What is a Mutual Fund?

Mutual Fund is essentially a Trust which has an agreed objective of investment of money mobilised from various investors. Through this vehicle of Mutual Fund, the investor is able to get professional fund management services. The Investor also has the access to securities market like equities, gilts and bonds.

It is a popular investment avenue that provides opportunity to small investors to access a well-diversified portfolio of equities, bonds and other securities.

In mutual funds, the fund manager trades the fund’s underlying securities, realizing capital gains or losses, and collects the dividend or interest income. The investment proceeds are then passed to the individual investors on redemption based on a net asset value (NAV).

How it works?

Mutual Fund, through various schemes, has access to a substantial corpus of fund collected from a large base of investors. Fund manager invests such collected money into various securities to generate returns for these investors. Investment is done as per the investment objective of the particular scheme of mutual fund.

All profits/losses in the scheme belong to the investors of that scheme.

Investors are offered options like growth option, dividend payout option and dividend reinvestment option within a particular scheme.

Investors can invest in units of a particular scheme at face value (At par) when a new scheme is launched which is called “New Fund Offer” (NFO). Post NFO, units can be bought at NAV only.

Let us understand it with an Example:
Suppose XYZ Mutual Fund launches a new scheme with a scheme name XYZ Sunrise Fund. Now scheme collects Rs 1 crore by issuing 10,00,000 units from 100 investors who invested Rs 1 lakh each. It means the fund house issues the units at an NAV (Face value) of Rs 10 and issued 10,000 units to each investor. Thus, the total number of units allotted by the fund house is 10 lakhs.
Fund manager invested this money as per the scheme objective to earn return for investors.
After some time, suppose there is no change in the portfolio holding (stocks present in the portfolio) or the number of investors. As the price of the stocks present in the portfolio moved up, the total value of stocks in the portfolio become Rs 1.2 crore. Therefore, the NAV of each unit is now Rs 12. There is a growth of 2 rupees per unit. Now every investor of this scheme will have a profit of Rs 20000 on this investment.
Note: Example given only for simple explanation. Loads/expenses/other technical aspects are not considered in this calculation.

Who can invest in mutual funds in India?

All investors can invest in any scheme barring a few schemes wherein only specified types of investors can make investment. For example, some Gilt schemes have specified that only PF Trust, Superannuation, Gratuity or Pension Funds, Religious and Charitable Trusts can invest. Hence, it is always better to go through the “WHO CAN INVEST” section of the Scheme Information Document (SID). Below given category of investors can invest in Mutual Funds-

a. Resident Indian Adult Individual An Indian Citizen, above the age of 18years, is eligible to invest individually or jointly in a mutual fund scheme.

b. Non- Resident Indians (NRI)/Persons of Indian Origin (PIO) – Non-Resident Indian means a person resident outside India who is a citizen of India. Person of Indian origin means a citizen of any country (other than Bangladesh or Pakistan) who had at any time held Indian passport or he or either of his parents or grandparents was a citizen of India by virtue of the constitution of India. NRI can invest in India on repatriable basis or non repatriable basis. Repatriable basis means that proceeds on redemption of investments can be remitted abroad. Non Repatriable basis means redemption proceeds cannot be remitted abroad.

 c. Hindu Undivided Family (HUF) Head of the family, known as Karta of HUF,can invest in mutual fund scheme on behalf of his family. This investment will be treated as the collective investment of the family.

d. Foreign Investors – Investors from other countries can also invest in mutual fund scheme in India according to the guidelines issued by SEBI. Those who fulfill the requirements of investment are called Qualified Foreign Investors.

Who regulates the Mutual funds in India?

Mutual funds in India are primarily regulated by the Securities and Exchange Board of India (SEBI). It also regulates the other mutual fund intermediaries like depositories, Custodians, Registrar & Transfer agents etc. The guidelines applicable on mutual funds   are set out in Securities Exchange Board of India (Mutual Fund) Regulations 1996, as amended till date.

Besides SEBI, wherever applicable, mutual funds have to follow the rules and regulations issued by other authorities like RBI, Stock exchange, and Ministry of Finance etc.E. Features- investment benefits and limitations

Benefits of Mutual Fund Investments:

Limitations of Mutual Funds investments:

There are a few limitations of a mutual fund which are detailed below:

Basis of Your Investment in mutual Fund

Investment should always be based on your own goals & objectives, risk taking capacity and time horizon. It plays a significant role in getting best results from your investment.

1.You Own Goal & Objective: If you are a beginner in mutual funds investment, primarily, define your own future financial goal & objectives before initiating an investment.

Suppose you want to create fund for buying your own house after 8 years from now. Decide the budget and start investing accordingly in a suitable scheme of SIP. This investment will help you to fulfill the goal of buying own house.

If you are investing randomly, there may be a possibility that when you need money to fulfill a life goal your random investment may fall short for it.

SIP Vs lump sum investment

2. Your Risk-Taking Capacity: Every individual has different risk-taking capacity. It is defined as the maximum amount of risk an investor is able to tolerate. Whereas, the risk appetite is the maximum amount of risk one is willing to tolerate. It depends on various factors i.e., income levels, savings potential, already saved amount, future earnings potential amongst others. It is necessary to assess it at a balanced platform keeping behavioral biases apart. Therefore, investing must be based on your risk profile.

All about SIP investments in mutual funds

3. Time Horizon:

Duration of investment is an important factor for every investor. it must be specifically decided before every investment.

Future financial objectives of an investor may be short/medium/long term. Investment horizon should also be in line of that goal & objective.

How it is suitable for all categories of investors

The variety of schemes available in mutual funds makes it suitable for every category of investor. Options of Equity-oriented investment, Debt-oriented investment, Balanced investment, Systematic investment plans, Retirement plans, tax saving plans and many other investor friendly schemes makes it suitable for all category of investors.

Investment facility through online/offline mode, direct/regular mode, Periodical investment/lump sum investment, small/big investment, diversification & professional care, Simple & investor friendly eco system, keeping investors interest at the top and many other facilities makes mutual fund a preferred investment destination for all category of investors.

It is now the responsibility to select the investment scheme best suitable for the investor.

Type of mutual fund schemes

1.Equity Schemes:

Investment objective of the equity scheme is to seek capital appreciation and growth by investing in equity and equity related instruments. These schemes predominantly invest in Equity related instruments like equity shares of listed companies.

A mutual fund scheme investing at least 65% of its portfolio in Indian stocks and equity-related instruments are treated as an equity mutual fund scheme for the purpose of taxation.

2.Debt Schemes: 

Investment objective of Debt Scheme is to earn regular income by investing in Debt securities like Government Securities, Treasury Bills, Bonds and Debentures. These schemes predominantly invest in Debt related instruments.

A mutual fund scheme other than the equity scheme is treated as a debt mutual fund scheme for the purpose of taxation.

3.Hybrid Schemes

Investment objective of Hybrid Scheme is to make investment both in equity and debt instruments. The proportion of investment may vary as per the objective and nature of scheme. A combination of debt and equity components makes the funds less risky to market volatility. Hybrid Schemes can be equity-oriented or debt-oriented, depending on their composition of investment portfolio.

4.Solution scheme

Schemes with an investment objective of achieving a particular goal aimed in future like Children’s education or retirement are called solution-oriented scheme.

I. SEBI Classification of Mutual Fund Schemes

SEBI has categorized open ended mutual fund schemes to ensure uniformity of similar type of schemes launched by different mutual funds. This has been done in order to enable investor to evaluate various schemes and take an informed decision.

SEBI Categorization of Equity Schemes

CategoryInvestment inMinimum Investment in Equity & Equity Related Instruments
Flexi CapAn open-ended dynamic
equity scheme investing across large cap, mid cap, small cap stock
65% of total assets
Multi CapMinimum Investment of 25%
Each in Large, Mid and Small cap
75% of total assets with a minimum of 25% each in Large, Mid and small cap
Large CapLarge Cap Co.80% of total assets
Large & Mid CapLarge & Mid Cap35% each in Large & Mid Cap
Mid CapMid Cap65% of total assets
Small CapSmall Cap65% of total assets
Dividend YieldDividend Yielding stocks65% of total assets
Value FundValue strategy65% of total assets
Contra FundContra Strategy65% of total assets
FocussedMaximum 30 stocks65% of total assets
Sector/Thematicsector/Theme80% of total assets
ELSSDiversified 80% of total assets

SEBI Categorization of Debt Schemes

Fund CategoryInvestment inDuration of Portfolio
Overnight FundOvernight SecuritiesMaturity of 1 day
Liquid FundDebt & Money market InstrumentsMaturity of Up to 91 Days
Ultra-Short-DurationDebt & Money market InstrumentsMacaulay duration between 3-6 months
Low DurationDebt & Money market InstrumentsMacaulay duration Between 6-12 months
Money MarketMoney Market InstrumentsMaturity of Up To 1 year
Short DurationDebt & Money market InstrumentsMacaulay duration Between 1-3 years
Medium DurationDebt & Money market InstrumentsMacaulay duration Between 3-4 years
Medium To longDebt & Money market InstrumentsMacaulay duration Between 4-7 years
Long DurationDebt & Money market InstrumentsMacaulay duration Over 7 years
Dynamic BondDebt & Money market InstrumentsAcross Durations
Corporate BondMinimum 80 % of total assets to be invested in AA+ and above rated corporate bonds
Credit Risk FundMinimum 65% of total assets to be invested in AA & below rated corporate bonds
Banking & PSUMinimum 80% of total assets to be invested in Debt Instruments of Banks/PSU/Public Financial Institutions & Municipal bond
Gilt Funds80% of total assets to be invested in Govt. Securities across duration
Floater Funds65% of total assets to be invested in Floating rate Instruments

SEBI Categorization of Hybrid Funds

CategoryInvests inProportion
ConservativePredominantly DebtDebt 75-90% of Total asset
Equity 10-25% of Total asset
BalancedEquity & DebtEquity 40-60% of total assets
Debt-40-60% of total assets
AggressivePredominantly EquityEquity- 65-80% of total assets
Debt -20-35% of total assets
Dynamic Asset AllocationEquity & DebtTo be managed dynamically
Multi Asset AllocationAt least 3 asset classesAt least 10% in each asset class
Arbitrage FundArbitrage opportunitiesMinimum 65% in equity and Equity related
Equity SavingsEquity, Debt & ArbitrageMinimum 65% in Equity and Equity related.
Minimum 10% of total asset In Debt.

Some Important & Useful Terms and jargons used in Mutual Fund Industry

Net asset value is the total asset value per unit of the mutual fund scheme after deducting all related and permissible expenses. NAV of the mutual Fund schemes are declared (based on the closing market value of securities held in the respective scheme Portfolio) at the end of the business day after markets are closed. The performance of a particular Mutual Fund scheme at a particular day is denoted by Net Asset Value (NAV).

We buy land, building, gold etc. These assets are called physical asset. We invest in shares, mutual funds, bank fixed deposits etc. It is called financial assets.

An asset class is a group of similar investments having similar trait, features and comparable responses to market fluctuations. As far as financial asset class is concerned, they operate quite similarly. Each asset class is unique and serves different purposes. Examples of different asset class -Equity asset class, Debt asset class, Real estate asset class etc.

Mutual fund invests in a variety of asset classes as per scheme objective to attain diversification and avoid the risk of concentration.

Securities and Exchange Board of India (SEBI) is the regulatory authority established under the SEBI Act 1992 to regulate the capital and securities market in India.  Basic function of SEBI is to protect the interests of investors in securities and to regulate & promote the development of securities market. The headquarters of SEBI is situated in Mumbai.

AMFI stands for Association of Mutual Funds of India. It is an industry body dedicated to promote interest of mutual fund industry. Asset Management Companies (AMCs) are its members. The objective of AMFI is to define and maintain high professional and ethical standards in all areas of operation of mutual fund industry.

AMFI recommends and promotes best business practices and code of conduct to be followed by members and others engaged in the activities of mutual fund and asset management including agencies connected or involved in the field of capital markets and financial services.

AUM stands for Assets under Management.  It refers to the total market value of the investments or assets managed by a mutual fund. The relative size of various mutual fund companies or scheme is assessed by their assets under management (AUM). The AUM of any scheme and consequently of any Mutual Fund company may increase depending on further subscriptions in the scheme and/or increase in the market value of the portfolio. It may fall due to redemption, income pay-outs or decrease in market value of portfolio.

AMC stands for Asset Management Company. An AMC is appointed by sponsors or trustees with the approval of SEBI to manage day to day business of Mutual Fund Schemes. The responsibilities of AMC are specified through an Investment Management Agreement executed between the Trustees and the AMC.

AMC needs to arrange for offices and infrastructure, engaging employees, software, handle publicity and promotion, interact with various service providers and regulators to conduct day to day business of the mutual fund.

AMC can appoint a Registrar & Transfer Agent (RTA) to maintain the record of unit holders or can maintain the same itself. Generally, AMCs are headed by a Managing Director, Executive Director or Chief Executive Officer and assisted by Chief Investment Officer, Fund Managers, Chief Marketing Officer, Chief Operating Officer, Securities Analysts and Compliance Officer. 

Registrar & Transfer Agents (RTA) are appointed by the AMC. It is not compulsory for AMC to appoint RTA. AMC can choose to handle the RTA activity in house. All RTAs are required to be registered with SEBI.

RTAs are responsible for maintaining the records of the unit holders and serve as Investor Service Centers at various locations. They process the investor transactions of purchase/redemption and manage funds relating to such transaction. They manage updating of information in investor accounts, called folios.

Two of the most prominent Registrar & Transfer Agents (RTA) are Computer Age Management Services (CAMS) and KARVY(K-Fintech).

Exit Load is an expense which the unit holder has to bear at the time of redemption of the units as per the terms of the scheme.

Exit Load refers to the difference between Repurchase Price and NAV of a scheme.

The price or NAV charged from an investor while investing in an open-ended scheme is called sales price. Repurchase or redemption price is the price or NAV at which an open-ended scheme purchases or redeems its units from the unit holders. It may include exit load, if applicable.

When Repurchase price is lower than the NAV, the difference between Repurchase Price and NAV is called Exit Load. Generally, exit load of scheme is pre-defined.

An AMC (Asset management Company) can appoint an Individual, a Distribution Company, a Bank or any NBFC as a distributor.

All MF Distributors, agents or any persons employed for distribution of MF products need to pass NISM Series V-A exam. These persons need to obtain a certification from National Institute of Securities Market (NISM) as required by SEBI. After passing the required NISM exam they have to get the ARN number by registering with AMFI. There after they need to get empaneled with AMCs to perform the distribution function.

Investors can contact the agents and distributors of mutual funds who are spread all over the country for necessary information and application forms. Investors must ensure that they invest through Association of Mutual Funds in India (AMFI) registered distributors and that the distributor has a valid AMFI Registration Number (ARN).

Advisor/ Distributor have a critical role in selling units to investors in the schemes of mutual funds with whom they are empaneled.

Direct Mode of Investment: Investment in mutual funds can be made directly without involving or routing the investment through any distributor/agent. This can be done directly through the mutual funds or through their authorized partner under the ‘Direct Plan’.

Direct Plan is more suitable for seasoned investors who are well versed with the process and comfortable in investing without the help of an intermediary.

Regular Mode of Investment: Investment in mutual funds can be made through a Mutual Fund distributor/agent. It is called regular mode of investment under a ‘Regular Plan’. The investor can get expert advice and processing support from the distributor if invested through a distributor in regular mode.

Comparison: Direct / Regular Mode of Investment both are part of the same mutual fund scheme and have the same portfolio and fund manager. But there is a difference in the expense ratio of these two. Direct Plan has lower expense ratio than the Regular Plan, as there is no distributor/agent involved, and hence there is saving in terms of distribution cost/commissions paid out to the distributor/agent, which is added back to the returns of the scheme. Hence, a Direct Plan has a little higher NAV than the “Regular” Plan’s NAV.

Open ended funds- are the funds which are open for entry or exit any time even after the New Fund Offer (NFO) period. Existing investor may purchase additional units or new investor can acquire fresh units any time in an open-ended fund at a price linked to NAV.

Close Ended Funds: There is a maturity and time frame in case of Close ended funds. Investors can purchase units only during NFO period. Units can be redeemed only at the end of tenure. Close ended funds are compulsorily listed on stock exchanges. Post NFO, units of close ended schemes can be bought or sold on stock exchanges, where the scheme is listed.

Active Funds:

These funds are actively managed by the fund manager with an objective to beat the benchmark.  In actively managed funds, fund manager chooses investment portfolio within the parameters of investment objectives. Fund Manager has got an important role to play. Due to active management, the fund running expenses tend to be higher. Better returns than the market is expected from actively managed funds. It is suitable for the seasoned investors who can take higher risk and wish to beat the benchmark. 

Example of active funds is fund like diversified equity fund, sector fund etc.

Passive funds

Passive funds invest on the basis of a specified index like BSE Sensex and therefore buy only the shares that are part of the composition of BSE Sensex. The proportion of each share in the scheme portfolio is equal to the weightage given to such stock in BSE Sensex. These are mirror of the index. They are not designed to perform better than the market. Fund manager has therefore no role in investment decisions. This results in low scheme expense.

Example of passive funds is fund like Index Funds, Exchange Traded Funds etc.

NFO stands for New Fund Offer. Units of a new mutual fund scheme are offered to public for the first time through New Fund Offer (NFO). The offer is made through a legal document called Offer Document.

During a New Fund Offer, investors have the opportunity to purchase units of the scheme at their face value.

NFOs can open for a maximum of 15 days (other than ELSS), then allot units or refund money within 5 business days. Scheme NFO will be reopened within 5 business days from the date of allotment. 

A capital gain is the profit realised by investors by the selling the units   held by them if it is higher than the purchase price. It can be termed as the gains realised due to the appreciation in the price of the mutual fund units. It is taxable in the hands of investors of mutual funds. It is categorized as short term and long-term capital gain and taxed as per prevailing tax rate for capital gains as detailed below.

Point of Importance

Equity Oriented Schemes- Short Term Capital Gain @ 15% plus surcharge plus cess for investment held for 12 months or less.
Long Term Capital Gain @ 10% plus surcharge plus cess for investment held for more than 12 months. Long term capital gain Tax will be applicable on gains exceeding Rs 1 lac in a financial year at the rate of 10% (Without Indexation benefit). However, all long-term capital gains up to 31st January ’2018 have been grandfathered.
Debt Schemes- Short Term Capital Gain for investment held for 36 months or less – (a) for Individual / HUF / NRI, tax will be at the rate which is applicable to him as per his income slab, (b) for Domestic Company/Firm, tax rate is 30% (25% in case of companies whose turnover during Financial Year 2018 – 19 does not exceed Rs. 400 crores).
Surcharge and cess wherever applicable will be extra.
Long Term Capital Gain, after indexation, @ 20% plus surcharge plus cess for investment held for more than 36 months for all types of investors except for NRI on unlisted units. For NRI on unlisted units, it will be at 10% plus surcharge plus cess, without indexation.

ETF stands for Exchange Traded Fund. Exchange Traded Funds (ETFs) are passive funds and the scheme portfolio is identical to the related Index or benchmark like an equity index. Investor has to keep such funds compulsorily in a Demat account. Post NFO transactions are done on stock exchanges

Riskometer is a risk indication method given in the Scheme information document (SID). There are six levels of risk. They represent risk to the principal invested by the investor. All six risk labels are tabulated in the below given table

Risk category                         Example of Funds in the category

Level of RiskExamples
LowLiquid Fund/ Overnight Fund
Low to Moderate RiskFixed Maturity Plan/ Capital Protection Oriented Scheme
ModerateIncome Fund/ Conservative Monthly Income Plan
Moderately HighIndex Fund/ Exchange Traded Fund/ Equity Dividend Yield Fund
HighSector Fund

Statement of Account (SOA)

Mutual Funds issue Statement of Account every month to investors if there is a transaction during the month. Details of the transaction like sale or purchase, value of transaction, the relevant NAV, number of units transacted, closing balance of units held and value of those units based on the latest NAV is shown in the statement.

Below given is the time line for sending the Statement of Account to the investor in a particular condition:

Dormant Investor (no transactions during last 6 months) – SOA can be sent along with Portfolio Statement or Annual Return

Soft copy will be mailed every month if instructed by investor.

Sample of Statement of Accounts

Consolidated Account Statement (CAS) 

A CAS details all the transactions and holding of the investor at the end of the month including transaction charges.

A consolidated Account Statement (CAS) is sent to investor by post or e mail for each calendar month. CAS is sent by 10th of the succeeding month in case there is a transaction in the fund during the preceding month. 

For sending CAS, investor will be identified across mutual funds by their PAN. If no PAN is available, individual account statement shall be sent to the investor.  

In case there are no transactions during six-month period, a CAS detailing the holding across all schemes of all mutual funds at the end of every six-month period (September/March) shall be sent.

Sample of CAS

Fund factsheets are official communication by a mutual fund. Factsheets are not mandatory but mutual funds still issue them. Information in factsheets is subject to SEBI’s advertisement guideline. It contains all the vital information of the fund scheme like minimum investment, plans and options, Load, expense ratio, Availability of systematic transaction facility, Inception date, corpus size, current NAV, benchmark and other necessary heads.

Sample Fact Sheet

Conversion of investor’s holding of investments from material form (paper/physical form) to digital form is called Dematerialization (Demat). Conversion of Demat units from Digital to material form is called Re-materialization.

Investor needs to open a Demat account with a depository participant (DP) if he wants to take mutual fund units in Demat form. Investor has to complete the KYC documents and provide Pan Card along with an agreement for opening a Demat account.

The access of Demat facility for mutual fund investor has increased with NSE and BSE providing screen-based platform for transactions in mutual fund schemes.

The Application Form of all the mutual funds schemes provide the details of Demat Account so that investor may hold units in Demat form.

Benefits of Demat Account:

a. Less paper work.

b. Bonus units are automatically credited into Demat account of the investor.

c. Only one Demat account is sufficient to hold investments in Mutual Fund, direct equity and debt instruments.

d. Any update or change in investors detail can be given to Depository participant (DP) and they will automatically update the required changes in all investments related transactions. Investors are not required to inform separately to all concerned AMCs.

A portfolio can be defined as a collection of financial assets and investments that are held by an individual, a financial institution or an investment firm. A Scheme portfolio refers to the portfolio of a mutual fund scheme which may consist of Equity shares, Bonds, Government securities, Gold etc. depending on the objectives and features of scheme. These assets are collectively owned by the pool of Investors who have invested in units of the particular scheme. For example, the portfolio of a Pharma sector fund scheme will own equity shares of the listed companies in pharmaceutical sector.

As per SEBI guidelines, all audio-visual print or electronic advertisements of mutual funds must contain the standard warning “Mutual fund investments are subject to market risks, read all scheme-related documents carefully” 

This standard warning caption should be displayed in both the visual and the voice-over of the advertisement and should run for at least 5 seconds.

This warning is displayed to alarm the investor to read the scheme related documents before investing and to make investor aware with the risk factor involved in the investment.