What is a Mutual Fund?

A mutual fund is just the connecting bridge or a financial intermediary that

allows a group of investors to pool their money together with a predetermined
investment objective. The mutual fund will have a fund manager who is
responsible for investing the gathered money into specific securities (stocks or
bonds). When you invest in a mutual fund, you are buying units or portions of
the mutual fund and thus on investing becomes a shareholder or unit holder of
the fund.

Diversification
Diversification is nothing but spreading out your money across available or
different types of investments. By choosing to diversify respective investment
holdings reduces risk tremendously up to certain extent. 
1. Open - Ended Schemes:
An open-end fund is one that is available for subscription all through the
year. These do not have a fixed maturity. Investors can conveniently buy and
sell units at Net Asset Value ("NAV") related prices. The key feature of open-
end schemes is liquidity.

2. Close- Ended Schemes:

These schemes have a pre-specified maturity period. One can invest directly
in the scheme at the time of the initial issue. Depending on the structure of
the scheme there are two exit options available to an investor after the initial
offer period closes. Investors can transact (buy or sell) the units of the
scheme on the stock exchanges where they are listed. The market price at
the stock exchanges could vary from the net asset value (NAV) of the
scheme on account of demand and supply situation, expectations of
unitholder and other market factors. Alternatively some close-ended
schemes provide an additional option of selling the units directly to the
Mutual Fund through periodic repurchase at the schemes NAV; however one
cannot buy units and can only sell units during the liquidity window. SEBI
Regulations ensure that at least one of the two exit routes is provided to the
investor.
Exchange Traded funds-
ETFs are a mix of a stock and a MF in the sense that 
Like ‘mutual funds’ they comprise a set of specified stocks e.g. an index like
Nifty/sensex or a commodity e.g. gold; and
Like equity shares they are ‘traded’ on the stock exchange on real-time basis.

How does an ETF work?

In a normal fund we buy/sell units directly from/to the AMC. First the money is
collected from the investors to form the corpus. The fund manager then uses this
corpus to build and manage the appropriate portfolio. When you want to redeem
your units, a part of the portfolio is sold and you get paid for your units. The units
in a conventional MF are, therefore, called ‘in-cash’ units.

But in ETF, we have something called the ‘authorized participants’ (appointed by

the AMC). They will first deposit all the shares that comprise the index (or the gold
in case of Gold ETF) with the AMC and receive what is called the ‘creation units’
from the AMC. Since these units are created by depositing underlying
shares/gold, they are called ‘in-kind’ units.
These creation units are a large block, which are then split into small units and
accordingly bought/sold in the open market on the stock exchange by these
‘authorized participants’.
Therefore, technically every buy and sell need not change the corpus of an ETF
unlike a conventional MF.
However, as and when there is more demand, these authorized participants deposit
more shares with the AMC and get more creation units to satisfy the demand. Or if
there is more redemption, then they give back these creation units to the AMC, take
back their shares, sell them in the market and pay the investor

Comparison of Open Ended Funds v/s Close Ended Funds v/s ETFs:
Fund Size Flexible Fixed Flexible
NAV Daily Daily Real-Time
Liquidity Provider Fund Itself Stock Market Stock Market / Fund Itself
Through Exchange Through Exchange where
Availability Fund itself
where listed listed / Fund itself.
Portfolio Disclosure Disclosed monthly Disclosed monthly Daily/Real-time
Intra-Day Trading Not possible Expensive Possible at low cost
Advantages of Investing Mutual Funds:

1. Professional Management - The basic advantage of funds is that, they are

professional managed, by well qualified professional. Investors purchase
funds because they do not have the time or the expertise to manage their
own portfolio. A mutual fund is considered to be relatively less expensive
way to make and monitor their investments.
2. Diversification - Purchasing units in a mutual fund instead of buying
individual stocks or bonds, the investors risk is spread out and minimized up
to certain extent. The idea behind diversification is to invest in a large
number of assets so that a loss in any particular investment is minimized by
gains in others.
3. Economies of Scale - Mutual fund buy and sell large amounts of securities
at a time, thus help to reducing transaction costs, and help to bring down
the average cost of the unit for their investors.
4. Liquidity - Just like an individual stock, mutual fund also allows investors to
liquidate their holdings as and when they want.
5. Simplicity - Investments in mutual fund is considered to be easy, compare
to other available instruments in the market, and the minimum investment is
small. Most AMC also have automatic purchase plans whereby as little as
Rs.2000, where SIP start with just Rs.50 per month basis.
Disadvantages of Investing Mutual Funds:

1.Professional Management- Some funds doesn’t perform in neither the market,

as their management is not dynamic enough to explore the available opportunity in
the market, thus many investors debate over whether or not the so-called
professionals are any better than mutual fund or investor him self, for picking up
stocks.

2. Costs – The biggest source of AMC income, is generally from the exit load
which they charge from an investors, at the time of purchase. The mutual fund
industries are thus charging extra cost under layers of jargon.

3. Dilution - Because funds have small holdings across different companies, high
returns from a few investments often don't make much difference on the overall
return. Dilution is also the result of a successful fund getting too big. When money
pours into funds that have had strong success, the manager often has trouble
finding a good investment for all the new money.

4. Taxes - when making decisions about your money, fund managers don't consider
your personal tax situation. For example, when a fund manager sells a security, a
capital-gain tax is triggered, which affects how profitable the individual is from the
sale. It might have been more advantageous for the individual to defer the capital
gains liability.
Holding mutual funds in a demat account

Investors can now hold their mutual fund units in dematerialized form.
It is however not mandatory to convert units into demat form.

For this, investors have to use a standard form specified by the depository (CDSL or
NSDL) called the conversion request form ( CRF )) or destatementization request
form (DRF). This form is available with the depository participant (DP). The
completed form, along with the statement of account (SoA) which shows the unit
holdings of the investor, has to be submitted to the DP. The DP will verify and
forward it to the registrar and transfer agent, who in turn will confirm the details of
units held in the SoA. Units will be credited to the demat account after this
confirmation.

Transacting with the mutual fund: Once units are dematerialised, investors cannot
transact in them directly with the mutual fund or investor service centres.
Transactions are routed through the stock exchange platform or through the DP.

Re-materialsation of units: Investors can also make an application for re-

materialisation of the dematerialised units and only then transact with the mutual
fund.
Mutual fund category: BY NATURE

1. Equity fund: These funds invest a maximum part of their corpus into equities
holdings. The structure of the fund may vary different for different schemes and
the fund manager’s outlook on different stocks. The Equity Funds are sub-
classified depending upon their investment objective, as follows:

Index funds
Diversified Equity Funds
Mid-Cap Funds /Large Cap funds
Sector Specific Funds
Tax Savings Funds (ELSS)
Arbitrage funds
Multi-cap funds
PE ratio funds
Growth fund

Equity investments are meant for a longer time horizon, thus Equity funds rank
high on the risk-return matrix.
2. Debt funds:

The objective of these Funds is to invest in debt papers. Government authorities,

private companies, banks and financial institutions are some of the major issuers of
debt papers. By investing in debt instruments, these funds ensure low risk and
provide stable income to the investors. Debt funds are further classified as:

Gilt Funds: Invest their corpus in securities issued by Government, popularly

known as Government of India debt papers. These Funds carry zero Default risk
but are associated with Interest Rate risk. These schemes are safer as they invest
in papers backed by Government.

Income Funds: Invest a major portion into various debt instruments such as
bonds, corporate debentures and Government securities.

MIPs: Invests maximum of their total corpus in debt instruments while they take
minimum exposure in equities. It gets benefit of both equity and debt market. These
scheme ranks slightly high on the risk-return matrix when compared with other debt
schemes.
Short Term Plans (STPs): Meant for investment horizon for three to six
months. These funds primarily invest in short term papers like
Certificate of Deposits (CDs) and Commercial Papers (CPs). Some
portion of the corpus is also invested in corporate debentures.

Liquid Funds: Also known as Money Market Schemes, These funds

provides easy liquidity and preservation of capital. These schemes
invest in short-term instruments like Treasury Bills, inter-bank call
money market, CPs and CDs. These funds are meant for short-term
cash management of corporate houses and are meant for an
investment horizon of 1day to 3 months. These schemes rank low on
risk-return matrix and are considered to be the safest amongst all
categories of mutual funds.
3. Balanced funds:

As the name suggest they, are a mix of both equity and debt funds. They
invest in both equities and fixed income securities, which are in line with pre-
defined investment objective of the scheme. These schemes aim to provide
investors with the best of both the worlds. Equity part provides growth and
the debt part provides stability in returns.
Structure of Mutual fund in India

Sponsor: Sponsor is basically a promoter of the fund. For example Bank

of Baroda, Punjab National Bank, State Bank of India and Life Insurance
Corporation of India (LIC) are the sponsors of UTI Mutual Funds.
The Sponsor approaches the Securities & Exchange Board of India (SEBI).
Once SEBI is convinced, the sponsor creates a Public Trust (the
Second tier) as per the Indian Trusts Act, 1882.

Contracts are entered into in the name of the Trustees. Once the Trust is
created, it is registered with SEBI after which this trust is known as the
mutual fund. Two third of the trustees are independent professionals who
own the fund and supervises the activities of the AMC. It has the authority
to sack AMC employees for non-adherence to the rules of the regulator. It
safeguards the interests of the investors. They are legally appointed i.e.
approved by SEBI.

AMC: Trustees appoint the Asset Management Company (AMC), to

manage investor’s money. Asset Management Company (AMC) is a set of
financial professionals who manage the fund. It takes decisions on when
and where to invest the money. It doesn’t own the money. AMC is only a
fee-for-service provider.
Custodian: A Custodian keeps safe custody of the investments (related
documents of securities invested). A custodian should be a registered
entity with SEBI. If the promoter holds 50% voting rights in the
custodian company it can’t be appointed as custodian for the fund. This
is to avoid influence of the promoter on the custodian. It may also
provide fund accounting services and transfer agent services. JP
Morgan Chase is one of the leading custodians.

Transfer Agents: Transfer Agent Company interfaces with the

customers, issue a fund’s units, help investors while redeeming units.
Provides balance statements and fund performance fact sheets to the
investors. CAMS is a leading Transfer Agent in India.