What are Mutual Funds

What are Mutual Funds?

There are various avenues of investment available to investors. Mutual funds also provide good investment opportunities to investors. Like all investments, there are some risks involved. Investors should compare the risk and expected returns after adjusting for tax on different instruments while making investment decisions. Investors can take advice from experts while making investment decisions.

If you are a new investor, you may be skeptical of buying the stock yourself. At such times mutual funds provide an easy way to build your portfolio, but you should know what they are before investing in them.

What is Mutual Fund in Hindi

Mutual fund is an investment medium, which collects money from investors with common investment objectives. It then invests its money in multiple properties as per the stated objective of the scheme. The investment is made by an Asset Management Company or AMC.

For example, an equity fund will invest in stocks and equity related instruments, whereas a debt fund will invest in bonds, debentures, etc.

As an investor, you invest your money in financial assets like stocks and bonds. You can do this either by buying directly or by using investment methods such as mutual funds.

In this section, we will understand mutual funds and how to trade in them.

What is meant by mutual funds? (Mutual Funds Meaning in Hindi)

A mutual fund is a professionally managed investment scheme, usually run by an asset management company, that brings together a group of people and invests their money in stocks, bonds and other securities.

As an investor, you can buy mutual fund ‘units’, which basically represent your stake in a particular scheme. These units can be bought or redeemed as required at the current Net Asset Value (NAV) of the fund. These NAVs fluctuate according to the holdings of the fund. Therefore, each investor participates proportionately in the profit or loss of the fund.

All mutual funds are registered with SEBI. They work within the provisions of strict regulation designed to protect the interest of the investor.

History of Mutual Funds in India

A strong financial market is essential for a developed economy with funding coming from retail investors. The first mutual fund was established in 1963 by the Unit Trust of India (UTI) at the initiative of the Government of India and RBI with a view to promote savings and investment. The income earned by UTI from the acquisition, holding, management and disposal of securities, profits and participation in profits were made available to retail investors.

Mutual funds in India have come a long way since 1964, when Unit Trust of India was the only player.

  1. Phase 1: In 1978, UTI was separated from RBI and IDBI took over regulatory and administrative control of UTI. US-64 was the first scheme launched by UTI which was the best scheme of UTI for a long time. By the end of 1988, UTI had total assets of Rs 6,700 crore.
  2. Phase II: SBI Mutual Fund was the first non-UTI mutual fund established in June 1987, followed by Can Bank Mutual Fund (December 1987), PNB Mutual Fund (August 1989), Indian Bank (November 1989), Bank of India (June 1990) ) and Bank of Baroda Mutual Fund (October 1992).
  3. Phase 3: The erstwhile Kothari Pioneer (now merged with Franklin Templeton MF) was the first private sector MF registered in July 1993. 1993 marked the beginning of a new era in the Indian MF industry when private sector mutual funds entered the fray, offering Indian investors a diverse choice of MF products.
  4. Fourth Phase: In February 2003, the UTI Act, 1963 was repealed and UTI was bifurcated into two separate entities. Unit Trust of India (SUUTI) and specified undertaking of UTI Mutual Fund which functions under SEBI MF Regulations, 1996.
  5. Fifth Phase since 2012: Keeping in view the lack of penetration of Mutual Funds, especially in Tier II and Tier III cities, and keeping in view the interests of various stakeholders, SEBI in September 2012 approved sluggish Indian Mutual Several positive measures were initiated to revive. To fund the industry and increase the penetration of Mutual Funds in the far flung corners of the country.

Today, the Indian mutual fund industry has opened up many exciting investment opportunities for the investors. As a result, we have started witnessing a phenomenon of savings which are now being handed over to funds instead of banks alone. Mutual funds are now probably one of the most sought-after investment options for most investors.

As financial markets become more sophisticated and complex, investors need a financial intermediary who can provide the necessary knowledge and professional expertise on making informed decisions. Mutual funds act as this intermediary.

Why Invest in Mutual Funds? (Why Invest in Mutual Funds)

There are many benefits of investing in mutual funds. Let’s see:

1. Professional Investment Management:

When you invest in mutual funds, your money is managed by professional experts. This is one of the primary benefits of investing in mutual funds. Being a full-time, high-level investment professional, a good investment manager is more resourceful and capable of monitoring the companies that mutual funds have invested in, rather than individual investors.

Managers have real-time access to critical market information and are able to execute trades at the largest and most cost-effective scale. Simply put, they have the information to trade in markets that retail investors may not have.

2. Low Investment Limit:

A mutual fund enables you to participate in a diversified portfolio for as little as Rs 5000, and sometimes even less. And with no-load funds, you pay little or no sales fees for owning them.

For example, some bonds and fixed deposits have a minimum investment amount of Rs 25,000. Instead, you can give your money to mutual funds, which in turn will invest in bonds and fixed deposits. This can be done for as little as Rs 1000.

3. Convenience:

Investing in mutual funds has its own convenience. You can expect the additional paperwork that comes with each transaction, the amount of energy you invest in researching the stock, as well as the actual market-monitoring and conduct of the transaction. With mutual funds, you don’t have to do anything like that.

To buy mutual funds simply go online or place an order with your broker. Another great advantage is that you can easily transfer your funds from one fund to another within a mutual fund family. This allows you to easily rebalance your portfolio to respond to significant fund management or economic changes.

4. Liquidity:

In open-ended schemes, you can get your money back anytime at the prevailing NAV (Net Asset Value) from the mutual fund itself.

This makes mutual fund investments highly liquid. Compare this with fixed deposits or bonds, which can have a fixed investment tenure.

5. Variety:

You have many options to choose from while investing in mutual funds. You have a range of mutual fund schemes to choose from, which can invest in a whole range of industries and sectors, a wide variety of assets, etc. You can find a mutual fund that matches any investment strategy you choose.

There are funds that focus on blue-chip stocks, technology stocks, bonds or a mix of stocks and bonds. In fact, the biggest challenge may be sorting out the variety and choosing the best one for you.

6. Transparency:

SEBI regulations for mutual funds have made the industry very transparent. You can track the investments made on your behalf to know the sectors and stocks being invested.

In addition, you get regular information about the value of your investments. Mutual funds are required to publish their portfolio details regularly.

How To Choose A Mutual Fund

Money is valuable. Earned by hard work. You cannot put your money in any investment vehicle or mutual fund without doing some research.

Here are some things to keep in mind while choosing a fund:

1. Previous Performance:

History is important. Before investing, check the historical performance of the mutual fund scheme, investment decisions of the asset manager, fund returns etc. While past performance is not an indicator of the future, it can help you figure out what to expect in the future.

You can understand the investment philosophy of the fund and the kind of returns it is offering to investors over time. It would also make sense to check two year and one year returns for consistency.

Data like how the fund has performed in the past bull and bear markets will help you understand the strength of the fund. Tracking fund performance in bear markets is especially important because an accurate examination of a portfolio can often reveal how little it falls in a downturn.

2. Match the risk of the scheme with your profile:

Even though a mutual fund diversifies its portfolio to reduce risk, they may ultimately invest in the same type of asset. The riskiness of the fund depends on the type of assets invested in it. For this reason, check whether the mutual fund suits your risk profile and investment horizon.

For example, some sector-specific schemes come with a high-risk, high-return tag. Such schemes are prone to crash if the industry or sector loses its choice of market. If the investor is risk averse, he can instead opt for a low-risk debt scheme.

However, if you are a long-term investor who is not averse to risk, you can go ahead with sector-specific mutual fund schemes. For this reason, most investors prefer balanced schemes, which invest in a combination of equity and debt. They are less risky than pure equity or growth funds, which are likely to deliver higher returns, but are more risky than pure debt schemes.

3. Diversification:

While choosing a mutual fund, one should always consider factors like the extent of diversification that a mutual fund offers to your portfolio. A mutual fund can offer diversification either by investing in multiple assets or by balancing your overall portfolio.

For example, suppose your portfolio has 70% exposure to stocks from various industries, then it makes sense to invest 30% in debt funds to balance the portfolio.

Similarly, if your portfolio is heavily invested in a particular sector like IT, avoid investing in mutual funds that also invest in IT. That way, you can balance your risk against the same kind of risk.

4. Know Your Fund Manager:

The success of a fund largely depends on the fund manager. Some of the most successful funds are run by the same managers. Before investing, it would always be wise to know about the fund manager as well as any changes in the strategy of the fund manager or any other significant developments in the AMC.

For example, if the portfolio manager who has generated the fund’s successful performance is no longer managing that particular fund, you would do well to wait and analyze the advantages and disadvantages of investing in that fund.

5. Read the Fine Print

The prospectus says a lot about the fund. Reading the prospectus of the fund is a must to know about its investment strategy and its risks. Funds with high rates of return may have a high element of risk. Therefore, it is of utmost importance that an investor always chooses a particular scheme after considering his financial goals and weighs them against the risk of the mutual fund.

Remember that all funds carry some level of risk. Just because a fund invests in government or corporate bonds, it does not mean that there is no risk involved.

6. Cost:

The higher cost fund must outperform the lower cost fund for you to generate returns. Even a small difference in fees can translate into a big difference in returns over time.

So, make sure to match the cost and return. If it is giving similar returns as a low cost fund then there is no point in spending extra.

7. Patience:

Lastly, an investor should not enter and exit a mutual fund during a market reversal. Market cycles are natural. Be patient. Like stocks, mutual funds pay out only if you have the patience to wait. This applies to both buying and selling. Don’t choose a fund just because it has shown a jump in value in the current rally.

Make sure its returns are consistent. Similarly, do not sell a mutual fund just because it is not performing well due to poor market conditions. However, there is no point in staying in a fund that lags the market year after year.

Basic Terms and Concepts of Mutual Funds

As you learn and understand everything about mutual funds, you will learn about mutual fund terms and concepts that are specific to it. Here’s a jargon de-buster for you:

1. Net Asset Value:

This is perhaps the most important term to know in relation to mutual funds. Net Asset Value (NAV) is important to understand the performance of a particular scheme of Mutual Funds. As an investor, when you invest in mutual funds, you will be issued units. Then you will become the unit holder. It is like buying shareholding shares.

Mutual funds invest money collected from investors in the securities market. In simple words, Net Asset Value is the market value of all the securities held by the scheme. It is measured on a per unit basis. Since the market price of securities changes every day, the NAV of a scheme also varies on a day-to-day basis.

The NAV is calculated by dividing the net asset by the total number of units issued. Total net assets are the market value of all assets of a mutual fund, as on a given date, minus liabilities.

For example, if a mutual fund scheme has a market value of Rs 200 crore of securities and has issued 10 crore units to investors, the NAV of the fund is Rs 20 per unit. Mutual funds are required to disclose NAV regularly – either daily or weekly depending on the type of scheme.

2. Assets Under Management (AUM):

A mutual fund collects money from investors and uses this money to buy assets like stocks, bonds and other securities. The total value of assets purchased by a fund is called Assets Under Management (AUM).

3. Capital Gains Distributions:

In addition to dividends, mutual funds also distribute profits from selling certain underlying assets at higher prices. This is called capital gains distribution. It can also be used to buy more MF units (reinvestment).

4. Diversification:

Diversification is one of the major advantages as well as a characteristic of mutual funds. It is the practice of investing in a variety of securities or asset classes. This is done to reduce the risk.

The underlying principle is that not every asset moves simultaneously. Some rise, some fall all at once. So when you own both stocks in your portfolio, any loss from one will be nullified by gains in the other, thus reducing your overall risk.

5. Compounding:

When you invest in a financial asset, you earn on the amount invested. Over time, you can either reinvest this amount or put it in a bank account. Either way, you earn some amount on your current profits – either through investment returns or from bank interest. Thus, your total returns increase over time. This is called compounding. Over time, compounding can significantly increase the value of an investment.

For example, you invest Rs 1000 today and make a profit of Rs 100 from now on – a return of 10%. You decide to reinvest this amount as well. Next year, a return of 10% gives you Rs 110, not Rs 100. The higher the frequency of investment or interest payments, the greater the effect of compounding.

6. Depreciation:

This is a drop in the value of your investment in mutual funds. This means that you will incur a capital loss when you sell mutual fund units. This is the exact opposite of Appreciation.

7. Average Portfolio Maturity:

The average maturity of all securities in a portfolio of bonds or money market funds.

8. Portfolio :

It is a collection of mutual funds or even assets owned by you as an individual. It includes all financial instruments invested such as stocks, bonds and other securities.

An expert in mutual funds handles all these assets. He also decides which assets to buy and sell. This specialist is called a portfolio manager. The frequency of trading activity in a fund’s portfolio — the number of times assets are bought and sold — is called portfolio turnover.

9. Load:

This is the amount that mutual funds charge investors for various reasons. There are different types of loads – management fee, entry or front-end load, exit load.

The amount paid to your fund manager for his expertise and portfolio management skills is called management fee.

Entry/front-end load is the amount that a mutual fund charges when investors buy units. This is usually rare.

Exit load is the amount that a mutual fund charges you for selling or redeeming your shares.

All these shares generally differ from one fund to another. There are funds that do not charge any fees or charges. These are called no-load funds. MFs that charge investors are called load funds.

Expense ratios are used to compare one fund to another based on the amount they charge investors. It is calculated by dividing the fund’s total expenses by its total assets, expressed in percentage format. In addition, investors may also have to pay a small fee called a commission to their brokers or sales agents.

10. Exchange-Traded Fund (ETF):

An exchange traded fund is an investment vehicle like a mutual fund, but it is traded on stock exchanges. It typically tracks an index, a basket of assets or a single commodity. The value of the fund fluctuates like a stock due to demand-supply forces.

Since most ETFs track a fixed benchmark asset, it does not require active portfolio management services. Because of this, its charges are usually less.

11. Funds of Funds:

Mutual funds invest in a variety of assets such as stocks and bonds. They can also invest in mutual funds. These are called Fund of Funds.

12. New Fund Offering (NFO):

When a stock is listed on the exchange, it comes with an IPO or Initial Public Offering. Similarly, when a mutual fund starts a new scheme and invites investors to invest in exchange of units, it is called New Fund Offering or NFO.

13. Redeem:

There are two ways to exit a mutual fund – sell it to another investor or return the fund. The latter is called ‘redeeming’. Once an investor has redeemed multiple MF units, the NAV of the fund changes. This is because the total number of units issued to investors varies.

Many mutual funds charge investors an exit fee within a certain period of time. This fee is deducted from the Net Asset Value (NAV) and the balance is paid to the investor. This price is called the Redemption Price.

Frequently Asked Questions on Mutual Funds

How many types of mutual funds are there?

There are four broad types of mutual funds: equity (stocks), fixed-income (bonds), money market funds (short-term debt), or both stocks and bonds (balanced or hybrid funds).

Are mutual funds safe?

All investments carry some risk, but mutual funds are generally considered a safer investment than buying individual stocks. Since they hold multiple company stocks within one investment, they offer more diversification than owning one or two individual shares.

Which is the safest type of mutual fund?

Bond funds are generally considered safer than equities, which also means they often have lower returns. But they often earn higher returns than money market funds, which also invest in debt securities.

Can I withdraw mutual funds anytime?

Most mutual funds are liquid investments, which means they can be withdrawn at any time. On the other hand, some funds have a lock-in period. Equity Linked Savings Scheme (ELSS), which has a maturity period of 3 years, is one such scheme.

Can I invest in cash?

Yes, cash up to Rs 50,000 can be invested in mutual funds per investor, per mutual fund, per financial year. However, any repayment (redemption/dividend) is done through bank channel only.

How to know the performance of Mutual Fund Schemes?

The performance of a scheme is reflected in its NAV which is disclosed on a daily basis. The NAV of the mutual fund is required to be published on the websites of the mutual fund. 

All mutual funds need to post their NAV on Association of Mutual Funds in India (AMFI) website www.amfiindia.com and thus investors can access the NAV of all mutual funds at one place. Also, each MF is required to have a dashboard on its website that provides performance and key disclosures related to each scheme managed by AMC.

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