Chapter 1 : Concept and Role of Mutual Funds


Learning Objective

This unit seeks to introduce the concept of mutual funds, highlight the advantages they offer, and describe the salient features of various types of mutual fund schemes.

Mutual funds are a vehicle to mobilize moneys from investors, to invest in different markets and securities

The primary role of mutual funds is to assist investors in earning an income or building their wealth, by participating in the opportunities available in the securities markets.

In order to accommodate investor preferences, mutual funds mobilize different pools of money. Each such pool of money is called a mutual fund scheme. Mutual funds address differential expectations between investors within a scheme, by offering various options, such as dividend payout option, dividend reinvestment option and growth option. An investor buying into a scheme gets to select the preferred option also.

The investment that an investor makes in a scheme is translated into a certain number of ‘Units’ in the scheme. The number of units multiplied by its face value (Rs10) is the capital of the scheme – its Unit Capital.

When the profitability metric is positive, the true worth of a unit, also called Net Asset Value (NAV) goes up.

When a scheme is first made available for investment, it is called a ‘New Fund Offer’ (NFO).

The money mobilized from investors is invested by the scheme as per the investment objective committed. Profits or losses, as the case might be, belong to the investors. The investor does not however bear a loss higher than the amount invested by him.

The relative size of mutual fund companies is assessed by their assets under management (AUM). The AUM captures the impact of the profitability metric and the flow of unit-holder money to or from the scheme.

Investor benefits from mutual funds include professional management, portfolio diversification, economies of scale, liquidity, tax deferral, tax benefits, convenient options, investment comfort, regulatory comfort and systematic approach to investing.

Limitations of mutual funds are lack of portfolio customization and an overload of schemes and scheme variants.

Open-ended funds are open for investors to enter or exit at any time and do not have a fixed maturity. Investors can acquire new units from the scheme through a sale transaction at their sale price, which is linked to the NAV of the scheme. Investors can sell their units to the scheme through a re-purchase transaction at their re-purchase price, which again is linked to the NAV.

Close-ended funds have a fixed maturity and can be bought and sold in a stock exchange.

Interval funds combine features of both open-ended and closed ended schemes.

Actively managed funds are funds where the fund manager has the flexibility to choose the investment portfolio, within the broad parameters of the investment objective of the scheme.

Passive funds invest on the basis of a specified index, whose performance it seeks to track.

Gilt funds invest in only treasury bills and government securities

Diversified debt funds on the other hand, invest in a mix of government and non-government debt securities

Junk bond schemes or high yield bond schemes invest in companies that are of poor credit quality.

Fixed maturity plans are a kind of debt fund where the investment portfolio is closely aligned to the maturity of the scheme.

Floating rate funds invest largely in floating rate debt securities

Liquid schemes or money market schemes are a variant of debt schemes that invest only in debt securities of less than 91-days maturity.

Diversified equity funds invest in a diverse mix of securities that cut across sectors.

Sector funds invest in only a specific sector.

Thematic funds invest in line with an investment theme. The investment is more broad-based than a sector fund; but narrower than a diversified equity fund.


  • A mutual fund is a pool of money collected from Investors and is invested according to stated investment objectives.
  • The birth place of Mutual Fund is U.S.A.
  • Mutual fund investors are like shareholders and they own the fund.
  • Mutual fund investors are not lenders or deposit holders in a mutual fund.
  • Everybody else associated with a mutual fund is a service provider, who earns fee.
  • The money in the mutual fund belongs to the investors and nobody else.
  • Mutual funds invest in marketable securities according to the investment objective.
  • The value of the investments can go up or down, changing the value of the investor’s holdings.
  • The net asset value (NAV) of a mutual fund fluctuates with market price movements.
  • The market value of the investor’s funds is also called as net assets.
  • Investors hold a proportionate share of the fund in the mutual fund.
  • New investors come in and old investors can exit at prices related to net asset value per unit.
  • Advantages of mutual funds to investors are:
    • Increases the purchasing power of the investors
    • Portfolio diversification
    • Professional management
    • Reduction in risk
    • Reduction in transaction cost
    • Liquidity
    • Convenience and flexibility
  • Disadvantages of mutual funds to investors are:
    • No control over costs
    • No tailor made portfolios
    • Problems of managing a large portfolio of funds
  • Important Milestones in the MF history in India
    • 1963: UTI (special privileges – assured return schemes, guarantees, loans)
    • 1987: Public Sector MFs
    • 1993: Private Sector MFs
    • 1995: AMFI was set-up (internal checks & balances, representation to the govt and consumer education – publish a book titled “Making Mutual Funds Work for You – an Investor’s Guide”)
    • 1996: SEBI (MF) Regulations
    • 1999: Dividend income made tax free in the hands of investor
    • 2003: UTI Act repealed (level playing field, UTI split, UTIMF created)
    • 2004-onwards: Consolidation & Growth (AUM at the end of FY 2004-05 was appx. Rs.153,000 crores)
  • UTI was the only mutual fund during the period 1963-1988.
  • UTI was the only fund for a long period and enjoyed monopoly status.
  • UTI is governed by the UTI Act, 1963
  • In 1987 banks, financial institutions and insurance companies in the public sector were permitted to set up mutual funds.
  • SEBI got regulatory powers in 1992.
  • SBI Mutual Fund was the first bank-sponsored mutual fund to be set up.
  • The first mutual fund product was UTI’s Master Share in 1986.
  • The private sector players were allowed to set up mutual funds in 1993.
  • In 1996 the mutual fund regulations were substantially revised and modified.
  • In 1999 dividends from mutual funds were made tax exempt in the hands of investors.
  • Mutual funds can be open ended or closed ended, Load or No-Load, Taxable or Tax exempt, Commodities and Real Estate funds.
  • In an open ended fund, sale and repurchase of units happen on a continuous basis, at NAV related prices, from the fund itself.
  • The corpus of open ended funds, therefore, changes everyday.
  • A closed end fund offers units for sale only in the NFO. It is then listed in the market.
  • In closed end fund investors wanting to buy or sell units have to do so in the stock markets.
  • The corpus of a closed end fund remains unchanged.
  • Mutual funds also offer equity linked savings schemes (ELSS) that have the following features:
    • 3 year lock in
    • Minimum investment of 90% in equity markets at all times
    • Open ended or closed end
    • Rebate under section 80C for investments up to Rs. 1,00,000/-
  • Gilt funds are funds that invest only in government securities
  • Sectoral funds are also called as specialty funds.
  • Equity funds are risky; liquid funds have the lowest risk.
  • Equity funds are for the long term; liquid funds are for the short term.
  • Investors choose funds based on their objectives, risk appetite, time horizon and return expectations.
  • Load is charged to the investor when the investor buys or redeems (repurchases) units.
  • Load is an adjustment to the NAV, to arrive at the price.
  • Load that is charged on sale of units is called as Entry Load.
  • An entry load will increase the price, above the NAV, for the investor.
  • Load that is charged when the investor redeems his units is called an Exit Load.
  • Exit load reduces the redemption proceeds of the investor.
  • Load is primarily used to meet the expenses related to sale and distribution of units.
  • An exit load that varies with the holding period of an investor is called a (Contingent Deferred Sales Charge) CDSC.
  • The repurchase price cannot be less than 95% of the sale price.

5 comments:

  1. its a very goood blog

    ReplyDelete
  2. Your are really sharing this information this will really help investors in many ways.

    ReplyDelete
  3. this content is very useful to beginners in mutual fund investors

    ReplyDelete
  4. How to select a Mutual Fund? and Pls give some information on mutual fund, which mutual fund is good to invest?

    ReplyDelete
  5. Nice posting, thanks for sharing with us. Your blog is great and helped me feel better knowing about the Closed End Mutual Funds Scheme. Thanks again!

    ReplyDelete

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