What is Mutual Fund

What is Mutual Fund?

Mutual fund is pooled collection of assets from many investors. It is a trust or company that collects money from many investors and invests in various asset classes such as, equity, debt, liquid asset etc.

Since all the profit, loss, risks and dividends from the investment are shared among all the investors according to their contributions, it is called “Mutual.”

Mutual funds in India are regulated by SEBI.

History of Mutual Funds

• Unit Trust of India (UTI) was the 1^st mutual fund set up in India in 1963.
• The government allowed public sector banks and institutions to set up mutual funds in 1990.
• Securities and Exchange Board of India (SEBI) Act was established in 1992 for development of securities market and to formulate policies and regulates the mutual funds. After the notified regulations by SEBI in 1993, private sector companies started to offer mutual funds.

Types of Mutual Funds

There are various types of Mutual Funds (MF) based on investment objectives as listed below:

1. Types by company size:

• Large cap funds: These funds invest a large portion of their corpus in companies with large market capitalization, and generally offer stable and sustainable returns over a period of time. These funds are classified as “less volatile, less risk, less returns”
• Midcap funds: These funds invest a large portion of their corpus in companies with mid-size market capitalization, and generally offer medium returns over a period of time. These funds are classified as “medium volatile, medium risk, medium returns”
• Small cap funds: These funds invest a large portion of their corpus in companies with small size market capitalization and generally offer more returns over a period of time. These funds are classified as “more volatile, more risk, more returns”

2. MF types by structure:

• Open ended schemes: These schemes don’t have a fixed maturity period. Key feature is that, you can buy or sell the units at any time of the year as per NAV prices. These schemes announce NAV on a daily basis.
• Close ended schemes: These schemes have fixed maturity period. You can invest only at the time of initial issue called “New Fund Offer (NFO)”. These schemes are listed on the stock exchange where you can buy or sell units of the fund. These schemes announce NAV on a weekly basis.
• Interval schemes: It is combination of both open ended and close ended schemes. You can buy or sell the units at pre-determined intervals at NAV price.

3. MF types by Investment objectives:

• Equity schemes: These schemes invest a majority of their funds in equities (shares) and hence these are high risk investments, so known as “high risk, high return.” These are suitable for long term investors because they provide capital appreciation over long term.
• Income or Debt schemes: These schemes invest a majority of their funds in fixed income securities like bonds, government securities, corporate debentures etc. These investments are low risk investments hence these schemes are also known as “less risk, less return.” These schemes provide regular and steady income hence suitable for short term investors and retired people, but not suitable for long term investors.
• Money market or Liquid schemes: These schemes invest in safe and short term instruments like treasury bills, certificate of deposits and, aim to provide capital protection and moderate income hence provide easy liquidity. The returns vary based on interest rate in the market.
• Tax saving schemes: Provides capital appreciation and tax benefit. These schemes come with a specific lock-in period and invest mainly in equities, hence are high risk oriented schemes. Examples- Equity linked saving schemes (ELSS).
• Gilt schemes: These schemes invest exclusively in government securities. NAV of these schemes fluctuate due to change in interest rate.
• Index schemes: Such schemes represent the portfolio of a particular index such as BSE index, NSE index etc. These schemes invest in the shares that represent an index. NAV rise or fall according to the rise or fall in the index.
• Sector schemes: Such schemes invest in shares that are a part of a specific sector like technology sector schemes invest in INFOSYS, WIPRO etc. These schemes are high risky and here returns depend on the performance of the chosen sector.
• Exchanged traded schemes: These schemes contain a basket of shares that represent the combination of index like BSE index, NSE (Nifty) index etc. Unlike Index funds, these schemes allow to buy or sell based on end of the day NAV only.
• Fund of funds schemes: Such schemes invest in other mutual fund schemes that help investors to diversify the risk through one scheme.

4. MF types by Payout:

• Growth schemes: As the name suggests, these are suitable for those who expects a growth over long term and not in need of money during short term. The number of units you bought will remain same till you sell them. You will get money only when you sell the units.
• Dividend payout schemes: These schemes payout dividends (profit made by Mutual fund schemes) to investors from time to time, but the amount and the frequency of dividends are not guaranteed. The number units will remain the same but the NAV comes down after the dividends are declared. Suitable for those who expect to receive income flow on a regular basis.
• Dividend Re-investment schemes: As the name implies, this schemes declares dividends but it is not paid to the investors instead, they are re-invested into the schemes. The number of units thus, will increase as the dividends are re-invested. NAV gets re-adjusted after the dividends are declared and re-invested.

Key Features and Benefits of Mutual Funds

• It offers a wide variety of schemes; thus, you can choose as per your need and convenience. It also diversifies the risks by investing in various companies of various sectors.
• Schemes are managed by professional fund managers.
• It can deliver higher returns over medium to long term.
• Some MF schemes provide liquidity hence; you can take out the money whenever you want.
• Less expensive to invest in equities as compared to direct investment in share markets.
• Provides transparency in the form of disclosing the investment strategy, proportion of asset class for investment, value of your investment and periodic statements too.
• Regulated by SEBI.
• It provides SIP (systematic Investment Plan) option to invest small amount of money on regular basis.
• Few MF schemes like ELSS also provide tax benefits. It provides benefits in Section 80C, dividend payout tax, capital gain tax, and TDS.

Drawbacks of Mutual Funds

• Returns are not guaranteed as it may vary based on market condition.
• There are various fees charged by MF companies, like transaction charges, exit charges, recurring annual charges and/or for various professional fund management, even funds give negative returns. Hence, returns may be affected.
• One can buy or sell mutual fund units only at the end of the day but not during trading hours.
• In order to pay the investors when they sell the units due to any reason, MF companies have to keep a large amount of cash at hand and, this may impact the returns.

Nomination facility

• Available, but can be made only by individuals either singly or jointly. Non-individuals like trust, society, partnership firm, body corporates etc., can’t nominate.
• You can nominate up to 3- people as nominees and in case of multiple nominees, you need to specify the percentage of share of each nominee. Total percentage of share should be 100%.
• You can nominate a minor as a nominee but nomination is not allowed for a folio that is in the name of a minor.

How to invest in Mutual funds?

If you want to invest in Mutual Funds, you may invest either directly or through Agents.

1. Direct investment

• You can invest by visiting mutual fund scheme office and completing necessary paper work or may invest through their website.
• This approach provides advantage that, you will not be charged any transaction fee or commission fee hence your entire amount will be invested.
• Meanwhile, if investment through website is not available, you will have to go to each and every mutual company when you wish to invest in various mutual fund schemes.

2. Investment through Agents

• This mode can help you with things like investment, redemption, any query or doubt, and completing necessary paper work. With the help of agent, you can invest in various mutual fund schemes. Thus, it provides “one stop” for any things related to mutual funds.
• Agents charge you a one-time fee for investment above Rs.10, 000/-. Charges levied are as per SEBI guidelines. All such charges are reflected in the statement.

Frequently Asked Questions (FAQ)

What is NAV?

NAV stands for “Net Asset Value”, it is the current market price of one unit of a mutual fund scheme. NAV is calculated on a daily basis for open ended schemes and weekly basis for close ended schemes. Its value depends on the performance of the mutual fund scheme.

Who can invest in Mutual Funds?

Resident Individuals, HUF, NRI, PIO (people of Indian origin), companies, Trusts, Co-operative Societies etc.

See also….
What is Systematic Investment Plan (SIP)?
Fund Based and Non-Fund Based Credit Facilities