MUTUAL FUND

A mutual fund is nothing more than a collection of stocks and/or bonds. You can think of a
mutual fund as a company that brings together a group of people and invests their money in
stocks, bonds, and other securities. Each investor owns shares, which represent a portion of
the holdings of the fund.

A mutual fund is a special type of company that pools together money from many investors and
invests it on behalf of the group, in accordance with a stated set of objectives. Mutual funds raise the
money by selling shares of the fund to the public, much like any other company can sell stock in itself
to the public. Funds then take the money they receive from the sale of their shares (along with any
money made from previous investments) and use it to purchase various investment vehicles, such as
stocks, bonds and money market instruments. In return for the money they give to the fund when
purchasing shares, shareholders receive an equity position in the fund and, in effect, in each of its
underlying securities. For most mutual funds, shareholders are free to sell their shares at any time,
although the price of a share in a mutual fund will fluctuate daily, depending upon the performance of
the securities held by the fund.

You can make money from a mutual fund in three ways:

 Income is earned from dividends on stocks and interest on bonds. A fund pays out
nearly all of the income it receives over the year to fund owners in the form of a
distribution.
 If the fund sells securities that have increased in price, the fund has a capital gain.
Most funds also pass on these gains to investors in a distribution.
 If fund holdings increase in price but are not sold by the fund manager, the fund's
shares increase in price. You can then sell your mutual fund shares for a profit.

Funds will also usually give you a choice either to receive a check for distributions or
to reinvest the earnings and get more shares.

Types of Mutual Fund

Schemes according to structure:

A mutual fund scheme can be classified into open-ended scheme, close-ended scheme & Interval
Schemes depending on its maturity period.

1. Open-ended Fund: An open ended fund is one that is available for subscription and
repurchase on a continuous basis. These Funds do not have a fixed maturity period. Investors
can conveniently buy and sell units at Net Asset Value (NAV) related prices which are
declared on a daily basis. The key feature of open-end schemes is liquidity.

2. Close-ended Fund: A close-ended Mutual fund has a stipulated maturity period e.g. 5-7
years. The fund is open for subscription only during a specified period at the time of launch of
the scheme. Investors can invest in the scheme at the time of the initial public issue and
thereafter they can buy or sell the units of the scheme on the stock exchanges where the units
are listed. In order to provide an exit route to the investors, some close-ended funds give an
option of selling back the units to the mutual fund through periodic repurchase at NAV
related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to

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 the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual
funds schemes disclose NAV generally on weekly basis.

3. Interval Schemes: Interval Schemes are that scheme, which combines the features of open-
ended and close-ended schemes. The units may be traded on the stock exchange or may be
open for sale or redemption during pre-determined intervals at NAV related prices.

Fund according to Investment Objective:

A scheme can also be classified as growth fund, income fund, or balanced fund considering its
investment objective. Such schemes may be open-ended or close-ended schemes as described earlier.
Such schemes may be classified mainly as follows:

1. Growth / Equity Oriented Scheme: The aim of growth funds is to provide capital
appreciation over the medium to long- term. Such schemes normally invest a major part of
their corpus in equities. Such funds have comparatively high risks. These schemes provide
different options to the investors like dividend option, capital appreciation, etc. and the
investors may choose an option depending on their preferences. The investors must indicate
the option in the application form. The mutual funds also allow the investors to change the
options at a later date. Growth schemes are good for investors having a long-term outlook
seeking appreciation over a period of time.

2. Income / Debt Oriented Scheme: The aim of income funds is to provide regular and steady
income to investors. Such schemes generally invest in fixed income securities such as bonds,
corporate debentures, Government securities and money market instruments. Such funds are
less risky compared to equity schemes. These funds are not affected because of fluctuations in
equity markets. However, opportunities of capital appreciation are also limited in such funds.
The NAVs of such funds are affected because of change in interest rates in the country. If the
interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa.
However, long term investors may not bother about these fluctuations.
Ideal for:
• Retired people and others with a need for capital stability and regular income.
• Investors who need some income to supplement their earnings.

3. Balanced Fund: The aim of balanced funds is to provide both growth and regular income as
such schemes invest both in equities and fixed income securities in the proportion indicated in
their offer documents. These are appropriate for investors looking for moderate growth. They
generally invest 40-60% in equity and debt instruments. These funds are also affected because
of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely
to be less volatile compared to pure equity funds.
Ideal for:
• Investors looking for a combination of income and moderate growth.

4. Money Market or Liquid Fund: These funds are also income funds and their aim is to
provide easy liquidity, preservation of capital and moderate income. These schemes invest
exclusively in safer short-term instruments such as treasury bills, certificates of deposit,
commercial paper and inter-bank call money, government securities, etc. Returns on these
schemes fluctuate much less compared to other funds. These funds are appropriate for
corporate and individual investors as a means to park their surplus funds for short periods.
Ideal for:
• Corporates and individual investors as a means to park their surplus funds for short periods or
awaiting a more favourable investment alternative.

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 5. Gilt Fund: These funds invest exclusively in government securities. Government securities
have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and
other economic factors as is the case with income or debt oriented schemes.

6. Index Funds: Index Funds replicate the portfolio of a particular index such as the BSE
Sensitive index, S&P NSE 50 index (Nifty), etc. These schemes invest in the securities in the
same weightage comprising of an index. NAVs of such schemes would rise or fall in
accordance with the rise or fall in the index, though not exactly by the same percentage due to
some factors known as "tracking error" in technical terms. Necessary disclosures in this
regard are made in the offer document of the mutual fund scheme.

7. Tax Saving Schemes (Equity Linked Saving Scheme - ELSS): These schemes offer tax
incentives to the investors under tax laws as prescribed from time to time and promote long
term investments in equities through Mutual Funds. Eligible for deduction under section 80C.
Lock in period three years
Ideal for:
• Investors seeking tax incentives.

ADVANTAGES

It may not be obvious at first why you would want to purchase shares in different securities through a
mutual fund "middleman" instead of simply purchasing the securities on your own. There are,
however, some very good reasons why millions of Americans opt to invest in mutual funds instead of,
or in addition to, buying securities directly. Mutual funds can offer you the following benefits:

1. Diversification: It can reduce your overall investment risk by spreading your risk across
many different assets . With a mutual fund you can diversify your holdings both across
companies (e.g. by buying a mutual fund that owns stock in 100 different companies) and
across asset classes (e.g. by buying a mutual fund that owns stocks, bonds, and other
securities). When some assets are falling in price, others are likely to be rising, so
diversification results in less risk than if you purchased just one or two investments.

2. Professional Management: Mutual funds are managed by a team of professionals, which

usually includes one mutual fund manager and several analysts. Presumably, professionals
have more experience, knowledge, and information than the average investor when it comes

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 to deciding which securities to buy and sell. They also have the ability to focus on just a
single area of expertise. (However, it should be noted that this apparent benefit has not always
translated into superior performance, and in fact the majority of all mutual funds don't manage
to keep up with the overall performance of the market.)

3. Regulation: Mutual funds are regulated by the government under the Investment Company
Act of 1940. This act requires that mutual funds register their securities with the Securities
and Exchange Commission. The act also regulates the way that mutual funds approach new
investors and the way that they conduct their internal operations. This provides some level of
safety to you, although you should be aware that the investments are not guaranteed by
anyone and that they can (and often do) decline in value.

4. Choice: Mutual funds come in a wide variety of types. Some mutual funds invest exclusively
in a particular sector (e.g. energy funds), while others might target growth opportunities in
general. There are thousands of funds, and each has its own objectives and focus. The key is
for you to find the mutual funds that most closely match your own particular investment
objectives.

5. Liquidity is the ease with which you can convert your assets--with relatively low
depreciation in value--into cash. In the case of mutual funds, it's as easy to sell a share of a
mutual fund as it is to sell a share of stock (although some funds charge a fee for redemptions
and others you can only redeem at the end of the trading day, after the current value of the
fund’s holding has been calculated.

6. Low Investment Minimums: Most mutual funds will allow you to buy into the fund with as
little $1,000 or $2,000, and some funds even allow a "no minimum" initial investment, if you
agree to make regular monthly contributions of $50 or $100. Whatever the case may be, you
do not need to be exceptionally wealthy in order to invest in a mutual fund.

7. Convenience: When you own a mutual fund, you don't need to worry about tracking the
dozens of different securities in which the fund invests; rather, all you need to do is to keep
track of the fund's performance. It's also quite easy to make monthly contributions to mutual
funds and to buy and sell shares in them.

8. Low Transaction Costs: Mutual funds are able to keep transaction costs -- that is, the costs
associated with buying and selling securities -- at a minimum because they benefit from
reduced brokerage commissions for buying and selling large quantities of investments at a
single time. Of course, this benefit is reduced somewhat by the fact that they are buying and
selling a large number of different stocks. Annual fees of 1.0% to 1.5% of the investment
amount are typical.

9. Additional Services: Some mutual funds offer additional services to their shareholders,
such as tax reports, reinvestment programs, and automatic withdrawal and contribution
plans.

DISADVANTAGES

There are certainly some benefits to mutual fund investing, but you should also be aware of the
drawbacks associated with mutual funds.

1. No Insurance : Mutual funds, although regulated by the government, are not insured
against losses. The Federal Deposit Insurance Corporation (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,

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 losses can occur, and it is possible (although extremely unlikely) that you could even lose
your entire investment.

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 in value
because that security is only one small part of the fund's holdings. By holding a large number
of different investments, mutual funds tend to do neither exceptionally well nor 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). 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 are trusting 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
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. Different Types: 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.

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