Why
One should invest in mutual funds?
Reason
1:
They are investments instruments
which are capable of giving high returns
. An average mutual fund scheme returns
easily beats inflation in longer run and
a good scheme can give far superior
returns.
Reason
2:
Our Mutual Fund industry is one of the
best regulated industry in the world.
They are governed by the strict
guidelines layed down by SEBI(Securities
& Exchange Board of India).
Reason
3:
Investments decision of a Mutual Fund is
taken by their AMCs and Fund Managers.
They are experts who make investments
decisions after doing intensive research
and analysis of a company &
industry. (Individuals generally don't
have time and resources to do research
hence best option is to let MF manage
your investments)
Reason
4:
This industry is highly liquid. Even
more liquid than stock markets. Payments
are generally made through cheques or in
some cases they are directly credited to
your bank accounts , If your bank is
allowing RTGS & electronic clearing
and mutual fund AMC is providing such
facility.
Reason
5:
Investments are diversified into many
companies & sectors. Which make our
investments safer and consistent growth
prospects. Diversifying is usually not
done by small investors , for such a
actions one requires lots of funds.
Reason
6 :
Tax treatments- Governments encourage
investments in capital markets and has
given many tax sops. Under i) 80(c)
investments done upto one lakh in
specific mutual funds schemes which is
called ELSS(Equity Linked Saving
Schemes.) are exempt from tax. ii) Any
units held for more than one year if
redeemed is treated under long term
capital gain tax which is zero percent
currently i.e. the whole profit is tax
free. If one plans to redeem before one
year then he has to pay tax of only15%
on the profits.
Reason
7:
Mutual Funds are much cheaper compared
to direct exposure to capital market
since one does not need demat account
,annual charge to maintain account,
charges imposed on demat holdings, stamp
duty on transaction are not levied .
Now, let's assume that this group of
individuals is a novice in investing and
so the group turns over the pooled funds
to an expert to make their money work
for them. This is what a professional
Asset Management Company does for mutual
funds. The AMC invests the investors'
money on their behalf into various
assets towards a common investment
objective.
Hence, technically speaking, a mutual
fund is an investment vehicle which
pools investors' money and invests the
same for and on behalf of investors,
into stocks, bonds, money market
instruments and other assets. The money
is received by the AMC with a promise
that it will be invested in a particular
manner by a professional manager
(commonly known as fund managers). The
fund managers are expected to honour
this promise. The SEBI and the Board of
Trustees ensure that this actually
happens.
Typical classification of mutual fund
schemes on various basis:
Tenor
Tenor refers to the 'time'. Mutual funds
can be classified on the basis of time
as under:
1.Open
Ended funds
These funds are available for
subscription throughout the year. These
funds do not have a fixed maturity.
Investors have the flexibility to buy or
sell any part of their investment at any
time, at the prevailing price (Net Asset
Value - NAV) at that time.
2.Close
Ended funds
These funds begin with a fixed corpus
and operate for a fixed duration. These
funds are open for subscription only
during a specified period. When the
period terminates, investors can redeem
their units at the prevailing NAV.
Asset
Classes
1.Equity
funds
These funds invest in shares. These
funds may invest money in growth stocks,
momentum stocks, value stocks or income
stocks depending on the investment
objective of the fund.
2.Debt
funds or Income funds
These funds invest money in bonds and
money market instruments. These funds
may invest into long-term and/or
short-term maturity bonds.
3.Hybrid
funds
These funds invest in a mix of both
equity and debt. In order to retain
their equity status for tax purposes,
they generally invest at least 65% of
their assets in equities and roughly 35%
in debt instruments, failing which they
will be classified as debt oriented
schemes and be taxed accordingly.
(Please see our Tax Section on Page 39
for more information.) Monthly Income
Plans (MIPs) fall within the category of
hybrid funds. MIPs invest up to 25% into
equities and the balance into debt.
4.Real
asset funds
These funds invest in physical assets
such as gold, platinum, silver, oil,
commodities and real estate. Gold
Exchange Traded Funds (ETFs) and Real
Estate Investment Trusts (REITs) fall
within the category of real asset funds.
Investment
Philosophy
1.Diversified
Equity Funds
These funds diversify the equity
component of their Asset Under
Management (AUM), across various
sectors. Such funds avoid taking
sectoral bets i.e. investing more of
their assets towards a particular sector
such as oil & gas, construction,
metals etc. Thus, they use the
diversification strategy to reduce their
overall portfolio risk.
2.Sector
Funds
These funds are expected to invest
predominantly in a specific sector. For
instance, a banking fund will invest
only in banking stocks. Generally, such
funds invest 65% of their total assets
in a respective sector.
3.Index
Funds
These funds seek to have a position
which replicates the index, say BSE
Sensex or NSE Nifty. They maintain an
investment portfolio that replicates the
composition of the chosen index, thus
following a passive style of investing.
4.Exchange
Traded Funds (ETFs)
These funds are open-ended funds which
are traded on the exchange (BSE / NSE).
These funds are benchmarked against the
stock exchange index. For example, funds
traded on the NSE are benchmarked
against the Nifty. The Benchmark Nifty
BeES is an example of an ETF which links
to the stocks in the Nifty. Unlike an
index fund where the units are traded at
the day's NAV, in ETFs (since they are
traded on the exchange) the price keeps
on changing during the trading hours of
the exchange. If you as an investor want
to buy or sell ETF units, you can do so
by placing orders with your broker, who
will in-turn offer a two-way real time
quote at all times. The AMC does not
offer sale and re-purchase for the
units. Today, ETFs are available for
pre-specified indices. We also have Gold
ETFs. Silver ETFs are not yet available.
5.Fund
of Funds (FOF)
These funds invest their money in other
funds of the same mutual fund house or
other mutual fund houses. They are not
allowed to invest in any other FOF and
they are not entitled to invest their
assets other than in mutual fund
schemes/funds, except to such an extent
where the fund requires liquidity to
meet its redemption requirements, as
disclosed in the offer document of the
FOF scheme.
6.Fixed
Maturity Plan (FMP)
These funds are basically income/debt
schemes like Bonds, Debentures and Money
market instruments. They give a fixed
return over a period of time. FMPs are
similar to close ended schemes which are
open only for a fixed period of time
during the initial offer. However,
unlike closed ended schemes where your
money is locked for a particular period,
FMPs give you an option to exit.
Remember though, that this is subject to
an exit load as per the funds
regulations. FMPs, if listed on the
exchange, provide you with an
opportunity to liquidate by selling your
units at the prevailing price on the
exchange. FMPs are launched in the form
of series, having different maturity
profiles. The maturity period varies
from 3 months to one year.
Geographic
Regions
1.Country
or Region Funds
These funds invest in securities (equity
and/or debt) of a specific country or
region with an underlying belief that
the chosen country or region is expected
to deliver superior performance, which
in turn will be favorable for the
securities of that country. The returns
on country fund are affected not only by
the performance of the market where they
are invested, but also by changes in the
currency exchange rates.
2.Offshore
Funds
These funds mobilize money from
investors for the purpose of investment
within as well as outside their home
country. so we have seen that funds can
be categorized based on tenor,
investment philosophy, asset class, or
geographic region. Now, let's get down
to simplifying some jargon with the help
of a few definitions, before getting
into understanding the nitty-gritty of
investing in mutual funds.
DEFINITIONS
Net
Asset Value (NAV)
NAV is the sum total of all the assets
of the mutual fund (at market price)
less the liabilities (fund manager fees,
audit fees, registration fees among
others); divide this by the number of
units and you get the NAV per unit of
the mutual fund.
Standard
Deviation (SD)
SD is the measure of risk taken by, or
volatility borne by, the mutual fund.
Mathematically speaking, SD tells us how
much the values have deviated from the
mean (average) of the values. SD
measures by how much the investor could
diverge from the average return either
upwards or downwards. It highlights the
element of risk associated with the
fund.
Sharpe
Ratio (SR)
SR is a measure developed to calculate
risk-adjusted returns. It measures how
much return you can expect over and
above a certain risk-free rate (for
example, the bank deposit rate), for
every unit of risk (i.e. Standard
Deviation) of the scheme. Statistically,
the Sharpe Ratio is the difference
between the annualised return (Ri) and
the risk-free return (Rf) divided by the
Standard Deviation (SD) during the
specified period. Sharpe Ratio = (Ri-Rf)/SD.
Higher the magnitude of the Sharpe
Ratio, higher is the performance rating
of the scheme.
Compounded
Annual Growth Rate (CAGR)
What Does Compound Annual
Growth Rate - CAGR Mean?
The year-over-year growth rate of an
investment over a specified period of
time.
The compound annual growth rate is
calculated by taking the nth root of the
total percentage growth rate, where n is
the number of years in the period being
considered.
This can be written as follows:
Absolute
Returns
These are the simple returns, i.e. the
returns that an asset achieves, from the
day of its purchase to the day of its
sale, regardless of how much time has
elapsed in between. This measure looks
at the appreciation or depreciation that
an asset - usually a stock or a mutual
fund - achieves over the given period of
time. Mathematically it is calculated as
under:
Ending Value - Beginning Value x 100
Beginning
Value
Generally returns for a period less than
1 year are expressed in an absolute form
