Mutual Funds

Mutual fund is a trust that pools the savings of a number of investors who share a common financial goal. A mutual fund is the most suitable investment for the cautious investor as it offers an opportunity to invest in a diversified professionally managed basket of securities at a relatively low cost.
Anybody with an investible surplus of as little as a few thousand rupees can invest in mutual funds by buying units of a particular mutual fund scheme that has a defined investment objective and strategy.

Classification of Mutual Funds

There are three different types of classification of mutual funds.
(1) Functional
(2) Portfolio and
(3) Ownership.

Functional Classification:
Funds are divided into- Open ended funds and Close ended funds.
–In an  open ended scheme, the investor can make entry and exit at any time. Also, the capital of the fund is unlimited and the redemption period is indefinite.
–In a  close ended scheme, the investor can buy into the scheme during Initial Public offering or from the stock market after the units have been listed. The scheme has a limited life at the end of which the corpus is liquidated. The investor can make his exit from the scheme by selling in  the  stock market, or at the expiry of the scheme or during repurchase period at his option.
–Interval schemes are a cross between an open ended and a close ended structure. These schemes are open for both purchase and redemption during pre-specified intervals (viz. monthly, quarterly, annually etc.) at prevailing NAV based prices.
Interval funds are very similar to close-ended funds, but differ on the following points:
*They are not required to be listed on the stock exchanges, as they have an in-built redemption window.
*They can make fresh issue of units during the specified interval period, at the prevailing NAV based prices.
*Maturity period is not defined.

Portfolio Classification:
Funds are classified into Equity Funds, Debt Funds and Special Funds.

Equity Funds are of the following types:
Growth Funds: They seek to provide long term capital appreciation to the investor and are best to long term investors.
Aggressive Funds: They look for super normal returns for which investment is made in start-ups, IPOs and speculative shares. They are best to investors willing to take risks.
Income Funds: They seek to maximize present income of investors by investing in safe stocks paying high cash dividends and in high yield money market instruments. They are best to investors seeking current income.
Balanced Funds: They are a mix of growth and income funds. They buy shares for  growth and bonds for income and best for investors seeking to strike golden mean.

Debt Funds are of two types:
Bond Funds: They invest in fixed income securities e.g. government bonds, corporate debentures, convertible debentures, money market.
Investors seeking tax free income go in for government bonds while those looking for safe, steady income buy government bonds or high grade corporate bonds. Although there have been past exceptions, bond funds tend to be less volatile than stock funds and often produce regular income. Gilt Funds: They are mainly invested in Government securities.

Special Funds are of following types:
Index Funds: Every stock market has a stock index which measures the upward and downward sentiment of the stock market. Index Funds are low cost funds and influence the stock market. The investor will receive whatever the market delivers.
International Funds: A mutual fund located in India to raise money in India for investing globally.
Offshore Funds: A mutual fund located in India to raise money globally for investing in India.
Sector Funds: They invest their entire fund in a particular industry e.g. utility fund for utility industry like power, gas, public works.

Ownership Classification:
Funds are classified into Public Sector Mutual Funds, Private Sector Mutual Funds and Foreign Mutual Funds.
Public Sector Mutual Funds are sponsored by a company of the public sector.
Private Sector Mutual Fund are sponsored by a company of the private sector.
Foreign Mutual Funds are sponsored by companies for raising funds in India, operate from India and invest in India.

Types of Schemes:

Balanced Funds: Balanced funds make strategic allocation to both debt as well as equities. It mainly works on the premise that while the debt portfolio of the scheme provides stability, the equity one provides growth. It can be an  ideal option for those who do not like total exposure to equity, but only substantial exposure. Such funds provide moderate returns   to the investors as the investors are neither taking too high risk nor too low a risk.

Equity Diversified Funds: A Diversified funds is a fund that contains a wide array of stocks. The fund manager of a diversified fund ensures a high level of diversification in its holdings, thereby reducing the amount of risk in the fund.
(a) Flexicap/ Multicap Fund: These are by  definition, diversified funds. The only difference is that unlike a normal diversified fund, the offer document of a multi-cap/flexi-cap fund  generally spells out the limits for minimum and maximum exposure to each of the market caps.
(b) Contra fund: A contra fund invests in those out-of-favour companies that  have unrecognised value. It is ideally suited for investors who want to invest in a fund that has the potential to perform in all types of market environments as it blends together both growth and value opportunities. Investors who invest in contra funds have an aggressive risk appetite.
(c) Index fund: An index fund seeks to track the performance of a benchmark market index like the BSE Sensex or S&P CNX Nifty. Simply put, the fund maintains the portfolio of all the securities in the same proportion as stated in the benchmark index and earns the same return as earned by the market.
(d) Dividend Yield fund: A dividend yield fund invests in shares of companies having high dividend yields. Dividend yield is defined as dividend per share dividend by the share’s market price. Most of these funds invest in stocks of companies having a dividend yield higher than the dividend yield of a particular index, i.e., Sensex or Nifty. The prices of dividend yielding stocks are generally less volatile than growth stocks. Besides, they also offer the potential to appreciate.
Dividend yield schemes are of two types:
*Dividend Payout Option: Dividends are paid out to the unit holders under this option. However, the NAV of the units falls to the extent of the dividend paid out and applicable statutory levies.
*Dividend Re-investment Option: The dividend that accrues on units under option is re- invested back into the scheme at ex-dividend NAV. Hence investors receive additional units n their investments in lieu of dividends.

Equity Linked Tax Savings Scheme: ELSS is one of the options  for  investors  to save taxes under Section 80C of the Income Tax Act. They also offer the perfect way to participate in the growth of the capital market, having a lock-in-period of three years. Besides, ELSS has the potential to give better returns than any traditional tax savings instrument.

Sector funds: These funds are highly focused on a particular industry. The basic objective is to enable investors to  take advantage of  industry cycles. Since sector funds ride on market cycles, they have the potential to offer good returns if the timing  is  perfect. However, they are bereft (lacking) of downside risk protection as available in diversified funds.
Sector funds should constitute only a limited portion of one’s portfolio, as they are much riskier than a diversified fund. Besides, only those who have an existing portfolio should consider investing in these funds.

Thematic Funds: A Thematic fund focuses on trends that are likely to result in the ‘out- performance’ by certain sectors or companies. In other words, the key factors are those that  can make a difference to business profitability and market values.

Arbitrage Funds: Typically these funds promise safety of deposits, but better returns, tax benefits and greater liquidity. Pru-ICICI is the latest to join the list with its equities and derivatives funds.
This fund is aimed at an investor who seeks the return of small savings instruments, safety of bank deposits, tax benefits of RBI relief bonds and liquidity of a mutual fund. Arbitrage fund finally seeks to capitalize on the price differentials between the spot and the futures market.

Hedge Fund: A hedge fund (there are no hedge funds in India) is a lightly regulated investment fund that escapes most regulations by being a sort of a private investment vehicle being offered to selected clients.
The big difference between a hedge fund and a mutual fund is that the former does not reveal any thing about its operations publicly and charges a performance fee.

Cash Fund: Cash Fund is an open ended liquid scheme that aims to generate returns with lower volatility and higher liquidity through a portfolio of debt and money  market instrument.

Exchange Traded Fund (ETF): It is a hybrid product that combines the features of an index fund. These funds are listed on the stock exchanges and their prices are linked to the  underlying index. The authorized participants act as market makers for ETFs.
ETFs can be bought and sold like any other stock on an exchange. In other words, ETFs can    be bought or sold any time during the market hours at prices that are expected to be closer to the NAV at the end of the day. Therefore, one can invest at real time prices as against the end of the day prices as is the case with open-ended schemes.

Open Ended Funds V/s Close Ended Funds V/s ETFs

Points to be considered before the Selection of Mutual Funds:

• Past Performance
• Timing
• Size of Fund
• Age of Fund
• Largest Holding
• Fund Manager
• Expense Ratio
• PE Ratio
• Portfolio Turnover