Mutual Fund Investment

Intro to MF

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 instruments. The income earned through these investments and the capital appreciation realized by the scheme are shared by its 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 in Mutual Funds. Each Mutual Fund scheme has a defined investment objective and strategy.

A mutual fund is the ideal investment vehicle for today’s 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 transactions etc.

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 and 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). E.g. 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 fund schemes may be classified on the basis of its structure and its investment objective.

By Structure:

Open-ended Funds
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.

Closed-ended Funds

A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 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.

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 Funds

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 proven 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 Funds

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 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.

Load Funds

A Load Fund is one that charges a commission for entry or exit. That is, each time you buy or sell units in the fund, a commission will be payable. Typically entry and exit loads range from 1% to 2%. It could be worth paying the load, if the fund has a good performance history.

No-Load Funds

A No-Load Fund is one that does not charge a commission for entry or exit. That is, no commission is payable on purchase or sale of units in the fund. The advantage of a no load fund is that the entire corpus is put to work.

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. The Act also provides opportunities to investors to save capital gains u/s 54EA and 54EB by investing in Mutual Funds, provided the capital asset has been sold prior to April 1, 2000 and the amount is invested before September 30, 2000.

Special Schemes

Industry Specific Schemes

Industry Specific Schemes invest only in the industries specified in the offer document. The investment of these funds is limited to specific industries like InfoTech, FMCG, Pharmaceuticals etc.

Index Schemes

Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50.

Sectoral Schemes

Sectoral Funds are those, which invest exclusively in a specified industry or a group of industries or various segments such as ‘A’ Group shares or initial public offerings.

Basic MF terms

As you probably know, a mutual fund is an investment that pools together money from a number of investors. It then uses professionals to manage and invest this money with the aim of achieving a return.

The mutual funds industry is regulated by the Securities and Exchange Board of India.

If you are interested in investing in mutual funds, here are some terms you need to understand.


An Asset Management Company is the fund house or the company that manages the money.

The mutual fund is a trust registered under the Indian Trust Act. It is initiated by a sponsor. A sponsor is a person who acts alone or with a corporate to establish a mutual fund. The sponsor then appoints an AMC to manage the investment, marketing, accounting and other functions pertaining to the fund.

For instance, ABN AMRO Trustee (India) Private Limited is appointed as the trustee to the ABN AMRO mutual fund.

ABN AMRO Asset Management (India) Limited is appointed as its investment manager.

Various funds with different objectives can be floated under the umbrella of one parent.

So ABN AMRO Equity Fund, ABN AMRO Opportunities Fund and ABN AMRO Flexi Debt Fund are all independent schemes of ABN AMRO Mutual Fund. They are managed by the ABN AMRO AMC.


The Net Asset Value is the price of a unit of a fund. When a fund comes out with an NFO, it is priced Rs 10. Later, depending on the value of the investments, this price could rise or fall.


This is a fee that is charged when you buy or sell the units of a fund.

When you buy the units of a fund, you pay a percentage of it as a fee. This is known as the entry load.

Let’s say you are investing Rs 10,000 and the entry load is 2%. That means you pay Rs 200 as the entry load and Rs 9,800 is invested in the fund.

Now, let’s assume you are selling the units of your fund. And the Rs 10,000 you invested initially is now Rs 15,000. Let’s further assume the exit load is 2%. So you pay Rs 300 and get back Rs 14,700.

Generally, if funds charge an entry load, they will not charge an exit load. Or vice versa. Only one of the loads is charged.

The load is a percentage of the NAV.


This is the term given to all the investments made by the fund as well as the amount held in cash.


Let’s assume a very small mutual fund has an initial investment of 1,000 units and each unit is worth Rs 10. Hence, the total amount with the fund is Rs 10,000. This is referred to as the corpus. Later, some other investors invest Rs 2,000. Now the corpus will be Rs 12,000 (Rs 10,000 + Rs 2,000).

The total amount invested (Rs 12,000) is called the corpus or the total amount of money invested in the fund.


Assets Under Management is the total value of all the investments currently being managed by the fund.

Let’s say the corpus is Rs 12,000 but, due to a rise in the price of the shares it has invested in, the value of the units has increased. So the Rs 12,000 invested is now worth Rs 15,000. This figure is referred to as AUM.

Diversified equity mutual fund

This is a mutual fund that invests in stocks of various companies in various sectors.


Equity Linked Saving Schemes are diversified equity mutual funds with a tax benefit under Section 80C of the Income Tax Act.

To avail of the tax benefit, your money must be locked up for at least three years.

Balanced fund

A fund that invests in both equity (shares) and debt (fixed return investments) is known as a balanced fund.

Debt fund
These are funds that invest in fixed return investments like bonds. A liquid fund is one that invests in money market instruments, these are fixed return investments of a very short tenure.


A New Fund Offering is the term given to a new mutual fund scheme.


A Systematic Investment Plan refers to periodic investing in a mutual fund. Every month or every three months, the investor will have to commit to putting in a fixed amount. This will go towards the purchase of units.

Let’s say that every month you commit to investing, say, Rs 1,000 in your fund. At the end of a year, you would have invested Rs 12,000.

If the NAV on the day you invest in the first month is Rs 20, you will get 50 units.

The next month, the NAV is Rs 25. You will get 40 units.

The following month, the NAV is Rs 18. You will get 55.56 units.

So, after three months, you would have 145.56 units. On an average, you would have paid around Rs 21 per unit. This is because, when the NAV is high, you get fewer units per Rs 1,000. When the NAV falls, you get more units per Rs 1,000.

What to keep in mind in order to pick a good mutual fund?

The way to do it is by comparing it rightly with other benchmarks and parameters.

Absolute returns

Absolute returns measure how much a fund has gained over a certain period. So, you look at the Net Asset Value on one day and look at it, say, six months or one year or two years later. The percentage difference will tell you the return over this time frame.

Compare the returns of various funds. But, when using this parameter to compare one fund with another, make sure that you compare the right fund. To use the age-old analogy, don’t compare apples with oranges.

So if you are looking at the returns of a diversified equity fund, compare it with other diversified equity funds. Don’t compare it with a sector fund.

Don’t even compare it with a balanced fund (one that invests in equity and debt).

For instance, compare HDFC Equity with Franklin India Prima. Both are diversified equity funds. Similarly, compare UTI Auto with J M Auto, both being auto sector funds. Or Birla Midcap with Magnum Midcap, both being funds that invest in mid-cap companies.

Don’t compare the performance of Alliance Equity with UTI Auto or even Alliance Equity with Birla Midcap.

Benchmark returns

This will give you a standard by which to make the comparison. It basically indicates what the fund has earned as against what it should have earned.

A fund’s benchmark is an index that is chosen by a fund company to serve as a standard for its returns. The market watchdog, the Securities and Exchange Board of India, has made it mandatory for funds to declare a benchmark index.

In effect, the fund is saying that the benchmark’s returns are its target and a fund should be deemed to have done well if it manages to beat the benchmark.

Let’s say the fund is a diversified equity fund that has benchmarked itself against the Sensex.

So the returns of this fund will be compared vis-a-viz the Sensex.

Now, if the markets are doing fabulously well and the Sensex keeps climbing upwards steadily, then anything less than fabulous returns from the fund would actually be a disappointment.

If the Sensex rises by 10% over two months and the fund’s NAV rises by 12%, it is said to have outperformed its benchmark. If the NAV rose by just 8%, it is said to have underperformed the benchmark.

But if the Sensex drops by 10% over a period of two months and during that time, the fund’s NAV drops by only 6%, then the fund is said to have outperformed the benchmark. This is because it dropped less than the benchmark.

A fund’s returns compared to its benchmark are called its benchmark returns.

Compare a fund with its own stated benchmark, and not another one. For instance, Fidelity Equity and BoB Growth are both diversified equity funds with different benchmarks.

Fidelity Equity is benchmarked against BSE 200 while BoB Growth is benchmarked against the Sensex.

Time period

The most important thing while measuring or comparing returns is to choose an appropriate time period.

The time period over which returns should be compared and evaluated has to be the same as the one that fund type is meant to be invested in.

If you are comparing equity funds then you must use three to five year returns. But this is not the case of every other fund.

For instance, cash funds are known as ultra short-term debt funds or liquid funds that invest in money market instruments. These are fixed return instruments of very short maturities. Their main aim is to preserve the principal and earn a modest return. The money you invest will eventually be returned to you with a little something added.

Investors invest in these funds for a very short time frame of around a few months. It is alright to compare these funds on the basis of their six month returns.

When returns are compared between funds, make sure the time period is identical. Else, you may be looking at the one-year returns for one fund and the three-year returns for another.

For instance, let’s assume you are told the return of Fund A was 60% and that of Fund B was 70%. But, if Fund A’s return is a one-year return while Fund B’s return is a three-year return, the answer you would get would be very misleading.

While there are other factors that have to be considered when investing in a mutual fund, returns is the most important. So make sure you do your homework right on this count.

It’s also important to know who the fund manager is and what is the philosphy of that fund..the basic intent of the fund should align with your own short and long terms financial goals.

How risky is your MF?

Investors always judge a fund by the return it gives, never by the risk it took.

In any historical analysis of a mutual fund, the return is remembered but the risk is quickly forgotten.

So a fund manager may have used very high-risk strategies (that are bound to fail disastrously in the long run), hoping that his wins will be remembered (as they often are), but the risk he took will soon be forgotten.

What is risk?

Risk can be defined as the potential for harm.

But when anyone analysing mutual funds uses this term, what is actually being talked about is volatility.

Volatility is nothing but the fluctuation of the Net Asset Value (price of a unit of a fund). The higher the volatility, the greater the fluctuations of the NAV.

Generally, past volatility is taken as an indicator of future risk and for the task of evaluating a mutual fund, this is an adequate (even if not ideal) approximation.

How risk is measured

There are two ways in which you can determine how risky a fund is.

Standard Deviation

Standard Deviation is a measure of how much the actual performance of a fund over a period of time deviates from the average performance.

Since Standard Deviation is a measure of risk, a low Standard Deviation is good.

Sharpe Ratio

The Sharpe Ratio of a fund measures whether the returns that a fund delivered were commensurate with the kind of volatility it exhibited.

This ratio looks at both, returns and risk, and delivers a single measure that is proportional to the risk adjusted returns.

Since Sharpe Ratio is a measure of risk-adjusted returns, a high Sharpe Ratio is good.

So how would you figure out how risky a mutual fund is?

Value Research, a mutual fund research outfit, carries out a rating every month which is also carried on

In this rating, each fund is given a star. The funds with a 5-star rating are the best. Those with a 1-star rating are the worst.

This star rating is based on risk-adjusted return. In a very simple way, it gives investors an understanding of whether a fund is taking an acceptable amount of risk in generating the kind of returns it is doing.

A fund’s return for each month is taken since the day it is launched (only funds with a minimum performance of history of three years are considered).

This return that a fund gives is compared to other ‘riskless’ investments, like government investments, which have no risk per se. This means funds do not rate very high if they give phenomenal returns, but have taken tremendous risks to do so.

What you must note

1. Don’t just look at the NAV, also look at the risk

Alliance Buy India and Alliance Equity both have 3 stars. That does mean their NAV is identical. In fact, the NAV of Alliance Equity is 91.66 while that of Buy India is 16.05.

However, Alliance Buy India took an average risk and delivered an average return, while Alliance Equity took an above average risk to get the above average returns. Hence their stars are identical, depiste one having a higher NAV.

2. Higher rating does not mean better returns

A fund with more stars does not indicate a higher return when compared with the rest. All it means is that you will get a good return without putting your money at too much risk.

Birla Equity Plan has a 4-star rating while Alliance Tax Relief ’96 has a 2-star rating. However, the fund with the 2-star rating has a higher NAV (131.96) than the one with the 4-star rating (39.37).

3. Higher rating does not mean more risk

Birla Advantage has an NAV of 67.09 while Franklin India Prima has an NAV of 122.92.

This does not necessarily mean that Franklin India Prima is offering a higher risk since the return is higher.

In fact, according to our ratings, Franklin India Prima is a 5-star fund while (risk is below average) while Birla Advantage is a 2-star fund (risk is above average).

On a final note

When you decide to invest in a mutual fund, you must look at risk and return.

Always ask yourself one question: What are the chances of my losing money?

Do not get misled by high returns. You could also end up losing a substantial part of your savings.

Benefits of MF Investments

Professional Management

Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme.


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.

Convenient Administration

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.

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.

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.


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.


You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager’s investment strategy and outlook.


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.


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.

Choice of Schemes

Mutual Funds offer a family of schemes to suit your varying needs over a lifetime.

Well Regulated

All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.

Tax Benefits of Investing in MFs

Among the innumerable investment options currently available to investors, investment in mutual funds is one of the more popular ones.

The reasons are not far to seek: for an individual investor it is very difficult to keep abreast of the latest changes and the happenings whether in the stock market or fixed income instruments.

Besides, the liquidity that investment in mutual funds offers has also given a fillip to their increasing popularity. Most mutual funds nowadays provide investor friendly procedures which are easy to manage and handle.

The transfer, transmission and nomination of the units of mutual funds are comparatively easy and simple.

Which is why in the last two or three years in particular, investment in mutual funds has seen a steep growth. Then, too, mutual funds come loaded with terrific tax advantages.

Dividends are tax-free

The biggest tax advantage of investing in mutual funds arises from the provisions contained in Section 10(35) of the Income Tax Act, 1961, under which the entire income received by investors, whether from units issued by Unit Trust of India or those of any other mutual fund registered under the Securities and Exchange Board of India (Sebi), is fully exempt from income tax.

This complete exemption of income is applicable for all categories of taxpayers. As a result of the full tax exemption on income from mutual funds, the after-tax yield to the investor is higher in comparison with other comparable instruments available in the market.

Low or zero tax on capital gains

In the case of non-equity funds — namely mutual funds investing in debt, government securities, as also some exposure to equities — when units of mutual funds are sold after holding them for more than 12 months, there is a concessional rate of tax @ 20% on long-term capital gains after making appropriate adjustment for Cost Inflation Index.

If the investor chooses not to take advantage of the Cost Inflation Index, then the concessional rate of income tax payable would be only 10%. In view of the concessional rate of income tax payable on long-term capital gains, investment in mutual fund becomes a very lucrative option.

In the case of equity funds, namely for mutual funds investing mainly is shares there is zero-tax liability on long-term capital gains, while the tax rate would be 10% for short-term capital gains.

Tax Smart 1: The lesser-known Gift Tax benefit of mutual funds

In view of abolition of Gift Tax with effect from 1-10-1998, mutual fund units can be gifted to one’s relatives without any liability of gift tax.

However, gift should be avoided to one’s spouse and daughter-in-law in view of the clubbing provisions of Section 64 of Income Tax Act. This is a well-known fact.

Now, for the little-known Gift Tax benefit of mutual funds: as per law, gift of any sum received from non-relatives in excess of Rs 50,000 in a financial year is currently to be added to the total income of the recipient.

Mutual fund units, however, are an exception. The gift of units of mutual fund from non-relatives would not attract this annual limit of Rs 50,000. Thus, without any upper limit the gift in the form of units of mutual fund can be received even from non-relatives with no tax liability whatsoever.

Tax Smart 2: Taking a loan to invest in income funds can be a good idea

‘Finance available against shares,’ ‘Unlock the value of your demat shares,’ ‘Bank loans on shares’ — various loan packages are now available to investors for buying shares and mutual fund units. Such loans can provide easy liquidity without having to divest your portfolio.

Salaried professionals, self-employed persons or individuals having an independent source of income are eligible to take loans against your share and mutual fund portfolios.

Let us see if there is any tax benefit in going in for such loans for buying additional mutual fund units?

Ultimately, it is the utilisation of loan funds which determines the deductibility or otherwise of the interest on the loan taken.

And, in most cases, taking a loan by pledging one’s shares and mutual fund units as a security offers no tax benefit to the investor.

This is because Finance Act, 2001 had retrospectively inserted Section 14A in the Income Tax Act to specifically provide that expenditure incurred in relation to income not includible in the total taxable income would not be allowed as a deduction.

This means that an investor cannot deduct the interest on the loan amount from the income received in the form of dividend from shares or mutual fund units bought out of a loan amount since dividend income is completely exempted under the Income Tax Act, 1961 as per the provisions contained in Section 10(34) and 10(35) of the Income Tax Act, 1961.

Let us now see what happens if you buy shares or mutual fund units by taking a loan against his or her existing portfolio of assets and mutual fund units.

During the holding period of the shares, he receives dividends, and finally sells them. In this situation, the interest paid in respect of the loan will not be allowed as a deduction from the dividend income which is in any case completely tax-free.

However, when the shares are sold at a later stage and capital gains result, then this interest on loan would be allowed as a deduction from the capital gains. This benefit deducting the interest amount from the capital gains – or capital loss – will be available both in the case of long-term capital gains (holding period longer than 12 months).

Let us now turn to the case of capital gains made on the sale of mutual fund units purchased using a loan. As per Finance (No.2) Act, 2004 the income arising from long-term capital gains from shares as also equity mutual funds is tax-free.

Thus, if a loan is taken to buy units of equity funds units, there is no tax advantage in respect of interest paid on the loan.

On the other hand, you can deduct the interest paid from capital gains arising from income funds, as also balanced funds, which have less than 65% in equity. And this can give an additional fillip to your effective returns from investment in non-equity funds.


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