The contents in this can add to your learning for exam .

It is not supplement for workbook but a good guide

-Series-V- A: Mutual Fund Distributors Certification Examination

NISM

PPT FORMAT LEARNING

Agenda
By the end of the PPT, 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.

AMFI Syllabus
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

Concept & Role of Mutual Funds Fund Structure and Constituents Legal & Regulatory Framework The Offer Document Fund Distribution and Sales Practices Accounting, Valuation and Taxation Investor Services Investment Management Measuring & Evaluating Mutual Fund Performance Helping Investors with Financial Planning Recommending Financial Planning Strategies to Investors Selecting the right Investment Products for Investors Helping Investors understand risks in Fund Investing Recommending Model Portfolios and Selecting the right fund Business Ethics and Mutual Funds.

Agenda & Bolts Section 1: Nuts

Concept & Role of Mutual Funds Fund Structure and Constituents Legal & Regulatory Framework

Section 5: Return Concepts

Measuring & Evaluating Mutual Fund Performance

Section 2: Process of Investing

Offer Document Fund Distribution & Sales Practices Investor Services

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 3: Mutual Funds & Securities Markets

Investment Management

Section 4: Accounting Aspects

Accounting, Valuation and Taxation

Section 7: Business Ethics

Business Ethics & Mutual Funds

Section 1 Nuts and Bolts

1.

Concept & Role of Mutual Funds

2.
3.

Fund Structure and Constituents

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 funds assets when he buys into the fund The investor is allotted units for the amount subscribed.

What it means
Investors
Contribute money Receive dividend/capital appreciation

Trust (pool of money)

Invest in markets Receive interest, dividend or 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.

10

Advantages

11

Disadvantages
No Control Over Costs No Tailor Made Portfolios

Managing a large number

of funds/types.

12

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.

13

Types of Funds
Existing funds Open-ended (OEF) & Closeended (CEF) Growth, Income and Hybrid Equity, Debt and Balance Load & No-Load Guaranteed & NonGuaranteed Tax-exempt & Non taxexempt New Gen Mutual Funds Fund of Fund Commodity fund Real Estate fund Asset Allocation fund Exchange-traded fund Derivative fund Capital Protection Oriented Fund.

14

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).

15

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.

16

Equity Funds: A fund that invests primarily in equity (ownership) instruments. Equity Funds can be further classified as: Diversified Equity Fund: investing in a mix of equity from different sectors Index Funds: Portfolio replicates a selected Index Sectoral Fund: invests in equity instruments of one sector for eg. Technology Fund, Pharma Fund, Banking Fund etc. Aggressive Growth Fund: target maximum capital appreciation, invest in less researched or speculative shares Growth Fund: This fund invests in equities of Growth companies only i.e. the companies which have the potential to grow at higher rate in future Large Cap/Mid Cap/Small Cap Fund: These Funds invests in equities of Large/Mid/ Small Cap companies respectively. Specialty (or Thematic) Funds: have a narrow portfolio orientation and invest in companies that meet pre-defined criteria. Eg. Infrastructure Fund or ASEAN Fund Equity Linked Saving Scheme (ELSS) an Indian Variant: Investment in these schemes entitle the investor an income tax deduction u/s 80C (max Rs. 1 lakh in year 2007-08). These are open-ended funds but investment in these schemes (including the reinvested dividends) gets locked-in for a period of 3 years. Value Funds: try to seek out fundamentally sound companies whose shares are currently under-priced in the market. These fund add those shares to their portfolio that are selling at low price-earnings ratios, low market to book value ratios and are believed to be undervalued compared to their true potential. Equity Income or Dividend Yield Funds: invest in stocks which have a high Div Yield i.e., Div to Market Price ratio

17

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.

18

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

Primary objective: hybrid (regular income as well as capital appreciation).

19

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.

20

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.

21

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.

22

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.

23

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.

24

Exchange Traded Funds (ETFs) were first launched in India in December 2001 by Benchmark AMC. Now, a total of five ETFs are available to investors. ETFs are fundamentally different from normal funds and have thus developed something of a reputation for complexity. While some of the details of how AMCs run ETFs are genuinely more complex, that has nothing to do with investors. For the investors, ETFs are a straightforward instrument that offers some interesting features. Let's see what makes ETFs different. ETF are index funds. An index fund is an equity fund, which tracks a particular market index like the BSE Sensex or the Nifty. The index fund holds the same stocks as the underlying index and in the same proportion as the index. From an investment point of view, ETFs are simply index funds thatunlike normal index fundscan be bought and sold at intra-day prices throughout a trading day. In this respect they are more like shares rather than like mutual funds. Normal index funds are, of course, available only at end-of-day NAVs from fund distributors like any other fund. ETFs, since they need to be transacted upon throughout the day, are bought and sold through stockbrokers (using a demat account) just like shares. However, behind the scenes, ETFs are very different from any other kind of fund. Where an ETF really differs from an index fund is the manner in which it is created, bought and sold. In the case of normal mutual funds investors pays cash to the fund, which in turn buys the stocks and bonds which constitute the fund. When ETFs are first set up the initial participants will give the fund the basket of stocks, which constitute the underlying index and take units of the fund in exchange. These market makers will in turn sell these units to investors just like a distributor does. The market maker is usually a broker. Since ETFs are sold through brokers, you will pay brokerage in place of loads. ETFs tend to have lower brokerage than normal funds have loads. The NAV of an ETF is a fraction of the value of the index. Thus the NAV of an exchange-traded fund based on the Nifty can be one-tenth of the value of the Nifty. If the Nifty is at 1500 points the NAV will be Rs 150. Effectively, this fractional pricing means that a basket of stocks like the Nifty can be purchased by an investor with a much lower outlay than it would otherwise be possible. Compare this with trying to replicate the index by purchasing individual shares, where just one share of Infosys costs around Rs 4500. This also enables smaller initial investments than what most index funds offer, which is specially useful if you are just trying out index investing. By comparison, most nifty index funds require a minimum investment of Rs 5000. In the case of other mutual fund schemes the fund buys back and sells units. In a way, an ETF resembles a close-end scheme, where the units are not sold back to the fund and investors buy and sell the fund units on the market. However, there is obviously no discount to NAV like closed end funds. Also, unlike a close-end fund supply can be altered by creating additional units or extinguished by withdrawing existing ones. Trading of the units ensures that underlying stocks do not have to brought or sold. Investors entering and exiting do not also affect existing investors. As a result an ETF has a much lower tracking error than an index fund. Currently the equity ETFs available track the BSE Sensex, the S&P CNX Nifty and the S&P CNX Nifty Junior. The ETF on the Nifty Junior is in fact the only option for passive investing in mid-cap shares. On the debt side a liquid ETF is available.

25

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.

26

Derivative fund
Hedging
Futures Options

Arbitraging
Stock Arbitrage Index Arbitrage.

27

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.

28

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.

29

Risk-Return Hierarchy
Return
Index funds
Debt Funds Gilt funds ST debt funds Balanced funds Sectoral funds Equity funds

Liquid funds

Risk

30

Mutual Fund Structure & Constituents

31

MF Structure in India

A mutual fund has a 3-tier structure

Sponsor

Trustee
AMC

Trust

33

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.

34

MF Constituents in India
SEBI

Sponsor Trustee AMC Custodian & Depository Banker R&T Agent Distributor Trust

Securities Dealer / Broker

35

Investor

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.

36

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.

37

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.

38

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.

39

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.

40

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.
41

MF Constituents
SEBI

Sponsor Trustee AMC Custodian & Depository Banker R&T Agent Distributor Trust

Securities Dealer / Broker

42

Investor

Securities Markets

Other Constituents
Custodian & Depository Banker Securities Dealer / Broker

Investment back-office
Providing bank accounts & remittance services Purchase and sale of securities Not more than 5% through a related broker Research report to AMC Investor records and transactions Selling & Distributing schemes

R&T Agent Distributor

43

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.

44

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.

45

Mergers & Takeovers

Scheme takeover (HDFCZurich, 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.

46

Mergers & Takeovers

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

47

Regulatory framework
MoF SAT
Supervisor of both SEBI & RBI Created in 2003 Provide apex appeal mechanism for actions taken by SEBI Registration of AMC and Trustee Company RoC for Compliance RoC is supervised by DCA DCA is a part of CLB which is under Ministry of Law and Justice CLB is the interface for prosecution and penalties.

Companies Act
48

Regulatory framework
Office of Public Trustee
Registration of Trust Board of Trustees is accountable to the OPT Complaints against individual trustees
Derive powers from regulator Ability to make bye-laws Regulate own members in a limited way Example : Stock exchanges NSE, BSE etc.

SRO

Industry Association
49

Collective industry opinion Guidelines & recommendations 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.

50

Session 2 The Process of Investing

4. The Offer Document

5. Fund Distribution and Sales Practices

7. Investor Services

51

The process of investing

Offer Document

KIM
Application and form of holding Distribution channels

Investors rights & obligations.

52

Offer Document
Most important document for a prospective investor
Legal offer from AMC to investor
Contains vital information about fund and schemes SEBI approved format.

53

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 Investors Rights and Services Mandatory Disclaimer clause Standard and Scheme-specific Risk Factors.

54

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.

55

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.

56

Unit holder rights

Rights of unit holders

Right of proportionate beneficial ownership of schemes 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.

57

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.

58

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.

59

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.

60

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.

61

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.

62

KIM
Abridged OD

KIM is mandatory with every application form.

63

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.

64

Investor Rights & Obligations

Investors Rights Investors Obligations
Study the OD Provide PAN Monitor investment

Complaints Redressal Bodies

SEBI RoC/DCA/CLB.

65

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 clients 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.

66

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).

67

Investor Services
Telephone/Internet transactions

Cheque Writing
Periodic statement and tax information Loan against units

68

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.

69

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 Trustees of the mutual fund The Directors of the AMC the Registrar & Transfer Agents 1 and 2 above 2 and 3 above One year from date of issue Two years from date of issue Six months from date of issue None of these

The abridged offer document contains the address of

the following:

Offer document has to be updated within

70

Session 3 Accounting, Valuation & Taxation

6. Accounting, Valuation and Taxation

71

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.

72

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.

73

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.

74

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.

75

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.

76

Fees & Expenses

Initial Issues Expenses Recurring Expenses Investment Management Fee Entry & Exit Load.

77

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.

78

Recurring Expenses

Investment management fees Custodians fees Trustee Fees Registrar and transfer agent fees Marketing and distribution expenses Audit fees Legal expenses Costs of mandatory advertisements communications to investors.

and

79

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.

80

Recurring Expenses
Overall ceiling on expenses, including Investment

management and advisory fees Based on Weekly Average Net Assets (WANA) Equity Funds
First 100 Crores 100 - 400 Crores 400 700 Crores Above 700 Crores 2.50% 2.25% 2.00% 1.75%

For Bond funds, above figures are lower by 0.25% Limit for FOFs is 0.75% of the Weekly Average Net

Assets.

81

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?

82

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

83

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?

84

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.
85

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.

86

Pricing of Units
Sale and repurchase price are NAV-based

SALE PRICE = NAV + Entry Load REPURCHASE PRICE = NAV Exit Load

87

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.

88

Treatment of NPAs
Accrual to be stopped

Income accrued until date of classification to be

provided for
Provisioning for principal due
In graded manner after 3 months of classification.
Complete write off in 15 months from classification.

89

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 of interest.

90

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.

91

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.

92

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.

93

equity)

Dividend
Investor NIL

Capital Gain
Short-Term
(not exceeding 12 months) 10% + SC +EC

Long-Term DDT NIL

(exceeding 12 months)
NIL

94

Other than Equity Funds

Dividend
Investor
NIL DDT As per grid below
Liquid Individual/ HUF Others
95

Capital Gain
Short-Term (not exceeding 12 months) Marginal Tax Rate

Other than Liquid 12.5% + SC + EC

Long-Term (exceeding 12 months) Indexed Tax Rate

25% + SC + EC 20.0% + SC + EC

MF Taxation Summary
Equity Short Term Capital Gains Long Term Capital Gains Dividend Income in the hands of investor Dividend Distribution Tax Tax Deducted at Source 10% Debt As per Income Tax Slab

No capital gains tax payable. However, securities transaction tax payable at 0.25 percent of the redemption price.
Nil

20% with Cost Inflation Index benefit or 10% without Cost Inflation Index benefit, whichever is lower
Nil Individuals & HUFs 14.16% Others - 22.66% Nil

Nil

Nil Payable at the time of redemption @ 0.25% irrespective of whether a gain has been made or not

Securities Transaction Tax

Not Applicable

96

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.

97

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?

98

Stop Check!
An open-ended fund with 10,000 units outstanding has the

following items on the balance sheet:

Investment at market value Other assets Other Liabilities Rs, 1,00,000 Rs. 20,000 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.

99

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.

100

Session 4 Mutual Funds & Securities Markets

8. Investment Management

101

Mutual Funds & Securities Markets

Equity

Market and products Asset classes Investment styles Value indicators

Debt

Market and products Terminology Investment styles

Investment restrictions.

102

Equity investing
Equity implies ownership

Equity instruments
Ordinary shares Preference shares Convertible debentures Equity Warrants.

103

Equity investing
Classification of Equity Large Cap/ Mid Cap/ Small Cap Growth/ Value/ Cyclical Equity terminology Earnings per Share Market Capitalization Ratios P/E Ratio Dividend Yield.

104

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.

105

Approaches to portfolio management

Active management
Aim for Out-performance Higher fees Selection and timing

Passive Management
Replicate a chosen Index Low fees.

106

Growth vs. Value

a. MPS? b. P/E? c. DY?

107

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).

108

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.

109

Debt Terminology
Par or Principal or Face Value

Coupon or Interest
Maturity or tenor Callable Puttable Yield.

110

Measures of Bond Yield

Current Yield

Yield to Maturity
Yield Curve (TSIR).

111

Price & Yield

Increase

in rates reduces value of existing bonds value of existing bonds

Decrease in rates increases

Price and yield are inversely

related
The

relationship between yield and tenor can be plotted as the yield curve.

112

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%.

113

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%.

114

Risk in Bond Investing

Types of Risk
Interest Rate Risk

Reinvestment Risk
Default/Credit Risk Inflation Risk Liquidity Risk Call Risk

Risk Measures
Yield Spreads & Credit Ratings

Duration.

115

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.

116

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.

117

Investment Policy
Investment policy of each scheme dictated by the

schemes 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.

118

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.

119

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.

120

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.

121

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.

122

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.

123

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.

124

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

The financial working of a company Stock price movement of a company Both the above None of the above.

Technical analysis tries to predict future movement of

stock price by analyzing:

125

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 schemes 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.

126

SessionPerformance 5 9. Measuring & Evaluating Mutual Fund Return Concepts

127

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.

128

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

129

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%.

130

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

131

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%.

132

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.

133

Numerical
Q. On Jan 01, 2007 an investor bought 1000 units at 12.25. He redeemed the investment on 01st Jan 2008 when the funds 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%.

134

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.

135

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 exdividend NAV was Rs. 30.60. On Jan 01, 2008 the funds NAV was Rs. 32.25. Compute the CAGR.

136

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%.

137

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.

138

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 reinvestment of dividend at ex-dividend NAV Some funds use simple annualised return, without compounding.

139

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.

140

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.

141

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.

142

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.

143

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% 30 days 12 months 6 months 24 months Absolute return Simple annualized return Compounded annualized return Any of these

Returns can be annualized and compounded only if the scheme

has completed:

An equity scheme is 90 days old. To compute its yield, it can use

144

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

145

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.

146

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.

147

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.

148

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 ones life goals

To Planner
Ability to establish long term relationships Ability to build a profitable business.

149

Financial Planning Process

Establish & Define the Client Planner Relationship Define the Clients Goals Gather and Analyze Data Determine and Shape the Risk Tolerance level Recommend the appropriate Asset Allocation Ascertain the Clients Tax Situation Execute the Plan Review Progress

150

Role of participants
Client Financial Planner Fund Manager Portfolio Investments

Discussion Of Goals & Asset Allocation

Choice of Schemes & Fund Manager

Market Analysis & Choice of Securities

151

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

152

Classification of Investors
Life Cycle Stages

Wealth Cycle Stages

153

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.

154

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.

155

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.

156

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.

157

Useful Strategies
Power of Compounding

Rupee Cost Averaging (RCA)

Value Averaging Jacobs combined approach.

158

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

159

Power of Compounding

n FV = PV (1 + r)
Save More Earn More Start Early

160

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?

161

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 doesnt tell you when to buy,

sell or switch.

162

RCA An Example
Month Amount Invest ed NAV per Unit Units bought Cumulative Number of Units Value of holding

1
2 3 4

5000
5000 5000 5000

10
15 20 12

500.00
333.33 250.00 416.67

500.00
833.33 1,083.33 1,500.00

5,000
12,500 21,667 18,000

5
6

5000
5000

8
5

625.00
1,000.00 Average Cost/ Unit

2,125.00
3,125.00

17,000
15,625

Average NAV

11.67

9.60

163

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.

164

VA An Example
Month 1 2 3 4 5 6 Target Value 5,000 10,000 15,000 20,000 25,000 30,000 NAV per Unit 10.00 15.00 20.00 12.00 8.00 5.00 Units bought 500.00 166.67 83.33 916.67 1,458.33 2,875.00 Average Cost/ Unit Cumulative Units 500.00 666.67 750.00 1,666.67 3,125.00 6,000.00 Value of holding 5,000 7,500 13,333 9,000 13,333 15,625 Current portfolio value 5,000 10,000 15,000 20,000 25,000 30,000

Average NAV

11.67

5.00

165

VA another example
Month
1

Target Value
1,000

NAV (Rs)
10.00

Value of Holding
100.00

Units to invest
100.00

Cum no of units
100.00

2
3 4 5

2,000
3,000 4,000 5,000

12.50
14.25 11.75 10.50

1,250.00
2,280.00 2,473.68 3,574.47

60.00
50.53 129.90 135.76

160.00
210.53 340.43 476.19

6
7 8 9 10 11 12

6,000
7,000 8,000 9,000 10,000 11,000 12,000

9.00
8.50 7.65 8.80 9.25 12.00 15.00

4,285.71
5,666.67 6,300.00 9,202.61 9,460.23 12,972.97 13,750.00

190.48
156.86 222.22 (23.02) 58.35 (164.41) (116.67)

666.67
823.53 1,045.75 1,022.73 1,081.08 916.67 800.00

166

Jacobs Approach
Combine RCA and VA
Use an aggressive growth fund and a money

market fund of the same family.

167

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.

168

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.
169

Asset Allocation Approaches

Benjamin Grahams 50/50 balance
a 50/50 split between debt and equity

Grahams 50:50 is the basic asset allocation.

170

Grahams Portfolios
Portfolio Type Basic managed Portfolio Portfolio Mix 50% diversified equity value fund 25% Govt Securities fund 25% High grade corporate bond fund 50% total stock market/index fund 50% total bond market portfolio 85% Balanced 60/40 fund 15% Medium term bond fund

Basic Indexed Portfolio Simple Managed Portfolio

Complex Managed Portfolio 20% diversified equity fund 20% aggressive growth fund 10% specialty fund Readymade Portfolio 100% Single Index fund with 60/40 equity/bond holding

171

Jacobs Investment Strategies

5%

Liquid Funds
Income and Gilt Funds

15-30%

Diversified Equity

65-80%

Accumulation Phase
172

Jacobs Investment Strategies

5% 15-30%
Liquid Funds Diversified Equity

65-80%

Income and Gilt Funds

Distribution Phase

173

Asset Allocation Approaches

Bogles Approach
Bogle suggested variation to percentages based on

age, financial circumstances and objectives

Bogles thumb rule
debt portion of an investors portfolio equal to

investors age.

174

Bogles Asset Allocation Strategy

Accumulatio Distributio n Stage n Stage

Younger Investor
Older Investor

80% Equity 20% Debt

70% Equity 30% Debt

60% Equity 40% Debt

50% Equity 50% Debt

175

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 Rupee Cost Averaging Value Averaging Buy & Hold None of these.

SIP is best example of

176

Alternate Investment Products

177

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.

178

Investment Products
Issuer Bank Corporate Product Fixed Deposits Shares Bonds, Debentures Fixed Deposits Govt. Securities Government Available to Investor, MFs Investor, MFs Investor, MFs Investor, MFs Investor, MFs

PPF
Other personal investments Bonds

Investor
Investor Investor, MFs

FIs

Insurers

Insurance policies

Investor

179

QuickofWit Bonds? Tenor RBI

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?

180

Comparison of financial products

Convenience Equity FI Bonds Corp Debentures Company FDs Bank Deposits PPF LI (Traditional) LI (ULIPs) Gold Real Estate Mutual Funds Moderate High Low Moderate High High High High Low Low High Return High Moderate Moderate Moderate Low Moderate Low High Moderate High High Safety Low High Moderate Low High High High High High Moderate High Volatility High Moderate Moderate Low Low Low Low Moderate - High Moderate High Moderate-High Liquidity High-Low Moderate Low Low High Low-Moderate Low Low-Moderate Moderate Low High

181

Mutual Fund vs. Direct Equity

Feature Direct Equity Mutual Fund

Stock selection ability

Focussed activity Diversification Professional management Liquidity Transaction cost Convenience
Switches Cheque writing facilities

Low
Low Low Low Low High Low

High
High High High High Low High

Investing time, knowledge & resources

High

Low

182

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.

183

Investor Perspective
Investment Objective Risk Tolerance Investment Horizon

Equity
FI Bonds Corp Debentures Company FDs Bank Deposits PPF Life Insurance (Traditional) Life Insurance (ULIPs) Gold

Capital Appreciation
Income Income Income Income Income Risk Cover Risk Cover, Capital Growth, Income Inflation hedge

High
Low High-Moderate-Low High-Moderate-Low Low Low Low High-Moderate-Low Low

Long Term
Medium-Long Term Medium-Long Term Medium Short-Medium-Long Term Long Term Long Term Medium-Long Term Medium-Long Term

Real Estate
Mutual Funds

Capital Growth, Income

Capital Growth, Income

Low-Moderate
High-Moderate-Low

Long Term
Short-Medium-Long Term

184

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.

185

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.

186

Risk in Mutual Fund Investing

187

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 investors 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.

188

Jacobs recommendation based on risk level

Jacobs Recommendation of portfolio suballocation
Low-Risk (Conservative) portfolio Moderate Risk (Cautiously Aggressive) portfolio 50% G Secs + 50% MMMF 40% in Growth & Income + 30% Govt Bonds + 20% Growth Funds + 10% Index Funds 25% Aggressive Growth Funds + 25% International Funds + 25% Sector Funds + 15% High Yield Bond Funds + 10% Gold Funds

High Risk (Aggressive) Portfolio

189

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.

190

Measures of Risk
Risk Standard Deviation Beta Ex-marks Alpha Risk-adjusted return Sharpe Ratio Treynor Ratio.

191

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!
192

Beta
Shows how sensitive a fund is to market moves
If the Sensex moves by 25%, a funds bet number will tell you

whether the funds 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!
193

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!
194

Ex-marks comparison
Same beta in both cases

195

Sharpe & Treynor Ratio

197

Stop Check!
Ex-marks (R-Squared) of a fund measures
How much of a funds 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 funds 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.

198

Recommending model portfolios & Selecting the right fund

199

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.

200

Jacobs Model Portfolios

Investor Young, Unmarried Professional Young Couple with two Incomes and two Children Older Couple Single Income Recommended Model Portfolio 50% in Aggressive Equity Funds 25% in High Yield Bond Funds and Growth and Income Funds 25% in Conservative Money Market Funds

10% 30% 25% 35%

30% 35% 25% 10%

in in in in
in in in in

Money Market Aggressive Equity Funds High Yield Bond Funds Municipal Bond Funds
Short-term municipal Funds long-term Municipal Funds moderately aggressive equity emerging growth equity

Recently retired couple

35% in conservative Equity funds 25% in moderately Aggressive Equity 40% in Money Market Funds

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Fund Selection Bogles 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, Managers experience Bigger Size, Longer Age, Lower Costs and Higher Fund Managers 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.

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Fund Selection Bogles 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.

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Fund Selection Bogles Approach

Balanced Portfolio Balance match investors objective Debt Portfolio Quality higher the better Costs lower the better Portfolio Statistics similar to equity funds.

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Fund Selection Bogles 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.

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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.

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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.

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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.

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15. Business Ethics and Mutual Funds

Session 7 Business Ethics

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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Implementing Business Ethics

Fund Operations
Insider Trading Preferential Treatment to Select Investors Personal trading by Fund Manager & employees Compliance Officer

Code of Conduct for Distributors AGNI.

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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.

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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 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.

AMFI Code of Conduct for Intermediaries:

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Quest for more

AMFI Workbook

www.amfiindia.com
www.sebi.gov.in.

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