What is a Mutual Fund?
A mutual fund is a professionally-managed trust that pools the savings of many investors
and invests them in securities like stocks, bonds, short-term money market instruments
and commodities such as precious metals. Investors in a mutual fund have a common
financial goal and their money is invested in different asset classes in accordance
with the fund’s investment objective. Investments in mutual funds entail comparatively
small amounts, giving retail investors the advantage of having finance professionals
control their money even if it is a few thousand rupees.
Mutual funds are pooled investment vehicles actively managed either by professional
fund managers or passively tracked by an index or industry. The funds are generally
well diversified to offset potential losses. They offer an attractive way for savings
to be managed in a passive manner without paying high fees or requiring constant
attention from individual investors. Mutual funds present an option for investors
who lack the time or knowledge to make traditional and complex investment decisions.
By putting your money in a mutual fund, you permit the portfolio manager to make
those essential decisions for you.
How is a mutual fund set up?
A mutual fund is set up in the form of a trust that has a Sponsor, Trustees, Asset
Management Company (AMC). The trust is established by a sponsor(s) who is like a
promoter of a company and the said Trust is registered with Securities and Exchange
Board of India (SEBI) as a Mutual Fund. The Trustees of the mutual fund hold its
property for the benefit of unit holders. An Asset Management Company (AMC) approved
by SEBI manages the fund by making investments in various types of securities.
The trustees are vested with the power of superintendence and direction over the
AMC. They monitor the performance and compliance of SEBI regulations by the mutual
fund. The trustees are vested with the general power of superintendence and direction
over AMC. They manage the performance and compliance of SEBI Regulations by the
How does a mutual fund operate?
A mutual fund company collects money from several investors, and invests it in various
options like stocks, bonds, etc. This fund is managed by professionals who understand
the market well, and try to accomplish growth by making strategic investments. Investors
get units of the mutual fund according to the amount they have invested. The Asset
Management Company is responsible for managing the investments for the various schemes
operated by the mutual fund. It also undertakes activities such like advisory services,
financial consulting, customer services, accounting, marketing and sales functions
for the schemes of the mutual fund.
What is Net Asset Value?
Net Asset Value (NAV) is the total asset value (net of expenses) per unit of the
fund and is calculated by the AMC at the end of every business day. In order to
calculate the NAV of a mutual fund, you need to take the current market value of
the fund's assets minus the liabilities, if any and divide it by the number of shares
outstanding. NAV is calculated as follows:
For example, if the market value of securities of a Mutual Fund scheme is
500 lakh and the Mutual Fund has issued 10 lakh units of
10 each to investors, then the NAV per unit of the fund is
What are the different types of mutual fund schemes?
Based on the maturity period
An open-ended fund is a fund that is available for subscription and can be redeemed
on a continuous basis. It is available for subscription throughout the year and
investors can buy and sell units at NAV related prices. These funds do not have
a fixed maturity date. The key feature of an open-ended fund is liquidity.
A close-ended fund is a fund that has a defined maturity period, e.g. 3-6 years.
These funds are open for subscription for a specified period at the time of initial
launch. These funds are listed on a recognized stock exchange.
Interval funds combine the features of open-ended and close-ended funds. These funds
may trade on stock exchanges and are open for sale or redemption at predetermined
intervals on the prevailing NAV.
Based on investment objectives
Equity/Growth funds invest a major part of its corpus in stocks and the investment
objective of these funds is long-term capital growth. When you buy shares of an
equity mutual fund, you effectively become a part owner of each of the securities
in your fund’s portfolio. Equity funds invest minimum 65% of its corpus in equity
and equity related securities. These funds may invest in a wide range of industries
or focus on one or more industry sectors. These types of funds are suitable for
investors with a long-term outlook and higher risk appetite.
Debt/ Income funds generally invest in securities such as bonds, corporate debentures,
government securities (gilts) and money market instruments. These funds invest minimum
65% of its corpus in fixed income securities. By investing in debt instruments,
these funds provide low risk and stable income to investors with preservation of
capital. These funds tend to be less volatile than equity funds and produce regular
income. These funds are suitable for investors whose main objective is safety of
capital with moderate growth.
Balanced funds invest in both equities and fixed income instruments in line with
the pre-determined investment objective of the scheme. These funds provide both
stability of returns and capital appreciation to investors. These funds with equal
allocation to equities and fixed income securities are ideal for investors looking
for a combination of income and moderate growth. They generally have an investment
pattern of investing around 60% in Equity and 40% in Debt instruments.
Money Market/ Liquid Funds
Money market/ Liquid funds invest in safer short-term instruments such as Treasury
Bills, Certificates of Deposit and Commercial Paper for a period of less than 91
days. The aim of Money Market /Liquid Funds is to provide easy liquidity, preservation
of capital and moderate income. These funds are ideal for corporate and individual
investors looking for moderate returns on their surplus funds.
Gilt funds invest exclusively in government securities. Although these funds carry
no credit risk, they are associated with interest rate risk. These funds are safer
as they invest in government securities.
Some of the common types of mutual funds and what they typically invest in:
Type of Fund
Equity or Growth Fund
Equities like stocks
Fixed Income Fund
Fixed income securities like government and corporate bonds
Money Market Fund
Short-term fixed income securities like treasury bills
A mix of equities and fixed income securities
Sectors like IT, Pharma, Auto etc.
Equities or Fixed income securities chosen to replicate a specific Index for example
S&P CNX Nifty
Fund of funds
Other mutual funds
Tax-Saving (Equity linked Savings Schemes) Funds
Tax-saving schemes offer tax rebates to investors under specific provisions of the
Income Tax Act, 1961. These are growth-oriented schemes and invest primarily in
equities. Like an equity scheme, they largely suit investors having a higher risk
appetite and aim to generate capital appreciation over medium to long term.
Index schemes replicate the performance of a particular index such as the BSE Sensex
or the S&P CNX Nifty. The portfolio of these schemes consist of only those stocks
that represent the index and the weightage assigned to each stock is aligned to
the stock’s weightage in the index. Hence, the returns from these funds are more
or less similar to those generated by the Index.
Sector-specific funds invest in the securities of only those sectors or industries
as specified in the Scheme Information Document. The returns in these funds are
dependent on the performance of the respective sector/industries for example FMCG,
Pharma, IT, etc. The funds enable investors to diversify holdings among many companies
within an industry. Sector funds are riskier as their performance is dependent on
particular sectors although this also results in higher returns generated by these
What are the benefits of investing in a mutual fund?
Benefits of investing in mutual funds:
When you invest in a mutual fund, your money is managed by finance professionals.
Investors who do not have the time or skill to manage their own portfolio can invest
in mutual funds. By investing in mutual funds, you can gain the services of professional
fund managers, which would otherwise be costly for an individual investor.
Mutual funds provide the benefit of diversification across different sectors and
companies. Mutual funds widen investments across various industries and asset classes.
Thus, by investing in a mutual fund, you can gain from the benefits of diversification
and asset allocation, without investing a large amount of money that would be required
to build an individual portfolio.
Mutual funds are usually very liquid investments. Unless they have a pre-specified
lock-in period, your money is available to you anytime you want subject to exit
load, if any. Normally funds take a couple of days for returning your money to you.
Since they are well integrated with the banking system, most funds can transfer
the money directly to your bank account.
Investors can benefit from the convenience and flexibility offered by mutual funds
to invest in a wide range of schemes. The option of systematic (at regular intervals)
investment and withdrawal is also offered to investors in most open-ended schemes.
Depending on one’s inclinations and convenience one can invest or withdraw funds.
Low transaction cost
Due to economies of scale, mutual funds pay lower transaction costs. The benefits
are passed on to mutual fund investors, which may not be enjoyed by an individual
who enters the market directly.
Funds provide investors with updated information pertaining to the markets and schemes
through factsheets, offer documents, annual reports etc.
Mutual funds in India are regulated and monitored by the Securities and Exchange
Board of India (SEBI), which endeavors to protect the interests of investors. All
funds are registered with SEBI and complete transparency is enforced. Mutual funds
are required to provide investors with standard information about their investments,
in addition to other disclosures like specific investments made by the scheme and
the quantity of investment in each asset class.
What are the risks involved in investing in mutual funds?
Mutual funds invest in different securities like stocks or fixed income securities,
depending upon the fund’s objectives. As a result, different schemes have different
risks depending on the underlying portfolio. The value of an investment may decline
over a period of time because of economic alterations or other events that affect
the overall market. Also, the government may come up with new regulations,
which may affect a particular industry or class of industries. All these factors
influence the performance of Mutual Funds.
Risk and Reward: The diversification that mutual funds provide
can help ease risk by offsetting losses from some securities with gains in other
securities. On the other hand, this could limit the upside potential that is provided
by holding a single security.
Lack of Control: Investors cannot determine the exact composition
of a fund’s portfolio at any given time, nor can they directly influence which securities
the fund manager buys.