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8/8/2019 AMFI Advisory
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ALL ABOUTMUTUAL FUNDS
By - Dr. Y. P. Singh
Lucknow (India)
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Session 1: Concept,
Structure and RegulatoryFramework
• Introduction
• Sponsor-Trustee-AMC
• Other constituents
• Regulatory framework
• Mutual fund products• Merger and acquisitions
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What Is a Mutual Fund?
A mutual fund is a pool of moneycollected from investors and isinvested according to statedinvestment objectives
Terms to know Mutual: the ownership of the fund is joint or mutual
Pool Investment objectives
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Functioning of Mutualfund
MF org.
MF Scheme (Fund
Mgr)
Launches
Unit holders
Investors
SetofInv
estments (
Portfolio)
•* Fund mgr charges fees as per SEBI
regulation against its services.
•The role of MF org. is like financial
intermediary
Return pass
on to
investors*
Market
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Mutual Fund: Back ground
•Most appropriate investmentopportunity for small investors
•Birth of mutual funds – USA
•Good alternative to direct investing
•Size (AUM) in USA > Bank deposits
•Financial intermediary
•UTI only player between 1964-87
•Helps in the growth of capital markets
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Characteristics of a MutualFund
• Investors own the mutual fund.
• Professional managers manage thefund for a fee.
• The funds are invested in a portfolio of marketable securities, reflecting theinvestment objective.
• Value of the portfolio and the value of
investors’ holdings, alters with changein market value of investments.
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Advantages of MutualFunds to Investors
• Portfolio diversification
• Professional management• Reduction in risk
• Reduction in transaction cost
• Liquidity
• Convenience and flexibility
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Disadvantages of MutualFunds
• No control over costs
•
No tailor-made portfolios• Issues relating to management of
a portfolio of mutual funds
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Fund Structure &Constituents
• Mutual funds in US are setup asinvestment companies
• Mutual funds in UK are either unit trusts
(trust) or investment trust (companies)• Mutual funds in India are public trusts
under the Indian trust Act, 1882
• Mutual funds in India is a 3-tier structure Sponsor Trustee AMC
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Sponsor
• Promoter of the the mutual fund
• Appoints AMC and also appointsthe trustees
• Criteria Financial services business 5-year track record 3-year profit making record At least 40% contribution to AMC
capital
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Trustees
• Trustees represent the trust i.e. MF org. Trust has nophysical identity
• Fiduciary responsibility for investor funds
• Appointed by sponsor with SEBI approval
• Registered ownership of investments is with Trust
• Board of trustees or Trustee Company
appoints all other constituents• Trustees oversee the functioning of AMC
• Trustees approve each MF schemes floated by AMC
• Trustees receive fees for their services
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Trustees
• At least 4 trustees 2/3 should be independent
• Trustees of one mutual fund cannot
be trustee of another mutual fundexcept in case of Independent trusteeafter Board approval of Both the MFs
• Right to seek regular information andremedial action
• All major decisions need trusteeapproval
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Asset ManagementCompany• Responsible for operational aspects of
the mutual fund & can undertakefollowing businesses Asset mgt services
Portfolio Management Services Portfolio advisory services
• Investment management agreementwith trustees
• Registered with SEBI
• Rs. 10 crore of net worth to bemaintained at all times
• At least 1/2 of the board members to beindependent
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Asset Management
Company• Appoints other constituents with
trustees approval
• Cannot have any other business
interest & can be changed /terminated Majority of trustees or At least 75% majority of unit holders
• Structured as a private limitedcompany Sponsor and associates hold capital
• AMC of one MF cannot be trustee of another MF
• Quarterly reporting to Trustees
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Other Constituents
• Custodian Investment back-office: Safekeeping of
records & documents Registered with SEBI
• Registrar and Transfer agent Keeps Investors A/c’s & record of transactions:
purchase, redemption tranfer of units etc. Registered with SEBI
• Broker Purchase and sale of securities 5% limit per broker
• Banker Assist funds pay in & pay out obligations
• Auditor Separate auditor for AMC and mutual fund
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Regulatory Framework• SEBI:
Apex regulator of capital markets. It is theprimary regulator of mutual funds in India.
SEBI has enacted SEBI (Mutual Fund)Regulations 1996 to regulate MF industry.
Mutual funds mandatorily required registeringwith SEBI.
Mutual funds have to send half-yearlycompliance report.
Inspects and regulates other constituents of mutual fund.
• RBI: Monetary authority of the country and also
the regulator of the banking system. It is involved only with bank-sponsoredmutual funds.
• MoF: Supervisor of RBI and SEBI Appellate authority under SEBI regulations.
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Regulatory Framework
•
COMPANIES ACT: The AMC and the Trustee Company may bestructured as limited companies, which comeunder the regulatory purview of Company LawBoard (C L B),
Registrar of Companies (ROC) oversees thecompliance.
Department of Company Affairs (DCA) isresponsible for the formulation andamendments in laws relating to companies,including the Indian Companies Act. It has thepower to prosecute the directors.
• STOCK EXCHANGES: Regulatory role if the mutual fund is registered
with it.• PUBLIC TRUSTEE: Since the mutual funds are registered under
Indian Trusts Act, they come under regulatorypurview of the office of public trustee, which inturn reports to the commissioner.
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Regulatory Framework• UTI:
UTI was governed by provisions of the UTI Act, 1963. UTI has, however, subjected itself voluntarily to theprovisions of the SEBI regulations in 1996.
All the UTI schemes, except the US 64, are under dualregulation of both SEBI and UTI Act.
The Board of Trustees operates it. The Board has nominees from MoF, RBI and other
institutions who subscribed to the initial corpus.
The Chairman is appointed by MoF, in consultation withIDBI, the principal investor in the corpus. UTI does not have a three-tier structure. Hence no AMC. All expenses borne by the schemes. UTI has powers to
take loans, other mutual funds can’t. Major Differences
• Assured return schemes
• Different accounting norms
• Ability to take and make loans
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Self-regulatory Organisations(SROs)
• Derive powers from regulator
• Ability to make bye-laws
• Example : Stock exchanges
• Industry Associations Collective industry opinion Guidelines and recommendation Example: Association of Mutual Funds in
India
• AMFI is not yet a SEBI registered SRO
Regulatory Framework
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Mutual Fund Products -classification:
Mutual fund products can be classified onvarious parameters: On the basis of maturity:
– Open ended funds - no maturity– Close ended funds – having maturity
On the basis of Investment
– Equity or growth fund– Debt or income fund– Balanced or hybrid fund
On the basis of investment objective– Equity diversified fund– ELSS / index funds
– Sectoral fund– Money market fund / gilt-edge fund– Gold fund– Exchange traded fund– Funds of fund etc.
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Mutual Fund Products
• Open ended funds
Initial issue for a limited period Continuous sale and repurchase Size of the fund i.e. Unit capital
changes as investors enter and
exit NAV-based pricing
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Mutual Fund Products
• Closed end funds Sale of units by fund only during
Initial Public Offer Listing on exchange and liquidity for
investors
Size of fund i.e. Unit capital remains
constant Price in the market is usually at a
discount
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Equity Funds
• Pre-dominantly invest in equity markets Diversified portfolio of equity shares Select set based on some criterion
• Diversified equity funds that invest in the broad markets ELSS as a special case have the following features:
– 3 year lock in
– Minimum investment of 90% in equity marketsat all times
– Open or close ended
– Deduction u/s 80c for investments up to Rs.10000.
• Primary market funds• Small Cap funds
• Index funds which replicate an index• Sectoral funds which focus on a sector
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Debt Funds
• Predominantly invest in the debt markets Diversified debt funds Select set based on some criterion
• Income funds or diversified debt funds-Diversified debt funds which invest in the
broad debt market• Gilt funds that invest only in Government
securities• Liquid and money market funds which
invest only in short term securities• Short term funds which invest in debt of
tenor higher than the money market funds.• Fixed term plans that invest in securities
and hold them to maturity, for a fixedperiod.
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Balanced Funds
• Investment in more than oneasset class Debt and equity in comparable
proportions Pre-dominantly debt with some
exposure to equity Pre-dominantly equity with some
exposure to debt
• Education plans and children’splans are examples of balancedfunds
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Basis for Classification
Investors choose funds based on theirobjective, risk appetite, time horizon andreturn expectations.
• Risk Sectoral funds are most risky; money
market funds are least risky• Tenor
Equity funds require a long investmenthorizon; liquid funds are for the short term
liquidity needs• Investment objective Equity funds suit growth objectives; debt
funds suit income objectives
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Risk and Return
Liquidfunds
ST debtfunds
Giltfunds
Debt
Funds
Indexfunds
Equityfunds
Sectoral funds
Balanced funds
Risk
Return
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Mergers and Acquisitions
•
Scheme take over : If the schemes of one fund aretaken over by another fund, it is called as schemetake over. This requires SEBI and trustee approval.
• AMCs merger: If two AMCs merge, the stakes of sponsors changes and the schemes of both fundscome together. High court, SEBI and Trusteeapproval needed.
• AMC take-over : If one AMC or sponsor buys out theentire stake of another sponsor in an AMC, there is atake over of AMC. The sponsor who has sold out,exits the AMC. This needs high court approval aswell as SEBI and Trustee approval.
• Investors can choose to exit at NAV if they do notapprove of the transfer. They have a right to be
informed. No approval is required, in the case of open-ended funds.• For close-ended funds investor approval is required
for all cases of merger and take-over.
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Session 2: Investing inMutual Funds:Understanding theProcess
• Offer Document• Investors/ unit holders rights
• Verification and Due Diligence
• Investing in a Fund Scheme
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Offer Document/ KIM
• Legal offer from AMC to investor• Offer Document (OD) is the most important source
of information for investors.• Abridged version is called as Key Information
Memorandum (KIM).• Investors are required to read and understand the
offer document.• No recourse is available to investors for not reading
the OD or KIM• A glossary of important terms is included in the offer
document.• The cover page contains the details of the scheme
being offered and the names of sponsor, trustee and
AMC.• Mandatory disclaimer clause of SEBI should also be
on the cover page.• The borrowing restrictions on the mutual fund
should be disclosed. This includes the purposes andthe limits on borrowing.
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Offer Document/ KIMContinue……
• OD is issued by the AMC on behalf of thetrustees.• KIM has to be compulsorily made available
along with the application form.• Close ended funds issue an offer document
at the time of the IPO.
• Open ended funds have to update OD atleastonce in 2 years.• Any change in scheme attributes calls for
updating the OD.• Addendums for financial data should be
submitted to SEBI and made available to
investors.• Trustees approve the contents of the OD andKIM.
• The format and content of the OD has to beas per SEBI Guidelines
• The AMC prepares the OD and is responsible
for the information contained in the OD.
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• A scheme cannot make any guarantee of return,without stating the name of the guarantor, anddisclosing the networth of the guarantor.
• Information on existing schemes and financialsummary of existing schemes to be given for 3years.
• Information on transactions with associatecompanies to be provided for the past 3 years.• If any expense incurred is higher than what was
stated in the OD, for past schemes, explanationsshould be given.
• There is no information on other mutual funds,
their product or performance in the OD.• 3 years track record of investors’ complaints andredressal should be disclosed in the OD.
• Any pending cases or penalties against sponsorsor AMC should be disclosed in the OD.
• Investors’ rights are stated in the OD.
Offer Document/ KIMContinue……
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Contents of OfferDocument• OD has to be submitted to SEBI prior to the launch of
the scheme.• The OD contains
Preliminary information on the fund and scheme Information on fund structure and constitution Fundamental attributes of the scheme Details of the offer
Fee structure and expenses Investor rights Information on income and expenses of existing
schemes• Risk factors, both standard and scheme-specific,
have to be disclosed• Factors common to all funds are called as standard
risk factors. These include market risk, noassurances of return, etc.
• Factors specific to a scheme are scheme-specific,risk factors in the Offer Document. These includerestrictions on liquidity such as lock-in period, risksof investing in the first scheme of a fund, etc.
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Fundamental Attributes
Fundamental attributes of ascheme include:
Scheme type Objectives Investment pattern Fees and expenses
Liquidity conditions Accounting and valuation Investment restrictions, if any
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Changes in FundamentalAttributes
• Investors approval is not neededbut Investors have right to be
informed• Public announcement by AMC
• Option to exit without load
• SEBI and Trustee approval
• New offer document
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Unit Holder Rights/Investors
Investors have the right to inspecta number of documents. Theseare:
Trust deed Investment management agreement SEBI (MF) Regulations AMC Annual reports Unabridged offer document Annual reports of existing schemes
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Unit Holder Rights
• Cannot sue the mutual fund• Complaints against AMC, sponsor
and BoT
•
75% unit holders can• wind up a scheme• seek AMC termination
• Prospective investor has no
rights• Right to redeem for fundamental
changes without exit load
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Verification and DueDiligence
• Compliance Officer has to sign the duediligence certificate. He is usually anAMC employee.
• The due diligence certificate states that Information in the OD is according to
SEBI formats Information is verified and is true and fair
representation of facts
All constituents of the fund are SEBIregistered.
• SEBI does not approve or certify thecontents of the OD.
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Investing in a Fund
Scheme• Units or amount
• Certificates and account statement
• Minimum amount• Initial offer and subsequent buying
• List of eligible investors Check eligibility with offer document Foreign investors not eligible (FII
Regulations)
• Documents for classes of investors
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Distribution Channels
• Individual agents
• Institutional Distributors
Banks Distribution companies
• NBFCs Direct marketing channels
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Individual Agents
• Wide network
• Certification AMFI registration No. (ARN) card
necessary before selling
• Commission structure Initial and Trail
• Loyalty and volume incentives
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Institutional Distributors
• Banks HNIs and personal banking
• Distribution companies
NBFCs• Service and collection
• Advisory
• Direct Marketing Direct Service Agents Investor Service Centres e.g CAMS
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Procedure
• Proof of purchase Certificate Account statement
• Application form- contents Single Joint holding Minor Nomination PAN number Tax status Folio number Bank details
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Session 3: Accounting,
Valuation & Taxation
• Accounting
• NAV & Pricing• Accounting policies
• Valuation norms for mutual funds
• Taxation of mutual funds
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Mutual Fund Accounting
• Knowledge of MF accounting vital
• Separate balance sheet for each scheme of aMF
• MFs to follow Accounting policies laid down by
SEBI (Mutual Fund) Regulations, 1996• Unit holdes’ subscriptions accounted
Not as liabilities or deposits But as Unit Capital at face value
• Investments made by the fund appear on assetside in the Balance sheet
• All assets of the scheme belongs to investors
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NAV and Load
• Date on which NAV is calculated is called valuation date
• Open ended funds are required to compute and discloseNAV daily
• Close ended Funds can compute NAV’s every week NAVcalculation has to consider up to date transactions
• Sale and repurchase price are NAV-based
Cut-off time for NAV: The cut –off time for all mutualfund schemes except liquid fund schemes is 3 pm
For all valid applications received before the cut-off time, units are allotted /cancelled based on NAV at theend of the same day & after the cut-off time , NAV of the next business day.
The above rule does not apply to liquid fund schemes
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NAV and Load• Load is a charge on the NAV
Entry load is charged on NAV and increasesthe sale price
Exit load is charged on NAV and reduces therepurchase price
•
Load is defined as a percentage• 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 aninvestor is called as CDSC (Contingent deferred sales
charge).• Loads are subject to SEBI Regulation and vary
depending on industry practice
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Entry Load : Example
If the entry load (sales load) for a scheme is1.5% and the NAV of the scheme is Rs.24.50, the investor who wants to buy theunits will not be able to buy at Rs. 24.50.He will pay
= 24.5 + (24.5*1.5/100)
= 24.5 + 0.3675
= 24.8675
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Exit Load : Example
If a fund imposes an exit load of 1.25%, the investor who repurchaseshis units, will get a price that is:
= 24.5 – (24.5*1.25/100)
= 24.5 - 0.30625
= 24.19375
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SEBI Regulations : Load
For opened end funds :
The sale price cannot be more than 107% of the NAV and
The repurchase price cannot be less than 93%
of the NAV. That is, the maximum load can be only 7%.
For closed end funds The maximum entry or exit load cannot be
higher than 5%. The repurchase price cannotbe less than 95% of the sale price.
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Example
If the NAV is Rs. 10,• Sale price cannot be higher than Rs. 10.7.
• Repurchase price cannot be lower than Rs.9.3.
• However, the mutual fund cannot chargeboth these prices.
• If the sale price is Rs. 10.7, the repurchaseprice cannot be lower than Rs. 9.95(10.7*0.93).
•
If the repurchase price is Rs. 9.3, the saleprice cannot be higher than Rs.9.95(9.3*1.07).
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Industry Practice
Load is not imposed on NAV, buton the price.
NAV = Sale price - sale price x load
= Sale price (1-load)Sale price = NAV/(1-load).
NAV = Rep. price + Rep.price x load
= Rep. Price(1+load)Repurchase price = NAV/(1+load)
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Example
If the NAV is Rs. 10,
• Sale price cannot be higher than 10/0.93 =Rs. 10.753.
• Repurchase price cannot be lower than10/1.07 = Rs. 9.346.
• However, the mutual fund cannot chargeboth these prices.
• If the sale price is Rs. 10.753, therepurchase price cannot be lower than Rs.10 (10.753*0.93).
• If the repurchase price is Rs. 9.346, the saleprice cannot be higher than Rs.10(9.346*1.07).
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NAV Calculations
• Market value of investments
• Plus Receivables and other assets
• Plus accrued income
• Less Payables and other liabilities
• Less accrued expenses
• NAV = Net assets/Number of units
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Disclosing NAV of a Unit
• All income, expenditure to be accounted up todate of valuation
• Non accrual of small amounts not affectingNAV by more than 1% permitted
• Non recorded transactions should not affectNAV calculation by more than 1%
• If NAV is affected by more than 1% , AMC to:• Pay excess difference
• Recover excess paid
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Factors affecting NAV
NAV is affected by 4 set of factors:q Purchase & sale of
investment securities
q
Valuation of all investmentsecurities held
q Other assets and liabilities
q Units sold or redeemed
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Sources of Income• Interest
• Dividend
• Profit from sale of investments• Other income
• Extra-ordinary income
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Charges in MF
Mutual funds can recover two types of expenses:
• Initial issue expenses
• Recurring expenses
• Initial issue expenses: Expenses incurred
in floating schemes Effective April 04,2006 allowed up to 6% for
close ended funds only Close ended funds can not charge entry loads Open ended funds can recover initial expenses
through entry load
Initial issue expenses
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Initial issue expenses
• Limit of 6% of initial resources raised under the scheme;excess expenses to be borne by AMC/sponsor
• CEF : Amortise on weekly basis until maturity• OEF : For an open-ended scheme, the initial issue
expenses are carried in the balance sheet of the fund as“deferred revenue expenses.” They are written off over aperiod not exceeding 5 years.
• A fund that does not charge any of the initial issue
expenses is called a no-load fund. AMCs can charge 1%higher investment management fee in this case.
• Open-ended fund should meet the expenses related tosales and distribution of schemes from the entry load andnot through initial issue expenses.
• In case of CEF, Investors exiting before expiry of period of
scheme will be charged unrecovered initial expenses• Conversion of CEF into OEF allowed only after recovery of
un-recovered initial expenses
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Amortisation – An example
Assume close ended fund of five years, collectsRs. 100 Cr. and incurs initial issue expenses of Rs 5 Cr.
Units issued = 10 cr
Investment = 95 cr
Initial NAV = [{95+((260/260)*5)} / 10 ]=10
After 4 weeks let the market value of investments = 98 cr
Therefore,
NAV = [{98+((256/260)*5)} / 10 ]=10.29
Impact of initial issue expenses on
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Impact of initial issue expenses onNAV
Assume open ended fund collects Rs. 100 cr
Entry load = 2.25%
Initial issue expenses = 5 cr
Impact on NAV
Initial NAV = Rs. 10 per unit
As no. of units allotted would be:
[{100 - (100*2.25%)} / 10 ]=9.775 cr
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Recurring / OperatingExpenses
• Investment management fees
• Custodian’s fees
• Trustee Fees
• Registrar and transfer agent fees• Marketing and distribution expenses
• Other Operating expenses
• Audit fees
• Legal expenses• Costs of mandatory advertisements
and communications to investors
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Limits on recurringexpenses
Recurring expenses can not exceedthe following regulatory limits: 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% Applied on the weekly average net assets of
the mutual fund scheme. On debt funds the limits on expenses are
lower by 0.25%. For fund of funds the limit on expenses is
0.75%
Investment (Asset) Management
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Investment (Asset) ManagementFees
AMC charges Asset management fees: thelimits as per SEBI regulations are as follows: For the first Rs. 100 crore of net assets: 1.25% For net assets exceeding Rs. 100 crore: 1.00% 1% higher fee for no load funds
Asset management fees are not in addition to but a partof recurring expenses
Asset management fees are usually lower for debtfunds as compared to equity funds and are disclosed inOD
Balance of Deferred Revenue Expenses not included innet assets for computing investment management feeIn other words un-amortized portion added for NAVcalculation as other asset but no AMC fee on thisamount
h b
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Expenses that cannot becharged
• Penalties and fines for infraction of laws.
• Interest on delayed payments to unit holders.
• Legal, marketing and publication expenses notattributable to any scheme.
• Expenses on investment and generalmanagement.
• Expenses on general administration, corporateadvertising and infrastructure costs.
• Expenses on fixed assets and softwaredevelopment expenses.
• Such other costs as may be prohibited by SEBI.
Disclosure and reporting
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Disclosure and reportingrequirements
• AMC to prepare annual report and annualstatement of account for each scheme
• Annual statement of account to be audited byan auditor independent of the auditor of AMC
• Within 6 months of accounting year, Fund shall
–Publish scheme wise abridged summaryof report in newspapers
–Mail summary of report to all unit holders
–Forward to SEBI annual audited accounts,
half yearly unaudited accounts, Quarterlyportfolio statement
–Display the scheme wise annual reportson their website & on AMFI website
–Mail Annual reports to all unit holders
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Accounting Policies
• Investments to be marked to market• Unrealized appreciation can’t be distributed
• Dividend/bonus recognized on the date shareis quoted ex-dividend/ex-bonus
• Average cost considered for determining
gain/loss on sale of shares• Purchase / Sale of investments recognized: On
the trade date , not on settlement date
• Debt investments to be taken as NPA :
–If interest or principal amount remains
unpaid for more than 3 months–E.g. if interest due 30th June 2000 remainsunpaid on 1/10/2000 it becomes NPA on1/10/2000
Provisioning of NPA Debt
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Provisioning of NPA – Debtsecurities
If interest remain unpaid for6 months
10% of BV
If interest remain unpaid for9 months
20% of BV
If interest remain unpaid for12 months
Another 20% of BV
If interest remain unpaid for15 months
Another 250% of BV
If interest remain unpaid for18 months
Balance 25% of BV
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Valuation norms
for mutual funds
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• Valuation norms prescribed by SEBI toprotect investors’ interests
• Valuation Norms Based upon fair portfolio valuation
Uniform across all funds
• SEBI Prescribed detailed valuation methodologies
in its fund regulations Mandates disclosure of valuation methods
used for investors’ information
Valuation norms for mutual funds
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• Valuation of traded shares done on the basis of traded price if not more than 30 days old
• Valuation of thinly traded shares (less than50000 shares or Rs. 5 lacs or less amount) isdone as per SEBI approved norms
• Valuation of non traded shares is done as perSEBI approved norms
• If thinly traded & Non traded equity securitiesexceed 5% of the total assets of the scheme,then independent valuer should be appointed for
valuation
Valuation of Shares
V l ti f Sh
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• If illiquid securities (non traded, thinly traded & unlisted
equity shares) exceed• 15% of net assets for open ended funds• 20% of net assets for close ended funds
Then Value is taken zero for securities in excess of 15% / 20% The above mentioned is also limit for valuation of illiquid
shares• Valuation mechanism for illiquid equity instruments is as
follows:o Calculate book value per shareo Calculate earning value per share based upon industry
P/E and discount it by 75%. (latest audited EPS be takenfor this purpose) as,
o Earning value per share=discounted P/E x audited EPSo Calculate fair value per share taking 90% of average of
book value and earning value per share
Valuation of Shares
V l ti A l
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Assume net worth / share = Rs. 8
Audited EPS = Rs 2Industry P/E = 12Discounted P/E for company = 25% of 12 = 3
(discounted up to 75%)
Value of share (2*3) = 6Average value (8+6) = 7Value to be taken = 90% of average value = 90%
of 7=Rs. 6.30
Remark:If EPS is negative or not available for within
previous nine months, it should be taken aszero
Valuation – An example
Val ation of traded debt sec rities
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• A debt security is treated as traded if tradedany day during the last 15 days
• Trading can be on a stock exchange orbetween institutions
• Publicly traded price or private placement priceif private placement is within last 15 days istaken as valuation price
• Market lot for trading in debt securities is 5 cr.•
A debt security if not traded in last 15 days iscalled not traded or thinly traded debt security
Valuation of traded debt securities
Valuation of thinly traded and non
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Debt instruments:• Less than 182 days maturity
• Valued at cost plus accrued interest and• Difference between redemption value and cost
uniformly spread over remaining life of instrument
• More than 182 days maturity• Government securities valued at prices released
by CRISIL• Investment grade debt securities valued on the
basis of YTM derived from CRISIL valuation matrix
• Non investment grade :– Performing asset valued at 25% discount to
their face value– NPA valued as per valuation norms for NPAs
Valuation of thinly traded and non-
traded debt securities
Yield to Maturity (YTM)
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• YTM is the internal rate of return on investment in
bond also called Gross Redemption Yield (GRY)• Internal rate of return is computed based on:
•Coupon rate
•Purchase price
•Period to maturity
• If purchase price is the same as face value of bond,
YTM will be the same as coupon rate• If purchase price is more than the face value, YTM will
be the lower than the coupon rate
• If purchase price is less than the face value, YTM willbe the more than the coupon rate
Yield to Maturity (YTM)
Calculating price of bond with given
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Given data:
Face value : Rs. 1000Coupon rate : 10%Tenure : 5 YrsInterest payment : yearly
Yield (YTM) : 8.72%
Calculate price of the bond:Cash flows under the bond and their presentvalues are as under
= [{100/(1+8.72)}+ [{100/(1+8.72)2}+ [{100/
(1+8.72)3}+ [{100/(1+8.72)4}+ [{(100+1000)/(1+8.72)5}]
Thus Price of Bond = Rs. 1050
Calculating price of bond with given
YTM – An example
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Taxation of mutualfunds
• Income for investors
–Dividend
–Capital gain
Taxation of MFs and
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Taxation of MFs andInvestors
• Finance Act 1999 radically changed taxation of dividends received by investors in MFs.
• MF as an entity is not taxed since it is a Pass Through Entity. (defined under Section 10 (23D) of the IT Act)
• Finance Act 1999 made income (dividends) fromunits totally exempt from tax u/s 10(33) in thehands of all the investors.
• Income (dividends) distributed by a debt fund wasmade liable dividend distribution tax (DDT) atapplicable rate of 10%
• Open ended funds with more than 50% invested inequity do not pay any DDT (since changed to 65%in FY 06-07)
Taxation of MFs and
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Investors
• Impact of DDT: Investor pays the tax indirectly, since NAV comes down to
the extend of tax paid by the fund DDT bears no relationship to the investor’s tax bracket. Dividend reinvested is also subject to DDT
In growth plans, DDT not applied, since no dividend isdistributed.
• Securities transaction tax (STT) is charged as applicable
• 80 C benefit for ELSS upto Rs. 1 lac
• Restriction on dividend stripping (Sec 94(7))
Within 3 months prior to record date of dividenddistribution and
Within 3 months after record date for dividenddistribution
Treatment of Capital Gains
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Treatment of Capital Gains
• Long term: > 12 months
• Short term: < 12 months• Long term capital gains subject to indexation
benefit 20% +surcharge after indexation 10% + surcharge without indexation
• Short term capital gains taxed at normal tax ratesas applicable to investors.
• U/s 111(a) of IT Act: No long term gains tax on equity oriented schemes if STT
charged Short term capital gains tax at 10% on equity oriented
schemes if STT charged
• Indexation benefit on unlisted bonds not available
Treatment of Capital Gains
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Treatment of Capital Gains
• No capital gain tax payable if entirecapital gain invested in capital gainbonds of NABARD, NHAI, REC under sec54 EC with a lock in of 3 years.
• Long term Capital gains exempt u/s 54ED if invested within 6 months in sharesof companies formed and registered inIndia with a lock in of 1 year.
Session 4: Capital Markets and
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Session 4: Capital Markets andMutual Funds – Investment
management• Managing Equity portfolios
Equity investment options Equity markets: issue of concern Investment strategies Successful equity portfolio management Risk hedging techniques: use of equity derivatives
• Managing Debt portfolios Debt market securities- types and characteristics Risks of investing in debt securities /bonds Yield and duration Investment styles
• Investment restrictions
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Managing Equity portfolios
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Equity Investment
• Investment Options Equity shares Preference shares Convertibles: Debentures or
preference shares Equity Warrants: give holders option
to purchase specified number of
shares at predetermined rate.
E it M k t I f
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Equity Markets: Issue of concern
• Concentration of marketcapitalization and liquidity (shares atBSE: Grp A-140, B1-1100, B2- 4500)
• High levels of volatility
• Information inadequacies: Disclosure of information Insider trading
• Lack of depth for large volumes
Investment Strategies: is aimed at
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to produce capital appreciation & earningsand rewarding investors with superiorreturns
• Large cap, Mid cap and small cap
• P/E ratios & Dividend yield
•
Cyclical , Growth and value stocks• Active fund management style and
passive fund management style
• Fundamental analysis, Technical
analysis and quantitative analysis• Use of equity derivatives
Large cap, Mid cap and small
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g p pcap• Large cap companies:
• High liquidity
• Low transaction costs
• Mid cap companies:• Moderate liquidity
• More transaction cost
• Small cap companies:• High profit potential
• High transaction costs
• High volatility
• There are different indices & benchmarksfor Large/ Mid / Small Cap
P/E ratios & Dividend yield and
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Cyclical, Growth and value stocks• P/E ratios :
• Higher the P/E, greater the growth potential• Dividend yield :
• Lower the dividend yield, Higher the growth potential
• Cyclical stocks:• Earnings linked with market cycles i.e. macro economic
factors• Growth stocks:
• Low asset base
• High growth potential
• High P/E – Low dividend yield
• Value stocks:• Large Asset base
• Long term good track records
• Moderate P/E & Moderate dividend yield
Passive fund management style and
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Active fund management style• Passive fund management style :
• Replicates a chosen index• Low fees• Low costs• Index linked returns
• Active fund management style :
• Aim for out -performance• Higher fees• Higher costs• Stock selection and timing:
– Growth investment strategy: Fund managerselects stocks of cos. Having potential of
above average rate of growth in earnings.– Value investment strategy: Fund manager
selects stocks of cos. With good track record,stability of earnings and are undervalued
Fundamental analysis, Technical
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yanalysis and quantitative analysis
• Fundamental analysis :• Seeks where to invest
• Research inputs based upon fundamentals of thecompany and its profit potential
• Technical analysis :• Seeks when to invest
• Analysis of market price and volumes basedupon demand and supply position & past trendcharts
•
Quantitative analysis :• Helps in choosing asset class
• Analysis of sectors and industries based uponmacroeconomic factors
Equity portfolio management
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organization structure
• Fund manager:– focuses on a certain location
– select stocks &
– fixes price range for purchase & sale
• Analysts:– researches companies and
– recommends buy & sell
• Dealers:
–collects market intelligence
– Places bye and sell orders with brokers
For Successful equity portfolio
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q y pmanagement
• Set realistic returns based on abenchmark
• Be aware of the flexibility in managing aportfolio
• Decide on investment philosophy• Develop an investment strategy based
upon objectives & time horizons
• Avoid over diversification of portfolio &
have well diversified portfolio• Develop a flexible approach to investing
• Ensure risk hedging techniques
Risk hedging techniques: use of equity
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g g q q yderivatives
• Mutual funds have been allowed to make useof futures & option contracts in equities for Portfolio risk management Portfolio rebalancing
• Since September 2005 SEBI has also allowedmutual funds to trade in derivative contracts, To enhance portfolio returns
To launch schemes which invest mainly infutures & options
What are equity derivatives?
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What are equity derivatives?
• Equity derivatives instruments are specially designed contracts• They derive their value from an underlying assets
• They are traded separately in F&O segment of exchange• Main derivative instruments are:
• Futures,• options
• In a future contract :• You can buy & sell the underlying equity
• at a specified future date• at agreed price
• In option contract:• The buyer of option contract gets the right to buy (call)
or right to sell (put)• The underlying equity
• At agreed price• On a future date• Only if he exercises the option &• For the right he pays a price called premium.
• Option contracts are of two types viz: call option & put option
Equity derivatives as risk hedging tools
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Equity derivatives as risk hedging tools
• If fund manager expects the equity market to decline:
He may not sell the equity in cash market rather He can sell the index future at the current future pricefor future delivery.
• If markets fall the equity portfolio will decline, But future contract will show a corresponding profit
since fund manager have sold future contract at ahigher price.
• This is called hedging portfolio risk with the use of futurecontracts.
• If market rise, instead of declining, the fund will not gainout of rise in the market prices as future contract will showcorresponding loss since fund manager has sold futurecontract at lower price.
• Other method of hedging investment portfolio is by buyinga put option (an option to sell the underlying equity at anagreed price) by paying premium.
• A fund manager has to decide whether to sell a futurecontract or to buy a put option depending upon the relativemerits of each.
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Managing Debt portfolios
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Debt securities: Othertypes
Features based:
• Fixed rate / floating rate debt
securities• Coupon bonds / cumulative bonds
• Listed bonds / un-listed bonds
• Rated bonds / un-rated bonds
• Secured / unsecured bonds
M k t iti
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Money market securities
• All debt securities maturingwithin one year are calledmoney market securities
•
Money market securities(instruments) are:• T-Bills
• CDs
• CPs• Call money
• Repos
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Debt Markets• Tenor
short and long put and call options
• Interest payment Fixed and floating Periodic vs discounted
• Credit quality
Gilt, guaranteed, and others• Traded and non-traded
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Price and Yield• Increase in rates reduces value of
existing bonds.
• Decrease in rates increases value of existing bonds
• Price and yield are inversely related
• The relationship between yield andtenor can be plotted as the yieldcurve.
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Current Yield and YTM• Coupon as a percentage of current
market price
•
If we bought a 8% bond at Rs. 110,the current yield is:
= (8/110)*100
= 7.27%
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Credit Risk• Probability of default by the
borrower
• Change in credit rating: downgrade increases the yield
and decreases the price
upgrade decreases the yield andincreases the price.
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Debt Portfolio
Management Styles• Buy and hold
Portfolio exposed to interest rate risk.
• Duration management increase duration if rates are expected to fall decrease duration if rates are expected to
rise
• Credit selection
invest in low grade bonds that are likely tobe upgraded.
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Investment Restrictions• Invest only in marketable
securities.
• Investment only on delivery basis• A mutual fund under all its
schemes, cannot hold more than10% of the paid-up capital of a
company.
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Investment Restrictions• Not more than 10% of its NAV in a single
company. Exceptions: Index Funds and Sectoral funds
• Rated investment grade issues of a singleissuer cannot exceed 15% of the net assets Can be extended to 20%, with the approval of
the trustees.
• Investment in unrated securities of one
company cannot exceed 10% of the netassets of a scheme and not more than 25%of net assets of a scheme can be in suchsecurities.
Investment in Sponsor
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pCompany
A mutual fund scheme cannot investin unlisted securities of the sponsoror an associate or group company of the sponsor.
A mutual fund scheme cannot investin privately placed securities of thesponsor or its associates.
Investment by a scheme in listedsecurities of the sponsor or associate
companies cannot exceed 25% of thenet assets of the scheme
Oth Li it
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Other Limits
• Mutual funds cannot make loans
• Mutual funds can borrow upto 20% of netassets for a period not exceeding 6 months.
• Derivatives can be used only after informing
investors
• Any change in investment objectives requiresinformation to investor, and provision of optionto exit at NAV, without exit load.
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Session 5: Risk and
Return• Return Methods
Change in NAV
Total Return Total Return with dividend re-investment CAGR
• Risk
Standard deviation Beta and Ex-Marks
• Benchmark and comparison
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Computing Returns• Sources of return
Dividend
Change in NAV• Return = Income earned for
amount invested over a givenperiod of time
• Standardise as % per annum
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Alternate Methodologies• Computing return
Percentage change in NAV. Simple total return ROI or Total return with
dividend re-investment
Compounded rate of growth
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Percentage Change in
NAV• Assume that change in NAV is the
only source of return.
• Example: NAV of a fund was Rs. 23.45 at
the beginning of a year Rs. 27.65 at the end of the year.
• Percentage change in NAV
= (27.65 – 23.45)/23.45 *100
= 17.91%
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Annualising the Rate of
ReturnIf NAV on Jan 1, 2001 was Rs. 12.75 and the
NAV on June 30, 2001 was Rs. 14.35,
Percentage change in NAV
= (14.35 – 12.75)/12.75 x 100
= 12.55%
Annualised return:
= 12.55 x 12/6
= 25.10%
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Total ReturnInvestor bought units of a mutual fund
scheme at a price of Rs.12.45 per unit.
He redeems the investment a year later,at Rs. 15.475 per unit.
During the year, he also receives dividendat 7%.
The rate of return on his investment canbe computed as
=((15.475 – 12.45) + 0.70)/12.45 x 100
= (3.725/12.45) x 100
= 29.92%
Total Return or ROIMethod
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Method
• (Value of holdings at the end of the period - value of holdings at the beginning of the period)/ value of holdings at the beginning of the period x 100
• Value of holdings at the beginning of the period =
number of units at the beginning x begin NAV.• Value of holdings end of the period = (number of
units held at the beginning + number of units re-invested) x end NAV.
• Number of units re-invested = dividends/ex dividendNAV.
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ROI Method: ExampleAn investor buys 100 units of a fundat Rs. 10.5 on January 1, 2001. On
June 30, 2001 he receives dividendsat the rate of 10%. The ex-dividendNAV was Rs. 10.25. On December31, 2001, the fund’s NAV was Rs.12.25.
What is the total return oninvestment with dividends re-invested?
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ROI Method: Solution
• The begin period value of the investmentis
= 10.5 x 100 = Rs. 1050
• Number of units reinvested
= 100/10.25 = 9.756 units
• End period value of investment
= 109.756 x 12.25 = Rs. 1344.51
• The return on investment is
=(1344.51-1050)/1050 x 100
= 28.05%
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Compounded Average Growth
Rate
• CAGR is the rate at which investmenthas grown from begin point to the endpoint, on an annual compounding basis.
V0(1+r)n = V1
r =((V1/V0)1/n )-1
Where n is the holding period in years.
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CAGR: Example 1
An investor buys 100 units of a fundat Rs. 10.5 on January 6, 2001. On
June 30, 2001 he receives dividendsat the rate of 10%. The ex-dividendNAV was Rs. 10.25. On March 12,2002, the fund’s NAV was Rs.
12.25.
Compute the CAGR.
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CAGR: Solution
• The begin period value of the investment is
= 10.5 x 100 = Rs. 1050• Number of units reinvested
= 100/10.25 = 9.756 units
• End period value of investment
= 109.756 x 12.25 = Rs. 1344.51
• Holding period = 6/01/01 - 12/3/02
= 431 days
• The CAGR is
=(1344.51/1050)365/431 - 1 x 100
= 23.29%
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Returns: Industry Practice
• Growth Option: CAGR implicit in thechange in holding period NAVs.
• Dividend Option: CAGR implicit in
the change in value over the holdingperiod, assuming re-investment of dividend at ex-dividend NAV.
• Less then 1 year, simple return
without compounding orannualisation.
• Some funds use simple annualisedreturn, without compounding.
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SEBI Regulations
• Standard measurements andcomputation
• Compounded annual growth ratefor funds over 1 year old.
• Return for 1,3 and 5 years, or since
inception, which ever is later.• No annualisation for periods less
than a year.
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Risk in Mutual Fund
Returns• Risk arises when actual returns are
different from expected returns.
•
Historical average is a good proxyfor expected return.
• Standard deviation is an importantmeasure of total risk.
•
Beta co-efficient is a measure of market risk.
• Ex-marks is an indication of extent of correlation with market index.
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Benchmarks
• Relative returns are important thanabsolute returns for mutual funds.
• Comparable passive portfolio is used asbenchmark.
• Usually a market index is used.
• Compare both risk and return, over thesame period for the fund and the
benchmark.• Risk-adjusted return, is the return per
unit of risk.
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SEBI Guidelines
• Benchmark should reflect the assetallocation
• Same as stated in the offer document
• Growth fund with more than 60% in equityto use a broad based index.
• Bond fund with more than 60% in bonds touse a bond market index.
• Balanced funds to use tailor-made index• Liquid funds to use money market
instruments.
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Other Measures of
Performance• Tracking error
Tracking error for index funds should be nil.
•
Credit quality Rating profile of portfolio should be studied
• Expense ratio Higher expense ratios hurt long term investors
• Portfolio turnover Higher for short term funds and lower for longer
term funds.
• Size and portfolio composition
Session 6: Financial
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Session 6: FinancialPlanning and MutualFunds
• Concept of financial planning• Mapping life cycles and wealth
cycles of investors• Financial products
• Investment Strategies for Investors• Asset allocation
Concept of Financial Planning
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p g
Financial planning process involves following
steps:
• Study client’s profile• Identifies all the financial needs of client• Translates the needs into monetarily
measurable goals e.g. Need of Rs. 30 lakhafter 5 yrs for purchase of house property• These goals can be short term, medium term
and long term• Recommend Asset mix (asset allocation) /
Portfolio under the framework of client's profile
• Implement recommendations and review theperformance time to time and suggestchanges in changed circumstances toaccomplish desired goals in time.
Assessing client’s profile
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Parameters to assess:
•
Age, gender, physical status• Source of income & nature of income : steady or
fluctuating & Level of income
• Details of recurring expenses and life style (habits of spending) to assess all time liquidity need.
• Risk tolerance level or risk appetite• Tax status
• Current savings & Investments
• Details of Assets & Liabilities
• Family details & number of dependents
Note: Structured questionnaire should be used toassess client’s profile and risk tolerance level
Objective of Financial Planning
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Objective of Financial Planning
The ultimate objective of financialplanning is to ensure that the right amountis available at right time to meet definedfinancial goal.
Thus financial planning comprises of :
• Defining financial goals
• Recommending and implementingappropriate assets mix
• Reviewing performances and makesuitable changes to achieve definedfinancial goals.
Who is a Financial Planner
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Who is a Financial Planner(FP)?
• Is a person who uses the financialplanning process to help anotherperson determine how to meet his
or her financial goals• Key functions of a FP is to help
people identify their financialneeds, priorities and the products
that are most suitable to meettheir needs
Role of a FinancialPlanner?
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Financial planner Assets mix
Financial
Assets
PhysicalAssets
Client
ConsultM k
texpe
rts**
** Market experts are those having knowledge about market& products. E.g. Brokers/PMS provider/Mf advisor, insurance
advisor, property dealer, bullion mkt dealer etc,
Benefits of FinancialPlanning
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• Financial planning provides directionand meaning to financial decisions
• Financial decisions comprises of
financing and investment decisions toattain financial goals
g
Importance of FinancialPlanning
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• Financial goals are meant to fulfill human needswhich comprises of physical, social and spiritual
needs.• Physical need to remain fit and fine, social need to
fulfill family responsibility and spiritual need toattain peace & happiness which comes throughlove, affection, freedom and space which in turncomes from power/influence (intangible attribute)
and authority (tangible attribute) in society• The above mentioned needs involve cost viz.
survival cost (for basic need & reasonable std of living), social cost (for education, marriage,settlement etc. of family members) and protectioncost (for post retirement life and health care etc.)which in turn require sufficient liquidity,Investments, and variety of insurance.
• Financial planning helps in realizing above
Common mistakes inFinancial Planning (FP)
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• Measurable financial goals are not set• Financial decisions made in isolation• FP is confused with investing• Financial plans are not re-evaluated
periodically• Considered relevant only for wealthy• FP is required only when clients get older
• FP is considered same as retirementplanning and estate planning
• FP is primarily tax planning• Only after a crisis FP is started• Expectation of unrealistic returns on
investments
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MFs in Financial Planning
• Forms the core foundation andbuilding block for any type of FP
•
Variety of products available tosuit any need or combination of needs
• Barring life and property
insurance, rest of the productportfolio can be created out of bouquet of MFs
Wh h ld F d
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• Strong potential demand for suchservices
• Limited supply of financial planners
• Ability to establish Long termrelationships
• Ability to build a profitable business
Why should a Fund
distributor become an FP
Att ib t f G d
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Attributes of a Good
Financial PlannerUnderstands:
• The universe of investment products
• Risk-return attributes
• Tax and estate Planning
• Has the ability to convert life cycles of investors into need and preferencebased financial products
• Organised approach to work• Excellent communication and
interpersonal skills
Process of FP in Practice
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• Step I: Establish and define therelationship with the client
• Step II: Gathering client’s data,
Define the client’s goals
• Step III: Analyze and evaluateclient’s financial status
• Step IV: Determine and shapethe client’s risk tolerance level
Process of FP in practice
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p
• Step V: Ascertain client’s tax situation
• Step VI: Recommend the appropriateasset allocation and specificinvestments
• Step VII: Executing the plan & makingthe client invest
• Step VIII: Review the progress &portfolio rebalancing
Mapping life cycles and wealth cycles of investors
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The life cycle stages of an investor can be
classified as follows:– Childhood stage
– Young unmarried stage
– Young married with children stage
– Married with older children stage
– Post-family/Pre-retirement stage
– Retirement stage The income level of investors, the saving potential,
the time horizon and the risk appetite of an investordepend on his life cycle.
Younger investors have higher income and saving
potential, take longer-term view and may be willing totake risks.
Older investors may have limited income and saving,shorter time horizon, and unwilling to risk theirsavings.
Life Cycle Stages
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Birth &
Education
Earning Years Retirement
(0-22) Yrs (23-60) Yrs (61-90)Yrs
EXPENSES
Marriage
Child’s birth
Child’s
education
Child’s
marriage
I
N
C
O
M
E
Mapping life cycles and wealth cycles of investors
Continue
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Continue……. There are 3 wealth cycle stages for investors:
• Accumulation stage is when investors are earning and havelimited need for investment income. They focus on savingand accumulating wealth for the long term. Equityinvestments 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 haveboth debt and equity.
• Reaping stage or distribution stage in when investors needthe income from their investment, and cannot save further. They reap the benefits of their savings. They prefer debtinvestments and preserving of capital at this stage.
Mapping life cycles and wealth cycles of investors
Continue
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Continue…….
• Inter generational fund transfer refers totransfer of wealth to an investor. Thepreferred investment avenue willdepend on the life cycle and wealth
cycle stage of the beneficiaries.• Sudden wealth surge refers to winningsin games and lotteries. Investors shouldbe advised to temporarily park theirfunds in money market investments andcreate a long-term plan after thinkingthrough the plan.
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Investment Products:There are two broadcategories of products
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categories of products
available:Physical Assets:
Gold ,Real Estate, Fine Arts, Commodities
Financial Assets:
• Bank Deposits, CPs, CDs• Corporate –Shares, Bonds, Debentures & Fixed
Deposits
• Government – G. Secs, PPF, RBI Relief Bondsand other post office savings-KVP,NSC etc.
• Financial Institutions – Bonds, Shares• Insurance Companies – Insurance Policies
Physical Assets:
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• Individuals can invest in physical assets e.g. Gold andReal estate
• Govt. has permitted issue of gold bonds by banks
• Gold bonds represent securitization of gold where theyearn some returns and avoid risks associated withstorage of gold
• Investors are likely to be allowed to invest in goldlinked unit schemes
• Real estate MF are also in the offing which will offer theinvestors the twin benefits of Real estate investing & Mutual fund investing
Investment Products:Guaranteed and Non-
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guaranteed Investments
Guaranteed Investments: Capital Protectionand interest rates are guaranteed by theborrower
• Bank deposits• Government savings instruments
Non Guaranteed Investments : Capitalprotection and Interest rates are Notguaranteed
• Mutual funds
• Equity investments
Evaluating Financial products
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Product Risk Liquidity Return Volatility
Equity High High/Low High-Mod. High
FI Bonds Low Moderate Mod-high Moderate
Debentures Medium Low Mod.-Low Moderate
Corp. FD Medium Low Moderate LowBank Deposit Low High Low-High Low
PPF Low Moderate Moderate Low
Life ins. Low Low Low-Mod Low
Gold Low Moderate Mod-Low High
Real estate Medium Low High-Low High
MF H-M-LOW High High Moderate
Investor’s perspectives : MF’s v/s Other
products
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Product Investmentobjective
Risk tolerance
Timehorizon
Equity Capital appre. High Long term
FI Bonds Income Low Med-Long
Debentures Income Medium Med-LongCorp. FD Income Medium Medium
Bank Deposit Income Low Flex-All terms
PPF Income Low Long
Life ins. Risk cover Low Long
Gold Inflation hedge Low Long
Real estate Inflation hedge Medium Long
MF Cap.,gwth,incmeH-M-LOW Flex-All terms
products
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Bank Deposits
• Available since a long period of time
• Large geographical network –transactions made easy & convenient
•
Fund transfer mechanism available• Perception of bank deposits being free of default; Deposits guaranteed up to Rs 1lakh per depositor
• Electronic facilities make it liquid and
easy to use
PPF
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• 15 years deposit product madeavailable through banks.
• 9% p.a. interest payable onmonthly balances
• Minimum Rs. 100 & maximum Rs.60,000 p.a investment allowed.• Tax benefits u/s 80C under IT Act.
Limited by taxable income slabs.
•
Interest receipt and withdrawal of principal exempt from tax.• Limited liquidity available.
RBI Relief Bonds
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• Issued by banks on behalf of theRBI
• Tenure of five years
• 8% p.a. interest payable
• Proposed to be converted tofloating rate instrument linked togovernment yields
• Option to receive or reinvest
interest• Interest income exempt from tax
Other Government
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Other Government
Schemes• IVP & KVP issued by central
government & sold by post offices
• Interest is taxable
• Investor identity is protected andinvestment in cash is possible
Other Government
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Other Government
Schemes• Post office savings and RD – gives
fixed rate of interest but are notliquid.
• These are governmentguaranteed deposits
• Attractive for their safety and
cash investment options
Instruments issued by
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Instruments issued by
Companies
• Commercial Paper
• Debentures• Equity Shares
• Preference Shares
• Fixed Deposits
• Bonds of FI
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How to Compare Products
• Compare products by nature of investments – Characteristics,benefits and risks.
• Current performance andsuitabilityon the basis of Taxability, age &risk profile of Investors.
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Why MF is the Best Option
• Mutual funds combine theadvantages of each of theinvestment products
• Dispense the short comings of theother options
• Returns get adjusted for the
market movements
Investment Strategies forIn estors
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Investors
Basic strategy:
• Harness the power of
compounding by choosing growthoption for long term
• Start early
•
Have realistic expectations• Invest regularly
Investment Strategies forInvestors
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Continue…….• Buy and hold strategy which is preferred by many investors,
may not be beneficial because investors may not weed outpoor performing companies and invest in better performingcompanies , it is the fund manager who takes the decisionbut this strategy can be adopted for good mutual fundschemes
• Rupee-cost averaging (RCA) involves the following: A fixed amount is invested at regular intervals More units are bought when price is low and fewer units
are bought when price is high. Over a period of time, the average purchase price of the
investor’s holdings will be lower than if one tries to guessthe market highs and lows• RCA does not tell indicate when to sell or switch from one
scheme to another. This is a disadvantage.• Investors use the Systematic investment plan to implement
RCA.
Investment Strategies forInvestors
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Continue…….• Value averaging involves the following:
A fixed amount is targeted as the desired value of theportfolio at regular intervals.
If markets have moved up, the units are sold and the targetvalue is restored.
If markets move down, additional units are bought at thelower prices.
Over a period of time, the average purchase price of theinvestors holdings will be lower than if one tries to guess themarket highs and lows
• Value averaging is superior to RCA, because it enablesthe investor to book profits and rebalance the portfolio.
• Investors can use the systematic withdrawal andautomatic withdrawal plans to implement value investing.• Investors can also use a money market fund and an
equity fund to implement value averaging.
Asset Allocation
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• Asset allocation is basic tool to translate financial
plans into action.
• Asset allocation is about allocating money betweenequity, debt and money market segments.
• Asset allocation varies from investor to investor
depending on their situation, financial goals and riskappetite.
• Equity, debt and money market products are calledasset classes. Allocating resources to each of theseis called asset allocation.
• The asset allocation for an investor will depend onhis life cycle and wealth cycle.
Asset Allocation Strategies:
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• Asset allocation strategy differ forinvestors depending upon: Their financial situation Financial goals and, Risk appetite
• Investors can have following strategies:• Fixed v/s flexible asset allocation strategy
• Tactical asset allocation strategy
• Benjamin Graham’s 50/50 balance strategy forAsset Allocation
• Bogle’s strategic asset allocation strategy
Fixed and Flexible Asset Allocationstrategy
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• Fixed ratio between asset classes
Portfolio has to be periodically re-balanced Disciplined approach Enables investor to book profits in a rising
market and invest more in a falling market.
• Flexible allocation
No re-balancing; asset class proportions canvary when prices change.
If equity returns are higher than debt returns,equity allocation will go up at a faster rate.
• Fixed ratio approach works better in bullmarkets
Tactical asset allocation strategy
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• Change in asset allocation percentagesbased on fund manager’s views on thefuture movements in asset prices.
• May invest more in shares of small
companies than large companies• Fixed ratio approach works better in
bull markets
Benjamin Graham’s 50/50 balancestrategy for Asset Allocation
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50/50 split between equities and bonds-
A common sense approach
Conservative investment approach
When value of equity goes up, balance restoredby liquidating part of equity portfolio or vice versa
Good to get half the returns of a rising marketand avoid the full losses of a falling market
Bogle’s strategic asset allocationstrategy
B l d h f ll i f b id d i i
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• Bogle recommends the following factors to be considered in strategic assetallocation strategy for investors:
– Age
– Financial circumstances
– Objectives
Older investors in distribution phase - 50% equity; 50% debt Younger investors in distribution phase - 60% equity; 40% debt Older investors in accumulation phase - 70% equity; 30% debt Younger investors in accumulation phase - 80% equity; 20% debt
• Bogle’s rule of thumb for asset allocation: Debt portion of an investor’s portfolio to be equal to his age. E.g. 30 Yrs old investor - 70/30 (Equity/ Debt Allocation)
Session 7: Recommendingd l tf li d
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model portfolios and
selecting the right funds
•
Model portfolios• Fund selection
Developing a Model Portfolio
d l f li id l h f h
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A model portfolio creates an ideal approach for the
investors’ situation and is a sensible way to invest.
Steps in developing a model portfolio for the investors:
• Develop long term goals
– Investment avenues, time horizon, return and risk
• Determine asset allocation
– Allocation to broad asset classes
• Determine sector distribution
– Allocation of sectors of the mutual fund industry
• Select specific fund schemes for investment
– Compare products and choose actual funds to invest in
Developing a Model Portfoliocontinue…..
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Bogle recommends that age, risk profile and preferenceshave to be
combined in asset allocation
• Older investors in distribution phase - 50% equity;50% debt
• Younger investors in distribution phase - 60% equity;40% debt
• Older investors in accumulation phase - 70% equity;
30% debt• Younger investors in accumulation phase - 80%
equity; 20% debt
Developing a Model Portfoliocontinue…..
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Model portfolios according to life cycle stage:
• Young unmarried professional: 50% in aggressive equityfunds,25% in high yield bond funds, growth and incomefunds,25% in conservative money market funds
• Young couple with 2 incomes and 2 children: 10% inmoney market funds,30% in aggressive equity funds,25%
in high yield bond funds and long-term growth funds,35%in municipal bond funds
• Older couple in single income:30% in short term municipalfunds,35% in long term municipal funds,25% in moderatelyaggressive equity,10% in emerging growth equity.
• Recently retired couple:35% in conservative equity funds
for capital preservation/income,25% in moderatelyaggressive equity for modest capital growth,40% in moneymarket funds
Developing a Model Portfoliocontinue…..
J b’ M d l P tf li
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Jacob’s Model Portfolios
• Accumulation phase– Diversified equity: 65 - 80%
– Income and gilt funds: 15 - 30%
– Liquid funds: 5%
•transition phase:– They will benefit from the income component of
their asset allocation.
• Distribution phase
– Diversified equity: 15 - 30%
– Income and gilt funds: 65 - 80%– Liquid funds: 5%
Developing a Model Portfoliocontinue…..
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Recommended portfolio for investors in inter-generational transition phase Investors who plan to leave behind wealth for their
heirs, tend to create portfolios that serve the needs of the heirs:
• Growth and income funds in a balanced manner forgrown up heirs
• Higher percentage of growth funds could be appropriateif the heirs are young.
• In case of trusts and charities, income funds would be
more appropriate.• In case of wealth surge, it is advisable to keep the money
in liquid avenues, while deciding a long term plan.
Developing a Model Portfoliocontinue…..
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Recommended portfolio for investors foraffluent investors: In case of wealth creating affluent investors, who
are focused on setting aside a good part of theirwealth in savings, 70-80% allocation to sectoral
and growth funds should be recommended. Theseinvestors do not have immediate incomerequirements, and can bear higher risks.
Incase of wealth preserving affluent investors, whodo not like to take risks, and want to conserve their
funds, 70-80% exposure to income, gild and liquidfunds would be appropriate. The remaining fundscan be invested in diversified equity or balancedfunds. These investors are risk-averse.
Fund Selection
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Fund selection refers to theactual choice of funds
according to the chosenmodel portfolio for theinvestor.
Fund Selection
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Equity funds: Characteristics Fund category – the fund chosen should be
suitable to investor objective Investment style – Choose between growth
and value depending on investor’s riskperception
Age of the fund – Experienced funds arepreferred to new funds
Fund management experience –Track recordof the fund managers is important
Size of the fund – Larger funds have lowercosts Performance and risk – risk adjusted
performance matters
Equity Funds: SelectionCriteria
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Percentage holding in cash should be low –Funds can always sell liquid stocks forliquidity requirements.
Concentration in portfolio should be low – Anequity 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 exploitationof opportunities. Low turnover representspatience and stable investments.
Equity Funds: SelectionCriteria
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Risk Statistics• Beta – represents market risk, higher
the beta higher the risk.
• Ex-Marks – represents correlation withmarkets – higher the ex-marks, lower
the risk. A fund with higher ex-marks isbetter diversified than a fund withlower ex-marks.
• 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
Debt Funds: SelectionCriteria
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• A smaller or new debt fund may notnecessarily be risky.• 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 rating of the
holdings, safer the fund.• Average maturity - Higher average
maturity means higher duration and
interest rate risk. Funds with higheraverage maturity are more risky than fundswith lower average maturity.
Money Market Funds: SelectionCriteria
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• Liquidity and high turnover rate is high.
• Shorter-term instruments are turnedover more frequently.
•
Protection of principal invested isimportant.
• NAV fluctuation limited due to lowduration and lack of interest rate risk.
• Credit quality of portfolio should be
high.• Low expense ratio is important.
Recommended