Mutual Fund

An In-Depth Study of Mutual Fund Industry In India

Chapter 1

Introduction to Mutual Fund

1.0 Introduction 1.1 Advantage of Mutual Fund 1.2 Drawbacks of Mutual Fund 1.3 Defining Mutual Fund Risk 1.4 Safety of Mutual Fund 1.5 Types and process of Mutual Fund 1.6 Styles of Mutual Fund 1.7 Process of Mutual Fund 1.8 Net Asset Value (NAV) 1.9 Eligibility For Investing in Mutual Fund In India

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1.0 Introduction A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested by the fund manager in different types of securities depending upon the objective of the scheme. These could range from shares to debentures to money market instruments. The income earned through these investments and the capital appreciat ion realized by the scheme is shared by its unit holders in proportion to the number of units owned by them (pro rata). 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 portfolio at a relatively low cost. Anybody with an inventible surplus of as as a few thousand objective rupees can invest in Mutual Funds. Each Mutual Fund scheme haslittle a defined investment and strategy. A Mutual Fund is the ideal investment vehicle for today’s complex and modern financial scenario. Markets for equity shares, bonds and other fixed income instruments, real estate, derivatives and other assets have become mature and information driven. Price changes in these assets are driven by global events occurring in faraway places. A typical individual is unlikely to have the knowledge, skills, inclination and time to keep track of events, understand their implications and act speedily. An individual also finds it difficult to keep track of ownership of his assets, investments, brokerage dues and bank transactions etc. A Mutual Fund is the answer to all these situatio ns. It appoints professionally qualified and experienced staff that manages each of these functions on a full time basis. The large pool of money collected in the fund allows it to hire such staff at a very low cost to each investor. In effect, the Mutual Fund vehicle exploits economies of scale in all three areas - research, investments and transaction processing. While the concept of individuals coming together to invest money collectively is not new, the Mutual Fund in its present form is a 20th century phenomenon. In fact, Mutual Funds gained popularity only after the Second World War. Globally, there are thousands of firms offering tens of thousands of Mutual Funds with different investment objectives. Today, Mutual Funds collectively manage almost as much as or more money as compared to banks. A draft offer document is to be prepared at the time of launching the fund. Typically, it pre specifies the investment objectives of the fund, the risk associated, the costs involved in the process and the broad rules for entry into and exit from the fund and other areas of operation. In India, as in most countries, these sponsors need approval from a regulator, SEBI (Securities exchange Board of India) in our case. SEBI looks at track records of the sponsor and its financial strength. A sponsor then hires an asset management company to invest the funds according to the investment objective. It also hires another entity to be the custodian of the assets of the fund and perhaps a third one to handle registry work for the unit holders (subscribers) of the fund. In the Indian context, the sponsors promote the Asset Management Company also, in which it holds a majority stake. In many cases a sponsor can hold a 100% stake in the Asset Management Company (AMC). E.g. Birla Global Finance is the sponsor of the Birla Sun Life Asset Management Company Ltd., which has floated different Mutual Funds schemes and also acts as an asset manager for the funds collected under the schemes. LJIMS

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1.1 Advantages of Mutual Fund Mutual Funds serve as a link between the saving public and the capital markets. They mobilize savings from the investors and bring them to borrowers in the capital markets. Today Mutual Funds are fast emerging as the favorite investment vehicle because of the many advantages they have over other forms and avenues of investing. The major advantages offered by Mutual Funds to all investors are: 

Professional Management

Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme. 

Diversification

Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. 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 paperwork and helps you avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient. 

Return Potential

Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities. 

Low Cost

Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors. 

Liquidity

In open-end schemes, the investor gets the money back promptly at net asset value related prices from the Mutual Fund. In closed-end schemes, the units can be sold on a stock exchange at the prevailing market price or the investor can avail of the facility of direct repurchase at NAV related prices by the Mutual Fund. LJIMS

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Transparency

You get regular information on the value of your inves tment in addition to disclosure on the specific investments made by your scheme , the proportion invested in each class of assets and the fund manager's investment strategy and outlook. 

Flexibility

Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience. 

Affordability

Investors individually may lack sufficient funds to invest in high-grade stock. A Mutual Fund because of its large corpus allo ws even a small investor to take the benefit of its investment strategy. 

Choice of schemes

Mutual Funds offer a family of schemes to suit your varying needs over a lifetime. 

Well Regulated

All Mutual Funds are registered with SEBI and they function within the provision of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.

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1.2 Drawbacks of Investing In Mutual Fund

Drawbacks of investing in Mutual Funds are given below: 

Potential loss

Unlike a bank deposit, the investment in a Mutual Fund could fall in value, as the fund is nothing but a portfolio of different securities. Apart from a few assured returns schemes, the fund does not guarantee any minimum percentage of return. 

The Diversification Penalty

While diversification reduces the risk of loss from holding a single security, it also limits the larger gains if a single security increases dramatically in value. Also, diversification does not protect the unit holders totally from an overall decline in the market. 

Risks and Costs

Changing market conditions can create fluctuations in the value of a Mutual Fund investment. There are fees and expenses associated with investing in Mutual Funds that do not usually occur when purchasing individual securities directly. As with any type of investment, there are drawbacks associated with Mutual Funds. 

No Guarantees

The value of your Mutual Fund investment, unlike a bank deposit, could fall and be worth less than the principle initially invested. And, while a money market fund seeks a stable share price, its yield fluctuates, unlike a certificate of deposit. In addition, Mutual Funds are not insured or guaranteed by an agency of the U.S. government. Bond funds, unlike purchasing a bond directly, will not re-pay the principle at a set point in time. 

Costs

In some cases, the efficiencies of fund ownership are offset by a combination of sales commissions, 12b-1 fees, redemption fees, and operating expenses. If the fund is purchased in a taxable account, taxes may have to be paid on capital gains. Keep track of the cost basis of your initial purchase and new shares that are acquired by reinvesting distributions. It's important to compare the costs of funds you are considering. Always look at "net" returns when comparing fund performances. Net return is the bottom line; an investment's true return after all costs is deducted.

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Prospectuses will not contain all the costs that affect the net return on your investment. This is why it is importa nt to compare net returns whe ther or not the fund in a no-load or load fund. 

Expenses

Because Mutual Funds are professionally managed investments, there are management fees and operating expenses associat ed with investing in a fund. These fees and expenses charged by the fund are passed onto shareholders and deducted from the fund's return. These expenses are typically expressed as the expense ratio - the percent of fund assets spent (annually) on day-to-day operations. Expense ratios can vary widely among funds. Expense ratios for Mutual Funds commonly range from 0.2% to 2.0%, depending on the fund. Consult the fund's prospectus to determine the expense ratio for a specific fund.

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1.3 Defining Mutual Fund Risk

Different Mutual Fund categories as previously defined have inherently different risk characteristics and should not be compared side by side. A bond fund with below-average risk, for example, should not be compared to a stock fund with below average risk. Even though both funds have low risk for their respective categories, stock funds overall have a higher risk/return potential than bond funds. Of all the asset classes, cash investments (i.e. money markets) offer the greatest price stability but have yielded the lowest long-term returns. Bonds typically experience more short-term price swings, and in turn have generated higher long-term returns. However, stocks historically have been subject to the greatest short-term price fluctuations—and have provi ded the highest long-term retur ns. Investors looki ng for a fund which incorporates all asset classes may consi der a balanced or hybrid Mutual Fund. These funds can be very conservative or very aggressive. Asset allocation portfolios are Mutual Funds that invest in other Mutual Funds with different asset classes. At the discretion of the manager(s), securities are bought, sold, and shifted between funds with different asset classes according to market conditions. Mutual Funds face risks based on the investments they hold. For example, a bond fund faces interest rate risk and income risk. Bond values are invers ely related to interest rates. If interest rates go up, bond values will go down and vice versa. Bond income is also affected by the change in interest rate s. Bond yields are direc tly related to interest rates falling as interest rates fall and risin g as interest ris e. Income risk is greater for a short-term bond fund than for a long-term bond fund. Similarly, a sector stock fund (which invests in a single industry, such as telecommunications) is at risk that its price will decline due to developments in its industry. A stock fund that invests across many industries is more sheltered from this risk defined as industry risk. Following is a glossary of some risks to consider when investing in Mutual Funds: •

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Call Risk: The possibility that falling interest rates will cause a bond issuer to redeem —or call—its high-yielding bond before the bond's maturity date. Country Risk: The possibility that political events (a war, national elections), financial problems (rising inflation, government default) , or natural disasters (an earthquake, a poor harvest) will weaken a country's economy and cause investments in that country to decline. Credit Risk: The possibility that a bond issuer will fail to repay interest and principal in a timely manner. Also called default risk. Currency Risk: The possibility that returns could be reduced for Americans investing in foreign securities because of a rise in the value of the U.S. dollar against foreign currencies. Also called exchange-rate risk. Income Risk: The possibility that a fixed-income fund's dividends will decline as a result of falling overall interest rates.

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An In-Depth Study of Mutual Fund Industry In India •

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Industry Risk: The possibility that a group of stocks in a single industry will decline in price due to developments in that industry. Inflation Risk: The possibility that increases in the cost of living will reduce or eliminate a fund's real inflation-adjusted returns. Interest Rate Risk: The possibility that a bond fund will decline in value because of an increase in interest rates. Manager Risk: The possibility that an actively managed Mutual Fund's investm ent adviser will fail to execute the fund's investment strategy effectively resulting in the failure of stated objectives. Market Risk: The possibility that stock fund or bond fund prices overall will decline over short or even extended periods. Stock and bond markets tend to move in cycles, with periods when prices rise and other periods when prices fall. Principal Risk: The possibility that an investment will go down in value, or "lose money," from the srcinal or invested amount.

1.3.1 Risk Factor Associated With Income Mutual Funds Income funds invest in a diversified portfolio of debt instruments, which provide interest income. There is a possibility that some of these instruments are of low credit quality and the issuers of these instruments default in the payment of interest or principal. Such losses, called "credit losses", constitute an area of risk for income funds. The process of diversification mitigates this risk i.e. by the fund investing in a number of debt instruments. However, it should be noted that the funds returns could be eroded considerably if even 10% of the investments have credit quality problems. Also, the problem can be accentuated for investors who are investing for a short period if the losses show up in a particular period resulting in a short term decline in NAV. Investors can check the credit quality of the investment portfolio, which is published by most funds on a quarterly basis. The second area of risks comes from the fluctuations in the prices of the underlying instruments in which the fund invests. Any rise in interest rates will result in a fall in the value of the investments causing a dip in the NAV. The fall in value is maximum for longer dated instruments and negligible for short dated instruments. Hence, the risk is higher in a fund that has an investment portfolio with a higher average maturity. This can again be checked from the investment portfolio, which is published by the funds. Even if interest rates rise by 2-3%, the fall in NAV for most Mutual Funds is unlikely to exceed 5%. Similarly, a portfolio with as high as 10% of poor quality instruments will result in a fall in NAV by 10%. Regular interest income will take care of the losses in a few months. Thus, there is unlikely to be permanent erosion of capital in most reasonable circumstances. Hence, debt or income funds have a much lower risk than equity funds, which can have permanent erosion in value. Today’s environment is characterized by a deep industrial recession and consequent high level of defaults on loans provided by banking sector to industry. In such a scenario, it LJIMS

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may be prudent to look at the credit quality aspect very carefully before investing in an income Mutual Fund.

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1.3.2 Risk Management associated with Mutual Funds The basic objective of a Mutual Fund is to provide a diversified portfolio so as to reduce the risk in investments at a lower cost. The Mutual Fund industry worldwide is based on this premise. Investors who take up Mutual Fund route for investments believe that their risk is minimized at lower costs, and they get an optimum portfolio of securities that match their risk appetite. They are ignorant about the diverse techniques and hedging products that can be used for minimizing the market volatility and hence take the help of the fund managers. It is very daunting to note that the drop in the NAV of some of the schemes is higher than the erosion of value in some of the ICE stocks. The recent survey conducted by PricewaterhouseCoopers (PWC) on risk management by Mutual Funds has posted interesting as well as worrying results. According to the survey, as many as 50 percent of the respondent Mutual Funds are not managing risk properly. If this is not all, 50 percent of the respondents did not even have documented risk procedures or dedicated risk managers. The respondents included among others, some of the heavyweights of the Indian MF industry viz. Templeton, Alliance, Prudential and IDBI Principal MF. Worrisome news it is, for the investor who still believes MFs are a route to manage one’s money in a better and safe manner. The recent wild movements in the NAVs of several equity funds have belied all expectation of a diversified portfolio from the fund managers when the basic tenet behind portfolio management is risk management. Mr. Shyam Bhat, Fund Manager-Tata asset Management Ltd. said ‘Indian Mutual Fund industry is not using statistical techniques of risk management but is using diversification effectively within the market limitations. As far as use of derivatives is concerned, they are not presently used because of the low volumes, low liquidity and absence of sufficient hedging products in the market ’. Aggression has been the key word followed by the AMCs when it comes to taking positions in stocks. With investment in volatile ICE sectors being the driver of growth last season, almost everybody had taken big exposures to them. Birla MF maintained its exposures in Infosys to almost 25 percent in all of its equity schemes throughout last year. The same is true of ING Savings Trust that has Rs. 60 crores invested in Wipro and Infosys out of the total fund size of 135 crores in its growth fund. The result of these exposures is that the fund witnessed a movement of almost 9 percent in a single day on budget when the market saw an appreciation of around 4.36 percent. In their quest for growth, many funds have seen very volatile movements in NAVs. The investor confidence may not be lost but such volatility sure dents it. The point is not whether AMCs should be chastised or not but just to question the practices as the fate of many investors is linked to it. An ordinary investor considers Mutual Funds as the experts in investment decisions and so naturally expects the decision of investing in Mutual Funds to bear fruit. However, AMCs often leave a lot to be desired as they falter on important fronts like NAV and portfolio disclosure besides posting high fluctuations and poor returns. The Beta of some of the favorite stocks is shown below. The Table contains the Beta of some of the ICE scrips that constitute the top 10 holdings across various equity funds. As can be seen, some of the stocks are too volatile and can cause wild movements in the NAVs of funds that have taken exposures in them. The standard deviation of the returns LJIMS

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in some of these funds points to it. While Alliance Equity Fund has a Standard Deviation of 2.53, Birla Advantage has its Standard Deviation at 2.57. ING Growth has a standard deviation of 3.3, which is relatively high due to its exposure to two volatile ICE scrip. Birla Advantage has reduced its exposures to Infosys drastically in the last two months and taken steps to contain volatility. Similar steps are being planned by SBI Mutual Fund that is recasting its equity portfolio to reduce risks as they can scare investors. It is unfortunate that the fund managers are not taking due care for minimizing the risk and are in a race to post higher and higher returns during the phase of bull-run. They should understand that the investors forget the high returns posted in any specific period very soon but they take hell lot of time to forget the burns they get during periods of losses. Hence for maintaining the confidence of the retail investors it is very important to control wild fluctuations in the NAVs. The basic technique of portfolio management thrusts on diversification, which preaches inclusion of negative beta, stocks in the portfolio so as to minimize the impact of fluctuation in the market. Diversification always has a cost and investors are willing to pay for it if it is properly done. The fund manager should disclose what they are doing at the hedging front. They should come up and tell their investors as to what they do at times of high fluctuations. Normally it has been seen that they outperform the broad market indices during the bull-runs and under-perform the indices during the bear-phases. The industry needs to revise their attitude and try to streamline their actions with their objectives. Some Mutual Fund houses are quite disciplined but every body should embrace the same spirit. There are some infrastructural problems but fund managers need to be more vigilant on the market movements. Mr. Bhupinder Sethi, Fund Manager - Dundee Mutual Fund said ‘We are actively monitoring the market movements and taking calls accordingly. Though we are presently not using derivatives for hedging riskthe because of lackofofhuge depthcorrections in the market for the we go into cash when weofsee expectations coming in.’product, but Poor performance, poor servicing to clients and failure of third party service provider s, are the three major risk factors identified in the survey by PWC. These are also going to be crucial in a rapidly growing competitive scenario. Under this setting, it is not just growth that should be the focus area but also better management of all risks and hence, AMCs would do well to keep the investor and his interest in mind before taking any decision.

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1.4 Safety of Mutual Funds

Any Mutual Fund is as safe or unsafe as the assets that it invests in. There are two basic categories of Mutual Funds with others being variations or mixtures of these. Firstly, there are those that invest purely in equity shares (called equity funds or "Growth funds") and secondly, there are those that invest purely in bonds, debentures and other interest bearing instruments called "income" or "debt" funds. The NAV of growth funds fluctuates in line with the fluctuation of the shares held by them. They can also witness face substantial erosion in value, which could be permanent in some cases. On the other hand, prices of debt instruments fluctuate to a much lesser degree and an income fund is extremely unlikely to face erosion in value – especially of the permanent kind. Most Mutual Funds have qualified and experienced personnel, who understand the risks of investing. But, nobody is immune from making mistakes. However, funds diversify the investment portfolio substantially so that default in any single investment (in the case of an income fund) will not affect the overall performance of a fund in a significant manner. In the event of default of a part of the portfolio, an income fund is extremely unlikely to face erosion in face value. Generally, Mutual Funds are not guaranteed by anybody. However, in the Indian context, some of the Mutual Funds have floated "guaranteed" or "assured" return schemes, which guarantee a certain annual, return or guarantee a buyback at a specified price after some time. Examples of these include funds floated by the UTI, Canbank Mutual Fund, SBI Mutual Fund, LIC Mutual Fund etc. Many of these funds have not earned returns that they promised and the asset management companies of the respective Mutual Funds or their sponsors have made good their promises. The biggest case pertains to the US 64, which never guaranteed any returns but is being bailed out by the Government due to the millions of individuals who have invested in it.

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1.5 Types of Mutual Funds Mutual Fund schemes may be classified on the basis of its structure and its investments.

By Structure: Open-ended Funds

An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at liquidity. Net Asset Value ("NAV") related prices. The key feature of open-end schemes is Closed-ended Funds

A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. 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 they 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 through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor. Interval Funds

Interval funds combine the features of open-ended and close-ended schemes. They are open for sale or redemption during pre-determined intervals at NAV related prices.

By Investment Objective:Income Funds

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, corporate debentures and government securities. Income Funds are ideal for capital stability and regular income. Balanced Funds

The aim of balanced funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securit ies in the proportion indicated in their offer document s. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls. These are ideal for investors looking for a combination of income and moderate growth.

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Growth Funds

The aim of growth funds is to provide capital appreciation over the medium to long-term. Such schemes normally invest a majority of their corpus in equities. It has been proven that returns from stocks, have outperformed most other kind of investments held over the long term. Growth schemes are ideal for investors having a long-term outlook seeking growth over a period of time.

Money Market Funds

The aim of money market funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market. These are ideal for Corporate and individual investors as a means to park their surplus funds for short periods.

Load Funds: A Load Fund is one that charges a commission for entry or exit. That is, each time you buy or sell units in the fund, a commission will be payable. Typically entry and exit loads range from 1% to 2%. It could be worth paying the load, if the fund has a good performance history.

No-Load Funds: A no-Load Fund is one that does not charge a commission for entry or exit. That is, no commission is payable on purchase or sale of units in the fund. The advantage of a no load fund is that the entire corpus is put to work.

Other Schemes:Tax saving Schemes

These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax Investments laws as the Government offers tax incentives for investment in specified avenues. made in Equity Linked Savings Schemes (ELSS) and pension Schemes are allowed as deduction u/s 88 of the Income Tax Act, 1961. The Act also provides opportunities to investors to save capital gains u/s 54EA by investing in Mutual Funds, provided the capital asset has been sold prior to April 1, 2000 and the amount is invested before September 30, 2000.

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Special Schemes:

Industry Specific Schemes

Industry Specific Schemes invest only in the industries specified in the offer document. The investment of these funds is limited to specific industries like InfoTech, FMCG and Pharmaceuticals etc. 

Index Schemes

Index Funds attempt to replicate the performance of a particular index such as the BSE Sense or the NSE 50 

Sector Schemes

Sector Funds are those, which invest exclusively in a specified industry or a group of industries or various segments such as 'A' Group shares or initial public offerings.

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1.6 Different styles of Mutual Funds

Different Mutual Funds have very different investing styles. These styles are a function of the individuals managing the fund with the overall investment objectives and policies of the organization acting as a constraint. These are manifest in things like Portfolio turnover – Buy and hold strategy versus frequent investment changes. Kind of investments made – small versus large companies, multi baggers (investments which yield high gains) versus percentage players (investing in shares which will give small gains in line with the market), high quality – low yield bonds versus low quality – high yield bonds. Asset allocations – Varying percentage of cash depending on aggressive views on markets The following examples serve to illustrate a few styles of equity fund managers: Some fund managers are passive value seekers and some are value creators . The former type buys undervalued assets and patiently waits for the market to discover the value. The latter aggressively promote the undervalued stocks that they have bought. Some fund managers restrict themselves to liquid stocks while some thrive on illiquid stocks, which offer themselves easily to large price changes. Some fund managers are masters of the momentum game and seek to buy stocks that are in market fancy. They attach lesser importance to fundamentals and believe that a rising stock price and favorable momentum indicators imply that fundamentals are changing. In effect, they are following the philosophy, "The trend is my friend". Other fund managers go more by deep fundamental analysis completely ignoring price movements. They do not mind price going down and are in fact happy to buy more. Some fund managers are growth investors i.e. they buy stocks with a high P/E using the forecasted growth to justify the high valuation. Others are value investors who buy shares with low P/E or P/BV multiples - typically companies rich with undervalued assets.

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1.7 Process of Mutual Fund

In the above graph shows how Mutual Fund works and how investor earns money by investing in the Mutual Fund. Investors put their saving as an investment in Mutual Fund. The Fund Manager who is a person who takes the decisi ons where the money should be invested in securities according to the scheme’s objective. Securities include Equities, Debentures, Govt. Securities, Bonds, and Commercial Paper etc. These Securities generates returns to the Fund Manager. The Fund Manager passes back return to the investor.

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1.8 Net Asset Value (NAV)

The net asset value of the fund is the cumulative market value of the assets fund net of its liabilities. In other words, if the fund is dissolved or liquidated, by selling off all the assets in the fund, this is the amount that the shareholders would collectively own. This gives rise to the concept of net asset value per unit, which is the value, represented by the ownership of one unit in the fund. It is calculate d simply by dividing the net asset value of the fund by the number of units. However, most people refer loosely to the NAV per unit as NAV, ignoring the "per unit". We also abide by the same convention. Calculation of NAV

The most important part of the calculation is the valuation of the assets owned by the fund. Once it is calculated, the NAV is simply the net value of assets divided by the number of units outstanding. The detailed methodology for the calculation of the asset value is given below. Asset value is equal to Sum of market value of shares/debentures + Liquid assets/cash held, if any + Dividends/interest accrued Amount due on unpaid assets Expenses accrued but not paid Details on the above items For liquid shares/debentures, valuation is done on the basis of the last or closing market price on the principal exchange where the security is traded. For illiquid and unlisted and/or thinly traded shares/debentures, the value has to be estimated. For shares, this could be the book value per share or an estimated market price if suitable benchmarks are available. For debentures and bonds, value is estimated on the basis of yields of comparable liquid securities after adjusting for illiquidity. The value of fixed interest bearing securities moves directionsince opposite rate changes Valuation of debentures and bonds is a in biga problem mostto ofinterest them are unlisted and thinly traded. This gives considerable leeway to the AMCs on valuation and some of the AMCs are believed to take advantage of this and adopt flexible valuation policies depending on the situation. Interest is payable on debentures/bonds on a periodic basis say every 6 months. But, with every passing day, interest is said to be accrued, at the daily interest rate, which is calculated by dividing the periodic interest payment with the number of days in each period. Thus, accrued interest on a particular day is equal to the daily interest rate multiplied by the number of days since the last interest payment date. LJIMS

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Usually, dividends are proposed at the time of the Annual General meeting and become due on the record date. There is a gap between the dates on which it becomes due and the actual payment date. In the intermediate period, it is deemed to be "accrued". Expenses including management fees, custody charges etc. are calculated on a daily basis.

1.9 Eligibility for investing Mutual Fund in India Mutual Funds have been emerging as a big financial intermediary in India. In a vast country like India it is a challenge to market these funds. Fund distributors are a very important link between the fund management industry and the investors. However, it is equally essential to know who can invest in Mutual Funds in India. Mutual Funds in India are open to investment for:

A. Residents Including:1. 2. 3. 4. 5. 6. 7.

Resident Indian Individuals Indian Companies Indian Trusts / Charitable Institutions Banks Non-Banking Finance Companies Insurance Companies Provident Funds

B. Non Residents including:1. Non-Resident Indians 2. Other Corporate Bodies (OCBs)

C. Foreign Entities:1. Foreign Institutional Investors (FIIs) registered with SEBI Foreign citizens and other foreign entities are not allowed to invest in Mutual Funds in India.

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Chapter 2

Organization of Mutual Fund

2.1 Legal Structure of Mutual Fund 2.2 Role of AMC Behind Mutual Fund

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2.1 Legal Structure of Mutual Fund

The Fund Sponsor:

“Sponsor” is defined under SEBI regulations as any person who, acting alone or in combination with another body corporate, establishes a mutual fund. The sponsor of a fund is akin to the promote of a company as he gets the fund registered with SEBI. The sponsor will form a Trust and appoint a Board of Trustees. The sponsor will also generally appoint an Asset Management Company as fund managers. The sponsor, either directly or acting through the Trustees, will also appoint a Custodian to hold the fund assets. All these appointments are made in accordance with SEBI Regulations. As per the existing SEBI regulations, for a person to qualify as a sponsor, he must contribute as least 40% of the net worth of the AMC and possess a sound financial track record over five year prior to registration. Mutual Funds as Trusts:

A mutual fund is India is constituted in the form of a Public Trust created under the Indian Trusts Act, 1882. The Fund Sponsor acts as the Settler of the Trust, contributing to its initial capital and appoints a Trustee to hold the assets of the Trust for the benefit of the unit-holders, who are the beneficiaries of the Trust. The fund then invites investors to contribute their money in the common pool, by subscribing to “units” issued by various schemes established by the trust as evidence of their beneficial interest in the fund. Trustees:

A Board of Trustees – a body of individuals or a Trust Company - a corporate body, may manage the Trust -the mutual fund. Board of Trustees manages most of the funds in LJIMS

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India. While the provisions of the Indian Trusts Act, will govern the Board of Trustees where the Trustee is a corporate body, it would also be required to comply with the provisions of the Companies Act, 1956. The Board of the Trustees does not directly manage the portfolio of securities. For this specialist function, they appoint an Asset Management Company. They ensure that the fund is managed by the AMC as per the defined objectives and in accordance with the Trust Deed and SEBI Regulations. The Asset Management Company:

The role of an Asset Management Company (AMC) is to act as the investment manager of the Trust under the Board supervision and direction of the Trustees. The AMC is required to be approved and registered with SEBI as an AMC. The Trustees are empowered to terminate the appointment of the AMC and may appoint a new AMC with the prior approval of the Board and unit-holders. The sponsor, or Board of Trustees, if so authorized, appoints the Asset Management Company (AMC) which would, in the name of the Trust, float and then manage the different investment “scheme” as per SEBI Regulations and as per the AMC Agreement it signs with the Trustees. The AMC of a mutual fund must have a net worth of at least of Rs. 10 crores at all times. The AMC cannot act as a trustee of any other mutual fund.

2.2 Role of AMC (Asset Management Company) Behind a Mutual Fund

AMC controls the operati ons and functioning of a Mutual Fund. It is very critical to the performance of athe Mutual as it decidestoonservice the style of functioning, people who are going to manage funds,Fund the commitment quality and overall supervision. The financial strength and the commitment of the AMC sponsors to the business are very key issues. This is because most AMCs lose money in the first few years of operations. In most cases, these losses are much more than the capital requirements stipulated by SEBI. Hence, a sponsor who is financially weak or which cannot capital to the business either because of its inability or unwillingness will result in an unhealthy operation. This is the last place where high quality persons would want to remain and work. The AMC then remains stunted and the sponsors lose interest. The worst affected are the investors. This is also a problem that has afflicted some of the AMCs floated by nationalized banks. In these organizations, the traditional thinking is prevalent which can be summarized, as "money is power". Since Mutual Fund business did not have access to too much money, a posting in the AMC became punishment postings for some personnel who were not doing well in the parent organization or who lost out in the organizational politics. The CEO’s of the AMCs did not have any clue of the Mutual Fund business and neither were they interested in it – the entire effort was spent in getting a posting back in the parent. The fund managers had no experience in the activity making a mockery of "professional management". The sad results are there to see. Some of the parents had to provide funds to bridge the gap in "assured return schemes". It looks extremely likely that some of these AMCs will no longer exist in a few years.

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Chapter 3

Mutual Fund Industry

3.0 History 3.1 Mutual Fund Swelling Corpuses 3.2 Structure of Indian Mutual Fund Industry 3.3 Some Current AMCs 3.4 Recent Trends in Mutual Fund Industry 3.5 Market Trends 3.6 Investment Trends 3.7 Future Scenario 3.8 Performance of Mutual Fund 3.9 Global Scenario

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3.0 History of Mutual Fund The end of millennium marks 36 years of existence of Mutual Funds in this country. The ride through these 36 years is not been smooth. Investor opinion is still divided. While some are for Mutual Funds others are against it.

First Phase – 1964-87

An Act of Parliament established Unit Trust of India (UTI) on 1963. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. UTI commenced its operations from July 1964. The impetus for establishing a formal institution came from the desire to increase the propensity of the middle and lower groups to save and to invest. UTI came into existenc e during a period marked by great political and economic uncertainty in India. With war on the borders and economic turmoil that depressed the financial market, entrepreneurs were hesitant to enter capital market.

The already existing companies found it difficult to raise fresh capital, as investors did not respond adequately to new issues. Earnest efforts were required to canalize savings of the community into productive uses in order to speed up the process of industrial growth. The then Finance Minister, T.T. Krishnamachari set up the idea of a unit trust that would be "open to any person or institution to purchase the units offered by the trust. However, this institution as we see it, is intended to cater to the needs of individual investors, and even among them as far as possible, to those whose means are small." His ideas took the form of the Unit Trust of India, an intermediary that would help fulfill the twin objectives of mobilizing retail savings and investing those savings in the capital market and passing on the benefits so accrued to the small investors. UTI commenced its operations from July 1964 "with a view to encouraging savings and investment and participation in the income, profits and gains accruing to the Corporation LJIMS

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from the acquisition, holding, management and disposal of securities." Different provisions of the UTI Act laid down the structure of management, scope of business, powers and functions of the Trust as well as accounting, disclosures and regulatory requirements for the Trust. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory 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.6700 Crores of assets under management. One thing is certain – the fund industry is here to stay. The industry was one-entity show till 1986 when the UTI monopoly was broken when SBI and Canbank Mutual Fund entered the arena. This was followed by the entry of others like BOI, LIC, GIC, etc. sponsored by public sector banks. Starting with an asset base of Rs0.25bn in 1964 the industry has grown at a compounded average growth rate of 26.34% to its current size of Rs1130bn. 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 first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual 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 end of 1993, the Mutual Fund industry had assets under 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 (now merged with Franklin Templeton) was the first private sector Mutual Fund registered in July 1993. The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996. The number of Mutual Fund houses went on increasing, with many foreign Mutual Funds setting up funds in India and also the indus try has witnessed sever al 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.

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Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs. 29,835 Crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit 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. The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs.76,000 crores of assets under management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place among different private sector funds, the Mutual Fund industry has entered its current phase of consolidation and growth. As at the end of August 31, 2003, there were 31 funds, which manage assets of Rs. 1,21,040 Crores under 380 schemes.

A Mutual Fund is an ideal investment vehicle where a number of investors come together to pool their money with common investment goal. Respective Asset Management Company (AMC) manages each Mutual Fund with different of inschemes. An schemes investor of can invest his type money one or more Mutual Fund according to his choice and becomes the unit holder of the scheme. Fund manager in different types of suitable stock and securities, bonds and money market instruments then invests the invested money in a particular scheme of a Mutual Fund. Qualified professional man, who uses this money to create a portfolio, which includes stock and shares, bonds, gilt, money-market instruments or combination of all, manages each Mutual Fund. Thus Mutual Fund will diversify your portfolio over a variety of investment vehicles. Mutual Fund offers an investor to invest even a small amount of money. Mutual Funds schemes are managed by respective Asset Management Companies sponsored by financial institutions, banks, private companies or international firms. The biggest Indian AMC is UTI while Alliance; Franklin Templeton etc are international AMC's. Mutual Funds offer several benefits to an investor such as potential return, liquidity, transparency, income growth, good post tax return and reasonable safety. There are number of options available for an investor offered by a Mutual Fund. LJIMS

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Before investing in a Mutual Fund an investor must identify his needs and preferences. While selecting a Mutual Fund's schemes he should consider the effect of inflation rate, diversification of investment, the time period of investment and the risk factors. (Source: AMFI)

3.2 Structure of the Indian Mutual Fund Industry

The Indian Mutual Fund industry is dominated by the Unit Trust of India, which has a total corpus of Rs700bn, collected from more than 20 million investors. The UTI has many funds/schemes in all categories i.e. equity, balanced, income etc with some being open-ended and some being closed-ended. The Unit Scheme 1964 commonly referred to as US 64, which is a balanced fund, is the biggest scheme with a corpus of about Rs200bn. UTI was floated by financial institutions and is governed by a special act of Parliament. Most of its investors believe that the UTI is government owned and controlled, which, while legally incorrect, is true for all practical purposes. The second largest category of Mutual Funds is the ones floated by nationalized banks. Canbank Asset Management floated by Canara Bank and SBI Funds Management floated by the State Bank of India are the largest of these. GIC AMC floated by General Insurance Corporation and Jeevan Bima Sahayog AMC floated by the LIC are some of the other prominent ones. The aggregate corpus of funds managed by this category of AMCs is about Rs150bn. The third largest category of Mutual Funds is the ones floated by the private sector and by foreign asset management companies. The largest of these are Prudential ICICI AMC and Birla Sun Life AMC. The aggregate corpus of assets managed by this category of AMCs is in excess of Rs250bn.

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3.3 Some of the AMCs operating currently are:

NameotfheAMC

Natureoo f wnership

Alliance Capital Asset Management (I) Private Limited

Private foreign

Birla Sun Life Asset Management Company Limited

Private Indian

Bank of Baroda Asset Management Company Limited

Banks

Bank of India Asset Management Company Limited

Banks

Canbank Investment Management Services Limited

Banks

Cholamandalam Cazenove Asset Management Company Limited Dundee Asset Management Company Limited DSP Merrill Lynch Asset Management Company Limited

Private foreign

Private foreign Private foreign

EscortsAssetManagementLimited

PrivateIndian

FirstIndia Asset Management Limited

Private Indian

GIC Asset Management Company Limited

Institutions

IDBI Investment Management Company Limited IndfundManagementLimited

Institutions Banks

ING Investment Asset Management Company Private Limited Private foreign JMCapitalManagementLimited Jardine Fleming (I) Asset Management Limited

PrivateIndian Private foreign

Kotak Mahindra Asset Management Company Limited

Private Indian

Kothari Pioneer Asset Management Company Limited

Private Indian

Jeevan Bima Sahayog Asset Management Company Limited

Institutions

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Morgan Stanley Asset Management Company Private Limited Private foreign Punjab National Bank Asset Management Company Limited

Banks

Reliance Capital Asset Management Company Limited

Private Indian

State Bank of India Funds Management Limited

Banks

Shriram Asset Management Company Limited

Private Indian

Sun F and C Asset Management (I) Private Limited

Private foreign

Sundaram Newton Asset Management Company Limited Tata Asset Management Company Limited

Private foreign Private Indian

Credit Capital Asset Management Company Limited

Private Indian

Templeton Asset Management (India) Private Limited

Private foreign

UnitTrustofIndia

Institutions

Zurich Asset Management Company (I) Limited

Private foreign

3.4 Trends in Mutual Fund Industry Recent Trends in Mutual Fund Industry The most important trend in the Mutual Fund industry is the aggressive expansion of the foreign owned Mutual Fund companies and the decline of the companies floated by nationalized banks and smaller private sector players. Many nationalized banks got into the Mutual Fund business in the early nineties and got off to a good start due to the stock market boom prevailing then. These banks did not really understand the Mutual Fund business and they just viewed it as another kind of LJIMS

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banking activity. Few hired specialized staff and generally chose to transfer staff from the parent organizations. The performance of most of the schemes floated by these funds was not good. Some schemes had offered guaranteed returns and their parent organizations had to bail out these AMCs by paying large amounts of money as the difference between the guaranteed and actual returns. The service levels were also very bad. Most of these AMCs have not been able to retain staff, float new schemes etc. and it is doubtful whether, barring a few exceptions, they have serious plans of continuing the activity in a major way. The experience of some of the AMCs floated by private sector Indian companies was also very similar. They quickly realized that the AMC business is a business, which makes money in the long term and requires deep-pocketed support in the intermediate years. Some have sold out to foreign owned companies, some have merged with others and there is general restructuring going on. The foreign owned companies have deep pockets and have come in here with the expectation of a long haul. They can be credited with introducing many new practices such as new product innovation, sharp improvement in service standards and disclosure, usage of technology, broker education and support etc. In fact, they have forced the industry to upgrade itself and service levels of organizations like UTI have improved dramatically in the last few years in response to the competition provided by these.

3.5 Market Trends A lone UTI with just one scheme in 1964 now competes with as many as 400 odd products and 34 players in the market. In spite of the stiff competition and losing market share, UTI still remains a formidable force to reckon with. Last six years have been the most turbulent as well as exiting ones for the industry. New players have come in, while others have decided to close shop by either selling off or merging with others. Product innova tion is now passing with the game shifting to performance delivery in fund management as well as service. Those directly associated with the fund management industry like distributors, registrars and transfer agents, and even the regulators have become more mature and responsible.

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The industry is also having a profound impact on financial markets. While UTI has always been a dominant player on the bourses as well as the debt markets, the new generations of private funds which have gained substantial mass are now seen flexing their muscles. Fund managers; by their selection criteria for stocks have forced corporate governance on the industry. By rewarding honest and transparent management with higher valuations, a system of risk-reward has been created where the corporate sector is more transparent then before. Funds have shifted their focus to the recession free sectors like pharmaceuticals, FMCG and technology sector. Funds performances are improving. In India, Mutual Funds have shown continuous improvement in terms of the quantum under their management over the last couple of years. Total assets of the Mutual Funds have grown from Rs. 68193.08 cr. In 1998-99 to Rs. 121039.70 cr. As on August 31, 2003. Mutual Funds are now also competing with commercial banks in the race for retail investor’s savings and corporate float money. The power shift towards Mutual Funds has become obvious. The coming few years will show that the traditional saving avenues are losing out in the current scenario. Many investors are realizing that investments in savings accounts are as good as locking up their deposits in a closet. The fund mobilization trend by Mutual Funds in the current year indicates that money is going to Mutual Funds in a big way. India is at the first stage of a revolution that has already peaked in the U.S. The U.S. boasts of an Asset base that is much higher than its bank deposits. In India, Mutual Fund assets are not even 10% of the bank deposits, but this trend is beginning to change. Recent figures indicate that in the first quarter of the current fiscal year Mutual Fund assets went up by 115% whereas bank deposits rose by only 17%. This is forcing a large number of banks to adopt the concept of narrow banking wherein the deposits are kept in Gilts and some other assets, which improves liquidity and reduces risk. The basic fact lies that banks cannot be ignored and they will not close down completely. Their role as intermediaries cannot be ignored. It is just that Mutual Funds are going to change the way banks do business in the future.

3.6 Investment Trends Recent trends in Earlier, MutualMutual Funds Fund suggest investment been takingavenue place toin diversified areas. wasthat considered to behas an investment invest only in equity shares. Today, with the evolution of the soft interest rate regime, the investment has been taking place more on the debt products, G-sacs and money market instruments. If we look at the profile of the Mutual Fund industry as a whole, around 74% are debt investment of total asset under management, followed by nearly equiproportional shares of equity and balanced schemes at 13%. So, today the Mutual Fund industry investment pattern has been more diversified into all these segments. Scheme-wise Resource Mobilization by Mutual Funds (Rs. In Cr.) LJIMS

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Year 2001-02 2002-03 Source: SEBI

EquityOriented -534 43

Debt-Oriented 13064 5781

Balanced -5354 -1628

Total 7175 4196

In last few years, the debt market has given excellent returns and debt funds will continue to serve as safer investment option for investors. The level of returns which one could expect from debt funds will now be much more moderat e than what one has received in the last three years and there has been the tendency of the investors to shy away from the equity markets because of the kind of the loses they have suffered.

3.7 Future Scenario The asset base will cont inue to grow at an annual rate of about 30 to 35 % over the next few years as investor’s shift their assets from banks and other traditional avenues. Some of the older public and private sector players will either close shop or be taken over. Out of ten public sector players five will sell out, close down or merge with stronger players in three to four years. In the private sector this trend has already started with two mergers and one takeover. Here too some of them will down their shutters in the near future to come. But this does not mean there is no room for other players. The market will witness a flurry of new players entering the arena. There will be a large number of offers from various asset management companies in the time to come. Some big names like Fidelity, Principal and Old Mutual etc. are looking at Indian market seriously. One important reason for it is that most major players already have presence here and hence these big names would hardly like to get left behind. The Mutual Fund industry is awaiting the introduction of derivatives in India as this would enable it to hedge its risk and this in turn would be reflected in its Net Asset Value (NAV). SEBI is working out the norms for enabling the existing Mutual Fund schemes to trade in derivatives. Importantly, many market players have called on the Regulator to initiate the process immediately, so that the Mutual Funds can implement the changes that are required to trade in Derivatives.

3.8 Performance of Mutual Funds Out performance of Mutual Funds. Is it good?

Mutual Fund performance of index may not always be a positive indicator. In several cases one notice that the funds performance is very lop-sided and is driven by few Scrip. In other words the fund manager has taken significa ntly higher risks and in the game of probability he would have made more money. But it is very likely that if his call had not been right, he would have under performed and lost badly. From an investor’s point of view, when he is looking at such out-performances in the past, he cannot derive confidence and comfort in the fund managers' ability to repeat the performance in future. As markets are not rational, there is no methodology in the world to scientifically predict LJIMS

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stock prices. Therefore it is not possible for anyone to beat the market on a consistent basis and hence there is no guarantee that the fund manager would perform well all the while. Benchmark performance of Mutual Funds

All Mutual Funds have different objectives and therefore their performance would vary. A Mutual Funds performance should be benchmarked against Mutual Funds of similar type or India infoline Mutual Fund index for a particular type. E.g. equity fund index, income fund index or balanced fund index or liquid fund index. One can also benchmark the fund against the Sensex or any other broad based index for the particular asset class. One has to be very careful about choosing the comparison period. Ideally, one should compare the performance of equity or an index fund over a 1-2 year horizon. Any comparison over a shorter period would be distorted by short term, volatile price movements. Comparisons over a longer period need to be interpreted carefully by looking at other factors such as change in individuals managing the fund, one-time investment successes etc. Similarly, the ideal comparison period for a debt fund would be 6-12 months while that for a liquid/money market fund would be 1-3 months. Apart from the entire period, one should also compare the performance in smaller intervals within the same period say intervals of one month duration. To make comparison meaningful, one has to compare the average annual compounded rate of return. This adjusts for comparisons of differing period and also facilitates comparison across different classes. The return also incorporates dividend payouts. Thus, for example, one can say that ABC income fund has given a compounded annual growth rate (CAGR) of 13% p.a. including dividends in the last 2 years while XYZ income fund has given a CAGR of 13.2% p.a. over the last 3 years.

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Reason of Poor Performance of Mutual Funds in India (In Past)

Most investors associate Mutual Funds with Mastergain, Monthly Equity Plans of SBI Mutual Fund, UTI and Canbank Mutual Fund and of course Morgan Stanley Growth Fund. This is so because these funds truly had participation from masses, with a fund like Morgan Stanley having more than 1 million investors. Investors feel that after 5 years, Morgan Stanley Growth Fund units still trade below the srcinal IPO price of Rs 10. It is incorrect to think that all Mutual Funds have performed poorly. If one looks at some income funds, they have come with reasonable returns. It is only the performance of equity funds, which has been poor. Their poor performance has been amplified by the closed end discounts i.e. units of these funds quoting at sharp discounts to their NAV resulting in an even poorer return to the investor. One must remember that a Mutual Fund does not provide assured returns and neither can it "manufacture" returns out of thin air. Returns provided by Mutual Funds are a function of the returns in the underlying asset class in which the fund invests. Good funds can beat returns in their asset class to some extent but that’s all. E.g. take the case of a sector specific fund like a Pharma fund, which invests only in shares of pharmaceutical companies. If the Govt. comes with new regulation that severely restricts the pricing freedom of these companies resulting in negative outlook for the sector, the prices of all stocks in the sector could fall substantially resulting in severe erosion in the NAV of the fund. No one can do anything about it. A good fund manager would probably sell part of the fund before prices fall too much and wait for an opportune time to reinvest at lower levels once the dust has settled. In that case, the NAV of the fund would fall to a lesser extent – but fall it will. If the investor in the fund has invested in some stocks in the sector on his own, in all probability, his personal investments may have depreciated to a larger extent. Let us extend this example to an analysis of the investment climate in the last 7 years. The stock markets have done very badly in the last seven years. The BSE Sensex crossed 3000 for the first time in early 1992. Since then it has gone up and come down several times but has remained in the same range. Effectively, for a seven-year invest ment period, the total return has been almost zero. The prices of many leading stocks of yesteryear have fallen by more than 50% in these seven years. If one considers the fact that the Sensex has been changed several times, with all the weak stocks having been weeded out, the effective returns on the old Sensex, existing in 1992, have been substantially negative. Most Mutual Fund managers took some time to realize the changed circumstances wherein the open economy ushered in by the liberalization took the full impact of the global deflation in commodity prices. This problem was compounded further by the Asian crisis after which cheap imports from Asia caused severe pressure on profits. To add to this, most funds had invested some part of their portfolio in medium sized "growth" companies. Many of these companies have performed even worse than bigger ones and quite a few have seen share prices dip more than 90% from their 1994 highs. More important, funds could not sell these shares because of complete lack of liquidity with, at best, few hundred shares being traded every day. LJIMS

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Meanwhile, shares of companies in sectors like consumer goods (FMCG) and software were showing good growth and they went up rapidly in price. Most fund managers were unwilling to sell shares of erstwhile "blue chips " at low prices and buy share s of emerging "blue chips" at high prices. This resulted in poor performance and negative returns. One more issue is that the fund managers in many funds were not "prof essionally qualified and experi enced". This is especially true of some of the funds floated by nationalized banks. Some of these individuals were transferred from the parent organization and did not really know much about investment management. Lastly, investors would do well to have a look at the investments, which they made on their own. In most cases, they would have done much worse than the Mutual Funds.

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3.9 Global Scenario Some basic facts•

•

The money market Mutual Fund segment has a total corpus of $ 1.48 trillion in the U.S. against a corpus of $ 100 million in India. Out of the top 10 Mutual Funds worldwide, eight are bank- sponsored. Only Fidelity and Capital is non-bank Mutual Funds in this group.

•

In the in U.S. thewe total number of schemes schemes is higher than that of the listed companies while India have just 400 •

•

•

•

Internationally, Mutual Funds are allowed to go short. In India fund managers do not have such leeway. In the U.S. about 9.7 million households will manage their assets on-line by the year 2003, such a facility is not yet of avail in India. On- line trading is a great idea to reduce management expenses from the current 2 % of total assets to about 0.75 % of the total assets. 72% of the core customer bases of Mutual Funds in the top 50-broking firms in the U.S. are expected to trade on-line by 2003.

(Source: The Financial Express) Internationally, online investing continues its meteoric rise. Many have debated about the success of e- commerce and its breakthroughs, but it is true that this aspect of technology could and will change the way financial sectors function. However, Mutual Funds cannot be left far behind. They have realized the potential of the Internet and are equipping themselves to perform better. In fact in advanced countries like the U.S.A, Mutual Funds buy- sell transactions have already begun on the net, while in India the Net is used as a source of Information. Such changes could facilitate easy access, lower intermediation costs and better services for all. A research agency that specializes in Internet technology estima tes that over the next four years Mutual Fund Assets traded online will grow ten folds from $ 128 billion to $ 1,227 equity assets traded on-line will period from $ 246billion; billion whereas to $ 1,561 billion. This will increase the increase share of during Mutualthe Funds from 34% to 40% during the period. Such increases in volumes are expected to bring about large changes in the way Mutual Funds conduct their business.

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Here are some of the basic changes that have taken place since the advent of the Net. •

•

Lower Costs: Distribution of funds will fall in the online trading regime by 2003. Mutual Funds could bring down their administrative costs to 0.75% if trading is done online. As per SEBI regulations, bond funds can charge a maximum of 2.25% and equity funds can charge 2.5% as administrative fees. Therefore if the administrative costs are low, the benefits are passed down and hence Mutual Funds are able to attract mire investors and increase their asset base. Better advice: Mutual Funds could provide better advice to their investors through the Net rather than through the traditional investment routes where there is an additional channel to deal with the Brokers. Direct dealing with the fund could help the investor with their financial planning.

In India, brokers could get more Net savvy than investors and could help the investors with the knowledge through get from the Net. •

New investors would prefer online: Mutual Funds can target investors who are young individuals and who are Net savvy, since servicing them would be easier on the Net.

India has around 1.6 million net users who are prime target for these funds and this could just be the beginning. The Internet users are going to increase dramatically and Mutual Funds are going to be the best beneficiary. With smaller administrative costs more funds woul d be mobilized .A fund manager must be ready to tackle the volatility and will have to maintain sufficient amount of investments which are high liquidity and low yielding investments to honor redemption. •

Net based advertisements: There will be more sites involved in ads and promotion of Mutual Funds. In the U.S. sites like AOL offer detailed research and financial details about the functioning of different funds and their performance statistics. A is witnessing a genesis in this area. There are many sites such as indiainfoline.com and indiafn.com that are doing something similar and providing advice to investors regarding their investments.

In the U.S. most Mutual Funds concentrate only on financial funds like equity and debt. Some like real estate funds and commodity funds also take an exposure to physical assets. The latter type of funds are preferred by corporate who want to hedge their exposure to the commodities they deal with. For instance, a cable manufacturer who needs 100 tons of Copper in the month of January could buy an equivalent amount of copper by investing in a copper fund. For Example, Permanent Portfolio Fund, a conservative U.S. based fund invests a fixed percentage of it’s corpus in Gold, Silver, Swiss francs, specific stocks on various bourses around the world, short –term and long-term U.S. treasuries etc. In U.S.A. apart from bullion funds there are copper funds, precious metal funds and real estate funds (investing in real estate and other related assets as well.). In India, the Canada based Dundee Mutual Fund is planning to launch gold and a real estate fund before the year-end. LJIMS

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In developed countries like the U.S.A there are funds to satisfy everybody’s requirement, but in India only the tip of the iceberg has been explored. In the near future India too will concentrate on financial as well as physical funds. A Mutual Fund and the company that manages it are 2 entirely different companies. Legally speaking, a Mutual Fund is a trust formed and registered under the Indian Trust Act. The sponsor asset management company is formally appointed by the trustees of the trust to manage money on their behalf e.g. DSP Merrill Lynch equity fund is a mutual benefit trust registered under the Indian Trust Act. The trustees have appointed DSP Merrill Lynch Asset Management Company Pvt. Ltd. to manage the funds in the trust and the company cannot touch one rupee from the trust except to the extent of the fees that it receives for managing the funds. Repatriation of money outside India comes under the purview of the Foreign Exchange Regulation Act, 1973 which specifies the situations in which money can be remitted outside India. Under the act, banks that repatriate money on behalf of their clients have to ensure compliance with various legal formalities and ensure that the entity, which remits money, is entitled to do so. Any failure or violation leads to serious consequences for both the remitter and the bank. Money collected by a Mutual Fund domestically is not allowed to be remitted outside India. However, with the repeal of FERA, 1973, regulations are likely to be eased.

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Chapter 4

A Statistical Profile 4.0 Profile 4.1 Asset Under Management 4.2 Fund Mobilization 4.3 Mutual Fund Investment (Equity) India 4.4 Comparison Of Scheme 4.5Comparison Of Investment Product 4.6 Investment Pyramid

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4.0 India's Mutual Fund Industry: A Statistical Profile

Make-up of the industry •

•

•

The Indian Mutual Fund industry managed assets worth Rs 12010.40 billion as of Aug 31, 2003.

There are currently 36 asset management companies operating in India. Nine AMCs are majority owned by state-run banks or institutions. That nine includes the Unit Trust of India, which is the single-largest investor in the Indian markets with assets of Rs 576.84 billion under management.

,

•

There are 13 AMCs majority owned by foreign or global investment houses, 10 privately run domestic asset management companies and 4 domestic/foreign joint ventures.

Funds by type •

•

•

In all, investors have a choice of 397 funds to choose from covering the gamut of financial offerings. Types include income, growth, balanced, liquid or money market, gilt and equity linked tax savings schemes.

Income funds constitute the largest category with assets under management of Rs 523 billion or 54 per cent. Balanced schemes account for Rs 195 billion or 20 per cent, and growth funds Rs 138 billion or 14 per cent.

Liquid or money market funds account for 6 per cent or Rs 60 billion; gilt funds have AUM of Rs 29 billion or 3 per cent and equity-linked tax savings funds account for Rs 23 billion or 2.4 per cent of the industry's assets.

•

Some Rs 642.6 billion or 66.4 per cent of the industry's assets are managed by openended funds; Rs 133.3 billion or 13.8 per cent by closed-end funds, or funds which will terminate at a particular date; and Rs 192 billion or 19.8 per cent is invested through schemes with assured returns.

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Mutual Fund history •

Between 1964 and 1987, the industry was a 'one-man show', with UTI being the only player in the market.

•

In the following six years, the industry was opened up but limited to state-run players. Six state-run banks and two government insurance firms established asset management companies.

•

The industry remained a public-sector preserve till 1993, when the first private Mutual Fund - the Kothari Pioneer Mutual Fund -- launched one closed- and one open-ended fund.

•

Nevertheless, state-run AMCs and the remainder by privately run asset management companies manage about two-thirds of the industry’s assets.

•

UTI alone controls about 60 per cent of the industry's assets; 17.6 per cent is managed by AMCs that are largely foreign owned and 10.4 per cent by Indian-owned AMCs.

•

Indian private Mutual Funds have 4.9 per cent of the industry's AUM; state-run institutions control 3.8 per cent and bank-sponsored AMCs have a 3.6 per cent share of the pie.

Performance data •

The industry's equity assets are divided among diversified, tax planning, balanced, technology, pharmaceutical, consumer non-durable and specialty funds.

•

Pharmaceutical funds provided a negative 4.65 per cent return for the past year to May. The other six categories posted double-digit percentage losses over the same time span.

•

By comparison the 30-issue Sensex declined 18 per cent in the year to May.

•

Technology funds have been the worst performers, plunging 45.41 per cent -- against

•

a 35.59 per cent drop by the Bombay Stock Exchange's infotech index. The average return of diversified equity funds was -20.69 percent for the past year to May. Tax planning schemes on average lost 23.08 per cent.

•

Funds investing in the consumer non-durable sector posted an average return of -14.16 percent, slightly better than the 16.50 per cent fall in the BSE's sectoral index.

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Average returns for speci alty funds were -10.96 percent and the balanced fund category posted a return of -9.84 per cent against the 0.41 per cent decline in its benchmark, the Value Research balanced index.

•

Debt funds have been a far better source of income in the past year to May posting average returns between 9.23 and 14.61 per cent.

4.1 Market Share in Total Fund size MutualFund

UTI MF PruICICIMF Franklin Templeton Investment HDFC MF BirlaSunlifeMF StandardCharteredMF RelianceCapitalMF SBI MF DSP ML MF

No.Of Schemes 52 100 118

70 61 53 37 52 28

Kotak MahindraMF Others Total

52

AUM

17466 15056 14628 14132 9381 8640 6321 4923 4421 4360 21740 121068

Asset Und er Management 18%

14%

4%

UTI M F Pru ICICI MF

12% 4%

Franklin Templeton Investment HDFC M F Birla Sunlife M F Standard Chartered MF

4%

Reliance Capital MF SBI M F

12%

5% 7% 8%

LJIMS

12%

DSP M L MF Kotak MahindraM F Others

42


Mutual Funds in India are finally coming of age. Although UTI MF is still predominantly the leader, other private MFs are fast catching up. And it is clear from other Mutual Funds by asset under management (AUM) that private MFs are attacking aggressively by way of various innovative and investor-friendly schemes, plans and options. (Source: www.Mutualfundsindia.com)

4.2 Fund Mobilization Fund Mobilization

(Rs. in cr.) Category

Sales-AllSchemes

Assets Under

Redemption

Management From new schemes

From Existing schemes

No. Amt.

Amt.

Total Total Cumulative Cumulative For For Apr'03 to Apr'03 to the The May '03 May '03 Month Month

As on 31st May 2003

A) Bank Sponsored (5)

-

-

2417

2417

4944

2086

3872

19521

B) Institutions (4)

-

-

2319

2319

4691

1940

3780

6936

C) Private Sector 1.Indian(7) 2. Joint Ventures: Predominantly Indian(6) 3. Joint Ventures : Predominantly Foreign (10) Total(1+2+3) Grand Total (A+B+C+D)

1

61

7411

7472

16625

6272

14482

12756

2

186

8640

8826

18606

6532

13790

20837

-

-

14888

14888

33041

11961

25799

38074

3

247

3

30939

247

35675

31186

68272

24765

54071

71667

35922

77907

28791

61723

98124

17787

38775

17319

36535

102231

(Source: www. Indiainfoline.com)

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4.3 Mutual Fund Investment (Equity) in India

Year

Dec-2000 Dec-2001 Dec-2002 UptoOct-2003

Purchases (Rsmn) 178788 122196 143818

Sales (Rsmn) 186138 172459 173304

210343

Net Investment (Rsmn) -6239 -30181 -50259

216583

-7347

Mutual Fund Inves tm ent (Equity) 250000 200000 n m 150000 . s 100000 R 50000 0

Purchase Sales

Dec2000

Dec2001

Dec2002

Upto Oct2003

Year

(Source: www.Indiainfoline.com) Interpretation:

In Year 2000 there was a bull period in the stock market. While in the year 2001 trading has came down. The trading in the stock market has shown in the above table and chart respectively. Again there is bull market currently so the trading has big hype in equities.

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4.4 Comparison of the Scheme of Different Fund Open Ended - Equity: Index - one Year Return off

UTI Master Index UTI Nifty Index

Fund

NAV 15.03 9.65

FTIndiaIndexFundNifty NiftyBenchmarkETS IL&FSIndexFundNifty MagnumIndexFund PrudentialICICIIndex IL&FSIndexFundSensex HDFC Index Nifty Birla Index

15.45 155.03 13.65 14.26 13.34 13.5 15.7 16.03

Retur(n%) 58.11 54.96

54.77 54.49 54.22 53.44 53.00 52.85 52.82 52.80

(Source:www.valueresearchonline.com)

Open Ended - Equity: Index - one Y ear Return 200 150 100 50 0

NAV Return(%) r te s a M I T U

ty if N I T U

ia d In T F

tfy i N

S F & IL

l m a u it n n g e a d r M u P

S F & IL

C F D H

x e d In lra i B

Fund

Interpretation: From the above data we can say that the investor will prefer the fund, which gives higher return with lower NAV. In above table UTI gives higher return while NAV is low while Nifty Index gives low return with high NAV.

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Open Ended - Gilt: Medium & Long-term - one Year Return Fund INGGiltPortfolio Libra Bond SundaramSelectDebtLT BoB Gilt SUNF&CFISFInternational

NAV 10.63 11.86 10.53 10.44 10.52

GIC Debt GIC Gilt SundaramSelectDebt3-Yr PrincipalDep-EA/EB BoB Income

10.71 10.65 10.58 15.46 11.04

Retur(n%) 2.52 2.61 3.25 3.57 3.78

3.82 3.95 4.52 4.84 5.56


Open Ended - Gilt: Medium & Longterm - one Year Return 20.00 15.00 10.00 5.00 0.00

NAV Return(%)

e ilt ... bt ilt ... .. lio nd ... tf o Bo S B G FIS De IC G S De. c om r o ra am Bo C IC G am al In r ip & G B lt P Lib dar a F i o G N n nd inc B G Su SU Su Pr IN Fund

Interpretation:

From the above table show that in Gilt Medium & Long terms the return is quite low. The average return in above scheme is around 3.5% but NAV is high compare to the return. We would like to suggest investing in BoB Income Fund for getting good return.

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Open Ended - Hybrid: Monthly Income - one Year Return

Fund TataMIP AllianceMIP FT India Monthly Income Plan TempletonMIP-G

NAV 11.94 18.88

Return (%) 19.09 17.78

15.03 15.11

16.19 15.92

Magnum 11.40 14.76 BirlaMIP MIP-DY 14.82 14.34 MagnumMIP-DQ 10.50 14.03 MagnumMIP-DM 10.62 13.92 PrincipalMIP 12.28 13.16 PrudentialICICIMIP 14.16 12.78 (Source:www.valueresearchonline.com)

Open Ended - Hybrid: Monthly Income - one Year Re turn 25 20 15 10 5 0

NAV RETURN

.. IP ... ... IP .. t.. ... . a... tia. . M M e i e l . . ta nc nd p nu la nu nu ip en Ta llia FT I Tem a g Bir a g a g r inc rud A M M M P P

Fund

Interpretation:

In this Scheme, investor gets monthly income and Fund Manager invests Equity and Debt in both. We suggest that Invest in Magnum MIP-DQ for invest less money and get more return.

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Open Ended - Equity: Diversified - one Year Return

Fund Sun F&C Res India Equity Alliance Basic Industries RelianceGrowth FranklinIndiaPrima RelianceVision

Sundaram Select Midcap HDFCEquity DSPML Opportunities DSPMLEquity TataPureEquity (Source:www.valueresearchonline.com)

NAV 27.42 23.10 63.28 61.28 55.48

Return (%) 133.76 130.08 128.61 126.96 126.91

21.54 44.29 16.20 24.61 19.12

122.31 115.65 114.85 112.52 110.82

Open E nde d - Equity : Dive rsifi ed - one Ye ar Return 150 100 50 0

NAV Return(%)

y . .. . B... ce.. . n I... e . .. a... quit .. . Eq.. ur. .. C L i E r c & ce n k l n a M L P n F llian Re lia ran e lia und DFC S P S PM Tat a u F R S H D D S A Fund

Interpretation:

The return of Equity diversification depends on the Fund Manager Ability and condition of stock market. Currently there is boom period in the stock market so there is wide scope of getting higher return is open, but all depend on the Mutual Fund company. We suggest that invest in DSPML Opportunities for invest.

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Open Ended - Debt: Short-term - one Year Return Fund First India Short-term ING Income Portfolio Short-term Chola Freedom Inc Short-term SundaramSelect Short-term JMShort-term SUN F&C FISF Medium-term

GrindlaysSSIShort-term Prudential ICICI Short-term KotakBondShortTerm TataShort-termBond

NAV 10.98 10.93 18.10 10.91 11.14 11.17

12.57 11.75 11.19 10.98

Return (%) 7.59 6.99 6.99 6.98 6.92 6.79

6.58 6.52 6.50 6.49


Open Ended - Debt: Short-term - one Year Return 20 15 10 5 0

NAV Return(%)

. .. m.. e. .. ... - term FI.. S.. l I... n... ort... . s o d ia Inc la Fr aram hort F&C d la y n t ia k Bo S h n I d S N rin ude o ta ata st G ho n Fir IN C Su J M S U G Pr K T

Fund

Interpretation:

The return in a Debt market is comparatively low as equity market, but it is also a less risky as compare to the equity market. We suggest that invest in First India short-term fund is good.

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49


Open Ended - Equity: Technology - one Year Return Fund SunF&CEmergingTech FranklinInfotech Chola FreedomTechnology Kotak Tech ING Growth Sectors Portfolio IL&FS Ecom

Magnum IT FranklinFMCG UTISoftware PrudentialICICIFMCG (Source:www.valueresearchonline.com)

NAV 3.82 16.84 10.92 3.91 8.89 3.53

7.19 13.56 9.69 10.85

Return(%) 15.41 19.18 23.11 23.29 25.04 25.18

25.92 26.97 27.17 37.87

Open E nded - Equity : Technology - one Yea r Return

40 30 20

NAV Return(%)

10 0

. h G e ... h M IT . g.. otec m.. Tec e... CO um MC war CIC r e f e n S F ft l I do k Em l in In ree o ta wth FS Mag kl in I So n tia & C n o K F k a UT ude IL Gr F& ra n ol a Fr n G h F Pr C IN Su

Fund

Interpretation:

Indian economy is currently in growing phase. There are so many changes in technological environmentThe oftop theequity country. Therereturn is good potential growthtable. of Technological investment. technology is shown in the above Kotak Tech is giving good return.

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Closed Ended - Debt: Speciality - one Year Return Fund SUN F&C Fixed Maturity Yearly Series 4 UTI MIP 2000 Prudential ICICI Fixed Maturity Plan Year Plus6 I UTI MIP 2000 (II) CholaLiquidSeriesApril2006

NAV 12.9 8.5

11.65 9 12.39

SUN 11.46 SUN F&C F&C Fixed Fixed Maturity Maturity Yearly Yearly Series Series 1 2 11.33 UTI MIP 99 (II) 9.17 UTI MIP 98 (IV) 9.17 SUN F&C Fixed Maturity Yearly Series 3 11.09 (Source:www.valueresearchonline.com)

Return (%) 24.84 15.75

11.6 8.84 8.39 7.81 7.14 7.07 6.99 6.78

Closed Ended - Debt: Spe cial ity - one Year Return 30 20 10 0

N SU

NAV Return(%)

... 8... 00 .. .. .. ... ... 9 9 ... 9 2 0 tial. 2. Liq. C C C P P I & & & I IP la I P en F F F I M TI M N I M rud TI M ho UN UN C U P UT UT U S S SU

C F&

...

Fund

Interpretation:

This Scheme is Close Ended one cannot sell his unit before the end of maturity to the Mutual Fund company. The return in a Debt market is comparatively low as equity market, but it is also a less risky as compare to the equity market. We suggest that invest in SUN F&C Fixed Maturity Yearly Series 4 fund is good.

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51


4.5 Comparison of Investment Product Investors tend to constantly compare one form of investment with another. However, such comparisons ought to be done carefully, comparing only options that are comparable. Until 1980s, Indian investors had bank deposits as virtually the only investment option. The only Mutual Fund scheme UTI’s US-64 Scheme was perceived by investors and managed as a fixed return investment, as safe as banks, and paying out comparable though slightly higher dividends. Later, the investors were introduced to direct investing on the stock markets including direct purchases of capital market securities in the primary markets. This form of high-risk investment was not perceived as such because of the under-pricing of primary share issues. Only after the crises of 1992 and the introduction of free market pricing of shares, the virtual guarantee of secondary market prices being higher than issue prices ended. Comparison by Nature of Investment and By Performance

There are tow kinds of comparisons possible among different investment options. First, one must compare the options by the nature of investments – their characteristics, benefits and risks. From this comparison will emerge certain types of investment, which may be considered superior to other types. Next, one needs to look at the specifics of each investment option in terms of its current performance and its suitability for the investor in the light of the investor’s specific situation (taxability, age, etc.). From this comparison at a given point of time will emerge the options considered superior to others for a given investor. 4.5.1

Comparison by Nature of Investment

Investors certainly look for the best returns on different options. However, to determine which option is better, the comparison should also be made in terms of other benefits that the investor ought to look for in any investment. Besides returns, other potential benefits of any investment also include the safety of the capital, the risk or the stability of returns, the liquidity of access to the funds when needed, and the convenience with which the investment can be managed. The table below compares the investment options discussed in the previous section under the broad heads viz. return, safety, volatility, liquidity and convenience.

Equity FI Bonds Corporate Debentures Company Fixed Deposits Bank Deposits PPF Life Insurance Gold Real Estate Mutual Funds LJIMS

Return High

Safety Low

Volatility High

Liquidity High/Low

Convenience Moderate

Moderate

High

Moderate

Moderate

High

Moderate

Moderate

Moderate

Low

Low

Moderate Low Moderate Low Moderate High High

Low Low High High High Moderate High

Low Low Low Low Moderate High Moderate

Low High Moderate Low Moderate Low High

Moderate High High Moderate Low Low High 52


Although the table provides a qualitative evaluation of various financial products, the comparison serves as a useful guide toward determining the best option. It is clear from the above that equity investing in general has good potential in terms of return, liquidity and convenience. However, as discussed in the previous section, individual stocks can give varied performance, one stock being more liquid than another or one stock giving lower return that another. For this reason, equity investing is fraught with risk and is not ideal for every individual investor. It is recommended only for investors who are willing to invest the time required for research in stock selection (or have access to sound financial advice) and possess the capacity to bear the inherent risk. Bonds issued by institutions are an attractive option, particularly now with the liquidity that accompanies their listing on stock exchanges. Bonds are a stable option in terms of fixed returns, and are recommended for the risk-averse investor. However, bonds can lose value when general interest rates go up. Bonds are also subject to credit risk or risk of default by the borrower. In indicated by the credit rating assigned to the bonds. In the absence of credit rating, it is extremely difficult for the investor to decide on the quality of the bonds or debentures. The secondary market in corporate bonds in India is also very thin, leading to lack of liquidity for the investors who wish to sell. Company fixed deposits fall short on several counts and recommended only if the issuing company and the deposits on offer are rated highly by credit rating agencies. The major advantage of bank deposits other productatisa the liquidity theyover offer. Banks are usually willing to give loansrelative against to fixed deposits nominal charge the interest rate applicable to the deposits. Deposit rates offered by banks vary as per RBI directives and the interest rate scenario in the economy. Bank deposits score high on safety, as the return of capital is guaranteed to the depositor by the bank. However, the financial soundness of the bank is important to look at. PPF combines stability with a respectable return. Its tax-exempt status makes it an attractive mechanism for the small investor to build his saving portfolio. However, the lock in period involved in PPF means that the investor loses out in terms of liquidity, particularly during the early years of the scheme. Being a government supported investment, PPF scores very high on safety, compared even to bank deposits. Insurance could become a serious investment vehicle once the insurance market in India is opened to private players. In today’s scenario, the opportunity cost in terms of return is too high for insurance to be compared on even terms with the other options. Its liquidity is also extremely low, though safety is considered high at present for the governmentowned LIC as the only insurer.

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4.5.2

Comparison by Current Performance

Besides the inherent advantages of investing through Mutual Funds, recent tax amendments have also helped to enhance the attractiveness of Mutual Funds. Dividends distributed by Mutual Funds are exempt from tax in the hands of the investor. Investments in recognized Mutual Funds also qualify for tax rebate under section 88 and as approved investments under Section 54EA/EB. Comparisons among different investment options are not valid for all time as the financial markets are now deregulated and dynamic, causing frequent changes in comparative returns form time to time. Each year, the Mutual Funds and other options may give different returns. For example, when the banks increase or reduce the deposit interest rates, the Mutual Funds performance may look better or worse. If the government changes the PPF interest rate, again there will be an impact on the comparative status of different options. Similarly, the individual taxpayer’s situation may change, whereby he may pay higher or lower tax on his income. That will make a difference in his after-tax return on different options. That is why; it is recommended that the specific comparisons of different investment options be made at a given point of time, using the then prevalent return data.

i.

Direct Equity Investment versus Mutual Fund Investing

Investors the Mutual option toFunds. investHowever, directly inaequities through the stock market investing have through practical evaluation reveals that instead Mutual of Funds are indeed a more recommended option for the individual investor. •

•

•

•

LJIMS

Identifying stocks that have growth potential is difficult process involving detailed research and monitoring of the market. Mutual Funds specialize in this area and possess the requisite resources to carry out research and continuous market monitoring. This is clearly beyond the capability of most individual investors. Another critical element towards successful equity investing is diversification. A diversified portfolio serves to minimize risk by ensuring that a downtrend in some securities/sectors is offset by an upswing in the others. Clearly, diversification requires substantial investment that may be beyond the means of most individual investors. Mutual Funds pool the resources of many investors and thus have the funds necessary to build a diversified portfolio, and by investing even a small amount in a Mutual Fund, an investor can, through his proportionate share, reap the benefit of diversification. Mutual Funds specialize in the business of investment management, and therefore employ professional management for carrying out their activities. Professional management ensures that the best investment avenues are tapped with the aid of comprehensive information and detailed research. It also ensures that expenses are kept under tight control and market opportunities are fully utilized. An investor who opts for direct equity investing loses out on these benefits. Mutual Funds focus their investment activities based on investment objectives such as income, growth or tax savings. An investor can choose a fund that has 54


•

•

•

investment objectives in line with his objectives. Therefore, funds provide the investor with a vehicle to attain his objectives in a planned manner. Mutual Funds offer liquidity through listing on stock exchanges (for closed-end funds) and repurchase options (for open-end funds). This is in contrast to direct equity investing where several stocks are often not traded for long periods. Direct equity investing involves a high level of transaction costs per rupee invested in the form of brokerage, commissions, stamp duty, etc. while Mutual Funds charge a management fee, they succeed in keeping transaction costs under control because of the economies of scale they enjoy. In terms of convenience, Mutual Funds score over direct equity investing. Funds serve investors only through their investor services networks, also through associates such not as banks and other distributors. Many funds allowbut investors the flexibility to switch between schemes within a family of funds. They also offer facilities such as check writing and accumulation plans. These benefits are not matched by direct equity investing.

The Investor Perspective: Funds Vs. Other Products Investment Risk Investment Objective Tolerance Horizon Capital Equity Appreciation High LongTerm Medium to Long FI Bonds Income Low Term CorporateDebentures Income H-M-Low TheSame Company Fixed Deposits Income TheSame Medium Generally Flexible All BankDeposits Income Low Terms PPF Income Low Long Term LifeInsurance RiskCover Low LongTerm Gold InflationHedge Low LongTerm RealEstate InflationHedge Low LongTerm Capital Growth, Flexible All Mutual Funds Income H-M-Low Terms

The comparison above highlights the flexibility offered by Mutual Funds from the investor’s perspective. An investors can choose from a wide variety of fund to suit his risk tolerance, investment horizon and investment objective. Bank Deposits offer similar flexibility in investment horizon and risk level, but only a fixed income. An investor looking for capital growth has to consider Mutual Fund, both equity and debt. Direct equity investment offers the capital growth potential, but a high risk and without benefits of diversification and professional management offered by Mutual Fund. Gold and real Estate are attractive only in high inflation economies. Other options are largely for the risk-averse, income-oriented investor. Mutual Funds present the widest choice to the investors.

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55


Banks v/s Mutual Funds

Returns Administrative exp. Risk Investment options Network Liquidity Qualityofassets Interest calculation

BANKS

MUTUALFUNDS

Low

Better

High Low Less High penetration At cost a Nottransparent Minimum balance between 10th. &

Low Moderate More Low but improving Better Transparent Everyday

30th. Of every month The Guarantee

MaximumRs.1Lakhondeposits

None

From the above table we can say that in overall comparison Mutual Fund is becoming strong option as investment against the Banks. It can be seen that the Banks are not totally free from risk, while generally giving lower returns. Mutual Fund can give higher returns then a Bank, even if there is no contractually guarantee as in a Bank. Mutual Fund provides better investment options as well as high liquidity compare to Banks.

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4.6 Investment Pyramid:

Interpretation:

The above investment pyramid shows the period for investment and the risk associated with the same. In Capital Growth, there is medium to high risk and the investment period is above the 5 years it includes the stocks and Growth fund. In Capital Growth & Current Income, which is, also known as balanced fund it is combination of Debt and Equity Fund and the time-pe riod of holding inv estment is 3 to 5 Years. Income Fund includes Bonds and Debentures. It gives regular income to the investor and time-period is 1 to 3 years. In Capital Preservation includes money market, liquid funds, short-term deposits, Govt. paper. In this time period is less than 1 year and low risk it contain.

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Chapter 5

Industry Analysis

5.1 OT Analysis 5.2 Five force Analysis 5.3 PEST Analysis

LJIMS

58


5.1 OT Analysis 5.1.1 Opportunities: 1. Market Risk:

Now a day’s investment is being riskier. Private Banks and company went in to scam or bankruptcy, so the investment market is very risky. Investor has to be very careful at the time of choosing right investment media. This fact of hasMutual been one ofisthe Mutual Industries. The it to objective Fund to opportunities minimize riskfor andthe increase theFund mutual benefit lead the way of success. 2. Interest Rate:

Govt. has let the interest rate down. Before some years the rate was around 13% so investor were preferred to invest in the bank deposit for getting higher return in the past. Now a day’s economic condition is strong which has let the interest rate down to 5 to 6%. This is an Opportunities for the Mutual Fund that it can give the more return on diversify portfolio management. Investor can get return more then he can anticipate. 3. Investment Pattern:

In present scenario, Investor’s investment pattern is getting higher return with a less risk. Before 5 to 6 year investor were trustworthier with Govt. and Post Office. While now a days they have diversify their investment pattern. This can led to success of Mutual Fund. Mutual Fund is only investment media where one can have all types of investment pattern. So it can be stated for investor’s attractiveness to the industry. 4. Investor’s Profile:

The literacy level in India is growing. Investors are being educated, so they consider all facts and have good investment opportunity. Mutual Fund can be well explained to the qualified investors. It is opportunity for concept the industry.

5. Bull Equity Market:

Currently equity market is in the boom period. The indexes are rapidly increasing. Sensex has crossed the level of 5000. The equity holders are getting more return or gains. Mutual Fund industry has good potential in the equity market. Investors can be pulled to the market with having investment in the equity scheme. LJIMS

59


Mutual Fund provides several types of equity Scheme that can easily track the equity investor’s perspective. It provides long term capital appreciation and as well as dividend. 6. Rapid growth in economy and saving:

Indian economy is currently in growing level. In the past the country was in underdeveloped country while now it is a developing country. The GDP growth is round about 6 to 7%. Economy has got success in reducing the inflation rate, which is 4.4%. The effect of this kind of economy is that the people have more income, while low inflation rate tends to increase in saving. This is good opportunity for the Mutual Fund industry. It can attract the investors by showing them the emergence of fund or diversification. 7. Commodities Fund:

With approval for the Real Estate Funds in place, there is a huge opportunity for Mutual Funds to explore values through investment in commodities, bullion, metal etc.

5.1.2 Threats: 1. Rules & Regulation:

Mutual Fund has to work under rules and Regulation guided by SEBI, AMFI and RBI. It has some limitation under the law. Law board has given protection to the investor this is the threats for the industry. 2. Investors Awa reness:

Still investors are not aware of the Mutual Fund and its scheme. Investors have lower awareness regarding the companies concerning with Mutual Fund. Some investors fill difficulty in understanding Mutual Fund concept and its scheme objectives. This unawareness has proved to be failure aspect for the industry. Industry cannot cover potential market. 3. Reachness:

Mutual Fund has failed to reach to the interior of the country. Currently major players have their market from metro and big cities. Still the way to the small towns and villages is open. Industry is in lack of Reachness.

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5.2 Porter’s Five-Force Analysis

Threat of new entrants

Rivalry Among competitio n sellers

Bargaining power of suppliers

Bargaining power of buyers

Threat of substitutes

1. Rivalry among competing sellers:

A. Types of Schemes: All companies provide different types of schemes, which are best, suited to the investor’s objectives. Companies in the industry are more and more concern to the investors objective and try to give them same. B. Better Services: In the industry companies are trying to provide better services to the investors. Competitors are providing better communication facility as well as the guidelines. C. Switching Cost: Rivalry is strong because of cost of switching the scheme is low. Investors can easily switchover to another company or scheme. When investor feels LJIMS

61


better return or security then he will switchover to the other company or scheme.

2. The potential entry of new competitors:

Until 1987, the UTI was the sole Mutual Fund in India. Then Banks, LIC and GIC floated Mutual Fund. In the past 1992 public and private financial institution with foreign collaboration came in the market. Thus we can see the entry of new competitors is high. Banking companies, NBFCs, Merchant Bankers, Insuranc es Companies are now entering into the Mutual Fund as the purpose of diversified business. New entrance increase in the competition and decline market share of exiting company. In the Mutual Fund industry the investor’s loyalty level is very low. So, the investors will switchover the new company, which gives him high returns. 3. Competitive Pressure from substitute products:

Equity shares, Bank Deposits, Insurance etc. are substitute of the Mutual Fund. Currently there is boom period in the stock market, as investor prefers to invest directly to the stock market. Risk aversion people prefer the insurance or post office schemes. New insurance company gives the better product and security for the long term plan.

4. Suppliers (Investor) Bargaining Power:

We can consid er the inves tor inves ting in Mutual Funds is the supplier of the company. For bargaining power to suppliers provide different scheme to the investor, which is reach, the investor objective like High Liquidity, High Return, Low Risk, Safety against investment. Investors prefer those securities, which fulfill their investment objective. There are so many companies in the market, which give different kinds of schemes. Investor can choose the best scheme according to his objective and bargain for the same. Companies are facing threats from the bargain power of investors. Investor can easily switchover the scheme and cost of switching is also low. Investor fully utilizes their bargain skill while choosing the fund.

5. Bargaining Power of Customer (Listed Companies):

We can consider the Listed Companies in Indian Stock market, Stock Market, Govt. Security, and Money Market etc. are the customers of the Mutual Fund. Blue chip companies attract the Mutual Fund companies to invest in their securities. Companies are more concentrate on Mutual Fund companies because of there is wide scope of investment in Mutual Fund.

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5.3 PEST Analysis 5.3.1 POLITICAL & LEGAL FACTOR: Regulation:

The Govt. of India constituted SEBI, by an act of Parliament in 1992, as the apex regulator of all entities that either raise funds in the capital markets or invest in capital market securities such as shares and debentures listed on stock exchanges. Mutual Funds have emerged as an important institutional investor in capital market securities The primary legal interface for all companie s is the registrar of companies (RoC). The department of company affairs in turn supervises rocs. The DCA forms part of the company law board, which is part of the Ministry of Law and Justice of the Govt. of India. The India Trust Act, 1882, governs Mutual Funds, being Public Trusts. The Board of Trustees or the Trustee Company is accountable to the Office of the Public Trustee, which in turn reports to the Charity Commissioner. These Regulators enforce provisions of the Indian Trusts Act, to be complied with by the fund trustees. If the Govt. comes with new regulation that severely restricts the pricing freedom of these companies resulting in negative outlook for the sector, the prices of all stocks in the sector could fall substantially resulting in severe erosion in the NAV of the fund. No one can do anything about it. A good fund manager would probably sell part of the fund before prices fall too much and wait for an opportune time to reinvest at lower levels once the dust has settled.

Recent legislative amendments to the SEBI Act have put SEBI on a better footing in terms of enforcement of proper market conduct. This should help reduce the extent of market malpractice and improve market efficiency. The UTI Act was repealed to break UTI into UTI-1 and UTI-2, with UTI-2 handed over to a new set of owners.

Tax Benefits:

Under Sec 54 EB if the capital gain portion (after indexation) of the sale proceeds are invested in Mutual Fund units and locked-in for a period of 7 years. The benefit under this section has been withdrawn by the finance bill 2000 and there for, the capital gains made up to the 31st march 2000 can only be invested under this scheme before the 30th September 2000, then after this benefit will no more be available. Exemption on dividends 10(33) The investor in a Mutual Fund is exempt from paying any tax on the dividend received by him from the Mutual Fund, irrespective of the type of the Mutual Fund. Exemption on dividends/interest/capital gains (Section 10 (23D)) LJIMS

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The Mutual Fund is completely exempt from paying taxes on dividends/interest/capital gains earned by it. While this is a benefit to the fund, it is the indirect benefit of unit holders as well.

Exemption on dividends for equity funds (Section 115R)

A Mutual Fund has to pay a withholding tax of 10% on the dividends distributed by it under the provisions of the prevailing I.T. Act putting them on par with corporate. However, if a Mutual Fund has invested more than 50% of its assets into equity shares, then it is exempt from paying any tax on the dividend distributed by it, for a period of three years till the year 2001-02, by an overriding provision. Tax benefit under section 88 of Income-tax Act for investments in Mutual Funds .

As per Income-tax Act, contributions made from taxable income in the specified investments qualify for a tax rebate @ 20% of the invested amount subject to a maximum investment ceiling of Rs.80, 000/- The rebate would be available in the year of investment. In case of Mutual Funds, the rebate under Section 88 can be availed of by investing in Equity linked saving schemes (ELSS). The basic features of ELSS schemes are: Any Mutual Fund can offer an open-ended ELSS. There is a 3-year lock-in period for the investment that is reckoned from the date of allotment Rebate can be claimed only up to a maximum investment of Rs.10, 000/- per financial year. Fund of Fund:

SEBI has allowed investing in fund of fund. Now the companies concern in the Mutual Fund business it can invest its fund in the other Mutual Funds company fund or its own other fund. Commodities:

SEBI has allowed funds to invest in commodities like Gold, Silver and Real Estate etc. Now companies have funds like Gold Fund, Silver Fund etc. FDI:

Overseas investment liberalized and flexibility allowed to overseas investor for flow of FDI. Changes in overseas investment by Mutual Funds. At present Mutual Funds are allowed to invest in ADRs/GDRs of Indian companies and rated foreign debt instruments/equity within an overall capital of US $ 1.0 billion with permission of SEBI and RBI. In order to simplify the procedure and to facilitate expeditious processing of investment proposals general permission within the capital. Once SEBI approval has been obtained. This general permission will be available until further notice. LJIMS

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5.3.2 ECONOMIC FACTOR

GDP Growth Rate:

The pick-up in growth of the Indian economy observed in 2001-02 was stronger than what had been initially anticipated. Data on quarterly GDP at factor cost at constant 1993-94 prices, available only for the first half of 2002-03, indicated that in the first and quarters of the current year, year, GDP grew by 6 percent and 5.8 percent -second rates that are markedly higher thanyear 3.5on percent and 5.3 percent respectively, registered in the corresponding periods of the previous year. The monsoon failure, however, affected agriculture severely, with agriculture and allied GDP declining by 3.1 percent, as per the advance estimates released by the CSO on February 7, 2003. Overall GDP growth in the current year is likely to be only 4.4 percent. This agriculture-pulled deceleration in growth, in 2002-03, clouds an across-the-board improvement in the growth performance of industry and services from 3.3 percent to 6.1 percent and from 6.8 percent to 7.1 percent, respectively, between 2001-02 and 2002-03. Indications are that, in spite of a severe monsoon deficiency, the rebound in growth observed since 2001-02 gained momentum in industry and services sectors in the current year. Till 1987 there was only one player in the market and it was UTI, but after that in 1988 public banks and in 1993 private players enter in the mutual fund industry. Afterwards industry is growing stage. In year 2000 after the scam of US64 scheme industry faced in decline stage. In year 2003 the Indian GDP for services is more then 7%. As the GDP increase the Mutual Funds industry also increase. Money Supply:

The money multiplier - the ratio of broad money (M 3) to reserve money - which had increased from 4.3 to 4.4 in the previous year, increased further to 4.8 as on January 10, 2003. In the current financial year up to January 10, 2003, broad money grew at 9.8 percent (net of merger of ICICI and ICICI Bank) as compared with 11.2 percent in the corresponding period of last year. The year-on-year growth in M 3, as on January 10, 2003, amounted to 12.8 percent (net of mergers) compared with 14.5 percent last year. As a money supply rate increase which increase in circulation of money in the market. The people who have access money, they want to do some investment. This is good opportunity for mutual fund industry. Interest Rate:

Facilitated by relatively lower inflation, interest rates continued to soften during the year. The RBI reduced the bank rate by 25 basis points to 6.25 percent in October 2002. At its present level, the bank rate is the lowest since 1973. The cash reserve ratio (CRR) was reduced by 50 basis points to 5.0 percent from June 1, 2002, and further to 4.75 percent from the fortnight beginning November 16, 2002. The PLR of five major commercial banks declined from 11.00-12.00 percent to 10.75-11.50 percent in the current year. A noticeable development in the current year is sub-PLR lending by commercial banks. LJIMS

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Yields on government securities continued to maintain their downward trend. The yield on 7.4 percent 12-year government paper reached a low of 6.13 percent on December 31, 2002. In present time the interest rate is come done to 3 to 4% and people wants to wants to get more return for their investment and mutual fund gives good return of the investment. So if the interest rate comes done, which increase the good opportunity for the mutual fund industry for getting more investment.

Inflation: The growth recovery was accompanied by continued macroeconomic stability in terms of low inflation, orderly currency market conditions and comfortable reserves. In the past, droughts, with their impact on price and availability of food grains, have been particularly harsh on the poor. In the current year, notwithstanding the deficient monsoon, there were no shortages in availability of essential commodities, or flare-ups in their prices. The 52-week average inflation rate based on the Wholesale Price Index (WPI) was only 2.6 percent in mid January 2003. Prices of primary products remained below 4 percent for the larger part of the year, while inflation in manufactured products was around 3 percent. The transition to a market-based pricing regime for petroleum products was also devoid of disruptions, with fuel group inflation barely touching 5 percent for much of the year. However, the latest Gulf-related uncertainty has caused fuel price inflation to touch 6.4 percent in mid-January, 2003. Inflation, as measured by the Consumer Price Index for industrial workers (CPI-IW) declined from 4.7 percent at the beginning of 2002-03 to 3.2 percent in December 2002. The abundant stocks of wheat (28.8 million tonnes on January 1, 2003) and rice (19.4 million tonnes on January 1, 2003) held by the Food Corporation of India (FCI), while complicating the task of agricultural diversification and fiscal consolidation, did however, help to quell inflationary pulls. Low inflation rate tends to higher savings and investment opportunities. In the current situation the rate is around 4%. Economy is trying to decrease the inflation rate as low as possible. Public Investment:

Public investment has been partly constrained by increasing government consumption expenditure, which includes expenditure on wages and salaries, commodities, and services for current use. As a proportion of total expenditure of the Central Government, it increased from 22.8 percent in 1990-91 to 23.6 percent in 1997-98, in the aftermath of the increase in wages and salaries following the recommendations of the Fifth Central Pay Commission. Although the share of wages and salaries in total expenditure declined from 11.1 percent in 1998-99 to 10.1 percent in 2001-02 (RE), the share of consumption expenditure in total expenditure again shows a rising trend from 2000-01. The share of consumption expenditure in total central expenditure rose from 21.9 percent in 2000-01 to 22.9 percent in 2001-02, and is budgeted to increase further to 23.2 percent in 2002-03. This is primarily due to a rise in the expenditure on commodities and services for current use.

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In 2001-02, gross and net domestic savings at current prices, grew by 11.8 percent and 13.3 percent respectively, to increase their share in GDP at market prices. Gross (net) domestic savings, as a proportion of GDP (NNP) at market prices, improved to 24.0 (16.0) percent in 2001-02, from 23.4 (15.4) percent in 2000-01 ( Table 1.3). The household sector was once again the best performer, with the increase in its gross savings exceeding the total increase in gross domestic savings. Households increased the share of financial savings in their total savings from 48.0 percent in 2000-01 to 49.8 percent in 2001-02. Private corporate savings increased roughly at half the rate of increase of household savings. The public sector not only continued to be a net dis-saver, but it increased its dissavings by nearly Rs 10,000 crore. The departmental enterprises became net dis-savers in 2001-02. The increased net dissavings of government administration more than neutralized the increased savings by non-departmental enterprises.

5.3.3 SOCIAL ENVIRONMENT: 

Code of Conduct:

The Trustees should abide by the code of conduct as specified below: •

•

Mutual Funds schemes should not be organized, operated, managed or the portfolio of securities selected, in the interest of sponsors, directors of asset management companies, members of Board of Trustees of Trustee Company, associated persons as in the interest of special class of unit holders other than in interest of all classes of unit holders of the scheme. Trustees and AMCs (I) must ensure the dissemination to all unit holders of adequate, accurate, explicit and timely information fairly presented in a simple language about the investment policies, investment objectives , financial position and general affairs of the scheme, (II) should avoid excessive concentration of business with broking firms, affiliates and also excessive holding of units in a scheme among a few investors, (III) must avoid conflicts of interest in managing the affairs of the schemes and keep the interest of all unit holders paramount in all matters, (IV) must ensure scheme wise segregation of bank accounts and securities accounts, (V) should carry out the business and invest in accordance with the investment objectives stated in the offer documents and take investment decisions solely in the interest of unit holders, and (VI) must not use any unethical means to sell, market or induce any investor to buy their schemes, (VII) should standard integrity (VIII) and fairness and in maintain the conduhigh ct of their tobusiness, renderinatallalltheir timdealings e high standards of service, exercise due diligence, ensure proper care and exercise independent professional judgment and (IX) the AMCs should not make any exaggerated oral/written statement either about their qualifications or capability to render investment management services or their achievement.



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Trustees should (I) be discerning in the appointment of the directors on the Board of the AMC, (II) review the desirability /continuance of the AMC if substantial irregularities are observed in any scheme and not allow it to float new schemes, (III) ensure that the trust property is properly protected, held and administered by proper persons and by a proper number of such persons, (IV) ensure that all service providers are registered with SEBI/concerned regulatory authority, (V) arrange for test checks of service contracts and (VI) immediately report to SEBI of any special developments in the Mutual Fund.



Specific Due Diligence:

The trustees should: •

• • •

• •

•

Obtain internal audit reports at regular intervals from independent auditors appointed by them; Obtain compliance certificates at regular intervals from the AMC; Hold meetings of trustees more frequently; Consider the reports of independent auditor and compliance reports of AMC at their meetings for appropriate action; Maintain records of decisions/minutes of their meeting; Prescribe and here to a code of ethics by the trustees/AMC and its personnel; and Communicate in writing to the AMC of the deficiencies and checking on the rectification of the deficiencies.

5.3.4 TECHNOLOGICAL ENVIRONMENT: Online Trading:

In Mutual Fund unit are traded in the stock market and present time the stock market become online i.e. on a terminal of the stock market any body can trade their units easily and very fast. Online trading and T+1 settlement become unit holders are becomes highly liquidate. Online Price Formation:

In Mutual Fund online trading is available so that by demand and supply rules the price of the units are changes respectively and load and no-load of particular fund are also consider in the price formation. NAV Fluctuation:

In Mutual Fund unit price known by the NAV and it is allowed trading in the stock market. So daily fluctuation done in the NAV of the Mutual Fund unit. In newspaper they show the NAV of the fund, Purchase price and sell price is given.

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Chapter 6 Regulatory Aspects

6.1 Regulatory Aspects 6.2 Tax Benefits of Mutual Fund 6.3 Role of Regulators in India

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6.1 Regulatory Aspects

Schemes of a Mutual Fund •

•

•

•

The asset management company shall launch no scheme unless the trustees approve such scheme and a copy of the offer document has been filed with the Board. Every Mutual Fund shall along with the offer document of each scheme pay filing fees. The offer document shall contain disclosures which are adequate in order to enable the investors to make informed investment decision including the disclosure on maximum investments proposed to be made by the scheme in the listed securities of the group companies of the sponsor a close-ended scheme shall be fully redeemed at the end of the maturity period. "Unless a majority of the unit holders otherwise decide for its rollover by passing a resolution".

The Mutual Fund and asset management company shall be liable to refund the application money to the applicants, -

If the Mutual Fund fails to receive the minimum subscription amount referred to in clause (a) of sub-regulation (1); (ii) If the moneys received from the applicants for units are in excess of subscription as referred to in clause (b) of sub-regulation (1). (i)

•

The asset management company shall issue to the applicant whose application has been accepted, unit certificates or a statement of accounts specifying the number of units allotted to the applicant as soon as possible but not later than six weeks from the date of closure of the initial subscription list and or from the date of receipt of the request from the unit holders in any open ended scheme.

Rules Regarding Advertisement: •

The offer document and advertisement materials shall not be misleading or contain any statement or opinion, which are incorrect or false.

Investment Objectives and Valuation Policies: •

The price at which the units may be subscribed or sold and the price at which such units may at any time be repurchased by the Mutual Fund shall be made available to the investors.

General Obligations:

Every asset management company for each scheme shall keep and maintain proper books of accounts, records and documents, for each scheme so as to explain its LJIMS 70 •


•

•

transactions and to disclose at any point of time the financial position of each scheme and in particular give a true and fair view of the state of affairs of the fund and intimate to the Board the place where such books of accounts, records and documents are maintained. The financial year for all the schemes shall end as of March 31 of each year. Every Mutual Fund or the asset management company shall prepare in respect of each financial year an annual report and annual stateme nt of accounts of the schemes and the fund as specified in Eleventh Schedule. Every Mutual Fund shall have the annual statement of accounts audited by an auditor who is not in any way associated with the auditor of the asset management company.

Procedure for Action In Case Of Default: •

On and from the date of the suspension of the certificate or the approval, as the case may be, the Mutual Fund, trustees or asset management company, shall cease to carry on any activity as a Mutual Fund, trustee or asset management company, during the period of suspension, and shall be subject to the directions of the Board with regard to any records, documents, or securities that may be in its custody or control, relating to its activities as Mutual Fund, trustees or asset management company.

Restrictions on Investments: •

•

•

•

•

•

•

A Mutual Fund scheme shall not invest more than 15% of its NAV in debt instruments issued by a single issuer, which are rated not below investment grade by a credit rating agency authorized to carry out such activity under the Act. Such investment limit may be extended to 20% of the NAV of the scheme with the prior approval of the Board of Trustees and the Board of asset Management Company . A Mutual Fund scheme shall not invest more than 10% of its NAV in unrated debt instruments issued by a single issuer and the total investment in such instruments shall not exceed 25% of the NAV of the scheme. All such investments shall be made with the prior approval of the Board of Trustees and the Board of asset Management Company. No Mutual Fund under all its schemes should own more than ten per cent of any company's paid up capital carrying voting rights. Such transfers are done at the prevailing market price for quoted instruments on spot basis. The securities so transferred shall be in conformity with the investment objective of the scheme to which such transfer has been made. A scheme may invest in another scheme under the same asset management company or any other Mutual Fund without charging any fees, provided that aggregate interscheme investment made by all schemes under the same management or in schemes under the management of any other asset Management Company shall not exceed 5% of the net asset value of the Mutual Fund. The initial issue expenses in respect of any scheme may not exceed six per cent of the funds raised under that scheme. Every Mutual Fund shall buy and sell securities on the basis of deliveries and shall in all cases of purchases, take delivery of relative securities and in all cases of sale, deliver the securities and shall in no case put itself in a position whereby it has to make short sale or carry forward transaction or engage in badla finance.

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•

•

Every Mutual Fund shall, get the securities purchased or transferred in the name of the Mutual Fund on account of the concerned scheme, wherever investments are intended to be of long-term nature. Pending deployment of funds of a scheme in securities in terms of investment objectives of the scheme a Mutual Fund can invest the funds of the scheme in short term deposits of scheduled commercial banks. No Mutual Fund scheme shall make any investment in; ii. Any unlisted security of an associate or group company of the sponsor; or iii. Any security issued by way of private placement by an associate or group company of the sponsor; or

The listed securities of group companies of the sponsor, which is in excess of 30% of the net assets [of all the schemes of a Mutual Fund] •

•

No Mutual Fund scheme shall invest more than 10 per cent of its NAV in the equity shares or equity related instruments of any company. Provided that, the limit of 10 per cent shall not be applicable for investments in index fund or sector or industry specific scheme. A Mutual Fund scheme shall not invest more than 5% of its NAV in the equity shares or equity related investments in case of open-ended scheme and 10% of its NAV in case of close-ended scheme.

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6.2 Tax Benefits of Mutual Funds The tax benefits for investing in Mutual Funds are as follows: 

Investments in ELSS (Section 88).

20% of the taxable income invested in specified Mutual Funds. (Called equity schemes or ELSS i.e. "tax savings schemes"), is deductible from linked the tax savings payable by an investor. The maximum rebate available is 20% on an investment of Rs.10, 000/- in ELSS (i.e. Rs.2000/- in any financial year). 

Capital Gains (Section 54EA and 54EB).

Capital gains are the difference between the purchase price and the sale price of an asset. When a capital asset is sold, be it real estate or financial assets such as Mutual Funds, shares etc, the capital gains made on account of this sale is subject to capital gains tax. Sec 54 EA and EB provide for complete exemption from capital gains tax if investments are made in Mutual Fund units. The specific conditions, which entitle the investor for a total exemption from Capital Gains tax on sale of any long-term capital asset, are: Under Sec 54 EA if the entire sale proceeds are invested in Mutual Fund units and locked-in for a period of 3 years. Under Sec 54 EB if the capital gain portion (after indexation) of the sale proceeds are invested in Mutual Fund units and locked-in for a period of 7 years. The benefit under this section has been withdrawn by the finance bill 2000 and there for, the capital gains made up to the 31st march 2000 can only be invested under this scheme before the 30th September 2000, then after this benefit will no more be available. 

Exemption on dividends 10(33)

The investor in a Mutual Fund is exempt from paying any tax on the dividend received by him from the Mutual Fund, irrespective of the type of the Mutual Fund.



Exemption on dividends/interest/capital gains (Section 10 (23D))

The Mutual Fund is completely exempt from paying taxes on dividends/interest/capital gains earned by it. While this is a benefit to the fund, it is the indirect benefit of unit holders as well.

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

Exemption on dividends for equity funds (Section 115R)

A Mutual Fund has to pay a withholding tax of 10% on the dividends distributed by it under the provisions of the prevailing I.T. Act putting them on par with corporate. However, if a Mutual Fund has invested more than 50% of its assets into equity shares, then it is exempt from paying any tax on the dividend distributed by it, for a period of three years till the year 2001-02, by an overriding provision. Tax benefit under section 88 of Income-tax Act for investments in Mutual Funds.

As per Income-tax Act, contributions made from taxable income in the specified investments qualify for a tax rebate @ 20% of the invested amount subject to a maximum investment ceiling of Rs.80, 000/- The rebate would be available in the year of investment. In case of Mutual Funds, the rebate under Section 88 can be availed of by investing in Equity linked saving schemes (ELSS). The basic features of ELSS schemes are: Any Mutual Fund can offer an open-ended ELSS. There is a 3-year lock-in period for the investment that is reckoned from the date of allotment Rebate can be claimed only up to a maximum investment of Rs.10, 000/- per financial year. Capital gain and how is it charged to tax in case of Mutual Funds. Capital Gains are profits or gains arising from the sale or transfer of a capital asset such as shares and securities, Mutual Funds, house, jewllery, etc. These gains are charged to Income tax under the head "Capital Gains" in the financial year in which the transfer of capital asset takes place.

The profit/loss on sale of units of a Mutual Fund are charged to Capital Gains Tax as follows: 



In case the units are sold within 12 months of investment, the profit or loss on such sale is treated as short-term capital gain and charged to tax as normal income. In case the units are sold after 12 months of investment, the profit or loss on such sale is treated as short-term capital gain and charged to tax at a lower rate of:

20% of the difference between the transfer price and indexed cost of acquisition. 10% of the difference between transfers price and cost of acquisition securities until September 30, 2000 to avail of benefit under this section.

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6.3 Regulators in India SEBI- The Capital Market Regulator

The Govt. of India constituted SEBI, by an act of Parliament in 1992, as the apex regulator of all entities that either raise funds in the capital markets or invest in capital market securities such as shares and debentures listed on stock exchanges. Mutual Funds have emerged as an important institutional investor in capital market securities. Hence they come under the purview of SEBI. SEBI requires all Mutual Funds to be registered with them. It issues guidelines for all Mutual Fund operations including where they can invest, what investment limits and restrictions must be complied with, how they should account for income and expenses, how they should make disclosures of information to the investor and generally acts in the interest of investor protection. Other entities that SEBI also regulates are companies when they issue equity or debt, share registrars, custodians, bankers in the primary markets, stock exchanges and brokers in the secondary markets, and foreign and institutional investors such as FIIs, offshore Mutual Funds with dedicated Indian Mutual Funds or venture capital investors. RBI – the Money Markets Regulator •

RBI as Supervisor of Bank-Owned Mutual Funds: Public sector banks started the first non-UTI Mutual Funds. Banks come under the regulatory jurisdiction of the RBI. Therefore, the operations of bank-owned Mutual Funds are governed by guidelines issued by the Reserve Bank of India. Subsequently, it has been clarified that all Mutual Funds, being primarily capital market players, come under the regulatory umbrella of SEBI. Thus, the bank-owned funs continue to be under the joint supervision of both the RBI and the SEBI. It is generally understood that all market related and investor related activities of the funds are to be supervised by SEBI, while any issues concerning the ownership of the AMCs by banks fall under the regulatory ambit of the RBI. For example, if banks as funds sponsors have offered assured return schemes, RBI would have to review the capital adequacy and financial implications of the guaranteeing bank. Any fund mergers of bank-sponsored funds with others will also involve RBI approvals. However, the RBI guidelines on bank funds avoid issuing instructions on investment and market operations that may conflict with SEBI instructions.

•

RBI as Supervisor of Money Market Mutual Funds: Reserve Bank of India is the only government agency that is charged with the sole responsibility to control the money supply in the country. They also, therefore, have the sole supervisory responsibility over all entities that operate in the money markets, be it banks and companies that issue securities such as certificates of deposit or commercial paper, or banks and Mutual Funds who are allowed to borrow from or lend in the call money market. For this reason, if a Mutual Fund manager offers a Money Market Mutual Fund scheme; such MMMF has to abide by the policies laid down by the RBI.

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Money Market Mutual Funds are regulated by RBI guidelines dated 23-111995 specially issued for the purpose. The following are the salient features of these guidelines: •

•

•

• •

•

Banks, institutions and private sector are allowed to set up MMMFs. There are no restrictions on fund size. Private sector MMMFs must however obtain clearance from SEBI to ensure that they do not infringe SEBI Guidelines on money market investments. MMMFs can invest in treasury bills, government securities with an unexpired maturity up to one year, call and notice money, commercial bills accepted by of deposit. MMMFs canbanks be setand upcertificates as Money Market Deposit Accounts (MMDAs) or MMMFs. Units of MMMFs can only be issued to individuals. Resources raised under MMMFs set up by banks are not subject to reserve requirements. Setting up of MMMFs requires the prior approval of RBI.

Recently, it has been decided that MMMF’s of registered Mutual Funds will be regulated by SEBI, and SEBI is to frame guidelines for such funds. Ministry of Finance:

The Ministry of Finance, which is charged with implementing the government policies, ultimately both the RBI and the Besides beingthethe ultimate policy making andsupervises supervising entity, the MOF hasSEBI. also been playing role of an appellate authority for any major disputes over SEBI guidelines on certain specific capital market related guidelines- in particular any cases of insider trading or merger and acquisition.

Company Law Board, Department of company affairs and register of companies:

Mutual Fund Asset Management Companies corporate trustees are companies registered under companies act 1956 and therefore answerable to regulatory authority empowered by the companies act. The primary legal interface for all companies is the Registrar of companies (RoC). The department of company affairs in turn supervises rocs. The DCA forms part of the company law board, which is part of the Ministry of Law and Justice of the Govt. of India. The RoC ensures that the AM, or the trustee company as the case may be is in compliance with all companies act provisions. All AMC accounts and records are filled with the RoC, who may demand additional information and documents from the company. The RoC plays the role of a watchdog with respect to regulatory compliance by companies. The overall responsibility for formulating and modifying regulation relating to companies lies with the DCA. The DCA has legal power to prosecute company directors for failure LJIMS

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to comply with any of company’s law provisions as also for non repayment of deposits or frauds and other offences. The company law board (CLB) is the apex regulatory authority under the companies Act. While the CLB guides the DCA, another arm of the CLB called the company law bench is the appellate authority for corporate offences. The company Law Board is a body specially constituted by the central Government for carrying out judicial proceeding with respect to company affairs. Since Mutual Fund AMCs are companies, the CLB’s role assumes importance. Member of a company who feel that the company is being managed in a manner which is oppressive to any member or which is against public interest or the company’s interests can appeal to the CLB for redressal. The CLB, in such cases, may regulate the conduct of the company’s affairs, have the shares of the aggrieved members purchased by other members and/or terminate/modify the company’s arrangement with the managing director, other director(s) or senior officials. The CLB has the legal standing of a civil court, and may call for inspection of documents, enforce attendance and examine witness on oath and pass judgments in the same manner as a civil court. Any person aggrieved by a decision of the CLB may appeal to the High Court.

As the members of AMC or Trustee companies will usually be the sponsors and their joint venture partners or associates, it is unlikely that Mutual Fund investors will have anything to do with any of these regulators. The authorities would generally regulate the AMCs whose shareholders may have recourse to them in specific cases.

Stock Exchanges Stock Exchanges are self regulatory organization supervised by SEBI. Many closed-end schemes of Mutual Funds are listed on one or more stock exchanges. Such schemes are subject to regulation by the concerned stock exchanges through a listing agreement between the fund and the stock exchange. Exchange Rules and the companies Act provisions would generally decide on trading clearing, transfer and settlement of the buying and selling of Mutual Fund units on the markets. Funds or AMCs do not get directly involved with purchase and sales of units of such listed closed-end schemes, as the registrars handle all such transfers as in case of shares.

Office of the Public Trustee The India Trust Act, 1882, governs Mutual Funds, being Public Trusts. The Board of Trustees or the Trustee Company is accountable to the Office of the Public Trustee, which in turn reports to the Charity Commissioner. These Regulators enforce provisions of the Indian Trusts Act, to be complied with by the fund trustees.

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Chapter 7

Guidelines for Investing in Mutual Fund 7.1 Choosing a Fund 7.2 Selection Of Fund 7.3 Expenses 7.4 Reason for Investing in Debt/Income Mutual Fund 7.5 Risk & Return Graph 7.6 Performance Measure of Mutual Fund 7.7 Fund Rating 7.8 Searching Your Scheme

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7.1 Choosing a Fund Choosing a fund is similar to choosing a stock. As with a stock, you need to do research and decide which fund is best for your investment goals. If you have a short time horizon and are reasonably risk adverse you may want to consider growth and income funds. If you are investing for the longer-term and feel like you can take a risk, you may want to look at aggressive growth funds. Afterlike choosing willyou need look specific funds.AThe Ameritrade site, others aonfund the category, Web, willyou allow to to look upfor funds by family. fund family is the group of funds run by one company. At some sites, you can also view a Mutual Fund screen. In a fund screen, you can enter criteria that you would like to find in a fund. For example, you can search for no-load growth and income funds having investment returns greater than 5%. This Fund Fact screen will provide much of the information you need to make an informed decision. The information you should look for is outlined below. Basics - This section provides basic information on the fund such as the fund family, its categories, its NAV, and how much it has invested in the market. Minimums - Some funds have minimum initial and subsequent investments of $1000 or more. Note that these minimums may vary for regular investments and IRAs. Fees - This section lists all the fees involved with buying into, carrying and/or selling your shares in the fund. The list should include the loads, the 12b-1 fees, the management fee and the expense ratio. Fundamental Statistics -This section provides some important statistics that are described below:

Portfolio Turnover - This tells you how much a fund trades in its stock. If its turnover is 100% or greater it means that it changes its entire portfolio at least once a year. A fund having higher turnover will have more expenses. Again, this can be positive or negative, but it is up to you to research the reasons and decide whether or not you want to invest. Alpha of ato fund, given itsthat risk. In other words, it given takes the the returns -ofMeasures the fund the andperformance compares them the returns would be predicted market's performance and the fund's beta. If Alpha is positive, it means the fund outperformed expectations. If it is negative, then the fund under performed against expectations. Beta - Represents the risk of the fund in relation to the stock market as a whole as represented by the S&P 500 Index. The S&P 500 Index has a beta of 1.00. If a Mutual Fund has a beta of 1.25 it means that its portfolio is 25% riskier than the market as a whole. If it has a beta of 0.75 then the fund carries 25% less risk than the market as a LJIMS

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whole. If two funds with the same investment objective have the same returns you may want to compare their betas. Standard Deviation - Measures the range of performance by a Mutual Fund. It shows how volatile the returns of a fund are over a 3-year (generally) period of time. Ninety-five percent of the time, a fund will perform within 2 standard deviations of its mean or average. This means that if a fund has a 10% return and a Standard Deviation of 5%, it has exhibited returns between 0% and 20%, ninety-five percent of the time. If you have to choose between two funds with the same average returns and you are more risk averse, you may want to consider the fund with the lower standard deviation. R-squared - Is the correlation (between 1 and 100) of the fund to the stock market as measured by an index, normally the S&P 500. For example, if a fund has an R-Squared of 90, 90 percent of the movement was due to the market; not to the actions of the fund manager. This number can help you decide whether or not the beta is relevant to the fund's performance. If the number is high, then the beta is a more relevant measure of fund risk compared to the R-squared correlation. If it is low, then the fund's beta is not as important a measure of its risk. Operations - Provides the basic information about the fund such as the address, phone number and Web site. Most importantly, it provides you with a profile of the fund manager. This is important because managers have individual styles and different track records. If a fund has a new manager, their investment pattern and track record could diverge dramatically from the past performance of the fund. Investment Objective and Graph - This is a description of how the fund views its investments. It tells you the categories of stocks it invests in and might tell you one of the rankings from a rating agency. It can also tell you the top holdings of the fund, which will give a clearer picture of the manager's philosophy. Historical Data - Shows the history of the fund, including total returns, which are the returns of the fund including all expenses incurred during the year. It also shows the best and worst returns for a period. There is a caveat in looking at historical data; one year will not necessarily be reflective of the next year. Conditions will vary from year to year, as will returns. Allocations - This table will allow you to evaluate a fund's risk and investment philosophy by looking at the types of assets in the portfolio, the sectors they invest in and their top 10 holdings. Over time, you can compare these numbers to get a feel for how long a fund holds investments or assets. This can be valuable information in deciding whether the fund's philosophy and risk matches your own.

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7.2 Selection of Mutual Fund      

How to choose a scheme Specify investment needs Assess the risk one can take Ask: How long can one park his/her cash? Getting the right fund A mixed basket for diverse needs

7.2.1 How to choose a Scheme

Funds and more funds. There is no end to verbosity when educating on funds. But getting to actually choose a fund may not be eased with more funds. It often turns out, like with most ventures in life, that picking your fund is like crossing the saddle point – the first time is always the most difficult. There are more than 350 schemes and choosing one of them is not an easy task. We will provide you an easy way to filter this huge number down to a more manageable size so that you can look spend more time looking at schemes in greater detail. What are you looking for when investing in Mutual Funds? What are your investment needs? The more well defined these answers are the easier it is to find schemes best for you. So how do you assess your needs? The answers obviously lie with you. But the questions investors ask to assess their needs are possibly the same. You might ask yourself: At my age what am I expecting out of investing? To assess the needs investors look at their lifestyles, financial independence, family commitments, and level of income and expenses among other things. The father of an aspiring engineer who would have to shell out the boy's institute fees soon enough, could reply: I want a fixed monthly income of about Rs.5000 per month. To the second query he might say: Yes, for the next four years. When asked, the just-out-ofB-school graduate planning for his new Zen could reply: I should make about Rs. 60,000 by the end of one year. Believe us, but getting the right answers to these questions does a lot to simply your fund picking exercise. Having defined the needs that direct you to invest, one can find a category of funds that come close to satisfy your needs with their objectives. While we are on the topic of what returns to expect, someone might as well wish for a fund that assures returns. Some of the Mutual Funds have floated "assured" return schemes that guarantee a certain annual return or guarantee a buyback at a specified price after a specified period. Examples of these include funds floated by the UTI, SBI Mutual Fund, etc. Many of these funds have not earned returns that they promised and the asset management companies of the respective Mutual Funds or their sponsors have made good their promises. Nowadays, there are very few funds that come out with such schemes as the funds have realized it is not viable to assure returns in a volatile market.

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7.2.2 Assess the risk one can take

Contrary to the commonplace thinking, Mutual Funds do carry risks. And there are some that can become as risky as stocks. Given the almost diverse objectives with which schemes operate, there are some with more risks and some relatively safer. Ask yourself if you are ready for a scheme whose investment value might fluctuate every week or one that gives a minimum amount of risk? Or are you in for a short-term loss in order to achieve a long-term potential gain? At this point it is good to ask oneself how will you take it if your investment fails to deliver the returns you expected or makes losses. Knowing this will reduce your chances (or even temptation) to select a fund that doesn’t come close to your objective. Evaluate a scheme by looking at how its NAV has behaved over the past. Do you see the scheme behaving rather erratically i.e., the NAV changes just too often? More the volatility more is the risks involved. Great returns are not the only thing to look for in a scheme. If you feel while researching a scheme, which we will do later, that it’s returns are modest and steady and good enough for your needs avoid other schemes that have recently delivered high returns. Because great returns in the past is no guarantee for the fabulous performance to continue in the future. Never forget one of the commonplace morals of investment: The schemes that are expected to give the highest returns have the greatest probability to fall flat! Investors comfortable with numerical recipes do a technical check of what the returns of a scheme would be in the worst case. They check is done with the Sharpe ratio. The higher the Sharpe ratio, the better the fund's historical risk-adjusted performance.

7.2.3 Ask: How long one can you park his/her cash ?

Is the cash you have earmarked for your investment meant to be spent for something else? Do you need a regular cash flow? Or you don’t mind locking your cash in the scheme so that your assets can appreciate over time? Settle this question upfront on what your cash flow requirements will be till the time your money is invested in Mutual Funds. 7.2.4 Getting the right Fund

The success of your investment depends in a large measure on the objective you define. Having defined that, choosing a fund isn’t difficult. Through a search of schemes on our advanced search you can draw up a list of schemes that come close to the objectives you have set. Our search allows you to set criteria based on your objectives. The criteria you can set are:

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The scheme’s expense: All schemes have a minimum requirement for the total amount of money you can invest. Usually they begin from a minimum of Rs.5000. Do a check for the expense ratio and sales charges the fund has. The NAV is good enough to know what each unit of the scheme will cost you. But, remember a low NAV (sometimes even below the usual offer price of Rs.10) may make a scheme more affordable as you can acquire more units but chances are the scheme is not performing well. The scheme’s performance: Returns from schemes are calculated over various periods from a week to one year or more. For each time period specify the returns. While you enter returns figures the maximum, minimum and average returns for all schemes in the category you have chosen are also displayed. The scheme’s fund house: Over the years fund houses in India have established a name for themselves for their investment style and their performance. Hence, some investors usually try to satisfy their diverse investments through one fund house. If you have been recommended a fund house choose the fund to list all schemes under it. Investment mix: If you know of an industry that has been doing particularly well, you can select schemes that have invested in that industry. You can also select schemes that have invested in companies with a dazzling performance.

7.2.5 A mixed basket for diverse needs

Once again, back to the basic question. You came here looking for schemes that can suffice your investment needs. You might be like many others who actually have multiple needs. Consider going for a combination of schemes. Yet another recap of the basics: one of the things that made these Mutual Funds great was diversification. While you might have selected a scheme that has a diversified portfolio, you can also go for more than one scheme to further diversify your investments. It is well possible that just by picking more than one scheme from one fund house you can achieve enough diversification. In fact many investors who have tried out a fund house for long and developed a trust with the fund, prefer to pick another scheme from the fund's basket for their new investment needs. But convenience sometimes leads to venerable prejudices that might deprive you of trying something new and better. There could be a better-managed scheme in a different fund house that you are missing out on if you decide to stick to your old fund house for convenience sake.

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7.3 Expenses It's a trick company ads often do. A tempting offer is always accompanied with the fine print tucked in a corner at the bottom of the ad. And sometimes reading the applied conditions in the fine print might squeeze all the attractiveness out of a great sounding offer. Buying a scheme also requires that you give a careful look at the fine print. Look for one thing in the fine print: the scheme's expenses. One such expense is the bomb of a salary paid to the investment experts who manage the fund. Apart from management fee there is also the money the fund spends on advertising and marketing a scheme. There is a host of operating expenses from buying stationery to maintaining the fund house's staff. Should it matter to you if the fund house purchases a new computer? It does. In whatever way the fund spends the money; the net expenses are all billed in one way or the other to the unit holder. The expenses of a scheme do not include brokerage commissions. The part of Mutual Fund assets that gets removed each year for expenses expressed as a percentage is the expense ratio. It provides a quick check of efficiently the fund manager is handling the fund. The costs of the fund management process that includes marketing and initial costs are charged when you enter the scheme. These charges are term ed the entry load; the additional charge you pay when you join a scheme and something everyone will tell you to watch out for. And if there is nothing to watch out for, i.e., the bold font in the new scheme's ad says `No entry load'. Will you jump for it? Come on, investment was all about smartness. No fund can do away with these charges unless, of course, a reformed Harshad Mehta decided he would help Indians make money without charging a rupee. What funds that come with such offers usually do is to include these charges not in the entry load but somewhere else. It could also be deducted from the returns that you get. Just like entry load some funds impose a fee when you leave the scheme, i.e., redeem your units, called the exit load. Loads are usually not flat amounts but have a structure. For example, for most schemes the entry load depends on the number of units of the scheme you buy. Similarly, exit load in most cases is based on the number of units you sell and also on the duration for which you held those units. As per SEBI regulations, the maximum exit load applicable is 7%. There is a further stipulation by SEBI that the entry load and exit load put together cannot exceed 7% of the sale price. Contingent Deferred Sales Load (CDSL) is a charge imposed when the units of a fund are redeemed during the first few years of ownership. Under the SEBI Regulations, a fund can charge CDSL to unit holders exiting from the scheme within the first four years of entry. Funds can change the load structure periodically. If you are a unit holder of a scheme that charges an exit load, and the scheme change its exit load structure, then you will get a prior notice of the change. The new structure will be applicable to you rather than the load structure you were informed about when you joined the scheme. LJIMS

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Now don't get too hassled about loads. Best thing to do when a scheme imposes a new load, is not to invest more money if the load charged is unreasonable. Needless to say, loads if any are only applicable to open schemes. And not close-ended schemes because you can only buy such units from the fund only when the scheme is launched. So what's the smart tip? Any day, lower the expenses the better it is. Smart and wellmanaged funds keep their expenses low. Smarter funds know exactly how to make their offerings attractive by smartly tucking away expenses either in entry load or exit load or by cutting on returns. And smart investors always get to beat the funds by figuring out where all the expenses are included. Right? Looking at the past performance you cannot for sure predict what returns the fund will give in the future. However, by examining past performance you can get an almost certain idea of what the expenses for a scheme could be in the future. That's because the expenses don't depend on a scheme performance. It's dependent on the deftness of the fund manager. Badly managed funds that have schemes with consistently higher expenses compared to funds of the same category with lower expenses, find it tough to curb their expenses. Schemes with smaller assets to manage and particularly those that are not part of a large fund house will generally have higher expenses relative to schemes with larger assets. Fresh schemes generally take some time to overcome their expense burden.

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7.4 Reason for Debt/Income Mutual Funds (Fixed interest instrument) The returns differ from year to year on account of the following reasons: An income fund invests in instruments from which it earns two kinds of returns – The first comes from interest income. The second comes from any increase in the market price of invested instruments. The second component could also be negative when there is a fall in the market value of the invested instruments. The rise and fall in market prices of debt instruments is a function of the prevailing interest rates. Thus changes in interest rate environment cause fluctuations in returns. Secondly, income Mutual Funds invest in an array of instruments with different maturity. Whenever any debt instrument in which the fund has invested is redeemed, the redemption proceeds have to be reinvested in a fresh instrument(s). This fresh investment would earn a rate of return depending on the prevailing interest rate, which could be higher or lower than that prevailing in the earlier period. Accordingly, the overall return of the portfolio will change. A third reason can be active view taking by the fund manager e.g. a fund manager can take a view that interest rates are expected to rise. Accordingly, he would disinvest a large part of his holdings and convert them into cash so as to avoid loss in the value of his holdings. If this view is wrong, he may end up having a low return on a large part of his portfolio, since cash is invested in low yielding money market avenues. On the other hand, if the view is right, the cash can be deployed in higher yielding instruments after interest rates rise, thus improving the overall return and more important avoiding the loss. There is a fourth reason, which is relevant only for open-ended income funds. Such funds have a fluctuating level of idle cash (depending on the level of fresh collections), which is typically invested in low yielding money market instruments. This causes change in the rate of return. Lastly, there is always the possibility of a credit loss for any income Mutual Fund i.e. losses arising out of default in any of the instruments in which the fund has invested. The fund will declare a low return in the period in which such losses show up.

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7.5 Risk & Return Graph

As Per The Different Schemes Offered By The Mutual Fund Companies

7

In vestment Graph

6

Sec tor funds

5

Growth funds

n4 r u t e R3

Balanced funds Debt funds

2 1

Liquid funds Gilt funds

0 Risk

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7.6 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 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 their selection of stocks. In other words, there must be some performance indicator that will reveal the quality of stock selection of various AMCs. Return alone should not be considered as the basis 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 fluctua tions 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, fluctuations due to specific securities present in the portfolio of the fund, called unsystematic risk. The Total Risk of a given fund is sum of these two and is measured in terms of standard deviati on 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 market. While unsystematic risk can be diversified through investments in a number of instruments, systematic risk cannot. By 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 order to determine the risk-adjusted returns of investment portfolios, several eminent authors have worked since 1960s to develop composite performance indices to evaluate a portfolio by comparing alternative portfolios within a particular risk class. The most important and widely used measures of performance are:  

The Treynor Measure The Sharpe Measure



Jenson Model



Fama Model

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Developed by Jack Treynor, this performance measure evaluates funds on the basis of Treynor's Index. This Index is a ratio of return generated by the fund over and above risk free rate of return (generally taken to be the return on securities backed by 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 and positive Treynor's Index shows a superior risk-adjusted performance of a fund, a low and negative Treynor's Index 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 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, 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 performance of a fund, a low and negative Sharpe Ratio 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 diversified portfolios or individual stocks. For a well-diversified portfolio the total risk is equal to systematic risk. Rankings based on total risk (Sharpe measure) and systematic risk (Treynor measure) 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 performan ce measure. This measure was developed by Michael Jenson and is sometimes referred to as the Differential Return Method. This measure involve s 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 LJIMS

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surplus between the two returns is called Alpha, which measures the performance of a fund compared with the actual returns over the period. Required return of a fund at a given level of risk ( Bi) can be calculated as: Ri = Rf + Bi (Rm - Rf)

Where, Rm is average market return during the given period. 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 mitigate unsystematic risk, as his knowledge of 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 return commensurate with the total risk 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 returns 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. Among the above performance measures, two models namely, 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 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.

Source: Mutualfundsindia Research Team CRISIL's composite performance ranking (CPR) measures the performance for each of the open-ended scheme of Mutual Fund. There are four parameters considered to measure LJIMS

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the performance of a Mutual Fund such as Risk-adjusted returns of the scheme's NAV, Diversification of Portfolio, Liquidity and Asset Size.

7.7 Fund Rating Trying to find good funds? It is not easy. To begin with, you can check the returns. But that may not be good enough. By now, most investor knows that usually higher returns are accompanied by higher risk. And that you should keep your return expectation in line with your appetite for risk. But how do you compare the risk of one fund with another? With over 400 fund of a wide variety, it can be complicated exercise. Fund rating simplifies yourif fund It is an innovativeyour measure and effective used selection. properly whic h simplified fundeasily selectunderstood, ion. There objective are certain research companies like valueresearchonline.com, crisilindia.com etc. Which rate mutual fund. They offer investor a quick and easy way to identify funds that have produced strong risk adjusted performance relative to their peers. The rating is an evaluation of the past, not a prediction of future. Fund Rating:

Fund rating (risk-adjusted rating) is a convenient composite measure of both returns and risk. The fund rating is purely quantitative and there is no subjective component to the fund rating. The assessment does not reflect the future potential of any fund. It only gives a quick summary of how a fund has performed historically relative to peers. How funds are rated? For equity and hybrid fund, the fund rating for the two time periods (3 and 5 years) are combined to give a single assessment of each fund’s risk rating’ relative to other funds in the category. For debt the fund the fund rating is based on 18month weekly risk adjusted performance, relative to the other funds in the category. Value research does not rate an equity fund with less than 3 years of performance, and debt fund with less than 18-month performance. Besides a minimum of 18 funds in a fund category with performance data is necessary for fund rating. Fund rating is based on the following classification of universe of Indian mutual fund: Equity fund: diversified, tax planning,infotech/technology,fmcg, pharma, and specialty. Hybrid fund: balanced fund, debt with marginal equity and debt funds with any equity

exposure in the past 18 month. Debt-medium-term: debt medium and long-term and gilt medium and long term.

Debt short guaranteed return by investing your money in a bank term deposit. And the risk in investing in mutual fund not only includes the possibility of losing money, but also the chance of earning less than you would have with a guaranteed investment. To calculate fund risk, monthly fund returned are compared against the monthly risk free return for equity and hybrid funds and weekly risk free return for debt fund. Risk free return is defined as state bank’s 45-180 days term deposit rate. For all monthly/week the fund has performed the risk free return, the magnitude of under performance is added. LJIMS 91


This helps us to arrive at the average underperformance and how the fund has performed vis-à-vis its category average. The relative performance of the fund is expressed as a risk score.

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7.8 Searching Your Scheme Which schemes will suit you best? First decide what your investment goals are. Take a short quiz, and our Asset Allocator will prescribe the right investment mix for you. Or choose a fund sub-category under the categories mentioned. A scheme objective indicates the desired returns by way of capital appreciation by the Mutual Fund. Based on broad objectives there are 6 categories.

Equity Invest predominantly in stocks. Provide returns by way of capital appreciation. More volatile, but better returns. Good for long-term investors. Typical returns over long term of 15-25% p.a. Equity schemes are of the type:

Equity-Diversified

Provide capital appreciat ion over a medium to long period (2 - 5 years). Invest in stocks from a diverse array of industries. Prevent adverse impact due to a downturn in one or two sectors. Less volatile to sectoral schemes. Typical returns between 15-25% p.a.

Equity-ELSS

Offer tax rebates under section 88 of the IT law. Diversify the equity risk by investing in a wider array of stocks across sectors. Variant of diversified equity. Typical returns between 15-20% p.a. Equity-Index

Invest in stocks that make up a particular index. Investment in each stock is in proportion to the stock's weight in the index. Volatility in sync with the index. A bull market can get max returns of 40% p.a. Bad year can erode principal by 30%.

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Sectoral-Bank

Sectoral-Basic

Invest only in stocks in the basic industry (core industries like petrochemicals, cement, steel, etc.) sector e.g., TISCO & Reliance. Least volatile to other sectoral schemes. Benefit in the medium term (2 years). Typical returns could be as high as 15%. Sectoral-FMCG

Invest only in stocks in the fast moving consumer goods sector e.g., HLL & Cadbury's. Medium risk-reward ratio. Benefit in the short term (2 years). Typical returns could be as high as 25%. Sectoral-MNC

Invest only in stocks of multi-national companies in various industries e.g., HLL & ABB. Medium risk-reward ratio. Benefit in the medium term (2 years). Typical returns could be as high as 25%. Sectoral-Pharma

Invest only in stocks in the pharmaceutical sector e.g., Ranbaxy & Novartis. Medium risk-reward ratio. Benefit in the medium term (2 years). Typical returns could be as high as 25%. Sectoral-TMT

Invest only in stocks in the technology, media & telecom sector e.g., Infosys & Zee Telefilms. High risk-reward ratio. Benefit in the short term (1 year). Typical returns could be as high as 50%.

Debt Invest mainly in income-bearing instruments like bonds, debentures, government securities, commercial paper & call money. Less volatile than equity schemes. Volatility depends on rupee depreciati on, fiscal deficit, inflationary pressure etc. Returns depend on bond ratings. Typical returns between 7 to 12% p.a. Debt schemes are of the type:

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Gilt Invest in government and money market securities or their combination. Tend to give higher returns than money market schemes. Good for parking short-term surplus funds. Easy entry & exit without load. Instant cash on redemption. Slightly volatile. Typical returns of 8.5-10% p.a.

Income Slightly more overweighed on corporate bonds (50-60% of portfolio). Also invests in government securities and money market beyond 1 year. Typical returns of 11-12% p.a.instruments. Ideally suited for investment

Liquid Invest in short-term debt instruments like T-bills, CDs, commercial papers & call money. Preserve the principal while yielding a modest return. Ideal for corporate investors. Good for parking short-term surplus funds. Easy entry & exit without load. Instant cash on redemption. Typical returns between 7-8% p.a.

MIP Variant of income scheme. Provide option to get monthly returns in the form of dividends. Returns are however not assured (except UTI). Typical returns of 10.5 -11.5% p.a.

Balanced Invest both in equity and income-bearing instruments. Reduce risks of investing in stocks by having a stake in both the equity and the debt markets. Flexibility in changing asset composition between equity and debt. Less risky than equity schemes, higher returns than debt schemes. Typical returns of 15-18% p.a.

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Chapter 8

Marketing of Mutual Fund 8.1 Marketing Plan 8.2 Marketing hype of Mutual Fund 8.3 Distribution Channels

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8.1 Marketing Plan

A marketing plan for Mutual Fund services needs to stress the firm-product-customer relationship. Marketing plan as per 8 C's model

Customer Service

Customizatio n

Commodity (Scheme) Planning Cost

Marketing Plan

Campaign

Commodity Branding

Convenienc Channels

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1. COMMODITY (SC HEME) PLA NNING

Mutual Fund commodity (scheme) is basically investment-oriented and the savings mobilized by the Mutual Fund are invariably invested in the instruments (shares, debentures) projected in the schemes. There is little scope for flexibility. Therefore, due care needs to be taken while designing particular commodity taking into account excepted changes in capital / stock market in view of future investment returns. The changing profile of customers (investors) must be taken into account in identifying the savings market. Different segments of thetax potential savings market havecommodities different expectations-long growth, regular income, benefits, and so on. New must be aimed term at satisfying one or more objectives. Tax laws and other related regulations also play an important role in designing a new product because benefits can be offered to investors within the exiting framework of tax regulations. Most of the schemes launched in India are either income or income-cum-growth schemes; few are pure growth schemes. Investor's options have been restricted due to limited commodity range. This has probably happened on account of lack of experience and the risk-averse, conservative attitude of Mutual Fund managers. LJIMS

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Like, commodity planning, commodity launching is a crucial element in marketing. Many Indian Mutual Funds have performed poorly due to wrong timing of launch. Market research can help to assess the needs of potential customers, availability of existing schemes and future growth in demand. Befor e formally launching a new commodity, test marketing can be conducted. 2. COST

The cost of Mutual Fund products is inextricably linked with returns. Indian Mutual Funds follow the historic costing structure. The scheme may provide for the price (cost) at which the units may be subscribed or sold to the independent participants in the scheme. The scheme may also declare the price at which such units may at any time be purchased by the Mutual Fund. This repurchase price (cost) is based on the Net Asset Value (NAV). It signifies the realizable value that the investor will get for each unit that one is holding, if the scheme is liquidated on that date. It is computed by deducting all liabilities (except unit capital) of the fund from the realizable value of all assets and dividing it by number of units outstanding. The net asset value of the fund is the cumulative market value of the assets fund net of its liabilities. Mutual Fund is also to publish the sale and repurchase prices at least once in a week. Mutual Fund Management should also ensure that the difference between the sale and repurchase price does not exceed 7% of the sale price. While deciding on the price, incentives, brokerage charges, and commissions are also to be decided in advance because the expenses towards these items will affect the ultimate returns to investors. 3. COMMODITY BRANDING

An important function of scheme development is the selection of brand name and pricing of the scheme. Brand name highlights the market segments, inherent benefits and investment objectives, and ensures customer loyalty. Brand identity is an important marketing factor because it facilitates product identification at the market place. In India, most of the schemes are linked to the names of organizations: the "DHAN Series" is identified with LIC Mutual Fund, "Master Series" with Unit Trust of India and "Magnum" with SBI Mutual Funds. It can be said that Indian funds have been quite successful in brand policy and brand identification.

4. CONVENIENCE Better advice: Mutual Funds could provide better advice to their investors through the Net rather than through the traditional investment routes only, where there is an additional channel to deal with the Brokers. Direct dealing with the fund could help the investor with their financial planning. In India, brokers could get more Net savvy than investors and could help the investors with the knowledge they get from the Net. New investors would prefer online: Mutual Funds can target investors who are young individuals and who are Net savvy, since servicing them would be easier on the Net.

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India has around 1.6 million net users who are prime target for these funds and this could just be the beginning. The Internet users are going to increase dramatically and Mutual Funds are going to be the best beneficiary. With smaller administrative costs more funds would be mobilized. A fund manager must be ready to tackle the volatility and will have to maintain sufficient amount of investments, which are high liquidity, and low yielding investments to honor redemption.

5. CHANNEL

A new Mutual Fund scheme may have all the qualities but that does not ensure its spontaneous acceptance by customers. Success would greatly depend on appropriate channel. The identification of appropriate market segment for the product, selection of channel and promotional aids are essential. Mutual Fund is mainly sold through marketing intermediaries whose job is really marketing of these types of financial services. Mutual Funds are also marketing of these types of financial services. Mutual Funds are also marketed through stockbrokers who are members of stock exchanges, institutional, merchant bankers, corporate agents etc. They are also marketed by distribution of application forms through a tie-up with newspapers. Public sector Mutual Funds like LIC MF, UTI have an edge over others due to their well-established agency network, Through the corporate offices formulated the overall marketing strategy and coordinate the activities relating to publicity and product distribution, local level activities are supervised and coordinated by the zonal and branch offices. In order to tap the savings tendency of the rural India, Mutual Fund are paying greater attention to rural marketing. Investors can also buy units through direct subscription. Some of the innovative distribution channels to attract prospective investors are:Direct sales: - In the case of direct sales funds are offered to investors directly at NAV and no sales load is charged. Sales through Underwriters: - Shares of open-ended Mutual Funds are available through distributors (also called brokers / dealers / sponsors) who act as underwriters. An underwriter purchases shares at NAV and sells them to the investing public. The commission of the underwriters depends on the spread of bid and offering price. Underwriters / distributors are prohibited from buying Mutual Funds shares for themselves unless it is for a bona fide investment account. Group selling: - many underwriters for maximum market penetration practice Group selling. The entire members get shares at reduced prices, which enable distributors to realize economies of scales. Automatic Monthly Investing: - This is a very convenient way to acquire Mutual Fund shares. Many companies operate this plan that allows shareholders to authorize a fund to debit their bank accounts monthly for the purchase of bank shares. Telephone or mail purchase: - Shares can be purchased over telephone or through mail by sending filled application forms along with cheques to the Mutual Fund.

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Share exchange plan: - Mutual Fund investor can exchange there existing investment in the Mutual Fund with another Mutual Fund of similar amount. 6. CAMPAIGN

Scheme campaign / promotion in India has taken the usual routes of advertisement and publicity. Mutual Fund advertisements are regulated by SEBI, which prohibits material and contents of publicity, which may mislead the investing public. Advertisement campaigns mainly aims at creating awareness of the product, its comparative advantages and future potential, past performance of similar products and superiority of the fund in relation to others in terms of assets, management and performing servicing. Many incentives for early subscription; some Mutual Fund also offers insurance benefits to attract investors.

7. CUSTOMIZATION

The financial goals will very, based on investor's age, lifestyle, financial independenc e, family commitments, and level of income and expenses among many other factors. Therefore, the first step should be to assess your needs. One can being by defining the investment objectives, which could be regular income, buying a home or finance a wedding or educate your children or combination of all these needs. Also the risk appetite of the investor and his cash flow requirements need to be mentioned clearly. 8. CUSTOMER SERVICE

The marketing of services is significantly influenced by the quality of service and the interpersonal relationship between customers and the service organization. Servicing has great significance in Mutual Funds, as in any other financial service industry. Prompt and timely service in issuing certificates / cheques and in attending to any customer problems would make a distinct difference. Expected return being more or less same for all the schemes, it is the quality of services which becomes the deciding factor. In India most Mutual Funds provide after-sales service through both external agencies and internal service department, although they rely on external agencies and internal agencies (transfer and registrar agents) that are specialized in these jobs. Mutual Fund does need to develop to in-house expertise to render after-sales service more promptly and cost effectively.

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8.2 Marketing hype it of Mutual Funds It is amazing how fund marketers can come up with statistics to show how their particular fund has done extremely well. Standard techniques include the following: Defined period returns: Some period is depicted in which the particular fund outperformed others or some benchmark. One should look very carefully at start and end dates – they can always be chosen in a way that shows the fund in a favorable light Out performance vs. performance: Sustained periods of low absolute perform ance are a cause for concern. It is all right to look at relative returns with respect to benchmark indices; but there is no sense if a particular fund produces absolute returns less than the deposit interest rates, even after a few years of existence. Promise of long-term performance: Lack of performance is often explained away as temporary with promises of good performance in the long term. Few define what this "long term" is – 1 or 2 or 5 or 10 years. Do not forget that the longer the period, the longer is the uncertainty in between – in other words, would you want to wait for 10 years to get an uncertain 2% higher returns as compared to the certain returns that you get in say the Public Provident Fund. Rupee cost averaging: This is a term that has found its way into the marketing literature of all Mutual Funds. What it means is that if you put in a fixed amount of money every month in a fund, then, in months when the NAV is low, the investor gets more units, which benefits him when the NAV rises. Do not forget the implicit assumption behind this – that the NAV will rise eventually. If it does not, you are no better off than by not buying. Equities are the best bet in the long run: Ask this to any investor who put money in the Sensex in 1992. After a long run of 7 years, the investor is down on his investment by 50%. He would have been better off by investing in other avenues.

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8.3 Distribution Channels Role of distribution channels

Mutual Funds device investment plans for the institutional and the individual investors. Some funds target and contact the institutional investors directly, without using any external distribution channels. For e.g. UTI and some private funds have some schemes targeted at provident funds, which are contacted directly by their own sales officers. Other funds work through distributors for institutional clients as well as individual ones. But, it is important to note that Mutual Funds are primarily vehicles for large collective investments, working on the principle of pooling the funds of a large number of investors. That is why a large majority of schemes are targeted at individual investors. A substantial portion of investment in Mutual Funds takes place at the retail level. Retail distribution channels are therefore a critical element in the distribution of Mutual Funds. This is particularly relevant in the Indian context, in view of the diverse nature of the investor community and the vast geographic spread of the country. The agents or distributors are a vital link between the Mutual Funds and investors.

Traditionally in India, financial products such as insurance or bank and corporate deposits have been distributed through individuals who serve as independent brokers/agents. The increasing number of players in the Mutual Fund industry has resulted in opening up new channels of distribution.

Types of Distribution Channels Individual Agents

Use of agents has been the most widely prevalent practice for distribution of funds over the years. By definition, an agent acts on behalf of a principal-in this case; the Mutual Fund an agent is essentially a broker between a fund and the investor. In India, we also have the unique system whereby a broker has a number of sub-brokers working under him. The vast sub broker network ensures a larger geographic coverage. According to AMFI, there are nearly 100,000 agents selling Mutual Funds and other financial products. Of this number, 80-85,000 are a UTI agent. Note that Mutual Fund agents are not exclusive but usually sell other financial products as well. The system has the advantage that the distributor has a broader knowledge of financial services available, and is therefore potentially in a position to act as investment advisors. Investors expect the right kind of recommendations from the agents. From the perspective of the Mutual Funds them. Such multi product distributors mean loss of exclusivity in the marketing of their particular products. However , the drawback can be converted into a benefit for the funds, if the agents are properly trained in their role and responsibility as financial advisors to investors. Hence, this training program from AMFI. In India, any person who signs an agreement with a fund on non-judicial stamp paper can act as its agent. In the U.S. there is a qualifying examination is prescribed for agents/distributors. In India, too from November 1,2001 SEBI has made it mandatory for LJIMS

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newly distributors to pass the AMFI Certification test and has recommended the test for existing distributors. As financial markets, investment options and the variety of Mutual Funds gets more and more sophisticated, distributors need more and more information, knowledge and skills. That is why; the distributors in India will find that many Mutual Funds now prescribe minimum qualification that a person must possess to be its agent. These qualification may be in terms of education, experience or even registration on an exchange, For example, UTI requires its agents to have at least passed the level of matriculation and also to provide two references. Some private sector funds like to deal with only stockbrokers. Eventually, some funds may even require their distributors to pass this AMFI Testing Program.

In the case of UTI, agents are provided with in house training and refresher courses. Agents’ meetings are also organized at periodic intervals. Once appointed, a UTI agent may sell any of its schemes. Agent’s performance is monitored and they receive commissions at a basic rate plus incentives depending on the volume of business generated by them. UTI has also evolved the concept of a Chief Represent ative for each district, who is assigned a target and has several agents reporting to him. UTi also has franchisee officers that function as small, decentralized distribution centres. In addition, agents are allowed privileges such as memberships to the Chairman’s club, based on performance. Private Mutual Funds also rely on agents for distributing their schemes. However, for many of the relatively smaller funds, Interaction with a large force is both costly and difficult to administer. For this reason, the recent trend has been to shift to distribution companies as opposed to individual agents. Distribution Companies

Availing of the services of established distribution companies is practice accepted by Mutual Funds internationally. This practice evolved with a view of circumvent the huge administrative required to support a large agent force. Instead of having to deal with several agents. A fund can interact with a distribution company, which has several employees or sub-brokers under it. A distribution company usually manages distribution for several funds simultaneously and receives commission for its services. Many private funds have preferred to adopt this practice because of its sophisticated nature and because they benefit from the specialist knowledge and established client contacts of these marketing firms. In India, there are about 10 major distribution companies in addition to a few hundred smaller ones. Names of most of the large distribution companies may be obtained from the AMC sales officers of some of the private funds.

Banks and NBFCs

In developed countries, banks are an important marketing vehicle for Mutual Funds, given the banks themselves have a large depositor/client base or their own. We can see the opening up of this new channel in India now. Several banks, particularly private and foreign banks are involved in fund distribution by providing services similar to those of LJIMS

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distribution companies, on a commission basis, Some NBFCs are also providing such services. All funds do not yet use this channel. Nor all banks have yet taken up the fund distributor role. But increasing use of banks networks for Mutual Fund distribution almost a certain development. Direct Marketing

Direct Marketing means that the Mutual Funds sell their own products without the use of any intermediaries, Usually, this takes the form of the sales officers and employees of the AMC who approach the investors and accept their contributors directly, However, In India, independent agents may really be treated as a direct marketing channel, in the sense that they do not form a well-knit, independent and organized single entity and act more like fund employees. Other channels like the distribution companies or banks or even stockbrokers are clearly distinct and independent intermediates.

Direct marketing by the funds themselves accounts for a very small percentage of Mutual Fund sales. In the case of UTI, only 5-6% of total sales come through registered brokers and they do not accept direct subscriptions from investors.

Mutual Funds often use their employees to mobilize funds from high net worth individuals and institutional investors. In case of short/medium term investment in liquid and/or income funds, targeted at companies funds often resort to direct marketing.

Current Distribution Patterns

In recent times, it has been observed that non-UTI funds rely less on individual agents primarily on the major distribution companies. A reasonable level of business is generated by smaller distribution the companies, which also act as financial planners/consultants. Banks have also been playing an increasing role as fund distributors. Newer private sector funds depend on 250 to 300 smaller distribution companies and banks across the country. The exact statistics are not yet available on which distribution channel accounts for how much of the fund collections, as emergence of channels other than individual agents is too recent a development. However, the figures of collections of five or six large private sector Mutual Funds would indicate the distribution companies and banks share put together, as these funds depend largely on these two channels. Much of this inflow would have come from the distribution companies and banks.

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Chapter 9

Some Tribulations in Mutual Fund Industry

9.1 Problem faced by US64 9.2 Problem face by Morgan Stanley 9.3 Debt Mutual Funds: a paragon for VRS beneficiaries

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9.1 Problem faced by US64 Basically, for a period of 2-3 years, the UTI distributed more dividends to the unit holders of US 64 than the return earned from the investments in the scheme. This reduced the value of the residual investments in the scheme. This problem was compounded by the persistent fall in the prices of shares, especially the shares of companies in basic commodity industries like cement, steel, manmade fibres etc. and shares of public sector units. Throughout this period, when the NAV of US 64 was going down, UTI kept increasing the sale and repurchase prices of US 64 units. The stock market collapse after the Pokhran II nuclear tests was the last straw, which resulted in the erosion of the scheme’s book reserves and a wide difference between the actual NAV and the sale/repurchase price. When this became known, it set a panic amongst investors of US 64. Many people felt that if there were large-scale redemptions, UTI would not be able to meet them without support of outside bodies like the RBI. Further, theoretically, if all investors wanted to redeem their US 64 units on the same day, the US 64 simply did not have the money to meet the redemptions on its own (due to the difference between NAV and the repurchase price).

9.2 Problem face by Morgan Stanley Morgan Stanley raised large corpus (more than Rs10bn) in around early 1994. The entire exercise in fund raising was centered on the hype of the fund being the first fund promoted by an internationally acclaimed asset management company. It was marketed like any other public issue and fund investors rushed to invest in the scheme hoping to get superior returns. No one bothered to explain to them that Morgan Stanley AMC was a service provider - providing them the service of investment advice and management. No one explained to them that they were not investi ng in a share of a company – in fact the artificial gray market premium served to perpetrate this feeling. The IPO was a great success. It ensured that the name "Morgan Stanley" was now a part of the dreams of more than 1 million Indians. The fund raising exercise, unfortunately, coincided with the peak of stock market boom. Indian stock markets lack depth and are quite illiquid. The fund managers were compelled to invest in equities in a big hurry as a number of Foreign Institutional Investors were investin g huge sums of money in the country resulting in a mad rush for equity stocks. The fund’s managers invested a considerable amount of money in smaller companies with low floatingprivate stock and low market capitalization, either through the secondary market or through placements. These companies had experienced the highest appreciation in prices in the immediate past. The market position started changing from late 1994. The boom in the market made it possible for many companies to raise equity capital and literally hundreds of public/rights issues opened for subscriptions every week, many of them at high issue prices. There were also massive private placements of equity shares and GDR issues at huge premiums. There were very few companies, which did not wash their hands in this great gravy train. This deluge of paper soaked up money and reduced the amount available for fresh LJIMS

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investment both from resident Indians, domestic Mutual Funds and from foreign institutional investors. At this time, the RBI commenced on its tight money policy in a bid to control inflation from raising its head. Money supply tightened and bond yields started increasing dramatically. High industrial growth and tight money created a shortage for credit and rates started going sky high. Many corporates and banks started redeeming their holdings in the Unit Trust of India and other Mutual Funds. This put major pressure on the market, which was already showing signs of weakness. What followed was the great crash. And in this crash, the biggest losers were the smaller capitalization stocks. Many of these stocks lost more than 90% of their peak prices. Morgan Stanley AMC restructured the funds portfolio at big losses. As the NAV went below par, investors’ confidence was shattered. Being a closed-ended scheme the Morgan Stanley’s Mutual Fund unit is also listed on the stock markets. Crisis of confidence led to its price on the stock exchange crashing and it started quoting at a steep discount to its NAV. The fund started buying back units in order to reduce the discount and also to boost the NAV (buying back units at prices below the NAV results in a profit, which will reduce the NAV). Given its large corpus size no amount of buy back or otherwise support could help boost the investor confidence. Since then the equity markets have gone nowhere with the index still below the level at which the fund was invested. Most of the stocks in the Sensex have performed poorly with markets punishing commodity companies and companies with non-transparent Indian managements. To top it, many erstwhile bluechips have reported disastrous financial performances. Consequently, the NAV of MSGF mirrors this gory saga of the Indian markets. In fact, the fund invested considerable amount of money in FMCG, pharmaceutical and software companies at the right time, which improved the NAV from 1998 onwards.

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9.3 Debt Mutual Funds: a paragon for VRS beneficiaries Mutual Fund Industry is gearing up with prognostic saplings to woo VRS beneficiaries. The potential of the VRS beneficiaries has forced the industry to create the prophecy by announcing new schemes that are tailor-made to gratify the investors. The banking industry, in an attempt to optimise their efficiency and effectiveness, has decided upon curtailing their workforce after adequate compensation to its employees. The idea has also been received with fanaticism. Around 22000 public sector bank employees have opted for VRS-2000 scheme. The obsession was such that Bank of Maharashtra received 1500 applications from employees opting for VRS during the first ten days of the announcement of the scheme. A number of banks and corporates are still in the advanced stage for finalizing the structures of their VRS. Cash stripped banks like United Bank of India is still struggling to find out the mode of funding the voluntary retirement programme. The bank is looking at shedding almost 10-12 per cent from a total strength of 21,000 employees. Mutual Fund industry could not stop itself from getting wowed. Mr. K. K. Mittal, Fund Manager of Escorts Mutual Fund said, "This is the right time to invest in Mutual Funds as the stock market is very low and the interest rate in the economy has stabilised. Intelligent investors will have confidence in the industry and Mutual Funds will garner good portion of the money collected by VRS". The Fund-houses have started the arduous task of educating the VRS beneficiaries with vigor through camps and banners at banks and other strategic places. Especially designed danglers, posters and advertisements in the media are trying their might to attract investors. The huge money of around Rs. 20,000 crores flowing from the VR scheme can revolutionise the industry. Mr. Akhilesh Gupta, Associate Vice President and fund manager of Dundee Mutual Fund said "The investment objective of the employees opting for VRS is to get regular returns with safety of capital. They also have long-term investment horizon, so open ended gilt funds and bond funds will be very good options for investment. Investors with high-risk profile may also invest in balanced funds or growth funds". Private sector Mutual Funds in an attempt to be called a solution to the investors’ requirement have also dedicated themselves to carve new schemes to suit the investment requirements of the employees going for VRS. First in the list is IDBI Principal Mutual Fund, which has decided to launch a scheme for the specific purpose. This shall be done in a tie-up with various banks that have come out with a VRS scheme. The fund proposes to have an asset allocation scheme where the investor will be allowed to decide upon the investment allocation based on his risk perception. This allocatio n would be allowed to change over a certain period of time or at pre-decided trigger points. The Mutual Fund is also the first to have a tie up with post offices regarding the distribution of its schemes. Prudential ICICI has filed the draft prospectus of its new scheme - Prudential ICICI Fixed Maturity Plan which targets investors who want to wave off the interest rate risk by defining their time horizon at the time of investment. The level of risk comes down drastically in fixed maturity plans as they invest in securities that mature on a fixed date and hence the money that the investors will be getting at the time of maturity will be somewhat fixed. The list of other innovators comprises of Fund-houses like Kotak Mahindra and Reliance Mutual Fund who has tailored serial plans which indicate the rate of return the investors will be getting with a higher degree of precision. If Mutual Funds LJIMS

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are trying to woo the VRS beneficiaries, they are not doing anything, which is against the investors’ interest. As an investment option, Mutual Funds have no match in terms of the benefits provided by them. They are tailored to match the requirements of the investors. The only problem the industry is facing in India is in terms of low level of awareness about the product among investors and their irrational expectations. For a VRS beneficiary regular returns and safety are the basic requirements apart from liquidity and tax efficiency. Banks can be one of the options for parkin g VRS money but the investor will have to compromise on the return front. The returns from bank deposits are very low implying a high premium for the level of safety provided by them. If the investor has the capability to understand his requirements, the best product for a VRS beneficiary can be Open Ended Debt funds. Open Ended Debt funds provide high quality customer service. As far as safety of the investments is concerned, Debt Funds are highly safe as they invest in very high quality debt instruments and that too after a rigorous research by a team of experts. The portfolio is disclosed regularly to imbibe confidence among the investors. The net asset value (NAV) is announced daily and sale / purchase of units is done on the NAV related prices on any working day. Above all, the dividends are taxfree in the hands of the investors. At redemption, the Long Term Capital Gains from Mutual Fund units are taxed at a maximum rate of 10 % whereas the maturity proceeds from a bank deposit are considered to be Short Term Capital Gains and are taxed at normal rates depending upon the tax slab of the investor and can go as high as 38.5%. In Mutual Funds, investors can ask for dividends at convenient frequency. The best part is that investors can do away with the interest rate risk that is attached to the bank deposits by investing in open-ended debt funds. The investor in a bank deposit at a particular rate can not get the gains of increase in market rate of interes t but this element of risk is not there in Mutual Funds. The NAV of Mutual Fund schemes are marked to market regularly the the movements interest rate are adjusted the daily basis. The only challenge and before industry in in the India is to juxtapose the righton Mutual Fund schemes and the investors according to the investors’ risk profile. This is the only reason why our Mutual Fund industry is not as huge as that in the developed economies. As far as performances of the fund managers are concerned, we have world-class fund managers but we are unable to match the collection in the industry to that in banking industry because of lack of awareness among investors.

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Conclusion Up till now sought after investment avenues like bank deposits, real estate, gold, provident fund etc. especially due to fall in interest rates coupled with the rising inflation, and Mutual Fund obviously become a viable alternative.

Mutual Funds are in the business of managing trust. If Mutual Funds gain investors trust, money will follow. It is important to gain mind-share rather than wallet share of the investors. Currently industry is gradually growing phase and Indian Mutual Fund industry has been definitely maturing over the last few years and the level of awareness today is much more than what it was in the past. But the level of awareness has not yet reached the rural and other smaller towns and it is more of a smaller towns and it is more of an urban phenomenon. What is needed is the spread of awareness beyond regional limits. Mutual Fund as a concept is well known, but the target audience still needs to gain more awareness. The future is very bright. This industry is very important role to play in providing alternative avenues to the entire gamut of investors in a scientific and professional manner. Mutual Fund industry has been evolving very well for an important reason that, today we have the best system and procedure, good regulatory mechanism, use of technology, transparency and sharing of details and dissemination of information at an improved level.

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BIBLIOGRAPHY Books:

1. Bodie, Kane, Marcus “Security Analysis and Portfolio Management”, 5 th edition Tata Mc Graw hill publications.

2. M.Y.Khan “ Indian Financial System”, 2nd edition, Tata Mc Graw hill publications.

3. “Mutual Fund testing program Book” AMFI Publication.

4. Association of Mutual Fund in India work book.

Websites www.amfi.com www.indiainfoline.com www.rbi.org.in www.valueresearchonline.com www.myiris.com www.google.com www.mutualfundresearchonline.com www.mutualfundsindia.com

Magazine & Newspaper:

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