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Topics Covered

Concept Organization of a Mutual Fund Advantages and Disadvantages of Mutual Funds Types of Mutual Fund Schemes Investment Styles NAV Performance measures of MF

Concept A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

Mutual Fund Operation Flow Chart

Organisation of a Mutual Fund

The regulation of mutual funds operating in India falls under the preview of authority of the Securities and Exchange Board of India (SEBI). Any person proposing to set up a mutual fund in India is required to be registered with the SEBI, under the SEBI (Mutual Funds) Regulations, 1996 Sponsor

Akin to the Promoter of the company, Contribution of minimum 40% of net worth of AMC, Posses sound financial record over five years period, Establishes the Fund, Gets it registered with the SEBI, Forms a trust, & appoints Board of trustee.

Trustees Holds assets on behalf of unit holders in trust, Trustees are caretaker of unit holders money, Two third of the trustees shall be independent persons (not associated with the sponsor), Trustees ensure that the system, processes & personnel are in place, Resolves unit holders GRIEVANCES, Appoint AMC & Custodian, & ensure that all activities are accordance with the SEBI regulation. Asset Management Company

Floats schemes & manages according to SEBI, Can not undertake any other business activity, other than portfolio mgmt services, The AMC must have a net worth of at least 10 crore at all times. At least 50% of directors of the AMC are independent directors who are not associated with the Sponsor in any manner Chairman of AMC can not be a trustee of any MF.


Holds the funds securities in safekeeping, Settles securities transaction for the fund, Collects interest & dividends paid on securities, Records information on corporate actions.

Distributor / Agents Sell units on the behalf of the fund, It can be bank, NBFCs, individuals. Banker Facilitates financial transactions, Provides remittance facilities.

Registrar & Transfer Agent Maintains records of unit holders accounts & transactions Disburses & receives funds from unit holder transactions, Prepares & distributes a/c settlements, Tax information, handles unit holder communication Provides unit holder transaction Service Unit Holders

They are the parties to whom the mutual fund is sold. They are ultimate beneficiary of the income earned by the mutual funds.

UTI UTI Asset Management Company Private Limited, established in Jan 14, 2003, manages the UTI Mutual Fund with the support of UTI Trustee Company Private Limited. The sponsors of UTI Mutual Fund are Bank of Baroda (BOB), Punjab National Bank (PNB),State Bank of India (SBI), and Life Insurance Corporation of India (LIC). The schemes of UTI Mutual Fund are Liquid Funds, Income Funds, Asset Management Funds, Index Funds, Equity Funds and Balance Funds. Tata Mutual Fund Tata Mutual Fund (TMF) is a Trust under the Indian Trust Act, 1882. The sponsors for Tata Mutual Fund are Tata Sons Ltd., and Tata Investment Corporation Ltd. The investment manager is Tata Asset Management Limited and its Tata Trustee Company Pvt. Limited.

SBI Mutual Fund

Mutual Fund Trust SBI Mutual Fund Sponsor State Bank of India Trustee SBI Mutual Fund Trustee Company Private Limited AMC SBI Funds Management Private Limited Custodian HDFC Bank Limited, Mumbai CITI BANK Mumbai Stock Holding Corporation of India Ltd,Mumbai Bank of Nova Scotia (custodian for Gold) RTA Computer Age Management Services Pvt. Ltd

Advantages of Mutual Funds

Economies of Scale Liquidity Simplicity Diversification Affordability Professional Management Flexibility Performance Monitoring: Choice of schemes Tax benefits Well regulated

Economies of Scale - Because a mutual fund buys and sells large amounts of securities at a time, its transaction costs are lower than what an individual would pay for securities transactions. Liquidity - Just like an individual stock, a mutual fund allows you to request that your shares be converted into cash at any time. Units or shares of mutual funds can be redeemed at any time. Simplicity - Buying a mutual fund is easy! Pretty well any bank has its own line of mutual funds, and the minimum investment is small. Most companies also have automatic purchase plans where a little amount can be invested on a monthly basis. Diversification: Investing in a number of different securities helps reduce the risk of investing. When you buy a mutual fund, you are buying an interest in a portfolio of dozens of different securities, giving you instant diversification, at least within the type of securities held in the fund.

Affordability: With many mutual funds, you can begin buying units with a relatively small amount of money. Professional Management: Mutual funds are managed by professionals who are experienced in investing money and who have the skills and resources to research many different investment opportunities. Flexibility: Many mutual fund companies administer several different mutual funds (e.g., money market, fixed-income, growth, balanced and international funds) and allow you to switch between funds within their fund family at little or no charge. This can enable you to change the balance of your portfolio as your personal needs or market conditions change. Performance Monitoring: The value of most mutual funds is reported daily in the financial press and on many internet sites, allowing you to continually monitor the performance of your investment.

Disadvantages of Mutual Funds Professional Management - When you invest in a mutual fund you place your money in the hands of a professional manager. The return on your investment will depend heavily on that managers skill and judgments. Even the best portfolio advisers are wrong sometimes, and studies have shown that few portfolio advisers are able to consistently out-perform the market. Costs - Creating, distributing, and running a mutual fund is an expensive proposition. Everything from the managers salary to the investors statements cost money. Those expenses are passed on to the investors. Since fees vary widely from fund to fund, failing to pay attention to the fees can have negative long-term consequences. Remember, every rupee spend on fees is a rupee that has no opportunity to grow over time.

Dilution - It's possible to have too much diversification. Because funds have small holdings in so many different companies, high returns from a few investments often don't make much difference on the overall return. Dilution is also the result of a successful fund getting too big. When money pours into funds that have had strong success, the manager often has trouble finding a good investment for all the new money.

Taxes - Mutual funds are not the most tax-friendly investment in the world. Capital gain taxes are incurred as the shares within the mutual fund are traded during the life of the investment.

No Guarantees: Mutual funds do not give any guarantee of the returns for the investments made in the various schemes of the mutual fund. The value of your mutual fund investment, could fall and be worth less than the principle initially invested Diversification of portfolio doesnt maximize returns: Mutual fund helps to diversify the portfolio. However, though the diversification of portfolio helps in minimization of risk, these do not results in maximization of returns to the

Loss of Control: The managers of mutual funds make all of the decisions about which securities to buy and sell and when to do so. This can make it difficult for you when trying to manage your portfolio. For example, the tax consequences of a decision by the manager to buy or sell an asset at a certain time might not be optimal for you. You also should remember that you are trusting someone else with your money when you invest in a mutual fund.

Types Of Mutual Fund Schemes

On the basis of Structure

o Open - Ended Schemes An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity.

o Close - Ended Schemes

These schemes have a pre-specified maturity period. One can invest directly in the scheme at the time of the initial issue. Depending on the structure of the scheme there are two exit options available to an investor after the initial offer period closes. Investors can transact (buy or sell) the units of the scheme on the stock exchanges( at market price) where they are listed. Alternatively some close-ended schemes provide an additional option of selling the units directly to the Mutual Fund through periodic repurchase at the schemes NAV.

On the basis of Investment Objective o Growth / Equity Oriented Scheme The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time. The Equity Funds are sub-classified depending upon their investment objective, as follows: Diversified Equity Funds Mid-Cap Funds Sector Specific Funds Tax Savings Funds (ELSS)

o Income / Debt Oriented Scheme The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Debt funds are further classified as: Gilt Funds: Invest their corpus in securities issued by Government, popularly known as Government of India debt papers. These Funds carry zero Default risk but are associated with Interest Rate risk. These schemes are safer as they invest in papers backed by Government. Income Funds: Invest a major portion into various debt instruments such as bonds, corporate debentures and Government securities.

MIPs (Monthly income plans): Invests maximum of their total corpus in debt instruments while they take minimum exposure in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the risk-return matrix when compared with other debt schemes. Short Term Plans (STPs): Meant for investment horizon for three to six months. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures. Liquid Funds: Also known as Money Market Schemes, These funds provides easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, inter-bank call money market, CPs and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. These schemes rank low on risk-return matrix and are considered to be the safest amongst all categories of mutual funds

o Balanced Fund The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds. o Money Market or Liquid Fund These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.

Special Schemes
o Tax Saving Schemes Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time to time. Under Sec.88 of the Income Tax Act, contributions made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate. o Index Schemes Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks that constitute the index. The percentage of each stock to the total holding will be identical to the stocks index weightage and hence, the returns from such schemes would be more or less equivalent to those of the Index.

o Sector

Specific Schemes

These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time.

Mutual Fund Investment Styles Active Vs. Passive Active investors believe in their ability to outperform the overall market by picking stocks they believe may perform well. Passive investors, on the other hand, feel that simply investing in a market index fund may produce potentially higher long-term results. The majority of mutual funds underperform market indexes.* Passive investors believe this is due to market efficiency. In other words, all information available about a company is reflected in that companys current stock price, and its impossible to forecast profit and future stock prices. Rather than trying to second-guess the market, passive investors can buy the entire market via index funds. Active investors counter that managed funds dont always underperform the general market. Many funds have earned significantly higher returns. Active investors counter that the market is not always efficient and that through research, active fund managers may be able to uncover information not already reflected in a security's price and potentially profit by it.

Growth Vs. Value Active investors can be divided into growth and value seekers. Proponents of growth seek companies they expect (on average) to increase earnings by 15% to 25%. Of course, there is no assurance that this objective will be obtained. Stocks in these companies tend to have high price to earnings ratios (P/E) since investors pay a premium for higher returns. They usually pay little or no dividends. The result is that growth stocks tend to be more volatile, and therefore more risky. Value investors look for bargains cheap stocks that are often out of favor, such as cyclical stocks that are at the low end of their business cycle. A value investor is primarily attracted by asset-oriented stocks with low prices compared to underlying book, replacement, or liquidation values. Value stocks also tend to have lower P/E ratios and potentially higher dividend yields. These potentially higher yields tend to cushion value stocks in down markets while certain cyclical stocks will lead the market following a recession. Other investors choose not to lock themselves into any one investment style. Returns on growth stocks and value stocks are not highly correlated. This means that an increase or decrease in one type usually has little effect on the other. By diversifying between growth and value, investors can help manage risk and still have high long-term return potential.

Small Cap Vs. Large Cap Some investors use the size of a company as the basis for investing. Studies of stock returns going back to 1925 have suggested that "smaller is better." On average, the highest returns have come from stocks with the lowest market capitalization (common shares outstanding times share price). But since these returns tend to run in cycles, there have been long periods when large-cap stocks have outperformed smaller stocks. Small-cap stocks also have higher price volatility, which translates into higher risk. Some investors choose the middle ground and invest in mid-cap stocks with market capitalizations less than Rs. 2500 crores but more than Rs. 500 crores seeking a tradeoff between volatility and return. In so doing, they give up the potential return of small-cap stocks.

Bottom-Up Vs. Top-Down

A top-down investor looks first at economic factors and then selects industries accordingly. For example, during periods of low inflation, consumer spending increases, which might be a good time to buy automobile stocks or retail stocks. The top-down investor would then search for the best values in these industries. A bottom-up investor is more concerned with individual companies fundamentals. They reason that even if its industry is doing poorly, a h2 company will still outperform the market. Both of these styles emphasize fundamentals, but place different emphasis on the economic environment.

Technical Vs. Fundamental Analysis

Another difference is that some equity investors look at the fundamentals of individual stocks, while others invest based on technical analysis. Fundamentalists, who represent the majority, spend time poring over annual reports and visiting companies attempting to uncover investment opportunities and seek greater return potential over the long run. Technical analysts pore over charts of stock prices and economic data in an attempt to divine patterns that could be indicative of future trends, and are more concerned with short-term market timing than individual stock picking. Although technical analysts fell out of favor as studies questioned their forecasting powers, increased access to information and the growing power of computers have led to a resurgent interest.

Asset Allocation: Another Element Of Investing "Style"

Another popular investment strategy is asset allocation. Market timing purists move in or out of specific asset classes (stocks, bonds, and money markets), based on the forecasts of their technical models. A more conservative approach, dynamic asset allocation, uses risk/return tradeoffs to determine which class of assets to favor. However, asset allocation does not guarantee a profit or protect against a loss. If bonds are seen to be "cheaper" than stocks, then the allocation will favor bonds. Asset allocators continually adjust their portfolios based on market and economic conditions.

NAV CALCULATIONS Net Asset Value (NAV) is the total asset value (net of expenses) per unit of the fund calculated by the Asset Management Company (AMC) at the end of every business day. Net Asset Value on a particular date reflects the realizable value that the investor will get for each unit that he is holding if the scheme is liquidated on that date. The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV). Net Asset Value may also be defined as the value at which new investors may apply to a mutual fund for joining a particular scheme. It is the value of net assets of the fund. The investors subscription is treated as the capital in the balance sheet of the fund, and the investments on their behalf are treated as assets. The NAV is calculated for every scheme of the MF individually. The value of portfolio is the aggregate value of different investments. The Net Asset Value (NAV) = Net Assets of the scheme / Number of units outstanding Net Assets of the scheme will normally be: Market value of investments + Receivables + Accrued Income + Other Assets Accrued Expenses Payables Other Liabilities Since investments by a Mutual Fund are marked to market, the value of the investments for computing NAV will be at market value. NAV of MF schemes are published on a daily basis in Newspapers and electronic media and play an important part in investors decisions to enter or to exit. Analyst use the NAV to determine the yield on the schemes.

Performance Measures Of Mutual Funds

The Treynor Measure Developed by Jack Treynor, this performance measure evaluates funds on the basis of Treynor's Index. This Index is a ratio of return generated by the fund over and above risk free rate of return (generally taken to be the return on securities backed by the government, as there is no credit risk associated), during a given period and systematic risk associated with it (beta). Symbolically, it can be represented as: Treynor's Index (Ti) = (Ri - Rf)/Bi. Where, Ri represents return on fund, Rf is risk free rate of return and Bi is beta of the fund. All risk-averse investors would like to maximize this value. While a high and positive Treynor's Index shows a superior risk-adjusted performance of a fund, a low and negative Treynor's Index is an indication of unfavorable performance.

The Sharpe Measure In this model, performance of a fund is evaluated on the basis of Sharpe Ratio, which is a ratio of returns generated by the fund over and above risk free rate of return and the total risk associated with it. According to Sharpe, it is the total risk of the fund that the investors are concerned about. So, the model evaluates funds on the basis of reward per unit of total risk. Symbolically, it can be written as: Sharpe Index (Si) = (Ri - Rf)/Si Where, Si is standard deviation of the fund. While a high and positive Sharpe Ratio shows a superior risk-adjusted performance of a fund, a low and negative Sharpe Ratio is an indication of unfavorable performance.

Comparison of Sharpe and Treynor Sharpe and Treynor measures are similar in a way, since they both divide the risk premium by a numerical risk measure. The total risk is appropriate when we are evaluating the risk return relationship for well-diversified portfolios. On the other hand, the systematic risk is the relevant measure of risk when we are evaluating less than fully diversified portfolios or individual stocks. For a welldiversified portfolio the total risk is equal to systematic risk. Rankings based on total risk (Sharpe measure) and systematic risk (Treynor measure) should be identical for a well-diversified portfolio, as the total risk is reduced to systematic risk. Therefore, a poorly diversified fund that ranks higher on Treynor measure, compared with another fund that is highly diversified, will rank lower on Sharpe Measure.

Jenson Model Jenson's model proposes another risk adjusted performance measure. This measure was developed by Michael Jenson and is sometimes referred to as the Differential Return Method. This measure involves evaluation of the returns that the fund has generated vs. the returns actually expected out of the fund given the level of its systematic risk. The surplus between the two returns is called Alpha, which measures the performance of a fund compared with the actual returns over the period. Required return of a fund at a given level of risk (Bi) can be calculated as: Ri = Rf + Bi (Rm - Rf) Where, Rm is average market return during the given period. After calculating it, alpha can be obtained by subtracting required return from the actual return of the fund. Higher alpha represents superior performance of the fund and vice versa. Limitation of this model is that it considers only systematic risk not the entire risk associated with the fund and an ordinary investor can not mitigate unsystematic risk, as his knowledge of market is primitive.

1. Calculate the NAV of Great Fund from the following data: Size of the fund- Rs.200 Crores Face Value Rs. 10/- per unit Market Value of Investment- Rs. 280 Crores Accrued Incomes- Rs. 2 Crores Receivables- Rs. 2 Crores Liabilities- Rs. 1 Crore Accrued Expenses- Rs. 1 Crore. 2. The following portfolio details of a fund are available: Stock A B C D Shares 2,00,000 3,00,000 4,00,000 6,00,000 Price (Rs.) 35 40 20 25

The fund has accrued management fees with the portfolio manager totaling Rs. 30,000. There are 40 lakhs units outstanding. What is the NAV of the fund? If the fund is sold with a front end load of 5%, what is the sale price?

3. Calculate the NAV in each of the following cases (treating each sub-question independently): Sale Price is Rs. 11 and entry load is 5% Repurchase price is Rs. 11 and exit load is 5% Sale price is Rs.11 & Repurchase price is Rs. 10.80 and there is no entry load Sale price is Rs.11.40 & Repurchase price is Rs. 10.20 and there is no exit load Sale price is Rs.10.50 & Repurchase price is Rs. 9.80 and Entry load is 5% and exit load is 2%. 4. Calculate the todays NAV of Flexi Fund if the following details are given: Yesterdays NAV = Rs. 12.8700 Total number of outstanding units = 125 lakhs Face Value = Rs. 10 Expenses = Rs. 1 lakh (Assume sales NAV & Repurchase NAV to be Rs. 12.87) Appreciation of portfolio today Units- Fresh subscription Units- Redemption Dividends received Rs. 12 lakhs 2 lakhs .75 lakh Rs. 1 lakh

5. A new equity based mutual fund collected Rs. 50 Crores through the New Fund Offer at Rs. 10 a unit. On the first day when The NAV was to be released, the following stock purchases were made. The balance was parked in reverse repo for a day at 6% yield. The initial expense is 6% and is expected to be amortized over 5 years. The total recurring expenses which would be deducted on a daily basis (which also includes investment and advisory fees for this fund size) is 2.5% per annum. Assume recurring expenses is charged on opening balance of net assets. Find 1st day NAV for the fund.
Qty 2500 3000 2500 25600 16500 Cost 1968.00 1600.00 928.45 169.00 265.00 Closing Price 1968.25 1630.20 928.45 164.55 258.20

BHEL Infosys TCS ITC Reliance Communications

6. A fund had an NAV of Rs.21.50 at the beginning of the year. An investor subscribed to this fund had to pay a load of Rs.1.85 per unit. NAV increased to Rs. 23.04 at the end of the year. During the year dividend and capital gains were distributed to the extent of Rs. 1.05. What is the total return? Had there been no load what would have been the return? 7. A has invested in three mutual fund schemes as per details given below: MF A 1.12.10 Rs.50000 Rs. 10.50 Rs.950 Rs. 10.40 MF B 1.1.2011 Rs. 1 lakh Rs.10.00 Rs. 1500 Rs. 10.10 MF C 1.3.2011 Rs. 50000 Rs. 10.00 Nil Rs. 9.80

Date of investment Amount of Investment NAV at entry date Dividend received up to 31.03.2011 NAV as on 31.03.2011

Required: What is the effective yield on per annum basis in respect of each of the three schemes to Mr. A up to 31.03.2100?

8. Sun Moon Mutual Fund sponsored open-ended equity oriented scheme Chanakya Opportunity Fund. There were three plans viz. A Dividend Re-investment Plan, B Bonus Plan & C Growth Plan. At the time of Initial Public Offer on 1.4.1995, Mr. Anand, Mr. Bacchan & Mrs. Charu, three investors invested Rs. 1,00,000 each & chosen B, C & A plan respectively The History of the fund is as follows:
Date Dividend (%) 20 70 40 25 40 Bonus Ratio Net asset value per unit (F.V. Rs. 10) Plan A Plan B Plan C 30.7 58.42 42.18 46.45 42.18 48.10 53.75 31.4 31.05 25.02 29.10 20.05 19.95 22.98 33.42 70.05 56.15 64.28 60.12 72.40 82.07

On 31 July all three investors redeemed all the balance units. Calculate annual rate of return to each of the investors. Consider: Long-term capital gain is exempt from income-tax. Short term capital gain is subject to 10% income-tax. S.T.T. 2% only on sale/redemption of units.

28.07.1999 31.03.2000 31.10.2003 15.03.2004 31.03.2004 24.03.2005 st31.07.2005


1:3 1:4

9. A Mutual fund analyst has collected the following past performance reports of five funds and the sensex. Rank these funds based on Sharpe Ratio, Treynor Ratio, and Jensenss Measure. Assume Risk free rate of 7%. Explain the behavior of these rankings

A B C D E Sensex

Return (%)
16.5 15.3 9.5 22.5 18.5 14

Standard Deviation (%)

25.6 20.5 15.8 16.5 18.5 13.5

1.25 .95 .85 .15 1.05 1.00

10. The following table describes how three mutual funds performed over a 5 year period:
Fund Average Annual Return (%) Beta S.D. of Annual Return (%)

A B C Market Index Risk free Asset

19.2 15.8 20.8 13.5 2.2

1.2 .9 1.32

24.7 28.3 26.5 20.6

Compute the Sharpe ratio, the Treynor measure and Jensens Alpha for each fund. Which fund exhibited the best performance over this period from the perspective of an investor for whom the fund is the entire risky portfolio? Which fund exhibited the best performance over this period from the perspective of an investor for whom the fund is just one component of a broader risky portfolio?