International School of Business & Media
Dissertation Topic
“PORTFOLIO MANAGEMENT THROUGH MUTUAL FUNDS”
Submitted by
Nitish Agarwal
In partial fulfillment of the MBA(Finance) Final
Batch: 2008-2010
:
Name of student Roll no: Name of supervisor
:
Nitish agarwal D-9206
:
Mr Avaneesh Jhumde
DECLARARTION
Research Topic An investigation on the effectiveness of turnaround strategies. The case of Hwange Colliery Company Limited.
I, the undersigned do or do not acknowledge that the above student has consulted me for supervision on his research project or dissertation until completion. I therefore, do or do not advise the student to submit his work for assessment.
Signature
…………………………………
Date
…………………………………
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ACKNOWLEDGEMENT
Concentration, dedication, hard work and application are essential but not the only factor to achieve the desired goal. Those must be supplemented by the guidance assistance and cooperation of experts to make it success.
I am extremely grateful to my institute for providing me the opportunity to undertake this research project in the prestigious field. With profound pleasure, I extend my extreme sincere sense of gratitude and indebtedness to my faculty for extensive and valuable guidance that was always available to me ungrudgingly and a nd instantly, which help me complete my project without difficulty. I express my deep and sincere gratitude to Mr Avaneesh Jhumde, faculty member for providing me first hand knowledge about other related subjects.
(Nitish Agarwal)
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INDEX 1)
INTRODUCTION
2)
PROJECT TITLE
3)
OBJECTIVES
4)
PURPOSE
5)
SCOPE
6)
LIMITATION
7)
METHODOLOGY
8) 9)
OVERVIEW OF MUTUAL FUNDS CURRENT SCENARIO
10)
ORGANIZATION OF MUTUAL FUNDS
11)
TYPES OF MUTUAL FUNDS SCEMES
12)
PERFORMANCE MEASURES OF MUTUAL FUNDS
13)
RISK FACTORS
14)
DIFFERENT AMC’S IN INDIA
15) REFERNECES
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ABSTRACT The rise in the level of capital market has manifested the importance Mutu Mu tual al Fund Funds s as inve invest stme ment nt medi medium um.. Mu Mutu tual al Fund Funds s are now now are are becoming a preferred investment destination for the investors as fund houses offer not only the expertise in managing funds but also a host of other services. Over Over the the last last five five year year peri period od from from Mar’ Mar’03 03 to Mar’ Mar’08 08,, the the mone money y invested by FIIs was Rs.2,09,213cr into the stock market as compared to Rs.3 Rs.38, 8,96 964c 4crr by mutu mutual al fund funds, s, yet yet MFs MFs coll collec ecti tive vely ly made made an annualized return of 34% while it was 30% in case of FIIs. Total Assets Under Management(AUM) in India as of today is $92b. Volatile markets and year end accounting considerations have shaved 6% off in March, but much of that money should flow back in April. The next five years will see the Indian Asset Management business grow at least 33% annually says a study by McKinsey. Funds in the diversified equity category which has the largest number of funds(194) as well as the highest investor interest lost an average of 28.3% in Q4,2007-08 but gained an average of 21.4% over the four quar quarte ters rs.. Equi Equity ty fund funds s are are esti estima mate ted d to have have had had net net infl inflow ows s of Rs.7000cr for March 2008.More than 80% of equity funds managed to outperform Sensex in terms of returns over the last five years. Investor’s money inflow to mutual funds has sidelined for the time being but the overall long term fundamental outlook on the economy remains remains intact. To lower lower the impact of volatilit volatility y one can stay invested invested in diversified equity funds over a longer period of time through the route of Systematic Investment Plan. When it comes to investing, everyone has unique needs based on their own objectives and risk profile. While many investment avenues such
5
as fixed deposits, bonds etc. exist, it is usually seen that equities typically outperform these investments, over a longer period of time. Hence we are of the opinion that, systematic investment in equity allows one to create substantial wealth.
INTRODUCTION: Mutual funds have been a significant source of investment in both governm government ent and corpor corporate ate securi securitie ties. s. It has been been for decade decades s the monopoly of the state with UTI being the key player, with invested funds exceeding Rs.300 bn. (US$ 10 bn.). The state-owned insurance companies also hold a portfolio of stocks. Presently, numerous mutual funds exist, including private and foreign companies. Banks - mainly stat statee-ow owne ned d too too have have estab stabli lish shed ed Mu Mutu tual al Fund Funds s (MFs (MFs). ). Fore Foreig ign n partici participat pation ion in mutual mutual funds funds and asset asset manage managemen mentt compan companies ies is permitted on a case by case basis. A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collecte collected d is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capita capitall apprec appreciat iation ions s realiz realized ed are shared shared by its unit unit holder holders s 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 securi securitie ties s at a relati relativel vely y low cost. cost. The flow flow chart chart below below descri describes bes broadly the working of a mutual fund:
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PROJECT TITLE “PORTFOLIO MANAGEMENT THROUGH MUTUAL FUNDS”
7
OBJECTIVE The objectives of the study on this topic are a re as follows:
Primary objective: •
To study the influence and role of mutual funds in managing a portfolio.
•
To analyze the various risk-return characteristics of Mutual funds and attempt to establish a link between the demographics (age, income, employment status etc), risk tolerance of investors.
•
To analyze the performance of Top Mutual Funds in India.
Secondary objectives: •
Unders Understan tandin ding g the various various charact characteri eristi stics cs of differ different ent Mutual Mutual funds.
•
Understanding the Investment pattern of AMC’s
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•
To To get get addit additio iona nall clie client nts s for for the the comp company any and maki making ng them them aware about the benefits of mutual funds.
•
To come up with recommendations for investors and mutual fund companies in India based on the above study.
PURPOSE Investment in mutual funds gives you exposure to equity and debt mark market ets. s. Thes These e fund funds s are are mark market eted ed as a safe safe have haven n or as smart smart investment vehicles for novice investors. The middle-class Indian investor who plays hot tips for a quick buck at the bourses is the stuff of legends. The middle-class Indian investor who runs out of luck and loses not only his money but his peace of mind too is somewhat less famous by choice. Mutual funds, on the other hand, sell us middling miracles. Consequently proof enough for a research on Mutual Funds, which has exacting returns. Every investor requires a healthy return on his/her investments. But since the market is very volatile and due to lack of expertise they may fail to do so. So a study of these mutual funds will help one to equip with with unwa unwarra rrant nted ed know knowle ledg dge e abou aboutt the the elem elemen ents ts that that help help trad trade e between risk and return thereby improving effectiveness. A meticulous study on the scalability at which the mutual funds operate along with diag diagno nosi sis s of the the mark market et cond condit itio ions ns woul would d endu endure re mana managi ging ng the the invest investmen mentt portfo portfolio lio effici efficient ently. ly. The study study would would also also immun immunize ize on
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risks and foresee healthy returns; incidentally in worst of conditions conditions it has given a return of 18 per cent.
SCOPE The project covers the financial instruments mobilizing in the Indian Capital market in particular the Mutual Funds. The mutual funds analysed for their performance are determined over a period of 5 years fluctuati fluctuations ons and returns. returns. The elements elements taken into into consideration for choosing some of the top funds is on the basis of their respective respective sharpe , beta, ratio, . The project shelves some of the top asset management companies operating operating in India , segregated segregated on the basis of their performance performance over a period of time. Scooping further the project inundates the success ratio of the funds administered by top AMC’s.
LIMITATIONS A well managed portfolio of various individual scripts which is rare, would not help to draw a line of difference between portfolio managed through mutual funds and the former. The median used to choose the top AMC’s and the mutual funds to be anal analyse ysed d is rela relati tive ve and and pers person onal aliz ized ed and need need not not be acce accept pted ed industry wide. Inaccessibility to certain information and data relating to the project on account of it being confidential. Market volatility would affect individuals perception which would rather not be likely the way it is expressed, thus resulting in a very relative data.
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METHODOLOGY A thorough study of literature on the mutual fund industry both in India and and abro abroad ad will will be done done.. Diff Differ eren entt meas measur ures es will will be adop adopte ted d to understand understand and evaluate evaluate the risks and returns returns of funds efficiently efficiently and effectively. An extensive study of various articles and publications of SEBI, AMFI and gove govern rnme ment nt of Indi India a and and othe otherr agen agenci cies es with with respe respect ct to the the demogr demographi aphics cs of the popula populatio tion n of the countr country y and their their invest investing ing pattern will be a part of the methodology adopted. The project will be carried out mainly through two researches: Primary research: •
Field visits
•
Meeting with the clients
Secondary research: •
Internet.
•
AMFI book.
•
Fact sheets of various mutual fund houses.
Overview of Indian Mutual Fund Industry Assets under management As of the end end on 31 January 2008, 2008, the mutual fund industry had a debt 5,50,157 57 crore crore. Its and equi equity ty asse assets ts of Rs 5,50,1 Its equi equity ty corp corpus us of Rs 2,20,263 lakh crore accounts for over 3 per cent of the total market
capital capitaliz izati ation on of BSE, BSE, at Rs 58 lakh Its hold holdin ing g in Indi Indian an lakh cror crore e. Its companies ranges between 1 per cent and almost 29 per cent, making them them an infl influe uent ntia iall share shareho hold lder er.. Toge Togeth ther er with with bank banks, s, insu insuran rance ce companies and FIIs- collectively called institutional institutional investors- they
11
have the ability to ask company managements some tough questions. India’s market for mutual funds has generated substantial growth in assets under management over the past 10 years. Ownership of mutual fund shares
One notable characteristic of India’s mutual fund market is the high perc percen enta tage ge of shar shares es owne owned d by corp corpor orat atio ions ns.. Ac Acco cord rdin ing g to the the Association of Mutual Funds in India ( AMFI ) , Individual investors held slightly under 50% of mutual fund assets, and corporations held over 50% as of the end of march 2007. This high percentage of corporate ownership can be tracked back to tax reforms instituted in 1999 that lowered the tax rate on dividend and interest income from mutual funds, and made that rate lower than the corporate tax levied on income from securities held directly by corporations. Although there is no official data regarding the type investor in each clas class, s, the the typi typica call patt patter ern n seem seems s to be that that indi indivi vidu dual al inve invest stor ors s primarily invest in equity funds, while corporate investors favor bond funds, particularly short-term money market products that provide a way for corp[orations to invest surplus cash.
HISTORY OF MUTUAL FUNDS: The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and 12
Rese Reserve rve Bank. Bank. The The hist histor ory y of mutu mutual al fund funds s in Indi India a can can be broad broadly ly divided into four distinct phases. First Phase – 1964-87
Unit Un it Trus Trustt of Indi India a (UTI) UTI) was estab stabllishe ished d on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of Indi India. a. In 1978 1978 UTI UTI was was de-l de-lin inke ked d from from the the RBI RBI and and the the Indu Indust stri rial al Deve Develo lopm pmen entt Bank Bank of Indi India a (IDB (IDBI) I) took took over over the the regu regula lato tory ry and and administrative control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of assets under management. Second Phase – 1987-1993 (Entry of Public Sector Funds)
1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund was the firs firstt nonnon- UTI UTI Mu Mutu tual al Fund Fund esta establ blis ishe hed d in June June 1987 1987 foll follow owed ed by Canbank Canbank Mutual Mutual Fund Fund (Dec (Dec 87), 87), Punjab Punjab Nation National al Bank Bank Mutual Mutual Fund Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990. At the the end end of 1993 1993,, the the mutu mutual al fund fund indu indust stry ry had had asse assets ts unde underr management of Rs.47,004 crores. Third Phase – 1993-2003 (Entry of Private Sector Funds)
With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer 13
(now (now merged merged with with Frankli Franklin n Temple Templeton ton)) was the first first private private sector sector mutual fund registered in July 1993. The 1993 SEBI (Mutual Fund) Regulations were substituted by a more compre comprehen hensiv sive e and revise revised d Mutual Mutual Fund Fund Regula Regulatio tions ns in 1996 1996.. The indu indust stry ry now now func functi tion ons s unde underr the the SEBI SEBI (Mut (Mutual ual Fund Fund)) Regu Regula lati tion ons s 1996 1996.The .The number number of mutual mutual fund fund houses houses went went on increas increasing ing,, with with many many fore foreig ign n mutu mutual al fund funds s sett settin ing g up fund funds s in Indi India a and and also also the the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets under management was way ahead of other mutual funds. Fourth Phase – since February 2003
In February 2003, following the repeal of the Unit Trust of India Act 1963 1963 UTI UTI was was bifu bifurc rcat ated ed into into two two sepa separa rate te enti entiti ties es.. One One is the the Specif Specified ied Undert Undertaki aking ng of the Unit Unit Trust Trust of India India with with assets assets under under mana manage geme ment nt of Rs.2 Rs.29, 9,83 835 5 cror crores es as at the the end end of Janu January ary 2003 2003,, representin representing g broadly, broadly, the assets assets of US 64 scheme, assured assured return and certai certain n other other schem schemes. es. The Specif Specifie ied d Undert Undertakin aking g of Unit Unit Trust Trust of India, functioning under an administrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations.
CURRENT SCENARIO: The fund industry has grown phenomenally over the past couple of years, and as on 31 January 2008, it had a debt and equity assets of Rs 5,50,157 crore. Its equity corpus of Rs 2,20,263 lakh crore
accounts for over 3 per cent of the total market capitalization of BSE, 14
at Rs 58 lakh crore . Its holding in Indian companies ranges between 1 per per cent cent and and almo almost st 29 per per cent cent,, maki making ng them them an infl influe uent ntia iall share shareho hold lder er.. Toge Togeth ther er with with banks, banks, insu insuran rance ce comp compan anie ies s and FIIs FIIs-collectively called institutional institutional investors investors - they have the ability to ask company managements some tough questions. More significant than this stupendous growth has been the regulatory changes that the capital market watchdog, Securities and Exchange Boar Board d of Indi India, a, intr introd oduc uced ed in the the past past two two year years. s. Outg Outgoi oing ng Sebi Sebi Chairman M.Damodaran’s two year stint as chairman of Unit Trust of Indi India a help helped ed him him refo reform rm the the indu indust stry ry by maki making ng it much much more more transparent than before. In the process, mutual funds have become a tad cheaper. Until 2007, for instance, initial issue expenses on close-ended funds, which could be as high as 6 per cent of the amount raised, could be amortized over the tenure of the fund. This basically meant that even if an investor put in Rs 1 lakh, effectively only Rs 94,000 got invested by the fund. The initial expenses of the fund include commissions paid to distributors and money spent on billboards for advertising the new offer. In 2006, the regulator had scrapped the amortization benefit for open-ended schemes. Not surprisingly, asset management companies started launching closed-ended funds. Of the 34 new fund offers in 2007, 24 were closed-ended. In January this year, SEBI said all closedende ended d mutu mutual al fund fund sche scheme mes s too too will will meet eet sale sales s and and mark market etin ing g expe expens nses es from from the the entr entry y load load.. This This made made it more more tran transp spor ortt for for inve invest stor ors, s, beca becaus use e fund funds s had had to eith either er hike hike thei theirr expe expens nse e rati ratio o (management fee and operating charges as a percentage of assets under management) or change higher entry load.
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More About Mutual funds According to SEBI "Mutual Fund" means a fund established in the form of a trust to raise monies through the sale of units to the public or a sect sectio ion n of the the publ public ic unde underr one one or more more sche scheme mes s for for inve invest stin ing g in securities, including money market instruments;" To the ordinary individual investor lacking expertise and specialized skill in dealing proficiently with the securities market a Mutual Fund is the the most most suit suitabl able e inve invest stme ment nt foru forum m as it offe offers rs an oppo opport rtun unit ity y to invest in a diversified, professionally managed basket of securities at a relatively low cost. India has a burgeoning population of middle class now estimated around 300 million. A typical Indian middle class family can pool liquid savings ranging from Rs.2 to Rs.10 Lacs. Investment of this money in Banks keeps the fund liquid and safe, but with the falling rate of interest offered by Banks on Deposits, it is no longer attractive. At best a small part can be parked in bank deposits, but what are the other other source sources s of remune remunerat rative ive invest investmen mentt possib possibili ilitie ties s open open to the comm common on man? an? Mu Mutu tual al Fund Fund is the the read ready y answ answer er,, as dire direct ct PMS investment is out of the scope of these individuals. Viewed in this sens sense e Indi India a is glob global ally ly one one of the the best best marke arkets ts for for Mu Mutu tual al Fund Fund Business, so also for Insurance business. This is the reason that foreign compani companies es compet compete e with with one anothe anotherr in settin setting g up insura insurance nce and mutu mutual al fund fund busi busine ness ss shop shops s in Indi India. a. The The shee sheerr magn magnit itud ude e of the the population of educated white-collar employees with raising incomes and a well well-o -org rgani anize zed d stoc stock k marke markett at par par with with glob global al stand standar ards, ds, provide unlimited scope for development of financial services based on PMS like mutual fund and insurance. The alternative to mutual fund is direct investment by the investor in equities and bonds or corporate deposits. All investments whether in shares, debentures debentures or deposits deposits involve risk: share value may go down depending upon the performance of the company, the industry, state of capital markets and the economy. Generally, however, longer the 16
term, lesser is the risk. Companies may default in payment of interest/ principal on their debentures/bonds/deposits; the rate of interest on an inve invest stme ment nt may may fall fall shor shortt of the the rate rate of infl inflat atio ion n redu reduci cing ng the the purch rchasi asing
power.
While
risk
cannot
be
eliminate ated,
skillful
mana manage geme ment nt can can mini minimi mise se risk risk.. Mu Mutu tual al Fund Funds s help help to redu reduce ce risk risk through diversification and professional management. The experience and expert expertise ise of Mutual Mutual Fund Fund manage managers rs in select selecting ing fundam fundament entall ally y sound securities and timing their purchases and sales help them to build a diversified portfolio that minimises risk and maximises returns.
ORGANISATION OF A MUTUAL FUND: There are many entities involved and the diagram below illustrates the organizational set up of a mutual fund:
The Advantages of Investing in a Mutual Fund The advantages of investing in a Mutual Fund extending PMS to the small investors are as under:
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•
Professional Management - The investor avails of the services of expe experi rien ence ced d and and skil skille led d prof profes essi sion onal als s wh who o are backed backed by a dedi dedica cate ted d inve invest stme ment nt rese resear arch ch team team,, wh whic ich h
anal analys yses es the the
performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme. •
Diversific Diversification ation- Mutual Funds invest in a number number of companies companies acro across ss a broa broad d cros cross-s s-sec ecti tion on of indu indust stri ries es and and sect sector ors. s. This This divers diversifi ificat cation ion reduce reduces s the risk risk because because seldom seldom do all stocks stocks decl declin ine e at the the same same time time and and in the the same same prop propor orti tion on.. You You achieve this diversification through a Mutual Fund with far less money than you can do on your own.
•
Convenient Administration - Investing in a Mutual Fund reduces pape paperw rwor ork k and and help helps s you you avoi avoid d many many prob proble lems ms such such as bad bad delive deliverie ries, s, delayed delayed payment payments s and unnece unnecessa ssary ry follow follow up with with brokers and companies. Mutual Funds save your time and make investing easy and convenient.
•
Return Return Potential Potential Over a medium medium to long-term long-term - Mutual Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities.
•
Low Costs - Mutual Funds are a relatively less expensive way to invest invest compar compared ed to direct directly ly invest investing ing in the capita capitall market markets s because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors.
•
Liquidity- In open-ended schemes, you can get your money back promptly at net asset value related prices from the Mutual Fund itself. With close-ended schemes, you can sell your units on a stock exchange at the prevailing market price or avail of the facility of direct repurchase at NAV related prices which some close-ended and interval schemes offer you periodically. 18
•
Transparency- You get regular information on the value of your investment investment in addition addition to disclosure disclosure on the specific investments investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook.
•
Flexibilit Flexibility y- Through Through features features such as regular regular investmen investmentt plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience.
•
Choice of Schemes- Mutual Funds offers a family of schemes to suit your varying needs over a lifetime.
•
Well Regulated- All Mutual Mutual Funds are registered registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.
Other Special Features of MFs in terms of Portfolio Functions
These are special safeguards for the investor prescribed by SEBI. •
Portfolio Investment operations are entrusted to a professional company company,, i.e. i.e. The Asset Asset Manage Manageme ment nt Company Company.. (AMC) (AMC).. Thus Thus while MFs offer PMS functions on behalf of its unit holders, the actual PMS services are rendered by the AMCs.
•
Physical custody of the securities is not with the AMC but with a cust custod odia ian, n, an inde indepe pend nden entt orga organi nisat satio ion, n, appo appoin inte ted d for for the the purpose. For instance, the Stock Holding Corporation of India Ltd. (SCHIL) is the custodian for most fund houses in the country.
Disadvantages: 1. No Control over Costs
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2. No Tailor-made Portfolios 3. Managing a Portfolio of Funds
20
Types of mutual fund schemes The The expert expertise ise and profes professio sional nal skill skill develo developed ped by differ different ent Mutual Mutual Funds in Portfolio Management can be better expressed by listing the different financial products they have developed to be offered to the investors:
1. Schemes Schemes accordi according ng to Maturity Maturity Period Period:: A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period. o
An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period
o
Close-ended Fund/Scheme: A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund
21
through periodic repurchase at NAV related prices. These mutual funds schemes disclose NAV generally on weekly basis 2. Schemes according a ccording to Investment Inves tment Objective Obj ective :
A sche scheme me can can also also be class classif ifie ied d as grow growth th sche scheme me,, inco income me sche scheme me,,
or
bala balanc nced ed
sche scheme me
cons consid ider erin ing g
its its
inve invest stme ment nt
object objective ive.. Such Such schem schemes es may be open-e open-ende nded d or closeclose-end ended ed schemes as described earlier. Such schemes may be classified mainly as follows: o
Growth / Equity Oriented Scheme: The aim of growth funds is to provide capital appreciation over the medium to longterm. Such schemes normally invest a major part of their corpus corpus in equiti equities. es. Such Such funds funds have compara comparativ tively ely high high risks risks.. Thes These e sche scheme mes s provi provide de diff differ eren entt opti option ons s to the the invest investors ors like like divide dividend nd option option,, capit capital al apprec appreciat iation ion,, etc. etc. and the investors may choose an option depending on their preferences. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good good for for inve invest stor ors s havi having ng a long long-t -ter erm m outl outloo ook k seek seekin ing g appreciation over a period of time.
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, bonds, corpor corporate ate debent debenture ures, s, Govern Governmen mentt securi securitie ties s and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected beca becaus use e of fluc fluctu tuat atio ions ns in equi equity ty marke arkets ts.. Howe Howeve ver, r, opport opportuni unitie ties s of capita capitall apprec appreciat iation ion are also also limite limited d 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 22
short run and vice versa. However, long term investors may not bother about these fluctuations. o
Balanced Balanced Fund: The aim of balanced balanced funds is to provide provide both growth and regular income as such schemes invest bot both in equi quities ties and and fixe fixed d incom ncome e secur ecuriities ties in the the proportion indicated in their offer documents. These are appropr appropriat iate e for invest investors ors lookin looking g for modera moderate te growth growth.. They
generall ally
invest vest
40-60 -60%
in
equity
and
debt
inst instrum rumen ents ts.. Thes These e fund funds s are are also also affec affecte ted d becau because se 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. 3. Money Market or Liquid Liq uid Fund F und:
These funds are also income funds and their aim is to provide easy easy liquid liquidity ity,, preserv preservati ation on of capita capitall and modera moderate te income 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. The These se fund funds s are are appr approp opri riat ate e for for corp corpor orat ate e and and indi indivi vidu dual al inve invest stor ors s as a mean means s to park park thei theirr surp surplu lus s fund funds s for for shor shortt periods. 4. Gilt Gi lt Fund Fu nd :
The These se
fund funds s
inve invest st
excl exclus usiv ivel ely y
in gove govern rnme ment nt secu securi riti ties es..
Gove Govern rnme ment nt secu securi riti ties es have have no defa defaul ultt risk risk.. NAVs NAVs of thes these e schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes. 5. Index In dex Fund Fu nds s:
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc. These 23
sche schem mes inve nvest in the the secu securi riti ties es in the sam same weig weight htag age e comprising of an index. NAVs of such schemes would rise or fall in acco accord rdan ance ce with with the the rise rise or fall fall in the the inde index, x, thou though gh not not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this rega regard rd are are made ade in the the offe offerr docu docume ment nt of the the mutu mutual al fund fund scheme. There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges. 6. Sector specific funds/schemes funds/ schemes :
These are the funds/schemes, which invest in the securities of only only thos those e sect sector ors, s, or indu indust stri ries es as spec specif ifie ied d in the the offe offerr docu docume ment nts. s.
e.g. e.g.
Phar Ph arma mace ceut utic ical als, s,
Soft Softwa ware re,,
Fast Fast
Movi Moving ng
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 they are more more risky risky compare compared d to divers diversifi ified ed funds. funds. Invest Investors ors need
to
keep
a
watch
on
t he
performance
of
those
sectors/industries and must exit at an appropriate time. They may also seek advice of an expert. 7. Tax Ta x Savin Sa ving g Schemes Sch emes :
These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues. e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual mutual funds funds also offer tax benefi benefits. ts. These These scheme schemes s are growth growth orient oriented ed and invest invest pre-do pre-domi minant nantly ly in equiti equities. es. Their Their growth opportunities and risks associated are like any equityoriented scheme 8. Load or no-l n o-load oad Fund Fun d:
24
A Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time one buys or sells units in the fund, a charge will be payable. This charge is used by the mutual fund for marketing and distribution expenses. However, the investors should also consider the performance track record and service stan standa dard rds s of the the mutu mutual al fund fund,, wh whic ich h are are more more impo import rtan ant. t. Efficient funds may give higher returns in spite of loads. 9. No-loa No-load d fund fund: is one that that does does not charge charge for entry entry or exit. exit. It
means the investors can enter the fund/scheme at NAV and no additional charges are payable on purchase or sale of units.
10.
Monthly Income Plan: •
To generate regular income through investments in debt and money market instruments and also to generate longterm capital appreciation by investing a portion in equity related instruments.
•
Fund Objective :-Investors seeking regular income through inve nvestme stment nts s in fixe fixed d incom ncome e secur ecuriities ties so as to get get monthl monthly/q y/quar uarter terly/ ly/hal halff yearly yearly divide dividend. nd. The second secondary ary objective of the scheme is to generate long term capital appreciation by investing a portion of scheme’s assets in equity and equity related instruments. Suitable for investor with medium risk profile and seeking regular income.
11. FMP’s ( Fixed Maturity Plans ):
These are close-ended income
schemes with a fixed maturity date. The period could range from fifteen days to as long as two years or more. When the period comes to an end, the scheme matures and money is paid back. Like an income scheme, FMPs invest in fixed income instruments i.e. bonds, government government securities, securities, money market instrument instruments s 25
etc. The tenure of these instruments depends on the tenure of the scheme.
•
FMPs effectively eliminate interest rate risk. This is done by employing a specific investment strategy. FMPs invest in instruments that mature at the same time their schemes come to an end. So a 90-day FMP will invest in instruments that mature within 90 days.
•
For all practical purposes, an FMP is an income scheme of a mutual fund. Hence, the tax incidence would be similar to that on traditional income schemes. The dividend from an FMP will be tax free in the hands of an individual investor. However, it would be subject to the dividend distribution tax.
•
Redemptions from investments held for less than a year will be short-term gains and added to the investor's income to be taxed at slab rates applicable. If such an investment were held for more than a year, the long-term gains would get taxed at 20 per cent with indexation or at 10 per cent with withou out. t. Thes These e rate rates s are subj subjec ectt to the the surc surchar harge ge and and education cess as normally applicable. One can avail the benefit of double indexation and save tax on FMPs held for more than one year.
PERFORMANCE
MEASURES
OF
MUTUAL
FUNDS Mutual Fund industry today, with about 34 players and more than five hundred schemes, is one of the most preferred investment avenues in India. However, with a plethora of schemes to choose from, the retail investor faces problems in selecting funds. Factors such as investment strategy and management style are qualitative, but the funds record 26
is an important indicator too. Though past performance alone cannot be indicative of future performance, it is, frankly, the only quantitative way to judge how good a fund is at present. Therefore, there is a need to correctly assess the past performance of different mutual funds. Worldwide, good mutual fund companies over are known by their AMCs and this fame is directly linked to their superior stock selection skills. For mutual funds to grow, AMCs must be held accountable for thei theirr sele select ctio ion n of stoc stocks ks.. In othe otherr word words, s, ther there e must must be some some performance indicator that will reveal the quality of stock selection of various AMCs. Return alone should not be considered as the basis bas is of measurement of the performance of a mutual fund scheme, it should also include the risk taken by the fund manager because different funds will have different levels of risk attached to them. Risk associated with a fund, in a general, can be defined as variability or fluctuations in the returns generated by it. The higher the fluctuations in the returns of a fund during a given period, higher will be the risk associated with it. These fluctuations in the returns generated by a fund are resultant of two guiding forces. First, general market fluctuations, which affect all the securities present in the market, called market risk or systematic risk and second second,, fluctu fluctuati ations ons due to specif specific ic securi securitie ties s presen presentt in the portfol portfolio io of the fund, called called unsyste unsystemat matic ic risk. risk. The Total Total Risk Risk of a given fund is sum of these two and is measured in terms of standard deviation of returns of the fund. Systematic risk, on the other hand, is measured in terms of Beta, which represents fluctuations in the NAV of the fund vis-à-vis market. The more responsive the NAV of a mutual fund is to the changes in the market; higher will be its beta. Beta is calculated by relating the returns on a mutual fund with the returns in the the marke market. t. Wh Whil ile e unsy unsyst stem emat atic ic risk risk can can be dive diversi rsifi fied ed thro throug ugh h investments in a number of instruments, systematic risk can not. By
27
using the risk return relationship, we try to assess the competitive strength of the mutual funds vis-à-vis one another in a better way. In orde orderr to dete determ rmin ine e the the risk risk-a -adj djus uste ted d retu return rns s of inve invest stme ment nt port portfol folio ios, s, seve severa rall emin eminen entt auth author ors s have have work worked ed sinc since e 1960 1960s s to devel develop op compos composite ite perfor performan mance ce indice indices s to evalua evaluate te a portfo portfolio lio by compari comparing ng altern alternati ative ve portfo portfolio lios s withi within n a partic particula ularr risk risk class. class. The most important and widely used measures of performance are: Ø The Treynor Measure Ø The Sharpe Measure Ø Jenson Model Ø Fama Model The Treynor Measure
Develo Developed ped by Jack Jack Treyno Treynor, r, this this perfor performan mance ce measur measure e evalua evaluates tes funds on the basis of Treynor's Index. This Index is a ratio of return gene genera rate ted d by the the fund fund over over and and abov above e risk risk free free rate rate of retu return rn (gen (gener eral ally ly take taken n to be the the retu return rn on secu securi riti ties es back backed ed by the 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 high and posi positi tive ve Trey Treyno nor's r's Inde Index x show shows s a super superio iorr riskrisk-adj adjus uste ted d perf perfor orma manc nce e of a fund fund,, a low low and negat negativ ive e Trey Treyno nor's r's Inde Index x 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 28
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, Sy mbolically, 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 perf perfor orma manc nce e of a fund fund,, a low low and and nega negati tive ve Shar Sharpe pe Rati Ratio o 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 dive divers rsif ifie ied d port portfo foli lios os or indi indivi vidu dual al stoc stocks ks.. For For a well well-d -div iver ersi sifi fied ed portfolio the total risk is equal to systematic risk. Rankings based on total total risk risk (Sharpe (Sharpe measur measure) e) and system systemati atic c risk risk (Treyn (Treynor or measu measure) re) 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
29
period. Required return of a fund at a given level of risk (Bi) can be calculated as: Ri = Rf + Bi (Rm - Rf) Where, Where, Rm is average average market market return return during during the given given period period.. After 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 cannot cannot mitig mitigate ate unsyste unsystemat matic ic risk, risk, as his knowle knowledge dge of market market is primitive. Fama Model
The Eugene Fama model is an extension of Jenson model. This model compares the performance, measured in terms of returns, of a fund with the required required return commensurate commensurate with the total risk associated associated with it. The difference between these two is taken as a measure of the performance of the fund and is called net selectivity. The net selectivity represents the stock selection skill of the fund manager, as it is the excess return over and above the return required to compensate for the total risk taken by the fund manager. Higher value of which indicates that fund manager has earned returns well above the return commensurate with the level of risk taken by him. Required return can be calculated as: Ri = Rf + Si/Sm*(Rm - Rf) Where, Sm is standard deviation of market returns. The net selectivity is then calculated by subtracting this required return from the actual return of the fund. Amon Among g the the abov above e perf perfor orma manc nce e meas measur ures es,, two two mode models ls name namely ly,, Treynor measure and Jenson model use systematic risk based on the premise that the unsystematic risk is diversifiable. These models are suitable for large investors like institutional investors with high risk 30
taking capacities as they do not face paucity of funds and can invest in a number of options to dilute some risks. For them, a portfolio can be spread across a number of stocks and sectors. However, Sharpe measure and Fama model that consider the entire risk associated with fund are suitable for small investors, as the ordinary investor lacks the necessary skill and resources to diversified. Moreover, the selection of the fund on the basis of superior stock selection ability of the fund manager will also help in safeguarding the money invested to a great extent. The investment in funds that have generated big returns at higher levels of risks leaves the money all the more prone to risks of all kinds that may exceed the individual investors' risk appetite. a ppetite.
RISK FACTOR All All inve invest stme ment nts s invo involv lve e some some form form of risk risk.. Even Even an insu insure red d bank bank account is subject to the possibility that inflation will rise faster than your earnings, leaving you with less real purchasing power than when you started (Rs. 1000 gets you less than it got your father when he was your age). The The disc discus ussi sion on on inve invest stme ment nt obje object ctiv ives es woul would d not not be comp comple lete te with withou outt a disc discus ussi sion on on the the risk risks s that that inve invest stin ing g in a mutu mutual al fund fund entails. At the cornerstone of investing is the basic principle that the greater the risk you take, the greater the potential reward. Remember that the value of all financial investments will fluctuate. Typically, risk is defined as short-term price variability. But on a long-term basis, risk is the possibi possibili lity ty that that your your accumu accumulat lated ed real real capital capital will will be insuff insuffici icient ent to meet your financial goals. And if you want to reach your financial goals, you must start with an honest appraisal of your own personal comfort zone with regard to risk. Individual tolerance for risk varies, creating a distinct "investment personality" for each investor. Some investors can accept short-term volatility with ease, others with near
31
panic. So whether you consider your investment temperament to be cons conser ervat vativ ive, e, mode moderat rate e or aggr aggres essi sive ve,, you you need need to focu focus s on how how comf comfor orta tabl ble e or unco uncomf mfor orta tabl ble e you you will will be as the the valu value e of your your investment moves up or down. Managing risks
Mutual funds offer incredible flexibility in managing investment risk. Dive Divers rsif ific icat atio ion n and and Syst System emat atic ic Inve Invest stin ing g Plan Plan (SIP (SIP)) are are two two key key techniques you can use to reduce your investment risk considerably and reach your long-term financial goals. Diversification
When you invest in one mutual fund, you instantly spread your risk over a number of different companies. You can also diversify over several different kinds of securities by investing in different mutual funds, further reducing your potential risk. Diversification is a basic risk management tool that you will want to use throughout your lifetime as you rebalance your portfolio to meet your changing needs and goals. Investors, who are willing to maintain a mix of equity shares, bonds and and mone money y marke arkett secu securi riti ties es have have a grea greate terr chan chance ce of earn earnin ing g significantly higher returns over time than those who invest in only the most conservative investments. Additionally, a diversified approach to investing -- combining the growth potential of equities with the higher income of bonds and the stability of money markets -- helps moderate your risk and enhance your potential return.
Types of risks: Consi Conside derr thes these e comm common on type types s of risk risk and and eval evaluat uate e them them agai agains nstt potential rewards when you select an investment.
32
Market Risk
At times the prices or yields of all the securities in a particular market rise or fall due to broad outside influences. When this happens, the stock prices of both, an outstanding, highly profitable company and a fledgling corporation may be affected. This change in price is due to "market risk.” Inflation Risk
Some Someti time mes s refe referr rred ed to as "loss "loss of purc purchas hasin ing g powe power. r."" Wh When enev ever er inflation sprints forward faster than the earnings on your investment, you run the risk that you'll actually be able to buy less, not more. Inflation risk also occurs when prices rise faster than your returns. Credit Risk
In short, how stable is the company or entity to which you lend your money when you invest? How certain are you that it will be able to pay the the inte intere rest st you you are prom promis ised ed,, or repa repay y your your prin princi cipal pal wh when en the the investment matures? Interest Rate Risk
Changing interest rates affect both equities and bonds in many ways. Investors are reminded that "predicting" which way rates will go is rarely successful. A diversified portfolio can help in offsetting these changes. Effe Effect ct of loss loss of key key prof profes essi sion onal als s and and inab inabil ilit ity y to adap adaptt business to the rapid technological change
An industries' key asset is often the personnel who run the business i.e. i.e. intell intellect ectual ual proper propertie ties s of the key emplo employee yees s of the respec respectiv tive e companies. Given the ever-changing complexion of few industries and the high high obsole obsolesce scence nce levels levels,, availa availabil bility ity of qualif qualified ied,, traine trained d and motivated personnel is very critical for the success of industries in few 33
sectors. It is, therefore, necessary to attract key personnel and also to retain them to meet the changing environment and challenges the sector offers. Failure or inability to attract/retain such qualified key personnel may impact the prospects of the companies in the particular sector in which the fund invests. Exchange Risks
A number of companies generate revenues in foreign currencies and may may have have inve invest stme ment nts s or expe expens nses es also also deno denomi mina nate ted d in fore foreig ign n currencies. Changes in exchange rates may, therefore, have a positive or negative impact on companies which in turn would have an effect on the investment of the fund. Investment Risks
The The sector sectoral al fund fund schem schemes, es, invest investme ments nts will will be predom predomina inantl ntly y in equities of select companies in the particular sectors. Accordingly, the NAV of the schemes are linked to the equity performance of such companies companies and may be more volatile volatile than a more diversified diversified portfolio portfolio of equities. Changes in the Government Policy
Changes in Government policy especially in regard to the tax benefits may impact the business prospects of the companies leading to an impact on the investments made by the fund. Measuring Risks:
34
Risk Measure Implication sensitive High average More maturity
and interest rate changes
modified duration Low average Less maturity
Impact On Investor to Higher volati atility in
sensitive
returns
to Lower
and interest rate changes
volatility
in
returns
modified duration Grea Gr eate terr allo alloca cati tion on Low risk default
Lower yield with lower
to high credit rated
risk
instruments Grea Gr eate terr allo alloca cati tion on Highe igherr risk risk of defa defaul ultt
Higher gher yie yield but but with
to
greater risk
low
rated
instruments
Wealth Management Wealth Management Management is a type of financial planning that provides
high net worth individuals and families with private banking, banking, estate planning, planning, legal resources, resources, and investment management, management, with the goal of sust sustai aini ning ng and and grow growin ing g long long-t -ter erm m weal wealth th.. Wh Wher erea eas s fina financ ncia iall planning can be helpful for individuals who have accumulated wealth or are are just just start startin ing g to accu accumu mula late te weal wealth th,, you you must must alre alread ady y have have 35
acc accumulated
a
significant ant
amount
of
wealth
for
t he
wealt alth
management process to be effective. Services typically include: •
Portfolio Management and Portfolio Rebalancing
•
Investment Management and Strategies
•
Trust and Estate Management
•
Private Banking and Financing
•
•
Tax Advice Family Office Structures
Portfolio Management PORTFOLIO: A Portfolio is a diversified professionally managed basket of securities. A healthy investment portfolio has the following features: •
The right mix of assets and liabilities
•
Regular monitoring
•
Rebalancing portfolio when the asset mix gets skewed
•
Optimum returns in a reasonable time period
As per defini definitio tion n of SEBI SEBI Portfo Portfolio lio means means "a collec collectio tion n of securi securitie ties s owned by an investor”. It represents the total holdings of securities belonging to any person". Obviously Portfolio Management refers to the management or administration of a portfolio of securities to protect and enhance the value of the underlying investment. SEBI has directed that portfolio management as a service by a financial intermediary is to be carried out only by corporate entities. Portfolio management by a corp corpor orat ate e body body can can be eith either er for for mana manage geme ment nt of its its own own pool pool of securities created out funds collected from diverse sources or it can be offered as a financial service to other investors, who choose to avail the the expe expert rtiise and and ski skill of thi this comp compan any y to carry arry out out port portfo follio investment/management on their behalf. Insurance companies, mutual
36
fund funds, s, pens pensio ion n and and prov provid iden entt fund funds s etc. etc. carr carry y out out oper operat atio ions ns of portfolio management for investing their own funds in remunerative channels. These companies are also referred as investment companies or institutional investors. In fact they are portfolio managers in respect of the back-end of their business activities. After initially pooling these funds from smaller investors, they choose to invest them in a portfolio of securities intended as a lucrative deployment option.
Portfolio Management The goal of Portfolio Management assemble various securities securities Management is to assemble and other assets into portfolios that address investor needs and then to manage these portfolios so as to achieve investment objectives. The investor’s needs are defined in terms of risk, and the portfolio manager maximizes return for investment risk undertaken. Port Portfo foli lio o Mana Manage geme ment nt cons consis ists ts of thre three e majo majorr acti activi viti ties es:: 1) Asse Assett Allocation, 2) Shifts in weighting across major assets classes, and 3) Security selection within asset classes. Asset allocation can best be characterized as the blending together of major asset classes to obtain the highest long-run return at the lowest risk. Managers can make opportunistic shifts in asset class weightings in order to improve return prospects over the longest-term objective. RISK RETURN TRADE OFF
In select selecting ing asset asset classe classes s for portfo portfolio lio alloca allocatio tion, n, invest investors ors need need to consider consider both the return potential potential and the riskiness riskiness of the asset class. It is clear from empirical estimates that there is a high correlation betw betwee een n risk risk and and retu return rn meas measur ured ed over over long longer er peri period ods s of time time.. Furt Furthe herm rmor ore e capi capita tall marke markett theo theory ry,, posi posits ts that that ther there e shoul should d be a systematic systematic relationship relationship between risk and return. return. This theory indicates indicates that that secu securi riti ties es are priced priced in the the marke markett so that that high high risk risk can can be rewa reward rded ed with with high high retu return rn,, and and conv conver erse sely ly,, low low risk risk shou should ld be accom accompan panie ied d by corr corres espo pond ndin ingl gly y lowe lowerr
retu return rn..
37
Expected Return
Capital Marke ket Lin ine
Corporate Bonds
Real Estate
In the the abov above e figu figure re a capi capita tall mark market et line line show showin ing g an expe expect cted ed relationship between risk and return for representative asset classes arrayed over a range of risk. Note that the line is upward-sloping, indicating that higher risk should be accompanied by higher return. Conv Conver erse sely ly,, the the capi capita tall mark market et rela relati tion onshi ship p can can be consi conside dere red d as showing that higher return can be generated only at the “expense” of higher risk. When measured over longer periods of time, the realized return and risk of the asset classes conform to this sort of relationship. Note that treasury bills are positioned at the low end of the risk range, cons consis iste tent nt with with thes these e secu securi riti ties es’’ gene general rally ly bein being g cons consid ider ered ed as representative of risk-free investing, at least for short holding periods. Correspondingly, the return offered by T-bills is usually considered as a basi basic c riskrisk-re retu turn rn.. On the the othe otherr hand hand,, equi equiti ties es as a class class show show the the high highes estt risk risk and retu return rn,, with with vent ventur ure e capi capita tall at the the very very high highes estt position on the line, as would be expected. International equities, in turn, are shown as higher risk than domestic equities. Bonds and real estate are at an intermediate position on the capital market line, with
38
Dome Equiti
real real esta estate te show showin ing g high higher er risk risk rela relati tive ve to both both corp corpor orat ate e and and government bonds. Types of portfolio based on Risk and Return
Whenever the money is invested a risk of not getting the money back is borne by the investor. An investor wants a compensation for bearing such a risk risk also known known as returns. In theory “the higher is the risk the greater are the returns ” and vice versa. The chart below can explain
the different types of securities and their associated risk.
Located towards the right of the diagram are ar e investments that offer investors a higher potential for above-average returns, but this potential comes with a higher risk. Towards the left are much safer investments, but these investments having a lower potential for high returns. Conservative Portfolio
This model is ideal for those who wish to take least amount of risk and want a steady income over a period of time from his investments. Conservative portfolio is designed by investing greater proportion in the lower risk securities. Such a portfolio always tends to generate income for the investor. Such a model aims at protecting the principal value of the portfolio. Hence the investment is generally done in fixed income and money market securities. Very less amount of the capital
39
is invested in the equities. The model is often known as the ‘capital preservation portfolio’.
Moderately Conservative Portfolio
A moderately conservative portfolio is ideal for those who want a fixed and steady income as well as capital appreciation. appreciation. This model not only offe offers rs a fixe fixed d inco income me but but also also grow grows s the the mone money y of the the inve invest stor or.. Alth Althou ough gh maxim aximum um amou amount nt of allo alloca cati tion on is done done in lowe lowerr risk risk securities, investment is also made in equities to some extent so that the capital grow Source: Investopedia.c Investopedia.com om
Source: Investopedia.c Investopedia.com om
40
Moderately Aggressive Portfolio
A moderately aggressive portfolio is ideal for those who want a balance of growth and income. The asset composition is divided among a mong equity and fixed income securities. Maximum amount of investment is made in the equities. Assets allocated to the fixed income securities is also no less. Such a model is often referred r eferred to as “balance portfolio”
Source: Investopedia.c Investopedia.com om
Aggressive portfolios mainly consist of equities. So the value tends to fluctuate. Such a portfolio provides long term appreciation to the capital. But to have some liquidity fixed income securities are also added to the portfolio. It is always better to invest in such a portfolio portfolio for a longer period of time so that the money gets sufficient time to grow. Such a portfolio is risky.
41
Source: Investopedia Investopedia.com .com
42
Very Aggressive Portfolio
A very aggressive portfolio is one which consist mostly of equities. The portfolio is suitable for those who have hav e risk taking ability. Since the investment is done in equities hence it provides a growth to the capital. The portfolio is designed for those who can invest for a longer time period.
Source: Investopedia. Investopedia.com com
Investment Risk Pyramid
Once the risk acceptable in the portfolio has been decided by acknowledging the time horizon and bankroll one can use the risk pyramid approach for balancing the assets.
43
Source: Investopedia. Investopedia.com com
This pyramid can be thought of as an asset allocation tool that investors can use to diversify their portfolio investments according to the risk profile of each security. The pyramid, pyr amid, representing the investor's portfolio, has three distinct tiers: •
Base of the pyramid: this area is comprised of investments that are low in risk and have good returns.
•
Middle portion: this area is made of medium risk investments that not only offers stable returns but also allows capital appreciation.
•
Summit (top): the summit is for high risk investments. This is the area of the pyramid and should be made up of money one can afford to lose.
Portfolio Management Process of Portfolio Management Following is the process of portfolio management: 1. Understanding the present market conditions 2. Framing of an Investment Policy This involves mainly the following two parts: 44
Investment Objectives of an investor Investment Constraints of an investor 3. Portfolio Policies and Strategies 4. Asset Allocation Process 5. Security Selection 6. Portfolio Construction 7. Portfolio Implementation and Execution 8. Portfolio Analysis 9. Portfolio Rebalancing and Revision After you've built your portfolio of mutual funds, you need to know how to maintain it. Four common strategies can be followed for the same:
o
The "Wing-It" Strategy
Thi This s is the the most most comm common on mutu mutual al-f -fun und d stra strate tegy gy.. Basi Basica call lly, y, if your your portfolio does not have a plan or a structure, then it is likely that you are employing a wing-it strategy. If you are adding money to your portfolio today, how do you decide what to invest in? Are you one that searches for a new investment because you do not like the ones you already have? A little of this and a little of that? If you already have a plan or structure, then adding money to the portfolio should be really easy. Most experts would agree that this strategy will have the least success because there is little to no consistency. o
Market-Timing Strategy
The market timing strategy implies the ability to get into and out of sectors or assets or markets at the right time. The ability to market time means that you will forever buy low and sell high. Unfortunately few few inve invest stor ors s buy buy low low and and sell sell high high beca becaus use e inve investo storr beha behavi vior or is usua usuall lly y driv driven en by emot emotio ions ns inst instea ead d of logi logic. c. The The real realit ity y is most most investors tend to do exactly the opposite – buy high and sell low. This
45
leads many to believe that market timing does not work in practice. No one can accurately predict the future with any consistency. o
Buy-an -and-Hold
Strategy
This is by far the most commonly preached investment strategy. The reason for this is that statistical probabilities are on your side. Markets generally go up 75% of the time and down 25% of the time. If you employ a buy-and-hold strategy and weather through the ups and downs of the market, you will make money 75% of the time. If you are to be more successful with other strategies to manage your portfolio, you must be right more than 75% of the time to be ahead. The other issue that makes this strategy most popular is it is easy to employ. This does not make it better or worse. It is just easy to buy and a nd hold.
o
Performance-Weighting Strategy
This is somewhat of a middle ground between market timing and buy and hold. With this strategy, you will revisit your portfolio mix from time time to time time and and make make some some adju adjust stme ment nts. s. Let' Let's s walk walk thro throug ugh h an oversimplified example using real performance figures. Let's say that at the end of 2007, you started with an equity portfolio of four mutual funds and split the portfolio into equal weightings of 25% each.
Fund
Allocation(Rs)
Allocation (%)
Fund A
25000
25
Fund B
25000
25
Fund C
25000
25
Fund D
25000
25
100000
100 46
After the first year of investing, the portfolio is no longer an equal 25% weighting because some funds performed better than others.
•
Fund
•
1-yr return
•
End balance(Rs)
•
Allocation (%)
•
Fund A
•
13.60%
•
28000
•
26.28
•
Fund B
•
6.80%
•
26700
•
24.71
•
Fund C
•
8.50%
•
27125
•
25.10
•
Fund D
•
3.40%
•
25850
•
23.92
•
108075
•
100
•
•
The reality is that after the first year, most investors are inclined to dump the loser (Fund D) for more of the winner (Fund A). However, the righ rightt stra strate tegy gy is to do the oppo opposi site te to prac practi tice ce sell sell high high,, buy buy low. Performance weighting simply means that you sell some of the funds that did the best to buy some of the funds that did the worst. Your heart will go against this logic but it is the right thing to do because the one constant in investing is that everything goes in cycles. In year four, Fund A has become the loser and Fund D has become the winner.
•
Fund
•
1-yr return
•
Fund A
•
-16.00%
•
Fund B
•
22.30%
•
Fund C
•
9.60%
•
Fund D
•
15.20%
47
Performance weighting this portfolio year after year means that you would have taken the profit when Fund A was doing well to buy Fund D when it was down. In fact, if you had re-balanced this portfolio at the end of every year for five years, you would be further ahead as a result of performance weighting. The The key to port portfo foli lio o mana manage geme ment nt is to have have a disc discip ipli line ne that that you you adhere adhere to. The most most succes successful sful money money manager managers s in the world world are successful successful because they have a disciplin discipline e to manage money and they they have a plan. Warren Buffet said it best: "To invest successfully over a life lifeti time me does does not not requ requir ire e a stra strato tosp sphe heri ric c I.Q. I.Q.,, unus unusua ual l busine business ss insigh insightt or inside inside inform informati ation. on. What What is needed needed is a sound sound intel intellec lectua tuall framew framework ork for making making decisi decisions ons and the ability to keep emotions from corroding that framework."
What drives portfolio performance? According to Mahindra Finance team of wealth management, the most important step in wealth management is asset allocation. But the least time is spent on this investment decision. This step affects almost 92% of the returns expected from any portfolio.
48
49
Complex Copounds The crisil crisil comple complexit xity y classi classific ficati ation on denote denotes s how easy easy it is for an invest investor or to understand the risks associated with different products.
PRODUCT Debt
SIMPLE
COMPLEX
Funds
funds,Fixed
HIGHLY COMPLEX
Gilt, Gilt, Liquid Liquid,, Debt Maturity Plan Plans, s, Funds, ds,
Inte Interv rval al Monthly
Income Funds
Mutual
Capi apital tal
prot protec ectted Capita Capitall protec protected ted fundsfunds-
Funds-
funds-s funds-stat tatic ic
Structure
arbitrage funds
hedge, hedge, Leveraged, constant,proportion portfolio
d
insurance,dynamic
Mutual
Plain
Derivative
Funds-
equity,sector
funds,fund
Eqit Eqity y and and based Others
Equity Shares Equity
of
funds,international,
balanced,gold,etf’ s,index
portfolio insurance Art funds
special
situation
linked funds
funds Exchange-traded equity shares Buyi Buying ng
inde index/ x/st stoc ock k Selling
options
Derivative
index/stock
options(short positions) (long
s
options),index/stock future futures(b s(buyi uying ng
and
selling) Commodity futures
Commodit y Derivative s Others
PPF,NSC/Kisan
Unit-linked
Rea Real
Vikas
insurance plans
trusts
Patra,Recuring deposit
esta estate te
inve invest stme ment nt 50
Dummy portfolio Here I have taken two portfolios- 1) only scripts
2) scripts and
mutual funds
This dummy portfolio will enable us to understand how the portfolio is managed managed through through mutual funds. funds. In the first first portfolio portfolio I have taken taken a total amount of approx Rs 100000 invested in 5 securities covering 5 diff differ eren entt sect sector ors s so as to tast taste e the the flavo flavorr of dive diversi rsifi fica cati tion on.. The The portfolio has taken the exposure of 100% equity with a blend of growth and large as its style. style. The companies companies taken into the portfolio portfolio contains contains topost companies in its sector like ITC, Bharti Airtel, ONGC,Parsvnath and ICICI bank. The time duration of 1 year has been taken so as to taste the long term results. But the overall results as of 1st juiy, 2008 stands negative. The portfolio gives a loss of Rs 1643.70. The detailed analysis of the
portfolio can be well understood with the tables mentioned below.
51
52
The second portfolio contains a blend of securities and mutual funds so as to manage the portfolio in an efficient manner.
Here to get a feel of diversification I have taken 5 scripts which are common as in the first portfolio but this time with a little changes in the amount. This time I have taken a total amount of Rs 100000 with Rs 50000 in scripts and Rs 50000 in mutual funds which are again not
concentrated. In the mutual funds I have taken gold ETFs , balanced fund fund,, inde index x fund fund and and oppo opportu rtuni niti ties es fund fund.. The The reas reason on bein being g as the the portfolio has already taken the exposure of 100% equity in the scripts. The There refo fore re to bang bang upon upon the the dive diversi rsifi fica cati tion on I have have take taken n diff differ eren entt mutual fund schemes. The result has been astonishing with approx 1 year as the time duration and a net profit profit on the whole portfolio standing at Rs 14513. The analysis can be observed with the charts provid provided ed below. below. This This portfol portfolio io explor explores es the experi experienc ence e of portfo portfolio lio
53
diversification with an asset allocation in equity and a little in debts and others. It also gets an exposure of mid cap and small cap.
54
Finally to summarise and come to a conclusion we can for sure observe and deduce that portfilo can really be managed through mutual funds. A number of permutation and combination can be applied to design a model portfolio containing mutual funds. I have just arrived at one portfolio which if present has really done wonders.
55
Different AMC’s in India The Mutual Fund Industry in India has grown steadily over the last couple of years and is today managing assets in excess of Rs 5,50,000 crore crore meeti meeting ng differ different ent invest investmen mentt needs needs of milli millions ons of retail retail and institutional clients across debt, equity and hybrid asset class.
56
Incorpo Owners As on 31st march rated 2008 ABN
hip
Forei
Domest
gn-
ic -
Sponsor
On AMRO
Mutual Fund
ABN 27/5/20 04
AMRO
Asset
Management Private
75%,
25%
(Asia)
Ltd.
Benchmark Mutual Fund Birla
Niche _
Private
23/12/1
Foreign
100%
994
Investme Investments nts Inc., Inc., Birla Birla
JV
50%,
30/10/1
992 Canbank Canbank Mutual Mutual 15/12/1
Public
0%,
Fund DBS
Public
0%, 100% 37.48
987 Chola 3/1/199
Mutual Fund
7
Private
%,
Deutsche Mutual 28/10/2 Fund
002
DSP
Merrill
Lynch
Mutual 16/12/1
Fund Esco Escort rts s
996 Mutu Mutual al 15/4/19
Fund Fide Fideli lity ty
96 Mutu Mutual al 17/2/20
Fund
100%
Bank of Baroda Canara Bank Chol Cholam aman anda dala lam m
62.52%
100% Private
,
0%
Management
(Asia)
00
40%,
Escorts Finance Ltd Fidelity Internal
0%
JV
75%, 0%,
Investment Advisors Fran Frankl kliin Resourc ource es, 25Inc. %
100%
Mutual 7/2/200 2
Pvt. Pvt.
60Pvt. % Ltd.
0%, 100% 100%
Private , Foreign
Private
Inve Invest stme ment nt
Ltd., ADIKO Investment Investment
JV
96 Mutual 30/6/20
Fund
Asset
Limited DSP Merri Merrill ll Lync Lynch h Ltd, Ltd,
Foreign
Private
DBS DBS
Finance Ltd. Deutsche
HMK HMK
05 19/2/19
Fund HSBC
50Global % Finance Ltd
Mutual
Fund
Franklin HDFC
Services Private Ltd Sun Sun Life (Indi India) a) AM AMC C
Mutual
Fund BOB
0%,
Financial
HDF Corporation Ltd HSBC Securi urities ies and Capital Markets (India)
Private
--
100%
Private Limited Natio Nationa nall Nede Nederla rland nden en Inte Interf rfin inan ance ce
B.V B.V
(ING (ING
Group),ING Vysya Bank 57
11/2/19 ING Mutual Fund
99
Foreign JV
85.68 %,
Ltd., Kirti Equities Pvt. 14.32%
Ltd.(Mehta
Fund House
Top 5 Fund Houses No. of top Total rated
Reliance
rated funds 10
funds 17
Mutual Fund ICICI
21
38
14
30
Fund Birla Birla Sunlife Sunlife 18
39
Mutual Fund HSBC Mutual
13
Prudential Mutual Fund Tata Tata Mutua Mutuall
6
fund Source: Value Research
58
Fund Analysis Parameters
59
Top Q (Amo Secon (Amo Third (Amo
Valuati
Growth Ble Blend
00 00 00 00 00 00 00 00 00 60
REFERENCES:
61
I.
http://en.wikipedia.org/wiki/Mutual_fund
II.
http://finance.indiamart.com/markets/mutual_funds/
III.
http://www.moneycontrol.com/mutualfundindia
IV.
http://www.mutualfundsindia.com/icra_m_power_institutional.asp #q3
V.
http://www.amfiindi.com/navhistoryreport.asp
VI.
www.nseindia.com
VII.
www.bseindia.com
VIII.
http://www56.homepage.villanova.edu/david.nawrocki/briefhistor yofdownsiderisknawrocki.pdf
IX.
www.businessweek.com/investing/insights/blog/archives/2007/10 /new_research_co.html
X.
www.unf.edu/~oschnuse/draft7.pdf
XI.
www.sebigov.in
XII.
www.kotaksecurities.com
XIII.
http://www.moneycontrol.com/indiamutualfunds/mfinfo/14/51/sn apshot/imdesc/UTI%20Leadership%20Equity%20Fund %20(G)/fdec/UTI%20Asset%20Mgmt%20Company%20Pvt. %20Ltd./imid/MUT096/imffid/UT
XIV.
www.valueresearchonline.com
XV.
www.waytowealth.com
XVI.
www.eurekasecurities.comm
XVII.
www.myrisis.com
XVIII.
www.geojit.com
XIX.
www.capitalmarket.com
XX.. XX
Inve Investo stors rs Gui Guide de to Mu Mutu tual al Fund Fundss- Janua January ry 2008 2008
XXI. XX I.
Busi Bu sine ness ss Toda Today( y(Ju July ly2, 2,20 2006 06 edi editi tion on))
62
XXII XX II..
Busi Bu sine ness ss Worl World( d( Marc March3 h3,, 2008 2008 edit editio ion) n)
XXIII.
Value research
XXIV.
Economic ti times
XXV.
& Factsheet of Different AMC’s.
63
