Welcome Delegates

AMFI Mutual Fund

(Advisor) Module
Preparatory Training Program
Agenda
 By the end of the workshop, you shall be able
to:
 understand the key mutual fund concepts required to
take the AMFI exam
 get useful exam practice through quiz and practice
tests.
Logistics
 Timing
 Breaks
 Participation
 Mobiles

“Learning is not a spectator sport”.

How this session would help
 Increased importance of
mutual funds
 Provide the right advice to
clients
 Make your Own/family’s
investments wisely
 You require AMFI
Certification to sell anyway!.
Exam logistics
 AMFI Mutual Fund (Advisor) Module
 2-hour examination – manual as well as online
 72-74 MCQs
 48Q 1 mark each and 26Q 2 marks each indicated with the
question
 Max marks 100
 Passing marks 50%
 Negative Marking 25% of the question score
 Each candidate has a different question paper
 Each chapter has a weightage which is not disclosed
 One needs to be thorough with the entire syllabus
 The language is the tricky part
 The exam emphasis is on conceptual clarity.
Sample
 A capital gain is treated as short-term when
the period of holding an asset before its sale
is:
a. less than 12 months from the date of purchase
b. more than 12 months from the date of purchase
c. not exceeding 12 months from the date of purchase
d. exceeding 12 months from the date of purchase
AMFI Syllabus
1. Concept & Role of Mutual Funds
2. Fund Structure and Constituents
3. Legal & Regulatory Framework
4. The Offer Document
5. Fund Distribution and Sales Practices
6. Accounting, Valuation and Taxation
7. Investor Services
8. Investment Management
9. Measuring & Evaluating Mutual Fund Performance
10. Helping Investors with Financial Planning
11. Recommending Financial Planning Strategies to Investors
12. Selecting the right Investment Products for Investors
13. Helping Investors understand risks in Fund Investing
14. Recommending Model Portfolios and Selecting the right fund
15. Business Ethics and Mutual Funds.
Agenda
Section 1: Nuts & Bolts
Concept & Role of Mutual
Funds
Fund Structure and
Constituents
Legal & Regulatory
Framework
Section 2: Process of
Investing
Offer Document
Fund Distribution & Sales
Practices
Investor Services
Section 3: Mutual Funds &
Securities Markets
Investment Management
Section 4: Accounting Aspects
Accounting, Valuation and
Taxation
Section 5: Return Concepts
Measuring & Evaluating Mutual
Fund Performance
Section 6: Financial Planning &
Mutual Funds
Helping Investors with Financial
Planning
Recommending Financial
Planning Strategies
Selecting the right Investment
Products
Helping Investors understand
risks
Recommending Model Portfolios
and Selecting the right fund
Section 7: Business Ethics
Business Ethics & Mutual Funds
Section 1
Nuts and Bolts

1. Concept & Role of Mutual Funds

2. Fund Structure and Constituents
3. Legal & Regulatory Framework
Concept of Mutual Fund
 A pool of money contributed by many
investors and collectively managed by an
asset management company
 Investments made in accordance with stated
objectives
 A financial intermediary that allows small
investors to participate in the securities
market
 Ownership of the fund is mutual and
beneficial
 An investor becomes part owner of the fund’s
assets when he buys into the fund
 The investor is allotted units for the amount
subscribed.
What it means

Investors

Receive
Contribute dividend/capital
money appreciation

Trust
(pool of money)
Receive
Invest in interest,
dividend or
markets
capital growth
Markets
(volatile, has fluctuation)
The MF Cycle
Characteristics
 Investors own the mutual fund
 Everyone else associated with the
fund earns a fee
 Things which are mutual
 Pool of money
 Investment objective
 Risk and return
 Funds are invested in a portfolio of
marketable securities reflecting
the investment objective
 Value of the portfolio and
investors’ holdings change with
change in the market value of
investments.
Advantages
Disadvantages
 No Control Over
Costs
 No Tailor Made
Portfolios
 Managing a large
number of
funds/types.
 History of Mutual Funds

 Birthplace of Mutual Funds – USA

 History in India:
 1964-1987 (Phase I) – Growth of Unit Trust of India
 1987-1993 (Phase II) – Entry of Public Sector Funds
 1993-1996 (Phase III) – Emergence of Private Funds
 1996-1999 (Phase IV) – Growth and SEBI Regulation
 1999-2004 (Phase V) – Emergence of large & uniform
Industry
 2004 onwards (Phase VI) – Consolidation and Growth.
Types of Funds
Existing funds New Gen Mutual Funds
 Open-ended (OEF) &  Fund of Fund
Close-ended (CEF)  Commodity fund
 Growth, Income and  Real Estate fund
Hybrid  Asset Allocation fund
 Equity, Debt and Balance
 Exchange-traded fund
 Load & No-Load
 Derivative fund
 Guaranteed & Non-
 Capital Protection
Guaranteed Oriented Fund.
 Tax-exempt & Non tax-
exempt
OEF & CEF
OEF
 No fixed tenor
 Continuous sale & purchase
by the fund
 Subscription is not
mandatory
 Redemption mandatory,
with certain obvious
conditions
 Fund size changes everyday
 No secondary market
trading
 Redemption pressure on
fund managers is higher
 Daily NAV (calc &
disclosure)
CEF
 Fixed tenor – 1/3/5/7 years
 Sale of units only during
NFO
 No subscription after
closure of NFO
 Redemption in 2 ways
 Exit window – periodically
repurchase of units by the
fund
 Listing – secondary market
trading of units, like stocks
 Fund size either constant or
decreases
 Lower redemption pressure
on fund managers
 Weekly NAV (calc weekly
but disclosure daily).
Equity-oriented
 Diversified
 Sectoral
 Thematic or Specialty
 ASEAN fund, Infrastructure Fund
 Growth & Value
 Large, Mid & Small Cap
 Dividend Yield or Equity Income
 Index
 ELSS

Primary objective: growth or capital

appreciation.
Equity-oriented funds

ACTIVE PASSIVE
Index Funds

NON–DIVERSIFIED
DIVERSIFIED
SECTORAL

GROWTH VALUE
Debt Oriented
 Diversified Debt
 Focussed/Sectoral Debt
 Gilt Fund
 Bond Fund
 Fixed Maturity/Term Plan (FMP/FTP)
 Liquid or Money Market MF

Primary objective: regular income.

Balance
 Investment in more than one asset class
 Debt and equity in various proportions

Primary objective: hybrid (regular income as

well as capital appreciation).
Fund of Funds
 Invest in other schemes of same or other
mutual fund
 Is considered like a Debt scheme for tax
purposes
 2 advantages:
 Since FOF is a mutual fund scheme, no tax on
income generated from buying and selling securities
 Allows fund managers to rebalance portfolio
freely
 Investor need not to decide when to sell units and
execute transactions
 Convenience to the investor.
Commodity Fund
 specialize in investing in different
commodities directly or through shares of
commodity companies or through commodity
futures contracts.
 Example - Precious Metals Funds
 As of date, Indian MF industry does not have
commodity funds except the ones that invest
in Gold.
Real Estate Fund
 Invest in real estate directly, or fund real
estate developers, or buy shares of housing
finance companies
 Fund to invest min 30 % corpus in real estate
projects
 Balance in equity, bonds/debentures of real
estate cos.
 Close-ended schemes with secondary market
trading
 Move to bring transparency, documentation
and fair valuation of property
 Allow small investors with small investments
to enjoy upswing of property without
downside of high stamp duty, legal expenses,
high initial investment, element of black
money and disposal at the right prices.
Asset Allocation Fund
 Fund manager has the flexibility to change
the allocation of funds between equity and
debt based on perception about direction of
the market.
Exchange-traded fund
 Passively managed fund that tracks a
benchmark index
 An ETF is like a hybrid financial instrument, a
cross between an index fund and a stock
 An equity-based ETF would invest in a basket of
stocks that reflects the composition of an index, say
Nifty or Sensex
 These funds are freely traded on the stock exchange
and derive value from the underlying asset, i.e.,
stocks.
Gold ETF
 Gold ETFs invest in physical gold and derive
their value from the underlying asset
 The price of gold ETFs will be directly linked to the
price of gold itself and hence the returns from a gold
ETF will more or less equal to returns from gold bars
or coins
 Investors can buy or sell units of these
schemes, like any other stock listed on the
exchange, through brokers.
Derivative fund
 Hedging
 Futures
 Options
 Arbitraging
 Stock Arbitrage
 Index Arbitrage.
Capital Protection Oriented
fund
 Close-ended with no exit option
 Debt scheme from a tax standpoint
 No guarantee by the AMC or sponsor
 Capital protection on account of the structure
 Eg. Debt component of 80 in zero coupon bonds
which give 100 on maturity and investment of the
balance 20 in equity
 With tools such as dynamic portfolio insurance,
increase equity component by a multiplier
 Rating of the scheme mandatory.
Classification of funds
 Risk
 Sectoral funds have higher risk
 Liquid or Money Market funds have least risk
 Tenor
 Equity funds require a long investment horizon
 Liquid funds are for the short term liquidity needs
 Investment objective
 Equity funds suit growth objective
 Debt funds suit income objective.
Risk-Return Hierarchy

Sectoral
Retur funds
Equity
n funds
Index
funds
Balanced
funds
Debt
Funds
Gilt
funds
ST debt
funds
Liquid
funds R
isk
 Stop Check!
 A mutual fund is not
 A company that manages an investment portfolio
 A portfolio of stocks, bonds and other securities
 A pool of funds used to purchase securities on behalf of investors
 None of the above
 Which of the following mutual funds was not set up in the
phase 1987-93:
 Canbank Mutual Fund
 Kothari Pioneer Mutual Fund
 SBI Mutual Fund
 LIC Mutual Fund
 Which of the following has the lowest risk?
 Liquid Fund (MMMF)
 Gilt Fund
 Diversified Debt fund
 Diversified equity fund.
Mutual Fund
Structure &
Constituents
Structure & Constituents
MF Structure in India
A mutual fund has a 3-tier
structure

Sponsor

Trustee Trust

AMC
MF Structure in other countries
Structure in USA
 Management Company – Similar to AMC
 Underwriter – for Sales
 Management Group – Similar to Sponsor
 Custodian

Structure in UK
 Open Ended - Unit Trusts – regulated by
Securities and Investment Board + by
relevant SRO
 Closed Ended - Investment Trusts – like a
Company.
 MF Constituents in India

SEBI

Sponsor

Trustee Trust

AMC

Custodian & Banker R&T Agent Distributor

Depository
Securities Investor
Dealer /
Broker
Securities
Markets
Trust
 Mutual funds in India constituted as a Public
Trust under Indian Trust Act, 1882
 The trust is registered with the Office of
Public Trustee
 OPT reports to the Charity Commissioner
 The trust or the fund has no independent
legal capacity itself
 Acts in relation to the trusts are taken on its
behalf by the trustees
 Treated as a separate entity and a pass
through vehicle
 Has its own auditors, separate from the AMC.
Sponsor
 Promoter of the mutual fund
 Creates a Trust under Indian Trusts Act, 1882
and registers it with Office of Public Trustee
 Appoints Board of trustees/trustee company
 Creates AMC under Indian Companies Act,
1956
 Fulfills necessary formalities and applies to
SEBI for registration of the Trust as a Mutual
Fund.
Sponsor Criteria
 Min 5 years track record in financial services
 Bank, corporate or an FI
 Profit making in at least 3 out of past 5
years, including the previous year
 Positive Net Worth in last 5 years
 At least 40% of the capital of the AMC
 Net worth in the immediately preceding year
more than the capital contribution to the
AMC.
Trustee
 Appointed by sponsor with SEBI approval
 Have Registered ownership of investments
 Formed either as Board of Trustees or
Trustee Company
 Power to appoints all other constituents
 Appoint AMC through the ‘Investment
Management Agreement’ and delegate
powers.
Trustee Criteria
 Minimum number of trustees is 4
 2/3rd should be independent trustees i.e. no
connection of profit (what so ever) with the
sponsor
 Meet at least 4 times in a year to review
functioning of AMC
 Trustees hold the unit-holders money in fiduciary
capacity
 All major decisions need trustee approval
 Right to seek regular information and take
remedial action.
AMC
 Required to be registered with SEBI
 Appointed as Investment Manager of the mutual fund
 Appointed by the trustees via an Investment
Management Agreement
 Responsible for operational aspects of the mutual fund
 Net Worth of at least Rs.10 crore at all times
 At least 1/2 of the board members must be independent
 Mostly, structured as a private limited company where
Sponsor and associates hold capital
 Quarterly reporting to Trustees.
 MF Constituents

SEBI

Sponsor

Trustee Trust

AMC

Custodian & Banker R&T Agent Distributor

Depository
Securities Investor
Dealer /
Broker
Securities
Markets
 Other Constituents

Custodian &  Investment back-office

Depository

Banker  Providing bank accounts & remittance services

Securities  Purchase and sale of securities

Dealer /  Not more than 5% through a related
Broker broker
 Research report to AMC

R&T Agent  Investor records and transactions

Distributor  Selling & Distributing schemes

Role Restrictions
 Sponsor of a fund cannot be its custodian
 Sponsor of a fund can be a distributor
 Trustee of one mutual fund cannot be trustee of
another mutual fund
 Exception is Independent trustees provided they
obtain approval of both the board of trustees
 Trustee of one fund cannot be AMC of another
 AMC of one fund cannot be Trustee of another
 AMC cannot have any business interest other
than fund advisory.
Mergers & Takeovers
 Scheme Merger
 Scheme merged with another scheme of the same
AMC
 AMC Takeover
 AMC is taken over by another set of sponsors
 AMC Merger
 One AMC may merge with another AMC
 Change of AMC/Trust
 Trustees decide to change the AMC and handover
the scheme to a new AMC
 Scheme Takeover
 Just the schemes taken over by another set of
trustees.
Mergers & Takeovers
 Scheme takeover (HDFC–Zurich, Birla-Apple)
 One AMC buys schemes of another AMC
 Organic growth in assets
 No change in AMC stakes
 AMC merger (HB-Taurus)
 Two AMCs merge
 Similar to merger of companies
 Sponsor stakes change
 AMC take-over (Zurich-ITC Threadneedle, Birla-Alliance)
 Stake of one sponsor in a AMC bought out by another
 Change in AMC and sponsor.
 Mergers & Takeovers

 Investor rights
 Right to be informed
 No prior approval required
 Option to exit at NAV without exit load.
 Regulatory framework

SEBI RBI
 Apex Banking
 Apex regulatory body regulatory body
 Equivalent to a  MFs are investors in
Securities and Gilts & Money Market
Investment Board in
and thus indirectly under
the UK
RBI’s regulation
 Set up by an Act of  Regulates bank
Parliament in 1992
assured return schemes
 Overall Capital  Bank sponsored AMC
Markets Regulator
wanting to offer assured
 SEBI (MF) Regulations,
return scheme require
1996
RBI approval as well.
 Regulatory framework

MoF  Supervisor of both SEBI & RBI

 Created in 2003
SAT  Provide apex appeal mechanism
for actions taken by SEBI
Registration of AMC and
Trustee Company
RoC for Compliance
RoC is supervised by DCA
Companies DCA is a part of CLB which is
under Ministry of Law and
Act Justice
CLB is the interface for
prosecution and penalties.
 Regulatory framework
Registration of Trust
Office of Public  Board of Trustees is accountable
to the OPT
Trustee  Complaints against individual
trustees
Derive powers from regulator
Ability to make bye-laws
Regulate own members in a limited
SRO way
Example : Stock exchanges – NSE,
BSE etc.

Collective industry opinion

Industry  Guidelines &
recommendations
Association  Example: Association of
Mutual Funds in India (AMFI).
 Stop Check!
 Mutual Funds in India are set up as
 Company
 Trust
 Partnership
 Association of persons
 Issuing additional fresh units and redeeming the existing units
of a mutual fund scheme is the role of:
 The custodian
 The transfer agent
 The trustees
 The bankers
 Minimum no of independent directors on the board of the AMC
 50%
 25%
 75%
 None of the above.
 Stop Check!
 Which of the following qualifies as an SRO
 SEBI
 RBI
 NSE
 AMFI
 To approve a change in fundamental attributes of a close-
ended fund, consent of the following is required:
 50% of unit holders
 50% of trustees
 75% of unit holders
 None of the above
 The body to which an investor may address their complaint is:
 SEBI
 RBI
 IRDA
 NSE.
Session 2
The Process of
Investing

4. The Offer Document

5. Fund Distribution and Sales Practices
7. Investor Services
The process of investing
 Offer Document
 KIM
 Application and form of holding
 Distribution channels
 Investors rights & obligations.
 Offer Document

 Mostimportant document for a

prospective investor
 Legal offer from AMC to investor
 Contains vital information about fund and
schemes
 SEBI approved format.
 Offer Document

 Contents
 Constitution of fund
 Details of Sponsor, Trustee & AMC & key personnel –
financial history for 3 years
 Description of Scheme & Investment Objective/Strategy
 Terms of Issue/Offer
 Historical Statistics
 Investor’s Rights and Services
 Mandatory Disclaimer clause
 Standard and Scheme-specific Risk Factors.
Details of Scheme offered
 Dates of NFO
 details regarding sale and repurchase
 Minimum Subscription and Face Value
 Initial Issue Expenses
 current and past schemes
 Special facilities to investors
 Eligibility for investing
 documentation
 Procedure for applying, and subsequent
operations relating to transfer, redemption,
nomination, pledge and mode of holding of
units.
Load, Fee and Expenses
 Load and the annual recurring expenses
 Proposed scheme and other schemes
 Comparison with offer document
numbers
 Scheme expenses for past 3 years
 Condensed financial information for 3 years.
Unit holder rights
 Rights of unit holders
 Right of proportionate beneficial ownership of
scheme’s assets
 Right to timely service
 Right to information
 Right to approve changes in fundamental attributes
 Right to wind up a scheme
 Right to terminate AMC services
 Protection of rights and problem resolution
 Details of information disclosure and their
periodicity
 Documents available for inspection
 Details of pending litigation and penalties.
Unit holder rights
 Cannot sue the mutual fund
 Can complain against AMC, sponsor and Board of
Trustees
 75% unit holders can
 wind up a scheme
 seek AMC termination
 Prospective investor has no rights
 Right to redeem without load in case of change in
fundamental changes.
Due Diligence
 SEBI approved format and content
 Trustee Approval
 Compliance Officer certifies that
 Information contained therein is true
and fair
 Is in accordance with SEBI regulations
 Fund constituents are all SEBI
registered entities
 The AMC is responsible for the contents and
the accuracy of information.
Offer Document
 Validity of OD
 For New Schemes - 6 months from the date of receipt by
the AMC of the letter containing observations from SEBI
 Revised at least once every two years for OEFs
 OD is printed only once for CEFs
 Updated for every major change
 Change in the AMC or Sponsor of the mutual fund
 Change in the load structures
 Changes in the fundamental attributes of the schemes
 Changes in the investment options to investors; inclusion
or deletion of options
 After completion of one year of an OEF,
condensed financial information mandatory
in the OD & KIM.
Fundamental Attributes
 Scheme type
 Investment objective
 Investment pattern
 Terms of the scheme with regard to liquidity
 Fees and expenses
 Valuation norms and accounting policies
 Investment restrictions.
Changes in fundamental
attributes
 Approval from Trustees & SEBI
 Public announcement by AMC
 In case of OEF - Investors have to be
informed and option given to exit at NAV
without any exit load
 In case of CEF – investor approval is
required
 New OD.
KIM
 Abridged OD
 KIM is mandatory with every application
form.
OD & KIM
 Principle of ‘BUYER BEWARE’ applies
 An investor who invests without studying the Offer
Document cannot subsequently hold the fund
responsible
 Investor has no recourse for not having read
the OD/KIM.
Investor Rights & Obligations
 Investor’s Rights
 Investor’s Obligations
 Study the OD
 Provide PAN
 Monitor investment
 Complaints Redressal Bodies
 SEBI
 RoC/DCA/CLB.
Sales Practices
 No mandatory guidelines for distributor role & service to
investor
 AMFI recommends certain practices for effective selling
 To be fully aware of the important characteristics of the schemes
 Know their clients
 Identify clients
 Understand each client’s needs
 Help a client chose his investments
 Encourage regular investments
 Provide personalized after sales service
 Distribution Commissions are paid by fund houses
 There are no rules governing the min and max
 SEBI (vide Circular dated June 26, 2002) has banned rebating
of commissions
 AMFI has also prohibited rebating as specified in AGNI.
Investor Services
 Applying for & Redeeming units
 Cut-off timing of 3:00 pm for same day NAV
 the next day NAV is applied in case of application
received after 3:00 pm
 in case of liquid funds 11:00 am is cut-off for
applying previous day NAV
 Dividend Reinvestment Plan (DRP)
 Systematic Investment Plan (SIP)
 Systematic Withdrawal Plan (SWP)
 Systematic Transfer Plans (STP).
Investor Services
 Telephone/Internet transactions
 Cheque Writing
 Periodic statement and tax information
 Loan against units
Investment Options
 Investors can achieve income and growth
objectives
 Growth option
 Dividend-payout option
Regular
Ad-hoc
 Dividend Re-investment option
 Most funds provide multiple options and the
facility to switch between options.
 Stop Check!
 The front page of on offer document contains:
 Date of its publication
 Name and type of fund
 Major objectives of the fund
 1 and 2 above
 The abridged offer document contains the address
of the following:
 The Trustees of the mutual fund
 The Directors of the AMC
 the Registrar & Transfer Agents
 1 and 2 above
 2 and 3 above
 Offer document has to be updated within
 One year from date of issue
 Two years from date of issue
 Six months from date of issue
 None of these
Session 3
Accounting, Valuation
& Taxation

6. Accounting, Valuation and Taxation

Accounting Policies
 Investments to be marked to market
according to SEBI Guidelines
 Unrealised appreciation cannot be
distributed
 Profit or loss on average cost basis
 Dividend on ex-dividend date
 Sale and purchase accounted on trade date
 Brokerage and stamp duties are capitalized
and added to cost of acquisition or sale
proceeds.
Reporting Requirements
 Audited accounts within 6 months of closure
of accounts
 Publish unaudited abridged accounts within
30 days of the closure of the half-year
 Summary of the accounts to be mailed to all
unit holders
 File with SEBI
 Copy of the annual report
 Six monthly unaudited reports
 Quarterly movement in net assets of
the fund
 Quarterly portfolio statements.
Specific Disclosures
 Complete portfolio to be disclosed every six
months
 Industry practice is monthly disclosure
 Any item of expenditure which is more than
10% of total expenses
 NPAs, provisioning and NPAs as percent of
total assets
 Number of unit holders holding more than
25% of unit capital.
Net Asset Value
 Frequency of NAV
 Calculated and published at least every
Wed for CEFs
 Calculated and published daily for
OEFs
 Updated on AMFI website by 8:00 pm
(as per text book) every business day
 NAVs are rounded off up to four
decimal places for liquid/money
market schemes and upto two decimal
places for all other schemes.
Net Asset Value
 NAV = Net Assets of the Scheme/No. of Units
Outstanding
 Net Assets of the Scheme
+ Market Value of investments
+ Receivables
+ Other accrued income
+ Other assets
- Accrued Expenses
- Other payables
- Other liabilities.
Fees & Expenses
 Initial Issues Expenses
 Recurring Expenses
 Investment Management Fee
 Entry & Exit Load.
Initial Issue expenses
 Expenses incurred in floating a new scheme
 Max 6% of funds mobilized charged to scheme; excess borne
by AMC/sponsor
 Only CEFs are permitted to charge IIE to the fund
 Amortize on weekly basis until maturity
 E.g. 6 crores amortized over a 5-year (260 weeks) tenor would
mean Rs. 230,769 charged every week as expense
 No-load fund i.e. funds which do not charge initial issue
expenses can charge additional investment management fees
of 1%

w.e.f. Apr 2006 OEFs cannot charge initial issue expenses to the
scheme.
Recurring Expenses
 Investment management fees
 Custodian’s fees
 Trustee Fees
 Registrar and transfer agent fees
 Marketing and distribution expenses
 Audit fees
 Legal expenses
 Costs of mandatory advertisements and
communications to investors.
Expenses that cannot be
charged
 Penalties and fines for infraction of laws
 Interest on delayed payments to unit holders
 Legal, marketing and publication expenses not
attributable to any scheme
 Expenses on investment and general management
 Expenses on general administration, corporate
advertising and infrastructure costs
 Expenses on fixed assets and software development
expenses
 Such other costs as may be prohibited by SEBI.
Recurring Expenses
 Overall ceiling on expenses, including
Investment management and advisory fees
 Based on Weekly Average Net Assets (WANA)
 Equity Funds
First 100 Crores 2.50%
100 - 400 Crores 2.25%
400 – 700 Crores 2.00%
Above 700 Crores 1.75%
 For Bond funds, above figures are lower by
0.25%
 Limit for FOFs is 0.75% of the Weekly
Average Net Assets.
Numerical
Q. An open-ended equity fund has Net Assets of
Rs. 3500 crores. What is the limit on
recurring expenses?

Q. A Bond fund has WANA of Rs. 850 crore.

What is the maximum recurring expenses it
can charge to the scheme?
Investment Management Fee
 SEBI Limits – Investment Management Fee
 For the first Rs. 100 crore of net assets: 1.25%
 For net assets exceeding Rs. 100 crore: 1.00%
 IMA can be 1% more for no load funds
Numerical
Q. A load scheme has Net Assets of Rs. 400
crore. What is the ceiling on the Fund
Management Charges (FMC)?

Q. What is the ceiling on Investment

Management Fee in case of a no-load scheme
with Net Assets of Rs. 1500 crore?
Loads
 Charged to recover sales and distribution expenses
 Entry Load
 At the time of sale of units i.e. subscription by investor
 Charged on NAV and increases the sale price
 Exit Load
 At the time of repurchase of units i.e. redemption by
investor
 Charged on NAV and reduces the repurchase price
 Load is a charge on the NAV
 Load is defined as a percentage
 CDSC is variable exit load, lower for longer duration of
holding
 Loads are subject to SEBI Regulations*

* Change expected in Jan 2008 - In case of Direct

investment, no entry load to be charged to investor.
SEBI Regulations - Loads
OEFs
 Maximum Exit load or Entry load : 7% of NAV
 Repurchase price more than or equal to 93%
of the Sale price

CEFs
 Max Entry or Exit Load: 5% of NAV
 Repurchase price more than or equal to 95%
of the Sale Price (NAV in this case)

w.e.f. Apr 2006, CEFs cannot charge entry load.

Pricing of Units
 Sale and repurchase price are NAV-based

SALE PRICE = NAV + Entry Load

REPURCHASE PRICE = NAV – Exit Load

 Numerical

 NAV is 25.50 NAV is 34.60

 Entry Load = 2.25% Entry Load = 2.50%
Exit Load = 1.25%
 Exit Load = 1.5%
To purchase 1000 units, what
 How many units can an is the investment required?
investor purchase with
Rs. 50,000/-?

NAV is 52.10 NAV is 47.20

Entry Load = 2.25% Entry Load = 3.25%
Exit Load = 0.75% Exit Load = 2.50%
An investor redeems 500 To get Rs. 25,000/- how many
units. How much money units must an investor
does he get? redeem?
Non Performing Asset
 An asset classified as non-performing if
interest or principal amount not been
received or remained outstanding for one
quarter from the due date
 Deep Discount Bonds (DDBs) are classified as
NPAs if,
 the grade falls to BB or below, OR
 it is defaulting on other commitments, OR
 in case of full Net worth erosion of the borrower.
Treatment of NPAs
 Accrual to be stopped
 Income accrued until date of
classification to be provided for
 Provisioning for principal due
 Ingraded manner after 3 months of
classification.
 Complete write off in 15 months from
classification.
 Non Performing Asset

 Provision for NPAs

 10% of BV - after 6 months past due date
of interest
 20% of BV – after 9 months past due date
of interest
 20% of BV – after 12 months past due date
of interest
 25% of BV – after 15 months past due date
of interest
 25% of BV – after 18 months past due date
Valuation of Securities
 Equity
 Traded Securities – Mark to Market –
i.e., last quoted closing price on the
stock exchange where it is ‘principally
traded’
 Thinly Traded Securities – Those
securities which are traded for less
than 5 lacs AND less than 50,000
shares – Complex valuation method is
used if the security is not traded for
more than 30 days otherwise last
traded price.
Valuation of Securities
 Debt
 Traded Securities – as quoted in
market upto last 15 days
 Thinly Traded Securities – those
securities (except GoI securities)
where there is no trade in marketable
lot of Rs 5 Cr on valuation date
 Securities with maturity upto 182 days
are valued on the basis of amortization
cost + accrued interest.
Taxation
 Mutual Fund is a pass through vehicle hence
not taxed
 Mutual funds are exempt from tax under
section 10(23D) of Income Tax Act, 1961
 Taxation for investor
 Dividend
 Capital Gain
 Taxation as per ‘Equity’ fund (at least 65% of
assets in domestic equity) or ‘Other than
Equity’ fund.
Equity Funds (Min 65%
domestic equity)
Dividend Capital Gain
Short-Term
Investor (not exceeding 12
months)
NIL
10% + SC +EC
Long-Term
DDT (exceeding 12
months)
NIL
NIL
 Other than Equity Funds

Dividend Capital Gain

Investor
Short-Term
NIL (not exceeding 12
months)
DDT
Marginal Tax Rate
As per grid
below

Liquid Other than Long-Term

Liquid (exceeding 12 months)
Individua 12.5% + Indexed Tax Rate
l/HUF 25% + SC + EC
Others SC + 20.0% +
EC SC + EC
 MF Taxation Summary
  Equity Debt
Short Term
10% As per Income Tax Slab
Capital Gains
20% with Cost Inflation
No capital gains tax payable.
Index benefit or 10%
Long Term However, securities transaction
without Cost Inflation
Capital Gains tax payable at 0.25 percent of
Index benefit, whichever
the redemption price.
is lower
Dividend Income
in the hands of Nil Nil
investor
Individuals & HUFs –
Dividend
Nil 14.16%
Distribution Tax
Others - 22.66%
Tax Deducted at
Source Nil Nil
Payable at the time of
redemption @ 0.25%
Securities irrespective of whether a gain
Transaction Tax has been made or not Not Applicable
Other tax aspects
 Securities Transaction Tax (STT)
 54EC
 Section 80C
 Section 111A
 Dividend Stripping
Section 94(7) of the IT act reads – If a person buys or
acquires securities or units within a period of three
months prior to the record date fixed for declaration of
dividend and sells or transfers the same within a period
of nine months after such record date and the dividend
recd is exempt, then the loss if any, arising from such
purchase or sale shall be ignored to the extent such loss
does not exceed the amount of such dividend income.
Numerical
Q. Investor buys on March 31, 2005 and sells on
April 1, 2007. What is the indexation
adjustment factor?
2004-05 – 520
2005-06 – 548
2006-07 – 582
2007-08 – 624
Investor buys on April 1, 2005 and sells on
March 31, 2008. What is the indexation
adjustment factor?
 Stop Check!
 An open-ended fund with 10,000 units outstanding has
the following items on the balance sheet:
Investment at market value Rs, 1,00,000
Other assets Rs. 20,000
Other Liabilities Rs. 25,000
Calculate the NAV per unit:
 Rs. 9.50
 Rs. 12
 Rs. 10
 Rs. 14.5
 Unit capital of a scheme is Rs. 20 million. The market
value of its investments is Rs. 55 million. The number of
units is 1 million. The NAV is
 Rs. 20
 Rs. 75
 Rs. 55
 Not possible to say.
 Stop Check!
 An investor bought a unit in 1995 for Rs. 75,000. he sold
the units in 1998 for Rs. 125000. the cost inflation index
for 1995 and 1998 are 281 and 351. the capital gains
chargeable to tax are:
 64,957
 31,317
 50,000
 75,000
 Income earned by a mutual fund registered with SEBI is
exempt from income tax as per section:
 10(23D)
 10(33)
 Total income is taxable @ 33.2%
 80C.
Session 4
Mutual Funds &
Securities Markets

8. Investment Management
Mutual Funds & Securities
Markets
 Equity
 Market and products
 Asset classes
 Investment styles
 Value indicators
 Debt
 Market and products
 Terminology
 Investment styles
 Investment restrictions.
Equity investing
 Equity implies ownership
 Equity instruments
 Ordinary shares
 Preference shares
 Convertible debentures
 Equity Warrants.
Equity investing
 Classification of Equity
 LargeCap/ Mid Cap/ Small Cap
 Growth/ Value/ Cyclical
 Equity terminology
 Earningsper Share
 Market Capitalization
 Ratios
 P/E Ratio
 Dividend Yield.
Equity portfolio management
 Approaches to Portfolio Management
 Passive
 Active
 Investment Styles
 Growth
 Value
 Securities Research
 Fundamental Analysis
 Quantitative Analysis
 Technical Analysis
 Portfolio Management Organization Structure
 Fund Managers
 Security Analysts & Researchers
 Dealers.
Approaches to portfolio
management
 Active management
 Aim for Out-performance
 Higher fees
 Selection and timing

 Passive Management
 Replicate a chosen Index
 Low fees.
Approaches to portfolio
management
Value
The Fund Manager looks to buy companies
Investing they believe are undervalued in the current
market, but whose worth (as estimated by
the fund manager) eventually will be
recognised by the market.

The Fund Manager looks for companies with

above average earnings growth and profits,
Growth
which they believe could be even more
Investing valuable tomorrow in the stock market than
today.
 Growth vs. Value

a. MPS?
b. P/E?
c. DY?
Debt Investing
 Debt implies lending/loan
 Types of debt instruments
 Govt. Securities
 PSU Bonds
 FI Bonds
 Corporate Bonds
 Debentures
 Money Market Securities
 Treasury Bills (T-Bills)
 Commercial Paper (CP)
 Certificate of Deposit (CD).
Debt Classification
 Classification of Debt Securities
 Tenor – long or short
 Credit quality
 Government Securities/Corporate Securities/FI
Bonds
 Secured/Unsecured
 Market Traded/Non-traded
 Interest
 Periodic or Discounted
 Fixed or Floating (Floater)
 Call or Put option.
Debt Terminology
 Par or Principal or Face Value
 Coupon or Interest
 Maturity or tenor
 Callable
 Puttable
 Yield.
Measures of Bond Yield
 Current Yield
 Yield to Maturity
 Yield Curve (TSIR).
Price & Yield
 Increase in rates
reduces value of
existing bonds
 Decrease in rates
increases value of
existing bonds
 Price and yield are
inversely related
 The relationship
between yield and
tenor can be plotted
as the yield curve.
Current Yield and YTM
 Coupon amount as a percentage of current
market price

If you bought an 8% bond at Rs. 110, the

current yield is,
= (8/110)*100
= 7.27%.
Interest Rate Sensitivity
 Measured by a number called duration
 If duration is 5 years, and interest changes
by 1%, price of the bond will change in the
opposite direction, by 5%

Example: Duration of a bond is 3 years. Yield

spreads increases by 1.5%. What is the
change in price?
= 1.5 *3
= -4.5%.
Risk in Bond Investing
 Types of Risk
 Interest Rate Risk
 Reinvestment Risk
 Default/Credit Risk
 Inflation Risk
 Liquidity Risk
 Call Risk
 Risk Measures
 YieldSpreads & Credit Ratings
 Duration.
Credit Risk
 Probability of default by the borrower
 Change in credit rating,
 downgrade increases the yield &
decreases the price
 upgrade decreases the yield &
increases the price.
Debt Portfolio Management
 Buy & Hold
 Portfolio exposed to interest rate risk
 Duration Management
 increase duration if rates are expected to fall
 decrease duration if rates are expected to rise
 Credit Selection
 Invest in low grade bonds that are likely to be
upgraded
 Prepayment Prediction.
Investment Policy
 Investment policy of each scheme dictated by
the scheme’s objective
 SEBI imposes certain restrictions on mutual
funds to ensure investor protection
 Minimum 20 investors per scheme
 No one to hold more than 25% of the corpus
 Record of Investment decisions to ensure
transparency.
Minimum Portfolio
Diversification
 Not more than 10% of NAV in a single
company
 Exceptions: Index & Sectoral funds
 Rated Investment grade debt of a single
issuer cannot be more than 15% of NAV
(extendable to 20% with AMC Board and
Trustees approval)
 Un-rated instruments
 10% of Net Assets for single issuer
 Overall 25% cap for investment in such securities
 Unlisted shares
 Max 10% of Net Assets for CEFs
 Max 5% of Net Assets for OEFs.
Investment Restrictions
 Invest only in marketable securities
 Investment transactions only on delivery
basis
 Securities have to be bought in the name of
the scheme
 A mutual fund under all its schemes, cannot
hold more than 10% of the paid-up capital of
a company
 Equity with voting rights representing 10% of paid-up
capital of one stock.
Approved & Unapproved
Investments
 Temporary Investment in Bank FDs – Max
15% of NAV
 ADR/GDR investment permitted
 lower of, 10% of net assets or $200 million
 cap for mutual fund industry as a whole $4 billion
 Limited investment in Treasury Bonds and
AAA rated corporate debt issued outside
India
 No Lending.
Investment in Sponsor
 No investment in unlisted securities of
sponsor or an associate or group company of
the sponsor
 No investment in privately placed securities
of the sponsor or an associate
 Investment in listed securities of the sponsor
or associate company permitted
 Max 25% of the net assets of the scheme.
Inter-scheme transfer
 Transfers only on a delivery basis, at market
prices
 Such transfers should not result in
significantly altering the investment
objectives of the schemes involved
 Such transfer should not be of illiquid
securities, as defined in the valuation norms
 One scheme can invest in another scheme, up
to 5% of net assets.
 No fee is payable on these investments.
Other Restrictions
 Mutual funds can borrow up to 20% of net
assets for a period not exceeding 6 months
 Any change in investment objectives requires
information to investor, and provision of
option to exit at NAV, without exit load.
 Stop Check!
 Current market price of a 9% coupon bond,
when other bonds of similar maturities pay
11% will be:
 Above par
 Below par
 At par
 Will be unrelated to other bonds
 Technical analysis tries to predict future
movement of stock price by analyzing:
 The financial working of a company
 Stock price movement of a company
 Both the above
 None of the above.
 Stop Check!
 Mutual Fund scheme can borrow within
certain limits,
 Upto 20% of net assets
 For max 6 months
 Both are true
 Neither is true
 Unlisted shares in a scheme’s portfolio can
be a maximum
 5% of net assets in a CEF
 10% of net assets in an OEF
 Both are true
 Neither is true.
Session 5
Return Concepts

9. Measuring & Evaluating Mutual Fund

Performance
Computing Return
 Return defined as Income earned for amount
invested over a given period of time
 Standardize as % per annum
 Sources of return
 Dividend
 Change in NAV
 Return Methods
 Change in NAV or Absolute Return Method
 Simple Total Return Method
 ROI or Return with Dividend Reinvestment Method
 CAGR Method.
Method 1: Change in NAV
Method
 Suitable for computing returns between two
dates
 Annualize using 12/n or 365/n

(NAV at the end of Period-NAV at the beginning

of Period)*100
NAV at the beginning of Period
Numerical
Q. NAV at start of period was Rs. 13.70. at the
end of 16 months the NAV was 18.50.
Calculate the change in NAV.

= (18.50 – 13.70) X 100

13.70
= 35.04%

Annualized return
= 35.04 X 12/16
= 26.28%.
Simple Total Return
 In this method, dividends distributed are
added to change in NAV to compute total
return

(Change in NAV + Dividend)*100

NAV at the beginning of period
Numerical
Q. NAV at start of period was Rs. 15.65. At the
end of the year it stood at Rs. 21.05. During
the year, investor received 10% dividend.
Calculate the return earned by the investor.

= ((21.05-15.65)+1.00) X 100
15.65
= 40.89%.
ROI Method
 The method assumes that dividends are reinvested, at
Ex-Div NAV

Value at end of period – Value at beginning of period X

100
Value at Beginning

Value of holdings at the beginning of the period =

number of units at the beginning x begin NAV
Value of holdings end of the period = (number of units
held at the beginning + number of units re-invested) x
end NAV
Number of units re-invested = dividends/ex dividend
NAV.
Numerical
Q. On Jan 01, 2007 an investor bought 1000 units at 12.25.
He redeemed the investment on 01st Jan 2008 when the
fund’s NAV stood at 19.50. During the year he received
dividend at the rate of 10%. The ex-Div NAV was Rs.
15.10.
Calculate his ROI.

= Value of holding at start – 1000 X 12.25 = 12,250

= No of units reinvested – 1000 / 15.10 = 66.2252
= Value of holding at end – 1066.2252 X 19.50 =
20,791.39
= ROI – (20,791.39 – 12,250) X 100
12,250
= 69.73%.
CAGR
 Compound Annual Growth Rate
 rate at which investment has grown from begin point
to the end point, on an annual compounding basis

A = P(1+r)n
V1 = V0(1+r)n
r = ((V1 / V0)1/n) -1

V1 = Amount at the end of Period

V0 = Principal
r = Rate of return
n = Number of periods.
Numerical
Q. An investor buys 1000 units of a fund at Rs.
24.15 on Jan 07, 2007. On June 30, 2007 he
receives dividends at the rate of 20%. The
ex-dividend NAV was Rs. 30.60. On Jan 01,
2008 the fund’s NAV was Rs. 32.25.
Compute the CAGR.
Solution
 The value of investment at beginning
= 24.15 x 1000 = Rs. 24,150
 Number of units reinvested
= 2000/30.60 = 65.36 units
 End period value of investment
= 1065.36 x 32.25 = Rs. 34,357.84
 Holding period
= 01/01/08 - 07/01/07 = 359 days
 The CAGR is
= (34,357.84/24,150)365/359 - 1 x 100
= 43.11%.
SEBI Regulation
 Standard measurements and computation
 CAGR for funds that are over 1 year old
 Return for 1,3 and 5 years, or since
inception, which ever is later
 No annualisation for periods less than a year.
Industry Practice
 Less then 1 year, simple return without
compounding or annualisation
 Growth Option: CAGR implicit in the change
in holding period NAVs
 Dividend Option: CAGR implicit in the change
in value over the holding period, assuming
re-investment of dividend at ex-dividend NAV
 Some funds use simple annualised return,
without compounding.
Evaluating fund performance
 Evaluation of a fund
 relative to the market as a whole
 relative to other mutual funds
 relative to other comparable investment options
 Rankings by external agencies
 Economic Times
 Lipper
 CRISIL CPRs, RRR, CQR
 CRISIL Volatility Rating
 CRISIL Fund Management Practice.
Benchmarks
 Relative returns are important than absolute
returns for mutual funds
 Comparable passive portfolio is used as
benchmark
 Usually a market index is used
 Compare both risk and return, over the same
period for the fund and the benchmark.
SEBI Guidelines
 Benchmark should reflect the asset allocation
 Same as stated in the offer document
 Growth fund with more than 60% in equity to
use a broad based index
 Bond fund with more than 60% in bonds to
use a bond market index
 Balanced funds to use tailor-made index
 Liquid funds to use money market
instruments.
Other Measures of
Performance
 Size and portfolio composition
 Credit quality
 Rating profile of portfolio
 Expense ratio
 Higher expense ratio hurts long term investors
 Tracking error
 For index funds this should be nil
 Portfolio turnover
 Higher for short term & lower for longer term
funds.
 Stop Check!
 An investor purchased an open-ended fund when NAV
was 20. 16 months later, the NAV stood at 22. the
percent change in NAV in the fund was:
 7%
 8%
 7.5%
 8.5%
 Returns can be annualized and compounded only if
the scheme has completed:
 30 days
 12 months
 6 months
 24 months
 An equity scheme is 90 days old. To compute its
yield, it can use
 Absolute return
 Simple annualized return
 Compounded annualized return
 Any of these
 Session 6
Financial Planning & Mutual Funds

10. Helping Investors with Financial Planning

11. Recommending Financial Planning Strategies to Investors
12. Selecting the right Investment Products for Investors
13. Helping Investors understand risks in Fund Investing
14. Recommending Model Portfolios and Selecting the right
fund
Financial Planning & Mutual
Funds
 Concept of financial planning
 Financial Planning Strategies
 Mapping life cycles & wealth cycles
 Alternate investment products
 Understanding Risk
 Asset allocation
 Model portfolios
 Fund selection.
Financial Planning

“It is an exercise aimed at

identifying all the financial
needs of an individual,
translating the needs into
monetarily measurable goals
at different times in the
future and planning the
financial investments that
will allow the individual to
provide for and satisfy his
future financial need and
achieve his life goals.”
Who is a financial planner?
 Is a person who uses the financial planning
process to help another person determine
how to meet his or her life goals
 Key functions of a FP is to help people
identify their financial planning needs,
priorities and the products that are most
suitable to meet their needs.
Benefits of Financial Planning
 To client
 Provides direction and meaning to financial decisions
 Helps understand how decision in one area effects
other areas
 Helps evaluate short and long term effects of
decisions on one’s life goals
 To Planner
 Ability to establish long term relationships
 Ability to build a profitable business.
Financial Planning Process

Establish & Define the Client Planner Relationship

Define the Client’s Goals
Gather and Analyze Data

Determine and Shape the Risk Tolerance level

Recommend the appropriate Asset Allocation

Ascertain the Client’s Tax Situation

Execute the Plan

Review Progress
Role of participants

Financial Fund Portfolio

Client
Planner Manager Investments

Discussion Choice of
Market Analysis
Of Goals Schemes
& Choice of
& Asset & Fund
Securities
Allocation Manager
 Important factors

Set Measurable Financial Goals

Understand the Effect of Each Decision

Re-evaluate Financial Situation Periodically

Start Planning ASAP

Set realistic expectations

Client is in-Charge of the process

Classification of Investors
 Life Cycle Stages
 Wealth Cycle Stages
Life Cycle Stages
 Childhood Stage
 Young Unmarried Stage
 Young Married Stage
 Young Married with Children Stage
 Married with Older Children Stage
 Post family/Pre-retirement Stage
 Retirement Stage.
Wealth Cycle Stages
 Sowing or Accumulation Stage
 Transition Stage
 Reaping or Distribution Stage
 Intergenerational Wealth Transfer Change
 Sudden Wealth Surge Stage
 Affluent investors
 Wealth preserving
 Wealth creating.
Other areas
 Constraints to Financial Planning
 Goal-Oriented Investing
 Planning for Affluent Investors
 Wealth Creating Individuals: These are aggressive
and tend to invest more in equity, maybe even
70% to 80%
 Wealth Preserving Individuals: Conservative and
thus tend to invest majority into income, gilt
and liquid funds.
Strategies for Investors
 Invest whenever there is money!
 Start Planning & Investing Early
 Have realistic Expectations
 Invest Regularly
 Buy and Hold
 may not be good strategy with stocks but is good in case
of a mutual fund for the investor willing to wait out a full
market cycle
 When to cash out needs more thought and skill
 in case of stock – sell out as the price rises beyond reason
or when fundamentals start to deteriorate
 in case of mutual funds – redeem when the goals have
arrived and money is needed or if the market appears
‘overvalued’ in terms of fundamentals and historic
valuations.
Useful Strategies
 Power of Compounding
 Rupee Cost Averaging (RCA)
 Value Averaging
 Jacob’s combined approach.
Power of Compounding
 Investing for the long term
 Higher the frequency, greater the growth
 six-monthly compounding of 100 rupees for 10
years would yield Rs. 321 instead of Rs. 311
with annual compounding
Power of Compounding

n
FV = PV (1 + r)
Save More

Earn More

Start Early
The legend of compounding
Amount Invested = Rs. 10,000
Year of investment = 1977
Growth rate = 49%
Value of holding at the end of 2007 = ???

Which company am I?
Rupee Cost Averaging
 Invest a predetermined amount regularly
 Purchase more units when the market is low;
less when the markets are high
 Reduces the average cost of purchase
 Implemented through SIP
 Disadvantage – it doesn’t tell you when to
buy, sell or switch.
RCA – An Example
Amount NAV Units Cumulative
Mont Value of
Inves per bough Number of
h holding
ted Unit t
500.0 Units
1 5000 10 0
333.3 500.00 5,000
2 5000 15 3
250.0 833.33 12,500
3 5000 20 0
416.6 1,083.33 21,667
4 5000 12 7
625.0 1,500.00 18,000
5 5000 8 0
1,000. 2,125.00 17,000
6 5000 5 00 3,125.00 15,625
           
Average
Average
11.6 Cost/ 9.60
NAV
  7 Unit  
Value Averaging
 Invest regularly to achieve a predetermined
value
 Book profits at highs, and add units at the
lows
 Implemented through SWP
 Reduces the average cost of purchase
 Superior to RCA – allows you to redeem at
the right opportunity.
 VA – An Example
NAV Units Value of Current
Target per bough Cumulative holdin portfoli
Month Value Unit
10.0 t Units g o value
1 5,000
10,00 0
15.0 500.00 500.00 5,000 5,000
2 0
15,00 0
20.0 166.67 666.67 7,500 10,000
3 0
20,00 0
12.0 83.33 750.00 13,333 15,000
4 0 0 916.67 1,666.67 9,000 20,000
25,00
5 0 8.00 1,458.33 3,125.00 13,333 25,000
30,00
6 0 5.00 2,875.00 6,000.00 15,625 30,000
             
Average
Average
11.6 Cost/ 5.00
NAV
  7 Unit    
 VA – another example
Mont Target Value of Units to Cum no of
NAV (Rs)
h Value Holding invest units
1 1,000 10.00 100.00 100.00 100.00
2 2,000 12.50 1,250.00 60.00 160.00
3 3,000 14.25 2,280.00 50.53 210.53
4 4,000 11.75 2,473.68 129.90 340.43
5 5,000 10.50 3,574.47 135.76 476.19
6 6,000 9.00 4,285.71 190.48 666.67
7 7,000 8.50 5,666.67 156.86 823.53
8 8,000 7.65 6,300.00 222.22 1,045.75
9 9,000 8.80 9,202.61 (23.02) 1,022.73
10 10,000 9.25 9,460.23 58.35 1,081.08
11 11,000 12.00 12,972.97 (164.41) 916.67
12 12,000 15.00 13,750.00 (116.67) 800.00
Jacob’s Approach
 Combine RCA and VA
 Usean aggressive growth fund and a
money market fund of the same family.
Asset Allocation
 Besides how much and for how long to
invest, the important question is where to
invest
 Equity, debt and money market products are
called asset classes
 Asset allocation means determining the
percentage of investments to be held in
equities, bonds and money market/cash
instruments
 Over 94% of returns on a managed portfolio
come from the right level of asset allocation
between stocks and bonds/cash
 The approach must incorporate product,
investor profile and preferences in the
portfolio.
 Types of Asset Allocation
Fixed Asset Allocation
Portfolio is periodically re-balanced
Disciplined approach
Profit booking in rising & more investment in a falling market
Better if stocks continue to return more than bonds

Flexible Asset Allocation

No re-balancing - proportions can vary when prices change

If equity returns are higher than debt, equity allocation will
go up faster
Better if bond returns are close to equity

Tactical Asset Allocation

making changes in asset allocation within the overall

percentage holding for extra return.
Asset Allocation Approaches
 Benjamin Graham’s 50/50 balance
a 50/50 split between debt and equity
 Graham’s 50:50 is the basic asset
allocation.
Graham’s Portfolios
Portfolio Type Portfolio Mix
Basic managed 50% diversified equity ‘value’ fund
Portfolio 25% Govt Securities fund
25% High grade corporate bond
Basic Indexed Portfolio fund
50% total stock market/index fund
50% total bond market portfolio
Simple Managed 85% Balanced 60/40 fund
Portfolio 15% Medium term bond fund
Complex Managed 20% diversified equity fund
Portfolio 20% aggressive growth fund
10% specialty fund
Readymade Portfolio 100% Single Index fund with
60/40 equity/bond holding
Jacob’s Investment Strategies

5% Liquid Funds

Income and Gilt Funds

15-30%

Diversified Equity

65-80%

Accumulation Phase
Jacob’s Investment Strategies

5% Liquid Funds

15-30% Diversified Equity

65-80% Income and Gilt Funds

Distribution Phase
Asset Allocation Approaches
 Bogle’s Approach
 Boglesuggested variation to
percentages based on age, financial
circumstances and objectives
 Bogle’s thumb rule
 debt
portion of an investor’s portfolio
equal to investor’s age.
Bogle’s Asset Allocation
Strategy
Accumulatio Distributio
n Stage n Stage

Younger 80% Equity 60%

Investor 20% Debt Equity
40% Debt
Older 70% Equity 50%
Investor 30% Debt Equity
50% Debt
 Stop Check!
 The strategy to maximize investment return
in the long run is:
 Buy and hold investments for a long time
 Liquidate poor performers from time to time
 Liquidate good performers from time to time
 Switch from poor performers to good performers
 SIP is best example of
 Rupee Cost Averaging
 Value Averaging
 Buy & Hold
 None of these.
Alternate Investment
Products
Alternate Investment Products
 Physical/Real Assets vs. Financial Assets
 Physical Assets – Gold & Real Estate
 High initial investment, liquidity concerns
 Financial Assets
 By class: equity, debt, money market
 By issuer: Govt, FIs, Corporate, Banks
 Guaranteed vs. Non-guaranteed
 Government - G-Secs, PPF, KVPs, NSCs, RBI Relief Bonds
 PSUs/FIs – Bonds
 Banks - FDs
 Corporate - Shares, Debentures, Bonds, FDs
 Insurer - Policies (With Profit or without profit, ULIPs)
 Mutual Fund – a combination asset.
 Investment Products
Issuer Product Available to

Bank Fixed Deposits Investor, MFs

Shares Investor, MFs
Corporate Bonds, Debentures Investor, MFs
Fixed Deposits Investor, MFs
Govt. Securities Investor, MFs
PPF Investor
Government
Other personal Investor
investments
FIs Bonds Investor, MFs
Insurers Insurance policies Investor
Quick Wit
 Tenor of RBI Bonds?
 Min/Max investment in PPF?
 Who assigns credit rating to Corporate
securities?
 Borrowers with lower rating need to give
higher/lower interest?
 Tax benefit in NSC?
 Liquidity in Mutual Funds higher/lower than
equity?
 Tax aspects of life Insurance proceeds?
Comparison of financial
products Convenienc Return Safety Volatility Liquidity
e
Equity Moderate High Low High High-Low
FI Bonds High Moderate High Moderate Moderate
Corp Debentures Low Moderate Moderate Moderate Low
Company FDs Moderate Moderate Low Low Low
Bank Deposits High Low High Low High
PPF High Moderate High Low Low-Moderate
LI (Traditional) High Low High Low Low
Moderate -
LI (ULIPs) High High High Low-Moderate
High
Gold Low Moderate High Moderate Moderate
Real Estate Low High Moderate High Low
Mutual Funds High High High Moderate-High High
 Mutual Fund vs. Direct Equity
Feature Direct Equity Mutual
Fund
Stock selection ability Low High
Focussed activity Low High
Diversification Low High
Professional management Low High
Liquidity Low High
Transaction cost High Low
Convenience Low High
Switches
Cheque writing facilities
Investing time, knowledge & High Low
resources
Mutual Fund vs. Bank Deposit
 Deposits
 Contractual agreement
 Guaranteed for repayment
 No direct holding of a
portfolio of investment
 Mutual Fund
 No contractual agreement
 No guarantee
 Direct holding of a
portfolio
 Return commensurate
with risk.
 Investor Perspective
Investment Objective Risk Tolerance Investment Horizon

Equity Capital Appreciation High Long Term

FI Bonds Income Low Medium-Long Term

Corp Debentures Income High-Moderate-Low Medium-Long Term

Company FDs Income High-Moderate-Low Medium

Short-Medium-Long
Bank Deposits Income Low
Term
PPF Income Low Long Term
Life Insurance
Risk Cover Low Long Term
(Traditional)
Risk Cover, Capital Growth,
Life Insurance (ULIPs) High-Moderate-Low Medium-Long Term
Income
Gold Inflation hedge Low Medium-Long Term

Real Estate Capital Growth, Income Low-Moderate Long Term

Short-Medium-Long
Mutual Funds Capital Growth, Income High-Moderate-Low
Term
Why MF is the best option
 Combine the advantages of all investment
products
 flexibility, convenience, affordability, liquidity,
potential for high returns
 Dispense the short comings of the other
options
 liquidity, low return expectation, risk diversification
 Returns are adjusted for market movements
 Commensurate with level of risk.
 Stop Check!
 An investor in regular need of income should not select:
 A bank deposit
 A debt fund
 An equity growth fund
 PPF
 Which of the following has highest level of liquidity
 Equity
 PPF
 Company Fixed deposits
 Mutual funds
 Which of the following should not be viewed primarily as an
investment option?
 Mutual funds
 Equity shares
 Life insurance
 None of the above.
Risk in Mutual Fund
Investing
Risk in MF investing
 What is Risk?
 Volatility of earnings viz. deviation (+ & - ) from
expected earnings
 Possibility of Financial loss
 Risk can be built into the investment
planning by
 Defining the risk appetite of the investor and aligning
investment objectives to risk tolerance
 Evaluating and measuring risks of portfolio to keep in
line with the investor’s risk appetite
 The right level of risk tolerance of any
investor depends upon age, investable funds,
circumstances including income level, job
security, family size etc.
Jacob’s recommendation based
on risk level
Jacob’s Recommendation of portfolio sub-
allocation
Low-Risk (Conservative)
50% G Secs + 50% MMMF
portfolio
40% in Growth & Income
Moderate Risk (Cautiously + 30% Govt Bonds + 20%
Aggressive) portfolio Growth Funds + 10%
Index Funds
25% Aggressive Growth
Funds + 25%
High Risk (Aggressive) International Funds +
Portfolio 25% Sector Funds + 15%
High Yield Bond Funds +
10% Gold Funds
Type of risk in Equity Funds
 Company Specific
 Sector Specific
 Market Risk
 Company and Sector risk can be reduced with
diversification but market risk cannot be diversified
 Market Cycles
 Portfolio performance over a market cycle
 Equity more rewarding in the long-term.
Measures of Risk
 Risk
 Standard
Deviation
 Beta
 Ex-marks
 Alpha

 Risk-adjusted
return
 Sharpe Ratio
 Treynor Ratio.
Standard Deviation
 Best measure of risk
 Measure of absolute or total risk of a
portfolio
 Dispersion around mean
 ‘Quality rating’ of the average
 Higher S.D. indicates more volatile returns
 Lower deviation means less risk
 High S.D. need not mean poor performance
 Sachin Tendulkar vs. Harbhajan Singh.

VOLATILITY!
Beta
 Shows how sensitive a fund is to market moves
 If the Sensex moves by 25%, a fund’s bet number will tell
you whether the fund’s return will be more or less than this
 Beta value for an Index is taken as 1
 Multiplying the beta value of a fund will expected
percentage movement of an index gives the
expected movement in the fund
 Higher beta means higher impact of market
returns
 Lower beta means less risk
 Higher beta funds do well in a rising market, lower beta
funds do better in a falling market.

SENSITIVITY!
Ex-Marks or R-Squared
 Quality of Beta depends on Ex-marks
 Beta depends upon the index used to calculate it
 Beta calculated for large cap fund against a mid-cap index
has no meaning
 Higher ex-marks means more reliable beta
 Measures return from a fund and the market
index and measures the extent of correlation in
their movement
 Lower ex-marks mean lower correlation with
market returns
 R-squared varies between 0 and 1
 R-squared of an index fund would be 1 (or Ex-
marks 100%).

SYMPATHY!
Ex-marks comparison
Same beta in both cases
Alpha
 Measure of a fund manager's performance
 Tells what the fund has earned over and above (or
under) what it was expected to earn
 This is the value added (or subtracted) by the fund
manager's investment decisions
 Alpha tells you whether that fund has produced returns
justifying the risks it is taking by comparing its actual
return to the one 'predicted' by the beta
 Say, a fund can be expected to earn—based on its beta—a
return of 15 per cent in a given year. However, it actually
fetches you 18 per cent. Then the alpha of the fund is
simply 18 - 15 = 3
 Index funds always have—or should have, if they track
their index perfectly—an alpha of zero.
Sharpe & Treynor Ratio
 Stop Check!
 Ex-marks (R-Squared) of a fund measures
 How much of a fund’s movement is due to the market
index movement
 How a fund's movement relates to the market index
movement
 How much of a fluctuation has occurred in the fund’s NAV
over a historical period
 How many marks a credit rating agency accords to a fund
 Which is a better investment option?
 Ex-marks 75% beta 0.9, gross dividend yield 8%
 Ex-marks 80% beta 0.9, gross dividend yield 8%
 Ex-marks 90% beta 0.9, gross dividend yield 9%
 Either 1 or 3 above.
Recommending model
portfolios & Selecting
the right fund
Jacobs’ Four-Step Program
 Develop long term goals
 Investment avenues, time horizon, return and
risk
 Determine asset allocation
 Allocation to broad asset classes
 Determine sector distribution
 Allocation of sectors of the mutual fund
industry
 Select specific fund managers and their schemes
 Compare products & choose actual funds to
invest in.
Jacob’s Model Portfolios
Investor Recommended Model Portfolio
50% in Aggressive Equity Funds
Young, Unmarried 25% in High Yield Bond Funds and Growth and
Professional Income Funds
25% in Conservative Money Market Funds
10% in Money Market
Young Couple with
30% in Aggressive Equity Funds
two Incomes and
25% in High Yield Bond Funds
two Children
35% in Municipal Bond Funds
30% in Short-term municipal Funds
Older Couple Single 35% in long-term Municipal Funds
Income 25% in moderately aggressive equity
10% in emerging growth equity
35% in conservative Equity funds
Recently retired
25% in moderately Aggressive Equity
couple
40% in Money Market Funds
Fund Selection – Bogle’s
Approach
Equity
 Category – Diversified, Sectoral, Index etc
 Strategy – Growth and Value
 Past Returns – Compare with benchmark and with
funds in same category over same time frames
 Fund Size, Age, Costs, Manager’s experience – Bigger
Size, Longer Age, Lower Costs and Higher Fund
Manager’s experience are better
 Characteristics – Lower Cash Position, Low
Concentration, Lower portfolio turnover are
generally better; Higher Cap assumes less risk
 Risk Statistics – Low Beta, High Ex-Marks, High Div
yield are generally better.
Fund Selection – Bogle’s
Approach
Debt
 Type – Income/Gilt/Liquid etc
 Fund Age & Size – higher the age and larger
the size, the better
 Costs – lower the better
 Loads – lower the better
 Average Maturity – higher average maturity
means higher interest rate risk
 Credit Quality – More AAA rated securities,
more secure the fund.
Fund Selection – Bogle’s
Approach
Balanced
 Portfolio Balance –match investor’s objective
 Debt Portfolio Quality – higher the better
 Costs – lower the better
 Portfolio Statistics – similar to equity funds.
Fund Selection – Bogle’s
Approach
MMMF
 Costs – lower the expense ratio the better
 Yields – higher the better
 Quality – higher is essential
 Liquidity and turnover rate
 Shorter term instruments are turned over more
frequently
 Principal protection
 Limited NAV fluctuation due to low duration
and low levels of interest rate risk.
 Stop Check!
 Which of the following portfolios is more
risky?
 75% equity – 25% debt
 40% equity – 60% debt
 60% equity – 40% debt
 80% equity – 20% debt
 What would you suggest a client who has
won a lottery of Rs. 1 crore?
 Invest the entire money in “old economy stocks” as they
are back in favour
 Invest in an equity index fund – since the index is at a
historic low
 Invest in a safe liquid investment option and take the time
needed to work out a financial plan
 Invest in IT stocks, since their valuation is quite attractive.
 Stop Check!
 What asset mix would you suggest to a 55
year old who plans to retire at 58?
 40% equity schemes and 60% balanced scheme
 40% equity schemes and 60% debt scheme
 20% equity, 20% liquid funds and 60% debt scheme
 100% monthly income scheme
 What portfolio would you recommend to a
recently retired couple?
 35% conservative equity, 25% moderately aggressive
equity, 40% money market funds
 30% short-term municipal funds, 35% long-term municipal
funds, 25% moderately aggressive, 10% emerging equity
 50% aggressive equity, 25% high yield bond funds and
growth and income funds, 25% conservative MMMF
 Either 2 or 3.
 Stop Check!
 For which of the following funds would you
consider “average maturity” as an important
factor in selecting the right fund?
 A debt fund
 A balanced fund
 A money market or liquid fund
 Both 1 and 2 above.
 Session 7
Business Ethics

15. Business Ethics and Mutual Funds

Meaning of business ethics
 Refers to rules of acceptable and good
conduct in business
 All persons engaged in business should
comply with rules of good conduct and have
strong ethics
 These rules may be set by those who own
and manage the business, or by those
agencies that have the right to regulate the
business
 Business ethics are hard to enforce, hence
desirable that they be self imposed
 In many countries, laws such as Consumer or
Investor Protection Act exist.
Need for business ethics
 Have honest and fair business practices
 Protect the interests of the customer or
investor
 Good ethics also mean good business
 Retention of customer and generates loyalty
 Transparency in operations and to ensure
that both potential and existing customers
are treated at par.
Objectives of Business Ethics
 Honest and transparent dealings with
customers
 Protect clients and customer from being
exploited or cheated
 Level playing field among all participants
 Healthy competition for the benefit of all
customers.
 Need for business Ethics in
Mutual Funds
 Mutual funds are vehicles of collective
investment managed by asset managed
companies for a fee
 AMC takes help of many entities including
distributors and individual financial advisors
 All entities need to abide by the rules of good
conduct
 Trustees, Directors of AMC set the rules for
distribution and employees
 AMFI has also set rules of good conduct for
AMCs, its employees and distributors.
SEBI Objectives
 Funds always conduct all activities in
the best interest of investors
 Areas monitored by SEBI
 Fund Structure & Governance
 Exercise of Voting Rights by Funds
 Fund Operations.
Implementing Business Ethics
 Fund structure
 Fiduciary responsibility for MFs
 A fund holds the investors money in trust
 The money continues to belong to investors
 Fund managers only manage it
 Structure designed to protect the investor
through a system of checks and balances on
the observance of ethical standards by all the
industry constituents
 Ethical and honest behavior on the part of the
fund trustees and managers is essential.
Implementing Business Ethics
 Fund Governance
 Regulator prime concern is investor
protection
 Protect the investor through a system
of independent controls or check and
balances
 Separation of functions
 Independence of organizations
 Independence of personnel.
Implementing Business Ethics
 Fund Operations
 InsiderTrading
 Preferential Treatment to Select
Investors
 Personal trading by Fund Manager &
employees
 Compliance Officer
 Code of Conduct for Distributors
 AGNI.
 Stop Check!
 Which of the following is an example of unethical
behaviour?
 Fund distributor buying shares that he knows are part of
the fund portfolio recommended to investors
 Fund employee buying shares that he knows the fund has
decided to buy
 Fund trustee owning a share portfolio of his own
 Fund manager buying shares in his own name

 The code of conduct may be put in place by:

 AMFI
 Board of Trustees
 Directors of AMC
 All of the above.
 Stop Check!
 Insider trading means:
 personal trading transactions done by anyone associated
with a Mutual Fund
 personal transaction done by anyone with knowledge of
the fund decision in the security
 personal trading transaction without prior approval of the
AMC
 personal trading transaction done by an insider of an
AMC/Fund
 AMFI Code of Conduct for Intermediaries:
 Prohibits fund distributors from accepting commissions
from an investor who renews his investment in a scheme
 Prohibits them from rebating the commission back to such
investors
 Encourages them to refrain from rebating the
commissions to such investors, but does not prohibit them
 Prohibits them from rebating commission back to all
investors.
Q&A
Practice Test
Quest for more
 AMFI Workbook
 www.amfiindia.com
 www.sebi.gov.in.
Important Next Steps
 Study the ICICI Pru AMC provided ‘AMFI
Revision Kit’
 Take practice tests (Series A-E)
 Take a mock test at ICICI Prudential
AMC office in your city (contact the I-Pru
branch office for details) before the
exam.
 Thank you for taking the
journey with us;
Good Luck!
The presentation has been prepared by I-PRU
AMC & PIVOT TRAINING PVT. LTD.