Mutual Funds Final Report

7/31/2019 Mutual Funds Final Report

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IBS HYDERABAD

2011

Project Prepared by:

NEELAM MANDOWARA (10BSPHH01044

HARSH MODI (10BSPHH010265)MANSI MATELA (10BSPHH010)

MILAN DHODIA (10BSPHH010)

INDER GARG (10BSPHH010280)

KUNAL BASU (10BSPHH010352)

10/9/2011

MUTUAL FUNDS INVESTMENTS


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MUTUAL FUNDS INVESTMENTS 2011

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ACKNOWLEDGEMENT

We take this proud privilege to acknowledge gracefully the help we received from different sources in

preparation of this report.

We are highly obliged to Mr. R. K. JAIN, our professor and faculty for Security Analysis at IBS Hyderabad

for giving us a chance to work in this project and providing us a comfortable work environment and his

continued guidance throughout the project. This would not have been possible without his sincerity and

dedication towards the subject ad helping us all the way through.

I would also like to extend my thanks to all my colleagues for the assistance, support and the

suggestions, throughout which have been valuable to me, and for providing a friendly work atmosphere

with healthy competition throughout the project.


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Contents

ACKNOWLEDGEMENT .............................................................................................................. 2

What are Mutual Funds? ................................................................................................................. 5

Investors in mutual funds ................................................................................................................ 5

Types of Mutual Funds Schemes in India....................................................................................... 6

Motive behind different schemes .................................................................................................. 11

Business Model of Mutual Funds ................................................................................................. 18

Revenue Expense Model of Mutual Funds ................................................................................... 19

Advantages of Mutual Funds ........................................................................................................ 20

Disadvantages of Mutual Funds.................................................................................................... 22

Risks in Mutual Funds investments .............................................................................................. 24

Evolution of Mutual Fund Industry .............................................................................................. 27

First Phase1964-87................................................................................................................ 27

Second Phase1987-1993 (Entry of Public Sector Funds) ..................................................... 27

Third Phase1993-2003 (Entry of Private Sector Funds) ....................................................... 27

Fourth Phasesince February 2003 ......................................................................................... 28

Choosing a Fund ........................................................................................................................... 30

Risk capacity ............................................................................................................................. 30

Liquidity .................................................................................................................................... 30

Specific needs ........................................................................................................................... 30

Track record .............................................................................................................................. 31

Transacting Mutual Funds ............................................................................................................ 31

Close-ended schemes ................................................................................................................ 31

Open ended schemes ................................................................................................................. 31

Buying close ended units post IPO ........................................................................................... 31

TAX .............................................................................................................................................. 32

Appreciation/Depreciation of the NAV ........................................................................................ 33

Total Return Method ................................................................................................................. 33

Reinvesting Dividend................................................................................................................ 33Investment Inflows and Outflows in Mutual Funds ..................................................................... 35

Investor Profile in the Mutual Fund Industry ........................................................................... 37

Regulations in Mutual fund Industry ............................................................................................ 38

Regulatory Authorities .................................................................................................................. 39

Challenges and Issues ................................................................................................................... 40


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Recent trends in Mutual Fund Industry ........................................................................................ 42

Current NEWS in Mutual Fund Industry ...................................................................................... 45

Performance Measurement: A Comparative Analysis .................................................................. 47

Standard Deviation.................................................................................................................... 48

Beta ........................................................................................................................................... 49

The Treynors Ratio .................................................................................................................. 51

Sharpe Ratio .............................................................................................................................. 52

Jensens Measure ...................................................................................................................... 53

Future Outlook of Mutual Funds Industry .................................................................................... 55

Research Papers ............................................................................................................................ 57

References ..................................................................................................................................... 60


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What are Mutual Funds?

A Mutual Fund can be considered a trust, a connecting bridge or a financial intermediary that pools

the savings of a number of investors who share a predetermined investment objective such as

capital appreciation and dividend earning. A Mutual Fund can comprise of many investments other

than stocks and bonds (including annuities, real estate, and precious metals), but the majority of

mutual funds invest in stocks and/or bonds.

One can think of a mutual fund as a company that brings together a group of people and invests

their money in stocks, bonds, and other securities or asset classes that match the stated objective of

that scheme. Each investor owns shares of the mutual fund company, which represents a portion of

the holdings of the fund and thus on investing becomes a shareholder or unit holder of the fund.

The fund manager is responsible for investing the gathered money into specific securities (stocks or

bonds), collect the income from investments and capital appreciation realized by the scheme &

distribute the gains to the unit holders in proportion to the number of units owned by them.

Mutual funds are considered as one of the best available investment option when compared to

others as they are very cost efficient and also easy to invest in, thus by pooling money together in a

mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they tried

to do it on their own.

Investors in mutual funds

Investor need to be aware of who can buy mutual funds units or shares. Mutual Funds in India are open

to Investment broadly by :

o FIIs 1%o NRIs 4%o Corporates/Institutions/Others 58%o Individuals 37%


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They can also be categorized as followings:

Residents including

o Resident Indian Individual.o Indian Companieso Indian trusts/charitable trustso Bankso Non-Banking Finance companieso Insurance companieso Provident fundsNon Residents Including

o Non resident Indianso Overseas corporate bodiesForeign entities

o Foreign Institutional Investors registered with SEBIo Foreign citizens/entities are however now allowed to invest in India.

Types of Mutual Funds Schemes in India

Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial position, risk

tolerance and return expectations etc. thus mutual funds has Variety of flavors, Being a collection of

many stocks, an investors can go for picking a mutual fund might be easy. There are over hundreds

of mutual funds scheme to choose from. It is easier to think of mutual funds in categories,

mentioned below.


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Classification Based on type of Structure:1. Open - Ended Schemes:

An open-end fund is one that is available for subscription all through the year. These do not

have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV")

related prices. The key feature of open-end schemes is liquidity.

2. Close - Ended Schemes:These schemes have a pre-specified or stipulated maturity period. One can invest directly in the

scheme at the time of the initial issue. Depending on the structure of the scheme there are two exit

options available to an investor after the initial offer period closes. Investors can transact (buy or

sell) the units of the scheme on the stock exchanges where they are listed. The market price at the

stock exchanges could vary from the net asset value (NAV) of the scheme on account of demand

and supply situation, expectations of unit holder and other market factors. Alternatively some

close-ended schemes provide an additional option of selling the units directly to the Mutual Fund

through periodic repurchase at the schemes NAV; however one cannot buy units and can only sell


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units during the liquidity window. SEBI Regulations ensure that at least one of the two exit routes

is provided to the investor.

3. Interval Schemes:Interval Schemes are that scheme, which combines the features of open-ended and close-

ended schemes. The units may be traded on the stock exchange or may be open for sale or

redemption during pre-determined intervals at NAV related prices.

Classification by type of nature1. Equity fund:

These funds invest a maximum part of their corpus into equity holdings. The structure of the fund

may vary different for different schemes and the fund managers outlook on different stocks. The

Equity Funds are sub-classified depending upon their investment objective, as follows:

Diversified Equity Funds

Mid-Cap Funds

Sector Specific Funds

Tax Savings Funds (ELSS)

Equity investments are meant for a longer time horizon, thus Equity funds rank high on the risk-

return matrix.

2. Debt funds:The objective of these Funds is to invest in debt papers. Government authorities, private

companies, banks and financial institutions are some of the major issuers of debt papers. By

investing in debt instruments, these funds ensure low risk and provide stable income to the

investors. Debt funds are further classified as:

o Gilt Funds: Invest their corpus in securities issued by Government, popularly known asGovernment of India debt papers. These Funds carry zero Default risk but are associated

with Interest Rate risk. These schemes are safer as they invest in papers backed by

Government.

o Income Funds: Invest a major portion into various debt instruments such as bonds,corporate debentures and Government securities.

o MIPs: Invests maximum of their total corpus in debt instruments while they take minimumexposure in equities. It gets benefit of both equity and debt market. These scheme ranks

slightly high on the risk-return matrix when compared with other debt schemes.


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o Short Term Plans (STPs): Meant for investment horizon for three to six months. These fundsprimarily invest in short term papers like Certificate of Deposits (CDs) and Commercial

Papers (CPs). Some portion of the corpus is also invested in corporate debentures.

o Liquid Funds: Also known as Money Market Schemes, These funds provides easy liquidityand preservation of capital. These schemes invest in short-term instruments like Treasury

Bills, inter-bank call money market, CPs and CDs. These funds are meant for short-term cash

management of corporate houses and are meant for an investment horizon of 1day to 3

months. These schemes rank low on risk-return matrix and are considered to be the safest

amongst all categories of mutual funds.

3. Balanced funds:As the name suggest they, are a mix of both equity and debt funds. They invest in both equities

and fixed income securities, which are in line with pre-defined investment objective of the

scheme. These schemes aim to provide investors with the best of both the worlds. Equity part

provides growth and the debt part provides stability in returns.

Classification by type of investment objectives1. Growth Schemes: Growth Schemes are also known as equity schemes. The aim of these

schemes is to provide capital appreciation over medium to long term. These schemes normally

invest a major part of their fund in equities and are willing to bear short-term decline in value

for possible future appreciation.

2. Income Schemes: Income Schemes are also known as debt schemes. The aim of these schemesis to provide regular and steady income to investors. These schemes generally invest in fixed

income securities such as bonds and corporate debentures. Capital appreciation in such

schemes may be limited.

3. Balanced Schemes: Balanced Schemes aim to provide both growth and income by periodicallydistributing a part of the income and capital gains they earn. These schemes invest in both

shares and fixed income securities, in the proportion indicated in their offer documents

(normally 50:50).

4. Money Market Schemes: Money Market Schemes aim to provide easy liquidity, preservation ofcapital and moderate income. These schemes generally invest in safer, short-term instruments,

such as treasury bills, certificates of deposit, commercial paper and inter-bank call money.


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Other Schemes1. Tax Saving Schemes: Tax-saving schemes offer tax rebates to the investors under tax laws

prescribed from time to time. Under Sec.88 of the Income Tax Act, contributions made to any

Equity Linked Savings Scheme (ELSS) are eligible for rebate.

2. Index Schemes: Index schemes attempt to replicate the performance of a particular index suchas the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks

that constitute the index. The percentage of each stock to the total holding will be identical to

the stocks index weightage. And hence, the returns from such schemes would be more or less

equivalent to those of the Index.

3. Sector Specific Schemes: These are the funds/schemes which invest in the securities of onlythose sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software,

Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are

dependent on the performance of the respective sectors/industries. While these funds may give

higher returns, they are more risky compared to diversified funds. Investors need to keep a

watch on the performance of those sectors/industries and must exit at an appropriate time.

Types of Returns

There are three ways, where the total returns provided by mutual funds can be enjoyed by investors:

1. Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly allincome it receives over the year to fund owners in the form of a distribution.

2. If the fund sells securities that have increased in price, the fund has a capital gain. Most fundsalso pass on these gains to investors in a distribution.

3. If fund holdings increase in price but are not sold by the fund manager, the fund's sharesincrease in price. You can then sell your mutual fund shares for a profit. Funds will also usually

give you a choice either to receive a check for distributions or to reinvest the earnings and get

more shares.


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Motive behind different schemes

1. Equity Funds

Equity funds are considered to be high risk funds as compared to other types, but they also provide

higher returns than other funds. It is advisable that an investor looking to invest in an equity fund

should invest for long term i.e. for 3 years or more. There are different types of equity funds each

falling into different risk bracket. In the order of decreasing risk level, there are following types of

equity funds:

Aggressive Growth Funds - In Aggressive Growth Funds, fund managers aspire for maximum

capital appreciation and invest in less researched shares of speculative nature. Because of these

speculative investments Aggressive Growth Funds become more volatile and thus, are prone to

higher risk than other equity funds.

Growth Funds - Growth Funds also invest for capital appreciation (with time horizon of 3 to 5

years) but they are different from Aggressive Growth Funds in the sense that they invest in

companies that are expected to outperform the market in the future. Without entirely adopting

speculative strategies, Growth Funds invest in those companies that are expected to post above

average earnings in the future.

Speciality Funds - Speciality Funds have stated criteria for investments and their portfolio

comprises of only those companies that meet their criteria. Criteria for some speciality fundscould be to invest/not to invest in particular regions/companies. Speciality funds are

concentrated and thus, are comparatively riskier than diversified funds.. There are following

types of speciality funds:

a. Sector Funds: Speciality Funds have stated criteria for investments and their portfoliocomprises of only those companies that meet their criteria. Criteria for some speciality

funds could be to invest/not to invest in particular regions/companies. Speciality funds

are concentrated and thus, are comparatively riskier than diversified funds.. There arefollowing types of speciality funds:

b. Foreign Securities Funds: Foreign Securities Equity Funds have the option to invest inone or more foreign companies. Foreign securities funds achieve international


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diversification and hence they are less risky than sector funds. However, foreign

securities funds are exposed to foreign exchange rate risk and country risk.

c. Mid-Cap or Small-Cap Funds: Funds that invest in companies having lower marketcapitalization than large capitalization companies are called Mid-Cap or Small-Cap

Funds. Market capitalization of Mid-Cap companies is less than that of big, blue chip

companies (less than Rs. 2500 crores but more than Rs. 500 crores) and Small-Cap

companies have market capitalization of less than Rs. 500 crores. Market Capitalization

of a company can be calculated by multiplying the market price of the company's share

by the total number of its outstanding shares in the market. The shares of Mid-Cap or

Small-Cap Companies are not as liquid as of Large-Cap Companies which gives rise to

volatility in share prices of these companies and consequently, investment gets risky.

d. Option Income Funds: While not yet available in India, Option Income Funds writeoptions on a large fraction of their portfolio. Proper use of options can help to reduce

volatility, which is otherwise considered as a risky instrument. These funds invest in big,

high dividend yielding companies, and then sell options against their stock positions,

which generate stable income for investors.

Diversified Equity Funds - Except for a small portion of investment in liquid money market,

diversified equity funds invest mainly in equities without any concentration on a particular

sector(s). These funds are well diversified and reduce sector-specific or company-specific risk.

However, like all other funds diversified equity funds too are exposed to equity market risk. One

prominent type of diversified equity fund in India is Equity Linked Savings Schemes (ELSS). As per

the mandate, a minimum of 90% of investments by ELSS should be in equities at all times. ELSS

investors are eligible to claim deduction from taxable income (up to Rs 1 lakh) at the time of

filing the income tax return. ELSS usually has a lock-in period and in case of any redemption by

the investor before the expiry of the lock-in period makes him liable to pay income tax on such

income(s) for which he may have received any tax exemption(s) in the past.

Equity Index Funds - Equity Index Funds have the objective to match the performance of a

specific stock market index. The portfolio of these funds comprises of the same companies that

form the index and is constituted in the same proportion as the index. Equity index funds that

follow broad indices (like S&P CNX Nifty, Sensex) are less risky than equity index funds that


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Diversified Debt Funds - Debt funds that invest in all securities issued by entities belonging to all

sectors of the market are known as diversified debt funds. The best feature of diversified debt

funds is that investments are properly diversified into all sectors which results in risk reduction.

Any loss incurred, on account of default by a debt issuer, is shared by all investors which further

reduces risk for an individual investor.

Focused Debt Funds - Debt funds that invest in all securities issued by entities belonging to all

sectors of the market are known as diversified debt funds. The best feature of diversified debt

funds is that investments are properly diversified into all sectors which results in risk reduction.

Any loss incurred, on account of default by a debt issuer, is shared by all investors which further

reduces risk for an individual investor.

High Yield Debt funds - As we now understand that risk of default is present in all debt funds,

and therefore, debt funds generally try to minimize the risk of default by investing in securities

issued by only those borrowers who are considered to be of "investment grade". But, High Yield

Debt Funds adopt a different strategy and prefer securities issued by those issuers who are

considered to be of "below investment grade". The motive behind adopting this sort of risky

strategy is to earn higher interest returns from these issuers. These funds are more volatile and

bear higher default risk, although they may earn at times higher returns for investors.

Assured Return Funds - Although it is not necessary that a fund will meet its objectives or

provide assured returns to investors, but there can be funds that come with a lock-in period and

offer assurance of annual returns to investors during the lock-in period. Any shortfall in returns

is suffered by the sponsors or the Asset Management Companies (AMCs). These funds are

generally debt funds and provide investors with a low-risk investment opportunity. However,

the security of investments depends upon the net worth of the guarantor (whose name is

specified in advance on the offer document). To safeguard the interests of investors, SEBI

permits only those funds to offer assured return schemes whose sponsors have adequate net-

worth to guarantee returns in the future. In the past, UTI had offered assured return schemes

(i.e. Monthly Income Plans of UTI) that assured specified returns to investors in the future. UTI

was not able to fulfill its promises and faced large shortfalls in returns. Eventually, government

had to intervene and took over UTI's payment obligations on itself. Currently, no AMC in India

offers assured return schemes to investors, though possible.

Fixed Term Plan Series - Fixed Term Plan Series usually are closed-end schemes having short

term maturity period (of less than one year) that offer a series of plans and issue units to


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investors at regular intervals. Unlike closed-end funds, fixed term plans are not listed on the

exchanges. Fixed term plan series usually invest in debt / income schemes and target short-term

investors. The objective of fixed term plan schemes is to gratify investors by generating some

expected returns in a short period.

3. Gilt Funds

Also known as Government Securities in India, Gilt Funds invest in government papers (named

dated securities) having medium to long term maturity period. Issued by the Government of

India, these investments have little credit risk (risk of default) and provide safety of principal to

the investors. However, like all debt funds, gilt funds too are exposed to interest rate risk.

Interest rates and prices of debt securities are inversely related and any change in the interest

rates results in a change in the NAV of debt/gilt funds in an opposite direction.

4. Money Market / Liquid Funds

Money market / liquid funds invest in short-term (maturing within one year) interest bearing

debt instruments. These securities are highly liquid and provide safety of investment, thus

making money market / liquid funds the safest investment option when compared with other

mutual fund types.

However, even money market / liquid funds are exposed to the interest rate risk. The typical

investment options for liquid funds include Treasury Bills (issued by governments), Commercial

papers (issued by companies) and Certificates of Deposit (issued by banks).

5. Hybrid Funds

As the name suggests, hybrid funds are those funds whose portfolio includes a blend of equities,

debts and money market securities. Hybrid funds have an equal proportion of debt and equity in

their portfolio. There are following types of hybrid funds in India:

o Balanced Funds - The portfolio of balanced funds include assets like debt securities,convertible securities, and equity and preference shares held in a relatively equal

proportion. The objectives of balanced funds are to reward investors with a regular income,

moderate capital appreciation and at the same time minimizing the risk of capital erosion.

Balanced funds are appropriate for conservative investors having a long term investment

horizon.

o Growth-and-Income Funds - Funds that combine features of growth funds and income fundsare known as Growth-and-Income Funds. These funds invest in companies having potential


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for capital appreciation and those known for issuing high dividends. The level of risks

involved in these funds is lower than growth funds and higher than income funds.

o Asset Allocation Funds - Mutual funds may invest in financial assets like equity, debt, moneymarket or non-financial (physical) assets like real estate, commodities etc.. Asset allocation

funds adopt a variable asset allocation strategy that allows fund managers to switch over

from one asset class to another at any time depending upon their outlook for specific

markets. In other words, fund managers may switch over to equity if they expect equity

market to provide good returns and switch over to debt if they expect debt market to

provide better returns. It should be noted that switching over from one asset class to

another is a decision taken by the fund manager on the basis of his own judgment and

understanding of specific markets, and therefore, the success of these funds depends upon

the skill of a fund manager in anticipating market trends.

6. Commodity Funds

Those funds that focus on investing in different commodities (like metals, food grains, crude oil

etc.) or commodity companies or commodity futures contracts are termed as Commodity Funds.

A commodity fund that invests in a single commodity or a group of commodities is a specialized

commodity fund and a commodity fund that invests in all available commodities is a diversified

commodity fund and bears less risk than a specialized commodity fund. "Precious Metals Fund"

and Gold Funds (that invest in gold, gold futures or shares of gold mines) are common examples

of commodity funds.

7. Real Estate Funds

Funds that invest directly in real estate or lend to real estate developers or invest in

shares/securitized assets of housing finance companies, are known as Specialized Real Estate

Funds. The objective of these funds may be to generate regular income for investors or capital

appreciation.

8. Exchange Traded Funds (ETF)

Exchange Traded Funds provide investors with combined benefits of a closed-end and an open-

end mutual fund. Exchange Traded Funds follow stock market indices and are traded on stock

exchanges like a single stock at index linked prices.

The biggest advantage offered by these funds is that they offer diversification, flexibility of

holding a single share (tradable at index linked prices) at the same time. Recently introduced in

India, these funds are quite popular abroad.


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9. Fund of Funds

Mutual funds that do not invest in financial or physical assets, but do invest in other mutual

fund schemes offered by different AMCs, are known as Fund of Funds. Fund of Funds maintain a

portfolio comprising of units of other mutual fund schemes, just like conventional mutual funds

maintain a portfolio comprising of equity/debt/money market instruments or non financial

assets. Fund of Funds provide investors with an added advantage of diversifying into different

mutual fund schemes with even a small amount of investment, which further helps in

diversification of risks. However, the expenses of Fund of Funds are quite high on account of

compounding expenses of investments into different mutual fund scheme.

Such a Fund scheme is not yet introduced in India mutual fund markets.


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Pool their

money with

Invest inCreates

Give back to

Via

Agents/Distributors

or directly, pool their

Dividend

and Capital

Business Model of Mutual Funds

First lets see how mutual funds are set up. There are four parties involved in setting up a mutual

fund.

1. Sponsor: The one who set up a mutual fund in the form of a trust by registering with SEBI and islike a promoter of a company.

2. Trustee: The one who have a fiduciary responsibility towards unit holders and check whetherinvestments are within limits.

3. Fund Managers / AMC: The one who actually manage the funds by making investments and areapproved by SEBI to do so. They do the due diligence, invest, report and give returns.

4. Custodian: The one who takes custody of securities and other assets of a mutual fund and isregistered with SEBI.

Once Mutual Fund is set up, we should know their basic operation as shown in below figure. We can

see that Investors (Unit Holders) pool in their money with Mutual Fund Managers who then select

securities to invest in accordance with the objectives stated and generate return for investors.

Agents and Distributors are the third parties involved in this complete process who are spread all

over the country for promoting and collecting application forms from potential investors. Investors

can also invest directly with Mutual Funds.

Investors

FundManagers

Securities

Return


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Revenue Expense Model of Mutual Funds

Entry Fee: Till August 2009, Mutual Funds used to charge entry fee to

the investors but after that it was banned by SEBI. This fee was used to bearound 2.25% of NAV. As a back door imposition of entry load, SEBI in Aug

2011 imposes initial transaction fees as explained below

Initial Transaction Fee: SEBI passed a circular in Aug 2011 stating that

new investors will pay Rs. 150 and existing investors will pay Rs. 100 for

investment of >= Rs. 10,000 . The payment will be to the distributor.

Expense Ratio / Annual Maintenance Charges: Depend on the type of

fund and size of fund. As per SEBI regulations, maximum charges for Equity

funds is 2.5% and Debt funds is 2.25% of total AUM in a year. The charges

decrease with increase in fund corpus and finally capped at 1.75% for

Equity funds and 1.5% for Debt funds each with a corpus of exceeding Rs.

900 crores. These charges are automatically deducted from investors' NAV

on daily basis. For index funds and ETFs, the expense ratio is capped at

1.5% irrespective of corpus accumulated. On an average Expense Ratio

varies between 1.25% and 1.5%.

Exit Fee / Backend Load: Around 1% of total redemption value is

charged if the investor withdraw within 1 year. This is to bring down the

frequency of withdrawal from funds.

Revenue

Brokerage or Trading Fee: It also includes the Securities Transaction Tax

in it. Brokerage fee is not incurred in expense ratio, instead it goes to the

cost of the security. But there are chances that Mutual Funds might have

to incorporate this into their expense ratios. (source: CNBC-TV18)

Fund's Advisor Fee

Marketing and Advertising Costs

Administrative Fees

Distribution Fee / Agent Commission

Expenses


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Advantages of Mutual Funds

1. Professional ManagementMarket is filled by three types of investors uninformed, informed and highly informed hence

the basic advantage of mutual fund is that the former two types of investors get an

opportunity to manage their fund by the latter hence in nutshell, qualified investment

professionals who seek to maximize returns and minimize risk monitor investor's money

It is also very difficult for new entrants to understand and analyze the stocks, and investors

neither have time tot rack markets nor skills hence comes in the role of mutual funds and by

virtue of being in the market, the fund manager is ideally placed to research various

investment options, and invest accordingly for the investor.

2. Small Investment Capability of an IndividualTo have good stocks or bonds in the portfolio high investment is required to get higher

returns for example to buy government securities or to build a decent portfolio of blue-chip

companies minimum requirement is 25000 which may be not affordable for number of

small investors.

A mutual fund, however, gives small investors an ownership of the same investment pie at

an outlay of Rs 1,000-5,000. This is because a mutual fund pools in funds of several

investors, and invests the resultant large sum in a number of securities. Therefore, on a

small outlay, investor gets to participate in the investment prospects of a number of

securities.

3. DiversificationOne of the most stated facts for portfolio management is: diversify. In other words, dont

put all your eggs in one basket. The rationale for this is that even if one pick in the portfolio

does not perform well, the others can check the erosion in the portfolio value.

Mutual Funds invest in a well-diversified portfolio of securities which enables investor to

hold a diversified investment portfolio and hence mitigate risk.

4. AffordabilityAs mutual funds deal with large pool of money hence as economies of scale is attained

transaction cost decreases hence mutual funds pay lesser transaction costs in the market

and such benefits are passed on to the investors.


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5. TransparencyThe investor gets regular information on the value of the investment made and disclosure

on the specific investments made under the scheme, the proportion invested in each class

of assets and the fund manager's investment strategy and outlook.

6. Well RegulatedAll Mutual Funds are registered with SEBI (Securities Exchange Board of India) and they

function within the provisions of strict regulations designed to protect the small retail

investors.

The regulatory body has clearly defined rules, which govern mutual funds. These rules are

related to the formation, administration and management of mutual funds and also

prescribe disclosure and accounting requirements, such a high level of regulations seeks to

protect the interest of investors.

7. LiquidityA distinct advantage of a mutual fund over other investments is that there is always a

market for its unit/ shares. It's easy to get ones money out of a mutual fund any time in an

open-ended mutual fund and redemptions can be made by filling a form attached with the

account statement of an investor.

Hence this quality of mutual funds makes the investments in the same highly liquid yet

profitable.

8. Choices of SchemesMutual funds provide investors with various schemes with different investment objectives.

Investors have the option of investing in a scheme having a correlation between its

investment objectives and their own financial goals.

An investor can also choose schemes depending upon his/her risk appetite, For example, an

investor can invest his money in a Growth Fund (equity scheme) and Income Fund (debt

scheme) depending on his risk taking capabilities and thus create a balanced portfolio easily

or simply buy a Balanced Scheme.

9. Tax benefitsLast but not the least, mutual funds offer significant tax advantages. Dividends distributed

by them are tax-free in the hands of the investor. They also give the advantages of capital

gains taxation.


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For holding units beyond one year, one gets the benefits of indexation that is indexation

benefits increase the purchase cost by a certain portion, depending upon the yearly cost-

inflation index (which is calculated to account for rising inflation), thereby reducing the gap

between the actual purchase costs and selling price. This reduces tax liability.

Mutual funds also provide tax-saving schemes and pension schemes which give added

advantage of benefits as under Section 88; one can avail of a 20 per cent tax exemption on

an investment of up to Rs 10,000 in the scheme in a year.

Disadvantages of Mutual Funds

1. No assured returns and no protection of capitalMutual funds do not offer assured returns and carry risk. For instance, unlike bank deposits,

your investment in a mutual fund can fall in value. Mutual funds are not insured or

guaranteed by any government body (unlike a bank deposit, where up to Rs 1 lakh per bank

is insured by the Deposit and Credit Insurance Corporation, a subsidiary of the Reserve Bank

of India).

There are strict norms for any fund that assures returns and it is now compulsory for funds

to establish that they have resources to back such assurances. This is because most closed-

end funds that assured returns in the early-nineties failed to stick to their assurances madeat the time of launch, resulting in losses to investors.

2. Restrictive gainsDiversification helps, if risk minimization is the objective. However, the lack of investment

focus also means that we gain less than if we had invested directly in a single security.

For example, say, Reliance appreciated 50 per cent. A direct investment in the stock would

appreciate by 50 per cent. But the investment in the mutual fund, which had invested 10 per

cent of its corpus in Reliance, will see only a 5 per cent appreciation.

3. Fees and commissionsInvestor has to pay investment management fees and fund distribution costs as a

percentage of the value of his investment (as long as he holds the units), irrespective of the

performance of the fund


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Some funds also charge sales commissions or "loads" to compensate brokers, financial

consultants, or financial planners. Even ifthe investor doesnt use a broker or other financial

adviser, he will pay a sales commission if he buys shares in a Load Fund

4. Management riskWhen an investor invests in a mutual fund, he/she depends on the fund's manager to make

the right decisions regarding the fund's portfolio. If the manager does not perform as

promised, investor might not make as much money on his investment as he had expected.

Of course, if one had invested in Index Funds, he/she foregoes management risk, because

these funds do not employ managers.

5. Evaluating FundsIn mutual funds it is difficult for investors interested in researching and evaluating the

different funds, unlike stocks, mutual funds do not offer investors the opportunity to

compare the P/E ratio, sales growth, earnings per share, etc.

A mutual fund's net asset value gives investors the total value of the fund's portfolio less

liabilities, but how do investor know if one fund is better than another.


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Risks in Mutual Funds investments

Every investment has risk associated with them; a risk is defined as any downside deviation from

the expected return and is measured by standard deviation. A fund's investment objective and its

holdings are influential factors in determining how risky a fund is. Risk has the potential for higher

return and it also has the greater potential for losses or negative returns.

Risk- Return Tradeoff for mutual funds

The risk return trade-off indicates that an investor is willing to take higher risk only if he can

expect higher returns and vise versa. For example, a bank FD , provides moderate return with

minimal risk. But capital protected funds and profit-bonds give out more return which is slightly

higher as compared to the bank deposits but the risk involved also increases in the same

proportion.

Thus investors choose mutual funds as their primary means of investing, as Mutual funds are

considered to have low risk but not risk free. This is because the money that is pooled in are not

invested only in debts funds which are less riskier but are also invested in the stock markets which

involves a higher risk but can expect higher returns.

The school of thought when investing in mutual funds suggests that the longer the investment

time horizon of the investor less is he/she affected by short-term volatility. Hence, shorter the

investment time horizon, the more concerned the investor is with short-term volatility and higher

is the risk. Different mutual fund categories have inherently different risk characteristics, the risks

are based on the investments an investor holds, as show in figure below:


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For example, a bond fund faces interest rate risk and income risk. Bond values are inversely

proportional to interest rates. If interest rates go up, bond values will go down and vice versa. Bond

income is also affected by the change in interest rates. Bond yields are directly related to interest

rates falling as interest rates fall and rising as interest rise. Income risk is greater for a short-term

bond fund than for a long-term bond fund.

Similarly, a sector stock fund (which invests in a single industry, such as telecommunications) is at

risk that its price will decline due to developments in its industry. A stock fund that invests across

many industries is more sheltered from this risk defined as industry risk.

Types of risks associated with Mutual Funds

1. Call RiskThe chance that a bond issuer to call its high yielding bond before the bonds maturity because

of falling interest rates in the market

2. Credit RiskThe possibility that a bond issuer will fail to repay interest and principal in a timely manner also

called as default risk


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3. Interest Rate RisksThe possibility that a bond fund value will decline because of an increase in interest rates

4. Manager RiskThe possibility that an actively managed mutual fund's investment adviser will fail to execute the

fund's investment strategy effectively resulting in the failure of stated objectives

5. Market RiskThe possibility that stock fund or bond fund prices overall will decline over short or even

extended periods. Stock and bond markets tend to move in cycles, with periods when prices rise

and other periods when prices fall

6. Principal RiskThe possibility that an investment will lose its value from the original or invested amount


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Evolution of Mutual Fund Industry

The concept of a mutual fund originated in 1870s with Robert Fleming establishing the first investment

trust in Scotland in 1890.

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the

initiative of the Government of India and Reserve Bank of India. The history of mutual funds in India can

be broadly divided into four distinct phases

First Phase 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve

Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of

India. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took

over the regulatory and administrative control in place of RBI. The first scheme launched by UTI was Unit

Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of assets under management.

Second Phase 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life

Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund

was the first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87),

Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90),

Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC had set up

its mutual fund in December 1990.

At the end of 1993, the mutual fund industry had assets under management of Rs.47,004 crores.

Third Phase 1993-2003 (Entry of Private Sector Funds)

With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry,

giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first

Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be

registered and governed. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the

first private sector mutual fund registered in July 1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised


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Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations

1996.

The number of mutual fund houses went on increasing, with many foreign mutual funds setting up

funds in India and also the industry has witnessed several mergers and acquisitions. As at the end ofJanuary 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of

India with Rs.44,541 crores of assets under management was way ahead of other mutual funds.

Fourth Phase since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two

separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under

management of Rs.29,835 crores as at the end of January 2003, representing broadly, the assets of US

64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India,

functioning under an administrator and under the rules framed by Government of India and does not

come under the purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and

functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTI which had in

March 2000 more than Rs.76,000 crores of assets under management and with the setting up of a UTI

Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place

among different private sector funds, the mutual fund industry has entered its current phase of

consolidation and growth.


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The graph indicates the growth of assets over the years.

0

100000

200000

300000

400000

500000

600000

700000

Mar-65

Nov-66

Jul-68

Mar-70

Nov-71

Jul-73

Mar-75

Nov-76

Jul-78

Mar-80

Nov-81

Jul-83

Mar-85

Nov-86

Jul-88

Mar-90

Nov-91

Jul-93

Mar-95

Nov-96

Jul-98

Mar-00

Nov-01

Jul-03

Mar-05

Nov-06

Jul-08

Mar-10

Rs(inC

rores)

Mar-

65

Mar-

87

Mar-

93

Jan-

03

Feb-

03

Mar-

03

Mar-

04

Mar-

05

Mar-

06

Mar-

07

Mar-

08

Mar-

09

Mar-

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Mar-

11

Rs (in crores) 25 4564 47000 12180 87190 79464 13961 14955 23186 32638 50515 41730 61397 59225

Asset Under Mnagement


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Track record

Check the schemes performance since its inception and compare it with similar schemes. By similar

schemes, one means, compare an equity scheme with another equity scheme and not with, say a debt

scheme. The instrument invested in being different in both these schemes will make a comparison have

no meaning. Performance comparison is done by comparing the annualized percentage growths in the

schemes NAV over a period of time. The higher the percentage of appreciation, the better is the

performance.

Transacting Mutual Funds

Close-ended schemes

An existing close-ended scheme invested who has purchased his units during the schemes IPO and does

not want to stay invested till maturity of the scheme, can sell his units on the stock exchange to a person

wanting to buy units of that scheme. While purchasing units during the IPO, the investor doesnt have to

incur any costs for purchase. However, while purchasing units from the stock exchange, the investor has

to pay his broker a brokerage fee for purchase of his units. Similarly, while selling units on the stock

exchange, the investor has to pay his broker a brokerage fee for sale of his units. While purchasing

units, the investor has to also incur costs of stamp duty to transfer the units in his name. However, if

the investor purchases units in the dematerialized form, no stamp duty is payable.

Open ended schemes

Units of open ended Mutual Fund schemes are first available during the schemes IPO at face value (i.e.

Rs. 10 per unit) and then the Mutual Fund offers sale and repurchase facilities thereafter ( at the current

NAV).While investing during the schemes IPO, the investor does not incur any cost for investment.

Buying close ended units post IPO

Contact your broker to find out the market price of the Mutual Fund scheme on the stock exchange andthe availability of units. On ensuring that the buy price is acceptable and there are sellers, place the

order with your broker for purchase of the units.

The broker will execute your order and hand over the unit certificates to you (if you have bought the

units in the physical segment) or will intimate you that the units have been credited to your

dematerialization account (if you have bought the units in the dematerialized segment). In case of


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receiving units in the physical form, fill in the transfer deed and lodge it along with the unit certificates

with the Registrar of the Mutual Fund. In case of purchase in the dematerialized form, nothing further

has to be done.

In case of an open-ended Mutual Fund scheme, ask your broker to find out the NAV of the scheme and

entry load, if any, on the day you are submitting your application form. The NAV and load, if any, is also

available on the website of the Mutual Fund or a personal finance site.

Submit the filled in application form along with the cheque to either your broker or directly to the

Mutual Funds banker (the names of the bankers and form collection centres are mentioned on the

application form). Your application is processed after which you receive an account statement

indicating the number of units allotted to you, the purchase date, the cost of your investment ( your

entry NAV) and the current value of your investment (i.e. the NAV on date the account statement was

made).

TAX

There are no tax implications while investing in Mutual Funds except while investing in Tax saving

schemes of Mutual Funds. These schemes are specifically designed to offer tax rebate to investors

under section 88 of the Income Tax Act. Rs 1 lakh can be invested under this section without any sub-

limits. Investment in pension funds under section 80CCC can still be up to a maximum of Rs 10,000 and

treated as a part of investments of Rs 1 lakh under section 80CCE.For individuals who are looking for

more returns from their investments, can move away from low-return infrastructure bonds. Earlier they

were bound to purchase for Rs 30,000 for getting maximum tax benefits. If they are close-ended, they

are listed after the initial 3 year lock in.

For instance, on 31st

March 2008, X invested Rs. 10,000 in Prudential ICICI Mutual Funds Tax

Saving Scheme. X will receive a tax rebate of Rs. 2,000 for the Financial year ended 31 st March 2001 and

will have to stay invested in Prudential-ICICI Mutual Funds scheme up to 31st

March 2011. If he sells,

transfers or pledges his units during this time he will be taxed on his investment of Rs. 10,000 in the

same year that he sells, transfers or pledges his units.


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Total Appreciation in value of new Rs.312.50 (Rs.5 x 62.5 Units)

Total Appreciation (Original Units + New Units)

Rs.7,000.00 + Rs.312.50 (Rs.5 x 62.5 Units)

Total Appreciation in value of Rs.7312.50

Total Cost of Investment Rs.15,000.00 (Rs.14,000.00 + Rs.1000.00)

Return on Investment = Rs.7,312.50/15,000.00 x 100 = 48.75%

Since investment is held of one year there is no question of having to annualize the return.


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Investment Inflows and Outflows in Mutual Funds

There are 44 Mutual Funds Houses registered with SEBI in India which generate and invest this corpus of

funds.

The Average Assets Under Management (AAUM) of the Indian mutual fund industry has witnessed a

decrease on a year on year basis, on account of substantial outflows from equity, liquid and income

schemes.

As of March 31, 2011

0

100000

200000

300000

400000

500000

600000

700000

800000

2008-09 2009-10 2010-11 Apr-Jun 11

Average Asset Under Management

(In Rs. Crore)

Liquid/M

oney

Market

Gilt DebtOriented

EquityOriented

Balanced Gold ETF

ETFs(othe

r than

Gold)

Fund of

Fundsinvesting

Overseas

AUM (Rs. Cr) 74699.86 3507.29 294217.44 197562.81 17552.4 4400.2 2516.43 2520.41

% Share 12.51% 0.59% 49.28% 33.09% 2.94% 0.74% 0.42% 0.42%

0

50000

100000

150000

200000

250000

300000

350000

AUM Category Wise


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In the above table we can see that Debt Oriented Mutual Funds were the most preferred type of mutual

fund holdings. Equity oriented funds are just behind debt Oriented funds. Gold ETFs has been glittering

and attracting investors attention during the year. The category witnessed a highest growth of 176.73%

in AUM to a total of Rs. 4,400 crore in the year. The category attracted inflows of Rs. 2,248 crore during

the period and yielded an annual return of 25.77% while the physical gold prices rose 27.35%. The

category Other ETFs, a collection of equity exchange traded funds (ETFs) also witnessed higher growth

of 162.90% during the year. Whereas AUM of Equity category, on a year-on-year basis, fell to Rs.

1,97,562 crore. Turbulences in the equity market hurt the investor sentiments which resulted in more

redemption on equity side.

The GDP to AUM ratio

The GDP to AUM Ratio is around 10% for India which is very low compared to other developed nations

with this ratio being from 20 % to 70 %. The industry needs to focus on inclusion of the rural sector in

mutual fund industry as mentioned in detail below. This also gives us an insight that the industry has alot of scope to grow and is far from saturation.

9.27%

11.76%

10.29%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

2008-09 2009-10 2010-11

GDP to AUM Ratio


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Investor Profile in the Mutual Fund Industry

Investor Classification AUM (Rs. Cr) % of Total

Corporate 263773.38 44.18%

Banks/FIs 26199.59 4.39%

FIIs 2969.81 0.50%

High Networth Individuals* 141808.54 23.75%

Retail 162225.48 27.17%

Total 596976.8

* Defined as individuals investing Rs 5 lakhs and above

As of March 31st 2011

As seen in the above table, corporate is the major investors in the mutual fund industry. Followed by the

retail investors, thus the industry must focus on spreading awareness among the general population in

order to gain a larger pie from the retail investors. HNIs are not far behind in terms of contributing to

the mutual fund investments. Banks, Financial Institutions and Foreign Institutional Investors are

minimal investors.


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Regulations in Mutual fund Industry

Mutual Funds in India are governed by the SEBI (Mutual Fund) Regulations 1996 as amended from time

to time.

Over the years established world class standards in Accounting, Valuation, NAV computation

and disclosure.

Valuation: CRISIL a third party research and rating agency developed Bond Valuer in

consultation with AMFI to provide uniform methodology for valuation of bonds, since 2000.

Full disclosure of portfolio twice a year Most Funds provide monthly disclosure.

Publication of Half Yearly unaudited results & Audited Annual Accounts.

Restrictions on business activities of the asset management company: The asset

management company shall, - not act as a trustee of any mutual fund; not undertake any

business activities other than in the nature of management and advisory services provided

to pooled assets including offshore funds, insurance funds, pension funds, provident funds,

if any of such activities are not in conflict with the activities of the mutual fund.

The asset management company shall not invest in any of its scheme, unless full disclosure

of its intention to invest has been made in the offer documents, in case of schemes

launched after the notification of Securities and Exchange Board of India (Mutual Funds).

The mutual fund shall appoint a Custodian to carry out the custodial services for the

schemes of the fund and sent intimation of the same to the Board within fifteen days of the

appointment of the Custodian.

No scheme shall be launched by the asset management company unless such scheme is

approved by the trustees and a copy of the offer document has been filed with SEBI.

The offer document shall contain disclosures which are adequate in order to enable the

investors to make informed investment decision

Simplification of Offer Documents & Key Information Memorandum recently further simplified.

Certification Test for Agent Distributors, code of conduct for AMCs & Distributors.

Uniform Cut-off Time for applicability of NAVs.

Benchmark indices for comparing performance of Mutual funds.

Comprehensive Risk Management System.


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Regulatory Authorities

In India, SEBI acts as regulator for the Mutual Fund Industry. To safeguard the investors from potential

irregularities, it formulates policies and regulates the mutual funds. It notified regulations in 1993 and is

fully revised in 1996. MF either promoted by public or by private sector entities including one promoted

by foreign entities is governed by these Regulations.

SEBI approved Asset Management Company (AMC) manages the funds by making investments in

securities. The investment made securities are not as strictly governed as in countries like US, or UK.

Custodian, registered with SEBI, holds the securities of various schemes of the fund in its custody.

According to SEBI Regulations, two thirds of the directors of Trustee Company or board of trustees must

be independent.

The Association of Mutual Funds in India (AMFI) is a Non-profit organization formed by the industry

players. It reassures the investors in units of mutual funds that the mutual funds function within the

strict regulatory framework. Its objective is to increase public awareness of the mutual fund industry. Itwould play a very important in overcoming some of the challenges currently faced by the MF Industry.

AMFI also focuses its attention on upgrading professional standards and in promoting best industry

practices in diverse areas.


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The internet revolution in our country is yet to penetrate to the grass root levels. The per capita

usage of internet in our country is still very low compared not only to the developed countries

but also as compared to our developing peers.

Mobile telephony comparatively has grown exponentially. It is a challenge to strike the right

balance while choosing to invest in technological advancements.

The industry is now at a stage where to progress to the next level of growth, it needs more

support from other sectors in the economy.

It is necessary to join hands with other sectors of the economy such as banking and

telecommunications.

5. Diminishing talent pool

As the Industry plans to spread awareness and penetrate deeper in the market, it would require

an army of professionals.

But the industry is facing an acute shortage of talented resources which is showing its impact.

The pool of talented people is diminishing and staff costs are soaring.

The key challenge is to find a permanent solution to tide over this acute shortage.

One possible solution could be for the industry is to tie up with universities and colleges to offer

programmes dedicated to the financial services and the mutual fund industry which would cover

various critical aspects of the industry.

6. Growth versus Governance

The Indian Mutual Fund industry was strong in the midst of adversities in the capital markets

due to the strong regulatory framework in place.

An increasing responsibility is being placed on the Trustees to ensure that the operations of the

funds are managed to the full benefit of the investors.

As the number of players in the market increases, competition may force fund houses to comply

not only with the laid down regulations and concentrate more on growth but endeavor in

creating excellence in governance as well.


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Recent trends in Mutual Fund Industry

The Indian Mutual Fund has passed through three phases. The first phase was between 1964 and

1987 with Unit Trust of India the only player with a total asset of Rs. 6,700 crores at the end of 1988.

The second phase was between 1987 and 1993 during this period 8 Funds were established (6 by

banks and one each by LIC and GIC). The total assets under management had grown to 61,028

crores at the end of 1994 and the number of schemes was 167. The third phase began with the

entry of private and foreign sectors in the Mutual Fund industry in 1993. Kothari Pioneer Mutual

Fund was the first Fund to be established by the private sector in association with a foreign Fund. As

at the end of financial year 2000 32 Funds were functioning with total assets under management

equal to Rs. 1, 13,005 crores and by the end of august 2000, there were 33 Funds with 391 schemes

and assets under management of Rs 1, 02,849 crores.

Major Fund houses to operate in India are:

o Fortiso Birla Sun Lifeo HDFCo ING Vysyao ICICI Mutual Fundso DSP Black Rocko Fidelityo Franklino SBI Mutual Fundso TATAo Kotak Mahindrao Unit trust of Indiao Reliance, etc.The Indian Mutual fund industry has witnessed considerable growth since its inception in 1963. The

assets under management (AUM) have surged to Rs 4,173 bn in Mar-09 from just Rs 250 mn in Mar-

65. In a span of 10 years (from 1999 to 2009), the industry has registered a CAGR of 22.3%, albeit

encompassing some shortfalls in AUM due to business cycles.

The impressive growth in the Indian Mutual fund industry in recent years can largely be attributed

to various factors such as rising household savings, comprehensive regulatory framework,


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Current NEWS in Mutual Fund Industry

Mutual funds are an under tapped market in India: Despite being available in the market for over

two decades now with assets under management equaling Rs 7,81,71,152 Lakhs as of 28 February

2010 given by Association of Mutual Funds, less than 10% of Indian households have invested in

mutual funds. A recent report on Mutual Funds Investments in India published by research and

analytics firm, Boston Analytics, suggests investors are holding back from putting their money in

mutual funds due to their perceived high risk and a lack of information on how mutual funds work.

This report is based on a survey of approximately 10,000 respondents in 15 Indian cities and towns

as of March 2010.There are 43 Mutual Funds at present.

Budget 2011: In the budget speech of Finance Minister of India, he has said Currently, only FIIs and

sub-accounts registered with the SEBI and NRIs are allowed to invest in mutual fund schemes. To

liberalize the portfolio investment route, it has been decided to permit SEBI-registered Mutual

Funds to accept subscriptions from foreign investors who meet KYC requirements for equity

schemes. This would enable Indian Mutual Funds to have direct access to foreign investors and

widen the class of foreign investors in Indian equity market.

Total MUF of dips by 4.3% in August 2011:

Total Assets Under Management (AUM) of the mutual fund (MF) industry that climbed up 8.2% in

July 2011, dipped by 4.3% (by Rs 31,449 crore) to Rs 6.96 lakh crore in August 2011. Liquid and

Income Funds that faced huge inflow of funds during the month of July, witnessed net outflows to atune of Rs 6925 crore and Rs 10066 crore respectively in August 2011. AUM of Other ETFs fell by

13.8%, Equity Linked Savings Scheme (ELSS) by 7.9% and Equity Funds by 6.9% among others.

NAVs end with positive returns: as published on Fri. 09-09-2011 on moneycontrol.com it says

Equity diversified NAVs ended positive with advance: decline ratio of 219:24, Among the Sector

fund banking, pharma and technology funds advance, while FMCG and MNC funds decline, Long

and Short term debt funds ended higher, their advance to decline ratio stood at 77:0 & 123:1

respectively.

CRISIL Rating: Large equity and ultra short term debt funds were the best performers in the equity

and debt categories, respectively, as per the latest CRISIL mutual fund ranking released for the

quarter ended march 2011. The debt funds and equity category had returns close to 2% and

negative 7%, respectively during the quarter ended March 2011 as compared to 1.35% and negative

return of 0.57% respectively during the quarter ended December 2010.


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Capital Inflow and Outflow in Mutual Funds Industry: Mutual funds were net sellers for the second

consecutive year in the equity spectrum to the tune of Rs 17703.90 crore during the financial year

2011 after being the net seller of Rs. 10161.60 crore in the financial year 2010.The net outflow

during the period was a result of gross purchases Rs 151450 crore and gross sales Rs 168695 crore.

On the debt front, mutual funds were seen as net buyers over years. MF bought debt securities

worth a net Rs. 237981 crore during the financial year 2011. The net inflow during the month was a

result of gross purchases Rs 737783 crore and gross sales Rs 501548 crore.SEBI plans to introduce new regulations for MF sales: Capital Market regulator is planning to

introduce a set of regulations to keep a check on the mis-selling of mutual fund schemes by the

distributors. Taking the first step towards forming these regulations, the Securities and Exchange

Board of India (Sebi) sent a note to all asset management companies (AMCs) in March 2011, asking

them to ensure that their distributors follow certain due diligence while selling MF schemes.


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Performance Measurement: A Comparative Analysis

The performance measurement of Mutual Funds is usually done on a risk- return basis. Both risk as well

as return is needed to provide a sufficient measure of the performance of a particular mutual fund.

There are many statistical measures used to evaluate the performance of mutual funds and almost all of

them measure either the risk associated or the returns expected, or sometimes both.

In the comparative analysis, we have taken the Index Growth funds of 12 AMCs. This analysis will give us

an idea of how the mutual funds are performing against the index and among themselves as well. For

this purpose, we have taken the following 12 Asset Management Companies:

1. Birla Sunlife Mutual Funds2. DSP Black Rock Mutual Funds3. Fidelty Mutual Funds4. Franklin Templeton Mutual Fund Investments5. HDFC Mutual Funds6. ICICI Prudential Mutual Funds7. Kotak Mahindra Mutual Funds8. Sundaram Mutual Funds9. Tata Mutual Funds10.

SBI Mutual Funds

11.UTI Mutual Funds12.Reliance Mutual Funds


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Beta

Beta gives a measure of the relationship between the returns from a fund and the market (NIFTY in this

case). Usually monthly returns from the fund are taken for a considerable number of years and are

correlated with the corresponding monthly returns of the index. Beta gives the sensitivity of a funds

return to fluctuations in the respective market considered.

The formula for calculating Beta is:

Where, Cov(i,m) is the covariance of the funds returns with the markets returns and Var(m) is the

variance of the market returns.

An average well diversified portfolio will have a beta of 1.0, i.e. it fluctuates in a similar fashion as the

market index does. Funds having beta more than 1.0, show above average volatility and thus a sign of

greater risk. Portfolio having beta less than 1.0 is considered to be a defensive portfolio that invests

primarily in slow moving stocks.

The following table shows the calculated Beta () of the selected Index Funds:

Beta ()

BIRLA SUNLIFE 0.805352

DSPBR 0.925317

FIDELITY 0.854562

FRANKLIN 0.864371

HDFC 0.911220

ICICI 0.966426

KOTAK 0.888937

SUNDARAM 1.046436

TATA 0.945825

SBI 0.962436

UTI 0.910732

RELIANCE 0.565029

It is clear from the table that almost all the funds, except Reliance and Sundaram, have Beta in the range

of 0.8 0.96, while reliance has the lowest of 0.5 and Sunadaram has the highest beta of 1.04. However,

risk cannot be evaluated alone, without taking into consideration the respective returns.


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The following table shows the calculated Return (Ri) of the selected Index Funds:

Returns

BIRLA SUNLIFE 21.3731%

DSPBR 8.4228%

FIDELITY 21.5091%

FRANKLIN 20.4608%

HDFC 23.7833%

ICICI 26.5990%

KOTAK 17.2754%

SUNDARAM 16.6556%

TATA 16.8040%

SBI 17.3123%

UTI 17.5851%

RELIANCE 11.8808%

Looking at both the returns as well as the risks associated, we can conclude that ICICI Index funds are

the best bet for an investor, as it has given the highest returns over the past 5 years of 26% (CAGR), and

have a beta of 0.96. a beta close to 1.0 indicates that it fluctuates in synch with the market, but

however, gives a much higher return.DSPBR has the lowest returns and a high beta, making it he most unattractive bet for an investor.

Reliance Mutual funds Index fund has a low beta as well as a low return of 11.8%. A highly risk averse

investor would be willing to invest in such a type of portfolio.


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The Treynors Ratio

This ratio was developed by Jack Treynor. It measures the returns from a fund earned over and above of

that which could have been earned on a riskless investment per unit of market risk. It is basically a risk-

adjusted measure of return based on systematic risk.

The formula for calculating Treynors Ratio is:

(Average Return of the Portfolio - Average Return of the Risk-Free Rate) / Beta of the Portfolio

While a high and positive Treynor's Index shows a superior risk-adjusted performance of a fund, a low

and negative Treynor's Index is an indication of unfavorable performance.

The following table shows the calculated Treynors Ratio of the selected Index Funds:

Treynor's Index (Ti)


DSPBR 0.034744

FIDELITY 0.190754

FRANKLIN 0.176462

HDFC 0.203851

ICICI 0.221343

KOTAK 0.135752

SUNDARAM 0.109397

TATA 0.122603

SBI 0.125768

UTI 0.135904

RELIANCE 0.118097

Since all the selected funds have a positive Teynors Ratio, we can conclude that all of them have been

able to outperform the market. All the funds have provided adequate return to investor per unit risk

taken, with ICICI being the best among others and DSPBR the worst.

Treynors Ratio is also known as Reward to Volatility Ratio.


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Sharpe Ratio

This ratio was developed by William F Sharpe. It also is a measure of the returns from a fund earned

over and above the expected return from the portfolio. It relates risk and return of the portfolio and

assesses the performance as return per unit of total risk. The difference between the Sharpe ratio and

the Teynors ratio is that the former takes into consideration the total risk associated with a portfolio,

while the latter considers only the systematic risk.

The formula for calculating Sharpe ratio is:

(Expected Return from the Portfolio - Average Return of the Risk-Free Rate) / Standard Deviation of

the Portfolio

While a high and positive Sharpe Ratio shows a superior risk-adjusted performance of a fund, a low and

negative Sharpe Ratio is an indication of unfavorable performance.

The following table shows the calculated Sharpes Ratio of the selected Index Funds:

Sharpes Ratio (Si)


DSPBR 1.182093

FIDELITY 1.288668

FRANKLIN 1.297091

HDFC 1.296891

ICICI 1.187196

KOTAK 1.294980

SUNDARAM 1.286248

TATA 1.307270

SBI 1.253997

UTI 1.228771

RELIANCE 0.632617

A higher Sharpes ratio means a higher volatility of portfolio return. The positive Sharpe Ratio of all the

selected funds shows that the risk taken by an investor of the respective funds have been rewarded by

adequate returns. Sharpes ratio is also thus known as Risk to Reward Ratio.


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Jensens Measure

This was developed by Michael Jensen. This is also a risk adjusted performance measure. It is a measure

of the returns from a fund in excess to the one predicted by the Capital Asset Pricing (CAPM) Model. The

difference between the actual returns and the ones predicted by CAPM Model for a particular period

denotes Alpha ().

The formula for calculating Jensens Alpha is:

Where, Ra is the average return of the portfolio for a particular period, Rfis the risk free rate, is the

Beta of the portfolio and Rm is the market return for that particular period.

If the fund fares better than predicted, it has a positive alpha & vice-versa. Higher alpha represents

superior performance of the fund and vice versa.

The following table shows the calculated Jensens Alpha () of the selected Index Funds:

Jenson's Alpha ()


DSPBR -0.076791

FIDELITY 0.062402

FRANKLIN 0.050765

HDFC 0.078473

ICICI 0.100132

KOTAK 0.016019

SUNDARAM -0.008722

TATA 0.004606

SBI 0.007734

UTI 0.016550

RELIANCE 0.000206

A higher positive Alpha () indicates better performance. Again ICICI emerges as the best investment

option as it has the highest alpha among the selected funds, which indicates that it is providing a highly

excessive return than the market. Also, DSPBR and Sundaram have a negative alpha, and Reliance has an

alpha of 0.0002, which is very near to Zero. This indicates that DSPBR and Sundaram have been giving

lesser returns than the market while reliances returns have been comparable to the market return.


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The following table gives a comparative picture of all the selected funds vis--vis the measures used to

evaluate their performance.

Standard

Deviation

()

Required

Return (Ri) Beta ()

Sharpe

Ratio (Si)

Jenson's

Alpha ()

Treynor's

Index (Ti)

BIRLA SUNLIFE 0.083 21.37% 0.81 1.148 0.067 0.201

DSPBR 0.092 8.42% 0.93 1.182 -0.077 0.035

FIDELITY 0.078 21.51% 0.85 1.289 0.062 0.191

FRANKLIN 0.078 20.46% 0.86 1.297 0.051 0.176

HDFC 0.083 23.78% 0.91 1.297 0.078 0.204

ICICI 0.096 26.60% 0.97 1.187 0.100 0.221

KOTAK 0.081 17.28% 0.89 1.295 0.016 0.136

SUNDARAM 0.096 16.66% 1.05 1.286 -0.009 0.109

TATA 0.085 16.80% 0.95 1.307 0.005 0.123

SBI 0.090 17.31% 0.96 1.254 0.008 0.126

UTI 0.087 17.59% 0.91 1.229 0.017 0.136

RELIANCE 0.105 11.88% 0.57 0.633 0.000 0.118

The whole analysis depicts a very high preference for ICICI Index funds as all the measures used give a

positive picture for this fund as far as high returns and low risks are concerned. Also, in the past five

years, the fund has constantly outperformed the market and has been able to give higher returns as

compared to the other funds.

Also DSPBR has shown the worst performance over the years, and is not a good option for a rational

investor to invest in such a portfolio. It has shown a low return of just 8%, a negative alpha of -0.077,

and a high standard deviation as well. Thus it is not advisable to invest in DSPBR.

Another observation has been made for Reliance Index Funds. Over the years, this fund has been

performing almost at par with the market. Also, a low beta of 0.57 shows a low volatility to market

fluctuations and thus a lower risk. Thus reliance index funds are a safe bet for a risk- averse investor.

The other funds taken in the analysis have a similar performance pattern in terms of risk and return.


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Future Outlook of Mutual Funds Industry

The Indian Mutual Funds Industry has been showing rapid growth in the past driven by favorable

economic and demographic factors. Although the industry witnessed a slight fall in value of AUM during

recession, we think that the industry has bright future prospects. Here we will discuss the growth driversand the possible changes in industry in future.

Growth Drivers

1. GDPWe see that the key macroeconomic driver GDP growth rate is being scaled down by

forecasters due to the rising inflation rates. According to a quarterly survey conducted by RBI,

the projection of real GDP growth rate for 2011-12 is 7.9%. But according to Moodys official

release Sept 2011, India's medium- to long-term economic potential continues to be buoyed by

its demographic profile, robust savings and investment rates and rising international

competitiveness of its corporations. Thus we think that the economic outlook of India will be

positive in future.

2. Savings Rate and Disposable IncomeAccording to India Economic Outlook 2011-12, domestic savings rate as a ratio of GDP is around

33.8% in 2010-11 and supposed to be at 34% in 2011-12. Also if we see the below figure, we can

say that the disposable income will increa