BASICS OF MUTUAL FUNDS

BASICS OF MUTUAL FUNDS (Part 1)

Definition: A mutual fund is an investment option where investors contribute small amounts of money, which are pooled together to make a large sum, and then invested in a portfolio of various securities.
Key Characteristics: Mutual funds enable investors to participate in securities markets and invest in equity shares, bonds, and other instruments by pooling their money together.
Investment Objective: A mutual fund states its investment objective upfront, indicating how the money will be invested and how the portfolio will be constructed.

Definition: A mutual fund is a collective investment vehicle, where investors invest their money in a product, and the money is pooled together and invested according to the stated objective.
Proportionate Ownership: Each investor has a proportionate share in the pool of funds, and the benefits from the investment portfolio accrue to them in proportion to their share.
Example: Three investors invest Rs. 10,000, Rs. 20,000, and Rs. 30,000 in a mutual fund, and the gains are distributed proportionately.

Definition: When investors subscribe to a mutual fund, they buy a share in the pool of funds, called a unit of the mutual fund scheme.
Face Value: Each unit has a face value, typically Rs. 10 per unit for most mutual funds.
Unit Capital: The unit capital of a mutual fund scheme denotes the total value of its corpus, which is the number of units outstanding multiplied by its face value.

Portfolio Diversification: Mutual funds offer portfolio diversification, reducing the risk of investment.
Professional Management: Mutual funds are managed by professional managers, who offer their expertise in managing the investors' funds.
Low Transaction Cost: Mutual funds offer low transaction costs due to economies of scale.
Flexibility and Liquidity: Mutual funds offer flexibility and liquidity, allowing investors to buy and sell units easily.

Open-Ended Funds: The number of units is not constant and changes based on daily purchases and redemptions.
Close-Ended Funds: The number of units is fixed after the NFO, and purchase and redemption transactions are not allowed post-NFO.
Liquidity: Open-ended funds are highly liquid, while close-ended funds provide liquidity through listing on stock exchanges.

Definition: The market value of the fund's portfolio is known as the assets under management (AUM) of the mutual fund.
Marking to Market: The portfolio is updated every day to represent its current market value, a process called 'marking to market'.

Definition: NAV is the current market value of a mutual fund's portfolio divided by the number of outstanding units.
Details: NAV is calculated as (Total Assets – Liabilities) / No. of units outstanding and is reported on a daily basis.

Assets: The market value of the mutual fund portfolio, plus accrued incomes.
Liabilities: Current liabilities, such as payables due, and accrued expenses associated with managing the portfolio.
Net Assets: The market value of the portfolio, plus accrued incomes, less any current liabilities and accrued expenses.

Formula: NAV = (Total Assets – Liabilities) / No. of units outstanding.
Example: If the market value of a fund's portfolio is Rs. 700 crore and the current liabilities are Rs. 5 crore, the net assets would be Rs. 695 crore.
NAV Calculation: If the net assets of a fund are Rs. 750 crore and the unit capital is Rs. 250 crore, the NAV would be Rs. 30 per unit.

Investor Evaluation: NAV is the most important data point for investors to evaluate the performance of their investments.
Reporting: NAV is reported on a daily basis and is publicly available, with strict timelines prescribed by SEBI.

RTA Responsibilities: RTAs play an important role in calculating the inflows and outflows of a mutual fund scheme and maintaining records of all transactions.
Importance: RTAs ensure timely communication of latest NAVs to the unitholders.