Mutual Fund FAQs

1.What is a Mutual Fund?

A Mutual Fund is a body corporate registered with the Securities and Exchange Board of India (SEBI) that pools up the money from individual / corporate investors and invests the same on behalf of the investors /unit holders, in equity shares, Government securities, Bonds, Call money markets etc., and distributes the profits. In other words, a mutual fund allows an investor to indirectly take a position in a basket of assets.


2.Which was the First Mutual Fund to be set up in India?

Unit Trust of India is the first Mutual Fund set up under a separate act, UTI Act in 1963, and started its operations in 1964 with the issue of units under the scheme US-64.


3.Who is the Regulatory Body for Mutual Funds?

Securities Exchange Board of India (SEBI) is the regulatory body for all the mutual funds mentioned above. All the mutual funds must get registered with SEBI. The only exception is the UTI, since it is a corporation formed under a separate Act of Parliament.


4.What are the broad guidelines issued for a MF?

SEBI is the regulatory authority of MFs. SEBI has the following broad guidelines pertaining to mutual funds : (1) MFs should be formed as a Trust under Indian Trust Act and should be operated by Asset Management Companies (AMCs). (2) MFs need to set up a Board of Trustees and Trustee Companies. They should also have their Board of Directors. (3) The net worth of the AMCs should be at least Rs.5 crore. (4) AMCs and Trustees of a MF should be two separate and distinct legal entities. (5) The AMC or any of its companies cannot act as managers for any other fund. (6) AMCs have to get the approval of SEBI for its Articles and Memorandum of Association. (7) All MF schemes should be registered with SEBI. (8) MFs should distribute minimum of 90% of their profits among the investors. (9) There are other guidelines also that govern investment strategy, disclosure norms and advertising code for mutual funds.


5.How do mutual funds diversify their risks?

According to basis financial theory, which states that an investor can reduce his total risk by holding a portfolio of assets instead of only one asset. This is because by holding all your money in just one asset, the entire fortunes of your portfolio depend on this one asset. By creating a portfolio of a variety of assets, this risk is substantially reduced.


6.Can mutual funds assumed to be risk-free investments?

No. Mutual fund investments are not totally risk free. In fact, investing in mutual funds contains the same risk as investing in the markets, the only difference being that due to professional management of funds the controllable risks are substantially reduced.


7.What are the types risks involved in investing in mutual funds?

A very important risk involved in mutual fund investments is the market risk. When the market is in doldrums, most of the equity funds will also experience a downturn. However, the company specific risks are largely eliminated due to professional fund management.


8.What are the different types of funds offered by fund house?

Currently there exist balanced funds, Income fund, Growth funds, Sector funds etc. To get more details about the different funds and their features please visit our mutual fund glossary.


9.What are the different types of plans that mutual fund offers?

That depends on the strategy of the concerned scheme. But generally there are 3 broad categories. A dividend plan entails a regular payment of dividend to the investors. A reinvestment plan is a plan where these dividends are reinvested in the scheme itself. A growth plan is one where no dividends are declared and the investor only gains through capital appreciation in the NAV of the fund.


10.What are open-ended and closed-ended mutual funds?

In an open-ended mutual fund there are no limits on the total size of the corpus. Investors are permitted to enter and exit the open-ended mutual fund at any point of time at a price that is linked to the net asset value (NAV). In case of closed-ended funds, the total size of the corpus is limited by the size of the initial offer.


11.What is the investor’s exit route in case of a closed-ended fund?

According to Sebi regulations, all closed-ended funds have to be necessarily listed on a recognized stock exchange. Thus the secondary market provides an exit route in case of closed-ended funds.


12.Why should one choose to invest in a mutual fund?

For retail investor who does not have the time and expertise to analyze and invest in stocks and bonds, mutual funds offer a viable investment alternative. This is because:(1) Mutual Funds provide the benefit of cheap access to expensive stocks (2) Mutual funds diversify the risk of the investor by investing in a basket of assets (3) A team of professional fund managers manages them with in-depth research inputs from investment analysts. (4) Being institutions with good bargaining power in markets, mutual funds have access to crucial corporate information which individual investors cannot access.


13.How investors invest in Mutual Funds?

One can invest by approaching a registered broker of Mutual funds or the respective offices of the Mutual funds in that particular town/city. An application form has to be filled up giving all the particulars along with the cheque or Demand Draft for the amount to be invested.


14.What are the parameters on which a Mutual Fund scheme should be evaluated?

Performance indicators like total returns given by the fund on different schemes, the returns on competing funds, the objective of the fund and the promoter’s image are some of the key factors to be considered while taking an investment decision regarding mutual funds.


15.What is a Systematic Investment Plan and how does it operate?

A systematic investment plan is one where an investor contributes a fixed amount every month and at the prevailing NAV the units are credited to his account. Today many funds are offering this facility.


16.What are the benefits of s Systematic Investment Plan?

A systematic investment plan (SIP) offers 2 major benefits to an investor: (1) It avoids lump sum investment at one point of time (2) In a scenario of falling prices, it reduces your overall cost of acquisition by a process of rupee-cost averaging. This means that (3) at lower prices you end up getting more units for the same investment.


17.What is the difference between mutual funds and portfolio management schemes?

While the concept remains the same of collecting money from investors, pooling them and investing the funds, the target investors are different. In the case of portfolio management the target investors are high networth investors while in case of mutual funds the target investors are the retail investors.


18.Is investor eligible for rebate on income tax by investing in a MF?

Yes in case of certain specific Equity Linked Saving Schemes, tax benefits are available under Section 88 of the Income Tax Act. In such cases the fund prospectuses explicitly states that it is a tax saving fund. In such cases 20% of your contribution will qualify for rebate under Section 88 of the Income Tax Act.


19.Do investments in mutual funds offer tax benefit on capital gains?

Yes. If the capital gains earned by you during a financial year are invested in specified mutual funds then such capital gains are exempt from capital gains tax under Section 54EA and Section 54EB of the Income Tax Act.


20.Do mutual fund investments attract wealth tax?

No. Under the Wealth Tax Act, all financial assets, including mutual fund units are exempt totally from Wealth Tax.


21.If I gift mutual fund units, does it attract gift tax?

No. With effect from 1st October 1998, units of a mutual fund gifted by unitholders are no longer chargeable to Gift Tax.


22.Is dividend earned from mutual funds exempt from income tax?

Yes. Income from mutual funds in the form of dividends is entirely exempt from income tax provided the fund in question is a equity/growth fund where more than 50% of the portfolio is invested in equities.


23.What are my major rights as a unit holder in a mutual fund?

Some important rights are mentioned below: (1) Unit holders have a proportionate right in the beneficial ownership of the assets of the scheme and to the dividend declared. (2) They are entitled to receive dividend warrants within 42 days of the date of declaration of the dividend. (3) They are entitled to receive redemption cheques within 10 working days from the date of redemption. (4) 75% of the unit holders with the prior approval of SEBI can terminate AMC of the fund. (5) 75% of the unit holders can pass a resolution to wind-up the scheme.

24. What is a fund house/family?

A group of funds managed under one umbrella. The most basic fund family would include a stock, bond and money market-portfolio, although many funds have variants like sector funds, balanced funds.
For instance, Zurich India Mutual Fund is a fund house with several funds under it.

25. What are a fund’s net assets?

The total value of a fund's cash and securities less its liabilities or obligations.

26. What is a fund portfolio?

A group of securities held by the mutual fund. A portfolio could be a mixture of stocks, bonds and cash.

27. What is the portfolio turnover of a fund supposed to mean?

A measure of the amount of buying and selling activity in a fund.Turnover is defined as the lesser of securities sold or purchased during a year divided by the average of monthly net assets. A turnover of 100 percent, for example, implies positions are held on average for about a year.

28. How are mutual funds classified?

Mutual Funds can be classified into the following 3 broad categories:
1. Portfolio classification
2. Functional classification
3. Geographical classification

29. How are mutual funds classified based on their portfolios?

Portfolio classification of mutual funds is done on the following basis:
Growth Funds
Investment objective: Capital appreciation of equity shares
Investment avenue: Equity shares of companies with high growth potential
For eg. Morgan Stanley Growth Fund
Income Funds
Investment objective: Providing safety of investments and regular income
Investment avenue: Bonds, debentures and other debt related instruments as well as equity shares of companies with high dividend payouts.
There are 2 aspects of income funds viz. low investment risk with constant income and high investment risk generating high income.
For eg. Templeton Income Fund
Balanced Funds
Investment objective: Modest risk of investment and reasonable rate of return Investment avenue: Judicious mix of equity shares, preference shares as well as bonds, debentures and other debt related instruments.
For eg. GIC Balanced Fund
Money Market Mutual Funds (MMMFs)
Investment objective: To take advantage of the volatility in interest rates in the money market Investment Avenue: Certificate of deposits (CDs), call money market, commercial papers. Investors can participate indirectly in the money market through MMMFs.
For eg. IDBI-PRINCIPAL Money Market Fund 1997
Specialised Funds
Investment Objective: To take advantage of conditions in a particular sector or a specific income producing security
Investment Avenue: Specialised investments in securities of companies in certain sectors or specific income producing securities
For eg. Kothari Pioneer's Internet Opportunities
Fund
Leveraged Funds
Investment objective: To increase the value of the portfolio and benefit the shareholders by gains exceeding the cost of borrowed funds
Investment avenue: Speculative and risky investments, like short sales to take advantage of declining market.
Not common in India
Index Funds
Investment Objective: To increase the value of the portfolio in line with the benchmark index (for eg. BSE Sensex, SP CNX 50)
Investment Avenue: Investments only in those shares that form a part of the benchmark index, in exactly the same proportion, so that the value of the index fund varies in proportion with the benchmark index.
For e.g. UTI Nifty Index Fund
Hedge Funds
Investment Objective: To hedge risks in order to increase the value of the portfolio
Investment Avenue: Employ speculative trading principles - buy rising shares and sell shares whose prices are likely to fall.
Not common in India

30. How are mutual funds classified functionally?

Functional classification of mutual funds is done on the following basis:
Open ended scheme
Investors under this scheme are free to join the fund or withdraw from the fund at any time after an initial lock-in period. Such funds announce sale and repurchase prices from time to time. In an open-ended scheme, investors can resell units in the fund to the issuing mutual fund at the net asset value (NAV) of the units. This is because open-ended schemes are permitted to buy/sell their own units. For e.g. Alliance Capital 1995 Fund
Close-ended scheme
Unlike the open-ended schemes, close-ended schemes do not issue units for repurchase redemption on a periodic basis. Its units can be redeemed only on termination of the scheme, or through dealings in the secondary market. In such schemes, the period of the scheme is specified at the outset. They have a definite target amount for the funds and cannot sell more after initial offering. For eg. UTI Mastergain 1986

31. How are mutual funds classified geographically?

Mutual funds can be classified geographically on the following basis:
Domestic funds
Domestic fund houses launch funds, which mobilise savings of the nationals within the country. These schemes could fall under any of the categories mentioned under portfolio classification and functional classification. Schemes launched by Indian MFs like GIC MF, UTI LIC MF, SBI MF, Canbank MF, Bank of Baroda MF, Bank of India MF, Morgan Stanley, Templeton, Alliance.
Offshore Funds
Offshore funds can invest in securities of foreign companies, after requisite permission from RBI. The objective behind launching offshore funds is to attract foreign capital for investment in the country of the issuing company. These funds facilitate cross border fund flow, which is a direct route for getting foreign currency. From the investment point of view, Offshore funds open up domestic capital markets to the international investors and global portfolio investments.

32. What are the different plans that mutual funds offer?

Mutual Funds in order to cater to a range of investors, have various investment plans. Some of the important investment plans include:
Growth Plan
Under the Growth Plan, the investor realises only the capital appreciation on the investment (by an increase in NAV) and does not get any income in the form of dividend.
Income Plan
Under the Income Plan, the investor realises income in the form of dividend. However his NAV will fall to the extent of the dividend.
Dividend Re-investment Plan
Here the dividend accrued on mutual funds is automatically re-invested in purchasing additional units in open-ended funds. In most cases mutual funds offer the investor an option of collecting dividends or re-investing the same.
Systematic Investment Plan (SIP)
Here the investor is given the option of preparing a pre-determined number of post-dated cheques in favour of the fund. He will get units on the date of the cheque at the existing NAV. For instance, if on 25th March, he has given a post-dated cheque for June 25th, he will get units on 25th June at existing NAV.
Systematic Withdrawal Plan
As opposed to the Systematic Investment Plan, the Systematic Withdrawal Plan allows the investor the facility to withdraw a pre-determined amount/units from his fund at a pre-determined interval. The investor’s units will be redeemed at the existing NAV as on that day.
Retirement Pension Plan
Some schemes are linked with retirement pension. Individuals participate in these plans for themselves, and corporates for their employees.
Insurance Plan
Some schemes launched by UTI and LIC offer insurance cover to investors.

33. Who is a custodian?

The custodian, an independent organisation, has the physical possession of all securities purchased by the mutual fund, and undertakes responsibility for its handling and safekeeping. For instance, the Stock Holding Corporation of India Ltd (SCHIL) is the custodian for most fund houses in the country.

34. What is an Asset Management Company (AMC)?

A highly regulated organisation that pools money from many people into a portfolio structured to achieve certain objectives. Hence it is termed as an Asset Management Company. Typically an AMC manages several funds - open-end /closed-end across several categories - growth, income, balanced. Every mutual fund has an AMC associated with it.
For instance, Alliance Capital Mutual Fund is associated with Alliance Capital Asset Management Company Ltd.

35. What is load?

It is a charge collected by a mutual fund when it sells units. It can be either front-end load (i.e., the charge is collected when an investor buys the units) or back-end load (i.e, the charge collected when the investor sells back the units). Some schemes do not charge any load and are called No Load Schemes

36. What is an ex-dividend date?

Normally, one business day after the record date. Investors purchasing unit on or after the ex-dividend date are not entitled to collect dividends or bonus units. The NAV falls by the amount of the dividend distributed and/or bonus issued. The terms ex-bonus and ex-dividend often are used synonymously.
For instance, if the record date for dividend is October 15th, then investors who don’t have their names in the list of unitholders as on that day, will not receive dividend. This works very similar to dividend and bonus declarations in the case of stocks.

37. What is an asset management fee?
The fee charged by the asset management company (AMC) for portfolio management. The fee charged on an annual basis is calculated as percentage of net assets under management.