All about Mutual Funds

a. What are New Fund Offers?

An asset management company (AMC) is eligible to bring out new schemes. These new schemes are called New Fund Offers (NFOs). Each of these schemes will have a defined investment objective. NFOs are launched alongwith Scheme offer documents and their abridged versions, called ‘Key Information Memorandum’(KIM). Schemes are available for subscripttion during NFO for a certain  period. After closure date of NFO, allotment is made to investors. An open-ended scheme receives subscripttion on ongoing basis even after the NFO closure whereas close-ended schemes are not eligible to receive subscripttion after NFO closure. In an interval scheme, subscripttion opens at regular intervals, say monthly, quarterly etc.

b. What should an investor look for into an offer document?

An offer document contains significant information. It is required to be given to prospective investors along with application form. SEBI has prescribed minimum disclosures in the KIM as well as offer document. An investor, before investing, should carefully read the offer document. Due care must be given to main features of the scheme, asset allocation, risk factors, load structure and annual recurring expenses, sponsor’s track record, educational qualification and work experience of key personnel including fund managers, performance of other schemes launched by the mutual fund in the past, pending litigations and penalties imposed, etc.

c. How are schemes classified according to Investment Objective?  

A scheme is classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:

·        Growth / Equity Oriented Scheme - Objective of growth funds is to provide capital appreciation over a time period. These schemes normally invest major corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences.

·        Income / Debt Oriented Scheme - Income or Debt funds aim to provide regular and steady income. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities, money market instruments, securitized debt and fixed income derivatives. Such funds are assumed to be less risky compared to equity schemes as these funds are not directly affected by fluctuations in equity markets. Rather these funds are affected largely because of change in interest rates in the economy.

·        Balanced Fund - Balanced funds have a fair share of  equities and fixed income securities in their asset allocation.  The proportion is indicated in their offer documents. These are appropriate for investors looking for moderate growth. NAVs of these funds are likely to be less volatile compared to pure equity funds.

·        Money Market or Liquid Fund - Primary objective of these schemes is to provide liquidity and moderate income. These invest exclusively in short-term instruments such as treasury bills, short term debt securities etc. These funds are appropriate for individuals and corporate as a means to park their surplus funds for short periods.

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

The above list is not exhaustive as classifications of schemes expand based on new investment objectives.

d. What is the difference between open-ended and close-ended schemes?

An open-ended scheme receives subscripttion and also redeems on regular basis. It does not have a maturity period. A close-ended scheme, on the other hand, receives subscripttion only during NFO period. After NFO closure, close-ended scheme can only redeem at periodic intervals, not accept fresh subscripttions. The duration of maturity for a close-ended scheme is specified in days/months/years in offer document of the scheme.  

e. What is Net Asset Value (NAV) of a scheme?

The performance of a scheme of mutual fund is represented by Net Asset Value (NAV). 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 the portfolio of a scheme divided by the total number of units of the scheme on a particular date.

f. What types of options are available to invest in mutual fund schemes?

The options available in a mutual fund scheme are Growth option and dividend option. Under growth option, the dividend is not declared. NAV of unit reflects whatever capital appreciation has occurred in the scheme. Investors who opt for dividend option would receive dividend if there is distributable surplus available as decided by trustees of the scheme. After payout of dividend NAV of the scheme falls by the amount of payout per unit. This dividend is tax free in hands of investor. Investors must indicate the option in their application form.

g. What is the importance of PAN for investors in mutual fund schemes?

Government has made it mandatory for PAN to be quoted in all transactions in securities market. Mutual fund schemes also belong to securities market. For investors without a PAN, should apply to income tax authorities/authorized agencies for issue of PAN. Till the time, income tax authorities issue a PAN, copy of application for PAN and form 61 can be attached with scheme application forms but latest till December 31, 2007. 

h. What is a Load or no-load Fund?

A Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time one buys or sells units in the fund, a charge will be payable. This charge is used by the mutual fund for marketing and distribution expenses. Suppose the NAV per unit is Rs.10. If the entry load is 1%, then the investors who buy would be required to pay Rs.10.10 and if exit load is 1%, those who offer their units for repurchase to the mutual fund will get only Rs.9.90 per unit.

i. What kinds of load and expense structures are applicable for open-ended and close-ended schemes? How much maximum can be charged under different load/expense heads?

Load is charged by schemes towards meeting marketing, sales and other distribution expenses. An open ended scheme can charge ‘entry load’ at time of subscripttion and ‘exit load’ at time of redemption. Maximum entry and exit loads for open-ended schemes are chargeable in such a way that maximum subscripttion price should be within 107% of NAV for subscripttion and minimum price within 93% of NAV for redemption. For close-ended schemes, minimum redemption price shall be within 95% of NAV. 

A close ended scheme can charge only ‘initial issue expenses’ at time of subscripttion, not entry load. Maximum chargeable initial issue expenses are 6%. Since Close-ended schemes have a maturity tenure, so if redeemed before maturity, can charge an exit load from investors.  

The annual recurring expenses are charged annually by each scheme to meet scheme related miscellaneous operational expenses and the investment management fee. Though annual recurring expenses can be different for various plans within a scheme, the Investment management fee is required to be same across different plans i.e. retail plan, institutional plan, super institutional plan etc. 

Such expenses vary depending on type of scheme. For equity oriented schemes, maximum annual recurring expenses can be upto 2.50%, for debt oriented schemes it can be upto 2.25%, for index funds and ETFs it can be upto 1.50% and for fund of funds it can be upto 0.75%. Annual expenses

j. What are Systematic Investment Plans (SIP), Systematic Withdrawal Plans (SWP), Systematic Transfer Plans (STP) ?

Systematic Investment Plan (SIP) is a monthly investment option.  Investor  deposits a fixed, small amount regularly, say, every month or quarter, into a particular mutual fund scheme at the prevailing NAV.   The investor can get out of the fund i.e. redeem his units any time irrespective of whether he has completed his minimum investment in that scheme. In such a case his remaining post-dated cheques will be returned back to him. SIP is possible only in open-ended schemes except ETFs.

Under Systematic Withdrawal Plan(SWP), the unitholder may redeem a fixed number of units on a monthly, quarterly or annual basis.

Under Systematic Transfer Plan (STP), an investor in one scheme can keep transferring funds to another scheme, depending upon his market outlook. Investor may transfer a fixed sum of money on a periodic basis. A transfer is treated as redemption of units from the existing scheme at applicable NAV and an investment in units of the new scheme.

k. What sources of information are furnished to investor after subscripttion for purchase of mutual fund units?

The investor in mutual fund units is entitled to receive a number of documents. When a mutual fund receives subscripttion from an investor, it is required to dispatch statements of accounts within maximum 30 days. The statement of accounts would contain information on allotment price and the load charged, number of units allotted, date of allotment, the folio number for the subscripttion, NAV as on date etc. Those investors who invest through SIP/STP/SWP, would receive statement of accounts within 10 days and an update on their investments every quarter of the year . 

Besides, mutual funds disclose quarterly portfolio statements. It contains details of securities constituting the portfolio and performance vis-à-vis the benchmark index.

Half-yearly statements are published in one all-India English language newspaper and a regional language newspaper. This contains portfolio disclosure and unaudited financial results.

Abridged annual report is mailed to all investors within six months of financial closure. It contains details about auditors’ report, balance sheet for each scheme and revenue  accounts. Full annual report is available at head office of mutual fund. It can be bought on payment of a nominal fee.

l. What are sector specific funds/schemes?

Investment objective of these schemes is to invest in the securities of those sectors or industries which would be specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. Returns in these funds would be largely dependent on the performance of the respective sectors/industries. While these funds may give higher returns during boom phase of those sectors, they would be risky compared to diversified equity funds. Investors need to keep a watch on those sectors/industries for comparing performance of the scheme and must exit at an appropriate time or seek advice of an expert.

m. What are Tax Saving Schemes?

These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified schemes e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.

n. What is Capital Protection Oriented Scheme ?

Capital Protection Oriented Schemes is “oriented towards protection of capital” and “not with guaranteed returns”. Such schemes derive their orientation towards capital protection from the specific nature of portfolio structure. For example, certain chunk of  portfolio may be placed in highest AAA rated bonds in such  a way that on maturity this chunk equals to 100 percent of original portfolio value. Thus original capital gets protected. The balance of portfolio may be invested in riskier assets in search of better returns. Trustees of the mutual fund company shall continuously monitor the portfolio of this type of scheme. In addition, a SEBI registered credit rating agency shall rate and review the portfolio structure every quarter of the year.

o. What are Index funds, Exchange traded funds and Fund of funds ?

An Index fund selects a market index and makes investments in the basket of stocks drawn from the constituents of that index. The fund may invest in any or all of the stocks constituting that index but not necessarily in the same proportion.

Exchange traded mutual funds, popularly known as ETFs also make investments based on a market index or commodity but in fixed number of units, say 1000 units. This is called a creation basket. Additionally, ETFs are listed on a stock exchange for trading of units. The role of stock exchanges for ETFs is that listing provides liquidity to units in less than creation size. Thus lots of less than 1000 ETF units can be traded by retail investors at the stock exchanges. In an ETF that are based on a market index, Creation baskets will have stocks of that index in same proportion as the index. Hence benchmark will be that particular index. Gold based ETFs were introduced in 2007. Units of Gold ETFs are backed by physical gold, not by any index. Hence the benchmark in Gold ETF is not an index, it is the physical price of gold.   

A fund of funds invests in other existing mutual fund schemes. It does not invest directly in securities. The NAV of a fund of funds depends on NAVs of the schemes in which it invests.      

A common feature in fund management of Index funds, Exchange traded funds and Fund of funds is that these are largely passive investment strategies. Instead of churning portfolio in search for winning stocks, fund manager is only expected to perform along with the given index/benchmark by staying invested. Hence total recurring expenses are expected to be low compared to active fund management. Presently, maximum annual expenses for index funds and ETFs are 1.50%. For fund of funds, annual expenses are 0.75% plus the annual charges of underlying schemes that can be transferred to investor, maximum limit being 2.50%.

What are KYC norms for Mutual Fund Investments ?

The need to ‘Know Your Client’ is vital for prevention for money laundering. The AMC may need to seek information and documentation to establish the identity of subscribers to units of scheme. In line with Government of India directives, Permanent Account Number(PAN) is compulsory as it is sole identification number for all investors transacting in securities market from January 1, 2008. 

2. What is the new Format of Offer Documents of AMCs ?

It was felt that Offer Documents had become lengthy and complex with repetitive details. To make the erstwhile mutual fund  offer documents user-friendly, it is simplified and now bifurcated into two parts. The first part is Scheme Information Document (SID)that   concentrates on the information relevant to investment decisions. Second part named as Statement of Additional Information (SAI) will contain the information about the sponsor, AMC, Trustee Co., other service providers, taxation details and other general information regarding mutual funds. SID will be separate for each scheme and SAI will be common for an asset management company. Both SID and SAI are accessible on websites of asset management companies. Besides, SID shall be available in printed form at time of NFOs. However, SID shall be read in conjunction with the SAI and not in isolation. It is expected that SID and SAI are handy from an investor’s perspective. The KIM shall continue to be provided alongwith application forms.

3. What is the ‘no load’ concept for direct applications in mutual fund schemes ?

Direct applications shall not have to pay any entry load. These are the applications received by the AMC i.e. application received through internet, submitted to AMC or Collection Centre/ Investor Service Centre but not routed through any distributor/ agent/ broker. Where direct application is made, investors shall mark the field for distributor/agent/broker code as ‘Direct’. If broker code is already printed on application form, direct investors should strike off the code, mention ‘Direct’ and countersign. Investors shall ensure that the field for broker code should not be left blank.

It shall also be applicable in case of switch-in to the Scheme from other Schemes if such a transaction is done directly by the investor.