II. CONCEPT AND ROLE OF A MUTUAL FUND

Table of Contents

Concept of a Mutual fund:

  • A mutual fund is a professionally managed investment vehicle.
  • It allows investors to access different markets and securities through professional fund management services offered by an asset management company.
  • Investors invest through mutual funds, not in mutual funds directly.
  • Mutual funds offer portfolio diversification and a regulated investment vehicle.

Role of Mutual Funds:

  • Mutual funds help investors earn income or build wealth by investing in securities markets.
  • They offer different types of schemes to cater to diverse investment objectives.
  • Mutual funds mobilize money from investors, which benefits governments, companies, and promotes economic development.
  • Mutual funds can act as a market stabilizer in countering large inflows or outflows from foreign investors.

Investment Objectives of Mutual Funds:

  • Mutual funds mobilize different pools of money called schemes, each with a pre-announced investment objective.
  • Investment objectives can include safety, liquidity, and returns, such as income or capital appreciation.
  • Different schemes invest in various asset classes based on their investment objectives.

Investment Policy of Mutual Funds:

  • The investment policy of a mutual fund scheme determines how it achieves its investment objective.
  • It includes asset allocation and investment style, which may vary based on the scheme’s objective.
  • Asset allocation determines the types of securities the scheme invests in, such as equities or debt instruments.
  • Investment style may be growth or value-oriented, and portfolio concentration can be focused or diversified.

Important Concepts in Mutual Funds:

  • Units: Investors are issued units of a mutual fund scheme, representing their investment.
  • Face Value: Units typically have a face value of Rs. 10, relevant for accounting purposes.
  • Unit Capital: The capital of a scheme is calculated by multiplying the number of units by their face value.
  • Recurring Expenses: Fees or commissions paid to mutual fund constituents are recurring expenses charged to the scheme.
  • Net Asset Value (NAV): NAV represents the true worth of a unit and is calculated based on the scheme’s underlying investments.
  • Assets Under Management (AUM): AUM is the sum of investments made by all investors in the scheme and reflects its size.
  • Mark to Market (MTM): Valuing each security in the scheme’s portfolio at its current market value on a daily basis.

Advantages of Mutual Funds for Investors:

  • Professional Management: Mutual funds provide professional fund management services, research, and investment expertise.
  • Affordable Portfolio Diversification: Investors can access a diversified portfolio even with small investments.
  • Economies of Scale: Pooling large sums of money allows for professional management and cost-sharing benefits.
  • Transparency: Mutual funds provide relevant information, transparency about investments, and regular NAV updates.
  • Liquidity: Investors can easily recover the market value of their investments from the mutual fund.
  • Tax Deferral and Tax Benefits: Mutual funds offer options to defer taxes and certain schemes provide tax deductions.
  • Convenient Options: Mutual funds offer various options for investing, withdrawing, and structuring returns.
  • Investment Comfort and Regulatory Comfort: Mutual funds simplify investing and benefit from SEBI’s regulations.
  • Systematic Approach: Investors can use systematic plans to invest regularly or withdraw funds systematically.

Limitations of Mutual Funds:

  • Lack of Portfolio Customization: Investors cannot influence the securities or investments chosen by the mutual fund scheme.
  • Choice Overload: Multiple schemes and options can make it challenging for investors to choose the right mutual fund.
  • No Control Over Costs: Investors have no control over the costs incurred by the scheme, which are shared proportionally.
  • No Guaranteed Returns: Mutual funds are subject to market fluctuations, and returns are not guaranteed.

Classification of Mutual Funds:

  1. Based on investment objective:
    • Growth funds
    • Income funds
    • Liquid funds
  2. By the structure of the fund:
    • Open-ended funds: Investors can enter or exit at any time.
    • Close-ended funds: Have a fixed maturity date and cease to exist thereafter.
    • Interval funds: Combine features of both open-ended and close-ended schemes, becoming open-ended at pre-specified intervals.
  3. By the management of the portfolio:
    • Actively managed funds: Fund manager chooses the investment portfolio.
    • Passive funds: Invest based on a specified index.
  4. By the investment universe:
    • Equity funds
    • Fixed income funds
    • Money market funds
    • Gold funds
    • International funds
    • Sectoral/Thematic funds
  5. Mutual fund scheme categorization and SEBI regulation:
    • Equity Schemes (11 sub-categories)
    • Debt Schemes (16 sub-categories)
    • Hybrid Schemes (6 sub-categories)
    • Solution Oriented Schemes (2 sub-categories)
    • Other Schemes (2 sub-categories)

Additional types of funds:

  • Fixed Maturity Plans (close-ended debt funds with a duration aligned to maturity)
  • Capital Protection Funds (closed-end hybrid funds providing principal protection)
  • Infrastructure Debt Funds (investment vehicles for institutional investors)
  • Real Estate Mutual Funds (investing in real estate assets)
  • Smart Beta Funds (index funds using alternative strategies)
  • Quant Funds (data-driven selection of securities)
  • International REITs Funds (investing in Real Estate Investment Trusts abroad)

Growth of the Mutual Fund Industry in India:

  • Mutual fund assets under management (AUM) in India have witnessed significant growth from Rs. 6.99 lakh crores in May 2012 to Rs. 37.37 lakh crore in May 2022.
  • The 10-year growth rate stands at 18.25 percent per annum compounded annually.
  • The number of folios (investor accounts) has increased from 4.80 crore in March 2010 to 13.33 crore in May 2022.
  • Mutual funds’ share in overall financial investments in India has risen from 10 percent in March 2016 to 14 percent in March 2018.
  • In comparison, the share of bank deposits has decreased from 71 percent to 65 percent during the same period.
  • The Indian mutual fund industry’s global market share has increased from 0.33 percent in 2008 to 0.60 percent in 2018.

Table: Growth of Mutual Fund Industry in India

YearAUM (in Rs. lakh crore)Folios (in crores)Mutual Fund Share in Financial Investments (%)
May 20126.994.80
May 202237.3713.33
10-year CAGR18.25%
March 201610%
March 201712%
March 201814%
March 20104.80
March 20208.97