Chapter One

Introduction to Mutual Fund

1. INTRODUCTION
A Mutual fund is a trust that pools the savings of a number of investors who share a
common investment objective. The income of investor is collected and invested by the
fund manager in various types of Asset classes. These include 1. Stocks 2. Debt
instruments 3.Short term Money Market Instruments and other securities depending on
the objectives of the scheme, which in turn gives Little Savings to its unit holders in
proportion of the number of unit s they own. There are many types of mutual funds like
equity funds, bond funds, balanced funds, growth funds, income funds, tax saving
funds, country funds, index funds, exchange traded funds, sector funds etc.
Mutual funds provide a mechanism to invest in the stock market without knowing the
complexities of stock market. Mutual funds provide the best option to the investors who
have no knowledge of the stock market. Mutual fund is just the connecting bridge or a
financial intermediary that allows a group of investors to pool their money together with
a predetermined investment objective. They are responsible for investing the gathered
money into specific securities (stocks or bonds). They invest their money on the behalf
of investors. For this they charge only nominal fees. When you invest in a mutual fund,
you are buying units or portions of the mutual fund and thus on investing becomes a
shareholder or unit holder of the fund. Mutual funds provide more return with less risk.
The main advantage of mutual fund is that it diversifies the risk because the pooled

money is invested in diversified portfolio. Mutual funds have started in India in 1964.
The first scheme was Unit Scheme 1964. In that year UTI has the monopoly over the
mutual fund industry up to 1987. In 1987 government institutes were allowed to start
mutual funds operations. In 1993 it has opened for private sector. The regulations on
mutual funds came in the year 1996. Today there are near about 42 mutual funds
companies operated in India. Moreover government is doing every effort to promote the
mutual funds in India. In 1999 it has exempted the all dividend incomes in the hands of
investors fully tax free. Mutual funds offer close ended and open ended schemes. Close
ended schemes have some stipulated time period that is normally between 3 to 15
years. Open ended schemes are available for subscription during the all time period.
These are further available in growth, income, balanced, ELSS, FMCG, ETF, gold fund
and sector specific. Mutual fund industry is doing every effort to attract the investors to
invest in mutual funds by offering innovative schemes. Moreover Investors have great
expectations from mutual funds. So this paper is an attempt to study the performance of
mutual funds in the framework of risk and return during the period 1st April 2013 to 31st
March 2014.
1.2. History of the mutual fund
1.2.1In the Beginning
The idea of pooling resources and spreading risk using closed-end investments soon
took root in Great Britain and France, making its way to the United States in the 1890s.
The Boston Personal Property Trust, formed in 1893, was the first closed-end fund in
the U.S. The creation of the Alexander Fund in Philadelphia in 1907 was an important

step in the evolution toward what we know as the modern mutual fund. The Alexander
Fund featured semi-annual issues and allowed investors to make withdrawals on
demand.
1.2.2.The Arrival of the Modern Fund
The creation of the Massachusetts Investors' Trust in Boston, Massachusetts, heralded
the arrival of the modern mutual fund in 1924. The fund went public in 1928, eventually
spawning the mutual fund firm known today as MFS Investment Management. State
Street Investors' Trust was the custodian of the Massachusetts Investors' Trust. Later,
State Street Investors started its own fund in 1924 with Richard Paine, Richard
Saltonstall and Paul Cabot at the helm. Saltonstall was also affiliated with Scudder,
Stevens and Clark, an outfit that would launch the first no-load fund in 1928. A
momentous year in the history of the mutual fund, 1928 also saw the launch of the
Wellington Fund, which was the first mutual fund to include stocks and bonds, as
opposed to direct merchant bank style of investments in business and trade.
1.2.3.Regulation and Expansion
By 1929, there were 19 open-ended mutual funds competing with nearly 700 closedend funds. With the stock market crash of 1929, the dynamic began to change as
highly-leveraged closed-end funds were wiped out and small open-end funds managed
to survive.
Government regulators also began to take notice of the fledgling mutual fund industry.
The creation of the Securities and Exchange Commission (SEC), the passage of the

Securities Act of 1933 and the enactment of the Securities Exchange Act of 1934 put in
place safeguards to protect investors: mutual funds were required to register with the
SEC and to provide disclosure in the form of a prospectus. The Investment Company
Act of 1940 put in place additional regulations that required more disclosures and
sought to minimize conflicts of interest.

1.3. FEATURES OF MUTUAL FUNDS

1. Investors purchase standard units of fixed value at the inception of a fund.
2. Most funds also offer investors opportunity to enter after inception at prevailing value
of the units.
3. Each fund has its own investment objective.
4. Depending on the objective, the investment avenues targeted by each fund will be
different.

5. Investors chose between various funds based on their own personal investment
objectives.
6. Funds are managed by professional fund managers for fees.
7. The value of a unit at any given point would depend upon the value of the various
investments made by the fund at that point in time.
8. Subject to conditions stated at the time of inception of the fund. The investors can
redeem their investments as and when they want.

1.4. Constituents of mutual funds

All mutual funds comprise of four constituents
1. Sponsors
2. Trust /Board of trustees
3. Asset management company or fund managers
4. Custodian
There are many entities involved and the diagram below illustrates the organizational
set up of a mutual funds

1.5. MUTUAL FUNDS IN INDIA

1. Monopoly by Unit Trust of India
2. Entry of Commercial Banks.
3. Launch of variety of schemes
4. Tie up arrangements with foreign collaborators

5. Entry of Private Sector Preferred as an avenue of investment.

1.6. Advantages of mutual fund
1 Advanced Portfolio Management
You pay a management fee as part of your expense ratio, which is used to hire a
professional portfolio manager who buys and sells stocks, bonds, etc. This is a
relatively small price to pay for help in the management of an investment
portfolio.
2 Dividend Reinvestment
As dividends and other interest income is declared for the fund, it can be used to
purchase additional shares in the mutual fund, thus helping your investment
grow.
3 Risk Reduction (Safety)
A reduced portfolio risk is achieved through the use of diversification, as most
mutual funds will invest in anywhere from 50 to 200 different securities depending on their focus. Several index stock mutual funds own 1,000 or more
individual stock positions.
4 Convenience and Fair Pricing
Mutual funds are common and easy to buy. They typically have low minimum
investments (some around $2,500) and they are traded only once per day at the

closing net asset value (NAV). This eliminates price fluctuation throughout the
day and various arbitrage opportunities that day traders practice.
1.7. Disadvantages of mutual funds, such as the following:
1 High Expense Ratios and Sales Charges
If you're not paying attention to mutual fund expense ratios and sales charges,
they can get out of hand. Be very cautious when investing in funds with expense
ratios higher than 1.20%, as they will be considered on the higher cost end. Be
weary of 12b-1 advertising fees and sales charges in general. There are several
good fund companies out there that have no sales charges. Fees reduce overall
investment returns.
2 Management Abuses
Churning, turnover and window dressing may happen if your manager is abusing
his or her authority. This includes unnecessary trading, excessive replacement
and selling the losers prior to quarter-end to fix the books.
3 Tax Inefficiency
Like it or not, investors do not have a choice when it comes to capital gain
payouts in mutual funds. Due to the turnover, redemptions, gains and losses in
security holdings throughout the year, investors typically receive distributions
from the fund that are an uncontrollable tax event.

4 Poor Trade Execution

If you place your mutual fund trade anytime before the cut-off time for same-day
NAV, you'll receive the same closing price NAV for your buy or sell on the mutual
fund. For investors looking for faster execution times, maybe because of short
investment horizons, day trading, or timing the market, mutual funds provide a
weak execution strategy.