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OPERATIONAL CONCEPTS OF MUTUAL FUNDS

OPERATIONAL CONCEPTS OF MUTUAL FUNDS

Operational Concepts of Mutual Funds (Part 1)

  • New Fund Offer (NFO): A mutual fund scheme is launched through an NFO, where units are offered to the public for the first time. The NFO period is typically not more than 15 days.
  • Allotment of Units: After the NFO closes, there is a 'no transaction period' (usually 5 days) before units are allotted to investors. The mutual fund must allot units and dispatch statements of accounts within the stipulated time notified by SEBI.
  • Inception Date: The date of allotment is the inception date of the fund, when its Net Asset Value (NAV) is set at face value. Transactions in an open-ended fund can begin from the next day when the first NAV of the fund will be declared.
  • Use of NFO Proceeds: The mutual fund shall make investments out of the NFO proceeds only on or after the closure of the NFO period.

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Key Concepts

  • Continuous/On-going Offer: Indicates that transactions are resumed in a fund after the allotment is over. Purchases and redemptions of units happen at NAV related prices during the on-going offer period.
  • Computation of Net Asset Value (NAV): NAV is calculated as (Market value of the portfolio - Expenses and liabilities) / (Number of units outstanding).
  • Operating Cycle of a Mutual Fund: The cycle includes investor transaction acceptance, transaction intimation to RTA, unit addition or reduction, and NAV computation.
  • Applicable NAV: The NAV that is applicable to a transaction depends on the day and time at which the transaction request was received at the official point of acceptance.
  • Time Stamping and Risk Control: Time stamping is mandatory for financial transactions related to mutual funds. The time stamping machine captures the time of receipt of a transaction, and all financial transactions are processed in the R&T system as per the applicable NAV according to the recorded time stamp.

Operational Concepts of Mutual Funds (Part 2)

  • Time Stamping: Each transaction request received at the Investor Service Centre (ISC) should be individually time stamped. The NAV on these transactions is applied as per the time stamp on each individual transaction request.
  • Transaction Requests: Applications for fresh purchases or additional purchases should always be accompanied by a payment instrument, and both should have identical time stamps.
  • Incomplete Documents: If a document is found to be incomplete during basic checks, the transaction request should not be time stamped and should be returned for corrections.
  • Time Stamping Machine Maintenance: The following procedures should be followed:
    • Machines should be tested daily to ensure they are in workable condition.
    • Machines should remain locked except when replacing the ribbon or ink cartridge.
    • A machine log should be maintained to record instances of the machine being opened.
    • The first time stamp serial number should be verified daily to ensure continuity.
    • Daily control reports should be generated to indicate the first, last, and time stamp serial number at cut-off time.

Cut Off Time

  • Applicable NAV: The applicable NAV for a mutual fund transaction depends on the day of the transaction, time of the transaction, type of scheme, and availability of clear funds.
  • Business Days: Markets and mutual funds do not work every day. If it is not a business day for the fund, there would be no NAV on that date.
  • Cut-off Time: The applicable NAV for transactions received on a business day depends on the cut-off time, which varies for different types of funds and transactions.
  • Liquid Funds: Liquid fund remittances may be made electronically and deployed on the same day, resulting in an earlier cut-off time.
  • Cut-off Timings: The following are the cut-off timings for different types of schemes:
    • Equity Oriented Funds and Debt Funds (except Liquid Funds): 3:00 pm
    • Liquid Funds: 1:30 pm
    • Overnight Funds: 3:00 pm (7:00 pm if application is received online)
  • Applicable NAV: The applicable NAV for transactions received on a business day depends on the cut-off time, as summarized in the provided table.
  • Exceptions: The above cut-off timings are not applicable to New Fund Offers (NFOs), International Schemes, and transactions in mutual fund units undertaken on a recognized stock exchange.

Operational Concepts of Mutual Funds (Part 3)

  • NAV Applicability: The Net Asset Value (NAV) applicable for purchase or redemption of mutual fund units depends on the timing of the application and realization of funds. For example:
    • If an application is made on Monday and the fund is realized by 2 pm on Wednesday, the applicable NAV will be Wednesday's NAV.
    • For liquid funds, if the application is made on Monday and the fund is realized by 1 pm on Monday, the applicable NAV will be Sunday's NAV.
  • Cut-off Time: The cut-off time for applying for redemption of units is crucial in determining the applicable NAV. If the application is submitted before the cut-off time, the redemption will be processed at the current day's NAV; otherwise, it will be processed at the next business day's NAV.
  • Segregated Portfolios: A Segregated Portfolio (also known as a side pocket) is created in case of debt or money market instruments facing default or downgrade. This concept involves separating the affected instruments from the main portfolio to ensure liquidity and fair treatment for all investors.
  • Key Points about Segregated Portfolios:
    • Creation of a segregated portfolio is based on issuer-level credit events and is implemented at the ISIN-level.
    • The Scheme Information Document (SID) must have a specific provision allowing for the creation of a segregated portfolio, which must be approved by the Trustees.
    • No redemption and subscription are allowed in the segregated portfolio, but units can be listed on a recognized stock exchange to facilitate exit for unitholders.
  • Investing in Mutual Funds through Stock Exchanges: Mutual fund units can be transacted through stock exchange terminals, offering advantages such as a single view of the customer's portfolio, reduced paperwork, and de-risking of settlement processes.
  • Holding Units in Dematerialized Form: Investors can choose to hold mutual fund units in dematerialized form, which applies to new units purchased and existing units represented by the statement of account.
  • Role of RTA in Tax Computation:
    • Tax Deducted at Source (TDS): Applicable for redemptions by Non-Resident Indians (NRIs) and dividends (IDCW) for resident Indians.
    • Securities Transaction Tax (STT): Applicable for equity-oriented mutual funds, with concessional rates for delivery-based transactions.
    • Stamp Duty: Payable at a rate of 0.005% (Rs 5 per lakh) for all mutual fund transactions since July 2020.

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OPERATIONAL CONCEPTS OF MUTUAL FUNDS (Part 4)

  • Stamp Duty: Imposed on the purchase of new mutual fund units, but not on selling or redeeming existing units. The Registrar and Transfer Agent (RTA) ensures the stamp duty amount is shown separately in the account statement and collects it from investors.
  • Reporting Requirements:
    • Foreign Account Tax Compliance Act (FATCA): A US law to combat tax evasion by US persons opening accounts offshore. Indian financial institutions provide necessary information to Indian tax authorities, which is then transmitted to the USA.
    • Common Reporting Standards (CRS): Requires financial institutions to collect and report information about account holders resident in other countries. The Central Board of Direct Taxes (CBDT) is the nodal agency for tax-related compliances and exchange of information between governments.
    • Statement of Financial Transactions (SFT): Specified entities must furnish a statement of financial transactions or reportable accounts to the income-tax authority. The RTA facilitates data in the reportable format for upload into the CBDT reporting portal.
    • Centralization of Certifications: SEBI has mandated that intermediaries who are Reporting Financial Institutions (RFI) shall upload FATCA CRA certifications onto the system of KRAs.
  • Key Concepts:
    • Net Asset Value (NAV): Calculated based on the unit capital required, provided by the Registrar and Transfer Agent.
    • Securities Transaction Tax (STT): Applicable on sale transactions of an equity scheme, but not on purchase of units of an equity mutual fund scheme or transactions of debt and liquid schemes.
    • Segregated Portfolio: Can be created only if the Scheme Information Document (SID) or Trust Deed has specific provisions allowing for it.
    • Time Stamping: Primarily mandated to determine the applicable NAV for the transaction.
    • Payment Mechanisms:
      • ASBA (Application Supported by Blocked Amount): Allows investors in NFOs to block funds in their bank account, with actual debit occurring only upon unit allotment.
      • ECS/NACH (Electronic Clearing Service/National Automated Clearing House): Enables electronic fund transfers.
      • Cheque: A traditional payment method.
      • SWIFT Wire: A method for international fund transfers.
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