In the recent times you may have seen a number of advertisements on social media and television regarding a campaign called “mutual fund sahi hai”. This article is targeted to let you know about the basics of mutual funds, the legal structure of mutual funds, the types of schemes and the types of funds etc.
We will try our level best to answer all your questions about mutual funds and that too in step by step manner.
What are Mutual Funds and why it is called that “mutual fund sahi hai” ?
Mutual funds are the tools of investment available to retail investors. These are being managed by the expert professionals known as Fund Managers.
You may be thinking ….. “If the money is mine then why should I give it to someone else to invest on my behalf”, before I give you the answer to this question can you answer my question? ….
“Why do you go to a doctor in case of fever even if you know that paracetamol is the treatment of fever”? …because a doctor is a professional who knows the disease better than you do, same is the case with mutual fund managers who have professional expertise more than you in regard to the investments. So it is advised generally to invest in mutual funds, if you are not aware about the investment avenues.
Understanding the legal structure of mutual funds
You know the mutual fund by its name say for example “SBI mutual fund” but it’s time to know the legal structure through which this mutual fund is created. Let us understand the legal structure of mutual fund by taking SBI mutual fund as an example, it is to be noted here that the name is taken for information purposes only, the situation and names taken here may vary but we took the example to let you understand the legal structure of mutual funds.
– So let us say SBI has decided to float a mutual fund in the name of SBI mutual fund. Here SBI will be called as the “Sponsor of mutual fund” and the name of mutual fund will be SBI mutual fund which is governed by Indian Trust Act 1882, so mutual funds are treated as “Trust”.
– Trust is not a real person as individuals, so for operating and managing a trust some persons has to be involved, these persons are called “Trustees” and for this purpose a “Trustee company” is created to manage the trust .i.e. mutual fund trust.
– Every trust is created for the benefit of some persons who are called “Beneficiaries”, in the case of mutual fund the beneficiaries are the investors who invest their money in mutual fund and for whose benefits the mutual fund trust will work.
– For the management of day to day functions of scheme “Asset Management Company (AMC)” is appointed by the trustees or the sponsor. This AMC manages the mutual fund schemes but the custody of all the investments of mutual fund schemes whether be it real estate assets, gold assets, any debt or equity shares is kept with the “Custodian” appointed by trustees. So all the assets have to be kept with the custodian.
– There are certain legal requirements to act at any of the above roles, these requirements are not relevant from the point of view of investors therefore these are not discussed here.
Synopsis about mutual fund schemes
The mutual fund scheme operates in the following manner:
Step one: The mutual fund schemes are created with the approval of SEBI.
Step two: The scheme makes a NFO (New Fund Offer) to the general public to obtain the money for investment (these schemes are managed by fund managers)
Step three: After the money received, it is then invested by fund managers on behalf of investors.
Step four: These investments generates returns for the investors.
Step five: These returns are given to investors after deduction of charges, if any.
Let us understand about the first document of a mutual fund scheme which is the “New Fund Offer (NFO)” document.
NFO is a legal document containing the following details:
NFO opening date
NFO closing date
Type of scheme (Open ended or close ended)
Type of fund (Equity fund, debt fund, hybrid fund etc)
Investment objective (Income/dividend fund, growth fund or both)
Fees or charges etc
Various other legal clauses
So, NFO is the detailed document containing the description about various aspects of the mutual fund so that the investors may become aware about the various necessary details about the mutual fund.
Initially when new fund offer (NFO) comes the price of mutual fund unit is decided by asset management company (AMC) on the basis of various regulated guidelines (generally it is Rs 10 per unit) and subsequently the value of the mutual fund unit is decided on the basis of net asset value (NAV).
Suppose if NFO is offering a unit of mutual fund at Rs 10 per unit and 1,000 units are taken by the public therefore the amount of money given by public (investors) to AMC is Rs 10,000 (1000 x 10) now this AMC will invest Rs 10,000,
If the investment done by AMC becomes Rs 11,000 then now the value of 1 unit of mutual fund will be Rs 11 (11,000 / 1,000) therefore the NAV is Rs 11 per unit.
It may be possible that investment of Rs 10,000 made by AMC can become 9,000, in this case NAV will be Rs 9, therefore it is said that mutual funds are subject to market risk.
Till now you have come to know what is Mutual Fund. What is AMC? Now time to know about “Charges”.
The first form of charge is called Total Expense Ratio, it can be charged by AMC on the basis of percentage decided by SEBI.
Since you know that the AMC is managing your money, for this the AMC has to employee the staff, setup the offices, software and various other expenses. The mutual fund scheme can charge these types of expenses from investors. This is covered under “Total Expense Ratio”, the upper limit of these expenses are fixed by SEBI on the basis of amount of assets managed by AMC.
The Other form of charge is “exit load”, the expense which is charged on investor when he exit the scheme is called exit load this is applied to discourage the investor to exit the scheme before the stipulated time.
Modes of Investment in Mutual funds
There are two ways by which you can invest your money in mutual funds. One is either lump sum or through systematic investment plans (SIP),
If you want to invest Rs.1,00,00 in mutual fund then you have two options either invest one lakh at one go or you have another option to start monthly investment (SIP) and the price at which the investment is done is known as NAV (Net Asset Value) Now once you have decided that you want to invest in mutual funds than the next step is to know about the type of schemes available in the market.
Types of Mutual fund schemes:
There are three types of schemes available in the markets which are known as open ended scheme, close ended scheme and Interval schemes.
Let us understand these schemes so that you can take the decision about the type of scheme you want to choose.
1. Open ended schemes
Following are the characteristics of an open ended scheme:
Investors can entry or exit at any time.
When the investor applies for NFO, per unit value of a mutual fund unit is decided as per the rate specified in NFO (generally it is Rs 10 per unit). If the investor is making an entry in the mutual fund scheme at a time other than NFO than per unit price is decided as per the NAV prevailing at that time.
Any sale transaction (.i.e. exit from the scheme) is done through the price as per NAV
2. Close ended schemes
Following are the characteristics of a close ended scheme:
Buying of mutual fund units can take place only during NFO.
In close ended schemes the units of mutual fund are compulsorily listed and traded in stock exchange.
Since the schemes are listed and traded on stock exchanges therefore the prices of the units are determined on the basis of demand and supply. The investor can exit from these schemes only through the stock market route.
If someone wants to buy a unit of mutual fund other than through NFO, he can do so only through stock exchanges because these schemes are listed on stock exchanges.
Suppose if someone wants to buy the units of mutual fund at Rs 12 per unit but the seller wants to sell it at Rs 13 per unit than either the buyer has to increase his buying price or the seller has to reduce his selling price so that a transaction can take place, therefore it is said that the price of close ended scheme mutual funds are dependent on the forces of demand and supply, not the net asset value (NAV)
3. Interval schemes
Interval schemes have the combined feature of both open ended schemes and close ended schemes. These are basically close ended in their nature but they become open ended for some pre-defined interval periods.
If you check back the characteristics of close ended scheme you would come to know that entry and exit from the close ended schemes can be done only through stock market route (if you have not purchased through NFO)
But Interval funds has the leverage to become open ended at some pre-defined interval periods therefore the investors have the option to enter and exit the scheme other than through stock market route because as we have mentioned above that the entry and exit from an open ended scheme can be done anytime.
Now once it has been decided that which scheme you want to select either an open-ended scheme or a close ended scheme or an interval scheme now the point to be decided is to go for whether equity oriented scheme, debt oriented scheme, solution oriented scheme or any other scheme. Let us discuss them one by one HERE
