Mutual Funds - Concepts, Management, Risks, and Investment Strategies | MODULE D: FINANCIAL PRODUCTS AND SERVICES
Mutual Funds: Concepts, Management, Risks, and Strategies
1. Mutual Funds and their Functions
Mutual Funds are investment vehicles that pool money from numerous investors to purchase a diversified portfolio of securities like stocks, bonds, and other assets. Their primary function is to offer small or individual investors access to professionally managed portfolios at relatively low cost.
2. Management of Mutual Funds
Mutual funds are managed by Asset Management Companies (AMCs) through professional fund managers. These managers make investment decisions based on market research, economic trends, and the investment objectives of the fund.
3. Evolution of Mutual Funds
The first mutual fund was introduced in the 18th century in the Netherlands. In India, mutual funds started with the Unit Trust of India (UTI) in 1963. Since then, the industry has expanded with private sector and foreign players entering the market post-liberalization in 1993.
4. Classification of Mutual Funds
Mutual funds can be classified as:
- Based on Structure: Open-ended and Close-ended Funds
- Based on Asset Class: Equity Funds, Debt Funds, Hybrid Funds, Money Market Funds
- Based on Investment Objective: Growth Funds, Income Funds, Liquid Funds, Tax-Saving Funds
5. Role of Mutual Funds
Mutual funds mobilize savings for productive investment in the capital market, provide liquidity, diversify risks for small investors, and contribute to the efficient allocation of resources in the economy.
6. Supervision of Mutual Funds
In India, mutual funds are regulated and supervised by the Securities and Exchange Board of India (SEBI) under SEBI (Mutual Funds) Regulations, 1996. SEBI ensures transparency, investor protection, and fair practices in the industry.
7. New Fund Offer (NFO)
A New Fund Offer (NFO) is the first-time subscription offer for a new scheme launched by a mutual fund. Investors can purchase units at the offer price, generally ₹10 per unit, during the NFO period.
8. Risks Associated with Mutual Funds
Risks include market risk, credit risk, liquidity risk, interest rate risk, and reinvestment risk. Different types of funds carry different risk levels depending on their investment portfolios.
9. Risk Depiction – Riskometer
The Riskometer is a tool mandated by SEBI that displays the risk level associated with a mutual fund on a scale from "Low" to "Very High". It helps investors match their risk appetite with fund choices.
10. Net Asset Value (NAV)
Net Asset Value (NAV) represents the per-unit value of a mutual fund scheme. It is calculated daily based on the total market value of all securities in the portfolio minus liabilities.
Mathematical Formula:
NAV = (Total Assets - Total Liabilities) /
Total Number of Outstanding Units
Advanced Example:
Suppose: Total Market Value of Securities = ₹500,00,000
Cash and Cash Equivalents = ₹20,00,000 Total Liabilities = ₹5,00,000 Total Units Outstanding = 1,00,000 NAV = (₹500,00,000 + ₹20,00,000 - ₹5,00,000) / 1,00,000 NAV = ₹515,00,000 / 1,00,000 NAV = ₹515 per unit
11. Expenses Ratio
The Expense Ratio measures the percentage of a fund's assets used for administrative and other operating expenses. A lower expense ratio is favorable as it leaves more returns for the investors.
Formula:
Expense Ratio = (Total Fund Expenses /
Average Assets Under Management) × 100
Example:
Total Expenses = ₹10,00,000 Average AUM = ₹50,00,00,000 Expense Ratio = (10,00,000 / 50,00,00,000) × 100 = 0.2%
12. Load/No-Load Funds
Load Funds: These funds charge a fee at the time of purchase (Entry Load) or redemption (Exit Load).
No-Load Funds: These funds do not charge any fee for entry or exit.
13. Strategies for Investment in Mutual Funds
Some effective strategies include:
- Systematic Investment Plan (SIP): Investing a fixed amount regularly.
- Asset Allocation: Diversifying investments across asset classes based on risk appetite.
- Value Investing: Choosing funds that invest in undervalued securities.
14. Role of Mutual Funds in the Capital Market
Mutual funds deepen capital markets by bringing in retail investors, enhance market liquidity, encourage savings, and provide stability against sudden market volatility by investing in diverse sectors and instruments.
15. Alternative Investment Funds (AIFs)
Alternative Investment Funds are privately pooled investment vehicles that collect funds from sophisticated investors and invest in venture capital, private equity, hedge funds, etc. AIFs are categorized into three classes under SEBI regulations:
- Category I: Investment in socially or economically desirable areas (startups, SMEs, infrastructure).
- Category II: Funds like private equity, debt funds which do not undertake leverage except for day-to-day operations.
- Category III: Hedge funds or funds that employ complex trading strategies.
Chapter List: MODULE D: FINANCIAL PRODUCTS AND SERVICES
- Overview of Financial Markets
- Money Markets and Capital Markets
- Fixed Income Markets - Debt / Bond Markets
- Forex Markets
- Interconnection of various markets/Market Dynamics
- Merchant Banking Services
- Derivatives Market including Credit Default Swaps
- Factoring, forfaiting & Trade Receivables Discounting System (TReDS)
- Venture capital
- Leasing and Hire Purchase
- Credit Rating agencies & their functions
- Mutual Funds
- Insurance Products
- Pension Funds (include APY, NPS)
- Guidelines on Para Banking & Financial Services provided by Banks
- Real Estate Investment Funds / Infrastructure Investment Fund (concept)
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