Scheme Selection based on Investor needs, preferences, and risk-profile:
Investor Need:
Long-term appreciation: Invest in schemes that have a history of providing consistent long-term growth.
Periodic income: Choose schemes that focus on generating regular income through dividends or interest payouts.
High liquidity: Opt for schemes that offer easy redemption and withdrawal options.
Risk Profile of the investor:
Assess the investor’s need, ability, and willingness to take risks.
Understand the risk appetite based on the investor’s financial goals, investment horizon, and overall financial situation.
Asset allocation:
Determine the suitable asset class based on the investor’s need, risk appetite, and investment horizon.
Equity: For growth-oriented investors with a long-term horizon and willingness to take risks.
Debt: For investors seeking stable income and lower risk tolerance.
Consider a balanced approach with a mix of equity and debt for a moderate risk profile.
Age of the investor:
Age alone should not be the sole factor in determining risk profile and investment decisions.
Evaluate the investor’s financial goals, situation, and risk tolerance on an individual basis.
Investment time horizon:
Longer investment horizon allows for higher risk tolerance.
Shorter timeframes may require more conservative investment choices to ensure capital preservation.
Core and satellite portfolio:
Divide the portfolio into core and satellite segments.
Core portfolio: Aligned with long-term goals, includes diversified equity funds, large-cap, and mid-cap funds.
Satellite portfolio: Utilized for short-term market movements, includes sector funds, long-term gilt funds, and gold funds.
Risk-return analysis:
Understand the risk-return levels associated with different categories of mutual fund schemes.
Evaluate historical performance, portfolio composition, and other relevant parameters.
Remember to analyze fund performance, portfolio composition, age of the scheme, and other key parameters when selecting a mutual fund scheme. It’s essential to align the chosen schemes with the investor’s specific needs, preferences, and risk profile.
Risk levels in mutual fund schemes:
Mutual fund schemes have different risk-return profiles based on their investment strategies and asset classes.
Risk and potential returns generally increase as one moves from left to right across different scheme categories.
Debt Funds:
The risk-return profile of debt funds is influenced by credit risk and interest rate risk.
As one moves from left to right, potential returns and interest rate risk increase.
Credit risk increases from left to right, indicating higher potential returns but also higher credit risk.
Equity Funds:
Equity funds have different risk levels based on the size of companies and portfolio concentration.
Smaller companies carry higher risk, so small-cap funds are riskier than mid-cap funds, which are riskier than large-cap funds.
Concentrated portfolios and sector funds are riskier than diversified funds.
Hybrid Funds:
Different categories of hybrid funds have varying risk levels, such as conservative, balanced, aggressive, dynamic asset allocation, multi-asset allocation, arbitrage, and equity savings funds.
Risk and potential returns generally increase as one moves from left to right across these categories.
Risk-o-Meter:
SEBI introduced the Risk-o-Meter to provide investors with a visual representation of the risk level in mutual fund schemes.
The Risk-o-Meter categorizes risk levels from low to very high.
The depiction of risk changed from color codes to a pictorial meter, providing a clear understanding of the risk involved.
The risk value of each scheme is calculated based on specific parameters and displayed on the Risk-o-Meter.
Evaluating Risk:
While the Risk-o-Meter helps in understanding risk levels, it should not be the sole factor in making investment decisions.
Investors should conduct thorough research and consider other factors before investing.
Seeking assistance from a mutual fund distributor or a registered investment adviser is recommended for those who require guidance.
Note: The Risk-o-Meter provides a simplified representation of risk levels, but it’s important to conduct detailed analysis and consider other risks associated with specific scheme categories.
Scheme Selection based on Investment Strategy of Mutual Funds:
Investment Objective, Investment Strategy, and Portfolio Characteristics are important factors in selecting mutual fund schemes.
Different investment strategies can be employed to achieve the same investment objective, and fund managers may construct different portfolios within the same strategy.
Active Funds vs. Passive Funds:
Passive funds, such as index funds and exchange-traded funds (ETFs), offer exposure to an asset class without the risks associated with active fund management.
Passive funds aim to replicate the performance of a specific market index and have lower costs compared to active funds.
Active funds involve higher costs and the risk of underperforming the benchmark, but they provide the potential for higher returns.
Open-ended Funds vs. Close-ended Funds:
Open-ended funds offer liquidity, allowing investors to redeem their units directly with the fund at the net asset value (NAV).
Close-ended funds offer liquidity through listing on a stock exchange, but trading volume may be limited. The market price of close-ended fund units may differ from the NAV.
Close-ended funds may have specific investment strategies and can target better returns by investing in stocks with growth potential or relatively illiquid stocks.
Diversified Funds vs. Sector Funds vs. Thematic Funds:
Diversified funds have exposure to multiple sectors, reducing risk. The fund manager aims to allocate more to better-performing sectors.
Sector funds concentrate investments in a specific sector, offering potential returns based on sector performance. They require a good understanding of sector dynamics and timing.
Thematic funds invest in stocks related to a specific theme, falling between diversified and sector funds. Examples include infrastructure funds or MNC (multinational corporation) funds.
Large-cap vs. Mid-cap vs. Small-cap Funds:
Large-cap funds invest in stocks of established companies with stable revenues and profitability.
Mid-cap and small-cap funds focus on companies in the early stages of growth, offering higher potential returns but higher risk.
Multi-cap funds spread investments across market capitalization categories, allowing exposure to various segments of the market.
Growth Funds vs. Value Funds:
Growth funds target stocks expected to grow at rates higher than the average market growth rate.
Value funds seek undervalued stocks that could appreciate in the future.
Both styles have their advantages and may be suitable based on market conditions and the investor’s risk profile.
International Equity Funds:
These funds provide exposure to international equity markets and foreign exchange fluctuations.
Investors may consider international equity funds for overall returns, diversification, or specific investment opportunities.
Fixed Maturity Plans (FMPs):
FMPs are close-ended debt funds with a fixed maturity period, offering predictable returns.
FMPs are suitable when the investment horizon matches the scheme’s maturity and when a more stable return is desired compared to conventional debt funds.
Short Duration Funds and Liquid Funds:
Short Duration Funds invest in securities with maturities between 1 and 3 years, providing relatively stable returns.
Liquid Funds are low-risk schemes suitable for short-term parking of funds, similar to a savings bank account.
Floater Funds:
Floater funds invest in floating-rate instruments and provide stable NAVs as they are less affected by interest rate fluctuations.
Investors should consider the strategy and risk profile of debt funds before investing.
Hybrid Schemes:
Hybrid schemes offer a mix of debt and equity exposures, providing both appreciation potential and stability.
Investors can choose a combination of equity and debt funds or invest in hybrid schemes based on their asset allocation preferences.
Gold Funds:
Gold ETFs track the price of gold, while Gold Sector Funds invest in shares of gold mining and processing companies.
Gold sector funds’ performance is linked to the profitability of these companies, while gold ETFs closely track the price of gold.
Investors should understand the structure and factors influencing the performance of gold schemes before investing.
Note: When selecting mutual fund schemes, it is important to consider investment objectives, risk tolerance, investment horizons, and seek professional advice if needed.
Selection of Mutual Fund Scheme Offered by Different AMCs or Within the Scheme Category:
AMC Evaluation: Different AMCs have varying approaches, styles, and values. Investors should feel comfortable with the AMC before investing in its schemes.
Matching Portfolio with Investment Objective: Evaluate whether the fund’s portfolio aligns with its investment objective and if the fund manager follows the intended strategy and style.
Fund Manager: Experienced investors often consider the fund manager’s skill and track record in identifying market trends and managing the portfolio.
Fund Performance: Evaluate the fund’s performance relative to its benchmark and peer group over various periods, considering both bull and bear market cycles.
Fund Portfolio: Assess the level of diversification, sector allocation, cash holdings, stock selection strategy, average maturity, duration, credit risk, and other factors relevant to the scheme’s risk and return.
Fund Age: Consider the fund’s track record, especially for newer funds managed by portfolio managers with limited experience.
Fund Size: Assess the fund’s size in relation to the investment universe, considering the advantages of diversification and economies of scale for large funds and the flexibility of smaller funds.
Portfolio Turnover: Evaluate the frequency of portfolio turnover, which affects broking costs and indicates the stability of investment management.
Scheme Running Expenses: Carefully consider the cost structure, particularly for debt schemes with potentially lower returns, and assess the appropriateness of expenses for passive index funds.
Risk, Return, and Risk-Adjusted Returns: Use these parameters to evaluate schemes and consider rankings and ratings assigned by mutual fund research agencies.
Note: When selecting mutual fund schemes, investors should consider their investment objectives, risk tolerance, and seek professional advice if needed.
Selecting Options in Mutual Fund Schemes:
Dividend Payout Option: This option provides regular income to investors as dividends are paid out periodically. However, dividend payments are subject to the availability of distributable surplus in the scheme, so there is no guarantee of receiving dividends even in schemes with a monthly payout option. Dividend income is also taxable as per the investor’s applicable tax slab, reducing overall returns. Investors seeking regular income may consider using a Systematic Withdrawal Plan (SWP) instead, which allows them to withdraw a specific amount from their investments regularly.
Dividend Reinvestment Option: In this option, dividends are reinvested back into the scheme, increasing the number of units held by the investor. This can lead to the benefit of compounding as the reinvested dividends generate additional returns over time. However, investors should be aware of the tax implications on dividends received and reinvested.
Growth Option: The growth option allows the investment to grow without any regular income payouts. It is suitable for investors who want their investments to compound over time without the annual taxation that dividends may attract. Investors can choose to sell units and withdraw funds as needed, which may have tax implications depending on the type of scheme (equity or debt) and the holding period.
Taxation and Liquidity: Consider the tax implications of different options based on the investor’s tax bracket and the type of scheme. Evaluate the liquidity needs and whether regular income can be achieved through other means like SWP. Discuss with a distributor or financial advisor to determine the most suitable option based on the investor’s circumstances.
Note: Taxation rules and regulations may vary across jurisdictions, so it’s important for investors to consult with a tax professional or financial advisor regarding their specific tax situation.
Do’s and Don’ts while Selecting Mutual Fund Schemes:
Do’s:
Ensure suitability: Comply with SEBI regulations by assessing the suitability of the scheme for the investor’s needs and situation.
Stick to investor’s asset allocation: Align the selection of schemes with the investor’s predetermined asset allocation strategy.
Understand investment objective and strategy: Evaluate the scheme’s investment objective and strategy to have a clear understanding of what to expect from the investment.
Consider taxes and loads: Take into account the impact of taxes and exit loads on investment returns, both during repurchases/redemptions and when choosing between dividend and growth options.
Develop a consistent methodology: Establish a consistent approach for scheme selection and maintain a written methodology to ensure consistency and adherence to investment principles.
Don’ts:
Chase past performance: Avoid selecting schemes solely based on their recent good performance, as past performance may not be sustained in the future.
Neglect investment objective and strategy: Do not overlook or disregard the scheme’s investment objective and strategy, as they provide important insights into the nature of the investment.
Overlook taxes and loads: Be mindful of the impact of taxes and loads on investment returns and consider them while making investment decisions.
Lack a consistent methodology: Avoid random or ad-hoc scheme selection without a consistent methodology, as it may lead to inconsistent or suboptimal investment choices.
Note: The above guidelines are general considerations and may vary depending on the specific circumstances and goals of the investor. It is always advisable to consult with a qualified financial advisor or professional before making investment decisions.
The benchmark for a hybrid fund is a blend of an equity and debt index.
For example, a hybrid scheme with 65% equity and the balance in debt can use a synthetic index calculated as 65% of S&P BSE Sensex and 35% of I-Bex.
CRISIL has created blended indices for hybrid funds (see Table 11.2).
CRISIL blended indices for hybrid funds
Scheme Category
Index
Debt Index
Equity Index
Aggressive Hybrid Fund
CRISIL Hybrid
25+75
–
Aggressive Index
Fund Index
Composite Bond
S&P BSE 200
(25% allocation)
Fund Index (75% allocation)
Balanced Hybrid Fund
CRISIL Hybrid
50+50
–
Moderate Index
Fund Index
Composite Bond
S&P BSE 200
(50% allocation)
Fund Index (50% allocation)
Conservative Hybrid Fund
CRISIL Hybrid
75+25
–
Conservative Index
Fund Index
Composite Bond
S&P BSE 200
(75% allocation)
Fund Index (25% allocation)
Gold ETF:
The benchmark for gold ETFs is the gold price.
Real Estate Funds:
Real estate funds may use real estate indices developed by real estate services companies, although these indices have shorter histories and less widespread acceptance compared to equity indices.
International Funds:
The benchmark for international funds depends on the country or region in which the scheme plans to invest.
For example, a scheme investing in China may use the Shanghai Composite Index as the benchmark, while a scheme investing in the US market may use the S&P 500.
A scheme investing across multiple countries can create a synthetic index that blends relevant indices from those countries.
Standard Benchmarks:
To standardize benchmarking and facilitate comparison, schemes need to disclose returns in INR and Compound Annual Growth Rate (CAGR) for specific benchmarks.
The benchmarks vary based on the scheme type, such as equity schemes using Sensex or Nifty as benchmarks and debt schemes using relevant government securities or T-Bills.
Hybrid funds, retirement funds, index funds, and exchange-traded funds (ETFs) have their specific benchmarks based on asset allocations or underlying indices.
Guiding Principles for Benchmarks of Mutual Fund Schemes:
SEBI has introduced guiding principles for uniformity in benchmarking mutual fund schemes.
The benchmarks are divided into two tiers: Tier-1 reflective of the scheme category and Tier-2 demonstrative of the investment style/strategy of the fund manager within the category.
Total Return Indices are used as benchmarks for all categories.
The type of scheme determines the type of benchmark, ranging from broad market indices to bespoke benchmarks based on investment style/strategy.
Quantitative Measures of Fund Manager Performance:
Relative Return Comparisons:
Comparing a scheme’s returns with its benchmark or peer group to determine outperformance or underperformance.
Periodic reviews of relative returns should be conducted by AMCs and trustees.
Risk-Reward Relationship:
Evaluating the performance of a fund manager based on the risk-reward relationship.
Return should be commensurate with the risk taken.
Risk-adjusted returns are used for such evaluations.
Sharpe Ratio:
Measures risk-adjusted returns.
Compares the risk premium earned by a scheme with the risk taken.
Calculated as (Rs – Rf) / Standard Deviation, where Rs is the scheme’s return, Rf is the risk-free rate, and Standard Deviation is a measure of risk.
Higher Sharpe Ratio indicates a better-performing scheme.
Sharpe Ratio comparisons should be done for comparable schemes.
Treynor Ratio:
Also measures risk-adjusted returns.
Uses Beta as a measure of risk instead of Standard Deviation.
Calculated as (Rs – Rf) / Beta, where Rs is the scheme’s return, Rf is the risk-free rate, and Beta measures the scheme’s risk compared to the market.
Higher Treynor Ratio indicates a better-performing scheme.
Treynor Ratio comparisons should ideally be restricted to diversified equity schemes.
Alpha:
Measures the performance of a scheme compared to a suitable market index.
Alpha is the difference between a scheme’s actual return and its optimal return.
Positive alpha indicates outperformance by the fund manager, while negative alpha suggests underperformance.
Alpha evaluations should be done for diversified equity schemes.
Note: Quantitative measures provide useful insights into performance, but should not be solely relied upon. A deeper understanding of underlying factors is crucial, and scheme evaluation requires expertise and analysis.
Tracking Error:
Beta of the market is defined as 1. An index fund that mirrors the index should also have a Beta of 1 and earn the same return as the market.
The difference between an index fund’s return and the market return is called the tracking error.
Tracking error measures the consistency of the fund manager’s outperformance relative to the benchmark.
Previously, tracking error was used to assess how closely an index fund tracked the benchmark’s returns, with a target of zero tracking error.
Now, tracking error is used to gauge how consistently a fund is able to outperform its benchmark.
Tracking error is calculated as the standard deviation of the excess returns generated by the fund.
A consistently outperforming fund should have a low tracking error.
Note: Tracking error helps evaluate the consistency of a fund’s outperformance but should not be the sole factor in assessing fund performance. Other factors, such as risk-adjusted returns and qualitative analysis, should also be considered.
Scheme Performance Disclosure:
SEBI mandates disclosure of performance data by AMCs, which can be accessed through scheme documents and the fund house’s website.
The Scheme Information Document (SID) needs to be updated annually, including the scheme’s performance numbers.
Fund fact sheets play a vital role and are published monthly by all fund houses, providing performance and other relevant information (not a statutory requirement).
Portals and product literature also provide access to scheme performance data and other performance measures.
Performance disclosure includes information on suitability, returns, and portfolio description.
Suitability highlights the scheme’s objective, asset class, investment period, and risk level.
Returns display cumulative returns, comparison with the benchmark, and discreet annual returns for assessing consistency.
Portfolio description explains how assets will be allocated and securities selected, reflecting the scheme’s risk and return characteristics.
Fund Factsheets:
Fund factsheets are official sources of information issued by the fund house monthly.
They provide details about the fund’s objective, performance, portfolio, and basic investment requirements.
Factsheets may also include the fund manager’s views on the economy and markets, helping investors and other observers understand the fund’s performance and market conditions.
While not mandatory, most fund houses publish factsheets as a means of communicating with investors.
Metrics of Analysis in Factsheet:
Factsheets include various metrics for analysis, such as market indices, corporate results, government spending, inflation levels, interest rate changes, investor activity, GDP numbers, overseas economic data, commodity prices, and input prices.
These metrics help assess the performance of the scheme, evaluate market conditions, and anticipate the impact on companies and the economy.
Scheme Performance on AMFI Website:
The Association of Mutual Funds in India (AMFI) website provides performance data for all mutual fund schemes.
Investors can access the data for different periods and fund categories.
Raw data of NAVs, dividends, etc., can be subscribed to and downloaded through various vendors for integration into investor-management systems.
Note: Scheme performance disclosure provides valuable information for investors to assess the performance and suitability of mutual fund schemes.
Restriction on liquidity due to trading volumes, settlement periods, and transfer procedures.
Market liquidity may be impacted by company/sector/general market-related events, causing price impact and potential losses.
Settlement delays or problems can lead to uninvested assets and missed investment opportunities.
Interest Rate Risk:
Fixed income securities are prone to price fluctuations based on changes in interest rates.
Rising interest rates can lead to a decrease in security prices, while declining rates can increase prices.
Derivatives are also exposed to price changes due to interest rate movements.
Reinvestment Risk:
The risk associated with reinvesting cash flows received from securities at lower rates.
The actual rate of reinvestment may be lower than initially assumed, affecting overall returns.
Political Risk:
Adverse impacts on investments due to changes in the political scenario at central, state, or local levels.
Government actions and policies can affect the economy, businesses, and market conditions.
Economic Risk:
Slowdown in economic growth or macroeconomic imbalances can negatively affect investments.
Central and state level fiscal deficits can impact the volume of new investments in the country.
Foreign Currency Risk:
Foreign investors may experience losses due to currency movements when investing in Indian Rupees (INR).
The responsibility to manage or reduce currency risk lies with the foreign investors.
Settlement Risk (Counterparty Risk):
Risk of default by the counterparty involved in specific floating rate assets or swaps.
Specific Risk Factors:
Risk related to equity and equity-related securities:
Volatility and daily price fluctuations in equity markets.
Liquidity restrictions and settlement problems can impact investments and potential losses.
Various factors like interest rates, currency exchange rates, changes in law/policies, and economic developments can affect securities.
Risk associated with short selling and Stock Lending:
Risks involved in securities lending, including the failure of the other party and loss of rights to collateral.
Short-selling carries counterparty and liquidity risks, and covering securities at higher prices can lead to losses.
Risks associated with mid-cap and small-cap companies:
Higher volatility and market liquidity risks compared to large-cap stocks.
Potential earnings variations and unexpected market changes can adversely affect investment results.
Risk associated with Dividend:
Dividends are not guaranteed, and companies may not continue to pay dividends in the future.
Variations in company profitability can impact dividend payments and scheme performance.
Risk associated with Derivatives:
Derivative products require specialized investment techniques and risk analysis.
High leverage and small margin can lead to significant profit or loss compared to the principal investment.
Price movements in the underlying securities can impact derivative values and the NAV of the scheme.
Note: The above notes can be presented in a tabular format for better organization and clarity.
General Risk Factors
Specific Risk Factors
Liquidity Risk
Risk related to equity and equity-related securities
Interest Rate Risk
Risk associated with short selling and Stock Lending
Reinvestment Risk
Risks associated with mid-cap and small-cap companies
Political Risk
Risk associated with Dividend
Economic Risk
Risk associated with Derivatives
Foreign Currency Risk
Settlement Risk (Counterparty Risk)
Risks Associated with Derivatives
– Counterparty Risk
– Market Liquidity Risk
– Model Risk
– Basis Risk
– Difficulty in executing derivative transactions
– Risks in index futures
– Leveraged nature of derivatives
– No assurance of profitable strategies
– Interest rate risk and liquidity risk in fixed income derivatives
Risks Related to Debt Funds
– Reinvestment Risk
– Rating Migration Risk
– Term Structure of Interest Rate Risk
– Credit Risk
Risks Associated with Floating Rate Securities
– Spread Risk
– Basis Risk
Risks due to Possible Prepayments
– Changes in tenor and yield
Risks Associated with Investments in Securitized Assets
– Risks related to asset class
– Risks related to pool characteristics
– Credit rating and adequacy of credit enhancement
– Limited liquidity and price risk
– Limited recourse to originator and delinquency
– Risk of co-mingling
– Bankruptcy of originator or seller
– Bankruptcy of investor’s agent
Risks Associated with Investments in REITs and InvITs
– Price-risk
– Interest rate risk
– Credit risk
– Liquidity or marketability risk
– Reinvestment risk
– Lower-than-expected distributions
Risk Management Strategies
– Managing market liquidity risk
– Managing credit risk
– Managing term structure of interest rates risk
– Managing rating migration risk
– Reinvestment risk management
– Conducting thorough research and due diligence
– Monitoring company-specific factors
– Limiting investments in floating rate securities
– Regular monitoring of equity exposure for favourable taxation
Factors that Affect Mutual Fund Performance
– Different asset classes and strategies
– Risks inherent in asset classes
– Risks taken by fund managers
– Outperformance of benchmark
Difference between Market/Systematic Risk and Company Specific Risk
– Market/Systematic Risk: Impacts entire economy or market
– Company Specific Risk: Impacts individual companies
– Market risk is non-diversifiable, while company risk is diversifiable
– Market risk is also known as systematic risk, while company risk is unsystematic risk
Mutual Fund Investments are Subject to Market Risks
– Mutual fund investments are pass-through vehicles
– Credit risk is the risk of default on investments
– Diversification helps reduce credit risk
– Market-wide price fluctuations are unavoidable
– Diversification can reduce security-specific risk
Drivers of Returns and Risk in a Scheme
– Portfolio composition determines returns
– Asset class, market segment, and investment strategies impact risk and return
– Factors differ for each asset class
Factors Affecting Performance of Equity Schemes
– Returns from equity linked to business earnings
– Risks include business performance and market volatility
– Strategies: security selection and market timing
– Fundamental analysis (business and financials) and technical analysis (price behavior)
Factors Affecting Performance of Debt Schemes
– Risks: interest rate risk and credit risk
– Yields influenced by interest rates and credit spreads
– Duration management and credit quality analysis
– Focus on accrual or interest income, or appreciation
– Money market, ultra-short term, and dynamic bond funds
Factors Affecting Performance of Gold Funds
– Gold prices influenced by global demand-supply balance
– Safe-haven asset, affected by political and economic turmoil
– Rupee exchange rate impacts returns
– Passive funds with no view on gold price movement
Factors Affecting Performance of Real Estate Funds
– Local factors influence real estate value
– Economic scenario, infrastructure development, and interest rates
– Residential, commercial, industrial, infrastructural, warehouse, hotel, or retail properties
– Rental income and capital appreciation
– Portfolio composition and neutral valuation agencies
Measures of Returns
Simple Return:
Formula: ((Later Value – Initial Value) / Initial Value) x 100
Example: If your investment grew from Rs. 12 to Rs. 15, the simple return would be 25%.
Annualized Return:
Formula: (((1 + Return A)^(1/n)) – 1) x 100
Example: Comparing returns of two investments with different time periods.
Compounded Return:
Formula: ((Later Value / Initial Value)^(1/n)) – 1
Example: Calculating returns when compounding is considered.
Compounded Annual Growth Rate (CAGR):
Formula: (((Later Value / Initial Value)^(1/n)) – 1) x 100
Example: Considering dividends and compounding for accurate returns.
Scheme Returns vs. Investor Returns:
Scheme returns may differ from investor returns due to loads, taxes, and other factors.
Use actual investment amounts and received/receivable amounts for accurate investor returns.
Holding Period Returns:
Calculated for fixed periods (e.g., one month, one year) using CAGR or simple absolute returns.
Rolling returns are averaged consecutive returns to eliminate the impact of extreme initial or end values.
Pros and Cons of Evaluating Funds based on Return Performance:
Return performance is an important factor but should be considered alongside consistency and benchmark comparison.
Risk assessment is crucial, including volatility in returns over time.
It’s important to note that these measures provide different perspectives on investment returns and should be used in conjunction with other factors for a comprehensive analysis.
SEBI Norms regarding Representation of Returns by Mutual Funds in India:
Mutual funds cannot promise returns unless it is an assured returns scheme with a guarantor.
SEBI has prescribed the Advertisement Code and guidelines for disclosing performance-related information of mutual fund schemes.
Risks in Fund Investing with a Focus on Investors:
Equity Funds:
Price fluctuations are inherent risks, with higher risks in small-cap and focused funds.
Small-cap and mid-cap companies carry higher business risks compared to large-cap companies.
Liquidity risk should be considered even for long-term equity investments.
Investors should align investments with their risk profile and maintain liquidity through liquid funds.
Debt Funds:
NAV fluctuations can occur due to changes in interest rates or credit migration.
Dividend distributions are not guaranteed, and some schemes may skip dividends in certain periods.
Limited liquidity may be experienced in liquid, ultra-short-term, or low-duration funds during gating provisions or segregated portfolios.
Remaining investors may face higher risks if others exit the scheme, in the absence of segregated portfolios.
Debt funds are not entirely risk-free, and low risk does not mean zero risk.
Hybrid Funds:
Distributors should carefully evaluate and select schemes based on the defined asset allocation between equity and debt.
Some arbitrage funds may have provisions to invest in debt securities, introducing price movement risks.
Gold Funds:
Gold prices provide better pricing transparency and perform well during financial market turmoil and currency weakening.
Gold funds carry the risk of loss if the value or price of gold falls.
Real Estate Funds:
Real estate investments involve risks such as subjective valuation, illiquidity, high transaction costs, regulatory risk, and litigation risk.
Real estate funds are relatively high-risk compared to other scheme types but less risky than direct real estate investment.
Family-owned real estate groups may have poor corporate governance standards, further increasing investment risks.
It is important for investors to understand the risks associated with different types of funds and align their investments with their risk tolerance and investment objectives.
Certain Provisions with respect to Credit Risk:
Credit Risk in Debt Markets:
Credit risk arises from default, delay in payments, or rating downgrade in debt securities.
Mutual funds may face stress if a large part of the scheme is redeemed during a credit event.
Gating or Restriction on Redemption:
Restriction on redemption applies during excess redemption requests in overall market crisis situations.
Imposed when there are liquidity issues or operational problems affecting the markets.
No restriction for redemption requests up to Rs. 2 lakhs; requests above Rs. 2 lakhs subject to restriction.
The restriction period should not exceed 10 working days in any 90-day period.
Segregated Portfolio or Side Pocketing:
Segregated portfolio creation is permitted for debt and money market instruments affected by a credit event.
It is optional and at the discretion of the AMC, with trustee approval and disclosure.
Units in the segregated portfolio are distributed to investors and cannot be redeemed or subscribed.
Units of the segregated portfolio can be listed on recognized stock exchanges for exit facilitation.
Illustration of Segregated Portfolio:
Example demonstrates the creation of a segregated portfolio for a downgraded security and its impact on the main portfolio.
Includes valuation, net assets, unit capital, and NAV (Net Asset Value) per unit for both portfolios.
NFO is the initial offering of units in a mutual fund scheme to investors.
Standardization of investor services is crucial for a consistent and predictable experience.
Standardization helps investors understand what to expect and what not to expect.
Key Steps in the NFO Process:
The Asset Management Company (AMC) selects a scheme based on inputs from the Chief Investment Officer (CIO) and Chief Marketing Officer (CMO).
AMC prepares the Scheme Information Document (SID), which requires approval from Trustees and the Board of Directors (BoD) of the AMC.
SID is filed with SEBI, and any observations made by SEBI are incorporated.
AMC determines the NFO timetable, considering market conditions.
Advertising and public relations campaigns are launched to create awareness about the NFO, complying with SEBI’s advertising code.
Events are conducted for intermediaries and the press to familiarize them with the scheme’s unique features and benefits.
Scheme Documents and Application Forms are distributed to market intermediaries and circulated in the market for investors to apply in the NFO.
Dates in the NFO of an Open-Ended Scheme:
NFO Open Date: The date from which investors can invest in the NFO.
NFO Close Date: The date until which investors can invest in the NFO.
Scheme Re-Opening Date: The date from which investors can offer units for re-purchase or buy new units at respective prices.
Sale and re-purchase prices are announced by the AMC from the Scheme Re-Opening Date.
Close-Ended Schemes:
Close-ended schemes have an NFO Open Date and NFO Close Date.
They do not have a Scheme Re-opening Date as units are not sold or re-purchased.
Investors buy or sell units from the stock exchange where the scheme is listed.
SEBI Guidelines for NFOs:
NFOs (excluding ELSS) can remain open for a maximum of 15 days.
Allotment of units or refund of money should be completed within 5 business days after the scheme closes.
Open-ended schemes must re-open for sale/re-purchase within 5 business days of the allotment.
New Fund Offer (NFO) Price vs. Ongoing Offer Price
NFO Price:
The NFO Price is the price per unit that investors need to pay during the New Fund Offer.
It is the initial price at which units of the mutual fund scheme are offered to investors during the NFO.
Investors can subscribe to the scheme at this price during the NFO period.
Ongoing Offer Price:
The Ongoing Offer Price is the price at which investors can purchase, redeem (sell), or switch out units in the mutual fund.
It applies after the NFO period has ended and the scheme is open for regular subscriptions and redemptions.
Investors can buy additional units or sell/switch out their existing units at the prevailing ongoing offer price.
Note: To present this information in a table format, you can use the following structure:
Type of Price
Description
NFO Price
Price per unit during the New Fund Offer (NFO) period
Ongoing Offer Price
Price for purchase, redemption (sale), or switch-outs
Investment Plans and Services
Direct and Regular Plans:
Investors have the choice to invest directly through the Asset Management Company (AMC) or through distributors.
Each mutual fund offers two plans: regular plan and direct plan.
Direct plans have a lower expense ratio as they exclude distribution expenses and commissions. No commission is paid from direct plans.
Regular plans have a higher expense ratio as they include distribution expenses and commissions.
Both plans have separate Net Asset Values (NAVs).
Income Distribution cum Capital Withdrawal (Dividend) Options:
Mutual fund schemes typically offer three options: Income Distribution cum Capital Withdrawal, Growth, and Reinvestment of Income Distribution cum Capital Withdrawal.
The dividend option has been renamed to Income Distribution cum Capital Withdrawal from April 1, 2021, to reflect the actual income situation for investors.
All three options have the same portfolio returns but differ in cash flows, income accruals, tax implications, and the number and value of units held.
In the Pay-out option, the fund declares dividends, resulting in a decline in NAV. The investor receives the dividend in their bank account, but the number of units held remains the same.
In the Reinvestment option, dividends are reinvested in the same scheme at the ex-dividend NAV. Additional units are allotted to the investor.
In the Growth option, no dividends are declared. The NAV captures the full value of portfolio gains, but there is no increase in the number of units held.
Note: The implications of different options can be summarized in a table format:
Parameter
Income Distribution cum Capital Withdrawal (Pay-out Option)
Income Distribution cum Capital Withdrawal (Reinvestment Option)
Growth Option
Dividend received in bank account
Yes
No
No
Tax on Dividend
Yes
Yes
N.A.
Increase in number of units on account of reinvestment of dividend
No
Yes
No
NAV change
NAV declines to the extent of dividend
NAV declines to the extent of dividend
NAV captures the portfolio gain
Allotment of Units to the Investor
NFO Allotment:
Units in a New Fund Offer (NFO) are sold at the face value, typically Rs. 10 per unit.
The number of units allotted to the investor is determined by dividing the investment amount by the face value.
All valid applications received during the NFO period, subject to meeting the specified minimum subscription amount, are fully allotted.
The Trustee reserves the right to reject any application without providing a reason.
Allotment is completed within 5 business days after the closure of the NFO.
For applicants who have provided their demat account details, the units are credited within 2 working days to their demat accounts.
On-Going Offer Allotment:
In an on-going offer for an open-end scheme, units are sold to investors at the applicable Net Asset Value (NAV).
The sale price is equal to the NAV since entry load is not permitted.
The number of units allotted to the investor is determined by dividing the investment amount by the sale price (NAV).
Rights Issue and Bonus Issue:
In a rights issue, the units are offered at a specific price, and the number of units allotted is determined by dividing the investment amount by the rights price.
In a bonus issue, no payment is required, and new units are allotted for free. The ratio of new units depends on the bonus issue (e.g., 1:3 means 1 new unit for every 3 existing units).
Allotment Process:
Allotted units are credited to the investor’s demat account if they have opted for receiving dematerialized units.
Dematerialized units are fully transferable.
In case of application rejection, the full amount is refunded within 5 business days from the closure of the NFO. Any delay in refund attracts 15% p.a. interest, payable by the AMC.
Note: The information can be presented in a table format for a clearer visual representation of the allotment process and options:
Type of Offer/Issue
Allotment Process
NFO
Units sold at face value (Rs. 10 per unit). Number of units allotted is investment amount divided by 10.
On-Going Offer
Units sold at applicable NAV. Number of units allotted is investment amount divided by the NAV.
Rights Issue
Units offered at a specific price. Number of units allotted is investment amount divided by the price.
Bonus Issue
Units allotted for free. Ratio determined by the bonus issue.
Allotment Process
Allotted units credited to demat account (if opted for). Demat units are fully transferable.
Refund in Case of Rejection
Full amount refunded within 5 business days. Delay attracts 15% p.a. interest payable by the AMC.
Account Statements for Investments
Monthly Statement of Account:
Mutual funds issue a Monthly Statement of Account if there is a transaction during the month.
The statement includes details of each transaction (sale/re-purchase), such as transaction value, relevant NAV, and number of units transacted.
It also provides the closing balance of units held in the folio and the value of those units based on the latest NAV.
Annual Account Statement:
Mutual funds provide an Annual Account Statement to unit holders who have not transacted in the last six months prior to the statement’s generation date.
The statement reflects the latest closing balance and value of units before the generation date.
Account statements may be generated and issued annually, or a soft copy may be sent to the registered email address of the investor if mandated.
Consolidated Account Statement (CAS):
A CAS is sent by post/email each calendar month if there has been a financial transaction in the folio during the previous month.
If an email ID is registered with the AMC, the CAS is sent via email.
CAS is sent to investors based on their Permanent Account Number (PAN) for identification across mutual funds.
In cases where PAN is not available, individual account statements are sent since a consolidated statement cannot be generated.
If there are no transactions in a folio for any six-month period, a CAS detailing holdings across all schemes of all mutual funds is sent at the end of that period (i.e., September/March).
The periodicity and time limit for sending these account statements to investors are specified by SEBI.
Note: The information can be presented in a table format to summarize the types of account statements and their distribution methods:
Account Statement
Description
Monthly Statement
Issued if there is a transaction during the month. Shows transaction details and closing balance.
Annual Account Statement
Provided to unit holders with no transactions in the last six months. Reflects the latest balance.
Consolidated Account Statement (CAS)
Sent monthly by post/email if there has been a financial transaction in the folio. PAN-based identification. Includes holdings across mutual funds.
Mutual Fund Investors: Eligibility and Sources of Information
Eligibility to Invest:
Individual Investors:
Resident Indian adult individuals above the age of 18 can invest, either singly or jointly (not exceeding three names).
Minors (persons below the age of 18) need to invest through their guardians.
Hindu Undivided Families (HUFs) can invest with the head of the family (Karta) investing on behalf of the family.
Non-Resident Indians (NRIs)/Persons of Indian Origin (PIO) residing abroad can invest on a repatriable or non-repatriable basis.
Foreign investors can invest in equity schemes after completing the KYC process.
Non-individual Investors:
Companies, registered societies, co-operative societies, religious and charitable trusts, private trusts, partnership firms, associations of persons, banks, financial institutions, investment institutions, mutual funds, foreign portfolio investors, international multilateral agencies, eligible institutions, scientific and industrial research organizations, universities, and educational institutions can invest.
Specific classes of non-individual investors may be permitted in certain schemes.
Sources of Information on Eligibility to Invest:
Individual investors can invest in any mutual fund scheme unless a specific scheme or plan within a scheme is not intended for any category of investors.
Non-individual investors can generally invest in any mutual fund scheme, but specific classes may be restricted in certain schemes.
It is recommended to check the “Who can Invest?” section of the Scheme Information Document (SID) to verify eligibility, especially for first-time investors.
Note: The information can be summarized in a table format:
Type of Investor
Eligibility to Invest
Individual Investors
Resident Indian adults, minors (through guardians), HUFs, NRIs/PIOs, Foreign investors
Non-individual Investors
Companies, registered societies, trusts, partnership firms, banks, financial institutions, mutual funds, foreign portfolio investors, research organizations, universities, etc.
Sources of Information
Check the “Who can Invest?” section of the Scheme Information Document (SID)
Filling the Application Form for Mutual Funds: Key Points
Direct Plan and Regular Plan:
Investors can choose between a Direct Plan (investing directly without a distributor) or a Regular Plan (investing through a distributor).
For Direct Plan, mention “Direct” in the space provided for the AMFI Registration Number (ARN).
For Regular Plan, provide the ARN/RIA number and other details.
Unit Holder Information:
A mutual fund investment can have up to three holders.
The primary investor is the first holder, and all benefits go to them.
Provide details such as name(s), nationality, identity proof, KYC compliance, signatures, address, and communication details.
Overseas address should be provided for FPI/NRI/PIO investors.
Minor as a Unit Holder:
Minors (below 18 years) must invest through a guardian.
Guardian complies with KYC and PAN requirements.
Provide proof of age of the minor and establish the relationship/legal guardianship.
POA as a Unit Holder:
Power of Attorney (PoA) holders must comply with KYC and PAN requirements.
Submit a certified copy of the PoA.
Grantor can continue to operate the account, except for nominations.
Status of the Holder and Mode of Holding:
Provide the status of the first holder as an individual or non-individual.
Select the mode of holding and operating the account (single/joint/either or survivor).
Joint holders cannot be added or deleted, except in the event of death.
KYC Details:
Provide the KYC acknowledgement letter for each holder.
Non-Indian applicants need to provide additional information under FATCA and CRS.
Include details of place/city of birth, country of birth, country of citizenship/nationality, and tax residency.
Bank Account Details:
Provide bank account details of the sole/first holder.
Include bank name, branch, account number, type, MICR code, and IFSC details.
Bank details should match those linked to the demat account for holding units in dematerialized form.
Investment Details:
Select the scheme, plan, option, and payout option.
Regular Plan involves a distributor, while Direct Plan does not.
Choose between growth and dividend options, with different dividend payout frequencies.
Payment Details:
Specify the payment instrument and account used for the investment.
Mention the application number or folio number on the reverse of the payment instrument.
Dividends and redemption proceeds are credited directly to the bank account.
Unit Holding Option:
Choose to hold units in physical or dematerialized form (demat account).
Provide beneficiary account details and depository participant (DP) information.
Dividends and redemption proceeds are paid to the bank account linked to the demat account.
Nomination:
Nominate up to three individuals and indicate the percentage for each nominee.
Some funds may require a separate declaration if not nominating.
Minimum Investment:
Refer to the Scheme Information Document (SID) for the minimum application amount.
Ensure the investment meets the minimum investment limit set by the mutual fund.
All holders must sign the application form, regardless of the mode of holding.
Financial Transactions with Mutual Funds
I. Initial Purchase of Mutual Fund Units:
Fresh purchase made during the new fund offer (NFO) period or in an ongoing open-ended scheme.
Application form and prescribed documentation required.
Existing investors can use the application form for fresh purchases or additional purchases in the same scheme.
Personal information provided in the application form is used to create the investor record or folio.
II. Additional Purchases:
Once an investor has a folio, subsequent investments don’t require a full application form.
Transaction slip with folio number and payment required for additional purchases.
Most mutual funds provide a transaction slip along with the Statement of Account.
Blank transaction slips are available at AMC branches, distributors, and ISCs.
Existing folio details override conflicting information in the application form.
III. Repurchase of Units:
Investor can offer units for repurchase to the mutual fund.
Transaction slip with folio number, scheme details, and re-purchase amount/units required.
Repurchase price is the applicable NAV less Exit Load.
Investor can specify the re-purchase amount or number of units.
Units are redeemed on a First-in-First-Out (FIFO) basis.
Redemption requests can be made physically or through a depository participant (DP) for dematerialized units.
IV. Switch:
A switch is a redemption from one scheme and a purchase into another combined into one transaction.
V. Payment Mechanism for Mutual Fund Purchases:
Payments should be made through approved banking channel modes.
Online transactions via internet banking, UPI, or digital payment mediums are convenient and secure.
ASBA (Application Supported by Blocked Amount) allows blocking the application money in the investor’s bank account.
AEPS (Aadhaar Enabled Payment Service) enables bank-to-bank transactions using the Aadhaar number.
NUUP (National Unified USSD Platform) facilitates mobile banking without a smartphone or internet.
Cards (debit, credit, prepaid) are commonly used for digital payments.
E-Wallets provide virtual wallets for making payments and transfers, subject to limits and regulations.
Other payment mechanisms include cheque/demand draft and cash (subject to restrictions).
VI. One-Time Mandate (OTM):
OTM allows authorization for the bank to process debits for mutual fund purchases.
Investors need to fill an OTM form to register a bank account for this facility.
OTM is valid at the folio level and eliminates the need for initiating payment with each transaction.
OTM can be used for physical, online, SMS, and other modes of transactions offered by the mutual fund.
VII. Other Payment Mechanisms:
Third-party payments are generally not accepted, except for specific cases with proper documentation.
Cash payments are allowed for small investors up to Rs. 50,000 per financial year, subject to compliance with regulations.
Instruments not accepted for payment include stock-invests, postal orders, money orders, outstation cheques, and post-dated cheques (except for systematic investments).
Payment Mechanism for Repurchase of Units:
I. Cheque:
Traditional approach with delayed receipt of money due to various processes involved.
Time taken by the AMC to prepare and send the cheque.
Time taken by postal authorities/courier to deliver the cheque.
Time taken by the investor to deposit the cheque in the bank.
Time taken by the banking system to transfer the proceeds to the investor’s bank account.
II. Electronic Modes:
Faster and more efficient than cheques.
Direct Credit from the mutual fund’s account to the investor’s bank account (if arrangement exists).
Other electronic modes include RTGS/NEFT/NACH, requiring account details (number, branch address, IFSC/MICR code).
Availability of electronic modes depends on geographic location and bank/branch relationship.
Cheques and demand drafts used if electronic modes are not available.
III. Redemption Proceeds:
Paid in favor of the sole/first holder of the folio.
Cheques sent to the unitholder’s address.
For dematerialized units, proceeds paid into the bank account registered with the DP.
Non-resident investors receive payment in rupees, with associated costs for converting into foreign currency if desired.
Repatriable investments can be credited to NRE/FCNR accounts.
Tax deducted at source for redemptions by NRIs.
IV. Multiple Bank Accounts:
Investors can register multiple bank accounts to receive redemption, dividends, and other payouts.
Individual investors can register up to five bank accounts, non-individual investors can register up to ten.
First holder of the folio must be an account holder in each registered account.
One account is designated as the default account for credits, unless otherwise specified.
Investors can change the default bank account by instructing the AMC.
V. NRI Investments:
Payment made through NRO account requires the registered account to be of the same type.
Payment made through NRE account allows registered accounts to be NRO or NRE.
VI. Instant Access Facility (IAF):
Available in Liquid schemes of the mutual fund.
Facilitates credit of redemption proceeds on the same day of the redemption request.
Monetary limit of Rs. 50,000 or 90% of the latest value of investment, whichever is lower.
Limit applicable per day per scheme per investor.
Cut-off Time and Time Stamping:
I. Cut-off Time for NAV Determination:
SEBI has prescribed cut-off timing to determine the applicable NAV for fairness to investors.
Applicable for equity-oriented funds and debt funds (except liquid funds) for purchases and switch-ins.
Cut-off time for purchases and switch-ins is 3:00 pm.
The NAV applicable is of the business day on which funds are available for utilization before the cut-off time.
Liquid funds have a different cut-off time and NAV determination.
II. Cut-off Time and Applicable NAV for Different Types of Schemes:
Equity Oriented Funds and Debt Funds (Except Liquid Funds):
Cut-off time for purchases and switch-ins: 3:00 pm.
Applicable NAV: NAV of the business day on which funds are available for utilization before the cut-off time.
Liquid Funds:
Cut-off time for purchases and switch-ins: 1:30 pm.
Applicable NAV: a. If the application is received before the cut-off time and funds are available for utilization before the cut-off time: Closing NAV of the day immediately preceding the day of the receipt of the application. b. If the application is received after the cut-off time and funds are available for utilization on the same day: Closing NAV of the day immediately preceding the next business day. c. If the funds are not available for utilization before the cut-off time: Closing NAV of the day immediately preceding the day on which the funds are available for utilization.
Equity Oriented Funds, Debt Funds (Other than Liquid Funds), and Liquid Funds:
Cut-off time for redemptions and switch-outs: 3:00 pm.
Applicable NAV: Same day NAV if received before the cut-off time, next business day NAV for applications received after the cut-off time.
III. Examples of Applicable NAV Calculation:
Examples provided for different scenarios of purchase, redemption, and liquid fund transactions.
Explanation on how the NAV is determined based on the cut-off time and availability of funds.
IV. Time Stamping Mechanism:
Mutual funds disclose Official Points of Acceptance (OPoAs) where transaction requests need to be submitted.
Time stamping is done at the OPoAs with tamper-proof machines.
Sequential numbering of applications for tracking and documentation purposes.
Stamping of applications, payment instruments, and acknowledgments with location code, machine identifier, serial number, date, and time.
Online transactions use the time of the web server for NAV determination.
Note: The cut-off time and time-stamping mechanism ensure transparency and accuracy in determining the applicable NAV for different types of transactions in mutual funds.
KYC Requirements for Mutual Fund Investors:
I. Who Needs to be KYC Compliant?
All investors, including individuals, non-individuals, joint holders, NRIs, PoA holders, and guardians of minors, must be KYC compliant.
KYC compliance is mandatory irrespective of the investment value.
Applicable for new/additional purchases, switch transactions, new SIP/micro-SIP registrations, new STP registrations, and new DTP registrations.
II. KYC Process and Required Documents:
KYC process establishes the identity and address of the investor as per Anti-Money Laundering Laws.
Application for investment must be accompanied by the KYC acknowledgement issued by the KYC Registration Agency (KRA).
The following documents are required for KYC: a. Permanent Account Number (PAN) Card with photograph (mandatory, except for specific exemptions). b. Proof of Address (e.g., Passport, Voter’s ID, Ration Card, etc.). c. Self-attested copies of the documents must be provided, and originals may be required for verification.
III. PAN Exemptions for Mutual Fund Investments:
Certain categories of investors are exempt from providing PAN for mutual fund investments: a. Transactions on behalf of Central/State governments and court-appointed officials. b. Investors residing in Sikkim. c. UN entities/Multilateral agencies exempt from taxes/filing tax returns in India. d. Mutual fund investments up to Rs. 50,000 per investor per year.
IV. Centralised KYC Registration Agencies (KRAs):
SEBI instituted a centralised KYC process for the capital market, including mutual funds.
Once KYC is completed with one intermediary, it is valid across the capital market.
KRAs facilitate the centralised KYC process and store investor data for access by reporting entities.
In-Person Verification (IPV) of the investor is mandatory and can be performed by intermediaries or scheduled commercial banks.
V. KYC through e-KYC service of UIDAI:
UIDAI’s e-KYC service is accepted as a valid process for KYC verification.
Investor authorizes intermediaries to access their data through UIDAI system for verification.
Registered intermediaries enter into agreements with KYC User Agencies (KUA) to undertake Aadhaar Authentication.
Investors submit their OVDs (Officially Valid Documents) for KYC through online/digital platforms or email.
VI. KYC for Minors, Power of Attorney (PoA) Holders, and NRIs:
For investments by minors, KYC requirements are complied with by the guardian.
KYC requirements must be met by both investor and PoA holder for investments made through PoA.
NRIs need to provide PAN, passport/PIO card/OCI card, and overseas address proof for KYC compliance.
VII. Additional Requirements for Institutional Investors:
Institutional investors require eligibility to invest, authorizations, and details of Ultimate Beneficial Owners (UBOs).
UBOs own or control a certain percentage of shares/profits or are beneficiaries of trusts.
UBO requirements are not applicable to listed companies or subsidiaries.
VIII. Legal Information and Mandatory Declarations:
Clients of SEBI registered intermediaries need to provide information to verify the identity of beneficial owners or controllers of securities accounts.
Compliance with Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standards (CRS) provisions.
Information regarding citizenship, nationality, place of birth, tax residency, and taxpayer reference ID may be required.
Note: The KYC process ensures compliance with anti-money laundering laws and helps establish the identity and address of mutual fund investors. It involves submitting required documents, verification processes, and adherence to PAN and FATCA/CRS regulations.
KYC Requirements for Mutual Fund Investors:
I. Who Needs to be KYC Compliant?
All investors, including individuals, non-individuals, joint holders, NRIs, PoA holders, and guardians of minors, must be KYC compliant.
KYC compliance is mandatory irrespective of the investment value.
Applicable for new/additional purchases, switch transactions, new SIP/micro-SIP registrations, new STP registrations, and new DTP registrations.
II. KYC Process and Required Documents:
KYC process establishes the identity and address of the investor as per Anti-Money Laundering Laws.
Application for investment must be accompanied by the KYC acknowledgement issued by the KYC Registration Agency (KRA).
The following documents are required for KYC: a. Permanent Account Number (PAN) Card with photograph (mandatory, except for specific exemptions). b. Proof of Address (e.g., Passport, Voter’s ID, Ration Card, etc.). c. Self-attested copies of the documents must be provided, and originals may be required for verification.
III. PAN Exemptions for Mutual Fund Investments:
Certain categories of investors are exempt from providing PAN for mutual fund investments: a. Transactions on behalf of Central/State governments and court-appointed officials. b. Investors residing in Sikkim. c. UN entities/Multilateral agencies exempt from taxes/filing tax returns in India. d. Mutual fund investments up to Rs. 50,000 per investor per year.
IV. Centralised KYC Registration Agencies (KRAs):
SEBI instituted a centralised KYC process for the capital market, including mutual funds.
Once KYC is completed with one intermediary, it is valid across the capital market.
KRAs facilitate the centralised KYC process and store investor data for access by reporting entities.
In-Person Verification (IPV) of the investor is mandatory and can be performed by intermediaries or scheduled commercial banks.
V. KYC through e-KYC service of UIDAI:
UIDAI’s e-KYC service is accepted as a valid process for KYC verification.
Investor authorizes intermediaries to access their data through UIDAI system for verification.
Registered intermediaries enter into agreements with KYC User Agencies (KUA) to undertake Aadhaar Authentication.
Investors submit their OVDs (Officially Valid Documents) for KYC through online/digital platforms or email.
VI. KYC for Minors, Power of Attorney (PoA) Holders, and NRIs:
For investments by minors, KYC requirements are complied with by the guardian.
KYC requirements must be met by both investor and PoA holder for investments made through PoA.
NRIs need to provide PAN, passport/PIO card/OCI card, and overseas address proof for KYC compliance.
VII. Additional Requirements for Institutional Investors:
Institutional investors require eligibility to invest, authorizations, and details of Ultimate Beneficial Owners (UBOs).
UBOs own or control a certain percentage of shares/profits or are beneficiaries of trusts.
UBO requirements are not applicable to listed companies or subsidiaries.
VIII. Legal Information and Mandatory Declarations:
Clients of SEBI registered intermediaries need to provide information to verify the identity of beneficial owners or controllers of securities accounts.
Compliance with Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standards (CRS) provisions.
Information regarding citizenship, nationality, place of birth, tax residency, and taxpayer reference ID may be required.
Note: The KYC process ensures compliance with anti-money laundering laws and helps establish the identity and address of mutual fund investors. It involves submitting required documents, verification processes, and adherence to PAN and FATCA/CRS regulations.
Operational aspects of Systematic Transactions:
I. Systematic Investment Plan (SIP):
Investors can choose the amount, frequency, and period of the SIP.
Submission of the application form and SIP enrollment form is required for registration.
Payment modes include post-dated cheques, NACH, direct debit, and standing instructions.
Renewal of SIP requires submitting a renewal form.
Cancellation of SIP requires giving notice to the AMC or insufficient funds in the bank account.
II. Systematic Withdrawal Plan (SWP):
Registration of SWP with the mutual fund is necessary.
Details such as scheme, plan, option, withdrawal amount, frequency, and period need to be provided.
SWP credits are made to the default bank account registered with the mutual fund.
Minimum amounts for each SWP tranche are specified by the mutual fund.
SWP can be cancelled by providing written notice to the mutual fund.
III. Systematic Transfer Plan (STP) and Switches:
Source and target schemes are selected during registration of STP or switch.
Minimum transfer amount is defined by the mutual fund.
STP and switch instructions need to be provided using the transaction slip.
Execution of STP and switch transactions occurs at the applicable NAV on the transaction date.
Mutual fund notice period is required for registering and cancelling STP.
IV. Triggers:
Triggers are offered by some mutual funds to seize investment opportunities.
Investors can set triggers for profit booking, stop-loss, or market decline.
Triggers can be based on NAV levels, market indices, or percentage depreciation.
Triggers can be set for redemption, transfer, or switch actions.
Each investment under a folio requires a separate trigger facility request.
Notice period may be specified for registering and cancelling triggers.
Note: Operational aspects include registration, cancellation, execution, and triggers for systematic transactions. Investors need to provide accurate information and follow the specified procedures for each type of transaction.
Non-Financial Transactions in Mutual Funds:
I. Nomination:
Nomination provides clarity on unit-holding in the event of the investor’s demise.
Nomination form specifies the nominee’s name.
Maximum of three nominees can be appointed.
Nomination is required for single folios unless specifically waived.
Nomination cannot be made in favor of trusts, societies, corporations, partnerships, etc.
Nomination can be changed or cancelled at any time by all original nominators.
II. Pledge/Lien of Units:
Units can be pledged as collateral for loans.
Pledge form executed by the unit-holder and includes details of the pledgee.
Pledged units should have completed the lock-in period.
Unit-holders cannot sell or switch pledged units without written no-objection from the pledgee.
Lender can enforce the pledge and redeem units after providing necessary documents.
III. Demat Account:
Dematerialization converts physical investments into a digital record.
Investor needs to open a demat account with a depository participant.
Mutual funds provide the option to hold units in demat form.
Application form allows for providing demat account details.
Units credited directly to the demat account after realization of funds.
Changes in demat account information should be made with the depository.
IV. Change in Folio Details:
Personal information changes need to be updated with each mutual fund.
Changes in name, address, status, contact details, etc., should be registered.
KYC Registration Agency (KRA) provides change forms for updating information.
Supporting documents and verification may be required for changes.
V. Change in Bank Account Details:
Investor can register up to five bank accounts with a mutual fund.
One account is designated as the default account for proceeds credit.
Form and cancelled cheque or bank statement required for adding a bank account.
Change of default bank account requires designating a new default account.
VI. Transmission of Units:
Transmission is the transfer of units to the person entitled in the event of the unitholder’s death.
Transmission depends on joint holding, nomination, and legal successors.
KYC documentation, death certificate, and indemnity may be required for transmission.
Standard Transmission Request Form and supporting documents are prescribed by AMFI.
Note: Non-financial transactions in mutual funds include nomination, pledge/lien of units, demat accounts, changes in folio details, bank account details, and transmission of units. Each transaction has specific procedures and requirements that need to be followed for smooth processing.
Change in Status of Special Investor Categories:
I. Minor turned Major:
Minors turning major cannot make financial transactions in their accounts.
KYC completion and PAN card update are required.
Change in bank account status and new cheque book with the major’s name.
Demat account needs to be opened in the major’s name, transferring securities from the minor account.
Existing standing instructions like SIP, SWP, STP cease if documents are not submitted.
II. NRI to Resident Indian:
Inform the bank about the change of status and open a Resident Rupee Account.
Notify the designated authorized dealer branch and DP about the change of status for investments and demat account.
Open a new demat account with ‘Resident’ status and transfer balances from the NRI demat account.
Inform AMCs about the change of status, address, and bank details for mutual fund investments.
III. Change in Karta of HUF:
Provide a letter from the new Karta stating the reason for the change in mutual fund records.
Submit KYC documents of the new Karta and HUF.
Enclose attested copy of the death certificate, bank certificate with new Karta details, and indemnity bond signed by all co-parceners and new Karta.
Note: Each change in status requires specific documentation and procedures to be followed for smooth transition and compliance with regulations.
Investor Transactions – turnaround times:
NAV Calculation and disclosure: Daily basis.
Mutual Fund Schemes (other than IPO of ELSS) to remain open for subscription: Maximum of 15 days.
Mutual Fund Schemes to allot units or refund money: Within 5 business days of closure of NFOs.
Re-opening for ongoing sale/re-purchase of open-ended scheme (other than ELSS): Within 5 business days of allotment.
Dispatch of Dividend warrants to investors: Within 15 days of declaration of the dividend.
Dispatch of Redemption/re-purchase cheques to investors: Within 10 working days from the date of receipt of transaction request.
Scheme-wise Annual Report or an abridged summary to all unitholders: Four months from the date of closure of the relevant account’s year.
Statement of portfolio to be sent to all unitholders: Before the expiry of 10 days from the close of each half-year (i.e., 31st Mar and 30th Sep).
Half Yearly Disclosures (unaudited financial results) on mutual fund website: Within 1 month from the close of each half-year.
Disclosure of debt and money market securities transactions: Daily basis with a time lag of 15 days.
Consolidated Account Statement (CAS) by post/email: As per SEBI’s specified timelines.
Unit certificate: To be issued within 5 working days of the receipt of the request for the certificate.
Statement of Account in case of SIP/STP/SWP: Within 5 working days from the date of closure of the initial subscription list or from the date of receipt of the application.
Note: The turnaround times are regulated by SEBI to ensure timely processing and transparency in investor transactions.
Applicability of taxes in respect of mutual funds:
When investing, consider taxes on investment returns.
Mutual funds are pass-through vehicles, with income at two levels: fund income and investor income.
Income earned by mutual fund schemes:
Mutual fund schemes invest in marketable securities like shares and debentures.
Securities generate income in the form of dividend, interest, capital gains, or losses.
Mutual fund income is exempt from income tax under Section 10(23)(D) of the Income Tax Act.
Income earned by the investor from investment in mutual fund units:
Two options within a scheme: Income Distribution cum capital withdrawal (dividend) and growth.
Growth option: No dividends, only capital gains (or losses) when selling units.
Income Distribution cum capital withdrawal option: Dividends and capital gains (or losses) when selling units.
Different tax treatments:
Tax structure varies for different types of investors and fund categories.
Capital gains and dividends have different tax rates.
Short-term and long-term capital gains have different tax rates.
Equity-oriented mutual funds have different tax rates compared to non-equity-oriented funds.
Types of investors:
Tax treatment varies for Resident Indian Investors, NRIs, and non-individual investors.
Joint holdings consider income earned by the first holder.
Table: Tax Rates for Mutual Fund Income
Type of Income
Tax Rates
Dividend Income
Varies based on investor’s category
Short-term Capital Gains
Varies based on investor’s category
Long-term Capital Gains
Varies based on investor’s category
Equity-oriented Schemes
Varies based on holding period
Non-equity-oriented Schemes
Varies based on holding period
CAPITAL GAINS
Capital gains arise when selling units of a mutual fund:
Selling price can be different from the purchase price.
Capital gain if selling price is higher, capital loss if lower.
Classification of capital gains:
Short-term capital gains: Holding period of less than 1 year for equity-oriented funds or 3 years for non-equity-oriented funds.
Long-term capital gains: Holding period of 1 year or more for equity-oriented funds, or 3 years or more for non-equity-oriented funds.
Tax rates for capital gains:
Equity-oriented funds:
Short-term capital gains: 15% tax rate.
Long-term capital gains: 10% tax rate.
Non-equity-oriented funds:
Short-term capital gains: Marginal tax rate applicable for the investor.
Long-term capital gains: 20% tax rate with indexation benefits.
Income tax of 10% (without indexation benefit) on long-term capital gains exceeding Rs.1 lakh, subject to STT.
Changes in taxation of equity-oriented funds:
Prior to April 2018, long-term capital gains from equity funds were tax-exempt.
Starting April 2018, long-term capital gains from equity funds are taxable at 10%.
Grandfathering of capital gains: Gains till January 31, 2018, are not taxable to avoid retrospective taxation.
Exemption up to Rs. 1 lakh: Only capital gains above Rs. 1 lakh are taxable for long-term gains from equity shares and equity-oriented funds.
Benefit of indexation:
Indexation adjusts the purchase price for inflation.
Cost Inflation Index (CII) is used to calculate indexed cost of acquisition.
Indexed capital gains are taxed at a lower rate.
Indexed cost of acquisition = Actual cost of acquisition x [CII in the year of sale / CII in the year of purchase].
Note: Tax rates, rules, and CII values are subject to change as per prevailing tax laws and government notifications.
Table: Capital Gains Tax Rates
Type of Fund
Holding Period
Short-term Capital Gains
Long-term Capital Gains
Equity-oriented Funds
< 1 year
15%
10%
Non-equity-oriented Funds
< 3 years
Marginal tax rate
20% with indexation
≥ 3 years
Marginal tax rate
20% with indexation
+ 10% tax (above Rs.1 lakh)
Note: Surcharge and cess are applicable in addition to the base tax.
Understanding the taxation of capital gains is important for investors to assess their investment returns accurately and plan their tax liabilities effectively.
DIVIDEND INCOME
Previous tax treatment of dividend income:
Dividend income from mutual funds used to be tax-free in the hands of the investor.
Dividend distribution tax was deducted from the scheme before paying dividends to investors.
Changes in tax treatment:
In the Union Budget of February 2020, dividend distribution tax was abolished.
Dividends are now added to the taxable income of the recipient and taxed at the applicable tax rate.
The tax on dividends depends on the total income and tax rate of the recipient.
Impact of the new regime:
Higher-income individuals may have a higher tax liability on dividend income compared to the previous regime.
Previously tax-exempt investors, such as charitable trusts and certain individuals, remain exempt from tax on dividends.
Difference between dividend distribution tax and tax on dividends in the new regime:
Dividend distribution tax was not considered a setoff against other tax liabilities for investors.
Tax on dividends in the new regime can be reduced through exemptions and adjustments applicable to the recipient.
Impact on NAV:
Both dividend distribution tax and tax on dividends in the new regime reduce the NAV of the mutual fund scheme.
The dividend received by the investor is net of the tax, resulting in a lower NAV.
Benefits of the growth option:
Growth option in mutual funds is more tax-efficient.
Mutual fund schemes are tax-exempt, and capital gains are realized only when booked.
Allows for deferment of taxes and takes advantage of compounding before tax.
Changes from April 1, 2021:
Mutual funds declaring dividends need to indicate the amount attributed to income distribution and capital distribution.
Tax calculation should be made based on this segregated basis.
STAMP DUTY ON MUTUAL FUND UNITS
Applicability of stamp duty:
From July 1, 2020, stamp duty is applicable to mutual fund units issued against purchase transactions.
Stamp duty is also applicable to transfer of mutual fund units between demat accounts.
Stamp duty rates:
Purchase transactions: Stamp duty is levied at 0.005% of the amount invested.
Transfer of units: Stamp duty is levied at 0.015% of the transferred units.
Notification and regulations:
Stamp duty on mutual fund units is governed by notifications issued by the Department of Revenue, Ministry of Finance, and Legislative Department, Ministry of Law and Justice, Government of India.
The relevant notifications are:
Notification No. S.O. 4419(E) dated December 10, 2019
Part I of Chapter IV of Notification dated February 21, 2019
Notification dated March 30, 2020
Note: Stamp duty rates and regulations are subject to change as per the prevailing laws and government notifications.
SETTING OFF OF CAPITAL GAINS AND LOSSES
Income Tax Act provisions:
Income Tax Act categorizes income under different heads, including capital gains.
Losses in one head of income can be set off against gains in the same head, subject to certain limitations.
Set-off limitations for capital gains:
Capital losses (short-term or long-term) cannot be set off against other heads of income, such as salaries.
Short-term capital losses can be set off against short-term or long-term capital gains.
Long-term capital losses can only be set off against long-term capital gains.
Limitations on setting-off in mutual funds:
Bonus Stripping: Capital losses from selling units after a bonus issue may not be available for setting off against capital gains.
If the original units were bought within 3 months prior to the bonus record date and sold within 9 months after the record date, the capital loss is treated as the cost of acquisition of the bonus units.
Note: Other factors and provisions may also affect taxation and tax exemptions. Consult a tax professional or refer to the Income Tax Act for complete details.
SECURITIES TRANSACTION TAX (STT)
Applicability of STT:
STT is applicable when selling units of an equity fund on the stock exchange or offering them for repurchase to the fund.
STT is applicable only on redemption/switch to other schemes/sale of units of equity-oriented mutual funds.
STT is not applicable on the purchase of units in an equity scheme or transactions in debt securities or debt mutual fund schemes.
STT rates and payable by:
Purchase of units of equity-oriented mutual funds: Nil (payable by the purchaser).
Sale of units of equity-oriented mutual funds (delivery-based): 0.001% (payable by the seller).
Sale of equity shares, units of business trust, units of equity-oriented mutual funds (non-delivery-based): 0.025% (payable by the seller).
Sale of units of an equity-oriented mutual fund to the mutual fund: 0.001% (payable by the seller).
Note: The rates mentioned are subject to change as per prevailing tax laws and government notifications
TAX BENEFIT UNDER SECTION 80C
Equity Linked Savings Schemes (ELSS):
ELSS is a type of mutual fund scheme eligible for deduction under Section 80C of the Income Tax Act.
ELSS schemes invest in equity shares and have a lock-in period of three years.
The tax benefit is available up to Rs. 1.50 lakh per year per taxpayer for individuals and HUFs.
Sharing the Section 80C limit:
The Section 80C limit is to be shared across eligible investment avenues.
If the limit is exhausted through other investments, additional investment in ELSS will not receive additional tax exemption.
However, the investment in ELSS remains locked-in for a minimum of three years.
Lock-in period for SIP and reinvested dividends:
In the case of SIP investments, each installment is locked-in from its respective investment date.
If opting for (dividend) Income Distribution cum capital withdrawal reinvestment plan, each reinvested dividend also attracts a 3-year lock-in.
Most AMCs now offer only the growth option or dividend payout for ELSS.
Tax benefit and joint holding:
The tax benefit under Section 80C is available to the first holder in case of joint holdings.
Parallel tax structures:
The Union Budget 2020 introduced a parallel tax structure with lower rates and different exemptions and deductions.
Those opting for the new regime would not be eligible for the tax-saving benefit under Section 80C for ELSS investments.
Retirement-oriented funds:
Some retirement-oriented funds offer Section 80C benefit with a lock-in period of 5 years.
These funds aim to accumulate a corpus for an individual’s later years.
Not all retirement funds have this Section 80C benefit, so it is essential to check the specific fund’s eligibility.
Note: Tax laws and regulations are subject to change. Investors should consult a tax professional or refer to the Income Tax Act for the most up-to-date information.
Understanding the tax benefit under Section 80C helps investors plan their tax-saving investments effectively and maximize their tax benefits.
TAX DEDUCTED AT SOURCE (TDS) AND APPLICABILITY OF GST
TDS on re-purchase proceeds:
There is no TDS on re-purchase proceeds for resident investors.
However, certain cases of non-resident investments may attract TDS.
TDS rates vary based on the nature of the investor, nature of investment, and nature of income (dividend/capital gain).
TDS on dividends from mutual fund schemes:
TDS is applicable even for resident Indians on dividends from mutual fund schemes.
TDS is deducted at a rate of 10% if the dividend amount exceeds Rs. 5,000.
Double Taxation Avoidance Agreements (DTAA):
India has DTAA with several countries, specifying rates for withholding tax.
For non-resident investors, TDS is the lower of the rates specified in income tax regulations or the DTAA of their resident country.
The investor must provide sufficient information and documents to avail the concessional rate specified in the DTAA.
Applicability of GST:
Asset Management Companies (AMCs) can charge GST to schemes within the prescribed limits under SEBI (Mutual Fund) Regulations.
GST is charged on investment management and advisory fees in addition to the overall Total Expense Ratio (TER) provisions.
Other fees, excluding investment and advisory fees, are subject to GST within the maximum TER limit.
GST on exit load is deducted from the load amount, and the net amount is credited to the scheme.
GST on brokerage and transaction costs for trade execution is within the TER limit.
GST on commission payable to distributors may apply as per the applicable tax laws but cannot be charged to the scheme.
Note: Tax rates, TDS provisions, and GST regulations are subject to change as per prevailing laws and government notifications.
Understanding the implications of TDS and GST helps investors and AMCs comply with tax regulations and ensure proper tax deductions and payments.
NET ASSET VALUE, TOTAL EXPENSE RATIO, AND PRICING OF UNITS
Net Asset Value (NAV):
NAV represents the per-unit value of a mutual fund scheme.
It is calculated by dividing the total value of the scheme’s assets minus liabilities by the number of units outstanding.
NAV is usually calculated at the end of each business day.
Total Expense Ratio (TER):
TER represents the total expenses incurred by a mutual fund scheme as a percentage of its average net assets.
It includes management fees, administrative costs, distribution expenses, etc.
Lower TER indicates a more cost-effective scheme.
Pricing of Units:
The price of units in a mutual fund scheme is determined based on the NAV.
Investors can buy or sell units at the prevailing NAV.
The purchase price is usually higher than the NAV due to additional charges like entry load, if applicable.
Fair Valuation Principles:
SEBI has established fair valuation principles to ensure fair treatment to all mutual fund investors.
Valuation of investments should be reflective of their realizable value and done in good faith.
Policies and procedures should be established for valuing different types of securities/assets.
Consistent valuation should be followed, with provisions for exceptional events where market quotations are unreliable.
Periodic review and independent audit of valuation policies and procedures are necessary.
Conflicts of interest should be addressed, and transparency in valuation norms should be ensured.
Asset management companies have the responsibility to value assets at fair value, even if it deviates from the disclosed policies and procedures.
Principle No.
Summary
1
Valuation based on fair value principles, in good faith and in a true and fair manner.
2
Approved methodologies for valuing each type of securities/assets, with the Board’s approval.
3
Consistent valuation of assets, with provisions for exceptional events where market quotations are unreliable.
4
Periodic review and independent audit of valuation policies and procedures.
5
Addressing conflict of interest in valuation policies and procedures.
6
Disclosure of valuation policies and procedures for transparency.
7
Responsibility of asset management company for fair valuation, with appropriate reporting and disclosures.
8
Policies and procedures to detect and prevent incorrect valuation.
9
Documentation and preservation of rationale for valuation.
10
Consideration of prices of trades of same or similar securities in valuation of debt and money market securities.
NET ASSET VALUE, TOTAL EXPENSE RATIO, AND PRICING OF UNITS
Fair Valuation Principles:
Valuation of investments should reflect the realizable value of the securities/assets and be done in good faith and in a true and fair manner.
Asset management companies (AMCs) should establish valuation methodologies for each type of security/asset held by mutual fund schemes.
Consistent valuation of assets should be maintained, with procedures to address exceptional events where market quotations are unreliable.
Periodic review of valuation policies and procedures should be conducted to ensure their appropriateness and accuracy.
Valuation policies and procedures should address conflicts of interest.
Transparency should be maintained through disclosure of valuation policies and procedures in the Statement of Additional Information and other specified locations.
The responsibility for fair valuation and correct Net Asset Value (NAV) lies with the AMC, and any deviation from established policies should be reported to the Board of Trustees and the AMC’s Board.
Policies and procedures should be in place to detect and prevent incorrect valuation.
Documentation of rationale for valuation, including inter-scheme transfers, should be maintained.
Fairness in the valuation of debt and money market securities should consider prices of trades of the same or similar securities reported at public platforms.
Valuation:
The Net Asset Value (NAV) of a mutual fund scheme depends on the value of its portfolio, including securities, money market instruments, gold, real estate assets, etc.
Traded securities are valued at the last quoted closing price on the principal stock exchange or the stock exchange where they are primarily traded.
Non-traded securities are valued “in good faith” based on approved valuation methods, considering factors like earnings, net asset value, and liquidity.
Gold and silver held by exchange-traded fund schemes are valued at the AM fixing price of London Bullion Market Association (LBMA) per troy ounce.
NAV can be calculated as Net Assets divided by the number of outstanding units.
Mark-to-market valuation is used to reflect the true worth of each unit based on the current market value of securities, ensuring fair prices for investors.
Total Expenses in Mutual Fund Scheme:
Mutual funds incur various expenses, including investment and advisory fees, marketing expenses, brokerage, audit fees, registrar services, etc.
Recurring expenses are charged to the scheme, and the total expense ratio (TER) sets limits on the expenses based on the type of scheme.
TER limits differ for different types of schemes, including equity-oriented, index fund, exchange-traded fund, and close-ended schemes.
Brokerage and transaction costs are allowed up to a certain percentage of the trade value.
Additional expenses may be charged for inflows from beyond the top 30 cities, subject to certain conditions.
Excess expenditure beyond the prescribed TER limit should be borne by the AMC.
TER and scheme-wise expenses must be prominently disclosed on the AMC’s and AMFI’s websites.
Valuation of Perpetual Bonds:
Mutual funds have limits on investing in perpetual bonds issued by a single issuer and overall exposure to such instruments.
Valuation of perpetual bonds is determined based on their deemed residual maturity, which changes over time.
Close-ended debt schemes cannot invest in perpetual bonds due to maturity constraints.
There is a phased movement towards valuing perpetual bonds with a 100-year maturity date.
Macaulay Duration is calculated based on the deemed residual maturity, and if the call option is not exercised, valuation considers 100 years from the date of issuance or contractual maturity.
Financial stress or bad news related to the issuer should be reflected in the valuation.
DIVIDENDS & DISTRIBUTABLE RESERVES
Valuation gains in the mutual fund scheme’s portfolio are not realized until the investments are sold.
Dividends can be paid out of distributable reserves, which consist of realized profits available for distribution.
Accrued income and expenses are considered in calculating distributable reserves, but valuation gains are ignored.
Valuation losses need to be adjusted against the profits before determining the distributable reserves.
Dividend quantum and record date are decided by the trustees, with possible delegation to AMC officials for dividends up to monthly frequency.
The record date is used to determine the eligibility of investors to receive dividends based on the register of unitholders.
The NAV is adjusted at the end of the record date to reflect the dividend payout.
The AMC is required to issue a public communication within one day of the trustees’ decision, providing details of the dividend and the record date.
Failure to pay dividends by the stipulated time may result in interest being calculated on the delayed payment from the record date.
Notice requirements for dividend distribution may vary based on the scheme type, with specific disclosures in the Scheme Information Document (SID).
Listed schemes must follow the requirements stipulated in the listing agreement for declaring and distributing dividends.
There is no guarantee or assurance to unitholders regarding the rate or quantum of dividend distribution.
Dividends may include a certain portion of the investors’ capital, as a proportion of the sale price of investments represents realized gains credited to an equalization reserve.
Mutual funds should clearly indicate the distinction between the appreciation of NAV and capital distribution in the dividend paid to investors.
CONCEPT OF ENTRY AND EXIT LOAD AND ITS IMPACT ON NAV
Open-ended schemes allow investors to acquire new units (sale transaction) or sell units back to the scheme (re-purchase transaction).
Entry load, which was previously charged as a difference between the Sale Price and NAV, is no longer permitted. Sale Price is now the same as the NAV.
Exit load is the difference between the NAV and re-purchase Price. It can be calibrated based on the holding period, incentivizing investors to hold units longer.
SEBI has banned entry loads, making the Sale Price equal to the NAV, subject to applicable transaction charges.
No distinction is made among unitholders for exit loads based on the amount of subscription. Any imposition or enhancement of the load applies only to prospective investments.
Exit loads are credited back to the scheme immediately and cannot be used by the AMC for selling expenses.
Bonus units and units allotted on reinvestment of dividends are exempt from exit loads.
Transaction charges do not affect the NAV per unit or the purchase price. They only impact the cost for the investor.
Example: If an investor invests Rs. 25,000 in a scheme with a NAV of Rs. 43.21, they will receive 578.570 units (Rs. 25,000 / Rs. 43.21). Transaction charges do not affect the unit price but impact the overall cost for the investor.
KEY ACCOUNTING AND REPORTING REQUIREMENTS
The accounts of mutual fund schemes must be maintained separately from the accounts of the Asset Management Company (AMC). The auditor for the AMC and the schemes should be different.
Specific norms are prescribed for reflecting interest, dividends, bonus issues, rights issues, and other events in the scheme’s accounts.
Net Asset Value (NAV) calculation:
For index funds, liquid funds, and other debt funds, NAV is calculated up to 4 decimal places.
For equity and balanced funds, NAV is calculated up to at least 2 decimal places.
Investors can hold units even in fractional amounts, but some stock exchange trading systems may restrict trading to whole units.
Frequency of disclosures:
NAV, portfolio details, and scheme accounts should be disclosed at specified intervals, as discussed earlier.
These accounting and reporting requirements ensure transparency, accuracy, and adherence to regulatory guidelines in the operations of mutual fund schemes. By maintaining separate accounts, following precise calculations of NAV, and providing timely disclosures, investors can make informed decisions and have confidence in the integrity of the mutual fund industry.
NAV, TOTAL EXPENSE RATIO, AND PRICING OF UNITS FOR THE SEGREGATED PORTFOLIO
To ensure fair treatment to all investors in case of a credit event and to address liquidity risks, mutual fund schemes are allowed to create segregated portfolios consisting of debt and money market instruments. The following key provisions apply to the NAV, Total Expense Ratio (TER), and pricing of units for the segregated portfolio:
Investment and Advisory Fees: The Asset Management Company (AMC) cannot charge investment and advisory fees on the segregated portfolio. However, TER (excluding investment and advisory fees) can be charged on a pro-rata basis only after recovering the investments in the segregated portfolio.
Daily NAV Declaration: The NAV of the segregated portfolio should be declared on a daily basis. This ensures transparency and provides investors with up-to-date information on the value of their investments.
Disclosure Requirements: Adequate disclosure of the segregated portfolio must be included in all scheme-related documents, including monthly and half-yearly portfolio disclosures, as well as the annual report of the mutual fund and the scheme. These disclosures help investors understand the composition and performance of the segregated portfolio.
The segregation of the portfolio allows for the appropriate management of credit events and liquidity risks, ensuring that the interests of all investors are protected. By exempting investment and advisory fees on the segregated portfolio and providing transparent disclosures, mutual funds maintain transparency and fairness in their operations.
Banks act as distributors of mutual funds by offering various schemes to their customers.
Independent Advisors
Independent financial advisors provide personalized advice and guidance on mutual fund investments.
Financial Institutions
Financial institutions like insurance companies and brokerage firms also distribute mutual funds.
Online Platforms
Online platforms and robo-advisors offer digital solutions for investing in mutual funds.
Notes:
Mutual fund distributors play a crucial role in helping investors build and manage their investment portfolios.
They assist investors in assessing their needs, goals, and resources to determine the most suitable asset allocation plan.
Mutual fund distributors analyze the investor’s situation and recommend appropriate mutual fund schemes.
Fund managers, on the other hand, analyze market factors and construct portfolios aligned with the mutual fund scheme’s objectives.
Different categories of mutual fund distributors include banks, independent advisors, financial institutions, and online platforms.
Banks offer mutual fund schemes to their customers as part of their financial services.
Independent advisors provide personalized advice and guidance on mutual fund investments.
Financial institutions like insurance companies and brokerage firms also distribute mutual funds.
Online platforms and robo-advisors provide digital solutions for investing in mutual funds.
Each category of mutual fund distributor offers unique advantages and services to investors.
Investors can choose a distributor based on their preferences, convenience, and the level of personalized guidance required.
Categories of Mutual Fund Distributors
Category
Characteristics
Individual Players
– Long history of distribution through individuals
– Operate as single-handed individuals or small-scale businesses
– Mainly involved in paperwork and distribution of financial products
Non-Individual Entities
– Partnerships, regional distributors, national distributors, NBFCs, banks, stockbrokers, etc.
– Include distribution companies and banks as institutional distributors
– Serviced by individuals (employees or sub-agents)
– Difference in operations and cost structure
Banks
– Prominent channel for mutual fund distribution
– MNC, private sector, public-sector, and cooperative banks involved
– Cater to different client segments (retail banking, wealth management, private banking)
– PSU banks with wide reach in non-urban centers play a significant role
Stockbrokers and NBFCs
– Classification between retail clients and wealthy clients
– Some reach clients through employees, while others use sub-agents
– National or regional presence
E-commerce platforms
– Online distributors without physical offices
– Operate through the internet for distribution of mutual fund schemes
Notes:
Mutual funds in India are distributed through various channels, including individual players, banks, non-individual entities, and e-commerce platforms.
Individual players have a long history of distributing financial products and often operate as individuals or small-scale businesses.
Non-individual entities include partnerships, regional distributors, national distributors, NBFCs, banks, and stockbrokers.
Banks have emerged as a prominent channel for mutual fund distribution, catering to different client segments and employing various business units.
Stockbrokers and NBFCs also distribute mutual funds, with some reaching clients through their employees and others using sub-agents.
E-commerce platforms and online distributors have entered the market, providing digital distribution of mutual fund schemes.
Distribution through these channels may involve paperwork, individual servicing, and different cost structures.
PSU banks with a wide reach in non-urban areas play a significant role in distributing mutual fund products.
Different players have varying national or regional presence in the mutual fund industry.
Each category of distributor offers unique advantages and may cater to specific client segments or geographic locations.
The availability of electronic platforms has facilitated the distribution process through websites, mobile phones, and stock exchanges.
Modes of Mutual Fund Distribution
Mode
Characteristics
Paper-based Distribution
– Traditional mode of distributing financial products
– Involves physical application forms and paperwork
– Preferred by some distributors and investors
Digital Distribution
– Shift towards digital mode of transactions
– Conducted through the internet and mobile phones
– E-commerce platforms and online distributors operate entirely through digital channels
Hybrid Mode
– Combination of digital and physical transactions
– Some transactions conducted digitally, while others involve physical paperwork
Online Channel Partners
– Distributors expand business through the internet
– Investors prefer online transactions
– Some distributors offer transaction support through their own websites
Stock Exchange Platforms
– SEBI facilitates buying and selling of mutual fund units through stock exchanges
– Mutual fund transaction engines developed by exchanges
– Retail investors can participate through stock exchange networks
– NSE’s NMF II Platform and BSE’s BSE StAR Mutual Funds Platform
– Provides a Common Account Number (CAN) for consolidated mutual fund holdings
– Common Transaction Form for multiple scheme transactions
Computer and Mobile Apps
– Distributor-created apps for convenient investment
– Transaction facilities available on smartphones, feature phones, and tablets
– Offered by distributors and AMCs
Electronic Platforms by AMCs
– Web-based and mobile-based applications created by AMCs
– Transaction facilities through SMS and WhatsApp
– Direct interaction with the mutual fund
New Age Investment Platforms
– Technology-based platforms for investing in mutual funds
– Simplicity of investment without excessive paperwork
– Low-cost options and availability of direct plans
– Examples: Groww, Kuvera, Paytm Money, Coin, etc.
Pre-requisites to Become a Mutual Fund Distributor
Pre-requisite
Description
Obtaining NISM Certification
– Mandatory certification from the National Institute of Securities Markets (NISM)
– NISM Series-V-A: Mutual Fund Distributors Certification Examination
– Exceptions for individuals aged 50 years or with at least 10 years of experience in the sale and/or distribution of mutual fund products as of May 31, 2010, who can qualify through Continuing Professional Education (CPE) or by passing the NISM certification examination
Know Your Distributor Requirements
– KYD process introduced by AMFI to verify information in registration documents and validate ARN holders
– Document verification and bio-metric process
– Submission of self-attested PAN card copy and proof of address
– Bio-metric process for fingerprint impression
Obtaining AMFI Registration Number
– Registration with AMFI
– Allotment of AMFI Registration Number (ARN)
– Exempted category individuals (aged 50 years or with 10 years of experience as of May 31, 2010) can obtain ARN without passing the certifying examination through prescribed CPE programs
Empanelment with AMCs
– Empanelment with the Asset Management Companies (AMCs)
– Agent of an already empaneled distributor can also sell mutual fund schemes
– Compulsory for selling mutual fund schemes and earning commissions
Employee Registration with AMFI
– Institutions into mutual fund distribution need to register with AMFI
– Employees must clear NISM Series V-A: Mutual Fund Distributors Certification Examination
– Obtain Employee Unique Identification Number (EUIN) from AMFI
– EUIN must be quoted in the application form for client investments
Empanelment Procedure with AMC
– Fill in a Request for Empanelment Form
– Provide personal information, contact details, PAN, ARN, business details, bank details, preferences, nominee information, and sign a declaration
– Declaration includes commitment to confidentiality, compliance with instructions and guidelines, use of approved advertisement material, provision of information, non-rebate of commissions, and termination of empanelment by the AMC
– AMC may have specific requirements and formats for empanelment
Notes:
Becoming a mutual fund distributor requires obtaining NISM certification, completing Know Your Distributor (KYD) requirements, and obtaining an AMFI Registration Number (ARN).
NISM Series-V-A: Mutual Fund Distributors Certification Examination is mandatory for distributors, with exceptions for individuals meeting specific age or experience criteria.
KYD process involves document verification, a bio-metric process, and submission of PAN card and address proof.
Empanelment with AMCs is essential for selling mutual fund schemes and earning commissions.
Employees of institutions involved in mutual fund distribution must register with AMFI, clear the NISM certification examination, and obtain an Employee Unique Identification Number (EUIN).
Empanelment procedures with AMCs include filling out an application form, providing personal and business details, preferences, nominee information, and signing a declaration of compliance.
AMCs may have specific requirements and formats for empanelment, and commission levels may be linked to the volumes generated by distributors.
The application forms and formats for empanelment may vary among different AMCs
Revenue for a Mutual Fund Distributor
Revenue Model
Description
Transaction-Linked Commission
– Commission income earned based on individual transactions made by investors
– Paid at the time of a transaction
– Typically a one-time payment
AUM-Linked Commission
– Commission income earned based on the assets under management (AUM)
– Paid on an ongoing basis as long as the investor remains invested
– Paid periodically (quarterly or monthly)
Upfronting of Trail Commission
– SEBI allows upfront payment of trail commission in certain cases
– Generally applicable for SIP inflows up to Rs. 3,000 per month for new investors
– Upfront payment is based on expected future trail commission for a specified period
– Upfronting is subject to certain conditions and review by SEBI
Trail Commission
– Commission calculated as a percentage of the net assets attributable to the units sold by the distributor
– Paid on a quarterly or monthly basis
– Dependent on the net asset value (NAV) of the scheme
Additional Commission for
– Higher commission paid to distributors for mobilizing funds from investors
Smaller Town Promotion
– Applicable in B-30 locations (cities and towns beyond the top 30 locations)
Transaction Charges
– Transaction charge per subscription of Rs. 10,000 and above
– Paid to distributors for mutual fund products
– No transaction charges for direct investments
– Different charges for first-time investors and other investors
GST on Distributors Commission
– Goods and Services Tax (GST) applicable to commission income
– Distributor required to raise an invoice and pay GST to the government
– Reverse charge mechanism may apply for procurements from unregistered suppliers
Notes:
Mutual fund distributors earn revenue through commission income, which can be transaction-linked or AUM-linked.
Upfronting of trail commission is allowed in certain cases, subject to specific conditions and review by SEBI.
Trail commission is calculated based on the net assets of units sold by the distributor and paid periodically.
Additional commission may be provided for promoting mutual funds in smaller towns (B-30 locations).
Transaction charges are applicable for subscriptions of Rs. 10,000 and above, with different rates for first-time investors and others.
GST is applicable to the commission earned by distributors, and they are required to raise an invoice and pay the GST to the government.
The reverse charge mechanism may apply for procurements from unregistered suppliers.
Commission Disclosure Mandated by SEBI
Disclosure Requirement
Description
Total Commission and Expenses Paid to Distributors
– Mandated for Mutual Funds/AMCs
– Disclosed on respective websites
– Applicable to distributors satisfying certain conditions:
– Multiple points of presence (More than 20 locations)
– AUM raised over Rs. 100 crores across the industry in the non-institutional category, including HNIs
– Commission received of over Rs. 1 crore p.a. across the industry
– Commission received of over Rs. 50 lakhs from a single Mutual Fund/AMC
– Data submitted to AMFI for consolidated disclosure
Distributor-wise Inflows
– Additional disclosure by Mutual Funds/AMCs
– Indicates whether the distributor is an associate or group company of the sponsor(s) of the mutual fund
– Disclosed on respective websites
Net Inflows
– Additional disclosure by Mutual Funds/AMCs
– Disclosed on respective websites
Average Assets Under Management (AUM)
– Additional disclosure by Mutual Funds/AMCs
– Disclosed on respective websites
Ratio of AUM to Gross Inflows
– Additional disclosure by Mutual Funds/AMCs
– Disclosed on respective websites
Excessive Portfolio Turnover Ratio and Due Diligence of Distributors
– Conducted by AMCs
– Triggered if a distributor has a portfolio turnover ratio more than two times the industry average
– Additional due diligence is required
– Data submitted to AMFI for consolidated disclosure
Consolidated Data Disclosure by AMFI
– AMFI discloses consolidated data regarding commission and expenses paid to distributors
– Consolidated data is disclosed on the AMFI website
Notes:
SEBI mandates Mutual Funds/AMCs to disclose the total commission and expenses paid to distributors on their websites.
Specific conditions are set for distributors who require commission disclosure, such as having multiple points of presence, raising AUM over Rs. 100 crores, or receiving a certain amount of commission from a single Mutual Fund/AMC.
Mutual Funds/AMCs are also required to disclose distributor-wise gross inflows, net inflows, average AUM, and the ratio of AUM to gross inflows on their websites annually.
Excessive portfolio turnover ratio by a distributor triggers additional due diligence by AMCs.
AMCs submit the data to AMFI, which then discloses the consolidated data on its website.
Due Diligence Process by AMCs for Distributors of Mutual Funds
Due Diligence Process
Description
Criteria for Due Diligence
– Distributors qualifying any of the following criteria:
– Multiple points of presence (More than 20 locations)
– AUM raised over Rs. 100 crores across the industry in the non-institutional category, including HNIs
– Commission received of over Rs. 1 crore p.a. across the industry
– Commission received of over Rs. 50 lakhs from a single Mutual Fund
Factors Considered in Due Diligence
– Business model, experience, and proficiency in the business
– Record of regulatory/statutory levies, fines and penalties, legal suits, customer compensations made
– Causes for the above and resultant corrective actions taken
– Review of associates and subsidiaries based on the above factors
Organizational Controls
– Ensuring delinkage of the following processes from sales and relationship management processes and personnel:
– Customer risk/investment objective evaluation
– Mutual Fund scheme evaluation and appropriateness to various customer risk categories
Notes:
SEBI mandates AMCs to conduct a due diligence process for distributors who meet specific criteria, such as having multiple points of presence, raising AUM over Rs. 100 crores, or receiving a certain amount of commission.
The due diligence process includes evaluating the distributor’s business model, experience, and proficiency in the business.
AMCs also review the distributor’s record of regulatory/statutory levies, fines and penalties, legal suits, and customer compensations, as well as the actions taken to address these issues.
Associates and subsidiaries of the distributor are also subject to review based on the above factors.
Organizational controls are implemented to ensure that customer risk assessment and evaluation of Mutual Fund schemes are independent from sales and relationship management processes and personnel.
Difference between Distributors and Investment Advisors
Distributors
Investment Advisors
Engaged in the business of
Engaged in the business of
distributing mutual fund products
providing investment advice
Cannot hold themselves out as
Hold themselves out as investment
investment advisors
advisors
Can offer advice while distributing
Provide investment advice subject
the product (advisory)
to appropriateness
Need to ensure product suitability
Need to ensure product suitability
for the customer
for the customer
Can earn both advisory and distribution
Cannot earn both advisory and
commission
distribution commission
Need to disclose conflict of interest
–
when selling group/associate products
Compliance and risk management
Compliance and risk management
processes include due diligence
processes include due diligence
on defined management processes
on defined management processes
Cannot project themselves as
Cannot project themselves as
investment advisors or financial
investment advisors or financial
planners
planners
Notes:
Distributors are primarily engaged in the business of distributing mutual fund products, while investment advisors provide investment advice.
Distributors cannot hold themselves out as investment advisors, and their advice is incidental to their primary activity of distribution.
Distributors can offer advice (advisory) while distributing the product, subject to appropriateness.
Both distributors and investment advisors need to ensure the suitability of the product for the customer.
Distributors cannot earn both advisory and distribution commission, whereas investment advisors solely earn from providing investment advice.
Distributors must disclose any conflict of interest when selling group/associate products.
Compliance and risk management processes for distributors include due diligence on defined management processes.
Distributors cannot present themselves as investment advisors or financial planners.
Nomination Facilities to Agents/Distributors and Payment of Commission to Nominee
Key Points
Description
Nomination Facility
AMCs offer nomination facility to mutual fund distributors at the time of empanelment to enable the nominee to receive commission in case of the distributor’s death. Distributors are encouraged to provide nominations to reduce hurdles faced by legal heirs in obtaining legal heir/succession certificates.
Payment of Commission to Nominee/Legal Heir
Commissions are paid to the nominee or legal heir (if no nominee is registered) of the deceased distributor. Legal heirs may be required to produce necessary documents evidencing legal heirship/succession if no nomination is registered. Commissions are payable until the ARN code of the deceased distributor is not changed by the investor. New business and systematic transactions are not permitted under the ARN code of the deceased distributor.
Nominations and Documentation
Nominees must be registered, and payment of commission can be made to them without the requirement of legal heir/succession certificates, upon submission of necessary documents such as the death certificate. A nominee/legal heir need not be an ARN holder to claim and receive the commission.
Transfer of Assets
Nominees or legal heirs are not allowed to transfer the assets to their account unless a specific request is received from the investor. In case of a specific request, the assets can be transferred if the nominee or legal heir is a valid ARN holder.
Intimation of Demise
The nominee/legal heir is required to inform AMFI about the demise of the ARN holder along with an attested true copy of the death certificate. AMFI will then inform all AMCs about the distributor’s demise. This process is not applicable for overseas distributors.
Eligibility for Transfer of AUM of the Deceased Distributor
To be eligible for the transfer of the deceased distributor’s assets under management (AUM): – The ARN of the deceased distributor should have been valid at the time of demise and not suspended. – The nominee/legal heir should have a valid ARN and be KYD compliant. – Only assets procured by the deceased distributor prior to their demise and during the validity of their ARN can be transferred.
Change of Distributor
Key Points
Description
Change of Distributor Code in Folio
Investors have the right to change their distributor or go direct. Written requests by investors for changing the distributor should be complied with by AMCs, without insisting on a ‘No Objection Certificate’ from the existing distributor. In such cases, no commission is payable to either the old or new distributor. This provision ensures investor choice while discouraging distributors from inducing or forcing investors to request a change of distributor code.
Initiating Change of Distributor Code
A distributor can initiate a change in the distributor code in folios under the following circumstances: – Change in name/legal status of the distributor – Merger/acquisition/consolidation/transfer of business within the same group for non-individual distributors – Transfer of AUM consolidation within the same family/close relatives for individual distributors – Transfer of business by individual distributors
Transfer of AUM
The transfer of assets under management (AUM) can only happen if the entire AUM is being transferred from the existing distributor. The transfer should be made in the name of a valid ARN holder who is KYD compliant. Once the AUM transfer is complete, the old ARN should be surrendered, and no further business can be conducted under that ARN. AMFI has defined a detailed procedure for effecting such a change of distributor.
Other Conditions
– The change of distributor code is not allowed under any other circumstances. – The change of distributor code should comply with the guidelines provided by AMFI.
Provides information about the particular mutual fund scheme.
Covers details such as scheme type, investment objectives, asset allocation, investment strategy, risk factors, fees and expenses, redemption and purchase prices, investment limits, plans and options, liquidity, and taxation.
Helps investors understand the features and suitability of the scheme.
Statement of Additional Information (SAI):
Contains statutory information about the mutual fund or Asset Management Company (AMC) offering the scheme.
Provides details about the constituents of the mutual fund, investment valuation norms, investor rights, taxation, legal information, and grievance procedures.
Relevant for all schemes offered by a mutual fund.
Key Information Memorandum (KIM):
Summary document accompanying the application form, providing key points from the SID and SAI.
Includes information about the mutual fund, scheme name, dates of issue, investment objective, asset allocation pattern, risk profile, plans and options, benchmark, performance, expenses, and investor grievance details.
Helps investors make informed decisions on the suitability of the investment.
Updating Scheme Documents:
SID: Updated within six months from the end of each half-year, and revised immediately after fundamental attribute changes. Addendum issued for other changes.
SAI: Regularly updated by the end of each financial year, and ongoing updates for material changes.
KIM: Updated at least once every half-year, within one month from the end of September and March.
Mandatory Disclosures:
Daily NAV: Published on the AMC’s and AMFI’s websites, disclosing the Net Asset Value of the scheme at the end of each business day.
Current Value of Investments: Calculated by multiplying the number of units with the NAV, which can be obtained from the latest account statement.
Disclosure of Total Expense Ratio:
Total Expense Ratio (TER) is an important factor that affects the NAV (Net Asset Value) of a mutual fund scheme.
TER is regulated by SEBI (Securities and Exchange Board of India) and should be disclosed prominently by Asset Management Companies (AMCs).
SEBI mandates that the TER of all schemes should be disclosed on a daily basis on the AMC’s website and the AMFI (Association of Mutual Funds in India) website.
AMCs must also notify investors through email whenever there is a change in the expense ratio.
The format of disclosing TER is presented in Table 5.1, showing the TER for a specific scheme on different dates.
Any change in the base TER must be communicated to investors at least 3 working days prior to the change and updated on the AMC website.
Scheme-wise performance dashboards should be published on the mutual fund website, providing information about scheme performance, classification, objectives, fund manager, benchmark index, plans, options, minimum investment, AUM (Assets Under Management), TER, inception date, and portfolio.
Risk-o-meter and benchmark information should be disclosed along with scheme performance.
Portfolio disclosures list the securities in which the scheme’s corpus is invested, including their market values.
AMCs should send scheme portfolio details to unitholders via email in fortnightly, monthly, and half-yearly statements.
Financial results should be displayed on the AMC website within one month of each half year.
Annual reports or abridged summaries should be hosted on the AMC’s website and AMFI’s website and emailed to registered investors.
Disclosures regarding change in control of the AMC should be submitted to SEBI, including draft letters/emails to unitholders and draft advertisements for newspapers.
Non-Mandatory Disclosures: Fund Factsheet
The Fund Factsheet is a monthly document voluntarily published by mutual fund houses.
It serves as a marketing and information document, providing key details about the mutual fund schemes.
The factsheet includes basic information like scheme inception date, AUM (corpus size), current NAV, benchmark, and a visual representation of the fund’s management style.
Performance data comparing the fund’s returns with the benchmark is included for different time periods, as required by SEBI regulations.
SIP returns, portfolio allocation to sectors and securities, and the top 10 holdings are typically disclosed in the factsheet.
For equity schemes, the factsheet provides security-wise and sector-wise allocation, and some may also disclose derivatives exposure.
Debt funds’ factsheets disclose the rating profile of securities and the scheme’s exposure to different rating baskets.
Additional portfolio features such as PE ratio, Beta, standard deviation, and Sharpe ratio (for equity funds) are provided.
Debt funds’ factsheets include details like credit rating profile, average maturity, and duration.
Investment-related information, such as minimum investment amount, available plans and options, loads and expenses, and systematic transaction facilities, are also included in the factsheet.
The regulations in financial markets aim to safeguard consumer interests and ensure regulated development of financial markets for economic growth.
There are four regulators in India:
Reserve Bank of India (RBI): Regulates banking system and money markets.
Securities and Exchange Board of India (SEBI): Regulates securities markets.
Insurance Regulatory and Development Authority of India (IRDAI): Regulates insurance market.
Pension Fund Regulatory and Development Authority of India (PFRDA): Regulates pension market.
These regulators fall under the Ministry of Finance.
Role of Securities and Exchange Board of India (SEBI)
SEBI regulates securities markets, including mutual funds, depositories, custodians, and registrars and transfer agents (RTAs).
The Preamble of SEBI describes its functions as protecting investor interests and promoting the development and regulation of the securities market.
SEBI regulations focus on:
Disclosures by issuers of securities (companies and mutual funds)
Efficiency of transactions in securities markets
Low transaction costs
Other areas requiring regulations include:
Deliberate speculation in stock markets
Insider trading
Excessive risks taken by mutual funds
Inadequate collateral by issuers of debt securities
Unchecked activities can erode investor trust, leading to a lack of financial resources and reduced investment activity in capital markets, hampering economic growth.
Regulators
Functions
Reserve Bank of India (RBI)
Regulates banking system and money markets
Securities and Exchange Board of India (SEBI)
Regulates securities markets
Insurance Regulatory and Development Authority of India (IRDAI)
Regulates insurance market
Pension Fund Regulatory and Development Authority of India (PFRDA)
Regulates pension market
Regulatory reforms by SEBI
SEBI (Securities and Exchange Board of India) has implemented various regulatory reforms in the mutual fund industry to protect investor interests and promote informed investment decisions.
The reforms have been introduced through regulations, circulars, and guidelines, covering different aspects of mutual fund operations.
The regulatory provisions can be categorized as follows:
Regulation Categories
Areas Covered
Scheme related documents
Objectives, content, and publication frequency of scheme-related documents
Conversion and consolidation of existing schemes
Mergers and consolidation of schemes to protect unitholder interests
New products
Approval and regulation of new product categories
Risk management system
Guidelines for robust operational risk management and exposure limits
Disclosures and reporting norms
Mandates for proper disclosures, reporting formats, and frequency
Governance norms
Governance requirements for funds and schemes, including committees and trustees
Secondary market activities
Regulations for mutual fund activities in equity, debt, government securities, and derivatives markets
Net Asset Value (NAV)
Disclosure, calculation, rounding-off, and time stamping of NAV
Valuation
Valuation norms for securities held by mutual fund schemes
Loads, fees, and expenses
Imposition and disclosure of limits on loads, fees, and expenses
Dividend distribution procedure
Procedures and norms for distribution of dividends
Investment by schemes
Guidelines and restrictions on investments by mutual fund schemes
Advertisements
Regulations on content, clarity, accuracy, and fair representation of advertisements
Investor rights and obligations
Regulations regarding investor rights, account statements, penalties, and facilities
Certification and registration of intermediaries
Norms for certification, registration, and continuous professional education of intermediaries
Transaction in mutual fund units
Guidelines for transactions, preservation of documents, and KYC norms
Categorization of mutual fund schemes
Guidelines for scheme categorization and consolidation, benchmarking, and performance disclosure
Segregated Portfolio
Provision for creating segregated portfolios to protect unitholders in credit events and manage liquidity risk
SEBI’s Advertising Code for mutual funds ensures accurate, fair, and transparent advertisements, prohibiting false or misleading statements and exploitation of investor knowledge.
Mutual funds also need to comply with regulations issued by other regulators such as RBI (Reserve Bank of India) and stock exchanges.
Advertisement Guidelines for Mutual Funds
The advertisement guidelines for mutual funds provide clear instructions on disclosing performance-related information, celebrity endorsements, circulation of unauthenticated news, and investors’ rights and obligations. Here are the key points summarized in a table:
Guidelines
Areas Covered
Disclosing performance-related information
– CAGR for different time periods
– Point-to-point returns for ease of understanding
– Differentiate between regular and direct plans
– Disclose if the fund manager has changed
– Performance data of other schemes managed by the same fund manager
– Disclosure for money market schemes and short-term investments
Celebrity endorsements at industry level
– Promote awareness of mutual funds as a financial product category
– Limit expenses and obtain prior approval from SEBI
Guidelines for circulation of unauthenticated news
– Implement internal code of conduct and controls
– Restrict access to blogs, chat forums, and messenger sites
– Maintain logs and seek approval from Compliance Officer
Investors’ rights and obligations
– Right to beneficial ownership, change distributor, inspect documents, etc.
– Right to appoint nominees, pledge units, and seek grievance redressal
– Rights in the context of change in fundamental attributes and termination of AMC
– Right to unclaimed amounts and disclosure of portfolio details
– Treatment of proceeds from illiquid securities
Due Diligence Process by AMCs for Distributors of Mutual Funds
Asset Management Companies (AMCs) are responsible for regulating the practices of distributors of mutual funds. They conduct due diligence on distributors as per SEBI guidelines. Here are the key points summarized in a table:
Due Diligence Process by AMCs for Distributors of Mutual Funds
Overview
Purpose
Regulate practices of mutual fund distributors
Process
Conduct due diligence on distributors
Key Steps
– Evaluate distributor’s background and experience
– Assess distributor’s infrastructure and systems
– Verify distributor’s compliance with regulations
– Review distributor’s track record and performance
Documentation
– Collect distributor’s registration and compliance documents
– Review distributor’s financial statements and audit reports
Ongoing Monitoring
– Regularly review distributor’s performance and conduct audits
– Take appropriate action for non-compliance or misconduct
SEBI Circular
SEBI has issued a circular providing detailed guidelines
Note: The table summarizes the due diligence process conducted by AMCs for distributors of mutual funds, highlighting the purpose, process, key steps, documentation, ongoing monitoring, and reference to the SEBI circular.
Investor Grievance Redress Mechanism
In case of any issues with the AMC or mutual fund scheme, investors can follow the grievance redress mechanism. Here are the key points summarized in a table:
Investor Grievance Redress Mechanism
Overview
Initial Approach
Contact investor service center for grievance redressal
Escalation Process
If the issue remains unresolved, escalate it to senior levels within the AMC
SEBI Complaint
If the issue is not resolved even after escalation, file a complaint with SEBI
SEBI Complaint Redress System
Lodge, follow up, and track complaints online using the SCORES system
Physical Complaint Submission
Investors unfamiliar with SCORES can submit complaints physically at SEBI offices
Entities Covered
Listed companies, registrar & transfer agents, brokers, mutual funds, and more
AMFI Code of Conduct for Intermediaries
The AMFI Code of Conduct for Intermediaries aims to maintain high ethical and professional standards in the mutual fund industry. Here are the key points summarized in a table:
AMFI Code of Conduct for Intermediaries
Overview
Objective
Promote investors’ interest by defining and maintaining ethical standards
Code of Ethics
ACE (AMFI Code of Ethics) sets out standards for AMCs in their operations
and dealings with investors, intermediaries, and the public
SEBI Regulation Compliance
Asset Management Companies and Trustees must abide by the Code of Conduct
specified in the Fifth Schedule of SEBI (Mutual Funds) Regulation, 1996
AMFI’s Supplemental Code
AMFI Code supplements SEBI’s Code to encourage higher standards for investors
AMFI Guidelines for Intermediaries
AGNI (AMFI Guidelines & Norms for Intermediaries) for agents, brokers, etc.
selling mutual fund products
Breach of Code
If an intermediary breaches the Code, AMFI initiates a sequence of steps
– Request explanation from the intermediary within 3 weeks
– Issue warning letter for subsequent violations
– Cancel registration upon proved second violation
Mutual funds in India are established as trusts governed by the Indian Trusts Act, 1882.
The trust is created by one or more sponsors who are the main individuals behind the mutual fund business.
The investors who invest in the mutual fund schemes are the beneficiaries of the trust.
The operations of the trust are governed by a Trust Deed, which is executed between the sponsors and the trustees. SEBI has specific clauses that need to be included in the Trust Deed.
The trustees are responsible for protecting the interests of the investors. They are named in the Trust Deed, and procedures for changing trustees are also mentioned.
Trustees can be individuals or a trustee company. If individuals are appointed, they form the ‘Board of Trustees.’ A trustee company operates through its Board of Directors.
Day-to-day management of the schemes is handled by an Asset Management Company (AMC), appointed by the sponsor or the trustees.
The trustees enter into an investment management agreement with the AMC, specifying its responsibilities.
The custody of scheme assets, such as securities, gold, silver, real estate assets, etc., is entrusted to a Custodian appointed by the trustees.
Investor records and unit holdings can be maintained by the AMC itself or by a Registrar & Transfer Agent (RTA) appointed by the AMC.
Table summarizing the structure of mutual funds in India:
Structure Component
Description
Trust Type
Mutual funds are established as trusts governed by the Indian Trusts Act, 1882
Sponsors
Main individuals behind the mutual fund business
Beneficiaries
Investors who invest in the mutual fund schemes
Trust Deed
Governing document executed between sponsors and trustees
Trustees
Responsible for protecting the interests of investors
Board of Trustees
If individuals are appointed as trustees, they form the Board of Trustees
Trustee Company
Operates through a Board of Directors
Asset Management Company (AMC)
Handles day-to-day management of the schemes
Investment Management Agreement
Agreement between trustees and the AMC, outlining responsibilities
Custodian
Appointed by trustees for custody of scheme assets
Registrar & Transfer Agent (RTA)
Maintains investor records and unit holdings
Key Constituents of a Mutual Fund:
Sponsors:
Sponsors make the application to SEBI for the registration of a mutual fund and invest in the capital of the Asset Management Company (AMC).
Eligibility criteria for sponsors include a track record of fairness, integrity, and at least 5 years of experience in financial services.
Sponsors should have a positive net worth for the preceding 5 years, which should be higher than their proposed capital contribution to the AMC.
They should have profits in 3 out of the last 5 years and a net worth of at least Rs. 100 crore if the profit criterion is not fulfilled.
Sponsors should be considered fit and proper for operating a mutual fund.
Board of Trustees:
Trustees play a critical role in ensuring regulatory compliance and protecting the interests of unit-holders.
Trustees must be persons of ability, integrity, and standing, with no involvement in moral turpitude or economic offenses.
No AMC director, officer, or employee can be appointed as a trustee.
Prior approval from SEBI is required for trustee appointments.
At least 4 trustees should be appointed, and if a trustee company is appointed, it must have at least 4 directors, with two-thirds being independent trustees.
Trustees have various responsibilities, including entering into an Investment Management Agreement with the AMC, reviewing service contracts, ensuring compliance with regulations, protecting unitholders’ interests, and filing reports to SEBI.
Mutual Fund Trust:
A mutual fund is constituted as a trust, and a trust deed is executed by the sponsor, duly registered under the Indian Registration Act, 1908.
The trust deed specifies the trustees named in the instrument.
Asset Management Company (AMC):
The AMC handles the day-to-day operations of the mutual fund.
The directors and key personnel of the AMC should have professional experience in finance and financial services.
They should have a clean record with no involvement in moral turpitude or violations of securities laws.
Approval from trustees is required before appointing a person as a director on the AMC’s board.
At least 50% of the directors should be independent directors.
The AMC must maintain a minimum net worth of Rs. 50 crores on a continuous basis.
Changes in AMC control require prior approval from trustees and SEBI.
Custodian:
The custodian is responsible for the custody of the fund’s assets and settles transactions on behalf of the mutual fund schemes.
All custodians must register with SEBI.
The custodian is appointed by the trustees, and a custodial agreement is entered into.
Independent custodians ensure the proper holding of securities for the benefit of investors.
Custodians track corporate actions such as dividends and bonuses in invested companies.
Organization Structure of Asset Management Company:
Function
Description
Compliance Function
Ensures legal compliance, reports directly to the head of the AMC, works closely with the Trustees
Fund Management
Analyzes investment opportunities, manages the fund in line with the scheme’s objective
Operations and Customer Services Team
Front office and back office teams that attend to customer queries, maintain investor records, process transactions, and generate account statements
Sales and Marketing Team
Responsible for branding, advertising, distribution of mutual fund products, relationship management with distributors
Other Functions
Finance/Accounts, Administration, Human Resources, Information Technology, support various operations and improve customer experiences
Note: The above table provides a summary of the various functions within an Asset Management Company (AMC). The structure may vary across different AMCs, and additional departments or variations may exist based on specific requirements and operations.
Role and Support Functions of Service Providers:
Service Provider
Description
Fund Accountant
Calculates the Net Asset Value (NAV) of the mutual fund schemes by collecting information about the assets and liabilities of each scheme. Can be handled in-house by the AMC or outsourced to a service provider. No SEBI registration required.
Registrars and Transfer Agents (RTAs)
Maintain investor records, process purchase and redemption transactions, update investor information, and handle financial transactions. Can be appointed by the AMC or managed in-house. Registration with SEBI is required.
Auditors
Responsible for auditing the accounts of mutual fund schemes and the AMC. Separate auditors appointed for the schemes and the AMC.
Distributors
Play a key role in selling mutual fund schemes to clients/investors. Can be individuals or institutions such as distribution companies, broking companies, and banks. Need to pass the NISM Certification Examination and register with AMFI.
Collecting Bankers/Payment Aggregators
Receive and process funds from investors for mutual fund purchases and redemptions. Facilitate the collection and payment of funds for the schemes.
KYC Registration Agencies
Ensure investor compliance with KYC (Know Your Customer) requirements under the Prevention of Money Laundering Act. Establish investor identity and address. Registered with SEBI.
Valuation Agencies
Provide fair valuation of non-traded or thinly traded debt securities. Guidelines issued by SEBI.
Credit Rating Agencies
Rate debt securities issued by various issuers. Important input for investment decisions. Some mutual fund categories have restrictions based on credit ratings.
Depositories and Depository Participants
Hold securities in dematerialized or electronic form on behalf of investors. Investors can hold mutual fund units in dematerialized form through a depository participant. Two depositories in India: NSDL and CDSL.
Stock Exchanges and Transaction Platforms
Enable investors to transact in mutual fund units through stock exchanges. Units of close-ended funds and ETFs are listed on stock exchanges. Transaction platforms like MF Utilities India allow investors to aggregate transactions across multiple mutual funds.
Role and Function of AMFI:
Function
Description
Define and maintain professional and ethical standards
AMFI aims to define and uphold high professional and ethical standards in all areas of operation within the mutual fund industry.
Recommend and promote best business practices and code of conduct
AMFI promotes best business practices and a code of conduct for its members and other entities involved in mutual fund and asset management activities.
Interact with SEBI
AMFI interacts with the Securities and Exchange Board of India (SEBI) on matters related to the mutual fund industry.
Represent to Government and other bodies
AMFI represents the mutual fund industry’s interests to the Government, Reserve Bank of India, and other relevant bodies.
Nationwide investor awareness program
AMFI undertakes initiatives to educate and create awareness among investors about the concept and functioning of mutual funds.
Disseminate information and conduct research
AMFI disseminates information about the mutual fund industry and conducts studies and research in collaboration with other organizations.
Regulate conduct of distributors and protect investor interests
AMFI regulates the conduct of distributors, including disciplinary actions such as the cancellation of ARN (AMFI Registration Number), for violations of the Code of Conduct. It also works to protect the interests of investors.
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