Chapter I

MUTUAL FUNDS: AN INTRODUCTION

CONTENTS

1.1 Financial System: An Overview

1.2 Elements of Financial System

13 Mutual Funds and Financial Market

1.4 Relevance of Mutual Funds in Financial System

1.5 Pattern of Financial Savings in Household Sector in India

1.6 Concept of Mutual Fund

1.7 Operational Style

1.8 Types of Mutual Funds

1.9 The Origin and Development of Mutual Funds

1.10 Mutual Funds: Global Scenario

1.11 Milestones in the Journey of Mutual Funds: Global Scenario

1.12 Mutual Fund Growth: Global Perspective

1.13 Some basic Facts of Mutual Funds

1.14 Growth of Mutual Funds: Indian Perspective

1.15 Phases of Growth of Mutual Funds in India

1.16 Milestones in the Journey of Mutual Funds: Indian Experience

1.17 Changing face of the Mutual Funds

1.18 Structure of Mutual Fund Industry in India

1.19 Trends of Asset Under Management

1.20 Recent Trend in Mutual Fund Industry

1.21 Emerging issues in Mutual Funds in India

1.22 Future Scenario

1.23 Prospects ofMutual Funds in India

1.24 SWOT Analysis ofMutual Fund Industryr

1.25 Legal & Regulatory environment ofMutual Funds

1.26 Regulations by SEBI

1.27 Self Regulatory Organization

1.28 Association ofMutual Funds in India

Chapter -1

MUTUAL FUNDS: AN INTRODUCTION

1.1 Financial System: An Overview

The financial system of an economy plays an intermediary role in linking between

the seekers and the suppliers of money for productive activity. The savers of money

could invest in financial assets, which are issued by the seekers of money. The nature of

the financial system is determined by such variables as the nature and number of financial

assets, the volume of trading these assets etc. The efficiency of the functioning of

financial system of a country greatly influences its economic growth. The close

relationship between financial structure and economic development is reflected in the

prevailing institutional arrangement delivery system and intermediation process. Thus

the financial system is possibly the most important institutional and functional vehicle for

economic transformation'.

Financial system includes different markets, the institutions, instruments, services

and mechanisms, which influence the generation of savings, investment, capital

formation and growth. It is the financial system that facilitates to supply fimds to various

sectors and activities of the economy in ways that promote the fullest possible utilization

of resources without the destabilizing consequence of price level changes or unnecessary

interference with individual desires^.

Indian financial system has witnessed revolutionary changes, developments and

innovations since 1991 due to economic reforms undertaken by the government. With

the advent of liberalization, privatization and globalization, the financial services sector

has become more dynamic and vibrant. Many innovative methods of finance products,

services, business and regulatory bodies have emerged to make the Indian Capital Market

more liquid and strong to face the global challenges. Emergence of increasing role of

Mutual Fund industry in financial intermediation is one such development following the

structural reforms initiated in the Indian economy.

1.2 Elementsof Financial System

The financial system is the channel through which funds flow from one market

participants to another. There are four important elements in the financial system of an

economy. They are:

• Investors- who are investing their savings in various financial instruments

viz, Shares, Debentures, Mutual Fund units. Govt. Securities etc. The

investors attempt to accumulate wealth, to alter or smooth their consumption,

or to change the risks attached to their consumption or portfolios of assets.

• Institutions (Borrowers) - corporate bodies say Business Houses, Financial

institutions etc who are mobilizing capital by way of issuing various financial

instruments. Borrowers transact to gain investable funds, to consume or to

alter the risks attached to their liabilities

• Intermediaries- who act as conduits between the investors and institutions.

Financial intermediaries earn a return by packaging financial assets for

borrowers or lenders increasing the variety of securities directly available in

the market. They can act as brokers by arranging deals between borrowers

and lender.

• Regulatory bodies- which promote, regulates and monitoring the functioning

of the financial markets. Rules that insure the smooth functioning of the

markets are developed and enforced. In addition these agencies can develop

markets for new types of securities.

The efficiency of financial system may be determined depending upon the nature

of relationship and functional integrity among these elements of financial system.

13 Mutual Funds and Financial Market

Mutual Funds are dynamic financial institutions, which play a crucial role in an

economy by mobilizing savings and investing them in the capital market. Mutual Funds

have emerged as dynamic financial intermediaries between the suppliers and the users of

money. Mutual Funds thus assist the process of financial deepening and intermediation.

They on one hand, mobilize funds in the savings market. On the other hand at the same

time they also compete with the banks and other financial institutions. The stock market

activities are also significantly influenced by mutual funds. However, the scope and

efficiency of mutual funds are influenced by overall economic fundamentals, the inter­

relationship between the financial and real sector and the nature of development of the

savings and capital markets, market structure, institutional arrangements and overall

policy regimes'.

The mutual funds in India have emerged as strong financial intermediaries and are

playing a very important role in bringing stability to the financial system and efficiency

to resource allocation. In the process they have challenged the dominant role of

commercial banks in the financial market and national economy. By the very nature of

their activities, and by virtue of being knowledgeable and informed investors, they

influence the stock market and play an active role in promoting good corporate

governance, investor protection and the health of capital markets.

The active involvement of mutual funds can be seen in the money and capital

market also. The mutual funds increase liquidity in the money market. The asset holding

pattern of mutual funds all over the world indicates the dominant role of mutual funds in

Money and capital market. Mutual Funds have been id^tified as one of the important

factors pushing up market prices of securities.

The direct lending by mutual funds to the corporate sector has substantially

increased after the SEBI guidelines allowed the corporate sector to reserve 20% of public

issues for Indian mutual funds. Mutual funds have also widened the private placement

market for corporate securities. Mutual funds have enabled the corporate sector to raise

capital at reduced costs and have opened an avenue for alternate source of capital.

Indian mutual funds are thus playing a very crucial developmental role in allocating

resources in the emerging market economy.

1.4 Relevance of Mutual Funds in Financial System

A mutual fund is the ideal investment vehicle for today's complex and modern

financial scenario. Markets for equity shares, bonds and other fixed income instruments.

real estate, derivatives and other assets have become mature and information driven.

Price changes in these assets are driven by global events occurring in far away places.

After introduction of free pricing of shares, and with greater volatility in the stock

markets, many investors who bought over priced shares lost money and withdrew from

the markets altogether. Even those investors who continued as direct investors in the

stock markets realized that the key to successful investing in the capital markets lay in

building a diversified portfolio which in urn required substantial capital. Besides,

selecting securities with growth and income potential from the capital market involved

careful research and monitoring of the market, which was not possible for all investors.

A typical individual is unlikely to have knowledge, skills, inclination and time to

keep track of events, understand their implications and act speedily. An individual also

finds it difficult keep track of ownership of his assets, investment, brokerage dues and

bank transactions etc. The concept of mutual funds is more relevant in the present

context among the investment community as MFs is the ideal solutions to all these

situations. Hence the mutual funds have emerged as major financial intermediaries all

over the world. The MFs besides providing the expertise in stock market investing, these

funds allow investing in small amounts and yet holding a diversified portfolio to limit

risk, while providing the potential for income and growth associated with the debt and

equity instruments.

1.5 Pattern of Financial Savings in Household Sector in India

According to RBI annual report 2003-04, the individual household now invests

more in financial sector. The trend of past five years reveals growing importance of

financial savings. They reached 15.1% of GDP in 2003-04. Assuming the GDP for

2003-04 at Rs. 27,52,000 crore, it means an amount as high as Rs 4,15,000 crore was

available for investment in various financial instruments.

Table 1.1 Year-wise Financial savings as percentage of GDP

Year Financial savings as % of GDP

1999-00 12.2

2000-01 11.9

2001-02 12.7

2002-03 13.5

2003-04 15.1

Source: RBI Annual Report 2003-04

1.6 Concept of Mutual Fund

Mutual Fund has been defined by different scholars as mentioned below:

"Mutual Funds are financial intermediaries which bring a wide variety of

securities within the reach of the most modest of investors"^.

As per Mutual Fact Book published by Investment Company Institute of USA, "a

mutual fund is a financial service organization that receives money from shareholders,

invests it, earns returns on it, attempts to make it grow and agrees to pay the shareholders

cash on demand for the current value of his investment".

Encyclopedia Britannica defines a mutual fund as "mutual fund - also called Unit

Trust or Open-ended Trust- Company that invests the fund of its subscriber in diversified

securities and in turn issues units representing shares in those holdings. They make

continuous offering of new shares at net asset value and redeem of shares on demand at

net asset value determined daily by the market value of the securities they hold".

A Mutual Fund is a trust that pools the saving of a number of investors who share

a common financial goal. The money thus collected is invested by the fund managers in

different types of securities depending upon the objective of the scheme. These could

range from shares to debentures to money market instruments. Thus, an Equity Fund

would buy equity assets namely ordinary shares, preference shares, warrants etc. A bond

fund would buy debt instruments such as debentures, bonds or government securities. It

is these assets, which are owned by the investors in the same proportion as their

contribution bears to the total contribution of all investors put together. The income

earned through these investments and the capital appreciation realized by the scheme is

shared by its unit holders in proportion to the number of units owned by them (on pro rata

basis). Thus a mutual fund is the most suitable investment for the common man as it

oflfers an opportunity to invest in a diversified, professionally managed portfolio at a

relatively low cost^.

When an investor buys into a mutual fund, he/she buys "shares" that is

recalculated at regular intervals. The fund calculates the value of all its investments

subtracts all the fund expenses (salaries, services and administrative costs) and divides by

the number of shares in the fund to arrive at the value of a single share called the Net

Asset Value or NAV.

Mutual funds charge for their services. Mutual funds charge a management fee,

paid to the managers of the mutual fund, to cover salaries and administrative expenses.

The annual fee may range from 0.5% to 1.5% of the all the assets in the fimd. These fees

are sometimes expressed as an expense ratio, or a percentage of the fund's assets that are

paid out in expenses. There are a variety of other fees that are used in various

cotibinations to compensate the fund's sales represent*tive or pay for the fund's

marketing program. Many funds charge a sales fee when one invests in the fund or a

redemption fee when money is taken out .

1.7 Operational Style

A mutual fund invests the money received from investors in instruments which

are in line with the objectives of the respective schemes. Regular expenses like custodial

fees, cost of dividend warrant, registrar fee, and the asset management fee are borne by

respective schemes. These expenses however, cannot exceed 3% of the assets in the

respective schemes every year. The balance is given back to the investors in full.

1.8 Types of Mutual Funds

Mutual fund schemes may be classified on the basis of its structure and its

investment objective.

A. By Structure

a) Open-ended Funds

b) Closed-ended Funds

c) Interval Funds

B. By Investment Objective:

a) Growth Funds

b) Income Funds

c) Balanced Funds

d) Money Market Funds

e) Load Funds

f) No-Load Funds

C. Other Schemes

a) Tax Saving Schemes

b) Special Schemes

• Industry Specific Schemes

• Index Schemes

• Sectoral Schemes

1.9 The Origin and Development of Mutual Funds

The economic progress of a country is, to certain extent, linked with the growth of

the capital market. The growth Capital market depends on the savings of the nation. The

savings of common man can be diverted to capital market by the financial intermediaries

through financial instruments. The most of the general investors know that there is ample

scope for profitable investment opportunity in capital market both in short term and long

term time horizon. But still they refrain from this avenue of investment due to lack of

awareness and investment skills. Hence the savings of common man has been directed

towards only bank deposits, real estate, gold etc. till recently, which indeed restricted the

growth of capital market and in turn economy too in India. The capital market can grow

fast only if the common man acquires necessary know-how himself to select appropriate

avenues of investment which will serve his needs. This is a Herculean task to a common

investor to analyze regularly the market movement for the sake of his investment due to

his routine busy schedule. The diversion of the part of the above savings into a new

sector is possible only if the common man is assured that there are organizations of

repute which have necessary expertise to select appropriate avenues of investment in

capital market where the yield is attractive enough with utmost security of the capital

invested. This sentiment of common investor has put the milestone for the evolution of

Mutual Fund in the economy. The evolution of Mutual Funds have not only catered the

needs of the different categories common investors but also increased in the depth in

capital market and in turn contributed to the sustained growth of the economy. In these

circumstances, there is enough scope for Mutual Funds to play in that capital market as a

dynamic intermediary to canalize the savings in to productive activities in the economy.

1.10 Mutual Funds: Global Scenario

Historically, mutual fund traces its origins to the early pioneering investments of

Scottish and English inA estors in America West in the 1800's. Mutual Funds have been

around for a long time, at least since King William I, the first king of Netherlands,

created the first known investment company in 1822. He came up with a novel idea of

close-ended fimd. It was initially a simple idea. A group of investors, individuals, and

institutions with common investment goals, pooled their investment and placed them with

fund managers. These professional money managers then invested these funds in

securities, and distributed the profits among the fund members. The 'investment trust'

concept spread rapidly through Europe.

On the same line the idea of mutual fimd had its formal origin in Belgium

(Societe'Generale' D Belgique, 1822) as Investment Company to finance investments in

national industries with high associated risks. Later on similar agencies were formed in

Switzerland and France. This system expended steadily for twenty years and reached the

heights of its development in the boom period of 1880's^.

In 1879, an enterprising Scot, Robert Fleming, set up the Scottish American

Investment Trust, the first international equity fund. This fund called the Foreign and

Colonial Government Trust was formed as a limited company to invest in a selection of

eighteen overseas Government Stocks at an average yield of 8% as compared to the yield

of 3% on British Government Securities. A sinking fund was created for taking care of

redemptions over a period of 24 years, with redemptions chosen by lots. This was

followed by a burst of activity and lull subsequent to a capital market crisis. By early

1900, there were 58 trusts in the U.K*.

The first American fund was created in 1893. And later on, this concept was

spread quickly around the world especially in industrialized countries^.

The stock market started to pick up steam in the 1950s. But it was during the

prosperous decade of the 1960s that mutual funds evolved from a stodgy investment for

the unimaginative to an exciting new investment vehicle with the opportunity for growth

rather than just preservation of capital. A "new breed" of money manager—people like

Gerry Tsai and Fred Carr—emerged as growth managers. Tsai's Capital Fund, which

focused on big glamour stocks, gained 50% in 1965. Carr's Enterprise Fund, which

looked for small, emerging growth companies, racked up a gain of over 117% in 1967^.

1.11 Milestones in tlie Journey of Mutual Funds: Global Scenario

The story of mutual fiind is full of twists and turns. Mutual funds went up on

rather a sharp learning curve before setting down to a steady performance they have

traversed the path of stunning growth as well as sudden reversals. It is interesting to

know funds' cycles of ups and downs before becoming widely popular.

Table 1.2 Mutual Fund Mile Stones in the Global Scenario

Year Milestones

1870 Robert Fleming establishes in Scotland, the first investment trust

1890 The Collapse of baring brothers in UK leaves a bitter experience for the investment trust industry

1914 The first open-ended fund launched in USA by the Massachusetts investment trust

1920 Collapse of the stock market imparts a second bitter shock for the

industry 1930 The US securities exchange commission (SEC) came into existence

as a regulators 1940 Investment Companies Act passed in USA

1950 The name 'Mutual Fund' started becoming popular in developed economy

1960 Mutual Fund mania unleashed

1969 Stock Markets' Crash

1972 The Money Market Fund was invented

1980 Financial product innovation, institutionalization of equity markets leashing the most forceful bullishness in the market

1987 Severe correction takes place in the overheated markets, the stock

market crashes again

1990 A decade of enormous growth for the mutual funds industry

1999 Size of the industry's Global assets cross $5.5 trillion and surpass the volume of the bank deposits

Source: Compiled from www.mutualfundsindia.com

The background for the growth of mutual funds throughout world has similar

characteristics. Mutual funds have emerged as rivals to banks in savings mobilization.

Individual investors over the years have developed keen interest in securities market and

changed their investment behaviour as witnessed in the shift in their preference from

bank deposits to acquire financial instruments for attaining higher returns and capital

gains accompanied with fiscal concessions. These phenomenons exist globally and

provide support to the growth of mutual fund industry.

1.12 Mutual Fund Growth: Global Perspective

• Mutual Funds in the USA

The USA is the pace-setter in the mutual funds industry. The first United States

open-ended fund was established in Boston in 1924, the Massachusetts Investors Trust.

But in the frenetic investment environment of the 1920s, open-ended funds were

overshadowed by closed-end funds, which were highly leveraged speculative accounts.

When the market collapsed in 1929, investors in closed-end funds suffered heavy losses.

The growth of mutual funds was retarded due to the stock market crash in 1929 and then

10

again due to the great depression and outbreak of the Second World War. However the

period of boo for the industry has been the 1990s with the industry's assets crossing the

US $1 trillion mark.

Presently the total assets under the mutual funds in the USA exceed US $2.5

trillion. There are more than 7000 mutual funds (equivalent to schemes in India) in USA

commanding investment of 25% of the household and having over 5 crores shareholders

account. Mutual fund industry in USA occupied third position in financial sector after

banks and insurance companies. Annual sales of mutual fund account for approximately

$100 billions. The 1970s saw the emergence of innovative funds in USA. Bond funds

made their appearance in 1977 and the first tax exempt; money market fund appeared in

1979, The international bond fund appeared in 1986 and he latest addition to the

industry, arm funds appeared in 1990^ Mutual fund industry in USA serves about 50

million investors .

• Mutual Funds in the UK

In UK, Mutual Funds are called Investment trusts and Unit trusts. This industry

started blooming in the beginning of thirty's. Presently there are about 313 investment

trusts managing total assets of GB Pounds 50.14 billion. By the end of Decembei 1995,

the total assets of 1,132 unit trusts stood at GB Pounds 110.17 billion under 85,83,837

unit holders' account^

• Mutual Funds in the Japan

The Japanese mutual funds industry has certain unique structural features. Mutual

funds in Japan are known as investment trusts but they differ from investment trusts of

the UK and mutual funds of USA. The Japanese investment trusts were established 'to

meet the changing requirement of government policy' and as such the establishment of

investment trusts was a considered action rather than a spontaneous response to economic

market developments. The mutual fiind industry in Japan dates back to 1937. But an

investment trust modeled after unit trusts of the UK was established only in 1941.

Investment trusts in Japan are set up under the Securities Investment Law 1951.

11

• Mutual Funds in other Countries

In many countries mutual funds had registered enormous growth. These

developed nations include Italy where mutual fund registered a growth of 200%, Japan

600%, UK 350%, and Germany 330%. Japan tops in number of mutual funds around

5400 whereas USA's total 3400 mutual funds command four times highest assets than

Japan. UK ranks third with 1400 mutual funds. France 950 mutual fiinds ranks second in

asset formation next to USA. Other European countries have the developed mutual fund

industry viz., Austria 307, Belgium 101, Denmark 117, Germany 388, Ireland 146, Italy

239, Luxembourg 770, Spain 373, Sweden 283, Netherlands 88, Portugal 91, Australia

and Canada have 549 and 482 mutual funds respectively. Besides above, third world

countries like Mexico, South Afirica, Indonesia and India have also witnessed significant g

growth in mutual fund industry .

1.13 Some basic Facts of Mutual Funds

• The money market mutual fund segment has a total corpus of $ 1.48 trillion in the

U.S. against a corpus of $ 100 million in India.

• Out of the top 10 mutual fiinds worldwide, eight are bank- sponsored. Only

Fidelity and Capital are non-bank mutual funds in this group.

• In the U.S. the total number of schemes is higher than that of the listed companies

• Internationally, mutual funds are allowed to go short. In India fund managers do

not have such leeway.

• In the U.S. about 9.7 million households will manage their assets on-line by the

year 2003, such a facility is not yet of avail in India.

• On- line trading is a great idea to reduce management expenses from the current 2

% of total assets to about 0.75 % of the total assets.

• 72% of the core customer base of mutual funds in the top 50-broking firms in the

U.S. are expected to trade on-line by 2003^.

Internationally, on- line investing continues its meteoric rise. Many have debated

about the success of e- commerce and its breakthroughs, but it is true that this aspect of

technology could and will change the way financial sectors function. However, mutual

12

funds cannot be left far behind. They have realized the potential of the Internet and are

equipping themselves to perform better.

In fact in advanced countries like the U.S.A, mutual funds buy- sell transactions

have already begun on the Net, while in India the Net is used as a source of Information.

Such changes could facilitate easy access, lower intermediation costs and better services

for all. A research agency that specializes in internet technology estimates that over the

next four years Mutual Fund Assets traded on- line will grow ten folds from $ 128 billion

to $ 1,227 billion ; whereas equity assets traded on-line will increase during the period

from $ 246 billion to $ 1,561 billion. This will increase the share of mutual funds from

34% to 40% during the period.

1.14 Growth of Mutual Funds: Indian Perspective

In India mutual fund concept took root only in sixties, after a century old history

elsewhere in the world. Reacting to the needs for a more active mobilization of

household savings to provide investible resources to industry, the idea of introducing he

concept of mutual fund in India was coined by the far sighted vision of Sri T

Krishnamachari the then Finance Minister. Considering the need for an institution which

would serve as the conduit for these resources to the Indian capital market, he took the

initiative for the formation of Unit Trust of India as public sector financial institution by

an Act of Parliament in 1963, which in turn laid foundation for the mutual fund operation

in India.

The growth of the Mutual Fund industry in India was very slow till end of the

1980's, primarily due to government controls and over regulation of the financial service

industry. State planning and development objective of the economic policy meant that

financial institutions assisted the government in development activities through

mobilization of domestic savings. Sever entry barriers restricted the growth of the mutual

fund industry in terras of number of players, mobilization of savings and creation of

assets. This was the scenario till 1986-87 when the mutual fund market in India, such as

it was, solely controlled by a single institution, namely Unit Trust of India. UTI

commenced operations in July 1964 "with a view to encouraging savings and investment

13

and participation in the income, profits and gains accruing to the corporation from the

acquisition, holding, management and disposal of securities"^

1.15 Phases of Growth of Mutual Funds in India

The Mutual Fund industry in India started in 1963 with the formation of UTI at

the initiative of RBI and Government of India. The objective then was to attract the small

investors and introduce them to market investments. Since the, the history of mutual

funds in India can be broadly divided into four distinct phases.

• Phase 1:1964-1987 (Monopoly of UTI)

This spans from 1964 to 1987. In 1963, UTI was established by an Act of

Parliament and given a monopoly. Operationally, UTI was set up by the Reserve Bank of

India, but was later de-linked from the RBI and entrusted main holding to IDBI. The first

and still one of the largest schemes, launched by UTI was Unit Scheme 1964. Over the

years, US-64 attracted the largest number of investors in any single investment scheme.

It was also at least partially the first open-ended scheme in the country, now moving

towards becoming fully open-ended. In absolute terms, the investible funds corpus of

even UTI was stUl relatively small till 1984. But, at the end of this Phase I, UTI had

grown large as evidence by the following statistics.

Table 13 Trends and Growth Rate of AUM of UTI Year 1965 1975 1987

Investible Funds

(Rs. in Billion)

0.25 1.7 45.0

CAGR % 21% 25%

Source: AMFI Work Book 2000

• Phase H: 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non-UTI, Public Sector mutual Funds, brining in

competition. With the opening up of the economy, many public sector banks and

financial institution were allowed to establish mutual funds. During 1987-92, six public

14

sector banks and two financial institutions set up mutual funds. The State Bank of India

established the first non-UTI mutual fund, SBI Mutual Fund in November 1987. This

was followed by Canbank Mutual Fund (launched in December, 1987), LIC Mutual Fund

(launched in 1989) and Indian Bank Mutual Fund (launched in 1990) followed by Bank

of India Mutual Fund, GIC Mutual Fund and PNB Mutual Fund. These mutual funds

helped enlarge the investor community and the investible funds as seen in the following.

Table 1.4 Trends and Growth Rate of AUM of UTI and PSU MFs

Investible Funds (Market Share) (Rs. in Billion as on March)

Year 1986-87 1988-89 1991-92

UTI Rs.46 Rs. 118

(88%)

Rs.318

(85%)

Public Sector Mutual Funds *** Rs. 16

(12%)

Rs.57

(15%)

Total Rs.46 Rs.134 Rs.375

CAGR % *** *** 71%

Source: AMFI Work Book 2000

• Phase m : 1993-1996 (Emergence of Private Sector Funds)

A new era in the mutual fiind industry began with permission granted for the entry

of private sector funds in 1993, giving the Indian investors a broader choice of 'funds

families' and increasing competition for the existing public sector funds. Quite

significantly, Foreign funds management companies were also allowed to operate

mutual funds, most of them coming into India through their joint ventures with India

promoters. These private funds have brought in with them the latest product

innovations, investment management techniques and investor servicing technology

that makes the India mutual fund industry today a vibrant and growth financial

intermediary. The following table indicates the evidence of growing popularity

of private mutual funds among the Indian investors in recent times.

15

Table 1.5 Trends and Growth Rate of AUM of UTI, PSU and Private MFs

Investible Funds (Market Share) (Rs. in Billion as on March)

Year 1994 2002 (upto October)

UTI 520 (85%)

447 (40%)

Public Sector Mutual Funds 84 (14%)

104 (9%)

Private Sector Mutual Funds 9 (1%)

580 (51%)

Total 613 1131

Source: AMFI Work Book 2000

• Phase IV: 1996 (SEBI Regulation for Mutual Funds)

The entire mutual fund industry in India, despite initial hiccups has since scaled

new heights in terms of mobilization of funds and number of players. Deregulation and

liberalization of the Indian economy has introduced competition and provided impetus to

the growth of the industry. Finally, most of the investors (both small and large) have

started shifting towards mutual fiinds as opposed to banks or direct market investments.

More investor friendly regulatory measures have been taken both by SEBI to

protect the investors and by the Government to enhance investors' returns through tax

benefits. A comprehensive set of regulations for all mutual funds operating in India has

been accomplished with SEBI (Mutual Fund) Regulation 1996^.

1.16 Milestones in the Journey of Mutual Funds: Indian Experience

It is quite interesting to know the path of historical developments of Mutual Fund

industry in India. It can be understood from the following historical events that the MFs

industry has taken almost three decades to reach from infancy to adolescent stage in

India.

16

Table 1.6 Milestones of Mutual Funds: Indian Scenario

Year Milestones

1963 The UTI Act enacted

1964 The first Mutual Fund scheme US 64 was launched

1978 Rs. 100 crores mobilized by UTI

1985 Rs. 1000 crores mobilized by UTI

1987 End of UTI monopoly and allowing public sector banks to start Mutual Funds

1990 Mutual Funds by LIC and GIC

1990 Rs. 5000 crores mobilized by UTI and Rs. 3000 crores mobilized by other PSU mutual funds

1992 Stock market gets into bull frenzy. Overheated markets crash as the magnitude of the stock market scam unfolds.

1993 Mutual Funds book heavy losses. And allowing Private sector participation in mutual funds

1994 Entry of Foreign Mutual Fund Morgan Stanly; Allowing the entry of FIIs to participate in Stock market investment; 20 new mutual funds registered with SEBI; Total corpus of all mutual funds reached Rs. 72,000 crores; UTI alone accounts for Rs. 55,000 crores

1995 Annual sales of mutual funds total Rs. 15,000 crores, representing around 7% of all household savings

1996 Stock markets crash, Fresh fiinds inflow reduced to a trickle. Mutual funds as a derivative of equity market reflect poor performance

1997 Mutual fund 2000 vision documents from SEBI, new guidelines introduced, government announces tax sops, fund with proven performance attract steady subscriptions.

1998 Funds riding on it, Pharma , FMCG and IT wave whip up spectacular performances

1999 Budget announces further concessions and the bull run for mutual funds' begin all over again.

2000 Establishment of the Association of Mutual Funds of India (AMFI)

2003 Splitting of UTI into UTI -1 and UTI - II

Source: Compiled from www.mutualfundsindia.com

1.17 Changing face of the Mutual Funds

By 1989-90, mutual funds started emerging as major mobilizers of savings.

Mutual funds were able to give higher returns than those available from bank deposits by

investing a large proportion of their funds in the equity market. Further, as the funds were

17

sponsored by banks themselves, there existed a perception amongst investors that their

investments in these flinds were as safe as the bank deposits. The announcement of tax

concessions for equity linked savings schemes in 1990 proved to be a shot in the arm for

the industry. By 1994, the percentage of Indian middle class households holding

investments in UTI and MF jumped from 37% in 1992 to 65%. Over 25% of this increase

included middle class households who became mutual fund investors for the first time^.

There are 30.8 million investor accounts in the mutual fund industry in India of

which 98% are individuals and about 2% are held by corporates and institutional. In

terms of assets, individual investors contributed to 55% of the total assets while

corporates and institutions held the rest. Dependence on institutional money may create

instability in the size of asset under management for the fund houses as this money is

considered 'hot money'.

Combined with the entry of private sector mutual funds, the shift in focus from

the individual to the institutional investors has led to the surge in mutual fund operation

during last one decade. This unprecedented growth of the mutual funds necessitated the

Securities and Exchange Board of India (SEBI) to frame guidelines for the mutual funds

regulation in 1993. The entry of private sector mutual funds imparted oompetitive

efficiency in the industry and has helped investors to choose from funds with different

maturity periods and offered different risk-return-trade-offs. The Indian mutual fund

industry has started opening up many of the exciting investment opportunities to Indian

investors. This industry has started witnessing the phenomenon of more savings now

being entrusted to the funds than to the banks. The mutual funds are growing

continuously as new financial intermediary in Indian financial market.

1.27 Structure of Mutual Fund Industry in India

a) Sponsor

b) Trustees

c) Asset Management Company (AMC)

d) Custodian and Depositories

e) Transfer Agent

18

f) Bankers

g) Distributors

1.19 Trends of Asset Under Management

Starting with an asset base of Rs. 0.25 billion in 1964, the industry has grown at a

compounded average growth rate of 26.34% to its current size (March, 2003) of Rs. 1130

billion. Of the total 33 players, 8 are in the public sector including UTI, while remaining

25 are in private sector and MNC sector. There are about 382 schemes offered by all the

Funds, of which around 53 are close-ended 9 (including assured return) and the

remaining are open-ended in 2002-03. Several innovative schemes, viz income, growth,

balanced, money market, gilt, tax saving, sector specific, etc have been designed to suit

the needs of the different types of investors. In India the activities of this fast growing

industry is regulated by the norms of Securities Exchange Board of India. Table 1.7

presents year-wise overall growth of mutual funds in terms of cumulative AUM during

the sample period. The above table reveals that the the cumulative resources of UTI and

Bank sponsored mutual funds has declined considerably while the magnitude of funds

mobilized by the private and MNC sector funds went up drastically during study period.

Table: 1.7 Year-wise Assets Under Management of Mutual Fu«ds (as on 31 ^ March)

(Rs. in Crores) Mutual Funds 2000 2001 2002 2003

A) Unit Trust of India 76547 58017 51434 43351®

B) Bank Sponsored (4) 7842 3333 3970 4491

C) Institution (4) 3570 3507 4234 5935

D) Private Sector

1. Indian (7) 2331 3370 5177 10180

2.JointVentures:Predominantly Indian (6) 9724 8620 15502 15459

3.JointVentures:PredominantlyForeign(ll) 12991 13740 20277 29883

Total (1+2+3) 25046 25730 40956 55522

Grand Grand Total (A+B+C+D) 113005 90587 100594 109299

@ UTI Mutual Fund Rsl3516 crore and the Unit Trust of India Rs.29835 crores. Source: www.amfiindia.com

19

The industry giant UTI has lost the corpus base about 43% (between 1999-00 and

2002-03) followed by Bank sponsored Funds at 43% (between 1999-00 and 2002-03).

The private sector (337%) funds and Indian and Foreign joint venture funds (100%) have

emerged as the biggest gainers despite the market crash. The overall trend of cumulative

collection of the funds shows a volatile trend during the sample period.

Table: 1.8 Type and category wise yearly assets under management

Rs. in crores 1999-00 2000-01 2001-02 2002-03

Income 48004 48863 55788 47564

Growth 30611 13483 13852 9887

Balanced 26757 19273 16954 3141

Liquid/Money Market 2227 4128 8069 13734

Gilt 2370 2317 4163 3910

ELSS 3036 2523 1768 1228

Total 113005 90587 100594 79464@

@UTI schemes excluded Source: www.amfi.india.com

The above table shows that the cumulative AMU all the sectors except

Liquid/Money Market and Gilt funds went down significantly during study period. The

cumulative AUM of growth, Balanced and ELSS has witnessed fall by 68%, 88% and

60% respectively between the sample periods.

Table: 1.9 Scheme-wise yeariy Assets Under Management

(Rs. in Crores) Year Open Ended Closed-ended Assured Return Total

1999-00 68833

(60.91%) 21608

(19.12%) 22564

(19.97%) 113005

2000-01 57293 (63.25%)

13613 (15.03%)

19681 (21.73%)

90587

2001-02 71938

(71.51%) 10977

(10.91%) 17679

(17.57%) 100594

2002-03 75071

(94.47%) 4033

(5.08%) 360

(0.45%) 79464@

Source: www.amfiindia.com @UTI schemes excluded

20

It can be witnessed from the above table that the open-ended schemes account

higher proportion in the total AUM over the years while the share of closed-ended and

assured return schemes in the total AUM has reduced drastically during study period.

Table 1.10 Type and category wise schemes launched

1999-00 2000-01 2002-02 2002-03

Income 114 126 146 117

Growth 108 110 114 120

Balanced 24 32 34 35

Liquid /Money Market 19 26 31 32

Gilt 14 19 29 31

ELSS 65 80 63 47

Total 344 393 417 382

Source: www.amfiindia.com

The funds have been trying to reach different segment of investors by introducing

most innovative schemes to suit the needs of the investors. It is evident from the above

table that only the number of ELSS has reduced from 65 to 47 while the number of rest of

the schemes has increased considerably during the sample period.

Table 1.11 AUM for Top 10 Mutual Funds (as on March 31,2003)

SI. No. Name of the Asset Management Company Asset Under Management

(Rs. in Crores) 1. Unit Trust of India 43351

2. Prudential ICICI Asset Management Co. Ltd. 9068

3. Templeton Asset Management (India) Pvt. Ltd. 8792

4. HDFC Asset Management Co. Ltd. 6482

5. Birla Sun Life Asset Management Co. Ltd. 5488

6. Standard Chartered Asset Mgmt Co. Pvt. Ltd. 4163

7. SBI Funds Management Ltd. 3220

8. Kotak Mahindra Asset Management Co. Ltd. 2987

21

9. Jeevan Bima Sahayog Asset Management Co. Ltd. 2939

10. Zurich Asset Management Co. (India) Pvt. Ltd. 2686

Source: www.amfiindia.com

The above table indicates the top ten Asset Management Companies in terms of

AUM as on 31^' March 2003. In spite of drastic fall in the total AUM of UTI over the

years, still it stood at the top in terms of magnitude of asset under management.

The assets under management of Indian mutual funds over the last four years have

more or less stagnated at around Rs 1,00,000 crore. The industry has seen shifting of

assets from one asset to another and one fund house to another without any significant

aggregate growth in total assets. This is possibly the greatest challenge facing the

industry today.

There are three important reasons for this phenomenon.

1. The mutual fund industry presently sells in the major metros and mini metres.

Outside these areas, there is little awareness for mutual ftinds. Thus, a large

potential section remains outside the reach of the industry.

2. The mutual fund products are seen to be reasonably complex and are not

understood by the common middle class person. While attempts have been

made by the industry in the recent past to enhance the awareness of mutual

fund, there is still a long way to go. As a result of this, savings are

channelized into the more traditional and trusted avenues.

3. The melt down of equity markets has had a negative rub-off on mutual funds.

Many investors still associate mutual funds with equity-oriented products

whereas potentially there is a very large opportunity and investor base for debt

oriented products as well.

4. Lack of investors' confidence, poor fund performance etc., which also

constrained the growth of the industry.

22

1.20 Recent Trends in Mutual Fund Industry

The most important trend in the mutual fund industry is the aggressive expansion

of the foreign-owned mutual fund companies and the decline of the companies floated by

nationalized banks and smaller private sector players. Private players have been largely

dependent upon big customers and have generally failed to get retail. Many nationalized

banks got into the mutual fiind business in the early nineties and got off to a good start

due to the stock market boom prevailing then. These banks did not really understand the

mutual fiind business and they just viewed it as another kind of banking activity. Few

hired specialized staff and generally chose to transfer staff from the parent organizations.

The performance of most of the schemes floated by these funds was not good. Some

schemes had offered guaranteed returns and their parent organizations had to bail out

these AMCs by paying large amounts of money as the difference between the guaranteed

and actual returns. The service levels were also very poor. Most of these AMCs have not

been able to retain staff, float new schemes etc. and it is doubtful whether, barring a few

exceptions, they have serious plans of continuing the activity in a major way. The

experience of some of the AMCs floated by private sector Indian companies was also

very similar. They quickly realized that the AMC business is a business, which makes

money in the long term and requires deep-pocketed support in the intermediate years.

Some have sold out to foreign owned companies, some have merged with others and

there is general restructuring going on.

The foreign owned companies have deep pockets and have come in here with the

expectation of a long haul. They can be credited with introducing many new practices

such as new product innovation, sharp improvement in service standards and disclosure,

usage of technology, broker education and support etc. In fact, they have forced the

industry to upgrade itself and service levels of organizations like UTI have improved

dramatically in the last few years in response to the competition provided by them.

Those directly associated with the fund management industry like distributors, registrars

and transfer agents and even the regulators have become more mature and responsible.

Considering the changing trend in the capital market, the funds have shifted their focus to

the recession-free sector like Pharma, FMCG etc. Mutual fiinds are now also competing

23

with commercial banks in the race to retain investors savings and corporate float money.

Recent figures indicate that mutual fund assets went up by 115% where as bank deposits

rose by only 17%. It is just that mutual funds are going to change the way banks do

business in the future .

1.21 Emei^ng issues in Mutual Funds in India

a. Rating of Mutual Fund schemes

Total return has been the criteria for measuring the performance of Mutual Funds.

Often in this methodology, factors like volatility, liquidity and portfolio composition are

ignored, which then may not give the right picture of performance. Hence the CRISIL

has developed Composite Performance Ranking, which measures performance for each

of the open-ended schemes - equity, debt and balance funds. There are four parameters

considered in this measure viz, Risk-adjusted returns of the scheme's NAV,

Diversification of the portfolio. Liquidity, and Asset size. Then ranks are assigned to the

schemes compared to the performance of the competing scheme within the category.

According to CRISIL, this measure is applicable only to those schemes, which are at least

two years old and are disclosing 100% of their portfolio.

b. Changes in MF industry due to the advent of Net

As per SEBI regulations, bond funds and equity fiinds can charge a maximum of

2.25% and 2.5% as administrative fees respectively. The Mutual Funds could bring

down their administrative cost to 0.75% if trading is done on-line and consequently

improves the return potential of the schemes. Mutual funds could provide better advice or

service to their investors through the Net. Mutual funds can target investors who are

young and net savvy, since servicing them would be easier on the net. There will be

more sites viz. www.indiainfoUn.com, www.indiafn.com etc involved in advertisement

and promotion of mutual funds.

c. New Norms on NPA classification

The Malegam committee has made important recommendations regarding norms

on classification of NPAs in debt securities and norms for valuation of illiquid securities

24

in a mutual fund scheme. The committee has recommended that debt securities held by

mutual funds in their portfolio be classified as NPA if the principal or interest is not

received for six months. The MFs will have to disclose the NPAs to unit holders on a

half yearly basis. New norms on valuation of illiquid securities would increase

transparency and put in place uniform accounting standards for all funds.

d. Influence of Technology

Majority of the mutual funds have their own website providing basic information

relating to the schemes. Some of the mutual funds enable purchase and redemption of

units online for clients in select locations. Mutual funds have begun to use electronic

fund transfer method to remit the dividends and redemption proceeds. Mutual funds have

been asked to electronically integrate the back office work relating to fund management.

U n is the first mutual fund to have integrated all these functions across in all its schemes

in a comprehensive manner.

However, the most significant influence of technology is seen in servicing

investors. In particular, agencies such as UTI Investor Services Ltd, Karvy Securities,

Computer Age Management Services, Datamatics have made huge investments to cope

with the volume of investor servicing transactions at acceptable speed and quality.

Beside the investments in technology, these processing centres boast of advanced

methods of quality control in investor services. Recognizing the risk of system failure in

the automated environment many mutual funds and service providers have established

disaster management back up systems in alternate locations.

Mutual funds need to use technology in reaching out the investors. This

technology can bridge the gap in investor education and product positioning.

e. Product Innovation

Product innovation is the emerging feature in the mutual fund industry in India.

This has enabled to cater the varied need of investors' preference. This in turn enhanced

the depth of mutual fiind activities. Most of the products offered by mutual funds can be

divided among three classes of cash funds, income funds and equity funds. The private

25

sector mutual fund entered the scene in early 1990s and introduced better service

standards and wider product choices. Schemes with systematic investment plan,

automatic redemption plan and linking current account to Money Market Mutual Funds,

Cheque writing facility etc., are attempts to create diversity with in the homogeneity of

fund operations. Products such as index funds, international funds sectoral funds and

ETFs have begun to make appearances. These various funds seem to offer a wide choice

for investment to the retail investors. Serial plans and a few liquid plans have essentially

attempted to manage funds for corporate treasuries. Many mutual funds actively pursue

the segment of institutions, charitable organizations, trusts and highly net worth

individual investors by offering customized products.

It is evident from the past experience that most of the products are introduced in

the head of the market. No careful analysis is done to estimate the appetite of the

investor. Some of the products, which can help attract money on its features, are

Principal Protected Funds, Floating Interest Rate Funds, High Yield Bonds/Equity Funds,

Real Estate Mutual Funds etc. The mutual fund industry can also introduce international

products under the newly permitted guidelines by SEBI and the RBI.

The year 2002 was different in that the products offered were for more innovative.

Templeton India launched a debt fund that would invest predominantly in floating rate

bonds. Benchmark Mutual Fund launched India's first exchange-traded fund (ETF),

Nifty BeEs, during the year; Prudential ICICI soon followed with SPICE, another ETF

based the Sensex.

f. Mergers & Acquisitions

The consolidation process in the industry, which was started by Birla Mutual

Mund with the take over of Apple Mutual Fund, has since gathered momentum. The Rs.

275 crore takeover of Pioneer ITI by Templeton in August 2002 made it the biggest ever

merger in the Indian mutual fund industry and turned Templeton into India's largest

private sector fund, with asset under management of Rs. 9,444 crore on 31*' December

2002. Sun F&C's acquisition of Jardine Flemming schemes was the other notable

consolidation move.

26

Table 1.12 Merger Moves

Buyers Sellers Date

Zurich Twentieth Century Feb. 99

Taurus HBMF Mar. 99

Birla Apple* Nov. 99

Zurich rrC Thread needle Dec. 99

Tata Ind Bank * Nov. 01

Taurus Bank of India* Feb. 02

Templeton Pioneer ITI Aug. 02

Sun F & C Jardine Fleming* Aug. 02

Prinicipal MF Sun & F«&C July '03

* Only schemes (assets and unitholders) were taken over, not the employees or infrastructure.

Source: 'Portfolio Organizer' March, 2004.

g. Restructuring of UTI

The most important development affecting the maximum number of investors was

the repeal of the UTI Act, 1963, and the spitting of the ailing colossus into two separate

asset management compames: UTI-I administering the assured return schemes and UTI-

II called UTI Mutual Fund (sponsored by LIC, SBI, BOB and PNB) managing NAV

based schemes in February 2003. UTI's flagship scheme US-64, was also split with the

NAV linked portion renamed US 2002.

h. Indices for Mutual Funds

The AMFI has recently launched four indices for gilt funds and another set of

indices for balanced funds, bond funds, monthly income plans and liquid funds. The

indices, which have been developed and will be maintained by ICICI securities &

Finance Company and Crisil.com respectively, will be mandated for use by MFs to

enable comparison of performance. The Mutual Funds are required to review the

performance of the schemes on a periodical basis with reference to these indices.

27

i. Funds of Funds

The SEBI has permitted the mutual funds to float a new category of funds called

'fund of funds' which will invest in other MF schemes. These schemes will enable

people to invest in different MF schemes through a single fund. Instead of putting money

in different schemes of a mutual fund, this scheme will allow investor to buy different

types of mutual funds like diversified equity funds or income funds.

1.22 Future Scenario

There is an immense potential in this sector in India. The MF industry is moving

from infancy to adolescence stage, and the industry is maturing and the investors and

funds are frankly and openly discussing difficulties, opportunities and compulsions. The

following may be the future trends in MFs in India .

> The asset base will continue to grow at an annual rate of about 30% to 35% over

the next few years as investors are shifting their assets from banks and other

traditional avenues.

> The industry can witness closure or take over of some of the weak, older public

and private sector players by the stronger players in next three to five years. In

the private sector this trend has already started with tiree mergers and one take

over.

> Open ended funds are becoming more popular than close ended funds among the

investors at present.

> The market will also witness a flow of new players entering the arena. There will

be large number of offers from various strong Asset Management Companies in

the coming years who are looking at Indian Market seriously.

> In the U.S. about 9.7 million households are managing their assets on-line. Such

facility is just introduced in India by few players. In future most of the players

will introduce on-line trading system in India which as a result reduces

management expenses from the current 2% to 0.75% of the total assets.

> In the near future in India, Mutual funds will concentrate even on physical funds

like bullion funds, precious metal funds and real estate funds etc. .

28

1.23 Prospects of Mutual Funds in India

The increasing rate of fund mobilization by the mutual funds under various

innovative schemes indicates the growing popularity of mutual funds in India. The entry

of private and foreign mutual funds in the market has provided environment for

competitiveness and more freedom of choice to investors. The frequent fall in the

interest rate and high level of volatility in the stock market has created more

complications in the investment environment both in retail and corporate segment. This

may give further boost to investments in the mutual fiind schemes. The future prospect

of mutual funds is considered to be very bright in view of expanding investors support

and Government's favourable outlook towards mutual funds. Till recently, in our country

mutual funds are only urban oriented. At present, the commercial banks in India have

started playing the role of distributor for mutual fund schemes. And also few designated

post offices are also joined the network of distribution of mutual fund schemes of few

public and private sector mutual funds. This will help in building a mutual fund culture

among the rural investors. The benefit of an enhanced activity level in the India mutual

fund industry is evident in the industry structure. The industry is beginning to show signs

of moving towards maturity.

Opportunities for the mutual fund industry in India are huge and barely the

surface of the potential opportunity has been scratched. However, the need is for greater

investor education, simplification of product communication and enhancement of the foot

print behind the metros and mini metros. These are key challenges.

1.24 SWOT Analysis of Mutual Fund Industry

In the light of present scenario and future outlook, the prospects of MF industry in

India can be analyzed briefly as mentioned below.

29

> >

> > >

STRENGTH Large number of potential customer base. Government support by way of tax concessions for MF investors. Sophisticated capital market Limited number of players at present as compared to advanced countries. Instability in Bank interest rate Vital Source of Capital formation Ensures steady returns at the calculated risk. Better scope for accessing market information Offer Liquidity to the investors at any time

WEAKNESS > Low rate of awareness among

investors about MF concept > Poor participation of retail investors > No assured return and no protection

of capital > Load on NAVs (front or back)

affect the return of investors > Performance is depending upon

market condition of capital market > Poor service conditions >• Distribution Network in most of the

cases restricted to Metro cities only > Lack of professional investment

management especially in case of PSU MFs.

> High level of impact cost > Increasing NPAs in the portfolios > Simultaneous joint action of all

mutual funds in the same direction will shaken the stock market

30

> >

> >

> >

OPPORTUNITIES Failures of NBFCs operations. Huge untapped market in Semi-Urban and Rural areas. High level of Savings habits among the people Free fall in Bank rate of interest Well established Self and Legal regulatory body Scope for products innovation to suit the need of large base of Customers. Liberalized business environment Increasing investors interest toward money market instruments ofMFs. Fast growth of Asset Base of MFs. Widening of Distribution Channel through Franchisees. Aggressive investors' education campaign by AMFI and other MFs. Using on-line mode of trading system. Relaxation on restriction of oversees investment upto Rs. 500 million crores under Capital Account convertibility norms

>

>

>

THREAT Increasing competition among the players. High level of volatility in the Stock market. Dominance of multi national investment companies. NAVs are highly sensitive to internal and market factors. Possibility of more stringent regulation by SEBI, RBI, AMFI etc. in future. Retail trading in G-Sec market Possible withdrawal of tax sops offered to mutual fund investors as per Kelkar committee recommendation.

There is no doubt that Mutual Funds have clearly emerged as a new and favoured

investment vehicle in the recent past both in retail and corporate segment. The mutual

fund industry will witness the growth similar to what was experienced in late 1980s in the

U.S. Spread of mutual fund cult to the smaller towns and rural areas will be a key

constituent to achieve high growth. Distribution and reach, as in the consumer goods

market, will be the key to success. Product innovation, focus, service and above all

performance will determine the winners in future.

1.25 Legal & Regulatory environment of Mutual Funds

The working of MFs is governed by UTI Act 1963; Indian Trust Act 1882;

relevant provisions of the Companies Act 1956; and various tax laws. The overall

regulation, overseeing and supervision of MF industry is done by the Ministry of Finance

31

of Government of India, the RBI and the SEBI. Initially the RBI had issued guidelines

for bank-sponsored MFs in 1987. Then followed the guidelines from Ministry of Finance

in 1991. Thereafter, the SEBI issued guideline in 1992 and a comprehensive set of

regulations in 1993. With the growth of Mutual Fund industry, it became necessary that

all MFs follow uniform norms for valuation of investments and accounting practices so

that any once could judge their performance on a comparable basis. Therefore, the SEBI

issued new mutual fiind regulations in December 1996, based on the recommendations of

the Mutual Fund 2000 Report prepared by it.

The new SEBI regulations (1996) are uniformly applicable to all the existing

mutual funds in all the sectors, including the UTI. Offshore funds are governed by the

Ministry of Finance, Government of India and the RBI. MMMFs are governed by the

RBI. The regulations aim at improving investor protection, facilitating competition,

imparting a greater degree of flexibility, and promoting innovation .

1.26 Regulations by SEBI

The Government of India constituted Securities and Exchange Board of India, by

an Act of Parliament in 1992, as the apex regulator of all entities that either raise funds in

the capital markets or invest in capital market securities such as shares and debentures

listed on stock exchanges. MFs have emerged as an important institutional investor in

capital market securities. Hence they come under the purview of SEBI. The SEBI

requires all mutual funds to be registered with them. It issues guidelines for all mutual

fund operations including where they can invest, what investment limits and restrictions

must be complied with, how hey should account for income and expenses, how they

should make disclosures of information to the investors and generally acts in he interest

of investor protection. Other entities that SEBI also regulates are companies when they

issue equity or debt, share registrars, custodian, bankers in the primary markets, stock

exchanges and brokers in the secondary markets, and foreign and institutional investors

such as FIIs, offshore mutual funds with dedicated Indian MFs or venture capital

investors.

32

Some of the salient features of these regulations are as under:

1. The MFs are required to be formed a trusts and managed by separately formed

AMCs. The minimum net worth of AMC is Rs 10 crores, of which the

minimum contribution of the sponsor should be 40%

2. AMCs can have cross trusteeship and directorship provided there is no

conflict of interest.

3. AMCs can undertake other fund-based business such as providing investment

management services and they can also diversify into management of pension

funds, offshore funds, and Venture Capital funds.

4. MFs cannot deal in option trading, short selling or carrying forward

transactions in securities.

5. They can invest only in transferable securities in the money and capital market

or any privately placed debenture or debt securities.

6. Restrictions to ensure that investments under an individual scheme do not

exceed 5% of the corpus of any company's share, and investments under all

schemes do not exceed 10% of the funds in the shares, debentures or securities

of a single company.

7. Investments under all the schemes cannot exceed 15% of the funds in the

shares and debentures of a single company.

8. The advertisement code or marketing schemes of the mutual funds, the

contents of the trust deed, investment management agreement and the scheme-

wise balance sheet have to be in prescribed form.

9. The MP should have a custodian, not associated in any way with the AMC

and registered with the Board.

10. The minimum amount to be raised with each closed-ended scheme should be

Rs. 20 crores and for the open-ended scheme Rs. 50 crores.

11. In case the amount collected falls short of the minimum prescribed, the entire

amount should be refunded not later than six weeks from the date of closure of

the scheme otherwise the amount should be refunded with a penalty of interest

at the rate of 15% p.a.

33

12. The mutual funds are obliged to maintain books of accounts, expenses,

appropriation of expenses, among the individual schemes, the limit of

expenses of the AMC that can be charged to the MF, provision for

depreciation and bad debt.

13. SEBI is empowered to appoint one or more persons as inspecting authority to

inspect the MF. And also empowered to appoint an auditor to investigate into

the books of accounts or the affairs of the MF

14. SEBI can impose suspension of registration in case of violation of the

provisions of the SEBI Act 1992 or the regulations.

15. The consent of investors must be obtained by MFs for making any change in

the 'fundamental attributes' of a scheme on the basis of which the unit-holders

had made initial investments.

16. MFs can mention, while floating different schemes, indicative but not assured

return on those schemes.

17. MFs must follow common or uniform methods of valuation of securities,

accounting, reporting and calculating NAVs. The valuation of investments

munt be made on a mark-to-raarket basis. The dates when the security has to

be treated as ex-dividend, ex-rights, and ex-bonus have been brought on par

with international practices.

18. MFs are now free to determine their portfolio composition.

19. MFs can not make any investment in privately placed (unlisted) securities

issued by associate or group companies of the sponsor.

20. The aggregate investments of MFs in the listed and or to be listed securities of

group companies of the sponsor should not exceed 25% of the net asset of all

their schemes^".

1.27 Self Regulatory Oi^anization

A Self Regulatory Organization is an association representing a group of market

participants, which is specially empowered by the apex regulatory authority to exercise

pre-defined authority over the regulation of their members. Normally, SRO s are given

powers to regulate the criteria and procedures for admission of its members, set a code of

34

conduct fro their members' market activities, determine the professional rules and bylaws

of the association, and so on. SROs facilitate decentralization in the regulatory structure,

involve the market players in the regulatory process and ensure that the regulatory

policies and procedures do not become uaacceptable to the market participants or

unmanageable for the apex regulatory body. It has to be noted that every body

representing a group of market participants does not automatically become a SRO; it has

to be granted specific powers and approval to become a SRO by the government,

appropriate laws and recognition by the regulatory authority.

While Stock Exchanges have a definite role as SROs in India, in other sectors of

the capital markets, SROs have yet to emerge as a potent force.

1.28 Association of Mutual Funds in India

As in the USA, where the Investment Company Institute plays a role as an

industry association for the MF industry, the AMFI plays a similar role in India. AMFI is

not a SRO, though it is conceivable that it may choose to apply for that status and become

one in the future.

• To define and maintain high professional and ethical standards in all areas

of operation of mutual fund industry

• To recommend and promote best business practices and code of conduct to

be followed by members and others engaged in the activities of mutual fund

and asset management including agencies connected or involved in the field

of capital markets and financial services.

• To interact with the Securities and Exchange Board of India (SEBl) and to

represent to SEBI on all matters concerning the mutual fund industry.

• To represent to the Government, Reserve Bank of India and other bodies on

all matters relating to the Mutual Fund Industry.

• To develop a cadre of well trained Agent distributors and to implement a

programme of training and certification for all intermediaries and others

engaged in the industry.

35

• To undertake nation wide investor awareness programme so as to promote

proper understanding of the concept and working of mutual funds.

• To disseminate information on Mutual Fund Industry and to undertake

studies and research directly and/or in association with other bodies.

(www.amfiindia.com)

Various AMFI committees are today involved with establishing standards for the

MF industries on different aspects like determining the NAV, Advertisement Code and

Investor relations etc. AMFI also takes up the taxation issues or ideas on regulatory

changes required for the MFs and their investors in India.

Mutual Funds have clearly emerged as a new and favoured investment vehicle in

the recent past both in retail and corporate segment. The mutual fund industry will

witness the growth similar to what was experienced in late 1980s in the U.S. Spread of

mutual fund cult to the smaller towns and rural areas will be a key constituent to achieve

high growth. Distribution and reach, as in the consumer goods market, will be the key to

success. Product innovation, focus, service and above all performance will determine the

winners in future. At this transition period, the Indian mutual fund industry needs to

develop better products, demonstrate robust investment processes and ensure better

service standards to gain and retain investor confidence. This retention of investor trust

and confidence will ultimately translate in to higher assets under management on

sustained basis. Indian mutual fund industry has to garner investor trust by way of better

products, better process and better services.

* ^ U a t* ^ U ^ > *Jm ^m ^ ^ ^ ^

36

Reference

1. H Sadak 1997, Mutual Funds India, Response Books, New Delhi. Pp 22-25,40-47, 57-59, 68-109,120-145

2. Vasant Desai,1999, The Indian Financial System, pOl, Himalaya Publishing House, Mumbai pp549-550

3. K G Sahadevan & M Thirupal Raju, Mutual Funds Data, interpretation and Analysis pp 1-12, Prentice Hall India Pvt Ltd, New Delhi 1997.

4. Reilly K Frank, Investments, CBS College Publishing, 1982, p. 526-28 5. Work book for Distributor and Employees of Mutual Funds 2000 - pp 4-5, AMFI

Mumbai, 40-42 6. www.ignouraeids.co.in 7. Lalit K Bansal 1997, Mutual Funds: Management & Workings, Deep & Deep

Publications, New Delhi pp 23-30 8. Dr. J C Verma 1997, p 16-18, Guide to Mutual Funds & Investment Portfolio,

Bharat Publishing House, New Delhi, 40-48 9. www.indiainfoline.com 10. Manual of SEBI guidelines on Capital Issue, Euro Issues, Merchant Banking,

Mutual Funds, NABHI Publications, New Delhi, p 1287-88 11. www.sebi.gov.in 12. L M Bhole, Financial Institutions & Markets, Tata McGraw-Hill Publishing Co

Ltd, 1999, pp 237

37