A mutual fund is a trust that pools the savings of a number of investors who share a common financial goal and investments may be in shares, debt securities, money-market securities or a combination of these. Those securities are professionally managed on behalf of the unit holders and each investor holds a pro-rata share of the portfolio, that is, entitled to profits as well as losses.
Income earned through these investments and the capital appreciation realized is shared by its unit holders in proportion to the number of units owned by them. A mutual fund is the most suitable investment scope for common people as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively lower cost.
The flow chart below describes broadly the working of a Mutual Fund:
The following is the structure of a typical Mutual Fund:
Sponsor: Sponsor is the person who either alone or in association with another corporate body, establishes a mutual fund. The sponsor must contribute at least 40% of the net worth of the investment managed and meet the eligibility criteria prescribed under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996. The sponsor is not responsible or liable for any loss or shortfall resulting from the operation of the schemes beyond the initial contribution made by it towards setting up of the mutual fund.
Trust: The mutual fund is constituted as a trust in accordance with the provisions of the Indian Trusts Act, 1882 by the sponsor. The trust deed is registered under the Indian Registration Act, 1908.
Trustee: Trustee is usually a company (corporate body) or a Board of Trustees (body of individuals). The main responsibility of the trustee is to safeguard the interest of the unit holders and ensure that the AMC functions in the interest of investors. At least 2/3rd of the directors of the Trustee are independent directors who are not associated with the sponsor in any manner.
Asset Management Company (AMC): The trustee appoints the AMC, which must be SEBI-approved. At least 50% of AMC directors are independent. AMC must have net worth of at least Rs. 10 crore.
Custodian: A trust company, bank, or financial institution registered with SEBI, responsible for holding and safeguarding securities. May also act as transfer agent.
Registrar & Transfer Agent: Appointed by AMC to process applications, redemption requests, send statements, handle communication, and update investor records.
Regulatory Authorities (SEBI): Formulates policies and regulates mutual funds. Ensures investor protection and compliance with regulations.
By Structure:
Open-Ended Schemes: Can issue and redeem shares anytime. Offers liquidity, investors buy/sell directly from fund house at NAV.
Close-Ended Schemes: Fixed number of units, traded on stock exchanges. Prices determined by market; may include repurchase options.
Interval Schemes: Combine features of open-ended and close-ended schemes. Units traded at intervals at NAV-related prices.
By Investment Objective:
Growth or Equity-Oriented Schemes: Capital appreciation over medium to long-term. Options include Large-Cap, Mid-Cap, Small-Cap, Multi-Cap, Sector Specific, Thematic, Diversified, ELSS.
Income or Debt-Oriented Schemes: Regular income. Invest in bonds, corporate debentures, govt securities, money-market instruments.
Balanced Schemes: Both growth and income. Equity 65%-75%, rest in debt instruments.
Money Market / Liquid Schemes: Short-term instruments, capital preservation.
Gilt Funds: Invest exclusively in government securities.
Fund of Funds Schemes: Invest in other mutual fund schemes.
Gold ETFs: Open-ended exchange traded fund tracking physical gold.
Floating Rate Funds: Income schemes with fixed/floating rate debt instruments.
Tax-Saving Schemes (ELSS, RGESS, etc.): Offer tax benefits under Income Tax Act, 1961.
Index Schemes: Replicate a particular index (BSE, Nifty).
Sector Specific Schemes: Invest only in specific sectors/industries.
Load Fund: Charges % of NAV for exit, used for marketing/distribution.
No-Load Fund: No charges for exit or purchase under SEBI circular SEBI/IMD/CIR No.4/168230/09 (Aug 1, 2009).
Dividend Payout: Receive profits regularly.
Dividend Reinvestment: Reinvest declared dividends in the same fund.
Dividends: Distributed from income earned through dividends and interest.
Capital Gains: Earned when appreciated securities are sold.
Profit from higher NAV: Increase in fund’s asset value reflected in NAV; profit realized by selling units.
Professional Management: Experienced managers handle investment research and portfolio management.
Diversification: Spread investments across sectors/asset classes to mitigate risk.
Liquidity: Redeem units anytime in open-ended schemes; sell on exchanges for close-ended schemes.
Flexibility: Various plans for investment, withdrawal, and reinvestment.
Cost-Effective: Lower transaction costs due to pooled investments.
Well Regulated: SEBI monitors funds for investor protection.
Convenient Administration: Invest through service centers or online.
Return Potential: Proper asset allocation can lead to higher returns.
Transparency: Information via fact sheets, offer documents, reports, promotional materials.
Choice of Schemes: Investors can choose schemes based on risk and preference.