Why Should We Invest In Mutual Funds Finance Essay - Free Essay Example

Sample details Pages: 12 Words: 3670 Downloads: 5 Date added: 2017/06/26 Category Finance Essay Type Cause and effect essay Did you like this example? 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 then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Don’t waste time! Our writers will create an original "Why Should We Invest In Mutual Funds Finance Essay" essay for you Create order 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 basket of securities at a relatively low cost. The flow chart below describes broadly the working of a mutual fund: Mutual Fund Operation Flow Chart (www.amfiindia.com) [online] 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. The money collected from the investors is invested by a fund manager in different types of securities. These could range from shares and debentures to money market instruments depending upon the schemes stated objectives. Why should we invest in mutual funds? The benefits of investing in mutual funds can be detailed as under: Affordable: Mutual funds can be bought by anyone and everyone. An investor can initiate his investment with Rs. 1,000/- as well. There is no specific minimum investment amount required. Professional Management: For retail investor, to decide which securities to buy and the required investment amount, is very difficult. Investing in a mutual fund gives the investor an edge, as it is managed by professional fund manager, who makes the necessary decisions as to which security to buy, how much to invest, when to buy and sell. These decisions are made after doing an in-depth market research about the economy, industries and companies. Diversification: Spreading the investments across the sectors, industries and securities reduces the risk; this is the basic of finance theory. A mutual fund is able to diversify more easily than an average investor across several companies, which an ordinary investor may not be a ble to do. With an investment of Rs 5000, you can buy stocks in some of the top Indian companies through a mutual fund, which may not be possible to do as an individual investor. Convenient administration: There are no administrative risks of share transfer, as many of the mutual funds offer services in a demat form which saves investors time and delay. Higher returns: Over a medium to long-term investment, investors always get higher returns in mutual funds as compared to other alternatives of investment. This is already seen from excellent returns, mutual funds have provided in the last few years. Low cost management: No mutual fund can increase the cost beyond prescribed limits of 2.5% maximum and any extra cost of management is to be borne by the AMC. Liquidity: Unlike several other forms of savings like the public provident fund or National Savings Scheme, you can withdraw your money from a mutual fund on immediate basis. Transparency: The Securities Exchange Boa rd of India (SEBI) regulations now compel all the mutual funds to disclose their portfolios on a half-yearly basis. However, many mutual funds disclose this on a quarterly or monthly basis to their investors. The Net Asset Values (NAV) are calculated on a daily basis in case of open ended funds and are now published through Association of Mutual funds in India (AMFI) in the newspapers. Tax benefits: Mutual funds have historically been more efficient from the tax point of view. A debt fund pays a dividend distribution tax of 12.5 per cent before distributing dividend to an individual investor or an HUF, whereas it is 20 per cent for all other entities. There is no dividend tax on dividends from an equity fund for individual investor. Highly regulated: Mutual funds all over the world are highly regulated and in India all mutual funds are registered with SEBI and are strictly regulated as per the Mutual Fund Regulations which provide excellent investor protection. Other benefi ts: Mutual Funds provide regular withdrawal and systematic investment plans according to the need of the investors. The investors can also switch from one scheme to another without any load. (Strategic Financial Management, 2008; www.valueresearchonline.com) Types of Mutual Funds Balanced funds: As the name suggests, balanced funds are the funds with strategic apportionment in debt as well as equities. The main premise behind the adoption of balanced funds is that the debt portfolio provides stability while the equity portfolio provides growth. This type of fund is more suitable for investors who prefer substantial exposure to equity rather than total exposure to equity. Equity Diversified funds: A diversified fund is a fund that contains wide array of stocks. There is a high level of diversification in the holdings which allows the fund manager to reduce the risk of the fund. There are various types of diversified funds as under: Flexicap/ Multicap fund: These are by definition, diversified funds. The only difference is that unlike a normal diversified fund, the offer document generally spells out the limits for minimum and maximum exposure to each of the market caps. Contra fund: A contra fund invests in those out-of-favour companies that have un recognised 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 oppurtunities. Index fund: An index fund seeks to track the performance of a benchmark market index like the Bombay Stock Exchange (BSE) Sensex or Standard Poors (SP) CNX Nifty. The fund maintains the portfolio of all the securities in the same proportion as stated in the benchmark index. Dividend yield fund: A dividend yield fund invests in shares of companies having high dividend yields. Dividend yield is defined as dividend per share divided by the shares market price. The prices of dividend yielding stocks are generally less volatile than growth stocks. They also possess the potential to appreciate. Among the diversified equity funds, dividend yield funds are considered to be a medium-risk proposition. However, it is important to note that dividend yield funds have not always proved resilient in short-term corrective phases. (iii) Equity Linked Tax Savings Scheme (ELSS): ELSS is one of the options for investors to save taxes under Section 80 C of the Indian Income Tax Act, 1961. They also offer the perfect way to participate in the growth of the capital market, having a lock-in-period of three years. ELSS also has the potential to give better returns than any traditional tax savings instrument. Moreover, by investing in an ELSS through a Systematic Investment Plan (SIP), one can not only avoid the problem of investing a lump sum towards the end of the year but also take advantage of averaging. (iv) 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 of downside risk protection as available in diversified funds. Se ctor funds should constitute only a limited portion of ones portfolio, as they are much riskier than a diversified fund. Also, only those who have an existing portfolio should consider investing in these funds. (v) 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. However, the downside is that the market may take a longer time to recognize views of the fund house with regards to a particular theme, which forms the basis of launching a fund. (vi) Arbitrage funds: These funds promise safety of deposits, but better returns, tax benefits and greater liquidity. The open-ended equity scheme aims to generate low volatility returns by inverting a mix of cash equities, equity derivatives and debt markets. The fund seeks to provide better returns than typical debt instruments and lower volatili ty in comparison to equity. This fund is aimed at an investor who seeks the return of small savings instruments, safety of bank deposits, tax benefits of Reserve Bank of India (RBI) relief bonds and liquidity of a mutual fund. This fund seeks to capitalise on the price differentials between the spot and the futures market. (vii) 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 anything about its operations publicly and charges a performance fee. If it out-performs a benchmark, it takes a cut off the profits. It is a one-way street; any losses are borne by the investors themselves. (viii) Cash fund: Cash fund is an open ended liquid scheme that aims to generate returns with lower volatility and higher liquidity through a port folio of debt and money market instrument. The fund will have retail institutional and super institutional plans. Each plan will offer growth and dividend options. The minimum initial investment for the institutional plan is Rs.1 crore and the super institutional is Rs.25 crore. For the retail plan, the minimum initial investment is Rs.5,000/-. The fund has no entry or exit loads. Investors can invest even through the Systematic Investment Planning (SIP) route with a minimum amount of Rs.500 per instalment with the total of all instalments not being less than Rs.5,000/-. (ix) Exchange-traded funds (ETF): An ETF 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 authorised participants can act as market makers for ETFs. Classification of mutual funds Mutual funds can be classified into three types and each is mutually exclusive. They are as under: Functional Classification: Based on the function funds can be classified as open ended and close ended. In an open ended scheme, an investor can make entry and exit at any time. The capital of the fund is unlimited and the redemption period is indefinite. In a close ended scheme, the investor can make an entry during the public offer or can buy from the stock market after the units are listed. The redemption period is definite at the end of which the corpus fund is liquidated. The investor can make his exit by selling the units in the stock market, or at the expiry of the scheme or during the repurchase period at his option. Portfolio Classification: On the basis of portfolio, funds are classified into three, viz., Equity funds, Debt funds and Special funds. Equity funds: Equity funds are invested in equity stocks. There are four types of equity funds. (a) Growth funds seek t o provide long term capital appreciation to the investor. This is best suited for long-term investor (b) Aggressive funds look for super normal returns for which investment is made in start-ups, IPOs and speculative shares, for risk-taking investors. (c) Income funds seek to maximise present income of the investors by investing in safe stocks paying high cash dividends and invest in high yield money market instruments. This is best suited for investors seeking current income. (d) Balanced funds 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: (a) Bond funds 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. (b) Gilt funds are mainly invested in Government secu rities. Special funds: (a) Index funds are low cost funds and influence the stock market. The investor will receive whatever the market delivers. (b) International funds raise money in India for investing globally. (c) Offshore funds are located in India to raise money globally for investing in India. (d) Sector funds invest their entire fund in a particular industry e.g. utility fund for utility industry like power, gas, and 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 is 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. Key players in Mutual funds Mutual Fund is formed by a trust body. The business is set up by the sponsor, the money invested by the asset management company and the operations monitored by the trustee. There are five principal constituents and three market intermediaries in the formation and functioning of mutual fund. The five constituents are: (1) Sponsor: A company established under the Companies Act forms a mutual fund. (2) Asset Management Company: An entity registered under the Companies Act to manage the money invested in the mutual fund and to operate the schemes of the mutual fund as per regulations. It carries the responsibility of investing and managing the investors money. (3) Trustee: The trust is headed by Board of Trustees. The trustee holds the property of the mutual fund in trust for the benefit of unit holders and looks into the legal requirements of operating and functioning of the mutual fund. The trustee may also form a limited company under the Companies Act in some situation s. (4) Unit Holder: A person/entity holding an undivided share in the assets of a mutual fund scheme. (5) Mutual Fund: A mutual fund established under the Indian Trust Act to raise money through the sale of units to the public for investing in the capital market. The funds thus collected are passed on to the Asset Management Company for investment. The mutual fund has to be registered with SEBI. The three market intermediaries are: Custodian: A custodian is a person who has been granted a Certificate of Registration to conduct the business of custodial services under the SEBI (Custodian of Securities) Regulations 1996. Custodial services include safeguarding clients securities along with incidental services provided. Maintenance of accounts of clients securities together with the collection of benefits / rights accruing to a client falls within the purview of custodial service. Mutual funds require custodians so that AMC can concentrate on areas such as investment and management of money. Transfer Agents: A transfer agent is a person who has been granted a Certificate of Registration to conduct the business of transfer agent under SEBI (Registrars to an Issue and Share Transfer Agents) Regulations Act 1993. Transfer agents services include issue and redemption of mutual fund units, preparation of transfer documents and maintenance of updated investment records. They also record transfer of units between investors where depository does not function. Depository: Under the Depositories 1996, a depository is body corporate who carries out the transfer of units to the unit holder in dematerialised form and maintains records thereof. Regulation of Mutual Funds SEBI, Reserve Bank of India (RBI), Ministry of Finance, Stock Exchanges, Registrar of Companies, Company Law Board, Department of Company Affairs are the agencies that govern the mutual funds in India. The guidelines range from the initial process of filling up the relevant applications for setting up a mutual fund to levying penalties for non-confirmation to the regulations as lay down by the SEBI. There are certain points relating to proper keeping of accounts so as to ensure transparency, thereby helping to protect the investors. General obligations: These are as under (1) To maintain proper books of accounts and records, etc; (2) Limitation on fees and expenses on issue of schemes; (3) Despatch of warrants and proceeds; (4) Annual Report; (5) Auditors Report; (6) Mailing of Annual Report and summary thereof; (7) Annual Report to be forwarded to the Board; (8) Periodic and continual disclosures; (9) Half yearly disclosures; (10) Disclosures to the investors. The final obligat ion regarding disclosures to the investors requires that the trustees shall be bound to make such disclosures to the unit holders as are essential in order to keep them informed about any information which may have an adverse bearing on their investments. Inspection and Audit: The provisions under this are: (1) Boards right to inspect and investigation; (2) Notice before inspection and investigation; (3) Obligation on inspection and investigation; Submission of report to the Board; (5) Communications of findings etc.; (6) Appointment of Auditor; (7) Payment of inspection fees to the Board. Procedure for action in case of default: The SEBI is empowered to undertake the following procedures in the event of default: (1) Suspension of certificate; (2) Cancellation of certificate; (3) Manner of making order of cancellation or suspension; (4) Show cause notice and order; (5) Effect of suspension or cancellation of certificate and registration; (6) Publication of order of suspensi on or cancellation; (7) Action against intermediaries. Mutual funds are also regulated in their investments in the primary market by the Securities and Exchange Board of India (SEBI) Mutual Funds Regulations, 1996. Broadly prescribes the important investment parameters under the regulations which are as follows: Not more than 5% of the corpus as reflected by the NAV can be invested in unlisted shares or convertibles. Not more than 10% of the NAV can be invested in shares or convertibles of a single company. The total investment in unrated debt instruments shall not exceed 25% of the NAV. No mutual fund under all its schemes can hold more than 10% of a companys share capital or voting rights. Mutual funds can now invest overseas upto US$ 3 billion up from US$ 2 billion previously. Operations of Mutual funds The operations of mutual funds generally include the following: Investment valuation norms Pricing of units Dividend distribution Apportionment of expenses Advertisement of schemes Investment approaches Offer document (Strategic Financial Management, 2008) History of the Indian Mutual fund history The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank of India. The history of mutual funds in India can be broadly divided into four distinct phases. First Phase 1964 1987: Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory and administrative control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of assets under management. Second Phase 1987 1993 (Entry of Public Sector Funds): 1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990. At the end of 1993, the mutual fund industry had assets under management of Rs.47,004 crores. Third Phase 1993 2003 (Entry of Private Sector Funds): With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993. The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996. The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets und er management was way ahead of other mutual funds. Fourth Phase since February 2003: In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs.29,835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India, functioning under an administrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations. The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs.76,000 crores of assets under management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place among different private sector funds, the mutual fund industry has entered its current phase of consolidation and growth. The graph indicates the growth of assets over the years. Note: Erstwhile UTI was bifurcated into UTI Mutual Fund and the Specified Undertaking of the Unit Trust of India effective from February 2003. The Assets under management of the Specified Undertaking of the Unit Trust of India has therefore been excluded from the total assets of the industry as a whole from February 2003 onwards. (www.amfiindia.com)[online]