… Curtains down on Classification..Specialty Funds …(contd.)

… Curtains down on Classification

Specialty Funds …(contd.)

The Arbitrage / Derivative Fund is the closest any mutual fund scheme in India can get to a Hedge Fund. SEBI has not allowed any AMC to float a Hedge Fund in India. Presently, there are arbitrage funds from JM (JM Equity & Derivative and JM Arbitrage Advantage), Kotak (Kotak Cash Plus), Prudential ICICI (Prudential ICICI Blended Plan),UTI Mutual (UTI Spread) and SBI (SBI Arbitrage Opportunities Fund).

A fund manager would buy the equities in the capital market and sell it in the futures market, making good the difference. This is how it works: if company ABC's stock is trading today at Rs 30 per share and is expected to rise over the next month, the one-month futures price of the stock will be higher, say, Rs 35. A fund manager would then buy the underlying stock and sell it in the futures market, making a gain of Rs 5. When settlement day arrives, it is irrelevant whether the share price of ABC Ltd. has risen or fallen. One would still make the same amount of money. This happens because on the date of expiry (settlement date) the price of the equity shares and their stock futures will tend to coincide. Now, all one has to do is to reverse the initial transaction i.e. buy back the contract in the futures market and sell off the equity. So four transactions have taken place - buy stock, sell futures, sell stock, buy futures. In this manner, irrespective of the share price, the investor earns the spread between the purchase price of the equity shares and the sale price of futures contract.

The equity arbitrage fund is market neutral; hence, it will not be affected by temporary fluctuations in the Sensex. It does sound like a very simple and effective way of making money in the market. If only life were indeed that simple…

The first hurdle is the presence of arbitrage opportunities. In a given period of time, the market may or may not provide any meaningful arbitrage opportunities that hold the key to the amount of money the fund will earn. No doubt, the fund management team has sophisticated softwares that flag such mispricing the moment it occurs and is extra vigilant in identifying such opportunities.

Secondly, there is the issue of costs. Each leg of the entire transaction i.e. buying stock, selling future, selling stock and buying futures will entail the payment of brokerage and security transaction tax (STT). These costs directly dilute the earnings.

Derivative Funds always yield limited returns. However, it is the risk free nature of the returns that is the USP of the product. After all, the problem that most investors have with entering into the equity market is the lack of assured risk free returns. Arbitrage/Derivative Fund is a product that gives you exactly that.

Mutual funds with tax benefits

Mutual Funds by their very nature are not tax saving instruments but investment products that may offer tax concessions. But the question is whether these can be looked at as tax saving instruments?

For an Equity Fund:
· Long-term capital gains are tax-free
· Short-term capital gains are taxed at only 10%
· Dividend is not subject to dividend distribution tax
· Redemption of units is subject to a Securities Transaction Tax (STT) of 0.25%.

Equity Linked Savings Scheme (ELSS) are special Equity Funds, which have to invest at least 80% of their corpus in equity and offer a tax benefit over and above those mentioned above. Any investment in an ELSS fund offers Sec. 80C deduction i.e. the amount invested is deductible from taxable income. However, Sec. 80C has a cap of Rs. 1 lakh and presupposes a lock-in of 3 years. Sec 80 C covers principal on housing loan, PF, pension plan, life premiums, so only what is left after that can give a tax benefit if invested in ELSS.

ELSS funds, in general, have been found to out-perform their Equity Diversified counterparts. This happens essentially as the fund manager has the money at his disposal over the long-term without having to cater to everyday redemptions. Therefore, regardless of the tax benefit, even investing over Rs. 1 lakh may be an idea to consider.

Socially Responsible (Ethical Funds) invest only in companies that meet the criteria of certain guidelines or beliefs. Most socially responsible funds don't invest in industries such as tobacco, alcoholic beverages, weapons or nuclear power. The idea is to get a competitive performance while still maintaining a healthy conscience. Such funds are not common in India.

In developed countries like the U.S.A there are funds to satisfy everybody's requirement, but in India only the tip of the iceberg has been explored. Innovation, they say, is the key to success. So, in the universe of mutual fund schemes, new ones keep passing by but it is those that stand apart that catch the discerning investor's eye.

Curtains down on Classification

Curtains down on Classification

Specialty Funds …(contd.)

A "Fund of Fund" (FoF) is a mutual fund scheme that uses an investment strategy of holding a portfolio of other mutual funds rather than investing directly in shares or bonds or other securities. This type of investing is often referred to as Multi-manager Investments. A Fettered FoF limits the fund selection to only include the range of funds they manage whereas Unfettered FoF includes funds from various AMCs.

In India, FoFs were initially offered by three funds- Franklin Templeton’s FT India Dynamic PE Ratio Fund of Funds, Birla SunLife’s Birla Asset Allocation Fund and Prudential ICICI Mutual Fund’s Prudential ICICI Advisor Series Plans. Now, there are more than a dozen FoFs.

“Does it make sense to invest in FoFs? “

Advantages

Double Diversification - A Fund of Fund diversifies across many different funds (which in turn diversify across securities). Thus there is diversification across asset classes and investment styles.

Simplicity - FoFs have access to the portfolio of various top-performing funds with just one investment. This allows for much less paperwork and easy monitoring.

Cheap for Beginning Investors -It is tough to diversify when starting out because of account minimums. Suppose you wanted to invest in 5 equity funds and 5 debt funds, assuming each fund has a minimum stipulated investment of Rs 5,000, you would need Rs 50,000. In a FoF, Rs 5,000 would suffice.

Institutional Advantages -Funds of funds can often invest in desirable institutional funds that are outside the purview of retail investors.They also have the ability to invest in some load funds without paying the load.

An investment manager may actively manage your investment with a view to selecting the best securities. A FoF manager will select the best performing funds to invest in based upon the managers’ performance. This additional level of selection can provide greater stability and take on some of the risk relating to the decisions of a single manager.

The in-built rebalancing feature ensures that market movements do not change the desired asset allocation. The fund composition can be altered in no time in FoFs whereas this process may take a long time to complete in a Balanced Fund since its constituents are instruments instead of funds. It is the difference between having 10 individual roses and a bouquet of 10 roses.The second benefit that FoF rebalancing offers is a psychological one. Usually people don't sell when the markets are rising and don't buy when the markets are falling. Yet this is exactly what one should be doing. FoF does it automatically (and it usually can be in your long term interest).

Disadvantages

Double diversification may at times introduce duplication as it is possible for the FoFs to own the same stock through several different funds and it can be difficult to keep track of the overall holdings. Investor may have to monitor whether the fund manager is sticking to the stated asset allocation. Investors should also be careful about the timing of their entry into the scheme.

As per the present tax laws, equity FoF does not enjoy the benefits available to a normal equity fund. Therefore, if one invested in an equity FoF he would be liable to pay dividend distribution tax of 14.03% or LTCG tax of 10% (without indexation), which is otherwise NIL for a normal equity MF. This higher tax can significantly reduce the post-tax returns.

Fund of Funds = Cost of costs

Investors should also be aware that cost heads like fund management fee and other expenses in each of the scheme, where FoF would be investing, reduce returns. The additional expense that an investor can incur is a maximum of 0.75 per cent that FoF is permitted to charge for meeting its expenses such as audit fees, statutory disclosures, etc. Thus the effective cost works out to around 3.25% and 2.25% for equity & debt MF respectively (the annual management fees are typically 2.5% for an equity MF and 1.5% for a debt MF).

The convenience that an FoF offers should more than make up for this marginally extra cost. Moreover, the entry load is taken at fund level. When the fund invests in underlying schemes, the load factor is waived off if the schemes are chosen from the same fund house.

The onus is on the investors to assess their profile in the light of these factors and then take a decision as to whether a FoF fits into their portfolio or not.

Curtains down on Classification --Specialty Funds …(contd.)

Curtains down on Classification

Specialty Funds …(contd.)

A "Fund of Fund" (FoF) is a mutual fund scheme that uses an investment strategy of holding a portfolio of other mutual funds rather than investing directly in shares or bonds or other securities. This type of investing is often referred to as Multi-manager Investments. A Fettered FoF limits the fund selection to only include the range of funds they manage whereas Unfettered FoF includes funds from various AMCs.

In India, FoFs were initially offered by three funds- Franklin Templeton’s FT India Dynamic PE Ratio Fund of Funds, Birla SunLife’s Birla Asset Allocation Fund and Prudential ICICI Mutual Fund’s Prudential ICICI Advisor Series Plans. Now, there are more than a dozen FoFs.

“Does it make sense to invest in FoFs? “

Advantages

Double Diversification - A Fund of Fund diversifies across many different funds (which in turn diversify across securities). Thus there is diversification across asset classes and investment styles.

Simplicity - FoFs have access to the portfolio of various top-performing funds with just one investment. This allows for much less paperwork and easy monitoring.

Cheap for Beginning Investors -It is tough to diversify when starting out because of account minimums. Suppose you wanted to invest in 5 equity funds and 5 debt funds, assuming each fund has a minimum stipulated investment of Rs 5,000, you would need Rs 50,000. In a FoF, Rs 5,000 would suffice.

Institutional Advantages -Funds of funds can often invest in desirable institutional funds that are outside the purview of retail investors.They also have the ability to invest in some load funds without paying the load.

An investment manager may actively manage your investment with a view to selecting the best securities. A FoF manager will select the best performing funds to invest in based upon the managers’ performance. This additional level of selection can provide greater stability and take on some of the risk relating to the decisions of a single manager.

The in-built rebalancing feature ensures that market movements do not change the desired asset allocation. The fund composition can be altered in no time in FoFs whereas this process may take a long time to complete in a Balanced Fund since its constituents are instruments instead of funds. It is the difference between having 10 individual roses and a bouquet of 10 roses.The second benefit that FoF rebalancing offers is a psychological one. Usually people don't sell when the markets are rising and don't buy when the markets are falling. Yet this is exactly what one should be doing. FoF does it automatically (and it usually can be in your long term interest).

Disadvantages

Double diversification may at times introduce duplication as it is possible for the FoFs to own the same stock through several different funds and it can be difficult to keep track of the overall holdings. Investor may have to monitor whether the fund manager is sticking to the stated asset allocation. Investors should also be careful about the timing of their entry into the scheme.

As per the present tax laws, equity FoF does not enjoy the benefits available to a normal equity fund. Therefore, if one invested in an equity FoF he would be liable to pay dividend distribution tax of 14.03% or LTCG tax of 10% (without indexation), which is otherwise NIL for a normal equity MF. This higher tax can significantly reduce the post-tax returns.

Fund of Funds = Cost of costs

Investors should also be aware that cost heads like fund management fee and other expenses in each of the scheme, where FoF would be investing, reduce returns. The additional expense that an investor can incur is a maximum of 0.75 per cent that FoF is permitted to charge for meeting its expenses such as audit fees, statutory disclosures, etc. Thus the effective cost works out to around 3.25% and 2.25% for equity & debt MF respectively (the annual management fees are typically 2.5% for an equity MF and 1.5% for a debt MF).

The convenience that an FoF offers should more than make up for this marginally extra cost. Moreover, the entry load is taken at fund level. When the fund invests in underlying schemes, the load factor is waived off if the schemes are chosen from the same fund house.

The onus is on the investors to assess their profile in the light of these factors and then take a decision as to whether a FoF fits into their portfolio or not.

… Curtains down on Classification…Specialty Funds

… Curtains down on Classification…

Specialty Funds

This classification of mutual funds is more of an all-encompassing category that consists of funds that have proved to be popular but don't necessarily belong to the categories that have been described so far.

Exchange Traded Fund

An Exchange Traded Fund (ETF) is a hybrid financial product, a cross between a stock and a mutual fund. Like a stock it can be traded on a stock exchange and like a mutual fund it behaves like a diversified portfolio and invests in the stocks of an index in approximately the same proportion as held in the index.

The ETFs represent ownership in a fund. Each ETF is designed as a share. Shares are only created or redeemed by institutional investors in large blocks (typically 50,000 shares). Investors purchase shares in small quantities through brokers at a small premium or discount to the net asset value through which the institutional investors make their profit.

The pros and cons of ETF investing are lucidly summed up below:

• ETFs replicate index products, although some benchmarks may be new and not have a track record;
• ETFs have lower expenses (institutional investors handle the majority of trades) and are tax efficient. ETFs do not buy and sell stocks, except to replace a stock that has been replaced on an index. Readjustments might generate small capital gains for investors, but generally the investor faces a tax liability only when he sells the ETF shares for a gain;
• ETFs trade throughout the day, giving investors flexibility;
• ETFs can be bought on margin;
• Buying or selling an ETF triggers a commission since it is bought through a broker. This may not be advantageous to someone investing every month or quarter.

Small investors, used to investing in units, need to remember that unlike mutual funds, the ETFs do not necessarily trade on NAV. Like stocks, they may trade at a premium or at a discount. This means that even if the underlying stocks in the basket are doing well, investors may still book a loss by buying the ETFs being traded at a discount. This apart, the ETFs may also be subject to a bid-ask spread. Simply explained, it means that while one may be able to buy an ETF at Rs 16.50 per share, he may be able to sell only at Rs 16. The 50 paise that he is unable to recover, denotes a hidden cost, which may be unknown to a novice not fully conversant with the downside of the new instrument. The ETFs are also not appropriate for investors who "rupee-cost average" their purchases or redemptions as they would have to pay brokerages on each transaction.

India joined the ETF club in December 2001 with the launch of India's first ETF 'Nifty BeES' (Nifty Benchmark Exchange-traded Scheme) by Benchmark Mutual Fund, based on the S&P CNX Nifty Index. Since then, Benchmark has launched the Junior BeES and the Liquid BeES. There are five ETFs in India at present, of which three are based on the 50-share S&P CNX Nifty index ( including SUNDER by UTI), one on the 200-share CNX Nifty Junior, and one on the 30-share BSE Sensex (SPICE by Prudential ICICI).

India is soon slated to begin trading the Gold Exchange Traded Fund (GETF) which will track the price of gold. Its appointed custodians will buy and sell gold bullion as investors initiate or offset positions in the ETF. An issue currently being resolved concerns who the custodian(s) of the underlying metal will be, and where it will be stored. Rather than outsourcing this activity, it appears that domestic banks will become gold custodians, leading to the launch of several other ETFs by Indian fund houses.

ETFs open up a world of new possibilities to investors whose investment habits have thus far been honed only on investing in pure equity, debt, units and, recently, derivatives. But domestic investors, still not conversant with the downside of investing in the capital market, need to first evaluate if the ETFs are the best investment option going for them, before taking the plunge. While they look more attractive compared to open-ended mutual funds, there are several hidden costs and charges involved in dealing with the ETFs, which need to be factored before investors "spice" up their portfolios.

…Gyrating to Geographical Classification…

…Gyrating to Geographical Classification…

Classification by Geography

Domestic Mutual Funds are funds launched with a view to mobilizing the savings of the citizens of the country. These funds could fall under any of the categories mentioned under portfolio classification and operational classification.

Offshore Mutual Funds are funds launched with a view to mobilizing the savings of the foreign countries for investments in local markets. These funds facilitate cross border fund flow, which is a direct route for getting foreign investment. From the investment point of view, Offshore Funds open up domestic capital markets to the international investors.

Mutual funds that invest in foreign stocks and bonds provide an excellent opportunity to diversify your portfolio. They also reduce the country risk or the risk that all Indian investments could be affected by changes in Indian economy, politics, etc. If investments are chosen carefully, international mutual fund may be profitable when some markets are rising and others are declining. However, fund managers need to keep a close watch on foreign currencies and world markets as profitable investments in a rising market can lose money if the foreign currency rises against the dollar.

Offshore funds can invest in securities of foreign companies in accordance with the SEBI Regulations. Previously, Indian Mutual Funds were not allowed to invest overseas in stocks except in the case of quoted companies that had at least 10 per cent equity holding in Indian companies. This meant that hardly 40 or 50 global corporations (like Lever Brothers) qualified for Mutual Fund investment from India, thus reducing investment options. The latest budget has removed this rule and now Indian Mutual Funds can invest in any listed company on a foreign exchange anywhere in the world. So technically, an Indian MF can invest in Microsoft or Toyota or any listed company on any exchange.

Before the budget, Indian Mutual Funds were allowed to invest up to $1 billion abroad. Now this limit has been trebbled to $3 billion without any restrictions. Now Mutual Funds can spread their risk by investing more abroad and reducing their stake in Indian companies, if they so wish. With the rise in investment ceiling, each fund house will be able to invest approximately $125-$150 million. The Mutual Fund industry views the increase in overseas investment to $3 billion as a progressive roadmap for foreign investments through Mutual Funds in the future. Indian markets provide better returns currently. However, increased investment overseas imply increased risks and commensurate returns.

The combined corpus of the two existing schemes that invest a chunk of their assets in overseas instruments is just around $3.2 million. These are Principal PNB Mutual Fund’s Global Opportunity Fund and Franklin Templeton’s International Fund (the latter is a debt scheme that invests in US government securities). The first one off the block after the budget announcement was Franklin Templeton Investment, which launched the Templeton India Equity Income Fund. This is an open-ended diversified equity fund that can take an exposure of up to 50% in overseas stocks, which have a current or potentially attractive dividend yield.

Regional Funds make it easier to focus on a specific area of the world. This may mean focusing on a region (say Latin America) or an individual country (for example, only Brazil). An advantage of these funds is that they make it easier to buy stock in foreign countries, which is otherwise difficult and expensive. Similar to sector funds, you have to accept the high risk of loss, which occurs if the region goes into a bad recession. They are not found in India.

…On to Operational Classification…(3)

…On to Operational Classification…

By Trading Strategy

Active Funds are constantly active in the market. They buy and sell the securities in their portfolio very frequently.

Passive Funds normally follow a buy and hold strategy and do not trade their holdings very frequently.

Balanced Funds are those that follow the middle path between the active and passive funds.

By Security Selection

Top Down Funds are those that select stocks using the top down approach, where the fund manager first identifies the sector in which he would like to invest and then the potential scrips within the sector.

Bottom Up Funds use the bottom up approach to investing, where the fund manager focuses on the scrips, irrespective of what sector they come under.

Technical Funds are those that use technical analysis to select scrips.

By Market Capitalisation

Small Cap Funds focus on small cap stocks (companies with a market capitalization of up to Rs 500 crore) for their investment portfolio. Mid-Cap Funds invest in mid cap scrips (companies that have a market capitalization between Rs 500 crore and Rs 1,000 crore). Small/mid cap companies tend to be under researched. Thus they present an opportunity to invest in a company that is yet to be identified by the market. Such companies offer higher growth potential going forward and therefore an opportunity to benefit from higher than average valuations. But mid cap funds are very volatile and tend to fall like a pack of cards in bad times. So, caution should be exercised while investing in mid cap mutual funds.

Large Cap Funds are those that invest in large cap scrips (companies with a market capitalisation in excess of Rs 1000 crore). Large cap funds are those mutual funds, which seek capital appreciation by investing primarily in stocks of large blue chip companies with above-average prospects for earnings growth. Investing in large caps is a lower risk-lower return proposition, because such companies are usually widely researched and information is widely available.

…On to Operational Classification…( Cont,,)

…On to Operational Classification…

By Trading Strategy

Active Funds are constantly active in the market. They buy and sell the securities in their portfolio very frequently.

Passive Funds normally follow a buy and hold strategy and do not trade their holdings very frequently.

Balanced Funds are those that follow the middle path between the active and passive funds.

By Security Selection

Top Down Funds are those that select stocks using the top down approach, where the fund manager first identifies the sector in which he would like to invest and then the potential scrips within the sector.

Bottom Up Funds use the bottom up approach to investing, where the fund manager focuses on the scrips, irrespective of what sector they come under.

Technical Funds are those that use technical analysis to select scrips.

By Market Capitalisation

Small Cap Funds focus on small cap stocks (companies with a market capitalization of up to Rs 500 crore) for their investment portfolio. Mid-Cap Funds invest in mid cap scrips (companies that have a market capitalization between Rs 500 crore and Rs 1,000 crore). Small/mid cap companies tend to be under researched. Thus they present an opportunity to invest in a company that is yet to be identified by the market. Such companies offer higher growth potential going forward and therefore an opportunity to benefit from higher than average valuations. But mid cap funds are very volatile and tend to fall like a pack of cards in bad times. So, caution should be exercised while investing in mid cap mutual funds.

Large Cap Funds are those that invest in large cap scrips (companies with a market capitalisation in excess of Rs 1000 crore). Large cap funds are those mutual funds, which seek capital appreciation by investing primarily in stocks of large blue chip companies with above-average prospects for earnings growth. Investing in large caps is a lower risk-lower return proposition, because such companies are usually widely researched and information is widely available.

…On to Operational Classification…

…On to Operational Classification…

By Liquidity

Open-end Funds are like bank accounts. Such funds enable you to invest and redeem your money any time! Units are continuously offered for sale and continuously bought back. They do not have a set number of shares. Units are bought and sold at their current net asset value disclosed on a daily basis. Open-end funds keep some portion of their assets in short-term and money market securities to provide available funds for redemptions. They offer better liquidity due to continuous repurchase.

Closed-end Funds have a set number of shares issued to the public through an initial public offering. The corpus normally does not change throughout the year. These funds have a stipulated maturity period 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. The market price of closed-end funds is determined by supply and demand and not by net-asset value (NAV), as is the case in open-end funds. Usually closed mutual funds trade at discounts to their underlying asset value. These mutual fund schemes disclose NAV generally on a weekly basis.

SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor – listing on Stock Exchanges or giving an option of selling back the units to the Mutual Fund through periodic repurchase at NAV related prices.

Interval Funds combine the features of open-end and closed-end schemes. They are open for sale or redemption during pre-determined intervals at NAV related prices. So, basically it is a closed-end scheme with a peculiar feature that every year for a specified period (interval) it is made open.

By Investment Strategy

A number of mutual fund families use the word Growth Funds to describe their equity funds. But growth funds are funds that invest in companies which are growing at a rate faster than the rest of the economy and industry. The goal is to capitalize on the increase in stock prices. The risk is that many growth companies are not very big and may not be able to absorb bad news as easily as blue chip companies.

Value Funds are those mutual funds that tend to focus on safety rather than growth, and often choose investments providing dividends as well as capital appreciation. They invest in companies that the market has overlooked, and stocks that have fallen out of favour with mainstream investors, either due to changing investor preferences, a poor quarterly earnings report, or hard times in a particular industry. Value stocks are often mature companies that have stopped growing and that use their earnings to pay dividends. Thus value funds produce current income (from the dividends) as well as long-term growth (from capital appreciation once the stocks become popular again). They tend to have more conservative and less volatile returns than growth funds.

Value cum Growth Funds follow a mix of the growth and value approaches.

Portfolio Classification… (Cont.)

Passing through the portals of Portfolio Classification…

Index Funds

Index funds are equity funds that invest in exactly the same stocks (and in the same proportion) that make up the market indices like the BSE Sensex or the NSE Nifty Index. So what's the advantage of an index fund? The fund manager can programme a computer to just follow the index and pick stocks without putting in hours of his time in research and stock picking. So, the cost to the mutual fund for managing an index fund is low. It benefits investors in the form of low fees. The other advantage is that you cannot do worse than the BSE Sensex or the NSE Nifty. Simply because the index fund is replicating the movements of the index, NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.

Sector Funds

Sector Mutual Funds are those mutual funds that restrict their investments to a particular segment or sector of the economy. There are a host of sector specific funds like FMCG, MNC, IT, New Technologies, Services, PSUs, Infrastructure, Pharma, e-commerce, Petroleum, Contra etc. These funds concentrate on only one industry. The idea is to allow investors to place bets on specific industries or sectors, which have strong growth potential. These funds tend to be more volatile than funds holding a diversified portfolio of securities in many industries. Such concentrated portfolios can produce tremendous gains or losses, depending on whether the chosen sector is in or out of favour. If the sector performs well, sector funds yield higher returns when compared to other funds. Diversified Equity Funds might not profit much from windfall gains in one sector, as they will be neutralised by bad performance results in other sectors.
The basic disadvantage of Sector Funds is that the portfolio manager has to confine his investment to one area. Even if the manager knows that the performance of the sector may not be good, he is forced to do so and is limited because of the scope of the fund.

Hedge Funds

Hedge Funds employ speculative trading principles - buy rising shares and sell shares whose prices are likely to fall. They hedge risks in order to increase the value of the portfolio. Hedge funds typically charge a fee greater than 1%, plus a "performance fee" of 20% of a hedge fund's profits. There may be a "lock-up" period, during which an investor cannot cash in shares. They are not common in India

Leveraged Funds

Leveraged Funds make speculative and risky investments, like short sales to take advantage of declining market. The main objective of the fund is to increase the value of the portfolio and benefit the shareholders by gains exceeding the cost of borrowed funds. They are not common in India

Portfolio Classification…

Passing through the portals of Portfolio Classification…

Equity/Growth Funds

Equity/Growth Funds normally invest a majority of their corpus in equities. They provide capital appreciation over the medium to long term. They have comparatively high risks.

Blue chip funds invest in stocks of very well respected companies. The purpose is to build a stock portfolio of conservative stocks so that it does not do worse than the stock market indices. Such funds return less than funds that invest in growth oriented companies.

Debt/Income Funds

Debt/Income Funds invest in fixed income assets such as corporate debentures, government securities, bonds and other debt related instruments .They provide capital stability and regular income to the investors. Such funds are less risky compared to equity funds. However, opportunities of capital appreciation are also limited . 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.

Floating-Rate Debt Fund comprises of bonds for which the interest rate is adjusted periodically according to a predetermined formula, usually linked to an index.

Monthly Income Plan aims at providing regular income (not necessarily monthly, don't get misled by the name) to the unitholder, usually by way of dividend, with investments predominantly in debt securities (upto 95%) of corporates and the government, to ensure regularity of returns, and having a smaller component of equity investments (5% to 15%) to ensure higher return.

Marginal Equity Funds are funds which have investment of atleast 75% in debt instruments & the balance in equities. These funds offer the security of debt with the flavour of equities.

Balanced Funds

Also known as Hybrid Funds, Balanced Funds invest in a mix of equity and debt (a minimum of 65 percent in equity is mandatory). Hence, they are less risky than equity funds, but at the same time provide commensurately lower returns. Balanced funds are ideal for diversifying investments without spending time on the process. NAVs of such funds are likely to be less volatile compared to pure equity funds.

A similar type of fund is known as an Asset Allocation Fund. The objectives are similar to those of a Balanced Fund, but these kinds of funds typically do not have to hold a specified percentage of any asset class. The portfolio manager is given freedom to switch the ratio of asset classes as the economy moves through the business cycles.

Money Market Mutual Funds

A Money Market Fund is a mutual fund that invests solely in money market instruments. Money market instruments are forms of debt that mature in less than one year and are very liquid. It is also known as Liquid Fund. It invests only in safe short term instruments such as T-Bills, Certificate of deposits (CDs), Corporate Commercial Papers, and inter-bank call money market. The investment will remain intact because this is the overriding concern the fund has and it sacrifices greater returns by picking absolutely safe short term investments.

Gilt Funds

Gilt Funds invest in Government of India and State Government securities and bonds that are guaranteed by the Central and State Governments. These mutual funds are the safest type of debt funds available since they invest in bonds backed by the full faith of the government. The original investment is as safe as it can be though the returns may be lower than what you can get in a debt mutual fund that invests in corporate debt.

Fund Flavours …

Fund Flavours …

If the concept of Mutual Fund is so simple, why does Mutual Fund investing seem so complex? A common man is so much confused about the various kinds of Mutual Funds that he is afraid of investing in these funds as he cannot differentiate between various types of Mutual Funds with fancy names. There are nearly 30 AMCs offering close to 500 schemes in India today. A systematic categorization will put things in the proper perspective and guide you while investing in Mutual Funds. Let's go over the many different flavors of funds.

Mutual Funds can be classified into the following 4 broad categories:

1. Portfolio 2. Functional 3. Geographical and 4. Specialised

In the first place, we have the Portfolio Classification on the following basis

Equity/Growth Funds, Debt/Income Funds, Balanced Funds, Money Market Mutual Funds (MMMFs), Gilt Funds, Index Funds, Sector Funds, Hedge Funds and Leveraged Funds.

Secondly, the Functional or Operational Classification is done on the following basis

Liquidity - Open-ended Funds, Close-ended Funds and Interval Funds
Investment Strategy – Growth and Value Funds
Trading Strategy - Active and Passive Funds
Security Selection – Top Down, Bottom Up Funds and Technical Funds
Market Capitalisation – Small Cap, Mid Cap and Large Cap Funds
Load and Expenses – Load Funds and No Load Funds

Thirdly, under the Geographical Classification, we have the Domestic Mutual Funds and Offshore Mutual Funds.

Last but not the least, we have Specialized Funds like Exchange Traded Funds (ETFs), the Funds of Funds, Mutual Funds with Tax Benefits and Socially Responsible or Ethical Funds which are all attempting to take the Mutual Fund concept to the next level.

A detailed discussion of each category, taken one at a time , will be taken up in the subsequent blogs.

Expenses Exposed !!!!

Expenses Exposed!!

"Dazzled by performance, indifferent to cost," is a common accusation hurled at Mutual Fund investors. I would have succeeded in my endeavour if I elevate you to well above the average in the next 500 words or so.

Management Expense Ratio or MER.
The MER is the total expense of operating a Mutual Fund expressed as a percentage of the fund's Net Asset Value (NAV).

The major components of Expense Ratio are

The Investment Advisory Fee or The Management Fee: This is the money that goes to pay the salaries of the fund managers and other employees of the Mutual Funds. The management fees (which could range from 1% to 1.25% of the fund's corpus) are one of the highest expenses incurred by a Mutual Fund.

Administrative Costs: These are the costs associated with the daily activities of the fund. These include the costs of record keeping, mailings, maintaining a customer service line, etc. These are all necessary costs, though they vary in size from fund to fund. The thriftiest funds can keep these costs below 0.20% of fund assets, while the ones who use engraved paper, colorful graphics etc. might fail to keep administrative costs below 0.40% of fund assets.

Limits have been mandated by SEBI on operating expenses. On the

First Rs. 100 crores 2.25%
Next Rs. 300 crores 2.00%
Next Rs. 300 crores 1.75%
On the balance of assets 1.50%

Any excess over the specified limits has to be borne by the asset management company, the trustees or the sponsor.

One ongoing expense that is not included in the expense ratio is brokerage costs incurred by a fund as it buys and sells securities. These costs are listed separately in a fund's annual report. When mutual fund managers buy and sell a high number of stocks, with frequency, within a fund, it will have a high turnover rate, causing a higher capital gains tax and vice versa. Check the fund reports for the turnover rate. A rate of 80 or less is usually considered low.

For actively managed funds, the average expense ratio is rising as funds shift fees away from the up-front loads that they know are driving sales away, into the annual expense ratios where they are more easily hidden. This fee is charged and deducted from the fund regardless of its performance and for as long as you hold this Mutual Fund.

All these expenses that we have mentioned so far can be thought of as coming out of the portfolio's raw return, skimmed off the top, so to speak. For a full understanding of fund expenses, a careful perusal of the Offer Document and the Annual Report is absolutely essential. An informed investor knows where his money is going. He keeps tab on the toll he doles out on the highway to big money.

Loaded !!!!

Loaded!

A quick review…

Loads are fees or expenses recovered by Mutual Funds against compensation paid to brokers, their distribution and marketing costs. These expenses are generally called as sales loads. These are also referred to as front end loads and along the same line of thought there are back end loads that are charged on you even while you exit from the share holding of the fund (sales fees). Entry loads generally vary between 1.00% and 2.25%. Exit loads vary between 0.25% and 3.00%.

The Mutual Fund Regulations Act, 1996, has not clearly defined 'load'. However, the Act stipulates that the redemption price cannot be lower than 93% of the NAV, while resale price cannot be higher than 107% of the NAV in case of open-end schemes. In case of closed-end scheme, the repurchase price of units shall not be lower than 95% of the NAV.

Schemes cannot charge an entry load beyond 6% during the initial launch. If the load during the initial launch of a scheme is borne by the AMC, then these schemes are known as no-load funds. However, these no-load funds will have an exit load when the initial investor gets out of the scheme before a stipulated period, which is clearly stated during the initial offer. This is done to restrict short-term investors from getting into the scheme. Besides restricting short-term investors, the AMC can levy an additional management fee not exceeding 1% of the daily net assets in schemes floated on a 'no-load basis'. Under the exit load, besides the flat load, an AMC may be entitled to levy a contingent deferred sales charge (CDSC) for redemption during the first four years after purchase. However, the CDSC cannot exceed 4% of the redemption proceeds in the first year, 3% in the second year, 2% in the third year, and 1% in the fourth year.

Normally, closed-end schemes charge an entry load while having no exit load. But open-ended schemes do charge the load either at entry level/exit level, or at both stages. Equity-oriented schemes entail a higher cost in terms of brokerage, as these schemes require a greater persuasion from the intermediaries. Therefore, debt-oriented schemes do have a lower load when compared to equity-oriented schemes. Almost 98% of the debt-oriented schemes do not carry an entry load, but most of these schemes carry an exit load if the investor exits within 6 months from the date of making investments. The primary reason for this might be due to the returns generated by the schemes. The returns from these schemes generally hover around 12-13% per annum. If the scheme imposes a load, the real returns of investors from these schemes further come down making the scheme unattractive for investors.

Besides this, the funds do review the load structure periodically and have been using this as a selling proposition for mobilising new funds. Funds have also moved out from a uniform slab structure to a differential slab structure. This is done with the objective of mobilising funds from high net worth individuals and corporates.

The load might differ with the amount invested. The larger the amount invested, the lower the sales load. For example, Reliance Growth fund charges a 2.25 per cent sales load for investments up to Rs 1.999 Crores but only 1.25 per cent load is charged for investments over Rs 2.0 crores to 4.999 Crores.

Besides, the load could also depend on the period of investments. Birla Advantage charges a back load of 2 per cent for investments of less than two years and is a no load fund for investments over two years.

Funds also charge different loads from different class of investors. Initial investors, who had a no load entry into Chola Triple Ace are being charged a 2 per cent exit load. On the other hand, new investors in the scheme are being charged an entry load of 0.5 per cent and redemption is at NAV.

Mutual funds cannot increase the load beyond the level mentioned in the offer document. Any change in the load will be applicable only to prospective investments and not to the original investments. In case of imposition of fresh loads or increase in existing loads, the mutual funds are required to amend their offer documents so that the new investors are aware of loads at the time of investment.

Entry Load; Exit Load; Contingent Deferred Sales Charge –Within proper limits,Don't look at these as a burden, just think of them as tolls you pay on the highway to big money!

Further Concepts Clarified… !!!!

Further Concepts Clarified…

NAV is the most important measure of the performance of a Mutual Fund. Let us say you have invested Rs 10000 in a scheme at Rs 13 a unit and now its NAV is Rs 15. Quite simply, that means your investment has appreciated by 15%. But wait before you jump in joy - you may not actually get that much when you redeem your units. That is because of the expenses charged by Mutual Funds.

Let me introduce you to some concepts associated with Mutual Fund expenses before we proceed with the example. Mutual Fund’s costs are categorized as Sales charges or Loads and Operating expenses or Expense Ratio.

Loads include expenses like agent’s commission, marketing and selling expenses that are charged directly to the investor. Front End load or Entry load is a fee that is charged up-front, when you purchase the mutual fund units. It is charged on a percentage basis (eg. 1%, 1.5%, 2%, 3%, etc) based on the amount of purchase. Back End or Rear End load or Exit load is a fee that is charged at redemption.

Expense Ratio is an annual operating expense expressed as a percentage of the fund's average daily net assets. It refers to costs incurred in operating a mutual fund and is paid out of the Fund’s earnings. It includes advisory fees paid to investment managers, audit fees, custodial fees, transfer agent fees, trustee fees etc. Operating expenses are calculated on an annualized basis and are normally accrued on a daily basis. Therefore, you pay expenses pro-rated for the time you are invested in the Fund.

Let us return to our example. If the entry load levied is 1.00%, the price at which you invest is Rs.13.13 per unit. This is the Purchase Price, the price paid by a customer to purchase a unit of the Fund. You receive 10000/13.13 = 761.6146 units.

Let us now assume that you decide to redeem your 761.6146 units and the exit load is 0.50%. The Redemption Price per unit works out to Rs.14.925. Redemption price is the price received by the customer on selling units of an open-ended scheme to the Fund. You, therefore, receive 761.6146 x 14.925 = Rs.11367.10. The returns have reduced to 13.6% as a result of entry and exit loads.

Repurchase Price is different from Redemption Price and refers to the price at which a close-ended scheme repurchases its units. Repurchase can either be at NAV or can have an exit load. (Open-ended and Close-ended Funds will be discussed under classification of Mutual Funds).

Suppose the Expense Ratio is 2%, you will see a return of only11.6%. So your returns have come down by 3.4 % as a result of the Loads and Expense Ratio.

Now, you can appreciate the extent to which Mutual Fund Expenses eat into your real returns. This should not scare you away from Mutual Funds since the associated cost for Mutual Funds is still very low when compared to making investments directly in equities. This notwithstanding, a proper understanding of Mutual Fund expenses will stand you in good stead when you have to choose from among equally well-performing Funds.

Mutual Fund expenses will be explained and analysed threadbare in the subsequent blogs.

Exploding a myth - NAV

Exploding a myth

People carry the perception that a fund with a lower NAV is cheaper than that with a higher NAV since they are under the notion that the NAV of a Mutual Fund is similar to the market price of an equity share. This, however, is not true. There is no concept as market value for the Mutual Fund unit. Therefore, when we buy Mutual Fund units at NAV, we are buying at book value. We are paying the right price of the assets whether it be Rs 10 or Rs.100. There is no such thing as a higher or lower price. But the market price of a share is generally different from its book value depending on its fundamentals, the perception of the company’s future performance & the demand-supply scenario.

Now let me make this point clear by using an analogy. Consider this: If you are investing Rs 100,000 in Fixed Deposit (FD), there would be 4 Fixed Deposit Receipts (FDRs) if the denomination is Rs 25,000 and 2 FDRs, if the denomination is Rs 50,000. If you have Rs 1 lac to invest, you will get either 2 or 4 fixed deposit receipts on which your income (interest earning) will remain the same. If you choose to invest in 4 FDs of denomination 25,000, it does not mean you have got those cheaper and therefore you will earn more interest. Please appreciate that the level of NAV is as irrelevant in Mutual Fund investment decision as the number of the FDRs while investing in FD. It is just an equation; as long as the numerator (investment amount) does not change, the denominator (NAV / number of FDRs) does not have ANY material impact on the return potential of your investment.

An example will make it clear that returns from Mutual Funds are independent of the NAV. Let us say you have Rs 10,00000 to invest. You have two options, wherein the funds are the same as far as the portfolio is concerned. But say one Fund X has a NAV of Rs 10 and another Fund Y has a NAV of Rs 50. You will get 100000 units of Fund X or 20000 units of Fund Y. After one year, both funds would have grown equally as their portfolio is the same, say by 20%. Then NAV after one year would be Rs 12 for Fund X and Rs 60 for Fund Y. The value of your investment would be 100000*12 = Rs 12,00000 for Fund X and 20000*60 = Rs 12,00000 for Fund Y. Thus your returns would be same irrespective of the NAV.

It is quality of fund, which would make the difference to your returns. In fact, for equity shares also broadly this logic would apply. An IT company share at say Rs 1000 may give a better return than say a jute company share at Rs 50, since IT sector would show a much higher growth rate than jute industry (of course Rs 1000 may fundamentally’ be over or under priced, which will not be the case with Mutual Fund NAV).

Concepts Clarified !!!!

Some Concepts Clarified

There are certain concepts that I would like to clarify before we touch upon the much awaited subject of Mutual Fund investing.

NAV is a term that you will often hear in the context of Mutual Fund investment.


Net Asset Value is the market value of the assets of the scheme and cash on hand minus its liabilities and management fees.


The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date. So, Net Asset Value is the market value of a unit of a scheme after accounting for all expenses on any given business day. The market value of the investments is determined on the basis of their closing prices on the principal stock exchange.

For most funds, the NAV is determined daily, after the close of trading on some specified financial exchange, but some funds update their NAV multiple times during the trading day. Open-end funds sell and redeem their shares at the NAV, and so only process orders after the NAV is determined.


Closed-end funds may trade at a higher or lower price than their NAV; this is known as a premium or discount, respectively. If a fund is divided into multiple classes of shares, each class will typically have its own NAV, reflecting differences in fees and expenses paid by the different classes.

Some mutual funds own securities which are not regularly traded on any formal exchange. These may be shares in very small or bankrupt companies; they may be derivatives; or they may be private investments in unregistered financial instruments (such as stock in a non-public company). In the absence of a public market for these securities, it is the responsibility of the fund manager to form an estimate of their value when computing the NAV. How much of a fund's assets may be invested in such securities is stated in the fund's prospectus.

The NAV is what one share or unit is worth right now. You don't invest in a mutual fund by buying a fixed number of units but rather by a lump rupee sum such as Rs.1,000. Since it would be a fluke for the unit price to be an exact, even multiple of your investment, you will be issued some partial units to make up enough to cover your investment to the paise.

In the next blog, I shall explode a myth commonly associated with NAV.

Organisation of MF

Organisation of MF

Now, let us see the parties involved in the initiation and operation of a Mutual Fund.

A sponsor (promoter) creates a trust (the Mutual fund). The fund should be approved by the regulator, i.e., SEBI (Securities and Exchange Board of India).

The Trustee appointed by the sponsor is authorised to accept funds from various investors for management in accordance with a specified objective. The Trustee safeguards the interest of investors in the mutual fund and also ensures that the operations of the fund comply with the relevant regulations.

The investment of the funds and other functions are managed by an Asset Management Company (AMC) appointed by the Trustee of the fund. The Trustee oversees the performance of the AMC. The AMC employs professionals to manage the funds.

The AMC is assisted by a custodian and a registrar (transfer agent). The custodian, normally a bank or any other financially sound institution, is responsible for the custody of the assets of the fund and safeguarding the interests of the fund arising from the assets. The registrar maintains the records of the unitholders (the MF beneficiaries)and handles communications with them..

SEBI has laid down that a Mutual Fund, the Trustees and the AMC should be three distinct entities. It also mandates that the Custody of the Portfolio should not be with the AMC but with a Custodian, specifically approved by SEBI. SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be independent.

THE MONEY MULTIPLYING MATRIX OF MUTUAL FUNDS

THE MONEY MULTIPLYING MATRIX OF MUTUAL FUNDS

Mutual Funds – a globally proven investment vehicle – is slowly finding a place in the investment itinery of Indians. For those averse to Mathematics, the title might sound a little intimidating but it is all the same inviting.There is no magic mathematical formula for successful Mutual Fund investing… all it requires is pure common sense and a clear understanding of the concept.

Welcome to the world of mutual funds…..

In this blog, it will be my endeavour to demystify the concept of Mutual Funds so that even a layman can reap the benefits it offers and build his wealth.

What is a Mutual Fund?

A Mutual Fund is a trust that is mutually beneficial to all those who have put their money in it. It is an investment vehicle that pools the money of several investors and invests it in different securities. It is not an alternative investment option to shares and debentures.Rather it pools the money of several investor s and invests in the same.

To understand Mutual Funds, we need to take a step back. If you want to invest, say in shares or debentures of companies, how do you go about it?

First, you decide on what level of risk you are willing to take and what kind of returns you are expecting. Your decision at this stage will determine the amount of investment you will do in shares (equities) and debentures (debt). Normally, shares carry a higher risk and result in higher returns while debentures carry a lower risk and have lower returns. This allocation of investments is known as asset allocation.

Once you have done this, you have to select the shares and debentures you want to invest in. You can do this by independently researching companies or act on tips. This process of choosing specific investments is known as scrip selection.

If you have selected shares, which are quoted on the stock markets, you will have to call up your broker and place the order. Alternatively, if you have selected a company whose share is available by way of a public issue, you will have to fill up the necessary application form and pray that you will get some amount of shares (especially if the public issue is considered attractive). Similarly you could be buying debentures, which are listed on the stock markets, or apply for them in public issues.

Now that you are invested in the companies of your choice and in the manner you choose, equity and/or debt, you have to continually monitor your investments. You have to track the company's performance, collect your dividends and interest payments and take that most crucial decision of selling your shares when you feel you have achieved your target price OR live with your losses if the share prices/investments have tanked.

Seems a lot of work, doesn't it? Wish there was someone who would do it all for you?

That's what a Mutual Fund does. It collects money from lots of small investors and invests on their behalf.

The investors pool their money with the Fund Manager who in turn invests it in securities. These securities generate dividends, interest and sales proceeds that are distributed to the investors on a pro-rata basis. The owner of a MF unit gets a proportional share of the fund’s gains losses , income and expenses.
And the cycle continues…

Thus, buying a MF is like buying a small slice of a big pizza.

Introduction

Hi

Welcome to the Blog of Indian Mutual Funds.