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Chapter 9: Structure and Constituents of Mutual Funds

Chapter 9: Mutual Fund Structure and Constituents

Learning Objectives

After studying this chapter, you should understand:

  • Legal trust architecture of a Mutual Fund under the Indian Trusts Act, 1882.
  • Eligibility, financial track record, and regulatory capital requirements of the Sponsor.
  • Fiduciary responsibilities, appointment rules, and independent representation on the Board of Trustees.
  • Composition, capital adequacy, and governance mandates of the Asset Management Company (AMC).
  • Independent operational roles of the Custodian, Registrar and Transfer Agent (RTA), and Auditors.

9.1 The Three-Tier Legal Trust Structure

Under the SEBI (Mutual Funds) Regulations, 1996, mutual funds in India operate as an independent Public Trust under the Indian Trusts Act, 1882:

┌─────────────────────────────────────────────────────────────────┐
│              SEBI MUTUAL FUND INSTITUTIONAL FRAMEWORK           │
├────────────────────┬────────────────────────────────────────────┤
│ 1. Sponsor         │ Settlor of the trust; promotes the fund    │
│ 2. Board of        │ Fiduciary protectors of unit holders'      │
│    Trustees        │ interests; holds trust property in custody │
│ 3. Asset Management│ Appointed by Trustees; professional team   │
│    Company (AMC)   │ managing portfolio investment decisions    │
│ 4. Custodian       │ Independent bank holding portfolio assets  │
│ 5. Registrar &     │ Processes applications, unit allotments,   │
│    Transfer Agent  │ KYC verification, and dividend transfers   │
└────────────────────┴────────────────────────────────────────────┘

9.2 Key Constituents Defined

1. The Sponsor

  • The Sponsor is the primary promoter that conceives the mutual fund and settles the public trust.
  • Eligibility Criteria under SEBI Regulations:
    • Must have carried on business in financial services for at least 5 years.
    • Must possess a positive net worth in all immediately preceding 5 years.
    • Must have earned net profit after tax in at least 3 out of the last 5 years (including the immediately preceding year).
    • Must contribute at least 40% of the net worth of the Asset Management Company.

2. The Board of Trustees / Trustee Company

  • The Trustees hold legal ownership of the mutual fund's property in trust for the exclusive benefit of unit holders.
  • Independent Representation: At least two-thirds (2/3rds) of the Trustees must be independent persons who are not associated with the Sponsor or any of its associates.
  • Fiduciary Duties:
    • Ensure the AMC's investment decisions adhere strictly to SEBI regulations and scheme offer documents.
    • Approve all scheme launch documents (SID/KIM).
    • Review transaction reports, brokerage payments, and related-party deals quarterly.
    • Cannot act as directors of any Asset Management Company.

3. Asset Management Company (AMC)

  • The investment management company appointed by the Trustees to manage the fund's investment portfolio.
  • Net Worth Mandate: Must have a minimum net worth of at least ₹50 Crores.
  • Independent Directors: At least 50% of the directors on the AMC Board must be independent persons.
  • Restrictions: An AMC cannot act as a trustee of any other mutual fund, and cannot undertake any business activity other than asset management, portfolio management services (PMS), or advisory services.

4. Custodian

  • Responsible for holding the physical securities and electronic demat holdings of all mutual fund schemes in safe custody.
  • Collects corporate action benefits (dividends, bonus shares, rights) on behalf of schemes.
  • Must be registered with SEBI under the Custodian of Securities Regulations and must be completely independent of the AMC.

5. Scheme Auditors vs. AMC Auditors

  • To ensure audit independence and eliminate conflict of interest, SEBI mandates that the Statutory Auditor of the Mutual Fund Schemes cannot be the same as the Auditor of the AMC!

Chapter Summary & Exam Cheat Sheet

  • Trust Model: Mutual funds are organized as Trusts under the Indian Trusts Act, 1882.
  • Sponsor Eligibility: Min 5 years financial services experience; profit in 3 of 5 years; positive net worth in all 5 years.
  • Sponsor Equity in AMC: Minimum 40% contribution to AMC net worth.
  • Independent Trustees Rule: Minimum two-thirds (2/3rds) must be independent.
  • AMC Minimum Net Worth: Statutorily fixed at ₹50 Crores.
  • Independent AMC Directors: Minimum 50% must be independent.
  • Auditor Independence: Scheme Auditor and AMC Auditor MUST BE DIFFERENT FIRMS; cannot audit both.
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