Mutual Funds
RETURNS
FUND MANAGER
SECURITIES
The funds are invested in a portfolio of marketable securities in accordance with the investment objective. Value of the portfolio and investors holdings, alters with change in the market value of investments.
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Profitability Matrix
A. B. C. D. E. F. G. Interest Income + Dividend Income + Realized capital Gains + Valuation Gains - Realized Capital Loss - Valuation Losses - Scheme Expenses
Open-End Funds
Schemes which sell/ buy units round the year Buying/ selling price is based on NAV Schemes under no obligation to keep selling units at all times Schemes have to repurchase units at all times Schemes corpus keeps changing due to portfolio performance & buying/ selling of units
Close-End Funds
Units are sold only once at the launch of the scheme (NFO) Investors money is locked in the scheme for a stipulated time Schemes are listed on exchanges to provide liquidity to investors Unit capital is fixed and corpus changes only on portfolio performance SEBI regulations ensure investors get exit option once or twice a year
c.
d.
Diversified equity funds Sector funds Thematic funds ELSS Dividend Yield schemes (less fluctuating shares) Arbitrage funds
c. d. e.
Evolution In India
Phase 1 1964 87 Growth of UTI
Phase 2 1987 93 Entry Of Public Sector Funds Phase 3 1993 86 Emergence Of Pvt. Funds
Evolution In India
Phase 4 1996 99 Growth & SEBI Regulations
Phase 5 1999 2004 Emergence Of A large & Uniform Industry Phase 6 2004 Onwards Consolidation & Growth
Fund of Funds
Investment of its corpus in other mutual fund schemes
Schemes of same mutual fund house Schemes of other mutual fund house
Is considered like a Debt scheme for tax purposes The effective expenses become higher as the investors have to bear the expenses of the invested schemes as well
Investment Options
Investors can achieve income and growth objectives in all funds
Dividend pay-out option Regular dvidend Ad-hoc dividend Growth option Re-investment option
Most funds provide multiple options and the facility to switch between options
Basics of Classification
Risk
Sectoral funds are most risky; money market funds are least risky
Tenor
Equity funds require a long investment horizon; liquid funds are for the short term liquidity needs
Investment objective
Equity funds suit growth objectives; debt funds suit income objectives
Growth Funds
Aggressive, Value, Growth
Sectoral Funds
Balanced Funds
Ratio of Debt : Equity
Liquid Funds
Risk
Trustee Company
Fiduciary responsibility to
the
Fund Management
Brokers
Operations
Marketing
Registrar
Distribution
Custody
Investors
Markets
Bank
SPONSOR : Role
Promoter of the mutual fund Creates a Trust under Indian Trusts Act, 1882 Appoints trustees Creates AMC under Companies Act, 1956 Fulfils necessary formalities and applies to SEBI for registration of the Trust as a Mutual Fund
TRUSTEE
Fiduciary responsibility to the Investors. Directors to be approved by SEBI. Execution of trust deed by sponsor in favour of trustee. Trust deed is stamped and registered with SEBI Legally responsible for administering the Trust and Compliance with Regulations. Norms for Trustees:
Experience in Financial Services Minimum 4 members on the board and 2/3rd of the members not to be connected with the sponsor All major Decisions need trustee approval
TRANSFER AGENTS
Issue of Account Statements to Investors Arranges payment to Investors when they redeem Takes care of Non commercial transactions like change of address,loss of account statement etc. Should be registered with SEBI Appointed by Board of AMC
CUSTODIAN
Safe keeping of the assets held by the Fund Receives and Delivers Securities for payment Follow up on Corporate benefits Provide an independent means of control Independent of Sponsors Should be registered with SEBI Appointed by the Board of Trustee
Other Constituents
Broker -Purchase and sale of securities -Not more than 5% through a related broker
Auditor -Separate auditor for AMC and mutual Fund
Scheme takeover
Unit holders permission - 75% SEBIs permission
SEBI
All Mutual Funds / AMC/ Trustee Companies to be registered with SEBI Responsible for protecting investors interest promote orderly growth of Mutual Fund Industry and
Formulates regulations,monitors performance and conduct of Mutual funds and enforces compliance to regulations through reviewing reports and regular inspections
Trustee Co or Board of Trustee accountable to office of Public Trustee Public trustees reports to Charity Comm.
Ministry of Finance
Supervises both SEBI and RBI
Ultimate policy making & supervising body Appellate Authority for any disputes over SEBI guidelines
Investors rights
Proportionate ownership in schemes assets Rights of information from Trustee To received dividend warrants, inspect major docs (Trust deed, investment management agreement, R&T A Agreement, custodian services agreement) with 75% voting rights and approval of SEBI can close the scheme, change the AMC. Rights of info for fundamental change in the scheme features and also an opportunity to redeem units without any load. Receive annual report and a/c statement
Obligations
Must read offer doc AOD (Abridged Offer Document) Beware of risk factors Must monitor investments regularly
Compliance Officer
Investors cannot be protected by companies Act
Significance
Legal document that protects and governs the right of the investor to information Is the primary vehicle for the investment decision Is the operating document and fundamental attributes of schemes. describes the
One of the most important sources of information for the prospective investor Is a reference document for the investor to look for relevant information at any time
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
OD: Contents
Details of the Sponsor & the AMC Description of the Scheme & the investment objective/ strategy Terms of issue Historical statistics Investor Rights & services
Period of Validity
For New Schemes: 6 months from the date of receipt. Updated every 2 years for Open Ended Funds Regular Addendum for modification Updated for every major change -Change in the AMC or Sponsor of the mutual fund -Changes in the fundamental attributes of the schemes -Changes in the investment options to investor; inclusion or deletion of options
Procedure for applying, and subsequent operations relating to transfer, redemption, nomination, pledge and mode of holding of units
The AMC is responsible for the contents and the accuracy of information
Distribution Channels
Individual Agents Distribution Companies Banks and NBFCs Direct marketing channels
Sales Practices
Advertising:
Divd declared to be mentioned in Rs. Per unit along with NAV Only CAGR if the scheme has been in existence for more than 1 yr.Less than 1 year to be on absolute basis For liquid schemes simple annualisation of yields possible if performance figure is available for more than 30 days
For funds in existence for more than 1 yr. annualized return have to be furnished for 1,3,5 yr and since inception
NAV - COMPUTATION
NAV = Net assets of scheme / No of units Outstanding i.e. Market value of investments+ Receivables+ Other accrued income+ Other assets- accrued expenses- Other Payables- Other liabilities No. of units outstanding as at the NAV date Imp : Day of NAV Calculation is known as valuation day NAV is computed for each business day
NAV
NAV is influenced by
Purchase and sale of Investment Valuation of Investment Other assets and Liabilities Units sold or redeemed.
Loads
Entry Load or front ended load Paid at the time of purchase
Sale Price = NAV * (1+ Sales Load, if any)
PRICING OF UNITS
Sale price = NAV
Re-purchase price to be not lower than 93% (95% for close-end funds) of the NAV Difference between the repurchase & sale price can not be more than 7% of the sale price
For example
If the NAV is Rs 10, Sale price = Rs. 10 Repurchase price cannot be lower than Rs 9.3
Transaction Cost
Entry / Exit load
Custodian Fee
Registry Exp. Trustee Fee Audit Fee Mktg. & Selling Exp. Brokerage Exp. Others
Recurring Expenses
Mkt & selling exp including brokerage Transaction cost R&T cost Custodian Fees Audit fees etc Investor Communications cost
Accounting Policies
Investments to be marked to market on market prices. Unrealised appreciation cannot be distributed. Purchase & sale of investments to be recognised on the trade date and not on settlement date. Investments to be taken as NPA if it gives no return through interest for more than 6 months Dividend / Bonus/ rights to be recognised on exdividend / ex-bonus dates and not on declared dates. Income receivable on Invest NOT accrued for more than 3 months , should be provided for. For determining gain/ loss on investments - avg cost is to be taken
Communication to investor
Qtr portfolio Annual report
Taxation
Mutual fund is exempt from paying taxes (section 10 (23D)) Income for investors -Dividend -Capital Gain Present position -Dividend exempt from tax in the hands of Investor -Funds with >65% in Indian equity pay no DDT -Other funds pay DDT (14.025% for individual and HUF and 22.44% for others including companies)
Taxation
Securities Transaction Tax(STT) of 0.25% sale on Equity Mutual Fund Scheme As per Section 80C of the Finance Act Investor can claim a rebate for maximum of Rs 1 lakh in ELSS. Mutual Funds units are not included under wealth tax
Indexation
Investor buys on March 31, 1999 and sells on April 1, 2000. What is the indexation adjustment factor?
1998-99 351 1999-00 386 2000-01 406
Investor buys on April 1, 1998 and sells on March 31, 2001. What is the indexation adjustment factor?
Valuation
Marking
to Market Equity Valuation Norms - Listed, Unlisted, NPA, Un-traded Debt valuation norms - Listed, Unlisted, Illiquid Money Market Instruments - valuation norms Effect of Buybacks, Mergers Valuation Models - CRISIL
Valuation
TRADED SECURITIES Last quoted closing price on the SE where principally traded If Not traded on any SE on a particular day, then earliest previous day price is taken (not more than 30 days) Valuation = MP * current holding
NON - TRADED SECURITIES Stocks which are not traded for more than 30 days on any SE are valued on good faith basis by AMC within following parameters Debt - YTM basis Equity
Capitalisation of earning or NAV or combination of both
Risk Parameters
Standard Deviation is used to measure total risk. Beta co-efficient is used to measure market risk.
Benchmarks
As per SEBI guidelines,
benchmark should reflect asset allocation Funds with 65% and more in Equity to use a broad based index (Sensex, S&P CNX 500) Bond fund with more than 65% in bonds to use a bond market index Balanced funds to use a tailor-made index (Crisil Balanced Fund index) Liquid funds to use money market instruments.
Debt
Investment restrictions
Equity investment
Options
Investment Strategies
Growth and value Active and passive Large and small cap Cyclical stock Stock selection
P/E ratio Dividend yield Undervalued companies
Debt Markets
Tenor
Short and long Put and call options
Interest payment
Fixed and floating Periodic vs discounted
Credit quality
Gilt, guaranteed and others
Debt instruments
Commercial Deposits
Corporate Debentures Zero coupon bond
Debt instruments
Commercial papers (CPs)
Govt Securities T - bills (7- 364 days)
Reinvestment Risk
Call Risk
Liquidity
Inflation
Example
Duration of a bond is 4 years. Yield spread increases by 1.5% What is the change in price
= 1.5*4 = - 6%
Credit Risk
Probability of default by the borrower Change in credit rating:
Downgrade increases the yield and decreases the price Upgrade decreases the yield and increases the price
Debt
Buy and hold - Passive Duration management - Active Credit Selection - in anticipation of changes in credit ratings Prepayment predictions
Performance Evaluation
Different valuation methods Change in Nav Total Return Total Return with dividend reinvested at NAV CAGR
Performance Evaluation
Change in Nav - The most common Nav on day 1 = Rs.10 Nav on day x = Rs.12 % Change in nav = dayx-day1/day1 * 100 = 2/10 *100 = 20 % Limitations: Does not account for dividend Suitable only for growth plans
Performance Evaluation
Total Return Nav on day 1 = Rs.20 Nav on day x = Rs.22 Dividend = Rs.4 per unit Total Return = (( Distribution + Change in nav)/day1 nav)* 100 = ((4+(22-20)/20)*100 = 30% Limitation: does not account for reinvestment
Performance Evaluation
Return on Investments - most suitable Nav on day 1 = Rs.20 Dividend = Rs.4 per unit Nav at Rs. 21 Div reinvested = Rs (4 /21) = 0.19 units allotted Total units = 1.19 (original +new allotted) NAV at year end = Rs.22 Total Return = (Nav on year end*total units )-day1 nav)/ day 1 NAV* 100
= ((22*1.19)- 20))/20*100
= 30.9%
Formula : A = P (1+r/100) ^n Where A is the total amount at the end of the investment period, P is the principal amount invested, r is the rate of return and n is the time period of the investment.
Performance Evaluation
Other Parameters Expense ratios - indicates fund efficiency and cost effectiveness Portfolio Turnover ratio - measures amount of buying and selling done by the fund Transaction cost Fund size Cash holdings
Financial Management
Financial Planning
Financial Goals
identifying various needs for money
Assist clients in choosing the right investment mix keeping in mind clients -- saving ability -- risk appetite -- cash flow requirements -- tax status
Create asset allocation plan - tailor make portfolio suiting client needs Enable actual performance - role of an intermediary Review and Rebalance continually - periodic review of performance - take corrective action, if required
Client Responsibilities
Set measurable goals Appreciate effect of financial decisions on cash flows Be open to review and re-balance portfolio on an ongoing basis Start early
Investors Needs
Protection Need To protect living standards, current and survival requirements - Regular Income - Retirement Income - Insurance Cover Investment Need Financial needs served through investments and savings - Children education - Housing - Children professional growth
Asset Allocation
Process of deciding portfolio composition
Allocate funds across equity, debt and other asset classes based on risk-return profile
Basic Indexed Portfolio - Stock market index fund - Bond market index fund
50% 50%
60% 40%
Older investors in distribution phase Younger investors in distribution phase Older investors in accumulation phase
Disciplined approach that ensures profit booking and purchases at lower prices Example - 50% Equity and 50% Debt - Equity markets rise ensuring profit booking - 50:50 Ratio maintained
Model Portfolio
Set long term goals keeping risk-return profile and time horizon in mind Asset allocation exercise based on growth, income and liquidity criteria
Sector Distribution exercise - Allocation of funds across various Mutual Fund products
Fund manager selection - Which scheme? Which Fund house?
Older couple single income - Short term municipal funds - Long term municipal funds - Moderately aggressive funds - Emerging growth equity
Recently retired couple - Conservative equity funds - Moderately aggressive equity funds - Money market funds
Value Averaging
Invest regularly to achieve a pre-determined value
Fund Selection
Average maturity
Duration
Remember :
1. Investment Decision Are Long Term Decision
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Business Ethics
Business Ethics are rules of acceptable and good conduct in business.
All persons involved with business should follow ethical codes of conduct. Business ethics are made by managers or operators of business. Business ethics are hard to enforce, hence ideally should be self-imposed.