Investments in mutual funds

“If you do the little jobs well, the big ones will tend to take care of themselves”

What is Mutual Fund?

A mutual fund is a trust that pools the savings of a investor who share a common financial goal. It is a professionally managed investment fund that pools money from many investors to purchase securities. It is most commonly applied only to those collective investment vehicles that are regulated and sold to the general public. They are sometimes referred to as "investment companies" or "registered investment companies". Hedge funds are not considered a type of mutual fund, primarily because they cannot be sold to the general public.

Early Stage

The first mutual funds were established in Europe. One researcher credits a Dutch merchant with creating the first mutual fund in 1774.Mutual funds were introduced into the United States in the 1890s. They became popular during the 1920s. These early funds were generally of the closed-end type with a fixed number of shares which often traded at prices above the value of the portfolio.

The first open-end mutual fund with redeemable shares was established on March 21, 1924. This fund, the Massachusetts Investors Trust, is now part of the MFS family of funds. However, closed-end funds remained more popular than opennd-e funds throughout the 1920s. By 1929, open-end funds accounted for only 5% of the industry's $27 billion in total assets.

How does a Mutual Fund Works?

Who can invest in Mutual Fund?

Anyone with an investible surplus of as little as few thousand rupees can invest in mutual funds by buying units of a particular mutual fund scheme that has a defined investment objective and strategy.

Should we invest in Stocks or Mutual Funds?

First consider, What kind of Investor are you?, Consider the kind of disposable income you have to invest in 10-15 stocks .ie. how many stocks you will have to invest in if you want to create a well diversified portfolio. The Family Adage “Do not put all your eggs in one basket”.

Many beginners tend to focus on stocks that have a market price of less than Rs.100; that should never be criterion for choosing a stock. Also, brokerage could eat into your returns if you purchase small quantities of stocks. That brings to a next point , do you have time to invest in stocks?, you need to invest considerable amount of time in reading newspapers . Magazines, annual reports, quarterly updates, industry reports. Else. You certainly wont catch a trend or pick a stock ahead of market.

As compared with Mutual Funds Systematic investment plans(SIPs) has become the mode of simply getting out rich of market. The only reason for getting out rich is investing religiously.

Functional Classification of Mutual Funds

a. open-end funds

b. closed-end funds

Open-end mutual funds

Open-end mutual funds are funds which can buy back their shares from their investors at the end of every business day at the net asset value computed that day. Most open-end funds also sell shares to the public every business day; these shares are also priced at net asset value. The total investment in the fund will vary based on share purchases, share redemptions and fluctuation in market valuation. There is no legal limit on the number of shares that can be issued. These are most common type of mutual fund.

Closed-end funds

Closed-end funds generally issue shares to the public only once, when they are created through an initial public offering. Their shares are then listed for trading on a stock exchange. Investors who no longer wish to invest in the fund cannot sell their shares back to the fund (as they can with an open-end fund). Instead, they must sell their shares to another investor in the market; the price they receive may be significantly different from net asset value. It may be at a "premium" to net asset value (meaning that it is higher than net asset value) or, more commonly, at a "discount" to net asset value (meaning that it is lower than net asset value).

Types of schemes of mutual funds

1. Income Category

This category of schemes invests only into debt instruments issued by government, public or private companies. 

Liquid Funds: These schemes invest in short term income instruments such as certificate of deposits, treasury bills and short-term bonds. The objective of these schemes is to provide current income with high liquidity. The ideal investment horizon is 1 day to 1 month.

Short-Term Income Funds: These schemes invest in short-term money market instruments and corporate bonds. The objective of these schemes is to provide a higher current income than liquid funds but without compromising the liquidity. The ideal investment horizon is 1 month to 3 months.

Medium-Term Income Funds: These schemes invest in medium-term treasury bills and corporate bonds. The objective of these schemes is to provide a higher current income than short-term income funds with reasonable liquidity. The ideal investment horizon is 3 months to 6 months. 

Long-Term Income Funds: These schemes invest in medium to long term treasury bills, dated government securities and corporate bonds. The objective of these schemes is to provide consistent returns higher than medium term income funds with reasonable liquidity. The ideal investment horizon is more than 6 months to 2 years.

Floating Rate Funds: These schemes invest in short-term to long-term instruments comprising of government securities and corporate bonds. The objectives of these schemes to provide consistent returns by investing in floating rate instruments, which are indexed to interest rate or consumer price indexes. These schemes also provide reasonable liquidity to the investors. The ideal investment horizon depends on the type of floating rate scheme chosen short term floating rate scheme, medium term floating rate scheme, floating rate income scheme, etc.

GILT Funds: These schemes invest in securities issued by the government. The securities in which these funds invest are called sovereign securities and they are assigned the highest credit rating. These securities, usually, doesn’t carry any credit risk. However, they carry interest rate risk due to fluctuations of their trading prices based on current interest rate environment in the economy and a plethora of fundamental economic conditions. The ideal investment horizon depends on the type of gilt security scheme chosen medium term or long term. Usually, an investment horizon of more than 1 year is recommended.

Bond funds: These schemes invest in securities issued by central government, state government, public sector companies and private sector companies. The objective of these schemes is to provide a consistent high return from a portfolio of bonds comprised of the securities described above. The ideal investment horizon is about 1 year to 2 years.

Fixed Maturity Plans: These schemes have a fixed maturity date wherein the scheme gets matured. These schemes are closed ended in nature. They are open for a fixed duration, at first, during which investors can subscribe for units of the scheme. After the fixed duration gets over, the schemes close for further subscriptions. Units are allotted only to the persons who have invested during the initial opening period. The plans have fixed maturities like 3 months, 6 months, 1 year, etc. After such a fixed period or on maturity date, units of the investors are bought back by the mutual fund at the NAV applicable on that day. The objective of these schemes is to provide a fixed income for a fixed period to the unit holders from a portfolio of various types of debt instruments.

2. Equity Category

This category of schemes invests only into shares of companies.

Diversified Equity Funds: These schemes invest in equity shares of public and private companies across different sectors. The objective of the scheme is to provide long term capital appreciation while reducing risk by diversifying investments into various sectors of the economy.

Broadly, all the companies can be categorized into three types large cap companies, mid cap companies and small cap companies. Mutual funds offer diversified equity schemes even in these narrow classifications. The following are the sub categories of funds under the diversified equity class:

Large Cap Funds: These schemes invest only in large capitalized companies.

Mid Cap Funds: These schemes invest only in medium capitalized companies.

Small Cap funds: These schemes invest only in small-capitalized companies.

Mix of large, mid and small cap funds: These schemes invest in a mix of large, mid and small-capitalized companies.

Sector Equity Funds: These schemes invest in shares of public and private companies of a particular sector of the economy only. The objective of these funds is to focus on a particular sector, which presents opportunities for high capital appreciation in the medium to long-term time horizon. Even this class of equity funds can have narrower classifications of large cap, mid cap and small cap schemes.

Index Funds: These schemes are a replicate or try to replicate a popular index of a stock exchange. The objective of the fund is to allow investors to invest in stocks, which represent the popular index and in the same proportions in which the stocks are in that popular index.

Tax Funds: These schemes are basically diversified equity schemes but with a tax advantage. Amounts invested into these schemes qualify for deduction while computing taxable income of an individual. Hence, these schemes not only give returns from investment but also save us taxes. However, investment into these schemes for tax deductions is restricted to a certain amount. 

3.Hybrid Funds

These funds invest in a mix of equity and debt securities

Balanced Funds: These funds invest in a mix of equity and debt in the proportions of 50:50 or 60:50 or other proportions of similar kind. The objective of these funds is to provide a reasonable and consistent return from the mix of both the asset classes.

Monthly Income Schemes: These funds invest in a mix of equity and debt in the proportions of 20:80 or 30:70 or other proportions of similar kind. The objective of these funds is to provide enhanced regular returns to risk-averse investors by taking small positions in equity assets.

Systematic Investment Planning (SIP’s)... Need of the hour for beginners

…Believes in investing religiously

Systematic Investment Plan (SIP) is an investment vehicle offered by mutual funds to investors, allowing them to invest using small periodically amounts instead of lump sums. The frequency of investment is usually weekly, monthly or quarterly.

In SIP, a fixed amount of money is debited by the investors banks account periodically and invested in a specified mutual fund. The investor is allocated a number of units according to the then current Net asset value. Every time a sum is invested, more units are added to the investors account.

The strategy claims to free the investors from speculating in volatile markets by Rupee cost averaging. As the investor is getting more units when the price is low and less units when the price is high, in the long run the average cost per unit is supposed to be lower.

SIP claims to encourage disciplined investment. SIPs are flexible, the investors may stop investing a plan anytime, or may choose to increase or decrease the investment amount. SIP is usually recommended to retail investors who do not have the resources to pursue active investment. In India, a recurring payment can be set for SIP using Electronic Clearing Services (ECS). Some mutual funds allow tax benefits under Equity-linked savings schemes. This however has a lock-in period of three years. Thus, the final payment of SIP also must clear the lock-in before this scheme can be availed

SIPs also help in availing benefits of compounding. This means  the earlier one starts an SIP and the longer the investment horizon , the large the benefits  .The reason being, each rupee one invests earns a return , which ends up as more rupees to earn a return , allowing investment to grow at a fast pace. Higher rates of return or longer investment time periods increase the principle amount in geometric proportions .This is the single important reasons for investors to start investing early and keep investing on a regular basis to achieve the long term financial goals.

Conclusion

Investment is all about doing it in continuity; Money to be earned is an art and not a one go attempt. Mutual Funds investments though might be said subject to market risk but taking a bit of risk is of no harm if better returns are to be churned out. Mutual Fund Investments is the one which is not to be looked for again as there is always a one taking care of your return rates ie. The Mutual Fund Manager.

The great majority of mutual fund investors really take volatility at Stride… Vamosss…

Mr.Nimish.A.Chodankar

CA FINAL STUDENT

Reg. No.:WRO0455539

Email id: nimish@caaa.in