|What is a Mutual
Mutual funds provide a way for investors to "mutually" share
the benefits of investing. A mutual fund is an investment company that
professionally invests a pool of money on behalf of individuals and
institutions with similar investment goals by issuing units to the investors
and investing funds in securities in accordance with objectives as disclosed in
Investors of mutual funds are known as unitholders. Mutual
fund issues units to the investors in accordance with quantum of money invested
The profits or losses are shared by the investors in proportion to their
Investments in securities are spread across a wide
cross-section of industries and sectors and thus the risk is reduced.
Diversification reduces the risk because all stocks may not move in the same
direction in the same proportion at the same time.
Different Types of Mutual Funds
A wide variety of Mutual fund schemes cater to different
preferences of the investors based on their financial position, risk tolerance
and return expectations. The mutual fund schemes can be broadly categorized
under 3 headings:
Funds by Structure/ Maturity Period
Funds by Investment objective
Funds by Structure/ Maturity Period:These include
open ended and close ended schemes.
An open ended fund
provides the investors with an easy entry and exit option at NAV (Net Asset
Value), which is declared on a daily basis. The key feature of these schemes is
A close-ended fund has a stipulated maturity period e.g. 5-7 years. The
fund is open for subscription only during a specified period at the time of
launch of the scheme. Investors can invest in the scheme at the time of the
initial public issue and thereafter they can buy or sell the units of the
scheme on the stock exchanges where the units are listed. In order to provide
an exit route to the investors, some close-ended funds give an option of
selling back the units to the mutual fund through periodic repurchase at NAV
related prices. SEBI Regulations stipulate that at least one of the two exit
routes is provided to the investor i.e. either repurchase facility or through
listing on stock exchanges. These mutual funds schemes disclose NAV generally
on weekly basis.
Funds by Investment Objective: A scheme can also be
classified as growth scheme, income scheme, or balanced scheme considering its
investment objective. Such schemes may be open-ended or close-ended schemes as
described earlier. Such schemes may be classified mainly as follows:
Growth/ Equity Oriented Schemes
provide capital appreciation over medium to long – term by investing a major
part of their corpus in equities. Such funds have comparatively high risks.
These schemes provide different options to the investors like dividend option,
capital appreciation, etc. and the investors may choose an option depending on
their preferences. The investors must indicate the option in the application
form. The mutual funds also allow the investors to change the options at a
later date. Growth schemes are good for investors having a long-term outlook
seeking appreciation over a period of time.
Income/ Debt Oriented Schemes
provide regular and steady income to investors by investing in fixed income
securities such as bonds, corporate debentures, government securities and money
market instruments. Hence they are less risky compared to equity schemes. These
funds are not affected because of fluctuations in equity markets. However,
opportunities of capital appreciation are also limited in such funds. The NAVs
of such funds are affected because of change in interest rates in the country.
If the interest rates fall, NAVs of such funds are likely to increase in the
short run and vice versa. However, long term investors may not bother about
provide both growth and regular income as such schemes invest both in equities
and fixed income securities in the proportion indicated in their offer
documents. These are appropriate for investors looking for moderate growth.
They generally invest 40-60% in equity and debt instruments. These funds are
also affected because of fluctuations in share prices in the stock markets.
However, NAVs of such funds are likely to be less volatile compared to pure
Money Market or Liquid Funds
provide easy liquidity and preserve capital but generate moderate income. As
they invest exclusively in safer short- term instruments such as treasury
bills, certificates of deposit, commercial paper, inter bank call money and
government securities. These funds are appropriate for corporate and individual
investors as a means to park their surplus funds for short periods.
Gilt Funds invest exclusively in government securities. Government
securities have no default risk. NAVs of these schemes also fluctuate due to
change in interest rates and other economic factors as is the case with income
or debt oriented schemes.
Other Schemes: These include index schemes, sector
specific schemes, tax saving schemes and fund of funds schemes.
Index Funds replicate the portfolio of a particular index such as the
BSE Sensitive index, S&P NSE 50 index (Nifty), etc. These schemes invest in
the securities in the same weightage as in the index. NAVs of such schemes
would rise or fall in accordance with the rise or fall in the index, though not
exactly by the same percentage due to some factors known as "tracking error" in
There are also exchange traded index funds launched by the mutual funds which
are traded on the stock exchanges.
Sector specific Funds/ Schemes
invest in the securities of only those sectors or industries as specified in
the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods
(FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the
performance of the respective sectors/industries. While these funds may give
higher returns, they are more risky compared to diversified funds. Investors
need to keep a watch on the performance of those sectors/industries and must
are traded on the stock exchanges.
exit at an appropriate time. They may also seek advice of an expert.
Tax Saving Schemes
offer tax rebates to the investors under specific provisions of the Income Tax
Act, 1961 as the Government offers tax incentives for investment in specified
avenues. e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by
the mutual funds also offer tax benefits. These schemes are growth oriented and
invest pre-dominantly in equities. Their growth opportunities and risks
associated are like any equity-oriented scheme.
Fund of Funds (FoF) scheme invests primarily in other schemes of the
same mutual fund or other mutual funds. An FoF scheme enables the investors to
achieve greater diversification through one scheme. It spreads risks across a
Why invest in Mutual Funds?
Mutual funds are popular investments, primarily because of
their numerous benefits:
Mutual funds help you diversify your portfolio, or spread your money over a
number of different investments that are handpicked and tracked by professional
money managers. This strategy can help decrease risk to your portfolio because
when your investment return isn't dependent on any single investment, the
impact of one poor performer on your portfolio is reduced.
Convenience: Mutual funds make investing easy and flexible by
emphasizing convenience to the investor in several ways:
Low minimum investment:
Most mutual funds require low minimum investments making it easy for investors
to build a diverse portfolio fairly quickly.
You can cash in any or all of your mutual fund shares on any business day. The
value of your shares is based on the closing market price (net asset value, or
NAV) of the underlying securities.
You can automatically purchase more mutual fund shares by reinvesting your
dividends and capital gains distributions.
Systematic withdrawal: You can request that regular payments from
systematically selling shares be sent directly to you.
Professional Management: Experienced, full-time money managers
manage each mutual fund. These professional money managers:
Research general market and economic trends. Using the information
they gather, the fund's professional money managers decide when to buy or sell
securities to increase return potential and keep constant tabs on individual
holdings and the overall performance of particular markets, adjusting the
portfolio for the strongest possible performance.
Strive to achieve specific objectives: Because each fund has a specific
investment objective, such as long-term growth or aggressive growth, managers
can focus on the strategic goals of their funds.
Financial benefits: These include:
Mutual fund unitholders can earn dividends on their mutual fund units.
Unitholders can also profit from the sale of their units if they sell them for
more than their original value.*
Unitholders can receive their dividend payments directly or reinvest them back
into the fund and purchase additional units.
(*An investment in mutual funds will fluctuate such that an
investor's shares when redeemed may be worth more or less than the original
Systematic Investment Plans
Investing regularly through a Systematic Investment Plan (SIP) in an equity
fund is one strategy that can ensure success to a large extent for those who
are looking to build up their capital over the longer term and are not familiar
with equity markets. It is a proven fact that a steady saving and investing
plan helps pursue financial goals. What SIP really means is that you invest a
fixed sum every month.
Some of the Benefits of SIPs are as follows:
Rupee Cost Averaging - SIP makes market timing irrelevant. In other words, you
can invest a certain amount of money every month at various entry prices buying
fewer units when the share prices are high and more units when the share prices
are low. Besides, you take advantage of the fact that over a period of time
stock markets generally go up, so your average cost price tends to fall below
the average NAV. This "averaging" ensures that you buy at different levels, not
just the top.
Benefit of Compounding - The profits you earn from your investments get
reinvested. Therefore you earn returns on your primary investments and
Cost Effective Method of Investment - Instead of blocking your money by making
a one-time investment, in an SIP, you can spread the same amount over a certain
period of time and maintain liquidity.
Building for the Future - SIP is an effective method of ensuring regular
savings and achieving your short-term or long-term financial goals. It is also
an excellent method of utilizing your funds, which may be, otherwise, lying
Step-wise Approach to an SIP
Choose the amount you want to invest at each interval. (The amount must be such
that you will be comfortable investing regularly over the long term)
Choose the frequency of your investment - every month, every quarter, every six
Continue investing the same amount each period irrespective of whether the
market falls or rises.
Maintain a long-term perspective. Ignore the day-to-day fluctuations in the
market. Keep investing over a long period of time to give your money a chance
Significance of Mutual Fund Offer Document
There is no doubt that reading a 100-odd pages Mutual Fund
Offer Document is a cumbersome and time-consuming process. However, the
importance of this document for any potential investor should not be undermined
at any point of time. The significance of the Offer Document is emphasized by
the line “Mutual Fund investments are subject to market risks.
Please read the offer document carefully before investing ”, which
accompanies all Mutual Fund advertisements. Thankfully, Sebi has made the
investor’s job easier by evolving an abridged version, the Key Information
What is a Mutual Fund Offer Document?
The Mutual Fund Offer Document is the fund's selling
document and contains valuable information, such as the fund's investment
objectives or goals, principal strategies for achieving those goals, principal
risks of investing in the fund, fees and expenses, and past performance. The
prospectus also identifies the fund's managers and advisers and describes how
to purchase and redeem fund shares. This document can be obtained from fund
companies directly, through mail, email, phone or from their websites or from a
While they may seem daunting at first, mutual fund
prospectuses contain a treasure trove of valuable information. Here's some of
what you'll find in a mutual fund prospectus:
Date of Issue:
It is mandatory for mutual funds to update their prospectus at least once a
year. You must always ensure that you have received the most recent version of
Check the minimum initial investment and minimum amount for subsequent
investments specified in the Offer Document, since these vary from one fund to
The Offer Document specifies the investment objectives of the fund, whether it
is a growth-oriented, income-oriented or balanced fund. You need to decide
whether your personal investment goal is long term capital appreciation with a
higher risk exposure or a lower risk, regular income flow. Only if your
investment objective matches with that of the fund, should you invest in it.
The general investment strategies (equity/debt) that the fund managers intend
to adopt to achieve the pre-specified goals, are outlined in the Offer
Document. Minimum bond ratings and types of companies considered appropriate
for a fund, may also be mentioned.
Do not be under the misconception that mutual funds are free from risk. While
risks vary depending on the fund, the potential danger is the same - loss of
principal and income. You must determine your own risk tolerance level based on
your investment goals. Risks that may be acceptable for a long-term investor
seeking capital appreciation may not be suitable for an investor seeking income
and principal protection. It is essential for you to refer to the Offer
Document to understand the various kinds of risks (eg. credit risk, market
risk, interest-rate risk etc.) associated with the fund and how they fit into
the balance of risk in your overall portfolio.
Financial Highlights: This section contains audited data concerning the
fund's financial performance for different time periods since the fund's
inception. Here you'll find net asset values (for both the beginning and end of
each period), total returns, and various ratios, including the ratio of
expenses to average net assets, the ratio of net income to average net assets,
and the portfolio turnover rate. Such performance data listed in an Offer
Document are based on standard formulas established by Sebi and enable
investors to make comparisons with other funds.
While past performance does not necessarily predict future returns, it can tell
you how volatile (or stable) a fund has been over a period of time. Generally,
the more volatile a fund, the higher the investment risk. If you'll need your
money to meet a financial goal in the near-term, you probably can't afford the
risk of investing in a fund with a volatile history because you will not have
enough time to ride out any declines in the stock market. So, you must read the
historical performance of the fund critically, looking at both the long and
short-term performance. When evaluating performance, you must look at the track
record of a fund over a time period that matches your own investment goals.
Fees and Expenses Structure:
As with any business, running a mutual fund involves costs — including
shareholder transaction costs, investment advisory fees, and marketing and
distribution expenses. Funds pass along these costs to investors by imposing
fees and expenses (eg. Entry loads, exit loads, switching charges, annual
recurring expenses, management fees, investor servicing costs). The Offer
Document lists the limits on these fees and also shows the impact these have
had on the fund investment historically. Be sure to review carefully the fee
tables of any funds you are considering. Even small differences in fees can
translate into large differences in returns over time.
The offer document gives the tax benefits enjoyed by the fund. This can help
you plan your taxes better and help you enhance your post tax returns.
Fund Managers & other Key Personnel:
The offer document gives details on the education and work experience of the
key management of the fund company, including the CEO and the Fund Managers.
Additional Investor Services: This section describes any specific
services which the investors can enjoy, such as automatic reinvestment of
dividends and systematic investment/withdrawal plans and how one can take
advantage of them.
All the information mentioned above will help you get a fair
idea of the mode of functioning of the fund, and enable you to take the crucial
decision – Is this fund suitable for my portfolio?