Mutual Funds

Indian mutual fund Industry:

Reliance Mutual Fund dominates the Indian mutual fund industry, which has a total
corpus of over Rs.1000bn collected from more than 20 million investors. Reliance has
many funds/schemes in all categories. i.e. equity, balanced and income with some being
open-ended and some being closed-ended. Reliance Growth fund is one of the top
performer of the group which aims to achieve long term growth of capital by investment
in equities, it has a corpus of about Rs.2740 Crores. The company has a presence in
around 118 cities throughout India.

Next largest from the perspective of AUM is HDFC mutual fund followed closely by
ICICI prudential at number 3. Both companies are floated by the private sector largest
asset management companies. HDFC has a corpus of around 78200 crores whereas ICICI
has a corpus of 70200 crores.

UTI AMC which one of the pioneers in the mutual fund industry is at the fourth position
with a corpus of 67980 crores. It has a nationwide network consisting 114 UTI Financial
Centres and UTI International offices in London, Dubai and Bahrain, it has recently
opened 1 satellite office with a view to reach investors at District level.

Major Mutual Fund Companies in India

ABN AMRO Mutual Fund

ABN AMRO Mutual Fund was setup on April 15, 2004 with ABN AMRO Trustee (India)
Pvt. Ltd. as the Trustee Company. The AMC, ABN AMRO Asset Management (India)
Ltd. was incorporated on November 4, 2003. Deutsche Bank A G is the custodian of ABN
AMRO Mutual Fund.

Birla Sun Life Mutual Fund

Birla Sun Life Mutual Fund is the joint venture of Aditya Birla Group and Sun Life

1
 Mutual Funds

Financial. Sun Life Financial is a golbal organisation evolved in 1871 and is being
represented in Canada, the US, the Philippines, Japan, Indonesia and Bermuda apart from
India. Birla Sun Life Mutual Fund follows a conservative long-term approach to
investment. Recently it crossed AUM of Rs. 10,000 crores.

Bank of Baroda Mutual Fund (BOB Mutual Fund)

Bank of Baroda Mutual Fund or BOB Mutual Fund was setup on October 30, 1992 under
the sponsorship of Bank of Baroda. BOB Asset Management Company Limited is the
AMC of BOB Mutual Fund and was incorporated on November 5, 1992. Deutsche Bank
AG is the custodian.

HDFC Mutual Fund

HDFC Mutual Fund was setup on June 30, 2000 with two sponsorers nemely Housing
Development Finance Corporation Limited and Standard Life Investments Limited.

HSBC Mutual Fund

HSBC Mutual Fund was setup on May 27, 2002 with HSBC Securities and Capital
Markets (India) Private Limited as the sponsor. Board of Trustees, HSBC Mutual Fund
acts as the Trustee Company of HSBC Mutual Fund.

ING Vysya Mutual Fund

ING Vysya Mutual Fund was setup on February 11, 1999 with the same named Trustee
Company. It is a joint venture of Vysya and ING. The AMC, ING Investment
Management (India) Pvt. Ltd. was incorporated on April 6, 1998.

Prudential ICICI Mutual Fund

The mutual fund of ICICI is a joint venture with Prudential Plc. of America, one of the
largest life insurance companies in the US of A. Prudential ICICI Mutual Fund was setup
on 13th of October, 1993 with two sponsorers, Prudential Plc. and ICICI Ltd. The Trustee
Company formed is Prudential ICICI Trust Ltd. and the AMC is Prudential ICICI Asset
Management Company Limited incorporated on 22nd of June, 1993.

2
 Mutual Funds

Sahara Mutual Fund

Sahara Mutual Fund was set up on July 18, 1996 with Sahara India Financial Corporation
Ltd. as the sponsor. Sahara Asset Management Company Private Limited incorporated on
August 31, 1995 works as the AMC of Sahara Mutual Fund. The paid-up capital of the
AMC stands at Rs 25.8 crore.

State Bank of India Mutual Fund

State Bank of India Mutual Fund is the first Bank sponsored Mutual Fund to launch
offshor fund, the India Magnum Fund with a corpus of Rs. 225 cr. approximately. Today
it is the largest Bank sponsored Mutual Fund in India. They have already launched 35
Schemes out of which 15 have already yielded handsome returns to investors. State Bank
of India Mutual Fund has more than Rs. 5,500 Crores as AUM. Now it has an investor
base of over 8 Lakhs spread over 18 schemes.

Tata Mutual Fund

Tata Mutual Fund (TMF) is a Trust under the Indian Trust Act, 1882. The sponsorers for
Tata Mutual Fund are Tata Sons Ltd., and Tata Investment Corporation Ltd. The
investment manager is Tata Asset Management Limited and its Tata Trustee Company
Pvt. Limited. Tata Asset Management Limited's is one of the fastest in the country with
more than Rs. 7,703 crores (as on April 30, 2005) of AUM.

Kotak Mahindra Mutual Fund

Kotak Mahindra Asset Management Company (KMAMC) is a subsidiary of KMBL. It is
presently having more than 1,99,818 investors in its various schemes. KMAMC started
its operations in December 1998. Kotak Mahindra Mutual Fund offers schemes catering
to investors with varying risk - return profiles. It was the first company to launch
dedicated gilt scheme investing only in government securities.

3
 Mutual Funds

Unit Trust of India Mutual Fund

UTI Asset Management Company Private Limited, established in Jan 14, 2003, manages
the UTI Mutual Fund with the support of UTI Trustee Company Privete Limited. UTI
Asset Management Company presently manages a corpus of over Rs.20000 Crore. The
sponsorers of UTI Mutual Fund are Bank of Baroda (BOB), Punjab National Bank
(PNB), State Bank of India (SBI), and Life Insurance Corporation of India (LIC). The
schemes of UTI Mutual Fund are Liquid Funds, Income Funds, Asset Management
Funds, Index Funds, Equity Funds and Balance Funds.

Reliance Mutual Fund

Reliance Mutual Fund (RMF) was established as trust under Indian Trusts Act, 1882. The
sponsor of RMF is Reliance Capital Limited and Reliance Capital Trustee Co. Limited is
the Trustee. It was registered on June 30, 1995 as Reliance Capital Mutual Fund which
was changed on March 11, 2004. Reliance Mutual Fund was formed for launching of
various schemes under which units are issued to the Public with a view to contribute to
the capital market and to provide investors the opportunities to make investments in
diversified securities.

Standard Chartered Mutual Fund

Standard Chartered Mutual Fund was set up on March 13, 2000 sponsored by Standard
Chartered Bank. The Trustee is Standard Chartered Trustee Company Pvt. Ltd. Standard
Chartered Asset Management Company Pvt. Ltd. is the AMC which was incorporated
with SEBI on December 20,1999.

Franklin Templeton India Mutual Fund

The group, Frnaklin Templeton Investments is a California (USA) based company with a
global AUM of US$ 409.2 bn. (as of April 30, 2005). It is one of the largest financial
services groups in the world. Investors can buy or sell the Mutual Fund through their
financial advisor or through mail or through their website. They have Open end
Diversified Equity schemes, Open end Sector Equity schemes, Open end Hybrid
schemes, Open end Tax Saving schemes, Open end Income and Liquid schemes, Closed

4
 Mutual Funds

end Income schemes and Open end Fund of Funds schemes to offer.

Morgan Stanley Mutual Fund India

Morgan Stanley is a worldwide financial services company and its leading in the market
in securities, investmenty management and credit services. Morgan Stanley Investment
Management (MISM) was established in the year 1975. It provides customized asset
management services and products to governments, corporations, pension funds and non-
profit organisations. Its services are also extended to high net worth individuals and retail
investors. In India it is known as Morgan Stanley Investment Management Private
Limited (MSIM India) and its AMC is Morgan Stanley Mutual Fund (MSMF). This is the
first close end diversified equity scheme serving the needs of Indian retail investors
focussing on a long-term capital appreciation.

2. DEFINITION-MUTUAL FUNDS:

A Mutual Fund is an institution/trust that pools the savings of a number of

investors who share a common financial goal. The money thus collected is then invested
in capital market instruments such as shares, debentures and other securities. The income
earned through these investments and the capital appreciation realised are shared by its
unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is
the most suitable investment for the common man as it offers an opportunity to invest in a
diversified, professionally managed basket of securities at a relatively low cost.

WORKING OF MUTUAL FUND:

A mutual fund is a common pool of money into which investors place their contributions
that are to be invested in accordance with a stated objective.
The ownership of the fund is thus joint or mutual; the fund belongs to all investors. A
single investors ownership of the fund is in the same proportion as the amount of
contribution made by him or her bears to the total amount of the fund.

5
 Mutual Funds

A mutual fund uses the money collected from investors to buy those assets
which are specifically permitted by its investment objective. Thus, an equity fund would
buy mainly equity assets- ordinary shares, pref.shares, warrents etc. A bond fund would
mainly buy debt instrument such as debentures, bonds or govt.securities.

The investors pool their money and give it to the fund managers and they are responsible
for the better fund management whereby they invest in the securities and help the
investors to get better returns. These returns are passed back to the investors. To achieve
better return and have good choice the investors have to beforehand follow a few basic
rules of investing:

1. Diversify your investments;

2. Understand the relationship between risk and reward;
3. Maintain realistic expectations about investment performance;
4. Keep short-term market movements in perspective;
5. Consider the impact that fees and taxes will have on your investment return; and
6. Remember that an investment's past performance is not necessarily indicative of
its future results.

6
 Mutual Funds

ADVANTAGES OF MUTUAL FUNDS:

The advantages of investing in a Mutual Fund are:

Professional Management - The primary advantage of funds ( atleast

theoretically) is the professional management of your money. Investors purchase
funds because they do not have the time or the expertise to manage their own
portfolios. A mutual fund is a relatively inexpensive way for a small investor to
get a full-time manager to make and monitor investments.
Economies of scale - Because a mutual fund buys and sells large amounts of
securities at a time, its transaction costs are lower than what an individual would
pay for securities transactions.
Diversification There is overall reduction of risk, that is, by owning shares in a
mutual fund instead of owning individual stocks or bonds, your risk is spread out.
The idea behind diversification is to invest in a large number of assets so that a
loss in any particular investment is minimized by gains in others. In other words,
the more stocks and bonds you own, the less any one of them can hurt you. Large
mutual funds typically own hundreds of different stocks in many different
industries. It wouldn't be possible for an investor to build this kind of a portfolio
with a small amount of money.
Liquidity - Just like an individual stock, a mutual fund allows you to request that
your shares be converted into cash at any time.
Convenient Administration
Return Potential- Over a medium to long-term, mutual funds have a potential to
provide higher returns, as they invest in a diversified basket of selected securities.
Low Costs- Investing in the capital markets because the benefits of scale in
brokerage, mutual funds are a relatively less expensive way to invest compared to
directly custodial and other fees translate into lower costs for investors.
Transparency You get regular information on the value of your investment in
addition to the disclosure of the specific investment made by your scheme, the
proportion invested in each class of assets and the fund managers investment
strategy and outlook.

7
 Mutual Funds

Flexibility Through features such as regular investment plans, regular

withdrawal plans and dividend reinvestment plans, you can systematically invest
or withdraw funds according to your need and convenience.
Choice of schemes
Tax benefits- Any income distributed after March 31, 2002 will be subject to tax
in the assessment of all unit-holders. However as a measure of concession to Unit-
holders of open-ended and equity-oriented funds, income distribution for the year
ending March 31,2003 ; will be taxed at the concessional rate of 10%.
Well regulated- All mutual funds are registered with SEBI and they function
under the provisions of strict regulations designed to protect the interest of the
investors.

DISADVANTAGES OF MUTUAL FUNDS:

Some disadvantages of mutual funds are:

No Guarantees: No investment is risk free. If the entire stock market declines in
value, the value of mutual fund shares will go down as well, no matter how
balanced the portfolio. Investors encounter fewer risks when they invest in mutual
funds than when they buy and sell stocks on their own. However, anyone who
invests through mutual fund runs the risk of losing money.
Fees and Commissions: All funds charge administrative fees to cover their day-
to-day expenses. Some funds also charge Sales commission or loads to
compensate brokers, financial consultants and/or financial planners. Even if you
dont use a broker or other financial advisor, you will pay a sales commission if
you buy shares in a Load fund.
Taxes: During a typical year, most actively managed mutual funds sell anywhere
from 20% to70% of the securities in their portfolio. If your fund makes a profit on
its sales, you will pay taxes on the income you receive, even if you reinvest the
money you made.
Management Risk: When you invest in the mutual fund, you depend on the fund
manager to make right decisions regarding the funds portfolio. If the manager

8
 Mutual Funds

does not perform as well as you had hoped, you might not make as much money
on your investments as you expected. Of course, if you invest in Index funds, you
forego management risk, because these funds do not employ managers.

3. TYPES OF MUTUAL FUND SCHEMES:

Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial
position, risk tolerance and return expectations etc. The table below gives an overview
into the existing types of schemes in the Industry.

MUTUAL FUND SCHEMES

BY STRUCTURE BY INVESTMENT OBJECTIVE OTHER SCHEMES

- Open-Ended schemes - Growth schemes - Tax-saving schemes
- Closed-Ended schemes - Income schemes - Special schemes:
- Interval Schemes - Balanced Schemes # Index schemes
- Money market schemes # Sector specific Schemes
# Exchange traded
fund

Any mutual fund has an objective of earning income for the investors and/ or getting
increased value of their investments. To achieve these objectives mutual funds adopt
different strategies and accordingly offer different schemes of investments. On this basis,
the simplest way to categorize schemes would be to group these into two broad
classifications: Operational Classification and Portfolio Classification.

Operational classification highlights the two main types of schemes, i.e., open-ended and
close-ended which are offered by the mutual funds.

9
 Mutual Funds

Portfolio classification projects the combination of investment instruments and

investment avenues available to mutual funds to manage their funds. Any portfolio
scheme can be either open ended or close ended.
A. Operational Classification

(a) Open Ended Schemes: As the name implies the size of the scheme (Fund) is open
i.e., not specified or pre-determined. Entry to the fund is always open to the investor who
can subscribe at any time. Such fund stands ready to buy or sell its securities at any time.
It implies that the capitalization of the fund is constantly changing as investors sell or buy
their shares. Further, the shares or units are normally not traded on the stock exchange but
are repurchased by the fund at announced rates. Open-ended schemes have comparatively
better liquidity despite the fact that these are not listed. The reason is that investor can
any time approach mutual fund for sale of such units. No intermediaries are required.
Moreover, the realizable amount is certain since repurchase is at a price based on
declared net asset value (NAV). No minute-to-minute fluctuations in rates haunt the
investors. The portfolio mix of such schemes has to be investments, which are actively
traded in the market. Otherwise, it will not be possible to calculate NAV. This is the
reason that generally open-ended schemes are equity based. Moreover, desiring
frequently traded securities, open-ended schemes hardly have in their portfolio shares of
comparatively new and smaller companies since these are not generally traded. In such
funds, option to reinvest its dividend is also available. Since there is always a possibility
of withdrawals, the management of such funds becomes more tedious as managers have
to work from crisis to crisis. Crisis may be on two fronts, one is, that unexpected
withdrawals require funds to maintain a high level of cash available every time implying
thereby idle cash. Fund managers have to face questions like what to sell. He could very
well have to sell his most liquid assets. Second, by virtue of this situation such funds may
fail to grab favorable opportunities. Further, to match quick cash payments, funds cannot
have matching realisation from their portfolio due to intricacies of the stock market.
Thus, success of the open-ended schemes to a great extent depends on the efficiency of
the capital market.

10
 Mutual Funds

Summarizing the Key characteristics of Open-Ended scheme:

No fixed Maturity

Variable Corpus

Not Listed

Buy from and sell to the fund

Entry/ Exit at NAV related Prices

(b) Close Ended Schemes: Such schemes have a definite period after which their shares/
units are redeemed. Unlike open-ended funds, these funds have fixed capitalisation, i.e.,
their corpus normally does not change throughout its life period. Close ended fund units
trade among the investors in the secondary market since these are to be quoted on the
stock exchanges. Their price is determined on the basis of demand and supply in the
market. Their liquidity depends on the efficiency and understanding of the engaged
broker. Their price is free to deviate from NAV, i.e., there is every possibility that the
market price may be above or below its NAV. If one takes into account the issue
expenses, conceptually close ended fund units cannot be traded at a premium or over
NAV because the price of a package of investments, i.e., cannot exceed the sum of the
prices of the investments constituting the package. Whatever premium exists that may
exist only on account of speculative activities. In India as per SEBI (MF) Regulations
every mutual fund is free to launch any or both types of schemes.

Summarizing the Key characteristics of Closed-Ended scheme:

Fixed Maturity

Fixed Corpus

Generally listed

Buy and Sell in the Stock Exchanges

Entry/ Exit at the Market prices

11
 Mutual Funds

B. Portfolio Classification of Funds:

Following are the portfolio classification of funds, which may be offered. This
classification may be on the basis of (a) Return, (b) Investment Pattern, (c) Specialised
sector of investment, (d) Leverage and (e) Others.

(a) Return based classification:

To meet the diversified needs of the investors, the mutual fund schemes are made to
enjoy a good return. Returns expected are in form of regular dividends or capital
appreciation or a combination of these two.

i. Income Funds: For investors who are more curious for returns, Income funds are
floated. Their objective is to maximise current income. Such funds distribute periodically
the income earned by them. These funds can further be splitted up into categories: those
that stress constant income at relatively low risk and those that attempt to achieve
maximum income possible, even with the use of leverage. Obviously, the higher the
expected returns, the higher the potential risk of the investment.

ii. Growth Funds: Such funds aim to achieve increase in the value of the underlying
investments through capital appreciation. Such funds invest in growth-oriented securities,
which can appreciate through the expansion production facilities in long run. An investor
who selects such funds should be able to assume a higher than normal degree of risk.

iii. Conservative Funds: The fund with a philosophy of all things to all issue offer
document announcing objectives as: (i) To provide a reasonable rate of return, (ii) To
protect the value of investment and, (iii) To achieve capital appreciation consistent with
the fulfillment of the first two objectives. Such funds, which offer a blend of immediate
average return and reasonable capital appreciation, are known as middle of the road
funds. Such funds divide their portfolio in common stocks and bonds in a way to achieve
the desired objectives. Such funds have been most popular and appeal to the investors
who want both growth and income.

(b) Investment Based Classification:

Mutual funds may also be classified on the basis of securities in which they invest.
Basically, it is renaming the subcategories of return based classification.

12
 Mutual Funds

i. Equity Fund: Such funds, as the name implies, invest most of their investible
shares in equity shares of companies and undertake the risk associated with the
investment in equity shares. Such funds are clearly expected to outdo other funds in
rising market, because these have almost all their capital in equity. Equity funds again can
be of different categories varying from those that invest exclusively in high quality blue
chip companies to those that invest solely in the new, unestablished companies. The
strength of these funds is the expected capital appreciation. Naturally, they have a higher
degree of risk.

ii. Bond Funds: such funds have their portfolio consisted of bonds, debentures, etc.
this type of fund is expected to be very secure with a steady income and little or no
chance of capital appreciation. Obviously risk is low in such funds. In this category we
may come across the funds called Liquid Funds which specialise in investing short-term
money market instruments. The emphasis is on liquidity and is associated with lower
risks and low returns.

iii. Balanced Fund: The funds, which have in their portfolio a reasonable mix of equity
and bonds, are known as balanced funds. Such funds will put more emphasis on equity
share investments when the outlook is bright and will tend to switch to debentures when
the future is expected to be poor for shares.

(c) Sector Based Funds:

There are number of funds that invest in a specified sector of economy. While such funds
do have the disadvantage of low diversification by putting all their all eggs in one basket,
the policy of specialising has the advantage of developing in the fund managers an
intensive knowledge of the specific sector in which they are investing. Sector based funds
are aggressive growth funds which make investments on the basis of assessed bright
future for a particular sector. These funds are characterised by high viability, hence more
risky.

13
 Mutual Funds

MUTUAL FUND CLASSIFICATIONS:

Open-end & Closed-end Funds

Load & No-load Funds
Tax-exempt &Non-tax-exempt Funds

OPEN-END & CLOSED-END FUNDS:

An open-end fund is one that has units available for sale & repurchase at all time. An
investor can buy or redeem units from the funds itself at a price, based on the NAV per
unit.

The no. of units outstanding goes up or down every time the funds issues new units or
repurchase existing units. In other words, the unit capital of an open-end fund is not
fixed but variable. The fund size & its total investment amount goes up if more new
subscription come in the form new investor than redemption by existing investors; the
fund shrinks when redemption of units exceed fresh subscription

It is important to note that an open-end fund is not obliged to keep selling/issuing new
units at all time & many successful funds stop issuing new units after they reach a certain
size & think they cant manage a larger fund without adversely affecting profitability.
On the other hand, an open-end fund rarely denies to its investors the facility to redeem
existing units, subject to certain obvious condition.

Unlike an open-end fund, the unit capital of a closed-end fund is fixed, as it makes a
one-time sale of a fixed number of units. Unlike open-end funds, closed-end funds dont
allow investors to buy or redeem units directly from funds. However, to provide the
much-needed liquidity to investors, many closed-end funds get themselves listed on a
stock exchange.
Here it is important to note that no. of outstanding units of a closed-end fund doesnt vary
on account of trading in the funds unit at the stock-exchange.

14
 Mutual Funds

LOAD & NO-LOAD FUNDS

Marketing of a new fund involve initial expenses. Charges made by the fund manager to
recover these selling/marketing/distribution expenses are called load.
SEBI has defined a load as the one-time fee payable by the investor to allow the fund to
meet initial issue expenses. Including brokers/agents/distributors commission,
advertisement & marketing expenses.

There is different type of loads:

a) FRONT-END or ENTRY LOAD:

The load charged to the investor at the time of his entry into scheme is called as a
Front-end or entry load.
Sale Price = NAV / (1- Sales Load, if any)

b) DEFERRED LOAD:
The load amount charged to the scheme over a period of time is called as a
Deferred load.

c) BACK- END or EXIT LOAD:

The load that investor pays at the time of his exist is called as a Back-End or
Exist Load.
Redemption Price = NAV/(1+ Exit Load)

Funds that charges front-end, back-end or deferred loads are called LOAD FUNDS.

Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time
one buys or sells units in the fund, a charge will be payable. This charge is used by the
mutual fund for marketing and distribution expenses. Suppose the NAV per unit is Rs.10.
If the entry as well as exit load charged is 1%, then the investors who buy would be
required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund

15
 Mutual Funds

will get only Rs.9.90 per unit. The investors should take the loads into consideration
while making investment as these affect their yields/returns. However, the investors
should also consider the performance track record and service standards of the mutual
fund which are more important. Efficient Mutual funds may give higher returns in spite
of loads.
Funds that make no such charges or loads are called NO-LOAD FUNDS.
It means the investors can enter the fund/scheme at NAV and no additional charges are
payable on purchase or sale of units.

SEBI regulations allow AMC to recover loads from investor up to a certain limit. This
limit currently stands at 6%. This means that initial issue expenses shouldnt 6% of the
initial corpus mobilized during the initial offer period.

TAX-EXEMPT & NON-TAX-EXEMPT FUNDS

When a fund invests in tax-exempt securities, it is called TAX-EXEMPT FUNDS.

When a fund invests in a taxable securities, it is called NON- TAX-EXEMPT FUNDS.
In India, after the 1999 Union Govt. Budget all the dividend income received from any of
the mutual funds is tax-free in the hands of investors. However funds other than equity
funds have to pay distribution tax before distributing income to investors.

MUTUAL FUND TYPES:

(A) MONEY MARKET FUNDS:

Money Market Funds invest in securities of a short-term nature, which generally

means securities of less than 1 year maturity. These type of funds generally invest in
treasury bills issued by govt., certificate of deposit issued by banks, commercial paper
issued by co. & inter-bank call money market.

16
 Mutual Funds

Examples- PruICICI Liquid Fund, Reliance Short Term Fund, Reliance Liquid Fund,
Kotak Liquid Fund, Magnum Insta Cash Fund, Principal Cash Management Fund,
UTI Money Market Fund.

(B) GILT FUNDS:

Gilts Funds invest in govt. securities. Here, since the issuer is govt./s of India/states,
these funds have little risk of default & better protection of principal.
Examples- Pru ICICI Gilt-Treasury Fund, Pru ICICI Gilt-Investment Fund, Reliance
Gilt Securities Fund, Kotak Gilt Fund, Magnum Gilt Fund, Birla Gilt Plus Fund, UTI
G-Securities Fund.

(C) DEBT FUNDS:

Debts Funds invest in debt instrument issued not only by govt., but also by pvt.
Cos, banks & financial institution etc. By investing in debts, these funds target low
risk & stable income for investors.
However as compared to money market funds, they do have a higher price fluctuation
risk, since they invest in longer-term securities.
Debts funds are largely considered as Income funds as they dont target capital
appreciation look for high current income & therefore distribute a substantial part of
their surplus to investor.
Examples-Pru ICICI Income Plan, Reliance Medium Term Fund, Magnum Income
Fund, Principal Income Fund.

Debts Funds are of different type:

(1)DIVERSIFIED DEBT FUNDS:

A debt fund that invests in all available type of debt securities, issued by entities
across all industries & sectors is a properly diversified debt fund.

17
 Mutual Funds

A diversified debt fund has the benefit of risk reduction through diversification &
sharing of any default-related losses by a large number of investors.

(2) FOCUSSED DEBT FUNDS:

These types of funds have a narrower focus, with less diversification in its
investment. These types of funds invest only in corporate deb. & bonds or only in tax-
free infrastructure or municipal bonds.

(3)HIGH YIELD DEBT FUNDS:

These type of funds seek to obtain higher interest return by investing in debt
instrument that are considered below investment grade. Clearly, these funds are
exposed to higher risk.
Examples: Birla Dividend Yield Plus, Tata Dividend Yield Fund.

(D) ASSURED RETURN FUNDS :

These types of funds are prevalent in India. These type of funds offer assured return
scheme to investors. Returns are indicated in advance for all the future years of
these closed-end schemes. If there is any shortfall, it is borne by sponsors.
Examples: Monthly Income Plan of UTI., Pru ICICI MIP, Reliance MIP, Magnum
MIP, Birla MIP.

(E) FIXED TERM PLAN SERIES:

A mutual fund scheme normally is either open-end or closed-end. Fixed term

Plan series offer a combination of both these features to investors as a series of
plans are offered & units are issued at frequent intervals for short plan duration.

18
 Mutual Funds

(F) EQUITY FUNDS :

These type of funds mainly invest in equity market.

Equity funds are of different types. These are following:
(a)AGGRESSIVE GROWTH FUNDS:
This type of funds target max. capital appreciation ,invest in less researched stock that
are considered to have future growth potential & may adopt speculative investment
strategies to attain their objective of high return for the investors.
Examples: Birla Midcap Fund, Franklin India Prima Fund, HDFC Capital Builder
Fund, Kotak Opportunities Fund.

(b) GROWTH FUNDS:

These types of funds invest in companies whose earning are expected to rise at an
above avg. rate. These companies may be operating in sectors like tech. considered to
have a growth potential, but not entirely unproven & speculative .The primary
objective of growth fund is capital appreciation over three to five years span.
Examples: Pru ICICI Power Fund, Kotak 30 Fund, Magnum Equity Fund, Tata
Growth Fund, Principal Growth Fund.

) SPECIALTY FUNDS:
These funds have a narrow portfolio orientation & invest in companies that meet pre-
defined criteria.
These are also of different types:-.
(c1) SECTOR FUNDS:
These funds portfolios consist of investment in only one industry or sector of the
market such as IT or Pharma or FMCG. Since sector funds dont diversify into
multiple sectors; they carry a higher level of sector & company specific risk than
diversified equity funds.

19
 Mutual Funds

Examples: Pru ICICI FMCG Fund, Pru ICICI Technology Fund, Kotak Technology
Fund, Tata Infrastructure Fund.

(c2)OFFSHORE FUNDS:
These funds invest in equities in one or more foreign countries there by achieving
diversification across the countrys border.
However they also have additional risks such as the foreign exchange rate risk & their
performance depend on the economic condition of the country they invest in.

(c3)SMALL-CAP EQUITY FUNDS:

These funds invest in shares of companies with relatively lower market capitalization
than that of big, blue chip companies. They may thus be more volatile than other
funds, as smaller companies share are not very liquid in market.

(c4)OPTION INCOME FUNDS:

These funds write options on a significant of their portfolio. These funds invest in
large dividend paying companies & then sell options against their position.

(d) DIVERSIFIED EQUITY FUNDS:

A fund that seeks to invest only in equity, but is not focused on any one or few sectors
or shares may be a termed a diversified equity fund.

(e) EQUITY INDEX FUNDS:

These funds track the performance of a specific stock market index. The objective of
these funds is to match the performance of stock market by tracking an index that
represents the overall market.
Examples: Pru ICICI SPIcE Fund, Magnum Index Fund, Birla Index Fund, Tata Index
Fund.

20
 Mutual Funds

(f) VALUE FUNDS:

These funds try to seek out fundamentally sound companies whose shares are
currently under-price in the market. These funds will add only those shares to their
portfolio that are selling at low price-earning ratios, low market to book value ratios
& are undervalued by other yardsticks.
Examples: Prudential ICICI Discovery Fund, Tempelton India Growth Fund.

(g) EQUITY INCOME FUNDS:

These funds are designed to give the investors a high level of current income along
with some steady capital appreciation, investing mainly in shares of companies with
high dividends yields.
These funds are therefore less volatile &less risky than nearly all other `equity funds.

(h) BALANCED FUNDS:

A balanced fund is one that has a portfolio comprising debt instrument, convertible
securities, pref. shares, equity shares. Their assets are generally held in more or less
equal proportions between debt/money market securities & equities.
Examples: Pru ICICI Balance Plan, Kotak Balanced Fund, Birla Balance Fund, Tata
Balanced Fund, Principal Fund.

INVESTMENT OPTIONS OF A MUTUAL FUND:

Growth Option

Dividend Option

Dividend Reinvestment Option

Growth Option:
No dividend to Unit Holders
Income will remain reinvested and reflected in NAV

21
 Mutual Funds

Benefit of long term capital gains for Unit holders where units are redeemed
after one year date of purchase.

Dividend Option:
Dividend out of the net surplus as approved by the Trustees
Balance of net surplus to be ploughed back and reflected in NAV
Quantum & frequency of distribution may vary between various plans
Options for investors to choose between quarterly, semi annual and annual
dividend.

Dividend Re-Investment:
Investor can reinvest dividend in additional units
Dividend automatically reinvested in the respective in the respective Plans at the
first ex-dividend NAV
Dividend reinvested shall be constructive payment of dividend to Unit Holders
and will be tax exempt in the hands of Unit holders

Systematic Investment Plan (SIP):

SIP allows to invest a fixed amount on monthly / quarterly basis at NAV based
prices
Investors can enroll by ticking the application
Post dated advance cheques to be provided by the investor
Allotment of units on the date of investment / date of realisation for local /
outstation cheques

Main Features of SIP :

The Goal of Most Investors it to Buy when the prices are Low, and Sell when the
prices are High
Sounds simple, but trying to time the market like this is:
Time Consuming

22
 Mutual Funds

Risky
and Almost Impossible
A more successful strategy is to adopt Rupee Cost Averaging

Rupee Cost Averaging

The Markets are volatile: they move up and down in an unpredictable manner
Invest a fixed amount, at regular, predetermined intervals and use the market
fluctuations to your benefit
How does it help you:
You buy more and more when the market is down
You buy less when the market is up
Over time the market fluctuations are averaged
Most likely you will realise a saving on the cost per unit
This leads to HIGHER RETURNS
Difficult to predict the market and know when to Buy Low, Sell High, hence
invest Systematically
Takes advantage of Rupee Cost Averaging: buy more when the price is low and
buy less when its high. This reduces the average cost of purchase.
Low maintenance, payments are made automatically
Contribute as little as Rs. 500 or say Rs. 10000 every month
Instills investing discipline: no temptation to time the market

23
 Mutual Funds

Systematic Withdrawal Plan (SWP):

Facility for Unit holders to withdraw a specified sum each month
Ideal for investors who invest a lump sum amount and withdraw regularly for their
needs
Minimum interval between two withdrawals will be one month
Withdrawals converted into units at applicable NAV based prices to be subtracted
from the balance units to the credit of Unit holder
The Fund can close the account if the balance in Unit holders account falls below
the minimum prescribed

24
 Mutual Funds

5. ORGANISATION OF A MUTUAL FUND:

There are many entities involved and the diagram below illustrates the organizational set
up of a mutual fund:

UNIT HOLDERS

SPONSORS

TRUSTEE AMC

THE MUTUAL FUND TRANSFER AGENT

CUSTODIAN

SEBI

25
 Mutual Funds

STRUCTURE OF MUTUAL FUNDS IN INDIA

In India, open & closed-end funds operate the same regulatory structure as units.
Therefore, a mutual fund may have several different schemes (open & closed-end)
under it.
The structure which is required to be followed by mutual funds in India is laid down
under SEBI (Mutual Fund) Regulations, 1996

FUND
SPONSER

TRUSTS

TRUSTEES

A.M.C

Custodian & BANKERS TRANSFER DISTRIBUTERS

Depositors AGENTS

(A) FUND SPONSER:

26
 Mutual Funds

The sponsor of a fund is akin to the promoter of a company as he gets the fund
registered with SEBI. The sponsor appoints a Board of Trustees. As per SEBI
regulation for a person to qualify as a sponsor; he must contribute of at least 40% of
the net worth of AMC & posses a sound financial track record over 5 years prior to
registration.

(B) TRUSTS:

A mutual fund in India is constituted in the form of a Public Trust created under the
Indian Trusts Act 1882.
Trust or the fund has no independent legal capacity itself, rather it is the trustees who
have the legal capacity & therefore all acts in relation to the trust are taken on its
behalf by the trustees.

(C) TRUSTEES:

Most of the funds in India are managed by the Board of Trustees. These trustees are
governed by the provisions of the Companies Act, 1956.
These trustees dont directly manage the portfolio of securities. For this specialized
function, they appoint an AMC.
The trustees being the primary guardian of the unit-holders funds & assets, so trustees
have to be a person of a high repute & integrity. They must ensure that the investors
interest is safeguarded & that the AMCs operations are along professional line.

(D) ASSET MANAGEMENT COMPANY (AMC):

The role of an AMC is to act as the Investment Manager of the Trust. The AMC, in
the name of the trust, float & then manage the different investment scheme as per
SEBI regulations & as per the investment management agreement it signs with the
trustees.

27
 Mutual Funds

The AMC of a mutual fund must have a net-worth of at least Rs. 10 Crs. at all times.
Directors of the AMC, both independent & non-independent, should have adequate
professional experience in financial service & should be individual of high moral
standing.
The AMC cannot act as a trustee of any other mutual fund.

OBLIGATION OF THE AMC & ITS DIRECTORS:

AMC & its directors must ensure that:
(1) Investment of funds is in accordance with SEBI regulation & the trust deed.
(2) They take responsibility for the acts of its employees & other whose services
it has procured.
(3) They are answerable to the trustees & must submit quarterly reports to them
on AMC activities & compliance with SEBI regulation.
(4) They dont undertake any other activity conflicting with managing the fund.
(5) They will float scheme only after obtaining the prior approval of the trustees
& SEBI.
(6) If AMC uses the services of a sponsor, associate or employees, it must make
appropriate disclosure to unit-holders, including the amount of brokerage or
commission paid.
(7) They will make the required disclosures to the investors in areas such as
calculation of NAV & repurchase price.
(8) Each days NAV is updated on AMFIs website by 8 p.m of the relevant day.

(E) CUSTODIAN & DEPOSITORS:

Mutual funds are in the business of buying & selling of securities in large volumes.
Handling these securities in terms of physical delivery & eventual safekeeping is
therefore a specialized activity.

28
 Mutual Funds

The custodian is appointed by the board of trustees for safekeeping of physical

securities or participating in any clearing system through approved depository
companies on the behalf of the mutual fund in case of dematerialized securities.
The custodian should be an entity independent of the sponsors is required to be
registered with SEBI.
A mutual funds dematerialized securities holding is held by a depository through a
Depository Participants. Mutual funds physical securities are held by a custodian.

(F) BANKERS:

A funds activities involve dealing with money on a continuous basis primarily with
respect to buying & selling units, paying for investment made, receiving the proceeds
on sale of investments & discharging its obligations towards operating expenses.
A funds bankers therefore play a crucial role with respect to its financial dealing by
holding its bank accounts & providing it with remittance service.

(G) TRANSFER AGENT:

They are responsible for issuing & redeeming units of the mutual fund & provide
other related services such as preparation of transfer documents & updating investor
records.

(H) DISTRIBUTORS:

Since, mutual fund operates as collective investment vehicles, on the

Principle of accumulating funds from a large numbers of investors & then
investing on a big scale. For these activities, distributors are appointed.
Anyone from individual agent to large bank can become distributor.

29
 Mutual Funds

NET ASSET VALUE (NAV):

NAV- COMPUTATION:

The NAV of the fund reflects the Average Market value of the portfolio.

NAV = Net Assets of the Scheme / No of units Outstanding

Or
NAV= 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

Or
NAV = Income on Investments: [Dividend/Appreciation/Profit]
Less
Expenses: [AMC fees/ Custodian fees/ Registrar Fees]

Note: Day of NAV Calculation is known as Valuation Day

EXAMPLE: HOW NAV IS COMPUTED?

Market value of Equities - Rs.100 crore - Asset

Market value of Debentures - Rs.50 crore - Asset
Dividends Accrued - Rs.1 crore -Income
Interest Accrued - Rs.2 crore - Income
Ongoing Fee payable - Rs.0.5 crore - Liability
Amt..payable on shares purchased -Rs.4.5 crore - Liability
No. of units held in the Fund : 10 crore units
NAV per unit = [(100+50+1+2)-(0.5+4.5)]/10
= [153-5]/10 = Rs. 14.80

30
 Mutual Funds

Investment Restrictions as a % of Net assets AMC

Max. Investment under all schemes of the AMC in paid up capital carrying voting
rights in single Co. - 10 %
Max. Inter scheme investments of the same AMC - 5 % (no AMC fee payable)
Inter scheme transfers at CMP and within the objectives of scheme
Max. Investment in listed shares of Group Cos - 25 % for each scheme.
No investments allowed in unlisted/private placement of group/associate cos.
Can borrow only to meet liquidity requirements. Max for 6 months & not more than
20% of NAV of scheme.

Investment Restrictions as a % of Net Assets Debt

Max. Investment in Rated paper in single Co - 15% (can be increased to 20% with
approval by Board of AMC/Trustee)
Max.Investment in Unrated/ Rated but below invt grade in single issuer- 10% of
NAV
Max. Investment in Unrated/Rated but below investment grade in all cos - 25%
(subject to approval of Board of AMC /Trustee).
Restrictions not applicable to Govt. Securities/Money Market
Can only invest in marketable securities - no loans

Investment Restrictions as a % of Net Assets Equity

Max. Investment in Equity/Equity related instruments of single Co. - 10%

No restrictions in case of Index Fund
Max. Investment in Unlisted Cos. - 10% in close ended & 5% in open ended funds
Buy & Sell securities on Delivery position , No short selling/ carry forward allowed.
Security should be transferred to schemes immediately. Cannot remain in general a/c

31
 Mutual Funds

NAV is influenced by four factors:

Purchase and sale of Investment
Valuation of Investment
Other assets and Liabilities
Units sold or redeemed.

NAV Other Information:

Open end funds to declare NAV daily

NAV to be published at least weekly
Close end Schemes (which are not listed) may publish NAV monthly/qt with
prior approval from SEBI (MIP)
NAV has to consider up-to-date transactions
Non - recorded transactions not to affect NAV calculation by more than 2%

Change in NAV:

For NAV change in absolute terms

= (NAV at end of period - NAV at beginning of period) * 100
NAV at beginning of period

For NAV change in Annualised Terms =

(NAV change in % in absolute terms) * (365 / No. of days)

32
 Mutual Funds

Pricing of Units:

Sale price not greater than 107% of the NAV

Re-purchase price to be not lower than 93% (95% for close-end funds) of the NAV
Difference between the repurchase & sale price cannot be more than 7% of the sale
price

Sales Price:

Sale Price is the price at which units are sold to investors.

Sale Price = NAV + Entry load

Formula for computation of Sale Price = NAV/ (1-Load)

E.G : Assuming an entry load of 2% in the earlier

NAV computation example
Sale Price = 14.80/(1- 0.02) = 15.10

7. RISK AND RETURN:

1. RETURN METHODS:
Change in NAV
Simple Total Return
ROI or Total Return with dividend reinvested
Compounded Rate of Growth

2. RISK:
Standard Deviation
Beta and Ex-Marks

33
 Mutual Funds

3 .BENCHMARK AND COMPARISON

1.COMPUTING RETURNS:

There are two main sources of Returns:

Dividend
Change in NAV

Return= Income earned for the amount invested over a period of time

Standardize as % per annum.

Methods used for Computing Returns are as follows:

A) Percentage Change in NAV:

Assume that change in NAV is the only source of return.

Example: The NAV of the fund was Rs 23.45 at the beginning of the year.
Rs. 27.65 at the end of the year.
% Change in NAV = (27.65-23.45)/23.45 * 100 = 17.91 %

Limitations:
Does not account for dividend
Suitable only for growth plans
Does not account for reinvestment

Annualizing the Rate of return we get:

If NAV on Jan 1,2001 was Rs.12.75 and NAV on June 30, 2001 was Rs.14.35
Percentage Change in NAV =(14.35-12.75)/12.75 * 100 = 12.55%

Annualized Return= 12.55 * 12/6 = 25.10%

34
 Mutual Funds

B) Total Return:

Investor bought units of a mutual fund scheme at a price of Rs.12.45 per unit.
He redeems the investment a year later, at Rs. 15.475 per unit.
During the year, he also receives dividend at 7%.
The rate of return on his investment can be computed as
=((15.475 12.45) + 0.70)/12.45 x 100
= (3.725/12.45) x 100
= 29.92%

Formula used is:

Total Return = (( Distribution + Change in nav)/day1 nav)* 100

C) Total Return OR Return on Investments Method:

(Value of holdings at the end of the period - value of holdings at the beginning
of the period)/ value of holdings at the beginning of the period x 100
Value of holdings at the beginning of the period = number of units at the
beginning x begin NAV.
Value of holdings end of the period = (number of units held at the beginning +
number of units re-invested) x end NAV.
Number of units re-invested = dividends/ex dividend NAV.

ROI Method Example:

An investor buys 100 units of a fund at Rs. 10.5 on January 1, 2001. On June 30,
2001 he receives dividends at the rate of 10%. The ex-dividend NAV was Rs. 10.25.
On December 31, 2001, the funds NAV was Rs. 12.25.

What is the total return on investment with dividends re-invested?

35
 Mutual Funds

Solution:
The begin period value of the investment is
= 10.5 x 100 = Rs. 1050
Number of units reinvested
= 100/10.25 = 9.756 units
End period value of investment
= 109.756 x 12.25 = Rs. 1344.51
The return on investment is
=(1344.51-1050)/1050 x 100
= 28.05%

D) Compounded Average Growth Rate:

CAGR is the rate at which investment has grown from begin point to the end point,
on an annual compounding basis.

V0(1+r)^n = V1

r =((V1/V0)^(1/n))-1

Where n is the holding period in years.

CAGR: Example

An investor buys 100 units of a fund at Rs. 10.5 on January 6, 2001. On June 30, 2001
he receives dividends at the rate of 10%. The ex-dividend NAV was Rs. 10.25. On March
12, 2002, the funds NAV was Rs. 12.25.

Compute the CAGR.

Solution:

36
 Mutual Funds

The begin period value of the investment is

= 10.5 x 100 = Rs. 1050
Number of units reinvested
= 100/10.25 = 9.756 units
End period value of investment
= 109.756 x 12.25 = Rs. 1344.51
Holding period = 6/01/01 - 12/3/02
= 431 days
The CAGR is
=(1344.51/1050)365/431 - 1 x 100
= 23.29%

RETURNS: Industry Practice

Growth Option: CAGR implicit in the change in holding period NAVs.
Dividend Option: CAGR implicit in the change in value over the holding period,
assuming re-investment of dividend at ex-dividend NAV.
Less then 1 year, simple return without compounding or annualisation.
Some funds use simple annualized return, without compounding.

SEBI Regulations:
Standard measurements and computation
Compounded annual growth rate for funds over 1 year old.
Return for 1,3 and 5 years, or since inception, which ever is later.
No annualisation for periods less than a year.

2 .RISKS IN MUTUAL FUND RETURNS:

Risk arises when actual returns are different from expected returns.
Historical average is a good proxy for expected return.
Standard deviation is an important measure of total risk.

37
 Mutual Funds

Beta co-efficient is a measure of market risk.

Ex-marks is an indication of extent of correlation with market index.

3. BENCHMARK:

Relative returns are important than absolute returns for mutual funds.
Comparable passive portfolio is used as benchmark.
Usually a market index is used.
Compare both risk and return, over the same period for the fund and the
benchmark.
Risk-adjusted return is the return per unit of risk.

SEBI Guidelines:

Benchmark should reflect the asset allocation

Same as stated in the offer document
Growth fund with more than 60% in equity to use a broad based index.
Bond fund with more than 60% in bonds to use a bond market index.
Balanced funds to use tailor-made index
Liquid funds to use money market instruments.

OTHER MEASURES OF PERFORMANCE:

Expense ratios - Expenses ratio is an indicator of the funds efficiency & cost-
effectiveness. It must be evaluated in the light of the fund size, avg. account
size & portfolio composition- equity or fixed income. E.g. funds with small
corpus size will have a higher expenses ratio affecting rather than large corpus
fund.

38
 Mutual Funds

If a funds income levels or return are small then expenses ratio becomes
important & difference of even 0.5% between two funds can affect investors
return.
Higher Expense Ratio hurts Long term investors.

Portfolio Turnover ratio - measures amount of buying and selling done by the
fund. Higher for short term funds and lower for Long term funds.

This ratio measures how many times the fund manager turn over his portfolio
by buying or selling of securities in the market. A 100% turnover implies that
the manager replaced his entire portfolio by buying or selling of securities in
the market.
This % turnover is a good indicator of the extent to which the fund is active in
terms of its dealing on the market. However, high turnover ratio also indicates
high transaction costs charged to the fund.
This ratio would be most relevant to analyze in case of equity & balance
funds, particularly those that derive a large part of their income from active
trading.

Transaction cost- It include all expenses related to trading such as the

brokerage, commissions paid, stamp duty on transfers, registrars fees &
custodian fees. Transaction costs, therefore have a significant bearing on fund
performance & its total return. Funds with small size or small return have to
be judged more on their expenses ratio & transaction cost.

Cash holdings- Mutual fund allocates their assets among equity shares, debt
securities & cash/ bank deposits. The % of a funds portfolio held in cash
equivalents can be important element in its successful performance.
A large cash holding allows the fund to strengthen its position in preferred
securities without liquidating its other portfolio. Cash also allow the fund a
cushion against decline in the market prices of shares or bonds.

39
 Mutual Funds

But the fund also guard against large, consistent net redemption because these
not only indicate dissatisfaction on the part of investors, but also force the
fund to maintain large cash resources lowering the return on the portfolio.

Fund Size- Fund size also affects performance. Small funds are easier to
maneuver & can achieve their objectives in a focused manner with limited
holding. Large funds benefit from economies of scale with lower expenses &
superior fund management skills. There can be no definition of what is a small
fund or big fund, as small & big are relative term.

Credit Quality- Rating profile of portfolio should be studied

Tracking Error- Tracking error for index funds should be nil

Size and Portfolio Composition

SOME IMPORTANT RISK RATIOS:

1. Sharpe Ratio:

The Sharpe ratio or Sharpe index or Sharpe measure or reward-to-variability

ratio is a measure of the excess return (or Risk Premium) per unit of risk in an
investment asset or a trading strategy, named after William Forsyth Sharpe. Since its
revision by the original author in 1994, it is defined as:

where R is the asset return, Rf is the return on a benchmark asset, such as the risk free
rate of return, E[R Rf] is the expected value of the excess of the asset return over the
benchmark return, and is the standard deviation of the asset.[1]
Note, if Rf is a constant risk free return throughout the period,

40
 Mutual Funds

The Sharpe ratio is used to characterize how well the return of an asset compensates
the investor for the risk taken, the higher the Sharpe ratio number the better. When
comparing two assets each with the expected return E[R] against the same benchmark
with return Rf, the asset with the higher Sharpe ratio gives more return for the same
risk. Investors are often advised to pick investments with high Sharpe ratios.
Example:
Suppose the asset has an expected return of 15% in excess of the risk free rate. We
typically do not know if the asset will have this return; suppose we assess the risk of
the asset, defined as standard deviation of the asset's excess return, as 10%. The risk-
free return is constant. Then the Sharpe ratio (using a new definition) will be 1.5 (R
Rf = 0.15 and = 0.10).

2. Treynor Ratio:

The Treynor ratio (sometimes called the reward-to-volatility ratio or Treynor

measure[1]), named after Jack L. Treynor,[2] is a measurement of the returns earned in
excess of that which could have been earned on an investment that has no
diversifiable risk (e.g., Treasury Bills or a completely diversified portfolio), per each
unit of market risk assumed.
The Treynor ratio relates excess return over the risk-free rate to the additional risk
taken; however, systematic risk is used instead of total risk. The higher the Treynor
ratio, the better the performance of the portfolio under analysis.

where
Treynor ratio,
portfolio i's return,
risk free rate
portfolio i's beta

41
 Mutual Funds

Like the Sharpe ratio, the Treynor ratio (T) does not quantify the value added, if any,
of active portfolio management. It is a ranking criterion only. A ranking of portfolios
based on the Treynor Ratio is only useful if the portfolios under consideration are
sub-portfolios of a broader, fully diversified portfolio. If this is not the case, portfolios
with identical systematic risk, but different total risk, will be rated the same. But the
portfolio with a higher total risk is less diversified and therefore has a higher
unsystematic risk which is not priced in the market.
An alternative method of ranking portfolio management is Jensen's alpha, which
quantifies the added return as the excess return above the security market line in the
capital asset pricing model. As the two both determine rankings based on systematic
risk alone, they will rank portfolios identically.

3. Jensens Alpha:

Jensen's alpha (or Jensen's Performance Index, ex-post alpha) is used to

determine the abnormal return of a security or portfolio of securities over the
theoretical expected return.
The security could be any asset, such as stocks, bonds, or derivatives. The theoretical
return is predicted by a market model, most commonly the Capital Asset Pricing
Model (CAPM) model. The market model uses statistical methods to predict the
appropriate risk-adjusted return of an asset. The CAPM for instance uses beta as a
multiplier.
Jensen's alpha was first used as a measure in the evaluation of mutual fund managers
by Michael Jensen in the 1970s. The CAPM return is supposed to be 'risk adjusted',
which means it takes account of the relative riskiness of the asset. After all, riskier
assets will have higher expected returns than less risky assets. If an asset's return is
even higher than the risk adjusted return, that asset is said to have "positive alpha" or
"abnormal returns". Investors are constantly seeking investments that have higher
alpha.
In the context of CAPM, calculating alpha requires the following inputs:
the realized return (on the portfolio),

42
 Mutual Funds

the market return,

the risk-free rate of return, and
the beta of the portfolio.

Jensen's alpha = Portfolio Return - [Risk Free Rate + Portfolio Beta * (Market
Return - Risk Free Rate)]

4. Information Ratio:

The Information ratio is a measure of the risk-adjusted return of a financial security

(or asset or portfolio). It is defined as expected active return divided by tracking error,
where active return is the difference between the return of the security and the return
of a selected benchmark index, and tracking error is the standard deviation of the
active return; i.e., the information ratio IR is:

,
where R is the portfolio return, Rb is the benchmark return, = E[R Rb] is the
expected value of the active return, and = is the standard deviation of the active
return, which is an alternate definition of the aforementioned tracking error.
The information ratio is often used to gauge the skill of managers of mutual funds,
hedge funds, etc. In this case, it measures the expected active return of the manager's
portfolio divided by the amount of risk that the manager takes relative to the
benchmark. The higher the information ratio, the higher the active return of the
portfolio, given the amount of risk taken, and the better the manager. Top-quartile
investment managers typically achieve information ratios of about one-half.[1]
Generally, the ratio compares annualized returns of the manager's portfolio with those
of benchmarks such as the yield on three-month Treasury Bills or an equity index
such as the S&P 500. Since this ratio considers the annualized standard deviation of
both series (as measures of risks inherent in owning either the portfolio or the

43
 Mutual Funds

benchmark), the ratio shows the risk-adjusted active return of the portfolio over the
benchmark.
The information ratio is similar to the Sharpe ratio but, whereas the Sharpe ratio
compares the excess return of an asset against the return of a risk free asset, the
information ratio compares active return to the most relevant benchmark index. That
is to say, the Sharpe ratio equals the information ratio where the benchmark is a risk-
free asset (e.g. cash or government bonds).
Some hedge funds use Information ratio as a metric for calculating performance fee.
Snapshot Below gives us important Risk ratios for various Mutual fund schemes
available (Calculated directly by using software developed by CRISIL Called CRISIL
Investment Manger):

44
Mutual Funds

45
 Mutual Funds

8. COMPARISION OF DIFFERENT MUTUAL FUND SCHEMES:

We have taken into account following Mutual Fund Schemes and compared them
hdfc longterm equity,hdfc equity,hdfc top 200,relianceMIP,rel banking fund,rel longterm
equity,icici prudential,icici equity opp,icici top 200
HDFC longterm equity

46
 Mutual Funds

HDFC Equity

47
 Mutual Funds

Reliance MIP

48
 Mutual Funds

HDFC TOP 200

49
 Mutual Funds

Reliance Banking Fund

50
 Mutual Funds

Reliance Longterm equity

51
 Mutual Funds

ICICI PrudentialBanking

52
 Mutual Funds

ICICI Prudential Equity Opportunity

53
 Mutual Funds

ICICI Prudential top 200

54
 Mutual Funds

9. CONCLUSION: MUTUAL FUNDS- THE BEST INVESTMENT OPTIONS:

Mutual Fund Investment is easy way of investing money where you dont have to be
expert because the AMC will take care of yours asset.
You can invest in different type of schemes depending on your need and capacity to
take risk. There are regular income schemes where you get your money periodically
on monthly or quarterly bases depending on your priority example Monthly Income
Plan Scheme (MIP).
If a person is ready to take risk he can invest in Equity fund.
If a person want to save Tax he can invest in Tax Plan and get Tax Rebate but his
investment has to be under lockin period of 3 years
If a person want to invest money for one day then also he can invest his money where
his money will be invest in call money market.
Investor Perspective: Funds Vs Other Products

55
 Mutual Funds

From the Comparative analysis provide, it emerges that each investment alternative
has its strengths and weakness. Some options seek to achieve superior returns but
with correspondingly higher risks. Others provides safety (PPF) but add the expense
of liquidity and growth. Options such as bank deposit offer safety and liquidity but
add the cost of return. Mutual funds seek to combine the advantages of investing in
each of these alternatives while dispensing with the shortcoming. Clearly it is in the
investor's interest to focus his investment on mutual funds however a note of caution
is in order. while the mutual funds are one of the best options for the individual small
investors there are many mutual funds already available for the investor to choose
from it must be realised that the performance of different funds varies from time to
time also the Indian mutual fund sector have been fortunate to be with good
performers. Currently in India there are limited investment opportunities available to
mutual funds and their track record must be studied in the context therefore the Indian
investors have moved over to mutual funds in a gradual process but there is little

56
 Mutual Funds

doubt that mutual fund will increasingly attract the small investors as compared to
other intermediaries such as bank and insurance companies.

57
 Mutual Funds

BIBLIOGRAPHY

1. NCFM Study Material (AMFI Mutual Fund Guide)

2. www.Mutualfundsindia.com (Icra online website)

3. http:// www.amfiindia.com/

4. http://www.sebi.gov.in/,

5. http://www.moneycontrol.com/

6. http://about.reuters.com/productinfo/s/equity_portfolio_management

7. http://finance.indiamart.com/

8. Article Taken from Book:-

o Mutual Funds - Author Jaspal Singh

o Investors India(Nov2006)- A Bajaj Capital Publication

o AMFI Mutual Fund Testing Programme Workbook

o Invest India Mutual Fund Handbook

o HDFC Factsheet and DSP Blackrock MF Factsheet

o HDFC Key Information Memorandum

58