Mutual Fund Scheme Selection

Mutual Fund Scheme Selection (Part 1)

• Scheme Selection: The selection of a mutual fund scheme depends on the investor's needs, preferences, and risk-profile.
• Investor Needs: The investor's need from the investment will determine the asset class that is most suitable for the investor.
• Risk Profile: The investor's risk appetite is a function of three things—the need to take risks, the ability to take risks, and the willingness to take risks.
• Asset Allocation: The investor's need from the investment will determine the asset class that is most suitable for the investor, along with the investor's ability to take risk and the investor's investment horizon.
• Core and Satellite Portfolio: The portfolio should be divided into core and satellite portfolios, where the core portfolio is invested according to the long-term needs and goals of the investor, and the satellite portfolio is invested to take advantage of expected short-term market movements.

Key Concepts

• Risk-Return Hierarchy: The risk-return profile of different types of mutual fund schemes, including liquid funds, debt funds, hybrid funds, and equity funds.
• Debt Funds: The risk-return profile of debt funds, including overnight funds, liquid funds, ultra short duration funds, and long duration funds.
• Equity Funds: The risk-return profile of equity funds, including small cap funds, mid-cap funds, and large cap funds.
• Hybrid Funds: The risk-return profile of hybrid funds, including arbitrage fund, equity savings fund, and balanced hybrid fund.
• Product Labelling: The product labelling of mutual funds, which provides investors with an easy understanding of the kind of product/scheme they are investing in and its suitability to them.

Important Terms

• Risk Appetite: The investor's willingness and ability to take risks.
• Investment Horizon: The time period for which the investor is investing.
• Asset Class: A category of investments, such as equity, debt, or hybrid.
• Core Portfolio: The part of the portfolio that is invested according to the long-term needs and goals of the investor.
• Satellite Portfolio: The part of the portfolio that is invested to take advantage of expected short-term market movements.

Mutual Fund Scheme Selection (Part 2)

• Investment Objective: The investment objective is a brief description of the kind of product in which the investor is investing, such as Equity or Debt.
• Risk Level: The level of risk is depicted by a Riskometer, which categorizes the risk in the scheme at one of five levels:
  • Low: principal at low risk
  • Moderately Low: principal at moderately low risk
  • Moderate: principal at moderate risk
  • Moderately High: principal at moderately high risk
  • High: principal at high risk
• Disclaimer: A disclaimer that investors should consult their financial advisers if they are not clear about the suitability of the product.

Scheme Selection based on Investment Strategy

• Investment Strategy: The investment strategy of the scheme is devised to achieve the investment objective.
• Portfolio Characteristics: The portfolio is constructed in line with the investment strategy.
• Evaluation: Investors must evaluate the investment objective, investment strategy, and portfolio characteristics to select a suitable mutual fund scheme.

Types of Mutual Fund Schemes

• Active Funds: Funds that aim to beat the market benchmark, with a higher cost and risk.
• Passive Funds: Funds that track a market index, with a lower cost and risk, such as Index Funds and Exchange Traded Funds (ETFs).
• Open-Ended Funds: Funds that offer liquidity, with the option to buy and sell units at the Net Asset Value (NAV).
• Close-Ended Funds: Funds that offer liquidity through listing on a stock exchange, but may have a discount to the NAV.

Diversified, Sector, and Thematic Funds

• Diversified Funds: Funds that invest in a variety of sectors, with a lower risk.
• Sector Funds: Funds that invest in a specific sector, with a higher risk.
• Thematic Funds: Funds that invest in a specific theme, such as infrastructure or MNCs.
• Focused Funds: Funds that invest in a concentrated portfolio of stocks, with a higher risk.

Large-Cap, Mid-Cap, and Small-Cap Funds

• Large-Cap Funds: Funds that invest in established companies with stable revenues and profitability.
• Mid-Cap and Small-Cap Funds: Funds that invest in companies with growth potential, but higher risk.
• Multi-Cap Funds: Funds that invest across the market capitalization spectrum, with a balanced risk and return profile.

Mutual Fund Scheme Selection (Part 3)

• Equity Funds: Can be categorized based on market capitalization (large cap, mid-cap, small-cap) or investment style (growth or value).
• Growth Funds: Invest in companies expected to grow at rates higher than the average economic growth rate, performing well in bull markets but riskier in market downturns.
• Value Funds: Seek to identify stocks available at a price seen as cheap relative to their potential future value, outperforming in falling markets and providing benefits over longer holding periods.
• International Equity Funds: Offer exposure to international equity markets and exchange rates, suitable for diversifying investments and benefiting from global opportunities.
• Fixed Maturity Plans (FMPs): Close-ended debt funds ideal for investors with a fixed investment horizon, offering more predictable returns than conventional debt schemes but with credit risk and limited liquidity.
• Target Maturity Funds (TMFs): Gradually replacing FMPs, offering multiple maturity options, comprising government securities or top-notch corporate bonds, with the advantage of liquidity.
• Short Duration Funds: Invest in securities with maturities between 1-3 years, earning market yields, suitable for investors expecting interest rate increases, with low volatility and suitable for core portfolios.
• Liquid Funds: Suitable for the lowest risk investors, with low returns, comparable to savings bank accounts, ideal for parking funds for very short periods (up to 91 days).
• Floater Funds: Invest in floating rate instruments, with steady NAV, suitable for investors seeking steady returns with low volatility.
• Hybrid Schemes: Offer a mix of debt and equity exposures, suitable for investors seeking equity exposure with lower risk, with the equity component providing appreciation and the debt component providing stability.
• Gold Funds: Can be categorized into Gold ETFs, which track the price of gold, and Gold Sector Funds, which invest in shares of gold mining companies, with different performance characteristics.
• Selection of Mutual Fund Scheme: Investors should consider the AMC's approach, style, and value system, ensuring comfort with the AMC before investing.
• Matching Fund's Portfolio with Investment Objective: Investors should evaluate whether the fund's portfolio reflects its investment objective and the fund manager's strategy and style.
• Fund Manager: Long-term performance and ability to identify market trends are important considerations when evaluating a fund manager.

Mutual Fund Scheme Selection (Part 4)

• Fund Performance: The primary criterion in selecting a mutual fund scheme, evaluated by comparing returns to its benchmark over time.
• Key Evaluation Parameters:
  • Consistent outperformance of the benchmark
  • Protection of downside in a falling market
  • Comparison with peer group performance
  • Evaluation over different time periods (e.g., 1 year, 3 years, 5 years, since inception)
• Fund Portfolio:
  • Diversification: Across sectors and stocks for equity funds
  • Market Segment: Where the fund invests
  • Cash Holding: Extent of cash held in the portfolio
  • Conviction: Length of holding in stocks and churn in the portfolio
  • Strategy: For selecting securities and managing the portfolio
• Fund Age:
  • Importance of a long history for track record analysis
  • Avoiding new funds with lackluster portfolio manager track records
  • Evaluating new funds for suitability based on investment opportunities
• Fund Size:
  • Impact on investment universe and diversification
  • Advantages of large fund size (e.g., economies of scale) and small fund size (e.g., flexibility)
• Portfolio Turnover:
  • Calculation: Value of purchase and sale of securities divided by average net assets
  • Implication: Frequent churning adds to broking costs and indicates unsteady investment management
• Scheme Running Expenses:
  • Impact on investor returns, particularly in debt schemes and index funds
  • Importance of cost structure in investment decisions
• Risk, Return, and Risk-Adjusted Returns:
  • Parameters for evaluating schemes
  • Basis for mutual fund research agencies to assign rankings
• Selecting Options in Mutual Fund Schemes:
  • Income Distribution Cum Capital Withdrawal (Dividend) Payout Option: Benefits and limitations, including tax implications
  • Growth Option: Benefits of letting money grow in the fund without annual taxation
  • Re-purchase Transactions: Treatment as sale of units, with potential capital gain or loss
• Do’s and Don’ts While Selecting Mutual Fund Schemes:
  • Ensuring Suitability: Compliance with SEBI regulations on fraudulent and unfair trade practices
  • Sticking to Investor’s Asset Allocation: Prudent approach based on investor’s situation and goals
  • Avoiding Chasing Past Performance: Recognizing that past performance may not be sustained in the future
  • Understanding Investment Objective and Strategy: Crucial for evaluating and selecting mutual fund schemes
  • Keeping an Eye on Taxes and Loads: Importance in investment decisions to maximize returns

Mutual Fund Scheme Selection (Part 5)

• Importance of Tax and Load Consideration: Both taxes and loads reduce investment returns, making it crucial for distributors to consider these aspects during repurchases/redemptions, including assessing capital gains tax and exit loads.
• Taxation Comparison: Periodically comparing taxation aspects of dividend and growth options helps evaluate the impact of tax on returns.
• Consistent Scheme Selection Methodology: Developing a consistent approach to scheme selection and keeping it in writing helps distributors stay on course.
• Risk Assessment: Understanding the risk involved in different mutual fund schemes, such as credit risk, is essential for informed decision-making.

Key Concepts in Mutual Fund Scheme Selection

• Least Risky Scheme Category: Gilt funds are considered the least risky in terms of credit risk.
• Risk Assessment Framework: SEBI's Risk-o-meter provides a simplified framework for assessing the level of risk involved in a mutual fund scheme.
• Passive Funds: The statement that passive funds are safe and their NAV does not go down even when the respective markets fall is False.
• Risk of Concentration: A Multi-cap fund would have a lower risk of concentration compared to focused, thematic, or sector funds.
• Close-Ended Debt Funds: Fixed Maturity Plans (FMPs) are an example of close-ended debt funds.
• Focused Mutual Fund Risk: A focused mutual fund is indeed riskier than a diversified mutual fund, making the statement True.
• Risk-Return Profile: Moving from liquid funds to debt funds increases investment risk, and moving from liquid funds to equity funds increases potential returns, making both statements True.

Code of Conduct and Ethics

• Mutual Fund Schemes: Should be organized, operated, and managed in the interest of all unit holders, not just sponsors, directors, or a special class of unit holders.
• Trustees and Asset Management Companies: Must ensure timely dissemination of adequate, accurate, and explicit information to all unit holders.
• Conflicts of Interest: Should be avoided in managing scheme affairs, keeping unit holders' interests paramount.
• Segregation of Assets and Liabilities: Each scheme's assets and liabilities should be segregated and ring-fenced from other schemes.
• Investment Objectives and Policies: Should be followed, with investment decisions made solely in the interest of unit holders.

AMFI Code of Ethics

• Integrity and Fairness: Members should observe high standards of integrity and fairness in all dealings.
• Due Diligence: Members should render high standards of service, exercise due diligence, and employ independent professional judgment.
• Disclosures: Timely dissemination of adequate, accurate, and explicit information to all unit holders is essential.
• Professional Selling Practices: Unethical means to sell or market schemes should be avoided, with no exaggerated statements about performance.
• Investment Practices: Schemes should be managed according to fundamental investment objectives and policies, with decisions made solely in the interest of unit holders.
• Operations: Conflicts of interest should be avoided, with the interest of all unit holders kept paramount in all matters.

Mutual Fund Scheme Selection (Part 6)

• Scheme Changes: Members shall not make any change in the fundamental attributes of a scheme without the prior approval of unitholders, except when such change is consequent on changes in regulations.
• Business Concentration: Members shall avoid excessive concentration of business with any broking firm and excessive holding of units in a scheme by few persons or entities.

Reporting Practices

• Valuation Policies: Members shall follow comparable and standardized valuation policies in accordance with the SEBI Mutual Fund Regulations.
• Performance Reporting: Members shall follow uniform performance reporting on the basis of total return.
• Account Segregation: Members shall ensure scheme-wise segregation of cash and securities accounts.

Unfair Competition

• Fair Practices: Members shall not make any statement or become privy to any act, practice, or competition that is likely to be harmful to the interests of other members or place them in a disadvantageous position.

Observance of Statutes, Rules, and Regulations

• Compliance: Members shall abide by the letter and spirit of the provisions of the Statutes, Rules, and Regulations applicable to their activities.

Enforcement

• Code Dissemination: Members shall widely disseminate the AMFI Code to all persons and entities covered by it.
• Compliance Mechanisms: Members shall establish internal controls and compliance mechanisms, including assigning supervisory responsibility.
• Record Maintenance: Members shall maintain records of all activities and transactions for at least three years, subject to review by the Trustees.

Definitions

• AMFI: Association of Mutual Funds in India.
• Associate: As defined in regulation 2(c) of SEBI (Mutual Fund) Regulations 1996.
• Fundamental Investment Policies: Investment objectives, policies, and terms of a scheme considered fundamental attributes.
• Member: A member of the Association of Mutual Funds in India.
• SEBI: Securities and Exchange Board of India.
• Significant Unit Holder: An entity holding 5% or more of the total corpus of any scheme managed by the member.
• Trustee: A member of the Board of Trustees or a director of the Trustee Company.
• Trustee Company: A company incorporated as a Trustee Company for managing a mutual fund.

Code of Conduct for Mutual Fund Distributors

• Purpose and Scope: Establishes professional standards for Mutual Fund Distributors to demonstrate core values of being a fiduciary.
• Obligations: Distributors must consider investors' interests as paramount, exercise due diligence, and avoid conflicts of interest.
• Compliance: Distributors shall adhere to SEBI Mutual Fund Regulations, AMFI guidelines, and the Code of Conduct.
• Infrastructure and Record Keeping: Distributors shall maintain necessary infrastructure, internal control procedures, and financial and operational systems to support high service standards and prevent mis-selling.

Mutual Fund Scheme Selection (Part 7)

• Introduction: Mutual Fund Distributors (MFDs) play a crucial role in the mutual fund industry, and it is essential for them to understand their obligations and responsibilities.
• Record Keeping: MFDs should maintain adequate records in relation to clients, including KYC records and correspondence with investors, in compliance with applicable laws and SEBI regulations.

Client Related Obligations

• Information Disclosure: MFDs should provide full and updated information on schemes to investors, including Scheme Information Document (SID), Statement of Additional Information (SAI), and Key Information Memorandum (KIM).
• Risk Factors: MFDs should highlight risk factors of each scheme to investors and advise them to go through the SAI/SID/KIM before making investment decisions.
• Commission Disclosure: MFDs should disclose all commissions received or receivable for different competing schemes to investors.
• Affiliation Disclosure: MFDs should disclose their affiliation with mutual funds and inform clients that they may consider other alternate products not offered by the MFD.

Other Obligations

• NISM Certification: Individual MFDs should obtain NISM certification and register themselves with AMFI to obtain an ARN and EUIN.
• Training and Processes: MFDs should set up adequate training and processes to ensure that their representatives undergo training on proper conduct and procedures to prevent fraudulent activities.
• Cooperation with Authorities: MFDs should cooperate with AMCs, AMFI, SEBI, and competent authorities in relation to their services, including providing relevant documents and information.

Obligations towards Integrity of the Mutual Fund Industry

• Professional Conduct: MFDs should observe high standards of integrity and conduct their dealings in a manner that upholds the professional image of the mutual fund industry.
• Fair and Balanced Perspective: MFDs should maintain a fair and balanced perspective and refrain from making false or defamatory statements about any AMC, AMFI, or mutual fund schemes.

Additional Resources

• SEBI Website: For information on scheme information documents, statement of additional information, and key information memorandum.
• AMFI Website: For information on KYC related information and forms.

Mutual Fund Scheme Selection (Part 8)

• Indian Mutual Fund Industry: The Indian mutual fund industry can be researched through the Association of Mutual Funds in India (AMFI) website, which provides industry data analysis.
• Global Mutual Fund Trends: Worldwide and US trends and data can be found on the Investment Company Institute (ICI) website, offering insights into global mutual fund trends.
• New Fund Offers: Draft new fund offers can be accessed through the Securities and Exchange Board of India (SEBI) website, providing information on newly launched mutual fund schemes.
• Scheme Information Documents: Mutual funds file Scheme Information Documents for their schemes, which can be found on the SEBI website, offering detailed information about each scheme.
• Key Information Memorandum: The Key Information Memorandum of mutual funds provides essential information about the scheme, available on the SEBI website.
• Statement of Additional Information: The Statement of Additional Information of mutual funds offers additional details about the scheme, accessible on the SEBI website.
• Mutual Fund Education: Mutual fund basics to educate investors can be found on the AMFI website, providing educational resources for investors.
• Mutual Fund Data and Flows: Data about mutual funds and flows can be accessed on the AMFI website, which publishes monthly research information.
• Scheme Performance Data: Mutual fund scheme performance data is available on the AMFI website, allowing investors to research and compare scheme performance.
• Research and Analysis: Investors can utilize the aforementioned resources to conduct research and analysis, making informed decisions when selecting mutual fund schemes.