Training on Mutual Fundsfor AMFI Certification

Uma ShashikantPrudential ICICI AMC Ltd

About the NCFM-AMFI ExaminationThe exam is now available in 2 languages : Hindi and English.Candidates can take the computer based exam at the NSE centers or the written exams arranged by Prudential ICICI or UTI, and conducted by UTIICM.The computer based exam is only in English. The written exam is in English and Hindi.Last date to clear the exam is December 31, 2003 for employees of mutual funds who deal with customers (Sales, marketing and customer care).

Format of the ExamMultiple choice examination Example:The NAV of an open-ended fund has to be disclosedEvery FridayEvery MondayEvery DayNone of the aboveAll questions are multiple choice with four or five options.

MarksThe paper has 69 questions, with 38 questions of 1 mark each and 31 questions of 2 marks each.Candidates have to score a minimum of 50% to pass.A wrong answer will lead to negative marking of 25%. If you get a 2 mark question wrong, you loose 2 marks for getting it wrong, and 0.5 marks as penalty for the wrong answer (25% of 2). The marks for each question is given along with the question.

Question paper designEach chapter has a weightage: not disclosed. Read the whole book. The question bank has questions stored for each chapter.The paper is generated by the computer, by randomly choosing from the bank.The question paper for each candidate is different. In the written exam, there are 5 sets of papers in the hall.

Chapters and Weightages

Sheet1

Chapter NumberQuestionMarks

21Fiduciary relationship means: beenficial interest2

31Characteristic of open ended funds1

181Functions of the registrar1ChapterNo of questionsNo of marks

331Which was the first mutual fund?11&26738

661Open ended fund13&42331

322Benchmark for debt funds2544

582Trustees Approve gen due diligence16,7,8,91422

303AMFI code of ethics110,11,12710

373What can an SRO do?113,1446

623Merger of funds115,16711

643Regulation by stock exchnage117 - 222537

124Offer document: Investment options269100

154Items on offer document cover page1

204Rights of a prospective investor1

214Offer document: peer comparison not there2

224Problem sum on capital gains tax2

244Investor rights: cannnot sue for performance1

254Due diligenc ecertificate2

284Jurisdictio for legal recourse : OD or KIM?1

344OD: Charitable Trust1

384Commission is paid to agents to2

424Can divestment proceeds be paid in cash2

454Who can sell MFS?2

564Who approves appmt of agent1

634Recourse for not reading OD2

295Objectives of a value fund2

315Interest rate changes depend on1

355Inflations impact on returns1

595Duration and int rate risk problem2

615Active equity fund manager1

655Equity fund management dividend yield2

76Expenses of a RS. 1000 crore fund2

105Limits on MF borrowing1

146Valuation of debt instruments1

446NAV calculation2

476Why has SEI liad down valn norms1

47Problem on simple total return2

177Total return methoid advantage1

527When inte rate flcutuates, which is volatile2

537Equity and debt funds risk1

547Performance mesurement with respect to2

557Performance if 20% market move beta or R2?2

677Tracking fudn perforamnce1

18Which is not an advantage of value averaging?2

58Rupee cost averaging2

68What is financial planning1

88Characteristic of company fixed deposit2

98Features of bank deposit1

118Section of liquid funds1

138Equity funds order for selection2

168Choice of funds for a high risk investor2

198Comparing bank and mutual fund1

238Asset allocation for investor having to pay a tax2

268Low risk portfolio2

278order for fund selection2

368Recommending MFs to investors2

398Who should plan for retirement ?2

408Inter generational fund transfer1

418Asset allocation means1

438Where is NAV a factor for decision makiing? SIP etc2

468FP means1

488Which stage is FP required most1

498Investor in dstrn pahse2

508WC classification1

518Why MF is useful in FP1

578PPF1

608Good FP will not1

688MF and financial planning1

691Fund definition1

100

Sheet2

Sheet3

Attempting the paperThere are 2 hours to do the paper. Most do it in 1 hour.Written exam:There is an answer sheet with boxes for each question. Color the appropriate box with pencil.Valuation is done using an optical reader. Results are announced in 10 daysNSE Online ExamAnswers are chosen with the click of the mouseResults is known as soon as the paper is submitted.

Some tipsIt is not a great idea to read the paper fully. Attempt questions as you see them.Mark and keep aside questions for which you are not sure of the answers. Revert only to these questions.Do not revise and redo the questions that have been already attempted.Remember the negative marking.

Session 1: Structure and RegulationIntroductionMutual fund productsSponsor-Trustee-AMCOther constituentsRegulatory frameworkMerger and acquisitions

What Is a Mutual Fund?A mutual fund is a pool of money collected from investors and is invested according to stated investment objectives

Terms to knowMutualPoolInvestment objectives

Characteristics of a Mutual FundInvestors own the mutual fund.Professional managers manage the affairs for a fee.The funds are invested in a portfolio of marketable securities, reflecting the investment objective.Value of the portfolio and investors holdings, alters with change in market value of investments.

Advantages of Mutual FundsPortfolio diversificationProfessional managementReduction in riskReduction in transaction costLiquidityConvenience and flexibility

Disadvantages of Mutual FundsNo control over costsNo tailor-made portfoliosIssues relating to management of a portfolio of mutual funds

Mutual Fund ProductsOpen ended fundsInitial issue for a limited periodContinuous sale and repurchaseSize of the fund changes as investors enter and exitNAV-based pricing

Mutual Fund ProductsClosed end fundsSale of units by fund only during IPOListing on exchange and liquidity for investorsSize of fund is kept constantPrice in the market is usually at a discount

Equity FundsPre-dominantly invest in equity marketsDiversified portfolio of equity shares Select set based on some criterionDiversified equity fundsELSS as a special casePrimary market fundsSmall stock fundsIndex fundsSectoral funds

Debt FundsPredominantly invest in the debt marketsDiversified debt fundsSelect set based on some criterionIncome funds or diversified debt fundsGilt fundsLiquid and money market fundsSerial plans or fixed term plans

Balanced Funds Investment in more than one asset classDebt and equity in comparable proportionsPre-dominantly debt with some exposure to equityPre-dominantly equity with some exposure to debtEducation plans and childrens plans

Investment OptionsInvestors can achieve income and growth objectives in all fundsDividend optionRegular dividendAd-hoc dividendGrowth optionRe-investment optionMost funds provide multiple options and the facility to switch between options

Basis for ClassificationRiskSectoral funds are most risky; money market funds are least riskyTenorEquity funds require a long investment horizon; liquid funds are for the short term liquidity needsInvestment objectiveEquity funds suit growth objectives; debt funds suit income objectives

Risk and ReturnLiquid fundsST debt fundsGilt fundsDebt FundsIndex fundsEquity fundsSectoral fundsBalanced fundsRisk

Return

Fund Structure & Constituents3-tier structureSponsorTrusteeAMC

SponsorPromoter of the the mutual fundCreates AMC and appoints trusteesCriteriaFinancial services business5-year track record3-year profit making recordAt least 40% contribution to AMC capital

TrusteesFiduciary responsibility for investor fundsAppointed by sponsor with SEBI approvalRegistered ownership of investments is with TrustBoard of trustees or Trustee CompanyAppoints all other constituents

TrusteesAt least 4 trustees 2/3 should be independentTrustees of one mutual fund cannot be trustee of another mutual fundIndependent trusteeBoard approvalRight to seek regular information and remedial actionAll major decisions need trustee approval

Asset Management CompanyResponsible for operational aspects of the mutual fundInvestment management agreement with trusteesRegistered with SEBIRs. 10 crore of net worth to be maintained at all timesAt least 1/2 of the board members to be independent

Asset Management CompanyAppoints other constituentsCannot have any other business interestStructured as a private limited companySponsor and associates hold capitalAMC of one MF cannot be trustee of another MFQuarterly reporting to Trustees

Other ConstituentsCustodianInvestment back-officeRegistrar and Transfer agentInvestor records and transactionsBrokerPurchase and sale of securities5% limit per brokerAuditorSeparate auditor for AMC and mutual fund

Regulatory FrameworkSEBI (Mutual Fund) Regulations, 1996RBI as regulatorGuarantees of sponsors in bank-sponsored mutual fundsRegulator of G-Secs and money marketsStock exchangelisted mutual funds

Regulatory FrameworkCompanies Act AMCs and Trustee CompanyDCA as regulator RoC for ComplianceCLB for prosecution and penaltiesOffice of the public trusteeRegistration Complaints against trustees

UTI: DifferencesFormed as a trust under UTI Act, 1963Voluntary submission to SEBI regulationNo separate sponsor or AMCMajor DifferencesAssured return schemesDifferent accounting normsAbility to take and make loans

Self-regulatory OrganisationsDerive powers from regulatorAbility to make bye-laws Example : Stock exchangesIndustry AssociationsCollective industry opinionGuidelines and recommendationExample: Association of Mutual Funds in India

Mergers and AcquisitionsScheme takeoverOne AMC buys schemes of another AMCOrganic growth in assetsNo change in AMC stakesAMC mergerTwo AMCs merge Similar to merger of companiesSponsor stakes change

Mergers and AcquisitionsAMC take-overStake of one sponsor in a AMC bought out by another sponsorChange in AMC and sponsorInvestor rightsNo prior approval neededOption to exit at NAVRight to be informed

Uma ShashikantHead, Training and DevelopmentPrudential ICICI AMC LtdContractor Bldg, III FloorBallard Estate, Mumbai 400 038Ph: 283 4325/269 7989 Ext 325Email:uma_shashikant@pruicici.com

Session 2: Offer DocumentOffer DocumentKey Information MemorandumApplication and form of holdingDistribution channelsInvestors rightsTaxation of Income and capital gainNAV and Load

Offer DocumentLegal offer from AMC to investorContains vital information about Fund and schemesSEBI approved formatKIM is a mandatorily enclosed to application formsInvestor has no recourse for not having read the OD/KIM

Period of ValidityUpdated every 2 years for OEFsRegular Addendum for resultsUpdated for every major changeChange in the AMC or Sponsor of the mutual fund.Change in the load structures.Changes in the fundamental attributes of the schemes.Changes in the investment options to investors; inclusion or deletion of options.

Fundamental AttributesScheme typeInvestment objectiveInvestment patternTerms of the scheme with regard to liquidityFees and expensesValuation norms and accounting policiesInvestment restrictions

Changes in Fundamental AttributesInvestors have right to be informedPublic announcement by AMCOption to exit without loadSEBI and Trustee approvalNew offer document

Contents of Offer DocumentPreliminary informationSummary information about the mutual fund, the scheme and the terms of offer.Mandatory disclaimer clauses as required by SEBI. Glossary of terms in the offer document, which defines the terms used.Standard and scheme specific risk factors pertaining to the scheme being offered.

Fund Specific InformationConstitution of fund, details of sponsor, trustees and AMC.Financial history of sponsor(s) for 3 years, in summary form.Director of Boards of the trustees and the AMC.Details of key personnel of the AMC.Details of Fund constituents

Details of the SchemeDates of IPO details regarding sale and repurchase.Minimum subscription and face valueInitial issue expensescurrent scheme and the past schemes.Special facilities to investors Eligibility for investing documentation required.Procedure for applying, and subsequent operations relating to transfer, redemption, nomination, pledge and mode of holding of units.

Loads and Expenses

Load and the annual recurring expenses Proposed scheme and other schemesComparison with offer document numbersScheme expenses (3 years)Condensed financial information (3 years)

Unit Holder RightsRights of unit holders servicesinformationprotection of rights and problem resolution.Details of information disclosure and their periodicity.Documents available for inspectionDetails of pending litigation and penalties

Unit Holder RightsCannot sue the mutual fundComplaints against AMC, sponsor and BoT75% unit holders canwind up a schemeseek AMC terminationProspective investor has no rightsRight to redeem for fundamental changes

Associate TransactionsSummary information on associate companies being used as constituents.Summary information of associates investing in schemes of the mutual fund.Summary information on investment made by mutual fund schemes in associate company securities.

Verification and Due DiligenceSEBI: Format and ContentTrustee ApprovalCompliance Office certifies thatinformation contained therein is true and fairis in accordance with SEBI regulationsconstituents of the fund are all SEBI registered entities.The AMC is responsible for the contents and the accuracy of information

Investing in a Fund SchemeUnits or amountCertificates and account statementMinimum amount Initial offer and subsequent buyingList of eligible investorsCheck eligibility with offer documentForeign investors not eligible (FII Regulations)Documents for classes of investors

Distribution Channels

Individual agentsDistribution companiesBanks and NBFCsDirect marketing channels

Individual AgentsWide networkNo exclusivityCertificationNew agents from November 2001Exiting agents by March 2003Commission structureInitial and TrailLoyalty and volume incentives

Institutional DistributorsBanksHNIs and personal bankingDistribution companiesNBFCsService and collection AdvisoryDirect MarketingDirect Service AgentsInvestor Service Centres

ProcedureProof of purchaseCertificateAccount statementApplication Joint holdingMinorNominationPAN numberTax statusFolio numberBank details

NAV and LoadSale and repurchase price are NAV-basedCut-off time for NAVLoad is a charge on the NAV Entry load is charged on NAV and increases the sale priceExit load is charged on NAV and reduces the repurchase priceLoad is defined as a percentageCDSC is variable exit load, charged depending on duration of stay in the fundLoads are subject to SEBI Regulation and vary depending on industry practice

Entry Load : ExampleIf the entry load (sales load) for a scheme is 1.5% and the NAV of the scheme is Rs. 24.50, the investor who wants to buy the units 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

Exit Load : ExampleIf a fund imposes an exit load of 1.25%, the investor who repurchases his units, will get a price that is:

= 24.5 (24.5*1.25/100)

= 24.5 - 0.30625

= 24.19375

SEBI Regulations : LoadThere are 2 regulatory requirements: 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%. The repurchase price cannot be less than 93% of the sale price.

For a close ended fund, the limits are set at 5% of NAV.

ExampleIf 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 charge both these prices. If the sale price is Rs. 10.7, the repurchase price cannot be lower than Rs. 9.95 (10.7*0.93). If the repurchase price is Rs. 9.3, the sale price cannot be higher than Rs.10 (9.3/0.93).

TaxationMutual fund is exempt from paying taxes (Section 10 (23D))Income for investorsDividendCapital gainPresent position (AMFI examination)Dividend exempt from tax.Fund pays dividend distribution tax at 10%.Open end funds with >50% in equity, fully exempt. No tax is paid by the fund or the investor.

Taxation:Finance Act 2002-03Dividend fully taxable in the hands of investorsTDS @10% for dividends above Rs.1000Deductions under Section 80L along with other interest and dividend income, up to Rs. 9000.Section 88 benefit reducedGTI less than 1.5 lakhs :20%GTI >1.5 lakhs < 5 lakhs:15%GTI > 5 lakhs, no rebate.

Treatment of Capital GainsLong term: > 12 monthsShort term: < 12 monthsLong term capital gains subject to indexation benefit20% +surcharge after indexation10% + surcharge without indexationApplicable surcharge for the exam: 2%Short term capital gains taxed at marginal rate of taxation.

IndexationInvestor buys on March 31, 1999 and sells on April 1, 2000. What is the indexation adjustment factor?1998-99 - 3511999-2000 - 3862000-01 - 406Investor buys on April 1, 1998 and sells on March 31, 2001. What is the indexation adjustment factor?

Capital Markets and Mutual FundsEquity Market and productsAsset classesInvestment stylesValue indicatorsDebtDebt marketsTerminologyYield and durationInvestment stylesInvestment restrictions

Equity InvestmentInvestment OptionsEquity sharesPreference sharesConvertiblesEquity with Warrants

Investment StrategiesGrowth and valueActive and passiveLarge and small capCyclical stockStock selectionP/E ratioDividend yieldUndervalued companiesFundamental analysisTechnical analysisQuantitative analysis

Debt MarketsTenorshort and longput and call optionsInterest paymentFixed and floatingPeriodic vs discountedCredit qualityGilt, guaranteed, and othersTraded and non-traded

Price and YieldIncrease in rates reduces value of existing bonds.Decrease in rates increases value of existing bondsPrice and yield are inversely relatedThe relationship between yield and tenor can be plotted as the yield curve.

Current Yield and YTMCoupon as a percentage of current market priceIf we bought a 8% bond at Rs. 110, the current yield is:

= (8/110)*100 = 7.27%

Yield to MaturityRate at which present value of future cash flows equals the current market price.Given price, YTM can be calculated through iteration.Given YTM, price can be computed, using the YTM rate to discount the future cash flows.

Interest Rate SensitivityMeasured by a number called duration.If duration is 3 years, and interest changes by 1%, price of the bond will change in the opposite direction, by 3%.

ExampleExample: Duration of a bond is 4 years. Yield spreads increases by 1.5%. what is the change in price?

= 1.5 *4

= -6%

Credit RiskProbability of default by the borrower

Change in credit rating:downgrade increases the yield and decreases the priceupgrade decreases the yield and increases the price.

Debt Portfolio Management StylesBuy and holdPortfolio exposed to interest rate risk.Duration managementincrease duration if rates are expected to fall decrease duration if rates are expected to riseCredit selectioninvest in low grade bonds that are likely to be upgraded.

Investment RestrictionsInvest only in marketable securities. Investment only on delivery basis A mutual fund under all its schemes, cannot hold more than 10% of the paid-up capital of a company.

Investment RestrictionsNot more than 10% of its NAV in a single company.Exceptions: Index Funds and Sectoral fundsRated investment grade issues of a single issuer 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 net assets of a scheme and not more than 25% of net assets of a scheme can be in such securities.

Investment RestrictionsInvestment in unlisted shares cannot exceed 5% of net assets for an open-ended scheme, 10% of net assets for a close-ended scheme.Mutual funds can invest in ADRs/GDRs up to a maximum limit of 10% of net assets or $50 million, whichever is lower. The limit for the mutual fund industry as a whole is $500 million.Mutual funds can also invest in a limited manner in treasury bonds and AAA rated corporate debt issued outside India.

Inter-scheme TransferSuch transfers happen on a delivery basis, at market prices.Such transfers should not result in significantly altering the investment objectives of the schemes involved.Such transfer should not be of illiquid securities, as defined in the valuation norms.One scheme can invest in another scheme, up to 5% of net assets. No fee is payable on these investments.

Investment in Sponsor CompanyA 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 cannot exceed 25% of the net assets of the scheme

Other LimitsMutual funds cannot make loansMutual funds can borrow upto 20% of net assets for a period not exceeding 6 months.Derivatives can be used only after informing investorsAny change in investment objectives requires information to investor, and provision of option to exit at NAV, without exit load.

Accounting and Valuation AspectsNet assetsAccounting policyInitial issue expensesOperating expenses: LimitsAMC feesDisclosure and reporting normsValuation norms

Net AssetsMarket value of investmentsPlus current assets and other assetsPlus accrued income Less current liabilities and other liabilitiesLess accrued expensesNAV = Net assets/Number of units

Factors Impacting NAVSale and purchase of securitiesCannot impact NAV by more than 2%Sale and repurchase of unitsCannot impact NAV by more than 2%Valuation of assetsAccrual of income and expensesCannot impact NAV by more than 1%

Frequency of NAV CalculationEveryday by 8.00 p.m on AMFI websiteOpen ended funds: DailyClose ended funds: weeklyExempt funds: CEFs which are not listed (UTIs Monthly income schemes)

Historic and Prospective NAVBusiness day definition and applicable NAV are stated in the offer documentCut off time for each scheme is also announced.Prospective NAV applies to applications made before the cut-off time.

Accounting PoliciesInvestments to be marked to market according to SEBI Guidelines.Unrealised appreciation cannot be distributed.Profit or loss on average cost basis.Dividend on ex-dividend date.Sale and purchase accounted on trade date.Brokerage and stamp duties are capitalised and added to cost of acquisition or sale proceeds.

Sources of IncomeInterestDividendProfit from sale of investmentsOther incomeExtra-ordinary income

Initial Issue ExpensesExpenses incurred in floating schemesLimit of 6%; excess expenses to be borne by AMC/sponsorCEF : Amortise on weekly basis until maturityOEF : Amortise over period not exceeding 5 yearsNo-load fund: additional fees

Operating ExpensesInvestment management fees Custodians feesTrustee FeesRegistrar and transfer agent feesMarketing and distribution expensesOperating expensesAudit feesLegal expensesCosts of mandatory advertisements and communications to investors

Limits on ExpensesFor 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%.

Expenses that cannot be chargedPenalties and fines for infraction of laws.Interest on delayed payments to unit holders.Legal, marketing and publication expenses not attributable to any scheme.Expenses on investment and general management.Expenses on general administration, corporate advertising and infrastructure costs.Expenses on fixed assets and software development expenses.Such other costs as may be prohibited by SEBI.

Investment Management Fees

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 fundsBalance of DRE not included in net assets for computing investment management fee and expense limits.

Reporting RequirementsAudited accounts within 6 months of closure of accounts.Publish within 30 days of the closure of the half-year, unaudited abridged accounts. Summary of the accounts has to be mailed to all unit holders.File with SEBI: A copy of the annual report Six monthly unaudited reports Quarterly movement in net assets of the fund Quarterly portfolio statements

Specific DisclosuresComplete portfolio to be disclosed every six months.Industry practice: monthly disclosure.Any item of expenditure which is more than 10% of total expensesNPAs, provisioning, NPAs as % of total assets.Number of unit holders holding more than 25% of unit capital.

Non Performing AssetAn asset shall be classified as an NPA, if the interest and/or principal amount have not been received or have remained outstanding for one quarter, from the day such income/installment has fallen due.

Such assets will be classified as NPAs, soon after the lapse of a quarter from the date on which payments were due.

Treatment of NPAsAccrual to be stopped.Income accrued until date of classification to be provided for.Provisioning for principal due In graded manner after 3 months of classification.Complete write off in 15 months from classification

Valuation PrinciplesMarket price for all frequently traded securitiesIlliquid and thinly traded equity Valuation procedureDebt: < 182 days accrual principal.> 182 days common valuation methodologyIlliquid securities to not exceed 15% of net assets.

Valuation: EquityMarket price for Liquid sharesPrice should not be more than 30 days oldFair valuation for Illiquid sharesEarnings based SEBI approved modelFair Valuation for Thinly traded sharesLess than Rs. 5 lakh value and Less than 50,000 shares

Valuation DebtYTM based for Gilt and Corporate securities with investment grade rating25% discount for speculative grade performing assetsNPA norms for NPAsAccrual for money market securities

Liquid securities

Last traded price in the exchange where the security is principally traded.Previous traded date as long as such date is not over 30 days ago.

Thinly Traded SecuritiesEquity sharesTraded value in a month is less than Rs. 5 lakhs; and Total volume of shares traded is less than 50,000 shares a month.Debt securityTraded value of less than Rs. 15 crore in the 30 days prior to the valuation date.

Valuation of Thinly Traded EquityBook value of the shareEarnings capitalisation valueDiscount the industry P/E by 75%Average of the two methods10% discount for illiquidity Earning capitalisation is zero ifEPS if negativeAccounts not available for 9 months after closing date.If illiquid securities are more than 5% of the portfolio, independent valuation to be done

Valuation of a Thinly Traded Debt Security (

Valuation of other debt securities (>182 days) G-Secs are valued at market prices or using the CRISIL Gilt valuer.Corporate bonds are valued at market prices or using the CRISIL Bond valuer.Both these methods use duration to classify bonds and assign a rate for each duration bucket.

Session 6: Risk and ReturnReturn MethodsChange in NAVTotal ReturnTotal Return with dividend re-investmentCAGRRiskStandard deviationBeta and Ex-MarksBenchmark and comparison

Computing ReturnsSources of return Dividend Change in NAVReturn = Income earned for amount invested over a given period of timeStandardise as % per annum

Alternate MethodologiesComputing returnPercentage change in NAV.Simple total returnROI or Total return with dividend re-investmentCompounded rate of growth

Percentage Change in NAVAssume that change in NAV is the only source of return.Example:NAV of a fund was Rs. 23.45 at the beginning of a yearRs. 27.65 at the end of the year.Percentage change in NAV= (27.65 23.45)/23.45 *100= 17.91%

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%

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 dividend at 7%. The rate of return on his investment can be computed as =((15.475 12.45) + 0.70)/12.45 x 100= (3.725/12.45) x 100= 29.92%

Total Return or ROI 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 100Value 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 dividend NAV.

ROI Method: ExampleAn investor buys 100 units of a fund at Rs. 10.5 on January 1, 2001. On June 30, 2001 he receives dividends at the rate of 10%. The ex-dividend NAV was Rs. 10.25. On December 31, 2001, the funds NAV was Rs. 12.25.

What is the total return on investment with dividends re-invested?

ROI Method: SolutionThe begin period value of the investment is = 10.5 x 100 = Rs. 1050Number of units reinvested = 100/10.25 = 9.756 unitsEnd period value of investment = 109.756 x 12.25 = Rs. 1344.51The return on investment is =(1344.51-1050)/1050 x 100 = 28.05%

Compounded Annual Growth RateCAGR is the rate at which investment has grown from begin point to the end point, on an annual compounding basis.

V0(1+r)n = V1

r =((V1/V0)1/n)-1

Where n is the holding period in years.

CAGR: Example 1 An investor buys 100 units of a fund at Rs. 10.5 on January 6, 2001. On June 30, 2001 he receives dividends at the rate of 10%. The ex-dividend NAV was Rs. 10.25. On March 12, 2002, the funds NAV was Rs. 12.25.

Compute the CAGR.

CAGR: SolutionThe begin period value of the investment is = 10.5 x 100 = Rs. 1050Number of units reinvested = 100/10.25 = 9.756 unitsEnd period value of investment = 109.756 x 12.25 = Rs. 1344.51Holding period = 6/01/01 - 12/3/02 = 431 daysThe CAGR is =(1344.51/1050)365/431 - 1 x 100 = 23.29%

Returns: Industry PracticeGrowth Option: CAGR implicit in the change in holding period NAVs.Dividend Option: CAGR implicit in the change in value over the holding period, assuming re-investment of dividend at ex-dividend NAV.Less then 1 year, simple return without compounding or annualisation.Some funds use simple annualised return, without compounding.

SEBI RegulationsStandard measurements and computationCompounded annual growth rate for 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.

Risk in Mutual Fund ReturnsRisk arises when actual returns are different from expected returns.Historical average is a good proxy for expected return.Standard deviation is an important measure of total risk.Beta co-efficient is a measure of market risk.Ex-marks is an indication of extent of correlation with market index.

BenchmarksRelative returns are important than absolute returns for mutual funds.Comparable passive portfolio is used as benchmark.Usually a market index is used.Compare both risk and return, over the same period for the fund and the benchmark.Risk-adjusted return, is the return per unit of risk.

SEBI GuidelinesBenchmark should reflect the asset allocationSame as stated in the offer documentGrowth fund with more than 60% in equity to use a broad based index.Bond fund with more than 60% in bonds to use a bond market index.Balanced funds to use tailor-made indexLiquid funds to use money market instruments.

Other Measures of PerformanceTracking errorTracking error for index funds should be nil.Credit qualityRating profile of portfolio should be studiedExpense ratioHigher expense ratios hurt long term investorsPortfolio turnoverHigher for short term funds and lower for longer term funds.Size and portfolio composition

Session 7: Financial PlanningConcept of financial planningMapping life cycles and wealth cyclesFinancial productsAsset allocationModel portfoliosFund selection

What is Financial Planning?Financial planning comprisesDefining a client's profile and goalsRecommending appropriate asset allocationMonitoring financial planning recommendationsThe objective of financial planning is to ensure that the right amount of money is available at the right time to the investor to be able to meet his financial goals.Tax implications on investment income can affect the choice of products and the financial plan.Financial planning is more than mere tax planning.

Steps in Financial PlanningSteps in financial planning are:Asset AllocationSelection of fundStudying the features of a schemeFinancial planning is concerned only with broad asset allocation, leaving the actual selection of securities and their management to fund managers.A fund manager has to closely follow the objectives stated in the offer document, because financial plans of investors are chosen using these objectives.

Investor and Financial PlannerThe financial planner can only work with defined goals and cannot take up larger objectives that are not well defined.The client is responsible ultimately for realizing the goals of the financial plan.The basis of genuine investment advice should be financial planning to suit the investor's situationRisk tolerance of an investor is not dependent on the market, but his own situations.

Is a person who uses the financial planning process to help another person determine how to meet his or her life goalsKey functions of a FP is to help people identify their financial planning needs, priorities and the products that are most suitable to meet their needsWho is a Financial Planner?

Provides direction and meaning to financial decisionsTo understand how each financial decision effects other areas of ones financesBy viewing each financial decision as part of a whole one can consider its short and long term effects on ones life goalsBenefits of Financial Planning

MFs in Financial PlanningForms the core foundation and building block for any type of FPVariety of products available to suit any need or combination of needsBarring life and property insurance, rest of the product portfolio can be created out of bouquet of MFs

Strong potential demand for such services Limited supply of financial planners Ability to establish Long term relationships Ability to build a profitable businessWhy should a Fund distributor become an FP

Attributes of a Good Financial PlannerUnderstands:The universe of investment productsRisk-return attributesTax and estate Planning Has the ability to convert life cycles of investors into need and preference based financial productsOrganised approach to workExcellent communication and interpersonal skills

Process of FP in PracticeStep I: Establish and define the relationship with the client Step II: Define the clients goals Step III: Analyse and evaluate clients financial status Step IV: Determine and shape the clients risk tolerance level

Process of FP in practiceStep V: Ascertain clients tax situation

Step VI: Recommend the appropriate asset allocation and specific investments

Step VII: Executing the plan

Step VIII: Periodic Review

Life Cycle and Wealth CycleLife Cycle classification of investorsChildhood stageYoung adultYoung married with childrenMiddle ageRetirementPost retirementThe ability of an investor to save, his income and dependence on investment income, his investment horizon and risk taking ability depend on the phase of the life cycle he is in.

Wealth Cycle Classification Accumulation StageInvestor is earning and has ability to invest and requires no supplementary income from investmentsTransition StageInvestor is able to save, but has also started drawing on his investments to meet his financial goals.Distribution StageInvestor is not earning and has ability to invest has reduced and requires supplementary income from investments

Other Wealth StagesInter-generational Fund TransferThe investment of funds depends on the the beneficiarySudden Wealth SurgeInvestments on funds from winnings and lotteries to be done carefully. It is safe to invest in a short tern fund and allocate assets later.Affluent InvestorsWealth creating investors prefer to invest in equityWealth preserving investors prefer to invest in debt

Products AvailablePhysical Assets Gold & Real EstateBank DepositsCorporate Shares, Bonds, Debentures & Fixed DepositsGovernment G. Secs, PPF, RBI Relief Bonds and other personal InvestmentsFinancial Institutions Bonds, SharesInsurance Companies Insurance Policies

Physical assetsInvestors like the idea of physical possession of gold and property.These products are believed to be hedges against inflation.These products are illiquid and cannot be sold easily.For purchase of property, initial investment may be very high.

Bank DepositsAvailable since a long period of timeLarge geographical network transactions made easy & convenientFund transfer mechanism availablePerception of bank deposits being free of default; Deposits guaranteed up to Rs 1 lakh per depositorElectronic facilities make it liquid and easy to use

PPF15 years deposit product made available through banks.9.5% p.a. interest payable on monthly balancesMinimum Rs. 100 & maximum Rs. 60,000 p.a investment allowed.Tax benefits u/s 88 under IT Act. Interest receipt and withdrawal of principal exempt from tax.Limited liquidity available. 50% of the balance at the end of the 4th year can be withdrawn from the 7th year.

RBI Relief BondsIssued by banks on behalf of the RBITenure of five years8.5% p.a. interest payable s.a.Proposed to be converted to floating rate instrument linked to government yieldsOption to receive or reinvest interestInterest income exempt from tax

Other Government SchemesIVP & KVP issued by central government & sold by post officesInterest is taxableInvestor identity is protected and investment in cash is possible

Other Government SchemesPost office savings and RD gives fixed rate of interest but are not liquid.These are government guaranteed depositsAttractive for their safety and cash investment options

Instruments issued by companiesCommercial PaperShort term borrowing of companiesDebenturesSecured borrowings of companiesEquity SharesLiquid but no assurance of principalPreference SharesFixed dividend form post tax profitFixed DepositsUnsecured borrowings. Not liquid.Bonds of FIUnsecured borrowings

How to Compare ProductsCompare options by nature of investments Characteristics, benefits and risks.Current performance and suitability Taxability, age, risk profile.

Why MF is the Best OptionMutual funds combine the advantages of each of the investment productsDispense the short comings of the other optionsReturns get adjusted for the market movements

Strategies for InvestorsHarness the power of compoundingStart earlyHave realistic expectationsInvest regularly

Useful StrategiesRupee Cost AveragingValue AveragingJacobs rebalancing strategyGrahams 50:50 rebalancing strategy

Rupee Cost AveragingInvest regularly a predetermined amount Invests in more units when the market is low; less when the markets are high. Reduces the average cost of purchase

Rupee Cost Averaging

Amount Invested (Rs)

NAV per unit

Number of units bought

Cum number of units

Value of holding

1000

12.5

80.00

80.00

1000.00

1000

11.25

88.89

168.89

1900.00

1000

10.75

93.02

261.91

2815.56

1000

11

90.91

352.82

3881.03

1000

12.75

78.43

431.25

5498.47

1000

13.35

74.91

506.16

6757.22

1000

13.85

72.20

578.36

8010.30

1000

14.45

69.20

647.57

9357.32

1000

13.85

72.20

719.77

9968.78

1000

13.5

74.07

793.84

10716.86

Average cost

12.60

Value AveragingInvest regularly to achieve a predetermined value Books profits at a high, and adds units at the low, and enables meeting financial goals. Reduces the average cost of purchase

Value Averaging

Target Value

NAV Per Unit

Value Of Holding

Units To Invest

Cumulative Balance

1000

12.5

0.00

80

80

2000

11.25

900.00

97.78

177.78

3000

10.75

1911.11

101.29

279.07

4000

11

3069.77

84.57

363.64

5000

12.75

4636.36

28.52

392.16

6000

13.35

5235.29

57.28

449.44

7000

13.85

6224.72

55.98

505.42

8000

14.45

7303.25

48.22

553.63

9000

13.85

7667.82

96.19

649.82

10000

13.5

8772.56

90.92

740.74

Asset Allocation and Model PortfoliosDeciding the allocation of funds amongst equity, debt and money market.Incorporating product, investor profile and preferences in the portfolio.Equity, debt and money market products are called asset classes. Allocating resources to each of these is called asset allocation.

Grahams Model PortfolioBased on the 50:50 rule.Basic managed portfolio.Basic indexed portfolio.Simple managed portfolio.Complex managed portfolio.Readymade portfolio.

Bogles Strategic Asset AllocationCombine age, risk profile and preferences in asset allocationOlder investors in distribution phase50% equity;50% debtYounger investors in distribution phase60% equity; 40% debtOlder investors in accumulation phase70% equity; 30% debtYounger investors in accumulation phase80% equity; 20% debt

Fixed and Flexible Asset AllocationFixed ratio between asset classesPortfolio has to be periodically re-balancedDisciplined approachEnables investor to book profits in a rising market and invest more in a falling market.Flexible allocationNo re-balancing; asset class proportions can vary when prices change.If equity returns are higher than debt returns, equity allocation will go up at a faster rate.

Developing a Model PortfolioDevelop long term goalsInvestment avenues, time horizon, return and riskDetermine asset allocationAllocation to broad asset classesDetermine sector distributionAllocation of sectors of the mutual fund industrySelect specific fund schemes for investmentCompare products and choose actual funds to invest in

Jacobs Model PortfoliosAccumulation phaseDiversified equity: 65 - 80%Income and gilt funds: 15 - 30%Liquid funds: 5%Distribution phaseDiversified equity: 15 - 30%Income and gilt funds: 65 - 80%Liquid funds: 5%

Fund SelectionEquity funds: CharacteristicsFund categorySuitability to investor objectiveInvestment styleGrowth vs ValueAge of the fundExperience preferred to new fundFund management experienceSize of the fundLarger funds have lower costsPerformance and risk

Equity Funds: Selection CriteriaPercentage holding in cash.Concentration in portfolio.Market capitalisation of the fund.Portfolio turnover.Risk StatisticsBetaEx-MarksGross dividend yieldFunds with low beta, high ex-marks and high gross dividend yield is preferable

Debt Funds: Selection CriteriaA smaller or new debt fund may not necessarily be riskyTotal return rather than YTM is importantExpense very importantHigh expense ratios lead to yield sacrificeCredit qualityBetter the rating of the holdings, safer the fundAverage maturityHigher average maturity means higher duration and interest rate risk

Money Market FundsLiquidity and high turnover rateShorter term instruments are turned over more frequently.Protection of principal investedNAV fluctuation limited due to low duration and low levels of interest rate risk.Credit quality of portfolioLow expense ratio

Thank you and all the very best!!

Keep this slide displayed while participants walk in and settle. This will enable early participants to see our name and register the same.