Mutual funds

Concepts and meaning
• A Mutual Fund is a trust that pools the savings of a number of investors who
share a common financial goal.
• The money thus collected is then invested in capital market instruments such as
shares, debentures and other securities.
• The income earned through these investments and the capital appreciation
realised are shared by its unit holders in proportion to the number of units owned
by them.
• Thus a Mutual Fund is the most suitable investment for the common man as it
offers an opportunity to invest in a diversified, professionally managed basket of
securities at a relatively low cost.
• SEBI defines Mutual Funds as “ a fund established in the form of a
trust by a sponsor, to raise monies by the trustees through sale
of unites to the public, under one or more schemes ,for investing
in securities in accordance with these regulations

You can make money from a mutual fund in three
ways:
1) Income is earned from dividends on stocks and
interest on bonds. A fund pays out nearly all of
the income it receives over the year to fund owners
in the form of a distribution.
2) If the fund sells securities that have increased in
price, the fund has a capital gain. Most funds also
pass on these gains to investors in a distribution.
3) If fund holdings increase in price but are not sold by
the fund manager, the fund's shares increase in
price. You can then sell your mutual fund shares for
a profit.

Mutual Funds
Operations Flow Chart
(Reference: amfiindia.com)

History of Mutual Funds
Phase I – 1964 – 87: In 1963, UTI was set up by Parliament
under UTI act and given a monopoly. The first scheme
launched by UTI was Unit Scheme-64. Later in ’70’s and
’80’s, UTI started offering some special purpose schemes
like ULIP and Children’s Gift Growth Fund. Master share, the
first equity fund was launched in 1986. These were launched
to suit the needs of different class of investors.
Phase II – 1987 – 93: 1987 marked the entry of non-UTI,
Public Sector mutual funds. Some of the mutual funds
launched during this period are SBI Mutual Fund, Canbank
Mutual Fund, LIC Mutual Fund, Indian Bank Mutual Fund,
GIC Mutual Fund and PNB Mutual Fund.
Also marked a spurt in launch of assured funds like

History of Mutual Funds
Cantriple, Magnum Triple, BOI Double Square Plus. Equity
funds with assured returns were launched which later ended
in disaster.
Phase III – 1993 – 96: Permission was granted for entry of
private sector funds. It gave greater choice to the Indian
Investors. These private funds have brought in with them the
latest product innovations, investment management
techniques and investor servicing technology that makes the
Indian mutual fund industry vibrant and growing. This phase
also marked the launch of an open-end funds.
Phase IV – 1996: Investor friendly regulatory measures have
been taken both by SEBI to protect the investor, and by the
government to enhance investor’s returns through tax
benefits.

Advantages of Mutual Funds
• Portfolio diversification: It enables him to hold a diversified investment
portfolio even with a small amount of investment like Rs. 2000/-.
• Professional management: The investment management skills, along
with the needed research into available investment options, ensure a
much better return as compared to what an investor can manage on his
own.
• Reduction/Diversification of Risks: The potential losses are also
shared with other investors.
• Reduction of transaction costs: The investor has the benefit of
economies of scale; the funds pay lesser costs because of larger volumes
and it is passed on to the investors.
• Wide Choice to suit risk-return profile: Investors can chose the fund
based on their risk tolerance and expected returns.

Advantages of Mutual Funds
• Liquidity: Investors may be unable to sell shares directly, easily and
quickly. When they invest in mutual funds, they can cash their investment
any time by selling the units to the fund if it is open-ended and get the
intrinsic value. Investors can sell the units in the market if it is closed-
ended fund.
• Convenience and Flexibility: Investors can easily transfer their
holdings from one scheme to other, get updated market information and
so on. Funds also offer additional benefits like regular investment and
regular withdrawal options.
•Transparency: Fund gives regular information to its investors on the
value of the investments in addition to disclosure of portfolio held by their
scheme, the proportion invested in each class of assets and the fund
manager's investment strategy and outlook

Disadvantages of Mutual Funds
• No control over costs: The investor pays investment
management fees as long as he remains with the fund, even while
the value of his investments are declining. He also pays for funds
distribution charges which he would not incur in direct investments.
• No tailor-made portfolios: The very high net-worth individuals or
large corporate investors may find this to be a constraint as they will
not be able to build their own portfolio of shares, bonds and other
securities.
• Managing a portfolio of funds: Availability of a large number of
funds can actually mean too much choice for the investor. So, he
may again need advice on how to select a fund to achieve his
objectives.
• Delay in redemption: It takes 3-6 days for redemption of the units
and the money to flow back into the investor’s account.

How do mutual funds diversify
their risks?
• Financial theory states that an investor can
reduce his total risk by holding a portfolio of
assets instead of only one asset. This is because
by holding all your money in just one asset, the
entire fortunes of your portfolio depend on this
one asset. By creating a portfolio of a variety of
assets, this risk is substantially reduced.

Open-end Vs. Closed-end Funds
Open-end Fund
• Available for sale and repurchase at all times based on the net asset
value (NAV) per unit.
• Unit capital of the fund is not fixed but variable.
• Fund size and its total investment go up if more new subscriptions
come in than redemptions and vice-versa.
Closed-end Fund
• One time sale of fixed number of units.
• Investors are not allowed to buy or redeem the units directly from the
funds. Some funds offer repurchase after a fixed period. For example,
UTI MIP offers a repurchase after 3 years.
• Listed on stock exchange and investors can buy or sell units through
the exchange.
• Units maybe traded at a discount or premium to NAV based on
investor’s perception about the funds future performance and other
market factors.

Load Vs. No-load Funds
Marketing a new mutual fund scheme involves initial expenses.
These expenses are charged to the investors through loads and are
recovered from the investors in different ways:
• Front-end or entry load is charged to the investor at the time of
his entry into the scheme.
• Back-end or exit load is charged to the investor at the time of his
exit from the scheme.
• Deferred load is charged to the investor over a period of time.
• Contingent deferred sales charge: Different amount of loads are
charged to the investor depending upon the time period the investor
has stayed with the fund. The longer he stays with the fund, lesser
the amount of exit fund he is charged.
Very often, AMC’s do not charge any initial expenses to the investor
in the IPO. These are hence are no-load funds. In no-load funds,
the investors get units for the complete amount invested.

Mutual Fund Types
Money Market Funds/Cash Funds
• Invest in securities of short term nature I.e. less than one year
maturity.
• Invest in Treasury bills issued by government, Certificates of
deposit issued by banks, Commercial Paper issued companies and
inter-bank call money.
• Aim to provide easy liquidity, preservation of capital and moderate
income.
Gilt Funds
• Invest in Gilts which are government securities with medium to
long term maturities, typically over one year.
• Gilt funds invest in government paper called dated securities.
• Virtually zero risk of default as it is backed by the Government.
• It is most sensitive to market interest rates. The price falls when
the interest rates goes up and vice-versa.

Debt Funds
Debt Funds/Income Funds
• Invest in debt instruments issued not only by government, but also
by private companies, banks and financial institutions and other
entities such as infrastructure companies/utilities.
• Target low risk and stable income for the investor.
• Have higher price fluctuation as compared to money market funds
due to interest rate fluctuation.
• Have a higher risk of default by borrowers as compared to Gilt
funds.
• Debt funds can be categorized further based on their risk profiles.
• Carry both credit risk and interest rate risks.

Equity Funds
Equity Funds:
• Invest a major portion of their corpus in equity shares issued by
companies, acquired directly in initial public offering or through
secondary market and keep a part in cash to take care of
redemptions.
• Risk is higher than debt funds but offer very high growth potential
for the capital.
• Equity funds can be further categorized based on their investment
strategy.
• Equity funds must have a long-term objective.

Hybrid Funds
Balanced Funds:
• Has a portfolio comprising of debt instruments, convertible
securities, preference and equity shares.
• Almost equal proportion of debt/money market securities and
equities. Normally funds maintain a Equity-Debt ratio of 55:45 or
60:40.
• Objective is to gain income, moderate capital appreciation and
preservation of capital.
• Ideal for investors with a conservative and long-term orientation.

Options Available to the Investor

Mutual Funds Vs. Other Investments
Product Return Safety Liquidity Tax
Benefit
Conven-
ience
Bank
Deposit
Low High High No High
Equity
Instruments
High Low High or
Low
No Moderate
Debentures Moderate Moderate Low No Low
Fixed
Deposits by
Companies
Moderate Low Low No Moderate
Bonds Moderate Moderate Moderate Yes Moderate

Benefit
Conven-
ience
RBI Relief
Bonds
Moderate High Low Yes Moderate
PPF Moderate High Low Yes Moderate
National
Saving
Certificate
National
Saving
Scheme
Monthly
Income
Scheme

Benefit
Conven-
ience
Life
Insurance
Mutual
Funds
(Open-end)
Moderate Moderate High No High
Mutual
Funds
(Closed-
end)
Moderate Moderate High Yes High

Bank Deposits Vs. Debt Funds
• Bank Deposits cater to investor class that look for safety and
accepts a relatively low return. They cannot be compared with equity
funds but with debt funds.
• A bank deposit is guaranteed by the bank for repayment of principal
and interest whereas a debt fund has no contractual guarantee for
repayment of principal or interest.
• In bank deposits, the investor has to assess the risk in terms of
credit ratings of the bank which gives an indication of the financial
soundness of the bank. However, a debt fund is not rated by any
agency. The investor has to assess the risk on the portfolio held by
the fund.
• Bank deposits are not totally free from risk and generally give lower
returns. A conservative debt fund can give higher returns than a bank
deposit, even though there is no contractual guarantee as in a
deposit.

Mutual Funds Prove Best!
While instruments like shares give high returns at the cost of
high risk, instruments like NSC and bank deposits give lower
returns and higher safety to the investor.
Mutual Funds aim to strike a balance between risk and
return and give the best of both to the investor.

Fund Structure and its Constituents

Fund Structure
Fund Sponsor
Trustees
Asset Management
Company
Depository
Custodian
Agent

Fund Sponsor
The Fund Sponsor
• Any person or corporate body that establishes the Fund
and registers it with SEBI.
• Form a Trust and appoint a Board of Trustees.
• Appoints Custodian and Asset Management Company
either directly or through Trust, in accordance with SEBI
regulations.
SEBI regulations also define that a sponsor must contribute
at least 40% to the net worth of the asset management
company.

Trustees
Trustees
• Created through a document called the Trust Deed that is
executed by the Fund Sponsor and registered with SEBI.
• The Trust-the mutual fund may be managed by a Board of
Trustees- a body of individuals or a Trust Company- a
corporate body.
• Protector of unit holders interests.
• 2/3 of the trustees shall be independent persons and
shall not be associated with the sponsors.

Trustees
Rights of Trustees:
• Approve each of the schemes floated by the AMC.
• The right to request any necessary information from the
AMC.
• May take corrective action if they believe that the
conduct of the fund's business is not in accordance with
SEBI Regulations.
• Have the right to dismiss the AMC,
• Ensure that, any shortfall in net worth of the AMC is
made up.

Trustees
Obligations of the Trustees:
• Enter into an investment management agreement with the
AMC.
• Ensure that the fund's transactions are in accordance with
the Trust Deed.
• Furnish to SEBI on a half-yearly basis, a report on the
fund's activities
• Ensure that no change in the fundamental attributes of any
scheme or the trust or any other change which would affect
the interest of unit holders is happens without informing the
unit holders.
• Review the investor complaints received and the redressal
of the same by the AMC.

Asset Management Company
• Acts as an invest manager of the Trust under the Board
Supervision and direction of the Trustees.
• Has to be approved and registered with SEBI.
• Will float and manage the different investment schemes in
the name of Trust and in accordance with SEBI regulations.
• Acts in interest of the unit-holders and reports to the
trustees.
• At least 50% of directors on the board are independent
of the sponsor or the trustees.

Asset Management Company
Obligation of Asset Management Company:
 Float investment schemes only after receiving prior approval from
the Trustees and SEBI.
 Send quarterly reports to Trustees.
 Make the required disclosures to the investors in areas such as
calculation of NAV and repurchase price.
 Must maintain a net worth of at least Rs. 10 crores at all times.
 Will not purchase or sell securities through any broker, which is
average of 5% or more of the aggregate purchases and sale of
securities made by the mutual fund in all its schemes.
 AMC cannot act as a trustee of any other mutual fund.
 Do not undertake any other activity conflicting with managing the
fund.

Structure of Mutual Funds
Custodian
• Has the responsibility of physical handling and safe keeping
of the securities.
• Should be independent of the sponsors and registered with
SEBI.
Depositories
• Indian capital markets are moving away from physical
certificates for securities to ‘dematerialized’ form with a
Depository.
• Will hold the dematerialized security holdings of the Mutual
Fund.

10 Most Important Things to Read
in an Offer Document:
• Date of issue
Minimum investments
Investment objectives
Investment policies
Risk factors
Past Performance data
Fees and expenses
Key Personnel esp Fund Managers
Tax benefits information
Investor services

Distribution Channels
Mutual Funds are primary vehicles for large collective investments,
working on the principle of pooling funds.
A substantial portion of the investments happen at the retail level.
Agents and distributors are a vital link between the mutual funds and
investors.
Agents
- Is a broker between the fund and the investor and acts on behalf of the
principal.
- He is not exclusive to the fund and also sells other financial services. This
in a way helps him to act as a financial advisor.
Distribution Companies
- Is a company which sells mutual funds on behalf of the fund.
- It has several employees or sub-broker under it.
- It manages distribution for several funds and receives commission for its
services.

Distribution Channels
Banks and NBFCs
- Several banks, particularly private and foreign banks are
involved in a fund distribution by providing similar services like
that of distribution companies.
- They work on commission basis.
Direct Marketing
- Mutual funds sell their own products through their sales
officers and employees of the AMC.
- This channel is normally used to mobilise funds from high
net worth individuals and institutional investors.

Sales Practices
Agent Commissions
- No rules prescribed for governing the maximum or
minimum commissions payable by a fund to its agents.
- As per SEBI regulations, 1996 all initial expenses
including brokerage charges paid to agents cannot
exceed 6% of resources raised under the scheme.
- Excess distribution charges have to be borne by the AMC.
- A no-load fund is authorised to charge the schemes with the
commissions paid to agents as part of the regular
management and marketing expenses allowed by SEBI.

Accounting
Calculating Net Asset Value
Unit Capital is the investor’s subscriptions. In mutual funds it
is not treated as a liability.
Investments made on behalf of the investors are reflected on
the assets side of the balance sheet.
There are liabilities of short-term nature.
Fund’s Net Asset = Asset – Liabilities
Net Asset Value = Net Assets of the scheme / No. of
Outstanding Units
i.e
NAV = (Market value of investments + Receivables + Other
Accrued Income + Other assets – Accrued Expenses – Other
Payables – Other liabilities) / ( No. of Units Outstanding as at
the NAV date)

Accounting
The factors affecting the NAV are as following:
 Capital Gains or Losses on the sale or purchase of the
Investment securities.
 Dividend and income earned on the assets.
 Capital Appreciation in the underlying value of the stocks
held in the portfolio.
 Other assets and liabilities.
 Number of units sold or purchased.

Accounting
SEBI regulations for NAV
• The day on which NAV is calculated by a fund is called
valuation date.
• NAV of all schemes must be calculated and published
at least weekly.
• This is applicable to both open-end and closed-end fund.
• Some closed end funds (Monthly Income Schemes) that
are not listed on stock exchange may publish it monthly-
quarterly.

Accounting
SEBI Guidelines for Pricing of Units:
 The mutual fund shall ensure that the re-purchase
price is not lower than 93% of the NAV.
 The sale price is not higher than 107% of the NAV.
Repurchase price of closed end scheme shall not be
lower than 95% of the NAV.
 The difference between the repurchase price and the
sale price of the units shall not exceed 7% of the
sale price.

Accounting
Since investments held by a mutual fund in its portfolio are to
be marked to the market, the NAV includes two components:
a) Realized gains or losses.
b) Unrealized gains or losses.
As per SEBI guidelines, unrealized appreciation cannot be
distributed by a fund, whereas the realized gain can be
distributed.

Accounting
Investment Management Fees and Advisory Fees:
 1.25% of the first Rs.100 crores of weekly average net
assets outstanding in the accounting year.
 1% weekly average net assets in excess of Rs. 100
crores.
 A no load scheme can charge an additional
management fee up to 1% of weekly average net assets
outstanding in the accounting year.

Accounting
Total expenses charged by the AMC to a scheme,
excluding issue or redemption expenses but including
investment management and advisory fees have
following limits:
 2.5% - On the first Rs. 100 crores of average weekly
net assets
 2.25% - On the next Rs. 300 crores of average weekly
net assets
 2% - On the next Rs. 300 crores of average weekly net
assets
 75% - On the balance of average weekly net assets
 For bond funds, the above percentages are required to
be lower by 0.25%

Taxation
Taxation in the Hands of the Fund
 Income earned by any mutual fund registered with SEBI or set up by a
public sector bank/Financial Institution or authorised by RBI is exempt
from tax.
 Income distributed to unit holders by a closed-end or debt fund has to
pay a distribution tax of 10% plus surcharge of 1% I.e. a tax of 11%.
This tax is also applicable to distributions made by open-end funds
which have less than 50% allocation to equity.
The Impact on the Fund and the Investor
 Due to the tax payment by the fund, the NAV and the value of the
investor’s investment will come down.
 The tax bears no relationship to the investor’s tax bracket.
 This tax makes the income schemes less attractive than growth
schemes.
 The fund cannot avoid tax even if the investor chooses to reinvest the
distribution back into the fund.

In-dept classification of Mutual Funds

Equity Funds
Aggressive Growth Funds
• Objective is to earn very high returns for the investor.
• Target is maximum capital appreciation.
• Invest in less researched or speculative shares and may adopt
speculative investment strategies.
• High volatility and risk as compared to other funds.
Growth Funds:
• Objective is capital appreciation over a long time, 7 - 10 years
span.
• Invest in companies whose earnings are expected to rise at an
above average rate.
• These companies will be considered to have growth potential, but
not entirely unproven and speculative.
• Less volatile than aggressive growth funds.

Equity Funds
Specialty Funds
• Thematic funds that have a theme for investments.
• Narrow portfolio orientation and invest only in companies that meet
pre-defined criteria.
• Diversification is limited to one type of investment.
• More volatile than diversified funds.
• Specialty funds are further sub-categorized based on their
investments.
Diversified Equity Funds:
• Invest only in equities except for a very small portion in liquid
money market securities.
• It is not focused on any one or few sectors or shares.
• Reduce the sector or stock specific risks through diversification.
• Lower risks than growth funds.

Equity (Specialty) Funds
Sector Funds:
• Portfolios consists of investments in only in one industry or sector of the
market such as IT, Pharmaceuticals or FMCG.
• Higher level of company or sector specific risk than diversified funds.
Offshore Funds:
• Invest in equities in one or more foreign countries.
• Sensitive to foreign exchange rate risk and economic conditions of the
countries they invest in.
Small-Cap Equity Funds:
• Invest in shares of companies with relatively low market capitalization
that that of big blue chip companies.
• More volatile than other funds as smaller companies are not very liquid.
• In terms of investment style, it may be aggressive-growth or growth type
or even value fund.

Equity Funds
Equity Linked Savings Schemes - an Indian Variant:
• Investment in these schemes entitles the investor to claim an income
tax rebate.
• Usually has a lock-in period of 3 years before the end of which funds
cannot be withdrawn.
• There are no specific restrictions on the investment objectives for the
fund managers.
• Generally, such funds would be Diversified Equity Funds.
Equity Income Funds:
• Objective is to give high level of current income along with some steady
capital appreciation.
• Invest in shares of companies with high dividend yields and do not
fluctuate as much as other shares. Ex - Power/Utility sector.
• Less volatile and risky than other equity funds.

Equity Funds
Equity Index Funds:
• The objective is to match the performance of the stock market by
tracking an index that represents the overall market.
• Invests in shares that constitute the index and in the same proportion.
• Sensitive to overall market risk.
• Example: UTI Nifty Fund
Value Funds:
• Invest in fundamentally sound companies whose shares are currently
under-priced in the market.
• Have lower risk as compared to Growth Funds and take a long term
approach.
• Often invested in cyclical industries.
• Example: Templeton India Growth fund that has shares of
Cement/Aluminum and other cyclical industries.

Hybrid Funds
Growth & Income Funds:
• Strike a balance between capital appreciation and income for the
investor.
• Portfolio is a mix between companies with good dividend paying
records and those with potential for capital appreciation.
• Less risky than growth funds but more risky than income funds.
Asset Allocation Funds:
• Follow variable asset allocation policy.
• Move in an out of an asset class (equity, debt, money market or
even non-financial assets)
• Asset allocation funds that follow more stable allocation policies are
like balanced funds.
• Asset allocation funds that follow more flexible allocation policies
are like aggressive growth or speculative funds.

Investment Plans
Automatic Re-investment Plans
Allows the investor to re-invest in additional units the amount of dividends
or other distributions made by the fund instead of receiving it in cash.
 Investment takes place at ex-dividend NAV.
 The investors reap the benefit of compounding his investments.
Automatic Investment Plans
 Allows the investor to invest a fixed sum periodically. Enables him to
save in a disciplined and phased manner.
 Such funds help in ‘rupee cost averaging’.
 Mode of investment could be through direct debit to investor’s salary or
bank account.
 Voluntary Accumulation Plan, a modified version of AIP allows the
investor flexibility in terms of amount and frequency of investment.

Investment Plans
Systematic Withdrawal Plans
 Allow systematic withdrawals from his fund investment on a periodic
basis.
 The investor must withdraw a specific minimum amount and also
maintain a minimum balance in his fund account.
 The amount withdrawn is treated as redemption of units at the applicable
NAV as specified in the Offer Document.
 SWPs are different from MIPs. SWPs allows investors to get back the
principal amount invested while MIP’s will only pay the income part on
regular basis.
Systematic Transfer Plans
 Allow the investor to transfer on a periodic basis from one scheme to
another within the same fund family.
 A transfer will be treated as redemption of units from one scheme and
investment of units in another scheme.
 Such redemption and investment will be at applicable NAV as mentioned
in the Offer Document.

Measuring and Evaluating Mutual
Fund Performance

Why Measure Fund
Performance
The Investor Perspective
-To make intelligent decisions on whether he should continue with the
investment or not.
- He needs the basic knowledge of fund evaluation to judge the
performance of the fund.
The Advisor’s Perspective
-The potential investors would expect the advisor to give them a proper
advise on which funds have good performance.
- In order to compare different funds, the advisor must have the correct
knowledge and appropriate measures of evaluating the fund performance.

Different Performance Measures
Change in NAV
- most commonly used by investors to evaluate fund performance and
most commonly published by fund managers.
- Easily understood and applied to any type of fund.
- Should be interpreted in light of the investment objective of the fund,
current market conditions and alternative investment returns.
- Long term growth fund or infrastructure fund will give low returns in the
initial years.
NAV Change in absolute terms:
(NAV at the end of period) – (NAV at the beginning of period)
NAV Change in percentage terms:
(Absolute change in NAV/NAV at the beginning of period) * 100
Annualised NAV Change:
{[(Absolute Change in NAV/NAV at the beginning)/months
covered]*12}*100

Different Performance
Measures
No, percentage NAV change cannot give a correct picture as it does not
take into account the interim dividends paid. The correct measure here is
Total Return Method.
Total Return Method
- It takes into account the dividends paid in the interim period and is
suitable for all types of funds.
- It must be interpreted in the light of market conditions and investment
objective of the fund.
- Its limitation is that it ignores the fact that distributed dividends also get
reinvested if received during the year.
Total Return is:
[(Distributions + Change in NAV)/NAV at the beginning of the period]* 100

Measures
Return on Investment or Total Return with Dividends Reinvested at
NAV
-The shortcoming of Total return is overcome by computing the Total
Return with reinvestment of dividends in the fund at the NAV on the date
of distribution.
- Is a measure of cumulative wealth accumulation and is the same as ROI.
- Appropriate for measuring performance of accumulation plans,
monthly/quarterly income income schemes debt funds that distribute
interim dividends.
ROI or Total Return with Reinvestment is:
{(Units Held + div/ex-dNAV) * endNAV – begin NAV} /begin NAV * 100

Measures
Cumulative Aggregate vs. Average Annualised Returns
- Absolute NAV’s do not give a complete picture. Consistent performance
with respect to Total Return and compounded annual return is of
importance.
- Children’s Gift Fund and Rajalakshmi of UTI are based on cumulative
returns.
- When Cumulative Returns are received at the end of a long period,
Annualised Average Compound Rate of Return must be calculated from
the cumulative figure.
- Comparisons between two such schemes is possible only after the
Cumulative Returns are converted into Average Annualised Returns.
Formula for conversion:
A = P*(1+R/100)N where P = principal invested, A = Maturity value of the
investment, N = Period of investment in years, R = annualised compound
rate in percentage.

Measuring Fund Performance
Following things should also be considered while
comparing fund performance:
Use long-term performance data
– The longer the period covered by fund performance data,
the more reliable would be the conclusions about the funds
record.
Compare the Same Time Periods
- it is imperative to use the performance data over the same
periods of time as returns over different periods vary due to
different market conditions.

Measuring Fund Performance
Less than One Year Periods
- if the fund performance data relates to a period of less than
one year, it should not be annualised.
- Money market funds are an exception due to their short
term horizon.
Returns since Inception
-SEBI requires returns to be compared since the inception of
a scheme using Rs. 10 as the base amount.
- Adjustments have to be made in case loads are paid.

Expense Ratio
The Expense Ratio
- Indicator of fund’s efficiency and cost effectiveness.
- It is defined as the ratio of total expenses to average net assets of the
fund.
- Past and estimated expense figures and ratios are disclosed in the Offer
Document.
- Fluctuations in the ratio across periods require that an average over
three to five years be used to judge a fund’s performance. Also it should
be evaluated in the light of the fund size, average account size and
portfolio composition.
- Funds with small corpus size will have higher expense ratio.
- If a fund’s income levels or returns are small say a debt fund with 10%
return, expense ratio becomes important and difference of even 0.5%
between two funds can make lot of difference.

Income Ratio
The Income Ratio
- Defined as its net investment income divided by its net assets for the
period.
- Useful for measuring income oriented funds, particularly debt funds and
not suitable for funds looking for capital appreciation.
- Cannot be used in isolation, but only with expense ratio and total return.

Portfolio Turnover Rate
Portfolio Turnover Rate
- Measures the buying and selling done by a fund.
- A 100% turnover implies that the manager replaced his entire portfolio
during the period in question, lets say one year.
- A 50% turnover implies that the manager replaced his entire portfolio in 2
years.
- Most useful while evaluating equity and balance funds, but not
appropriate for equity funds with a value-based long term investment
philosophy.
- Higher T/o does not necessarily mean greater efficiency and must be
seen in relation to the total return to the investor.

Fund Size & Cash Holdings
Fund Size
- Small fund are easier to manoeuvre and can achieve their
objectives easily.
- Large funds benefit from economies of scale.
Cash Holdings
-A large cash holding allows the fund to strengthen its
position in preferred securities without liquidating others.
- Allows cushion against decline in market prices of shares or
bonds.

Benchmarking
Importance of Benchmarking
- A funds performance can be judged in relation to investor’s expectations.
- However, it is important for the investor to define his expectations in
relation to certain “guideposts”.
- These guideposts or indicators of performance can be thought of as
benchmarks against which a fund’s performance ought to be measured.
- For instance, BSE-30 will be a benchmark for diversified equity fund and
BSE IT index for tech funds.
While an advisor needs to look at the absolute measures of
performance, he needs to select the right benchmark to evaluate a
fund’s performance, so that he can compare the measured
performance figures against the selected benchmark.

Benchmarking
Basis for choosing an Appropriate Performance Benchmark
The appropriate benchmark has to be selected by reference to:
1. The Asset Class it invests in. Thus, an equity fund has to be judged
by from an appropriate benchmark from the equity market and so on.
2. The fund’s stated Investment Objective.
There are three types of benchmarks that can be used to evaluate a
fund’s performance:
1. Relative to the market as a whole.
2. Relative to other mutual funds.
3. Relative to other comparable financial products or investments
options open to the investor.

Benchmarking relative to market
Equity Funds
• Index Funds- a base index:
- If an investor were to chose an equity index fund, he can expect to
get the same return as on the Index, called the Base Index.
- For index funds, the benchmark is clear and pre-specified by the
fund manager in advance.
• Tracking Error:
- an Index Fund invests in all of the stocks included in the index
calculation, in the same proportion as the stocks’ weight in the index.
- An index funds actual return may be better or worse by what is
called the “tracking error.”
- The tracking error arises from the practical difficulties faced by the
fund manager in trying to remain in line with the weight that the stocks
enjoy in the index.

• Active Equity Funds:
- Using appropriate market index.
- The appropriate index to be used to evaluate a broad-based equity
fund should be decided on the basis of the size and the composition
of the fund’s portfolio.
- If the fund has a large portfolio, a broader market index like BSE 100
or 200 or NSE 100 may be used to benchmark rather than S&P
NIFTY or BSE 30.
- An actively managed fund expects to beat the index.
• Sector Funds:
- Benchmark will be the relative Sectoral Index.
- An investor in Infotech or Pharma Sector funds can expect the same
return as the relative sectoral indices.
In other words, the choice of a correct equity index as a benchmark
also depends upon the investment objective of the fund. For example,
a small cap fund has to be compared with a small cap index.

• Debt Funds:
- Using appropriate debt market index.
- A broad based bond fund or debt fund should be benchmarked with
broad based debt index whereas a narrower Government Securities
Fund, only the Government Sector sub-segment of the broad based
index has to be used.
- Closed-end funds with clear maturity can be compared with bank
deposits.
- I-SEC’s I-BEX is most commonly used by some analysts.
• Money Market Funds:
- Money market funds due to their short term nature are benchmarked
against the government funds of appropriate maturities.
- J.P.Morgan’s T-Bill index is used by analysts.
- NSE’s “mibid/mibor” rates that reflect interbank call money money
market interest rates can also be used as a benchmark.

Benchmarking relative to
other MFs
While comparing two funds, it is extremely important to ensure that the
comparisons are meaningful and meet the following criteria:
 The Investment Objectives and Risk Profiles
- Of two funds being compared must be same.
- For example an equity fund cannot be compared with a debt fund.
 Portfolio Compositions
- Of the funds compared must be similar.
- High returns fund investing in high risk-prone securities cannot be
compared with a scheme that invests in low risk securities.
 Credit Quality and Average Maturity
- The credit ratings of the investments have to be comparable, for
example a security with investments in AAA is not same as AA-.
- A fund with maturity of 3 yrs is not same as the fund with 6yrs.
 Fund Size
- Funds of equal size should be compared.

Benchmarking relative
to other MFs
Expense Ratio
- Expense ratios effect fund’s performance.
Even when two funds of similar characteristics are compared, their
returns must be calculated on the following comparable basis:
• Compare the returns over the same period only.
• Only annualised compound returns are comparable, I.e. data must be
available for long enough periods.
• Only after-tax returns of two different schemes should be compared.

Benchmarking relative to other
Financial Products
 An investor will compare the mutual fund performance with other -
investment products like bank deposits, NSC’s Indira Vikas Patra etc.
 Only instruments of similar investment characteristics and with returns
and calculated over the same periods should be used for meaningful
comparisons.

Evaluating the AMC
While every fund is exposed to market risks, good funds should at least
match major market indices. An AMC or the fund managers must be
evaluated on the following criteria:
 Operate with long-term perspective.
 Do not indulge in excessive trading that generates high transaction
costs and in turn reduce the NAV/risk of loss.
 Turns out a more consistent performance rather than a one time high
and otherwise volatile performance record.
 Team of managers with successful records as against fund that are
managed by one individual.
 The reliability and track record of the sponsors.
 Performance record against competing managers running similar funds.

Tracking MF Performance
To track fund performance, the first step is to find the relevant information
on NAV, expenses, cash flow, appropriate indices etc. The common
sources of information are:
• Mutual Fund’s Annual and Periodic Reports include data on the
fund’s financial performance which are indicators for expense ratios and
total return. It also includes a listing of the fund’s portfolio holdings at
market value, statement of revenue and expenses, unrealized
appreciation/depreciation at year end and changes in net assets.
• Financial Press: Daily newspapers like Economic Times provide daily
NAV figures for open-end schemes and share prices of closed-end
schemes. There are also weekly supplements like Smart Investor of
Business Standard and Investor Guide of Economic Times also give
enough information for evaluation.

Tracking MF Performance
• Fund Tracking agencies like Credence and Value Research are
sources for MF performance data and evaluation.
• Newsletters: Many MFs, banks and non-banking firms catering to retail
investors publish their own newsletters.
• Prospectus: SEBI regulations requires sponsors to disclose
performance data relating to schemes being managed by them.

Power of Compounding
Investing for Long Term – the power of compounding
- Invest for the long term and let your money grow on a compound basis.
- Higher the frequency of compounding, greater the growth of capital.
- An advisor must enable the investor to understand the benefits of
compounding.
Example:
If MR. Kapoor invests Rs. 1000 @ 10% interest rate for 10 years and the
amount is compounded annually, this is how the money grows:
 Interest generated in the first year would be Rs. 80 (1,000*.08)
 Interest generated in the second year would be 86.4 [(1,000+ 80)*.08]
instead of 80
 Interest in the third year would be 93[(1000 + 80+ 86.4) * .08)
 And so on till the interest keeps growing each year, resulting in a total of
Rs. 2,600 at the end of 10

Strategy to Maximize Returns
a) Buy and Hold
- Most common strategy adopted by investors and the most common
mistake.
- Long term investments does not necessarily mean buy and hold
without adjusting the portfolio.
- Continuous tracking needs to be for keeping the right funds.
b) Rupee Cost Averaging
- It is advisable to invest regularly in small amounts rather than
investing a lump sum at one go.
- A regular investor is always a winner.
- The disadvantage of this method is that it does not tell the investor
when to buy and sell a fund.
c) Value Averaging
- Investor keeps the target value of investment constant.
- He accordingly keeps changing the investment amount either by
increasing or decreasing the same.

Rupee Cost Averaging
Scenario 24.
Mrs. Sudhakar is investing Rs. 1000 every month for 3
months in ABC mutual fund. Following are the details:
Check whether rupee cost averaging method will prove
beneficial to Mrs. Sudhakar.
Date Amount
Invested
NAV
January 1000 R. 10/-
February 1000 Rs. 8/-
March 1000 Rs. 12.50

Rupee Cost Averaging
Solution 24.
Average cost per unit under the plan = 3000/305 = Rs. 9.84
Average NAV = (10 + 8 + 12.50)/3 = Rs. 10.17
Average of the three NAV’s is higher than the figure achieved
through rupee-cost averaging.
So, we can say that rupee-cost-averaging is beneficial to
Investors.
Date Amount
Invested
NAV Units
Purchased
January 1000 R. 10/- 100
February 1000 Rs. 8/- 125
March 1000 Rs. 12.50 80

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