MUTUAL FUND

1.1 INTRODUCTION TO MUTUAL FUND

All over the world, mutual fund is one of the most popular instruments for investment.
Its popularity with customer has dramatically increased over the last couple of years worldwide.
Mutual fund has a long and successful history. The popularity of mutual fund has increased
manifold. In developed financial market like United States, mutual fund has almost overtaken
bank deposits and total assets of insurance funds.
There are a lot of investment avenues available today in the financial market for an investor with
an investable surplus. He can invest in Bank Deposits, Corporate Debentures, and Bonds where
there is low risk but low return. He may invest in Stock of companies where the risk is high and
the returns are also proportionately high. The recent trends in the Stock Market have shown that
an average retail investor always lost with periodic bearish trends. People began opting for
portfolio managers with expertise in stock markets who would invest on their behalf. Thus we
had wealth management services provided by many institutions. However they proved too costly
for a small investor. These investors have found a good shelter with the mutual funds.
The mutual fund industry in India is regulated by Association of Mutual Fund in India (AMFI).
The total asset under management of mutual fund industry in India is of 493,287 crores
approximately. SBI Mutual Fund is India’s largest bank sponsored mutual fund and has an
enviable track record in judicious investment and consistent wealth creation. The institution has
grown immensely since its inception and today is India’s largest bank, patronized by over 80%
of the top corporate houses of the country.
Since mutual fund is an important and popular investment avenue then its study and analysis is
very important and necessary from the investment point of view and for the investors.

1.2 CONCEPT OF MUTUAL FUND

A mutual fund is a common pool of money into which investors place their contributions that are
to be invested in accordance with a stated objective. The ownership of the fund is thus joint or
“mutual”; the fund belongs to all investors. A single investor’s ownership of the fund is in the
same proportion as the amount of the contribution made by him or her bears to the total amount
of the fund.

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Mutual Funds are trusts, which accept savings from investors and invest the same in diversified
financial instruments in terms of objectives set out in the trusts deed with the view to reduce the
risk and maximize the income and capital appreciation for distribution for the members. A
Mutual Fund is a corporation and the fund manager’s interest is to professionally manage the
funds provided by the investors and provide a return on them after deducting reasonable
management fees. The objective sought to be achieved by Mutual Fund is to provide an
opportunity for lower income groups to acquire without much difficulty financial assets. They
cater mainly to the needs of the individual investor whose means are small and to manage
investors portfolio in a manner that provides a regular income, growth, safety, liquidity and
diversification opportunities.

Figure. 1 showing Concept of mutual fund

Mutual Fund is an investment tool that allows small investors access to a well-diversified
portfolio of equities, bonds and other securities. Each shareholder participates in the gain or loss
of the fund. Units are issued and can be redeemed as needed. The fund’s Net Asset value (NAV)
is determined each day.
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1.3 EARLY HISTORY

The first modern investment funds (the precursor of today's mutual funds) were established in
the Dutch Republic. In response to the financial crisis of 1772–1773, Amsterdam-based
businessman Abraham (or Adrian) van Ketwich formed a trust named Eendragt Maakt Magt
("unity creates strength"). His aim was to provide small investors with an opportunity to
diversify.
Mutual funds were introduced to the United States in the 1890s. Early U.S. funds were generally
closed-end funds with a fixed number of shares that often traded at prices above the portfolio net
asset value. The first open-end mutual fund with redeemable shares was established on March
21, 1924 as the Massachusetts Investors Trust. (It is still in existence today and is now managed
by MFS Investment Management.)

1.4 MUTUAL FUNDS TODAY

At the end of 2016, mutual fund assets worldwide were $40.4 trillion, according to the
Investment Company Institute. The countries with the largest mutual fund industries are:
 United States: $18.9 trillion
 Luxembourg: $3.9 trillion
 Ireland: $2.2 trillion
 Germany: $1.9 trillion
 France: $1.9 trillion
 Australia: $1.6 trillion
 United Kingdom: $1.5 trillion
 Japan: $1.5 trillion
 China: $1.3 trillion
 Brazil: $1.1 trillion
 India: $0.3 trillion

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1.5 MEANING OF MUTUAL FUND

A mutual fund is a professionally managed investment fund that pools money from many
investors to purchase securities. These investors may be retail or institutional in nature. Or
A mutual fund is an investment security that enables investors to pool their money together into
one professionally managed investment. Mutual funds can invest in stocks, bonds, cash or a
combination of those assets. The underlying security types, called holdings, combine to form one
mutual fund, also called a portfolio.
In simpler terms, mutual funds are like baskets. Each basket holds certain types of stocks, bonds
or a blend of stocks and bonds to combine for one mutual fund portfolio.

DEFINITION

 The SEBI (Mutual Funds) Regulations 1993 define a mutual fund (MF) as a fund established in
the form of a trust by a sponsor to raise monies by the Trustees through the sale of units to the
public under one or more schemes for investing in securities in accordance with these
regulations. The rationale behind a mutual fund is that there a large number of investors who
lack the time and or the skills to manage their money. Hence, professional fund managers, acting
on behalf of the Mutual Fund, manage the investments (investor’s money) for their benefit in
return for a management fee. The organization that manages the investment is called the Asset
Management Company (AMC).
 A Mutual Fund is a trust that pools the savings of numbers of investors who share a common
financial goal. The money thus collected is invested by the fund manager in different types of
securities depending upon the objective of the scheme. These could range from shares to
debentures to money market instruments. The income earned through these investments and the
capital appreciations realized by the scheme are shared by its unit holders in proportion to the
number of units owned by them. Thus, a Mutual Fund is the most suitable investment for the
common people as it offers an opportunity to invest in a diversified, professionally managed
portfolio at a relatively low cost.
The small savings of all the investors are put together to increase the buying power and hire a
professional manager to invest and monitor the money. Anybody with an investible surplus of as
little as a few thousand rupees can invest in Mutual Funds. Each Mutual Fund scheme has a

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defined investment objective and strategy. You can buy mutual fund shares directly from the
mutual fund company or from a stock broker or intermediary. Either way buying and redeeming
is relatively easy.

1.6 WHY SELECT A MUTUAL FUND?

The risk return trade-off indicates that if investor is willing to take higher risk then
correspondingly he can expect higher returns and vice versa if he pertains to lower risk
instruments, which would be satisfied by lower returns. For example, if an investors opt for bank
FD, which provide moderate return with minimal risk. But as he moves ahead to invest in capital
protected funds and the profit-bonds that give out more return which is slightly higher as
compared to the bank deposits but the risk involved also increases in the same proportion.
Thus investors choose mutual funds as their primary means of investing, as Mutual funds
provide professional management, diversification, convenience and liquidity. That doesn’t mean
mutual fund investments are risk free. This is because the money that is pooled in are not
invested only in debts funds which are less risky but are also invested in the stock markets which
involves a higher risk but can expect higher returns. Hedge fund involves a very high risk since it
is mostly traded in the derivatives market which is considered very volatile.

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Figure .2 showing The risk- return matrix

A mutual fund is the ideal investment vehicle for today's complex and modern financial scenario.
Markets for equity shares, bonds and other fixed income instruments, real estate, derivatives and
other assets have become mature and information driven. Price changes in these assets are driven
by global events occurring in faraway places. A typical individual is unlikely to have the
knowledge, skills, inclination and time to keep track of events, understand their implications and
act speedily. An individual also finds it difficult to keep track of ownership of his assets,
investments, brokerage dues and bank transactions etc.
A mutual fund is the answer to all these questions. It appoints professionally qualified and
experienced staff that manages each of these functions on a full time basis. The large pool of
money collected in the fund allows it to hire such staff at a very low cost to each investor. In
effect, the mutual fund vehicle exploits economies of scale in all three areas – Research ,
Investment and Transaction processing.

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1.7 CHARACTERISTICS OF THE BEST MUTUAL FUNDS

1. Low expenses

For any investment vehicle, there are some factors that are within your control and some that are
not. An example of a factor that you cannot control is the direction of the stock market. A key
factor that you can control knows the expense ratio of the mutual funds that you choose to invest
in.
A 2010 study by independent investment research firm Morningstar showed the impact of low
expenses in fund performance to be quite significant. In every mutual fund investment category
studied, the lowest-cost quintile of funds outperformed the highest-cost quintile by a decent
margin.

2. Strong fund management

One of Morningstar's key tenets of its medalist rankings of mutual funds is a strong manager or
management team. Beyond just the fund manager, top mutual funds also have a solid group of
analysts who research the stocks or other investments bought and sold by the fund managers.
Additionally, traders help make sure that the fund trades are properly executed. Even for index
funds, the underlying manager can have an impact.

3. Consistent investment process

You need to fully understand the costs and the investment strategy of any mutual fund before
you invest in it. For actively managed funds, look at the fund's investment process. Consider the
following questions:
Is the fund consistent?
Does it differentiate the fund from its benchmark index?
What makes it unique and different from other funds (in a positive fashion)?
Is this process sustainable year in and year out?
It is important that you are able to understand the fund's investment process and why this process
is unique and presumably better than other investment options available to you. If you can't

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answer the question "Why should I invest my money here?" then the answer is that you probably
shouldn't.

4. Strong parent company

Running a mutual fund is a complex proposition that requires more than just a skilled manager to
be successful. Having a strong parent company can help with the recruitment of talented support
staff. A strong, ethical parent company can set the tone for all of its funds in terms of
stewardship, which Morningstar defines as: The manner in which funds are run. The degree to
which the management company's and fund board's interests are aligned with fund shareholders.
The degree to which shareholders can expect their interests to be protected from potentially
conflicting interests of the management company.

5. Strong relative performance

When looking at mutual funds, investors should compare apples to apples. Comparing the
performance of a fund that invests in government bonds to one that invests in large-cap domestic
stocks is meaningless. These funds will be different in almost every way.
When judging the past performance of a fund that you are considering buying or one that you
already own, look at the fund's performance in the context of its category or peer group of funds.
Assess how the fund's trailing three-, five-, and 10-year performance histories rank. In the case of
an actively managed fund, find out if the fund's track record was achieved under the current
manager.

6. Size of the fund

Size matters when it comes to managing a mutual fund. Over the years, many mutual funds have
produced enviable track records in their early years of existence only to see that performance
taper off as their reputation grew and new investor money poured in.
Size is especially critical in mutual funds that invest in small- or mid-cap stocks. These stocks
have more limited investment opportunities, and at some point, a fund manager can run out of
good opportunities within the fund's investing niche.

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Mutual fund companies that are shareholder-centric might close the fund to new investment,
which can help. But as the fund grows in size due to its own success, management problems can
surface again.

7. Differences from the benchmark

For actively managed funds, consider differences from the benchmark. Many large-cap stock
funds have been accused of being "closet indexers" in that the composition of their holdings is
not that different from that of their benchmark index, which is usually the S&P 500.
Too often these closet indexers underperform the index, and investors pay higher expenses than
if they had just bought into an index fund. For example, T. Rowe Price Mid-Cap Growth has
provided a higher return with less volatility than the average fund in the mid-cap growth
category.

1.8 BENEFITS / ADVANTAGES OF MUTUAL FUNDS

The numerous benefits of mutual funds make them the first and best choice of investment for the
do-it-yourself crowd.
If you are a beginner and want to know why mutual funds are a good fit for your investment
needs or if you are an advanced investor and need a reminder of why mutual funds are best-
suited for your financial goals and lifestyle, here are some of the many benefits you need to
know.

1. Simplicity: Mutual Funds Are Easy to Understand

Anything can be made into something more complex than it needs to be and mutual funds are no
exception to this truth. However, mutual funds require no experience or knowledge of
economics, financial statements, or financial markets to be a successful investor.
Mutual Funds can be considered baskets of investments. Each basket holds dozens or hundreds
of security types, such as stocks or bonds. Therefore, when an investor buys a mutual fund, they
are buying a basket of investment securities.

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2. Accessibility: Mutual Funds Are Easy to Buy

Mutual funds are offered at brokerage firms, discount brokers online, mutual fund companies,
banks, and insurance companies. Even beginning investors can easily open an account at a no-
load mutual fund company, such as Vanguard Investments, and open an account within minutes.

3. Diversity: Mutual Funds Have Broad Market Exposure. One mutual fund can invest in
dozens, hundreds, or even thousands of different investment securities, making it possible to
achieve diversification by investing in just one fund. However, it is smart to diversify into
several different mutual funds.

4. Variety: Mutual Funds Come In Many Different Categories and Types As you grow your
portfolio of mutual funds, you will want to diversify into various mutual fund categories and
types. You can invest in mutual funds that cover the main asset classes (stocks, bonds, cash) and
various sub-categories or you can even venture into specialized areas, such as sector
funds or precious metals funds.

5. Affordability: Mutual Funds Have Low Minimums most mutual funds have minimum initial
investment requirements of $3,000 or less. In many cases, if the investor initiates a systematic
investment program, where they have a fixed dollar amount or fixed number of shares purchased
once per month, the initial investment can be as low as $1,000.

6. Frugality: Mutual Funds Cost Less to Manage Than Other Portfolio Types Costs as a
percentage of assets in the portfolio are usually lower for an actively-managed mutual fund when
compared to an actively-managed portfolio of individual securities.
When you add up transaction costs, annual fees paid to a brokerage firm, and the cost for
research tools or investment advice, mutual funds are less expensive than the typical portfolio of
stocks. Other variables influence the cost of managing a portfolio, such as the amount of trading
activity, the size of transaction, and taxes.

7. Professional Management: Mutual Funds Have a Team of Professionals Researching and

Analyzing Investments So You Don't Have To!

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Perhaps the greatest benefit of all is that investors can save countless hours of time, energy and
frustration involved with the research and analysis required to find quality investments to hold in
a portfolio. That's not to speak of the skill, desire and patience required to do a job well in any
professional pursuit. Mutual funds enable investors to do more of the things in life they enjoy
rather than spending time and energy on investment matters.

8. Flexibility: Mutual Funds Have Several Uses and Applications. All of the above benefits of
mutual funds overlap into simplicity and flexibility. You can invest in just one fund or invest in a
wide variety. Automatic deposit, systematic withdrawal, 401(k) plans, annuity sub-accounts,
dividends, short-term savings, long-term savings, and nearly limitless investment strategies make
mutual funds the best overall investment type for both beginners and advanced investors.

9. Transparency: You get regular information on the value of your investment in addition to
disclosure on the specific investment made by your scheme, the proportion invested in each class
of assets and the fund manager’s investment strategy and outlook.

10. Liquidity: If you ever want to get out of a mutual fund, all you have to do is instruct your
broker or financial advisor. They can sell it immediately. Normally, the funds take a day to come
back into your account, but that’s not so bad. Comparatively, individual stocks would take much
longer to liquidate.

1.9 DISADVANTAGES OF MUTUAL FUNDS

There are certainly some benefits to mutual fund, but you should also be aware of the drawbacks
associated with mutual funds which are as follows:

1. No Insurance: Mutual funds although regulated by the governments, are not insured against
losses. The Federal Deposit insurance Corporate (FDIC) only insures against certain losses at
banks, credit unions, and savings and loans, not mutual funds. That means that despite the risk-
reducing diversification benefits provided by mutual funds loses can occur.

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2. Dilution: although diversification reduces the amount of risk involved in investing in mutual
funds. It can also be a disadvantage due to dilution. For example if a single security held by a
mutual fund doubles in value, the mutual fund itself would not double because that security is
only one small part of the fund’s holdings. By holding a large number of investments, mutual
tend to do neither exceptionally well not exceptionally poorly.

3. Fees and Expenses: Most mutual funds charge management and operating fees that pay for
the fund's management expenses (usually around 1.0% to 1.5% per year for actively managed
funds). In addition, some mutual funds charge high sales commissions, 12b-1 fees, and
redemption fees. And some funds buy and trade shares so often that the transaction costs add up
significantly. Some of these expenses are charged on an ongoing basis, unlike stock investments,
for which a commission is paid only when you buy and sell.

4. Poor Performance: Returns on a mutual fund are by no means guaranteed. In fact, on

average, around 75% of all mutual funds fail to beat the major market indexes, like the S&P 500,
and a growing number of critics now question whether or not professional money managers have
better stock-picking capabilities than the average investor.

5. Loss of Control: The managers of mutual funds make all of the decisions about which
securities to buy and sell and when to do so. This can make it difficult for you when trying to
manage your portfolio. For example, the tax consequences of a decision by the manager to buy
or sell an asset at a certain time might not be optimal for you. You also should remember that
you trust someone else with your money when you invest in a mutual fund.

6. Trading Limitations: Although mutual funds are highly liquid in general, most mutual funds
(called open-ended funds) cannot be bought or sold in the middle of the trading day. You can
only buy and sell them at the end of the day, after they've calculated the current value of their
holdings.

7. Size: Some mutual funds are too big to find enough good investments. This is especially true
of funds that focus on small companies, given that there are strict rules about how much of a

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single company a fund may own. If a mutual fund has $5 billion to invest and is only able to
invest an average of $50 million in each, then it needs to find at least 100 such companies to
invest in; as a result, the fund might be forced to lower its standards when selecting companies to
invest in.

8. Inefficiency of Cash Reserves: Mutual funds usually maintain large cash reserves as
protection against a large number of simultaneous withdrawals. Although this provides investors
with liquidity, it means that some of the fund's money is invested in cash instead of assets, which
tends to lower the investor's potential return.

9. Too Many Choices: The advantages and disadvantages listed above apply to mutual funds in
general. However, there are over 10,000 mutual funds in operation, and these funds vary greatly
according to investment objective, size, strategy, and style. Mutual funds are available for
virtually every investment strategy (e.g. value, growth), every sector (e.g. biotech, internet), and
every country or region of the world. So even the process of selecting a fund can be tedious.

1.10 USING PORTER'S 5 FORCES TO ANALYZE MUTUAL FUND INDUSTRY

PORTER'S FIVE FORCES

Porter's five-force framework is a qualitative tool that applies to investment analysis. The
framework helps analyze a firm's competitive stance in its industry. Porter's forces examine
industry-specific conditions and help investors determine how well a corporation is positioned to
adapt to changes in its target market.
Michael Porter's analysis serves as an alternative to Albert Humphrey's more common SWOT
(strengths, weaknesses, opportunities, threats) model.

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Figure.3 showing Porter’s Five Forces Model for Indian Mutual Fund Industry

Porter's five forces are:

A. The bargaining power of suppliers
B. The bargaining power of customers
C. The threat of increased competition from rivals in the market
D. The threat of new entrants into the market
E. The threat of substitute services or products
Using these forces requires a solid understanding of the general industry/market, corporate
business model and an appreciation for how the business can adapt to changes in market
conditions. Basically, investors must analyze how a company can respond to the underlying
threats. For example, it's common for a company to rank high in terms of competitive
resistance on four forces and fail horribly on the fifth. Inevitably, determining how such a
scenario would affect an investment's appeal is up to the investor.

A) Bargaining power of suppliers: Suppliers of AMCs are the investors who invest their
surplus money in mutual funds who would like to invest in shares but who do not possess
either market knowledge or adequate funds for diversified investment to spread the risk and
who cannot withstand the volatility of capital market.

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 Nature of the supplier: No individual supplier is large enough to have control over AMCs.
Each supplier is investing a very nominal percentage in AMCs. Therefore the bargaining
power of suppliers is less.
 Fewer alternatives: Suppliers in mutual funds are those who take low to moderate risk. The
other investment option which offers similar services like professional guidance, diversified
investment option, liquidity, choice of schemes, flexibility, convenience of investment is
very limited, which in fact lowers the bargaining power of the suppliers.
 Suppliers are not concentrated: Existence of numerous investors with negligible portion of
surplus money to invest lowers their bargaining power. Even the investment made by
financial institutions or high net worth individuals is less than 5% of the total investment.
 Forward integration: Forward integration is not possible which will further reduce the
bargaining power of suppliers. On the whole the bargaining power suppliers are less.

B) Bargaining power of customers: Customers of AMCs are the companies in whose shares
and debentures/bonds the AMCs invest their money for making profits. The bargaining
power of customers is less due to the following reasons.
 Large number of companies: Existence of large number of companies in which AMCs can
invest and other multiple investment options available for AMCs lowers the bargaining
power of the customers.
 Low switching cost: Switching from one company to another by an AMC can be easily
carried out without much loss of time and money which also lowers the bargaining power of
customers.
 Full information about the market: AMCs are headed by fund managers assisted by a
research team with expertise knowledge about the market and about the economy. This
enables the fund managers to find out the most profitable and growth oriented companies and
invest their money. Non dependent on one or few companies by fund managers lowers the
bargaining power of the customers.

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C) Rivalry among competitors: Intense rivalry is found in case of mutual fund industry all
over the world including India. Many public and private players including foreign players are
operating in the industry fighting for the same pie. These players are coming up with highly
innovative products and try their level best to attract the investors towards them.
Factors contributing to increase in rivalry are:
 Number of players: Many bank sponsored, public and private players including foreign
players operating in the market fighting for the same pie has intensified the competition.
 High growth rate: Indian mutual fund industry is going through the growth phase of its life
cycle characterized by high growth rate.
 Low switching cost: Investors switching cost is low. The investors can easily switch from
one scheme to another and from one AMC to another without much loss of time and money.
This has intensified the competition among rivals to retain the investors.
 Undifferentiated products: Almost all players in the industry offer products with same or
similar features. Each AMC tries to copy each other’s products which have intensified the
competition.

D) Threat of new entrants: Free entry into the market is another important feature of Indian
mutual fund industry: The market is open for everybody. Low barriers to entry, supportive
government policies for the entry of new firms, lack of economies of scale to the existing
players, low switching cost and very less or no product differentiation paves way for new
entrants into the market. Hence, the threat of new entrants into the market is high in case of
Indian mutual fund industry.

E) Threat of substitutes: Substitutes like most innovative banking products, Government

securities and other investment options pose a high threat to mutual fund industry. Substitute
product qualities as well as performance are equal to or greater than the mutual funds. Low
switching costs for investors from mutual fund to other better avenues of investment and
availability of other innovative substitute products augment the threat to mutual fund
industry.

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