Concept & Role of a Mutual Fund

Concept and Role of a Mutual Fund (Part 1)

Definition: A mutual fund is a professionally managed investment vehicle that allows investors to access various securities, such as equities, bonds, and money market instruments, through a single investment.
Key Characteristics: Mutual funds offer a different way of investing, with professional management, portfolio diversification, and a regulated vehicle.
Role of Mutual Funds: The primary role of mutual funds is to help investors earn an income or build their wealth by investing in opportunities available in securities markets.

Key Concepts in Mutual Funds

Investment Objectives: Mutual funds have pre-announced investment objectives, which reflect the needs and preferences of investors, such as safety, liquidity, and returns.
Investment Policy: Each mutual fund scheme has an investment policy that includes asset allocation and investment style to achieve its investment objective.
Important Terms:
- Units: The investment made by an investor is translated into a certain number of units in the scheme.
- Face Value: Typically, every unit has a face value of Rs. 10.
- Unit Capital: The number of units issued by a scheme multiplied by its face value is the capital of the scheme.
- Recurring Expenses: Fees or commissions paid to various mutual fund constituents come out of the expenses charged to the mutual fund scheme.
- Net Asset Value (NAV): The true worth of a unit of the mutual fund scheme, which increases or decreases based on investment activity.
- Assets Under Management (AUM): The sum of all investments made by investors in the mutual fund scheme.

Advantages of Mutual Funds for Investors

Professional Management: Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds.
Diversification: Mutual funds provide a diversified portfolio, which helps to reduce risk and increase potential returns.
Regulated Vehicle: Mutual funds are regulated by SEBI, which ensures that they operate in a transparent and fair manner.

Concept & Role of a Mutual Fund (Part 2)

Investment Simplification: Mutual funds simplify the process of investing and holding securities, taking care of administrative tasks like collecting corporate benefits and following up on them.
Professional Management: Fund management involves research, selection of securities, and administrative tasks, all of which are done at a low cost, making it accessible even for small investments.
Affordable Portfolio Diversification: Investing in mutual fund units provides exposure to a range of securities, allowing for diversification and reducing risk, even with small investments.
Economies of Scale: Pooling large sums of money enables mutual funds to engage professional managers, negotiate better terms with service providers, and spread costs across investors.
Flexibility and Convenience: Mutual funds offer flexibility in structuring investments, options for income distribution and capital withdrawal, and convenient transaction options.
Transparency: Mutual funds provide transparency through scheme-related documents, portfolio disclosures, and daily NAV calculations, enabling informed investment decisions.
Liquidity: Mutual funds offer liquidity, allowing investors to recover their investments at market value, either at any time or during specific intervals, depending on the scheme's structure.
Tax Deferral and Benefits: Mutual funds are not liable to pay tax on income earned, and certain schemes offer tax benefits, such as deductions under Section 80C.
Convenient Options and Investment Comfort: Mutual funds provide options for structuring investments, convenient transaction options, and simplified subsequent investment activity.
Regulatory Comfort: SEBI's strict regulations and checks provide protection for mutual fund investors.
Systematic Approach to Investments: Mutual funds offer facilities for systematic investment plans, withdrawal plans, and transfer plans, promoting investment discipline and long-term wealth creation.

Limitations of Mutual Funds

Lack of Portfolio Customization: Mutual fund investors have limited control over the securities purchased and sold, unlike portfolio management services.
Choice Overload: The numerous mutual fund schemes and options can be overwhelming for investors, but SEBI's categorization and industry information can help.
No Control Over Costs: Investors have no control over the costs incurred by the scheme, although SEBI has imposed limits on expenses.
No Guaranteed Returns: Mutual funds are not guaranteed return products, and their performance is affected by market movements, individual security performance, and fund manager skills.

Classification of Mutual Funds

By Investment Objective: Mutual funds can be classified based on their investment objectives, such as growth, income, or liquid funds.
By Structure: Mutual funds can be classified as open-ended or close-ended, with open-ended funds allowing investors to enter or exit at any time and close-ended funds having a fixed maturity date.

Concept & Role of a Mutual Fund (Part 3)

Open-Ended Funds: The unit capital in an open-ended fund would keep changing on a regular basis. When an investor invests money in the scheme, new units would be created, and the unit balance would increase. On the other hand, when someone exits the scheme, the units sold back to the scheme would be cancelled, due to which the unit balance of the scheme would go down.
Close-Ended Funds: Have a fixed maturity, and investors can buy units of a close-ended scheme from the fund only during its New Fund Offer (NFO). The investors cannot transact with the fund after the NFO is over. At the end of the maturity period, the scheme is wound up, units are cancelled, and the money is returned to the investors.
Interval Funds: Combine features of both open-ended and close-ended schemes. They are largely close-ended but become open-ended at pre-specified intervals. The units must be compulsorily listed on stock exchanges to allow investors an exit route.
Exchange Traded Funds (ETFs): Are mutual fund schemes that are traded on a stock exchange like any other stock. They usually track an index or have a fixed portfolio strategy based on some index, making them passive in nature.
Classification of Mutual Funds: Can be done in several ways, including:
- By Structure: Open-ended, close-ended, or interval funds.
- By Management Style: Actively managed or passively managed (index funds or ETFs).
- By Investment Universe: Equity funds, fixed income funds, money market funds, gold funds, international funds, etc.
- By SEBI Regulation: Categorized into five broad categories: Equity Schemes, Debt Schemes, Hybrid Schemes, Solution Oriented Schemes, and Other Schemes.

Concept & Role of a Mutual Fund (Part 4)

Equity Schemes: These are open-ended schemes that invest in equity and equity-related instruments. The minimum investment in equity and equity-related instruments is 65% of total assets.
Types of Equity Schemes:
- Dividend Yield Fund: Invests predominantly in dividend-yielding stocks.
- Value Fund or Contra Fund: Follows a value investment strategy or a contrarian investment strategy.
- Focused Fund: Invests in a maximum of 30 stocks, with a minimum investment of 65% in equity and equity-related instruments.
- Sectoral/Thematic: Invests in a specific sector or theme, with a minimum investment of 80% in equity and equity-related instruments of that sector or theme.
- Equity Linked Savings Scheme: Has a statutory lock-in of 3 years and tax benefits, with a minimum investment of 80% in equity and equity-related instruments.
- Flexi-cap Fund: Invests across large cap, mid cap, and small cap stocks, with a minimum investment of 65% in equity and equity-related assets.
Debt Schemes: These are open-ended schemes that invest in debt and money market instruments.
Types of Debt Schemes:
- Overnight Fund: Invests in overnight securities with a maturity of 1 day.
- Liquid Fund: Invests in debt and money market securities with a maturity of up to 91 days.
- Ultra-Short Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 3-6 months.
- Low Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 6-12 months.
- Money Market Fund: Invests in money market instruments with a maturity of up to 1 year.
- Short Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 1-3 years.
- Medium Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 3-4 years.
- Medium to Long Duration Fund: Invests in debt and money market instruments with a Macaulay duration of 4-7 years.
- Long Duration Fund: Invests in debt and money market instruments with a Macaulay duration of more than 7 years.
- Dynamic Bond: Invests across duration.
- Corporate Bond Fund: Invests predominantly in AA+ and above rated corporate bonds.
- Credit Risk Fund: Invests in below highest rated corporate bonds.
- Banking and PSU Fund: Invests predominantly in debt instruments of banks, Public Sector Undertakings, and Public Financial Institutions.
- Gilt Fund: Invests in government securities across maturity.
- Gilt Fund with 10-year constant duration: Invests in government securities with a constant maturity of 10 years.
- Floater Fund: Invests predominantly in floating rate instruments.

Hybrid Schemes: These are open-ended schemes that invest in a combination of equity and debt instruments.
Types of Hybrid Schemes:
- Conservative Hybrid Fund: Invests predominantly in debt instruments, with 10-25% in equity and equity-related instruments.
- Balanced Hybrid Fund: Invests in equity and debt instruments, with 40-60% in equity and equity-related instruments.
- Aggressive Hybrid Fund: Invests predominantly in equity and equity-related instruments, with 20-35% in debt instruments.
- Dynamic Asset Allocation or Balanced Advantage: Invests in equity and debt that is managed dynamically.
- Multi Asset Allocation: Invests in at least three asset classes, with a minimum allocation of 10% each.
- Arbitrage Fund: Invests in arbitrage opportunities, with a minimum investment of 65% in equity and equity-related instruments.
- Equity Savings: Invests in equity, arbitrage, and debt, with a minimum investment of 65% in equity and equity-related instruments and 10% in debt.
Solution Oriented Schemes: These are open-ended schemes that are designed to meet specific investment goals.
Types of Solution Oriented Schemes:
- Retirement Fund: Has a lock-in of 5 years or till retirement age, and is meant for long-term planning.
- Children’s Fund: Has a lock-in of at least 5 years or till the child attains the age of majority, and is meant to build a corpus for the child.
Other Schemes:
- Index Funds/Exchange Traded Fund: Replicates or tracks a specific index, with a minimum investment of 95% in securities of that index.
- Fund of Funds (Overseas/Domestic): Invests in an underlying fund, with a minimum investment of 95% in that fund.
Fixed Maturity Plans: A type of close-ended debt fund where the duration of the investment portfolio is closely aligned to the maturity of the scheme.
Target Maturity Date Funds (TMF): A type of debt mutual fund that offers a unique investment strategy, with a specific maturity date and predictable returns.
Capital Protection Oriented Funds: Closed-end hybrid funds that invest in equity through the equity derivatives market, with the goal of protecting capital.

Concept & Role of a Mutual Fund (Part 5)

Infrastructure Debt Funds (IDFs): Investment vehicles that can be sponsored by commercial banks and NBFCs in India, allowing domestic/offshore institutional investors to invest through units and bonds.
IDF Structure: Can be set up as a Trust (regulated by SEBI) or a Company (regulated by the Reserve Bank).
SEBI Regulations: IDFs must invest at least 90% of scheme assets in debt securities or securitized debt instruments of infrastructure companies or projects.
Real Estate Mutual Fund: Invests directly or indirectly in real estate assets, with at least 35% of the portfolio held in physical assets and 75% of net assets in real estate assets.
Environmental, Social and Governance (ESG) Investing: A separate sub-category under thematic equity schemes, allowing for various investment strategies such as exclusion, integration, and impact investing.
New Types of Funds: Includes Smart Beta Funds, Quant Funds, International REITs, and Specialized Investment Funds (SIFs), which offer diverse investment strategies and risk-reward profiles.
Specialized Investment Fund (SIF): A new product line under mutual funds, introduced by SEBI to bridge the gap between mutual funds and portfolio management services, with a minimum investment amount of Rs. 10 lakhs.
SIF Investment Strategies: Includes equity-oriented, debt-oriented, and hybrid investment strategies, such as Equity Long-Short Fund, Debt Long-Short Fund, and Active Asset Allocator Long-Short Fund.
Growth of the Mutual Fund Industry: The industry has witnessed significant growth, with mutual fund assets under management (AUM) increasing from Rs. 11.89 lakh crores in March 2015 to Rs. 66.70 lakh crore in March 2025, representing a 10-year growth rate of 18.82% per annum.

Concept & Role of a Mutual Fund (Part 6)

Growth of Mutual Funds: The mutual fund industry has experienced significant growth, with the number of folios increasing from 23.45 crore in March 2010 to a growth rate of over 11 percent per year by March 2025.
Market Share: The share of mutual funds in overall financial investments in India has risen from 10 percent in March 2016 to 12 percent in March 2017 and to 14 percent in March 2018, while the share of bank deposits has decreased from 71 percent to 69 percent and then to 65 percent during the same period.
Global Comparison: The Indian mutual fund industry's share has increased from 0.33 percent in 2008 to 0.60 percent in 2018, indicating a significant growth compared to the global industry.
Rise of SIPs: The popularity of Systematic Investment Plans (SIPs) has grown, with the SIP contribution increasing from Rs. 8,055 crores in March 2019 to Rs. 26,400 crores in January 2025.
Key Statistics:
- The number of folios has grown at a rate of over 11 percent per year.
- The share of mutual funds in overall financial investments has increased by 4 percent between March 2016 and March 2018.
- The share of bank deposits has decreased by 6 percent during the same period.

Sample Questions

Question 1: The correct answer is b. Net Asset Value, as it indicates the value of each unit of a mutual fund scheme if it were to be liquidated.
Question 2: The correct answer is c. Economies of scale, as mutual funds provide investors with the benefit of economies of scale, allowing them to invest in a diversified portfolio at a lower cost.
Question 3: The correct answer is c. Close-ended funds, as they have a fixed maturity date, unlike open-ended funds, which can be bought or sold at any time.