NISM - AMFI Certification - Mutual Fund Distributor Certification Notes

Syllabus for NISM Certification for Mutual Fund Distributor

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1. Concept & Role of a Mutual Fund

1.1 Introduction
1.2 Types of Funds
1.3 Key Developments over the Years

2. Fund Structure & Constituents

2.1 Legal Structure of Mutual Funds in India
2.2 Key Constituents of a Mutual Fund
2.3 Other Service Providers

3. Legal & Regulatory Environment

3.1 Role of Regulators in India
3.2 Investment Restrictions for Schemes
3.3 Investors’ Rights & Obligations
3.4 Can a Mutual Fund Scheme go bust?
3.5 Appendix 1: AMFI Code of Ethics
3.6 Appendix 2: Code of Conduct for Intermediaries

4. Offer Document

4.1 Offer Document - NFO, SID, SAI
4.2 Key Information Memorandum
4.3 Appendix 3: Format of Scheme Information Document
4.4 Appendix 4: Format of Key Information Memorandum

5. Fund Distribution & Channel Management Practices

5.1 Distribution Channels
5.2 Channel Management Practices

6. Accounting, Valuation & Taxation

6.1 Accounting and Expenses
6.2 Valuation
6.3 Taxation

7. Investor Services

7.1 Mutual Fund Investors
7.2 KYC Requirements for Mutual Fund Investors
7.3 PAN Requirements for Micro-SIPs
7.4 Additional Documentation Requirements applicable for Institutional Investors
7.5 Demat Account
7.6 Transactions with Mutual Funds
7.7 Transactions through the Stock Exchange
7.8 Investment Plans and Services
7.9 Appendix 5: KYC Form for Individuals
7.10 Appendix 6: KYC Form for Non-Individuals

8 Return, Risk & Performance of Funds

8.1 Drivers of Returns in a Scheme
8.2 Measures of Returns
8.3 Drivers of Risk in a Scheme
8.4 Measures of Risk
8.5 Benchmarks and Performance
8.6 Quantitative Measures of Fund Manager Performance

9 Scheme Selections

9.1 How to choose between Scheme Categories?
9.2 How to select a Scheme within a Scheme Category?
9.3 Which is the Better Option within a Scheme?
9.4 Sources of Data to track Mutual Fund Performance

10 Selecting the Right Investment Products for Investors

10.1 Financial and Physical Assets
10.2 Gold – Physical or Financial?
10.3 Real Estate – Physical or Financial?
10.4 Fixed Deposit or Debt Scheme
10.5 New Pension Scheme
10.6 Other Financial Products

11 Helping Investors with Financial Planning

11.1 Introduction to Financial Planning
11.2 Alternate Financial Planning Approaches
11.3 Life Cycle and Wealth Cycle in Financial Planning

12 Recommending Model Portfolios & Financial Plans

12.1 Risk Profiling
12.2 Asset Allocation
12.3 Model Portfolios

About the NISM Certification Examination for Mutual Fund Distributors

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About the Certification Examination for Mutual Fund Distributors

The examination seeks to create a common minimum knowledge benchmark for all persons involved in selling and distributing mutual funds including:

• Individual Mutual Fund Distributors
• Employees of organizations engaged in sales and distribution of Mutual Funds
• Employees of Asset Management Companies especially persons engaged in sales and distribution of Mutual Funds

The certification aims to enhance the quality of sales, distribution and related support services in the mutual fund industry.

Examination Objectives

On successful completion of the examination, the candidate should:

• Know the basics of mutual funds, their role and structure, different kinds of mutual fund schemes and their features
• Understand how mutual funds are distributed in the marketplace, how schemes are to be evaluated, and how suitable products and services can be recommended to investors and prospective investors in the market.
• Get oriented to the legalities, accounting, valuation and taxation aspects underlying mutual funds and their distribution.
• Get acquainted with financial planning as an approach to investing in mutual funds, and an aid for advisors to develop long term relationships with their clients.

Assessment Structure

The examination consists of 100 questions of 1 mark each and should be completed in 2 hours. The passing score on the examination is 50%. There shall be negative marking of 25% of the marks assigned to a question.

Examination Structure

The exam covers knowledge competencies related to the basics of mutual funds and how mutual fund schemes are to be evaluated, and suitable mutual fund products and services offered to investors and prospective investors.

How to register and take the examination

To find out more and register for the examination please visit www.nism.ac.in

NISM to conduct AMFI Certification for Mutual Fund Distributor w.e.f 1 June 2010

2010-05-14T01:02:00.000-07:00

With effect from 1st Jun'10, certification program for mutual fund distributor will be managed by National Institute of Securities Markets (NISM). Hence, AMFI Mutual Fund Certification program will be discontinued.
Accordingly, test for AMFI Mutual Fund (Basic) Module and AMFI Mutual Fund
(Advisors) Module will not be conducted from June 1, 2010.

National Institute of Securities Markets (NISM) is a public trust, established by the Securities and Exchange Board of India (SEBI), the regulator for securities markets in India. NISM seeks to add to market quality through educational initiatives.

National Institute of Securities Markets (NISM) would be conducting Mutual Fund Distributors Certification Examination from June 1, 2010 onwards. The examination consists of 100 questions of 1 mark each and should be completed in 2 hours. The passing score for the examination is 50%. There shall be negative marking of 25% of the marks assigned to a question.

Registration for the examination can be done through NSE / BSE / MCX-SX.

About AMFI Certification

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Association of Mutual Funds in India (AMFI) is the committee which registers the fund distributors, test and certify their competence, and has the power to deny registration to distributors for failing the test or violating AMFI Code of Conduct. So to become a Mutual Funds Advisor one has to pass the AMFIs Mutual Funds Advisor test. There are two certification tests - one is Basic Module which is meant for general public students and others and this test is based on basic concepts and working of Mutual Funds. The second is Advisors Module which is mandatory for agent - distributors and all those engaged in the marketing and selling of mutual fund schemes to pass the Advisors Module and get themselves registered with AMFI.

Let us first know why one should sell Mutual Funds
1 - Its easy to make more clients
2 - Less competition in market for Distributors unlike Insurance Agents
3 - More satisfaction to clients
4 - Attractive source of income
5 - Strong industry growth ahead
6 - Retention and loyalty of clients
7 - Greater choice of products
8 - Be a competitive Financial Advisor
9 - Beating the competition and growing
So how to start for getting the AMFI Certified Mutual Funds Advisor.

1 - You have to register for the Advisor Module test first. The test is taken both ways i.e. online test as well as Written Test. Mostly people go for online test as it is convenient in process and the result is also on the spot. To register for the test online you can visit the NSE website at http://www.nseindia.com

2 - When you register you will get the all details like the date and venue of the exams, fees, where to get the study materials etc. For study materials I prefer to use AMFI Work book which is available at AMFI Office at address below

Association of Mutual Funds India
709, Raheja Centre, Free Press Journal Marg,
Nariman Point, Mumbai 400 021, India.
The price of the workbook is Rs.300/-. You can also get the book by ordering Post/Courier by sending DD.

3 - How to prepare for the exam? The best way is to study the full AMFI work book once thoroughly. After that you start solving the mock tests available in many AMCs websites and lot of Mock tests questions are available in ISC Question sections also for AMFI Mock test.

4 - The test is objective type multiple selection option test. You have to select the write answer. It’s a 3 hour test but usually the test completes by 1 hour time. The center of the test will be notified to you by email and SMS also.

5 - Once you clear the test you have to register your name with AMFI to get the ARN number. The ARN number is used to create the Asset under Management AUM which will in turn give the trail commission to you. For getting the ARN- Number you have to apply to AMFI registered CAMS center. The details of this process can be available from AMFI website at http://www.amfiindia.com

6 - Once you register for ARN Number you will get the ARN Number and a Certificate and ARN Card which is used for canvassing purpose. You can then either registers with any AMC like SBI, HDFC, UTI etc or start you own business by quoting your ARN Number. This ARN Number is valid for 5 years and it is to be renewed after that.
For more details about the AMFI Advisor Module please visit the AMFI Website at http://www.amfiindia.com

Register for AMFI Exam

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Please go to page http://www.nism.ac.in

If you are a first time user of NCFM programme, click on the "New User Sign Up" link, you will be directed to the ‘NCFM: Registration Page’.

Please enter all fields that are mandatory including contact details to ensure that all correspondence reaches at the right address. On successful registration the user-id and password confirmation will be sent to the e-mail address specified by the candidate.

When Registration Successfully Screen will be displayed; please note down your registration no for reference.

If you have already registered / taken any NCFM test earlier, please refer the ‘Already Registered’ section.

Candidates who have taken any NCFM tests earlier, including Life Insurance Modules or FPSB Modules (formerly known as AFP/CFP Exams) are already registered and the same registration is valid for all the tests. This registration no. is printed on the scorecard/ certificate issued to the candidates. This registration no. is required, to generate the user-id & password for online enrollment.
How to find your NCFM id?

Please click "Existing candidates can click here to obtain their User Id and password" or "Forgot Password" link mentioned on the Main Login page. Candidate need the following to change / reset password:-

NCFM Reg. No/Examinee Id.
Name as entered in the form (First Name & Last Name)
Date of birth

After entering the details as required it will take the candidate to another screen, where the username will be displayed. The candidate needs to reset his password by choosing a unique password and repeating the same as confirmation. The password will be reset, and the message "Password Changed Successfully" will be displayed. The screen given below will appear.

The candidate can log in through the Main Menu with the help of the userid and password.

When you select “On-line payment”, enrollment for a test is possible only after payment of fees. Hence a payment must be made to be able to enroll for a test.

If you choose to pay by credit card / debit card a service charge of 2.3% is applicable. You can make payments for multiple modules by selecting each module using Ctrl-key.

The fees will be calculated and the “Total amount to be paid” will be displayed. On clicking on the submit button, the screen will be directed to a secure payment gateway.

Please keep your credit card / debit card ready and enter all details as requested. An e-mail message will also be sent to the candidate confirming receipt of fees and status of dispatch of study material.

If the candidate chooses to pay by cash, he needs to click the Cash facility available. Candidate can select multiple modules and a confirmation box will appear which will alert the candidate to the no. of modules selected.

Once the candidate confirms the modules, the cash deposit will be generated and the candidate will have to print the same immediately. Please note that before you generate deposit slip; please ensure that the system is connected to the printer.

The candidate needs to print the deposit slip and visit the Bank Branch given in the link.

Please print 2 copies of the deposit slip.
One copy has to be submitted to the Bank and one copy of the deposit slip should be retained by the candidate after receiving the duly stamped acknowledgement from the Bank pay-in branch.
Please fill the date of deposit, the denomination of currency and sign the deposit slip.
Please do not tamper with any details, given on the face of the deposit slip.
Your cash payment has to be deposited at the specific Bank Branches along with the deposit slip, please refer to the link provided.
Please note the above process is only for cash deposit and cheques will not be accepted.
The credit for the cash deposited will be received only the next day after 1:00 p.m. For cash deposit completed on a Friday or Saturday, the credit will be received on Monday. Similarly for Exchange specified holidays, the credit will be received only on the next working day.
An email message will be sent to the candidates confirming receipt of fees and status of dispatch of study material.

Before enrolling for a test, an on-line payment is to be made. After the payment has been completed/ credit received, the candidate can enroll for the test of his choice as per the availability. To find out the availability of test at a center select the Enrollment link. Select the correct module details (only 1 at a time). The candidate can specify the Test Center and the range from date and to date of a test date he desires to be able to decide on a test date at a particular NSEIL Branch. (For tests at Non-NSE locations you are requested to get in touch with the nearest NSEIL Branch office).

You can choose a time slot for which you wish to enroll. The next screen is "REQUEST CONFIRMATION" of the test.

Once the ‘OK’ button is selected, candidate’s request will be processed and no changes will be possible thereafter.

A Hall ticket with the photograph will appear in another window. Please print the hall ticket and carry it with you for the test. Also, please carry a proof of identity (and photograph if the same has not been uploaded by you while enrolling).

If photo-upload has not been successful, please paste a recent colour passport size photograph in the space provided. (Polaroid photographs will not be allowed). Do not staple the photograph. Please carry 2 copies of the Hall ticket with you and submit the original with your photograph attached to the test administrator. Please read all the instructions given on the hall ticket.

All candidates are requested to upload their photographs to be able to ascertain identity. The photograph may be scanned and cropped to fit the dimensions 3 X 3 cms or 1 X 1 inch or 150 X 180 pixels on the system. The max file size of the photo can be 20 Kb. Photograph can either be clicked by a digital camera/camera phone or web camera and the file may be transferred on to the computer. The file has to be saved as .jpeg format. However, Polaroid photographs are not allowed. You may seek the services of any cybercafé/web stores etc that offer Digital printing services.

A message confirming that photo-upload has been successful will be displayed. Please note photo upload once completed cannot be changed.

Buy AMFI Exam Certification Preparation Kit

2009-03-28T00:30:00.001-07:00

AMFI Exam Preparation Kit contains 3 books and 1 CD. Pl go through the following details:

Book 1 AMFI exam preparation Book Price Rs.150

Book 2 AMFI exam Model Question papers (Along with Answers) Price Rs.100

Book 3 AMFI exam – Last Day Revision Price Rs.150

1 CD AMFI Exam - Training CD + AMFI Mock Tests (Animated) Price Rs.150

Total Cost of AMFI Kit Rs.550/- Only

For home delivery order please email me on tonileshpanchal@yahoo.com . For bulk orders we also give discounts. Please write for more details.

Career as a Mutual Fund Advisor

2009-03-28T00:29:00.001-07:00

There is a great opportunity exists for Financial Planners in India as >35% of the world's youth live in India of which 54% are below 25 Years of age and it is assumed that by year 2013, India will have 33% productive youth. Why Mutual Fund? Mutual Funds are the product that is not much penetrated in Indian market as compared to Insurance. So there is a great opportunity exists for young youth who are interested to make their career in Financial Planning as there are approximately more than 15 Lakhs Insurance Agents available whereas the Mutual Funds Agents are less than 50000 in the market. So there is less competition for selling the Mutual Funds.
Now coming to the question of why one should sell Mutual Funds? There are number of reasons can be listed for the answer. Lets us see one by one in brief why one should sell Mutual Fund products.

1. It is easy to make more clients by selling mutual funds because as told earlier the penetration of Mutual Funds in Indian market is low as compared to Insurance Products. So there is more opportunity to acquire clients. As you become certified consultant you know the product well and hence higher success ratio to begin with the selling Mutual Funds.

2. Less competition in market as again informed earlier there are very less Mutual Funds Agents available in India (AMFI Certification is Mandatory to sell Mutual Funds) as compared to Insurance Products. So you can easily sell the product. Also there is a huge demand of Quality Mutual Funds Agent across the Mutual Fund Companies.

3. With this Certification your client will be more satisfied as he knows that you have thorough knowledge of product as you have completed the AMFI Certification. With mutual funds in your offering, you are in a much better position to fully meet the client’s financial and investment needs.

4. Good Source of Income: Mutual Fund Agents gets attractive income in terms of commission. Mutual fund is one product today that potentially has no limits to the volumes that you can generate. Unlike insurance, where income is based on the premium you collect, in mutual funds income is only the amount collected as well as on the entire AUM (Assets Under Management) that you mobilize. Over long term you make much more money than doing insurance or any such product!!!

5. Strong Industry Growth ahead: Indian economy growth is intact. There is a very strong growth of mutual funds ahead. The reasons are many – good product, low penetration, huge market, growing income, changing mindset, lack of other attractive investment products, etc. Mutual funds have all the products to match the different needs of different investors.

6. Retention & Loyalty of the Clients: People today look for easy, fast, and single service point that provides them with solutions that meets their multiple needs. The client would probably invest in mutual funds some day or later. Why not you do the same before anyone else gets to your client?

7. Greater choice of products: Mutual Fund products basket is very big and varied meeting every individuals need and capacity. The basket would include pure Equity funds (Diversified / Sectoral / Index Funds) to pure Debt funds (Gilt / Income / Short Term Plans / Floating / Liquid Funds) to Hybrid funds (MIPs / Balance / Arbitrage Funds) to the Tax Saving ELSS.

The first step in becoming a Mutual Fund Advisor is appearing for AMFI Certification Examination. After clearing the same and taking the registration number (ARN code) you can start advising and selling mutual funds.

Be a Complete Financial Advisor

Instruction set for appearing AMFI Certification Exam

2009-03-28T00:28:00.001-07:00

This post will be useful for the candidates appearing for the AMFI Advisor Course Certification Test. If you are a new visitor and want to know what is AMFI Advisor Module Course then I would request you to please visit my earlier post on Career Planning in AMFI Certified Mutual Fund Advisor.

Here I will now list down the important instruction sets that a candidate must follow before giving the AMFI Advisor Test. As you know both written and online tests are available for this course. I personally would prefer to go for online test as it is fast and gives immediate result.

Important points to be remember are as follows
1. Calculators are allowed during the examination.
2. Candidate should carry a valid photo identity card such as PAN card, Driving License, Passport, Voter’ s Identity card, employer’s identity card etc.
3. The AMFI test paper would comprise questions aggregating 100 marks and the minimum mark to be scored by a candidate to be declared qualified is 50. Time duration of the exam is 90 minutes.
4. There will be penalty for wrong answers by one-fourth (25%) of the marks allotted to each question.
5. You have the option to skipping Questions.
6. Do not guess maximum questions.
7. Don’t Attempt ALL Questions unless you are confident.
8. But don’t attempt only 50 to 60% paper only as it will lead you to unsuccessful.
9. Be careful about the negative marking.
10. Read Googly & tough questions two times.
11. Attempt enough MOCK tests before appearing for actual test. Give AMFI mock test & AMFI model manual test as much as possible before appearing for AMFI exam. You can make use of the Mock Test questions I have uploaded in ISC Question Papers section. AMFI Model Mock Sample Tests
12. Read question twice before attempting it & try to understand the logic.
13. Do not try to guess all 2 marks category questions.

So I request all candidates appearing for the AMFI Certification please read the above points and understand it clearly. My experiences if I share then I have attempted all the questions listed in question paper section for AMFI Test and then appeared for online exam. As an online test is of 90 minutes, I have attempted the exam just in 30 minutes and scored 70% marks. So mind well the exam is objective type with multiple choice questions similar as given in mock tests. You just concentrate on the language and try to understand before you give answer.

All the Best for AMFI Advisor Certification Module Test

Useful Links

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1. Association of Mutual Funds in India: www.amfiindia.com
2. Reserve Bank of India: www.rbi.org.in
3. Securities & Exchange Board of India: www.sebi.gov.in
4. National Stock Exchange: www.nseindia.com
5. Bombay Stock Exchange: www.bseindia.com
6. Mutual Fund AMC List in India

Chapter 1 : Concept and Role of Mutual Funds

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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.

Chapter 2: Fund Structure and Constituents

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Learning Objective

In this unit, you will understand the salient features of the legal structure of mutual funds in India and the role of key constituents that make up the overall mutual fund eco-system.

Mutual funds in India are governed by SEBI (Mutual Fund) Regulations, 1996, as amended till date.

The regulations permit mutual funds to invest in securities including money market instruments, or gold or gold related instruments or real estate assets.

Mutual funds are constituted as Trusts. The mutual fund trust is created by one or more Sponsors, who are the main persons behind the mutual fund operation.

Every trust has beneficiaries. The beneficiaries, in the case of a mutual fund trust, are the investors who invest in various schemes of the mutual fund.

In order to perform the trusteeship role, either individuals may be appointed as trustees or a Trustee company may be appointed.

When individuals are appointed trustees, they are jointly referred to as Board of Trustees. A trustee company functions through its Board of Directors.

Day to day management of the schemes is handled by an AMC.

The AMC is appointed by the sponsor or the Trustees. Although the AMC manages the schemes, custody of the assets of the scheme (securities, gold, gold-related instruments & real estate assets) is with a Custodian, who is appointed by the Trustees.
Investors invest in various schemes of the mutual fund. The record of investors and their unit-holding may be maintained by the AMC itself, or it can appoint a Registrar & Transfer Agent (RTA).

The sponsor needs to have a minimum 40% share holding in the capital of the AMC.

The sponsor has to appoint at least 4 trustees – atleast two-thirds of them need to be independent. Prior approval of SEBI needs to be taken, before a person is appointed as Trustee.

AMC should have networth of at least Rs10crore. At least 50% of the directors should be independent directors. Prior approval of the trustees is required, before a person is appointed as director on the board of the AMC.

Mutual funds in India have a 3-tier structure of Sponsor-Trustee-AMC.
The mutual fund is formed as trust in India, and not as a company.
In the US mutual funds are formed as investment companies.
Investor’s money is held in the Trust (the mutual fund).

The Sponsor:

Sponsor is defined under the SEBI regulations as any person who, acting alone or in combination with another body corporate, establishes a mutual fund.
Sponsor is the promoter of the fund.
Sponsor could be a bank, a corporate or a financial institution.
Sponsors then form Trust and appoint Board of Trustees.
The sponsor also appoints Custodian.
As per SEBI regulations, sponsor must contribute at least 40% of the net worth of the AMC and possess a sound financial track record over five years prior to registration.
Sponsor signs the trust deed with the trustees.
Sponsor creates the AMC and the trustee company and appoints the board of directors of companies, with SEBI approval.
Sponsor should have at least a 5 year track record in the financial services business and should have made profit in at least 3 out of the 5 years.
The AMC’s capital is contributed by the sponsor.
Sponsor should contribute at least 40% of the capital of the AMC.

The Trustees:

A mutual fund in India is form as Trust under Indian Trust Act, 1882.
The trust-mf is managed by Board of Trustees.
The board of Directors i.e. Trustees do not manage the portfolio of securities directly rather they appoint as AMC (Asset Management Company)
Trustees ensure that fund is managed by stated objective and as per SEBI regulations.
Trusts always work for the interest of unit holders.
The trust is created through a document called Trust Deed that is executed by sponsor in favors of Trustees.
The Trustees being the primary guardians of unit holder’s funds and assets.
Trustees must ensure that the investor’s interests are safeguarded and that the AMC operations are as per regulation laid down by SEBI.
SEBI mandates a minimum of 2/3^rd independent directors on the board of the trustee company.
Trustees are appointed by the sponsor with SEBI approval.
Trustees are required to meet at least 4 times a yea to review the AMC.
The trustees make sure that the funds are managed according to the investor’s mandate.

Rights of Trustees:

The trustee appoints AMC with prior approval of SEBI.
They also approve each new scheme floated by AMC.
They have the right to request any necessary information from the AMC concerning the operations of various schemes.
The trustees may take any necessary action against AMC if they found AMC operations are not as per the SEBI regulations.
Manages the mutual fund and look after the operations of the appointed AMC.
Trustees approve each MF scheme floated by AMC
Trustees receive fee for their services.
The investments are held by the Trustee
Trustees can seek remedial actions from AMC
Trustees can dismiss the AMC
The trustees have the right to ensure that, based on their quarterly review of AMC’s net worth; any shortfall in the net worth is made by the AMC.

Obligations of Trustees:

To ensure that funds transactions as per SEBI regulations
To ensure that the proper key person of AMC has been appointed. And also operations of other staffs of AMC.
To ensure that the due diligence (care) has been given for empanelment of brokers.
Trustees Manages the Mutual Fund and look after the operations of the appointed AMC
The investments are held by the Trustee
At least 4 members should be there in Board of Trustees.
2/3 members in the Board of Trustees should be independent.
Sponsors execute and register Trust Deed in favors of Trustees.
Trustee of one MF can not be a trustee of another MF, unless he/she is an independent trustee in both the cases.
The appointment of all trustees has to be done with prior approval of SEBI.
Trusts are formed through “Trust Deed”
Trust ensures that AMC has not given any undue advantage to any associates.
Trustee ensures that AMC is managing the fund as per SEBI regulations
Meeting of Trustees should held once in every two months.
SEBI categorizes the Obligations of Trustees as
- General Due Diligence &
- Specific Due Diligence

General Due Diligence
- Appointment of AMC & its directors
- Observance of AMC functioning and desirability of its continuance
- Protection of Trust property
- Ensuring that all constituents and associations are registered entities
- Review of service contracts and terms
- Reporting to SEBI any special developments in the mutual fund

Specific Due Diligence
- Trust must appoint independent auditor and obtain from them periodic internal audit reports from AMC
- Obtain compliance test reports from the AMC once every two months.
- These reports are to be discussing in meeting of trustees.
- Trustees set a code of ethics for trustees and for AMC personnel

AMC-Appointments and Functions

The role of AMC is to act as investment manager of trust
The AMC (as appointed by trust/sponsor) require approving by a SEBI
The AMC supervision under its own board of directors and also the directors of trustees and SEBI
The trustees are empowered to terminate the appointment of AMC and appoint a new AMC with prior approval of SEBI and unit holders.
The AMC is the name of the Trust; manage different investment schemes as per investment management agreement with the trustees.
The AMC of a MF must have a net worth of at least Rs.10 Crores at all times.
Director of AMC should have complete finance professional experience.
The AMC can not act as a trustee of any other MF.
The AMC always act in the interest of unit holders (investor)
The AMC gets a fee for managing the funds, according to the mandate of the investors
At least ½ of the AMC’s Board should be of independent members
An AMC can not engage in any business other than portfolio advisory and management
An AMC of one fund cannot be Trustee of another fund
AMC should be registered with SEBI
AMC signs an investment management agreement with the trustees

Obligation of AMC & its directors

Investment of the fund according to the SEBI regulation & trust deed.
They are answerable to the trustees and must submit quarterly reports to them on AMC activities and compliance with SEBI regulations
Each day NAV is updated on AMFI website by 9 pm
In the event of merger or consolidation of schemes, the unit holders are intimated through a letter giving them option to exit at prevailing NAV without exit load.

Custodians & Depositories

For safekeeping of physical securities of MF custodian is appointed by board of trustees.
The custodian should be registered with SEBI. Dematerialized forms of securities are held in the custody of Depositories Participant.
The investor’s fund and the investments are held by the custodian, who is the guardian of the funds and assets of the investors.
Sponsor and the Custodian cannot be the same entity

Function of Custodian

Responsible for the securities held in the mutual funds portfolio
Keep an investment record of the mutual fund
Collect dividends and investment payments due on the mutual funds investment
Track corporate actions like bonus issues, right offers, offer for sale, buy back and open offers for acquisition.

Registrars & Transfer Agents

They are responsible for issuing and redeeming units of the MF and providing other MF related services to investors
Register and Transfer (R&T) Agents manage the sale and repurchase of units and keep the unit holders accounts.

Functions of Registrars

Process investors application
Record details of investors
Send information to investor
Process dividend payout
Incorporate changes in investor information
Keeping investor information up to date

Distributors

AMC appoints a distributor (also called MF advisor, agent, broker, intermediaries etc) who sells units MF to investors on the behalf of fund house.
A sponsor or an associate may act as distributors of AMC. For example, Bank which is sponsor of Mutual Fund Company may act as distributor also for selling its mutual funds products
AMC has the right whether to impaneled (appoint) or not distributor for selling his MF scheme.
They also have the right of commission structure which they offer to distributor
You may find different commission structure for different AMC scheme.
A distributor can act for several or all MF
For all employees and distributors of MF, AMFI certification test has been made mandatory by SEBI
All distributors are required to be registered with AMFI and obtain AMFI Registration Number (ARN)
The commission received by the distributors is split into initial commission which is paid on mobilization of funds and trial commission which is paid depending on the time the investors stay with the fund.

Fund Mergers & Takeovers

A running fund constitution can change in the following possible ways

Trustees may decide to change the AMC and handover the scheme to a new AMC
The scheme may be merged with another scheme of the same AMC
The AMC is taken over by another set of sponsors
One AMC may merge with another AMC
Just the schemes may be taken over by another set of trustees

Transaction Type	Trustee Approval	SEBI Approval	High Court Approval
AMC Takeover by new sponsor	Yes	Yes	No
AMC Merger	Yes	Yes	Yes
Trustees changing AMC	Yes	Yes	No
Schemes taken over by another AMC	Yes	Yes	No
Scheme Merger	Yes	Yes	No

Example of AMC Merger - HB & Taurus – Two MF companies in India which merged using the AMC merger route

Example of AMC Takeover - Zurich acquired Threadneedle globally and bought out ITC Threadneedle’s India business. Zurich similarly acquired Kemper Twentieth Century Finance. In recent times Alliance was taken over by Birla.

Example of Scheme Takeover – Zurich finally exited MF business in India and sold all its schemes in India to HDFC (technically the AMC was not sold but just the schemes)

Chapter 3: Legal and Regulatory Environment

2009-03-28T00:23:00.001-07:00

Learning Objective

The focus of this unit is on the overall regulatory environment of mutual funds in India, with a focus on the investor.

SEBI regulates mutual funds, depositories, custodians and registrars & transfer agents in the country.

AMFI is an industry body, but not a self regulatory organization.

The AMFI Code of Ethics sets out the standards of good practices to be followed by the Asset Management Companies in their operations and in their dealings with investors, intermediaries and the public.

AMFI has framed AGNI, a set of guidelines and code of conduct for intermediaries, consisting of individual agents, brokers, distribution houses and banks engaged in selling of mutual fund products.

Investment objective defines the broad investment charter. Investment policy describes in greater detail, the kind of portfolio that will be maintained. Investment strategies are decided on a day-to-day basis by the senior management of the AMC. At least 65% of the corpus should, in the normal course, be invested in the
kind of securities / sectors implied by the scheme’s name.

Statement of accounts is to be sent to investors within 5 days of closure of the NFO.

Investor can ask for a Unit Certificate for his Unit Holding. This is different from a Statement of Account.

NAV has to be published daily, in at least 2 newspapers

NAV, Sale Price and Re-purchase Price is to be updated in the website of AMFI and the mutual fund

The investor/s can appoint a nominee, who will be entitled to the Units in the event of the demise of the investor/s.

The investor can also pledge the units. This is normally done to offer security to a financier.

Dividend warrants have to be dispatched to investors within 30 days of declaration of the dividend

Redemption / re-purchase cheques would need to be dispatched to investors within 10 working days from the date of receipt of request.

Unit-holders have proportionate right to the beneficial ownership of the assets of the scheme.

Investors can choose to change their distributor or go direct. In such cases, AMCs will need to comply, without insisting on No

Objection Certificate from the existing distributor. Investors can choose to hold the Units in dematerialised form. The mutual fund / AMC is bound to co-ordinate with the RTA and

Depository to facilitate this. In the case of unit-holding in demat form, the demat statement given by the Depository Participant would be treated as compliance with the requirement of Statement of Account.

The mutual fund has to publish a complete statement of the scheme portfolio and the unaudited financial results, within 1 month from the close of each half year. In lieu of the advertisement, the mutual fund may choose to send the portfolio statement to all Unit-holders.

Debt-oriented, close-ended / interval, schemes /plans need to disclose their portfolio in their website every month, by the 3rd working day of the succeeding month.

Scheme-wise Annual Report, or an abridged summary has to be mailed to all unit-holders within 6 months of the close of the financial year.

The Annual Report of the AMC has to be displayed on the website of the mutual fund. The Scheme-wise Annual Report will mention that Unit-holders can ask for a copy of the AMC’s Annual Report.

The trustees / AMC cannot make any change in the fundamental attributes of a scheme, unless the requisite processes have been complied. This includes option to dissenting unit-holders to exit at the prevailing Net Asset Value, without any exit load. This exit window has to be open for at least 30 days.

The appointment of the AMC for a mutual fund can be terminated by a majority of the trustees or by 75% of the Unit-holders (in practice, Unit-holding) of the Scheme. 75% of the Unit-holders (in practice, Unit-holding) can pass a resolution to wind-up a scheme If an investor feels that the trustees have not fulfilled their obligations, then he can file a suit against the trustees for breach of trust.

Under the law, a trust is a notional entity. Therefore, investors cannot sue the trust (but they can file suits against trustees, as seen above).

The principle of caveat emptor (let the buyer beware) applies to mutual fund investments.

The investor can claim his moneys from the scheme within 3 years. Payment will be based on prevailing NAV. If the investor claims the money after 3 years, then payment is based on the NAV at the end of 3 years

If a security that was written off earlier is now recovered, within 2 years of closure of the scheme, and if the amounts are substantial, then the amount is to be paid to the old investors. In other cases, the amount is to be transferred to the Investor Education Fund maintained by each mutual fund.

PAN No. and KYC documentation is compulsory for mutual fund investments. Only exception is micro-SIPs.
Investors need to give their bank account details along with the redemption request.

Adequate safeguards exist to protect the investors from the possibility of a scheme going bust.

In 1992, Government of India constituted SEBI (Securities & Exchange Board of India) by an act of parliament.
It is mandatory for all the MFs to register with SEBI
Mutual Funds are regulated by the SEBI (Mutual Fund) Regulations, 1996.
SEBI is the regulator of all funds, except offshore funds.
Bank-sponsored mutual funds are jointly regulated by SEBI and RBI
If there is a bank-sponsored fund, it can not provide a guarantee without RBI permission.
RBI regulates money and government securities markets, in which mutual funds invest.
Listed mutual funds are subject to the listing regulations of stock exchanges.
Since the AMC and Trustee Company are companies, any complaints against their board can be made to the CLB (Company Law Board)
Investors can not sue the trust, as they are the same as the trust and cannot sue themselves.
UTI does not have a separate sponsor and AMC.
UTI is governed by the UTI Act, 1963 and is voluntarily under SEBI Regulations.

RBI – The Money Market Regulator

RBI act as Supervisor of Bank owned Mutual Funds
Bank MF comes under regulatory of RBI
All MF come under SBI regulation but bank owned AMC came under RBI regulation.
RBI banned all non banking entities access to the inter-bank call money market.
This means that liquid funds can no longer invest in the call money market.
The ministry of Finance supervises both the RBI & SEBI
In 2003, a Securities Appellate Tribunal (SAT) has been created to provide the apex appear mechanism for any decision taken by SEBI.
SAT works as independent judicial authority.

CLB, DCA, RoC

AMC are registered under companies act 1956 and hence answerable to regulatory authorities empowered by the companies act.
Registrar of Companies (RoC) is the legal interface for all companies
RoC, in turns is supervised by the Department of Company Affairs (DCA)
Above DCA there is the Company Law Board (CLB) which is part of Ministry of Law & Justice of the Govt. of India.

Self Regulatory Organisations (SRO)

Stock Exchanges are Self Regulatory Organisations supervised by SEBI
Many closed ended schemes are listed on stock exchanges through a signing agreement between the fund and the stock exchange.
SRO is an association representing a group of market participants which is specially empowered by the apex regulatory authority to exercise pre-defined authority over the regulation of their members.
Theses activities of the funds are regulated by respective SROs that report to the main regulatory body like SEBI
The SROs are given powers to regulate the criterion & procedures for admission of its members, set a code of conduct for their members market activities, and determine the professional rules & by laws of the association & so on.
To become SRO, need granted specific powers & approval by the government, appropriate laws & recognition by the regulatory authority.
SROs are the second tier in the regulatory structure
SROs get their powers from the apex regulating agency, act on their instructions and regulate their own members in a limited manner.
SROs cannot do any legislation on their own.
All stock exchanges are SROs
Stock Exchanges in most countries are granted the status of SRO
AMFI is an industry association of mutual funds. AMFI is not yet a SEBI registered SRO. AMFI is not a SRO.

Association of Mutual Fund in India (AMFI)

AMFI was incorporated in 1995
AMFI has the powers to deny registration to distributors for failing the test or violating AMFI code of conduct given in AGNI (AMFI Guidelines & Norms for Intermediaries)
For all employees and distributors of MF, AMFI certification test has been made mandatory by SEBI
All distributors are also required to be registered with AMFI & obtain AMFI Registration Number (ARN)
AMFI is regulated by its own board made up of its members.

AMFI main objectives

To promote the interest of MFs and units holders, interact with SEBI, RBI, and Government for same.
To set and maintain ethical, commercial and professional standards in the industry
To recommend and promote best business practices and code of conduct in the MF industry.
To increase public awareness and understanding for MF
To develop a team of well trained professional MF distributors
Implement a training and certification for all intermediaries engaged in MF industry.

Rights of Investor

Investors are beneficial owner of scheme asset which they own.
Investors are entitled to receive dividends declared in a scheme within 30 days.
Redemption proceeds have to be sent to investors within 10 days otherwise investor has the right to receive dividend with interest, borne by AMC.
If an investor fails to claim the dividend or redemption proceeds he has rights to claim up to a period of 3 years from the due date at the then prevailing NAV
Mutual funds have to allot units within 30 days of the IPO/NFO
Mutual funds have to publish their half yearly results in at least one national daily and publish their entire portfolios, at least once in 6 months. Such disclosures should be done within 30 days from 6 monthly account closing dates of the fund.
Trustees will have to ensure that any information having a material impact on the unit holder’s investments should be made publicly the mutual fund.
If 75% of the unit holders so decide, 1) The scheme can be wound up 2) Meeting of unit holders can be called 3) Appointment of the AMC of the mutual fund can be terminated.
If there is any change in the fundamental attributes of the scheme, the unit holders have to be notified through a letter. they also have a right to repurchase at NAV without any load, before such change is effected.

Investors Obligations

Study OD
Provide PAN
Monitor their investment

Investors Complaints Redressal Mechanism

Investor Grievances can be addressed to Trustee
SEBI is the primary body to address MF complaints
Investors cannot seek redressal under Companies Act since fund investors are neither share holders nor depositors in AMC

Limitations of Investor

Investors can not sue the trust as they are not distinct from the trust
Investors can lodge complaints with SEBI for non-compliance.
Investors can not be compensated if the performance of the fund is below expectations.

Chapter 4. The Offer Document

2009-03-28T00:22:00.001-07:00

Learning Objective

This unit will give you a good idea of what goes into a New Fund Offer and the legalities underlying the offer documents which are a key source of information for investors and prospective investors.

Under the SEBI guidelines, NFOs other than ELSS can remain open for a maximum of 15 days. Allotment of units or refund of moneys, as the case may be, should be done within 5 business days of closure of the scheme. Further, open-ended schemes have to re-open for sale / re-purchase within 5 business days of the allotment.

Investors get to know the details of any NFO through the Offer Document, which is one of the most important sources of information about the scheme for investors. Investments by the investor are governed by the principle of caveat emptor i.e. let the buyer beware.

Mutual Fund Offer Documents have two parts: (a) Scheme Information Document (SID), which has details of the scheme (b) Statement of Additional Information (SAI), which has statutory information about the mutual fund that is offering the scheme.

In practice, SID and SAI are two separate documents, though the legal technicality is that SAI is part of the SID. Both documents need to be updated regularly.

Offer Documents in the market are “vetted” by SEBI, though SEBI does not formally “approve” them.

KIM is essentially a summary of the SID and SAI. It is more easily and widely distributed in the market. As per SEBI regulations, every application form is to be accompanied by the KIM.

Offer document is the most important source of information for investors

Contents of the OD

Details of the sponsor and the AMC
Description of the scheme and the investment objective
Terms of issue
Historical statistics
Investor’s rights and services
Fee structure and expenses
Information on income and expenses of existing schemes

Front page of the offer document contains its date of publication, name & type of fund and its major objectives. Specifically the following

Name of Mutual Fund
Name of Scheme
Type of Scheme (Equity/Income/Balanced)
Name of AMC
Unit Price
Opening, Closing & Earliest Closing date
Name of Guarantor if the scheme is an assured return
SEBI disclaimer
Statement to the effect that it is important for a prospective investor to read it and retain for future reference

More about OD:

Abridged version of the OD is called as Key Information Memorandum (KIM)

Investors are required to read and understand the offer document before investing in mutual funds

No recourse is available to investors for not reading the OD or KIM, as they sign the form stating that they have read the OD

OD is issued by the AMC on behalf of the Trustees

KIM has to be compulsorily made available along with the application form.

Closed end funds issue an offer document at the time of the NFO

Open ended funds have to update OD at least once in 2 years.

Trustees approve the contents of the OD and KIM

The format and content of the OD has to be as per SEBI guidelines.

The AMC prepares the OD and is responsible for the information contained in the OD

The Compliance Officer has to sign the due diligence certificate. He is usually an AMC employee

The due diligence certificate states that:

Information in the OD is according to SEBI formats
Information is verified and is a true and fair representation of facts
All constituents of the fund are SEBI registered

SEBI does not approve or certify the contents of the OD

Factors common all funds are called as standard risk factors. These include market risk, no assurances of return, etc.

Factors specific to a scheme are scheme-specific risk factors in the Offer Document.

These include restrictions on liquidity such as lock-in period, risks of investing in the first scheme of a fund etc.

Fundamental attributes of a scheme include its basic features

For any change in the fundamental attributes, investor approval is not needed. Trustees and SEBI should approve the change.

Each investor should be informed through a communication and given the option to exit without paying any exit load.

A scheme can not make any guarantee or return, without stating the name of the guarantor, and disclosing the net worth of the guarantor. The past performance of the assured return schemes should also be given.

Information on existing schemes and financial summary of existing schemes to be given for 3 years

Information on transaction with associate companies to be provided for past 3 years

If any expense incurred is higher than what was stated in the OD, for past schemes, explanation should be given.

There is no information on other mutual funds, their product or performance in the OD

Investors’ rights are stated in the OD

The borrowing instructions on the mutual fund should be disclosed. This includes the purposes and the limits on borrowing

Investors have the right to inspect a number of documents. These are:

Trust deed
Investment management agreement
SEBI (MF) Regulations
AMC annual reports
Unabridged Offer Document
Annual reports of existing schemes
3 years track records of investor’s complaints and redressal should be disclosed in OD

Any pending cases or penalties against sponsors or AMC should be disclosed in the OD

The offer document contains detailed information, while the KIM is a summary form of the OD

If any information is crucial to the investor, it will be found in both KIM and OD. For example, the details of guarantee if the scheme is an assured return scheme.

The name and addresses of the Trustees and AMC directors will be found in the KIM, but the details of their role, responsibilities and duties will not be found in the KIM, but only in the OD

The OD and KIM are documents of a mutual fund and there will be no information about other mutual funds in an OD. There will be no comparisons are data on performance of other mutual funds.

The OD and KIM will not contain names of securities in which the mutual fund plans to invest. Only broad allocation will be given.

Chapter 5. Fund Distribution and Channel Management Practices

2009-03-28T00:21:00.001-07:00

Learning Objective

This unit seeks to give you an understanding of the distribution channels through which mutual fund schemes reach the investors, and how these channels are managed.

The changing competitive context has led to the emergence of institutional channels of distribution, to supplement the individuals who distribute mutual funds. Institutional channels build their reach through employees, agents and sub-brokers.

AMCs keep exploring newer channels of distribution to increase the size of assets managed.

The internet has increased the expectations of advice that investors have from their distributors.

The stock exchange brokers have become a new channel for distribution of mutual funds. These brokers too need to pass the prescribed test, get the AMFI Registration No. and get them empanelled with AMCs whose schemes they want to distribute.

The scheme application forms carry a suitable disclosure to the effect that the upfront commission to distributors will be paid by the investor directly to the distributor, based on his assessment of various factors including the service rendered by the distributor.

AMCs pay a trail commission for the period the investment is held in the scheme.

Since trail commission is calculated as a percentage on AUM, distributors get the benefit of valuation gains in the market.

Investor, such as a trust or a company can invest in a fund, depends on the list of eligible investors in the OD

Any investor, who becomes a foreign citizen after investing in a fund, has to be compulsorily redeeming the units after obtaining foreign citizenship.

Therefore any Indians seeking foreign citizenship should redeem their units.

FIIs can invest in mutual funds. They invest through the Non-resident rupee account called NRE account.

Investors have the right to receive redemption proceeds within 10 days.

Investors cannot sue the Trust as they are the Trust and can’t sue themselves

An open ended fund opens for sale and repurchase within 30 days from the date of closure of the IPO/NFO

With the approval of 75% investors of the unit capital, the AMCs services can be terminated, or the scheme can be wound up.

If a fund does not redress their complaint investors can go to SEBI

Who can invest in Mutual Fund in India

Residents of Indian including,

Resident Indian Individual/HUF
Indian companies/Partnership Firms
Indian Trusts/Charitable Institutions
Banks/Finance Institutions
Non-Banking Finance Companies (NBFC)
Insurance Companies
Provident Funds

Non Resident Including

Non-Resident Indian, & persons of Indian origin
Overseas Corporate Bodies (OCBs)

Foreign entities like FIIs (Foreign Institutional Investors) Registered with SEBI

(Foreign Citizens/entities are not allowed to invest in MF in India)

Individual Agents & Distributors (National Distributors)

An individual agent (advisor) is the broker between fund and the investor.

Instead of having to deal with several individual distributors, a fund can interact with Distribution Company that has several employees or sub broker under it.

These sub brokers are the agents of main distributors and these sub brokers will not at all having any relation with AMC.

All persons engaging in MF sales have to pass AMFI certification test. Even employees of distributors, bank etc has to clear AMFI exam.

It is mandatory to get ARN (AMFI Registration Number) from AMFI after passing the AMFI exam.

Agents can sell products of multiple mutual funds.

Agents are appointed after they clear the AMFI exam and sign an agreement with the AMC on non-judicial stamp paper.

Commission Rates for MF Distributors

Commission payable to distributor is not fixed. It varies from AMC to AMC and Scheme to Scheme.

Upfront commission for open ended scheme may vary from 1.5% to 2.5% whereas for ELSS scheme it varies from 2% to 3.5%

Apart from upfront commission, agent also entitled to get Trail commission which varies from 0.4% to 0.6% paid on quarterly basis.

As per SEBI rules, Distributor (MF Advisor) get commission on investments made through them but they are not entitled to get commission in their own investment.

SEBI Advertising Code

The dividends declared or paid shall be mentioned in rupees per unit along with the face value of each unit of that scheme

Only compounded annualized yield can be advertised if the scheme has been in existence for more than 1 year.

Annualized yield when used must be shown for lat 1 year, 3 years, 5 years ad since launch of the scheme

For funds in existence for less than 1 year, performance may be advertised in terms of total returns and such returns should not be annualized.

Performance should compare with appropriate benchmarks only.

Advertisements showing yields should display a sentence that “Past performance may or may not sustained in future”

Chapter 6. Accounting, Valuation & Taxation

2009-03-28T00:19:00.001-07:00

Learning Objectives

Your learning of mutual funds is incomplete, if you do not know a few aspects of accounting of mutual fund schemes, valuation of securities in the scheme’s portfolio, calculation of net asset value, and the impact of taxation on various types of mutual fund schemes and investors in these schemes.

The unit-holders’ funds in the scheme is commonly referred to as “net assets”.

Net asset includes the amounts originally invested, the profits booked in the scheme, as well as appreciation in the investment portfolio. It goes up when the market goes up, even if the investments have not been sold.

A scheme cannot show better profits by delaying payments. While calculating profits, all the expenses that relate to a period need to be considered, irrespective of whether or not the expense has been paid. In accounting jargon, this is called accrual principle.

Similarly, any income that relates to the period will boost profits, irrespective of whether or not it has been actually received in the bank account. This again is in line with the accrual principle.

In the market, when people talk of NAV, they refer to the value of each unit of the scheme. Higher the interest, dividend and capital gains earned by the scheme, higher would be the NAV. Higher the appreciation in the investment portfolio, higher would be the NAV. Lower the expenses, higher would be the NAV.

The difference between the NAV and Re-purchase Price is called the “exit load”.

Schemes can also calibrate the load when investors offer their units for re-purchase. Investors would be incentivized to hold their units longer, by reducing the load as the unit holding period increased. Such structures of load are called “Contingent Deferred Sales Charge (CDSC)

SEBI has banned entry loads. So, the Sale Price needs to be the same as NAV. Exit loads / CDSC in excess of 1% of the redemption proceeds have to be credited back to the scheme immediately i.e. they are not available for the AMC to bear selling expenses. Exit load structure needs to be the same for all unit holders representing a portfolio.

Initial issue expenses need to be met by the AMC. There are limits to the recurring expenses that can be charged to the scheme. These are linked to the nature of the scheme and its net assets.

Dividends can be paid out of distributable reserves. SEBI has prescribed a conservative approach to its calculation.

NAV is to be calculated upto 4 decimal places in the case of index funds, liquid funds and other debt funds. NAV for equity and balanced funds is to be calculated upto at least 2 decimal places.

Investors can hold their units even in a fraction of 1 unit. However, current stock exchange trading systems may restrict transacting on the exchange to whole units.

Detailed norms on valuation of debt and equity securities determine the valuation of the portfolio, and therefore the NAV of every scheme.

Mutual funds are exempt from tax. However, Securities Transaction Tax (STT) is applicable on investments in equity and equity mutual fund schemes. Additional tax on income distributed (Dividend distribution tax) is applicable on dividends paid by debt mutual fund schemes.

Taxability of capital gains, and treatment of capital losses is different between equity and debt schemes, and also between short term and long term. Upto 1 year investment holding is treated as short term.

There is no Tax Deducted at Source (TDS) on dividend payments or re-purchase payments to resident investors. Withholding tax is applicable for some non-resident investors.

Setting of capital losses against capital gains and other income is subject to limitations to prevent tax avoidance.

Investment in mutual fund units is exempt from Wealth Tax.

Net Asset Value (NAV):

NAV = Net assets of the scheme / No. of units outstanding

= [(market value of investments + Receivables + Other Accrued Income + Other Assets – Accrued Expenses – Other payables – Other Liabilities)] / No. of units outstanding on valuation date

The maximum limit on the expense that can be charged to an equity mutual funds are:

For net assets up to Rs.100 Crore:-2.5%
For the next Rs.300 Crore of net assets:-2.25%
For the next Rs.300 Crore of net assets:-2%
For the remaining net assets:-1.75%
These limits are lower by 0.25% for debt funds

These regulatory ceilings are applied on the weekly average net assets of the mutual fund scheme.

The investment management fees are regulated by SEBI as follows:

For the first Rs.100 crore of net assets:-1.25%
For net assets exceeding Rs.100 crore:-1.00%

Valuation of equity shares is done on basis of traded price; provided that price is not more than 30 days old.

Illiquid securities can not be more than 15% of the portfolio’s net assets. Any illiquid assets above this limit have to be valued at zero.

Thinly Traded Equity / Equity Related Securities: Equity / equity related instruments are thinly traded if:

Monthly trading value is less than Rs. 5 lacs and value less than 50,000 share volume.
When trading is suspended up to 30 days take the last traded price.
Trading is suspended for more than 30 days AMC/Trustee to make valuation
Thinly Traded Debt Securities: Traded value (other than g-sec) is less than Rs. 15 crore for a period of 30 days prior to valuation date.
Non-Traded Securities: When not traded on any Stock Exchange for 30 days prior to valuation date.
Non-traded/thinly traded securities shall be valued “in good faith” by AMC

The following expenses cannot be charged to the scheme:

Penalties and fines
Interest on delayed payment to unit holders
Expenses which is not related with schemes
Expenses on investment management
Expenses on general administration, corporate advertising and infrastructure costs
Software development cost
Other costs which are prohibited by SEBI

Tax Structure in Mutual Fund:

Mutual funds themselves pay no tax on the incomes they earn. They are fully exempt from tax.

If an investor holds units for 12 months or less, any gain from selling the units is called as short-term capital gain

Short-term capital gains are taxable at the marginal rate of taxation of the investor

If an investor’s holding period is more than 12 months, any gain or loss from sale is called as long-term capital gain.

Long-term capital gain can be indexed for inflation

Indexing refers to the updating of the purchase price, based on the cost of inflation index published by CBDT. The formula for indexation is purchase price X (index in the year of sale/index in the year of purchase)

Investors can pay either 10% tax (plus surcharge) on the capital gain tax without indexation or 20% tax (plus surcharge) on capital gains after indexation, which ever is lower.

Chapter 7. Investor Services

2009-03-28T00:18:00.001-07:00

Learning Objectives

Who can invest in mutual funds in India? What documentation is required? How do the sale and re-purchase transactions really get implemented?

Individual and non-individual investors are permitted to invest in mutual funds in India. Foreign nationals, foreign entities and OCBs are not permitted to invest. Since FIIs are permitted to invest, foreign entities can take this route. The ‘Who can invest’ section of the Offer Document is the best source to check on eligibility to invest.

All investments of Rs 50,000 and above need to comply with KYC documentation viz. Proof of Identity, Proof of Address, PAN Card and Photograph. Once an investor obtains a Mutual Fund Identification Number (MIN) from CDSL Ventures Ltd, the investor can apply with any mutual fund.

Micro SIPs i.e. SIPs with annual investment below Rs 50,000 is exempted from the PAN Card requirement. Simplified documentation has been prescribed in such cases.

Besides KYC, non-individual investors need to provide additional documentation to support their investment.

Demat makes it possible to trade in Units in the stock exchange.

Full application form is to be filled for a first time investment in a mutual fund. Thereafter, additional investments in the same mutual fund are simpler. Only transaction slip would need to be filled.

Investors can pay for their Unit purchases through cheque / DD, Net-based remittances, ECS / Standing Instructions or ASBA. MBanking is likely to increase in importance in the days to come. Non-resident investment on repatriation basis has to be paid through cheque on NRE account, or a banker’s certificate that investment is made out of moneys remitted from abroad.

Transaction Slip can be used for re-purchase. Investors can indicate the amount to re-purchase or the number of units to repurchase.

Cut-off timings have been specified for different types of schemes and different contexts to determine the applicable NAV for sale and re-purchase transactions. These are not applicable for NFOs and International Schemes.

Time Stamping is a mechanism to ensure that the cut-off timing is strictly followed.

NSE’s platform is called NEAT MFSS. BSE’s platform is BSE STAR Mutual Funds Platform.

Dividend payout, Dividend investment and Growth are 3 possible options within a scheme. Each option has different implications on the investor’s bank account, investor’s taxation and scheme NAV.

A constant amount is regularly invested in SIP, withdrawn in SWP and transferred between schemes in STP. These minimize the risk of timing the decisions wrongly.

Triggers are another way of bring discipline into investing.

Nomination and Pledge options are available for mutual fund investors.

Investment Pattern:

The investment pattern of the fund is primarily dictated by the fund objectives

A fund manager whose style is value investing, will prefer to invest in established profit making companies, and will buy only if the price is right. He will look for “undervalued” shares, which have value proposition that is yet to be recognized by the market.

A fund manager, whose style is growth, is more aggressive and is willing to invest in companies with future profit potential. He is willing to buy even if the stock looks expensive. He focuses on sectors that are expected to do well in future, and will be willing to buy them even at higher prices.

Equity stocks can be classified as large cap and small cap stocks

Large cap stocks are liquid and trade every day. They are established companies offering normal profit potential.

Small cap stocks provide higher return potential. But they are generally not very liquid.

Cyclical stocks are those whose performance is closely linked to macro economical factors.

P/E ratio is the ratio of earnings per share (EPS) to market price per share. Growth shares sell at higher P/E ratios than value shares.

Dividend yield is the ratio between the dividend per share and market price per share.

Growth shares have lower dividend yields than value shares.

If market prices move up, P/E ratios are higher and dividend yields are lower.

An active fund manager hopes to do better than the market by selecting companies, which he believes, will outperform the market.

A passive fund manager simply replicates the index, and hopes to do as well as the index.

A passive fund manager tries to keep costs down and has to rebalance his portfolio if the composition of the index changes.

Fundamental analysis is the analysis of the profit potential of a company, based on the numbers relating to products, sales, costs, profits etc. and the management of a company.

Technical analysis is an analysis of market price and volumes, to identify clues to the market assessment of a stock.

A fund manager focuses on asset allocation; a dealer buys and sells shares; and an analyst’s researches company and recommends them for buy and sell.

Investment Plans:

Automatic Reinvestment Plan (ARP): Reinvestment plan reinvest the amount of dividends in the same scheme instead of receiving cash.

Systematic Investment Plan (SIP): It requires the investor to invest a fixed amount periodically and hence save investing amount in a disciplined manner. Rupee Cost Averaging is one of the most important benefits of SIP.

Systematic Withdrawal Plans (SWP): It allows investor to withdraw some amount either fixed or variable amount from scheme.

Systematic Transfer Plan (STP): It allows the investor to transfer on a periodic basis a specified amount from one scheme to another with the same fund family.

Debt Instruments:

Debt instruments are issued by government, banks and companies

They can pay interest on fixed rates, floating rates or on discounted basis

If no interest is paid, such an instrument is zero coupon instruments

Debt markets are wholesale markets in which large institutional investors operate

Banks are the largest players in the debt markets

About 96% of secondary market trading happens in government securities

Principle values, par value, or face value is the amount representing the principle borrowed and the rate of interest is calculated on this sum. On redemption this amount is payable.

Coupon is the interest paid periodically to the investor.

Maturity date is the date on which a bond is redeemed. Term to maturity or tenor is the period remaining for the bond to mature.

Put option refers to the option to the investor to redeem the bond before maturity

Call option is the option to the borrower to redeem before maturity

If interest rates go up, above the coupon rate, investors may exercise the put option. If interest rates fall below the coupon rate, issuers may exercise the call option.

Current yield is the ration of coupon amount to market price of a bond. If a bond, paying coupon at 8% is selling in the market for Rs.105, the current yield is 8/105=7.62%

Changes in interest rates impacts bond values, in the opposite direction. An increase in interest rates leads to a fall in bond values; a decrease in interest rates leads to an increase in bond values.

Duration of a bond helps measure the interest rate risk of a bond. It is weighted average maturity of a bond.

Credit risk refers to the risk of default

The base rate or benchmark rate in the bond market is the rate at which the government borrows in the market. All other borrowers pay a rate that is higher, due to the presence of credit risk.

The difference between the benchmark rate and the rate that is paid by other borrowers is called the credit spread. (Called as yield spread in the AMFI book).

Investment by Mutual Fund:

Mutual funds can invest in only marketable securities

A mutual fund, under all its schemes, cannot hold more than 10% of the paid-up capital of a company.

Except in the case of Sectoral funds and index funds, a mutual fund scheme cannot invest more than 10% of its NAV in a single company.

Investments in rated investment grade issues of a single issuer cannot exceed 15% of the net assets and can be extended to 20% with the approval of the trustees

Investment in unrated securities can not exceed 10% of the net assets for one issue and 25% of net assets for all such issues

Investment in unlisted shares cannot exceed 5% of net assets of an open-ended scheme, and 10% of net assets for a closed end scheme

Inter scheme transfers are allowed by the SEBI regulations, provided,

Such transfers happens on a delivery basis, at market prices

Such transfers do not result in significantly altering the investment objectives of the schemes involved.

Such transfer is not of illiquid securities, as defined in the valuation norms

A mutual fund can borrow a sum not exceeding 20% of its net assets, for a period not exceeding 6 months. This facility is clearly designed as a stopgap arrangement, and is not a permanent source of funds for the scheme.

A fund can borrow only to meet liquidity requirements for paying dividend or meeting redemptions

All investment made in the marketable securities of the sponsor and its associated companies must be disclosed by the mutual fund in its annualized report and offer document.

A mutual fund scheme cannot invest in unlisted securities of the sponsor or an associate or group company of the sponsor.

A mutual fund scheme cannot invest in privately placed securities of the sponsor or its associates.

Investment by a scheme in listed securities of the sponsor or associate companies or group companies of sponsor cannot exceed 25% of the net assets of the scheme

Mutual funds were allowed to make use of Future & Options contracts in Equities for Portfolio risk management Portfolio Rebalancing

Since September 2005 SEBI has also allowed mutual fund to trade in Derivatives contracts to enhance portfolio returns, to launch schemes which invest mainly in Future & Options

Equity Derivatives:

Equity derivatives instruments are specially designed contracts

They derive their value from an underlying asset

They are traded separately in F&O segment of Exchange

Mainly derivative instruments are Future and Options

In a future contract you can buy and sell the underlying equity at a specified future date at agreed price. Contract is liquidated before maturity date without taking or giving delivery of underlying asset.

In option contract the buy gets the right to buy or sell the underlying equity at agreed price on a future date only if he exercises the options & for this right he pays a price called Premium.

Option contracts are of two types:

If Fund manager expects the equity market to decline: he may not sell the equity in the Cash Market.

But can sell the index Future at the current price for future delivery. If markets fall the equity portfolio value will decline, but future contract will show a corresponding profit, since fund manager has sold future contract at a higher price.

If market rises equity portfolio value will rise but future contract will show corresponding loss, since fund manager has sold future contract at lower price. This is called Hedging Portfolio risk.

Other method of hedging investment portfolio risk by buying a Put Option (an option to sell the underlying equity at an agreed price) by paying premium

A fund manager can execute the option only if the price falls, since he has right to sell at a higher price

If the price rises he will not execute the option and forgo the premium

Chapter 8. Return, Risk & Performance of Funds

2009-03-28T00:17:00.001-07:00

Learning Objectives

This unit is an invaluable guide to understanding the risk and return aspects of mutual fund schemes. Here, you will understand the nitty-gritty of how to calculate the returns from a mutual fund, and gain an overview of how risk can be measured. Benchmarking and risk adjusted returns are other key concepts discussed in this unit.

The portfolio is the main driver of returns in a mutual fund scheme. The underlying factors are different for each asset class.

Fundamental Analysis and Technical Analysis are two disciplines of securities analysis. Fundamental Analysis entails review of the company’s fundamentals viz. financial statements, quality of management, competitive position in its product / service market etc. Technical analysts study price-volume charts of the company’s share prices.

It is generally agreed that longer term investment decisions are best taken through a fundamental analysis approach, while technical analysis comes in handy for shorter term speculative decisions, including intra-day trading. Even where a fundamental analysis-based decision has been taken on a stock, technical analysis might help decide when to implement the decision i.e. the timing.

Growth investment style entails investing in high growth stocks. Value investment style is an approach of picking up stocks which are valued lower, based on fundamental analysis.

In a top-down approach, sector allocation is the key decision. Stock selection is important in bottom-up approach.

The returns in a debt portfolio are largely driven by interest rates and yield spreads.

If the portfolio manager expects interest rates to rise, then the portfolio is switched towards a higher proportion of floating rate instruments; or fixed rate instruments of shorter tenor. On the other hand, if the expectation is that interest rates would fall, then the manager increases the exposure to longer term fixed rate debt securities.

This additional return offered by a non-government issuer, above the yield that the government offers, is called yield spread. Better the credit quality, lower the yield spread.

Gold is a truly international asset, whose quality can be objectively measured. The value of gold in India depends on the international price of gold (which is quoted in foreign currency), the exchange rate for converting the currency into Indian rupees, and any duties on the import of gold.

Unlike gold, which is a global asset, real estate is a local asset. It cannot be transported – and its value is driven by local factors.

Returns can be measured in various ways – Simple Returns, Annualised Returns, Compounded Returns, Compounded Annual Growth Rate. CAGR assumes that all dividend payouts are reinvested in the scheme at the ex-dividend NAV.

SEBI guidelines govern disclosures of return by mutual fund schemes.

Loads and taxes pull the investor’s returns below that earned by the Scheme. Investor returns are also influenced by various actions of the investor himself.

Risks in mutual fund schemes would depend on the nature of portfolio, its liquidity, outside liabilities and composition of unit holders.

Fluctuation in returns is a measure of risk. Variance and Standard Deviation are risk measures for all kinds of schemes; beta is relevant for equity; modified duration and weighted average maturity are applicable for debt schemes.

Benchmarking is a form of relative returns comparison. It helps in assessing under-performance or out-performance.

Choice of benchmark depends on scheme type, choice of investment universe, choice of portfolio concentration and the underlying exposure.

Sharpe Ratio, Treynor Ratio and Alpha are bases to evaluate a fund manager’s performance based on risk-adjusted returns.

Quantitative measures are based on historical performance, which may or may not be replicated in future. Scheme evaluation is an art, not a science.

Classification of Equity Shares:

Classification in terms of Market capitalization: Large-Cap, Mid-Cap & Small-Cap Capitalization companies.

Classification in terms of Earnings: Earnings of the companies are generally classified on the basis of their market price in relation to one of the following measures:

Price/Earning Share:

It is the price of a share divided by the earnings per share, and indicates what the investors are willing to pay for the company’s earning potential.

Young and/or fast growing companies usually have high P/E ratios. Established companies may have lower P/E

Dividend Yield:

DY of the stock is the ratio of dividend paid per share to current market price.

Low P/E stocks usually have high dividend yields.

Cyclical Stocks:

These are shares of companies whose earnings are correlated with this state of the economy.

Growth Stocks:

These are shares of companies whose earnings are expected to increase at above normal market level.

They reinvest the profit.

Value Stock:

These are stocks of companies in mature industries and are expected to yield low growth in earnings.

Portfolio Management:

Portfolio Management has two styles: 1. Passive 2. Active

Passive Fund Management: There are mutual funds that offer stock index funds whose objectives is to track a specified share index and offer returns equal to the return from that index. The investment style is passive only in the sense that the fund manager does not have to go through the process of stock selection.

Active Fund Management: There are two basic investment styles in active fund management: Growth Investment Style: Invest only in growth stocks which give above average earnings growth. Value Investment Style: Invest in companies that are currently undervalued in the market, but whose worth they estimate will be recognized in the market valuations.

Securities Research in Active Fund Management: Following are the three major categories are in Securities Research.

Fundamental Analysis: It involves research into the operations and finances of a company.

Technical Analysis: It involves the study of historical data on the company’s share-price movements and trading volume.

Quantitative Analysis: It uses mathematical models for equity valuation and may use fundamental and technical information. Now a day’s computer based models (exclusively made sophisticated high level software) are uses for such analysis.

Portfolio Management Organization Structure: Three types of skilled employees in the equity portfolio management function:

Fund Managers: They take overall decisions on asset allocations industry exposures.

Security Analysts & Researchers: They support the fund managers with continuous tracking of the funds target sectors, companies and the overall markets. Both fundamental and technical analyses are performed by the analysts.

Security Dealers: Executes the actual buy and sell orders originated by the fund managers.

Debt Instruments: Following are the debt instruments available in the market

Certificate of Deposit (CD): CD is issued scheduled commercial banks. It’s having maturity period of 91 days to one year.

Commercial Paper: This is a short term, unsecured instrument issued by corporate bodies to meet short term working capital requirements. These instruments can be issued to individual, banks, companies etc.

Corporate Debentures: These are issued by manufacturing companies with physical asset as secured instruments in the form of certificates. They are assigned a credit rating by rating credit agencies.

Floating Rate Bonds: These are short to medium term interest-bearing instruments issued by financial intermediaries and corporations. Maturity of these bonds is 3 to 5 years.

Treasury Bills: Treasury bills are also called as T-Bills. These are short term obligations issued through the RBI by the government of India at a discount for 91 days to 364 days. Theses are issued through an auction procedure. The yield is determined on the basis of bids tendered and accepted.

Bank/FI Bonds: These are negotiable certificates issued by FI such as the IDBI/ICICI etc. Theses have been issued both as regular income bonds and as discounted long term instruments (deep discount bonds)

Public Sector Undertakings (PSU) Bonds: These are medium and long term obligations by public sector companies in which the government share holding is generally greater than 51%. Some PSU bonds carry tax exemptions having minimum maturity of 5 years for taxable bonds and 7 years for tax free bonds.

SEBI guidelines in different investments:

A mutual fund is not allowed to own more than 10% of any company’s equities.

This is to prevent MF fund sponsors trying to acquire control pf any company through fund investment route.

A scheme may invest in another scheme under the same AMC without charging any fees, provided investments limits of 5% of the NAV of Mutual Fund.

This limit does not apply to a fund of fund scheme.

Debt securities should be rated as investment grade by at least one recognized rating agency.

Mutual funds are allowed to buy and sell only delivery based securities. Mutual funds are not allowed to advance any loans but may lend securities as per SEBI stock lending regulations.

Mutual funds are restricted to invest not more than 25% of the net assets of any of mf schemes to the companies of sponsor.

A fund of funds invests in schemes of other mutual funds. But a normal mutual fund scheme cannot invest in any FOF scheme. Also, a FOF scheme cannot invest in another FOF scheme.

Chapter 9. Scheme Selection

2009-03-28T00:16:00.001-07:00

Learning Points

This unit will help you do this. It also informs you about the sources where you can easily access data related to mutual fund schemes.

Asset allocation is the approach of spreading one’s investments between multiple asset classes to diversify the underlying risk.

The sequence of decision making in selecting a scheme is: Step 1 – Deciding on the scheme category (based on asset allocation); Step 2 – Selecting a scheme within the category; Step 3 – Selecting the right option within the scheme.

While investing in equity funds, a principle to internalize is that markets are more predictable in the long term, than in the short term. So, it is better to consider equity funds, when the investment horizon is adequately long.

In an actively managed diversified fund, the fund manager performs the role of ensuring higher exposure to the better performing sectors or stocks. An investor, investing or taking money out of a sector fund has effectively taken up the role of making the sector choices.

It can be risky to invest in mid-cap / small cap funds during periods of economic turmoil. As the economy recovers, and investors start investing in the market, the valuations in front-line stocks turn expensive. At this stage, the mid-cap / small cap funds offer attractive investment opportunities. Over longer periods, some of the mid/small cap companies have the potential to become large cap companies thus rewarding investors.

Arbitrage funds are not meant for equity risk exposure, but to lock into a better risk-return relationship than liquid funds – and ride on the tax benefits that equity schemes offer.

The comparable for a liquid scheme in the case of retail investors is a savings bank account. Switching some of the savings bank deposits into liquid schemes can improve the returns for him. Businesses, which in any case do not earn a return on their current account, can transfer some of the surpluses to liquid schemes.

Balanced schemes offer the benefit of diversity of asset classes within the scheme. A single investment gives exposure to both debt and equity.

Investors need to understand the structure of the gold schemes more closely, before investing.

Equity investors would like to convince themselves that the sectors and companies where the scheme has taken higher exposure, are sectors / companies that are indeed promising.

Debt investors would ensure that the weighted average maturity of the portfolio is in line with their view on interest rates.

Investors in non-gilt debt schemes will keep an eye on credit quality of the portfolio – and watch out for sector concentration in the portfolio, even if the securities have a high credit rating.

Any cost is a drag on investor’s returns. Investors need to be particularly careful about the cost structure of debt schemes.

Amongst index schemes, tracking error is a basis to select the better scheme. Lower the tracking error, the better it is. Similarly,

Gold ETFs need to be selected based on how well they track gold prices.

Mutual fund research agencies assign a rank to the performance of each scheme within a scheme category (ranking). Some of these analyses cluster the schemes within a category into groups, based on well-defined performance traits (rating).

Seeking to be invested in the best fund in every category in every quarter is neither an ideal objective, nor a feasible target proposition. Indeed, the costs associated with switching between schemes are likely to severely impact the investors’ returns.

The underlying returns in a scheme, arising out of its portfolio and cost economics, is what is available for investors in its various options viz. Dividend payout, dividend re-investment and growth options.

Dividend payout option has the benefit of money flow to the investor; growth option has the benefit of letting the money grow in the fund on gross basis (i.e. without annual taxation). Dividend re- investment option neither gives the cash flows nor allows the money to grow in the fund on gross basis. Taxation and liquidity needs are a factor in deciding between the options. The advisor needs to understand the investor’s situation before advising.

Many AMCs, distribution houses and mutual fund research houses offer free tools in their website to help understand performance of schemes.

Investors generally compute Return on Investment (ROI). Change in NAV is a very easy approach to find out the ROI. The following are the important characteristics:

The Expense Ratio:

It is the ratio of total expenses to average net assets of the fund.

It indicates the fund’s efficiency and cost effectiveness.

It is important to note that brokerage commissions on the fund’s transactions are not included in the fund expenses figure while computing this ratio.

The expense ratio is most important in case of bond funds or debt funds, since such funds performance can be adversely affected if a large proportion of its income is spent on expenses.

The Income Ratio:

It is the net investment income divided by its net assets for the period. For evaluating income oriented fund, particularly debt funds.

Portfolio Turnover Rate:

It is defined as the lesser of assets purchased or sold divided by the funds net assets.

Portfolio turnover rate measures the amount of buying and selling of securities done by a fund. And hence net return can be lower with high transactions costs.

Transaction Costs:

It includes all expenses related to trading such as the brokerage commissions paid, stamp duty on transfers, registration fees and custodian’s fees.

Brokerage commission is an important component of transaction costs. Transaction costs therefore have a significant bearing on fund performance and its total return.

Funds with small size or small returns have to be judged more on their expense ratios and transactions costs, given their impact on total return.

Fund Size:

Fund size can affect performance.

Small funds are easier to manage and can achieve their objectives in a focused manner with limited holdings.

Large funds benefit from economies of scale with lower expense ratios and superior fund management skills.

They also gain through greater risk bearing and management capacity.

Cash Holdings:

Mutual funds allocate their assets among equity shares, debt securities and cash or bank deposits.

The percentage of the funds portfolio held in cash equivalent can be an important element in its successful performance.

A large cash holding allows the fund to strengthen its position in preferred securities without liquidation its other portfolios.

Cash also allows the fund a cushion against decline in the market prices of shares or bonds.

Benchmark:

There are 3 types of Benchmarks for evaluating funds performance.

Benchmarking relative to the market: If invested need to choose equity index fund than investor should compare return to the index fund with index only. This is passive investment management style. The fund would invest in the index stocks and expect its NAV changes to mirror the changes in the index itself.

Benchmarking relating to the other similar MFs: These are those which compare the performance of different schemes with that of other fund manager’s schemes. Such comparisons are called “peer group comparisons”. Only average annualized compound returns are comparable.

Benchmarking relative to other investment options or financial products: Means comparing with the market other financial products like FD, PPF, and NSC etc.

Ranking by external agencies:

Lipper Analytical Services, CRISIL, etc are the Credit rating agency which evaluated the fund performance of MF.

CRISIL evaluates fund performance and ranks the schemes by performance. CRISIL ranks both debt and equity funds.

The basic thing here for evaluating performance is funds financial performance, income/expense ration and total return etc.

AMFI’s Website: www.amfiindia.com provides meaningful guidance like past NAV history of fund, benchmark for all MF schemes etc. Financial Press like daily news paper “the economic times, business standard etc

Fund Tracking agencies like www.valueresearchonline.com or www.moneycontrol.com etc.

News letters by AMCs, renowned national stock brokers etc, Offer Document and KIM

Borrowing by MF:

In India, MF is not allowed to borrow to increase their corpus.

SEBI regulations allow MF to borrow only for the purpose of meeting temporary liquidity needs for a period not exceeding six months and to the extent of 20% of its net assets.

Hence, it would be uncommon to be fund schemes with borrowings on their balance sheets, and if borrowings are seen, caution may need to be exercised in evaluating the fund performance.

Tracking Error:

In order to obtain the same returns as the index, an index fund invests in all of the stock included in the index calculation, in the same proportion the stocks weight-age in the index.

An index funds actual return may, however, be better or worse by what is called “the tracking error”

The tracking error arises from the practical difficulties faced by the fund manager in trying to always buy or sell stocks to remain in line with the weightage that the stocks enjoy in the index.

Chapter 10. Selecting the Right Investment Products for Investors

2009-03-28T00:15:00.001-07:00

Learning Objectives

Investors tend to block their money in physical assets. This unit compares physical assets with financial assets. Distributors and financial advisors perform an invaluable role in helping investors decide on investment products. Mutual fund schemes are just one of the various alternatives that investors consider for investment. This unit discusses some of these alternatives in the context of mutual fund schemes.

Physical assets like land, building and gold have value and can be touched, felt and used. Financial assets have value, but cannot be touched, felt or used as part of their core value. Shares, debentures, fixed deposits, bank accounts and mutual fund schemes are all examples of financial assets that investors normally invest in.

The difference in comfort is perhaps a reason why nearly half the wealth of Indians is locked in physical assets.

There are four financial asset alternatives to holding gold in physical form – ETF Gold, Gold Sector Fund, Gold Futures & Gold Deposits.

Wealth Tax is applicable on gold holding (beyond the jewellery meant for personal use). However, mutual fund schemes (gold linked or otherwise) and gold deposit schemes are exempted from Wealth Tax.

Real estate in physical form has several disadvantages. Therefore, investors worldwide prefer financial assets as a form of real estate investment.

Bank deposits and mutual fund debt schemes have their respective merits and demerits.

Pension Funds Regulatory and Development Authority (PFRDA) is the regulator for the New Pension Scheme. Two kinds of pension accounts are envisaged: Tier I (Pension account), is non withdrawable. Tier II (Savings account) is withdrawable to meet financial contingencies. An active Tier I account is a pre-requisite for opening a Tier II account.

The NPS offers fewer portfolio choices than mutual funds. However, NPS offers the convenience of a single Personal Retirement Account Number (PRAN), which is applicable across all the PFMs where the investor’s money is invested. Further, the POPs offer services related to moneys invested with any of the PFMs.

Financial Planning

Financial Planning is the overall process of advising clients on how to achieve their financial goals.

The objective of financial planning is to ensure that the right amount of money is available in the right hands at the right point in the future to achieve an individual’s financial goal.

Financial planning is the process that helps a person work out where he/she is now, what he/she may need in the future and what he/she must do to reach the defined goals.

The role of financial planner is one of the most respected professions in the developed countries. It is for the same reason the profession for financial planning is emerging.

Financial health is as important as physical and spiritual health and people should approach a financial planner who can advise them on achieving financial fitness.

The Financial Planner is someone who uses the financial planning process to help another person determine how to meet his or her life goals.

The planner can look at all of clients needs including budgeting and saving, taxes, investments, insurance and retirement planning.

Risk tolerance of an investor is not dependent on the market, but his own situations.

Characteristics of Good Financial Planner:

Capacity to build trust with the client
Good knowledge of financial products
Familiarity with taxation
Knowledge of life and wealth cycle
Regular in touch with clients
Client need focus rather than own benefit focus

Financial Plan:

It is the document that details clearly in writing the financial goals, available resources, time frame for investment, asset allocation and implementing the financial planner’s recommendations.

The life cycle stages of an investor can be classified as follows:

Childhood stage
Young unmarried stage
Young marriage with children stage
Married with older children stage
Pre-retirement stage
Retirement stage

The income level of investors, the saving potential, the time horizon and the risk appetite of an investor depend on his life cycle.

Younger investors have higher income and saving potential, take longer-term view and may be willing to take risks.

Older investors may have limited income and saving, shorter time horizon, and unwilling to risk their savings.

There are 3 wealth cycle stages for investors:

Accumulation Stage is when investors are earning and have limited need for investment income. They focus on saving and accumulating wealth for long term. Equity investments are preferred in this stage.

Transition Stage is when financial goals are approaching investors still earn incomes, but have also draw on their earnings. Investors choose balanced portfolios that have both debt and equity.

Reaping Stage or Distribution Stage: In this stage, investors need the income from their investment, and cannot save further. They reap the benefits of their savings. They prefer debt investments and preserving of capital at this stage.

Inter-generational fund transfer refers to transfer of wealth to an investor. Such sudden wealth surge refers to winning in games and lotteries investors should be advised to temporarily park their funds in money market investments and create a long-term plan after thinking through the plan. They must also take into account the impact of tax.

Affluent investors are of two types:

Wealth preserving investors who are risk-averse and like to invest in debt
Wealth creating investors who prefer growth and are willing to take the risk of equity investments

Steps of Financial Planning & Closing:

Establishing and defining the client relationship
Gathering client data, defining client goals
Gather and Analyze data, assess the current resources and future income potential of the client
Determine and shape the risk tolerance level of the client
Analyzing and evaluating a clients financial status
Determine the client’s tax situation
Developing and presenting financial planning recommendations and options
Recommend the appropriate asset allocation, and specific investments
Executing the plan and making the client invest
Implementing the financial planning recommendations
Reviewing progress and portfolio rebalancing

Chapter 11. Helping Investors with Financial Planning

2009-03-28T00:14:00.001-07:00

Learning Objective

Financial Planning is an approach to building long term relationships with clients. It is also a need for large sections of investors. This unit introduces the concept of financial planning.

Financial planning is a planned and systematic approach to provide for the financial goals that will help people realise their aspirations, and feel happy.

The costs related to financial goals, in today’s terms, need to be translated into the rupee requirement in future. This is done using the formula A = P X (1 + i) n

The objective of financial planning is to ensure that the right amount of money is available at the right time to meet the various financial goals of the investor.

An objective of financial planning is also to let the investor know in advance, if some financial goal is not likely to be fulfilled.

The process of financial planning helps in understanding the investor better, and cementing the relationship with the investor’s family. This becomes the basis for a long term relationship between the investor and the financial planner.

A “goal-oriented financial plan” is a financial plan for a specific goal. An alternate approach is a “comprehensive financial plan” where all the financial goals of a person are taken together, and the investment strategies worked out on that basis

The Certified Financial Planner – Board of Standards (USA) proposes the following sequence of steps for a comprehensive financial plan:

• Establish and Define the Client-Planner Relationship
• Gather Client Data, Define Client Goals
• Analyse and Evaluate Client’s Financial Status
• Develop and Present Financial Planning

Recommendations and / or Options
• Implement the Financial Planning Recommendations
• Monitor the Financial Planning Recommendations

Life Cycle and Wealth cycle approaches help understand the investor better

The first step in financial planning process and the basic tool needed to translate financial plans into action is what is known as Asset Allocation.

Financial Planning Strategies:

Buy & Hold:

It is the most common strategy, and the most common mistake that investor make.

Rather you should track your investments, discard the non performances stock and keep the good performers stock in your portfolio.

Long term investment doesn’t mean buy and hold without adjusting the portfolio to sort out winners from losers.

Rupee Cost Averaging:

Rupee Cost Averaging is regular discipline in which investor never loses.

But there is the one limitations of rupee cost averaging i.e. it doesn’t tell investor exactly when to buy or sell a fund.

But in the long term investor always gain in the systematic investor plan because of rupee cost averaging.

Value Averaging:

The investor keeps the target value of his investment constant by investing the amount by which the investment value has come down or by cashing the increased value of his investment or by doing nothing if the value is unchanged.

Investing for long term:

Long term gives you the power of compounding
In any MF scheme “growth” option means reinvestment of dividend.
It is nothing but the power of compounding

Jacob’s Recommendation:

It combines the rupee cost averaging and value averaging method.
To accomplish this, Jacobs recommends using an aggressive growth fund and a money market fund of the same family.
Place Rs.X in a liquid fund every month. Set a target value for the aggressive equity fund.
Later if the value of equity fund has declined, transfer 100 from the liquid fund to the equity fund.
If the equity fund value has increased by 100 do nothing if the value has risen by 200 transfer 100 from equity fund to the liquid and book the profit.

Asset Allocation:

Asset allocation means determining the percentage of your investments to be held in equities, bonds and money market/cash instruments.

Asset allocation is about allocating money between equities, debt and money market segments

Asset allocation varies from investor to another depending on their situation financial goals and goals and risk appetites.

Asset allocation depends for an investor on his life cycle and wealth cycle

Boggle Recommends following strategic allocations:

Older investor’s in distribution phase: 50/50 (equity/debt)
Younger investor’s in distribution phase: 60/40
Older investor’s in accumulation phase: 70/30
Younger investor’s in accumulation phase: 80/20

Steps in developing a model portfolio for the investors:

Develop long term goals
Determine asset allocation
Determine sector distribution
Select specific fund schemes for investment

Boggle gives a simple thumb rule asset allocation i.e. debt proportion portfolio should equivalence to investor age. Example if investor age is 30yrs than its asset allocation would be 70/30 (equity/debt) and so on.

Benjamin Grahamin’s 50/50 Balance:

Benjamin Grahamin advocates 50/50 split between equities and bonds. When value of equities goes up, balance can be restored by liquidating part of the equity portfolio and vice versa.

As per Benjamin Graham

Basic managed portfolio:

Diversified Equity Value funds – 50%

Govt. Sec funds – 25%

High grade corporate bond fund – 25%

Basic Indexed portfolio:

Stock Market Index Fund – 50%

Bond Market Index Fund – 50%

Simple Managed portfolio:

Balanced Fund – 85%

Medium Term Bond Fund – 15%

Complex Managed Portfolio:

Diversified Equity Fund – 20%

Aggressive Growth Fund – 20%

Specialty Fund – 10%

Long Term Bond Fund – 30%

Short Term Bond Fund – 20%

Readymade Portfolio:

Single Index Fund with equity – 60%

& Debt – 40%

As per Jacob’s Model Portfolio

Accumulation Phase:

Diversified Equity – 65 to 80%

Income & Gilt funds – 15 to 30%

Liquid funds – 5%

Distribution Phase:

Diversified Equity – 15 to 30%

Income and gilt funds – 65 to 80%

Liquid funds – 5%

Chapter 12. Recommending Model Portfolios and Financial Plans

2009-03-28T00:13:00.001-07:00

Learning Objective

This concluding Unit discusses three key aspects of financial planning – how to understand the risk profile of investors, how to decide on an asset allocation mix for the investor, and an approach to deciding on model portfolios.

There are differences between investors with respect to the levels of risk they are comfortable with (risk appetite).

Risk profiling is an approach to understand the risk appetite of investors - an essential pre-requisite to advice investors on their investments. Risk profilers have their limitations.

Risk profile is influenced by personal information, family information and financial information.

Spreading one’s exposure across different asset classes (equity, debt, gold, real estate etc.) balances the risk.

Some international researches suggest that asset allocation and investment policy can better explain portfolio performance, as compared to being exposed to the right asset classes (asset allocation) is a more critical driver of portfolio profitability than selection of securities within an asset class (stock selection) and investment timing.

Strategic Asset Allocation is the ideal that comes out of the risk profile of the individual. Tactical Asset Allocation is the decision that comes out of calls on the likely behaviour of the market.

Financial planners often work with model portfolios – the asset allocation mix that is most appropriate for different risk appetite levels. The financial planner would have a model portfolio for every distinct client profile.

Asset Types: There are two types of Assets, 1. Physical Asset and 2. Financial Asset

Physical Asset:

Real Estate and Gold are examples of physical assets
Recently, the union Finance Minister has announced Gold Linked Unit Scheme launched by MF scheme.
Real Estate has also been a preferred investment alternative with the Indian investor.
However the capital required is often beyond the means of the small individual investor.
Quick liquidity is also one of the restrictions to enter into real estate.
Good is news is that the investors who wants to invest in real estate but having less amount and also wants liquidity can invest through Real Estate MF scheme.
Government has given green signal for Real Estate MF scheme which is going to be launched AMCs

Financial Asset:

In the financial asset category, Indian category have generally had guaranteed or fixed return products.
Such as Bank Deposits, Company Deposits and Government savings instruments such as public provident fund, Indira Vikas Patra, National Saving Certificate etc
Financial assets include capital market securities such as equity shares, bonds/debenture (issued by companies or FI), money market instruments such as commercial paper or certificates of deposits.
Individual investor can buy capital market instruments but do not have any direct access to money markets instruments.

Major type of Financial Assets:

Banks:

Bank Deposit have been a favored investment option with the Indian investor, mainly because of the liquidity and safety benefits, they think which is not so in most of cases.
In fact the real reason of investment in banks FD by most of the common people is the unawareness about the other debt products and unawareness cause of very few MF advisors in the market.
Yield on bank deposit is negligible after accounting for inflation and tax.
While the return on the capital is guaranteed by the bank, deposit is not a secured investment, its perceived safety coming from the soundness of the bank management or ownership
Investors should be advised to park only a part of their savings in bank deposits.

Corporate:

The corporate borrowers – companies also issue debentures paying fixed rates of interest.
Companies pays different rates of interest depending upon how strong their rating
Credit Rating given by Credit rating agencies such as CRISIL, ICRA, CARE etc decides the secured ness of the companies debentures and hence its effect on interest rate given to the investor.
Less the rating more the interest rate will given to investor and hence high would be the risk for investor and vice versa.

Financial Institutions (FI):

FI such as ICICI, IDBI issues bonds on a regular basis.
These bonds issued with the intent of financing infrastructure development in the country.
These bonds qualify for a tax deduction under section 80C. Because of its government utility purpose they are been treated much secured one.

Government:

Public Provident Fund (PPF): PPF is a government obligation, hence virtually risk free. PPF carries tax free interest of 8% PA and eligible for tax rebate under section 80C
Indira & Kisan Vikas Patra (IVP/KVP): The current yield is 8% over the 6 years but fully taxable hence less attractive.
RBI Relief Bond: These issued by the RBI pay interest at 8% which is taxable and have maturity period of 5 years.
Other National Saving Scheme: Other National scheme such as Post Office accounts, Recurring Deposits etc. Now a days it not so popular.
Government Securities: This is Government paper normally issued on a long term basis. The amount required for direct investments can be large. Hence, for large investors, they are best accessible through MF.

Life Insurance:

Premium paid on life insurance qualifies for deduction under sec 80C and maturity is also tax free under sec 10(10)D
Hence investors prefer life insurance because it also acts as forced saving apart from tax saving and life insurance
But careful evaluation proved that investor should buy insurance, not just as an investment but mainly to provide for his dependents in as of his untimely death.
ULIP: A recently developed phenomenon between MF and insurance companies has been the development of Unit Linked Insurance Plans offered both life insurance as well as investment in MF by life insurance organization. ULIP combines the benefits of MF investing with the added benefit of life insurance.

Features of PPF:

15 year deposit product made available through banks
Risk-free government obligation
Open to individuals and HUFs
Only one account permitted per entity
Offers tax-free interest of 8% P.A. and contribution up to Rs.70,000 (min Rs.500) are eligible for deduction under sec 80C
Option to withdraw 50% of 4^th year balance in the 7 year
Restriction on withdrawal reduces liquidity
Interest receipt and withdrawal of principal exempt from tax.
Only individuals and HUFs are eligible to invest

Features of RBI Relief Bonds:

Issued by RBI on behalf of the Government of India
A 5-year investment product with 8% interest offering
Interest is currently taxable (used to be tax free earlier) and payable semi-annually
Free of risk of default

Government Securities:

Long term government paper
Risk-free government obligation
Low-return and define the benchmark rate of return on the yield curve
Specially appointed Primary dealers deal in G-Secs
Generally high ticket investments
Best accessible to small investors through mutual funds

Features of other Government Schemes

Indira Vikas Patra and KVP issued by central government and sold by post offices
Current yield on IVP is 8%
Interest is taxable
Investor identity is protected and investment in cash is possible

Direct Equity Investment (Share Trading) vs Investment through Mutual Funds

Investment through mutual funds is more secured, easy, convenient and profitable than direct equity investment because
- In direct investment investor need to identify good return stock by themselves which is very critical and need specialization with time and infrastructure.
- Whereas MF specialize in this area which carry out the research and analysis by team of fund managers whom are dedicated for that job only.
- MF gives investor a broad diversification and hence risk reduction even by investing small amount which is not possible in direct investment
- MF provides much professional management advice which is not in direct investment
- Tax saving along with market linked investment return is only in MF
- Low level of transaction cost in MF because of economies of scale.
- MF gives investors a complete satisfaction, complete peace of mind with convenience.

Bank Deposit vs. Debt Funds

Bank deposit is guaranteed by the bank for repayment of principal and interest
Any risk associated with investment of the investor’s funds have to be borne by the bank
The depositor has a contractual commitment from the bank to pay
A mutual fund, on the other hand, invests at the risk of the investor
Hence, there is no contractual guarantee for repayment of principal or interest to the investor
The investor need to assess the risk in terms of the credit rating of the bank, which provides an indication of the financial soundness of the bank.
In case of investments in debt funds, investor needs to know whether the fund invests in high quality assets or lower rated debt.
It can be seen that the bank deposits are not totally free from risk
A conservative debt fund can give higher returns than a bank deposit.

Chapter 13. Helping Investors Understand Risk in Found Investing

2009-03-28T00:12:00.001-07:00

The right level of risk tolerance of any investor depends upon his age, the amount of inevitable funds available and his financial circumstances including income level, job security, family size etc.
Investor should be categorized into low risk, moderate risk and high risk categories

Low Risk Fund:

Money market funds
Government securities funds

Moderate Risk Funds:

Income funds
Balanced funds
Growth and income funds
Growth funds
Short term bond funds
Intermediate bond funds
Index funds

High Risk Funds:

Aggressive growth funds
Intermediate funds
Sector funds
Precious metals funds
High yield bond funds
Commodity funds

Jacobs recommends the following portfolio

Low Risk (Conservative) Portfolio
- 50:50 Govt securities : money market funds

Moderate Risk (Cautiously Aggressive) Portfolio:
- 40% in Income Fund
- 30% in Govt Bond
- 20% in Growth Fund
- 10% in Index Fund

High Risk (Aggressive) Portfolio:
- 25% in aggressive Growth
- 25% in international Funds
- 25% in Sector Fund
- 15% in High Yield Fund
- 10% in Gold Funds

Standard Deviation (SD)

Risk is measurable by the statistical concept of standard deviation
SD measures the fluctuations of a fund’s returns around a mean level
SD basically gives you an idea of how volatile the earnings are
SD can compute for both equity and debt funds, SD of different funds can be compared with each other, or with SD of a market index or even that of another category

Beta Coefficient

This also measures the fund risk
It relates a funds return with a market index and measures the sensitivity of the funds returns to change in the market index.
Higher beta gives greater return in rising market and vice versa
Beta is based on past performance and it doesn’t indicate the future performance
Fund with the specialize portfolio (sector) can’t be assessed by beta based
Beta measures sensitivity of the funds returns to changes in the market index
- Beta of 1: Fund moves with market (Index Fund)
- Beta < 1: Less volatile than market (Conservative portfolio)
- Beta > 1: Higher volatile than market (software fund)

Bogles’ ExMarks or R-Squared:

R-squared measure how much of a funds fluctuations are attributable to movements in the overall market from 0 to 100%
Like an index fund will have ExMarks of nearly 100%
ExMarks measures Funds performance in relation to the benchmark index.
It is given from 0-100. With 100% meaning highest relation like an index fund has ExMark of 100%
If ExMark is lower than 80%, fund is less than predictable in relation to index and may be riskier
But, overall SD is the best measures of risk

Sharpe Ratio:

It gives risk and return relation
Higher the Sharpe ratios better the fund
Sharpe ratio indicates the quality of returns
It shows the return given by fund per unit of risk it takes
William Sharpe created a metric for fund performance, which enables the ranking of funds on risk-adjusted return basis.
This measure is based on the comparison of “excess return” per unit of risk, risk being measured by standard deviation
Excess return is defined as the actual return of the fund less risk free rate.

Alpha:

It compares the funds actual results with what would have been expected give the funds beta and the market index performance
It is the difference between a security’s expected return and its equilibrium expected return
Positive alpha indicates undervalued securities
Negative alpha indicate over valued securities
Alpha gives the incremental returns over the expected returns
It calculates what should be expected returns for the fund given the realized risks of the fund.
Higher the ratios better the fund

Treynor Ratio:

Treynor Ratio measures the fund performance in terms of market risk
Higher the treynor ratio better is the fund. It shows how much more return a fund has given, per unit of portfolio risk it took.

Price/Earning Multiple (P/E):

P/E = Market price per share / Earnings per share
Higher the P/E as compared to the market, higher the probability of its fall in the future
Low P/E ratio indicates that the securities of the fund are undervalued
It is a simple risk measure
Fund P/E ratio – Weighted average of P/E ratio of all the stock held in the portfolios

Expense Ratio:

The expense ratio is an indicator of the funds efficiency and cost effectiveness
Expense Ration = Total expenses / Average Net Assets of the fund
Expense Ratio excludes brokerage commissions as brokerage commission has to be capitalized as per SEBI
Expense ratio has to use for average of 3 to 5 years to judge the performance of the fund
Expense ratio evaluated in the light of fund size and portfolio composition

Income Ratio:

Income Ratio = Net Investment Income / Net Assets
It is useful for evaluating debt funds

Portfolio Turnover Rate:

It is the amount of buying / selling in the market
It is useful to judge the transaction cost of fund
It is useful in analysis of equity and balanced funds

Transaction Costs:

It includes brokerage commission, stamp duty, registrar’s fees, custodian fees, dealers spreads

Debt Funds:

Debt funds are exposed to credit risk, risk of borrower defaults and interest rate risk that comes from the average maturity of the funds portfolio
The longer the maturity of a portfolio, the greater the risk it has from interest rate fluctuations

Fixed Maturity Plan (FMP):

To those investors who like to buy a bond and hold it to maturity, without talking any market risk, the FMP is an ideal choice
FMP is like a Fixed Deposit (FD) with additional convenience and liquidity of a Mutual Fund
They are like FD product with the difference being that the interest rate is not known in advance
Whereas in case of a FD, the deposit holder is aware of the maturity and the interest he will be earning
FMPs have a fixed time horizon as the maturity of the scheme, e.g if one invests in an FMP with maturity of 1 year, at the end of the year, the money and the earnings are returned to the investor.
FMPs invest in short term corporate paper and AAA rated long term corporate bonds
This help fund to avoid unnecessary churning in the portfolio. As investments are held till maturity, there is no interest rate risk.
FMPs at maturity tend to pay returns as dividend, which are taxed at lower rate than those for interest payment on FDs
This along with indexation benefit helps investor to get better returns on post tax basis than FDs
FMPs are available for subscription only during the period of launch with maturities ranging from 3 months to 5 years
FMPs with 1 year maturity is most popular
NAV is declared on a daily basis any withdrawal before maturity is subject to an exit load.

Floating Rate Plan:

This plan focuses on debt instruments which have a floating interest rate.
Hence it seeks to protect the portfolio from the fluctuations arising out of changes in interest rates.
It helps the investor earn a steady leveled of market return comparable to a liquid fund

Long Term Floating Rate Plan:

Apart from seeking to protect the portfolio from market risks, the long term floating rate plan also seeks to capture the benefit of loading interest rate by investing in bonds where term rate of interest is periodically fixed.

Income Plan:

Income plan invests in a basket of debt securities of various maturities that seeks to maximize income while at the same time maintaining the optimum balance of yield, safety and liquidity

Flexible Income Plan:

Flexible income plan may be ideal if one wants to take advantage of fluctuations in the debt markets for it has the flexibility to shift investment to debt securities with higher or lower maturities depending on market conditions
The fund seeks to actively manage the interest rate risks

Income Multiple Funds (IMF):

IMF scheme enables you to enjoy the highs of equity investing along with the cushion of the relative safety of debt investments
That’s because a minimum of 70% is invested in debt and up to 30% of your money is put in equity to make it work harder for you.

Monthly Income Plan:

This is an open ended fund. Monthly income plan doesn’t means investor as surely get monthly income
If you like a steady growth in your portfolio, or desire a regular income stream periodically, the monthly income plan is ideal for you.
It invests in good quality debt instruments to generate income, and a small allocation of 15% (Max) to equity, to ensure some growth.

Measure of Bond Yields:

Current Yield = Coupon Rate / Current Market Price
Yield to Maturity (YTM):
- It’s also known as bond’s IRR
- It is annual rate of return
- Investor would realize if he bought a bond at a particular price, received all the coupon payments, reinvested the coupon at same YTM and received the principal at maturity.
There is inverse relationship between price and YTM of a bond

Chapter 14. Recommending Model Portfolios & Selecting the Right Funds

2009-03-28T00:10:00.001-07:00

The investors and the distributors should avoid ad-hoc investment decisions and instead follow a well thorough out plan suited to the investor needs
Most experts are now agreeing that on of the most effective ways to invest through MFs is to develop a model portfolio for each investor.
It is also extremely important for the distributors to know how to choose a particular scheme or set of schemes from all of the options available

Equity Funds Characteristics:

Fund category – the fund chosen should be suitable to investor objective
Investment style – choose between growth and value depending on investors risk perception
Age of the fund – experienced funds are preferred to new funds
Fund Management Experience – track record of the fund managers is important
Size of the fund – larger funds have lower costs
Performance and risk – risk adjusted performance matters
High beta means higher risk
High turnover means high transaction costs

Risk Statistics:

Beta – represents market risk, higher the beta higher the risk
Ex-Marks – represents correlation with markets – higher the ex-marks, lower the risk. A fund with higher ex-marks is better diversified yield should be preferred.
Gross dividend yield represents return. Funds with higher gross dividend yield should be preferred.
Funds with low beta, high ex-marks and high gross dividend yield are preferable

Money Market Funds:

Liquidity and high turnover rate is high.
Shorter-term instruments are turned over more frequently
Protection of principal invested is important
NAV fluctuation limited due to low duration and lack of interest rate risk
Credit quality of portfolio should be high
Low expense ratio is important

Jacob’s 4 Step Program for Developing a Model Portfolio:

Work with investors to develop Long Term Goals
Determine the Asset Allocation of the investment portfolio
Determine the Sector Distribution
Select Specific Fund Managers and their Schemes

Recommended Investment Portfolio as per Investors 5 Life Cycle Phase:

Investor in the Accumulation Phase (age 25-30)

During this phase, clients are looking to build wealth because their financial goals are quite some time away and investments can be made for the long term
Recommended Portfolio for this phase: Equity (65-80%); Gilt (15-30%); liquid fund (5%)

Investor in the Transition Phase (age 30-50)

During this phase, one or more of the clients goals are approaching
Example (1) a salaried executive is planning to retire at 60 years of age, he should start preparing about 3 years in advance by gradually transitioning from growth to income generating investments. Example (2) a couple in their mid 40s who have children approaching the age of higher education or marriage.

Investor in the distribution or Reaping Phase (age 50+)

This is the cashing out stage. For example, if the client has retired, investments need to generate income for as comfortable post retirement life
Recommended portfolio for this phase: Equity (15-30%); Gilt fund (65-80%); liquid fund (5%)

Investor in the Inter-Generational Transfer Phase (Older age)

This phase belongs to older investors who wants to transfer their wealth
Recommended Portfolio for this phase is depends upon the beneficiaries given as follows
Children: Balance of Growth & Income Funds
Grandchildren: Growth Fund for Long terms
Charitable Causes: Income Funds

Investor in the Sudden Wealth Stage: Keep money in liquid fund and plan for financial planning as per investor’s objective and need without failing to keep in mind about taxes.

Financial Planning for Affluent (High Net worth Individual (HNI)) Investors:

There are two classes in Affluent (Wealthy) Investors

Wealth Creating Individuals:

Such investors have a higher risk bearing capacity
Recommended portfolio is 70-80% in diversified equity and rest in sector funds

Wealth Preserving Individuals:

These are low risk bearing capacity class investors
Recommended portfolio should be conservative like 70-80% in income, gilt and liquid funds and rest in diversified equity or balanced fund

Bogle 4 step advice for selecting right equity fund:

Classify the available equity schemes
Choose one of the strategies
Evaluate past returns of available funds
Review the salient features of a scheme

Equity funds characteristics:

Cash Position: Theses are nothing but holding cash position in liquid format by fund manager and depends upon the fund manager skill by prediction of market. Like in up market holding cash and investing in down market.
Portfolio Concentration: Fund largest top tem holding and their proportion in scheme
Market Capitalization of the fund: The holding scripts are large or mid or small or mix and ultimately decide the level of risk of fund.
Portfolio Turnover: Frequent sales and purchase in portfolio means higher transaction costs

Portfolio Statistics:

Ex-mark
Beta
Gross Dividend Yield

3 Steps for selecting right Debt/Bond/Income funds:

Narrow down the choice
Know your investor objective
Determine the right selection criteria and select following:
1. Fund age & size
2. Relative yields
3. Costs
4. Portfolio Characteristics
5. Average Maturity
6. Tax Implications
7. Bonds versus bond funds
8. Past returns

Selecting Right Money Market / Liquid fund:

Following are factors needs to consider for selecting right liquid/money market fund
- Costs
- Quality
- Yields

Selecting Right Balanced Funds:

There are two basic types of equity oriented balanced funds that invest
- Investment in equities up to 65% and
- Investment in debt up to 65%

Hence for selection of balanced fund portfolio we need to think equity as well as debt selection steps approach
Select balanced fund by looking at following factors:
- Portfolio Balance
- Debt Portfolio Character
- Costs
- Portfolio Statistics
- Returns

Selecting Right Equity Funds:

Percentage holding in cash should be low – Funds can always sell liquid stocks for liquid requirements
Concentration in portfolio should be low – An equity fund should be well diversified
Market Capitalization of the fund – High capitalization means better liquidity
Portfolio Turnover – Higher turnover means more transactions and costs, but exploitation of opportunities. Low turnover represents patience and stable investments.

Selecting Right Debt Funds:

A smaller or new debt fund may not necessarily be risky
For debt funds expenses is important
For short-term investors, load is more important than expense ratio
Total return rather than yield to maturity (YTM) is important
Expenses are very important because high expense ratios lead to yield sacrifice
Credit quality – Better the ratings of the holdings, safer the fund
Average Maturity – Higher average maturity means higher duration and interest rate risk
Funds with higher average maturity are more risky than funds with lower average maturity

Chapter 15. Business Ethics for Mutual Funds

2009-03-27T23:35:00.001-07:00

The term refers to route of acceptable and good conduct in business
All those persons who are engaged in business should comply with rules of good conduct
Those who own and manage the business may set the business ethics
These may also be made and imposed by agencies that regulate the business
Many countries have made laws for protection of consumers and investors
However, laws cannot help in eliminating the potential malpractices in businesses
Therefore, it is desirable, probably required that the business ethics be made and adopted by those who are engaged in and involved with the business themselves
Business ethics are self imposed and adopted, whereas laws are enforced
Need of business ethics:
- These are required to have honest and fair business practices
- These are required to insure that the business is not done dishonesty and false promises are not made to the investors
- From social angle, business ethics are required to protect the consumers
- From the angle of business itself, good ethics mean good business. Honest and fair practices will insure that the customer remains satisfied, will not feel cheated and loyalty will increase.
They are also required to have transparency in business dealings and insuring that both the existing as well as potential clients and, or consumers are treated at par.
Mutual funds are vehicles of collective investments, which are managed by asset-management companies. AMC manages this money to earn a fee. In this process the AMC takes the help of many other entities including distributors and individual financial advisors. All these need to abide by the rules of good conduct.
In this process, the following points are important:
The rules of conduct for distributors and employees are set by trustees, and directors of Asset Management Companies
AMFI has also set rules of good conduct for AMC’s, its employees and distributors
Objectives of business ethics:
- The major objective is to have honest and transparent dealing with existing and potential consumers
- Another objective is protection of consumers or clients from being cheated or exploited
We also require business ethics to ensure level playing filed among all business participants
Business ethics also help in ensuring healthy competition for the benefit of all consumers. Government of India and SEBI both are concerned with the protection of investor interests.
SEBI has incorporated the rules of good conduct in MF regulations
It has also issued guidelines to AMFI and mutual funds to develop codes of conduct for fund distributors, fund managers and all employees and associates of AMC and Trustee Company.
Insider Trading: Fund Managers should not collude with insiders of various companies and use information for their own benefit
Mutual funds being vehicles of collective investment, all investors should be treated equally.
The regulators keep check to see that no discrimination is in favor of any investor.
Regulations of personal trading: AMC is required to file a quarterly statement of dealing in securities by key personal of AMC
Compliance Officer:
- SEBI has made it mandatory for every AMC to have a compliance office who would be responsible for implementation of all laws, guidelines and voluntary codes of conduct
- Compliance officer not only reviews but can also give approval to personal trading and investment transactions
All the distributors and agents have to follow the code of conduct laid down in the fifth schedule of the SEBI MF regulations (1996) as well as AGNI.
AMFI has put detail version of code of conduct called AGNI. (AMFI guidelines & Norms for Intermediaries)
SEBI watches out for any unethical or unfair business practices, by AMC for example.
- Insider Trading: Insider trading means buying or selling securities on the basis of privileged information available to the funds by persons who are seems as insiders to the company.
- Preferential treatment to selected investors: Fund managers are not insiders but they can collude with to other insiders to gain access to private information and use that information to trade on their personal account
- Personal trading by fund managers and employees: Normally funds ban personal trading by fund manager. However, even when personal trading is permitted funds place many restrictions
SEBI has taken the view that fund employees at all levels should not be barred from trading or investing
However, they should disclose their holdings and transactions made during a given period
It would be clearly an unethical practice if the fund manager buy and sells securities and doing the same transactions for the fund. This practice is called as front running. Front running is banned by market regulators the world over.
Regulations on Personal Trading: The directors of a trustee company also have to file the details of transactions in securities with the mutual fund, where they exceed the value of Rs. 1 Lakh.