MUTUAL FUNDS

 Definition: MF is a collective investment vehicle

formed with the specific objective of raising money
from large number of individuals .
 Proceeds are used to invest in portfolio of
shares, bonds, debentures, money market
instruments etc. according to a pre-specified
objective.
 “mutual” – the benefits of the investment
accrue pro rata to all the investors in
proportion to their investment.

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 MF operation flowchart

Investor
Passed back Pool their money
to with

Returns Fund Manager

generates Securities Invests in

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 Advantage of MFs
 Professional Management
 Diversification
 Convenient administration
 Return potential
 Low cost
 Liquidity ( willingness to repurchase the MF units )
 Transparency
 Flexibility
 Choice of Schemes
 Tax Benefits
 Well-regulated.
 Switching

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 Choices Galore
 ABN AMRO Cash Fund
 Birla Sunlife Income Fund
 Fidelity Equity Fund
 UTI Thematic Large Cap Fund
 Sundaram S.M.I.L.E Fund - Growth
 Franklin India Smaller Companies Fund
 HDFC MIP LTP Fund
 LICMF Bond Fund -Growth
 UTI-SPREAD Fund
 Deutsche Alpha Equity Fund - Growth
 HDFC Multiple Yield Fund
 Principal Dividend Yield Fund
 DWS Money Plus Fund - Growth
 Birla Gen next Fund - Growth
 Franklin India Taxshield-Growth
 DSP ML Balanced Fund - Growth
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 MFs and Regulation
 Highly regulated as invests money of small scale
investors.
 SEBI is the regulator.
 Prospectus should contain:
 Minimum amount of investment required
 Investment objective of the fund
 Return of the fund in past 1 year, past 3, 5 years.
 The exposure of fund to various types of risk.
 Fees incurred by the fund ( management fees) that are
passes on to investors.
 Important features of NFO

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 Types of Fund
 The broad categories are:
 Asset Class
 Investment Sector
 Liquidity
 Trading Strategy
 Investment Strategy
 Security Selection
 Objective
 Load Charged / Cost
 Place of origin
 Asset Class

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 Asset Class
 This criterion classifies funds according to the asset class they
invest in:
 Equity Funds invest in equity shares of a company
 Debt Funds invest in debt market instruments such as bonds,
debentures etc.
 Money market funds invest in money market instruments T-
bills, .
 Balanced Funds invest in a mix of equity, debt and money
market instruments.
 Gilt Funds invest in Government Securities.

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 Investment Sector
 Categorization according to Sub-Sector
 General Funds do not specify any particular sector for
investment purposes.
 Rated AAA Funds invest in AAA and above rated paper.
 Aggressive Equity Funds are mixed funds, which have an equity
exposure of between 60 to 80 %, with the rest in debt.
 Balanced Funds have 40 to 60 % of the assets in equity and the
rest in debt.
 Passive Equity have an equity exposure of between 10 to 20 %
in equity and the rest in debt.

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 Investment Sector
 Sector FMCG Funds limit their investments to companies engaged in the
business of Fast Moving Consumer Goods and other similar businesses.
 Sector MNC Funds invest in multinationals and other similar companies.
 Sector IT Funds invest in companies engaged in the business of
Information Technology and other similar businesses.
 Sector Pharmaceuticals and Healthcare Funds invest in companies
engaged in the pharmaceuticals and healthcare business and other similar
businesses.
 Sector E Commerce Funds invest in Internet, dotcom and e-commerce
companies.
 Index-NSE 50 Funds are index funds that invest in NSE 50 companies.
 Index NIFTY + invest major part in NIFTY company and minor part in
some other company – may be left to fund managers.

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 Liquidity
 By Liquidity : As the name suggests, this uses the parameter of
time - how long will the funds be invested, how soon can you
redeem them and so on.

 Open Ended Funds: Such funds enable you to invest and redeem
your money any time! Units are continuously offered for sale, and
continuously bought back. Moreover, the schemes under which
they're sold are perpetual and do not have a fixed duration. Thus,
if you want your money to be readily accessible to you, this is the
kind of mutual fund you should go for.

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 By Liquidity
 Close Ended Funds : The exact opposite of open ended funds.
These schemes come with a fixed life! Unlike open-ended
schemes, once the initial offer closes, there is no fresh sale of
units. Normally, they do not offer repurchase and sale of
repurchased units (though there are a few exceptions). However,
as units of such funds are normally listed on one or more of the
stock exchanges, you still will be able to get liquidity from the
exchange itself.
 Interval Funds : These are a cross-breed between open and close-
ended schemes! Such funds offer resale and repurchase of units at
fixed intervals. There's only one constraint - no sale or purchase of
units takes place at any time other than the time fixed for this
purpose
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 By Trading Strategy
 This category depends on the pace at which the funds trade their securities:
 Active Funds : These are funds that are constantly active in the market - buying
and selling the securities in their portfolio very frequently. Such funds intend to
take advantage of the cycles in the market, and the opportunities in individual
securities. Technically, these funds are said to have a 'high portfolio turnover'.
 Passive Funds : As you may have expected, these are funds with low portfolio
trading. They normally follow a buy and hold strategy and do not trade their
holdings very frequently.

 Balanced Funds : Balanced Funds are those that follow the middle path between
the active and passive fund approaches! So if you're undecided about which of
the two you prefer, go in for this one!

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 By Investment Strategy
 This category is based on the various processes by which funds examine, analyze
and then invest the securities in their portfolios. Thus:
 Growth Funds pick stocks with a high growth potential. Normally, such stocks
have high price to earning ratios (P/E).
 Value Funds pick stocks that are out of favour in the market believing that their
prevailing market prices do not fully reflect their intrinsic worth.
 Value cum growth follow a mix of the growth and value approaches
 Asset Allocation funds use asset allocation as a tool to maximize returns. Here,
the fund manager attempts to earn returns by shifting between asset classes. In
doing so, he can increase exposure to debt when equity markets are down and
vice versa. Investments in this case are generally made in index heavy stocks.

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 By Security Selection
 The type of security that the fund invests in is what determines this particular
group:
 Top Down Funds are those that select stocks using the top down approach,
where the fund manager first identifies the sector in which he'd like to invest
and then the potential scrips within the sector.
 Bottom Up Funds use the bottom up approach to investing, where the fund
manager focuses on the scrips, irrespective of what sector they come under.
 Technical Funds are those that use technical analysis to select scrips.
 Small Cap Funds focus on small cap stocks for their investment portfolio.

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 By Security Selection
 Mid-Cap Funds invest in mid cap scrips.
 Large Cap Funds are those that invest in large cap scrips.

 [Note: Caps have nothing to do with headgear - they're simply funds that invest in
companies above or below certain market values!]
 AAA rated Funds are those funds that invest only in triple A rated or higher
rated securities.
 G Sec / Gilt Funds invest in gilts or government securities (g-secs)
 Combination Funds are those that use a mix of each of the above security
selection strategies.
 General Funds funds that do not follow any specified security selection criteria.

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 By Objective
 General Funds do not have any specific objectives and are ideal for investors
with no particular purpose in mind, apart from a good investment of course!

 Children's Funds enable parents or relatives to invest with the specific purpose
of generating money to meet anticipated expenses on their children in the
future. Normally, such funds are meant to fund a child's education or marriage.
In view of the medium to long term nature of investments in such funds and the
need for regular distributions to the investor, such funds follow an investment
pattern that is different from that of an ordinary open-ended fund. Many such
funds also carry a lock-in.

 Dematerialised Shares Funds invest in dematerialized shares only.

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 By Objective
 Tax Saving (ELSS) Funds operate in conformity with the guidelines issued for
Equity Linked Savings Schemes. Such schemes offer investors a tax rebate under
Section 88 of the Income Tax Act upto a maximum of Rs.20000. However, ELSS
funds also prescribe a three year lock-in period during which the funds aren't
accessible.. These funds are also required to invest a minimum of 80 % of their
corpus in equity and related securities.

 Tax Saving (Pension) enable unit holders to invest for their pension needs.
Investments in such funds normally carry a tax benefit under Section 88.
Normally, these funds also carry a lock-in period which is determined
according to the age of the investor.

 Tax Saving (Insurance Linked) offer a tax-saving option along with insurance
benefits.

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 By Objective
 Assured Return assure unit holders of a minimum return in a prescribed
period. Normally, debt funds assure returns, however, there have been instances
in India of assured return equity schemes as well.

 Short Term Funds invest with a short-term perspective. The investment

timeframe influences the security selection strategy of the fund.

 Medium Term Funds invest with a medium term perspective. Here too,
investment timeframe influences security selection.

 Long Term Funds invest purely with a long-term perspective.

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 By Load Charged/Cost
 These are based on whether a fee is charged or not for a particular transaction:

 Load Funds impose a charge on a transaction carried out by the investor. For
example, when the fund sells units, it might charge an amount over and above
the value of the units. Similarly at the time of redemption, the fund may return
a slightly smaller amount than the total value of the units. This charge imposed
by the fund is called a "load". Thus, load funds are those that impose a charge
either on entry into the fund or on exit from the fund, or in some cases both on
entry and exit, within the limits laid down by the regulatory authorities.

 No-load Funds do not charge any fee on the transactions carried out by an
investor with the fund.

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 By Place of Origin
 By Place of origin

 Offshore Funds raise money abroad to be invested in India.

 Domestic Funds raise and invest money in India.

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 Types of MF
 By Structure
 Open-end Funds: willing to repurchase the MF units from
investor at any time. Provides liquidity to investors.

 Close-end Funds: MF company do not repurchase the

Units. Investors can sell units on a stock exchange.
 Interval Funds : Combination of above two. May remain open
for some time and then becomes close ended.

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 Types of MF
 By Investment Objective
 Equity Funds
 Debt/Bond Funds
 Balanced/asset allocation Funds
 Equity Funds
 Growth Funds
 Aggressive Growth
 Index Fund
 Sector/Industry Specific Fund
 International/global equity Fund

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 Types of MF
 Bond/Debt Funds
 Income Funds
 Money Market Funds
 Tax-Free Fund
 High-Yield Bond Fund
 International and global bond funds.
 Balanced Funds

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 MFs By Structure
 Open-end Funds:
 Available for subscription all through the year
(open for subscription and redemption every
day)
 Funds don’t have fixed maturity
 Investors can buy and sell units at NAV ( Net
Asset value) related prices.
 Provides liquidity to investors.

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 On NAV
 NAV( Net Asset Value) of a MF unit indicates the value per
share.
 Estimated by using the market value of all securities
comprising the MF portfolio and the cash holding of MF.
 Any interest or dividend accrued from investment will also
be added and expenses subtracted.
 Total amount is divided by no. of outstanding units to get
NAV.

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 Close-end Funds
 Has a stipulated maturity ( 3 to 7 years)
 Open for subscription only once and can only
be redeemed after a fixed investment period.
 Units can be traded as the funds are listed in
stock exchanges ( subscribers can exit the
fund anytime through the secondary market)
OR, MFs have to periodically repurchase at
NAV related prices.

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 Close-ended Funds

 The regulating body stipulates that at least

one of the exit route is provided.
 Funds are not very liquid and usually trade at
a discount to NAV.
 Can be rolled-over by passing a resolution by
majority shareholders.

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 Open vs. close-end funds
 In close-end funds, fund managers are able to make long term
investments that may be temporarily illiquid as these funds are not
evaluated on a day to day basis.

 In open-end funds fund managers have to be extremely adept at investing

funds while providing for redemption.

 In open-end funds fund mangers sometimes make sub-optimal

investments in money market instruments due to redemption pressure.

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 Interval Fund
 Combine feature of both open-ended and close-
ended schemes.
 Open for sale or redemption during pre-
determined intervals at NAV related price.
 No sale or purchase of units takes place at any
other time other than the time fixed for this
purpose

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 MFs by Investment Objectives

 Growth Funds :
 Normally invest majority of corpus in
equities.
 As equities value fluctuate widely, NAV of
these funds fluctuate widely – funds are
riskiest.
 Investors buy these funds expecting higher
returns through increase in investment value
rather than getting steady income.

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 Growth Funds
 Ideal for investors having a long-term outlook
seeking growth over a period of time.
 Ideal for:
 investors in their prime earning years.
 investors seeking growth over the long-term

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 Capital Appreciation Fund

 Also known as aggressive growth fund.

 Portfolio consists of stocks that have potential for high
growth but unproven.
 High return potential and high risk.

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 Balanced Funds
 Invest both in equity and income bearing
instruments in proportion indicated in the offer
document.
 Aim is to provide both growth and regular income (
reduce the volatility of the fund while providing for
some upside for capital appreciation).
 In a rising market NAV of these funds neither keep
pace nor fall equally when the market falls.

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 Sector Funds
 Funds invest in a particular business sector or
industry like infotech, pharma or FMCG.
 Diversification of risk is very limited. But the
potential rewards can be high if the sector does very
well.
Index Funds
 Funds invest in same pattern imitating a popular
market index.
 This concept is referred as passive investment.
 Popular in America ( S&P 500 and NASDAQ)

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 Index Fund
 Growing acceptance of stock market efficiency
 Empirical research shows that majority of active funds under
performed popular indexes.
 Index funds are perfect for the buy-and-hold investor - the kind
of person who likes to sit back and let their investment grow,
rather than moving in and out of the market in an effort to beat
the market.
 Index funds normally have lower fees.

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 Multifund Funds
 Fund investing in portfolio of different mutual funds.
 Provides more diversification than a typical MF.
 Incur 2 types of Management Expenses:
 Expense of Managing Each individual mutual; fund
 Expense of managing multifund mutual fund.

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 International & Global Stock Funds
 A small difference in these two types of fund.
 International Fund: Investment is done purely in foreign
country securities sometimes to a specific region: pacific Rim
or, Europe etc.
 Global Fund: Domestic securities forms a part of the
portfolio along with international securities.

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 International & Global Stock Funds

 Riskier than domestic equity funds.

 Returns are affected by:
 Foreign company stock prices.
 Foreign currency appreciation/depreciation.
 NAV can change
 Foreign currency appreciation/depreciation &/or
stock price increase/decrease.

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 Bond Fund Investment Objective
 Investors in bond are concerned about
 Interest rate risk: Bond prices are inversely related to the
interest rate movements.
 Credit risk
 Tax implications
 Bond funds can be classified according to
 Maturities ( affect interest rate risk)
 Type of bond issuers (affects credit risk)

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 Income Funds
 Also known as debt funds.
 Invests in income bearing instruments like bonds,
debentures, government securities , commercial
papers etc.
 Return is less volatile but carry credit risk.
 Less risky than “equity” funds.
 Ideal for:
 Retired people and others with a need for capital
stability and regular income.
 investors who need some income to supplement
their earnings

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 Liquid Funds/ Money Market Funds

 Invests in highly liquid money market

instruments safer short-term instruments.
 Instruments normally having duration of 1
Year.
 like t-bills
 certificate of deposits
 commercial papers
 inter-bank call money

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 Liquid Funds/ Money Market Funds
 Returns on these schemes may fluctuate depending
upon the interest rates prevailing in the market.

 Act as alternative for saving and short-term fixed

deposit accounts.

 Internationally such funds operate like savings

accounts with check writing facility.

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 International & Global Bond Funds
 Returns are affected by:
 Financial positions of corporations or, governments that issued
the stock (credit risk)
 Interest rate risk.
 Exchange Rate risk.

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 Tax-Free Funds
 Investment in these bonds allows investors to pay less tax.
 Normally invested by high tax bracket individuals.
 Companies bonds with less credit risk are preferred.

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 High Yield ( Junk) Bond Funds:

 Portfolio contains sub investment grade

company bonds/debentures.
 Bonds/debentures issued by highly leveraged
firms.
 Provides higher return potential with high risk.

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 Bond Funds (Different Maturity)
 Bond Funds can be classified according to maturity.
 Intermediate-term bond fund : Invests in bonds with 5-10 yr.
maturity period
 Long-term bond fund: Invests in bonds with 15-30 yr.
maturity period.
 Investors expecting interest rate to decline in future and also
concerned about credit risk, would invest in “Long-term
Treasury bond fund”

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 Balanced Funds
 Invest both in equity and income bearing
instruments in proportion indicated in the offer
document.
 Aim is to provide both growth and regular income (
reduce the volatility of the fund while providing for
some upside for capital appreciation).
 In a rising market NAV of these funds neither keep
pace nor fall equally when the market falls.

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  Risk/Return Profile

Balanced
Fund
Equity Fund
Bond Funds

Global/
International
Money Market
Equity Fund
Funds

Lower Risk/Lower Return High Risk/High Return

Potential Potential
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Some MF Schemes
Name Aim Size (Rs. Equity Debt Cash
Lakh)
Birla Adva Equity- 377.91 86.17% 0.03% 13.80%
G Div

Alliance Equity-IT 281.32 83.70% 5.54% 10.76%

New Mill.
G
Sunda. DT-MT NA 0.00% 94.6% 5.4%
Bond
Saver
Magnum Balanced 114.38 65.97% 29.84% 4.19%
Balanced

Birla MIP DT-ME 82.71 1.24% 84.9% 13.86%

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 Mutual Fund Plans
 Growth Plan : Dividend is not paid-out under a Growth
Plan and the investor realises only the capital
appreciation on the investment (by an increase in NAV).

 Income Plan : Dividends are paid-out to investors under

an Income Plan to the investors. However, the NAV of
the mutual fund scheme under an Income Plan falls to
the extent of the dividend payout.

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 Mutual Fund Plans
 Dividend Re-investment Plan : Here the dividend
accrued on mutual funds is automatically re-invested in
purchasing additional units in open-ended funds. In most
cases mutual funds offer the investor an option of
collecting dividends or re-investing the same.

 Retirement Pension Plan : Some schemes are linked with

retirement pension. Individuals participate in these plans
for themselves, and corporates participate for their
employees.

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 Mutual Fund Plans
 Insurance Plan: UTI and LIC Mutual Funds have some
schemes that offer insurance cover to investors.

 Systematic Investment Plan (SIP) : Here the investor is

given the option of preparing a pre-determined number
of post-dated cheques in favour of the fund. The investor
is allotted units on the date of the respective cheques at
the applicable NAV.

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 Mutual Fund Plans
 Systematic Withdrawal Plan : As opposed to SIP , the SWP
allows the investor the facility to withdraw a pre-determined
amount / units from his fund at a pre-determined interval.
The investor's units will be redeemed at the applicable NAV
as on that day.

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  Growth vs. Dividend Option of Funds
 Options available in most balanced and income funds wherein the investor
can choose either to receive the dividend in cash or reinvest it
back in the fund.
 The former is called “dividend plan” and the latter is called “growth
plan”.
 Funds with “growth plan” should not be confused with
“Growth/Equity Funds”
 Examples
o IDBI Balanced G ( Growth Plan)
o Reliance Income-DM ( dividend Plan with dividend paid monthly)
o Dundee Bond Corporate DY( dividend plan with dividend paid
yearly)

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  Index Funds ( Passive Vs. Active):
 Passive Fund:
 Same stocks representing the index
 Same weightage
 Passive funds don’t have management risk.
 UTI India Access Fund (offshore) tracks S&P CNX NIFTY

 Active Fund:
 Same stock representing the index
 Different weightage.
 UTI Master Index fund tracks BSE SENSEX

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  More on Index Funds
 Index funds are diversified funds having a lower risk as a result of
their diversification.
 Returns generated by these funds are always greater than the
average returns generated by all the diversified funds put together.
 Some funds which beat the index and many more funds which do
not beat the index.
 So an investor who is not sure about which fund or fund manager
he can trust, is safe in putting his money in an index fund. This is
the best way to avoid the possibility of being with the wrong fund
at the wrong time

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  Any Fund can have active or passive trading strategy.
 Active Funds
 funds that buy and sell frequently the securities in their portfolio.
 Funds intend to take advantage of the cycles in the market, and
the opportunities in individual securities.
 funds are technically said to have a high portfolio turnover.
 Turnover ratio:
 The mutual fund asset turnover ratio measures the
percentage of the portfolio that the mutual fund replaces
on an annual basis.
 Turnover ratio: Total sales/ Total AUM asset Under
Management)
 Turnover ration of 20% indicates that the company
changes 20% of portfolio within a year and within 5 year
it changes the portfolio completely.
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  Passive Funds
 Funds with low portfolio trading.
 Funds normally follow a buy and hold strategy and do not trade
their holdings very frequently.

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 Exchange Traded Funds ( ETFs)
 Exchange traded funds (ETFs) also commonly known as
index shares is a hybrid instrument combining the
features of index mutual funds and stocks.
 An ETF is a combination of an open-end and a close-end
fund. Like any open-end fund, you can buy units with the
fund.
 In an open-end fund, investors pay cash to buy units. In
the case of an ETF, investors are required to provide the
underlying shares to buy the units.

59
 Exchange Traded Funds ( ETFs)
 For Example, Nifty BeEs, is an ETF.
 Sponsored by the Benchmark Asset Management, and
tracks the S&P CNX Nifty index.
 If an investor wants to buy units from the sponsor,it has
to deliver shares constituting the Nifty index in the
proportion defined by sponsor – which may be costly
for retail investor.
 So authorised participants are appointed to buy units
from the sponsor.

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 Exchange Traded Funds ( ETFs)
 APs exchange their portfolio of stocks and a cash
component for ETFs also known as creation units.
 Portfolio deposit consists of basket of shares that
make up an index and the cash component is the
difference between the applicable NAV and the market
value of the portfolio deposit, which arises mainly due to
transaction costs, rounding of shares and incidental
expenses involved.

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 Exchange Traded Funds (ETFs)
 Investor can buy the ETF units directly from the stock
exchange, like you buy shares of Infosys and Satyam.
 Nifty BeES are priced at one-tenth of the S&P CNX
Nifty value.
 Investors can buy/sell them directly in the secondary
market.
 Investors can not redeem the units. Have to sell them in
the secondary market?
 Only authorised participants can sell the units to the
sponsor, and receive the shares constituting the Nifty.

62
 ETFs in India
 NIFTY BENCHMARK Exchange Traded Scheme(NIFTY BeEs)
 Valuation of each unit is approximately 1/10th of the S&P CNX NIFTY.
 Inception : 18th December 2001.
 Fund Size : 8.5439 crores (31/07/2003)
 Minimum Lot Size : One Unit

 Sensex Prudential ICICI Exchange Traded Fund (SPICe):-

 Benchmark BSE Sensex. The minimum lot size is one unit, which is approximately
1/100th of the Sensex value.
 Inception : January 9th 2003
 Fund Size : 21 crores(31/07/2003)

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 ETFs in India
 JUNIOR BeEs
 Benchmark: Nifty Junior Index.
 Inception : 14th February 2003
 Fund Size : 8.5439 crores(31/07/2003)
 Minimum Lot Size : One Unit

 S&P CNX NIFTY UTI Notional Depository Receipts scheme(UTI

SUNDER)
 Benchmark S&P Nifty. Valuation of each unit of sunder would be
approximately 1/10th of the S&P CNX NIFTY.
 Inception : 11th July 2003
 Fund Size : 389.94 crores(31/07/2003)
 Minimum Lot Size : One Unit

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 ETFs in India
 Liquid BeES:
 Not based on any index.
 Invests in floating-rate instruments - mainly floating-rate debt
and short-dated debt securities.
 This scheme is suitable for investors to park their short term
surplus and who trade actively in stocks.
 Inception : 3rd July 2003
 Minimum Lot Size : One Unit

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 ETFs Vs. Index Funds
ETFs Index Funds
Intraday trading Yes No
Low Expense ratio Yes No
Real Time Quotes Yes End of the day.
Tracking Error Less More
Liquidity Risk More Nil
Short Facilty Yes More
Load Not applicable Either entry or exit
Unless redeemed
to mutual fund
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 Organization Structure of MF

SPONSOR

TRUSTEE AMC Custodian

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  SPONSOR:
 MF Scheme is initiated by a sponsor.
 Sponsor organizes and markets the fund
 It pre specifies the investment objective, cost
involved in the process and broad rules for
entry and exit from the fund
 A registered company, banks, all India or state level
financial institution of good track record and
positive networth can be sponsor– SEBI approval is
required.
 Appoints a Trustee, AMC ( Asset Management
company) and custodian

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  Trustee:
 MF scheme is a trust registered under Indian Trust Act
(1882)
 Trust is administered by a Trust Company promoted by
sponsor.
 Eligibility of Trustees depends upon their past experience,
professional qualification etc.
 Safeguards interest of investors of MF and ensure compliance
of the MF operation as per SEBI guidelines.
 AMC
 Sponsor promotes AMC ( Minimum 40% stake, rest can be
from public issue, NRI, foreign equity participation)
 Undertakes actual implementation of the policy and
investment operation
 Reports to Trustees
69
  Custodian:
 Sponsor hires a outside custodian, responsible for
the custody of assets of the fund.
 Responsible for receipt of all kinds of cash
(dividends) and non-cash benefits such as bonus,
rights etc.
 Generally a bank or other financial sound
institution.
 If the sponsor has a custodian division, it can act as a
custodian division for other MFs not set up by
sponsor.

70
  Registry & Transfer Agent: ( R & T agent)
 AMCs may hire R&T agent to manage
 Purchase and sell of units
 Issue certificates/account statements to investors
 Issues redemption checks
 Makes dividend payment
 Handles investor related service like change of address, replacement of
lost unit certificates etc.

71
  AMC fee:
 Management Fee
 Investment and advisory fees AMC charges to the fund
 SEBI permits a maximum of 1.25% of the asset value of the fund for fund
< 100cr.
 As the asset size increases, fee structure falls progressively to 0.75% on
the incremental asset value.
 Expenses
 Up front expense related to fund marketing and initial account opening–
up to maximum of 6% of the investment amount. ( termed as “load”)
 Advertising & marketing expenses,
 Brokerage & selling commission
 Printing & mailing expenses
 Legal fees
 Recurring Fees

72
  All expenses ( management fee and expenses) mentioned
earlier have an upper limit
 Maximum of 2.5% per year for equity funds and 2.25%
per year for debt funds
 As the asset size increases, the maximum limit falls
progressively to 1.75%.
 Both management fee and the expenses are
charged directly to individual MF schemes.
 Total Expense Ratio (TER) = (Total expenses during an
accounting period)/ Total net assets of the fund *100

73
  Details of Recurring expenses:
 Investment Management & Advisory Fees - meant to remunerate the asset
management company for managing the investor's money.
 Trustee Fees : Fees payable to the trustees for managing the trust.
 Custodian Fees: Fees paid by the fund to its custodians, the organisation
which handles the possession of the securities invested in by the fund.
 Registrar and Transfer Agents Charges : Fees payable to the R &T for
handling the formalities related to the transfer of units and other related
operations.
 Broker/Dealer Remuneration, Audit Fees, Cost of Funds Transfer, Cost of
providing a/c statements, Cost of Statutory Advertisements.
 Staff Cost
 Provision for depreciation in value of investment

74
  HDFC Limited ( Sponsor)

 HDFC Mutual Fund is a trust set up by HDFC Ltd. (

liability restricted to the initial corpus of Rs. 1 lakh) with
HDFC Trustee Company ( TRUSTEE)

 HDFC Asset Management company (AMC)

75
 AMCs
 Name of AMC  Nature of Ownership

 UTI Ltd.  Institution

 Tata AMC
 Private Indian
 Templeton Asset
 Private Foreign
Management (India) Pvt. Ltd.
 SBI funds AMC Ltd.
 Sundaram Newton AMC Ltd  Banks
 Private Foreign

76
 Load fund :
 Funds that impose a charge on a transaction carried out by the investor with
the fund.
 While selling units, mutual funds may charge an amount in addition to the
value of the units called “entry load”.
 Funds may at the time of redemption, return an amount slightly less than
the value of the units. This charge imposed by the fund is called a “exit load".
 Funds can have either entry or exit load or both.

 No Load Funds:
 Funds that do not impose any charge on the transactions carried out by an
investor with the fund.

77
  Load Funds:
 The entry load is the premium charged on the NAV on entry in
the scheme. The exit load is the discount charged on NAV on
exit from the scheme
 Sales Price = Applicable NAV x ( 1 + entry load % )
 Repurchase Price = Application NAV x ( 1 - exit load %)
 Entry Load: If the entry load is 5% and the unit NAV is Rs. 10,
then fresh units selling price is 10.50

 Exit Load: If the entry load is 5% and the unit NAV is Rs. 10,
then repurchase price will be Rs. 9.50

78
 Turnover Ratio
 Every mutual fund has a portfolio turnover rate.
 It is a measure of how actively a fund manager trades the
portfolio of your fund
 The turnover rate is basically the percentage of
the portfolio that is bought and sold to
exchange for other stocks.

79
 Turnover Ratio
 Expressed in percentage, the inverse of a fund's turnover
ratio is the average holding period for a security in that
fund.
 If a fund has a 20 per cent turnover ratio - on average -
the fund will hold a security for five years before selling
it.
 A fund with a 200 per cent turnover ratio will change its
portfolio in six months or in other words, replace the
entire holdings in its portfolio with new stocks in six
months.
80
 Turnover Ratio
 The turnover ratio is calculated by taking the
lesser of the annual purchases or sales and
dividing it by the average net assets of the fund.
 For instance, a fund has purchased stocks worth Rs 500
million and sold Rs 1000 million during a given year. The
turnover ratio is arrived at by dividing the lesser of the
two (in this case, purchases) by the total average assets of
the fund (say Rs 2000 million), which is 25 per cent.

81
 Turnover Ratio
 Fund managers who do extensive research on their holdings,
for example, usually have lower turnover rates than those who rely
on factors such as price momentum.
 Value-oriented funds, for the most part, have a lower turnover
than growth-oriented funds.
 Index funds have extremely low turnover ratios and
understandably so, since they are not actively managed but merely
replicate the stated benchmark.
 Further, these funds buy and sell only in the event of fresh inflows
or redemption and when there are changes in the composition of
the index
82
  Net Asset Value (NAV):
 The net asset value of the fund is the cumulative
market value of the assets net of its liabilities.
 Asset value is equal to
 Sum of market value of shares/debentures
 (+) Liquid assets/cash held, if any
 (+) Dividends/interest accrued
 (+) Amount due on unpaid assets
 (-) Expenses accrued but not paid

83
  Market Value of Shares /Debentures:
 For liquid shares/debentures, last/closing market price on
the principal exchange where the security is traded.
 For illiquid/unlisted or thinly traded shares/debentures, the
value has to be estimated.
 For shares, book value or an estimated market price if
suitable benchmark are available.
 For debentures and bonds, value is estimated on basis of
yields of comparable liquid securities.
 Valuation of debentures/bonds is a big problem ( mostly
unlisted or thinly traded) and AMC use this to value
according to their requirement.

84
  Dividends/interest accrued
 Interest is payable on debenture/bonds held by the
fund on periodic basis ( Qrly, semiannually etc.)
 Every passing day, interest is accrued at daily interest
rate.
 Daily interest rate:
 Periodic interest payment / no. of days in each
period
 Accrued interest on a particular day
 Daily interest rate * no. of days since the last interest
payment is due.

85
  Dividend Accrued:
 Dividends are proposed at the time of AGM and become due on
the record date.
 There is gap between the announcement and the actual payment
date.
 In intermediate period, dividend is ‘accrued”.
 Amount Due on unpaid assets

 Management expenses:
 Expenses including management fees, custody charges etc. are
calculated on a daily basis.

86
  Funds performance measurement:

 Relative to Benchmark method

 Risk-return method
 Sharpe Ratio
 Trynor Ratio
 Alpha
 Sortino Ratio

87
  Relative to Benchmark:
 Comparison is made between the returns given by a
market index, and the fund over a given period of
time.
 Returns generated by the fund as measured by
changes in NAV over that given period of time
 Fund return greater than the benchmark fund
return then the fund has outperformed the market
portfolio.
 very simplistic -- does not incorporate any
measure of risk in its calculation.
88
  Relative to Benchmark:

Qr. Ended Qr. Ended

Dec 00 Mar 01
Return on 3.4% ( point (-ve) 8.9%
BSE Sensex to point
basis)
Fund A 4.6% - 17.7%

Fund B 4% -12.6%

89
  Relative to Benchmark:

 For Dec 00, Fund A is better than Fund B.

 But for Mar 01, Fund A has relatively worse
performance compared to Fund B.
 Mar 01 Qr. Witnesses tech. Meltdown.
 Fund A was less diversified ( heavy exposure to IT
stocks) than Fund B.

 So return from a fund should always be adjusted to the risk.

 How much risk a fund manager has taken to generate the
return.
90
 Risk Adjusted Return
 Sharpe Ratio
 Trynor Ratio
 Alpha
 Standard deviation
 Deviation below or above mean return.
 Mean return can be average daily/weekly/monthly return.

91
 Sharpe Ratio
 Sharpe ratio = (average return – risk free
return)/ standard deviation of return.
 Sp = (rp –rf)/ p
 Higher the ratio better is the fund performance.
 A fund may have higher absolute return
compared to another fund but may have less risk-
adjusted return.

92
 Sharpe Ratio
 Sharpe Ratio:
 Sharpe ratio measures the risk adjusted return
of a fund. Simply put, the ratio measures the
variability of ' excess returns'
 Excess retuns are defined by
 For Income Funds - Returns of the fund over
the 'riskless' 91 day T-bill
 For Growth Funds - Returns of the fund over
the Sensex & Nifty
 For Balanced Funds - Returns of the fund over
the Sensex & Nifty.
93
 Treynor’s Ratio
 Treynor Ratio - A measure of the excess return
per unit of risk, where excess return is defined as
the difference between the portfolio's return and
the risk-free rate of return over the same
evaluation period and where the unit of risk is
the portfolio's beta.
 Sp = (rp –rf)/ p
 Higher the ratio better the fund performance

94
 Alpha
 Alpha: measure of selection risk (also known as residual
risk) of a mutual fund in relation to the market.
 A positive alpha is the extra return awarded to the
investor for taking a risk, instead of accepting the market
return.
 For example, an alpha of 0.4 means the fund
outperformed the market-based return estimate by
0.4%. An alpha of -0.6 means a fund's return was 0.6%
less than would have been predicted from the change in
the market alone.

95
 Calculation of Alpha
 An alpha is usually generated by regressing the security
or mutual fund's excess return on market index. The
beta adjusts for the risk (the slope coefficient). The alpha
is the intercept.
 Example:
 Suppose the mutual fund has a return of 25%, and the short-term interest
rate is 5% (excess return is 20%).
 During the same time the market excess return is 9%. Suppose the beta of
the mutual fund is 2.0
 The expected excess return given the risk is 2 x 9%=18%. The actual excess
return is 20%. Hence, the alpha is 2% or 200 basis points. Alpha is also
known as the Jensen Index

96
 Alpha
 Higher alpha, better the fund performance
 Positive Alpha: extra return due to superior
management talent (better stock picking ability)
 Alpha =0: Neutral performance by management
( equivalent to Buy-and-Hold strategy).
 Negative Alpha: Inferior management performance.
Unmanaged portfolio gave a better return.

97
 Fama’s net selectrivity
 Excess return of portlfolio over total risk
 Fams’ net selectivity = Actual Return-Excess Return
 Excess return of portfolio = Rf + (SD portfolio/ SD of
market) * (Rm-Rf)
 Higher the return better the fund.

98
  Modern Portfolio Theory
 Few simple and fundamental insights into investor behaviour
 Notion of Risk
 Notion of Portfolio Diversification
 Notion of Dominance
 Notion of Non-diversifiable or Market Risk
 Notion of Beta

99
  Notion of Risk
 Investor evaluating two shares M & N
 Return for past five years:
 M : 30%, 28%, 34% , 32% and 31%
 N : 26% ,13% ,48% ,11% and 57%
 Approaches to evaluation :
 Choose one share which has higher average return
 Both have 31 % average return
 But investors intuitively would regard share N to be riskier as as its
returns fluctuates substantially from year to year.

100
  Investors make their choice on two considerations:
 Expected return
 Riskiness of returns
 What is Risk:
 Measured by standard deviation ( )of security returns.
 for M is 2% and for N is 18.5%
 So share N is nine times riskier than share M

101
  Notion of Portfolio Diversification:
 Investor seems to follow well-known adage “don’t put all your
eggs in one basket”
 Set of all securities held by an investor is called his portfolio and
the portfolio is analysed in its entirety, not by a security in
isolation.
 Does diversification really reduce risk ?
 Read Example 7.1 of Portfolio Management
 Diversification eliminated all risk
 returns of two companies moved diametrically opposite to each other as
there is only one source of risk -- “weather”
 In reality, several sources of risk acting on securities affects the
relationship between securities.

102
  Notion of Portfolio Diversification:
 The relationship between two securities is measured by the
correlation coefficient ( )
 Can be from –1 to +1.
 Positive but less than 1 is the most commonly observed
(imperfect positive correlation).
 Two different securities from two different firms will very rarely move in
harmony.
 Give photocopy of Appendix 6 of Portfolio Management.

103
  Portfolio Diversification
 Two securities: X and Y
 E(R) :20 % & 30%
 Weights : 40% in X and 60% in Y
 SD : 10% & 16%
  of X and Y : -1 or 0 or 0.5 or +1
 Expected Portfolio return = wi E(Ri) = 26%
 SD of portfolio = wx2x2 + wy2y2 + 2wxwyxyxy
 13.6 % ( = 1)
 10.4 % ( = 0)
 12.1 % ( = 0.5)
 5.6 % ( = -1)
 Two security portfolio risk = Risk X + Risk Y +
Interactive Risk

104
  Portfolio Diversification
 The expected return of a portfolio is the weighted average of
the component expected return.
 The total risk of the portfolio comes from the variance from the
components and from the relationship among the components.
 Low correlation are valuable in portfolio risk reduction
 Point of diversification is to achieve a given level of expected
return while bearing the least possible risk.

105
  Notion of Dominance
 If two portfolios have identical expected return, then investors
would choose the one with lower volatility of return ( ).
 If two portfolios have identical volatility of return, then
investors would choose the one with higher expected return.
 Two portfolio: X and Y
 E(R) :20 % & 30%, SD : 10% & 16%
 Neither X nor Y dominate each other.
 But if Portfolio Y’s SD is 9%, then Y would dominate X.

106
  Notion of Dominance

B C
P

E (R) Q
A

RISK

107
  Enclosed area is the opportunity set ( set of all possible
portfolios)
 The concave part of the set is known as efficient set or efficient
frontier.
 Applying the dominance rule, only portfolios on this frontier
would be chosen by investors for a given level of E( R) or risk.
 Portfolio P dominates Q and no investor would choose Q.
 But neither A, B or C dominate each other.
 Investor of portfolio A will have less return and less risk than
that of Investor of Portfolio C.
 Give copy of “Taking stock” page 311 from Robert Strong

108
  Portfolio Choice with riskfree security
 Part of portfolio is invested in risk free securities (securities
yield a fixed return (rf)& has a correlation coefficient of zero
with all other securities– govt. bond)

C’

C
M
E (R ) A’
A

rf
RISK
109
  Portfolio A’ dominates A
 Combination of portfolio lying in rfM line will provide a better
expected return for a given level of risk and thus new efficient
frontier.
 M represents market portfolio – portfolio consist of all risky
securities traded in the market.
 rfM line is also called Capital Market line (CML)

110
  Return and Risk of Portfolio
 Risk premium of a portfolio (A)= Risk premium of a market
(B)* (risk of a portfolio / risk of market)
 A: excess of expected portfolio return over the rf
 B: excess of expected market return over a
 Risk of a portfolio and market :  of the portfolio and market
return

111
  Notion of Non-diversifiable or Market Risk:
 Diversification reduce risk– adding new securities reduces
portfolio 
 But can we reduce portfolio  to zero?
 Even market portfolios fluctuate.
 Diversifying does reduce risk but upto a certain level
 Adding up to 20-25 securities reduces the portfolio risk rapidly.
 Then after, marginal reduction of portfolio risk of any further
diversification becomes very small.

112
  Reduction of Risk through Diversification

R
i
s Diversifiable Risk
k
Non Diversifiable Risk

20 Shares

113
  Diversifiable/unsystematic Risk: Can be eliminated by
adding new securities to the portfolio–
 poor management risk
 low productivity risk
 commodity price risk etc.
 Non-diversifiable/ Systematic risk: Can not be
eliminated by diversification.
 Steep increase in the international crude oil price will affect all
industries
 Real riskiness of a security is its non-diversifiable risk/
market risk

114
  Notion of Beta
 Market risk (sensitivity of the security return vis-à-vis the
market return ) measured by  .
 i = Cov(Ri,Rm)/ 2 m
  of 2 implies that if market return increases/decreases by
10%, then the security return increases/decreases by 20%.
 Market portfolio has  of 1
 Risk-free security( a government bond) has  of 0

115
  Notion of Beta
 Beta of a portfolio– weighted average of the betas of the
securities that constitute the portfolio, the weights being the
proportion of investment in different securities
  >1 is Aggressive Stocks
  < 1 defensive stock.
  = 1, neutral stocks.
 “Ideal” stock for portfolio: prices should go up faster in a bull
phase and fall slower in a bear phase.

116
  Notion of Beta
 If  of X is 1.5 and Y has  of 0.9 with 70% and 30% weights
respectively,  of the portfolio will be 1.32 ( 1.5*0.7 +
0.9*0.3)
 Beta Shortcomings:
 Fama & French and host other researchers found that  is no
longer useful predictor of performance.
 High beta portfolios are not necessarily produce better returns
than low-beta portfolios.
 Specialized portfolios (industry specific) may have  well below
1 or even close to 0.
 That does not mean that these portfolios are less risky.

117
  Systematic Risk/Non Systematic Risk:
 Security Market Line(SML)
 Rit = i+ i Rmt +eit
 I and t are ith security and time period respectively.
 eit: deviation of the return from the regression line.
 i is the slope of the line and is the vertical intercept of the line.
 If Rit and Rmt are perfectly correlated eit will be zero for all
periods.

118
  Take the variance from both side :
 2 i= i 22 m + 2 e
 i 22 m = systematic risk associated with market fluctuation
 2 e = nonsystematic risk/ variance which can be eliminated by
combining security in a diversified portfolio ( variance around
the regression line)
 Give photocopy from levy and Sarnat –page 436—437.
 Give the problem 12—10.

119
  Turnover: A measure of the amount of buying and
selling activity in a fund.Turnover is defined as the
lesser of securities sold or purchased during a
year divided by the average of monthly net
assets. A turnover of 100 percent, for example,
implies positions are held on average for about a
year.

120