NISM Mutual Fund distributor exam syllabus

NISM Mutual Fund distributor exam syllabus

NISM Mutual Fund Distributor Exam Mock Test

If you also want to give NISM Mutual Fund Distributor exam mock test of SEBI (Securities and Exchange Board of India), then you are reading the right article. If you pass this test nism mutual fund distributor exam mock test, then when you give the real exam, you will pass that exam very easily. This mock test has been made from the syllabus of NISM Mutual Fund Distributor exam, if you want to pass the exam then you have to answer all the questions correctly.

CHAPTER 1: Investment Landscape

Investment and their Financial Goals

  • Assigning amounts and timelines to the objectives are referred as financial goals. Example: Funding a child’s education, buying a vehicle, cost of one’s son or marriage.
  • Financial goals are about the need for money that cannot be fulfilled through the inflow at that time.
  • One needs to invest money as the income (from salary, professional fees, etc.) may be less than the amount required to fund the goal even though the expenses for the goal may be high or low.
  • While assigning amounts to long term financial goals, inflation adjustment for goal value must be considered as the cost are likely to go up. On the other hand, the immediate term and near-term goals may not have a big impact due to changes in price.

Step 1: Identify the Goals: Desirable or Undesirable.

Step 2: Assign priorities: Which goal is more important than the other.

Step 3: Assign timeline as well as the amount of funding required at the time of event.

Factors to Evaluate Investments 

  • Convenience wrt investing, withdrawing money, checking current value
  • Liquidity (How easily can one convert investments into case)
  • Returns (Current income, Capital Appreciation/Capital Gains)
  • Ticket Size: Minimum amount required for investment
  • Taxability of Income (Lower Tax on Less Risky Products)
  • Tax Deductions

DIFFERENT ASSET CLASSES:

An asset class is a grouping of investments that exhibit similar characteristics. There are four broad asset categories or asset classes-

  1. Real estate
  2. Commodities
  3. Equity
  4. Fixed Income

     1. Real State

Certain traits of real estate as an asset category are:

  • Location.
  • Illiquid Asset.
  • Investment can be in physical real estate as well as in the financial form.
  • Transaction cost eg. Brokerage, registration cost are high which would bring down ROI.
  • Cost of maintenance of property and taxes payable must be adjusted before calculating ROI.

    2. Commodities

While commodities derivatives are available on many commodities, two commodities that many investors are quite familiar with as investment avenues, viz., gold, and silver. They can be used as investments or storage of value for long.

 3. Fixed Income

  • These securities include bonds and debentures.
  • Issuers: Companies, Union Government, State Government, Municipal Corporations, Banks, FIs.
  • Regular Interest.
  • Safer than equity.
  • Type: short term bonds (ideal for liquidity needs), medium term bonds, and long-term bonds (income generation needs).

 4. Equity

  • Owner’s capital in a business.
  • Equity investing has generated returns in excess of inflation, which means the purchasing power of one’s money has increased over the years.
  • Capital Appreciation & dividends out of profits from business operations.

Equity
Blue-chip Companies
Mid-sized companies
Small-sized companies
Unlisted Companies
Foreign Stocks
Equity Mutual Funds
Exchange Traded Funds
Index Funds

Fixed Income
Fixed deposit
Recurring deposit
Public Provident Fund
Post office Monthly Income Scheme
Recurring deposit with a post office
Company fixed deposit
Debentures/bonds
Debt Mutual Funds

Real Estate/Infrastructure
Physical Asset
Residential/ Commercial Financial Asset
Real Estate Mutual Funds (REMF)
Real Estate Investment Trusts (ReIT)
Infrastructure Investment Trust (InvIT)

Commodities
Gold
Silver
Gold Funds
Commodity ETFs

Investment Risk-

1. Inflation Risk: General rise in the prices of various products, and services that we consume. This risk hits hard over long periods. If this is not properly accounted for in the investment plan, one may fall short of the target when the need arises. The investment return should be at least as much as inflation.

2. Liquidity Risk: Investments in fixed income assets are usually considered less risky than equity. Some products like PPF may offer no liquidity for a certain period, and even after that, there may be only partial liquidity.

3. Credit Risk: When someone lends money to a borrower, the borrower commits to repay the principal as well as pay the interest as per the agreed schedule. Credit Risk arises when either the issuer pays the dues with some delay or issuer does not pay principal or interest at all

4. Interest Rate Risk: It is the risk that an investment’s value will change as a result of a change in interest rates. This risk affects the value of bonds/debt instruments more directly than stocks. Any reduction in interest rates will increase the value of the instrument and vice versa.

5. Market Risk & Price Risk: When there is a possibility of a country getting into a warlike situation, the prices of all or at least a large number of stocks in the market may witness a fall. This is a market-wide fall. On the other hand, Price risk may arise when the sales of a company’s products fall either due to technological changes, or the arrival of a better product, the company’s share price falls while shares price of other companies may rise.

BEHAVIORAL BIASES IN INVESTMENT DECISION MAKING
  • Availability Heuristic
  • Confirmation Bias
  • Familiarity Bias
  • Herd Mentality
  • Loss Aversion
  • Recency bias
  • Overconfidence
  • Interest of the investors
ASSET ALLOCATION

Asset Allocation is a process of allocating money across various asset categories in line with a stated objective. The two popular approaches to asset allocation are:

Strategic Asset Allocation is allocation aligned to the financial goals of the individual. Such an analysis would help a mutual fund distributor to arrive at allocation between various asset categories in percentage terms.

Tactical asset allocation is where one may choose to dynamically change the allocation between the asset categories. The purpose is to take advantage of the opportunities presented by various markets at different points in time and improve the risk-adjusted return of the portfolio.

Risk Measures and Management Strategies-

Many of the risks cannot be eliminated, and the investor must take some of those, in order to earn decent returns on one’s investment portfolio:

1. Avoid: Investments which one does not understand or does not want to take risk.

2. Take a position to benefit from some event/development : An investor can also take an investment position in anticipation of some developments in the market.

3. Diversity: Investor shall diversify various investment options. This spreads the risk of loss and thus the probability of losing everything can be significantly reduced through diversification.

Risk Profiling

The risk profilers try to ascertain the risk appetite of the investor so that one does not sell mutual fund schemes that carry a higher risk than what the investor can handle. Risk appetite must be evaluated on the followings:

    1. The need to take risks: which arises when the investor needs higher returns to reach one’s goals.

    2. The ability to take risks: refers to the financial ability, and the investment horizon.

    3. The willingness to take risks: willingness is linked to the psychological capacity to handle risk

    4. The distributor has to evaluate and strike a balance between them, whenever there is a conflict.

CHAPTER 2: CONCEPT AND ROLE OF A MUTUAL FUND

Mutual fund is a vehicle (in the form of a “trust”) to mobilize money from investors, to invest in different markets and securities, in line with stated investment objectives. Through investment in a mutual fund, an investor can get access to equities, bonds, money market instruments and/or other securities, that may otherwise be unavailable to them and avail of the professional fund management services offered by an asset management company.

ROLE OF MUTUAL FUNDS

1. Help investors in earning an income or building their wealth, by investing in the opportunities available in securities markets

2. Offers livelihood to a large number of employees of mutual funds, distributors, registrars and various other service providers.

3. Mutual funds can also act as a market stabilizer, in countering large inflows or outflows from foreign investors. Mutual funds are therefore viewed as a key participant in the capital market of any economy.

Advantages of Mutual Funds for Investors

  • Professional Management
  • Affordable Portfolio Diversification
  • Liquidity and Transparency
  • Economies of Scale
  • Investment and regulatory comfort
  • Systematic Approach to investments

Investment objectives of Mutual Funds:

Every scheme has a pre-announced investment objective. Investors invest in a mutual fund scheme whose investment objective reflects their own needs and preference.

The primary objective of various schemes stems from the basic needs of an investor, viz., safety, liquidity, and returns.

Investment Policy of Mutual Funds

Once the investment objective is finalised, the mutual fund scheme’s investment policy is arrived at. The investment policy includes the scheme’s asset allocation and investment style.

Important Concepts in Mutual Funds
  • Face Value
  • Net Asset Value
  • Unit Capital
  • Assets under Management
  • Recurring Expenses
  • Mark to Market
  • Units                                                                                                      
Limitations of Mutual Funds for Investors
  • Lack of Portfolio Customization
  • No Control Over Costs
  • No Guaranteed Returns
  • Choice Overload

MUTUAL FUND SCHEME CATEGORISATION AND SEBI REGULATION

The objective was to bring uniformity in the characteristics of similar type of schemes launched by different mutual fund houses so that the investor can objectively evaluate the schemes chosen for investment. Accordingly, there are five broad categories of mutual fund schemes. Within each category, there are many sub- categories.

A. Equity Schemes (11 sub-categories)

B. Debt Schemes (16 sub-categories)

C. Hybrid Schemes (6 sub-categories)

D. Solution Oriented Schemes (2 sub-categories)

E. Other Schemes (2 sub-categories)

A. Equity Schemes

SR No. Name Investment in Minimum Investment in Equity and Equity Related Instruments
1 Multi Cap Funds Large Cap, Mid Cap & Small Cap Stocks of large Cap Companies : 25% of Total Assets of Mid Cap Companies : 25% of total Assets of Small Cap Companies : 25% of total Assets
2 Large Cap Funds Large Cap Stocks of large Cap Companies : 80% of Total Assets
3 Large and Mid-Cap Funds Large Cap & Mid Cap Stocks of Large Cap Companies : 35% of Total Assets Of Mid Cap Companies : 35% of total Assets
5 Small Cap Fund Small Cap Stocks of Small Cap Companies : 35% of Total Assets
6 Dividend Yield Fund Dividend Yield Stocks 65% of total assets
7 Value Fund Value investment Strategy 65% of total assets
8 Focused Funds Maximum 30 Stocks (the Scheme needs to mention where it intends to focus, viz, multi Cap, Large cap, mid Cap, Small Cap) 65% of Total Assets
9 Secretarial/ Thematic Specific Sectors Such as Power, Bank, Steel of Particular Sectors : 80% of Totals Assets
10 Equity Linked Saving Scheme - 80% of total Assets
11 Flexi Cap Funds Large Cap, Mid Cap & Small Cap Stocks 65% of Total Assets

B. DEBT Schemes

SR No. Name Investment in Duration/ Minimum Investment
1 Overnight Fund Overnight Securities 1 Day
2 Liquid Fund Debt & Money Market Securities 91 Days
3 Ultra Short Duration Fund Debt & Money Market Securities 3-6 Months
4 Low Duration Fund Debt Securities 6-9 Months
5 Money Market Fund Money Market Securities 1 Years
6 Short Duration Fund Debt & Money Market Securities 1-3 Years
7 Medium Duration Fund Debt & Money Market Securities 3-4 Years
8 Long Duration Fund Debt & Money Market Securities > 7 Years
9 Dynamic Bond Dynamic Debt Scheme -
10 Corporate Bond Fund AA+ and above rated Corporate Bonds 80 % of total Assets
11 Banking & PSU Funds Debt Instruments of Banks, PSU' s, PFIs 80 % of total Assets

C. Hybrid Schemes

SR No. Name Investment in Duration/ Minimum Investment
1 Conservative Hybrid Fund Predominantly in Debt instruments Equity: 10-25% of Total Assets Debt: 75-90% of Total Assets
2 Balanced Hybrid Fund Equity and Debt Instruments Equity: 40-60% of Total Assets Debt: 40-60% of Total Assets
3 Aggressive Hybrid Fund Predominantly in Equity and Equity Related Instruments Equity: 65-80% of Total Assets Debt: 20-35% of Total Assets
4 Arbitrage Fund Arbitrage Opportunities 65% of Total Assets
5 Equity Savings Equity, Arbitrage and Debt Equity: 65% of Total Assets Debt: 10% of Total Assets
6 Dynamic Assets Allocation Equity/ Debt that is Managed Dynamically -
7 Multi Asset Allocation at Least three Asstes Classes 10% in all three Assets Classes

D. Solution Oriented Schemes 

1. Retirement Fund: Retirement solution-oriented scheme having a lock-in of 5 years or till (whichever is earlier). retirement age

2. Children’s Fund: Fund for investment for children having a lock-in for at least 5 years or till the child attains the age of majority (whichever is earlier).

E. Other Schemes 

1. Index Funds/Exchange Traded Fund: An open-ended scheme replicating/tracking a specific index. Minimum investment in securities of a particular index shall be 95 percent of total assets.

2. Fund of Funds (Overseas/Domestic): An open-ended fund of fund scheme investing in an underlying fund. Minimum investment shall be 95 percent of total assets.

Certain other Categories of Funds

  1. Fixed maturity Plan
  2. Capital Protection Fund
  3. Infrastructure Debt Fund
  4. Real Estate Mutual Fund

Classification of Mutual Funds-

  • by Structure of the Mutual Funds

Open Ended Funds:

Allow the investors to enter or exit at any time, after the NFO. Investors can buy additional units any time after the scheme opens for ongoing transactions. Existing investors can redeem i.e. sell the units back to the scheme to get their money back.

Close Ended Funds:

Such funds have a fixed maturity. Investors can buy units only during its NFO and cannot transact after NFO is over. At the end of the maturity period, the scheme is wound up, units are cancelled and the money is returned to the investors. Post NFO, units are listed on SE to provide liquidity. The sale and purchase transactions happen on the SE between two different investors.

Interval Funds:

They are largely close-ended but become open-ended at pre-specified intervals. they are not dependent on the SE to buy or sell units. However, to provide liquidity between these intervals, the units must be compulsorily listed on SE to allow investors an exit route.

Transaction Period: The periods when an interval scheme becomes open- ended Minimum Duration is 2 days.

Interval Period: Period between the close of a transaction period, and the opening of the next transaction period. Maximum duration is 15 days.

  • by Management of Portfolio

Actively Managed Funds:

Actively managed funds are funds where the fund manager has the flexibility to choose the investment portfolio, within the broad parameters of the investment objective of the scheme.

Passive Funds:

Passive funds invest on the basis of a specified index; whose performance it seeks to track. Thus, a passive fund tracking the S&P BSE Sensex would buy only the shares that are part of the composition of the S&P BSE Sensex. The proportion of each share in the scheme’s portfolio would also be the same as the weightage assigned to the share in the S&P BSE Sensex.

  • by Management of Portfolio

There are equity funds, fixed income funds, money market funds, gold funds, international funds, etc. This classification may get further specific depending on narrowing the investment universe. Here, the category names indicate where the money could be invested.

New Type of Funds

There is an increase in the variation seen in the kinds of funds that are being launched by mutual fund houses. Some of them are:

1. Smart Beta Fund: Smart beta funds are an extension of index or ETFs as they change the basis of the exposure in the portfolio to the index using alternative strategies.

2. Quant Funds: Quant funds rely on data analysis and numbers usually undertaken by machines to select the securities in the portfolio. There are pre-determined models that are created and these are derived through analysis of past data.

3. International REIT: A fund that invests in Real Estate Investment Trusts abroad gives an exposure to the investor both to international funds plus the commercial real estate sector.

CHAPTER 3: LEGAL STRUCTURE OF MUTUAL FUNDS IN INDIA

Mutual fund is a vehicle (in the form of a “trust”) to mobilize money from investors, to invest in different markets and securities, in line with stated investment objectives. Through investment in a mutual fund, an investor can get access to equities, bonds, money market instruments and/or other securities, that may otherwise be unavailable to them and avail of the professional fund management services offered by an asset management company.

SEBI has stipulated the legal structure under which mutual funds in India need to be constituted. The Structure is as follows:

LEGAL STRUCTURE OF MUTUAL FUNDS IN INDIA

> MFs are constituted as Trusts under the Indian Trusts Act, 1882. MF trust is created by one or more Sponsors

> Every trust has beneficiaries who are the investors who invest in various schemes of the mutual fund.

> Operations of the MF trust are governed by a Trust Deed, which is executed between the sponsors and the trustees.

> Day to day management of the schemes is handled by an Asset Management Company (AMC) appointed by the sponsor or the Trustees.

> The record of investors and their unit- holding may be maintained by the AMC itself, or it can appoint a RTA.

Key Constituents of a Mutual Fund

  • Sponsors
  • Board of Trustees
  • Custodians
  • Assets Management Company
  • mutual Fund Trust

Sponsors-

  • The application to SEBI for registration of a mutual fund is made by the sponsor(s).
  • The sponsor should have a soundtrack record and reputation of fairness and integrity in all business transactions.
  • The sponsor should be a fit and proper person for.
  • Association of Mutual Funds in India’s (AMFI) website lists the names of all the Asset Management Companies, which are members of AMFI, in terms of the category of the sponsor, viz., Banks, Institutions, Private sector, etc.

Board of Trustees-

  • Trustees ensure mutual fund complies with all the regulations and protects the interests of the unit-holders.
  • The sponsor will have to appoint at least 4 trustees. If a trustee company has been appointed, then that company would need to have at least 4 directors on the Board.
  • Further, at least 2/3rd of the trustees on the Board of the trustee company would need to be independent trustees i.e., not associated with the sponsor in any way.
  • Prior approval of SEBI needs to be taken before a person is appointed as Trustee.
  • SEBI regulations prescribe eligibility criteria of trustee.

Assets Management Company-

  • The AMC is responsible for conducting the activities of the mutual fund.
  • A minimum net worth of Rs. 50 crores maintained on a continuous basis.
  • It arranges for the requisite offices and infrastructure, engages employees, provides software, handles advertising and sales promotion, and interacts with regulators and various service providers.
  • AMC ensure that the investment of funds pertaining to any scheme is not contrary to the provisions of the SEBI regulations and the trust deed.
  • The appointment of an AMC can be terminated by a majority of the trustees, or by 75% of the Unit- holders.

Custodians-

  • The custodian has custody of the assets of the fund. As part of this role, the custodian needs to accept and give delivery of securities for the purchase and sale transactions of the various schemes of the fund. Thus, the custodian settles all the transactions on behalf of the mutual fund schemes.
  • All custodians need to register with SEBI under the SEBI (Custodian) Regulations 1996. The Custodian is appointed by the trustees.
  • A custodial agreement is entered into between the trustees and the custodian.
  • The custodian also tracks corporate actions such as dividends, bonuses and rights in Companies where the fund has invested.

Organization Structure of Asset Management Company

Organization Structure of Asset Management Company

The various functions within an AMC are:

  • Compliance: Compliance Officer needs to ensure all the legal compliances. In the scheme documents of new issues, the Compliance Officer signs a due-diligence certificate to the effect that all regulations have been complied with, and that all the intermediaries have the statutory registrations and approvals.
  • Fund Management: This team is to invest the investors’ money in line with the stated objective of the scheme and to manage the same effectively. The team can be generally broken into three sub- teams, viz., the analysts, the fund managers, and the dealers.
  • Sales and Marketing Team: This team reaches out to the investors through mass media, marketing campaigns and through a distribution channel.
  • Operations & Customer Service Team: When a customer visits a branch office of an AMC, he is attended to by the customer services team known as front office team. There is also a team in the back office to help investors by resolving various queries. Many AMCs have adopted information technology solutions and have set up call centers and chat bots to answer customer queries and resolve service issues.

Other Functions:

  • The Accounts team handles the finances of the AMC.
  • Administration Department looks after various facilities, offices, and other infrastructure.
  • HR department is responsible for attracting and retaining talent within the firm.
  • Information Technology department takes care of the IT infrastructure required by various functions and departments, AMC website, as well as many facilities offered to investors and distributors with the help of technology.

Role and Support function of Service Providers

1. Fund Accountants: performs the role of calculating the NAV, by collecting information about the assets and liabilities of each scheme. The AMC can either handle this activity in-house or engage a service provider.

2. Registrar and Transfer Agents: The RTAS maintain investor records. Their offices in various centers serve as Investor Service Centers (ISCs), which perform a role in handling the documentation of investors. The appointment of RTA, though not compulsory, is done by the AMC. The AMC can choose to handle this activity in- house. All RTAs need to register with SEBI.

3. Auditors: Accounts of the mutual fund schemes need to be maintained independently of the accounts of the AMC. The auditor appointed to audit the mutual fund scheme accounts needs to be different from the auditor of the AMC. While the scheme auditor.

4. Collecting Bankers: The investors’ money goes into the bank account of the scheme they have invested in. These bank accounts are maintained with collection bankers who are appointed by the AMC.

5. KYC Registration Agencies: KRAs process various details and documents to establish the identity of the investor and assign a number through a letter. A copy of this letter can be submitted to any SEBI registered intermediary with whom the investor wants to transact.

6. Valuation agencies: Fair valuation of debt securities that are non-traded or thinly traded. According to these guidelines, there have to be at least two valuation agencies that provide valuation matrix.

7. Distributors: Distributors have a key role in selling suitable types of MF Schemes to their clients/investors. A distributor can be empaneled with more than one AMCs. Distributors can be individuals or institutions such as distribution companies, broking companies and banks.

8. Credit Rating Agencies: Credit rating agencies rate debt securities issued by various issuers. Certain categories of debt funds such as corporate bond funds, credit risk funds are defined on the basis of credit rating.

9. Stock exchanges and the transaction platforms: Investors can now transact in mutual fund units through the SEs. While units of close-ended funds and ETFs are compulsorily listed on at least one SE, units of open- ended funds are also available through special segments on the SE. At BSE, this segment is known as BSE-Star MF; while at the NSE, it is called NSE Mutual Fund II Platform (NMF-II).

Role and Function of AMFI

1. Association of Mutual Funds in India (AMFI) is the association of all the registered Asset Management Companies.

2. Objectives of AMFI is to define and maintain high professional and ethical standards in all areas of operation of the mutual fund Industry.

3. Functions are:

  • To interact with SEBI and to represent to SEBI on all matters concerning the mutual fund industry.
  • To represent to the Government, RBI and other bodies on all matters relating to the mutual fund Industry.
  • To undertake a nationwide investor awareness programme to promote proper understanding of the concept and working of mutual funds.
  • To protect the interest of investors/unitholders.
  • To regulate the conduct of distributors including disciplinary actions (cancellation of ARN) for violations of Code of Conduct.

4. Major role of AMFI involves the registration of mutual fund distributors, by allotting them AMFI Registration Number (ARN).

CHAPTER 4: LEGAL AND REGULATORY FRAMEWORK

Currently there are Four Regulators in the Financial Market which are RBI, SEBI, IRDAI and PFRDA.

Role of SEBI in Regulating Mutual Funds

SEBI issued the mutual fund regulations in 1996 in the form of SEBI (Mutual Funds) Regulations, 1996. The Objective has been to protect the interests of the mutual fund investors, and to empower investors to take informed investment decisions. Some provisions covered by the regulations are:

  • Risk Management Systems
  • Investment by Scheme
  • Disclosure & Reporting Norms
  • Secondary Market Activities
  • Valuation

Scheme Related Document: The provisions cover the objectives and content of the respective documents, frequency of publication of the that ensures the relevant information is up-to-date.

New products: These regulations govern the new product categories that may be approved from time to time.

Governance norms: These provisions cover fund level governance norms that include formation of audit and valuation committees, role of independent directors and trustees to scheme level governance norms that include minimum number of investors in a scheme.

Net Asset Value (NAV): NAV disclosures, rounding-off of NAV, cut-off time for various commercial transactions and uniformity in calculation of sale and purchase price.

Scheme Performance: SEBI has mandated that the scheme performance should be compared with the total return index, as against the price return Index.

Investment Restriction and Portfolio Diversification for MF Schemes

SR No. Types of Restrications Restriction
1. General Restriction 1. MF will buy and sell securities on delivery basis.2. MF shall not advance any loans.3. Scheme may invest in other schemes of the same MF or other MF. This will be limited to not more than 5% of the net asset value of the scheme.
2. Investment in DEBT Securities 1. A MF scheme shall not invest more than 10% of its NAV in debt instruments comprising money market instruments and non-money market instruments issued by a single issuer2. Open-ended debt funds have to maintain a minimum of 10% of their corpus in liquid assets.3. Parking of funds in Short-term deposits with all SCB shall be limited to 15% of the net assets of the scheme
3. Investment in Equity 1. ELSS notification requires that at least 80% of the ELSS funds should be invested in equity and equity-linked securities.2. Scheme shall not invest more than 10% of its NAV in the equity shares and equity related instruments of a company. The limit is not applicable for investments index/sector/industry specific schemes. in
4 Investment in REITs and invITs No mutual fund under all its schemes shall own more than 10% of units issued by a single issuer of REIT and InvIT.

Investors’ Rights & Obligations

Mutual fund investors are entitled to some important rights which are meant to protect the investments and bring more transparency to the mutual fund investors. Some rights are discussed below:

SR No. Rights Content
1 Right to beneficial Ownership The investor can ask for a Unit Certificate for his Unit-holding. Investors also have the option to receive an allotment of mutual fund units of open ended and closed end schemes in their demat account
2 Right to Inspect Documents Such as the Trust Deed, Investment Management Agreement, Custodial Services Agreement, RTA agreement and Memorandum & Articles of Association of the AMC.
3 Right to Appoint Nominees The investors can appoint up to 3 nominees, who will be entitled to the 'Units' in the event of the demise of the investors.
4 Right to terminate the Appointment of an AMC 75% of unitholders can terminate the appointment of an AMC They can also pass a resolution to wind up a scheme.
5 Rights of Investors in the Context of Change in Fundamental Attributes. In case of change in the fundamental attributes of a mutual fund scheme, then the unitholders are provided the option to exit at the prevailing NAV without any exit load. This exit window has to be open for at least 30 days.

SEBI Advertisement Code for Mutual Funds

Advertisement Shall:

  1. Be accurate, true, fair, clear, complete, unambiguous and concise.
  2. Not contain statements that are false, misleading, biased or deceptive, based on assumption/projections.
  3. not be so designed as likely to be misunderstood.
  4. not carry any slogan that is exaggerated or unwarranted.
  5. No celebrities shall form part of the advertisement.
  6. contain information that is timely and consistent with the disclosures made in the SID, SAI and the KIM.
  7. Be accompanied by a standard warning in legible fonts which states ‘Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
  8. While advertising pay out of dividends, all advertisements shall disclose the dividends declared or paid in rupees per unit along with the face value of each unit of that scheme and the prevailing NAV at the time of declaration of the dividend.

Investors Rights & Obligations:

SR No. Rights
1 Right to Change the Distributors
2 Right to Grievance Redressal
3 Right to Unclaimed Amount

Disclosing Performance-Related Information of Mutual Funds Schemes:

1. When the mutual fund scheme has been in existence for more than three years:

  •  Performance advertisement of MF Schemes shall be provided in terms of CAGR for the past 1 year, 3 years, 5 years and since inception.
  •  It should be clearly mentioned whether the disclosed performance is of regular or direct plan of the Mutual Fund.

2. Point-to-point returns on a standard investment of Rs. 10,000 shall also be shown in addition to CAGR for the scheme to provide ease of understanding to retail investors.

3. Where the scheme has been in existence for less than 6 months, past performance shall not be provided.

4. When the performance of a particular mutual fund scheme is advertised, the advertisement shall also include the performance data of all the other schemes managed by the fund managers of that particular scheme.

5. For the sake of standardization, a similar return in INR and by way of CAGR must be shown for certain scheme types apart for scheme benchmarks.

Celebrity Endorsement of Mutual Fund at Industry Level:

SEBI has Permitted Such Celebrity Endorsement of MF at Industry Level are Subject to the Following Conditions:

  • Prior Approval of SEBI Shall be Required for Issuance of any Endorsement of MF Which Features a Celebrity for the Purpose of Increasing Awareness of MF.
  • Expenses towards such Celebrity Endorsement Shall BE Limited to the amounts that are Aggregated by MF for Conducting Investor Education and Awareness Initiatives.

SEBI GUIDELINES FOR CIRCULATION OF UNAUTHENTICATED NEWS:

  • Proper internal code of conduct and controls should be put in place by market intermediaries registered with SEBI.
  • Access to Blogs/Chat forums/Messenger sites etc. should either be restricted or under supervision or access should not be allowed.
  • Employees should be directed that any market related news received in their official mail/personal mail/blog should be forwarded only after the same has been approved by the concerned Intermediary’s Compliance Officer.

Investors Grievance Redress Mechanism

Investor can First Approach the Investor Service Centre. If the Issue is not Redressed, even after taking it up at Senior Level in the AMC, then the Investor can Write to SEBI with the Complaint Details.

SEBI Complaint Redress Systems (Scores)

It is a Web- based Centralized grievance redress system of SEBI. Scores Enables Investors to Lodge, follow up on their Complaints and Track the Status of Redressal of Such Complaints online on the Website (http: //scores.gov.in).

Entities Against which Complaints are handled by SEBI include:

  • Listed Companies/Registrar & Transfer Agents.
  • Brokers/Stock Exchanges.
  • Depository Participants/Depository.
  • Mutual Funds.
  • Portfolio Managers.
  • Others Entities (KRAs, collective Investment Scheme, Merchant Banker, Credit Rating, FPI etc.)

CHAPTER 5: SCHEME RELATED INFORMATION

Investors are Governed by the Principle of Caveat Emptor i.e. , let the Buyer Beware. They are Presumed to have read and Understood the Scheme Related Documents before investing in a MF Scheme. Such Documents can be Used for making an informed Investment Decision.

There Documents are:

  1. Scheme Information Documents (SID), Which has Details of the Particular Scheme.
  2. Statement of Additional Information (SAI), Which has Statutory information about the MF or AMC, that is Offering the Scheme.

SEBI Does not Approve or Disapprove the Scheme Related Documents, It Gives its Observations Which are to be Incorporated in these Documents. Thus, the Documents in the Market are “Vetted” by SEBI, and not Approved by SEBI.

Draft SID and SAI Available for Viewing on SEBI’ s Website. The Final Documetns have to be Hosted on AMFI’s Website (www.amfiindia.com) two days before the Issue opens.

Scheme Information Documents: Structure

  • Table of Contents
  • Highlights
  • Introduction
  • Information about the Scheme
  • Unit and offer
  • Fees & Expenses
  • Rights of Unit-Holders
  • General Unit-Holders Information
  • Penalties, Litigations etc.

Scheme Information Documents: Structure

Content Place Found Content
Eligible Investors Section III, Sub-Section A and B New Fund Offer (NFO) and Ongoing Offer Details provides a list of categories of investors eligible to invest in the scheme
Buying Units of the Scheme From Mutual Funds. Cover Page of SID Part A and B of Segment III of the SID. 1. In Open-ended scheme, investors can buy units during the NFO and in continuing investment period.2. In Close-ended scheme, investors can buy units only during the NFO3. In Interval Scheme, the investors can buy units directly from the mutual fund at the time of the NFO and during the Specified Transaction Periods
Applying for Units of a Mutual Fund Scheme Section III, Sub-Section A and B of SID. The information available in the SAI and SID have to be read together to get all the information on how to apply for the units of a scheme.
Transactions: Purchase and Repurchase Prices Section III, Sub-Section A and B of SID. Information on the price at which investors can purchase and redeem units. This price will depend upon the applicable NAV for the transaction, which in turn will depend upon the cut-off time prescribed for the particular type of scheme and the transaction value.
Calcution of the Scheme's NAV per Units Sub-Section D of Section III of the SID Provides the Details of the Computation of the NAV.
Sources of Information Section III of the SID Details of the Peroidic Information that the Mutual Fund will Provide to the Investor on the Investments held in Thier Folio Through an Account Statement or Other Communications.
Modes of Transaction 'How to Apply' Found in Segment II of the SAI various ways in which the investor can transact with the mutual fund. This includes transacting directly with the mutual fund either physically or via Internet, through channel distributors, electronic mode, stock exchanges and others.
Load Structure Segment IV, Sub -Section C of the SID. Impact of Loads on the Redeemption Price of Units.
Tax Implications Section III, Sub-Section C. Prevalent tax Laws Applicable to Investing in Mutual Funds

Statement of Additonal Information

SAI has statutory information about the mutual fund or AMC, that is offering the scheme. Therefore, a single SAI is relevant for all the schemes offered by a mutual fund. Every mutual fund, on its website, provides for download of its SAI. Through the AMFI website (www.amfiindia.com), investors can access the SAI of all the mutual funds. Some contents of SAI are:

  • Tax, Legal and General Information
  • Investor Greviance
  • How to Apply
  • Right of Unit holders
  • Investment Valuation Norm
  • Constituents of the Mutual Funds : Sponsers, AMC & Trustee Company of Service Providers.

Key Information Memorandum:

A KIM is mandatorily circulated along with the application form. KIM is essentially a summary of the SID and SAI. It contains the key points of these documents that are essential for the investor to know to make a decision on the suitability of the investment for their needs.

Some of the key items contained in the KIM are as follows:

  • Name of the AMC, mutual fund, Trustee, Fund Manager and scheme.
  • Dates of Issue Opening, Issue Closing and Re-opening for Sale and Re-purchase.
  • Investment Objective.
  • Asset allocation pattern of the scheme.
  • The risk profile of the scheme i.e., a snapshot of the risk to the principal invested, the suitable investment horizon for investment and the type of securities that the scheme will invest in.
  • Plans and Options.
  • Benchmark Index.
  • Dividend Policy.
  • Performance of scheme benchmark over last 1 year, 3 years, 5 years and since inception.

Updation of Scheme Documents – Regulatory provisions

  • Updation of SIDs: For the open ended and interval schemes, the SID shall be updated within next 6 months from the end of the 1st half or 2nd half of the FY in which schemes were launched, based on the relevant data as at the end of previous month. Subsequently, SID shall be updated within 1 month from the end of the half-year, based on the relevant data as at the end of September and March respectively.
  • Updation of SAI: Regular update has to be done by the end of 3 months of every FY. Material changes have to be updated on an ongoing basis and uploaded on the websites of the mutual fund and AMFI.
  • Updation of KIM: Update shall be made within one month from the end of the respective half-year, based on the relevant data and shall be filed with SEBI forthwith through electronic mode only.

Non Mandatory Disclosures:

Fund Factsheet:

Used By: Investors, fund distributors, fund rating agencies, research analysts, media and others.

Purpose: To access information about the various schemes of the mutual fund.

Regulatory norms: While it is not a regulatory requirement to publish the monthly fact sheet, it is a market practice followed by all the fund houses, on a voluntary basis.

Contents: Basic information of each scheme such as the inception date, corpus size (AUM), current NAV, benchmark and a pictorial depiction of the fund’s style of managing the fund. security wise as well as sector wise allocation is provided for equity schemes.

ADDENDUM:

While the SID, SAI and KIM need to be updated periodically, the interim changes are updated through the issuance of such addendum.

Other Mandatory Information/Disclosures:

  • Value of One’s Investment: Unit balance in the investor’s account X current NAV.
  • Financial Results: The mutual fund shall before the expiry of one month from the close of each half year, (Mar 31 and Sep 30 shall display the unaudited financial results on the AMC website.
  • Daily NAV: Each scheme’s NAV is required to be disclosed at the end of each business day. The same is published on the website of the AMC. NAV is calculated for all the business days for Open-ended schemes and on weekly basis for close-ended schemes.
  • Scheme-wise dashboard on mutual fund website: Each AMC is also required to publish a scheme performance dashboard on the website, and update it on a regular basis. The dashboard highlights how various schemes of the mutual fund have performed over various holding periods.
  • Portfolio disclosure: This is a list of securities where the corpus of the scheme is currently invested.
  • Risk-o-meter
  • Annual reports and related disclosures.
  • Disclosure pertaining to change in control of the AMC.

CHAPTER 6: FUND DISTRIBUTION & CHANNEL MANAGEMENT PRACTICES

CHAPTER 6 FUND DISTRIBUTION & CHANNEL MANAGEMENT PRACTICES

  • The fund manager could be a mutual fund manager managing a mutual fund portfolio in line with the scheme’s investment objectives.
  • The mutual fund distributor’s job is to assess the needs, limitations, resources and financial goals of the investor. This analysis would help the mutual fund distributor arrive at a suitable asset allocation plan for the investor.
  • The mutual fund distributor analyses the situation of the investor; whereas the fund manager analyses the market factors.

Different Kinds of Mutual Funds Distributors

  • Individual Players
  • NBFC’s and Stock Brokers
  • Banks : Distribution of MF to Accountholders
  • National or Regional Distributors

Modes of Distribution

SR No. Mode Particular
1 Stock Exchange Platforms SEBI has facilitated buying and selling of the units of open- ended MFs through the SE. AMCs are required to list the units of close ended & interval schemes on a SE. NSE's platform is called NMF II Platform. BSE's platform is the BSE STAR Mutual Funds Platform.
2 MF Utilities The MFU offers a Common Transaction Form to transact in multiple schemes across participating MFs using a single form. The form can be submitted through a mutual fund distributor or to neutral Points of Service (PoS). Investors who register on the MFU are allotted a Common Account Number (CAN) under which all their MF holdings are consolidated.
3 New Age Investment Platforms Technology-based platforms that allow investors to invest in MFs like Groww, Kuvera, Paytm money, Coin.
4 Computer-based and Mobile based apps offered by Distributors
5 Online Channel partners

Pre-requisites to become Distributor of a Mutual Fund

In order to be eligible to sell or market mutual funds, the following are compulsory :

1. Obtaining NISM Certification: The individual needs to pass the NISM certification examination mandated by SEBI.

2. Know Your Distributor Requirements: AMFI has introduced the KYD process to verify the correctness of the information provided in the registration documents and to have verification of the ARN holders.

3. Obtaining AMFI Registration Number: After obtaining the certification and completing KYD requirements, the next stage is to register with AMFI. On registration, AMFI allots an AMFI Registration Number (ARN).

4. Empanelment with AMCs: Armed with the ARN No., the distributor/stock exchange broker can get empaneled with any number of AMCS. Alternatively, they can become agents of a distributor who is already empaneled with AMCs. This is compulsory to be able to sell MFs.

Due Diligence Process by AMCs for Distributors of Mutual Funds

SEBI has mandated AMCs to put in place a due diligence process to regulate distributors who qualify any one of the following criteria:

  •  Multiple point presence (More than 20 locations).
  •  AUM raised over Rs. 100 crores across the industry in the non-institutional category but including high net worth individuals (HNIs).
  •  The commission received of over Rs. 1 Crore p.a. across industry.
  •  The commission received of over Rs. 50 Lakhs from a single mutual fund.

At the time of empaneling distributors and during the period i.e., review process, mutual funds/AMCs have to undertake a due diligence process to satisfy ‘fit and proper’ criteria that incorporate, amongst others, the following factors:

  • Distributor-wise gross inflows (indicating whether the distributor is an associate or group company of the sponsor(s) of the mutual fund).
  • Net inflows.
  • Average assets under management.

Difference between distributors and Investment Advisors

An investment advisor means any person, who for consideration, is engaged in the business of providing investment advice to clients or other persons or group of persons and includes
any person who holds out himself as an investment adviser, by whatever name called; It excludes any distributor of mutual funds who is registered with an association of asset
management companies of mutual funds, providing any investment advice to its clients incidental to its primary activity.

Thus, a distributor cannot call themselves an investment advisor.

The due diligence process also defines the customer relationships or transactions only in two ways, viz. advisory, or execution only. In both cases, however, the common thing for the mutual fund distributor is to see whether the product is suitable for the client or not. No third categorization of customer relationships or transactions is allowed. The distributor must perform an analysis of suitability.

Further, the MF Distributor shall not get involved in mis-selling of units of MFs as defined under SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to securities market) 2003.

Nomination facilities to Agents/Distributors and Payment of Commission to Nominee

  • The commissions are paid to the nominees or legal heirs (where no nominee is registered) of the deceased MFDs. Such commission shall be payable till such time the ARN code of the deceased agent/distributor is not changed by the investor. However, no new business is permitted under the ARN code of the deceased MFD.
  • Where nomination is not registered, the AMCs may require the legal heirs to produce necessary documents evidencing legal heirship/succession and wherever the nominees are registered, commission can be made without the requirement of legal heir certificate, succession certificate etc.
  • A nominee/legal heir need not be an ARN holder to claim and receive the commission.
  • Nominees or legal heirs are not allowed to transfer the assets to his/her account unless a specific request is received from the investors provided the nominee or legal heir is a valid ARN Holder.

Change of Distributor

Investors can choose to change their distributor or go direct. This needs to be done through a written request by the investor. In such cases, AMCs will need to comply, without insisting on any kind of ‘No Objection Certificate from the existing distributor. In such a case, the commission would not be payable to either of the distributors the old or the new.

If the change of distributor code is initiated by the investor on account of voluntary cessation of business by the distributor, the new distributor would get the trail commission.

  • A distributor can initiate a change in the distributor code in the folios of one’s clients on account of.
  • Change in the name/legal status of the distributor (converting his MF distribution business to a partnership firm, a partnership firm converting itself into LLP etc).
  • Merger/acquisition/consolidation/transfer of business/new code acquired within the same group in case of non-individual distributors.
  • Transfer of AUM consolidation initiative within the same family/close relatives in case of individual distributors.
  • Transfer of business by individual distributors.

CHAPTER 7: NET ASSET VALUE, TOTAL EXPENSE RATIO & PRICING OF UNITS

In Order to Ensure Such Fair Treatment to all Investors, SEBI has Laid Down Certain Fair Valuation Principles.

Principle Content
Principle No.1 The valuation of investments shall be based on the principles of fair valuation i.e., valuation shall be reflective of the realizable value of the securities/assets.
Principle No.2 Investment in new type of securities/assets by the MF Scheme shall be made only after establishment of the valuation methodologies for such securities with the approval of the Board of the AMC.
Principle No.3 The assets held by the mutual funds shall be consistently valued according to the policies and procedures.
Principle No.4 The AMC provide for the periodic review of the valuation policies and procedures to ensure the appropriateness and accuracy of the methodologies used and its effective implementation in valuing the securities/assets.
Principle No.5 The valuation policies and procedures approved by the Board of AMC - should seek to address conflict of interest.
Principle No.6 shall be disclosed in Statement of Additional Information, website of AMC and other place as approved by Board.
Principles No.7 The responsibility of true and fairness of valuation and correct NAV shall be of the AMC, irrespective of disclosure of the approved valuation policies and procedures.
Principles No.8 The AMC shall have policies and procedures to detect and prevent incorrect valuation.
Principles No.9 Documentation of rationale for valuation including inter scheme transfers shall be maintained and preserved by the AMC.
Principles No.10 To have fairness in the valuation of debt and money market securities, the AMC shall take in to consideration prices of trades of same security or similar security reported at all available public platform.

Valuation-

NAV of the scheme will depend upon the value of the portfolio, which in turn, depends upon the value of the securities held in it. The valuation of these securities to determine the NAV has to be done as per guidelines laid down by SEBI and AMFI.

1. Traded Securities other than money market and debt securities:

  •  The securities shall be valued at the last quoted closing price on the stock exchange.
  •  When the securities are traded on more than one RSE, the securities shall be valued at the last quoted closing price on the SE where the security is principally traded. It is on the AMC to select the appropriate SE but the reasons for the selection should be recorded in writing.

2. Non-traded Securities’ other than money market and debt securities:

  •  When a security is not traded on any SE for a period of 30 days prior to the valuation date, the script must be treated as a ‘non-traded’ scrip.
  •  Non-traded securities shall be valued “in-good faith” by the AMC on the basis of appropriate valuation methods based on the principles approved by the Board of the AMC.

3. Value of Gold: the gold held by a gold exchange traded fund scheme shall be valued at the AM fixing price of London Bullion Market Association (LBMA) in US dollars per troy ounce for gold having a fineness of 965.0 parts per thousand.

4. Value of Silver: The silver held by a silver exchange traded fund scheme shall be valued at the AM fixing price of LBMA in US dollars per troy ounce for silver having a fineness of 999.0 parts per thousand.

Computation of Net Assets of Mutual Funds Scheme & NAV

Particulars Amount (Rs. Crore)
Unit Capital (20 crore units of Rs 10 each) 200
Profits (Rs 8 crore (interest and dividend received) minus Rs 4 crore (expense paid) minus Rs 1 crore (expenses payable) 3
Capital Appreciation on Investments held (10 percent of Rs 140 crore) 14
Unit-holders' Funds in the Scheme 217
Expenses payable 1
Scheme Liabilities 218
Assets
Market value of Investments (Rs 140 crore + 10 percent) 154
Bank Deposits (Rs 60 crore (original) plus Rs 8 crore (interest and dividend received) minus Rs 4 crore (expenses paid)} 64
Scheme Assets 218

1. NET ASSETS OF THE SCEME

Eg: Investors have bought 20 crore units of a mutual fund scheme at Rs. 10 each. The scheme has thus mobilized 20 crore units X Rs. 10 per unit i.e., Rs 200 crore. An amount of Rs. 140 crores, invested in equities, has appreciated by 10 percent. The balance amount of Rs 60 crore was placed in bank deposits. Interest and dividend received by the scheme is Rs 8 crore, scheme expenses paid is Rs 4 crore, While a Further Expense of Rs. 1 Crore is Payable.

Net Asset Value:

  • Unit-holders’ Funds in the Scheme (Net Assets) + No. of outstanding Units
  • In the above example, it can be calculated as: Rs 217 crore + 20 crore i.e., Rs 10.85 per unit.
  • Alternate formula: (Total Assets minus Liabilities other than to Unit holders) + No. of outstanding Units.

MARK TO MARKET: The process of valuing each security in the investment portfolio of the scheme at its current market value is called ‘mark to market i.e., marking the securities to their market value.

The NAV is meant to reflect the true worth of each unit of the scheme because investors buy or sell units on the basis of the information contained in the NAV. If investments are not marked to market, then the investment portfolio will end up being valued at the cost at which each security was bought.

Unit Capital Rs. 100000
Face Value Per Unit Rs. 10
No. of Units issued (unit Capital / Face Value per unit 10,000 Units (Rs. 1,00,000 / Rs. 10 per unit)
Net Assets of the Scheme Rs 1,50,000
Net Asset Value (Net Asset of the Scheme / No. of Units Issued) Rs. 15 (Rs. 1,50,000 / 10,000)

Valuation-

Case1: Assume an investor buys 100 Units when the NAV is Rs. 15 at FV of Rs. 10. Post the purchase, the numbers Will be:

Particulars Value Calculation
Unit Capital Rs 101000 Rs. 100000 + (100*10)
No. of Outstanding Units Issued (unit Capital / Face Value Per unit) 10100 Units 101000/ 10
Net Asset of the Scheme Rs 151000 Rs 150000 + ( 100*10)
Net Asset Value (Net Asset of the Scheme / No. of Units Issued) 14.95 151000/10100

Case 2: An Investor Redeems 100 units When the NAV is Rs. 15 at FV of Rs.10. Post the Redemption, numbers Will be:

Particulars Value Calculation
Unit Capital Rs 99000 Rs 100000 + (100*10)
No. of Outstanding Units Issued 9900 Units 99000/10
Net Asset of the Scheme Rs 14900 Rs 150000 - (100*10)
Net Asset Value Rs 15.95 149000/9900
  • Issuing Fresh units at a price Lower than the NAV will Result in the Post issue NAV Coming Down for all Investor (Case 1).
  • Redeeming units at price Lower than the NAV will Increase the NAV for the Remaining Investors (Case 2).

Total expenses in mutual fund scheme

Investment and Advisory Fees are charged to the scheme by the AMC. The details of such fees are fully disclosed in the Scheme Information Document.

Recurring Expenses: The AMC may charge the mutual fund scheme with recurring expenses some of which are:

  •  marketing and selling expenses including agents’ commission, if any
  •  brokerage and transaction cost
  •  registrar services for transfer of units sold or redeemed
  •  fees and expenses of trustees
  •  audit fees
  •  custodian fees
  •  costs related to investor communication

Any expense other than the investment advisory fee and recurring expenses shall be borne by the asset management company or trustee or sponsors.

In case of an index fund scheme or exchange traded fund, the total expense ratio of the scheme including the investment and advisory fees shall not exceed 1.00 per cent of the daily net assets.

In case of open-ended schemes other than as specified for fund-of-fund and index fund schemes, the total expense ratio of the scheme shall not exceed the following limits:

Total expenses in mutual fund scheme

In Case of Close Ended and interval Schemes,

  1. The TER of Equity-Oriented Scheme (s) Shall not Exceed 1.25 percent of the Daily net Assets of the Scheme.
  2. The TER of Schemes other than Scheme Specified Above Shall Not Exceed 1.00 Percent of the Daily Net Assets the Scheme.

Dividends and Distributable Reserves

SEBI guidelines stipulate those dividends can be paid out of distributable reserves. In the calculation of distributable reserves:

  • All the profits earned (based on the accrual of income and expenses as detailed above) are treated as available for distribution.
  • Valuation gains are ignored. But valuation losses need to be adjusted against the profits.
  • That portion of the sale price on new units, which is attributable to valuation gains, is not available as a distributable reserve.

This conservative approach to calculating distributable reserves ensures that dividend is paid out of real and realized profits, after providing for all possible losses.

The trustees shall decide the quantum of dividend and the record date. With respect to dividends up to monthly frequency the trustees can delegate to the officials of the AMC to declare and fix the record date as well as the quantum of dividend. This would have to be ratified by the trustees in the immediately following Board meeting.

CONCEPT OF ENTRY AND EXIT LOAD AND ITS IMPACT ON NAV

Open-ended schemes is the ongoing facility to acquire new units from the scheme or sell units back to the scheme (re-purchase transaction).

Schemes are permitted to keep the re-purchase Price lower than the NAV. The difference between the NAV and re-purchase Price is called the “exit load”. If the NAV of a scheme is Rs 11. per unit, and exit load of 1% was charged, the re-purchase Price would be Rs. 111% on Rs. 11 i.e., Rs. 10.89.

  • SEBI has banned entry load. So, the Sale Price is same as the NAV.
  • While charging exit loads, no distinction will be made among unitholders on the basis of the amount of subscription.
  • No exit load will be charged on bonus units and units allotted on reinvestment of dividend.
  • Exit loads have to be credited back to the scheme immediately i.e.. they are not available for the AMC to bear selling expenses.
  • Upfront commission to distributors will WISDO distributors will be paid by the investor directly to the distributor, based on his assessment of various factors including the service rendered by the distributor.

CONCEPT OF ENTRY AND EXIT LOAD AND ITS IMPACT ON NAV

CHAPTER 8: TAXATION

Income earned by Mutual Fund Schemes

As per the prevailing tax laws in India, a mutual fund’s income is exempt from income tax, since MF are constituted as trusts in India for the benefits of the unitholders. Section 10(23)(D) of the Income Tax Act exempts all the income earned by the mutual fund schemes from any tax

The applicable tax rates in case of capital gains and dividend would vary as under:

  • Type of income: The capital gains are taxed differently in comparison to the dividend income. At the same time, within capital gains, short term capital gains attract different tax rates in comparison to long term capital gains.
  • Type of mutual fund schemes: Income from equity-oriented mutual fund schemes (schemes where more than 65% of AUM in equity shares are listed on RSE) is taxed at different rates in comparison to non-equity-oriented schemes.
  • Type of investor: The tax treatment may differ for Resident Indian Investors, NRIs, and non-individual investors. It must be noted that in case of joint holding, the income, be it capital gains or dividend, would be considered to have been earned by the first holder.

Capital Gain Tax

Equity Oriented Funds Non Equity Oriented Funds
Short Term Capital Gain 15 percent Marginal Tax Rate, as Applicable for the Investor
Long Term Capital Gain 10 Percent 20% with Indexation Benefits
SETTING OFF CAPITAL GAINS & LOSSES UNDER THE INCOME TAX ACT
  • Capital loss, short term or long term, cannot be set off against any other head of income (e.g., salaries).
  • Short term capital loss is to be set off against short term capital gain or long term capital gain.
  • Long term capital loss can only be set off against long term capital gain.

Dividend Income

Union Budget presented by the finance minister in February 2020 has done away with dividend distribution tax has. As per the new regime, the dividend would henceforth be added to the taxable income of the assessee for the year. This means the dividends would be taxable in the hands of the recipient at the applicable tax rate.

Post-tax dividend received by the investor Dividend paid out by the scheme – Tax payable thereon, as per the applicable tax slab

  • Tax on dividends can be reduced through various exemptions and adjustments, as applicable.
  • Dividend income would be tax exempt for investors in various tax- exempt categories, for example charitable trusts, mutual fund schemes and individuals in the tax-exempt slab.
  • For growth option, the mutual fund schemes are tax-exempt, and the capital gains are realized only when booked, one can allow the gains to run without worrying about tax on the same. This concept is known as deferment of taxes and allows one the benefit of compounding before tax.

STAMP DUTY ON MUTUAL FUNDS

Post amendments carried out in the Indian Stamp Act in February 2019, stamp-duty is required to be paid for issue and transfer of Mutual Fund units with effect from 1 July 2020.

  •  Stamp duty @0.005% of the investment amount shall be applicable at the time of issue of units for both physical and demat units.
  •  Units will be allotted for the amount available post deduction of stamp duty.
  •  Stamp duty will be applicable to all transactions pertaining to scheme inflows:
  • Purchase
  • Additional Purchase
  • Dividend reinvestment
  • Systematic Transfer Plan (STP)
  • Systematic Investment Plan (SIP)
  • Income distribution cum capital withdrawal (Dividend) Transfer Plan (DTP).

Securities Transaction Tax

STT is applicable only on redemption/switch to other schemes/sale of units of equity oriented mutual funds whether sold on stock exchange or otherwise.

STT is not applicable on purchase of units of an equity scheme. It is also not applicable to transactions in debt securities or debt mutual fund schemes.

STT applicability for Investors in Equity oriented Mutual funds

Transactions Rates (In Percentage) Payable By
Purchase of units of equity oriented mutual fund Nil Purchaser
Sale of units of equity oriented mutual fund (delivery based) 0.001 Seller
Sale of equity shares, units of business trust, units of equity oriented mutual fund (non- delivery based) 0.025 Seller
Sale of units of an equity oriented mutual fund to the mutual fund 0.001 Seller

TAX BENEFITS UNDER SECTION 80C OF INCOME TAX ACT

Certain mutual fund schemes, known as Equity Linked Savings Schemes (ELSS) are eligible for deduction under Section 80C of the Income Tax Act. The benefit is available up to Rs. 1.50 lacs per year per taxpayer in case of individuals and HUFs. The scheme has a lock- in period of 3 years from the date of investment.

  • If the limit under this Section has been exhausted through some other avenue, any investment in ELSS would not get any additional tax exemption, but the investment would still be locked-in for atleast 3 years.
  • Where investment is made through SIP, each investment would be locked-in from the date of the respective investment. The lock-in for the entire amount would not get over on completion of 3 years from the date of the first SIP installment.
  • Tax benefit would be available to the first holder, in case of a joint holding.

Tax Deducted at Source

There is no TDS on re-purchase proceeds to resident investors. However, for certain cases of non-resident investments, the same is applicable.

The income tax regulations prescribe different rates, depending on the nature of the investor (Indian/ Foreign and Individual/Institutional), nature of investment (equity/debt) and nature of the income (dividend/capital gain).

In case of dividends from mutual fund schemes, even for resident Indians, TDS is applicable. The tax is required to be deducted at 10% on the dividend amount if it exceeds Rs. 5,000.

Bonus Stripping

  • If an investor buys units of a scheme at Rs. 30 and later declares a 1:1 bonus issue i.e., the investor receives 1 new unit, for every unit that was bought earlier. Logically, the NAV of the scheme will halve, and its NAV would now be of value of Rs. 15. At this stage, if the investor sells the original unit at Rs. 15, a loss of Rs 15 is incurred [Rs 30 (original purchase price for the Units) minus Rs 15 (currently realised)].
  • However, such capital loss is not available for setting off against capital gains, if the original units were bought within a period of 3 months prior to the record date for the bonus issue and sold off within a period of 9 months after the record date.
  • In such cases, the capital loss will be treated as the cost of acquisition of the bonus units.

APPLICABILITY OF GST

AMC(s) can charge GST, as per applicable Taxation Laws, to the schemes within the limits prescribed under SEBI (Mutual Fund) Regulations.

  • GST on fees paid on investment management and advisory fees shall be charged to the scheme in addition to the overall limits specified as per the Total Expense Ratio (TER) provisions.
  • GST on all the fees other than investment and advisory fees shall be charged to the scheme within the maximum limit of TER.
  • GST on exit load, if any, shall be deducted from the exit load and the net amount shall be credited to the scheme.
  • GST on brokerage and transaction cost paid for execution of trade, if any, shall be within the limit of TER.
  • The commission payable to the distributors of mutual funds may be subject to GST, as applicable in case of the ARN holder. Such tax cannot be charged to the scheme.

CHAPTER 9: INVESTOR SERVICES

NFO PROCESS

Units in a mutual fund scheme are offered to investors for the first time through a New Fund Offer (NFO). The AMC decides on a scheme to take to the market.

  • AMC prepares the SID for the NFO which is approved by the Trustees and the Board of Directors of the AMC.
  • The documents are then filed with SEBI for observations that are incorporated in SID. After approval by the trustees, the same can be issued in the market.
  • The AMC decides on a suitable timetable for the issue considering the market situation.
  • The AMC launches its advertising and public relations campaigns to make investors aware of the NFO in compliance with SEBI’s advertising code.
  • The AMC holds events for intermediaries and the press to make them familiar with the scheme, its unique features, benefits for investors, etc
  • The Scheme Application is distributed to the market The Scheme Documents and Application Forms distributed to intermediaries, and circulated in the market so that investors can apply in the NFO.

Investor Plans and Services

1. Direct Plan: Investors invest directly through the AMC without incurring charges for availing various services provided by the distributor. The direct plan shall have a lower expense ratio excluding distribution expenses, commission, etc.

2. Regular Plan: If investment (purchase/repurchase) is routed through a distributor, then it is considered that one has chosen to invest in the Regular Plan.

3. Income Distribution cum capital withdrawal (Dividend) Pay-out: the investor receives the dividend in his bank account. However, the plan does not change the number of units held by the investor. When a dividend is paid, the NAV of the units falls to that extent. The reduced NAV, after a Pay-out of dividend is called ex-Dividend NAV. Once dividend is announced, and until it is paid out, it is called cum-Dividend NAV,

4. Income Distribution cum capital withdrawal (Dividend) Re-Investment: The investor does not receive the dividend in his bank account. The amount is re- invested in the same scheme and additional units are allotted to the investor. The reinvestment happens at the ex-dividend NAV.

Eg: Rs. 2 per unit dividend on a Unit-holder’s 100 units amounting to Rs. 200 is given. Assuming the ex- dividend NAV of the scheme is Rs. 20, then Rs. 200 Rs. 20 i.e., 10 units will be added to the unit- holder’s portfolio.

5. Growth Option: Dividend is not declared. Nothing is received in Bank Account and there is nothing to re-invest. The NAV would therefore capture the full value of the portfolio gains.

Allotment of Units to Unitholders

NFO: NFO are sold at the face value i.e., Rs. 10. So the investment amount divided by Rs. 10 would give the number of units the investor has bought Allotment is completed within 5 business days after the closure of the New Fund Offer.

Ongoing Offer: Sale price is equal to the NAV. The investment amount divided by the sale price would give the number of units the investor has bought. Thus, an investor who has invested Rs. 12,000, in a scheme where the applicable sale price is Rs 12, will be allotted Rs 12,000+ Rs 12 i.e., 1,000 units.

Right Issue: The investment amount divided by the rights price gives the number of units that the investor has bought.

Bonus Issue: The investor does not pay anything. The fund allots new units for free. Thus, in a 1:3 bonus issue, the investor is allotted 1 new unit (free) for every 3 units already held by the investor. Since the net assets of the scheme remain the same only the number of units’ increases the NAV will get reduced proportionately and the value of the investor’s holding does not change as a result of the bonus issue.

MUTUAL FUND INVESTORS

  • Individual Investors:
  • Resident Indian adult individuals
  • Minors
  • Foreign investors
  • Hindu Undivided Families (HUFs)
  • Non-Resident Indians (NRIs)
  • Persons of Indian Origin (PIO) resident abroad

Non Individual Investors

  • Companies/corporate bodies, registered in India
  • Registered Societies and Co-operative Societies
  • Trustees of Religious and Charitable Trusts
  • Trustees of private trusts
  • Partner(s) of Partnership Firms
  • Association of Persons or BOI whether incorporated or not
  • Banks (including Co-operative Banks and Regional Rural Banks) Fls and Ils
  • Foreign Portfolio Investors registered with SEBI

FILLING THE APPLICATION FORM FOR MFS

  •  Direct Plan and Regular Plan
  •  Unit Holder Information
  •  Status of the Holder and Mode of Holding
  •  KYC Details
  •  Bank Account Details
  •  Investment Details
  •  Payment Details
  •  Unit Holding Option: Physical or Demat
  •  FATCA and CRS Details: Foreign Account Tax Compliance Act and Common Reporting Standards
  •  Nomination: Maximum 3 nominees
  • Minimum Investment: Provided in SID & KIM

Account Statement for Investors:

  • Monthy Statement of Account
  • Annual Account Statement
  • Consolidated Account Statement

FINANCIAL TRANSACTIONS WITH MUTUAL FUNDS

  • Initial Purchase of Mutual Fund Units: initial purchase of mutual fund units in a scheme can be made during the new fund offer (NFO) period or even subsequently in an open-ended scheme, during the open offer period.
  • Additional Purchases: Once an investor has a folio with a mutual fund, subsequent investments with the same mutual fund do not call for the full application form and documentation
  • Repurchase of Units: The re-purchase price is the applicable NAV less Exit Load.
  • Switch: A switch is redemption from one scheme and a purchase into another combined into one transaction.

NON FINANCIAL TRANSACTIONS WITH MUTUAL FUNDS

  • Nomination
  • Pledge /Lien of Units
  • Demat Account
  • Change in Folio Details
  • Change in Bank Account Details
  • Transmission of Units

PAYMENT MECHANISM FOR MUTUAL FUND PURCHASES

  • Internet Banking
  • M-Banking
  • Unified Payment Interface
  • Stock exchange platform and MFU platform
  • Application Supported by Blocked Amount
  • Aadhaar Enabled Payment Service
  • National Unified USSD Platform
  • E-Wallets
  • Cheque/Demand Draft
  • One-Time Mandate (OTM) allows investors to authorize their bank to process debits to their specified bank account raised by a specified mutual fund for purchase of units
  • Cash Transactions: MFs usually do not accept cash. Cash Transactions are allowed for Small investors, who may not be taxpayers and may not have PAN/bank accounts, such as farmers, small traders/businessmen/workers for the purchase of MF units of Rs. 50,000/-per investor, per MF per FY.

TIME STAMPING

Mutual funds disclose Official Points of Acceptance (OPoA is) and their addresses in the SID and their website. All transaction requests need to be submitted at the OPoA is. The time stamping on the transaction requests is done at the official points of acceptance.

As a convenience, the distributor may accept the transaction request from the investor, but this would need to be sent to an OPOA at the earliest. When the cut-off timing is applied, the time when it is submitted to the OPOA is relevant-not the time when the investor submits the transaction request to the distributor.

  • Application for purchase of units is stamped with automatically generated location code, machine identifier, serial number, date and time; the reverse of the payment instrument has to be similarly stamped with the same number; the acknowledgement issued to the investor gets a similar stamp.
  • Applications for re-purchase and investor’s acknowledgement are stamped with the same information.
  • Applications for non-financial transactions like the change of address, and investor’s acknowledgement are stamped. However, here stamping of time is not relevant; the date stamping is pertinent.

KYC REQUIREMENTS FOR MUTUAL FUND INVESTORS

  • Applies to transactions such as new/additional purchases, switch transactions, new systematic investment plan (SIP), new systematic transfer plan (STP), Transfer of Income Distribution cum capital withdrawal plan (DTP) registrations from effective date.
  • KYC process involves establishing the identity and address of the investor as required under the Anti-Money Laundering Laws. The application for investment must be accompanied by the acknowledgement for having completed the KYC process issued by the KYC Registration Agency (KRA).
  • KYC Documents: PAN, Proof of Address.
  • In consultation with the Unique Identification Authority of India (UIDAI) and the market participants, the e-KYC service launched by UIDAI has also been accepted as a valid process for KYC verification.
  • SEBI has instituted a centralised KYC process for the capital market, including mutual funds. Based on the completion of the KYC process with one capital market intermediary, the investor can invest across the capital market. KYC Registration Agencies (KRAs) facilitate this centralised KYC process.

SYSTEMATIC TRANSACTIONS

1. Systematic Investment Plan: SIP is an approach where the investor invests constant amounts at regular intervals.

2. Systematic Withdrawal Plan (SWP): Investors can opt for the safer route of offering to re-purchase a constant value of units over a period of time.

3. Systematic Transfer Plan (STP): In a STP, the amount that is withdrawn from a scheme (called the source scheme) is re-invested in some other scheme (called the target scheme) of the same mutual fund. Thus, it operates as a SWP from the source scheme, and a SIP into the target scheme. Since the investor is effectively switching between schemes, it is also called “switch”

4. Transfer of Income Distribution cum capital withdrawal plan: Transfer of Income Distribution cum capital withdrawal plan (DTP) is a facility that allows investors to invest the dividend earned in a mutual fund investment into another scheme of the same mutual fund.

5. Switch: A switch is a redemption from one scheme and a purchase into another combined into one transaction.

CHAPTER 10 : RISK, RETURN AND PERFORMANCE OF FUNDS

GENERAL RISK FACTORS

These are risks that all mutual funds are exposed.

  1.  Liquidity Risk
  2.  Interest Rate Risk
  3.  Re-investment Risk
  4.  Political Risk
  5.  Economic Risk
  6.  Foreign Currency Risk
  7.  Risks associated with transactions in Units through stock exchange (s).

SPECIFIC RISK FACTORS

1. Risk related to equity and equity related securities

2. Risk associated with Dividend

3. Risks associated with mid-cap and small-cap companies:

  •  Large-Cap Stocks: 1st-100th company in terms of full market capitalization.
  •  Mid-Cap Stocks: 101st -250th company in terms of full market capitalization.
  •  Small-Cap Stocks: 251st company onwards in terms of full market capitalization.

In equity investments, there is a risk that such companies may not achieve their expected earnings results, or there could be an unexpected change in the market.

4. Risk associated with Derivatives: Derivatives are highly leveraged instruments. Even a small price movement in the underlying security could have an impact on their value and consequently, on the NAV of the Units of the Scheme.

5. Risk factors associated with repo transactions in Corporate Bonds: The Scheme may be exposed to counter party risk in case of repo lending transaction in the event of the counterparty failing to honour the repurchase agreement.

6. Risk Factors Associated with Investments in REITs and InvITs: RelTs and InvITs are exposed to price-risk, interest rate risk, credit risk, liquidity or marketability risk, reinvestment risk.

7. Risks related to debt funds :

  • Reinvestment Risk: Interest rates prevailing on the coupon payment or maturity dates may differ from the original coupon of the bond.
  • Rating Migration Risk: Fixed income securities are exposed to rating migration risk, which could impact the price on account of change in the credit rating.
  • Credit Risk: Fixed income securities (debt and money market securities) are subject to the risk of an issuer’s inability to meet interest and principal payments on its debt obligations.

Risk Management Strategies

Managing Market Liquidity Risk: The liquidity risk is managed by creating a portfolio which has adequate access to liquidity.

Managing Credit Risk: Risk associated with fixed income securities is managed by making investments in securities issued by borrowers, which have a good

Managing Rating Migration Risk: The aim is to invest in high grade/quality securities.

Managing Term Structure of Interest Rates Risk: The Investment Manager actively manages the duration based on the ensuing market conditions.

Managing Risk associated with favourable taxation of equity-oriented Scheme: This risk is mitigated as there is a regular monitoring of equity exposure of each of the equity- oriented Scheme of the Fund.

Re-investment Risk: Prevalent for fixed income securities, but as the fixed income investments of the Scheme are generally short duration in nature, the impact can be expected to be small.

FACTORS AFFECTING PERFORMANCE OF EQUITY SCHEMES

Fundamental and Technical analysis

Earnings per Share (EPS): Net profit after tax + No. of equity shares outstanding. This indicates how much profit the company earned for each equity share that they own.

Price to Earnings Ratio (P/E Ratio): Market Price per share + Earnings Per Share (EPS). P/E ratio indicates how much investors in the share market are prepared to pay in relation to the company’s earnings.

Book Value per Share: Net Worth + No. of equity shares outstanding. This is an indicator of how much each share is worth, as per the company’s own books of accounts.

Price to Book Value: Market Price per share + Book Value per share. An indicator of how much the share market is prepared to pay for each share of the company, as compared to its book value.

Dividend Yield: Dividend per share Market price per share.

Portfolio building approach Top down and Bottom up.

In a top-down approach, the portfolio manager evaluates the impact of economic factors first and narrows down on the industries that are suitable for investment. Thereafter, the companies are analysed and the good stocks within the identified sectors are selected for investment.

A bottom-up approach analyses the company-specific factors first and then evaluates the industry factors and finally the macro-economic scenario and its impact on the companies that are being considered for investment. Stock selection is the key decision in this approach.

FACTORS AFFECTING PERFORMANCE OF DEBT SECURITIES

Investment in a debt security, entails a return in the form of interest (at a pre-specified frequency for a pre-specified period), and repayment of the invested amount at the end of the pre-specified period.

The pre-specified period is called tenor. At the end of the tenor, the securities are said to mature. The total return that an investor earns or is likely to earn on a debt secure said to its yield.

Securities issued by the Government are called Government Securities or G-Sec or Gilt. Since the government is unlikely to default on its obligations, Gilts are viewed as safe as there is no credit risk associated with them. The difference between the yield on Gilt and the yield on a non- Government Debt security is called its credit spread.

Interest Rates: Suppose Company X issued a debenture for a period of 5 years carrying a coupon rate of 9.5% p.a. The debenture carried a credit rating of AAA, which denotes highest safety.

Two years later, the debenture has residual maturity of 3 years, i.e., the debenture will mature after 3 years. At this stage, the interest rate for AAA rated debentures having 3-year maturity is 8.5% p.a. In such a case, the Company X debenture would fetch premium in the secondary market over its face value.

Credit Spreads Suppose an investor has invested in the debt security of a company. Subsequently, its credit rating improves. The market will now be prepared to accept a lower credit spread. Correspondingly, the value of the debt security will increase in the market.

MEASURES OF RISKMEASURES OF RISK

RISK IN FUND INVESTING WITH A FOCUS ON INVESTORS

Type of Risk Particular
Risks in Equity Funds An investor would be exposed to the risk of price fluctuations in an equity fund. The risk is likely to go up when one moves from large-cap to mid-cap to small-cap schemes.
Risk in Debt Funds Debt fund NAVs may fluctuate due to change in interest rates or due to credit migration. That means the debt fund portfolio may not be as stable as one expected.
Risk in Hybrid Funds SEBI on Mutual fund scheme categorization defined the asset allocation between equity and debt in case of certain categories within the hybrid funds. The distributor must be careful in evaluating and selecting the schemes.
Risk in Gold Funds gold does well when the other financial markets are in turmoil. When a country goes into war, and its currency weakens, gold funds generate excellent returns.
Risk in Realstate Funds Transaction costs, in the form of stamp duty, registration fees, etc. and regulatory riik is high in real estate. The transparency level is low even among the real estate development and construction companies.

Measures of Risks

1. Variance: Variance measures the fluctuation in periodic returns of a scheme, as compared to its own average return. This can be easily calculated in MS Excel: var (range of cells where the periodic returns are calculated)

2. Standard Deviation: Standard deviation is a measure of total risk in an investment. As a measure of risk, it is relevant for both debt and equity schemes.

A high standard deviation indicates greater volatility in the returns and greater risk. Comparing the standard deviation of a scheme with that of the benchmark and peer group funds gives the investor a perspective of the risk in the scheme

3. Beta: Beta is based on the Capital Asset Pricing Model (CAPM), which states that there are two kinds of risk in investing in equities systematic risk and non-systematic risk. Since non-systematic risk can be diversified away, investors need to be compensated only for systematic risk, according to CAPM. This systematic risk is measured by its Beta.

4. Modified Duration: Modified duration measures the sensitivity of value of a debt security to changes in interest rates. Higher the modified duration, higher is the interest sensitive risk in a debt portfolio.

5. Credit Rating: The credit rating profile indicates the credit or default risk in a scheme.

Certain Provisions with Respect to Credit Risk

GATING OR RESTRICTION ON REDEMPTION IN MUTUAL FUNDS

The circumstances calling for restriction on redemption should be such that illiquidity is caused in almost all securities affecting the market at large due to a systematic crises or event, rather than in any issuer specific securities.

When restriction on redemption is imposed, the following procedure shall be applied:

  • No redemption requests up to Rs. 2 lakhs shall be subject to such restriction;
  • When redemption requests are above Rs. 2 lakhs, AMCs shall redeem the first Rs. 2 lakhs without such restriction and remaining part, i.e., amounts over and above Rs. 2 lakhs shall be subject to the restriction.

The above information to investors shall be disclosed prominently and extensively in the scheme related documents regarding the possibility that their right to redeem may be restricted in such exceptional circumstances and the time limit for which it can be restricted.

CHAPTER 11 : MUTUAL FUND SCHEME PERFORMANCE

BENCHMARKS AND PERFORMANCES

A credible benchmark should meet the following requirements: It should be in sync with:

  1.  the investment objective of the scheme.
  2.  asset allocation pattern.
  3.  investment strategy of the scheme.

The benchmark should be calculated by an independent agency in a transparent manner, and published regularly.

PRICE RETURN INDEX OR TOTAL RETURN INDEX

The mutual fund schemes are benchmarked to the Total Return variant of an Index (TRI). The TRI takes into account all dividends/interest payments that are generated from the basket of constituents that make up the index in addition to the capital gains. The scheme performance Would be Calculated after adding the Dividends that the Scheme has earned from the investments. The gap between the returns between PRI and TRI is the amount of dividend.

Basis of Choosing an Appropriate Performance Benchmark

SEBI has mandated:

  • Selection of a benchmark for the scheme of a mutual fund to be in alignment with the investment objective, asset allocation pattern and investment strategy of the scheme.
  • The performance of the schemes of a mutual fund to be benchmarked to the Total Return variant of the Index chosen as a benchmark.
  • Mutual funds should use a composite CAGR figure of the performance of the PRI benchmark.

bnechmark for equity scheme

benchmark for debt scheme

Gold ETF: Gold price would be the benchmark for such funds. Real Estate Funds: A few real estate services companies have developed real estate indices. International Funds: The benchmark would depend on where the scheme proposes to invest. Thus, a scheme seeking to invest in China might have the Shanghai Composite Index (Chinese index) as the benchmark. S&P 500 may be appropriate for a scheme that would invest largely in the US market.

 

QUANTITATIVE MEASURES OF FUND MANAGER PERFORMANCE

A relative comparison shows how did a scheme perform vis-à-vis its benchmark or peer group. Such comparisons are called relative return comparisons.

If a comparison of relative returns indicates that a scheme earned a higher return than the benchmark, then that would be indicative of outperformance by the fund manager. In the reverse case, the initial premise would be that the fund manager under- performed.

There are various measures of risk-adjusted returns

1. Sharpe Ratio

Sharpe ratio is a very commonly used measure of risk-adjusted returns. Sharpe Ratio (Rs minus Rf) Standard Deviation

Where: Rs is the return; Rf is risk free return Rs minus Rf is the Risk Premium

2. Treynor Ratio: Treynor Ratio (Rs minus Rf) + Beta

Higher the Treynor Ratio, better the scheme is considered. Since the concept of Beta is more relevant for diversified equity schemes, Treynor Ratio comparisons should ideally be restricted to such schemes.

3. Alpha:

Non-Index schemes too would have a level of return, which is in line with its higher or lower beta as compared to the market. Let us call this the optimal return.

The difference between a scheme’s actual return and its optimal return is its Alpha-a measure of the fund manager’s performance. Alpha, therefore, measures the performance of the investment in comparison to a suitable market index.

TRACKING ERROR

The Beta of the market, by definition is 1. An index fund mirrors the index. Therefore, the index fund too would have a Beta of 1, and it ought to earn the same return as the market. The difference between an index fund’s return and the market return is the tracking error.

The tracking error is used to measure how consistently a fund is able to out-perform its benchmark. It is not enough if the fund is able to generate a high excess return, it must do so consistently.

SCHEME PERFORMANCE DISCLOSURES

SEBI has mandated disclosure of performance data by all the AMCS. These disclosures can be accessed through certain scheme documents and websites of the fund house.

The SID of each scheme needs to be updated once every year, accordingly, the scheme performance numbers have to be updated as a part of this exercise. That is where the fund fact sheet plays a vital role which is published on a monthly basis by all the fund houses. Fact Sheet is not a statutory requirement.

Mutual funds also make available product literature that can be used by distributors and investors to evaluate schemes. This information is made available in physical and online mode and typically includes information about suitability, returns and portfolio description.

Suitability: A snapshot of the suitability of the product can be assessed from the product labels that have to be provided with any product literature. It identifies the objective of the scheme as wealth creation, regular income generation or providing liquidity, and also the asset class in which the scheme will invest to achieve the objective.

Returns: The cumulative returns that the scheme has generated over different holding periods helps assess if the fund is able to generate returns to meet the investment objectives.

Portfolio Description: The description of the way the portfolio will be managed in terms of how assets will be allocated and securities selected will help investors assess the suitability of the scheme to investors.

Fund Factsheet: The fund factsheets are an official source of information of the fund’s objective, performance, portfolio and basic investment requirements issued by the fund house each month. The factsheet is also used by the fund manager to communicate their views on the economy and the markets to the investors and other observers such as research analysts, rating agencies and media.

AMCS may also provide periodic updates on markets and the economy. These are typically part of the factsheets or may be issued as separate notes.

Scheme performance available on AMFI website:

AMFI website (www.amfiindia.com) carries the performance data of all the mutual fund schemes. This is an exhaustive resource and one can access the same for various different periods, and fund categories. A sample screen shot of the report is shown below:

Screenshot 2024 04 30 193755

 

Investors, who wish to access the raw data of NAVs, dividends etc. in a systematic manner – and distributors who wish to integrate such information into their investor-management systems and processes can subscribe to the data from different vendors.

CHAPTER 12 : MUTUAL FUND SCHEME SELECTION

SCHEME SELECTION BASED ON INVESTOR NEEDS, PREFERENCES AND RISK-PROFILE

1. Investor Need: The investor may need long term appreciation in the value of his investment, or the investor may need periodic income from the investment, or the investor may be looking for an avenue to park funds and need an investment with high liquidity. Therefore, the first step is to set one’s financial goals.

2. Risk Profile of the investor: The investor’s risk appetite is a function of three things the need to take risks, the ability to take risks, and the willingness to take risks.

3. Asset Allocation: The investor’s asset allocation is a decision regarding how much money should be allocated to which scheme category (asset class). This decision can be taken only after assessing the investor’s risk profile and analysing the investor’s goals and situation.

4. Age of the investor: One of the common factors that many people use to evaluate the investor’s risk profile is the investor’s age Different investors have different financial goals at different age levels. In fact, investors in the same age group may also have different goals.

5. Investment Horizon: Longer the horizon to the goal, the ability to take risks is higher, whereas one may avoid risks when the goal is in the near future.

6. Core and Satellite Portfolio: It is good to consider the role that the scheme will play in the investor’s portfolio. Ideally the portfolio should be divided into core and satellite portfolios. The core portfolio will be invested according to the long-term needs and goals of the investor. The satellite portfolio will be invested to take advantage of expected short-term market movements. For example, a diversified equity fund, large cap, mid-cap funds, among others may form part of the core portfolio since they generate long-term returns in broad alignment with the markets.

SELECTING OPTIONS IN MUTUAL FUND

The underlying returns in a scheme, arising out of its portfolio and cost economics, is what is available for investors in its various options.

Income distribution cum capital withdrawal (Dividend) payout option has the benefit of money flow to the investor and seems attractive for investors wanting a regular income.

Growth option has the benefit of letting the money grow in the fund on gross basis (i.e., without annual taxation).

Re-purchase transactions are treated as a sale of units by the investor. Therefore, there can be an element of capital gain (or capital loss), if the re-purchase price is higher (or lower) than the cost of acquiring those units.

Dividend income is subject to tax as per the applicable tax slab of the respective investor. The tax on dividend reduces the returns for the investor. Thus, Income distribution and capital withdrawal (dividend) option is not preferable, except in the case of tax-exempt investors.

The need for regular income is better met through a SWP for the requisite amount. Sale of units under an SWP may have STT implication (equity schemes) and capital gains tax implications (equity and debt schemes.

SELECTION OF MUTUAL FUND SCHEME OFFERED BY DIFFERENT AMCS OR WITHIN THE SCHEME CATEGORY

Fund Portfolio: The fund’s portfolio has to be evaluated to determine the risk and return in the scheme.

Fund Age: A fund with a long history has a track record that can be studied. Fund age is especially important for categories of schemes, where there are more investment options, and divergence in performance of schemes within the same category tends to be more.

Fund Size: The size of funds needs to be seen in the context of the proposed investment universe. A large fund size will allow better diversification and economies of scale. A small sized fund on the other hand is more flexible and better able to take advantage of market
opportunities.

Portfolio Turnover: Frequent churning of the portfolio would not only add to the broking costs, but also be indicative of unsteady investment management. Portfolio Turnover Ratio is calculated as Value of Purchase and Sale of Securities during a period divided by the average size of net assets of the scheme during the period.

Scheme Running Expenses: Any cost is a drag on investor’s returns. Investors need to be OM WISD particularly careful about the cost structure of debt schemes, because in the normal course, debt returns can be much lower than equity schemes.

Growth or Value funds:

Funds that follow the growth strategy seek to identify companies that are expected to grow at rates higher than the average economic growth rate. Stocks of such companies tend to do well in a bull phase in the markets. But in a market downturn the price of such stocks tends to fall much more too, making them riskier.

Value strategy seeks to identify stocks that are available at a price that is seen as cheap relative to the value that could be unlocked in the future.

Gold Funds

Investors need to differentiate between Gold ETF and Gold Sector Funds. The latter are schemes that invest in shares of gold mining and other gold processing companies. The performance of these gold sector funds is linked to the profitability of these gold companies unlike Gold ETFs whose performance would track the price of gold.

Hybrid Schemes:

Investing in a hybrid scheme makes things simpler for the investor, because fewer scheme selection decisions need to be taken. However, the investor would need to go by the debt- equity mix in the Investment portfolio of the schemes.

The equity component in a hybrid fund provides the appreciation in value, while the regular returns from the debt component provide the stability to the returns.

International Equity Funds:

When an Indian Investor invests in equities abroad, he is essentially taking two exposures:

  • An exposure on the international equity market.
    An exposure to the exchange rate of the rupee.

Taking this kind of exposure is possible and convenient through the international equity funds, which invest in stocks of companies listed in stock exchanges located outside of India.

Fixed Maturity Plans

These are close-ended debt funds. Fixed Maturity Plan is ideal when the investor’s investment horizon is in sync with the maturity of the scheme, and the investor is looking for a more predictable return than any conventional debt scheme, and a return that is generally superior to what is available in a fixed deposit.

Short Duration Fund

Short Duration Funds invest in securities with maturities between 1 year and 3 years. As such they earn returns in line with the market yields.

Liquid Funds

An investor seeking the lowest risk ought to go for a liquid scheme. However, the returns in such Instruments are low.

Screenshot 2024 04 30 201401

Screenshot 2024 04 30 201911

 

DO’S AND DON’TS WHILE SELECTING MUTUAL FUND SCHEMES

While selecting the mutual fund schemes, there are few things that a mutual fund distributor must keep in mind. Some of them are listed below:

  • Ensuring suitability
  • Sticking to investor’s asset allocation
  • Chasing past performance
  • Understanding the investment objective and investment strategy of the scheme.
  • Developing a consistent methodology for scheme selection.
  • Keeping an eye on the taxes and loads.

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