MUTUAL FUND REFERENCER

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1 SUMMARY A primer on Mutual Funds with a brief description of the various types of fund types followed by a list of top performing funds in each category. CIL Securities Research Team MUTUAL FUND REFERENCER

2 1. An Introduction to Mutual Funds A mutual fund is an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. A mutual fund is a professionally-managed investment scheme, usually run by an asset management company, who invest the fund's capital in order to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus. Investors can invest in mutual fund by purchasing 'units' of the scheme, which basically represents a share in holdings of a particular scheme. These units can be purchased or redeemed as needed at the fund's current net asset value (NAV). The NAV of a scheme keeps fluctuating on a daily basis, according to movement in prices of fund's holdings. So, each investor participates proportionally in the gain or loss of the fund. In order to better understand mutual funds, we must first understand the terms that are associated with the mutual fund industry. Here are a few terms which are essential to understanding the mutual fund industry AMC Asset Management Company AUM Asset Under Management Expense Ratio - Exit Load - NAV Net Asset Value NFO New Fund Offer SIP Systematic Investment Plan SWP Systematic Withdrawal Plan Turnover - It is a company that invests its clients' pooled funds into securities that match declared financial objectives It is the total market value of assets that an investment company or financial institution manages on behalf of investors. It is the annual fee that funds charge their shareholders. It expresses the percentage of assets deducted each year for fund expenses, management fees, administrative fees, operating costs and all other asset-based costs incurred by the fund. Charges that are levied in case of withdrawal of funds during a stipulated period of time which may vary according to different schemes. It is value per unit of a mutual fund on a specific date. It is based on the total value of all the securities in the portfolio, any liabilities the fund has and the number of units outstanding. NAV is computed once per day based on the closing market prices of the securities in the fund's portfolio. An initial offering in which investors may purchase units of a mutual fund. A new fund offer occurs when a mutual fund launches a new scheme, allowing the AMC to raise capital for purchasing securities. It is an investment strategy wherein an investor invests the same amount of money in a particular mutual fund scheme at a stipulated time interval. which allows an investor to withdraw a fixed or variable amount from his mutual fund scheme on a pre decided time interval as per his needs. Portfolio turnover is calculated by taking either the total amount of new securities purchased or the amount of securities sold - whichever is less - over a particular period, divided by the total NAV of the fund

3 2. Benefits of Investing via Mutual Funds In a falling interest rate scenario where the returns that investors receive from traditional savings such as fixed deposits are falling, the primary reason to invest in mutual funds is to get higher returns. But investors should also understand the other benefits of investing in mutual funds Professional Management: Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. There are several aspects to such professional management viz. investing in line with the investment objective, investing based on adequate research, and ensuring that prudent investment processes are followed. Affordable Portfolio Diversification: Units of a scheme give investors exposure to a range of securities held in the investment portfolio of the scheme. Thus, even a small investment of Rs 5,000 in a mutual fund scheme can give investors a diversified investment portfolio. With diversification, an investor ensures that all his eggs are not in the same basket. Liquidity: At times, investors in financial markets are stuck with a security for which they can t find a buyer! Such investments are called illiquid stocks and may result in losses for the investor. Investors in a mutual fund scheme can recover the value of the moneys invested, from the mutual fund itself. Tax Benefits: There are a number of tax benefits that accrue to mutual fund investors. Capital gains on equity mutual fund units held for more than one year are exempt from tax, dividend that the investor receives from any mutual fund scheme is tax-free in his hands. Also, indexation benefits are available to investors in case of debt mutual funds which are held for more than three years. Investment in specific schemes of mutual funds (Equity Linked Savings Schemes - ELSS) can be reduced from the investor s income that is liable to tax. This reduces their taxable income, and therefore the tax liability. The ELSS investment limit is Rs 1.5 lakh per financial year, along with other eligible investments such as life insurance premium, PPF, NSC etc. Convenient Options: The options offered under a scheme viz. growth and dividend, allow investors to structure their investments in line with their liquidity preference and tax position. Systematic Approaches to Investment: Mutual funds also offer facilities that help investor invest regularly through a SIP; or withdraw amounts regularly through a SWP). Such systematic approaches promote an investment discipline, which is useful in long term wealth creation and protection. Regulatory Comfort: SEBI has mandated strict checks and balances in the structure of mutual funds and their activities. Mutual fund investors benefit from such protection.

4 3. Classification of Mutual Funds There are a number of mutual funds that are available to investors today. It is important to understand the various options in order to take an informed decision based on suitability based on time horizon and risk profile of investors. A brief description of major types of mutual funds is given below S.No. Type of Fund Description Based on Asset Type A Equity Funds A.1. Large Cap Invest in stocks of large, liquid blue-chip companies with stable performance and returns. A.2. Mid Cap Invest in mid-cap companies that have the potential for faster growth and higher returns. These companies are more susceptible to economic downturns and evaluating and selecting the right companies becomes important. A.3. Small Cap Invest in companies with small market capitalisation with intent of benefitting from the higher gains in the price of stocks. The risks are also higher. A.4. Multi Cap Invest in companies across the different capitalization categories in order to benefit from higher growth in small cap companies but limit the amount of risk taken by also investing in large cap companies. B Debt Funds B.1. Short Term Combines short term debt securities with a small allocation to longer term debt securities. Short term plans earn interest from short term securities and interest and capital gains from long term securities. Fund managers take a call on the exposure to long term securities based on their view for interest rate movements. If interest rates are expected to go down, these funds increase their exposure to long term securities to benefit from the resultant increase in prices B.2. Ultra Short Term Are also known as treasury management funds, or cash management funds. They invest in money market and other short term securities of maturity up to 365 days. The objective is to generate a steady return, mostly coming from accrual of interest income, with minimal NAV volatility B.3. Liquid They can invest in debt securities of up to 91 days maturity. This helps in positioning liquid schemes as the lowest in price risk among all kinds of mutual fund schemes. Therefore, these schemes are ideal for investors seeking high liquidity with safety of capital C Hybrid Funds C.1. Equity Oriented (Balanced Funds) Invest primarily in equity (at least 55%-60%), with a portion of the portfolio invested in debt to bring stability to the returns. These schemes give investor exposure to both equity and debt simultaneously in one portfolio. Investors benefit from the returns of equity with the stability of debt. C.2. Debt Oriented invest primarily in debt with a small allocation to equity. The equity allocation can range from 5% to 30% and is stated in the offer document. The debt component is conservatively managed to earn coupon income, while the equity component provides the booster to the returns. Based on Pay-out Option D Growth In the growth option, profits made by the scheme are invested back into it. This results in the NAV of the scheme rising over time. The only option to realise the profit in the growth option is to sell or redeem units that the investor owns. E Dividend The dividend option does not re-invest the profits made by the fund. Profits or dividends are distributed to the investor from time to time. Dividends are declared at the discretion of the fund manager. The dividend is paid from the NAV of the unit. Thus, the NAV of the dividend option will be lower than the NAV of the growth option in the same scheme.

5 4. Selection of Funds Everyone has needs and aspirations. Most needs and aspirations call for a financial commitment. Providing for this commitment becomes a financial goal. Planning for these financial goal sets investors on the path towards realizing their needs and aspirations. Mutual funds can help in achieving financial goals. But selection of appropriate funds plays a vital role in determining whether goals of investors are realised or not. There are a number of factors play a role in determining whether a fund is ideal for the accomplishing an identified financial goal. Investors must consider these factors before taking a decision as to which mutual fund scheme to invest in. Two essential factors that need to be considered are as follows Time Horizon: Time is the first and foremost consideration when it comes investing in mutual funds. The time available to the investor will determine the category of fund one must invest in. A short term investor may not be willing to take the risk that are associated with small cap equity funds, he would be better off sticking with debt funds. Risk Appetite: Various schemes have different levels of risk. Similarly, there are differences between investors with the respect to the level of risk that they are comfortable with. At times they are difference with the level of risk that investors think they are comfortable and the level of risk that they ought to be comfortable with. It is crucial that investors understand their risk taking appetite as well as their risk taking ability before taking an investment decision. Some the factors that affect the risk appetite are age, source of income, number of dependents, capital base, personal psyche, etc. 5. Building a Mutual Fund Portfolio Diversification is the most valuable quality that mutual funds bring to investors. The spread of different companies across different sectors and sizes of companies within the scheme portfolios provide an optimum level of safety to investors. But as investors have different financial goals with different time horizons it is necessary to diversify across mutual fund houses and schemes as well. Thus, an investor must create a portfolio of mutual fund schemes as per his varying needs. There is no straightforward formula for computing which type of fund or how much an investor must invest since investors risk appetites and requirements vary, a single portfolio cannot be suggested for all. A thorough analysis must be done to ascertain the asset allocation mix that is most appropriate for an individual investor. Even though it is not possible to suggest readymade mutual fund portfolios, we can work with model portfolios to determine a base level to work with. Here a few model portfolios for illustrative purposes Young call centre / BPO employee with no dependents: 50% diversified equity schemes (preferably through SIP); 20% sector funds; 10% gold ETF, 10% diversified debt fund, 10% liquid schemes. Young married single income family with two school going kids: 35% diversified equity schemes; 10% sector funds; 15% gold ETF, 30% diversified debt fund, 10% liquid schemes. Single income family with grown up children who are yet to settle down: 35% diversified equity schemes; 15% gold ETF, 15% gilt fund, 15% diversified debt fund, 20% liquid schemes. Couple in their seventies, with no immediate family support: 15% diversified equity index scheme; 10% gold ETF, 30% gilt fund, 30% diversified debt fund, 15% liquid schemes.

6 6. List of Recommended Mutual Funds Equity Oriented Large Cap SBI Bluechip Fund 12.8% 10.1% 16.0% 19.9% , % Birla Sun Life Frontline Equity Fund 15.3% 10.5% 14.3% 19.2% , % ICICI Prudential Focused Bluechip Euity Fund 16.7% 10.1% 13.0% 17.5% , % Equity Oriented Mid Cap Mirae Asset Emerging Bluechip Fund HDFC Mid-Cap Opportunities Fund 27.0% 18.6% 27.0% 31.1% , % 19.6% 13.7% 20.8% 25.5% , % Sundaram Select Midcap Fund 19.0% 12.3% 22.8% 25.2% , % Equity Oriented Small Cap DSP Black Rock Micro Cap Fund 16.1% 15.2% 26.5% 30.1% , % Franklin India Smaller Comapanies Fund 16.4% 14.4% 21.6% 30.1% , % Equity Oriented Multi Cap Birla Sun Life Equity Fund 21.5% 14.8% 17.7% 22.7% , % Kotak Select Focus Fund 20.7% 13.0% 19.6% 21.7% , % Franklin India Prima Plus Fund 13.7% 8.7% 16.5% 19.9% , % Balanced HDFC Balanced Fund 18.6% 12.4% 15.5% 19.1% , % ICICI Prudential Balanced Fund 16.9% 11.9% 14.7% 19.4% , % DSP BlackRock Balanced Fund 12.8% 9.2% 16.1% 16.1% , %