The Expression: An International Multidisciplinary e-journal

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2 RISK AND RETURN ON INVESTMENT IN MUTUAL FUND Dr. Rohit Bansal Assistant Professor, Department of Management Studies Vaish College of Engineering, Rohtak :::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::: Abstract Investments goals vary from person to person. While somebody wants security, others might give more weightage to returns alone. Somebody else might want to plan for his child s education while somebody might be saving for the proverbial rainy day or even life after retirement. With objectives defying any range, it is obvious that the products required will vary as well. All over the world, mutual fund is one of the most popular instruments for investment. Its popularity with consumer has dramatically increased over the last couple of years worldwide; the mutual fund has a long and successful history. The popularity of mutual fund has increased manifold. In developed financial market like United States, mutual has almost overtaken bank deposits and total assets of insurance funds. This research tried to explain the concept of mutual fund, further it tried to explain benefits and risk associated with mutual funds. Key-Words Mutual Fund, Risk & Benefits of Mutual Fund, Investment, Diversification. :::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::: 49

3 RISK AND RETURN ON INVESTMENT IN MUTUAL FUND Dr. Rohit Bansal Assistant Professor, Department of Management Studies, Vaish College of Engineering, Rohtak :::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::: Introduction Indian Mutual Funds industry offers a plethora of schemes and serves broadly all types of investors. The range of products includes equity funds, debt, liquid, gilt and balanced funds. There are also funds meant exclusively for young and old, small and large investors. Moreover, the setup of a legal structure, which has enough teeth to safeguard investors interests, ensures that the investors are not cheated out of their hard earned money. All in all, benefits provided by them cut across the boundaries of investor category and thus create for them, a universal appeal. Investors of all categories could choose to invest on their own in multiple options but opt for Mutual Funds for the sole reason that all benefits come in a package. The Mutual Fund industry is having its hands full to cater to various needs of the investors by coming up with new plans, schemes and options with respect to rate of returns, dividend frequency and liquidity. Mutual fund is a buzz in the market these days. The mutual fund industry is burgeoning, it is completely untapped market. Only 5% of total potential of this industry has been grabbed. Hence this industry has a lot of opportunities in it. That s why it is so much interactive. As Indian economy is growing at the rate of approx. 7.5% per annum, we can see its effect in all areas. The Indian stock market and companies have become lucrative for 50

4 foreign investors. More and more fund is pouring in our country. This is increasing liquidity in the market and hence increasing the money in the hands of people and thus investment. As the future prospects for Indian companies are bright, they have lots of opportunities to expand their business worldwide, the investment in Indian companies. What is Mutual Fund? A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. It offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. The flow chart below describes broadly the working of a mutual fund: Pool their money with Investors Fund managers Invest in Passed back to Returns Securities Figure 1- Mutual Fund Explained These Trusts are run by experienced Investment Managers who use their knowledge and expertise to select individual securities, which are classified to form portfolios that meet predetermined objectives and criteria. These portfolios are then sold to the public. They offer the investors the following main services: Portfolio Diversification Marketability: A new financial asset is created that may be more easily marketable than the underlying securities in the portfolio. Organization of Mutual Fund A mutual fund is set up in the form of a trust, which has sponsor, trustees, asset management company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of a company. The trustees of the mutual fund hold 51

5 its property for the benefit of the unit holders. Asset Management Company (AMC) approved by SEBI manages the funds by making investments in various types of securities. Custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI Regulations by the mutual fund. Objective Figure 2- Organization of Mutual Fund To know about the concept of mutual funds To know about benefits and risk associated with mutual funds. Research Design The research design is descriptive in nature. It tried to describe how the mutual fund works and what are the different types of mutual funds and how does it works. Data Collection The data collected is of secondary nature. It is collected mainly through different websites and books. 52

6 Types of Mutual Funds Mutual Funds Schemes may be classified on the basis of its structure and its investment objectives. Mutual fund Structure Investment Special schemes Open-ended Interval funds Tax gain Index Sectoral Close ended Industry specific Growth Income Money market Balanced Load No-load Figure 3- Types of Mutual Funds By Struture Open ended Funds 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. Closed ended Fund A close end fund has a stipulated maturity period which generally ranging from 3 to 15 years. A closed end fund has a stipulated maturity period which generally is a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter can buy or sell the units of the scheme on the stock exchanges where they are listed. 53

7 Interval Funds Interval Funds combine the features of open ended and close ended schemes. They are open for sale or redemption during predetermined intervals at NAV related prices. By Investment Growth Funds The aim of growth funds is to provide capital appreciation over the medium to long term. Such schemes normally invest a majority of their corpus in equities. It has been proven that returns from stocks, have outperformed most other kind of investments held over the long term. Income Funds The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and Government securities. Balanced Funds The aim of balanced funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are ideal for investors looking for a combination of income and moderate growth. Money Market Funds The aim of money market funds is to provide easy liquidity, preservation of capital 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. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market. These are ideal for corporate and individual investors as a means to park their surplus funds for short periods. Load Funds A load fund is one that charges a commission for entry or exit. That is, each time you buy or sell units in the fund, a commission will be payable. Typically entry and exit loads range from 1% to 2.25%. No Load Funds A no load fund is one that does not charge a commission for entry or exit. The advantage of a no load fund is that the entire corpus is put to work. Special Schemes Tax Saving Schemes These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws as the Government offers tax incentives for investment in specified avenues. Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction u/s 80C of the Income Tax Act, The Act also provides 54

8 opportunities to investors to save capital gains u/s 54EA and 54EB by investing in Mutual Funds, provided the capital asset has been sold prior to April 1, 2000 and the amount is invested before September 30, Industry Specific Schemes Industry specific schemes invest only in the industries specified in the offer document. The investment of these funds is limited to specific industries like InfoTech, FMCG, Pharmaceuticals etc. Index Schemes Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. Sectoral Schemes Sectoral funds are those, which invest exclusively in a specified industry or a group of industries or various segments such as A group. Structure of Mutual Funds in India Figure 4-Structure of Mutual Funds in India 55

9 Like other countries, India has a legal framework within which mutual funds must be constituted. In India, open and close end funds operate under the same regulatory structure, i.e. in India, all mutual funds are constituted along one unique structure as unit trust. A mutual fund in India is allowed to issue open end and close end schemes under a common legal structure. The structure, which is required to be followed by mutual funds in India, laid down under SEBI (Mutual Fund) Regulations, The Fund Sponsor Sponsor is defined under SEBI Regulations as any person who, acting alone or in combination with another body corporate establishes a mutual fund. The sponsor of a fund is akin to the promoter of companies he gets the fund registered with SEBI. The sponsor will form a Trust and appoint a Board of Trustees. All these appointments are made in accordance with the SEBI Regulations. As per the existing SEBI Regulations, for a person to qualify as a sponsor, must contribute at least 40% of the net worth of the AMC and issues a sound financial track over five years prior to registration. Mutual Funds as Trusts Mutual Fund in India is constituted in the form of a Public Trust under the Indian Trust Act The fund invites investors to contribute their money in the common pool by subscribing to units issued by various schemes established by the Trust as evidence of their beneficial interest in the fund. The Trust or Fund has no legal capacity itself rather it is the Trustee(s) who have legal capacity and therefore the trustees take all acts in relation to the Trust itself. Trustees A Board of Trustees a body of individuals, or a trust company a corporate body, may manage the Trust. Board of Trustees manages most of the funds in India. The Trust is created through a document called the Trust Deed that is executed by the Fund Sponsor in favors of the trustees. They are the primary guardian of the unit holder s funds and assets. They ensure that AMC s operations are along professional lines. Asset Management Company The role of an Asset Management Company (AMC) is to act as the investment manager of the trust under the Board supervision. Transfer Agents Transfer Agents are responsible for issuing and redeeming units of the mutual fund and provide other related services such as preparation of transfer documents updating investor s records. A fund may choose to opt this activity in-house or by an outside transfer agent. Distributors AMCs usually appoint distributors or brokers, who sell units on behalf of the fund. Some funds require that all transactions to be routed through such brokers. 56

10 Bankers A fund s activities involved dealing with the money on a continuous basis primarily with respect to buying and selling units, paying for investment made, receiving the proceeds from sale of investment and discharging its obligations towards operative expenses. A fund s banker therefore plays a crucial role with respect to its financial dealings. Custodian and Depository The custodian is appointed by the Board of Trustees for safekeeping of securities in terms of physical delivery and eventual safe keeping or participating in the clearing system through approved depository companies. Benefits of Mutual Funds: Professional Management Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme. Diversification Mutual Funds invest in a number of companies across a broad cross section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own. Affordability A mutual fund invests in a portfolio of assets, i.e. bonds, shares etc. depending upon the investment objective of the scheme. An investor can buy into a portfolio of equities, which would otherwise be extremely expensive. Tax Benefits Any income distributed after March 31, 2002 will be subject to tax in the assessment of all unit-holders. However, as a measure of concession to Unit holders of open ended and equity oriented funds, income distributions for the year ending March 31, 2003, will be taxed at a concessional rate of 10%. Return Potential Over a medium to long term, mutual funds have the potential to provide a higher return as they invest in a diversified basket of selected securities. Low Costs Investing in the capital markets because the benefits of scale in brokerage, mutual funds are a relatively less expensive way to invest compared to directly custodial and other fees translate into lower costs for investors. Liquidity In open ended schemes, the investor gets the money back promptly at MAV related prices from the mutual fund. In closed ended schemes, the units can be sold on a stock exchange 57

11 at the prevailing market price or the investor can avail of the facility of direct repurchase at NAV related prices by the mutual fund. Transparency You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager s investment strategy and outlook. Flexibility Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience. Well Regulated All mutual funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. Risk associated with Mutual Funds Market Risk Sometimes prices and yields of all securities rise and fall. Broad outside influences affecting the market lead to this. This is true, may it be big corporations or smaller midsized companies. This is known as Market Risk. A Systematic Investment Plan (SIP) that works on the concept of Rupee Cost Averaging (RCA) might help mitigate the risk. Credit Risk The debt servicing ability of a company through its cash flows determines the Credit Risk faced by you. This credit risk is measured by independent rating agencies like CRISIL who rate companies and their paper. A AAA rating is considered the safest whereas a D rating is considered poor credit quality. A well diversified portfolio might help mitigate this risk. Inflation Risk Inflation is the loss of purchasing power over a time. A lot of times people make conservative investment decisions to protect their capital but end up with a sum of money that can buy less than what the principal could, at the time of investment. A well diversified portfolio with some investment in equities might help mitigate this risk. Interest Rate Risk In a free market economy interest rates are difficult and not impossible to predict. Changes in interest rates affect the prices of bonds as well as equities. If interest rates rise, the prices of bonds will fall and vice versa. Equity might be negatively affected as well in a rising interest rate environment. A well-diversified portfolio might help mitigate this risk. Political Risk Changes in government policy and political decision can change the investment environment. They can create a favourable environment for investment or vice versa. 58

12 Liquidity Risk Liquidity risk arises when it becomes difficult to sell the securities that one has purchased. It can be partly mitigated by diversification, staggering of maturities as well as internal risk controls that lean towards purchase of liquid securities. It simply means that you must spread your investment across different securities (stocks, bonds, money market instruments, real estate, fixed deposits etc.). This kind of a diversification may add to the stability of your returns, for example, during one period of time equities might underperform but bonds and money market instruments might do well enough to offset the effect of a slump in the equity markets. Conclusion `The future of primary market is growing at a very high pace. Taking this thing into consideration, there are lots of opportunities for the investors to tap the golden opportunities from the Indian market. `There is little awareness about mutual fund in India; people have accepted it as a one of the major investment avenue. Mutual funds will become one of the sought after investment avenues. Looking at the return generated from the mutual funds and that too to the specific needs of people, mutual fund can be a good option for the people and have bright future in India. References What is a Mutual Fund? ( accessed on Mutualfundindia.com is a complete guide to mutual funds ( accessed on SBi Mutual fund ( accessed on Association of Mutual Funds of India ( accessed on National Stock Exchange ( accessed on CRISIL ( accessed on Bombay Stock Exchange ( accessed on