account Tax Compliance Act (FATCA)

To comply with the requirements of Foreign Account Tax Compliance Act (FATCA) and Common
Reporting Standards(CRS) provisions, financial institutions, including mutual funds, are required to
undertake due diligence process to identify foreign reportable accounts and collect such information
as required under the said provisions and report the same to the US Internal Revenue Service/any
other foreign government or to the Indian Tax Authorities for onward transmission to the concerned
foreign authorities.

Distributor Processes for KYC

There are some differences in the processes adopted by the KRAs. The distributor can check the
specifics on the website of the relevant KRA. The following are the generalized processes
adopted by KRAs:
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 Registration with KRA

 Confirmation of KYC Compliance of Client
 Registration of KYC of client

Demat Account

Dematerialisation is a process whereby an investor’s holding of investments in physical form (paper),

is converted into a digital record. Benefit of holding investments in demat form is that investors’
purchase and sale of investments get automatically added or subtracted from their investment demat
account, without having to execute cumbersome paperwork. Settlement of most transactions in the
stock exchange need to be compulsorily done in demat form. The benefits of demat facility for mutual
fund investors have increased, with the National Stock Exchange of India and the Bombay Stock
Exchange making available screen-based platforms for purchase and sale of mutual fund schemes.

Investors Transactions with the Fund

Fresh Purchases: Application forms are available with offices of AMCs, distributors and ISCs. They
are also downloadable from the websites of the AMCs concerned. The normal application form, with
KIM attached, is designed for fresh purchases i.e. in situations where the investor does not have an
investment account (known as “folio”) with the specific mutual fund.

Additional Purchases: Once an investor has a folio with a mutual fund, subsequent investments with
the same mutual fund do not call for the full application form and documentation. Only transaction
slip needs to be filled and submitted with the requisite payment.

Online Transactions: This facility is given to an existing investor in a mutual fund. The investor is
required to fill the requisite details in an application form. Based on this, the registrar would allot a
user name and password. This can be used by the investor to make further transactions.

Re-purchase of Units: The investor in an open-ended scheme can offer the units for repurchase to the
mutual fund (in the market the transaction is commonly referred to as “redemption”). The transaction
slip would need to be filled in to affect the re-purchase.

Payment Mechanism for Purchases: The following routes can be used to make investments:
 Cash
 E-Wallet
 Cheque/ Demand Draft
 Remittance
 Electronic Clearing system (ECS)
 Application Supported by Block Amounts (ASBA)
 M-Banking
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Unified Payment Interface (UPI)

The UPI allows fund transfer between accounts through the mobile app. The users have to register for
mobile banking facility to be able to the app. Currently this is available only to android phone users.
There are many UPI apps available such as BHIM, SBI UPI app, HDFC UPI app, iMobile, PhonePe
app, Aadhaar app etc. which you can download on the phone. After the application (app) is
downloaded you have to create a Virtual Payment Address (VPA) by going through an authentication
process. This is like an email address and links the UPI app to the user’s bank account through the
mobile phone registered with the bank. The VPA can be changed if so desired. Multiple bank
accounts can be linked to a VPA.

Aadhaar Enabled Payment Service (AEPS)

AEPS allows bank to bank transaction using the Aadhar number of the customer. The Aadhaar
number has to be linked to the bank account to be able to use AEPS. The account holder can withdraw
and deposit cash and transfer money to another account linked to the Aadhaar account. The AEPS
uses the fingerprint of the individual as the password to authorize transactions and is thus a secure
mode of transfer of funds.

National Unified USSD Platform (NUUP)

NUUP based mobile banking allows transactions even without a smartphone and internet. The
code*99# dialed from the phone registered with a bank for a bank account allows transactions such as
making payments, checking balances, fund transfers and getting a mini statement. Most leading banks
support this service. NUUP is currently available in 11 regional languages.

Cards

Cards are the most commonly used mode of digital payments. Debit cards are issued by banks to their
account holders and allow card holders to use it conduct fund transactions linked to their bank
account. Credit cards are issued by banks and other approved entities and allow credit card holders to
use the card up to approved credit limits. Prepaid cards can also be used to make card payments. The
cards are used by swiping it at the merchants’ PoS device.
A One-Time Mandate (OTM) is a payment facility that investors can use to authorize their bank to
process debits to their specified bank account raised by a specified mutual fund for purchase of units.
The debits happen through the National Automated Clearing House (NACH). It eliminates the need
for the investor to initiate payment every time a purchase transaction is conducted.

Transactions through Stock Exchange

Closed-end scheme units can be bought and sold like any share through the normal screen-based
trading system of the stock exchange. The system can be accessed through a broker’s terminal or
through the internet. Both National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) have
extended their trading platforms to the mutual fund distributors (registered with AMFI) to transact in
Mutual Fund Units directly from Mutual Fund/Assets Management Companies on behalf of their
clients. In order to broad base the reach of this platform, SEBI has also allowed SEBI Registered
Investment Advisors (RIAs) to use the stock exchange infrastructure to purchase or redeem mutual
fund units on behalf of their clients.

NSE’s platform is called NEAT MFSS (Mutual Fund Service System). BSE’s platform is called BSE
StAR Mutual Funds Platform.
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IX. Investment Services

Options within a scheme

Most schemes offer a dividend option and growth option. The dividend option can have two options: -
dividend payout and dividend re-investment. The options are offered with a single scheme portfolio.
Therefore, portfolio performance is the same for all options. The difference is in the treatment of
dividend and related taxation, and therefore their NAV as discussed.

Systematic Plans

Systematic Investment Plan or SIP is considered to be a good practice to invest regularly. SIP is an
approach where the investor invests constant amounts at regular intervals. A benefit of such an
approach, particularly in equity schemes, is that it averages the unit-holder’s cost of acquisition.

Mutual funds make it convenient for investors to manage their Systematic Withdrawal Plans by
indicating the amount, periodicity (generally, monthly) and period for their SWP. Just as investors do
not want to buy all their units at a market peak, they do not want all their units redeemed in a market
trough. Investors can therefore opt for the safer route of offering for re-purchase, a constant value of
units.
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While in a SWP the constant amount is paid to the investor at the pre-specified frequency, in a
Systematic Transfer Plan, the amount which is withdrawn from a scheme is reinvested in some
other scheme of the same mutual fund. Thus, it operates as a SWP from the first scheme, and a SIP
into the second scheme. Since the investor is effectively switching between schemes, it is also called
“switch” (if it is just one transaction or tranche).

 Mutual funds issue Statement of Accounts (SoA) for every folio, every month, if there is a
transaction during the month. It shows for each transaction (sale/re-purchase) during the
period, the value of the transaction, the relevant NAV and the number of units transacted.

 The Consolidated Account Statement (CAS) is a single account statement that consolidates
financial transactions in all folios of an investor across all schemes. The consolidation of
investor’s records across schemes and mutual funds is done on the basis of PAN.

 Unlike SoA and CAS, which shows the flow of unit-holding during the period, a Unit
Certificate only confirms the number of units held in the name of the investor. In a way, the
Statement of Account is like a bank pass book, while the Unit Certificate is like a Balance
Confirmation Certificate issued by the bank.

Nomination

Most investors like clarity about what would happen to their unit-holding, in the unfortunate event of
their demise. This clarity can be achieved by executing a Nomination Form, where the nominee’s
name is specified. If the nominee is a minor, then a guardian too can be specified.

Pledge

Banks, Non-Banking Financial Companies (NBFC) and other financiers often lend money against
pledge of units by the Unit-holder. Once units are pledged, the unit-holder/s cannot sell or transfer the
pledged units, until the pledgee gives a no-objection to release the pledge.
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X. Asset Class
Equity

Equity is a growth asset. Investment in equity shares of a company represents an exposure to the
future profits and performance of the company. Better the performance of the investee company,
higher is likely to be the price at which its equity shares trade in the market. Investors can earn capital
gains by selling their shareholding in the company at a higher price than their acquisition cost.
However, if the investment does not work out, then the investor may have to book capital losses. In

order to minimize the possibility of losing money in equity investments, it is advisable that every
investor spreads his investment across different industries (sectors). This is called diversification.
Investors can take equity exposure, either by buying equity shares of companies, or buying units of
equity mutual fund schemes. Capital appreciation is a significant part of the returns that an investor
hopes to earn from equity investments. The investor also earns an income in the form of dividends,
which profitable companies and mutual fund schemes declare. People invest in equities because it
protects them from inflation. Over the long term, share prices appreciate faster than prices of goods
and services. Equities are also a volatile asset. The price of equity shares can fluctuate widely, even
within a day.

Debt

Debt is an income asset. A greater proportion of the income from debt comes in the form of interest
income. Debt is considered safer than equity because most debt securities have a maturity date on
which the principal will be redeemed. Thus, subject to credit risk, investor in a debt security has an
exit option that is not linked to the market. Exposure to debt can be taken in various ways, such as
bank deposits, company fixed deposits, post office deposits, PPF, NSC and debt mutual fund schemes.
Investors are advised to take a part of their debt exposure through debt mutual fund schemes.

Gold

Gold is considered a safe haven asset. Its value appreciates when there is any turmoil in the world,
usually. It therefore is a good hedge against losses in other investments that an investor may have.
Price of gold in India is determined by international prices of gold and the value of the rupee. An
Indian investor in gold benefits, both, when international prices of gold rises, or the Indian rupee
becomes weaker. Thus, investment in gold is an investment in a truly international asset. In a situation
where rupee becomes weaker, an Indian family finds it more challenging to send its children abroad
for further studies. Appreciation in gold offers an effective hedge during such scenarios. Gold is also
an extremely liquid asset. It can be easily sold or pawned to meet cash flow needs anywhere in the
country.

Real Estate

A large portion of investible surplus is locked into real estate in the form of land, house, commercial
office, warehouse and the like. The tangible nature of this asset class makes it an attractive investment
proposition across all classes of investor. It is important to note that residential house is not
considered as an investment asset. Investment in real estate requires huge initial outlay, considered as
a good hedge against inflation, the gestation period is high and a high risk- high return asset. Price
discovery is difficult in real estate market in the absence of transparency in transactions.
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XI. Financial Planning Concepts

Everyone has needs and aspirations. Most needs and aspirations call for a financial commitment.
Providing for this commitment becomes a financial goal. Fulfilling the financial goal sets people on
the path towards realizing their needs and aspirations. People experience happiness, when their needs
and aspirations are realized within an identified time frame. Financial planning is a planned and
systematic approach to provide for the financial goals that will help people realize their needs and
aspirations, and be happy.

Assessment of Financial Goals

This involves defining the nature and quantum of one’s goals. An estimate of these future expenses
(the financial goals) requires the following inputs:
 How much would be the expense, if it were incurred today?
 How many years down the line, the expense will be incurred?
 During this period, how much is likely to be the rise in expense on account of inflation?
 If any of these expenses are to be incurred in foreign currency, then how would changes in
exchange rate affect the financial commitment?

he costs mentioned above, in today’s terms, need to be translated into the rupee requirement in future.
This is done using the formula:
A = P X (1 + i) n,

where, A= Rupee requirement in future, P= Cost in today’s terms, i= Inflation, n= Number of years.

Investment Horizon

The year-wise financial goals statement throws up the investment horizon. It would be risky to expect
the first three to five years expenses to be met out of equity investments being made today. But
equity is a viable investment option for expenses beyond that period.

Assessing Investment Requirement

Suppose the investor is comfortable about meeting Rs.100,000 of the expense each year. The balance
would need to be provided out of investments being made today. How much is that investment
requirement? This can be calculated using a variation of the formula used earlier i.e.

P = A ÷ (1 + r) n,

where: P, A and n have the same meaning as in the earlier formula. r represents the return expected
out of the investment portfolio.
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XII. Helping Investors with Financial Planning

Financial Planning Steps

Certified Financial Planner – Board of Standards (USA) proposes the following steps in financial
planning:
 Establish and Define the Client-Planner Relationship
 Gather Client Data, Define Client Goals
 Analyze and Evaluate Client's Financial Status
 Develop and Present Financial Planning Recommendations and / or Options
 Implement the Financial Planning Recommendations
 Monitor the Financial Planning Recommendations

Wealth Cycle

This is an alternate approach to profile the investor. The stages in the Wealth Cycle are:

Accumulation: This is the stage when the investor gets to build his wealth. It covers the earning years
of the investor i.e. the phases of the life cycle from Young Unmarried to Pre-Retirement.

Transition: Transition is a phase when financial goals are in the horizon. E.g. house to be purchased,
children’s higher education/marriage approaching etc. Given the impending requirement of funds,
investors tend to increase the proportion of their portfolio in liquid assets viz. money in bank, liquid
schemes etc.

Inter-Generational Transfer: During this phase, the investor starts thinking about orderly transfer of
wealth to the next generation, in the event of death. The financial planner can help the investor
understand various inheritance and tax issues, and assist in preparing Will and validating various
documents and structures related to assets and liabilities of the investor. It is never too early to plan
for all this. Given the health consequences of stress faced by most investors, it should ideally not be
postponed beyond the age of 50.

Reaping / Distribution: This is the stage when the investor needs regular money. It is the parallel of
retirement phase in the Life Cycle.

Sudden Wealth: Winning lotteries, unexpected inheritance of wealth, unusually high capital gains
earned – all these are instances of sudden wealth. However, given the human nature of frittering away
such sudden wealth, the financial planner can channelize the wealth into investments, for the long-
term benefit of the investor’s family.
Understanding of both life cycle and wealth cycle is helpful for a financial planner. However, one
must keep in mind that each investor may have different needs and unique situations; the
recommendations may be different for different investors even within the same life cycle or wealth
cycle stages.
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Asset Allocation

‘Don’t put all your eggs in one basket’ is an old proverb. It equally applies to investments. Asset
allocation may not give the investor the best return available in the market, but the investor will not
also get the worst returns or see his capital getting wiped off. Risk and return in various asset classes
(equity, debt, gold etc.) are driven by different factors. For Economic environments and markets are
dynamic. Predictions about markets can go wrong. With a prudent asset allocation, the investor does
not end up in the unfortunate situation of having all the investments in an asset class that performs
poorly.

Risk Profiling

As seen earlier, various schemes have different levels of risk. Similarly, there are differences between
investors with respect to the levels of risk they are comfortable with (risk appetite). At times there are
also differences between the level of risk the investors think they are comfortable with, and the level
of risk they ought to be comfortable with. Risk profiling is an approach to understand the risk appetite
of investors - an essential prerequisite to advise investors on their investments.

Contingency Funds

Financial planning should also provide for liquidity to meet contingencies that the investor might face.
For example, he may lose his job. If, for a few months, the investor does not receive a regular
income, how will the subsistence be met? This is the reason that contingency funds are provided in
the financial plan. The contingency funds should help the investor tide over loss of income for a few
months.

Scheme Selection

Equity Schemes:

Active or Passive: Index funds are passive funds. They are expected to offer a return in line with the
market. An investor in an active fund is bearing a higher cost for the fund management, and a higher
risk. Therefore, the returns ought to be higher i.e. the scheme should beat the benchmark, to make the
investor believe that choice of active scheme was right. Investors who are more interested in the more
modest objective of having an equity growth component in their portfolio, rather than the more
aggressive objective of beating the equity market benchmark, would be better off investing in an
index fund. Several pension funds are limited by their charter, to take equity exposures only through
index funds.

Open-ended or Close-ended: The significant benefit that open-end funds offer is liquidity viz. the
option of getting back the current value of the unit-holding from the scheme. A close-ended scheme
offers liquidity through listing in a stock exchange. Unfortunately, mutual fund units are not that
actively traded in the market. A holder of units in a close-ended scheme will need a counterparty in
the stock exchange in order to be able to trade. Open-end schemes are also subject to the risk of large
fluctuations in net assets, on account of heavy sales or re-purchases. This can put pressure on the fund
manager in maintaining the investment portfolio.
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Diversified, Sector or Thematic: The critical difference between the two is that the multi-sector
exposure in a diversified fund makes it less risky. An investor, investing or taking money out of a
sector fund has effectively taken up the role of making the sector choices. Diversified funds should be
part of the core portfolio of every investor. Investors who are comfortable with risk can invest in
sector funds. Further, an investor should have the skill to make the right sector choices, before
venturing into sector funds.

Fund Size: The size of funds needs to be seen in the context of the proposed investment universe.
Thus, a sector fund with net assets of Rs.1,000 crore, is likely to find investment challenging if all the
companies in the sector together are worth only about Rs.10,000 crore. On the other hand, too small a
fund size means that the scheme will not benefit from economies of scale.

Portfolio Turnover: Purchase and sale of securities entails broking costs for the scheme. Frequent
churning of the portfolio would not only add to the broking costs, but can also be indicative of
unsteady investment management.

Debt Schemes:

Regular Debt Funds v/s MIPs: MIP has an element of equity in its portfolio. Investors, who do not
wish to take any equity exposure, should opt for a regular debt fund.

Open-end Funds v/s FMP: FMP is ideal when the investor’s investment horizon is in sync with the
maturity of the scheme, and the investor is looking for a return that is superior to what is available in a
fixed deposit, yet not entirely uncertain. The portfolio risk needs to be considered too.

Gilt Funds v/s Diversified Debt Funds: Diversified debt funds invest in a mix of government
securities (which are safer) and non-government securities (which offer higher yields, but are subject
to credit risk). A diversified mutual fund scheme that manages its credit risk well can generate
superior returns, as compared to a Gilt Fund.

Long-Term Debt Fund v/s Short Term Debt Fund: As discussed in the previous unit, the value of
longer-term debt securities fluctuates more than that of short-term debt securities. Therefore, NAVs
of long-term debt funds tend to be more volatile than those of short-term debt funds.

Money Market Funds v/s Liquid Schemes: An investor seeking the lowest risk ought to go for a
liquid scheme. However, the returns in such instruments are lower. The comparable for a liquid
scheme in the case of retail investors is a savings bank account. Switching some of the savings bank
deposits into liquid schemes can improve the returns for him. Businesses, which in any case do not
earn a return on their current account, can transfer some of the surpluses to liquid schemes.

Points to consider while selecting a fund

 Fund Age
 Scheme Running Expenses
 Tracking Error
 Regular Income Yield in a Portfolio
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XIII. Legal and Regulatory Environment

SEBI regulates the capital markets including mutual funds, other funds, depositories, custodians and
registrars & transfer agents in the country. The applicable guidelines for mutual funds are set out in
SEBI (Mutual Funds) Regulations, 1996, as amended till date.
AMFI: AMCs in India are members of AMFI, an industry body that has been created to promote the
interests of the mutual funds industry. Various objectives of AMFI include maintaining high
professional standards, promote best business standards, interact with SEBI and industry players, etc.

Expense Limits

As a measure of investor protection, SEBI has set limits on the recurring expenses that can be levied
in the scheme. The recurring expense cannot go higher than 2.5% of AUM for equity schemes, and
2.25% of AUM for debt schemes. This limit goes down as the scheme AUM increases. GST on AMC
fees can be charged in addition to the above limit.

Unclaimed Amounts

The unclaimed redemption and dividend amounts, that were earlier allowed to be deployed only in
call money market or money market instruments, shall also be allowed to be invested in a separate
plan of Liquid scheme / Money Market Mutual Fund scheme floated by Mutual Funds specifically for
deployment of the unclaimed amounts.

NISMTOP500 GUARANTEES PASSING OF NISM EXAMS OR

WE REFUND THE MONEY.

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