A mutual funds is a trust that pools the savings of a number of investors who share a common
financial goal.
Index
1. What is mutual funds?
2.Who can invest in mutual funds?
3.Classification of mutual funds
4.What are the advantages of Mutual Funds?
5.What are the drawbacks of mutual funds?
1. What is mutual funds?
A mutual fund is a trust that pools the savings of a number of investors who share a common
financial goal. Further, a mutual fund is that most suitable investment for the cautious investor as it offers an opportunity to invest in a diversified professionally managed basket of securities at a relatively low cost
So, we can say that mutual funds are trusts which pool resources from large number of investors through issue of units for investments in capital market instruments such as shares , debentures and bonds and money-market instruments such as commercial papers , certificate of deposits and treasury bonds.
2.Who can invest in mutual funds?
Anybody with an investible surplus of as a few thousands rupees can invest in mutual funds by buying units of a particular mutual fund scheme that has a defined investments objective and strategy.
3.Classification of mutual funds
There are three different types of classification of mutual funds :
A) Functional
B) Portfolio
C) and Ownership
A) Functional Classification
Funds are divided into
- Open-Ended Funds
- Close-Ended Funds
In Open-Ended Funds , the investors can make entry or exit at any time . Also the capital of the funds is unlimited , and the redemption period is indefinite.
On the contrary, in a Close-Ended Funds, the investors can buy into the scheme during initial public offering or from the stock market after the units have been listed. The scheme has limited life at the end of which the corpus is liquidated. The investors can make his exit from the scheme by selling in the stock market, or at the expiry of the scheme or during repurchases period at his option.
Interval schemes are a cross between an Open-Ended and a Close-Ended structure. These
schemes are open for both purchase and redemption during pre-specified intervals (viz. monthly, quarterly, annually etc.) at prevailing NAV based prices. Interval funds are very similar to Close-Ended funds, but differ on the following points:
- They are not required to be listed on the stock exchanges as they have an in-built redemption window.
- They can make fresh issue of units during the specified interval period , at the prevailing NAV based prices.
- Maturity period is not defined.
B) Portfolio Classification
Funds are classified into Equity Funds, Debt Funds and Special Funds.
Equity funds invest primarily in stocks. A share of stock represents a unit of ownership in a company. If company is successful , shareholders can profit in two ways :
- the stock may increase in value
- the company can pass its profit to shareholders in the form of dividend.
If company fails a shareholders can lose the entire value of his or her shares; however a shareholders is not liable for the debts of the company.
Equity Funds
Equity funds are of the following types viz:
a) Growth Funds:
They seek to provide long term capital appreciation to the investor and are best to long term investors.
b) Aggressive Funds:
They look for super normal returns for which investment is made in start-up, IPOs, and speculative shares. They are best to investors willing to take risk.
c) Income Funds:
They seek to maximize present income of investors by investing in safe stocks paying high cash dividends and in high yield money market instruments. They are best to investors seeking current income.
Debt Funds
Debts funds are of two types
a) Bond Funds:
They invest in fixed income securities e.g. government bonds , corporate debentures , convertible debentures, money market . Investor seeking tax free income go in for government bonds while those looking for safe , steady income buy government bonds or high grade corporate bonds.
Although there have been exceptions, bond funds tend to be less volatile than stock funds and often produce regular income. for this reason, investors often use bonds funds to diversify , provide a stream of income or invest for intermediate – term goals . However, like stock funds bond funds also have following risks and can lose money.
Interest Rate Risk:
This risk relates to fluctuation in market value of Bond consequent upon the change in interest rate (YTM) as discussed in the chapter on Security Valuation. Further, there is inverse relationship between market value of bond and interest rate . As interest rate goes up market value of bond falls and vice versa.
Credit Risk:
This risk is similar of default in repayment of loans or payment of interest or both by the borrowers of the bonds. Thus , this risk takes place when a mutual funds which invested money in the bonds of a company defaulted in the payment of interest or principal.
This risk is higher in case of companies with lower Credit Rating.
Prepayment Risk:
This risk is related to early refund of money by the issuer of bonds before the date of maturity. This generally happens in case of falling interest rates when company who already issued bond at higher interest rate issues fresh bonds at lower rate of interest exercising its right of early redemption of callable bonds and refunding the money raised out of fresh issue.
b) Gilt Funds:
They are mainly invested in Government securities.
Special Funds
Special funds are of four types viz:
(i) Index Funds:
Every stock market has a stock index which measures the upward and downward sentiment of the stock market . Index Funds are low cost funds and influence the stock market . The investors will receive whatever the market delivers.
(ii) International Funds:
A mutual fund located in India to raise money in India for investing globally.
(iii) Offshore Funds:
A mutual fund located in India to raise money globally for investing in India.
(iv) Sector Funds:
They invest their entire fund in a particular industry e.g. utility fund for utility industry like power, gas , public works.
(v) Money market funds:
These are predominantly debts-oriented schemes , whose main objectives is prevention of capital , easy liquidity and moderate income. To achieve this objectives , liquid funds invest predominantly in safer short-term instruments like commercial papers, certificates of deposits , Treasury bills etc.
Refer: https://taxandfinanceguide.com/money-market-instruments/
(vi) Fund of funds:
Fund of Funds (FoF) as the name suggests are schemes which invest in other mutual fund schemes. The concept is popular in markets where there are number of mutual fund schemes. Further, concept is popular in markets where there are number of mutual funds offerings and choosing a suitable schemes according to one’s objectives is tough .
(vii) Capital Protection Orientation Fund:
The term ‘capital protection oriented scheme’ means a mutual fund scheme which is designated as such and which endeavors to protect the capital invested therein through suitable orientation of its portfolio structure.
Moreover, the orientation towards protection of capital originates from the portfolio structure of the scheme and not from any bank guarantee, insurance cover etc.
(viii) Gold Funds:
The objective of these funds is to track the performance of Gold. The units represent the value of gold or gold related instruments held in the scheme.
C) Ownership Classification
Funds are classified into public sector mutual funds , Private sector mutual funds and foreign mutual funds. Public sector mutual funds are sponsored by a company of the public sector. Private sector mutual funds is sponsored by companies for raising funds in India , operate from India and Invest in India.
4.What are the advantages of Mutual Funds?
Following are the advantages of mutual funds:
- Professional Management :
The funds are managed by skilled and professionally experienced managers with a back up of a Research team.
- Convenient administration:
There are no administrative risks of share transfer as many of the mutual funds offer services in a demat form which save investors time and delay.
- Higher Returns:
Over a medium to long-term investment, investors always get higher returns in Mutual Funds as compared to other avenues of investment. This is already seen from excellent returns, mutual funds have provided in the last few years.
- Low cost of management :
No mutual fund can increase the cost beyond prescribed limits of 2.5% maximum and any extra cost of a management is to be born by AMC.
- Liquidity:
In all open ended funds, liquidity is provided by direct sales/ repurchase by the mutual fund and in case of close ended funds, the liquidity is provided by listing the units on the stock exchanges.
- Transparency :
The SEBI Regulations now compel all the Mutual Funds to disclose their portfolios on a half-yearly basis. However, many Mutual Funds disclose this on a quarterly or monthly basis to their investors.
Further, the NAVs are calculated on a daily basis in case of open ended funds and are now published through AMFI in the newspapers.
- Flexibility:
There are lot of features in a regular mutual fund scheme , which imparts flexibility to the scheme. Further, an investor can opt for systematic Investment Plan (SIP), Systematic Withdrawal Plan etc. to plan his cash flow requirements as per his convenience .
- Economies of scale:
The way mutual funds are structured gives it a natural advantages. The “pooled” money from a number of investors ensures that mutual funds enjoy economies of scale; it is cheaper compared to investing directly in the capital markets which involves higher charges.
5.What are the drawbacks of mutual funds?
Following drawbacks of mutual funds:
- There are no guarantee of return as some mutual funds may underperform and mutual fund investment may depreciate in value which may even effect erosion /depletion of principal amount.
- Further, all Mutual Funds cannot be winners. There may be some who may underperform the benchmark index i.e. it may not even perform well as a novice who invests in the stocks constituting the index.
- Diversification may minimize risk but does not guarantee higher return.
- Mutual funds performance is judged on the basis of past performance record of various companies. But this cannot take care of or guarantee future performance.
- Mutual fund cost is involved like entry load , exist load , fees paid to assist management company etc.
- There are many unethical practices e.g. diversion of mutual fund amounts by mutual fund to their sister concern for making gains from them.
- Redressal of grievances , if any, is not easy.
- When making decisions about your money, fund managers do not consider your personal tax situations. For example when a fund manager sells a security, a capital gain tax is triggered, which affects how profitable the individual is from sale. It might have been more profitable for the individual to defer the capital gain liability.
