Unit-4

Non banking financial institution:

A non-bank financial institution/ intermediaries (NBFI) is a financial institution that does
not have a full banking license or is not supervised by a national or international banking
regulatory agency. NBFIs facilitate bank-related financial services, such as investment, risk
pooling, contractual savings, and market brokering.
In other words, Non-Bank Financial Intermediaries (NBFIs) is a heterogeneous
group of financial institutions other than commercial and co-operative banks. They include a
wide variety of financial institutions, which raise funds from the public, directly or indirectly,
to lend them to ultimate spenders.
In other words, "The Non-Banking Financial Intermediaries (NBFIs) are just intermediaries
or middlemen transferring funds from ultimate lenders to ultimate borrowers. The financial
intermediaries obtain funds by issuing to the public their own liabilities such as saving
deposits and loan shares and then use this money to buy financial assets namely stocks, bonds
and mortgages for themselves.
Examples of these includes: insurance firms, pawn shops, cashier's check issuers, check
cashing locations, payday lending, currency exchanges, and microloan organizations.

Role of Non-Banking financial Institution (NBFI):

The following points highlight the top seventeen roles of Non-Bank Financial Intermediaries
(NBFIs). Some of the roles are: 1. Reduce Hoarding 2. Help the Household Sector 3. Help the
Business Sector 4. Help the State and Local Government 5. Help the Central Government 6.
Lenders and NBFIs both Earn 7. Provide Liquidity 8. Help in Lowering Interest Rate and
Others.

Role #1. Reduce Hoarding:

By bringing the ultimate lenders (or savers) and ultimate borrowers together, NBFIs reduce
hoarding of cash by the people under the “mattress”, as is commonly said.

Role # 2. Help the Household Sector:

The household sector relies on NBFIs for making profitable use of its surplus funds and also
to provide consumer credit loans, mortgage loans, etc. Thus they promote saving and
investment habits among the ordinary people.

Role # 3. Help the Business Sector:

NBFIs also help the nonfinancial business sector by financing it through loans, mortgages,
purchase of bonds, shares, etc. Thus they facilitate investment in plant, equipment and
inventories.

Role # 4. Help the State and Local Government:

NBFIs help the state and local bodies financially by purchasing their bonds.
Role # 5. Help the Central Government:
Similarly, they buy and sell central government securities and thus they help the central
government.

Role # 6. Lenders and NBFIs both Earn:

When savers deposit their funds with NBFIs, they earn interest. When NBFIs lend to ultimate
borrowers, they earn profits. In fact, the reward of intermediation arises from the difference
between the rate of return on primary securities held by NBFIs and the interest or dividend
rate they pay on their indirect debt.

Role # 7. Provide Liquidity:

NBFIs provide liquidity when they convert an asset into cash easily and quickly without loss
of value in terms of money. When NBFIs issue claims against themselves and supply funds
they, especially banks, always try to maintain their liquidity. This they do by following two
rules: first, they make short-term loans and finance them by issuing claims against themselves
for longer periods; and second, they diversify loans among different types of borrowers.

Role # 8. Help in Lowering Interest Rate:

Competition among NBFIs leads to the lowering of interest rates. NBFIs prefer to keep their
saving with NBFIs rather than in cash. The NBFIs, in turn, invest them in primary securities.
Consequently, prices of securities are bid up and interest rates fall. Moreover, when people
keep their cash holdings with NBFIs(which are safe and liquid), the demand for money falls
thereby lowering interest rates.

Role # 9. Low Interest Rates Benefit both Savers and Investors:

When interest rates decline, both savers and investors benefit. First, the real costs of lending
to borrowers are reduced. These, in turn, tend to reduce costs and prices of goods and
services. With reduction in interest rates, the return on time deposits is also’ reduced which
induces savers to deposit their funds with NBFIs even though the latter pay lower interest
rates.

Still the savers benefit because NBFIs provide greater safety, convenience and other related
services to them thereby increasing the savers’ real return and income.

Role # 10. Brokers of Loan-able Funds:

NBFIs play an important role as brokers of loan-able funds. They act as intermediaries
between the ultimate saver and the ultimate investor. They sell indirect securities to savers
and purchase primary securities from investors. Indirect securities are the short-term
liabilities of financial intermediaries.

On the other hand, primary securities are their earning assets but they are the debts of the
borrowers. Thus NBFIs act as brokers of loan-able funds by changing debt into credit.

Role # 11. Reduce Risks:

When the non-bank financial intermediaries convert debt into credit, they reduce the risk to
the ultimate lender. First, they create liabilities on themselves by selling indirect securities to
the lenders. Then they buy primary securities from borrowers of funds.
So by acting as intermediaries between the lenders and borrowers of funds, NBFIs take the
risk on themselves and reduce it on the ultimate lenders. Moreover, by holding varied types
of financial assets, they decrease their own risks. Low returns on some assets can be offset by
high returns on others.

NBFIs Mobilises Savings, it raises funds in the capital market and supply credit to investors.
Expert financial services provided by them have been attracting larger share of public
savings. Such services include easy liquidity, safety of principal and ready divisibility of
savings into direct securities of different values.

They have been able to mobilise more funds due to the development of two types of non-
bank financial intermediaries. The first are the depository intermediaries which include
savings and loan associations, credit unions, and mutual savings banks.

There is high liquidity of savings in such institutions which attract small savers. Moreover,
they issue fixed price assets whose value does not change like the market price of other types
of assets. The second are the contractual intermediaries which enter into contract with savers
and provide them various types of benefits over the long run. Such institutions are pension
funds, life insurance companies and public provident funds. These two types of financial
intermediaries in particular help in mobilising public savings.

Role # 12. Investment of Funds:

NBFIs exist because they want to earn profit by investing the mobilised savings. Different
financial intermediaries follow different investment policies. For instance, savings and loan
associations and mutual savings banks invest in mortgages, and insurance companies invest
in bonds and securities. Thus intermediaries mobilise public savings, invest them and thereby
help in capital formation and economic growth.

Role # 13. Create New Assets and Liabilities:

Gardner Ackley has shown that in intermediating between ultimate lenders and direct
investors, NBFIs add greatly to the stock of financial assets available to savers and for every
extra asset, they also create an equal new financial liability. But intermediation does not
affect total net worth. He concludes that although intermediation does not increase total
wealth or income, it can be assumed that it increases welfare.

Role # 14. Economies of Scale:

NBFIs reap a number of economies of specialisation and scale in mobilising savings and
making investments. It would be costly and cumbersome for individual savers to lend their
funds to individual borrowers. NBFIs make larger transactions with ultimate lenders and
borrowers.

They specialise in trading large financial assets and thus have lower costs in buying and
selling securities. They employ expert Staff and efficient machinery and equipment, thereby
increasing productivity in the transfer of funds.

Role # 15. Bring Stability in the Capital Market:

NBFIs deal in a variety of assets and liabilities which are mostly traded in the capital market.
If there were no NBFIs, there would be frequent changes in the demand and supply of
financial assets and their relative yields, thereby bringing instability in the capital market. As
NBFIs function within a legal framework and set rules, they provide stability to the capital
market and benefit savers and firms through diversified financial services.

Role # 16. Benefit to the Economy:

NBFIs are of immense help in the working of financial markets, in executing monetary and
credit policies of the central bank and hence in promoting the growth of an economy. By
transferring funds from surplus to deficit units, NBFIs create large financial assets and
liabilities.

They provide the economy with money supply and with near money assets. Thus they help in
the working of financial markets. Since the financial markets govern the working of the
economy, the monetary and credit policies of the central bank are changed in such a manner
from time to time that the financial markets function smoothly in the country.

In fact, the growth of the economy is dependent upon the proper functioning of the financial
system which in turn, depends to a large extent upon the NBFIs.

Role # 17. Help in the Growth Process of Economy:

NBFIs help in the growth process of the economy. They intermediate between ultimate
lenders who are savers and ultimate borrowers who are investors. By performing this
function, they discourage hoarding by the people, mobilise their savings and lend them to
investors.

Thus NBFIs encourage saving and investment which are essential for promoting economic
growth. Goldsmith’s study has shown that the growth of NBFIs has been responsible for the
economic growth of developed countries in a significant way.

We may conclude that NBFIs provide liquidity and safety to financial assets and help in
transferring funds from ultimate lenders to ultimate borrowers for productive purposes. They
increase capital formation and consequently lead to economic growth.

Functions of Non-Banking financial Institution(NBFI):

The role and importance of non-bank financial intermediaries is clear from the various
functions performed by these institutions. Major functions of the NBFIs are as follows:

1. Financial Intermediation:
The most important function of the non-bank financial intermediaries is the transfer of funds
from the savers to the investors.
Financial intermediation is economical and less expensive to both small businesses and small
savers,
(a) It provides funds to small businesses for which it is difficult to sell stocks and bonds
because of high transaction costs,
(b) It also benefits the small savers by pooling their funds and diversifying their investments.
 2. Economic Basis of Financial Intermediation:
Handling of funds by financial intermediaries is more economical and more efficient than
that by the individual wealth owners because of the fact that financial intermediation is based
on:
(a) The law of large numbers, and
(b) Economies of scale in portfolio management.

(a) Law of Large Numbers:

Financial intermediaries operate on the basis of the statistical law of large numbers.
According to this law not all the creditors will withdraw their funds from these institutions.
Moreover, if some creditors are withdrawing cash, some others may be depositing cash.
Again, the financial intermediaries also receive regular interest payments on loans or
investments made by them. All these factors enable the financial intermediaries to keep in
cash only a small fraction of the funds provided by the creditors and lend or invest the rest.

(b) Economies of Scale:

Large size of the asset portfolios enables the financial intermediaries to reap various
economies of scale in portfolio management. The main economies are:
(a) Reduction of risk through portfolio diversification:
(b) Employment of efficient and professional managers; and
(c) Low administrative cost of large loans and
(d) Low costs of establishment, information and transactions.

3. Inducement to Save:
Non-bank financial intermediaries play an important role in promoting savings in the country.
Savers need stores of value to hold their savings in. These institutions provide a wide range
of financial assets as store of value and make available expert financial services to the savers.
As stores of value, the financial assets have certain special advantages over the tangible
assets (such as, physical capital, inventories of goods, etc.). They are easily storable, more
liquid, more easily divisible, and less risky. In fact, saving- income ratio is positively related
to both financial institutions and financial assets; financial progress. It induces larger savings
out of the same level of real income.

4. Mobilisation of Saving:
Mobilisation of savings takes place when the savers hold savings in the form of currency,
bank deposits, post office savings deposits, life insurance policies, bills, bond's equity shares,
etc. NBFI provides highly efficient mechanism for mobilising savings. There are two types of
NBFTs involved in the mobilisation of savings;
(a) Depository Intermediaries, such as savings and loan associations, credit unions, mutual
saving banks etc. These institutions mobilise small savings and provide high liquidity of
funds.
(b) Contractual Intermediaries, such as life insurance companies, public provident funds,
pension funds, etc. These institutions enter into contract with savers and provide them various
types of benefits over the long periods.

5. Investment of Funds:
The main objective of NBFIs is to earn profits by investing the mobilised savings. For this
purpose, these institutions follow different investment policies. For example, savings and
loan associations, mutual saving banks invest in mortgages, while insurance companies invest
in bonds and securities.

Sources of Funds/finance:

1. Share Capital Benefit Funds have a low capital base:

In urban and semi-urban centres, the authorised capital ranged in between Rs.1lakh to
Rs.5lakhs and in metropolitan centres, up to Rs.25lakhs. The face value of a share was
fixed Rs.1 in 1980 and after it was changed in to Rs. 15 or Rs.25 as per discretion of
the members.

2. Deposits:
Deposits are the major source of funds for benefit funds. They have schemes for
saving deposits, recurring deposits, fixed deposits, cash certificates, jubilee
certificates and other cumulative deposits like Kamadhenu and Kalpaka Vriksha.

a) Saving Deposits:
A saving deposit can be opened by a member with Rs.5 or Rs. 10 with no limits
on maximum amount. There are restrictions on the number of withdrawals and the
amount per week or month. A minimum balance has to be maintained and interest
is calculated on the minimum balance in the account generally between the 6th
and 26th of every month. Members use the savings deposit account to make
periodical instalment payments on their loans or for transferring monthly
instalments to their recurring deposits. They cannot issue cheques against such
deposits. The interest paid on such deposits varies from one company to another
which ranges from 5 percent to 7 per cent.

b) Recurring Deposits (RD):

Benefit funds were the first to introduce recurring deposit schemes in India and
they borrowed the idea from a Scottish magazine. The minimum amount of RD
varies from Rs.5 to Rs.500. The duration of the deposit can be for a minimum of
12 months to a maximum of 120 months. The interest rates differ with the period
of maturity.

c) Fixed Deposits (FD):

Different benefit companies prescribe different minimum amounts for fixed
deposits. They vary from Rs.100 to Rs.500. The duration of the deposit can be as
low as three months to as high as seven or even ten years. The rates of interest
offered differ among various benefit companies, depending on the duration of
such deposits. Interest is payable monthly unless the depositors opt for quarterly
or half-yearly payments for the sake of convenience, in the case of small deposits.
 d) Cumulative Deposits (CD):
Besides the savings, RD and FD, some benefit companies have schemes for CDs
where the interest is compounded on monthly basis and maturity values payable at
the end of the stated period are fixed. The schemes also offer doubling or tripling
of amounts at the end of stated periods. Generally deposits double in 45 to 52
months and trebles in 68 to 80 months. Benefit companies which have completed
25, 50, 75 and 100 years introduced jubilee certificates with attractive interest
rates. There are a few benefit companies which have cash certificate schemes.

3. Loans:
In the matter of lending, benefit companies follow a conservative and cautious policy. The
loans are granted against acceptable securities like jewels, house property, life insurance
policies, NSS and UTI certificates, besides against the deposits of members. Each benefit
company decides on the securities against which they lend and the quantum of advance
against each. There are different types of loans:

I. Simple Loans:
A simple loan is granted against the fixed or recurring deposit of a member. The
maximum amount of a simple loan varies between 80 and 90 percent of a member's
deposit. The interest rate is generally 1 .5 to 2 percent over the contracted rates on
deposits. Benefit companies grant loans to salaried class on personal surety, after
assessing the member's repaying capacity as evidenced by the salary certificate and of
the guarantors. The maximum amount of the loan is generally related to the member's
income and is granted for a short period, not exceeding one year or two years. The
repayment is effected by taking an undertaking from the employer, wherever
possible, to deduct the monthly instalment from the salary payable.

ii. Mortgage:
Loans Benefit funds provide two types of mortgage loans namely
(a) Ordinary and
(b) Special.

(a) Ordinary Mortgage Loans: Refers loans granted to members against their
buildings, houses and flats within the specified civil jurisdiction. The ceiling varies from
Rs.25, 000 to Rs.5lakhs depending on the resources available with individual benefit
companies. The duration of the loan varies from three to seven years.

(b) Special Mortgage Loans: In the case of special mortgage loan it is not necessary
for a member to open a RD account. The loan amount is divided equally over the
duration of the loan to arrive at the monthly instalment. Rate of interest varies from 18
to 24 per cent. The amount of the loan is generally 50 percent of the market value of
the property offered as security.

iii. Jewel Loans:

Most of the benefit companies extend loans against gold jewellery. Generally, the loan
amount will be specified per sovereign, based on the market price of gold. With the
steady increase in the price of gold borrowers are able to get a higher loan amount. At
present benefit companies sanction loans at the rate of Rs.2, 500/- to Rs.3, 000/- per
sovereign (8 grams).
 iv. Other Secured Loans: Benefit companies advance loans against life insurance
policy, NSC, UTI certificates and government bonds, the loan amount varies from 50 to
75 percent of their face value. The rate of interest is varied from 16 to 18 percent.

Mutual funds:

A mutual fund is a type of financial intermediary that pools the funds of investors who seek
the same general investment objective and invests there in a number of different types of
financial claims (e.g., equity shares, bonds, money market instruments).

These pooled funds provide thousands of investors with proportional ownership of diversified
portfolios managed by professional investment managers. The term ‘mutual’ is used in the
sense that all its returns, minus its expenses, are shared by the fund’s unit holders.

Types of Mutual Funds:

For the purposes of this lesson, we'll focus on the three main types of mutual funds: equity
funds, fixed-income funds, and money market funds.
Let's explore each of these briefly.
1. Equity funds invest in stocks of various sizes and domicile. For example, there are
mutual funds that are classified as global, which have the ability to invest in both the
U.S. and anywhere in the world. Mutual funds that are classified as domestic are
mostly invested in the U.S. Growth funds typically invest in companies that are
expected to have higher growth rates than others.
2. Fixed-income funds mainly invest in bond-oriented investments, such as corporate
bonds and municipal bonds. You may come across a municipal bond mutual fund that
is state-specific. For example, an Ohio tax-free bond fund typically invests only in
Ohio municipal bond funds, so that interest received by the mutual fund holder is
exempt from taxation at both the federal and state income tax levels.
3. Money market funds invest in high-quality, short-term debt instruments, such as
government treasury bills (also known as T-bills). The returns on money market funds
have historically been greater than savings and checking accounts but less than
certificates of deposits. Please note that investments in money market funds are
typically not guaranteed by the FDIC, as most savings, checking, and certificates of
deposits are. It's important to understand this prior to investing.

ADVANTAGES of mutual funds:

The benefits on offer are many with good post-tax returns and reasonable safety being the
hallmark that we normally associate with them. Some of the other major benefits of investing
in them are:
 1. Number of available options:

Mutual funds invest according to the underlying investment objective as specified at the time
of launching a scheme. So, we have equity funds, debt funds, gilt funds and many others that
cater to the different needs of the investor. The availability of these options makes them a
good option. While equity funds can be as risky as the stock markets themselves, debt funds
offer the kind of security that aimed at the time of making investments. Money market funds
offer the liquidity that desired by big investors who wish to park surplus funds for very short-
term periods. The only pertinent factor here is that the fund has to selected keeping the risk
profile of the investor in mind because the products listed above have different risks
associated with them. So, while equity funds are a good bet for a long term, they may not find
favour with corporate or High Net worth Individuals (HNIs) who have short-term needs.

2. Diversification:

Investments spread across a wide cross-section of industries and sectors and so the risk is
reduced. Diversification reduces the risk because not all stocks move in the same direction at
the same time. One can achieve this diversification through a Mutual Fund with far less
money than one can on his own.

3. Professional Management:

Mutual Funds employ the services of skilled professionals who have years of experience to
back them up. They use intensive research techniques to analyze each investment option for
the potential of returns along with their risk levels to come up with the figures for
performance that determine the suitability of any potential investment.

4. Potential of Returns:

Returns in the mutual funds are generally better than any other option in any other avenue
over a reasonable period. People can pick their investment horizon and stay put in the chosen
fund for the duration. Equity funds can outperform most other investments over long periods
by placing long-term calls on fundamentally good stocks. The debt funds too will outperform
other options such as banks. Though they are affected by the interest rate risk in general, the
returns generated are more as they pick securities with different duration that have different
yields and so are able to increase the overall returns from the

5. Get Focused:

I will admit that investing in individual stocks can be fun because each company has a unique
story. However, it is important for people to focus on making money. Investing is not a game.
Your financial future depends on where you put your hard-earned dollars and it should not
take lightly.

6. Efficiency:
By pooling investors' monies together, mutual fund companies can take advantage of
economies of scale. With large sums of money to invest, they often trade commission-free
and have personal contacts at the brokerage firms.

7. Ease of Use:

Can you imagine keeping track of a portfolio consisting of hundreds of stocks? The
bookkeeping duties involved with stocks are much more complicated than owning a mutual
fund. If you are doing your own taxes, or are short on time, this can be a big deal.

Wealthy stock investors get special treatment from brokers and wealthy bank account holders
get special treatment from the banks, but mutual funds are non-discriminatory. It doesn't
matter whether you have $50 or $500,000; you are getting the exact same manager, the same
account access and the same investment.

8. Risk:

In general, mutual funds carry much lower risk than stocks. This is primarily due to
diversification (as mentioned above). Certain mutual funds can be riskier than individual
stocks, but you have to go out of your way to find them.

With stocks, one worry is that the company you are investing in goes bankrupt. With mutual
funds, that chance is next to nil. Since mutual funds, typically hold anywhere from 25-5000
companies, all of the companies that it holds would have to go bankrupt.

I will not argue that you should not ever invest in individual stocks, but I do hope you see the
advantages of using mutual funds and make the right choice for the money that you really
care about.

Demerits/Drawbacks of Mutual Funds:

Mutual funds have their drawbacks and may not be for everyone:

1. No Guarantees:
No investment is risk free. If the entire stock market declines in value, the value of
mutual fund shares will go down as well, no matter how balanced the portfolio.
Investors encounter fewer risks when they invest in mutual funds than when they buy
and sell stocks on their own. However, anyone who invests through a mutual fund
runs the risk of losing money.

2. Fees and commissions:

All funds charge administrative fees to cover their day-to-day expenses. Some funds
also charge sales commissions or "loads" to compensate brokers, financial
 consultants, or financial planners. Even if you don't use a broker or other financial
adviser, you will pay a sales commission if you buy shares in a Load Fund.

3. Taxes:
During a typical year, most actively managed mutual funds sell anywhere from 20 to
70 percent of the securities in their portfolios. If your fund makes a profit on its sales,
you will pay taxes on the income you receive, even if you reinvest the money you
made.

4. Management risk:
When you invest in a mutual fund, you depend on the fund's manager to make the
right decision regarding the fund's portfolio. If the manager does not perform as well
as you had hoped, you might not make as much money on your investment as you
expected. Of course, if you invest in Index Funds, you forego management risk,
because these funds do not employ managers

Performance appraisal/ performance evaluation in mutual funds:

Investing in mutual funds has an inherent risk assumed upon the ownership. However,
performance of the mutual funds can be quantified with the mathematical calculation of the
historical returns. The correlation of the potential risk and the potential returns constantly put
forth the opportunities to invest in mutual funds and drive maximum potential returns with
minimum underlying risk.

1. Risk adjusted returns:

Risk adjusted returns are the calculative returns your funds make compared to the risk
indicated over the period of time. If compared, a couple of mutual funds which drive the
same percentage of returns over the same period of time, the lesser risk funds have a higher
Risk Adjusted Returns.
2. Benchmark:
Benchmarking is the measurement of quality of the funds against the standard measurements.
It is a point of reference compared to the funds peer markets. Irrespective of the objectives of
investment in mutual funds, benchmark helps you gauge the performance of your investment
against the market competition. Considering historical returns against the market conditions
will help you determine the relevance of the performance benchmark for your investments.
However, historical return is not a reliable indicator of future results.

3. Relative Performance with peers:

Relative performance with peers is a yardstick of the effectiveness of your mutual fund of the
same category. Mutual Funds actively try to top the ranking of the fund universe. Intended
towards a higher return for the determined period of value learning, the relative peer
performance is recommended.
4. Quality of stocks in the portfolio:
Quality of stocks in the portfolio is reflected in its ability to drive superior returns on capital
invested for a specific period of time. It is wise to check the industry leadership position of
the mutual fund. Quality of the stocks in the portfolio would reflect in returns hence in the
performance. Qualitative statistics and historical performance of mutual funds would help
evaluating the performance.
5. Track record and competence of the fund manager:
Your fund manager is an important person who makes investment decisions and stock
selection in the portfolio. Understand your fund manager’s competence according to his/her
fund management knowledge and ability. Your fund manager’s past performance would be a
good parameter to track his/her record and could turn to be of a great value for your
investments.

Regulation of Mutual Funds ( with special reference to SEBI):

Important steps taken by SEBI for the regulation of mutual funds are listed below:

(1) Formation:
Certain structural changes have also been made in the mutual fund industry, as part of which
mutual funds are required to set up asset management companies with fifty percent
independent directors, separate board of trustee companies, consisting of a minimum fifty
percent of independent trustees and to appoint independent custodians.

This is to ensure an arm’s length relationship between trustees, fund managers and
custodians, and is in contrast with the situation prevailing earlier in which all three functions
were often performed by one body which was usually the sponsor of the fund or a subsidiary
of the sponsor.

Thus, the process of forming and floating mutual funds has been made a tripartite exercise by
authorities. The trustees, the asset management companies (AMCs) and the mutual fund
shareholders form the three legs. SEBI guidelines provide for the trustees to maintain an
arm’s length relationship with the AMCs and do all those things that would secure the right
of investors.

With funds being managed by AMCs and custody of assets remaining with trustees, an
element of counter-balancing of risks exists as both can keep tabs on each other.

(2) Registration:
In January 1993, SEBI prescribed registration of mutual funds taking into account track
record of a sponsor, integrity in business transactions and financial soundness while granting
permission.

This will curb excessive growth of the mutual funds and protect investor’s interest by
registering only the sound promoters with a proven track record and financial strength. In
February 1993, SEBI cleared six private sector mutual funds viz. 20th Century Finance
Corporation, Industrial Credit & Investment Corporation of India, Tata Sons, Credit Capital
Finance Corporation, CEAT Financial Services and Apple Industries.

(3) Documents:
The offer documents of schemes launched by mutual funds and the scheme particulars are
required to be vetted by SEBI. A standard format for mutual fund prospectuses is being
formulated.

(4) Code of advertisement:

Mutual funds have been required to adhere to a code of advertisement.

(5) Assurance on returns:

SEBI has introduced a change in the Securities Control and Regulations Act governing the
mutual funds. Now the mutual funds were prevented from giving any assurance on the land
of returns they would be providing. However, under pressure from the mutual funds, SEBI
revised the guidelines allowing assurances on return subject to certain conditions.

Hence, only those mutual funds which have been in the market for at least five years are
allowed to assure a maximum return of 12 per cent only, for one year. With this, SEBI, by
default, allowed public sector mutual funds an advantage against the newly set up private
mutual funds.

As per basic tenets of investment, it can be justifiably argued that investments in the capital
market carried a certain amount of risk, and any investor investing in the markets with an aim
of making profit from capital appreciation, or otherwise, should also be prepared to bear the
risks of loss.

(6) Minimum corpus:

The current SEBI guidelines on mutual funds prescribe a minimum start-up corpus of Rs.50
crore for a open-ended scheme, and Rs.20 crore corpus for closed-ended scheme, failing
which application money has to be refunded.
The idea behind forwarding such a proposal to SEBI is that in the past, the minimum corpus
requirements have forced AMCs to solicit funds from corporate bodies, thus reducing mutual
funds into quasi-portfolio management outfits. In fact, the Association of Mutual Funds in
India (AMFI) has repeatedly appealed to the regulatory authorities for scrapping the
minimum corpus requirements.

(7) Institutionalisation:
The efforts of SEBI have, in the last few years, been to institutionalise the market by
introducing proportionate allotment and increasing the minimum deposit amount to Rs.5000
etc. These efforts are to channel the investment of individual investors into the mutual funds.

(8) Investment of funds mobilised:

In November 1992, SEBI increased the time limit from six months to nine months within
which the mutual funds have to invest resources raised from the latest tax saving schemes.
The guideline was issued to protect the mutual funds from the disadvantage of investing
funds in the bullish market at very high prices and suffering from poor NAV thereafter.

(9) Investment in money market:

SEBI guidelines say that mutual funds can invest a maximum of 25 per cent of resources
mobilised into money-market instruments in the first six months after closing the funds and a
maximum of 15 per cent of the corpus after six months to meet short term liquidity
requirements.

Private sector mutual funds, for the first time, were allowed to invest in the call money
market after this year’s budget. However, as SEBI regulations limit their exposure to money
markets, mutual funds are not major players in the call money market. Thus, mutual funds do
not have a significant impact on the call money market.

(10) Valuation of investment:

The transparent and well understood declaration or Net Asset Values (NAVs) of mutual fund
schemes is an important issue in providing investors with information as to the performance
of the fund. SEBI has warned some mutual funds earlier of unhealthy market

(11) Inspection:
SEBI inspect mutual funds every year. A full SEBI inspection of all the 27 mutual funds was
proposed to be done by the March 1996 to streamline their operations and protect the
investor’s interests. Mutual funds are monitored and inspected by SEBI to ensure compliance
with the regulations.

(12) Underwriting:
In July 1994, SEBI permitted mutual funds to take up underwriting of primary issues as a part
of their investment activity. This step may assist the mutual funds in diversifying their
business.

(13) Conduct:
In September 1994, it was clarified by SEBI that mutual funds shall not offer buy back
schemes or assured returns to corporate investors. The Regulations governing Mutual Funds
and Portfolio Managers ensure transparency in their functioning.

(14) Voting rights:

In September 1993, mutual funds were allowed to exercise their voting rights. Department of
Company Affairs has reportedly granted mutual funds the right to vote as full-fledged
shareholders in companies where they have equity

How to design/build the mutual funds schemes:

Building a portfolio of mutual funds is similar to building a house: There are many
different kinds of strategies, designs, tools and building materials; but each structure shares
some basic features.

To build the best portfolio of mutual funds you must go beyond the sage advice, "Don’t put
all your eggs in one basket:" A structure that can stand the test of time requires a smart
design, a strong foundation and a simple combination of mutual funds that work well for your
needs.

1. Use a Core and Satellite Portfolio Design:

Before building begins, you will need a basic design—a blueprint—to follow. A common and
time-tested portfolio design is called Core and Satellite. This structure is just as it sounds:
You begin with the "core"—a large-cap stock fund—which represents the largest portion of
your portfolio, and build around the core with the "satellite" funds, which will each represent
smaller portions of your portfolio.

2. Use Different Types of Fund Categories for the Structure:

With a large-cap stock fund as your core, different types of funds—the "satellites"—will
complete the structure of your mutual fund portfolio. These other funds can include mid-cap
stock, small-cap stock, foreign stock, fixed income (bond), sector funds and money market
funds.

3. Know Your Risk Tolerance:

Before choosing your funds, you need to have a good idea of how much risk you can
tolerate. Your risk tolerance is a measure of how much fluctuation (a.k.a. volatility—ups and
downs) or market risk you can handle.

For example, if you get highly anxious when your $10,000 account value falls by 10% (to
$9,000) in a one-year period, your risk tolerance is relatively low—you can’t tolerate high
risk investments.

4. Determine Your Asset Allocation:

Once you determine your level of risk tolerance, you can determine your asset allocation,
which is the mix of investment assets—stocks, bonds and cash—that comprises your
portfolio.

The proper asset allocation will reflect your level of risk tolerance, which can be described as
either aggressive (high tolerance for risk), moderate (medium risk tolerance)
or conservative (low risk tolerance). The higher your risk tolerance the more stocks you will
have in relation to bonds and cash in your portfolio; and the lower your risk tolerance, the
lower your percentage of stocks in relation to bonds and cash.

5. Learn How to Choose the Best Funds:

Now that you know your asset allocation, all that remains is choosing the best funds for you.
If you have a broad choice of mutual funds you begin by using a fund screener or you may
simply compare performance to a benchmark. You’ll also want to consider important
qualities of mutual funds, such as fund fees and expenses and manager tenure.

How to market/sell mutual fund schemes:

Mutual funds can be excellent additions to your clients' portfolios, but many people –
especially those who are new to investing – aren't familiar with mutual funds or what they
entail. Providing information about the benefits of mutual funds and how specific products
can help your clients meet their investing goals will help you sell mutual funds to even the
most sceptical investors.

1. Automatic Diversification:

The first benefit of mutual funds that you should emphasize heavily is the incredible
diversification they offer. Explain how diversification helps your clients avoid catastrophic
losses and protects portfolios during economic turmoil by spreading total investments out
over several different types of assets in different industries.
To create optimally diversified portfolios on their own, your clients would need to invest in a
wide range of different securities from different sectors. A sufficiently diversified, self-
managed portfolio requires immense amounts of research and investment capital. Even with
your help selecting profitable assets, your clients would be looking at considerable expenses
for trading commissions and transactional fees. A mutual fund grants shareholders automatic
diversification, either across industries or within a single sector. Mutual funds allow your
clients to pick a mixture of high-risk, high-reward securities and stable growth assets
to spread their risk and benefit from both investment types.

2. Customization:

Besides diversification, the greatest advantage of mutual funds is the virtually endless
varieties, which makes it relatively simple to find funds that fit your clients' needs. As you
discuss the benefits of mutual funds with your clients, ask about specific investment goals
and assess your clients' risk tolerances. A clear understanding of these two factors determines
which funds you recommend and can mean the difference between successful investments
and very dissatisfied clients.

If your clients want to preserve their initial investments and are comfortable with modest
fixed rates of return, point them toward money market funds or bond funds that invest in
highly rated long-term debt.

If they are primarily focused on making big gains quickly, talk about stock funds that might
offer the best chance of speedy profits. Discuss the increased risk of loss that accompanies
aggressively managed high-yield funds so your clients know that sky-high profits don't come
without a price.

If regular investment income is your clients' main goal, discuss the benefits of dividend
funds that invest in dividend-bearing stocks and interest-bearing bonds. Explain that a variety
of funds can offer consistent annual income from different sources, depending on your
clients' risk tolerance.

3. Access to High-Value Assets:

Mutual funds pool the investments of thousands of shareholders, so they can invest in stocks,
bonds and other securities that may be well out of the price range of your clients if they
invested in them individually. This allows your clients to benefit from the growth and
dividend payments of big-ticket assets, such as the Coca-Cola Company and Costco
Wholesale Corporation, without requiring the massive amounts of capital necessary to
purchase any substantial holding in either company.

4. Affordability and Liquidity:

Mutual funds are far more affordable for the average investor than the assets in which the
mutual funds invest. Do the math, and show your clients how mutual funds allow them to
invest in the same assets as Warren Buffet without having his net worth.

Open-ended funds allow your clients to liquidate their holdings at any time; your clients can
easily access those dollars when they need them. In addition, many funds allow your clients
to set up redemption schedules, so they can liquidate part of their holdings on specified days
each month, quarter or year, ensuring regular investment income.

5. Professional Management:

Mutual funds are managed by professionals whose entire careers revolve around turning
profits for shareholders. While your role is still to help your clients choose the right assets,
investing in mutual funds recruits one more soldier to your clients' investment armies. You
help your clients select the mutual funds that best suit their needs, and the fund manager
ensures that your recommendation pays off.

6. Effortless Returns:

The benefit of professional management ties right in with the next advantage of mutual funds:
effortless returns. Initially, of course, there is some legwork that goes into selecting the right
fund. After making the investment, your clients can essentially sit back and watch their
returns roll in, knowing that the fund managers are working to keep the funds profitable.
Until they are ready to sell their shares, there is little for you and your clients to do except
monitor the funds' performance and net profits.

If your clients are inclined to self-manage their portfolios, point out the amount of research
and daily involvement that would be required to manage such a wide range of assets on their
own.

7. Honesty:

Even if you do not have a fiduciary duty to your clients, you should act as if you do. Be
honest with your clients about some of the less-attractive aspects of mutual funds so that they
are fully informed when they make their decision. Chief among these disadvantages are the
potentials for increased taxes and annual expenses.

Since you should already have a clear idea of what types of funds fit your clients' needs, talk
to them about the typical expenses incurred by those types of investments. If they are looking
for high-yield funds with active fund managers, for example, explain that the increased
trading activity will likely mean higher expense ratios.

Discuss the tax implications of their investment choices. While any type of investment will
impact your clients' tax liability to some degree, outline the effects of the specific types of
funds they're considering. If they are looking into dividend funds, for example, discuss the
taxation of dividend income and how investing in funds that employ a buy-and-hold strategy
can reduce tax liability by paying qualified dividends that are taxed at the capital gains rate
rather than as ordinary income.

Avoid recommending products based on the promise of commissions or other advantages.

Always direct your clients to the products that are best-suited to their specific needs,
regardless of which firm offers them.
 8. Know When to Say No:

Being a financial advisor requires a delicate balance of ambition and realism. While mutual
funds are a great fit for a wide variety of investors, heed the signs that this type of investment
may not be well-suited to your clients' investment style. If your clients enjoy playing active
roles in how and when their money is invested, mutual funds may not be for them. While the
professional management of mutual funds is a huge advantage, it also removes investors from
the day-to-day mechanics of investments. Be sure your clients are comfortable with
entrusting their investments to someone else and forfeiting any control over asset allocation
and trading strategy.

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