Mutual Funds

What are Mutual Funds? Define Mutual Fund / Definition of Mutual Funds ( MF ) in India

Mutual funds are in the form of Trust (usually called Asset Management Company) that manages the  pool of money collected from various investors for investment in various classes of assets to achieve certain financial goals.  We can say that Mutual Fund is trusts which  pool the savings of large number of investors and then reinvests those funds for earning profits and then distribute the dividend among the investors.    In return for such services,  Asset Management Companies charge small fees.    Every Mutual Fund / launches different schemes, each  with a specific objective.   Investors who share the same objectives invests in that particular Scheme.   Each Mutual Fund Scheme is  managed by a Fund Manager with the help of his team of professionals (One Fund Manage may be managing more than one scheme also).    

Where does Mutual Funds usually invest their funds :

The Mutual Funds usually invest their funds in equities, bonds, debentures, call money etc., depending on the objectives and terms of scheme floated by MF.   Now a days there are MF which even invest in gold or other asset classes.

What is NAV ? Define NAV :

NAV means Net Asset Value.   The investments made by a Mutual Fund are marked to market on daily basis.   In other words, we can say that current market value of such investments is calculated on daily basis.  NAV is arrived at after deducting all liabilities (except unit capital) of the fund from the realisable value of all assets and dividing by number of units outstanding.   Therefore,  NAV on a particular day reflects the realisable value that the investor will get for each unit if the scheme is liquidated on that date.   This NAV keeps on changing with the changes in the market rates of equity and bond markets.    Therefore, the investments in Mutual Funds is not risk free, but a good managed Fund can give you regular and higher returns than when you can get from fixed deposits of a bank etc.

WHAT ARE VARIOUS TYPES OF MUTUAL FUNDS :

A common man is so much confused about the various kinds of Mutual Funds that he is afraid of investing in these funds as he can not differentiate between various types of Mutual Funds with fancy names.  Mutual Funds can be classified into various categories  under the following heads:-

(A) ACCORDING TO TYPE OF INVESTMENTS :- While launching a new scheme,  every Mutual Fund is supposed to declare in the prospectus the kind of instruments in which it will make investments of the funds collected under that scheme. Thus, the various kinds of Mutual Fund schemes as categorized according to the type of investments are as follows :-

             

               (i) EQUITY FUNDS / SCHEMES

               (ii) DEBT FUNDS / SCHEMES (also called Income Funds)

               (iii ) DIVERSIFIED FUNDS / SCHEMES (Also called Balanced Funds)

               (iv) GILT FUNDS / SCHEMES

               (v) MONEY MARKET FUNDS / SCHEMES

               (vi) SECTOR SPECIFIC FUNDS

               (vii) INDEX FUNDS

B) ACCORDING TO THE TIME OF CLOSURE OF THE SCHEME :  While launching  new schemes, Mutual Funds also declare whether this will be an open ended scheme (i.e. there is no specific date when the scheme will be closed) or there is a closing date when finally the scheme will be wind up.  Thus, according to the time of closure schemes are classified as follows :-

         i. OPEN ENDED SCHEMES

         ii. CLOSE ENDED SCHEMES

Open ended funds are allowed to issue and redeem units any time during the life of the scheme, but close ended funds can not issue new units except in case of bonus or rights issue.   Therefore, unit capital of open ended funds can fluctuate on daily basis (as new investors may purchase fresh units), but that is not the case for close ended schemes.   In other words we can say that new investors can join the scheme by directly applying to the mutual fund at applicable net asset value related prices in case of open ended schemes but not in case of close ended schemes.  In case of close ended schemes, new investors can buy the units  only from secondary markets.

C) ACCORDING TO TAX INCENTIVE SCHEMES :  Mutual Funds are also allowed to float some tax saving schemes.   Therefore, sometimes the schemes are classified according to this also:-

           i. TAX SAVING FUNDS

           ii. NOT TAX SAVING FUNDS / OTHER FUNDS

(D) ACCORDING TO THE TIME OF PAYOUT :  Sometimes Mutual Fund schemes are classified according to the periodicity of the pay outs (i.e. dividend etc.).  The categories are as follows :-

           i. Dividend Paying Schemes

           ii. Reinvestment Schemes

The mutual fund schemes come with various combinations of the above categories.  Therefore, we can have an Equity Fund which is open ended and is dividend paying plan.   Before you invest, you must find out what kind of the scheme you are being asked to invest.   You should choose a scheme as per your risk capacity and the regularity at which you wish to have the dividends from such schemes

How Does a Mutual Fund Scheme Different from a Portfolio Management Scheme ?

In case of Mutual Fund schemes, the funds of large number of investors is pooled to form a common investible corpus and the gains / losses are same for all the investors during that given peirod of time.  On the other hand, in case of Portfolio Management Scheme, the funds of a particular investor remain identifiable and gains and losses for that portfolio are attributable to him only.  Each investor's funds are invested in a separate portfolio and there is no pooling of funds.

Are MFs suitable for Small Investors or  Big investors ?  Why Should I Invest in a Mutual Fund when I can Invest Directly in the Same Instruments

We have already mentioned that like all other investments in equities and debts, the investments in Mutual funds also carry risk.  However, investments through Mutual Funds is considered better due to the following reasons :-

• (a) Your investments will be managed by professional finance managers who are in a better position to assess the risk profile of the investments;
• (b) In case you are a small investor, then your investment cannot be spread into equity shares of various good companies due to high price of such shares.  Mutual Funds are in a much better position to effectively spread your investments across various sectors and among several products available in the market.   This is called risk diversification and can effectively shield the steep slide in the value of your investments. 

Thus, we can say that Mutual funds are better options for investments as  they offer regular investors a chance to diversify their portfolios, which is something they may not be able to do if they decide to make direct investments in stock market or bond market.  These are particularly good for small investors who have limited funds and are not aware of the intricacies of stock markets.   For example,  if you want to build a diversified portfolio of 20 scrips, you would probably need Rs 2,00,000 to get started (assuming that you make minimum investment of Rs 10000  per scrip).  However, you can invest in some of the diversified Mutual Fund schemes for an low as Rs.10,000/-

What are risks by investing funds in Mutual Funds :

We are aware that investments in stock market are risky as the value of our investments goes up or down with the change in prices of the stocks where we have invested.  Therefore, the biggest risk for an investor in Mutual Funds is the market risk.  However, different Schemes of Mutual Funds have different risk profile, for example, the Debt Schemes are far less risk  than the equity funds.   Similarly, Balance Funds are likely to be more risky than Debt Schemes, but less risky than the equity schemes.

What is the difference between Mutual Funds and Hedge Funds :

Hedge Funds are the investment portfolios which are aggressively managed and uses advanced investment strategies, such as leveraged, long, short and derivative positions in both domestic and international markets with a goal of generating high returns .  In case of Hedged Funds, the number of investors is usually small and minimum investment required is large.   Moreover, they are more risky and generally the investor is not allowed to withdraw funds before a fixed tenure.

Some other important Terms Used in Mutual Funds

Sale Price : It is the price you pay when you invest in a scheme and is also called "Offer Price". It may include a sales load.
Repurchase Price : - It is the price at which a Mutual Funds repurchases its units and it may include a back-end load. This is also called Bid Price.
Redemption Price : It is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related.
Sales Load / Front End Load : It is a charge collected by a scheme when it sells the units. Also called, ‘Front-end’ load. Schemes which do not charge a load at the time of entry are called ‘No Load’ schemes.

Repurchase / ‘Back-end’ Load : It is a charge collected by a Mufual Funds when it buys back / Repurchases the units from the unit holders.