Concept and Role of a mutual fund

Concept and Role of a Mutual Fund

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, which is designed to achieve the investment objective.
Important Terms:
- Face Value: The face value of a unit is typically 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 mutual fund constituents come out of the expenses charged to the 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.
- Mark to Market (MTM): The process of valuing each security in the investment portfolio at its current market value.

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.
Simplified Investing: Mutual fund investment simplifies the process of investing and holding securities, eliminating the need to open and manage multiple accounts and relationships.

Concept and Role of a Mutual Fund (Part 2)

Fund Management Function: The fund management function involves not only research and selection of securities but also various administrative tasks such as collection of corporate benefits and follow-up on the same.
Benefits of Professional Management: Professional management of funds provides benefits like affordable portfolio diversification, economies of scale, flexibility, transparency, liquidity, tax deferral, and tax benefits, all at a relatively low cost.

Key Benefits of Mutual Funds

Affordable Portfolio Diversification: Investing in mutual funds provides exposure to a range of securities, allowing for diversification and reducing risk, even with small investments.
Economies of Scale: Pooling of large sums of money enables mutual funds to engage professional managers and negotiate better terms with service providers, reducing costs for investors.
Flexibility: Mutual funds offer flexibility in structuring investments according to individual convenience and liquidity preferences.
Transparency: Mutual funds provide timely and relevant information, enabling informed investment decisions.
Liquidity: Investors can recover the market value of their investments from the mutual fund, depending on the scheme's structure.
Tax Deferral: Mutual funds allow investors to defer tax liability by letting their money grow in the scheme for several years.
Tax Benefits: Certain schemes offer tax benefits, such as deductions under Section 80C of the old tax regime.

Convenient Options and Regulatory Comfort

Convenient Options: Mutual funds offer options to structure investments according to liquidity preference and tax position, along with transaction conveniences.
Regulatory Comfort: SEBI's strict checks and balances protect mutual fund investors, ensuring a safe and regulated environment.

Systematic Approach to Investments

Systematic Investment Plan (SIP): Mutual funds offer facilities for regular investments, promoting investment discipline and long-term wealth creation.
Systematic Withdrawal Plan (SWP): Investors can withdraw amounts regularly, providing a systematic approach to income generation.
Systematic Transfer Plan (STP): Mutual funds allow for the transfer of money between different schemes, facilitating a systematic approach to investment management.

Limitations of Mutual Funds

Lack of Portfolio Customization: Unit-holders have limited control over the securities bought and sold in a mutual fund scheme.
Choice Overload: The numerous options available can make it difficult for investors to choose between schemes.
No Control Over Costs: Investors have no control over the costs incurred by the scheme, although SEBI imposes limits on expenses.
No Guaranteed Returns: Mutual funds are not guaranteed return products and pass on the risk and return to investors.

Classification of Mutual Funds

By Investment Objective: Mutual funds can be classified based on their investment objective, such as growth funds, income funds, and 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 and Role of a Mutual Fund (Part 3)

Close-Ended Funds: Have a fixed maturity period, and investors can buy units only during the New Fund Offer (NFO). After the NFO, investors can buy or sell units on a stock exchange, where the fund is listed to provide liquidity.
Interval Funds: Combine features of open-ended and close-ended schemes, becoming open-ended at pre-specified intervals. They provide liquidity to investors between these intervals through listing on stock exchanges.
Exchange Traded Funds (ETFs): Traded on a stock exchange like any other stock, tracking an index or having a fixed portfolio strategy. They provide additional liquidity and allow investors to benefit from price changes during the day.
Classification of Mutual Funds:
- By Structure: Open-ended, close-ended, or interval funds.
- By Management: 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.
SEBI Regulation: Introduced a framework for categorization and rationalization of mutual fund schemes to bring uniformity and standardization. There are five broad categories: Equity Schemes, Debt Schemes, Hybrid Schemes, Solution Oriented Schemes, and Other Schemes.
Equity Schemes: Include sub-categories like Multi Cap Fund, Large Cap Fund, Large and Mid-Cap Fund, Mid Cap Fund, Small Cap Fund, Dividend Yield Fund, Value Fund, and Contra Fund, each with specific investment requirements and strategies.
Key Terms:
- NFO: New Fund Offer, the launch of a mutual fund scheme.
- NAV: Net Asset Value, the market value of a fund's assets minus its liabilities.
- SEBI: Securities and Exchange Board of India, the regulator of the mutual fund industry in India.
- ETF: Exchange Traded Fund, a type of mutual fund that is traded on a stock exchange.
- Index Funds: A type of mutual fund that tracks a specific stock market index, like the S&P BSE Sensex.

Concept and Role of a Mutual Fund (Part 4)

Investment Strategy: Mutual Funds will be permitted to offer either Value fund or Contra fund.
Types of Funds: Various types of funds are available, including equity, debt, hybrid, solution-oriented, and other schemes.

Equity Schemes

Focused Fund: An open-ended equity scheme investing in maximum 30 stocks, with a minimum investment of 65% in equity and equity-related instruments.
Sectoral/Thematic: An open-ended equity scheme investing in a specific sector or theme, with a minimum investment of 80% in equity and equity-related instruments of a particular sector/theme.
Equity Linked Savings Scheme: An open-ended equity-linked saving scheme with a statutory lock-in of 3 years and tax benefit, with a minimum investment of 80% in equity and equity-related instruments.
Flexi-cap Fund: An open-ended equity scheme with a minimum investment of 65% in equity and equity-related assets, investing across large cap, mid cap, and small cap stocks.

Debt Schemes

Overnight Fund: An open-ended debt scheme investing in overnight securities with a maturity of 1 day.
Liquid Fund: An open-ended liquid scheme investing in debt and money market securities with a maturity of up to 91 days.
Ultra-Short Duration Fund: An open-ended ultra-short-term debt scheme investing in debt and money market instruments with a Macaulay duration of 3-6 months.
Low Duration Fund: An open-ended low duration debt scheme investing in debt and money market instruments with a Macaulay duration of 6-12 months.
Money Market Fund: An open-ended debt scheme investing in money market instruments with a maturity of up to 1 year.
Short Duration Fund: An open-ended short-term debt scheme investing in debt and money market instruments with a Macaulay duration of 1-3 years.
Medium Duration Fund: An open-ended medium-term debt scheme investing in debt and money market instruments with a Macaulay duration of 3-4 years.
Medium to Long Duration Fund: An open-ended medium-term debt scheme investing in debt and money market instruments with a Macaulay duration of 4-7 years.
Long Duration Fund: An open-ended debt scheme investing in debt and money market instruments with a Macaulay duration of more than 7 years.
Dynamic Bond: An open-ended dynamic debt scheme investing across duration.
Corporate Bond Fund: An open-ended debt scheme predominantly investing in AA+ and above rated corporate bonds, with a minimum investment of 80% in corporate bonds.
Credit Risk Fund: An open-ended debt scheme investing in below highest rated corporate bonds, with a minimum investment of 65% in corporate bonds.
Banking and PSU Fund: An open-ended debt scheme predominantly investing in debt instruments of banks, Public Sector Undertakings, and Public Financial Institutions, with a minimum investment of 80% in such instruments.
Gilt Fund: An open-ended debt scheme investing in government securities across maturity, with a minimum investment of 80% in G-secs.
Gilt Fund with 10-year constant duration: An open-ended debt scheme investing in government securities with a constant maturity of 10 years, with a minimum investment of 80% in G-secs.
Floater Fund: An open-ended debt scheme predominantly investing in floating rate instruments, with a minimum investment of 65% in floating rate instruments.

Hybrid Schemes

Conservative Hybrid Fund: An open-ended hybrid scheme investing predominantly in debt instruments, with an investment of 75-90% in debt instruments and 10-25% in equity and equity-related instruments.
Balanced Hybrid Fund: An open-ended balanced scheme investing in equity and debt instruments, with an investment of 40-60% in equity and equity-related instruments and 40-60% in debt instruments.
Aggressive Hybrid Fund: An open-ended hybrid scheme investing predominantly in equity and equity-related instruments, with an investment of 65-80% in equity and equity-related instruments and 20-35% in debt instruments.
Dynamic Asset Allocation or Balanced Advantage: An open-ended dynamic asset allocation fund with investment in equity/debt that is managed dynamically.
Multi Asset Allocation: An open-ended scheme investing in at least three asset classes with a minimum allocation of 10% each in all three asset classes.
Arbitrage Fund: An open-ended scheme investing in arbitrage opportunities, with a minimum investment of 65% in equity and equity-related instruments.
Equity Savings: An open-ended scheme investing in equity, arbitrage, and debt, with a minimum investment of 65% in equity and equity-related instruments and 10% in debt.

Solution Oriented Schemes

Retirement Fund: An open-ended retirement solution-oriented scheme with a lock-in of 5 years or till retirement age, meant for long-term planning related to acquiring a corpus for retirement.
Children’s Fund: An open-ended fund for investment for children with a lock-in for at least 5 years or till the child attains the age of majority, meant to invest to build a corpus for the child and their needs.

Other Schemes

Index Funds/Exchange Traded Fund: An open-ended scheme replicating/tracking a specific index, with a minimum investment of 95% in securities of a particular index.
Fund of Funds (Overseas/Domestic): An open-ended fund of fund scheme investing in an underlying fund, with a minimum investment of 95% in the underlying fund.

New Types of Funds

Smart Beta Fund: A type of fund that uses a rules-based approach to select and weight securities, offering a alternative to traditional market capitalization-based index funds.
Environmental, Social and Governance (ESG) Investing: A type of investing that considers the environmental, social, and governance practices of companies when making investment decisions.
Real Estate Mutual Fund: A type of fund that invests directly or indirectly in real estate assets or other permissible assets.
Infrastructure Debt Funds: A type of fund that invests in debt instruments of infrastructure projects, offering a low-risk investment option for investors.
Target Maturity Date Funds (TMF): A type of debt mutual fund that offers a unique investment strategy, designed to mature on a specific date, typically ranging from 2 to 10 years.

Concept and Role of a Mutual Fund (Part 5)

Smart Beta Funds: An extension of index or Exchange Traded Funds (ETFs) that change the basis of exposure in the portfolio to the index using alternative strategies, such as equal weightage or exposure based on additional parameters, to improve returns, increase diversification, and reduce risk.
Quant Funds: Rely on data analysis and numbers undertaken by machines to select securities in the portfolio, using pre-determined models derived from past data to make decisions about buying and selling, eliminating the human element in decision making.
International REITs: A fund that invests in Real Estate Investment Trusts abroad, providing exposure to international funds and the commercial real estate sector.
Specialized Investment Fund (SIF): A new product line under mutual funds introduced by SEBI, with a minimum required investment amount of Rs. 10 lakhs, offering a different kind of holding for investors.
Growth of the Mutual Fund Industry in India: The industry has witnessed a surge in assets under management (AUM) from Rs. 11.89 lakh crores in March 2015 to Rs. 66.70 lakh crore in March 2025, with a rising popularity of Systematic Investment Plans (SIPs), which has grown from Rs. 8,055 crores in March 2019 to Rs. 26,400 crores in January 2025.

Sample Questions

1. Net Asset Value (NAV) indicates how much money can be generated per unit of mutual fund in case the scheme is liquidated.
1. Each mutual fund scheme must have a stated investment objective: True
1. Economies of scale is an advantage of mutual funds.
1. The transparency levels in mutual funds are very low: False
1. Close-ended funds have a fixed maturity date.
1. ETFs are traded on stock exchanges throughout the day like stocks, differing from open-ended mutual funds in terms of trading.