A Study of Mutual Funds – As a vechicle for Investment.

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Index

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Introduction:

What are mutual funds:

An investment vehicle that is made up of a pool of funds collected from many

investors for the purpose of investing in securities such as stocks, bonds, money
market instruments and similar assets. Mutual funds are operated by money
mangers, who invest the fund's capital and attempt to produce capital gains and
income for the fund's investors. A mutual fund's portfolio is structured and
maintained to match the investment objectives stated in its prospectus.

Investopedia explains Mutual Fund

One of the main advantages of mutual funds is that they give small investors
access to professionally managed, diversified portfolios of equities, bonds and
other securities, which would be quite difficult (if not impossible) to create with a
small amount of capital. Each shareholder participates proportionally in the gain
or loss of the fund. Mutual fund units, or shares, are issued and can typically be
purchased or redeemed as needed at the fund's current net asset value
(NAV) per share, which is sometimes expressed as NAVPS.

As you probably know, mutual funds have become extremely popular

over the last 20 years. What was once just another obscure financial instrument is
now a part of our daily lives. More than 80 million people, or one half of the
households in America, invest in mutual funds. That means that, in the United
States alone, trillions of dollars are invested in mutual funds.

In fact, to many people, investing means buying mutual funds. After all, it's
common knowledge that investing in mutual funds is (or at least should be)
better than simply letting your cash waste away in a savings account, but, for
most people, that's where the understanding of funds ends. It doesn't help that
mutual fund salespeople speak a strange language that is interspersed with
jargon that many investors don't understand. 

Originally, mutual funds were heralded as a way for the little guy to get a piece
of the market. Instead of spending all your free time buried in the financial pages

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of the Wall Street Journal, all you had to do was buy a mutual fund and you'd be
set on your way to financial freedom. As you might have guessed, it's not that
easy. Mutual funds are an excellent idea in theory, but, in reality, they haven't
always delivered. Not all mutual funds are created equal, and investing in
mutuals isn't as easy as throwing your money at the first salesperson who solicits
your business.

A mutual fund is a professionally managed type of collective investment

scheme that pools money from many investors and invests typically in
investment securities (stocks, bonds, short-term money market instruments,
other mutual funds, other securities, and/or commodities such as precious
metals). The mutual fund will have a fund manager that trades (buys and sells)
the fund's investments in accordance with the fund's investment objective. In the
U.S., a fund registered with the Securities and Exchange Commission (SEC)
under both SEC and Internal Revenue Service (IRS) rules must distribute nearly
all of its net income and net realized gains from the sale of securities (if any) to its
investors at least annually. Most funds are overseen by a board of
directors or trustees (if the U.S. fund is organized as a trust as they commonly
are) which is charged with ensuring the fund is managed appropriately by its
investment adviser and other service organizations and vendors, all in the best
interests of the fund's investors.

Since 1940 in the U.S., with the passage of the Investment Company Act of
1940 (the '40 Act) and the Investment Advisers Act of 1940, there have been three
basic types of registered investment companies: open-end funds (or mutual
funds),unit investment trusts (UITs); and closed-end funds. Other types of funds
that have gained in popularity are exchange traded funds (ETFs) and hedge
funds, discussed below. Similar types of funds also operate in Canada, however,
in the rest of the world, mutual fund is used as a generic term for various types of
collective investment vehicles, such as unit trusts, open-ended investment
companies (OEICs), unitized insurance funds, undertakings for collective
investments in transferable securities (UCITS, pronounced "YOU-sits")
and SICAVs (pronounced "SEE-cavs").

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 History of Mutual Funds:

The mutual fund industry in India started in 1963 with the formation of Unit
Trust of India, at the initiative of the Government of India and Reserve Bank of
India. The history of mutual funds in India can be broadly divided into four
distinct phases

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 de-linked
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 crores of
assets under management. 

Second Phase – 1987-1993

(Entry of Public Sector Funds)1987 marked the entry of non- UTI, public sector
mutual funds set up by public sector banks and Life Insurance Corporation of
India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund
was the first non- UTI Mutual Fund established in June 1987 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 established its mutual fund in June 1989 while GIC
had set up its mutual fund in December 1990.At the end of 1993, the mutual fund
industry had assets under management of Rs.47,004 crores. 

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. Also, 1993 was the year in which the first Mutual
Fund Regulations came into being, under which all mutual funds, except UTI

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were to be registered and governed. The erstwhile Kothari Pioneer (now merged
with Franklin Templeton) was the first private sector mutual fund registered in
July 1993. The 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 crores. The Unit Trust of India with Rs.44,541 crores of
assets under management was way ahead of other mutual funds. 

Fourth Phase – since February 2003 In February 2003,

following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into
two separate entities. One is the Specified Undertaking of the Unit Trust of India
with assets under management of Rs.29,835 crores as at the end of January 2003,
representing broadly, the assets of US 64 scheme, assured return and certain
other schemes. 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 Regulations. The second is
the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with
SEBI and functions under the Mutual Fund Regulations. With the bifurcation of
the erstwhile UTI which had in March 2000 more than Rs.76,000 crores of assets
under management and with the setting up of a UTI Mutual Fund, conforming to
the SEBI Mutual Fund Regulations, and with recent mergers taking place among
different private sector funds, the mutual fund industry has entered its current
phase of consolidation and growth. 

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The graph indicates the growth of assets over the years:

Note:
Erstwhile UTI was bifurcated into UTI Mutual Fund and the Specified
Undertaking of the Unit Trust of India effective from February 2003. The Assets
under management of the Specified Undertaking of the Unit Trust of India has
therefore been excluded from the total assets of the industry as a whole from
February 2003 onwards.

Massachusetts Investors Trust (now MFS Investment Management) was founded

on March 21, 1924, and, after one year, it had 200 shareholders and $392,000 in
assets. The entire industry, which included a few closed-end funds, represented
less than $10 million in 1924.
The stock market crash of 1929 hindered the growth of mutual funds. In response
to the stock market crash, Congress passed the Securities Act of 1933 and
the Securities Exchange Act of 1934. These laws require that a fund be registered
with the U.S. Securities and Exchange Commission (SEC) and provide

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prospective investors with a prospectus that contains required disclosures about
the fund, the securities themselves, and fund manager. The Investment Company
Act of 1940 sets forth the guidelines with which all SEC-registered funds must
comply.

With renewed confidence in the stock market, mutual funds began to blossom.
By the end of the 1960s, there were approximately 270 funds with $48 billion in
assets. The first retail index fund, First Index Investment Trust, was formed in
1976 and headed by John Bogle, who conceptualized many of the key tenets of
the industry in his 1951 senior thesis at Princeton University. It is now called
the Vanguard 500 Index Fund and is one of the world's largest mutual funds,
with more than $100 billion in assets.

A key factor in mutual-fund growth was the 1975 change in the Internal Revenue
Code allowing individuals to open individual retirement accounts (IRAs). Even
people already enrolled in corporate pension plans could contribute a limited
amount (at the time, up to $2,000 a year). Mutual funds are now popular in
employer-sponsored "defined-contribution" retirement plans such as (401(k)s)
and 403(b)s as well as IRAs including Roth IRAs.

As of October 2007, there are 8,015 mutual funds that belong to the Investment
Company Institute (ICI), a national trade association of investment companies in
the United States, with combined assets of $12.356 trillion. In early 2008, the
worldwide value of all mutual funds totaled more than $26 trillion.

Concept

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 A Mutual Fund is a trust that pools the savings of a number of investors who
share a common financial goal. The money thus collected is then invested in capital
market instruments such as shares, debentures and other securities. The income earned
through these investments and the capital appreciation realised are shared by its unit
holders in proportion to the number of units owned by them. Thus a Mutual Fund is
the most suitable investment for the common man as it offers an opportunity to invest
in a diversified, professionally managed basket of securities at a relatively low cost. The
flow chart below describes broadly the working of a mutual fund:

Mutual Fund Operation Flow Chart

ORGANISATION OF A MUTUAL FUND

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

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 Organisation of a Mutal Fund

Advantages of Mutual Funds

There are several advantages of investing in a Mutual Fund and that is why
more and more people are taking to it. Some of the major benefits of mutual
funds in India are as follows:

 Diversification: The top Indian mutual funds create their portfolio designs in

such a manner that the interested individuals who invest in mutual funds react
differently even under similar economic conditions. This can be explained with
an example. An increase in the rates of interest may lead to the diminishing of
the asset value of securities in the portfolios. Again, an increase in the value may
result to the appreciation in value of the other set of portfolio securities. Over
time, a balance is created in the portfolio which leads to an overall increase of the
portfolio, even if some security values diminish.

 Professional Management: A majority of the mutual funds in India employ the

leading professionals in their investments management. These managers make
decisions on what securities, the buying and selling of the funds will take place.

 Regulatory oversight: There are certain rules and regulations framed by the

government which every Mutual fund are required to follow. This is to protect
the investors from any fraudulent activities.

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 Liquidity: Getting your money out from the mutual fund is no difficult task. All
you have to do is just write a check, make a telephone call and you are done.

 Convenience: Mutual fund shares can be bought via phone, mail, or even over
Internet.

 Low cost: The expenses of the Mutual fund seldom cross the 1.5 % mark of the
investment you make. The Index Funds expenses are usually lesser. Instead, the
company stocks are bought by them which are found on the specific index.

 Ease of process: Investing in a mutual fund is easy if you are a bank account

holder and you posses a PAN card. All you will need to do is fill up the
application form, attach the PAN card (for transactions over Rs 50,000), sign the
cheque and your Mutual Fund investment is complete.

 Well regulated: The SEBI (Securities Exchange Board of India) regulates the

India mutual funds for the security and convenience of the investors. SEBI
ensures that a transparency is maintained by keeping a strict vigilance on the
mutual funds. This keeps the investor informed and helps him/her to make
his/her choice. To keep a track whether the investment in Mutual Fund is in line
with the objective or not, SEBI demands the disclosure of portfolios once in
every six months

Disadvantages of Mutual Funds

• Professional Management - Many investors debate whether or not

the professionals are any better than you or I at picking stocks. Management is by

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 no means infallible, and, even if the fund loses money, the manager still gets
paid. 

• Costs - Creating, distributing, and running a mutual fund is an expensive

proposition. Everything from the manager’s salary to the investors’ statements
cost money. Those expenses are passed on to the investors. Since fees vary
widely from fund to fund, failing to pay attention to the fees can have negative
long-term consequences. Remember, every dollar spend on fees is a dollar that
has no opportunity to grow over time.

• Dilution - It's possible to have too much diversification. Because funds have

small holdings in so many different companies, high returns from a few
investments often don't make much difference on the overall return. Dilution is
also the result of a successful fund getting too big. When money pours into
funds that have had strong success, the manager often has trouble finding a
good investment for all the new money. 

• Taxes - When a fund manager sells a security, a capital-gains tax is triggered.

Investors who are concerned about the impact of taxes need to keep those
concerns in mind when investing in mutual funds. Taxes can be mitigated by
investing in tax-sensitive funds or by holding non-tax sensitive mutual fund in a
tax-deferred account, such as a 401(k)or IRA.

TYPES OF MUTUAL FUND SCHEMES

Wide variety of Mutual Fund Schemes exist to cater to the needs such as
financial position, risk tolerance and return expectations etc. The table below
gives an overview into the existing types of schemes in the Industry.

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Overview of existing schemes existed in mutual fund category: BY STRUCTURE

1. Open - Ended Schemes:

An open-end fund is one that is available for subscription all through the year. These
do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset
Value ("NAV") related prices. The key feature of open-end schemes is liquidity.

2. Close - Ended Schemes:

These schemes have a pre-specified maturity period. One can invest directly in the
scheme at the time of the initial issue. Depending on the structure of the scheme there
are two exit options available to an investor after the initial offer period closes.
Investors can transact (buy or sell) the units of the scheme on the stock exchanges
where they are listed. The market price at the stock exchanges could vary from the net
asset value (NAV) of the scheme on account of demand and supply situation,
expectations of unitholder and other market factors. Alternatively some close-ended
schemes provide an additional option of selling the units directly to the Mutual Fund
through periodic repurchase at the schemes NAV; however one cannot buy units and

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can only sell units during the liquidity window. SEBI Regulations ensure that at least
one of the two exit routes is provided to the investor.

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

Risk Heirarchy of Different Mutual Funds

Thus, different mutual fund schemes are exposed to different levels of risk and
investors should know the level of risks associated with these schemes before investing.
The graphical representation hereunder provides a clearer picture of the relationship
between mutual funds and levels of risk associated with these funds:

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The risk return trade-off indicates that if investor is willing to take higher risk then
correspondingly he can expect higher returns and vise versa if he pertains to lower risk
instruments, which would be satisfied by lower returns.  For example, if an investors
opt for bank FD, which provide moderate return with minimal risk. But as he moves
ahead to invest in capital protected funds and the profit-bonds that give out more
return which is slightly higher as compared to the bank deposits but the risk involved
also increases in the same proportion.

Thus investors choose mutual funds as their primary means of investing, as Mutual
funds provide professional management, diversification, convenience and liquidity.
That doesn’t mean mutual fund investments risk free. This is because the money that is
pooled in are not invested only in debts funds which are less riskier but are also
invested in the stock markets which involves a higher risk but can expect higher
returns. Hedge fund involves a very high risk since it is mostly traded in the
derivatives market which is considered very volatile.

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1.Equity Funds 
Equity funds are considered to be the more risky funds as compared to other fund
types, but they also provide higher returns than other funds. It is advisable that an
investor looking to invest in an equity fund should invest for long term i.e. for 3 years
or more. There are different types of equity funds each falling into different risk bracket.
In the order of decreasing risk level, there are following types of equity funds:
Aggressive Growth Funds - In Aggressive Growth Funds, fund managers aspire for
maximum capital appreciation and invest in less researched shares of speculative
nature. Because of these speculative investments Aggressive Growth Funds become
more volatile and thus, are prone to higher risk than other equity funds.
Growth Funds - Growth Funds also invest for capital appreciation (with time
horizon of 3 to 5 years) but they are different from Aggressive Growth Funds in the
sense that they invest in companies that are expected to outperform the market in the
future. Without entirely adopting speculative strategies, Growth Funds invest in
those companies that are expected to post above average earnings in the future.

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Speciality Funds - Speciality Funds have stated criteria for investments and their
portfolio comprises of only those companies that meet their criteria. Criteria for some
speciality funds could be to invest/not to invest in particular regions/companies.
Speciality funds are concentrated and thus, are comparatively riskier than diversified
funds.. There are following types of speciality funds:
i. Sector Funds: Equity funds that invest in a particular sector/industry of
the market are known as Sector Funds. The exposure of these funds is
limited to a particular sector (say Information Technology, Auto, Banking,
Pharmaceuticals or Fast Moving Consumer Goods) which is why they are
more risky than equity funds that invest in multiple sectors.
ii. Foreign Securities Funds: Foreign Securities Equity Funds have the option
to invest in one or more foreign companies. Foreign securities funds
achieve international diversification and hence they are less risky than
sector funds. However, foreign securities funds are exposed to foreign
exchange rate risk and country risk.
iii. Mid-Cap or Small-Cap Funds: Funds that invest in companies having
lower market capitalization than large capitalization companies are called
Mid-Cap or Small-Cap Funds. Market capitalization of Mid-Cap
companies is less than that of big, blue chip companies (less than Rs. 2500
crores but more than Rs. 500 crores) and Small-Cap companies have
market capitalization of less than Rs. 500 crores. Market Capitalization of a
company can be calculated by multiplying the market price of the
company's share by the total number of its outstanding shares in the
market. The shares of Mid-Cap or Small-Cap Companies are not as liquid
as of Large-Cap Companies which gives rise to volatility in share prices of
these companies and consequently, investment gets risky.
iv. Option Income Funds*: While not yet available in India, Option Income
Funds write options on a large fraction of their portfolio. Proper use of
options can help to reduce volatility, which is otherwise considered as a
risky instrument. These funds invest in big, high dividend yielding
companies, and then sell options against their stock positions, which
generate stable income for investors.

Diversified Equity Funds - Except for a small portion of investment in liquid

money market, diversified equity funds invest mainly in equities without any
concentration on a particular sector(s). These funds are well diversified and
reduce sector-specific or company-specific risk. However, like all other funds
diversified equity funds too are exposed to equity market risk. One prominent

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 type of diversified equity fund in India is Equity Linked Savings Schemes (ELSS).
As per the mandate, a minimum of 90% of investments by ELSS should be in
equities at all times. ELSS investors are eligible to claim deduction from taxable
income (up to Rs 1 lakh) at the time of filing the income tax return. ELSS usually
has a lock-in period and in case of any redemption by the investor before the
expiry of the lock-in period makes him liable to pay income tax on such income(s)
for which he may have received any tax exemption(s) in the past.

Equity Index Funds - Equity Index Funds have the objective to match the
performance of a specific stock market index. The portfolio of these funds
comprises of the same companies that form the index and is constituted in the
same proportion as the index. Equity index funds that follow broad indices (like
S&P CNX Nifty, Sensex) are less risky than equity index funds that follow narrow
sectoral indices (like BSEBANKEX or CNX Bank Index etc). Narrow indices are
less diversified and therefore, are more risky.

Value Funds - Value Funds invest in those companies that have sound
fundamentals and whose share prices are currently under-valued. The portfolio
of these funds comprises of shares that are trading at a low Price to Earning Ratio
(Market Price per Share / Earning per Share) and a low Market to Book Value
(Fundamental Value) Ratio. Value Funds may select companies from diversified
sectors and are exposed to lower risk level as compared to growth funds or
speciality funds. Value stocks are generally from cyclical industries (such as
cement, steel, sugar etc.) which make them volatile in the short-term. Therefore, it
is advisable to invest in Value funds with a long-term time horizon as risk in the
long term, to a large extent, is reduced.

Equity Income or Dividend Yield Funds - The objective of Equity Income or

Dividend Yield Equity Funds is to generate high recurring income and steady
capital appreciation for investors by investing in those companies which issue
high dividends (such as Power or Utility companies whose share prices fluctuate
comparatively lesser than other companies' share prices). Equity Income or
Dividend Yield Equity Funds are generally exposed to the lowest risk level as
compared to other equity funds.

2.Debt / Income Funds

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 Funds that invest in medium to long-term debt instruments issued by private
companies, banks, financial institutions, governments and other entities belonging to
various sectors (like infrastructure companies etc.) are known as Debt / Income Funds.
Debt funds are low risk profile funds that seek to generate fixed current income (and not
capital appreciation) to investors. In order to ensure regular income to investors, debt
(or income) funds distribute large fraction of their surplus to investors. Although debt
securities are generally less risky than equities, they are subject to credit risk (risk of
default) by the issuer at the time of interest or principal payment. To minimize the risk
of default, debt funds usually invest in securities from issuers who are rated by credit
rating agencies and are considered to be of "Investment Grade". Debt funds that target
high returns are more risky. Based on different investment objectives, there can be
following types of debt funds:
a. Diversified Debt Funds - Debt funds that invest in all securities issued by
entities belonging to all sectors of the market are known as diversified debt funds.
The best feature of diversified debt funds is that investments are properly
diversified into all sectors which results in risk reduction. Any loss incurred, on
account of default by a debt issuer, is shared by all investors which further
reduces risk for an individual investor.

b. Focused Debt Funds* - Unlike diversified debt funds, focused debt funds are
narrow focus funds that are confined to investments in selective debt securities,
issued by companies of a specific sector or industry or origin. Some examples of
focused debt funds are sector, specialized and offshore debt funds, funds that
invest only in Tax Free Infrastructure or Municipal Bonds. Because of their
narrow orientation, focused debt funds are more risky as compared to diversified
debt funds. Although not yet available in India, these funds are conceivable and
may be offered to investors very soon.

c. High Yield Debt funds - As we now understand that risk of default is present in
all debt funds, and therefore, debt funds generally try to minimize the risk of
default by investing in securities issued by only those borrowers who are
considered to be of "investment grade". But, High Yield Debt Funds adopt a
different strategy and prefer securities issued by those issuers who are considered
to be of "below investment grade". The motive behind adopting this sort of risky
strategy is to earn higher interest returns from these issuers. These funds are
more volatile and bear higher default risk, although they may earn at times

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 higher returns for investors.

d. Assured Return Funds - Although it is not necessary that a fund will meet its
objectives or provide assured returns to investors, but there can be funds that
come with a lock-in period and offer assurance of annual returns to investors
during the lock-in period. Any shortfall in returns is suffered by the sponsors or
the Asset Management Companies (AMCs). These funds are generally debt funds
and provide investors with a low-risk investment opportunity. However, the
security of investments depends upon the net worth of the guarantor (whose
name is specified in advance on the offer document). To safeguard the interests of
investors, SEBI permits only those funds to offer assured return schemes whose
sponsors have adequate net-worth to guarantee returns in the future. In the past,
UTI had offered assured return schemes (i.e. Monthly Income Plans of UTI) that
assured specified returns to investors in the future. UTI was not able to fulfill its
promises and faced large shortfalls in returns. Eventually, government had to
intervene and took over UTI's payment obligations on itself. Currently, no AMC
in India offers assured return schemes to investors, though possible.

e. Fixed Term Plan Series - Fixed Term Plan Series usually are closed-end schemes
having short term maturity period (of less than one year) that offer a series of
plans and issue units to investors at regular intervals. Unlike closed-end funds,
fixed term plans are not listed on the exchanges. Fixed term plan series usually
invest in debt / income schemes and target short-term investors. The objective of
fixed term plan schemes is to gratify investors by generating some expected
returns in a short period.

3. Gilt Funds 
Also known as Government Securities in India, Gilt Funds invest in government papers
(named dated securities) having medium to long term maturity period. Issued by the
Government of India, these investments have little credit risk (risk of default) and
provide safety of principal to the investors. However, like all debt funds, gilt funds too
are exposed to interest rate risk. Interest rates and prices of debt securities are inversely
related and any change in the interest rates results in a change in the NAV of debt/gilt
funds in an opposite direction. 

4. Money Market / Liquid Funds

Money market / liquid funds invest in short-term (maturing within one year) interest

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bearing debt instruments. These securities are highly liquid and provide safety of
investment, thus making money market / liquid funds the safest investment option
when compared with other mutual fund types. However, even money market / liquid
funds are exposed to the interest rate risk. The typical investment options for liquid
funds include Treasury Bills (issued by governments), Commercial papers (issued by
companies) and Certificates of Deposit (issued by banks).

5. Hybrid Funds 
As the name suggests, hybrid funds are those funds whose portfolio includes a blend of
equities, debts and money market securities. Hybrid funds have an equal proportion of
debt and equity in their portfolio. There are following types of hybrid funds in India:
a. Balanced Funds - The portfolio of balanced funds include assets like debt
securities, convertible securities, and equity and preference shares held in a
relatively equal proportion. The objectives of balanced funds are to reward
investors with a regular income, moderate capital appreciation and at the same
time minimizing the risk of capital erosion. Balanced funds are appropriate for
conservative investors having a long term investment horizon.

b. Growth-and-Income Funds - Funds that combine features of growth funds and

income funds are known as Growth-and-Income Funds. These funds invest in
companies having potential for capital appreciation and those known for issuing
high dividends. The level of risks involved in these funds is lower than growth
funds and higher than income funds.

c. Asset Allocation Funds - Mutual funds may invest in financial assets like equity,
debt, money market or non-financial (physical) assets like real estate,
commodities etc.. Asset allocation funds adopt a variable asset allocation strategy
that allows fund managers to switch over from one asset class to another at any
time depending upon their outlook for specific markets. In other words, fund
managers may switch over to equity if they expect equity market to provide good
returns and switch over to debt if they expect debt market to provide better
returns. It should be noted that switching over from one asset class to another is a
decision taken by the fund manager on the basis of his own judgment and
understanding of specific markets, and therefore, the success of these funds
depends upon the skill of a fund manager in anticipating market trends.

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6. Commodity Funds
Those funds that focus on investing in different commodities (like metals, food grains,
crude oil etc.) or commodity companies or commodity futures contracts are termed as
Commodity Funds. A commodity fund that invests in a single commodity or a group of
commodities is a specialized commodity fund and a commodity fund that invests in all
available commodities is a diversified commodity fund and bears less risk than a
specialized commodity fund. "Precious Metals Fund" and Gold Funds (that invest in
gold, gold futures or shares of gold mines) are common examples of commodity funds. 

7. Real Estate Funds

Funds that invest directly in real estate or lend to real estate developers or invest in
shares/securitized assets of housing finance companies, are known as Specialized Real
Estate Funds. The objective of these funds may be to generate regular income for
investors or capital appreciation. 

8. Exchange Traded Funds (ETF) 

Exchange Traded Funds provide investors with combined benefits of a closed-end and
an open-end mutual fund. Exchange Traded Funds follow stock market indices and are
traded on stock exchanges like a single stock at index linked prices. The biggest
advantage offered by these funds is that they offer diversification, flexibility of holding
a single share (tradable at index linked prices) at the same time. Recently introduced in
India, these funds are quite popular abroad. 

9. Fund of Funds
Mutual funds that do not invest in financial or physical assets, but do invest in other
mutual fund schemes offered by different AMCs, are known as Fund of Funds. Fund of
Funds maintain a portfolio comprising of units of other mutual fund schemes, just like
conventional mutual funds maintain a portfolio comprising of equity/debt/money
market instruments or non financial assets. Fund of Funds provide investors with an
added advantage of diversifying into different mutual fund schemes with even a small
amount of investment, which further helps in diversification of risks. However, the
expenses of Fund of Funds are quite high on account of compounding expenses of
investments into different mutual fund schemes. 
Regulations

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 Below are the regulation of SEBI for Mutual Funds in India as per the amendments
made by SEBI:

Date Details
29-Jul-10 Securities and Exchange Board Of India (Mutual Funds) (Amendment) Regulations, 2010 
05-Jun-09 Securities and Exchange Board of India (Mutual Funds) (Second Amendment) Regulations, 2009 
08-Apr-09 Securities and Exchange Board of India (Mutual Funds) (Amendment) Regulations, 2009
29-Sep-08 Securities and Exchange Board of India (Mutual Funds) (Third Amendment) Regulations, 2008
22-May-08 Securities and Exchange Board of India (Mutual Funds) (Second Amendment) Regulations, 2008
16-Apr-08 Securities and Exchange Board of India (Mutual Funds) (Amendment) Regulations, 2008
Notification under sub-regulation (1) of regulation 2 of the Securities and Exchange Board of India
08-Apr-08 (Mutual Funds) (Second Amendment) Regulations, 2007 and regulation 2 of the Securities and
Exchange Board of India (Foreign Institutional Investors) (Second Amendment) Regulations, 2007 
31-Mar-08 SEBI (Payment of Fees) (Amendment) Regulations, 2008
31-Oct-07 Securities And Exchange Board Of India (Mutual Funds) (Second Amendment) Regulations, 2007 
29-May-07 Securities And Exchange Board Of India (Mutual Funds) (Amendment) Regulations, 2007 
03-Aug-06 Securities And Exchange Board Of India (Mutual Funds) (Third Amendment) Regulations, 2006 

09-Dec-96 Securities And Exchange Board Of India (Mutual Funds) Regulations, 1996 -(as amended upto June
29, 2010") 

SEBI GUIDELINES GOVERNING MUTUAL FUNDS:

The market regulator is putting together guidelines for banks and national
distributors to check mis-selling of mutual funds
Market watchdog Securities and Exchange Board of India (SEBI) is further
strengthening the mutual fund (MF) distribution system to prevent possible cases of
mis-selling by banks and national distributors. Recently, the Association of Mutual
Funds in India (AMFI) had sent a strict warning to national distributors like HSBC, NJ
India Invest, HDFC Bank and Kotak Mahindra Bank who were actively engaged in the
this sector.

SEBI is working along with the National Institute of Securities Markets (NISM) to
formulate the guidelines. The working group committee will also include
representatives from banks and national distributors. 

Recently SEBI had asked fund houses to disclose all complaints received by them on
their respective websites and in their annual reports by 30 June 2010 in order to increase
transparency

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SEBI has now proposed that the risk appetite, investment objective and affordability of
the customer should match with the product. Besides, national distributors and banks
will have to seek an acknowledgement document from the clients before a client invests
in a scheme. The acknowledgement document will contain the customer category and a
statement of fee earned from a particular product. The market regulator has also
suggested recording the calls of all relationship managers with the customers for
auditing and has also proposed periodic auditing and compliance of these new norms. 

Mutual funds cannot invest more than 10 per cent of the total net assets of a scheme in
the short-term deposits of a single bank, the Securities and Exchange Board of India
guidelines recommend.

Announcing guidelines for parking of funds in short-term deposits of scheduled

commercial banks (SCBs) by mutual funds, the regulator said that investment cap
would also take into account the deposit schemes of the bank's subsidiaries.

The Sebi has also defined 'short term' for funds' investment purposes as a period not
exceeding 91 days.Besides, the parking of funds in short-term deposits of all SCBs has
been capped at 15 per cent of the net asset value (NAV) of a scheme, which can be
raised to 20 per cent with prior approval of the trustees.The parking of funds in short-
term deposits of associate and sponsor SCBs together should not exceed 20 per cent of
total deployment by the MF in short-term deposits, it added.

The Sebi said that these guidelines are aimed at ensuring that funds collected in a
scheme are invested as per the investment objective stated in the offer document of an
MF scheme.

The new guidelines would be applicable to all fresh investments whether in a new
scheme or an existing one. In cases of an existing scheme, where the scheme has already
parked funds in short-term deposits, the asset management company have been given
three-months time to conform with the new guidelines.

The Sebi has also asked the trustees of a fund to ensure that no funds are parked by a
scheme in short term deposit of a bank, which has invested in that particular
scheme.The Sebi guidelines say that asset management companies (AMCs) shall not be

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permitted to charge any investment and advisory fees for parking of funds in short-
term deposits of banks in case of liquid and debt-oriented schemes.

It has also asked the trustees to disclose details of all such funds parked in short-term
deposits in half-yearly portfolio statements under a separate heading and has said that
AMCs should also certify the same in its bi-monthly compliance test report.

All the short-term deposits by mutual funds should be held in the name of the scheme
concerned only, it added.

The Costs

Costs are the biggest problem with mutual funds. These costs eat into your return, and
they are the main reason why the majority of funds end up with sub-par performance. 

What's even more disturbing is the way the fund industry hides costs through a layer of
financial complexity and jargon. Some critics of the industry say that mutual fund
companies get away with the fees they charge only because the average investor does
not understand what he/she is paying for. 

Fees can be broken down into two categories:

1. Ongoing yearly fees to keep you invested in the fund. 
2. Transaction fees paid when you buy or sell shares in a fund (loads). 

The Expense Ratio 

The ongoing expenses of a mutual fund is represented by the expense ratio. This is
sometimes also referred to as the management expense ratio (MER). The expense ratio
is composed of the following: 

• The cost of hiring the fund manager(s) - Also known as the management fee, this cost
is between 0.5% and 1% of assets on average. While it sounds small, this fee ensures
that mutual fund managers remain in the country's top echelon of earners. Think about
it for a second: 1% of 250 million (a small mutual fund) is $2.5 million - fund managers
are definitely not going hungry! It's true that paying managers is a necessary fee, but
don't think that a high fee assures superior performance.

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• Administrative costs - These include necessities such as postage, record keeping,
customer service, cappuccino machines, etc. Some funds are excellent at minimizing
these costs while others (the ones with the cappuccino machines in the office) are not. 

• The last part of the ongoing fee (in the United States anyway) is known as the 12B-1
fee. This expense goes toward paying brokerage commissions and toward advertising
and promoting the fund. That's right, if you invest in a fund with a 12B-1 fee, you are
paying for the fund to run commercials and sell itself

On the whole, expense ratios range from as low as 0.2% (usually for index funds) to as
high as 2%. The average equity mutual fund charges around 1.3%-1.5%. You'll generally
pay more for specialty or international funds, which require more expertise from
managers. 

Are high fees worth it? You get what you pay for, right? 

Wrong. 

Just about every study ever done has shown no correlation between high expense ratios
and high returns. This is a fact. If you want more evidence, consider this quote from the
Securities and Exchange Commission's website: 

"Higher expense funds do not, on average, perform better than lower expense funds." 

Loads, A.K.A. "Fee for Salesperson" 

Loads are just fees that a fund uses to compensate brokers or other salespeople for
selling you the mutual fund. All you really need to know about loads is this: don't buy
funds with loads. 

In case you are still curious, here is how certain loads work: 

• Front-end loads - These are the most simple type of load: you pay the fee when you
purchase the fund. If you invest $1,000 in a mutual fund with a 5% front-end load, $50
will pay for the sales charge, and $950 will be invested in the fund. 

• Back-end loads (also known as deferred sales charges) - These are a bit more
complicated. In such a fund you pay the a back-end load if you sell a fund within a

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certain time frame. A typical example is a 6% back-end load that decreases to 0% in the
seventh year. The load is 6% if you sell in the first year, 5% in the second year, etc. If
you don't sell the mutual fund until the seventh year, you don't have to pay the back-
end load at all. 

A no-load fund sells its shares without a commission or sales charge. Some in the
mutual fund industry will tell you that the load is the fee that pays for the service of a
broker choosing the correct fund for you. According to this argument, your
returns will  be higher because the professional advice put you into a better fund. There
is little to no evidence that shows a correlation between load funds and superior
performance. In fact, when you take the fees into account, the average load fund
performs worse than a no-load fund.

How To Read A Mutual Fund Table

Mutual fund data is easy to find and easy to read. The most common method of

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accessing the information used to be via a mutual fund table in the newspaper, but
now this information is more commonly found online.

Online
Websites provide significantly more data about a given mutual fund than a fund table
does. Yahoo Finance, MSN Money and all of the major mutual fund companies
provide robust websites filled with fund information.
The following basic details are usually provided: fund name, net asset value, trade
time (provides date for last price), price change, previous close price, year-to-date
return, net assets, and yield. With a just a few clicks of the mouse you can also view
historical prices, headlines news, fund holdings, Morningstar ratings and more

Newspaper Fund Table

By providing key data points, mutual fund tables give an overview of a mutual fund’s
performance for the past 12 months in relation to its current price. They also provide
insight into how the fund’s price per share has changed over the course of the most
recent week. 

However, with the high prices of newsprint, declining readership, and increasing
adoption of technology, many newspapers are cutting back on the space allocated to
mutual fund tables. This is particularly true where smaller and less popular funds are
concerned. Going online or calling the fund company directly may be the only way to
get information about these products.

What Do You Need?

The wealth of information available can be daunting. What do you really need to
know? Where can you go to find it? How much detail is too much? The answers to
these questions largely depend on how you plan to invest. If you are looking to day
trade, for example, information about daily pricing trends may be critical to your
efforts. If you plan to buy and hold for decades, long-term performance information,
fund expense ratios, and the management team’s history are probably enough. Fund
fact sheets and a copy of the fund’s prospectus are available on most fund company
websites. These documents generally provide all the information long-term investors
require to make decisions. 
Net asset value

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The net asset value, or NAV, is the current market value of a fund's holdings, minus the
fund's liabilities, that is usually expressed as a per-share amount. For most funds, the
NAV is determined daily, after the close of trading on some specified financial
exchange, but some funds update their NAV multiple times during the trading day.
The public offering price, or POP, is the NAV plus a sales charge. Open-end funds sell
shares at the POP and redeem shares at the NAV, and so process orders only after the
NAV is determined. Closed-end funds (the shares of which are traded by investors)
may trade at a higher or lower price than their NAV; this is known as
a premium or discount, respectively. If a fund is divided into multiple classes of shares,
each class will typically have its own NAV, reflecting differences in fees and expenses
paid by the different classes.

Some mutual funds own securities which are not regularly traded on any formal
exchange. These may be shares in very small or bankrupt companies; they may
be derivatives; or they may be private investments in unregistered financial
instruments (such as stock in a non-public company). In the absence of a public market
for these securities, it is the responsibility of the fund manager to form an estimate of
their value when computing the NAV. How much of a fund's assets may be invested in
such securities is stated in the fund's prospectus.
The price per share, or NAV (net asset value), is calculated by dividing the fund's
assets minus liabilities by the number of shares outstanding. This is usually calculated
at the end of every trading day.

Average Annual Return

US mutual funds use SEC form N-1A to report the average annual compounded rates
of return for 1-year, 5-year and 10-year periods as the "average annual total return" for
each fund. The following formula is used:
P(1+T)n = ERV
Where:
P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.

ERV = ending redeemable value of a hypothetical $1,000 payment made at the

beginning of the 1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or

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fractional portion).

Turnover

Turnover is a measure of the fund's securities transactions, usually calculated over a

year's time, and usually expressed as a percentage of net asset value.
This value is usually calculated as the value of all transactions (buying, selling) divided
by 2 divided by the fund's total holdings; i.e., the fund counts one security sold and
another one bought as one "turnover". Thus turnover measures the replacement of
holdings.
In Canada, under NI 81-106 (required disclosure for investment funds) turnover ratio
is calculated based on the lesser of purchases or sales divided by the average size of the
portfolio (including cash).

Evaluating Performance

Perhaps you've noticed all those mutual fund ads that quote their amazingly high one-
year rates of return. Your first thought is "wow, that mutual fund did great!" Well, yes
it did great last year, but then you look at the three-year performance, which is lower,
and the five year, which is yet even lower. What's the underlying story here? Let's look
at a real example from a large mutual fund's performance:

1 year 3 year 5 year

53% 20% 11%

Last year, the fund had excellent performance at 53%. But, in the past three years,
the average annual return was 20%. What did it do in years 1 and 2 to bring the
average return down to 20%? Some simple math shows us that the fund made an
average return of 3.5% over those first two years: 20% = (53% + 3.5% + 3.5%)/3.
Because that is only an average, it is very possible that the fund lost money in one of
those years. 

It gets worse when we look at the five-year performance. We know that in the last year

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the fund returned 53% and in years 2 and 3 we are guessing it returned around 3.5%.
So what happened in years 4 and 5 to bring the average return down to 11%? Again, by
doing some simple calculations we find that the fund must have lost money, an
average of -2.5% each year of those two years: 11% = (53% + 3.5% + 3.5% - 2.5% -
2.5%)/5. Now the fund's performance doesn't look so good! 

It should be mentioned that, for the sake of simplicity, this example, besides making
some big assumptions, doesn't include calculating compound interest. Still, the point
wasn't to be technically accurate but to demonstrate the importance of taking a closer
look at performance numbers. A fund that loses money for a few years can bump the
average up significantly with one or two strong years. 

It's All Relative

Of course, knowing how a fund performed is only one third of the battle. Performance
is a relative issue, literally. If the fund we looked at above is judged against its
appropriate benchmark index, a whole new layer of information is added to the
evaluation. If the index returned 75% for the 1 year time period, that 53% from the
fund doesn't look quite so good. On the other hand, if the index delivered results of
25%, 5%, and -5% for the respective one, three, and five-year periods, then the fund’s
results look rather fine indeed.
To add another layer of information to the evaluation, one can consider a fund’s
performance against its peer group as well as against its index. If other funds that
invest with a similar mandate had similar performance, this data point tells us that the
fund is in line with its peers. If the fund bested its peers and its benchmark, its results
would be quite impressive indeed.
Looking at any one piece of information in isolation only tells a small portion of the
story. Consider the comparison of a fund against its peers. If the fund sits in the top
slot over each of the comparison periods, it is likely to be a solid performer. If it sits at
the bottom, it may be even worse than perceived, as peer group comparisons only
capture the results from existing funds. Many fund companies are in the habit of
closing their worst performers. When the "losers" are purged from their respective
categories, their statistical records are no longer included in the category performance
data. This makes the category averages creep higher than they would have if the losers
were still in the mix. This is better known as survivorship bias.

To develop the best possible picture of fund's performance results, consider as many

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data points as you can. Long-term investors should focus on long-term results, keeping
in mind that even the best performing funds have bad years from time to time

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