MUTUAL FUND

AN OVERVIEW
 N I S M

National Institute of Securities Market

SEBI has established NISM
To deliver financial and securities
education at various levels and across
various segments

2
 Format of the Exam

 100 questions of 1 mark each

 Time allotted – 2 hours
 Candidates have to score a minimum of
50% to pass.
 A wrong answer will lead to negative
marking of 25%.
 To register for the exam – www.nism.ac.in
Chapter – 1 – Concept & Role of
a Mutual Fund
• A mutual fund is a pool of money collected
from investors and is invested according to
stated investment objectives
• Mutual – Ownership of the fund is thus
joint or mutual, fund belong to all
investors.
• Fund’s Assets are owned by the investors
in the same proportion
 Characteristics of a Mutual Fund

• Professional managers manage the affairs

for a fee.
• The funds are invested in a portfolio of
marketable securities, reflecting the
investment objective.
• Value of the portfolio alters with change in
market value of investments
Advantages of Mutual Funds
• Portfolio diversification – Reduce risk
• Professional management
• Reduction in transaction cost – Economies
of scale
• Liquidity – Closed-end funds to be listed
on a stock exchange
• Convenience and flexibility
• Tax benefits – ELSS, Dividend
Disadvantages of Mutual Funds

• No control over costs

• No tailor-made portfolios – Lack of
portfolio customization
• Issues relating to management of a
portfolio of mutual funds – Too many
choice to the investors – need help
 Types of Funds
• Open-ended funds
• Close-ended funds – only during NFO
• Interval funds – Largely close-ended,
becomes open-ended at pre-specified
intervals.
• Actively Managed Funds
• Passive Funds – Index Schemes
 Types of Funds

• Money Market/ Liquid Funds – Short term nature, low

risk
• Gilt Funds – Govt sec with medium to long-term
maturities, over 1 year.
• Debt Funds – Floating rate, FMPs
• Junk bond schemes or high yield bond schemes invest in
companies that are of poor credit quality
• Equity – Growth (stocks to grow faster than economy),
Sectoral Funds, Midcap/ Small Cap, ELSS, Index funds,
Value Funds, Arbitrage funds
• Hybrid Funds
• Fund of Funds – invest in other mutual funds schemes.
 Types of Funds

• Gold exchange traded fund – Like an

index fund that invest in gold
• Commodity funds – Wheat, copper, cotton
– MF schemes not permitted to invest in
commodities in India
• Exchange Traded funds – open ended
index fund - Buy and sell units in stock
exchange at various prices during the day
 MF Industry
• AUM of the MF Industry – Rs.713281
crores

• Mutual Funds – Around 40

• Number of Schemes – Around 1000

• MF AUM is only 10% of bank deposits

 Risk and Return

Sectoral
funds
Index
funds
Balanced
Return funds
Risk
Debt
Funds
Gilt
funds
ST debt
funds
Liquid
funds
 Chapter – 2 – Fund Structure and
Constituents
• India – Constituted as a Trust
• MF Trust is created by 1 or more Sponsors
• Mutual fund trust are governed by a Trust
Deed, which is executed by the sponsors
• A trustee company functions through its
Board of Directors.
• AMC is appointed by the sponsor or the
Trustees.
 Constitution

• Trust - L&T Mutual Fund

• Sponsor - L&T Finance Limited
• Trustee – L&T Mutual Fund Trustee
Limited
• AMC - L&T Investment Management
Limited
• Custodian – HDFC Bank
• R&T Agent - CAMS
 Sponsor
• Promoter of the mutual fund – gets fund
registered with SEBI
• Creates AMC and appoints trustees
• Criteria
– Financial services business
– 5-year track record – positive networth (SC +
Reserves – Accumulated losses)
– 3-year profit making record
– At least 40% contribution to AMC capital
 Trustees
• Appointed by sponsor with SEBI approval
• Minimum 4 trustees
• 2/3 should be independent trustees
• Fiduciary responsibility – i.e. money
belongs to investors and is entrusted for
the purpose of investment.
• Complies with all the regulaions and
protect investor interest.
 Asset Management Company
• Responsible for operational aspects of the mutual
fund
• Registered with SEBI
• Rs. 10 crore of net worth to be maintained at all times
• At least 50% of the directors should be independent
• AMC can be terminated by a majority of the trustees
or by 75% of the Unitholders.
• AMC Directors are appointed with the permission of
Trustees
Chapter – 3 – Legal and Regulatory
Environment
• SEBI (Mutual Fund) Regulations, 1996
• RBI regulates Gsecs and Money Markets
• MF need to comply with RBI regulations
reg investments in money market,
remittances etc.
• SRO – Self regulatory organisations – Eg.
Stock Exchanges (MF,AMFI–Not an SRO)
• AMFI code of ethics, guidelines and norms
 Investors Rights and Obligations
• Allotment of units/ account statement within 5 business
days of closure of NFO (other than ELSS)
• Reopen within 5 business days from allot
• NAV to be published daily, in 2 newspaper
• NAV to be updated in AMFI and MF website -9 pm
• Investor can appoint upto 3 nominees
• Redemption cheque – within 10 working days
• Dividend – within 30 days of declaration of div
• 15% interest for delay – AMC to borne
• Investor can change the distributor or go direct
 Investor Rights
• MF to publish scheme portfolio and unaudited fin
results within 1 month from the close of each
half year
• FMP portfolios to disclose in website by 3rd
working day
• Schemewise annual report/ abridged summary –
within 6 months of financial year
• AMC/ trustees cannot make any change in the
fundamental attributes of a scheme
 Limitations to Investors Rights
• Unitholders cannot sue the TRUST, they
can initiate legal proceedings against the
Trustees.
• A prospective investor does not enjoy any
rights with respect to the fund.
• Principle of “caveat emptor (let the buyer
beware)
• Unclaimed – within 3 yrs – prevailing NAV,
after 3 years – NAV at the end of 3 years
 Chapter – 4 – Offer Document
• NFO – New Fund Offer – open for 15 days
• Offer Document to be approved by Trustees
• Significant Unitholder – 5% or more of the total
corpus of any scheme
• SEBI doesn’t approve or disapprove – gives its
observations
• KIM - Key information memorandum (summary
of SID and SAI) – appl form is attached to KIM
 Offer Document
• SID to be updated every year
• SID – Scheme details, exp, penalties etc
• SAI – Sponsor, AMC, Trustee company, contact
information, Condensed financial information
(schemes launched in last 3 financial years)
• SID to be updated end of 3 months of every
financial year
• KIM to be updated once a year
• 20:25 rule – scheme should have atleast 20
investor & no investor should represent more
than 25% of net assets
Chapter – 5 – Fund distribution and
Channel management practices
• Individual agents
• Distribution companies
• Banks and NBFCs
• Direct marketing channels
• Internet
• Appointment of IFA, Distributors
• All employees engaged in sales/marketing
– AMFI Certified
 Commission
• Commission structure vary between AMCs
• Disclosure in appl form reg upfront
commission paid to distributor by investor
• Trial commission – qtly basis on net
assets
• No commission payable on distributors
own investment
• Rebating – sharing part of commission is
banned
 SEBI Advertising Code
• SEBI’s Advertising Code – Lays down guidelines
to be followed
• Dividends declared or paid to be mentioned in
rupees per unit with face value and the
prevailing NAV
• Only compounded annualized yield – if scheme
is more than 1 year
• Compounded Annualized yields must be shown
for last 1 year, 3, 5 and since launch of the
scheme
 Chapter – 6 – Accounting,
Valuation and Taxation
• NAV – Net Assets / O/s units
(Market value of investments + Receivables
+Other Accrued Income +Other Assets
- Accrued expenses – other payables –
other liabilities)
• Valuation date – Day on which NAV is calculated
by a fund
 Accounting (contd…)

• Since, 1st Aug 2009, SEBI has banned

entry loads – Sale price = NAV
• CDSC – Contingent Deferred Sales
Charge – Longer the stay, load will be less
• Exit/ CDSC excess of 1% of redemption
proceeds – to be credited to scheme.
AMC cannot use for selling expenses
 Expenses

• Initial Issue Expenses – NFO – AMC to

bear
• Deferred load – NFO exp 6% to written off
• Recurring exp
• Scheme not to bear - Penalties, fine,
interest on delayed payment, legal etc,
exp on gen admn
 Recurring exp limit
Avg Net asset Equity Debt
Upto 100 cr 2.50% 2.25%
Next 300 cr 2.25% 2.00%
Next 300 cr 2.00% 1.75%
Over 700 cr 1.75% 1.50%

• MGMT Fees – 1.25% on first 100 crores and 1% on

balance net assets

• Mgmt fees cannot be charged for FD’s (Liquid and debt

schemes)
 Accounting policies
• Investments are required to be marked to market using
market prices
• Unrealized appreciation cannot be distributed
• Valuation losses needs to be adjusted against profit
• Dividend to be recognized – Quoted on ex-dividend
basis
• Purchase/ sale of investments – recognized on trade
date not on settlement date
• Bonus/ rights share – Only when the original shares are
traded on the stock exchange on an ex-bonus/ ex-rights
basis
 Accounting policies

• Scheme and AMC accounts are different

• NAV in decimal places
– Debt funds - 4
– Equity & balanced funds – 2
 Valuation
• Market price for Liquid shares
– Price should not be more than 30 days old
• Fair valuation for Illiquid shares
• Fair Valuation for Thinly traded shares
– Less than Rs. 5 lakh value and Less than 50,000
shares
– Non-traded/ thinly traded to be valued “in good faith” –
AMC valuation principles
– Fixed income debt securities that are greater than 91
days are to be valued through yield matrix (Crisil &
ICRA)
 Taxation
• Mutual fund trust is exempt from tax
• Trustee company will have to pay tax
• Dividend exempt from tax in the hands of investor
• STT is payable only for equity schemes (0.25% on
repurchase of units)
• Dividend dist tax – not in equity schemes
• Liquid – 25% + Surc + Edu cess
• Debt - 12.5% + Surc + Edu cess (individual)
• Debt – 20% + Surc + Edu cess (others)
• TDS applicable only for NRI transactions
 Capital Gains
Short Term Long Term
Equity 15% + Surc + NIL
Educ cess

Debt Added to the 10%+S+E-without

Income indexation

20%+S+E-with
indexation
 Dividend stripping

• Dividend Stripping – Buys within 3 months

prior to the record date of div and sell
within 9 months after the record date – not
allowed to set off against other capital
gains of the investor

• Investments in MF are exempt from wealth

tax
Chapter – 7 – Investor Services

• KYC – Rs.50000/- and above

• PAN card – compulsory except micro-sip
• Micro-sip – 12 month or (April-March)
<=50000
• RTGS – Real time gross settlement –
immediate
• NEFT – National electronic fund transfer –
batches/ different times in a day
 Services

• Cut off timings

• SIP – Rupee cost averaging
• SWP/ STP
• Triggers
• ASBA – Appln supported by blocked amt
 Chapter – 8 – Return, Risk &
Performance of Funds
• Market Capitalisation – current market price x
o/s shares
• EPS – Net profit after tax/ No of equity shares
• P/E ratio - Market price/ EPS
• Fundamental analysis – Research into the
operations/ finances of a co. Est its future
earnings and risk profile
• Technical analysis – Historical data on the
company’s share price movements/ trading
volume
 Debt Instruments – Types
• Commercial Paper – Corp bodies (upto 1 year)
• Certificates of Deposit – banks upto 1 year
• G-Sec or Gilt – Securities issued by Govt
• TBill – 91 days to 364 days – RBI
• Bonds – >1 year – Govt & public sector co.
• Debentures - Private sector companies
• Floating rate securities – MIBOR + 200
• Credit rating companies – ICRA, CRISIL,
Fitch, CARE
 Current Yield and YTM
• Price and yield are inversely related
• Coupon as a percentage of current market price
• If we bought a 8% bond at Rs. 110, the current
yield is:
= (8/110)*100 = 7.27%
• Modified Duration – Debt security likely to
fluctuate in response to interest rate
• Simple Return – (PV-IV)/IV * 100
• Annualised Return – Simple return X 12/ period
of simple return
 Returns - CAGR

• An investor buys 100 units of a fund at

Rs. 10.5 on January 6, 2001. On June
30, 2001 he receives dividends at the
rate of 10%. The ex-dividend NAV was
Rs. 10.25. On March 12, 2002, the
fund’s NAV was Rs. 12.25.
 CAGR - Solution
• The begin period value of the investment is
= 10.5 x 100 = Rs. 1050
• Number of units reinvested
= 100/10.25 = 9.756 units
• End period value of investment
= 109.756 x 12.25 = Rs. 1344.51
• Holding period = 6/01/01 - 12/3/02
= 431 days
• The CAGR is
=(1344.51/1050)365/431 - 1 x 100
= 23.29%
 Leveraging

• Practice of taking liabilities beyond what is

inherent to the normal business
• Mutual Fund cannot borrow more than
20% of its net assets
• It cannot be more than 6 months
• Borrowing only to meet dividend or
redemption payments
 Derivatives

• Instruments whose value is derived from

the value of one or more underlying
exposures
• Futures, Options, SWAPS
• Hedging against risk
 RISKS

• Equity
– Beta – More than 1 – more risky than the
market & vice versa
• Debt
– Variance / Standard Deviation - measures the
fluctuation in periodic returns of a scheme
– Weighted average maturity – Longer the
maturity of debt security, higher would be
interest rate sensivitity
 Chapter – 9 – Scheme Selection

• Scheme category
• Selecting a scheme within the category
• Right option within the scheme
• Fund Age, Scheme expenses, Tracking
error, past performance, Servicing,
Returns
 Chapter – 10 – Right investment
products for investors
• Financial and physical assets
• Gold, Real Estate, Fixed Deposits,
Pension Funds, Mutual funds
• Comfort, Unforeseen events, Economic
context
• New Pension scheme (Pension fund
regulatory and development authority –
PFRDA)
 Chapter – 11 – Helping investors
with Financial Planning
• Objective – right amount of money is available at the
right time to meet financial goals
• Financial Planning – Needs and aspirations
• Planned and Systematic approach
• Investment Horizon
• Assessing fund requirement
• Steps in financial Planning
– Asset Allocation
– Selection of fund
– Studying the features of a scheme
 Financial Planning (contd…)
• Financial planning comprises:
– Establish and define the relationship with the client
– Defining a client's profile and goals
– Analyse and evaluate client’s financial status
– Risk tolerance
– Clients tax situation
– Recommending appropriate asset allocation
– Executing the plan
– Monitoring financial planning recommendations
 Life Cycle and Wealth Cycle
Stages
• Life Cycle classification of investors
– Childhood stage
– Young adult
– Young married with children
– Middle age
– Retirement
– Post retirement
 Wealth Cycle Classification

• Accumulation Stage
– Investor is earning and has ability to invest and
requires no supplementary income from investments
• Transition Stage
– Investor is able to save, but has also started drawing
on his investments to meet his financial goals.
• Distribution Stage
– Investor is not earning and has ability to invest has
reduced and requires supplementary income from
investments
 Chapter – 12 – Model portfolios
and financial plans
• Strategic asset allocation – years of age =
debt portfolio – risk profiling is key
• Tactical asset allocation – Likely behaviour
of the market – seasoned investors and
large surplusses
Thank You

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