Mutual Funds are a preferred route of
Investment for many people and we have had multiple articles in this blog about
them. With the stock market being revived with a never before bull-run over the
past year, investor interest in mutual funds has gone up as well. The purpose
of this article is to help answer many of your common queries about Mutual
Funds.
If you have been a follower of this
blog (or any other investment blog/magazine) you may feel that some of the
questions are very basic and are ones for which you already know the answer
for. However, there may be many novice/new investors who may not be as
knowledgeable as you are. So, please bear with me while we cover the basics also
as part of this article.
If you cannot find the answer to your
query about Mutual Funds, feel free to sound off in the comments section and I
will try my best to answer them.
1. Are
investments in mutual fund units risk-free or safe?
This is a question that
cannot be answered in general because there are mutual funds that are safe and
there are also mutual funds that are extremely risky. A mutual fund as such is
nothing but a pool of money collected from Investors and invested in a certain
asset by a professional (AKA the Fund Manager). If the fund invests in the
stock market or related instruments, then the fund is definitely not Risk Free
or Safe. If the fund invests in Fixed Income Instruments like Bonds, it can be
considered relatively safe. Funds that invest only in Government Securities or
Government Bonds are the Safest.
Note: A Mutual Fund is not
a Bank. So, even if the fund invests in Fixed Income or Safe Instruments, it
always carries a default risk (What if the guy who issued the Bond declares
bankruptcy?).
2. Are
investments in mutual funds liquid?
Investors of open-ended
schemes can redeem their units on any business day and receive the current
market value on their investments within the next few days (Usually 3 to 5
working days).
Close Ended schemes or
funds on the other hand do not allow investors to redeem their investments
until the scheme matures. In this case, if the scheme is listed in the stock
market (Like stocks – Ex: Exchange Traded Funds), they may allow you to sell
them in the secondary market.
Investors of close-ended
schemes can redeem their units only on maturity but can sell it in the
secondary market like stocks
3. How much time
does it usually take to receive Dividends?
A mutual fund is required
to pay or release funds to the investors within 30 days of the declaration of
the dividend. In case of failures to settle the proceeds within the stipulated
time period, Asset Management Company is liable to pay interest as specified by
SEBI from time to time. This penalty rate is presently 15%.
4. What is the
history of Mutual Funds in India and role of SEBI in regulating the mutual
funds industry in India?
Unit Trust of India was
the first mutual fund set up in India in the year 1963. In early 1990s, Government
allowed public sector banks and other institutions to set up mutual
funds. In the year 1992, Securities and exchange Board of India (SEBI) Act
was passed. The objectives of SEBI are to protect the interest of investors in
securities and to promote the development of and to regulate the securities
market. You can learn more about SEBI’s role by clicking here
As far as mutual funds are concerned, SEBI formulates policies and regulates
the mutual funds to protect the interest of the investors. SEBI notified
regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by
private sector entities were allowed to enter the capital market. The
regulations were fully revised in 1996 and have been amended thereafter from
time to time. SEBI has also issued guidelines to the mutual funds from time to
time to protect the interests of investors.
All mutual funds whether promoted by public sector or private sector entities
including those promoted by foreign entities are governed by the same set of
Regulations. There is no distinction in regulatory requirements for these
mutual funds and all are subject to monitoring and inspections by SEBI. The
risks associated with the schemes launched by the mutual funds sponsored by
these entities are of similar type.
5. What is the
role of a Fund Manager?
Fund managers are
individuals who are responsible for implementing a consistent investment
strategy that reflects the goals and objectives of the mutual fund. Normally,
fund managers monitor market and economic trends and analyze securities in
order to make informed investment decisions. Each fund usually has one or more
fund managers who together take the investment decisions (what/when to
buy/sell).
6. What are
venture capital funds?
Venture Capital is the
fund/initial capital provided to businesses typically at a start-up stage and
many times for new/ untested ideas. Venture capital normally comes in where the
conventional sources of finance do not fit in. Venture capital funds are mutual
funds that manage venture capital money i.e. these funds aggregate money from
several investors who want to provide venture capital and deploy this money in
venture capital opportunities.
Typically venture capital funds have a higher risk/ higher return profile as
compared to normal equity funds and whether you should invest in these would
depend on your specific risk profile and investment time-frame. These type of
funds are pretty popular in developed markets like US/Europe but are not so
much in India.
7. Can a mutual
fund change the asset allocation while deploying funds of investors?
Again, this is a question
where I have to say – It Depends.
Most mutual funds invest
in a combination of assets (Equities, Bonds etc.) these days. If the Fund
Manager is taking a short-term decision to increase allocation to one asset
class to take advantage of a short term market momentum or to protect the fund
NAV in the short-term, he/she usually has this flexibility to take such a
decision.
However, if the fund or
the fund manager want to alter their asset allocation pattern permanently, they
have to follow the points explained in the next Question.
8. Can a mutual
fund change the nature of the scheme from the one specified in the offer
document?
Yes. But, any change to
the core or fundamental attributes of the scheme like Investment Pattern,
Structure etc., cannot be carried out unless a written communication is sent
out to all investors. The fund house must also advertise this change in at
least one English Daily News Paper that has a nationwide circulation along with
an advertisement in the local language of the region where the fund head office
is situated. In such a situation, the unit holders have the right to exit the
scheme at the current/prevailing NAV without any Exit Load if they don't wish
to continue with their investment.
9. Can I assign a
nominee for my investment in a mutual fund?
Yes. Individuals (and also
Joint Holders) can make nominations to their mutual fund investments. However,
Non-Individuals (like Society, Trust, Corporate Body, Hindu Undivided Family
etc.) cannot use the nomination facility when they invest in Mutual Funds.
10. Can a mutual
fund impose fresh load or increase the load beyond the level mentioned in the
offer documents?
No. Mutual funds cannot
increase the load beyond the level mentioned in the offer document. Any change
in the load will be applicable only to prospective investments and not to the
original investments. In case of imposition of fresh loads or increase in
existing loads, the mutual funds are required to amend their offer documents so
that the new investors are aware of loads at the time of investments. Even if
they amend now, they cannot backdate and charge existing investors the extra
fees/load.
11. Can
non-resident Indians (NRIs) invest in mutual funds?
Yes, Sure. NRI’s can invest
in mutual funds. However, they must have either an NRI DEMAT Account or specify
the fact that they are an NRI while applying via paper route and pay using an
NRE/NRO Account
12. How are
mutual funds regulated?
All Asset Management
Companies (AMCs) are regulated by SEBI and/or the RBI (in case the AMC is
promoted by a bank). In addition, every mutual fund has a board of directors
that represents the unit holders interests in the mutual fund.
13. How can the
investors redress their complaints?
Investors would find the
name of the contact person in the offer document of the mutual fund scheme whom
they may approach in case of any query, complaints or grievances. Trustees of a
mutual fund monitor the activities of the mutual fund. The names of the
directors of asset management company and trustees are also given in the offer
documents. Investors should approach the concerned Mutual Fund / Investor
Service Centre of the Mutual Fund with their complaints,
If the complaints remain unresolved, the investors may approach SEBI for
facilitating redressal of their complaints. On receipt of complaints, SEBI
takes up the matter with the concerned mutual fund and follows up with it regularly.
Investors may send their complaints to:
Securities and Exchange Board of India,
Office of Investor Assistance and Education (OIAE)
Plot No.C4-A , “G” Block, 1st Floor,
Bandra-Kurla Complex,
Bandra (E), Mumbai – 400 051.
Phone: 26449199-88-77
14. I don't have
a lot of investible surplus. Can I still invest via the Mutual Fund route?
Sure you can. Regular
investing is a very good way to build up an investment portfolio and this can
be done with any amount of money. You can check the fund prospectus/offer
documents to check the minimum investment expected by the fund you wish to
Invest. Most mutual funds expect an investment of at least Rs. 5000/- for One
Time Purchases or Rs. 500/- for Regular/SIP Investments.
15. What is an
Entry or Exit Load?
The Entry Load or Exit Load is nothing
but a small fee that you pay while buying into or selling your funds. The
amount that actually gest Invested in the fund is usually the Investment minus
the Entry Load. Similarly, when you sell your investments, the current market
value of your funds minus exit load is the amount you will receive.
16. Does this "Entry
Load" or “Exit Load” eat into our investment returns?
Yes, of course. When you
see an offer document for a fund mentioning 1% or 2% as entry load, it may
sound small or insignificant. But, it still bites a decent sized chunk of your
returns.
Lets take an example, I
want to invest Rs. 1 lakh into a fund that has a 2% entry load and the current
NAV is Rs. 10 (New Fund). You may think I will get 10,000 units. But, actually
I am only going to get 9,800 units (2% of my investment or Rs. 2,000/- is the
fee the fund house deducts as part of the Entry Load). Lets say I sell my
investments after 5 years when the NAV is Rs. 35 per unit, I will only get back
Rs. 3,43,000. I am effectively losing Rs. 7000/- (If there was 0 entry load, I
would have gotten an additional 200 units that at the selling price is worth
Rs. 7000)
If the fund also charges
an Exit load, I may not get this full amount either. If the fund house charges
a 1% Exit Load I will only get back Rs. 3,39,570 (Rs. 3430 is deducted as Exit
Load)
Note: Most funds these
days DO NOT charge an Entry Load and only charge an Exit Load if you sell your
investment without completing at least one full year. The fund house is
expected to clearly mention the Entry/Exit loads in the offer document.
17. What is Net
Asset Value (NAV)?
NAV is the total asset
value (net of expenses) per unit of the fund and is calculated by the Asset
Management Company (AMC) at the end of every business day. Net asset value on a
particular date reflects the realizable value that the investor will get for each
unit that he/she is holding if the scheme is liquidated on that date.
For ex: If a Mutual fund
has investments worth 10 lakhs and has 1 lakh units that are held by investors,
the NAV in simple terms will be Rs. 10/-
18. How long will
it take for transfer of units after purchase from stock markets in case of
close-ended schemes?
According to SEBI
Regulations, transfer of units is required to be done within thirty days from
the date of lodgment of certificates with the mutual fund.
19. How
significant are fund costs while choosing a scheme?
One thing that many people
fail to consider or even realize while investing in Mutual Funds is the “Cost”
incurred by the fund. Many different cost/fee like Management Fee, Sales Load,
Advertisement Expenses etc will get deducted from the actual NAV. As a general
rule of the thumb, about 1-2% of your annual returns will usually be used to
offset these fees. Any fund that can actually keep its costs in this range can
be considered an acceptable investment option.
Every investor must
carefully examine the offer document of the fund to make sure that he/she isn’t
investing in a fund that has exorbitant fees or charges.
20. How many
funds should I invest in, to achieve proper diversification for my Portfolio?
As our forefathers said,
keeping all our eggs in the same basket is not a good idea. However, if I want
to buy 100 eggs and think about carrying them one each in a basket, it will
become an overhead instead of protecting my Egg – right?
You can consider one or
two good funds from the various categories like Diversified Equity, Large Cap
Oriented, Small & Mid-Cap, Balanced, ELSS etc and form a core portfolio of
about 4-5 well managed funds to achieve optimal diversification. Having more
than 5 funds in your portfolio will make it complicated for tracking purposes
and result in a situation called “Over Diversification” which isn’t a good
thing.
21. What are the
different types of Mutual Funds that I can Invest in?
Mutual Funds are
classified by structure into Three Main Types: Open Ended, Close Ended and
Interval Schemes.
Based on Investment
Objectives, Mutual Funds can be classified as:
- Equity Schemes
- Income Schemes
- Money Market Schemes
- Tax Saving Schemes
- Balanced Schemes
- Offshore funds
- Index Funds
- Arbitrage Funds
- Hedge Funds etc.
22. What are
open-ended mutual fund schemes?
Open ended schemes usually
do not have a fixed maturity period and are available for subscription and
redemption on an ongoing basis. The units can be bought and sold any time
during the life of the scheme at NAV related prices.
23. What are
close-ended mutual fund schemes?
Close ended mutual fund
schemes are those that cannot be subscribed or redeemed by investors on an
ongoing basis. Investors can subscribe during the New Fund Offer (NFO) period
and have to wait until the scheme matures (usually 2, 3 or 5 years down the
line).
The good news however is
the fact that, most of these close ended funds can be bought or sold on the
stock exchanges where the scheme is listed. The market price at the stock
exchange could vary from the schemes NAV on account of demand and supply
situation (like regular stocks), unit holders expectations and other market
factors. As a result, you will need to compromise on a small % of your NAV Value
if you wish to redeem/sell your units before maturity.
24. Do Mutual
Funds offer any Income Tax Benefit?
Yes. A special type of Mutual Fund
called Equity Linked Savings Scheme (ELSS) offer income tax benefits to
Investors in India under the Section 80C of the Indian tax laws. These are
nothing but large cap oriented equity
mutual funds that have a lock-in period of 3 years.
25. What are
sector specific funds?
These are the funds which
invest only in the securities of only those sectors or industries as specified
in the offer documents. For Ex: a Pharma Fund will only invest in
Pharmaceutical and Healthcare stocks.
The returns generated by these
funds are dependent on the performance of the respective sectors/industries.
While these funds may give higher returns, they are more risky compared to
diversified funds. Investors need to keep a watch on the performance of those
sectors/industries and must exit at an appropriate time.
26. What are Offshore
Funds?
Offshore funds specialize
in investing in foreign companies and/or corporations. These funds have
non-residential investors and are regulated by the provisions of the foreign
countries where these are registered. These funds are also regulated by RBI
directives.
27. What are
Money Market Schemes?
Money Market Schemes aim
to provide easy liquidity, preservation of capital and moderate income. These
schemes generally invest in safer, short-term instruments, such as treasury
bills, certificates of deposit, commercial paper etc.
28. What are
Interval Schemes?
Interval Schemes are those
that combine the features of open-ended and close-ended schemes. The units may
be traded on the stock exchange or may be open for sale or redemption during
pre-determined intervals at NAV related prices.
29. What are
Index Funds?
Index schemes attempt to
replicate the performance of a particular index such as the BSE Sensex or the
NSE 50. The portfolio of these schemes will consist of only those stocks that
constitute the corresponding index. The percentage of each stock to the total
holding will be identical to the stocks index weightage. And hence, the returns
from such schemes would be more or less equivalent to those of the Index. As
the fund manager doesn't really have to decide on what or when to buy, the fees
associated with such funds are much lower than regular mutual funds.
30. What are
Income Funds?
Income Funds are also
known as debt funds. The aim of these schemes is to provide regular and steady
income to investors. These schemes generally invest in fixed income securities
such as bonds and corporate debentures. Capital appreciation in such schemes
may be limited because their aim is to provide a regular income and capital
protection to their investors.
31. What are Equity
Funds?
Equity Funds are those
funds that invest a big chunk (or even all) of their portfolio in equity and
other equity related instruments. The aim of these schemes is to provide
capital appreciation over medium to long term. Because of the nature of the
stock market which is volatile in the short term, investors who are willing to
bear short-term decline in value for possible future appreciation only should
consider them. Risk Averse investors who do not wish to incur any losses (ones
who choose capital preservation over capital appreciation) must stay away from
such funds.
These funds invest
exclusively in government securities. Government securities have no default
risk (on paper). NAVs of these schemes also fluctuate due to change in interest
rates and other economic factors as is the case with income or debt oriented
schemes. However, with added safety comes lower returns because Government
Securities usually offer much lower rate of interest than other bond issuers.
33. What are
Balanced Funds?
Balanced Funds are schemes
that aim to provide capital appreciation to its investors while at the same
time trying to preserve some/all of the capital. As a result of this two-fold
idea, these funds invest in both safe (fixed income) as well as risky
(equities) instruments. The % allocation for both sides usually hovers around
the 40% to 60% range with the fund manager having the flexibility to alter the
% based on market situations.
A point to note here is
that the returns generated by such funds may not be as high as pure equity
oriented funds if the market is rising. However, if the markets are falling,
the losses wouldn't be as much as equity funds either.
34. Should you
evaluate past performance, and look for consistency?
Yes, definitely.
Consistent Past performance is a good indicator for any well managed fund.
Though past performance is no guarantee that the fund would perform at the same
level in future, the chances of a good fund that has consistently given good
returns in the past, giving you good returns in future are much higher as
against funds that haven’t been so consistent.
The longer the time period
(1 year, 3 years, 5 years etc) where the fund has consistently performed, the
higher the fund should be on your shortlist.
35. Which is
better – SIP or one time Bulk Investment?
Actually, there is no One
Correct answer for this Question.
Both SIP and Bulk
Investment option have their own merits. For ex: In case of a volatile market
(one that is going up and down), going the SIP route would be beneficial
because it will help you average out your purchase price and make more profits.
On the other hand, if the market is purely going up, then the Bulk route will
be beneficial because you will get lesser and lesser units each month.
However, in the long run,
the chances of the SIP route outperforming the bulk route are pretty high
because, as I have said many times, the stock market is volatile and keeps
going up or down frequently. So, being a regular/consistent investor always has
its perks.
36. Are arbitrage
funds a good choice for earning high returns with low risk?
Arbitrage Opportunities
are a special class of investment where the fund manager tries to make
a profit out of the pricing mismatch between the Equity and Derivatives Market.
Anything that invest in either the Equities market or the Derivatives market
carries with it, the risk of a downside and hence, the low risk part is ruled
out. Yes, arbitrage funds can give you good returns but at a high risk (just
like regular equity funds)
37. Is it good to
buy a fund just before it goes ex-dividend?
This is one of those
misconceptions that people have. Buying into a fund just before the ex-dividend
date basically means that you are eligible to receive a dividend right after
you actually buy into the fund. However, what many people fail to note is that
the NAV of the fund falls by an appropriate amount after the fund house
actually gives you the dividend.
Let me explain with an
example. Lets assume I invest 1 lakh into XYZ mutual fund Dividend scheme which
is selling @ Rs. 24/- per unit just before the ex-dividend date where the fund
is declaring a Rs. 3/- dividend per unit.
Units purchased: 4166.67
(Value @ NAV Price = 1 lakh)
Dividend Earned = Rs.
12,500/-
Value/Worth of my units
after Dividend = Rs. 87,500/- (Same 4166.67 units)
Basically after I invest
the 1 lakh, the fund house is giving me Rs. 12,500/- of my own money back
thereby reducing my fund value. So, I might as well wait until the dividend is
declared and buy more units for the same amount (4761.9 units @ Rs.21 per unit)
which will give me a higher chance of returns in future.
38. If schemes in
the same category of different mutual funds are available, should one choose a
scheme with lower NAV?
This is yet another big
misconception that investors in India have. People feel funds with lower NAV’s
are cheaper and therefore are better. This is one of the reasons why New Fund
Offerings (NFOs) tend to get heavily subscribed even though there is no past
performance benchmark to prove how good the fund manager is.
Let me explain with an
example. Lets say MF X is available now for NAV of Rs. 15 per unit and then we
have MF Y that is available for NAV of Rs. 150 per unit. Suppose, I want to
invest 3 lakh lakh rupees now and I split my money equally between the 2 funds.
Units got from Investing
in Fund X = 10,000 (@ 15 per unit)
Units got from Investing
in Fund Y = 1,000 (@ 150 per unit)
10,000 units sounds a lot
more than 1,000 units – right? But, this is not a correct comparison because
the value of each unit of X is only 15 rupees whereas the value of each unit of
Y is 150 rupees. Meaning Y is 10 times more valuable than X. At today’s market
valuation (NAV) the value of my investments in both funds is the same – 1.5
lakhs.
Lets assume that the
investment philosophy of both funds is very similar and their returns follow
the BSE Sensex Index. At the end of the year, both the funds have grown by 12%.
So, are you thinking that my investment in fund X would’ve made more profits
for me? After all, I purchased 10000 units of fund X. Right?
Current NAV of Fund X =
Rs. 16.80 (12% Growth)
Value of Investments in
Fund X ( 10,000 * 16.8) = Rs. 1,68,000/-
Current NAV of Fund Y =
Rs. 168 (12% Growth)
Value of Investments in
Fund Y (1,000 * 168) = Rs. 1,68,000/-
Though I had 10,000 units
of Fund X and just 1000 units of Fund Y, the profit I made is exactly the same
because the two funds gave exactly the same 12% returns.
Unless the fund with the
smaller NAV outperforms the fund with the larger NAV (by better investment
choices) there is absolutely no reason on why you should choose either fund by
merit of just its NAV.
39. If mutual
fund scheme is wound up, what happens to money that people invested?
In case of winding up of a
scheme, the mutual funds pay a sum based on prevailing NAV after adjustment of
expenses. Unit holders are entitled to receive a report on winding up from the
mutual funds which gives all necessary details.
This is similar to a situation where
all the investors simultaneously want to exit the fund on one fateful day.
40. I am holding
XYZ Fund. Its NAV is down. Should I continue to hold this fund or exit it?
Your decision to retain or
sell the fund should not be based on market volatilities. The stock market is
volatile and the day to day ups or downs can be quite dramatic in the
short-run. Impulsive decisions are never a good idea and in the case of the
stock market it is probably the worst idea. If the fund is well managed, the
fund manager will use the market corrections to buy stocks of good companies at
discounted prices and by sticking on to your investment, you will get good
profits in the future.
You should consider selling
a fund Only If:
-
The
fund has consistently underperformed its benchmark index (At least for 1-2
years)
-
The
Fund’s investment objective or philosophy has changed
-
The
Fund Manager has changed
You may also want to sell your units to
rebalance your portfolio but this is not really considered selling because you
will effectively be investing in another fund. Right?
41. What is a
Fund of Funds (FoF) Mutual Fund Scheme?
A Fund of Funds mutual
fund is nothing but a mutual fund scheme that actually invests in other mutual
funds. This fund does not directly invest in stocks or bonds or other
investment instruments. They buy mutual fund units of other schemes. For Ex: A
diversified equity FoF will invest in various different diversified equity
mutual fund schemes.
42. What is an
Asset Management Company (AMC)?
The company that manages a
mutual fund is called an AMC. Reliance, HDFC, ICICI Prudential, Franklin
Templeton, Birla Sun Life etc are all popular AMCs in India. An AMC may have
several mutual fund schemes with similar or varied investment objectives. The
AMC hires a professional fund manager, who buys and sells securities in line
with the fund's stated objective.
43. What is
Systematic Investment Plan or SIP?
A Systematic Investment Plan is nothing
but a regular commitment from an investor wherein the investor agrees to invest
a predetermined amount of money regularly (Usually every month) for a
predetermined period (Usually 1 year or more). Simply speaking, a Mutual Fund SIP is like a Bank
Recurring Deposit with a difference that, the Mutual Fund will invest
in the stock market while the Bank does not
do so.
Every month, units
corresponding to the amount invested by us (At the prevailing NAV on the date
of investment) are credited into our MF Account.
44. What is the Benefit of taking the SIP Route to Investing?
SIPs are most useful when the stock market isnt on a steady upward trend. In the current economic
scenario, the markets are extremely volatile and you never know when the market
will go up or down. So, if we choose the SIP route, it gives us the benefit of
"Cost Averaging". In other words, since you are investing every
month, you can take advantage of any dips in the stock market and accumulate additional units. This way, at the end of the SIP Period,
you will end up with more units that what you would have accumulated if you had invested in one shot.
More importantly, parting with Rs. 5000/- every month may not look that
difficult, but if you are asked to cough up Rs. 75,000/- in one month that will
sound like a lot, wouldnt it? That is exactly why SIPs are easier than one time investments.
45. When will the
investor get the certificate or statement of accounts after investing in a
mutual fund?
Mutual funds are required
to dispatch certificates or statements of accounts within six weeks from the
date of subscription on the scheme. Depending on how you invested (Via paper
form or DEMAT), how you get the statement may vary. For example, investors
choosing the DEMAT route may get email statements while investors who chose the
traditional paper based route, would get paper based statements by post.
46. Why should
you monitor and review your fund performance?
Having made an investment
in a mutual fund, you should monitor it to see whether its management and
performance is in line with stated objectives and also whether its performance
exceeds or lags your expectations. Unlike individual stocks and bonds, mutual
fund reviews are required less frequently, once in a quarter should be sufficient.
A review of the fund’s performance should be carried out with the objective of
holding or selling your investment in the mutual fund. A simple check could be
– is the fund able to meet the performance/returns of its benchmark Index? A
fund that is based out of BSE Sensex should be able to at least meet or beat
the % returns generated by Sensex every quarter. If it is not able to do this
and misses the target during consecutive quarters, you may need to consider
exiting the fund.
We
have had numerous articles in the past that covered the topic of Mutual Funds
in great detail. Some of the useful articles which you can refer to now would
be:
Hope you found these
questions useful. If you have more questions use the comments section and I
would be happy to answer them.
