UGC NET Study Notes on Mutual Funds || Commerce || Management || Economics

INTRODUCTION

• Mr John father of four children entered a fruit shop. He wanted to make his family happy. As everyone in the family is of different age and taste, John decides to customize a basket rather than buying only one fruit.
• So, for his wife, he took some strawberries as she is expected to bake a cake by evening. For his Elder child, he puts in Banana as he is into building muscles and gain mass. For his second child, he takes apples as he was not doing well. For his daughter, he took mango as she has a sweet tooth. And lastly, he took Watermelon for his fourth child. John made sure to get a maximum return by diversifying his money in a customized basket.

Similarly, a Mutual fund can be seen as an investment car where many investors pool their savings/money to earn return the capital over a period.

• The pool of funds is managed by a professional called fund manager
• who is responsible to invest it in different securities and assets.
• The gains (or losses) from the investment are distributed among the investors in proportion to their contribution to the fund.

DEFINITION

In a Nutshell, A mutual fund is a basket of various investments, such as stocks, bonds, and cash. A mutual fund is funded by the investments of individual investors and institutions.

HISTORY OF MUTUAL FUNDS

Mutual funds always existed in India. Indian were well versed with the concept of diversification of risk.

• The first company dealing in mutual funds was the UTI (Unit Trust of India) in 1963 as a joint venture of the RBI and the GOI (Government of India).
• The mutual fund industry in India has gone through at least 4 phases:

First Phase – Phase of Inception (1964-1987)

• Mutual funds in India started in 1963 with the formation of When UTI was set up several years ago, the idea was to not just introduce the concept of mutual funds in India; an associated idea was to set up a corpus for nation-building as well.
• Therefore, to encourage the small Indian investor, the government built in several income-tax rebates in the UTI schemes.

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

• The year 1987 embarked the entry of Public Sector mutual funds set up by the Public sector Bank like Canara Bank, Indian Bank, Life Insurance Corporation, General Insurance Corporation, and Punjab National Bank.

Third Phase – Entry of Private Sector (1993-1996)

• Financial sector reforms were needed. India needed more private sector participation to rebuild the economy.
• Thus, the government opened up the mutual fund industry for private players and foreign players. Few of them are
  • ICICI Prudential AMC
  • HDFC Mutual Fund
  • Kotak Mahindra Mutual Fund

Fourth Phase – Phase of Consolidation (2003-2014)

• In February 2003, the UTI was split into two entities, viz.
• the UTI Mutual Fund (under the SEBI regulations for MFs) and the SUUTI (Specified Undertaking of the Unit Trust of India).

Fifth Phase – Steady Development And Growth (SINCE 2014)

• SEBI introduced several progressive measures in 2012 to
  e-energize to the Indian mutual fund and to improve MF penetration.
• Since May ’14, the Indian MF industry has experienced a consistent inflow and rise in the overall AUM as well as the total number of investor accounts (portfolio).

FEATURES

• Low expenses and fees
• Consistent performance
• Investment
• Flexibility
• Diversification
• Liquidity
• Availability of many choices
• Efficient taxes
• Easy trade and transaction
• Expert management

Types of Mutual Funds in India

• SYSTEMATIC INVESTMENT PLAN (SIP) – It works similar to a recurring deposit plan where the investor can make a monthly fixed contribution.
• LUMP SUM– This is an investment of money in one go rather than contributing over a period of time.

Funds Based On Maturity Period (Functional Classification)

• Open-ended- These funds buy and sell units on a continuous basis and hence allow investors to enter and exit as per their convenience.
• Close-ended- The Unit capital of close-ended funds is fixed, and they sell a specific number of units.
• Interval funds- Interval schemes are those that combine the features of both open-ended and close-ended schemes.

Funds Based On Investment Objective

1. Equity/growth funds – These invest predominantly in equities, i.e. shares of companies. When the price of shares rises, the investor makes a profit and vice versa. Equity funds are suitable for those who stay invested for a long time and who have a high-risk appetite.
2. Debt / Income funds- They invest in fixed income government securities like treasury bills and bonds or reputed corporate deposits. These are relatively safer investments and are suitable for income generation.
3. Balanced funds- They invest in both equity and fixed-income funds to balance the risk and maintain a certain return rate.
4. Money market funds- These funds invest in safer short- term instruments such as treasury bills, certificates of deposits and Commercial paper for less than 91days. They are ideal for a cooperate or Individual investor who wishes to earn a moderate return on surplus funds.
5. Gilt funds- They exclusively invest in government securities for the long term. They are virtually risk-free and can be an ideal investment for those who don’t want to take the risk.

Other Funds

• Tax saving (Equity linked saving scheme)- Investments made in these funds qualify for deductions under Income tax. Among other tax saving options, they have the lowest lock-in period of 3 years.
• Index funds- These funds purchase all the stocks in the same proportion as in a particular index. This means the scheme will perform in tandem with the index it is tracking. Ex- Nifty.
• Sector-specific funds- These invest solely in one specific sector. For e.g., Banking, IT, pharma etc. As these funds invest in only one sector with only a few stocks, the risk is on the higher side.

EVALUATION OF PERFORMANCE OF MUTUAL FUNDS

1. Net asset value (NAV) is calculated as the current value of total assets minus the total value of all liabilities, divided by the total number of outstanding units.
2. Expense ratio is the cost of running and managing a mutual fund which is charged to the scheme. It has a direct bearing on a scheme’s NAV – the lower the expense ratio of the scheme, the higher the NAV.
3. The holding period is also another key metric for evaluation of performance.
4. Portfolio Turnover Ratio indicates the frequency with which the fund’s Holdings have changed over the past year. It is calculated by dividing the lessee of purchases/ sales by average asset under management (AUM).

DRAWBACKS

• No guarantee of return.
• Diversification (only minimizes risk but does not maximize return)
• Selection of proper fund ( easier to select the right share rather than the right fund)
• Cost factor (loads fund management expenses etc.)
• Unethical practices (mutual funds may not play fair games)
• Tax implications on mutual funds as well as a unitholder.

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