Eco Times Mf

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Mutual Fund

WHAT ARE MUTUAL FUNDS ?

Mutual funds are investment vehicles that are finding a greater acceptance among investorsacross the country. Their scope is expanding with investors getting a larger bouquet ofschemes to choose from. However, to make an informed choice, the investor needs tounderstand the characteristics of the fund, which determine the kind of returns it generates

and the risk that will arise during the course of the investment.

A mutual fund is a vehicle that invests in various assets on behalf of its unit holders. Under thescheme, a large number of investors come together and pool their money. This sum is theninvested by professional fund managers according to the investment objective of the scheme.The investors, who put their money into a scheme, get units and are known as unit holders.Since the denomination of the holding of the investor is units, there is no need for them to berounded off. Therefore, one will find holdings in decimal places.

Thus the mutual fund entity allows small and individual investors to get the benefits of adiversified portfolio. It also gives the unit holders access to several investments that mighthave been out of their reach for want of funds. The value of the investment is known as the netasset value (NAV) of the scheme. The NAV is calculated on the value of the holdings of the

scheme. Investors can redeem and buy additional units depending upon the specific nature ofthe fund and these transactions take place at values related to the NAV of the scheme.

TYPES OF MUTUAL FUNDS

Mutual funds can be classified into three broad categories depending on their basiccharacteristics. The way in which the features of the scheme are considered will also impacttheir classification.

OPEN ENDED FUNDS

Open ended mutual funds have an infinite life which means that there is no ending date of the

scheme. This scheme can continue to go on forever and due to this factor the scheme allowsinvestors to come in and go out of the fund when they wish subject to some specific conditions fora few funds. For example a large number of schemes in the Indian market are open endedschemes that invest in equities where they can continue to operate for years on end. The realbenefit of these schemes is that an investor can put additional money into the scheme or taketheir money out when they feel like it rather than this being decided as a specific date by the fundor some other entity.

CLOSE ENDED SCHEMES

Close ended mutual fund schemes are those schemes that will come to an end after a specificperiod of time. In the strict sense when the time period comes to an end the assets of the schemeare sold off and these are distributed to the unit holders after deducting the necessary expensesfor the entire process. Due to this factor close ended schemes will allow entry to an investor onlyat the time of the initial offering and there would be no entry for additional investors after this.Many schemes also have a restriction on the time of the exit from the scheme.

This does not mean that new investors cannot come into the fund. As a measure of liquidity oftenequity close ended funds are listed on the stock exchange whereby investors can buy the units ofthe scheme from another investor. However the total units issued by the scheme remains thesame as the fund will not issue any additional units. This route has mostly witnessed the price of

The Economic Times Mutual Fund - 2006


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the units on the exchange quoting at a discount to the net asset value of the scheme. In such ascheme the fund manager knows precisely what is the amount that is available to them to investand they can take long term investment decisions accordingly.

Many close ended schemes are of this nature for a particular duration but they turn open endedafter the specified time period like 3 or 5 years whereby the nature of the scheme changes.Further in some kind of investments there is a necessity that the funds remain invested for acertain period of time and hence in that sense close ended schemes become necessary.

INTERVAL FUNDS

There is another category of funds whose characteristics fall between open ended and closeended funds and these are known as interval funds. These funds are not completely close endedor completely open ended in the sense that they are not of a fixed duration and they do allowinvestors to make purchases once the initial offer period is over but they will not be available forpurchase and sale everyday. There will be a specific time period like a few days every threemonths or every six months when investors can buy and/or sell these units back to the funds.Thus they provide liquidity without compromising on the restricted nature of the fund.

HOW CAN INVESTORS USE THIS INFORMATION?

The investor should look at the nature of the scheme and then match it against their specificrequirement to see whether this fits in with their goals. For example an investor might requirefunds after three and a half years but if it is a close ended scheme for five years then it will beworthless for the investor. This feature can be used to plan the liquidity for the portfolio of theinvestor. In addition specific types of schemes can also be matched with their features to ensurethat both are similar.

The other way of classifying scheme is through the composition of their assets and the type ofsecurities held by the schemes. This is available both in the offer document of the scheme as well

as other places where the investment is specified in terms of portfolio declaration.

EQUITY SCHEMES

Equity schemes invest the amounts that they collect from investors into stocks of variouscompanies listed on the stock exchanges as well as those that are unlisted. These schemes arealso called growth schemes because the idea behind such investments is to earn a high returnthrough the rise in the value of the investment.

The wide range of stocks available in the market and the different nature of styles of managementof the schemes will result in a different profile for various schemes within this area. For example ascheme which invests in large cap stocks will be different from a scheme that will invest its funds

into mid cap companies.

In addition there are schemes, which are diversified across various sectors without any biastowards market cap of the stocks it holds. In terms of other styles one can see funds that selectstocks based on their dividend yield and these are called dividend yield funds.

There is a chance of a high gain in such schemes and in the last three years the returns on manyschemes have even crossed more than 100% in a single year. Many investors however forgetthat there is a downside to the whole investment as a fall in the equity market can result in a fall inthe value of the scheme leading to a capital loss for the investors.



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EQUITY SCHEMES

Equity schemes invest the amounts that they collect from investors into stocks of variouscompanies listed on the stock exchanges as well as those that are unlisted. These schemes are

also called growth schemes because the idea behind such investments is to earn a high returnthrough the rise in the value of the investment.

The wide range of stocks available in the market and the different nature of styles of managementof the schemes will result in a different profile for various schemes within this area. For example ascheme which invests in large cap stocks will be different from a scheme that will invest its fundsinto mid cap companies.

In addition there are schemes, which are diversified across various sectors without any biastowards market cap of the stocks it holds. In terms of other styles one can see funds that selectstocks based on their dividend yield and these are called dividend yield funds.

There is a chance of a high gain in such schemes and in the last three years the returns on manyschemes have even crossed more than 100% in a single year. Many investors however forgetthat there is a downside to the whole investment as a fall in the equity market can result in a fall inthe value of the scheme leading to a capital loss for the investors.

SECTORAL SCHEMES

These are a variant of equity oriented schemes where the risk for the investor is higher than thediversified equity schemes. The funds of such schemes are invested into the shares of aparticular sector only or it could be in companies that comply with a particular theme only.

A good example of such schemes are those which invest in the shares of information technologycompanies or companies from the fast moving consumer goods (FMCG) sector. There is apossibility of a higher return from such schemes because even if the whole market is not doingwell a particular sector might be on the growth path. At the same time this has a higher riskbecause it is possible that nothing happens to a particular sector while the overall market is risingor it could be that just a specific sector is doing badly due to specific reasons. Further with otherinvestment options closed the entire portfolio of the scheme will be subject to a similar kind of riskleading to very little diversification in the portfolio.

Equity linked savings schemeEquity linked savings schemes are also known as ELSS or tax savings schemes. These are likediversified equity schemes in terms of their portfolio composition but they give investors a taxbenefit that other schemes do not. Investment upto Rs 1 lakh into these schemes qualify for adeduction under Section 80C of the Income Tax Act along with several other specifiedinvestment options.

Investors who put money into such schemes are looking at earning a higher return on theirinvestments and at the same time save on the tax. Unlike normal equity schemes there is also athree year lock in for such schemes.

EQUITY-LINKED SAVINGS SCHEMES

Equity-linked savings schemes are also known as ELSS or tax savings schemes. These arelike diversified equity schemes in terms of their portfolio composition but they give investors a



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tax benefit that other schemes do not. Investment up to Rs 1 lakh into these schemes qualifyfor a deduction under Section 80C of the Income Tax Act along with several other specifiedinvestment options.

Investors looking at earning a higher return on their investments and save on the tax at thesame time opt for such schemes. Unlike normal equity schemes, ELSS carry a three year lockin.

INDEX FUNDS

Index funds are known as passive schemes because here the fund manager does not have totake active investment decisions regarding selection of companies for investment. The corpus ofthese schemes is invested in such a manner that it mimics an index that is being tracked by thefund. Thus for example a scheme tracking the Sensex will have its portfolio in the exactproportion that the 30 sensex scrips are in and hence the performance should mirror thebehaviour of the index being tracked. At regular periods of time the portfolio is rebalanced so thatany deviation is corrected. These are meant for investors who would like to ensure that theirreturns match that of a specified index.

INCOME SCHEMES

Income schemes invest their assets into debt instruments that are either of medium to long termin duration. This means that the scheme will invest the money into debt instruments that matureafter a few years and these can stretch to several years.

In terms of the choice available for the fund manager there are bonds, debentures, governmentsecurities and other debt instruments. Typically most of these schemes hold a mixture of bonds,debentures, gilts and even short term securities in their portfolio and they keep changing the mixdepending upon the fund managers outlook for the future.

These schemes are steady in the growth that they witness and hence one should expect returnsaligned to the performance of the debt market, which means that under steady conditions itshould give reasonable returns and the risk to capital is accordingly lower. However the returns ofthe scheme turn negative when rates rise and positive when t he rates fall in line with thebehaviour of the debt instruments.

LIQUID SCHEMES

Liquid schemes are meant for very short term investors where the investor horizon ranges from acouple of days to around a week or slightly more. The liquid schemes invest the money intoovernight call money market and extremely short term options so that there is very risk forinvestors in terms of a capita loss in these schemes.

Ideally when the investment is made in this manner liquid schemes should not show any fall intheir value but the returns will vary depending upon the rates prevalent during the time period ofinvestment. Thus liquid schemes are meant to be the safest type of schemes where the risk forthe investor is minimum and returns are consequently lower.

SHORT TERM SCHEMES



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Short term schemes are debt oriented schemes and are meant for investors who want to parktheir money for a few months. Thus these are meant for those who do not want to invest for a justa few days and neither for a very long period amounting to a few years. Thus it is for middle of theroad investors who do not fall into either the very short or the long term category. The portfolio ofshort term schemes consists of short term securities including gilts, certificates of deposits and inseveral cases even bank deposits

The returns from such schemes is not very high but similarly the risk is also considerably lowerand this is useful for several investors who would like to put their money away for a short periodof time and earn high returns during this period.

FLOATING RATE FUNDS

One of the basic features of debt schemes is that the value of the debt holdings will fall in valueas the interest rates rise in the economy and they will rise when the rates fall. This makesinvestors in debt schemes susceptible to losses when conditions are adverse in the bond market.Floating rate funds are those schemes which invest their corpus into floating rate securities whichmeans that the interest rate on these funds are reset at regular intervals. This makes them betterpositioned to tackle tough times in the debt market as their earnings and rates will change

depending upon the resetting of the rates for the securities held. Again these schemes can beeither short term or long term schemes.

GILT SCHEMES

Gilt schemes are those schemes that invest their assets into only government securities. The giltschemes can be short term or long term schemes depending upon the composition of theportfolio of the scheme. These schemes have no credit risk, which means that there is nopossibility of the investments of the scheme turning out to be worthless because the issuer hasgone bankrupt as in this case the issuing authority is the government itself.

This does not mean that there is no risk for the investor in such schemes because there is

interest rate risk which means that in case interest rate rises there will be a fall in the value of theholdings and a consequent fall in NAV for the investors because the value of the holdings willdepend upon the conditions in the debt markets and the movements therein.

BALANCED SCHEMES

Balanced schemes are a mixture of equity and income schemes whereby they hold both equitiesand debt in their portfolio. Recently there was a change whereby in order to qualify for taxbenefits in terms of exemption from dividend distribution tax balanced schemes need to hold anaverage 65% of assets as equity. Due to this one will find the average equity holdings ofbalanced schemes rising above this level in the last few months.

These schemes are meant for those who want to earn some returns on their investment butwould like a small element of stability built into the scheme but with the new norms this will beslightly skewed in favour of equity.

FIXED MATURITY PLANS

Fixed maturity plans known as FMP are plans that are in operation for a short period of time butthey act like a quasi fixed deposit for the investors. This is because the fund manager selects the



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securities in the portfolio in such a manner that it matures on the same date as that of thescheme. This results in the situation where the investor will get a return near the yield of theinvestments when they were purchased because of reduced risk in the investment.

There is a reduced risk in this kind of an investment because of the fact that when the debtinstruments in the scheme are held till maturity the intervening movement of interest rates in themarket will not impact the investor in terms of the final returns because of the fact that the price ofthe debt instrument will converge to its face value at the time of maturity .

FUND OF FUNDS

Fund of funds is another type of scheme available in the market. This schemes invests its fundsinto another mutual fund scheme and is hence known as fund of funds. The target objective of thescheme is met through the selection of several other schemes in the portfolio with the desiredweights. Several funds invest their corpus into schemes of their own fund house while anothervariety of fund of fund schemes invest the amount into schemes from other fund houses too.


Investors need to look very closely at the composition of the assets of a scheme and how theyhave been invested. Depending upon the requirements of each individual the investment can bedirected to a specific fund. There is a need to ensure that the correct scheme is selected by theinvestor and depending upon the situation in the market the choice can be changed.

BENEFITS OF A MUTUAL FUND

Small investors can enjoy several advantages when they invest through the mutual fund route.Not all mutual fund schemes or investors can boast to give all these benefits to the investorsbut each one gives you one benefit or the other.

SMALL AMOUNTS

The biggest benefit for small investors is that they can invest using very small amounts of money.In the absence of mutual funds many of these investments would not have been possible at all.For example one can invest regularly each month into an mutual fund scheme with a sum as lowas Rs 500 or Rs 1000 each month. A similar amount would have got the investor precious little interms of actual holdings in the debt market. In case of a bond issue where the face is value is Rs10,000 they would not even be able to procure 1 bond.

If an investor has say Rs 1,000 with him then quite a few stocks would be out of reach becausetheir values are more than the sum available for investment. On the other hand they can use the

same sum to buy the available number of mutual fund units

The use of the small amounts for investment is not restricted to just the initial investment but isapplicable at all points of time, This means that at any point of time if there is some amount lyingin the account then this can be put to use whereby it will earn a higher amount of return than whatwould have been the case had it just remained in the savings account. In fact the money herecan do things which would not be possible otherwise. This means that the amounts can beutilized as pert he need both in terms of investing and withdrawal



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The use of the money in terms of withdrawing it from the scheme does not receive as muchattention as the investment part but its role is no less important. Being able to get some of yourmoney back when you need it without disturbing the other part of your entire investment is agreater benefit for investors because it ensures that their entire investment plan does not go for atoss due to some small decision on the side.

DIVERSIFICATION

Even if an investor is able to buy a few assets with the amounts available with them there is littlescope for diversification, which results in an increase in risk. Diversification in simple words isnothing but holding a large number of stocks or securities so that the entire holding is notinfluenced in the same way due to a certain event in the market. An investment in a mutual fundcan provide one with the necessary diversification even with the small amounts that one mayhave.

For example With a sum of Rs 5,000 an investor might be able to get just 1 share of Infosys, 1share of Bajaj Auto and 1 share of Tata Steel at July 2006 price levels. On the other hand thesame amount invested in a mutual fund which is diversified in nature would help the investor get

around 20-25 shares which would reduce the risk as compared to the small holdings in anindividual capacity

There are different levels of diversification that investors can make use of. The most commonone is to ensure that in a particular holding in an asset class all the investments do not bear thesame functions or features so that they will not move in a single direction based upon thehappening of certain events. However taken further the real benefit of diversification is to ensurethat your entire investment portfolio is such that there is adequate breadth as well as variety in it.

An individual can diversify across various asset classes when their portfolio increases. Thispossible with the help of a mutual fund whereby the money c an be moved to different types ofschemes both in the equity as well as the debt side. Similarly one can now also ensure that themoney is diversified between investment in various countries as there are international fundswhere one will hold equities or debt instruments of foreign countries. This gives the investor abenefit of really ensuring that his money is working well.

MANAGEMENT EXPERTISE

Most people do not have the time and resources to manage the funds on a day to day basis. Inthis sense giving the funds to a mutual fund who would the employ professionals to deal with theinvestments is like outsourcing the work t people who can do it the best. This ensures that anindividual can get the benefit of professionals at a small cost to take care of their investments.

The fund managers that are employed by mutual funds are professionals in the area ofinvestments. What is more important is that they do this job for the entire day which means thatunlike an investor who might have several things and areas to look into the job of a fund manager

is just to manage the funds in a particular scheme where they give their total attention. This isexpected to result in a better performance however this is not always the case. In that senseinvestors have to be careful while making their investments because just giving their funds to amutual fund because it ahs expert fund managers will not guarantee any results for the investor.There is a need to study the performance of the various fund managers too and then selectschemes managed by those fund managers who are good performers so that one is able tobenefit from the performance that they show in their schemes.



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CHOICE

With the development of the mutual fund industry there is a wide choice available for investorswhen they go out to invest their money. Options like debt schemes, equity schemes, monthlyincome plans, sectoral schemes are all present which means that an investor can select the

schemes in the right proportion to what they would like to achieve with the investment. They canalso select investments across asset classes and recreating the same kind of portfolio on anindividual basis along with its monitoring would be a very tough task indeed.

LIQUIDITY

There is adequate liquidity for a mutual fund investors when they want the necessary funds. Thismeans that the fund will be available to the investor when they require it would going throughlarge amounts of paperwork. This might not be the case with regular investments where it mighttake several days for one to liquidate the necessary amounts.

Using the right combination one can create the required liquidity in the mutual fund portfolio. One

of the best cases of liquidity is with respect to equity oriented schemes. In several cases withrespect to various shares it is very much possible that an investor will be unable to sell the shareson a particular days the volumes in the scrip have dried up. On the other hand when an investorputs through a sale transaction on a mutual fund then this has to be executed at the prevailing netasset value at the end of the day and the investor will receive his money. There are somerestrictions on this which is mentioned in the fine print of the offer document wherein in case thereis a major crisis the fund can restrict the redemptions however in normal market conditions thereis little to worry for the investor,

In addition the funds have developed a high quality service delivery whereby the funds areavailable to the investor in the shortest possible time. In case of several liquid schemes theinvestors also have the option of using instruments like direct cheques and even ATM cards.

CONVENIENCE

There is a lot of convenience that investors experience when they invest into mutual fundschemes. Starting with the amount of the payment to the place where the mutual fundinvestments are accepted there is an element of convenience that is built into the picture.

Assume a case where an investor wants to invest a fixed sum regularly each month into ascheme. Here they can make use of a systematic investment plan in order to ensure that there isa regular investment going in without much of a problem. On the other hand consider thesituation where an investor has landed up with a large sum of money right now and would like toinvest this but in a regular manner over the next one year. Mutual funds have the right options toensure that even this can be done through the use of a systematic transfer plan where the moneywill lie in a debt mutual fund so there is a small appreciation in the value here and at the sametime there is a transfer each month to the intended account of the investor.

Take one other case where the investor would like to say 20% returns and then take his moneyhome. Even this is possible as the mutual funds have a trigger limit option whereby when theinvestment reaches a certain level a specified action will take place in the fund. This means thateven the selling decision can be taken care of by the fund with the investor having little to do

TAX BENEFIT



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There are a host of tax benefits that an investor can earn with the help of mutual funds. Firstdividends are tax free in respect of all mutual funds while in case of equity oriented funds eventhe long term capital gains earned will be tax free in the hands of the investor. This means thatthe investment can be quite tax efficient with quite a bit of the payout free from the tax clutches ofthe investors. In case of equity oriented schemes there is no dividend distribution tax and hence

the investors benefit indirectly too and this is another tax benefit for them. While directinvestments into assets would also qualify for several of these benefits mutual funds are notworse of than elsewhere.


Investors have to match their needs with the specific benefits that are provided by mutual funds. Ithas to be noted that not all schemes will provide all the benefits and hence while making aninvestment one has to carefully look at the benefits and whether they match the requirement. Thiswill ensure that there is a better choice made by the investor and they are able to get themaximum advantage of the various schemes.

SIMILARITY WITH VARIOUS ASSET CLASSES

A mutual fund holds assets as part of its portfolio and this determines the performance of thescheme. The question that most people ask is how is a mutual fund different or similar to assetsthat it holds

One basic factor that investors have to consider is that the performance of the asset and themutual fund investing in the asset will move in a similar direction. Thus if there is a bond fundand the prices of bonds fall then the value of the bond fund will also decline. Similar is the casewith equity shares and equity oriented funds.

This means that a mutual fund cannot be divorced from the overall movement in the asset class

into which it is invested. Thus one should not expect miracles from mutual funds but the betterperforming mutual fund will be one which rises faster when the market is going up and at thesame time falls slower than the fall in the market. This is the way in which the performance of thefund will have to be considered rather than just look at the absolute figure.

One should look only at asset classes that are of the similar type rather than looking at differentasset classes. This means that if you are holding a debt oriented mutual fund then you cannotcompare its performance to that of equities because here you will end up comparing two entirelydifferent things. Once this difference is realized one can comfortably look at the various mutualfunds and how they have performed

While one would expect similar movement between a fund and its underlying assets there will besome difference in t he way the movement takes place. For example incase of equities the pricemay shoot up 20% in a day while in case of a mutual fund this will not happen unless the value of

he entire assets of the fund rise by a similar percent.

Similarly in case of a daily purchase of shares by an invest to these are made in the market andhere the shares are bought from another investor however in case of a mutual fund the units in anopen ended scheme are bought and sold to the fund itself and hence the total units outstandingwill keep changing every day. In that sense the most important thing to consider in case of amutual fund is its NAV rather than several other figures that one would normally look at.



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Having realistic expectations is a very important part of the mutual fund investment process and itis necessary that investors are on the right footing on this scale. In that respect having a clearidea about the workings of the mutual funds and how they stand up to an investment directly into

an asset class will help in removing incorrect notions about the investment.

TERMS USED IN MUTUAL FUND INVESTING

There are several terms and jargons that are commonly used in the mutual fund industry. Aninvestor will come across most or all of them while investing. Hence, it becomes important toknow what these terms actually mean.

LOADS

Loads are an extra charge that investors pay to the mutual fund. This is an additional expense for

the investor. Loads are of two kinds - entry loads and exit loads. Mutual funds can charge eitherof these loads or even both of these loads so one has to check about the features of a particularscheme as the type of loads as well as the amount of load differ from scheme to scheme. A loadis usually calculated as a percentage of the NAV.

An entry load is the load that is paid by the investor when they buy units in a mutual fund. Thecost for the investor will rise to the extent of the load and they will get a lower number of unitsthan what would have been available had there been no entry load. For example if there is anentry load of 2% in a scheme then an investors who goes out to buy units of the fund when theNAV is Rs 10 will get it at a cost of Rs 10.2.

An exit load is the load that is charged to investors when they withdraw money from a scheme.Here the investors get a price lower than the NAV applicable on the particular date. For example

when an investors goes to sell units in a scheme with an exit load of 2% when the NAV is Rs 20then the investor will get a sale value of Rs 19.6 per unit.

In both the cases these represent an extra charge that is paid by the investors when they make abuy or sell decision in the units of the fund. In this entire process two more terms come into thepicture. The first is the repurchase price which is the price paid by the fund to the investor when itbuys units from them. The other term is the sale price, which is the price at which the fund sellsthe units to the investor

SCHEME OPTIONS

After selecting a particular mutual fund and a specific scheme there is still some more work to be

done by the investor because they have to select the options available to them within a scheme.There are three such options available and these are the dividend payout, dividend reinvestmentand the growth option

In the dividend payout option the dividend declared by the scheme is paid out in cash to theinvestor. Investors have to be careful and select this as the option when they want the actualpayment to be received in cash. One has to note that the dividend declaration is always on theface value of the units and not on the current value. Thus if the NAV of a scheme is Rs 55 andthe fund declared a 60% dividend then the dividend declared is Rs 6 per unit because the



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percentage figure is considered on the face value of Rs 10 and not the current NAV of thescheme.

The dividend reinvestment option is one where the dividend declared by the scheme is thenpoured down back into the scheme at the applicable NAV. In reality what happens is that theinvestor first receives the dividend on paper and then the same figure is converted into additionalunits. An investor might earn Rs 6.000 as dividend but that is not received in cash but will beconverted into additional units. Many investors select the dividend option but tick the dividendreinvestment part resulting in no payout coming to them.

The growth option is one where the gains of the scheme are added on to the NAV of the schemeand no payout is received. This means that the value of the NAV keeps on increasing without anyintervention from the fund. If there is a scheme that has grown consistently over the years then itwill be witnessed that the NAV has also gone quite high while in the dividend option this will keepreducing as and when the dividend is paid.

EXPENSE RATIO

There are various expenses that are incurred by the mutual fund in respect to its operations.There are two expense ratios that one will read about. The first is the initial issue expense ratiowhich is the expense incurred at the time of a new fund offering. The other is the expense ratiothat is witnessed during the normal operation of the scheme.

There are limits prescribed for various expenses. According to the regulations issued by theSecurities and Exchange Board of India (SEBI) the total initial expenses shall not exceed 6% ofthe initial resources raised under a close ended scheme and any excess over this figure will haveto be borne by the asset management company (AMC). There has been a recent change to theprovisions of the charging of the initial issue expenses for an open ended scheme and therecannot be any initial issue expenses over and above the entry load on the scheme.The initialissue expenses will include advertising expenses, agent commission, registrar expenses,marketing expenses, bankers fees, legal fees, printing and distribution expenses etc.

There is a bit of calculation involved in terms of the maximum recurring expenses permitted bySEBI as it depends upon the assets under management. The list of such expenses includeinvestment management and advisory fees, trustee fees, custodian fees, marketing and sellingexpenses, registrar and transfer agent fees, audit fees, communication costs, cost of providingaccount statements, dividend, redemption warrants, cost of statutory advertisement and otherexpenses.

Investors need to watch this final figure as this will be the one that will affect them because theirearnings, which are linked to the NAV will be the net figure after the scheme has charged off theexpense made. While a better performing scheme might have some higher expense one has tolook carefully at the total expense figure and how they shape up over a period of time.

NET ASSET VALUE (NAV)The net asset value more popularly known as the NAV is the most important thing for the investorin a mutual fund because all purchases and sales that they make is related to this figure. TheNAV will determine the gains or losses that they will make on the investment. Consider the NAVas being similar to the price of a share as both of them play the same role of determining thevalue of the investment.



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There are however big differences between the NAV and the price of an equity share. The firstone is that the NAV depends upon the value of the assets being held by the scheme. Thus thevalue of the NAV can rise only when the value of the underlying holdings go up. In this case meredemand and supply can have no impact on the NAV of the scheme.

The price of a share on the other hand can be affected by demand and supply even when otherfundamental factors are constant. Thus one might see a sharp spike in the price of a share evenwhen there is no other movement all around. This will not happen in a NAV and hence investorwho mistakes a mutual fund for a share will learn it the hard way that NAV does not just double ortriple based on demand for the fund. However if there is large scale churning by short terminvestors then this can work to the detriment of long term investors not because NAV willsuddenly become half but because the long term investors end up bearing a larger part of thecost.

The NAV is the value of all the investments in the scheme plus the current assets of the schemeless the current liabilities of the scheme. This entire figure is then divided by the number of unitsoutstanding in the scheme to get the NAV per unit. This shows the value of each unit of thescheme and it is used for the purpose of buying and selling units by the fund

An important thing is the value of the NAV at a particular point of time does not matter. All that

matters is the future growth potential in the scheme, which is based on the change in the value ofthe assets held by the scheme. Thus for example a Rs 10 NAV if it rises by 20% will go to Rs 12while the same portfolio held by a scheme with a NAV of Rs 30 will go to Rs 36. In that sense ifthere is a decision regarding the purchase of a unit in either of the schemes then the actual NAVdoes not matter but only the growth there does.

The NAV of the scheme is usually calculated as follows

NAV (Rs) = Market or fair value of schemes Investments + Current assets CurrentLiabilities and provisions

-------------------------------------------------------------------------------------Number of units outstanding under the scheme

NEW FUND OFFER (NFO)

A new fund offer is a new scheme launched by a mutual fund. It is called a NFO to differentiate itfrom the IPO of a stock because there was large confusion among investors who were being soldnew units of mutual fund schemes like a new share offering.

As can be seen by the meaning of the NAV of the scheme there is no way that a NFO will open atdouble or triple the value of the offer price because the assets of the scheme will have not grownin value by the same extent during the period from which the new offer closed and the schemethen reopened for investment.

There is a difference also within the way in which a new offering has to be evaluated because

there cannot be under pricing or overpricing of the issue which can be the case with a shareoffering and hence one has to be careful in the way in which one is able to evaluate theseofferings that are available for the investor. In such offers unlike other mutual fund schemes thereis also no track record to measure the past performance of the scheme.

SYSTEMATIC INVESTMENT PLAN (SIP)



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Systematic Investment Plan is often called SIP and this is a method of investing used by mutualfund investors. In this method there is an investment of a fixed sum on the same day of eachmonth for a period of say 6 months or 1 year by an investor. This ensures that there is a regularinvestment each month and the idea is to ensure that the highs and lows are averaged out so thatthe investor is able to get an average price for the units.

The way a SIP plan works is that the investor has to decide on two factors when the decision ismade. The first is the amount of investment that one would like to make and this could besomething as low as Rs 1,000 or even higher like Rs 10,000 as this can be selected dependingupon the profile of the investment and the extent of funds that are to be invested. The next thingsto decide is the period of the investment and this will be 6 months or a year, which will enable theactual benefits for the investor to flow in.

The benefit for the investor is that when the prices are high there are a few units that are allottedto him but when the prices drop the same amount of money will ensure that there is automaticallya higher allocation of units. This ensures that the investor is able to gain in terms of higherallocation when the price is low. This will also ensure that the investor does not face the risk ofthe one time investment that would be present had the entire investment be made in a lumpsumat a single time point.

SYSTEMATIC TRANSFER PLAN (STP)

Systematic transfer plan is a variant of the SIP that has been explained above. In a SIP theinvestor makes a direct investment into a scheme on a regular basis. On the other hand in STPthere is a regular transfer of money into a particular scheme but this is a transfer from an existingscheme by an investor.

This is useful for any investor who has funds at his disposal and they still do not want to investthe whole amount at one go. What can be done in such a situation is that the funds are firsttransferred to a debt oriented scheme and from that scheme there is a movement each monthamounting to a specific sum into an equity oriented scheme. This will ensure that two objectivesof the investor are met. The first is that the funds of the investor are not lying vacant and earning

a low rate of return but they will be earning a slightly higher figure in the debt scheme and at thesame time there is the benefit of the systematic investment that is available because the money istransferred each month.


There are various terms that are used in the investment process and knowing these help in betterunderstanding as well as during actual use of the facilities provided by mutual funds. SIP andSTP can prove to be a very useful route of investing plus the loads and the NAV will impact thereturns for the investors. Keeping a close watch on all these terms will help in the investmentprocess being a smooth affair.

REGULATORY FRAMEWORK FOR WORKING OFMUTUAL FUNDS

Every action of the mutual fund is governed by the various regulations laid down by SEBI andthere is a need for mutual funds to follow these guidelines so that investors get the best servicesalong with a fair treatment with respect to their investments. All of the regulations are not relevantfor the lay investor and here we shall look at some of them that would be relevant and useful for



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them in their daily investment process. It is also to be noted that these can change anytime andone has to be alert for some of the changes are taking place on a regular basis.

FORMATION

One of the main regulations relate to the formation of a mutual fund. There are three entitiespresent as far as the functioning of the mutual fund is concerned. The first link in the entire mutualfund setup is the presence of a sponsor. The sponsor is expected to have a sound track recordalong with a general reputation of fairness and integrity in all business transactions. This includesthe requirement of carrying on business in financial services for a specified period of time. Inaddition there are also financial parameters relating to the net worth of the sponsor and its profitsthat are calculated after various adjustments as suggested by the guidelines. The whole ideabehind the entire exercise both in terms of business reputation as well as financial parameters isthat the sponsor should be sound enough so the mutual fund is backed by the right kind ofpeople.

As one goes down to the other conditions of the setting up of the mutual fund there is the actualmutual fund, which has to be in the form of a trust with a trust deed. Thus there has to be a boardof trustees who will acts as trustees of the mutual fund. The instrument of trust shall be in theform of a trust deed, duly registered under the provisions of the Indian Registration Act.

The trustees who have been appointed for the mutual fund have to be people of standing, abilityas well as integrity. Similarly there is a condition that an asset management company or itsofficers or employees will not be eligible to act as the trustees of the mutual fund. There is also arequirement for certain proportion of the trustees to be independent persons and who are notassociated with the sponsors in many manner. The reason behind such a move is to ensure thatthere is a clear separation between the management and the administration of the mutual fund.

After this is the process of management of the funds and for this there will be an assetmanagement company and the trustees and the asset management company will enter into aninvestment management agreement. The asset management company has to manage themutual fund schemes independently and take several other steps to ensure that the interest of

the investors of one of the scheme is not being compromised in any manner whatsoever. It is theresponsibility of the trustees to keep a check on the various activities of the asset managementcompany and to see that everything is in order and is being carried out in accordance with theguidelines for mutual funds.

The asset management companies too have the requirement of having a sound track record,general reputation and fairness in transactions along with right qualities for the directors and keypersonnel of the company

EXPENSE LIMITS

There is also the issue of recurring expenses of a mutual fund. The limits that are prescribed for

the fund to charge various expenses state that for the first Rs 100 crore of the average weekly netassets the expense is 2.5%, for the next Rs 300 crore it is 2.25%, for the next Rs 300 crore it is2% and for the figure over that amount (Rs 700 crore) it is 1.75%. In case of a scheme investingin bonds the limit shall be lesser by at least 0.25% of the weekly average net assets. Anyexpense over and above the prescribed ceiling will be borne by the asset management company.

CHANGE IN FEATURES



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There is also a condition that no change in the fundamental attributes of any scheme or the trustor even fees and expenses or some other change which would modify the scheme and affectsthe interest of unit holders will be carried out without a written communication being sent to eachunit holder. In addition an advertisement has to be given in one English daily newspaper havingnationwide circulation and in a newspaper published in the language of the region where thehead office of the mutual fund is situated. The unit holders also have to be given an option to exitthe scheme at this stage without paying any exit load.

INVESTOR SERVICES

Whenever there is an application by an investor for units in a mutual fund scheme then the assetmanagement company shall issue to the applicant unit certificates or a statement of accountsspecifying the number of units allotted to the applicant as soon as possible but this cannot belater than six weeks from the date of closure of the initial subscription list or the date of receipt ofthe request from an investor in an open ended scheme.

While calculating the prices of the units the mutual fund shall ensure that the repurchase price isnot lower than 93% of the net asset value and the sale price is not higher than 107% of the netasset value. However the total difference between the repurchase price and the sale price of theunits shall not exceed 7% calculated on the sale price. In case of a close ended scheme therepurchase price cannot be lower than 95% of the net asset value.

There has to be a dispatch to the unitholders of the dividend warrants within 30 days of thedeclaration of dividend in the scheme. In case of redemption proceeds this has to be within 10working days from the date of redemption or repurchase.

INVESTMENTS

In terms of investments no mutual fund shall invest more than 10% of its NAV in the equity sharesor equity related instruments of any company. This limit of 10% will not be applicable for index

funds and sector or industry specific schemes. A mutual fund shall also not invest more than 5%of the NAV in the unlisted equity shares of an open ended scheme and 10% of its NAV in case ofa close ended scheme. No mutual fund shall under all its schemes own more than 10% of anycompanys paid up capital carrying voting rights.

A mutual fund shall not invest more than 15% of its NAV in debt instruments issued by a singleissuer, which are rated not below investment grade by a credit rating agency. This can beextended to 20% with the prior approval of the Board of Trustees and the board of the assetmanagement company. These limits are not applicable to government securities and moneymarket instruments. A mutual fund shall not invest more than 10% of its NAV in unrated debtinstruments issued by a single issuer and the total investments in such instruments should notexceed 25% of the NAV of the scheme. All such investments have to be made with the priorapproval of the Board of Trustees and the board of the asset management company.

In case a company has invested more than 5 % of the net asset value of a scheme, theinvestment made by that scheme or any other scheme of the mutual fund in that company or itssubsidiaries shall be brought to the notice of the trustees by the asset management company anddisclosed in the half yearly and annual accounts of the scheme with justification for suchinvestments.




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When the figures are absolute it means that this is the actual return that has been earned by theinvestor if the money had been put in the scheme at the start of the particular period. When thefigure is compounded it means that this is the annual rate of earning that grows compounded forthe number of years mentioned.

There are several other columns that could be part of the tables that comprise the figures forvarious mutual funds. A few of such columns and their meanings are covered here. One suchfigure is the standard deviation of the scheme, which is the extent to which the figure moves fromthe average of the schemes. This figures shows how volatile is the schemes performance andhigher the standard deviation witnessed the higher is the volatility in the scheme.

Another figure that is also commonly used is the beta of the scheme. The beat of the schemeshows by how much the scheme NAV moves in relation to a movement in the overall market.When the beta is positive it means that a rise in the market will be accompanied by a rise in theNAV of the scheme. A figure of 1 means that the NAV moves in exact tandem with the marketwhile a higher figure shows higher reaction and a lower figure a lower movement.

RATIOS

Sharpe ratio is a commonly used figure and this shows the risk adjusted return of a scheme. It iscalculated as the return of the scheme less the return from the risk free securities divided by thestandard deviation of the scheme. This shows the extra return being generated by the scheme forthe risk that is being taken in terms of the standard deviation or volatility in the scheme. This ratiowill help analyst to understand the reason for the return in the scheme. The idea behind looking atthe Sharpe ratio is to see whether higher or excess returns earned by a particular scheme comeswith higher return or not.

Sharpe ratio = Return of the scheme- Risk free rate of return------------------------------------------------------

Standard deviation of the scheme

There is a variation of the Sharpe ratio, which is the Sortino ratio. Here the return against only the

downward price volatility is calculated, which means that in the denominator where there is thestandard deviation figure only the figure for the downside is calculated. It measures the excessreturn to bad volatility where the volatility on the downside is considered as bad volatility. A higherratio here means that there is low chance of a large loss in the scheme.

Sortino Ratio = Return of the scheme Risk free rate of return---------------------------------------------------------

Standard deviation of the scheme on theDownside


There is certain information that are given in the financial publications and a proper interpretationwill help the investors keep track of their investments. They will be able to value theirinvestments correctly once they interpret the figures given here correctly. Even when they want toanalyse some schemes for investment using these figures in the appropriate manner will enablethem to arrive at the right investment decisions.

LOOKING THROUGH THE OFFER DOCUMENT



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The offer document is the most important part of a mutual fund scheme offering. The offerdocument is the base upon which then entire structure of a mutual fund is set up and then thescheme is run according to it. There cannot be anything or any activity outside of the offerdocument that can be undertaken by a mutual fund. The offer document lays down the whole listof things that the fund will undertake and has all the details necessary for the investor to make adecision regarding the purchase of units in the scheme. In effect every investor is supposed toread the offer document before making an investment in the scheme but hardly anyone evenrefers to the offer document.

The offer document will on the whole contain the following things. Some funds might show them abit separately but these are the things that one will see in most of the fund offerings in one way orthe other.

HIGHLIGHTS

This is the opening part of the offer document where the entire details of the scheme arementioned upfront so that by a quick glance the investor can get some details of the scheme. Inmost cases this will include the details about the mutual fund so that investors are able to gothrough the history of the fund and its track record. Then there are details about the scheme,where it will invest, what will be the liquidity in the scheme along with the load structure and thetaxation issues. It is also likely that investors will be informed that they are not being offered anyguaranteed or assured returns as these are prohibited under the regulations.

DEFINITION

This section contains the definitions of the various terms that will be used in the offer documentwhich can include terms like NAV, registrar, Custodian and even terms like dividend, units, wherethe meaning of these terms are explained

RISK FACTORS

This is one of the most important parts of the offer documents because it entails what are therisks involved in the scheme. Reading through this will give the investors a clear idea about how adownside can come about in the fund that will affect their investment. Some of the risk factors arestandard risk factors, which means that these will be present for most schemes. The ones herewould include something like the point that the NAV of the scheme can go up or down dependingupon the performance of the scheme. Similarly the point that past performance is no guarantee ofthe future will be highlighted here along with some other ones, which could include one that saysthat the name of the scheme does not indicate the quality of the scheme or its future prospects orreturns. Many investors make these mistakes but they are clearly warned against this in the offerdocument itself.

Then there are scheme specific risk factors, which arise due to the fact that the nature of the

scheme will give rise to the risk. Thus it will be different when it is an equity scheme and when itis a debt scheme like a gilt scheme. Even within the equity scheme category there will be differentrisks for a diversified equity fund and even a sectoral scheme. In addition to all this there can bean additional head of special considerations which are additional risks that will be arising onaccount of the reason that there might be derivative products used in the scheme or evenbecause of securities lending that is used for the purpose of carrying on t he investments in thescheme,

SCHEME SUMMARY



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The scheme summary has various details that will be useful for the individual investor. This willinclude the structure of the fund plus the offer price that will be applicable for the investor both atthe time of the initial offer as well as subsequent purchase and sale of units. The investmentobjective of the scheme will be explained and the various options for investors also listed out. Theminimum and maximum application amounts will help the investor in knowing the figures in which

investments have to be made both at the time of the initial offer and the subsequent purchaseand sale. Initial issue expenses along with the load and the liquidity aspect will also be mentionedhere.

FUND DETAILS

There will be an entire section that is devoted to the various details of the fund that for investorswould be of academic interest but is still worth knowing. The constitution of the mutual fund willbe mentioned along with the sponsor of the fund, the details about the board of trustees, thetrusteeship fees and the substantive provisions of the Trust deed. Then comes the part of theinvestment manager of the funds and the board of directors of the asset management company,the powers and duties of the AMC and the asset management fees. Once this is known it is time

to get a little more specific which is in terms of the key employees of the AMC and their relatedexperience and the fund manager for the scheme. The rest of the details will be about thecustodian, registrar and transfer agents, fund accountant, auditors and the collecting bankers.

INVESTMENT DETAILS

The next section or part of the offer document will be based on the investment of the scheme.This will start with the investment objectives and polices of the scheme, which consists of thefundamental attributes of the scheme. This covers the type of scheme along with investmentobjective and the investment pattern. The investment pattern and the ability to change this patternwill determine the way in which the funds of the scheme are invested. This will mean that theallocation across various asset classes permitted by the scheme will be given. There will also be

a mention as to when the investment pattern of the scheme can be changed.

Another important point that one has to look out for in the details is the time after which theportfolio of the scheme will be disclosed in full to the investors and the liquidity that the fund willhave for the investors to sell their units and convert their investment into cash. There will also bea part about the fees and expenses of the scheme where there will be details about the initialexpenses and also the recurring expenses. These areas will mention the upper limit for theexpenses and the actual will be known only later but it cannot exceed this figure.

There will also be a clear outline about the investment approach of the fund manager and the wayin which they propose to control the risks in the scheme. The procedure that will be followed forthe investment decisions will be listed and there will be a mention of the portfolio turnover. In casethere are any changes to the fundamental attributes to the scheme it will be detailed as to how

this will be possible. The valuation parameters used for various types of investment in thescheme will also be mentioned along with the way in which the NAV of the scheme is calculated.

There are two other important areas that cannot be missed out because this determines the wayin which the NAV is reflected. The first is the accounting policies and standards that are followedby the scheme. These have to be clearly laid down which will be followed under all cases andthere will also be a note of the guidelines for the identification and the provisioning for non-performing assets in the scheme



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THE INVESTOR SECTION

There is another section, which is the most useful area for investors as it deals with details thatthey are interested in. One has to note that several things in the entire offer document will be

repeated and hence that should not be taken as a surprise. In this sector there will be generalinformation on the units and the initial offer. The initial offer period and the initial offer price will beclearly laid out and details about the extension of the initial offer period and the minimum amountof subscription for the scheme.

For investors the minimum amount that they have to pay on application and the allotment andrefund guidelines will be given. The option for the investors to choose from will be listed and thenthose who can invest in the scheme will be specified. The process of application will be laid outalong with details of the switch, sale and repurchase of units on an ongoing basis. The detailsabout the account statements will be given and the position of joint applications laid down. Thenthere will be additional information on transfer and transmission of units, folio details, fractionalunits and the right of the scheme to limit redemptions. Further suspension of sale or switch ofunits conditions will also be mentioned along with the position for NRI/OBC and FII investments in

the scheme.

EXPENSES

This part covers the load structure and the recurring expenses of the scheme. First the loadscharged along with the maximum amounts of the loads that can be charged by the scheme aregiven. This is accompanies by the expected initial issue expenses and the recurring expenses ofthe scheme. There will also be exhaustive details of condensed financial information about theschemes already launched by the fund

UNIT HOLDERS RIGHTS

There are several services that are offered to the unit holders for their ease of operations. Thiswill relate to the areas of account statements and even receiving various communications fromthe fund in the form of emails. It will also be mentioned as to where the NAV of the scheme canbe contained and at what time. Further mutual funds now allow online access of the holdings ofthe investor and for this the personal identification number and the login and password details asto how these are to be obtained will be mentioned. The rights of the unit holders of the schemewill be laid out along with the point as to how the scheme can be wound up and the procedurethat has to be followed for winding up.

There is another area where investors will be very interested and this is about the tax effect onthe scheme. Here the various tax benefits that are available to the investors will be explained in

detail under their various heads

OTHER ITEMS

There is one final area where a lot of miscellaneous details can be found. The mechanism for theredressal of the grievances of the unit holders will be mentioned along with the mention ofdifferent information. This will include stuff like the position of the investor complaints received bythe fund and the associate transactions that have taken place with the various entities within thefund. Further details about dealings with associate companies will be given and so will the



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disclosure about the investments made by the schemes of the fund in companies or theirsubsidiaries that have invested more than a specified figure of the net assets of any scheme.

Details about dividends and their distribution along with the pending litigations, borrowing by themutual fund and inter scheme transfers will be present. Further there will be a list of documentsthat will be available for inspection that will be given


The offer document is the place where one can know everything about the scheme that they areinvesting in. Very few people take the time to ask and read the offer document but this can giveanswer to all the procedural questions for investors. Going through the various details will enablethem to know several processes and even the way in which their fund will operate.

TAXATION OF MUTUAL FUND INVESTMENTS

There are different tax implications for investors when they invest their funds into mutual fundschemes. This depends upon their status, the type of scheme that they have invested in and thenature of the gain that they have earned. These are not very complicated and a lay investor cancheck out the kind of tax liability that they will encounter. Here we shall take a look at all thefactors that come into play while looking at the tax implications for investors.

DIFFERENT TYPES OF SITUATIONS WHERE TAX HASTO BE PAID

The first question before an investor is to check out what is the benefit that they have receivedand then classify this benefit under the appropriate head due to which the necessary tax effectwill be given. In effect one can say that there are two main types of gains that comes from mutual

funds for investors.

The first is the dividend received from the mutual fund. As far as the dividend is concerned thereare two options that one can choose in receiving the dividends. The first is the dividend payoutoption where the dividend is actually received by the investor either through a cheque or a directcredit into their bank account. In this case the situation is very clear, as the payout will beclassified as dividend for the purpose of taxation. The second is the dividend reinvestment optionwhere the dividend is not received in cash but is converted into additional units in the scheme. Inthis option too it is considered that the investor has first received the dividend when the figure isannounced and after that there is further purchase of units from the money. The effect that isgiven here will consider the amount of dividend reinvested as the dividend received for thepurpose of tax.

The second benefit that investors get from mutual fund schemes is that of a capital gain or whenthere is a loss a capital loss. This happens when the sale price of the units is more than the costprice at which the units were bought. There are two types of capital gains. When the units of thescheme are held for a period of not more than 12 months then the gains that arise form the saleare classified as short term capital gains and the appropriate tax is levied. On the other handwhen the units are held for a period of more than 12 months then the gains are classified as longterm capital gains. In a growth option selected by the investor the gains will be capital gains dueto the difference in the cost price on purchase and the sale price. In case of the dividend optionswhile there will be income from dividends there can also be capital gains in the picture because



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scheme do not always pay out the entire sum that it gains as dividend as there is also an additionto the NAV of the scheme.

EQUITY ORIENTED SCHEME

The gains that arise for the investor shave to be seen with respect to the different types ofschemes that are present in the market. The first question is which schemes would be classifiedas equity oriented schemes. As per the latest modified definition any scheme that has more than65% of its assets invested in equities of domestic companies will be considered as equityoriented schemes. This means that even balanced scheme with this percentage of assets inequities would be classified under this head.

As far as dividends from equity oriented schemes are concerned there is no tax to be paid by theinvestor on the amount received hence the entire amount that is received by the investor in theirhands will be completely tax free. The good news for the investors is that no dividend distributiontax will be charged on the equity oriented schemes whenever dividend is declared.

For example consider an investor who holds 900 units in equity oriented schemes whose facevalue is Rs 10 per unit and the NAV of the dividend option is Rs 45 per unit. If this schemedeclares a 50% dividend then the dividend to be paid to the investor will be Rs 5 per unit, whichcomes to Rs 4,500 and this amount, will be tax free in their hands. Further there is no dividenddistribution tax to be paid by the scheme too.

When it comes to capital gains too there is a favourable treatment for equity oriented funds.There is however the securities transaction tax payable only at the time of the sale of equityoriented funds. The long term capital gains on such schemes that have paid the STT will be zerowhile the short term capital gains on such scheme will be at 10%.

For example consider a purchase made by an investor in an equity oriented scheme on January1, 2005 of 1,000 units at Rs 12 per unit. If he sells the units on March 20, 2006 at Rs 15 per unit(after STT) then there is a gain of Rs 3,000 for the investor as long term capital gain. There willbe STT paid at the time of the sale but the gain will not be liable for tax. If the same investmenthad been sold at Rs 15 in September 2005 then the gains would have been short term capitalgains and a payment of 10% plus surcharge plus cess would be required from the investor.

The key point for a scheme to be classified as equity oriented is the 65% holding and hence onewill witness that even balanced funds are trying to ensure that their offer documents are in tunewith these guidelines so that they are able to get the tax benefit of the equity oriented schemesresulting in a lower tax outgo for the investors.

DEBT ORIENTED SCHEMES

The tax structure for investors in debt oriented schemes is slightly different and hence one has to

pay close attention to the various types of gains or losses that have originated in such schemes.

As far as the dividends from debt oriented schemes are concerned the investor does not have topay any tax on the dividend that is received by them. However there is an indirect expense for theinvestor in the form of dividend distribution tax that is present on such schemes, Here there aretwo rates for dividend distribution tax depending upon the category of the investor who isreceiving the dividend payout. For investors who are individuals and Hindu undivided families thetax payout is 12.5% plus surcharge plus cess while the figure for categories other than these two



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the rate is 20% plus surcharge plus cess. Thus individuals will witness an indirect effect becausethe tax will be charged off to the net asset values of the fund.

When a dividend is declared in a debt fund there are two figures that are being talked about. Thefirst is the gross dividend and the second is the net dividend. The net dividend is the importantfigure for the investor to consider because this is the payout that they will receive from the fund.So when an investor holds 2,000 units in a debt fund and the fund comes out with a net dividendof Rs 0.5 per unit then the actual payout that will be received by the investor will be Rs 1000. Thisfigure is entirely tax free in the hands of the investor.

Then there are capital gains that would arise from the investment in such schemes. Here wherethere is a short term capital gains the figure of the gain will be added to the income of theindividual and then taxed at the applicable rates. This means that the tax rate figure could jump toas high as 30% as several investors will fall into that particular tax bracket.

Consider the case where an investor bought 3,000 units in a debt oriented fund in April 2005 andthen sold it in August at a gain of Re 1 per unit. In this case the short term capital gains is Rs3,000 for the investor. This sum will be added to the income of the individual in the normal coursewhich means that if the taxable income of the person making the gain is say Rs 3.2 lakh then thiswill be added to the income and the applicable rate here is 30% plus cess when the tax

calculation is made.

On the other hand where there is long term capital gains there is a choice for the investor to makein terms of the rate of the tax that they will pay. The investor can either pay 10% tax withouttaking the benefit of indexation or pay 20% after taking the benefit of indexation. The benefit ofindexation is the method where by the investor raises the cost of the purchase of the investmentdepending upon the year in which the purchase is made and the year in which the sale is made.There is a cost inflation index that is announced each year by the tax authorities and this is thenused for the purpose of raising the cost so that that investor has a lower burden to pay as tax.There is no securities transaction tax in the case of debt oriented schemes.

Take an example of a long term capital gains where an investor has bought 1,000 units inJanuary 2003 at Rs 12 per unit. This was later sold in January 2005 at Rs 14 per unit. In terms of

the calculation here two options have to be considered. The first is 10% of the gain, which is Rs204 ( 10% of Rs 2,000 plus cess). The second figure is the gain after applying the cost inflationindex which comes to Rs 227 ( Cost price Rs 12.88 after indexation plus cess). The investor canchoose the lower of the two and pay the required tax that is beneficial to him.


Taxation is a very significant factor that will determine the final return coming to an investor. Butchoosing options that reduce their tax liability as well as meet their investment goals can ensurethat the investors end up with a higher return and this can add up to quite a significant sum over along time period. Some of the provisions are a bit complicated and hence a bit of care in thecalculations are very helpful.

SELECTING A MUTUAL FUND

There are various factors that one has to consider while selecting a particular mutual fund forinvestment. Before one looks at specific factors there has to be a clear distinction between thetype of funds that are present in the market. The overall funds have to be separated in equityfunds, debt funds, balanced funds, monthly income schemes or other funds that could be realestate funds or gold funds or some other funds that are newly introduced in the market . Within



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each of the categories there has to be selection of the relevant factors but here we shall considersome of the features that are important for investors under the areas of debt and equity.

TRACK RECORD OF THE FUND

The fund manager and the way that he manages the fund play a very important role in theoverall selection of debt-oriented mutual fund schemes. A lot of active management has to beundertaken in respect of debt schemes where the position for the individual matters quite a loteven when the difference might not seem to be very large. A good fund manager can ensurethat the right decisions are taken generating returns for the fund.

The various qualities and parameters used while judging the fund manager will have to beclearly defined and then considered carefully so that the exact ability of the fund manager isevaluated and this is differentiated from market conditions. In this case, the difference in thereturns can be quite small as compared to the equity side and hence this kind of careful studyis required.

TRACK RECORD OF THE FUND MANAGER

The fund manager is a very important component of the whole investment process. Even thoughthere might be the necessary systems in place in a particular fund house the ultimate buy and selldecisions have to be taken by the fund manager. In this respect the track record of the fundmanager and how they have performed through good as well as bad times need to beconsidered. What is also important is the element of continuity of the fund manager especiallywith the scheme under management. If there are fund managers who keep moving betweenfunds then it would be very difficult to judge the performance of the fund manager.

INVESTOR NEEDS AND SCHEME TYPES

The needs of the investors have to be considered paramount because they will set the base onwhich the entire investment is based. Once the needs of the investor are clear one has to seewhether the investment in that particular scheme fulfils the need of the investors. For example ifthere is an investor who wants to take risk that is higher than that of the market then evensectoral schemes might turn out to be a good investment option for the individual

Due to the differing needs of investors there are no schemes that are good or bad or relevant orirrelevant because they might be useful for someone while completely unsuitable for severalothers. Thus the final suitability will have to be considered in relation to the needs of the investor.

SOME SPECIAL FEATURE

These days there are similar funds belonging to different fund houses and hence making aselection for a particular scheme becomes a very important factor. The scheme that an investor is

putting their money into should have something that is different from the other options around sothat it has its own place in the investment plan. This means that the scheme should have adistinguishing character that will set it out and make the investment a must.

If the features of a newly launched scheme are completely same as that of schemes thatalready exist in the market then the investor should go towards the existing schemes because atleast there is a track record that one can look at and then make their investment decision. Thenew feature is something that will add to the overall portfolio of the investor and hence should bepresent there through a mutual fund investment.



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The fund manager and the way that he manages the fund plays a very important role in theoverall selection of debt oriented mutual fund schemes. A lot of active management has to beundertaken in respect of debt schemes where the position for the individual matters quite a loteven when the difference might not seem to be very large. A good fund manager can ensure thatthe right amount of decisions are taken generating returns for the fund

The various qualities and parameters used while judging the fund manager will have to be clearlydefined and then considered carefully so that the exact ability of the fund manager is evaluatedand this is differentiated from market conditions. In this case the difference in the returns can bequite small as compared to the equity side and hence this kind of careful study is required.

SIZE OF THE FUND

Take a very careful look at the size of debt funds because this can make a huge difference to theway in which they are managed. The lot size for putting through a transaction in the debt marketis quite huge and due to this fund with small corpus find themselves on the fringe with thesebeing unable to even gather a diversified portfolio. On the other hand the corpus can also balloonto thousands of crores and even this can be a very tough thing to manage and hence both theseextremes should be considered as factors by investors before they make an investment decisionwith regard to the fund.

When one can match the size of the fund along with the returns and its performance duringvarious phases then the relation between the size and the performance for a specific fund willbecome quite evident and then this can be used as a factor to decide upon the investment in ascheme.

TENURE AND COMPOSITION OF THE PORTFOLIO

There is a very simple rule as far as debt instruments are concerned which is that the longer thetime period of the security to maturity then greater is the impact on the performance of the fundfor a given change in the interest rates. Most fund manager use this as a tool to take variouspositions in the debt market. This feature of the portfolio will also tell you about the risk in theportfolio and the kind of return expected from it

For investors the lessons on t his point are quite clear. The composition of the portfolio in terms ofthe assets purchased as well as the maturity profile will give an idea about the risk and the kind ofexpected return from the portfolio. Thus long term schemes can generate high returns when theinterest rates are falling but when the rates are on the rise the negative impact can also be quitehigh for the scheme. On the other hand if one wants top play safe then short term schemes andportfolios would be the ideal choice for investors looking to put money in to a fund.

LOADS

Entry and exit loads are a common part of mutual fund investing and they are quite significantwhen it comes to equity oriented schemes. In many cases compared to he return that equityschemes generate the load becomes a small part of the investors gain. The situation changeswhen it comes to debt oriented funds. The best option here is of no loads in these schemesbecause with the overall returns already being quite low the loads can eat away a significantchunk of the total returns of the scheme.

Most schemes have no entry loads but several of them have an exit load if the investment iswithdrawn before a specific period of time. The danger here is that such an exit load can



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completely disrupt the entire calculation of the investor because of the fact that the overall returnshere are not very high and hence even a one percentage figure can make a huge difference tothe overall returns of the fund.

HOW CAN THE INVESTOR USE THIS INFORMATION?

Investors can use a combination of these factors for the purpose of selecting a particular scheme.These factors are not useful for determining whether an investment is required in a particularasset class but will help in selecting a specific scheme for investment. There might be someadditional factors that could be useful for the investor and these have to be taken intoconsideration.

DEVELOPMENT IN THE MUTUAL FUND INDUSTRY INTHE COUNTRY

There have been a lot of changes in the mutual fund industry in the country in the last few years.The industry has gone from being one dominated by debt funds to having more of a balance ofdebt and equity schemes and at the same time there has also been a change in the fund rankingsin terms of the assets under management as several funds have managed to acquire largeassets through new launches as well as inflows in to existing schemes.

In the initial period of the mutual fund industry in India, which started in the sixties there was oneentity, which dominated the entire sector and this was the Unit Trust of India. The term UTI wasused interchangeably with mutual funds as investors thought of it as a safe and secure option topark their funds into. The next wave of action saw the entry of the mutual fund arms of severalpublic sector banks like Bank of Baroda MF, Canbank MF, IndBank MF etc. They were followedin the nineties by the private sector mutual fund players and this is when the industry startedwitnessing a major change in all aspects of its operation.

In the last few years quite a few of these old things have changed in the mutual fund industry inthe country as several other players have established themselves and grown in size. The crisisthat hit UTI in terms of the US 64 issue as the well as the high assured returns for several otherschemes led to the restructuring of the institution wherein assets of the US 64 scheme and otherassured return schemes went to the undertaking called UTI 1 while the other schemes fell underUTI 2, which was called UTI Mutual fund. Even after this break up the fund had the largest assetsunder management for a few years till recently when private sector Prudential ICICI MF hasmanaged to edge ahead in some months.

At the same time various public sector bank arms that went into the mutual fund arena except fora few have failed to emerge as very big players in the competitive space while the private sectorfunds have established their position of preeminence in the mutual funds industry.

The biggest transformation however has come in the last few years and this has been on accountof the change in the composition of the assets under management of the various mutual funds.Till around three years ago the biggest type of schemes with assets under management wereincome schemes and this along with liquid schemes and other debt schemes comprised ofaround 80% of the total assets of the industry. This meant that just a small part of the industrycomprised of equity assets.

As the fall in the interest rates in the economy stopped the investor interest in income funds alsobegan to dry up and the consequence of this was that investors began shifting their money to



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different class of schemes. In the immediate aftermath of the change in the overall scenario thefunds first went towards liquid schemes and this category became the one with the largest assetsunder management in the industry but the prominence of debt oriented schemes in the overallindustry remained.

Beginning 2003 the continuous run in the equity markets changed the entire scenario for theindustry. For the first two years investors were still cautious as there was widespread doubts as towhether the gains will sustained whether the investor will be able to gain from the investments. Inthe last one year however there has been extreme optimism by investors towards equity-orientedschemes whereby thousands of crores has flowed into equity schemes.

There are two different ways in which one has to evaluate the whole situation. The first is the netinflow into equity-oriented schemes whereby investors make purchases into existing equityoriented schemes less the redemptions from the scheme and there i

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