XII. MUTUAL FUND SCHEME SELECTION

Scheme Selection based on Investor needs, preferences, and risk-profile:

1. 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.
2. 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.
3. 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.
4. 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.
5. Investment time horizon:
   • Longer investment horizon allows for higher risk tolerance.
   • Shorter timeframes may require more conservative investment choices to ensure capital preservation.
6. 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.
7. 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:

1. Ensure suitability: Comply with SEBI regulations by assessing the suitability of the scheme for the investor's needs and situation.
2. Stick to investor's asset allocation: Align the selection of schemes with the investor's predetermined asset allocation strategy.
3. 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.
4. 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.
5. 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:

1. Chase past performance: Avoid selecting schemes solely based on their recent good performance, as past performance may not be sustained in the future.
2. 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.
3. Overlook taxes and loads: Be mindful of the impact of taxes and loads on investment returns and consider them while making investment decisions.
4. 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.