Mutual Funds
Investing in mutual funds has become the new rage among investors. There are countless new funds that are launched on a regular basis. A variety of funds, each focusing on short and long- term period are easily available. There are plentiful funds obtainable in the market that can find a perfect match to suit your risk.
A mutual fund is an investment, which is operated by an investment company that raises money from shareholders and invests it in stocks, bonds, options, commodities, or money market securities. These funds offer investors the advantages of diversification and professional management.
What are Mutual Funds?
A mutual fund is a group of stocks, bonds and other investments that are owned by a large number of investors and managed by a professional investment company. The investor buys the units of a particular fund and becomes a part of the mutual fund and participates in the loss and profits.
As a rule, Investors should read the mutual fund prospectus clearly before investing. The reason being, the prospectus clearly defines a fund’s investment objective, the investment style of the manager and the types of securities in which the fund will invest.
How does a Mutual Fund work?
When you invest in a mutual fund, you become the shareholder of the selected mutual fund. The fund manger takes the entire pool of money from all of the fund’s investors and invests it in a carefully selected range of investments based on specific goals and procedures that are outlined in the fund’s prospectus.
The fund’s value keeps fluctuating from day to day. The NAVs of the funds don’t remain constant. The value of a fund’s units i.e. NAVs are updated on a daily basis and are available on the AMC’s website.
Many factors like change in interest rates, economic trends influence the performance of a mutual fund. When you purchase units in a mutual fund, you agree to pay certain fees and expenses in the form of entry and exit load.
Different Type of Mutual Fund?
Mutual Fund Schemes are generally classified into two types viz.
- Schemes according to Maturity Period
- Open-ended Fund/ Scheme: An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis.
- Close-ended Fund/ Scheme: A close-ended fund or scheme has a fixed maturity period. The fund is open for subscription only during a specified period at the time of launch of the scheme. During this period, investors can invest in the scheme at the time of the initial public issue. When the fund date closes, the investor can buy or sell the units of the scheme on the stock exchanges where the units are listed. Some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices, which serves as exit route.
- Schemes according to Maturity Period
A scheme can also be classified as growth, income or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:- Growth / Equity Oriented Scheme: The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities, which comparatively have high risks. These schemes provide options like dividend, capital appreciation, etc. and the investors can choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.
- Income / Debt Oriented Scheme: The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long-term investors may not bother about these fluctuations.
- Balanced Fund: The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.
- Money Market or Liquid Fund: These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.
- Gilt Fund: These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors like income or debt oriented schemes.
- Index Funds: Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc. These schemes invest in the securities in the same proportion comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as ‘tracking error’ in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.
There are also exchange traded index funds launched by the mutual funds, which are traded on the stock exchanges. - Sector specific funds/schemes: Sector funds are those funds, which invest in the securities of only those sectors or industries as, specified in the offer documents e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.
- Tax Saving Schemes: These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. The growth opportunities and risks involved are somewhat similar to an equity-oriented scheme.
What are the requirements in Mutual Fund?
- Bank account details
In order to protect unit holder interest from fraudulent encasement of cheques, the current SEBI Regulations, has made it mandatory for investors to mention in their application/repurchase-redemption request, the bank name and account number of the unit holders .The AMC will not be responsible for any loss arising out of fraudulent encasement of cheques and or any delay /loss in transit. In the absence of these details, applications are liable for rejection. - Permanent Account Number (PAN)
Permanent Account Number (PAN) is necessary for transaction, according to the rules, every investor should have a Permanent Account Number (PAN), which is why it is now gaining grounds with NRIs too. Although, Non Resident Indians are not required to provide a Permanent Account Number in their Mutual Funds, shares, stocks and other related investments till now, the Securities and Exchange Board of India has directed the depositories to make PAN compulsory for all demat accounts that are started off after April, 2003. After 30th September 2006 existing demat account holders will not be allowed to operate their accounts unless their PAN card is submitted.The procedures for availing a PAN are quite simple but, for NRIs not having their own residences and / or residential proofs can be a bit discomforting. Hence, before the procedure of acquiring a PAN becomes rigid, NRI can choose an easier alternate by providing proof of residence of his representative assessee.
Such representative assesses can be resident parents, brothers, close relatives or even friends. Details regarding PAN are mentioned herein. An NRI can avail a PAN by making an application to the Income Tax office or Office of Unit Trust of India. An NRI is required to submit the following:- Copy of passport
- Photograph
- Copy of Visa in case of an Indian citizen
- Details and photograph of representative assessee i.e. say, parents or brothers or even a friend’s details and
- Proof of residence of representative assesses being any one of the documents be that telephone bill, electricity bill, ration card, bank statement or driving licence, showing the address of representative assesses
What are the risks involved?
Investment in Mutual Fund are subject to market risks. The following risks are mentioned below:
- Mutual funds and securities are subject to market risks and there is no assurance and no guarantee that the objectives of the mutual fund will be achieved.
- The NAV of the units issued under the scheme may go up or down depending on the factors and forces affecting capital markets.
- Past performance of the Sponsor/AMC/Mutual fund does not indicate the future performance of the schemes of the Mutual Fund.
- Investors in the scheme are not guaranteed of any assured /guaranteed returns.
Can NRIs invest in Mutual Funds in India?
Investments by NRIs in Mutual Funds can be made on a repatriable or on a non-repatriable basis, as preferred by the investor
- Repatriable Basis: To invest on a repatriable basis, you must have an NRE or FCNR Bank Account in India. The Reserve Bank of India (RBI) has granted a general permission to Mutual Funds to offer mutual fund schemes on repatriation basis, subject to the following conditions:
- The mutual fund should comply with the terms and conditions stipulated by SEBI.
- The amount representing investment should be received by inward remittance through normal banking channels, or by debit to an NRE / FCNR account of the non-resident investor.
- The net amount representing the dividend / interest and maturity proceeds of units may be remitted through normal banking channels or credited to NRE / FCNR account of the investor, as desired by him subject to payment of applicable tax.
- Non-Repatriable Basis: The Reserve Bank of India (RBI) has granted a general permission to Mutual Funds to offer mutual fund schemes on non-repatriation basis, subject to the following conditions:
- Funds for investment should be provided by debit to NRO account of the NRI investor. Alternatively, funds may be invested by inward remittance or by debit to NRE / FCNR Account.
- The current income in the form of dividends is allowed to be repatriated.
No permission of Reserve Bank either by the Mutual Fund or the NRI investor is necessary.
Understanding Depository System
What is a Depository?
A depository is an organisation, which holds securities of investors in electronic form at the request of the investors through a registered Depository Participant. It also provides services related to transactions in securities.
How is a depository similar to a bank?
It can be compared with a bank, which holds the funds for depositors. A Bank – Depository Analogy is given in the following table:
| BANK | DEPOSITORY |
|---|---|
| Holds funds in an account | Hold securities in an account |
| Transfers funds between accounts on the instruction of the account holder |
Transfers securities between accounts on the instruction of the account holder |
| Facilitates transfer without having to handle money | Facilitates transfer of ownership without having to handle securities |
| Facilitates safekeeping of money | Facilitates safekeeping of securities |
How many depositories are registered with SEBI?
At present two Depositories viz. National Securities Depository Limited (NSDL) and Central Depository Services (I) Limited (CDSL) are registered with SEBI.
What is a depository participant?
A Depository Participant (DP) is an agent of the depository through which it interfaces with the investor. A DP can offer depository services only after it gets proper registration from SEBI. Banking services can be availed through a branch whereas depository services can be availed through a DP.
What is the minimum net worth required for a depository?
The minimum net worth stipulated by SEBI for a depository is Rs.100 crore.
How many Depository Participants are registered with SEBI?
As on 31/03/2006, total of 538 DPs are registered with SEBI. A list of DP’s and their addresses can be downloaded from SEBI website.
Is it compulsory for every investor to open a depository account to trade in the capital market?
As per the available statistics at BSE and NSE, 99.9% settlement takes place in demat mode only. Therefore, in view of the convenience in settlement through demat mode, it is advisable to have a beneficiary owner (BO) account to trade at the exchanges.
What are the benefits of availing depository services?
The benefits are enumerated below: A safe and convenient way to hold securities Immediate transfer of securities No stamp duty on transfer of securities Elimination of risks associated with physical certificates such as bad delivery, fake securities, delays, thefts etc. Reduction in paperwork involved in transfer of securities Reduction in transaction cost No odd lot problem, even one share can be sold Nomination facility Change in address recorded with DP gets registered with all companies in which investor holds securities electronically eliminating the need to correspond with each of them separately Transmission of securities is done by DP eliminating correspondence with companies Automatic credits into demat account of shares, arising out of bonus/split/consolidation/merger etc. Holding investments in equity and debt instruments in a single account.
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