2-Evolution of Mutual Funds

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Evolution of Mutual Funds


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History of Mutual Funds

The first mutual funds were established in Europe. One researcher creditsa Dutch merchant with creating the first mutual fund in 1774.

The first mutual fund outside the Netherlands was the Foreign & Colonial

Government Trust, which was established in London in 1868. It is now theForeign & Colonial Investment Trust and trades on the London stockexchange.

Mutual funds were introduced into the United States in the 1890s. Theybecame popular during the 1920s. These early funds were generally of theclosed-end type with a fixed number of shares which often traded at pricesabove the value of the portfolio.

The first open-end mutual fund with redeemable shares was establishedon March 21, 1924. This fund, the Massachusetts Investors Trust, is nowpart of the MFS family of funds.

However, closed-end funds remained more popular than open-end fundsthroughout the 1920s. By 1929, open-end funds accounted for only 5% ofthe industry's $27 billion in total assets.

After the stock market crash of 1929, Congress passed a series of actsregulating the securities markets in general and mutual funds in particular.


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The Securities Act of 1933 requires that all investments sold to the public,including mutual funds, be registered with the Securities and ExchangeCommission and that they provide prospective investors with a prospectus

that discloses essential facts about the investment. The Securities and Exchange Act of 1934 requires that issuers of

securities, including mutual funds, report regularly to their investors; thisact also created the Securities and Exchange Commission, which is theprincipal regulator of mutual funds.

The Revenue Act of 1936 established guidelines for the taxation of mutualfunds, while the Investment Company Act of 1940 governs their structure.

When confidence in the stock market returned in the 1950s, the mutualfund industry began to grow again. By 1970, there were approximately 360funds with $48 billion in assets.

The introduction of money market funds in the high interest rateenvironment of the late 1970s boosted industry growth dramatically. Thefirst retail index fund, First Index Investment Trust, was formed in 1976 byThe Vanguard Group, headed by John Bogle; it is now called theVanguard 500 Index Fund and is one of the world's largest mutual funds,

with more than $100 billion in assets as of January 31, 2011.


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Fund industry growth continued into the 1980s and 1990s, as a result ofthree factors: a bull market for both stocks and bonds, new productintroductions (including tax-exempt bond, sector, international and target

date funds) and wider distribution of fund shares. In 2003, the mutual fund industry was involved in a scandal involving

unequal treatment of fund shareholders. Some fund managementcompanies allowed favored investors to engage in late trading, which isillegal, or market timing, which is a practice prohibited by fund policy. Thescandal was initially discovered by then-New York State Attorney GeneralEliot Spitzer and resulted in significantly increased regulation of theindustry.

At the end of 2010, there were over 15,000 mutual funds of all types in theUnited States with combined assets of USD 13.1 trillion, according to theInvestment Company Institute (ICI), a national trade association ofinvestment companies in the United States. The ICI reports that worldwidemutual fund assets were USD 24.7 trillion on the same date.

Mutual funds play an important role in US household finances. At the endof 2010, they accounted for 23% of household financial assets. Their role

in retirement planning is particularly significant as roughly half of assets inindividual retirement accounts were invested in mutual funds.


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Top 10 Global Mutual Funds

BlackRock - USD 3.5 trillion

J P Morgan Chase - USD 2.3 trillion

State Street Global Advisors - USD 2 trillion

PIMCO - USD 1.8 trillion

Vanguard USD 1.7 trillion

Fidelity

USD 1.5 trillion American Funds (Capital Research) - USD 1 trillion

Franklin Templeton - USD 1 trillion

T. Rowe Price - USD 541.7 billion

Federated Investors - USD 351.7 billion


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MF Industry in US

In the United States, a mutual fund is registered with the Securitiesand Exchange Commission (SEC) and is overseen by a board ofdirectors (if organized as a corporation) or board of trustees (if

organized as a trust). The board is charged with ensuring that the fund is managed in the

best interests of the fund's investors and with hiring the fund managerand other service providers to the fund.

The fund manager, also known as the fund sponsor or fundmanagement company, trades (buys and sells) the fund's investmentsin accordance with the fund's investment objective. A fund manager

must be a registered investment advisor. Funds that are managed by the same fund manager and that have the

same brand name are known as a "fund family" or "fund complex". Mutual funds are not taxed on their income as long as they comply

with requirements established in the Internal Revenue Code.Specifically, they must diversify their investments, limit ownership ofvoting securities, distribute most of their income to their investors

annually, and earn most of the income by investing in securities andcurrencies.


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MF Industry in US

Mutual funds pass taxable income on to their investors annually. Thetype of income they earn is unchanged as it passes through to theshareholders. For example, mutual fund distributions of dividend

income are reported as dividend income by the investor. There is anexception: net losses incurred by a mutual fund are not distributed orpassed through to fund investors.

Mutual funds may invest in many kinds of securities. The types ofsecurities that a particular fund may invest in are set forth in the fund'sprospectus, which describes the fund's investment objective,investment approach and permitted investments.

The investment objective describes the type of income that the fundseeks. For example, a "capital appreciation" fund generally looks toearn most of its returns from increases in the prices of the securities itholds, rather than from dividend or interest income.

The investment approach describes the criteria that the fund manageruses to select investments for the fund.

A mutual fund's investment portfolio is continually monitored by the

fund's portfolio manager or managers, who are employed by the fund'smanager or sponsor.


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Some Fact & Figures of the Mutual

Funds Industry in US

The US mutual fund market with USD 11.6 trillion in assetsunder management at year-end of 2011 remained the largest inthe world, accounting for 49% of the USD 23.8 trillion in mutual

fund assets worldwide. Equity funds made up 45% of US mutual fund assets at year-

end 2011. Domestic equity funds (those that invest primarily inshares of U.S. corporations) held 33% of total industry assetswhereas World equity funds (those that invest primarily in non-domestic corporations) accounted for another 12%.

Bond funds accounted for 25% of US mutual fund assets.Money market funds (23%) and hybrid funds (7%) held theremainder of total US mutual fund assets.

More than 650 sponsors managed mutual fund assets in theUS in 2011. Long-run competitive dynamics have preventedany single firm or group of firms from dominating the market.

For example, of the largest 25 fund complexes in 1990, only 13remained in this top group in 2011.


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Some Fact & Figures of the Mutual

Funds Industry in US

The decline in the value of US fund assets was accentuated bynet outflows from money market funds. Overall, mutual funds

reported USD 100 billion of net outflows in 2011. Investors pulled USD 124 billion from money market funds, but

added USD 24 billion to long-term mutual funds. In addition,mutual fund shareholders reinvested USD 176 billion of incomedividends and USD 68 billion of capital gains distributions thatmutual funds paid out during the year.

Investor demand for exchange-traded funds (ETFs) was onpace with the previous year, with net share issuance (includingreinvested dividends) of USD 118 billion. Unit investment trusts(UITs) had new deposits of USD 36 billion and closed-endfunds issued USD 15 billion in net new shares during 2011,both up from 2010.


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MF Industry in India

The mutual fund industry in India started in 1963 with the formation of UnitTrust of India, at the initiative of the Government of India and Reserve Bank ofIndia. The history of mutual funds in India can be broadly divided into fourdistinct phases.

First Phase (1964-87) - Unit Trust of India (UTI) was established on 1963 byan Act of Parliament. It was set up by the Reserve Bank of India and functionedunder the Regulatory and administrative control of the Reserve Bank of India.In 1978 UTI was de-linked from the RBI and the Industrial Development Bankof India (IDBI) took over the regulatory and administrative control in place ofRBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of1988 UTI had Rs.6,700 crores of assets under management.

Second Phase (1987-1993) (Entry of Public Sector Funds) - 1987 markedthe entry of non- UTI, public sector mutual funds set up by public sector banksand Life Insurance Corporation of India (LIC) and General InsuranceCorporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fundestablished in June 1987 followed by Canbank Mutual Fund (Dec 87), PunjabNational Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bankof India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established itsmutual fund in June 1989 while GIC had set up its mutual fund in December1990.At the end of 1993, the mutual fund industry had assets undermanagement of Rs.47,004 crores.


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MF Industry in India Third Phase 1993-2003 (Entry of Private Sector Funds) - With the entry of private

sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indianinvestors a wider choice of fund families. Also, 1993 was the year in which the first MutualFund Regulations came into being, under which all mutual funds, except UTI were to beregistered and governed. The erstwhile Kothari Pioneer (now merged with Franklin

Templeton) was the first private sector mutual fund registered in July 1993. The 1993 SEBI(Mutual Fund) Regulations were substituted by a more comprehensive and revised MutualFund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund)Regulations 1996. The number of mutual fund houses went on increasing, with manyforeign mutual funds setting up funds in India and also the industry has witnessed severalmergers and acquisitions. As at the end of January 2003, there were 33 mutual funds withtotal assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assetsunder management was way ahead of other mutual funds.

Fourth Phase since February 2003 - In February 2003, following the repeal of the Unit

Trust of India Act 1963 UTI was bifurcated into two separate entities. One is the SpecifiedUndertaking of the Unit Trust of India with assets under management of Rs.29,835 croresas at the end of January 2003, representing broadly, the assets of US 64 scheme, assuredreturn and certain other schemes. The Specified Undertaking of Unit Trust of India,functioning under an administrator and under the rules framed by Government of India anddoes not come under the purview of the Mutual Fund Regulations. The second is the UTIMutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI andfunctions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTIwhich had in March 2000 more than Rs.76,000 crores of assets under management and

with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations,and with recent mergers taking place among different private sector funds, the mutual fundindustry has entered its current phase of consolidation and growth.


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Future of Indian MF Industry

Investor Education

High Penetration

KYC Hurdles

Lack of right kind of Product Innovation

Entry Barriers to new Mutual Funds

Disproportionate incentives in competing products Focus on institutional money rather than retail

money

Preference for a Push Model over a Pull Model


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2-Evolution of Mutual Funds