CHAPTER- 3 MUTUAL FUND IN INDIA

CONTENT : Mutual Fund In India Organization of M.F. -Feature of M.F. Participants In M.F. How to Invest In M.F.? -Rights of Investors. Advantage Drawback Frequently Used Term

Mutual Fund In India

The origin of mutual fund industry in India is with the introduction of the concept of mutual fund by UTI in the year 1963. The mutual fund industry can be broadly put into four phases according to the development of the sector. Each phase is briefly described as under:

First Phase 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. In 1978 UTI was delinked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory and administrative control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 corer of assets under management.

Second Phase - 1987-1993 (Entry of Public Sector Funds)

Entry of non-UTI mutual funds. SBI Mutual Fund was the first followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC in 1989 and GIC in 1990. The end of 1993 marked Rs.47,004 as assets under management.

Third Phase - 1993-2003 (Entry of Private Sector Funds)

With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993. In 1993, SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations,1996.

The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 cores. The Unit Trust of India with Rs.44,541 cores of assets under management was way ahead of other mutual funds.

Fourth Phase- since February 2003

This phase had bitter experience for UTI. It was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with AUM of Rs.29,835 crores (as on January 2003). The Specified Undertaking of Unit Trust of India, functioning under an administrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund.

ORGANISATION OF A MUTUAL FUND

There are many entities involved and the diagram below illustrates the organizational set up of a mutual fund:

Key points regarding the Organization of Mutual Funds:

Mutual Funds in India have a 3-tier structure of SponsorTrustee-AMC Sponsor is the promoter of the fund and it creates the AMC & the trustee company and appoints the Boards of both these companies, with SEBI approval A Mutual fund is constituted as a Trust. A Trust Deed is signed by trustees and registered under the Indian Trust Act.

The Trustees appoint the assets management company (AMC) to actually manage the investors money. The AMCs capital is contributed by the sponsor. Investors money is held in the Trust (the mutual fund). The AMC gets a fee for managing the funds, according to the mandate of the investors Sponsor should have at least 5-year track record in the financial services business and should have made profit in at least 3 out of the 5 years. Sponsor should contribute at least 40% of the capital of the AMC. An AMC cannot engage in any business other than portfolio advisory and management AMC should have a net worth of at least Rs. 10 crore at all times. AMC should be registered with SEBI. Trustees are required to meet at least 4 times a year to review the AMC The investors funds and the investments are held by the custodian. Sponsor and the custodian cannot be the same entity.

THE THREE BASIC FEATURES OF MUTUAL FUNDS

a) All mutual funds charge expenses. Whether they be marketing, management or brokerage fees, fund expenses are generally passed back to the investors. b) Investors exercise no control over what securities the fund buys or sells. c) The buying and selling of securities within the mutual fund portfolio generates capital gains and losses which are passed back to investors even if they have not sold any of their mutual fund shares.

PARTIES INVOLVED IN MUTUAL FUND DEALINGS

INVESTORS
Investors are the people who actually invest their money into the market. Every investor, given his financial position and personal disposition, has a certain inclination to take risk. The hypothesis is that by taking an incremental risk, it would be possible for the investor to earn an incremental return. Mutual Fund is a kind of solution for investors who have lack the time, the inclination or the skills to actively manage their investment risk in individual securities. Investing through a mutual fund would make economic sense for an investor, if he fetches a return that is higher than what he would otherwise have earned by investing directly.

TRUSTEES
Trustees are the people within a mutual fund organization who are responsible for ensuring that investors interests in a scheme are properly taken care of. In return for their services, they are paid trustee fees, which are normally charged to the scheme.

ASSET MANAGEMENT COMPANY

AMCs manage the investment portfolios of schemes. An AMCs income comes from the management fees it charges the schemes it manages. The management fee is calculated as a percentage of net assets managed. An AMC has naturally to employ people and bear all the establishment costs that are related to its activity out of its management fee earned.

DISTRIBUTORS
Distributors earn a commission for bringing investors into the schemes of a mutual fund. This commission is an expense for the scheme, although there are occasions when an AMC may choose to bear the cost, wholly or partly. Depending on the financial and physical resources at their disposal, the distributor could be; who have their own or franchised network reaching out to investors all across the country; distributors who are generally regional players with some reach within their region; distributors who are small and marginal players with limited reach.

HOW TO INVEST IN MUTUAL FUND?

Step One :- Identify your Investment needs.

Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, and level of income and expenses among many other factors. Therefore, the first step is to assess your needs. You can begin by defining your investment objectives and needs which could be regular income, buying a home or finance a wedding or educate your children or a combination of all these needs, the quantum of risk you are willing to take and your cash flow requirements.

Step Two :- Choose the right Mutual Fund

The important thing is to choose the right mutual fund scheme which suits your requirements. The offer document of the scheme tells you its objectives and provides supplementary details like the track record of other schemes managed by the same Fund Manager. Some factors to evaluate before choosing a particular Mutual Fund are the track record of the performance of the fund over the last few years in relation to the appropriate yardstick and similar funds in the same category. Other factors could be the portfolio allocation, the dividend yield and the degree of transparency as reflected in the frequency and quality of their

communications for selecting the right scheme as per your specific requirements.

Step Three :- Select the ideal mix of Schemes

Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals.

Step Four :- Invest regularly

The best approach is to invest a fixed amount at specific intervals, say every month. By investing a fixed sum each month, you buy fewer units when the price is higher and more units when the price is low, thus bringing down your average cost per unit. This is called Rupee Cost Averaging and is a disciplined investment strategy followed by investors all over the world. You can also avail the systematic investment plan facility offered by many open end funds.

Step Five :- Start early

It is desirable to start investing early and stick to a regular investment plan. If you start now, you will make more than if you wait and invest later. The power of compounding lets you earn income on income and your money multiplies at a compounded rate of return.

Step Six :- The final step All you need to do now is to click for online application forms of various mutual fund schemes and start investing. You may reap the rewards in the years to come. Mutual Funds are suitable for every kind of investor - whether starting a career or retiring, conservative or risk taking, growth oriented or income seeking.

RIGHTS OF A MUTUAL FUND UNIT HOLDER

A unit holder in a Mutual Fund scheme governed by the SEBI (Mutual Funds) Regulations is entitled to: 1. Receive unit certificates or statements of accounts confirming the title within 6 weeks from the date of closure of the subscription or within 6 weeks from the date of request for a unit certificate is received by the Mutual Fund. 2. Receive information about the investment policies, investment objectives, financial position and general affairs of the scheme. 3. Receive dividend within 42 days of their declaration and receive the redemption or repurchase proceeds within 10 days from the date of redemption or repurchase. 4. Vote in accordance with the Regulations to: Approve or disapprove any change in the fundamental investment policies of the scheme, which are likely to modify the scheme or affect the interest of the unit holder. The dissenting unit holder has a right to redeem the investment. Change the Asset Management Company. Wind up the schemes. 5. Inspect the documents of the Mutual Funds specified in the scheme's offer document.

Advantages of Mutual Funds

The advantages of investing in a Mutual Fund are:

Diversification
The best mutual funds design their portfolios so individual investments will react differently to the same economic conditions. For example, economic conditions like a rise in interest rates may cause certain securities in a diversified portfolio to decrease in value. Other securities in the portfolio will respond to the same economic conditions by increasing in value. When a portfolio is balanced in this way, the value of the overall portfolio should gradually increase over time, even if some securities make lose.

Affordability
Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy.

Professional Management
The idea behind a mutual fund is that individual investors generally lack the time, the inclination or the skills to manage their own investment. Thus mutual funds hire professional managers to manage the investments for the benefit of their investors in return for a management fee. The organization that manages the investment is the Asset Management Company (AMC). Employees of the AMC who perform this role of managing investments are the fund managers.

Regulatory oversight
Mutual funds are subject to many government regulations that protect investors from fraud. Liquidity Open-end schemes offer liquidity through on-going sale and re-purchase facility. Thus, the investor does not have to worry about finding a buyer for his investment a risk normally associated with direct investment in the securities market.

Convenience
Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient.

Low cost:
Mutual fund expenses are often no more than 1.5 percent of your investment. Expenses for Index Funds are less than that, because index funds are not actively managed. Instead, they automatically buy stock in companies that are listed on a specific index.

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

Flexibility
Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience.

Choice of schemes
A mutual fund can, and typically does have several schemes to cater to different investors preferences. The individual could choose to hire a professional manager to manage his money as per his investment and risk preferences. Such personal treatment often referred to as Portfolio Management Scheme (PMS).

Tax benefits
Dividend income from mutual fund units will be exempt from income tax with effect from July 1, 1999. Further, investors can get rebate from tax under section 88 of Income Tax Act, 1961 by investing in Equity Linked Saving Schemes of mutual funds. Further benefits are also available under section 54EA and 54EB with regard to relief from long term capital gains tax in certain specified schemes.

Well regulated
All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.

Drawbacks of Mutual Funds

No Guarantees
No investment is risk free. If the entire stock market declines in value, the value of mutual fund shares will go down as well, no matter how balanced the portfolio. Investors encounter fewer risks when they invest in mutual funds than when they buy and sell stocks on their own. However, anyone who invests through a mutual fund runs the risk of losing money.

Fees and commissions

All funds charge administrative fees to cover their dayto-day expenses. Some funds also charge sales commissions or "loads" to compensate brokers, financial consultants, or financial planners. Even if you don't use a broker or other financial adviser, you will pay a sales commission if you buy shares in a Load Fund.

Taxes
During a typical year, most actively managed mutual funds sell anywhere from 20 to 70 percent of the securities in their portfolios. If your fund makes a profit on its sales, you will pay taxes on the income you receive, even if you reinvest the money you made.

Management risk
When you invest in a mutual fund, you depend on the fund's manager to make the right decisions regarding the fund's portfolio. If the manager does not perform as well as you had hoped, you might not make as much money on your investment as you expected. Of course, if you invest in Index Funds, you forego management risk, because these funds do not employ managers.

Frequently used terms

Net Asset Value (NAV)

Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date. Sale Price The price you pay when you invest in a scheme. Also called Offer Price. It may include a sales load. Repurchase Price The price at which a close-ended scheme re-purchases its units and it may include a back-end load. This is also called Bid Price.

Redemption Price
The price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related. Sales Load An AMC may decide that investors should pay more than NAV for their investment in each unit of the scheme. This incremental amount is also called, Front-end load or Entry load. Schemes that do not charge a load are called

No Load schemes. Therefore, the amount that needs to be paid is, Sale Price = NAV + Entry Load Repurchase or Back-end Load An AMC may decide that sellers would recover less than NAV for the units they sell in a scheme. This shortfall, borne by existing investors, is called the Exit load or Back-end load. Thus the amount will be, Sale Price = NAV Exit Load

SYSTEMATIC INVESTMENT PLAN (SIP)

SIP refers to the practice of investing a constant amount regularly, generally every month. When the market goes up, then the money invested in that period gets translated into a fewer number of units for the investor. If the market goes down, then the same money invested gets translated into more units. This investment style is also called rupee cost averaging.

SYSTEMATIC WITHDRAWAL PLAN (SWP)

Under SWP, the investor would withdraw constant amount periodically. The investor can temper gains and losses, though it does not prevent losses.

SYSTEMATIC TRANSFER PLAN (STP)

Investors exposure to different types of securities, whether debt or equity, should flow from their risk profile or risk appetite which is a function of their

financial position and personal disposition. Through STP between plans, it is possible to maintain a target mix of debt and equity in ones portfolio.