FAQ – Mutual Fund

A mutual fund is an investment tool that allows small investors gain access to a well-diversified portfolio of equities, bonds, and other securities. Each shareholder participates in the gain or loss of the fund. Units are issued and can be redeemed as needed. The fund's Net Asset Value (NAV) is determined each day.

Mutual funds are financial intermediaries, set up by companies to receive your money and invest via an Asset Management Company (AMC). Also, a mutual fund is an ideal tool for people who want to invest but do not want to be bothered with deciphering the numbers and deciding whether the stock is a good buy or not. A mutual fund manager proceeds to buy a number of stocks from various markets and industries.

The beauty of mutual funds is that anyone with an investible surplus of a few hundred rupees can invest and reap returns as high as those provided by the equity markets or have a steady and comparatively secure investment as offered by debt instruments. Depending on the amount invested in a mutual fund, investors own a part of the overall fund.

Mutual fund schemes can be classified as open-ended or close-ended schemes depending on its maturity period.

Open-ended Funds

An open-ended mutual fund is the one that is available for subscription and repurchase on a continuous basis.

Close-ended Fund

A close-ended mutual fund has a stipulated maturity period; for example, 5-7 years. The fund is open for subscription only for a specific period from the time of launch of the scheme.

There are several benefits from investing in a Mutual Fund.

Small investments: Mutual funds help you to reap the benefit of returns by a portfolio spread across a wide spectrum of companies with small investments. Such a spread would not have been possible without their assistance.

Professional Fund Management: Professionals having considerable expertise, experience, and resources manage the pool of money collected by a mutual fund. They thoroughly analyze the markets and economy to pick good investment opportunities.

Spreading Risk: Investors with a limited amount of fund might be able to invest in only one or two stocks or bonds, thus increasing their risk. However, a mutual fund will spread its risk by investing a number of sound stocks or bonds. A fund normally invests in companies across a wide range of industries, so the risk is diversified at the same time taking advantage of the position it holds. Also in case of liquidity crisis where stocks are sold at a distress, mutual funds have the advantage of the redemption option at the NAVs.

Transparency and interactivity: Mutual funds regularly provide investors with information on the value of their investments. They also provide complete portfolio disclosure of the investments made by various schemes and also the proportion invested in each asset type. Mutual funds clearly layout their investment strategy to the investor.

Liquidity: Closed ended funds have their units listed at the stock exchange, thus they can be bought and sold at their market value. Over and above this the units can be directly redeemed to the mutual fund as and when they announce the repurchase.

Choice: Mutual funds offer investors a wide variety of schemes to choose from. Investors can pick up a scheme depending upon their risk or return profile.

Regulations: All mutual funds are registered with SEBI and they function within the provisions of strict regulation designed to protect the interests of the investors.

When you deposit money in a bank, the bank promises to pay you a certain rate of interest for the period you specify. On the date of maturity, the bank is supposed to return the principal amount and interest to you. Whereas, in a mutual fund, the money you invest, is in turn invested by the manager, on your behalf, as per the investment strategy specified for the scheme. The profit, if any, less expenses of the manager, is reflected in the NAV or distributed as income. Likewise, loss, if any, with the expenses, is to be borne by you.

NAV is the actual value of one unit of a given scheme on any given business day. It reflects the liquidation value of the fund's investments on that particular day after accounting for all expenses. It is calculated by deducting all liabilities (except unit capital) of the fund from the realizable value of all assets and dividing it by the number of units outstanding.

You can track the performance of a fund by checking its NAV. The NAVs are published in financial newspapers and also available on the AMFI (Association of Mutual Funds in India) website www.amfiindia.com on a daily basis.

Switching facility provides investors with an option to transfer the funds amongst different types of schemes or plans. Investors can opt to switch units between dividend plan and growth plan at NAV based prices. Switching is also allowed into/from other select open ended schemes currently within the fund family or schemes that may be launched in the future at NAV based prices.

While switching between debt and equity Schemes, one has to take care of exit and entry loads. Switching from a debt scheme to equity scheme involves an entry load while the vice versa does not involve the entry load.

This is an investment technique where you deposit a fixed, small amount regularly into the mutual fund scheme (every month or quarter as per your convenience) at the prevailing NAV, subject to applicable loads.

The unit holder may set up a systematic withdrawal plan on a monthly, quarterly or semi-annual or annual basis to redeem a fixed number of units.

It is the price paid by an investor while investing in a scheme of a mutual fund.

Redemption or repurchase price is the price at which an investor sells back the units to the mutual fund.

A mutual fund may not, through just one portfolio, be able to meet the investment objectives of all their unit holders. Some unit holders may want to invest in risk-bearing securities such as equity and some others may want to invest in safer securities such as bonds or government securities. Hence, mutual funds come out with different schemes, each with a different investment objective.

Under the Growth Plan, investors realize the capital appreciation of investments while under the Dividend Reinvestment Plan, the dividends declared are reinvested automatically in the scheme.

The aim of growth funds is to provide capital appreciation over the medium to long-term. Such schemes normally invest a major part of their 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. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.

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, government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

A debt fund invests in fixed-income instruments, where safety of capital and regular returns are assured. These include Commercial Paper, Certificates of Deposit, debentures, and bonds. While the rate of interest for these instruments stays the same throughout their tenure, their market value keeps changing, depending on how the interest rates in the economy move.

A debt fund's NAV is the market value of its portfolio holdings at a given point in time. As the interest rates change, so do the market value of fixed-income instruments - and hence, the NAV of a debt fund. Thus it is a misnomer that the debt fund's NAV does not fall.

A bond is a promise in which the issuer agrees to pay a certain rate of interest, usually as a percentage of the bond's face value to the investor at specific periodicity over the life of the bond. Sometimes interest is also paid in the form of issuing the instrument at a discount to face value and subsequently redeeming it at par. Some bonds do not pay a fixed rate of interest but pay interest that is a mark-up on some benchmark.

World over, a debenture is a debt security issued by a corporation that is not secured by specific assets, but rather by the general credt of the corporation. Stated assets secure a corporate bond, unlike a debenture. But in India, these are used interchangeably.

The charge collected by a mutual fund from an investor for selling the units or investing in it. When a charge is collected at the time of entering into the scheme, it is called an Entry load or front-end load or sales load. The entry load percentage is added to the NAV at the time of allotment of units. An exit load or back-end load or repurchase load is a charge that is collected at the time of redeeming or for transferring units between schemes (switch). The exit load percentage is deducted from the NAV at the time of redemption or transfer. Some schemes do not charge any load and are called "No Load Schemes" such as an Equity Linked Savings Scheme (ELSS).

These are the funds or schemes, which invest in the securities of only those sectors or industries as specified in the offer documents; for example, pharmaceuticals, software, Fast Moving Consumer Goods (FMCG), petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors or industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors or industries and must exit at an appropriate time. They may also seek advice from an expert.

ETFs are passively managed mutual fund schemes tracking a benchmark index and reflect the performance of that index. These schemes are listed on the stock exchange and therefore have the flexibility of trading like a share on a stock exchange. It can also be looked as a security that tracks an index, a commodity or a basket of assets such as an index fund, but trades like a stock on an exchange, thus experiencing price changes throughout the day as it is bought and sold.

FMPs are basically debt oriented investment schemes with a pre-specified tenure offered by mutual funds. They invest in a portfolio of debt instruments whose maturity coincides with the maturity of the concerned FMP. The primary objective of a FMP is to generate income while aiming to protect the capital by investing in a portfolio of debt and money market securities. Since FMPs are available with several maturity options, one can invest in the relevant plan depending upon his investment horizon and the requirement of cash flows.