Chapter 7. Investor Services

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