Concept of Mutual Funds

By | August 17, 2019
Concept of Mutual Funds

This article discusses the concept of mutual funds. Numerous investors, who are willing to make money or save it, contribute to making a pool of money. This pool of money is known as a mutual fund. By pooling their money, investors become capable to go for a diversified selection of securities present in the market, which are managed with the help of professional fund manager. The money accumulated for a mutual fund is used by the fund manager for the purpose of creating a portfolio. Typically, this portfolio comprises of money market instruments, bonds, stocks or a combination of all these. It provides a series of products which are innovative in nature like exchange- trader funds, sectoral funds, fund of funds, fixed maturity plans and a lot more.

SEBI (MUTUAL FUNDS) REGULATIONS

In 1998, it appeared that RBI has made one of the earliest attempts for the regulation of mutual funds with the help of schemes of various schemes for mutual funds of banks and their subsidiaries. Special legislation that was passed for governing Unit Trust of India was used for governing the mutual funds before a specific regulation governing mutual funds was passed by SEBI. Subsequently, guidelines were issued by Central Government for governing the mutual funds floating in the market in 1990 ( F. No. 1/ 44/ SE/ 86- PtIV dated 28.06.1990).

There were a lot of differences between the two set of guidelines in their material aspects. In addition to it, there was ambiguity in the scope of application of these guidelines and it was also perceived that these legislations are not capable to protect the interests of investors.

Owing to these problems, the Central Government made another set of guidelines to regulate mutual funds which are primarily invested in the capital market but partly invested in the money market. SEBI issued a detailed clarificatory press release on 06.03.1992 in order to do away with the ambiguity present in the third set of guidelines. Subsequently, SEBI notified guidelines for the operation of mutual funds in the money market in June 1992.

The recommendations of Dr S A Dave Committee forms the basis for the adoption of the SEBI (Mutual Funds) Regulation, 1993. Further, SEBI Mutual Funds Report which was published in 2000 brought into forefront various anticipated changes that the industry of mutual funds had gone through in the last few years. Along with this, the report also recommended that there is a necessity to review the current regulations and consequently, SEBI introduced its SEBI (Mutual Funds) Regulation, 1996 in the market.

MEANING OF MUTUAL FUNDS AS PER THE GUIDELINES

The nature of these funds can be easily understood with the help of the meaning ascribed to the term ‘mutual funds’. As per the guidelines which were issued in 1990, the mutual fund is that common organization that works on managing the funds received from various investors. In the guidelines which were notified in 1992 defined mutual funds as a major vehicle that helps in mobilizing the savings from the various household and small sectors, which are willing to make an investment in the stock market.

On the other hand, mutual funds, from the point of view of a committee of experts, are the investment vehicles in which the savings of various investors have been entrusted with a belief that these funds have better skills and expertise to invest the money of investors.[1]

SEBI (Mutual Funds) Regulations of 1996 threw light on the legal meaning of mutual funds as that fund which got established in the form of a trust for raising money with the help of selling units to the public in general or a particular section of public under more than one schemes notified for investing their money in the securities along with the gold or real estate assets or gold-related instruments or money market instruments.[2]

Primarily, mutual funds are governed with the help of SEBI (Mutual Fund) Regulation, 1996. All the applicable or existing circulars issued by SEBI for the purpose of mutual funds up to 31. 12. 2010 have been complied and were issued in the form of a master circular, viz. SEBI/ IMD/ MC No. 2/ 836/ 2011 dated 07. 02. 2011.

CLASSIFICATION OF MUTUAL FUNDS

Mutual funds can be classified on two grounds. These are as follows:

  1. Based on the maturity period of investment
  2. Based on the risk profile

These funds can be further divided on the basis of the above-mentioned grounds.

  1. BASED ON MATURITY PERIOD OF INVESTMENT

A mutual fund can be further divided into three categories on the basis of the maturity period of investment. They are as follows:

  1. Open-Ended Mutual Funds
  2. Closed-Ended Mutual Funds
  3. Interval Mutual Funds

 

Open-Ended Mutual Funds

Those mutual funds which are readily available in the market for subscription all through the year and are not listed on the stock exchanges are known as open-ended mutual funds. Majority of the mutual funds that are floating in the market are the open-ended type of mutual funds. Investors are allowed to trade in their securities i.e. purchase and sell the stock or any part of their investment at any time at a price linked to the next asset value of the fund. This is done on the basis of various schemes present in the market. These are as follows:

  • Debt/ Income Scheme: Major part of the fund which is to be invested in the market is channelized towards various government securities, debentures and various forms of other debt instruments. Capital appreciation is low for such mutual funds in comparison to the equity mutual funds. This is a type of investment avenue which is low risk and low return in nature. Investment on the basis of such a scheme is ideal for those investors who want to seek for a steady income.
  • Liquid/ Money Market Scheme: those investors, who are looking forward to utilizing their surplus funds in instruments that are short term in nature while awaiting for better options, prefer to invest their money on the basis of this scheme. These schemes are used to invest in short term debt instruments and are helpful in providing reasonable returns for the investors.
  • Equity/ growth Scheme: this type of scheme is very popular amongst the class of retail investors. Even though there is a high probability of capital appreciation, in the long run, this scheme appears to be of highly risky in nature. This scheme could prove to be an ideal form of investment if an investor is earning a lot and is looking forward to the benefits in the long run.

Closed-ended Mutual Fund

Mutual funds of this category consist of a fixed number of shares that are outstanding in nature. The closed-ended fund is for a fixed term which may range from 3 to 15 years and this duration is known as New Fund Offer Period (NFO). Subscription will be opened only during a particular period for this fund. There is a requirement of balance between sellers and buyers, due to which if an individual is interested in buying there must be another person who should be selling it.

It is necessary to get these types of funds listed on the stock exchange for trading similar to other securities or stocks over the counter or on an exchange. Typically, these funds have the specification of redemption as well indicating that they might be getting expired on a particular date making it easier for the investor to get his/ her unit redeemed. These funds can be further classified into the following two schemes:

  • Capital Protection Scheme: the main objective proposed by this scheme is to protect the principal amount and at the same time, it also tries to deliver reasonable returns. Investment is made in securities of high quality and fixed income in nature. Along with it, it has marginal exposure to equities and matures according to the maturity period as prescribed by the scheme.
  • Fixed Maturity Plans (FMPs): As suggested by the name itself, those mutual funds which take a definite period to get mature are known as fixed mutual funds. Typically, debt instruments form part of these schemes. They get matured with the pace of the maturity of the scheme and therefore, money is earned with the help of the component of interest known as ‘coupons’ that are present therein.

Interval Mutual Funds

These funds operate as a mixture of closed and open-ended schemes. It has made possible for investors to trade the units at pre-defined intervals.

  1. BASED IN RISK PROFILE

During the course of choosing any scheme of mutual fund which is appropriate for achieving his goal of timeframe, growth and stability, one of the most important factors to be kept in mind is the risk appetite of the investors.

  • The main objective of the conservative investor is to receive the regular income and safeguard the capital. There is a low tolerance rate of risk due to which a major part of the money invested should be allocated to money market mutual funds or debt in the form of FMPs, income schemes etc.
  • An investor who is moderately aggressive in nature is the one who is ready to take the controlled risk for moderate returns. Typically, a combination of index, income and balanced schemes are recommended to these investors that enables these investors to take advantage of such a balanced portfolio.
  • An investor who is aggressive in nature finds an opportunity in the risk and uses their knowledge and experience in order to decide intelligently upon any financial matter. A large chunk of the investment of such investors is managed with the help of equity and growth schemes.

For a lot of investment schemes, there exists a directly proportional relationship between returns and risk. There is a necessity to get the right balance between both on the basis of the risk appetite and objectives of the investors.

ADVANTAGES OF INVESTMENT IN MUTUAL FUNDS

  • Professional/ Export Management: these mutual funds are managed with the help of qualified professionals. The performance and prospects of the company are under a continuous analysis of the research team of these professionals. The objectives stated by the scheme are fulfilled by intelligently selecting the aptest investment. This is a process which is continuous in nature requiring expertise and time that adds value to the money invested. The investments are managed by the fund managers in a better way and get a higher rate of returns.
  • Diversification: the securities market runs on the proverb, Don’t put all your eggs in the same basket’. It helps in spreading the fund across different types of industries present in the market and other geographic regions that helps in reducing the risk of loss. On the other hand, the sector funds or the investment made only in one type of industry is less diversified and henceforth, it is more volatile in nature.
  • More Choice: A number of schemes are offered with the help of mutual funds and these schemes will suit the needs of an individual over a lifetime. When anyone steps into a new phase of life, all he/ she is needed to spend some time with the financial advisor who will help to get the portfolio rearranged which will well suit the altered lifestyle.
  • Low Cost: mutual funds offer the cost of investment at a very low rate in comparison to the investment done directly in the capital market. The major chunk of the securities demands a significant quantity of capital.
  • Tax Benefits: if an investor has invested his money for a duration of 12 months or more, then such investment will be qualified as capital gains and then, taxed accordingly. The advantage of indexation is also made available to these investors.
  • High Return Potential: if the investment is made on the basis of medium or long term investment, mutual funds are capable to generate the returns at a higher rate. This is so because the money is invested in such a diverse range of industries and sectors.

 

 

 

[1] Paragraph VII, PK Kaul Committee Report, 1998

[2] Regulation 2 (q) of the SEBI (Mutual Funds) Regulations, 1996.

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