Study of Mutual Funds and Investors Perception about them Finance Essay

Savings form an important part of die economy of any nation. With savings invested in various options available to the people, the money acts as the driver for growth of the country. Indian financial scene too presents multiple avenues to the investors. Though certainly not the best or deepest of markets in the world, it has ignited the growth rate in mutual fund industry to provide reasonable options for an ordinary man to invest his savings. Indian MF industry offers a plethora of schemes and serves broadly all type of investors. The range of products includes equity funds , debts, liquid, gilt, and balanced funds. There are also funds meant exclusively for young and old , small and large investors. Moreover, the stup of a legal structure, which has enough teeth to safeguard investors' interest, ensures that the investors are not cheated out of their hard-earned money. One can avail of the benefits of better returns with added benefits of anytime liquidity by investing in open-ended debt funds at lower risk. Many people have burnt their fingers by investing in fixed deposits of companies who were assuring high returns but have gone bust in course of time leading to distraught investors as well as pending cases in the Company Law Board.

This risk of default by any company that one has chosen to invest in, can be minimized by investing in mutual funds as the fund managers analyze the companies' financials more minutely than an individual can do as they have the expertise to do so. They can manage the maturity of their portfolio by investing in instruments of varied maturity profiles. Since there is no penalty on pre-mature withdrawal, as in the cases of fixed deposits, debt funds provide enough liquidity. Moreover, mutual funds are better placed to absorb the fluctuations in the prices of the securities as a result of interest rate variation and one can benefits from any such price movement. Apart from liquidity, these funds have also provided very good post-tax returns on year to year basis. Apart from small retail investor, the industry can attract investments from institutional and big investors as well. Liquid funds offer liquidity as well as better returns than banks and so attract investors. Many funds provide anytime withdrawal enabling a big investor to take maximum benefits. Like we said earlier, the appeal of mutual funds cuts across investor classes. In other developed countries, mutual funds attract much more investments as compared to the banking sector but in India the case is reverse. We lack awareness about the benefits that are offered by these schemes. It is time that investors irrespective of their risk capacities, made intelligent decisions to generate better returns and mutual funds are definitely one of the ways to go about it. CONCEPTUAL FRAME WORK

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 instrument. The income earned through these investments and the capital appreciation realized by the scheme is shared by 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 investible surplus of as little as a few thousand rupees can invest I mutual funds. Each mutual fund scheme has a defined investment objective and strategy. A mutual fund is the ideal investment vehicle for today 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 tractions etc. A mutual fund is an answer to all these situations. 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 -the 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 tons of thousands of mutual funds with different investment objectives. Today ,mutual funds collectively managed 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 nd its financial strength in granting approval to the fund for commencing operations.

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). Ex. 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. Mutual Funds invest basically in three types of asset classes. These include: Stocks: Stocks represent ownership or equity in a company. This asset class has historically outperformed all other asset classes over the long-term but tends to be more volatile in the short-term. Debt Instruments: This represents debt papers of corporate and government agencies. They provide income in the form of interest payments and principal if held till maturity. There can be price volatility due to interest rate movements as well as economic and political instability. Money Market Instruments: These are inter-bank Call Money, Commercial Paper, Treasury Bills, Certificates of Deposit (CDs), Bill Rediscounting and short-term bonds. They pay interest and are the least volatile of all the asset classes.

HISTORY OF INDIAN MUTUAL FUND INDUSTRY

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank of India. The history of mutual funds in India can be broadly divided into four distinct phases : First Phase - 1964-87 A  Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. 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.6,700 crores of assets under management. A 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. A Third Phase - 1993-2003 (Entry of Private Sector Funds) A  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. A  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. A  The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets under management was way ahead of other mutual funds.

A Fourth Phase - since February 2003 A  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. A  The second is the UTI Mutual Fund, 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. A The graph indicates the growth of assets over the years :

CONCEPT 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 then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. The flow chart below describes broadly the working of a mutual fund:

ORGANISATION OF A MUTUAL FUND

There are many entities involved and the diagram below illustrates the organisational set up of a mutual fund: Organisation of a Mutual Fund These are :-

Establishes the mutual fund as a trust and registers with SEBI

Managed by the board of trustees.

Sponsor Company

Hold unit holders funds in mutual fund. Enters into an agreement with SEBI.

Mutual fund

(For e.g. Reliance AMC)

Floats mutual funds as per the regulations of SEBI regulations.

Asset Management Company.

Provides the network for distribution of schemes to the investors.

Provides registrar and transfer services.

Provides custodial services.

Distributors

Registrar

Custodian

Types of Mutual Fund Schemes

Mutual fund schemes may be classified on the basis of its structure and its investment objective.

By Structure

Open-ended

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 Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity.

Close-ended

A closed-end fund has a stipulated maturity period which generally ranging from 3 to 7 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. These mutual fund schemes disclose NAV generally on a weekly basis.

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

Growth/Equity Oriented Schemes

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 proved 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.

Income/Debt Oriented Schemes

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 securities in the proportion indicated in their offer documents. 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.

Money Market Or Liquid 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.

Gilt Fund

These funds invest exclusively in government seA­curities. Government securities have no default risk. NAVs of these schemes also fluctuate due to changes in interest rates and other economic facA­tors as is the case with income or debt-oriented schemes.

Other Schemes

Tax Saving Schemes

These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws as the Government offers tax incentives for investment in specified avenues. Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction u/s 88 of the Income Tax Act, 1961.

PLANS THAT MUTUAL FUND OFFERS

Mutual Funds in order to cater to a range of investors, have various investment plans. Some of the important investment plans include the following:

Growth Plan

Under the Growth Plan, the investor realises only the capital appreciation on the investment (by an increase in NAV) and does not get any income in the form of dividend.

Income Plan

Under the Income Plan, the investor realises income in the form of dividend. However his NAV will fall to the extent of the dividend.

Dividend Re-investment Plan

Here the dividend accrued on mutual funds is automatically re-invested in purchasing additional units in open-ended funds. In most cases mutual funds offer the investor an option of collecting dividends or re-investing the same.

Systematic Investment Plan (SIP)

SIP is similar to a Recurring Deposit. Every month an amount the investor chooses, is invested in a mutual fund scheme of his/her choice. Under this plan Investors invest a specific amount for a continuous period, at regular intervals. By doing this, the investor get the advantage of rupee cost averaging. Which means that by investing the same amount at regular intervals, the average cost per unit remains lower than the average market price, irrespective of how the market is - rising, falling or fluctuating .i.e. with every fluctuation in the market the units are purchased systematically, thus resulting in averaging the purchase price. Whereas this is not true for a one-time investment. This is the reason why a SIP investor gets phenomenal rate of return compared to a one-time investor.

Systematic Withdrawal Plan

As opposed to the Systematic Investment Plan, the Systematic Withdrawal Plan allows the investor the facility to withdraw a pre-determined amount/units from his fund at a pre-determined interval. The investor's units will be redeemed at the existing NAV as on that day.

Retirement Pension Plan

Some schemes are linked with retirement pension. Individuals participate in these plans for themselves, and corporate for their employees.

Insurance Plan

Some schemes launched by UTI and LIC offer insurance cover to investors.

NET ASSET VALUE (NAV)

NAV is the total asset value (net of expenses) per unit of the fund and is calculated by the Asset Management Company (AMC) at the end of every business day. Net asset value on a particular date reflects the realizable value that the investor will get for each unit that he his holding if the scheme is liquidated on that date. The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV). Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs.20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme.

CALCULATION OF NAV

ADVANTAGES OF MUTUAL FUNDS

1. 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. Thus, with smaller amounts you can achieve a higher degree of diversification and reduce your risk. 2. PROFESSIONAL MANAGEMENT: Most mutual funds pay topflight professionals to manage their investments. These managers decide what securities the fund will buy and sell. 3. 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. 4. LIQUIDITY: It's easy to get your money out of a mutual fund. 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. 5. CONVENIENCE: 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. 6. TAX BENEFIT: Some mutual fund schemes offer you tax benefits under section 80C. 7. LOW COSTS: 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. 8. 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. Switch over option for switching to/from some other existing fund is also offered by some mutual funds. 9. AFFORDABILITY: Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy. 10. VARIETY OF SCHEMES: Mutual Funds offer a variety of schemes to investors thus giving an option to choose a scheme that suits the investors varying needs over a lifetime. 11. WELL REGULATED: All Mutual Funds are registered with SEBI and they function within the provisions and strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.

TYPES OF RISK INVOLVED

MARKET RISK

The NAV of the scheme investing in equity will fluctuate as the daily prices of the individual securities in which they invest fluctuate and the units when redeemed may be worth more or less than the original cost.A

NON-MARKET RISK

Bad news about an individual company can pull down its stock price, which can affect, negatively, funds holding a large quantity of that stock. This risk can be reduced by having a diversified portfolio that consists of a wide variety of stocks drawn from different industries.

INTEREST RATE RISK

Price of securities and interest rates move in opposite directions. When interest rates rise, security prices fall and this decline in underlying securities affects the NAV negatively. The extent of the negative impact is dependant on factors such as maturity profile, liquidity etc.

CREDIT RISK

Bonds are debt obligations. So when the funds invest in corporate bonds, they run the risk of the corporate defaulting on their interest payment and the principal payment obligations and when that risk crystallizes it leads to a fall in the value of the bond causing the NAV of the fund to take a beating. ASSOCIATION OF MUTUAL FUNDS IN INDIA (AMFI) With the increase in mutual fund players in India, a need for mutual fund association in India was generated to function as a non-profit organization. Association of Mutual Funds in India (AMFI) was incorporated on 22nd August, 1995. AMFI is an apex body of all Asset Management Companies (AMC) which has been registered with SEBI. Till date all the AMCs are that have launched mutual fund schemes are its members. It functions under the supervision and guidelines of its Board of Directors. Association of Mutual Funds India has brought down the Indian Mutual Fund Industry to a professional and healthy market with ethical lines enhancing and maintaining standards. It follows the principle of both protecting and promoting the interests of mutual funds as well as their unit holders. As of now, all the 39 Asset Management Companies that are registered with SEBI are its members. AMFI functions under the supervision and guidance of a Board of Directors

Its objectives are as follows:

*It maintains a high professional and ethical standards in all areas of operation of the industry. *It also recommends and promotes the top class business practices and code of conduct which is followed by members and related people engaged in the activities of mutual fund and asset management *AMFI interacts with SEBI and works according to SEBIs guidelines in the mutual fund industry. *Association of Mutual Fund of India do represent the Government of India, the Reserve Bank of India and other related bodies on matters relating to the Mutual Fund Industry. *It develops a team of well qualified and trained Agent distributors. *It implements a programme of training and certification for all intermediaries and other engaged in the mutual fund industry. *AMFI undertakes all India awarness programme for investors inorder to promote proper understanding of the concept and working of mutual funds.

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