Mutual Fund

Mutual Fund is a vehicle that enables a collective group of individuals to:

Investing in a mutual fund is like an investment made by a collective. An individual as a single investor is likely to have lesser amount of money at disposal than say, a group of friends put together. Now, let's assume that this group of individuals is a novice in investing and so the group turns over the pooled funds to an expert to make their money work for them. This is what a professional Asset Management Company does for mutual funds. The AMC invests the investors' money on their behalf into various assets towards a common investment objective.

Hence, technically speaking, a mutual fund is an investment vehicle which pools investors' money and invests the same for and on behalf of investors into stocks, bonds, money market instruments and other assets. The money is received by the AMC with a promise that it will be invested in a particular manner by professional managers (commonly known as fund managers). The fund managers are expected to honour this promise. The SEBI and the Board of Trustees ensure that this actually happens.

Tenor refers to the 'time'. Mutual funds can be classified on the basis of time as under:

These funds are available for subscription throughout the year. These funds do not have a fixed maturity. Investors have the flexibility to buy or sell any part of their investment at any time, at the prevailing price (Net Asset Value - NAV) at that time.

These funds begin with a fixed corpus and operate for a fixed duration. These funds are open for subscription only during a specified period. When the period terminates, investors can redeem their units at the prevailing NAV.

These funds invest in shares. These funds may invest money in growth stocks, momentum stocks, value stocks or income stocks depending on the investment objective of the fund. .

These funds invest money in bonds and money market instruments. These funds may invest into long-term and/or short-term maturity bonds.

These funds invest in a mix of both equity and debt. In order to retain their equity status for tax purposes, they generally invest at least 65% of their assets in equities and roughly 35% in debt instruments, failing which they will be classified as debt oriented schemes and be taxed accordingly. Monthly Income Plans (MIPs) fall within the category of hybrid funds. MIPs invest up to 25% into equities and the balance into debt.

These funds invest in physical assets such as gold, platinum, silver, oil, commodities and real estate. Gold Exchange Traded Funds (ETFs) and Real Estate Investment Trusts (REITs) fall within the category of real asset funds.

These funds diversify the equity component of their Asset Under Management (AUM), across various sectors. Such funds avoid taking sectoral bets i.e. investing more of their assets towards a particular sector such as oil & gas, construction, metals etc. Thus, they use the diversification strategy to reduce their overall portfolio risk.

These funds are expected to invest predominantly in a specific sector. For instance, a banking fund will invest only in banking stocks. Generally, such funds invest 65% of their total assets in a respective sector.

These funds seek to have a position which replicates the index, say BSE Sensex or NSE Nifty. They maintain an investment portfolio that replicates the composition of the chosen index, thus following a passive style of investing.

These funds are open-ended funds which are traded on the exchange (BSE / NSE). These funds are benchmarked against the stock exchange index. For example, funds traded on the NSE are benchmarked against the Nifty. The Benchmark Nifty BeES is an example of an ETF which links to the stocks in the Nifty. Unlike an index fund where the units are traded at the day's NAV, in ETFs (since they are traded on the exchange) the price keeps on changing during the trading hours of the exchange. If you as an investor want to buy or sell ETF units, you can do so by placing orders with your broker, who will in-turn offer a two-way real time quote at all times. The AMC does not offer sale and re-purchase for the units. Today, ETFs are available for pre-specified indices. We also have Gold ETFs. Silver ETFs are not yet available.

These funds invest their money in other funds of the same mutual fund house or other mutual fund houses. They are not allowed to invest in any other FOF and they are not entitled to invest their assets other than in mutual fund schemes/funds, except to such an extent where the fund requires liquidity to meet its redemption requirements, as disclosed in the offer document of the FOF scheme.

These funds are basically income/debt schemes like Bonds, Debentures and Money market instruments. They give a fixed return over a period of time. FMPs are similar to close ended schemes which are open only for a fixed period of time during the initial offer. However, unlike closed ended schemes where your money is locked for a particular period, FMPs give you an option to exit. Remember though, that this is subject to an exit load as per the funds regulations. FMPs, if listed on the exchange, provide you with an opportunity to liquidate by selling your units at the prevailing price on the exchange. FMPs are launched in the form of series, having different maturity profiles. The maturity period varies from 3 months to one year.

These funds invest in securities (equity and/or debt) of a specific country or region with an underlying belief that the chosen country or region is expected to deliver superior performance, which in turn will be favourable for the securities of that country. The returns on country fund are affected not only by the performance of the market where they are invested, but also by changes in the currency exchange rates.

These funds mobilise money from investors for the purpose of investment within as well as outside their home country.

So we have seen that funds can be categorised based on tenor, investment philosophy, asset class, or geographic region. Now, let's get down to simplifying some jargon with the help of a few definitions, before getting into understanding the nitty-gritty of investing in mutual funds.

NAV is the sum total of all the assets of the mutual fund (at market price) less the liabilities (fund manager fees, audit fees, registration fees among others); divide this by the number of units and you get the NAV per unit of the mutual fund.

Standard Deviation (SD)

SD is the measure of risk taken by, or volatility borne by, the mutual fund. Mathematically speaking, SD tells us how much the values have deviated from the mean (average) of the values. SD measures by how much the investor could diverge from the average return either upwards or downwards. It highlights the element of risk associated with the fund.

SR is a measure developed to calculate risk-adjusted returns. It measures how much return you can expect over and above a certain risk-free rate (for example, the bank deposit rate), for every unit of risk (i.e. Standard Deviation) of the scheme. Statistically, the Sharpe Ratio is the difference between the annualised return (Ri) and the risk-free return (Rf) divided by the Standard Deviation (SD) during the specified period. Sharpe Ratio = (Ri-Rf)/SD. Higher the magnitude of the Sharpe Ratio, higher is the performance rating of the scheme.

Compounded Annual Growth Rate (CAGR)

These funds invest in physical assets such as gold, platinum, silver, oil, commodities and real estate. Gold Exchange Traded Funds (ETFs) and Real Estate Investment Trusts (REITs) fall within the category of real asset funds.

These are the simple returns, i.e. the returns that an asset achieves, from the day of its purchase to the day of its sale, regardless of how much time has elapsed in between. This measure looks at the appreciation or depreciation that an asset - usually a stock or a mutual fund - achieves over the given period of time. Mathematically it is calculated as under:

Beginning Value Generally returns for a period less than 1 year are expressed in an absolute form.