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The concept of Mutual Fund is not new. Originating in the USA and moving on to the UK in the 1930s, this culture started in India only in 1960s, with setting up of UTI in 1964. Mutual Funds are financial intermediaries in the investment business. In a Mutual Fund, the resources of many investors are pooled and invested to create a diversified portfolio. Thus, the saving of many investors are combined to form a fairly large and well diversified portfolio of investment.
OBJECTIVES AND DIFFERENT TYPES OF MUTUAL FUNDS
The objectives of a Mutual Fund are as follows:
Mutual Funds can be classified into the following three broad categories:
Portfolio classification of Mutual Funds.
Function classification of Mutual Funds
Geographical classification of Mutual Funds.
Portfolio classification of mutual funds
Mutual funds differ with reference to the type of instruments in which the money has been invested as per the requirement of the investors. These are specified Mutual Funds structured for feeding a particular investible purpose. Therefore, different Mutual Funds are designed to meet the objectives of different types of savers and are named as such:
Bond Funds provide fixed return for those who desire safety. The saving are invested in various kinds of bonds that are more liquid, diversified and conservative investments with modest capital gains. Price of bond Mutual Funds fluctuates with changing interest rates. In India, income from Mutual Funds is tax exempt and as such no classified Mutual Funds have come to exist as in the USA where tax-free income in municipal bond funds or other fixed income bearing securities is an attractive investment.
Stock funds are established for those who are willing to accept significant risks in the hope of very high returns. These are called common stock funds. The assets held in the fund are entirely the common stocks of diversified list of industrial corporations. These may be future classified as ‘growth funds’ which assume high risk to obtain stocks expected to yield high return. When these funds are invested in stocks which pay consistently high dividend, they are known as Income Funds.
Income Fund is established to maximize the current income (i.e., interest and dividend) of investors. There are two aspects of Income Funds namely, low investment risk, generating constant income and high investment risk generating maximum income. Investment is made in various combinations of high yielding common stocks and bonds with a view to extract income on regular basis with the principal amount of investment enjoying safety. Conservative investment strategy characterizes the Income Funds with modest amount of risk.
MONEY MARKET FUNDS
Money Market Funds are used in short-term liquid assets like Certificate of Deposits [CD(S)] or commercial papers. Capital is raised by selling shares to the investing public at a price equal to the asset value of the then existing shares outstanding plus a loading fee or service charge. These are known as high liquid asset funds with very low risk and virtually no capital loss. Interest income fluctuates because of volatile interest rates, but investors get better yield then is available from passbook saving accounts. In the USA, Money Market Mutual Funds were set-up in November 1972 and have been a very successful vehicle of savings mobilization. In India, the Government has only recently taken a decision to allow establishment of MMMFs.
Specialized Mutual Funds envisage specializing investment in securities of firms of certain industries or specific income producing securities. Such funds carry more risk for lack of diversification approach.
Leveraged Funds or borrowed funds are used in order to increase the size of the value of the portfolio and benefit the shareholders by gains exceeding the cost of the borrowed fund. Such funds are used in speculative and risky investments like short sale to take advantage of declining market to realize gains.
Some Mutual Funds are called ‘Balanced funds’ where assets are a judicious mixture of industrial stocks and bonds. To embrace modest rice of investment and secure reasonable rate of return, the funds are employed in high grade common stock with 25% to 40% investment in conservative fixed income securities like debentures, bonds and preference shares.
Growth funds have the principal objective of capital appreciation of the investment over a period of time. The investment is made in equity stock which has above average growth potential. This is a high risk investment fund with high capital gain potential and low current income assurance.
These funds, as the name goes, are invested in equity shares of good track record companies which offer long-term capital growth and provide handsome dividend income. In the USA specialty companies include electronic, chemical or the foreign securities like Japanese stocks etc. sometime, specialty Mutual Funds are established to cater to financial requirement of one particular type of industry or unit within it, for example, commodity funds, offshore drilling funds, etc. These are highly risky investment funds and require deep knowledge and expertise and extensive experience.
DUAL PURPOSE FUNDS
Income and growth are two objectives, which are achieved by offering half of the amount of funds to those investors who wish regular income and half to those who wish growth. The funds thus received are pooled together and used for investment. Any income derived from the portfolio goes to the investors who hold income shares. The investors who hold capital shares receive no income. Instead they receive capital gains or losses that result from investments of total portfolio.
REAL ESTATE FUNDS
Real estate fund is of close-ended type. The fund is named so because of primary investment in real estate ventures. Such funds are of various types depending upon real estate transactions.
Thus, a Mutual Fund depends upon the nature of securities it issues or sells and purchases. In this way, it is observed that a mutual fund can be named keeping in view the immediate objective behind its creation.
Functional Classification of Mutual Funds
Functional classification of Mutual Funds is based on the basic characteristics of the mutual fund schemes for subscription. Mutual Funds on this account are classified into two broad types namely,
Open-ended Mutual Fund.
Close-ended Mutual Fund.
OPEN-ENDING MUTUAL FUND
The holders of the shares in the fund can resell them to the issuing mutual fund company at any time. They receive in turn the Net Assets Value (NAV) of the shares at the time of resale. Such mutual fund companies place their funds in the secondary securities market. Thus, they influence market price of corporate securities. Open-end investment companies can sell an unlimited number of shares and thus keep growing larger. An open-end mutual fund company buys or sells its own shares. Such companies sell new shares at NAV plus a loading or management fee and redeem shares at NAV. In other words, the target amount and the period both are indefinite in such funds. Unit scheme, 1964, UTI’S Magnum Multicap Funds, DWS Alpha Equity-G, FT India balanced, and Sahara Income Fund, Franklin India Blue chip fund, are few examples. For open ended schemes, Mutual Fund Units are sold and bought at NAV with or without loading charges.
NET ASSET VALUE
It is the actual value of the investments made by the mutual fund for each unit issued by it. It changes almost on a daily basis as the market prices of individual securities in its portfolio fluctuate. It is computed by the formulae given below:
Consider the following data of a Mutual Fund Trust (all figures in Rs. Millions):
Value of investments =10.00
Accrued Income =0.25
Other Current Assets =3.00
Accrued Expenses =0.50
Number of Outstanding Units =2.00million.
Given this data the NAV is calculated as shown below:
= Rs. 5.625.
We know that the value of the mutual fund varies with the value of the portfolio, as the prices of the securities which constitute the portfolio fluctuate day to day. As the intrinsic value of the security represents the fair value of the security, the NAV represents the fair value of a unit in a mutual fund.
If the maximum sales charge is 3% on the NAV of Rs. 13.50, the public offering price is given as,
POP= NAV1-Sales Charge=13.501-0.03
Usually, the fund units at the time of application are sold at Public Offering Price (POP). The difference between the NAV and the public offering price is the sales charge recovered by the Asset Management Company from the scheme to cover costs of raising funds on a continuous basis. The public offering price is generally calculated as follows:
=13.500.097 = Rs. 13.92.
CLOSE-ENDED MUTUAL FUND
Close-ended Mutual Funds are different from the open-ended Mutual Funds in the following respects.
The examples of close-ended Mutual Funds include: canstock, can share Master share, Magnum, can 80CC, Dhanashree, etc., which have the above features. It is to be noted that unlike in foreign countries where closed-ended and open-ended Mutual Funds are totally separate schemes, in India, this difference is not clearly demarcated. For example, UTI as Mutual Fund Manager has floated both close-ended schemes (Master Share, Master Plus, Growing Monthly Income Scheme ’92 (GMIS ’92,) etc.) and open-ended schemes (unit scheme ’64, ULIP ’71, Omni Unit Plan, etc.).
Geographical classification of Mutual Funds
Nationals’ boundaries provide territorial restriction on the sale and purchase of mutual fund units or shares as is the case in commodity trade or services. In view of this, Mutual Funds which operate within the nations’ boundaries are different from those which are meant for subscription of foreigners or the country’s nationals living away from its shores. This classification is broadly of two types namely,
Domestic Mutual Funds.
Offshore Mutual Funds.
DOMESTIC MUTUAL FUNDS
Domestic Mutual Funds are the saving schemes which are opened for mobilizing savings of the nationals within the country. These schemes may be of different types as discussed above under the portfolio classification and functional classification. The existing Mutual Funds namely, UTI, GIC Mutual Funds, LIC Mutual Fund, SBI Mutual Fund, Canbank Mutual Fund, BOI Mutual Fund, PNB Mutual Funds and Indbank Mutual Funds are all domestic schemes.
OFFSHORE MUTUAL FUNDS
The basic objective of opening an offshore mutual fund scheme is to attract foreign capital for investment purposes in the country of the issuing company. Offshore Mutual Funds thus facilitate cross-border fund flow which is a direct route for getting foreign currency without political strings or domination on the issuer country. From investment point of view too, offshore Mutual Funds open up domestic capital markets to the international investors and global portfolio investments.
The major point of difference between the offshore Mutual Funds and domestic Mutual Funds is the currency and country risk for the global investors as the source of fund is from abroad. Due to the high risk, higher return in the invested funds can be expected.
Like domestic Mutual Funds, the offshore Mutual Funds could also be functionally classified into close-ended or open-ended funds.
The major offshore Mutual Funds opened so far comprised close-ended schemes providing redemption of the units for individual investors only at the end of the specified period of the scheme. UTI’s India Fund 1986, India Growth fund, SBI’s India Magnum 1989, canbank’s Indo-Swiz Himalayan Fund 1990 and Commonwealth Equity Fund were all close-ended offshore funds.
ADVANTAGES OF MUTUAL FUNDS
Mutual Funds are advantageous to individual investors in relation to their direct involvement in investment portfolio activity covering the following aspects:
Mutual fund provides small investors access to reduced investment risk resulting from diversification, economies of scale in transaction cost and professional finance management.
Small investors participate in large basket of securities and share the benefits of efficiently managed portfolio by experts, and are freed of keeping any records of share certificates, etc., of various companies, tax rules, etc.
Investors get freedom from emotional stress involved in buying or selling securities. Mutual funds relieve them from such stress as it is managed by experts who act scientifically while buying and selling for their clients.
Revolving Type of Investment
Automatic reinvestment of dividends and capital gains provide relief to the members of Mutual Funds.
Selection and Timings of Investment
Expertise in stock selection and timing is made available to investors, so that invested funds generate higher returns.
Wide Investment Opportunities
Wide investment opportunities that create an increased level of liquidity for the funds holders become possible because of a package of liquid securities. These securities could be converted into cash without any loss of time.
Care for securities is available through mutual fund to the investors relieving them of various rules and regulations.
Income tax exemption has been ensured for Mutual funds. While originally, only such mutual funds as are set-up by public sector banks or a public financial institution were exempt from tax, now the benefit of tax exemption has been extended to all Mutual Funds. Investors are eligible for deduction under section 80L of the Income Tax Act in respect of the dividends from units or share of mutual funds and under section 88CC in respect of contributions made by investors to unit-linked insurance plan of UTI and LIC Mutual Fund.
The above advantages are only illustrative and not exhaustive as there is a scope of more to be added to the list in the light to individuals own experience(s).