Mutual Fund: It is
in the form of a “trust” that collects money from a number of investors who
share a common investment objective & invest the same in different
securities like equity, bonds & other securities.
Role &
Functions of Mutual Funds:
Diversification- Mutual funds invest in a diversified
portfolio of securities as it benefits investors by participating in the growth
of diverse sectors/companies while limiting the risks associated with
investments. Since mutual funds are pooled investment vehicles, investors get
access to a wider pool of investment avenues with money of as low as Rs. 500
which might not be possible in direct securities, particularly if the invested
amount is low.
Professional
Management- Mutual Funds are managed by
qualified & experienced fund managers who are responsible for researching, analysing,
and investing in various securities.
Liquidity- Mutual funds offer ample liquidity to
investors as in most mutual funds, investors can redeem their units on any
business day.
Advantage of
Mutual Funds:
Mutual fund investment simplifies the
process of investing & holding securities.
1. Affordable
Portfolio Diversification- An investor
can get proportionate ownership in a diversified investment portfolio even for
an investment as low as Rupees 500.
2. Tax Benefits- ELSS gives an investor the benefit of taxable
income deduction of up to Rs. 1,50,000 in a financial year under section 80C,
thereby reducing the tax liability.
3. Regulatory
Oversight- SEBI strictly regulates the
functioning of mutual funds and related intermediaries in the interest of
investors.
4. Systematic
Approach to Investment- Mutual
funds offers various facilities that help investor invest/withdraw/transfer
amounts regularly through SIP, SWP, and STP respectively. Such arrangements
help investors by inculcating discipline in their financial journeys.
5. Transparency- Investors have the right to access information about
their investments in mutual funds and can refer to scheme-related documents
anytime to have detailed insights about a particular scheme.
Types of Mutual
Funds:
Mutual Funds can be categorized on the
basis of organization structure, asset class, investment objective, risk
appetite, etc.
1. Mutual Fund
based on Structure
a. Open-ended
Funds- Investors can enter & exit these
schemes on all business days at the current net asset value.
b. Close-ended
Funds- Such funds have a fixed maturity.
Investors can buy units of close-ended schemes only during the NFO period (New
fund offer) & redeem the units only after the tenure of the scheme is over.
However, these funds are listed on stock exchanges to provide investors an exit
route during the running period.
2. Based on Asset
Class
a. Equity Funds- Equity funds invest money in shares of
companies and their return depends on the stock market performance and
performance of the business of portfolio companies over time. These funds come
under the category of high risk and high reward. These funds can be further
categorized into different categories such as Large Cap, Mid Cap, Small Cap,
Multi Cap, Flexi Cap funds, etc.
b. Debt Funds- Debt funds invest money in fixed-income
securities like government securities, treasury bills, corporate bonds, etc.
These funds have low risk compared to equity funds while providing investors
with a fixed stream of income. They can be further categorized into corporate
bond funds, banking & PSU funds, Gilt funds, etc.
c. Hybrid Funds- Such funds endeavour to provide investors
with a fixed stream of income with the potential of capital appreciation.
Hybrid funds are an optimum mix of debt and equity. These funds are further
categorized into conservative, balanced, aggressive, balanced advantage funds,
multi-asset allocation funds, arbitrage funds, etc.
d. Solution-Oriented Funds- These funds help you to invest for specific
goals like retirement purposes, marriage, or children’s education. These types
of funds are usually close-ended and have a lock-in period of at least 5 years.
e. Other Schemes- There are some other schemes as well in
which you can invest like Index funds, fixed maturity plans, Infrastructure
debt funds, etc.
3. Based on
Investment Objective
a. Growth Fund- Investors invest in these types of funds for
their high potential for capital appreciation. These funds come under the
category of high risk.
b. Income Funds- Income funds generally invest in debt
instruments like government securities, Commercial papers, corporate bonds,
etc. These schemes invest with the objective to give investors a regular stream
of fixed income.
c. Tax-Saving
Fund (ELSS)- Equity-linked
saving schemes help investors to save tax under section 80C of the Income Tax
Act,1961. It has a lock-in period of 3 years.
d.
Liquidity-based funds- These types
of funds invest in fixed–income instruments like commercial paper, treasury
bills, certificates of deposits, etc. with up to 91-days maturity period.
4. Based on
Specialty
a. Sectoral
Funds- These funds invest in particular
sectors such as real estate, banking, Automobiles, etc. The returns depend on
the performance of respective sectors.
b. Index Funds- These funds invest in stocks to mimic the
performance of benchmarks such as Sensex, Nifty, etc.
c. Global Funds- These funds can invest in companies located
anywhere in the world.
5. Based on Risk
Appetite
a. High Risk- Equity funds come under the category of high
risk with a potential of high capital appreciation.
b. Medium Risk- Such funds are a mix of equity and debt which provide a
fixed income stream while providing a scope of capital appreciation.
c. Low Risk- Such funds invest in debt markets like
government securities which are very safe instruments.
How do Mutual
Funds work?
New Fund Offer
(NFO) launch- The subscription
offer to a new mutual fund scheme is released for the first time by an Asset
Management Company (AMC). The fund houses use the NFO to raise money from the
general public, which it then uses to buy a variety of securities including
shares and debt instruments.
Pooling Money- Money is gathered by mutual funds from a
large number of investors who make smaller investments.
Investment in
Securities- Depending on the
fund's strategy, the portfolio manager subsequently invests the money in
various asset classes like stocks, bonds, commodities, etc. These investments
are made using their knowledge, thorough research, and analysis based on a plan
designed to achieve the stated objective of the scheme.
Returns to
investors- The Net Asset Value (NAV) of a mutual
fund scheme is used to evaluate its performance. It represents the total market
value of the securities that the plan owns. The market value of securities
fluctuates every day, which causes the NAV of a plan to alter daily. Mutual
funds may distribute investor rewards or reinvest them back into the fund.
Redemption- Investors can sell or buy back their
investment in a mutual fund. The fund manager uses the portfolio’s cash balance
to compensate investors for their investment repurchase.
Conclusion
Mutual funds are a very useful
investment option with the capacity of wealth creation. In Addition, mutual
funds offer various kinds of schemes. There are many benefits like
diversification of securities, low cost, and flexibility when investing in
smaller amounts.
