Risk-Return Analysis of Mutual Funds

8/3/2019 Risk-Return Analysis of Mutual Funds

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Risk Return Analysis

Of Mutual Funds


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Risk Return Analysis Of Mutual Funds

Project Mutual Fund ManagementTYBFM

MEMBERS -

Khushbu Gosher 11

Kavita Jain 16

Priya Narsale 28

Pooja Jadhav 15


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What are Mutual Funds?

The phrase Mutual Funds if analyzed refers to funds that are raised and invested

mutually, i.e. on behalf of everyone participating in the scheme. A mutual fund is a

form of collective investment that pools money from investors and invests the

money in stocks, bonds, short-term money-market instruments, and/or other

securities.

The money thus collected is then invested in capital market instruments such as

shares, debentures and other securities. The income earned through these

investments and capital appreciation realized is shared by its unit holders in

proportion to the number of units owned by them. Thus a Mutual Fund is the most

suitable investment for the common man as it offers an opportunity to invest in a

diversified, professionally managed basket of securities at a relatively low cost.

When we talk about all these, one hard fact is about risks that are faced by the

Mutual Fund investors. Whenever we see any Mutual Fund offer, there are fewstatements inevitably found along with that, which is commonly known as

Disclaimer Clause of the Mutual Fund".


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Risks

Every investment entails risk. Mutual funds too are not risk free investments. Even

funds investing in government bonds (sovereign paper) are susceptible to some

kind of risk. Before investing in mutual funds one must completely understand the

risk associated with the particular scheme.

Risk is a measure of the possibility that the investor will not receive an expected

return on his investment. Generally risk and reward move hand in hand. The

greater the risk that an investment may lose money, the greater is its potential for

providing a substantial return.

Following are the common types of risk associated with the Mutual Funds:

Market riskMarket risk exposes one to a potential loss of principal. In all likelihood the market

value of a stock will fluctuate based on factors such as developments affecting the

company's financial status, earnings of the company or impact of economic

slowdown on the company. Likewise, debt funds too are subject to market risk.

Prices of bonds and government securities fluctuate with change in interest rates.

One can minimize market risk by diversifying among a variety of instruments

rather than investing your money in one or two stocks. Diversification helps

minimize risks. Thus, when one asset class is adversely affected by market or other

conditions, another class may be less affected. Because mutual funds invest in a lot

of companies, they are the best way to diversify.

Interest Rate RiskThe risk that the value of a fixed income security will drop as interest rates rise.

Government security prices are inversely related to interest rates. If interest rates

decline then the prices of securities increase and vice versa. This risk cannot be

avoided.


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Inflation riskSometimes referred to as loss of purchasing power. Whenever inflation rises

forward faster than the earnings on your investment, you run the risk that you will

actually be able to buy less, not more. Inflation risk also occurs when prices rise

faster than your returns.

Business RiskThe risks that a company issuing a security may not be financially sound due to

factors like poor management, low product demand, or huge operating expenses.

Such situations can result in a decline in the security's value. Since mutual funds

invest in a variety of companies, the effect of such a risk spreads out.

Credit riskThe risk that an issuer will default on a fixed income security by failing to pay

interest or principal when due. Most of the bond instruments are rated by rating

agencies. The higher the rating given to the bond, the higher is the credit quality

implying low credit risk and vice versa. This risk can be limited by investing in

mutual funds having a high exposure to quality paper. Rating of AA/AAA denotes

high credit quality.

Manager RiskThis risk arises from the 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 the stated objectives.

Industry RiskThis risk arises from the possibility that a group of stocks in a single industry will

decline in price due to developments in that industry.

Exchange riskA number of companies generate revenues in foreign currencies and may have

investments or expenses also denominated in foreign currencies. Change rates

may, therefore, have a positive or negative impact on companies which in turn

would have an effect on the investment of the fund.


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Investment risksThe sectoral fund schemes, investments will be predominantly in equities of select

companies in the particular sectors. Accordingly, the NAV of the schemes are

linked to the equity performance of such companies and may be more volatile than

a more diversified portfolio of equities.

Changes in the government policyChanges in govt. policy especially in regard to the tax benefits may impact the

business prospects of the companies leading to an impact on the investment made

by the fund.

Liquidity RiskThe risk that a mutual fund's underlying securities cannot be sold at a fair price

when the need arises. Hence marketability of a security is a very important

consideration. You can minimize liquidity risk by investing in actively traded

companies. In mutual funds, invest in an open-ended scheme as you can enter and

exit at your own convenience. Close ended funds do not give you an option to exit

at your convenience.

Timing riskThe risk of buying or selling a security at the wrong time. For example, there is the

chance that a few days after you sell a fund it will go up in value or decline in

value of a fund after you buy it.

As mentioned some of the risks stated above can be avoided through strategic

planning.


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Returns

There are three primary ways that mutual funds provide returns, or increases in

value, for shareholders. These are

1. Dividends,

2. Capital gains, and

3. Increase in net asset value.

DividendsMutual fund dividends are distributions of the earnings which a fund receives from

the stocks and bonds in its portfolio.

Those earnings are comprised of:

1. dividends the fund receives from the portfolios stocks

2. interest the fund receives from the portfolios bonds

and reduced by the costs of operating the fund.

Those earnings, both dividends and interest, are then distributed to the shareholders

of the mutual fund, as mutual fund dividends.

Shareholders can choose to have their dividends:

1. credited as cash to their brokerage account

2. mailed to them in the form of a check

3. used to purchase additional mutual fund shares.

Capital Gains

Capital gains are the profits that occur when stocks or bonds are sold for more thantheir acquisition price. When the portfolio manager sells fund assets at a profit, the

fund realizes a capital gain. Securities can likewise be sold for a loss.

Capital gains distribution is the process of a fund passing on net capital gains

realized in the portfolio to its shareholders. Each share of the mutual fund is

entitled to an equal portion of the capital gains being distributed.


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Shareholders can choose to have their capital gains:

1. credited as cash to their account

2. mailed to them in the form of a check

3. used to purchase additional mutual fund shares.

Increase innet asset valueIncrease in net asset value occurs when the value of a funds securities exceeds the

cost of those securities. Conversely, decrease in net asset value occurs when the

cost exceeds the value.


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History of Indian Mutual Fund Industry

The mutual fund industry in India started in 1963 with the formation of Unit Trustof India, at the initiative of the Government of India and Reserve Bank. The

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

First Phase 1964-87Unit 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 ofPublicSector 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 Fundestablished 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 P

h

ase 1993-2003 (En

try of

Priv

ateS

ec

torFun

ds)

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


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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 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 of January 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 2003In 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 Ltd, 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.

The graph indicates the growth of assets over the years.


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GROWTHIN ASSETS UNDER MANAGEMENT

Note:

Erstwhile UTI was bifurcated into UTI Mutual Fund and the Specified undertaking

of the Unit Trust of India effective from February 2003. The Assets under

management of the Specified Undertaking of the Unit Trust of India has therefore

been excluded from the total assets of the industry as a whole from February 2003

onwards.

Documents

Risk-Return Analysis of Mutual Funds