BASICS OF MUTUAL FUNDS

BASICS OF MUTUAL FUNDS (Part 1)

Definition: A mutual fund is a Collective Investment Vehicle 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:
- Investors have proportionate ownership and share in the benefits of the fund.
- Each investor's share in the pool of funds is not equal, but the benefits from the fund accrue to all investors in proportion to their share.
- Mutual funds enable investors to participate in securities markets and invest in equity shares, bonds, and other instruments by pooling their money together.
Advantages of Mutual Funds:
- Portfolio diversification from securities spread over various companies, industries, issuers, and maturities.
- Low transaction cost from economies of scale.
- Professional management by employed fund managers.
- Risk reduction through diversification and professional management.
- Flexibility in investment choices and transactions.
- Liquidity through open-ended funds or listing on stock exchanges for close-ended funds.
Types of Mutual Funds:
- Open-ended funds: Allow purchase and redemption of units directly from the fund, with a changing number of units outstanding.
- Close-ended funds: Have a fixed number of units outstanding, with purchase and redemption transactions allowed only through stock exchanges.
Assets under Management (AUM): The market value of the fund's portfolio, which changes with changes in market value of the securities held.
Net Asset Value (NAV): The value of each unit of the mutual fund, calculated by dividing the total value of the portfolio by the number of units outstanding.
Total Expense Ratio (TER): The ratio of the fund's total expenses to its average net assets, which affects the fund's performance and investor returns.

BASICS OF MUTUAL FUNDS (Part 2)

Net Asset Value (NAV): The current market value per unit of a mutual fund, which can move up or down depending on the value of the portfolio.
Assets Under Management (AUM): The total value of the portfolio, representing the total market value of all the securities held in the mutual fund.
Key concepts:
- NAV and AUM are reported on a daily basis and are publicly available.
- The value of the investors' unit holdings changes along with the market value of the portfolio.
- New investors join the scheme by purchasing units at the prevailing NAV, while existing investors exit the scheme by selling their units at the prevailing NAV.

Total Expense Ratio (TER)

Definition: The percentage of AUM charged as expenses to the mutual fund scheme, including investment management and advisory fees.
Details:
- TER limits are prescribed by SEBI and vary depending on the investment objective and AUM of the fund.
- TER declines progressively with an increase in AUM.
- Examples of TER limits:
  - Equity schemes: 2.25% to 1.05%
  - Fund of funds (FoF) schemes: 1.00% to 2.25%
  - Index fund schemes: 1.00%
- TER applicability for direct and regular plans:
  - Direct plans have lower TER since no commission is payable to distributors.
  - Regular plans have higher TER to account for distributor commissions.

T-30 and B-30 Cities

Definition: Classification of cities by SEBI into Top 30 (T-30) and Beyond Top 30 (B-30) cities based on AUM.
Details:
- T-30 cities account for over 80% of the industry's AUM.
- SEBI allows mutual funds to charge additional expenses for distribution-related expenses in B-30 cities.
- Distributors mobilizing funds from B-30 cities earn higher commissions.
- Role of RTAs in tagging transactions to T-30 and B-30 PIN codes:
  - RTAs use city-wise PIN code files to tag transactions.
  - Standard procedure for tagging transactions includes using investor PIN codes and matching with T-30 PIN code files.

BASICS OF MUTUAL FUNDS (Part 3)

Transaction Tagging: The Association of Mutual Funds in India (AMFI) provides guidelines for tagging transactions based on the investor's location, using the T-30 and B-30 classification.
T-30 and B-30 Classification:
- T-30: Top 30 cities in India, as identified by AMFI.
- B-30: Cities outside of the T-30 list.
Transaction Tagging Rules:
- If the investor's PIN code matches the T-30 PIN code file, the transaction is tagged as T-30.
- If the PIN code is invalid or not available, the transaction is tagged based on the city name.
- If the city name is not available, the transaction is tagged as B-30.
Re-tagging: Transactions may need to be re-tagged at T+15 business days if the original tagging was based on incomplete information.
Net Assets: The net value of a mutual fund's portfolio, after charging expenses.
Net Asset Value (NAV): The net assets of a fund divided by the number of outstanding units.
NAV Calculation: NAV = (Total Assets - Liabilities) / Number of units outstanding.
NAV Importance: NAV is a crucial data point for investors to evaluate the performance of their investments.
Assets and Liabilities: A mutual fund's assets include the market value of its portfolio, while liabilities include current liabilities such as payables and accrued expenses.
NAV Examples:
- Example 7: Net assets = Portfolio value - Liabilities = Rs. 695 crores.
- Example 8: NAV = Net assets / Number of units = Rs. 30 per unit.
- Example 9: Net assets = NAV x Number of units = Rs. 1500 crore.

Sample Questions

Question 1: The securities a mutual fund invests in depend on its investment objective.
Question 2: The type of expenses charged to a fund and its limit is decided by the Securities and Exchange Board of India (SEBI).
Question 3: The number of outstanding units can be calculated using the formula: Number of units = Unit capital / Face value per unit.
Question 4: Expenses charged to a mutual fund scheme are limited by regulation.
Question 5: Distributors mobilizing funds from investors in B-30 locations earn lower commissions.
Question 6: The Total Expense Ratio (TER) is the annual expenses as a percent of Assets Under Management (AUM).
Question 7: The Net Asset Value (NAV) is the market value per unit after charges and liabilities.
Question 8: The report on AUM by geography (T-30/B-30) is generated based on the investor's PIN code.