Mutual Funds FAQs
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What is a mutual fund

A mutual fund is a pool of money contributed by individuals who have similar financial goals. The money collected is then invested in various securities such as equities, debentures/bonds and/or money market instruments.

What is a fund house/family?

A group of funds managed under one umbrella. The most basic fund family would include a stock, bond and money market-portfolio, although many funds have variants like sector funds, balanced funds.

For instance, Zurich India Mutual Fund is a fund house with several funds under it.

What is the Net asset value (NAV)?

The price or value of one unit of a fund. It is calculated by summing the current market values of all securities held by the fund, adding in cash and any accrued income, then subtracting liabilities and dividing the result by the number of units outstanding. Most open-ended funds companies compute NAVs once a day based on closing market prices.

What are a fund’s net assets?

The total value of a fund's cash and securities less its liabilities or obligations.

What is a fund portfolio?

A group of securities held by the mutual fund. A portfolio could be a mixture of stocks, bonds and cash.

What is the portfolio turnover of a fund supposed to mean?

A measure of the amount of buying and selling activity in a fund.Turnover is defined as the lesser of securities sold or purchased during a year divided by the average of monthly net assets. A turnover of 100 percent, for example, implies positions are held on average for about a year.

How are mutual funds classified?

Mutual Funds can be classified into the following 3 broad categories:

  • Portfolio classification
  • Functional classification
  • Geographical classification

How are mutual funds classified based on their portfolios?

  • Growth Funds
    • Investment objective: Capital appreciation of equity shares
    • Investment avenue: Equity shares of companies with high growth potential
    • For eg. Morgan Stanley Growth Fund

  • Income Funds
    • Investment objective: Providing safety of investments and regular income
    • Investment avenue: Bonds, debentures and other debt related instruments as well as equity shares of companies with high dividend payouts. There are 2 aspects of income funds viz. low investment risk with constant income and high investment risk generating high income.
    • For eg. Templeton Income Fund

  • Balanced Funds
    • Investment objective: Modest risk of investment and reasonable rate of return
    • Investment avenue: Judicious mix of equity shares, preference shares as well as bonds, debentures and other debt related instruments.
    • For eg. GIC Balanced Fund

  • Money Market Mutual Funds (MMMFs)
    • Investment objective: To take advantage of the volatility in interest rates in the money market
    • Investment Avenue: Certificate of deposits (CDs), call money market, commercial papers. Investors can participate indirectly in the money market through MMMFs.
    • For eg. IDBI-PRINCIPAL Money Market Fund 1997

  • Specialised Funds
    • Investment Objective: To take advantage of conditions in a particular sector or a specific income producing security
    • Investment Avenue: Specialised investments in securities of companies in certain sectors or specific income producing securities
    • For eg. Kothari Pioneer's Internet Opportunities Fund

  • Leveraged Funds
    • Investment objective: To increase the value of the portfolio and benefit the shareholders by gains exceeding the cost of borrowed funds
    • Investment avenue: Speculative and risky investments, like short sales to take advantage of declining market. Not common in India

  • Index Funds
    • Investment Objective: To increase the value of the portfolio in line with the benchmark index (for eg. BSE Sensex, SP CNX 50)
    • Investment Avenue: Investments only in those shares that form a part of the benchmark index, in exactly the same proportion, so that the value of the index fund varies in proportion with the benchmark index.
    • For e.g. UTI Nifty Index Fund

  • Hedge Funds
    • Investment Objective: To hedge risks in order to increase the value of the portfolio
    • Investment Avenue: Employ speculative trading principles - buy rising shares and sell shares whose prices are likely to fall.
    • Not common in India

How are mutual funds classified functionally?

Functional classification of mutual funds is done on the following basis:

  • Open ended scheme
    Investors under this scheme are free to join the fund or withdraw from the fund at any time after an initial lock-in period. Such funds announce sale and repurchase prices from time to time. In an open-ended scheme, investors can resell units in the fund to the issuing mutual fund at the net asset value (NAV) of the units. This is because open-ended schemes are permitted to buy/sell their own units. For e.g. Alliance Capital 1995 Fund

  • Close-ended scheme
    Unlike the open-ended schemes, close-ended schemes do not issue units for repurchase redemption on a periodic basis. Its units can be redeemed only on termination of the scheme, or through dealings in the secondary market. In such schemes, the period of the scheme is specified at the outset. They have a definite target amount for the funds and cannot sell more after initial offering. For eg. UTI Mastergain 1986

How are mutual funds classified geographically?

Mutual funds can be classified geographically on the following basis:

  • Domestic funds
    Domestic fund houses launch funds, which mobilise savings of the nationals within the country. These schemes could fall under any of the categories mentioned under portfolio classification and functional classification. Schemes launched by Indian MFs like GIC MF, UTI LIC MF, SBI MF, Canbank MF, Bank of Baroda MF, Bank of India MF, Morgan Stanley, Templeton, Alliance.

  • Offshore Funds
    Offshore funds can invest in securities of foreign companies, after requisite permission from RBI. The objective behind launching offshore funds is to attract foreign capital for investment in the country of the issuing company. These funds facilitate cross border fund flow, which is a direct route for getting foreign currency. From the investment point of view, Offshore funds open up domestic capital markets to the international investors and global portfolio investments.

What are the different plans that mutual funds offer?

Mutual Funds in order to cater to a range of investors, have various investment plans. Some of the important investment plans include:

  • Growth Plan
    Under the Growth Plan, the investor realises only the capital appreciation on the investment (by an increase in NAV) and does not get any income in the form of dividend.

  • Income Plan
    Under the Income Plan, the investor realises income in the form of dividend. However his NAV will fall to the extent of the dividend.

  • Dividend Re-investment Plan
    Here the dividend accrued on mutual funds is automatically re-invested in purchasing additional units in open-ended funds. In most cases mutual funds offer the investor an option of collecting dividends or re-investing the same.

  • Systematic Investment Plan (SIP)
    Here the investor is given the option of preparing a pre-determined number of post-dated cheques in favour of the fund. He will get units on the date of the cheque at the existing NAV. For instance, if on 25th March, he has given a post-dated cheque for June 25th, he will get units on 25th June at existing NAV.

  • Systematic Withdrawal Plan
    As opposed to the Systematic Investment Plan, the Systematic Withdrawal Plan allows the investor the facility to withdraw a pre-determined amount/units from his fund at a pre-determined interval. The investor’s units will be redeemed at the existing NAV as on that day.

  • Retirement Pension Plan
    Some schemes are linked with retirement pension. Individuals participate in these plans for themselves, and corporates for their employees.

  • Insurance Plan
    Some schemes launched by UTI and LIC offer insurance cover to investors.

What is a 401(k) plan?

A popular contribution program in the USA, available through many employers. Within these tax-sheltered plans, participants often can choose mutual funds as one or more of the investment choices.

This plan (or even a variant) is yet to be introduced in India.

What are the advantages of investing in a mutual fund?

Mutual funds are superior to other comparable investment avenues because of the following reasons:

Investors are exposed to reduced investment risk due to portfolio diversification, economies of scale in transaction cost and professional management.

  • Limited Risk
    Investors are exposed to reduced investment risk due to portfolio diversification, economies of scale in transaction cost and professional management.

  • Diversified investment
    Small investors can participate in larger basket of securities and share the benefits of efficiently managed portfolio by experts, and are freed from maintaining records of company share certificates, and tracking tax rules. Mutual fund investments are less risky due to portfolio diversification, which is possible mainly due to large funds available at their disposal. Small investors can never spread their risks across such a wide portfolio, as can mutual funds.

  • Freedom from tracking investments
    Investors do not have to track their investments regularly, as the tracking is done by experts who buy and sell securities for them. Investors are only required to track the performance of the mutual fund.

  • Professional management
    Mutual funds are run by professionals, with experience in portfolio management. Analysts employed by mutual funds analayse data and information available in a manner that cannot be matched by the lay investor.

  • Tax benefits
    Income tax benefits are granted to investors in mutual funds, making it more tax efficient as compared to other comparable investment avenues.

Who is a custodian?

The custodian, an independent organisation, has the physical possession of all securities purchased by the mutual fund, and undertakes responsibility for its handling and safekeeping. For instance, the Stock Holding Corporation of India Ltd (SCHIL) is the custodian for most fund houses in the country.

What is an Asset Management Company (AMC)?

A highly regulated organisation that pools money from many people into a portfolio structured to achieve certain objectives. Hence it is termed as an Asset Management Company. Typically an

AMC manages several funds - open-end /closed-end across several categories - growth, income, balanced. Every mutual fund has an AMC associated with it.

For instance, Alliance Capital Mutual Fund is associated with Alliance Capital Asset Management Company Ltd.

What is load?

It is a charge collected by a mutual fund when it sells units. It can be either front-end load (i.e., the charge is collected when an investor buys the units) or back-end load (i.e, the charge collected when the investor sells back the units). Some schemes do not charge any load and are called No Load Schemes

What is an ex-dividend date?

Normally, one business day after the record date. Investors purchasing unit on or after the ex-dividend date are not entitled to collect dividends or bonus units. The NAV falls by the amount of the dividend distributed and/or bonus issued. The terms ex-bonus and ex-dividend often are used synonymously.

For instance, if the record date for dividend is October 15th, then investors who don’t have their names in the list of unitholders as on that day, will not receive dividend. This works very similar to dividend and bonus declarations in the case of stocks.

How does one calculate the expense ratio for a fund?

The expense ratio for a fund is the annual expenses of a fund (at the end of the financial year), including the management fee, administrative costs, divided by the number of units on that day.

How relevant is the expense ratio?

As is evident from the definition, a lower expense ratio underlines the efficiency of a fund. This is a yardstick that investors need to apply to gauge the efficiency (or lack of it) between funds.

What is cheque-writing facility?

A service enabling investors to write cheques against their mutual fund account balances. Cheques usually must meet a certain minimum amount and the service is restricted to money-market funds.

What is a contingent deferred sales charge (or CDSC)?

A back-end load imposed on an investor if he exits from the fund before a pre-determined period (say 6 months). The charges decline the longer an investor stays invested with a fund.

What is a daily dividend fund?

A fund (money-market or bond) that calculates dividends daily, paying out or reinvesting the same.

What are derivatives?

Financial instruments based on some primary underlying asset or index such as a stock, bond, commodity, or a benchmark of stock prices. Derivative securities fluctuate up and down in tandem with the primary security. Derivatives often are leveraged, making them more volatile. They can be used to speculate as well as to reduce or control an unwanted risk. Options and futures are standardised derivatives. Others are customised to meet specific needs.

What is an Initial public offering (IPO)?

The sale of a company's shares or a fund house’s mutual fund to investors for the first time.

What is an asset management fee?

The fee charged by the asset management company (AMC) for portfolio management. The fee charged on an annual basis is calculated as percentage of net assets under management.

What is growth investing ?

A popular investment style whereby fund managers identify companies showing promise of above-average earnings. Stocks are held primarily for price appreciation as opposed to dividend income. Growth investors (or managers) are willing to pay a premium to acquire a stock if they feel it has the right prospects. Growth investing is an alternative to value investing. For instance, buying an over-valued software stock would be the part of a growth manager’s investment strategy.

What is value investing?

As opposed to growth investors, value investors (or managers) focus on identifying under-priced stocks. Value investors look out for stocks selling at low prices, but which have the potential to give attractive returns in future.

What is hedging?

A general term used to describe any of several risk-reduction strategies. A fund manager might partially hedge against a market decline simply by moving a larger fraction of the portfolio into cash. Alternatively, the manager could sell stock-index futures contracts. If the market falls, the gains on the shorted futures would more or less offset the decline in the portfolio's value.

What is passive investing?

This is the investment style espoused by index fund managers who simply invest by benchmarking their portfolio to a common stockmarket index like the BSE-30 or the SP CNX-50. The fund manager only invests in stocks in the index in exactly the same proportion. There is no attempt to beat the benchmark index, but to simply replicate it, and therefore it is called as passive investing. The index fund will never outperform the benchmark index, nor does it attempt to.