NISM SERIES VA

BOOK SUMMARY
BY NISMTOP500

NISMTOP500 – SERIESVA- MUTUAL FUND DISTRIBUTION

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NISM BOOK SUMMARY

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1.Investment Landscape

One often hears questions like “Please suggest some good investments.” “Which mutual fund
schemes should one buy this year?” and many similar questions, very regularly. There is an issue with
these questions. These are about the investments and not the investor. The investor’s needs are not
even discussed, and probably not even considered important.

Why Investments?

There are often common situations we see regularly in our own life, or the lives of people around us.
Though, there is no explicit mention of money in these situations, we intuitively know that money
would be involved in each of these situations, whether it is for higher education, or to buy a house, or
for a fund that helps for managing expenses post retirement. In the investment world, the requirements
of these four are known as financial objectives. When we assign amounts and timelines to these
objectives, we convert these into financial goals.

There are numerous examples of such financial goals. Goal setting is a very important exercise, while
planning for investments. As seen above, all the financial goals are about the need of money that
cannot be fulfilled through the inflow at that time. While the expenses for the goal may be high or
low, the income may be less than the amount required to fund the goal. This is where money needs to
be withdrawn from the investments – in other words, this is why one needs to invest the money.

Short term needs versus Long Term Goals

Various goals have various timelines. And thus they are needed to be planned accordingly. Let’s look
at the retirement goal for this. This goal can be broken into two parts: accumulating a sum for
retirement, and then taking income out of the corpus thus accumulated. Wisdom suggests that if one
plans well for those important and not urgent tasks (and goals), life changes for the better. In order to
achieve this, it is important to first classify the financial goals – those events in life in terms of
timeline and importance in one’s life.
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Savings or Investments?

The word “saving” originates from the same root as “safe”. The safety of money is of critical
importance here. Whereas, when one invests money, the primary objective typically is to earn profits.
The important point to note here is that there is a trade-off between risk and return. The other
difference is evident from the dictionary definition of “saving”– reduction in the amount of money
used. This definition refers to reducing consumption so that some money is saved. It is this saved
money that can be invested. In other words, saving and investing are not to be considered as two
completely different things, but two steps of the same process – in order to invest money, one need to
save first. Thus, saving precedes investing.

Factors to evaluate investments:

Safety: This begins with the safety of capital invested. In order to understand the safety of an
investment, it is important to understand the risks involved.

Liquidity: The degree of ease of converting an asset into cash is different across different categories,
and even within the categories, the same could be different across products. This another major factor
to be considered.

Returns: As seen earlier in the definition of investments, the major purpose is to get some returns
from investment. Such returns may be in the form of regular (or periodic) income, also known as
current income; and capital appreciation, or capital gains.

Convenience: Any investment must be evaluated in terms of convenience with respect to investing,
taking the money out–fully or partially, as well as the investor’s ability to conveniently check the
value of the investment, as well as to receive the income.

Ticket size: Ticket size refers to the minimum investment required to invest in that product. This
becomes an important factor while taking a decision about selection of investment options. At the
same time, this must not be the only factor.

Taxability of income: What one retains after taxes is what matters, and hence, taxation of the
earnings is another important factor that one must consider.

Tax deduction: A related matter is the tax deduction that may be available in case of certain
products. Such a deduction effectively increases the return on investment, since the same is calculated
after factoring the net amount invested.

Different Asset Classes

Real estate: It is considered as the most important and popular among all the asset classes. However,
the popularity of this asset category is largely because of a reason not related to investment. Real
estate could be further classified into various categories, viz., residential real estate, land, commercial
real estate, etc.

Commodities: One can invest in commodities in two ways- there are commodities derivatives
available on many commodities, it may not be wise to call these “investments” for two reasons, (1)
these are leveraged contracts, i.e. one can take large exposure with a small of money making it highly
risky and (2) these are normally short term contracts, whereas the investors’ needs may be for longer
periods. Another way is investing in precious metals like gold and silver. It is easy to understand the
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prices of gold and silver across countries by simply looking at the foreign exchange rate between the
two countries’ currencies, and making adjustments for various costs and restrictions imposed by any
of the countries.

Fixed Income: Bonds are generally considered to be safer than equity. However, these are not totally
free from risks. Bonds can be classified into subcategories on the basis of issuer type i.e. issued by the
government or corporates or on the basis of the maturity date: short term bonds (ideal for liquidity
needs), medium and long term bonds (income generation needs).

Equity: This is the owner’s capital in a business. Someone who buys shares in a company becomes a
part-owner in the business. In that sense, this is risk capital, since the owner’s earnings from the
business are linked to the fortunes, and hence the risks, of the business. When one buys the shares of a
company through secondary market, the share price could be high or low in comparison to the fair
price.

Investment Risks

Inflation Risk: Inflation or price inflation is the general rise in the prices of various commodities,
products, and services that we consume. Inflation erodes the purchasing power of the money.
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Liquidity Risk: This risk is also very closely associated with real estate, where liquidity is very low,
and often it takes weeks or months to sell the investment.

Credit Risk: Any delay or a default in the repayment of principal or payment of interest may arise
due to a problem with one or both of the two reasons: (1) the ability of the borrower, or (2) the
intention of the borrower.

Market Risk and Price Risk: Market risk is the risk of losses in positions arising from movements in
market prices. There is no unique classification as each classification may refer to different aspects of
market risk. The risk that occurs when the prices of the asset and its futures contract do not move in
tandem with each other. Location basis risk: The risk that arises when the underlying asset is in a
different location from the where the futures contract is traded. So in a way, both risks are quite
similar.

Interest Rate Risk: Interest rate risk is the risk that an investment's value will change as a result of a
change in interest rates. This risk affects the value of bonds/debt instruments more directly than
stocks. Any reduction in interest rates will increase the value of the instrument and vice versa.

Behavioral Biases in Investment Decision Making

Availability Heuristic: Most people rely on examples or experiences that come to mind immediately
while analyzing any data, information, or options to choose from. In the investing world, this means
that enough research is not undertaken for evaluating investment options. This leads to missing out on
critical information, especially pertaining to various investment risks.

Confirmation Bias: Investors also suffer from confirmation bias. This is the tendency to look for
additional information that confirms to their already held beliefs or views. It also means interpreting
new information to confirm the views.

Familiarity Bias: An individual tends to prefer the familiar over the novel, as the popular proverb
goes, “A known devil is better than an unknown angel.” This leads an investor to concentrate the
investments in what is familiar, which at times prevents one from exploring better opportunities, as
well as from a meaningful diversification.

Herd Mentality: “Man is a social animal” – Human beings love to be part of a group. While this
behavior has helped our ancestors survive in hostile situations and against powerful animals, this often
works against investors interests in the financial markets.

Loss Aversion: Loss aversion explains people's tendency to prefer avoiding losses to acquiring
equivalent gains: it is better not to lose Rs. 5,000 than to gain Rs. 5,000. Such a behavior often leads
people to stay away from profitable opportunities, due to perception of high risks, even when the risk
could be very low.

Overconfidence: This bias refers to a person’s overconfidence in one’s abilities or judgment. This
leads one to believe that one is far better than others at something, whereas the reality may be quite
different. Under the spell of such a bias, one tends to lower the guards and take on risks without
proper assessment.
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Recency bias: The impact of recent events on decision making can be very strong. This applies
equally to positive and negative experiences. Investors tend to extrapolate the event into the future
and expect a repeat.

Understanding Asset Allocation

Strategic Asset Allocation is allocation aligned to the financial goals of the individual. It considers
the returns required from the portfolio to achieve the goals, given the time horizon available for the
corpus to be created and the risk profile of the individual.

Tactical Asset Allocation is when one may choose to dynamically change the allocation between the
asset categories. The purpose of such an approach may be to take advantage of the opportunities
presented by various markets at different points of time, but the primary reason for doing so is to
improve the risk-adjusted return of the portfolio.

Rebalancing: An investor may select any of the asset allocation approach; however there may be a
need to make modifications in the asset allocations. This rebalancing of portfolio as per the initially
agreed ratios is called rebalancing.

II. Concept and Role of a Mutual Fund

Mutual fund is a vehicle to mobilize money from investors, to invest in different markets and
securities, in line with the common investment objectives agreed upon, between the mutual fund and
the investors. Through mutual funds, an investor can get access to equities, bonds, money market
instruments and/or other securities and they also avail of the professional fund management services
offered by an asset management company.

Role of Mutual Funds

 Assist investors in earning income or building wealth

 Mobilization of savings
 Facilitating the infusion of capital in the economy
 Market stabilizer

Different schemes according to investment objectives

Various investors have different investment preferences and needs. In order to accommodate these
preferences, mutual funds mobilize different pools of money. Each such pool of money is called a
mutual fund scheme. Every scheme has a pre-announced investment objective. Investors invest in a
mutual fund scheme whose investment objective reflects their own needs and preference.
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Investment Policy of Mutual Fund

Mutual fund schemes announce their investment objective and seek investments from the investor.
Thus, an investor in a scheme is issued units of the scheme. The scheme earns interest income or
dividend income on the investments it holds. Further, when it purchases and sells investments, it earns
capital gains or incurs capital losses. A mutual fund scheme with an objective of providing liquidity
would invest in money market instruments or in debt papers of very short-term maturity. At the same
time, a mutual fund scheme that aims to generate capital appreciation over long periods, would invest
in equity shares. This would reflect in the scheme’s asset allocation, which would be disclosed in the
Scheme Information Document (SID).

Important Concepts in Mutual Funds

 Units: The investment that an investor makes in a scheme is translated into a certain number
of ‘Units’ in the scheme. Thus, an investor in a scheme is issued units of the scheme.
 Face Value: Typically, every unit has a face value of Rs.10. The face value is relevant from
an accounting perspective.
 Unit Capital: The number of units issued by a scheme multiplied by its face value (Rs.10) is
the capital of the scheme–its Unit Capital.
 Recurring Expenses: The fees or commissions paid to various mutual fund constituents
come out of the expenses charged to the mutual fund scheme. These are known as recurring
expenses. These expenses are charged as a percentage to the scheme’s assets under
management (AUM). The scheme expenses are deducted while calculating the NAV.
 Net Asset Value: The true worth of a unit of the mutual fund scheme is otherwise called Net
Asset Value (NAV) of the scheme. When the investment activity is profitable, the true worth
of a unit increases. When there are losses, the true worth of a unit decreases.
 Assets under Management: The sum of all investments made by investors’ in the mutual
fund scheme is the entire mutual fund scheme’s size, which is also known as the scheme’s
Assets under Management (AUM).
 Mark to Market: The process of valuing each security in the investment portfolio of the
scheme at its current market value is called Mark to Market (MTM).

Advantages of Mutual Funds for Investors

1. Professional Management
Mutual funds offer investors the opportunity to earn an income or build their wealth through
professional management of their investible funds. Investing in the securities markets will require the
investor to get into a lot of formalities. Mutual fund investment simplifies the process of investing and
holding securities.

2. Affordable Portfolio Diversification

Investing in the units of a scheme provide investors the exposure to a range of securities held in the
investment portfolio of the scheme in proportion to their holding in the scheme. Thus, even a small
investment of Rs.500 in a mutual fund scheme can give benefits of a diversified investment portfolio.

3. Economies of scale
Pooling of large sum of money from many investors makes it possible for the mutual fund to engage
professional managers for managing investments. Large investment corpus leads to various other
economies of scale. Costs related to investment research, office space, brokerages and other bank
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services. Thus, investing through a mutual fund offers a distinct economic advantage to an investor as
compared to direct investing in terms of cost saving.

4. Liquidity
Investors in a mutual fund scheme can recover the market value of their investments, from the mutual
fund itself at any point of time (Except fund with a lock-in period). Schemes, where the money can be
recovered from the mutual fund only on closure of the scheme, are compulsorily listed on a stock
exchange. In such schemes, the investor can sell the units through the stock exchange platform to
recover the prevailing value of the investment.

5. Tax Deferral
Mutual funds are not liable to pay tax on the income they earn. If the same income were to be earned
by the investor directly, then tax may have to be paid in the same financial year. Mutual funds offer
options, whereby the investor can let the money grow in the scheme for several years. By selecting
such options, it is possible for the investor to defer the tax liability. This helps investors to legally
build their wealth faster than would have been the case, if they were to pay tax on the income each
year.

6. Tax benefits
Specific schemes of mutual funds (Equity Linked Savings Schemes) give investors the benefit of
deduction of the amount subscribed (Up to Rs. 150,000 in a financial year), from their income that is
liable to tax. This reduces their taxable income, and therefore the tax liability.

7. Convenient Options
The options offered under a scheme allow investors to structure their investments in line with their
liquidity preference and tax position. There is also great transaction conveniences like the ability to
withdraw only part of the money from the investment account, ability to invest additional amount to
the account, setting up systematic transactions, etc.

8. Investment Comfort
Once an investment is made with a mutual fund, they make it convenient for the investor to make
further purchases with very little documentation.

9. Regulatory Comfort
The regulator, Securities and Exchange Board of India (SEBI), has mandated strict checks and
balances in the structure of mutual funds and their activities. Mutual fund investors benefit from such
protection.

10. Systematic Approach to Investments

Mutual funds also offer facilities that help investor invest amounts regularly through a Systematic
Investment Plan (SIP); or withdraw amounts regularly through a Systematic Withdrawal Plan (SWP);
or move money between different kinds of schemes through a Systematic Transfer Plan (STP). Such
systematic approaches promote investment discipline, which is beneficial to investors

Limitations of a Mutual Fund

1. Lack of portfolio customization

A unit-holder in a mutual fund is just one of several thousand investors in a scheme. Once a unit-
holder has bought into the scheme, investment management is left to the fund manager. Thus, the
unit-holder cannot influence what securities or investments the scheme would invest into.
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2. Choice overload
There are multiple mutual fund schemes offered by 42 mutual funds – and multiple options within
those schemes which make it difficult for investors to choose between them.

3. No control over costs

All the investor's money is pooled together in a scheme. Costs incurred for managing the scheme are
shared by all the Unit-holders in proportion to their holding of Units in the scheme. Therefore, an
individual investor has no control over the costs in a scheme.

Types of Funds

On basis of structure :

Open Ended Funds:-These funds are open for investors to enter or exit at any time, even after the
NFO. Although some unit-holders may exit from the scheme, wholly or partly, the scheme continues
operations with the remaining investors. The scheme does not have any kind of time frame in which it
is to be closed.

Close ended funds:- These funds have a fixed maturity. Investors can buy units of a close-ended
scheme, from the fund, only during its NFO. The fund makes arrangements for the units to be traded,
post-NFO in a stock exchange.

Interval Funds:- The funds combine features of both open-ended and close-ended schemes. They are
largely close-ended, but become open-ended at pre-specified intervals. The periods when an interval
scheme becomes open-ended, are called ‘transaction periods’.

On basis of management style:

Actively managed funds:-These funds where the fund manager has the flexibility to choose the
investment portfolio, within the broad parameters of the investment objective of the scheme. Since
this increases the role of the fund manager, the expenses for running the fund turn out to be higher.
Investors expect actively managed funds to perform better than the market.

Passive funds:-These funds invest on the basis of a specified index, whose performance it seeks to
track. Thus, performance of a passive fund tends to mirror the concerned index. They are not designed
to perform better than the market

Exchange Traded Funds (ETFs):-They are also passive funds whose portfolio replicates an index or
benchmark such as an equity market index or a commodity index. The units are issued to the investors
in a new fund offer (NFO). The units of the ETF are traded at real time prices that are linked to the
changes in the underlying index.

Equity Schemes

Multi Cap Fund: An open ended equity scheme investing across large cap, mid cap, small cap stocks.
The minimum investment in equity shall be 65 percent of total assets.
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Large Cap Fund: An open ended equity scheme predominantly investing in large cap stocks. The
minimum investment in equity and of large cap companies shall be 80 percent of total assets.

Large and Mid-Cap Fund: An open ended equity scheme investing in both large cap and mid cap
stocks. The minimum investment in equity mid cap stocks shall be 35 percent of total assets.

Mid Cap Fund: An open ended equity scheme predominantly investing in mid cap stocks. The
minimum investment in equity of mid cap companies shall be 65 percent of total assets.

Small cap Fund: An open ended equity scheme predominantly investing in small cap stocks.
Minimum investment in equity of small cap companies shall be 65 percent of total assets.

Dividend Yield Fund: An open ended equity scheme predominantly investing in dividend yielding
stocks. Scheme should predominantly invest in dividend yielding stocks.

Value Fund or Contra Fund: A value fund is an open ended equity scheme following a value
investment strategy.

Focused Fund An open ended equity scheme investing in maximum 30 stocks (the scheme needs to
mention where it intends to focus, viz., multi cap, large cap, mid cap, small cap).

Sectoral / Thematic: An open ended equity scheme investing in a specific sector such as bank, power
is a sectorial fund. While an open ended equity scheme investing in line with an investment theme.
For example, an infrastructure thematic fund might invest in shares of companies that are into
infrastructure, construction, cement, steel, telecom, power etc.

Equity Linked Savings Scheme (ELSS): An open ended equity linked saving scheme with a statutory
lock in of 3 years and tax benefit.

Debt Schemes

Overnight Fund: An open ended debt scheme investing in overnight securities. The investment is in
overnight securities having maturity of 1 day

Liquid Fund: An open ended liquid scheme whose investment is into debt and money market
securities with maturity of upto 91 days only.3

Ultra Short Duration Fund: An open ended ultra-short term debt scheme investing in debt and money
market instruments with Macaulay duration between 3 months and 6 months.

Low Duration Fund: An open ended low duration debt scheme investing in debt and money market
instruments with Macaulay duration between 6 months and 12 months.

Money Market Fund: An open ended debt scheme investing in money market instruments having
maturity upto 1 year.

Short Duration Fund: An open ended short term debt scheme investing in debt and money market
instruments with Macaulay duration between 1 year and 3 years.

Medium Duration Fund: An open ended medium term debt scheme investing in debt and money
market instruments with Macaulay duration of the portfolio being between 3 years and 4 years.
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Medium to Long Duration Fund: An open ended medium term debt scheme investing in debt and
money market instruments with Macaulay duration between 4 years and 7 years.

Long Duration Fund: An open ended debt scheme investing in debt and money market instruments
with Macaulay duration greater than 7 years.

Dynamic Bond: An open ended dynamic debt scheme investing across duration.

Corporate Bond Fund: An open ended debt scheme predominantly investing in AA+ and above rated
corporate bonds. The minimum investment in corporate bonds shall be 80 percent of total assets (only
in AA+ and above rated corporate bonds)

Credit Risk Fund: An open ended debt scheme investing in below highest rated corporate bonds. The
minimum investment in corporate bonds shall be 65 percent of total assets (only in AA (excludes
AA+ rated corporate bonds) and below rated corporate bonds).

Banking and PSU Fund: An open ended debt scheme predominantly investing in debt instruments of
banks, Public Sector Undertakings, Public Financial Institutions and Municipal Bonds.

Gilt Fund: An open ended debt scheme investing in government securities across maturity.

Floater Fund: An open ended debt scheme predominantly investing in floating rate instruments
(including fixed rate instruments converted to floating rate exposures using swaps/derivatives).
Minimum investment in floating rate instruments (including fixed rate instrument)

Hybrid Schemes

Conservative Hybrid Fund: An open ended hybrid scheme investing predominantly in debt
instruments. Investment in debt instruments shall be between 75 percent and 90 percent of total assets
while investment in equity shall be between 10 percent and 25 percent of total assets.

Balanced Hybrid Fund: An open ended balanced scheme investing in equity and debt instruments.
The investment in equity shall be between 40 percent and 60 percent of total assets while investment
in debt instruments shall be between 40 percent and 60 percent. No arbitrage is permitted in this
scheme.

Aggressive Hybrid Fund: Investment in equity and equity related instruments shall be between 65
percent and 80 percent of total assets while investment in debt instruments shall be between 20
percent and 35 percent of total assets.

Dynamic Asset Allocation or Balanced Advantage: It is an open ended dynamic asset allocation fund
with investment in equity/debt that is managed dynamically.

Multi Asset Allocation: An open ended scheme investing in at least three asset classes with a
minimum allocation of at least 10 percent each in all three asset classes. Foreign securities are not
treated as a separate asset class in this kind of scheme.

Arbitrage Fund: An open ended scheme investing in arbitrage opportunities. The minimum
investment in equity and equity related instruments shall be 65 percent of total assets.
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Equity Savings: An open ended scheme investing in equity, arbitrage and debt. The minimum
investment in equity and equity related instruments shall be 65 percent of total assets and minimum
investment in debt shall be 10 percent of total assets.

Solution Oriented Schemes

Retirement Fund: An open-ended retirement solution-oriented scheme having a lock-in of 5 years or

till retirement age (whichever is earlier). Scheme having a lock-in for at least 5 years or till retirement
age whichever is earlier.

Children’s Fund: An open-ended fund for investment for children having a lock-in for at least years or
till the child attains age of majority (whichever is earlier). Scheme having a lock-in for at least 5 years
or till the child attains age of majority whichever is earlier.

Other Schemes

Index Funds/ Exchange Traded Fund: An open ended scheme replicating/ tracking a specific index.
This minimum investment in securities of a particular index (which is being replicated/ tracked) shall
be 95 percent of total assets.

Fund of Funds (Overseas/ Domestic):An open ended fund of fund scheme investing in an underlying
fund. The minimum investment in the underlying fund shall be 95 percent of total assets.

Fixed Maturity Plans are a kind of close-ended debt fund where the duration of the investment
portfolio is closely aligned to the maturity of the scheme. AMCs tend to structure the scheme around
pre-identified investments.

Capital Protection Funds are closed-end hybrids funds. In these types of funds, the exposure to
equity is typically taken through the equity derivatives market. The portfolio is structured such that a
portion of the principal amount is invested in debt instruments so that it grows to the principal amount
over the term of the fund.

Infrastructure Debt Funds are investment vehicles which can be sponsored by commercial banks
and NBFCs in India in which domestic/offshore institutional investors, specially insurance and
pension funds can invest through units and bonds issued by the IDFs. Infrastructure Debt Funds
(IDFs) can be set up either as a Trust or as a Company.

Real Estate Mutual Fund Schemes / Real Estate Investment Trusts

 Real Estate Mutual Fund

 Real Estate Investment Trusts (REIT)
 Infrastructure Investment
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III. Legal Structure of Mutual Funds In India

Structure of Mutual Funds in India

SEBI (Mutual Fund) Regulations, 1996 as amended till date define “mutual fund” as “a fund
established in the form of a trust to raise monies through the sale of units to the public or a section of
the public under one or more schemes for investing in securities including money market instruments
or gold or gold-related instruments or real estate assets.”

Key constituents of a Mutual Fund

Sponsor

The application to SEBI for registration of a mutual fund is made by the sponsor/s. Thereafter, the
sponsor invests in the capital of the AMC. Since sponsors are the main people behind the mutual fund
operation, they have a set of eligibility criteria as well. Association of Mutual Funds in India’s
(AMFI) website lists all the Asset Management Companies, which are members of AMFI, in terms of
the category of the sponsor, viz., Banks, Institutions, Private sector, etc. Within banks there are
predominantly Indian joint ventures, and others; and similarly within the private sector, there are
Indian, foreign, and predominantly Indian joint ventures.

Board of Trustees

The trustees have a critical role in ensuring that the mutual fund complies with all the regulations, and
protects the interests of the unit-holders. The sponsor will have to appoint at least 4 trustees. If a
trustee company has been appointed, then that company would need to have at least 4 directors on the
Board. The strict provisions go a long way in promoting the independence of the role of trusteeship in
a mutual fund.

Mutual Fund Trust

Asset Management Company: Day to day operations of mutual fund is handled by the AMC. The
sponsor or, the trustees if so authorized by the trust deed, shall appoint the AMC with the approval of
SEBI. The AMC needs to have a minimum net worth of Rs.50 crore. The AMC is responsible for
conducting the activities of the fund. It therefore arranges for the requisite offices and infrastructure,
engages employees, provides for the requisite software, handles advertising and sales promotion, and
interacts with regulators and various service providers.

Custodian: The custodian has custody of the assets of the fund. As part of this role, the custodian
needs to accept and give delivery of securities for the purchase and sale transactions of the various
schemes of the fund. Thus, the custodian settles all the transactions on behalf of the mutual fund
schemes. The custodian also tracks corporate actions such as dividends, bonus and rights in
companies where the fund has invested.
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Organization Structure of Asset Management Company

Compliance Function: Compliance Officer needs to ensure all the legal compliances. In the scheme
documents of new issues, the Compliance Officer signs a due-diligence certificate to the effect that all
regulations have been complied with, and that all the intermediaries mentioned in the scheme related
documents have the requisite statutory registrations and approvals.

Fund management: Fund management is the most critical function in an Asset Management
Company. It is at the core of the value proposition offered by the firm. The main function of this team
is to invest the investors’ money in line with the stated objective of the scheme, and to manage the
same effectively.

Operations and customer services team: The Registrar and Transfer Agency (RTA), which is a big
part of this unit, maintains investor records as well as allots or redeems units, processes
purchase/redemption/switch requests, dividends, etc. It also generates the account statement that an
investor receives. There is a Custody Team within this group that interacts with the custodian for the
purpose of settlement of various transactions that the fund management team initiates. Fund
accounting team maintains books of accounts of each individual mutual fund scheme and calculates
NAV on a daily basis.

Sales and Marketing Team: This team reaches out to the investors through mass media, marketing
campaigns and through distribution channel. Their major responsibilities include branding,
advertising, management of various events, and distribution of mutual fund products through various
distribution channels.

Other functions
 The Accounts team handles the finances of the AMC. This unit is different from the fund
accounting team.
 There is an Administration Department that takes care of various facilities, offices, and
other infrastructure. In many AMCs, the administration reports to the finance function.
 The HR department is responsible for attracting, nurturing and retaining talent within the
firm. They take care of learning and development requirements of the personnel.
 The Information Technology department, also referred as the Technology team, takes care
of the IT infrastructure required by various functions and departments. This may also include
the AMC website, as well as many facilities offered to investors and distributors with the help
of technology.

Role and Support function of Service Providers

Fund Accountants: The fund accountant performs the role of calculating the NAV, by collecting
information about the assets and liabilities of each scheme.

Registrars and Transfer Agents (RTA): The Registrars and Transfer Agents (RTA) maintain
investor records. Their offices in various centers serve as Investor Service Centers (ISCs), which
perform a useful role in handling the documentation of investors. The appointment of RTA is done
by the AMC.
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Auditors: Auditors are responsible for the audit of accounts. Accounts of the mutual fund schemes
need to be maintained independent of the accounts of the AMC. The auditor appointed to audit the
mutual fund scheme needs to be different from that of the AMC.

Distributors: Distributors have a key role in selling suitable types of units to their clients i.e. the
investors in the schemes of mutual funds with whom they are empanelled. Distributors can be
individuals or institutions such as distribution companies, broking companies and banks.

Collecting Bankers: The investors’ money go into the bank account of the scheme they have invested
in. These bank accounts are maintained with collection bankers who are appointed by the AMC.

KYC Registration Agencies: It is mandatory for all investors in the securities market, including the
mutual fund investors, to be KYC (Know Your Customer) compliant under the provisions of the
Prevention of Money Laundering Act. The KYC process (covered in detailed later in the book)
involves establishing the identity and the address of the investor.

Valuation agencies: SEBI has issued guidelines for the purpose of arriving at fair valuation of debt
securities that are non-traded or thinly traded. According to these guidelines, there have to be atleast
two valuation agencies that provide valuation matrix. The AMCs have to make use of this matrix to
arrive at fair valuation of these investments. AMFI has appointed CRISIL Ltd. and ICRA Ltd. for the
purpose.

Credit Rating Agencies: Credit rating agencies rate debt securities issued by various issuers. Fund
managers consider such ratings as a key input while taking investment decisions. In few mutual fund
products, credit rating assumes greater importance. Certain categories of debt funds such as corporate
bond funds, credit risk funds are defined on the basis of credit rating.

Depositories and the Depository Participants: A depository is an institution, which holds the
securities in dematerialised or electronic form on behalf of the investors. Initially depositories held
only equity shares on behalf of the investors, later other securities including mutual funds were also
dematerialised.

Stock exchanges and the transaction platforms: Investors can now transact in mutual fund units
through the stock exchanges. The units of close-ended funds and ETFs are compulsorily listed on at
least one stock exchange. At the same time, units of open-ended funds are also available through
special segments on the stock exchanges.
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IV. Legal And Regulatory Environment

Role of Regulators in India

 Reserve Bank of India (RBI) that regulates the banking system, as well as money markets
 Securities and Exchange Board of India (SEBI) that regulates the securities markets
 Insurance Regulatory and Development Authority of India (IRDAI) that regulates the
insurance market; and
 Pension Fund Regulatory and Development Authority of India (PFRDA) that regulates
the pension market.

Role of Securities and Exchange Board of India

Securities and Exchange Board of India (SEBI) is the regulatory authority for securities markets in
India. It regulates, among other entities, mutual funds, depositories, custodians and registrars and
transfer agents in the country. Stock Exchanges are regulated by SEBI. Every stock exchange has its
own listing, trading and margining rules. Mutual Funds need to comply with the rules of the
exchanges with which they choose to have a business relationship.

Regulatory reforms by SEBI:

SEBI issued the mutual fund regulations in 1996 in the form of SEBI (Mutual Funds) Regulations,
1996. Since then, there have been many amendments through various regulations and circulars. In all
the cases, the objective has always remained to protect the interests of the mutual fund investors, and
to empower investors to take informed investment decisions. The various provisions of the regulations
can be broken down into the following categories, with a brief discussion of what they cover:

 Scheme related documents

 Conversion and consolidation of existing schemes
 New products
 Risk management system
 Disclosures and reporting norms
 Governance norms
 Secondary market activities
 Net Asset Value (NAV)and Valuation
 Loads, fees and expenses
 Dividend distribution procedure
 Investment by schemes
 Advertisements
 Investor rights and obligations
 Certification and registration of intermediaries
 Categorization of mutual fund schemes
 Segregated Portfolio
 Scheme Performance
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Investment Restriction for schemes

The SEBI Regulations provide for various limits to the kind of investments that are possible in mutual
fund schemes, and the limits thereof. In a few cases, there are also aggregate limits for all schemes of
a mutual fund together. The regulator’s objective behind setting these limits is to ensure mitigation of
risks in the scheme and protecting the investor’s interests.

 General Restrictions
 Restrictions pertaining to investments in Debt Securities
 Restrictions pertaining to investment in Equity
 Restrictions pertaining to investment in REITs and INvITs

Investors Rights and Obligations

 Right to beneficial ownership

 Right to change the distributor
 Right to inspect documents
 Right to appoint nominees
 Right to pledge mutual fund units
 Right to grievance redressal
 Rights of investors in context of change in Fundamental Attributes
 Rights to terminate appointment of an AMCs
 Right to unclaimed amounts

SEBI Complaint Redress System

SEBI Complaint Redress System (SCORES) is a web based centralized grievance redress system of
SEBI. SCORES enables investors to lodge, follow up on their complaints and track the status of
redressal of such complaints online. This system enables the market intermediaries and listed
companies to receive the complaints from investors, redress such complaints and report redressal. All
the activities starting from lodging of a complaint till its closure by SEBI is online and works in an
automated environment. An investor, who is not familiar with SCORES or does not have access to
SCORES, can lodge complaints in physical form at any of the offices of SEBI. Such complaints are
scanned and then uploaded in SCORES for processing.
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V. SCHEME RELATED INFORMATION

Mandatory Documents

The legal documents that provide the information that the investor requires is available in the scheme
related documents (Scheme Information Document, Statement of Additional Information) and the
Key Information Memorandum. Investors need to note that their investments are governed by the
principle of ‘caveat emptor’ i.e. let the buyer beware. An investor is presumed to have read and
understood the scheme related documents before investing in a mutual fund scheme.

Objective of the scheme related documents

SID and SAI together are the primary source of information for any investor—existing as well as
prospective. These are the operating documents that describe the product. Since the investor is
required to make an informed investment decision, these documents serve the purpose of providing
the required information in an easy to understand language.

There are primarily two important documents for understanding about the mutual fund scheme:

 Scheme Information Document (SID): This has details of the particular scheme.
 Statement of Additional Information (SAI): This has statutory information about the
mutual fund or AMC, which is offering the scheme.

Scheme Information Document

The Scheme Information Document (SID) sets forth concisely the information about the scheme that a
prospective investor ought to know before investing. An SID remains effective until a 'material
change' occurs and thereafter changes are filed with SEBI.

Statement of Additional Information

Statement of Additional Information (SAI), has statutory information about the mutual fund or AMC,
that is offering the scheme. Therefore, a single SAI is relevant for all the schemes offered by a mutual
fund.

Key Information Memorandum (KIM)

KIM is essentially a summary of the SID and SAI. It contains the key points of the offer document
that are essential for the investor to know to make a decision on the suitability of the investment for
their needs. It is more easily and widely distributed in the market. As per SEBI regulations, every
application form is to be accompanied by the KIM.
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Other Mandatory information/disclosure

 Daily disclosure of NAV

 Disclosure of Total Expense Ratio
 Portfolio Disclosure
 Annual Reports and related disclosures


Non-Mandatory Disclosures

 Fund Factsheet

VI. Fund Distribution and channel management practices

The role and importance of mutual fund distributors

An investor needs to invest the money in a portfolio of various investment options to achieve financial
goals. This process of building a portfolio could be achieved with the help of selection of a basket of
mutual fund schemes. However, one may still need help in constructing a portfolio with the help of an
expert. The mutual fund distributor’s job is to assess the needs, limitations, resources and financial
goals of the investor. This analysis would help the mutual fund distributor arrive at a suitable asset
allocation plan for the investor.

Different kind of mutual fund distributors

Individual: Individual distributors, also referred to as Individual Financial Advisors (IFA) continue to
be a large force for distribution numerically, though the volume of sales generated are significantly
lower than other distribution channels such as Institutional Distributors.

Non-Individual Entities: A chain of offices manned by professional employees or affiliated sub-

brokers became the face of mutual fund distribution. Brand building, standardized processes and
technology sharing became drivers of business for these institutions – unlike the personal network,
which generated volumes for the individual agents. Investors also benefit from the investment
research and other services that these institutions provide to their clients.

Modes of distribution

Online: The internet gave an opportunity to mutual funds to establish direct contact with investors.
Direct transactions afford scope to optimize on the commission costs involved in distribution. Other
electronic/internet based modes of conducting financial and non-financial transactions include those
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offered by banks, financial institutions, distributors, registrar and transfer agent, electronic platforms
provided by stock exchanges such as NSE’s MFSS and BSE’s StAR platform.

Stock Exchanges: SEBI has facilitated buying and selling of mutual fund units through the stock
exchanges. Both NSE and BSE have developed mutual fund transaction engines for the purpose. The
low cost and deeper reach of the stock exchange network has increased the participation level of retail
investors in mutual funds, and thereby taking the mutual fund industry into its next wave of growth.

MF Utilities: MF Utilities (MFU) is a transaction aggregating platform that connects investors,

RTAs, distributors, banks, AMCs and others. MFU facilitates the distributors with online access to
submit investor transactions. This platform provides them with a single point for time stamping of
transactions, document submission, paperless transaction facility, and login facility for their clients.

Computer-based and Mobile-based Apps offered by distributors: Apart from the above platforms
and the websites of distributors, the transaction facilities are now available on the mobile devices –
the smart phones, feature phones, and tablet computers. This makes it even more convenient than
going to a website.

Electronic platforms created by the AMCs: Apart from the above, various AMCs have also created
their own facilities like web-based and mobile-based applications that facilitate various transactions.
Many AMCs also offer transaction facilities through SMS and WhatsApp.

Pre-requisites to become Distributor of a Mutual Fund

 Obtaining NISM certifications

 KYD Requirements
 Obtaining ARN No.
 Empanelment with AMC’s

Revenue for a mutual fund distributor

Initial or Upfront Commission is paid on the amount mobilized by the distributor.

Trail commission is calculated as a percentage of the net assets attributable to the Units sold by the
distributor. The commission payable is calculated on the daily balances and paid out periodically to
the distributor as per the agreement entered into with AMC.

Transaction charges are paid to distributors for investments of Rs.10,000 and over. This does not
apply to direct investments. For subscriptions from existing investors the distributor will be paid
Rs.100 per transaction and for new investors across mutual funds they will be paid Rs.150 to
encourage widening the investor base of mutual funds.

Additional commission for promoting mutual funds in small towns: With a view to promoting
mutual funds in smaller towns, SEBI has allowed mutual funds to charge additional expenses, which
can be used for distribution related expenses, including distributor commission. This means that the
distributors mobilizing funds from investors located in B-30 locations would earn higher commission.
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VII. Net Asset Value, Total Expense Ratio and Pricing of Units

Fair Valuation Principles

The asset management companies are required to compute and carry out valuation of investments
made by its scheme(s) in accordance with the investment valuation norms specified in the Eighth
Schedule of SEBI (Mutual Funds) Regulations, 1996. The primary objective behind introduction of
these principles was to ensure fair treatment to all investors including existing investors as well as
investors seeking to purchase or redeem units of mutual funds in all schemes at all points of time.

Valuation

A mutual fund scheme invests the investors’ money in a portfolio of securities created and managed
based on the investment objective and strategy of the scheme. The investments include securities,
money market instruments, privately placed debentures, and securitized debt instruments, gold and
gold related instruments, real estate assets and infrastructure debt instruments and assets. The NAV of
the scheme will depend upon the value of this portfolio, which in turn, depends upon the value of the
securities held in it. The valuation of these securities to determine the net asset value has to be done in
accordance with the valuation guidelines laid down by SEBI and AMFI.

Computation of Net Assets of Mutual Fund Scheme and NAV

Net Asset Value

NAV refers to the value of each unit of the scheme.

NAV = (Current value of investments held + Income accrued + Current assets – Current liabilities –
Accrued expenses) / No. of outstanding units

Mark to Market

The process of valuing each security in the investment portfolio of the scheme at its current market
value is called ‘mark to market’ i.e. marking the securities to their market value. This is because
investors buy or sell units on the basis of the information contained in the NAV.

Total Expenses in Mutual Fund Scheme

All types of expenses incurred by the Asset Management Company have to be clearly identified and
appropriated for all mutual fund schemes.
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Investment and Advisory Fees: They are charged to the scheme by the AMC. The details of such
fees are fully disclosed in the Scheme Information Document.

Recurring Expenses: In addition to the investment and advisory fee, the AMC may charge the
mutual fund scheme with recurring expenses including audit fees, marketing fees, custodian fees, etc.

Dividends & Distributable Reserves

It was seen that income and expense are accounted on the basis of accrual principle.
Therefore, even though they may not have been received or paid, they are accrued as income or
expense, if they relate to a period until the accounting date. Similarly, it was seen that income and
expense are accounted on the basis of accrual principle. Therefore, even though they may not have
been received or paid, they are accrued as income or expense, if they relate to a period until the
accounting date.

Concept of Entry and Exit Load and its impact on NAV

A distinctive feature of open-ended schemes is the ongoing facility to acquire new units from the
scheme (sale transaction) or sell units back to the scheme (re-purchase transaction). In the past,
schemes were permitted to keep the Sale Price higher than the NAV. The difference between the Sale
Price and NAV was called the “entry load”. Schemes are permitted to keep the re-purchase Price
lower than the NAV. The difference between the NAV and re-purchase Price is called the “exit load”.
However currently, SEBI has banned entry loads. So, the Sale Price needs to be the same as NAV.
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VIII. Taxation

When anyone considers making an investment, one of the objectives is to get some investment
returns. However, such returns on investments or income from investments may be subject to tax:

Applicability of taxes in respect of mutual funds

Income from investment in mutual fund units: Investors must consider the effect of taxes on their
investment returns. It is not how much you earn, but how much you keep after taxes that count. As
mutual fund is a pass-through vehicle, we must consider the income at two levels– income earned by
the fund, and income earned by the investor.

Income earned by mutual fund schemes: The schemes of the mutual funds invest in marketable
securities like shares and debentures. These securities generate income in the form of dividend or
interest. Apart from this, when the fund buys and sells the shares and debentures in the securities
market, there could be capital gains or losses.

Income earned by the investor from investment in mutual fund units: We have already seen that
the investor can choose from two options within the scheme, viz. dividend and growth. The one who
has opted for dividend may get income in form of dividends, whereas the investor in the growth plan
would not get any dividend whatsoever, irrespective of the profits earned by the fund. The investor in
growth plan would earn capital gains (or losses) whenever one sells the units of the scheme. On the
other hand, the investor in the dividend plan may get dividend, as and when declared by the fund, as
well as capital gains (or losses) when one sells the units.

Capital Gains

When a unit holder sells units of the scheme, the selling price could be different from the price at
which the units were bought. The difference between the purchase price of the units and the selling
price of the units would be treated as capital gain (or loss). If the selling price is higher than the
purchase price, there is an incidence of capital gain, whereas if the selling price is lower than the
purchase price, there is capital loss. The capital gains are subject to tax. Capital gains tax is classified
depending on the period of holding and the type of funds invested in.

Dividend Stripping

When a dividend is paid, the NAV (ex-dividend NAV) decreases. This dividend is exempt from tax in
the hands of investors. Capital loss may be available for set off against Capital gains. A potential tax
avoidance approach, called dividend stripping, works as follows: Investors buy units, based on
advance information that a dividend would be paid. They then receive the dividend as a tax-exempt
income. After receiving the dividend, they would sell the units. Since the ex-dividend NAV would be
lower, they would book a capital loss (with the intention of setting it off against some other capital
gain). In order to plug this loophole, it is provided that:
if, an investor buys units within 3 months prior to the record date for a dividend and sells those units
within 9 months after the record date, any capital loss from the transaction would not be allowed to be
set off against other capital gains of the investor, up to the value of the dividend income exempted.
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Securities Transaction Tax

When an investor sells units of equity fund in the stock exchange, or offers them for repurchase to the
fund, he will have to incur Securities Transaction Tax (STT) i.e. STT is applicable only on
redemption/switch to other schemes/sale of units of equity oriented mutual funds whether sold on
stock exchange or otherwise. STT is not applicable on purchase of units of an equity scheme. It is also
not applicable to transactions in debt securities or debt mutual fund schemes.

Tax benefit under Section 80C of the Income Tax Act

Certain mutual fund schemes, known as Equity Linked Savings Schemes (ELSS) are eligible for
deduction under Section 80C of the Income Tax Act. As the name suggests, this is an equity linked
scheme, and hence the scheme invests in equity shares. The benefit is available up to
Rs.1.5 lacs per year per taxpayer in case of individuals and HUFs. The scheme has a lock-in period of
three years from the date of investment.

IX. Investor Services

New Fund Offer

Units in a mutual fund scheme are offered to public investors for the first time through a NFO. The
offer is made through a legal document called the Offer Document.

NFO Open Date – This is the date from which investors can invest in the NFO
NFO Close Date – This is the date upto which investors can invest in the NFO

Direct and Regular Plans

The Direct plan is for investors who wish to invest directly in the mutual fund without routing the
investment through a distributor. The Plan will have a lower expense ratio since there are no
distribution expenses or commissions involved.

Under Regular plan, the investor indicates a distributor through whose services the investment
decision was made and executed. The AMFI Registration Number (ARN) is made available by the
investor in the application form and the mutual fund pays the transaction charges and commissions to
the distributor so identified.

Dividend Pay-out, Dividend Re-Investment and Growth Options

In a dividend payout option, the fund declares a dividend from time to time. Both debt and equity
schemes need to pay a dividend distribution tax (DDT) on the dividend distributed. This tax payment
too reduces the NAV.

In a dividend re-investment option, as in the case of dividend payout option, NAV declines to the
extent of dividend and dividend distribution tax. The resulting NAV is called ex-dividend NAV.
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However, the investor does not receive the dividend in his bank account; the amount is re-invested in
the same scheme and additional units are allotted to the investor.

In a growth option, dividend is not declared. Therefore, nothing is received in the bank account
(unlike dividend payout option) and there is nothing to re-invest (unlike dividend re-investment
option).

Allotment of Units to the Investor

NFO: Since entry load is banned, units in an NFO are sold at the face value i.e. Rs. 10. So the
investment amount divided by Rs.10 would give the number of units the investor has bought.
Subject to the receipt of the specified minimum subscription amount for the scheme, full allotment is
made to all valid applications received during the New Fund Offer. The Trustee reserves the right, at
their discretion without assigning any reason thereof, to reject any application.

On-going offer: The price at which units are sold to an investor as part of ongoing sales in an open-
end scheme is the sale price, which in turn is the applicable NAV (currently entry load is not
permitted by regulation, hence the sales price is equal to the NAV). The investment amount divided
by the sale price would give the number of units the investor has bought.

In a rights issue, the price at which the units are offered is clear at the time of investment.
The investment amount divided by the rights price gives the number of units that the investor has
bought. It may however be noted that rights issues, which are common for shares, are less meaningful
for units of mutual fund schemes.

In a bonus issue, the investor does not pay anything. The fund allots new units for free. Thus, in a 1:3
bonus issue, the investor is allotted 1 new unit (free) for every 3 units already held by the investor.
Since the net assets of the scheme remain the same – only the number of units’ increases - the NAV
will get reduced proportionately and the value of the investor’s holding does not change as a result of
the bonus issue.

Account statements for investments

Monthly Statement of Account: Mutual funds issue the Statement of Account every month if there
is a transaction during the month. It shows for each transaction (sale/re-purchase), the value of the
transaction, the relevant NAV and the number of units transacted. Besides, it also provides the closing
balance of units held in that folio and the value of those units based on the latest NAV.

Annual Account Statement: The Mutual Funds shall provide the Account Statement to the Unit-
holders who have not transacted during the last six months prior to the date of generation of account
statements. The Account Statement shall reflect the latest closing

Consolidated Account Statement (CAS): A Consolidated Account Statement for each calendar
month will be sent by post/email on or before 10th of the succeeding month provided there is a
financial transaction in the folio in the previous month.
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Eligibility to invest in Mutual Funds

Types of Individual Investors

 Resident Individuals
 Minors
 Hindu Undivided Families
 NRI’s
 Foreign Investors

Types of Non-Individual Investors

 Companies/ Corporate Bodies
 Registered societies
 Universities and educational institutions
 Association of persons of body of individuals
 Foreign Portfolio Investors
 Banks and financial Institutions

Filling the application form for Mutual Funds

 Direct Plan and Regular Plan
 Unit holder Information
 Status of the holder and Mode of Holding
 KYC Details
 FATCA and CRS Details
 Bank Details
 Investment Details
 Demat Account Details
 Payment Details
 Unit Holding Option
 Nomination

Financial Transactions with Mutual Funds

 Initial Purchase of Mutual Fund Units

 Additional Purchase
 Repurchase of units
 Switch

Payment Mechanism for Mutual Fund Purchase

 Online Transactions
 Internet Banking
 Electronic Clearing Services (ECS)
 M-Banking and Cash Payments
 Unified Payment Interface
 Aadhar Enabled Payment System
 National Unified USSD platform
 Cards and E-Wallets
 One-Time Mandate and Application supported by Blocked Amounts (ASBA)

The same payment mechanisms are used while re-purchasing the units.
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Time Stamping

The precision in setting cut-off timing makes sense only if there is a fool proof mechanism of
capturing the time at which the sale and re-purchase applications are received. These points of
acceptance have time stamping machines with tamper-proof seal. Opening the machine for repairs or
maintenance is permitted only by vendors or nominated persons of the mutual fund. Such opening of
the machine has to be properly documented and reported to the Trustees. For online transactions, the
time as per the web server to which the instruction goes, is used in determining the NAV for sale/re-
purchase transactions.

KYC Requirements for Mutual Fund Investors

KYC Documents

 PAN Card
 Proof of Address

KYC Registration Agencies

 Centralised KYC Registration Agencies

 KYC through e-KYC service of UIDAI
 KYC through Intermediaries

KYC Process

Once the KYC processes are completed and the details are uploaded on the KRA’s servers, the
KYC process is complete. The investor does not need any further KYC for dealing in any part of the
securities market.

Foreign Account Tax Compliance Act and Common Reporting Standards

To comply with the requirements of Foreign Account Tax Compliance Act (FATCA) and Common
Reporting Standards (CRS) provisions, financial institutions, including mutual funds, are required to
undertake due diligence process to identify foreign reportable accounts and collect such information
as required under the said provisions and report the same to the US Internal Revenue Service/any
other foreign government or to the Indian Tax Authorities for onward transmission to the concerned
foreign authorities. The application form requires information to be provided if the
citizenship/nationality/place of birth/tax residency are places other than India for all categories of
investors.

Systematic Transfers

Systematic Investment Plan (SIP)

SIP is an approach where the investor invests constant amounts at regular intervals. A benefit of such
an approach, particularly in equity schemes, is that it averages the unit-holder’s cost of acquisition
since more units are bought for the same amount of investment when the price/markets are down and
fewer units when the price/markets are up.
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Systematic Withdrawal Plan (SWP)

Mutual funds make it convenient for investors to manage their SWPs by registering a amount,
periodicity (generally, monthly) and period for their SWP. Some schemes even offer the facility of
transferring only the appreciation or the dividend. In this option, the withdrawal is not fixed but will
vary depending upon the availability of appreciation in the specific investment chosen by the investor.
The advantage of a variable SWP relative to a fixed amount of withdrawal is that the capital invested
will not be withdrawn.

Systematic Transfer Plan (STP)

In a STP, the amount that is withdrawn from a scheme (called the source scheme) is re-invested in
some other scheme (called the target scheme) of the same mutual fund. Thus, it operates as a SWP
from the source scheme, and a SIP into the target scheme. Since the investor is effectively switching
between schemes, it is also called “switch” if it is just one transaction or tranche. If there are multiple
tranches over a fixed period on pre-defined date of an amount that is defined ahead, then it is an STP.

Dividend Transfer Plan (DTP)

Dividend Transfer Plan (DTP) is a facility that allows investors to invest the dividend earned in a
mutual fund investment into another scheme of the same mutual fund. Investors with a low risk
profile can get some benefits of diversification by transferring dividends earned from debt funds into
equity funds. Similarly, dividends earned in equity funds can be transferred into debt funds to
rebalance the portfolio and manage risks. Mutual funds decide the schemes, plans and options from
which the dividends can be transferred and the target schemes to which they can be transferred.

Switch
A switch is redemption from one scheme and a purchase into another combined into one transaction.
For example, investors who believe that equity markets have peaked and want to book profits can
switch out from an equity scheme and switch into a short-term debt fund.

Operational Aspects of Systematic Transfers

 SIP Top-Up Facility:Mutual funds provide an additional facility through an SIP to enhance
the disciplined savings of investors. It is called the SIP Top-Up facility. Investors have the
option to increase the SIP amount at intervals chosen by them. The increase can be of a fixed
amount or a percentage of the existing SIP amount.
 Renewal and cancellation of SIP
 Registration and cancellation of SIP, STP and Switches
 Execution of systematic Transfers
 Triggers

Non-Financial Transactions in Mutual Funds

Following are the possible transactions under this category

 Nomination
 Pledge/Lien of units
 Demat Account
 Change in Folio Details
 Change in Personal Information
 Change in Bank Account Details
 Transmission of units
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Change in Status of Special Investor Categories

Following are the possible changes under this category

 Minor turned Major
 NRI to Resident Indian
 Change in Karta of HUF

X. Risk, Return and Performance of Funds

Investment in mutual fund units involves investment risks such as trading volumes, settlement risk,
liquidity risk, default risk, including the possible loss of principal. The Scheme Information
Document (SID) contains a list of all these risks. The SID also contains a discussion on risk
mitigation strategies. Investment in mutual fund units involves investment risks such as trading
volumes, settlement risk, liquidity risk, default risk, including the possible loss of principal.

Liquidity Risk: This risk is also very closely associated with real estate, where liquidity is very low,
and often it takes weeks or months to sell the investment. The liquidity of a bond may change,
depending on market conditions leading to changes in the liquidity premium attached to the price of
the bond. At the time of selling the security, the security can become illiquid, leading to loss in value
of the portfolio.

Interest Rate Risk: Interest rate risk is the risk that an investment's value will change as a result of a
change in interest rates. This risk affects the value of bonds/debt instruments more directly than
stocks. Any reduction in interest rates will increase the value of the instrument and vice versa.

Re-investment Risk: The investments made by the Scheme are subject to reinvestment risk. This risk
refers to the interest rate levels at which cash flows received from the securities in the Scheme are
reinvested. The additional income from reinvestment is the ‘interest on interest’ component. The risk
is that the rate at which interim cash flows can be reinvested may be lower than that originally
assumed.

Political Risk: Investments in mutual fund Units in India may be materially adversely impacted by
Indian politics and changes in the political scenario in India either at the central, state or local level.
Actions of the central government or respective state governments in the future could have a
significant effect on the Indian economy, which could affect companies, general business and market
conditions, prices and yields of securities in which the Scheme invest.

Economic Risk: A slowdown in economic growth or macro-economic imbalances such as the

increase in central and state level fiscal deficits may adversely affect investments in the country. The
underlying growth in the economy is expected to have a direct impact on the volume of new
investments in the country.

Foreign Currency Risk: The Scheme may be denominated in Indian Rupees (INR) which is different
from the home currency for Foreign Portfolio Investors in the mutual fund units. The INR value of
investments when translated into home currency by Foreign Portfolio Investors could be lower
because of the currency movements.
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Specific Risk Factors

Risk related to equity and equity related securities

Risk associated with short selling and Stock Lending: Securities Lending is lending of securities
through an approved intermediary to a borrower under an agreement for a specified period with the
condition that the borrower will return securities of the same type or class at the end of the specified
period along with the corporate benefits accruing on the securities borrowed. There are risks inherent
in securities lending, including the risk of failure of the other party.

Risks associated with mid-cap and small-cap companies: Investment in mid-cap and small-cap
companies are based on the premise that these companies have the ability to increase their earnings at
a faster pace as compared to large cap companies and grow into larger, more valuable companies.
However, as with all equity investments, there is a risk that such companies may not achieve their
expected earnings results, or there could be an unexpected change in the market, both of which may
adversely affect investment results.

Risk associated with Dividend: The schemes are vulnerable to instances where investments in
securities may not earn dividend or where lesser dividend is declared by a company in subsequent
years in which investments are made by schemes. As the profitability of companies are likely to vary
and have a material bearing on their ability to declare and pay dividend.

Risk associated with Derivatives: The use of a derivative requires an understanding not only of the
underlying instrument but of the derivative itself. Trading in derivatives carries a high degree of risk
although they are traded at a relatively small amount of margin which provides the possibility of great
profit or loss in comparison with the principal investment amount.

Risks related to debt funds

Reinvestment Risk: Investments in fixed income securities carry re-investment risk as interest rates
prevailing on the coupon payment or maturity dates may differ from the original coupon of the bond.

Rating Migration Risk: Fixed income securities are exposed to rating migration risk, which could
impact the price on account of change in the credit rating. For example: One notch downgrade of a
AAA rated issuer to AA+ will have an adverse impact on the price of the security and vice-versa for
an upgrade of a AA+ issuer.

Term Structure of Interest Rates Risk: The NAV of the Scheme’ Units, to the extent that the Scheme
are invested in fixed income securities, will be affected by changes in the general level of interest
rates. When interest rates decline, the value of a portfolio of fixed income securities can be expected
to rise. Conversely, when interest rates rise, the value of a portfolio of fixed income securities can be
expected to decline.

Credit Risk: Fixed income securities (debt and money market securities) are subject to the risk of an
issuer’s inability to meet interest and principal payments on its debt obligations. The investment
Manager will endeavor to manage credit risk through in-house credit analysis.
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Risk associated with floating rate securities

Spread Risk: In a floating rate security the coupon is expressed in terms of a spread or mark up over
the benchmark rate. In the life of the security this spread may move adversely leading to loss in value
of the portfolio. The yield of the underlying benchmark might not change, but the spread of the
security over the underlying benchmark might increase leading to loss in value of the security.

Basis Risk: The underlying benchmark of a floating rate security or a swap might become less active
or may cease to exist and thus may not be able to capture the exact interest rate movements, leading to
loss of value of the portfolio.

Risk factors associated with repo transactions in Corporate Bonds

The Scheme may be exposed to counter party risk in case of repo lending transactions in the event of
the counterparty failing to honour the repurchase agreement. However, in repo transactions, the
collateral may be sold and a loss is realized only if the sale price is less than the repo amount.

Risks associated with Creation of Segregated portfolio

Investor holding units of segregated portfolio may not able to liquidate their holding till the time
recovery of money from the issuer. Security comprises of segregated portfolio may not realize any
value. Listing of units of segregated portfolio on recognized stock exchange does not necessarily
guarantee their liquidity.

Risks associated with asset class

Underlying assets in securitized debt may assume different forms and the general types of receivables
include commercial vehicles, auto finance, credit cards, home loans or any such receipts.

Risks associated with pool characteristics:

 Size of the Loan
 Loan to Value Ratio
 Original maturity of loans and average seasoning of the pool
 Default rate distribution

Credit Rating and Adequacy of Credit Enhancement

The process of “Credit enhancement” is fulfilled by filtering the underlying asset classes and applying
selection criteria, which further diminishes the risks inherent for a particular asset class. The purpose
of credit enhancement is to ensure timely payment to the investors, if the actual collection from the
pool of receivables for a given period is short of the contractual pay-out on securitization.

Limited Liquidity & Price Risk: The secondary market for securitized papers is not very liquid.
Even if a secondary market develops and sales were to take place, these secondary transactions may
be at a discount to the initial issue price due to changes in the interest rate structure.

Limited Recourse to Originator & Delinquency: No financial recourse is available to the

Certificate Holders against the Investors Representative. Delinquencies and credit losses may cause
depletion of the amount available under the credit enhancement and thereby the investor pay-outs may
get affected if the amount available in the credit enhancement facility is not enough to cover the
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shortfall. On persistent default of an obligor to repay his obligation, the servicer may repossess and
sell the underlying Asset.

Risks due to possible prepayments: Asset securitization is a process whereby commercial or

consumer credits are packaged and sold in the form of financial instruments. Full prepayment of
underlying loan contract may arise only under certain circumstances.

Bankruptcy of the Originator or Seller: If originator becomes subject to bankruptcy proceedings

and the court in the bankruptcy proceedings concludes that the sale from originator to trust was not a
sale then an Investor could experience losses or delays inthe payments due.

Bankruptcy of the Investor’s Agent: If Investor’s agent becomes subject to bankruptcy proceedings
and the court in the bankruptcy proceedings, and then an Investor could experience losses or delays in
the payments due under the agreement.

Risk Factors Associated with Investments in REITs and InvITs

ReITs and InvITs are exposed to price-risk, interest rate risk, credit risk, liquidity or marketability
risk, reinvestment risk. Also, there is a risk of lower than expected distributions. The distributions by
the REIT or InvIT will be based on the net cash flows available for distribution. The amount of cash
available for distribution principally depends upon the amount of cash that the REIT/InvITs receives
as dividends or the interest and principal payments from portfolio assets.

Managing Market Liquidity Risk: The liquidity risk is managed by creating a portfolio which has
adequate access to liquidity. The Investment Manager selects fixed income securities, which have or
are expected to have high secondary market liquidity. Market Liquidity Risk will be managed actively
within the portfolio liquidity limits. The first access to liquidity is through cash and fixed income
securities.

Managing Credit Risk: Credit Risk associated with fixed income securities is managed by making
investments in securities issued by borrowers, which have a good credit profile. The credit research
process includes a detailed in-house analysis and due diligence.

Managing Term Structure of Interest Rates Risk: The Investment Manager actively manages the
duration based on the ensuing market conditions. As the fixed income investments of the Scheme are
generally short duration in nature, the risk is expected to be small.

Managing Rating Migration Risk: The endeavour is to invest in high grade/quality securities. The
due diligence performed by the fixed income team before assigning credit limits and the periodic
credit review and monitoring should address company-specific issues.

Re-investment Risk: Re-investment Risk is prevalent for fixed income securities, but as the fixed
income investments of the Scheme are generally short duration in nature, the impact can be expected
to be small.
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Factors that affect mutual fund performance

Difference between market/systematic risk and company specific risk: Various investments are
exposed to a number of risk factors. For example, stock prices move up or down based on various
factors that impact the business performance of the company, or the whole economy. Out of these, the
risks that impact the specific company are called company specific or firm specific risks. The risks
that impact the entire economy are known as systematic risks. The company specific risks are also
known as unsystematic risks.

Mutual fund investments are subject to market risks: “Mutual fund investments are subject to
market risks. Please read the scheme related documents carefully before investing.” – These lines are
part of any marketing communication by mutual fund companies. This is a regulatory requirement. It
is important to understand the meaning of this line, to be able to take the advantages of the mutual
funds. Let us understand this. Unlike most other products, mutual fund is a pass-through vehicle, in
which all the investment risks are passed onto the investor since the investor/unit-holder is the owner
of the fund. However, the fund may be subject to this risk as the investments made by the fund may
default on their commitments.

Drivers of Returns and Risk in a Scheme

Factors Affecting Performance of Equity Schemes

Fundamental and Technical analysis: Fundamental analysis is a study of the business and financial
statements of a firm in order to identify securities suitable for the strategy of the schemes as well as
those with high potential for investment returns and where the risks are low. The discipline of
Technical Analysishas a completely different approach. Technical Analysts believe that price
behaviour of a share over a period of time throws up trends for the future direction of the price. Along
with past prices, the volumes traded indicate the underlying strength of the trend and are a reflection
of investor sentiment, which in turn will influence future price of the share.

Price to Earnings Ratio (P/E Ratio): Market Price per share ÷ Earnings Per Share (EPS). When
investors buy shares of a company, they are essentially buying into its future earnings. P/E ratio
indicates how much investors in the share market are prepared to pay (to become owners of the
company), in relation to the company’s earnings. The forward PE ratio is normally calculated based
on a projected EPS for a future period.

The Price Earnings to Growth (PEG) ratio relates the PE ratio to the growth estimated in the
company’s earnings. A PEG ratio of one indicates that the market has fairly valued the company’s
shares, given its expected growth in earnings. A ratio less than one indicates the equity shares of the
company are undervalued, and a ratio greater than one indicates an overvalued share.

Book Value per Share: Net Worth ÷ No. of equity shares outstanding. This is an indicator of how
much each share is worth, as per the company’s own books of accounts. The accounts represent a
historical perspective, and are a function of various accounting policies adopted by the company.
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Price to Book Value: Market Price per share ÷ Book Value per share. An indicator of how much the
share market is prepared to pay for each share of the company, as compared to its book value. The
drawback with this is that the book value is an accounting measure and may not represent the true
value of the assets of the company.

Dividend Yield: Dividend per share ÷ Market price per share. This is used as a measure of the
payouts received from the company, in percentage, for each rupee of investment in the share.
Dividend yield is considered as a parameter by conservative investors looking to identify steady and
lower risk equity investments. A high dividend yield is the result of higher payout and/or lower
market prices, both of which are preferred by such conservative investors.

Investment Styles – Growth and Value

Growth investment style entails investing in high growth stocks i.e. stocks of companies that are
likely to grow much faster than the market. Many market players are interested in accumulating such
growth stocks.

Value investment style is an approach of picking up stocks, which are priced lower than their
intrinsic value, based on fundamental analysis. The belief is that the market has not appreciated some
aspect of the value in a company’s share – and hence it is cheap.

Portfolio building approach – Top down and Bottom up

In a top down approach, the portfolio manager evaluates the impact of economic factors first and
narrows down on the industries that are suitable for investment. Thereafter, the companies are
analyzed and the good stocks within the identified sectors are selected for investment.

A bottom-up approach on the other hand analyses the company-specific factors first and then
evaluates the industry factors and finally the macro-economic scenario and its impact on the
companies that are being considered for investment.

Factors affecting performance of Debt Schemes

Interest Rates: Suppose an investor has invested in a debt security that yields a return of 8 percent.
Subsequently, yields in the market for similar securities rise to 9 percent. It stands to reason that the
security, which was bought at 8 percent yield, is no longer such an attractive investment. It will
therefore lose value. Conversely, if the yields in the market go down, the debt security will gain value.
Thus, there is an inverse relationship between yields and value of such debt securities, which offer a
fixed rate of interest.

Credit Spreads: Suppose an investor has invested in the debt security of a company. Subsequently,
its credit rating improves. The market will now be prepared to accept a lower credit spread.
Correspondingly, the value of the debt security will increase in the market.

Factors Affecting Performance of Gold Funds

Global price of gold: Gold is seen as a safe haven asset class. Therefore, whenever there is political
or economic turmoil, gold prices shoot up. Most countries hold a part of their foreign currency
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reserves in gold. Similarly, institutions like the International Monetary Fund have large reserves of
gold. When they come to the market to sell, gold prices weaken. Purchases of gold by large countries
tend to push up the price of gold.

Strength of the Rupee: Economic research into inflation and foreign currency flows helps analysts
anticipate the likely trend of foreign currency rates. When the rupee becomes stronger, the same
foreign currency can be bought for fewer rupees. Therefore, the same gold price translates into a
lower rupee value for the gold portfolio.

Factors affecting performance of Real Estate funds

Economic scenario: At times of uncertainty about the economy (like recessionary situation), people
prefer to postpone real estate purchases and as a consequence, real estate prices weaken. As the
economy improves, real estate prices also tend to keep pace.

Infrastructure development: Whenever infrastructure in an area improves, real estate values

increases.

Interest Rates: When money is cheap and easily available, more people buy real estate. This pushes
up real estate prices. Rise in interest rates therefore softens the real estate market.

Measures of Returns

 Simple Return = (Sale Value- cost value)/ Cost Value

 Annualized Return = (Simple Return * 12)/ Period of simple return (in months)

 Compounded Return

 Compounded Annual Growth Rate

Pros and Cons of Evaluating Funds only on the Basis of Return Performance

The primary factor that investors use for selecting a mutual fund for investment is the return that ithas
generated. To make the selection more robust, it is important to consider the consistency of there turn
performance and the performance relative to the benchmark of the scheme and its peer group funds.
However, the return number alone is not adequate to make a decision to invest in a scheme or exit
from a scheme. The suitability of the scheme to an investor’s needs must also consider the risk
associated with the scheme. This includes evaluating factors like the volatility in returns over time.
The extent of volatility indicates the riskiness of the scheme. First, the asset allocation of the scheme
should be in line with the investor’s need for growth, income or liquidity. The discipline with which
the scheme sticks to the stated asset allocation, the scheme’s policy of moving to cash, the extent of
diversification across stocks and sectors and the credit rating and duration of debt securities will have
an impact on the returns but also on the risk.

Measures of Risk

Variance: Variance measures the fluctuation in periodic returns of a scheme, as compared to its own
average return. This can be easily calculated in MS Excel using the following function: = var (range
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of cells where the periodic returns are calculated) Variance as a measure of risk is relevant for both
debt and equity schemes.

Standard Deviation: Standard Deviation too measures the fluctuation in periodic returns of a scheme
in relation to its own average return. Mathematically, standard deviation is equal to the square root of
variance. Standard deviation is a measure of total risk in an investment. As a measure of risk it is
relevant for both debt and equity schemes. A high standard deviation indicates greater volatility in the
returns and greater risk.

Beta: Beta is based on the Capital Asset Pricing Model (CAPM), which states that there are two kinds
of risk in investing in equities – systematic risk and non-systematic risk. Beta measures the fluctuation
in periodic returns in a scheme, as compared to fluctuation in periodic returns of a diversified stock
index (representing the market) over the same period.

Modified Duration: The modified duration measures the sensitivity of value of a debt security to
changes in interest rates. Higher the modified duration, higher is the interest sensitive risk in a debt
portfolio.

Weighted Average Maturity: While modified duration captures interest sensitivity of a security
better, it can be reasoned that longer the maturity of a debt security, higher would be its interest rate
sensitivity. Extending the logic, weighted average maturity of debt securities in a scheme’s portfolio
is indicative of the interest rate sensitivity of a scheme.

Credit Rating: The credit rating profile indicates the credit or default risk in a scheme. Government
securities do not have a credit risk. Similarly, cash and cash equivalents do not have a credit risk.
Investments in corporate issuances carry credit risk. Higher the credit rating lower is the default risk.

Certain Provisions with respect to Credit risk

TER for Segregated Portfolio:AMC will not charge investment and advisory fees on the segregated
portfolio. However, TER can be charged, on a pro-rata basis only upon recovery of the investments in
segregated portfolio. The TER so levied shall not exceed the simple average of such expenses. The
legal charges related to recovery of the investments of the segregated portfolio may be charged to the
segregated portfolio in proportion to the amount of recovery.

Net Asset Value of Segregated Portfolio:The Net Asset Value (NAV) of the segregated portfolio is
required to be declared on a daily basis. Adequate disclosure of the segregated portfolio shall appear
in all scheme related documents, in monthly and half-yearly portfolio disclosures and in the annual
report of the mutual fund and the scheme.
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XI. Mutual Fund Scheme Performance

Benchmark

Mutual fund schemes invest in the market for the benefit of Unit-holders. An approach to assess the
performance is to pre-define a comparable – a benchmark – against which the scheme can be
compared. The benchmark should be calculated by an independent agency in a transparent manner,
and published regularly. Most benchmarks are constructed by stock exchanges, credit rating agencies,
securities research houses or financial publications. The investment objective is clear on the index that
the scheme would mirror. That index would then be the benchmark for the scheme.

Price Return Index or Total Return Index

Earlier, the Mutual Fund schemes were benchmarked to the Price Return variant of an Index (PRI).
PRI only captures capital gains of the index constituents. With effect from February 1, 2018, the
mutual fund schemes are benchmarked to the Total Return variant of an Index (TRI).
The Total Return variant of an index takes into account all dividends/interest payments that are
generated from the basket of constituents that make up the index in addition to the capital gains.

Basis of choosing an appropriate performance benchmark

Benchmarks for equity schemes

Scheme Type: A sector fund would invest in only the concerned sector; while there are some funds
that invest in all sectors. Therefore, funds investing in different sectors need to have a diversified
index as a benchmark index, like S&P BSE Sensex or Nifty 50 or S&P BSE 200 or S&P BSE 500.

Choice of Investment Universe: Some equity funds investing in different sectors invest in large
companies; while there are others that focus on mid-cap stocks or small cap stocks. S&P BSE Sensex
and Nifty 50 indices are calculated based on 30 (in the case of Sensex) / 50 (in the case of Nifty) large
companies.

Choice of Portfolio Concentration: Some equity funds investing in different sectors prefer to have
fewer stocks in their portfolio. For such schemes, appropriate benchmarks are narrow indices such as
S&P BSE Sensex and Nifty 50, which have fewer stocks.

Benchmarks for Debt Schemes

Scheme Type: Liquid schemes invest in securities of up to 91 days’ maturity. Therefore, a short term
money market benchmark such as NSE’s MIBOR or CRISIL Liquid Fund Index is suitable.

Choice of Investment Universe: Gilt funds invest only in Government securities. Therefore, indices
based on Government Securities are appropriate.

Benchmarks for Other Schemes

Hybrid Fund: Hybrid funds invest in a mix of debt and equity. Therefore, the benchmark for a hybrid
fund is a blend of an equity and debt index.
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Gold ETF: Gold price would be the benchmark for such funds.

Real Estate Funds: A few real estate services companies have developed real estate indices. These
have shorter histories, and are yet to earn the wider acceptance that the equity indices enjoy.

International Funds: The benchmark would depend on where the scheme proposes to invest. Thus, a
scheme seeking to invest in China might have the Hang Seng Index (Chinese index) as the
benchmark. S&P 500 may be appropriate for a scheme that would invest largely in the US market.

Standard benchmarks: For the sake of standardization, schemes need to disclose return in INR and by
way of CAGR for the following benchmarks apart from the scheme benchmarks:

Scheme Type Benchmark

Equity Scheme Sensex or NIFTY
Long Term Debt Scheme 10-year dated GOI Security
Short-Term Debt Fund 1 year T-Bill

This was proposed in order to bring standardization to the process of benchmarking as well as
comparing the scheme performance with easily available indices.

Quantitative Measures of Fund Manager Performance

1. Absolute and relative returns

2. Sharpe Ratio: Sharpe Ratio is effectively the risk premium generated by assuming per unit of
risk. Higher theSharpe Ratio, better the scheme is considered to be.

3. Treynor Ratio: Higher the Treynor Ratio, better the scheme is considered to be. Since the
concept of Beta is more relevant for diversified equity schemes, Treynor Ratio comparisons
should ideally be restricted to such schemes.

4. Alpha: The difference between a scheme’s actual return and its optimal return is its Alpha– a
measure ofthe fund manager’s performance.

5. Tracking Error: The Beta of the market, by definition is 1. An index fund mirrors the index.
Therefore, the index fund too would have a Beta of 1, and it ought to earn the same return as
the market. The difference between an index fund’s return and the market return is the
tracking error. Tracking error is a measure of the consistency of the out-performance of the
fund managerrelative to the benchmark.

Scheme Performance Disclosure

SEBI has mandated disclosure of performance data by all the asset management companies(AMCs).
These disclosures can be accessed through certain scheme documents and website of the fund house.
Following are the required disclosures:

 Suitability
 Returns
 Portfolio Description
 Fund Factsheets
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XII.MUTUAL FUND SCHEME SELECTION

Scheme Selection based on Investor needs, preferences and risk-profile

Investor Need: The selection of a mutual fund scheme for an investor will depend upon the need that
the investor has from the investment. The investor may need long term appreciation in the value of his
investment, or the investor may need periodic income from the investment, or the investor may need
periodic income from the investment, or the investor may be looking for an avenue to park funds and
need an investment with high liquidity. Therefore, understanding mutual fund schemes should
eventually help one to build a robust investment portfolio.

Risk Profile of the investor: The investor’s risk appetite is a function of three things—the need to
take risks, the ability to take risks, and the willingness to take risks. Thus, an understanding of the risk
profile and the investment risks associated with various mutual fund schemes would be essential for
deciding the asset allocation in an investor’s portfolio.

Asset Allocation: The investor’s need from the investment will determine the asset class that is most
suitable for the investor. Along with the need from the investment, the investor’s ability to take risk
and the investor’s investment horizon is equally important to select the appropriate asset class. The
investor’s asset allocation is a decision regarding how much money should be allocated to which
scheme category (asset class). This decision can be taken only after assessing the investor’s risk
profile and analyzing investor’s goals and situation.

Age of the investor: One of the common factors that many people use to evaluate the investor’s risk
profile is the investor’s age. It is popularly believed that younger investors have the potential for
taking higher risks compared to old people.

Investment time horizon: As against the investor’s age, one may consider the time horizon to the
respective financial goal for which one is investing. Longer the horizon to the goal, the ability to take
risk is higher, whereas one may avoid risks when the goal is in the near future.

Core and satellite portfolio: At this stage it is also good to consider the role that the scheme will
play in the investor’s portfolio. Ideally the portfolio should be divided into core and satellite
portfolios. The core portfolio will be invested according to the long term needs and goals of the
investor. The satellite portfolio will be invested to take advantage of expected short-term market
movements.

Risk levels in mutual fund schemes

As one moves from liquid funds to debt funds to hybrid funds to equity funds, the potential returns as
well as the investment risks increases. The risk-return profiles of debt funds may be seen in light of
two separate risks—credit risk and interest rate risk. The higher the market capitalization in equity
mutual fund schemes, higher is the potential returns as well as the investment risks. Smaller
companies are riskier than their larger counterparts, and hence small cap funds carry higher risk than
mid cap funds, which in turn are riskier than the large cap funds. A focused fund is riskier than a
diversified fund. The risk levels in different categories of mutual fund schemes can be understood
with the help of product labeling of Mutual Funds.
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Scheme Selection based on investment strategy of mutual funds

Active or Passive funds

Passive funds are suitable for investors looking for exposure to an asset class without the risks
associated with fund manager selection and strategies. Index funds are passive funds. They are
expected to offer a return in line with the market because they invest in a portfolio that mimics a
market index in the securities it invests in and in the weightages allotted to each security in the
portfolio. An investor in an active fund is bearing a higher cost for the fund management, and a higher
risk to earn returns better than the benchmark.

Open or close ended

The significant benefit that open-ended funds offer is liquidity viz. the option of getting back the
current value of the unit-holding from the scheme. A close-ended scheme offers liquidity through its
listing on a stock exchange. Unfortunately, mutual fund units are not that actively traded in the
market. A holder of units in a close-ended scheme will need counterparty in the stock exchange in
order to be able to sell his units and recover its value.

Diversified, Sector or Thematic

The critical difference between diversified and sector fund is that the multi-sector exposure in a
diversified fund makes it less risky. Sector funds are risky because of the concentration in one sector.
If the sector under-performs then the scheme’s returns is likely to be poor.

Large-cap v/s Mid-cap / Small Cap Funds

Growth or Value funds

Funds that follow the growth strategy seek to identify companies that are expected to grow at rates
higher than the average economic growth rate. Value strategy seeks to identify stocks that are
available at a price that is seen as cheap relative to the value that could be unlocked in the future

International Equity funds

Investors might consider investing abroad, for any of the following reasons. When an Indian investor
invests in equities abroad, he is essentially taking two exposures:
 An exposure on the international equity market.
 An exposure to the exchange rate of the rupee. If the investor invests in the US, and the US
Dollar becomes stronger during the period of his investment, he benefits; if the US Dollar
weakens (i.e. Rupee becomes stronger), he loses or the portfolio returns will be lower.

Others

 Monthly Income Plans (MIP)

 Fixed maturity Plans (FMP)
 Diversified Debt funds
 Liquid/ Short Term Debt/ Floating Rate schemes
 Hybrid Schemes
 Gold Funds
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How to select a fund with a category?

 Matching Portfolio with its investment objective

 Fund Manager
 Fund Performance
 Fund Portfolio
 Fund Age
 Fund Size
 Portfolio Turnover
 Scheme running schemes

Do’s and Don’ts while selecting mutual fund schemes

 Ensuring Suitability
 Sticking to Investor’s Asset allocation
 Chasing Past performance
 Understanding Investment objective and investment strategy of the scheme
 Keeping an eye on taxes and loads
 Developing a consistent method for scheme selection

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