CHAPTER 4 MUTUAL FUND: CONCEPT,

PAST AND PRESENT 4.1 CONCEPT .................................................................................................. 83

4.2 BENEFITS OF MUTUAL FUNDS .......................................................... 85

4.3 MUTUAL FUND SCHEMES .................................................................. 87

4.5 HISTORY OF MUTUAL FUND IN INDIA.......................... ... 89

4.6 LEGAL STRUCTURE AND CONSTITUENTS OF MUTUAL FUND ..... 93

4.6 SEBI REGULATIONS-AN OVERVIEW.................... ..................... 96

4.7 ASSOCIATION OF MUTUAL FUNDS OF INDIA (AMFI) ................. 100

4.8 PRESENT SCENARIO ......................................................................... 101

4.9 MUTUAL FUND STRUCTURE IN THE USA AND THE UK ................ 103

4.10 DISCLOSURE NORMS IN INDIA............................................. .. 113

4.11 RELEVANT PROVISION OF SEBI REGULATIONS: ........................ lIS

4.13 SUMMARy .............................................................................................. 125

82

4. CHAPTER FOUR

MUTUAL FUND: CONCEPT, PAST AND PRESENT

The chapter explains the concept of mutual fund and also covers the

structure. constituents and other operational detail. The history of mutual fund

industry in India as well as USA is also mentioned.

4.1 CONCEPT

Introduction33

A mutual fund is a financial intermediary that pools the saving of investors for

collective investment in a diversified portfolio of securities. A fund is "Mutual"

as all of its returns, minus is expenses, and is shared by the fund's investors.

The securities and Exchange Board of India (Mutual funds) Regulations, 1996

Defines a manual fund as a :A fund established in the form of a trust to raised

money through the sale of units to the public or a section of the public under

one or more schemes for investing in securities, including money market

instruments'~

According to the above definition, a mutual fund in India can raise resources

through sale of unit to the public. It can be set up in the form of a trust under

the Indian Trust Act. The definition has been further extended by allowing

mutual funds to diversify their activities in the following areas.

33 Bharati V. Pathak. -Indian Financial System (p.466)

83

1. Portfolio management services

2. Management of offshore funds

3. Providing advice to offshore funds

4. Management of pension or provident funds

5. Management of venture capital funds

6. Management of money market funds

7. Management of real estate funds

A mutual fund serves as a link between the investor and securities market by

mobilizing savings from the investors and investing them in the securities

market to generate returns. Thus, a mutual fund is akin to Portfolio

management services. Although both are conceptually same, they are

different from each other. Portfolio management service are offered to high

net worth individuals; taking into account their risk profile, their investment are

managed separately. In the case of mutual funds, savings of small investors

are pooled under a scheme and the returns are distributed in the same

proportion in which the investments are made by the investor/unit-holders.

Mutual fund is a collective saving scheme. Mutual funds play an important

role in mobilizing the savings of small investors and channelising the same for

productive ventures in the Indian economy.

84

4.2 BENEFITS OF MUTUAL FUNDS

An investor can invest directly in individual securities or indirectly through a

financial inventory. Globally mutual funds have established themselves as the

means of investment for the retail investor.

Professional management: An average investor lacks knowledge of capital

market operation and does not have large resources to reap the benefits of

investment. Hence, he requires the help of an expert. It is not only expensive

to 'hire the services' of an expert but it is more difficult to identify a real expert.

Mutual funds are managed by professional managers who have the requisite

skills and experienced to analyse the performance and prospects of

companies. They make possible and organized investment strategy, which is

hardly possible for an individual investor.

Portfolio diversification: An investor undertakes risk if he invests all his funds

in a single scrip. Mutual funds invest in number of companies across various

industries and sectors. This diversification reduces the riskiness of the

investments.

Reduction in transaction costs: Compared to direct investing in the capital

market, investing through the funds is relatively less expensive as the benefit

of economics scale is passed on to the investors.

Liquidity: Often investor can not sell the securities held easily, while incase of

mutual funds, they can easily encash their investment by selling their units to

85

the fund if it is an open-ended scheme or selling them on a stock exchange if

it is a close-ended scheme.

Convenience: Investing in mutual fund reduces paperwork, saves time and

makes investment easy.

Flexibility: Mutual funds offer a family of scheme and investor has the option

to transferring their holding from one scheme to the other.

Tax Benefit: Mutual fund investors now enjoy income-tax benefits. Dividends

received from mutual funds' debt scheme are tax-exempt to the overall limit

Rs.9000 allowed under section 801 of the Income tax act.

Transparency: Mutual funds transparently declare portfolio every month. Thus

an investor knows where his/her money deployed and in case they are not

happy with the portfolio they can withdraw at a short notice.

Stabilitv to the stock market: Mutual funds has a large amount of funds which

provide them economics of scale by absorb any losses in the stock market

and continue investing in the stock market .In addition, mutual funds increase

liquidity in the money an capital market.

Equity research: Mutual funds can afford information and data required for the

investment as they have large amount of funds and equity research available

with them.

The above description by the author can be summarised as under.

Mutual fund is mechanism for pooling the savings of number of individuals

and invested in the various financial and other assets as per common

86

objective of the pool. The investment management is assigned to the

specialized body called fund manager who function according to the mandate.

The return generated the investment is shared among the individual in

proportionate to original contribution.

4.3 MUTUAL FUND SCHEMES

The schemes can be classified broadly according to as well as the maturity

the investment objective.

Maturity: Open End I Closed End

Open-end scheme is one that is available for subscription and redemption as

well on a continuous basis. It does not have a fixed maturity period. Investors

can buy and sell units at every day value units (Net Asset Value- NAV). The

feature of open-end scheme is liquidity.

Closed end scheme has a stipulated maturity period say 5 or 7 years. The

scheme is open for initial subscription for specified period at the time of

launch of the scheme. Thereafter, the scheme is listed on recognized stock

exchange. The investor can buy sell their units on the exchange.

87

Objective:

Growth Scheme: The objective is to provide capital appreciation in long term

and the fund is invested mainly in blue chip equity. The return could be in

form of dividend or capital gain as per the option of the investor.

Income scheme: The objective of the scheme is to provide regular and

steady income. Accordingly, the fund is invested mainly in debt instruments

like corporate debentures and Government securities.

Balanced scheme: The scheme aims both partly regular income partly

capital appreciation. The fund is partly invested in equity and partly in debt

instruments.

Liquid I Short-term scheme: The scheme is available to park the fund for

short term or ultra short period. The return is very low. The investment is

made in money market instrument and other high liquid Government

securities.

Index Fund: The scheme is a growth oriented scheme and invest in equity

exactly in the proportion of the market index.

The other types of the schemes are sector specific, tax savings schemes,

monthly income schemes, etc. These schemes are broadly falling in above

classification only with some difference in the feature of return.

88

4.5 HISTORY OF MUTUAL FUND IN INDIA

The mutual fund industry in India started in 1963 with the formation of Unit

Trust of India, at the initiative of the Governmer:t of India and Reserve Bank

the. The history of mutual funds in India can be broadly divided into four

distinct phases

First Phase -1964-87

Unit Trust of India34

Unit trust of India is India's first mutual fund organisation. It is the single

largest mutual fund in India, which came into existence with the enactment of

UTI act in 1964. The economic turmoil and the wars in the early sixties

depressed the financial market, making it difficult for both exiting and new

entrepreneurs to raise fresh capital. The then Finance Minister, T. T.

Krishnamachari, set up an idea of unit trust which would mobilize saving of

the community and invest these saving in the capital market. His ideas took

the Unit Trust of India, which commenced operation from July 1964 'with a

view to encouraging saving and investment and partiCipation in income,

profits and gains accruing to the corporation from the acquisition, holding,

management and disposal of Securities'. The regulation passed by Ministry of

Finance and the parliament time to time regulated the functioning of UTI.

Different provisions of the UTI act laid down the structure of management,

34 Bharati V, Pathak."lndian Financial System (p 467)

89

scope of business, powers and function of the Trust as well as accounting,

disclosures, and regulatory requirements for the Trust.

UTI was set up a trust without ownership capital and with an independent

Board of Trustees. The Board of Trustees manages of affair and business of

UTI. The Board performs its functions, keeping in view the interest of the unit

holders under various schemes.

An Act of Parliament established Unit Trust of India (UTI) on 1963. It was set

up by the Reserve Bank of India and functioned under the Regulatory and

administrative control of the Reserve Bank of India. In 1978 UTI was de­

linked from the RBI and the Industrial Development Bank of India (lOBI) took

over the regulatory and administrative control in place of RBI. The first

scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had

RS.6, 700 crores of assets under management.

Second Phase -1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non- UTI, public sector mutual funds set up by

public sector banks and Life Insurance Corporation of India (LlC) and General

Insurance Corporation of India (GIC). SBI Mutual Fund was the first non- UTI

Mutual Fund established in June 1987 followed by Canbank Mutual Fund

(Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual

Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92).

90

L1C established its mutual fund in June 1989 while GIC had set up its mutual

fund in December 1990.

Third Phase -1993-2003 (Entry of Private Sector Funds)

With the entry of private sector funds in 1993, a new era started in the Indian

mutual fund industry, giving the Indian investors a wider choice of fund

families. Also, 1993 was the year in which the first Mutual Fund Regulations

came into being, under which all mutual funds, except UTI were to be

registered and governed. The erstwhile Kothari Pioneer (now merged with

Franklin Templeton) was the first private sector mutual fund registered in July

1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more

comprehensive and revised Mutual Fund Regulations in 1996. The industry

now functions under the SEBI (Mutual Fund) Regulations 1996.

The number of mutual fund houses went on increasing, with many foreign

mutual funds setting up funds in India and also the industry has witnessed

several mergers and acquisitions. As at the end of January 2003, there were

33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of

India with Rs.44, 541 crores of assets under management was way ahead of

other mutual funds.

91

Fourth Phase - since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI

was bifurcated into two separate entities. One is the Specified Undertaking of

the Unit Trust of India with assets under managemel1t of Rs.29, 835 crores as

at the end of January 2003, representing broadly, the assets of US 64

scheme, assured return and certain other schemes. The Specified

Undertaking of Unit Trust of India, functioning under an administrator and

under the rules framed by Government of India and does not come under the

purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and

Lie. It is registered with SEBI and functions under the Mutual Fund

Regulations. With the bifurcation of the erstwhile UTI which had in March

2000 more than Rs.76, 000 crores of assets under management and with the

setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund

Regulations, and with recent mergers taking place among different private

sector funds, the mutual fund industry has entered its current phase of

consolidation and growth. The total asset under management at the end of

February 2004 is Rs. 141600 crores i.e. Rs. 1400 billion

92

Consolidation

The MF industry in India has witnessed many mergers and acquisitions

activities. In the recent past, Kothari Pioneer was taken over by Pioneer ITI

and again Franklin Templeton acquires Pioneer IT!. Similarly, HOFC MF

acquires Zurich. UTI, born as financial institution has been split and UTI - II

AMC is incorporated which is now a Mutual Fund in true meaning. Further,

several joint venture were discontinued like Principal separated with lOBI and

Cazenave with Cholamandum,

Even at present, the news is flashing about possible new mergers. It is

interesting that the certain players, who are relatively new, are acquiring

others and few old timers are looking for either partners or out right sell of

their share.

4.6 LEGAL STRUCTURE AND CONSTITUENTS OF MUTUAL FUND

SEBI Mutual Fund Regulations 1996, lays down the procedure for registering

a mutual fund.

A Mutual Fund is a Trust registered under the Indian Trust Act, and approved

by Securities and Exchange Board of India.

The Sponsor, like a promoter of a limited company, forms this trust and

applies to SEBI for registration. The sponsor should have sound track record

93

of financial services business for at least 5 years. Sponsor appoints

independent Trustees. The prior approval of SEBI is required for the

appointment.

The trustees are the key persons in functioning of a mutual fund. The entire

investments under all schemes are held in the names of these trustees. They

have been vested wide powers under the regulations and also have the

ultimate responsibilities about the functioning of a mutual fund.

The fund management is entrusted to separate entity called Asset

Management

Company (AMC). The AMC should have minimum net worth of Rs. 10

crores and is mainly owned by the sponsor. The board of directors of AMC

should be independent t in majority. Thus, 50 % or more directors should not

be associated with sponsor in any manner.

The Trustees appoint it and thus AMC is accountable to the trustees. AMC

signs an Investment Management Agreement with the trustees and it is

entitled to fees purely linked to the performance of the various schemes.

The AMC, as a fund manager, float new schemes with approval of the

trustees, manages the fund as per the scheme objective .

. Other constituents are, registrar, custodians, bankers, distributors and agents.

94

• Registrars keep records of all unitholders,

• Custodians keep account of investments

• Bankers facilitates collections and transfer of funds

• Distributors I agents market the schemes.

All these constituents are appointed and monitored by AMC. The payment to

these constituents is variable with volumes.

The functioning of a Mutual Fund is shown in diagram form as under.

SPONSOR Aoooints TRUSTEES

FJrms •

Ap oint

Owned

TRUST (The Mutual Fund)

RE sponsible Mar ages

ASSET MANAGEMENT COMPANY (AMC) Manages Funds

.. OTHER CONSTITUENTS

Registrar Custodians Bankers Distributors

95

The mutual fund is entity, which gets services out sourced. The money

is vested with trustees, managed by AMC and other activities

performed by other constituents. Majority of the expenses of a mutual

fund is variable.

4.6 SEBI REGULATIONS -AN OVERVIEW

Securities and Exchange Board of India has framed detail regulations

governing functions of Mutual Fund India. It is called SEBI (MUTUAL FUND

REGULATIONS) 1996. The regulations have 10 chapters, 78 clauses and 12

schedules. It is amended on need basis to meet the changing requirements.

Further, guidelines, circulars and clarifications are issued by SEBI from time

to time with regard to specific issues.

Chapter I contains important definitions. Among others, two most vital are

'Asset Management Company' and 'Contro/'. Asset Management Company is

only body corporate incorporated under The Companies Act and no other

business entity. Control mea"s 1 0% of shareholding with voting rights.

Chapter II prescribes the procedure for registration of a mutual fund, and

eligibilities of a sponsor

Chapter III deals with appointment and role of Trustees, constitution of a

mutual funds its operation and management.

96

Chapter IV deals with constitution of the Asset Management Company and

its management. The chapter also describes the role and obligation of AMC.

It also covers

Chapter V contains the procedure of launching a scheme, the significance of

offer documents and its disclosure requirements. The chapter further,

prescribes detailing of allotment procedure, offer period, listing, and transfer

of units, winding up procedure as well.

Chapter VI contains the provisions for investment objectives, investment

valuation policies, pricing of units and NAV computations.

Chapter VII deals with provisions for general obligations. They include

maintenance of books and records, audit requirement, restrictions and

limitations with respect to the expenses of a mutual fund, contents and

periodicity of various disclosures.

Chapter VIII, IX and X contains the powers of SEBI, provisions for inspection

and audit and prescribes the actions for defaults

The schedules to regulations, contains certain formats for various

documents, fee structures, code of conduct for mutual funds and detailed

policy and rules. Among others, format for trust deed and investment

management agreement are vital. The investment restrictions and detailed

accounting policy are also given in the schedules.

As regards information dissemination to the investors the recent detail

guidelines issued by SEBI is summarised below

97

SEBI Guidelines (2001-02) Relating to Mutual funds3s

A common format is prescribed for all mutual fund schemes to disclose their

entire portfolios on half-yearly basis so that the investors can get meaningful

infonmation on the deployment of funds. Mutual fund are also required to

disclose the investment in various types of instruments and percentage of

investments in each scrip to the total NAV, illiquid and non- performing

assents, investment in derivatives and in ADRs and GDRs.

To enable the investor to make informed investment decisions, mutual funds

has been directed to fully revise and update offer document and

memorandum at least once in two years.

Mutual funds are also required to

I. Bring uniformly in disclosures of various categories of

advertisement, with a view to ensuring consistency and

comparability across scheme of various and mutual funds.

ii. Reduce initial offer period from a maximum of 45 days to 30

days.

iii. Dispatch statement s of account once the minimum subscription

amount specified in the offer document is received even before

the closure of the issue.

35 Bharati V, Pathak."lndian Financial System (p 467)

98

IV. Invest in mortgaged backed securities of investments grade

given by credit rating agency.

v. Identify and make provisions for the non-performing assets

(NPAs) according to criteria for classification of NPAs and

treatment of income assured on NPAs and to disclose NPAs in

half-yearly portfolio reports.

VI. Disclose information in a received format on unit capital,

reserves, performance in terms of dividend and rise/fall in NAV

during the half year period, annualized yields over the last 1, 3,

5 years in addition to percentage of management fees,

percentage of recurring expenses to net assets investments

made in associate companies, payment made to associate

companies for their services, and detail of large holdings, since

their operation.

vii. Declare the NAVs and sale/repurchase prices of all schemes

updated daily on regular basis on the AMFI website by 8:00

p.m. and declare schemes on every Wednesday.

The format for unaudited half-yearly results for the mutual fund has been

revised by SEBI. These results are to be published before your expiry one

month from the close of each half-year as against two months period

provided earlier. These results shall also be put in their websites by

manual funds.

99

All the schemes by mutual funds shall be launched within six months from

the date of the letter containing observations from SEBI on the scheme

offer document. Otherwise, a fresh offer document among with filling fees

shall be filed with SEBI.

Mutu~1 funds are required to disclose large unit-holdings in the scheme,

which over 25 per cent of the NAV.

·4.7 ASSOCIATION OF MUTUAL FUNDS OF INDIA (AMFI)

Association of Mutual Funds of India is a voluntary organisation set up by the

mutual funds doing business in India. The main objectives of AMFI are;

• To promote interest of mutual fund and investors

• To set ethical standards

• To increase public awareness in India

AMFI has framed the code of ethics that is mandatory for the members. It is

for setting out standards for good practices to be followed by asset

management companies in operation and dealing with investors. It is a

supplement to the code of conduct prescribed in the Fifth schedule of SEBI

Regulations.

100

4.8 PRESENT SCENARIO

As on February 2004, there are total 31 Mutual Fund managed by Asset

Management Companies. The ownership classification of these mutual funds

is as under.

• Banked sponsored

• Financial Institutions sponsored

• Private sectors (only Indian owner)

• Private sector (only foreign owner)

5

3

7

1

• Joint venture (major partner Indian) 6

• Joint venture (major partner Foreigner) 9

Total 31

The size of mutual fund industry is measured In terms Asset Under

Management (AUM). This mean the sum total of money invested and

managed under all schemes.

The AUM as on February 2004 is Rs. 141600 crores i.e. Rs.1400 billion or

31 billion USD as per current exchange rate.

Currently, there are about 490 schemes launched by different mutual funds.

These includes all types namely open end I closed end, income I growth,

liquid, balanced, etc.

101

The distribution of these AUM among the different category of players

Category Asset Under Management (AUM) (Rs. in crores)

Bank Sponsored including new UTI - 27,397 II Institutions 7,371 Indian Private sector 20,714 Joint Venture -Indian dominance 34,132 Joint Venture - Foreign dominance 51,999

Total 1,41,613 (Source: ww.mutualfundlndla.com)

The industry leaders are UTI II, Prudential ICICI, Templeton Franklin, HDFC

Mutual Fund and Birla Mutual Fund, in order of their total AUM. All these

leaders hold about Rs.77, 000 crores that is have market share of more than

50%.

The size of the industry to its true age of 10 years (since the mutual fund in

real meaning started in India in 1993 when private sector entry was permitted)

is notable but the several observations are critical.

Moody's Investors Services and ICRA Limited conducted the survey of

mutual fund in India titled "The Indian Mutual Fund Market: From Infancy

to Adolescence" in May 2002.

The relevant and significant findings are listed below.

• The open-end schemes are more than 70% of total number of

schemes

102

• The AUM is 11 % of the total bank deposits

• The corporate investors are 60%

• 70% of the investors money are in debt funds

• 45% of equity funds come from only 3 cities namely Mumbai,

Delhi and Kolkotta

4.9 MUTUAL FUND STRUCTURE IN THE USA AND THE UK36

In the USA mutual funds are set up as investment companies, which may be

thought of as "the fun sponsors". An investment company may be a

corporation, partnership or a unit investment trust. For our purposes, all the

legal entities may be broadly understood mutual funds. The investment

company in turn appoints a management company, which may be either a

closed-ended management company or an open-end management company.

Only open-end management companies are technically called "mutual funds"

in USA.

The constituents of mutual funds in the USA are the Management Company,

Underwriter Management Group and Custodian. The management company

is the Indian equivalent of an AMC. Underwriter of a fund is the distributor or

the marketing company that sells the shares to brokers or to the public. A

management group is a family of management companies owned by a group

36 AMFI Mutual Fund Test- Workbook

103

of people or a corporation. Custodian is the entity that holds the fund's assets

on behalf of the Management Company.

In the UK, mutual funds have two alternative structures. Open-end funds are

in the form of Unit Trusts, while close-end funds are in the form of corporate

entities although called Investment Trusts. Separate regulatory mechanism

exists for both types of entities. The Securities and Investment Board regulate

Unit Trusts. They must be authorised by the relevant "Self-regulatory

Organisations". Investment Trusts are structured as companies and

provisions of the companies Act are applicable to them.

History of Mutual Fund in USA37

The mutual fund in USA started in 1924. The comprehensive law governing

mutual funds namely Investment Company Act, was enacted in 1940.

The AUM as on January 2004 is about 7 trillion USD. As per the Fact Book

2003 of the Investment Company Institute, a Self-Regulatory Organisation

(SRO), pure equity funds are 45% and rest are debt, short term or balanced

funds.

The industry has attained maturity in terms of capturing sizable share of

household savings (more than 20 %) and also in terms of a comprehensive

. legal framework and discipline both by compliance and transparency.

37 Investment Company Institute- Fact Book (2003) 43"' Edition

104

Investment Company Institute

The Investment Company Institute (ICI) is the national association of the

investment company industry. Is mission is to advanced the interest of

investment companies (Mutual funds, closed-end funds, unit investment trust,

and exchange-traded funds) and their shareholders, to promote public

understanding of investment companies, and to serve the public interest by

encouraging adherence to high ethical standards by all element of business.

As only association of U.S. investment companies without regard to

distribution method of affiliation, the Institute is dedicated to the interest of the

entire investment company industry and all of its shareholders. The institute

represents members and their shareholders before legislative and regulatory

bodies at both the federal and state levels, spearheads investor awareness

initiatives, disseminates industry information to the public and the media,

provided economic policy and other policy research, and seek to maintain

high industry standards.

The association was originally formed by industry leaders who supported the

enactment of the Investment Company Act of 1940, legislation that provided

the strong regulatory structure that has been responsible for much of

industry's success. Established in New York at 1940 as the National

Committee of Investment Companies, the association was renamed the

National Association of Investment Companies in 1941 and the Investment

lOS

Company Institute in 1961. The Institute was relocated to Washington, DC in

1970.

Significant events in US Mutual Fund History

1924: The first mutual funds are established in Boston.

1933: The Securities Act of 1933 regulates the registration and offering of

new securities, including mutual finds shares, to the public.

1934: The Securities Exchange Act of authorized the U.S. Securities and

Exchange Commission to

Provide for fair and equitable securities market.

1936: The Revenue Act of 1936 established the tax treatment of mutual

funds and their shareholders

1940: The Investment Company Act of 1940 is signed into law, setting the

structure and regulatory framework for the modern mutual fund

industry. The forerunner to the National Association of Investment

Companies (NAIC) is formed. The NAIC will letter become the

Investment companies Institute (ICI).

1944: The NAIC begins collecting investment company industry statistics.

1951: The total number of mutual funds surpasses 100, and number of

shareholders exceeds 1 million for the first time.

1954: Households' net purchases of fund shares exceed those of corporate

stock for the first time. NAIC initiates a nationwide public information

106

program emphasizing the role of investor is the U.S. economy and

explaining the concept of investment companies.

1955: The first U.S. based international mutual fund is introduced.

1961: The first tax-free unit investment trust is offered. The NAIC changes

its name to the Investment Companies Institute and welcomes fund

advisers and underwriters as members.

1962: The Self -Employed Individuals tax Retirement Act creates savings

opportunities (Keogh Plans) for Self- Employed individuals.

1971; Money market mutual funds are introduced.

1974: The Employee Retirement Income Security Act (ERISA) creates the

individual Retirement Accounts (IRA) for workers not covered by

employer retirement plans.

u.s. Mutual Fund Developments in 2002

Mutual fund investor reacted to a harsh financial environment in 2002 much

as they have in the past. Shareholders in equity and money market funds

responded to the low fund returns by curtailing their net purchases, while

bond fund investors increased their net purchases as bond fund returns rose.

The bear market in stocks depressed equity fund assets, which declined to

$2.667 trillion at year-end 2002 from $3.418 trillion in 2001. Bond fund assets

reached a record $1.125 trillion by year-end 2002, lifted largely by new

investments. Money market fund assets-after experiencing record inflows

\07

and assets level in 2002--declined by 0.6 present to $2.272 trillion by year­

end 2002. Hybrid fund assets were little changes in 2002, finishing year at

$327 billion.

Household Demand for Mutual fund (US)

Owing to the decline in household wealth in the past few years, household

slowed their pace of consumption and increased their rate of saving.

Household used the addition saving increase their net purchases of financial

assets to a record $668 billion in 2002.

Even though households acquired a record amount of financial assets, their

net purchases of mutual funds, including reinvested dividends slipped to $164

billion, the lowest amount since 1994. Some of decline reflected the

showdown in net purchases of equity fund shares, but household's net

acquisition of money market fund shares also turned negative. The slowdown

in purchases of mutual funds largely reflected the normal cyclical fluctuation

in flows associated with low returns on equity and money market funds.

Instead of buying equity and money market funds, individuals increased their

purchases of time and savings deposits as well as bond funds and direct

holdings of municipal and U.S. government bonds.

The mutual fund portion of household financial assets approximately one

percentage point in 2002 to just below18 percent. Households continued to

108

hold the largest portion of their financial assets (23 percent) in direct holdings

of securities. These securities are typically held in accounts managed by

private money managers, brokerage firms, and bank trust departments.

Pension funds also manage a large portion of household financial assets

totaling 20 percent at year-end 2002. Deposits as banks and savings

association account for another 30 percent, and life insurance companies

manage 6 percent.

Equity funds (US)

Net new cash flow into equity funds turned negative for the first time since

1988, with the outflow for the year totaling $28 billion, or 0.9 percent of equity

fund assets. Although the outflow was the first in 14 years, it was a smaller

percentage of equity fund assets than the outflows that occurred during the

bear markets of the 1970s and 1980s. By comparison in 1988, shareholders

on balance sold 8 percent of their equity fund assets. During the 1970s, a

decade of low stock returns annual net outflows from equity funds ranged

between 1.2 percent and 11.9 percent of assets.

The combination of declining stock prices and the net outflow left equity funds

assets at $2.667 trillion at the end of 2002, the lowest level in five years and

down 42 percent from the peak in Aug. 2000. Equity funds portion of all

mutual fund assets declined to 42 percent, the smallest share since 1994.

109

Equity fund investor responded to the slide in the stock market in 2002 much

as that they did during market downtums in the 1990s when, during periods of

weak economic performance, net flows into equity funds tended to slow.

Furthermore, as during past bear markets, the outflow was caused by the

dollar volume of sales falling more than redemptions. Sales including

exchanges sales, of equity funds declined by 8 percent in 2002 whereas

redemptions, including exchanges, fell by 4 percent.

Domestic Equity funds (US)

Shareholders, on balance, sold $25 billion of domestic equity fund shares in

2002, totaling 0.9 percent of average domestic fund assets. The net outflow

reflected the weak performance of the stock market. Typically, when stock

prices fall, investors increase their net purchase. The outflow in 2002 was

attributable to the dollar volume of sales filing more than redemptions. Sales,

including exchange sales, fell by 8 percent while redemptions, including

exchanges, fell by 1 percent. As a percent of assets, however, both sales and

redemptions rose. The increased rates of sales and redemptions to assets

resulted from the 23 percent drop in assets of domestic equity funds in 2002

that offset the dollar decline in sales and redemptions.

Domestic equity fund's flows began the year on a strong note as a major

stock market indexes rebounded from lows reached in Sep. 2001. Investors

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added $50 billion in new cash to domestic equity funds during the first three

months of 2002, the largest three-month inflow since the fall of 2000.

The stock market's ascent ended in mid-March, and stock prices declined

modestly until early June. Inflows to domestic equity funds slowed, but

remained positive through May, totaling $65 billion for the first five months of

2002. However, new information about corporate accounting scandals and

downward revision to profit forecasts were a drug on a market, and the S&P

500 lost 16 percent of its value during June and July. Share prices continued

to decline, and by October major market indexes had fallen to their lowest

levels in five years. As stock prices slipped, so did domestic equity fund flows,

which turned negative in June and remained so through the end of the year,

except for the month of November. Over the last seven months of 2002, the

cumulative net outflow was $90 billion.

The outflow from domestic equity funds in 2002 was in line with the response

of shareholders to previous of failings stock prices. Indeed, the evidence

continues to indicate that domestic equity fund shareholders reacted to the

stock market in 2002 much as they had to market fluctuation during the

1990s.

Mutual fund ownership of U.S. corporate equity was about 20 percent in

2002, less than a percentage point lower than in 2001. Pension funds,

II I

insurance companies, household's direct holdings, and foreign investor

accounted for most of the remaining holdings.

Foreign eguity funds (US)

U.S. investors, on balance, sold $3 billion of foreign equity fund shares during

2002, amounting to 0.7 percent of average foreign equity fund assets Total

assets in these funds declining to $358 billion in Dec. 2002 from $429 billion

at the end of 2001. Virtually the entire decline was attributable to declining

foreign stock prices.

Many foreign equity markets suffered losses in 2002. European stock indexes

were down nearly 31 percent on average, and the Japanese stock market

posted a decline of more than 19 percent. Other markets in Asia and the

Pacific were off less than the Japanese stock market, while emerging markets

fared better than most otherworld stock markets. U.S. dollar offset some of

these losses because the foreign-currency denominated assets appreciates

in value relative to the dollar when the dollar declines.

The small outflow from foreign equity funds was consistent with past

transaction activity of investor in foreign equity funds. These shareholders

behave much the same as investors in domestic stock funds.

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Conclusion

The mutual fund as a unique investment instrument has benefits of capital

appreciation and liquidity as well. The other advantages of customized

products as per the need of the investor. Mutual fund is well established and

accepted as investment vehicle in USA that is reflected in the growth and the

present size of the AUM. In India, the industry has just completed a decade

and has good potentiality. The following chapter contains the savings pattern

and habit of Indian household.

4.10 DISCLOSURE NORMS IN INDIA

The disclosure norms have been prescribed under the SEBI Mutual Fund

Regulations and amendment and guideline made thereafter from time to time.

The objective is to briefly explain the provision and its significance so that the

research done the conclusion drawn can be explained in more effective

manner.

SEBI regulations on Disclosure

Transparency is accepted as a practice that reflects the prudent governance.

The practice refers to the dissemination of vital information that every

investors, stakeholder and society as a whole are supposed to know. The

information is made available on convenient periodicity. The information is not

only about the data of performance result but the manner in which the

business is conducted. The practice is generally called the 'DISCLOSURE'.

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Mutual Fund is a business of pooling the investment from many and to invest

as per the mandated objective. It is very important for every person

contributing to the pool, to know following;

• Investment objective

• The introductory information of THE FUND

• The management

• Investme:1t procedure, both entry and exit

• Investment policy

• Accounting policy

• Rights and obligation

• Grievance redressal mechanism

• Period performance

• The Independent comment on the performance

The above list an indicative one. There could be more points depending upon

the several specific features or situations.

Accordingly, the relevant disclosure made, are following.

• Offer Document

• Key Information Memorandum

• Half Yearly results

• Annual Report

• Daily Net Asset Value (NAV)

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• Portfolio Disclosure

• Advertisement including TV commercials

• Other periodic communication such as letters, circulars

SEBI Regulations for Mutual Fund have prescribed various disclosures

norms. These norms can broadly be classified as mandatory as well as

guidelines for voluntary disclosure namely advertisements. Mandatory norms

applied to Offer Documents, Key Information Memorandum, Half yearly

results, Annual Reports, and other periodic information dissemination

4.11 RELEVANT PROVISION OF SEBI REGULATIONS:

The relevant provisions of SEBI Regulations are described below.

Offer Document: This is the most vital piece of information. As per the

definition given in the regulations, it is an invitation to the public to subscribe

to a mutual fund scheme. It is akin to a Prospectus issued under the

Companies Act 1956 and accordingly is the basis of the investment decision.

Clause 29 of Chapter V of SEBI Regulations state that "The offer document

shall contain the disclosures which are 'adequate in order to enable the

investors to make informed investment decision· ... •

The offer document must be filed with SEBI before launching the scheme.

The trustees should approve it. Periodic updating of information and

modification, as may be required, are allowed under the regulations Further,

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every investor is supposed to have read the offer document before

investment and the ignorance of the disclosures made, is not a valid reason

for incorrect decision.

The contents of the offer documents are given in annexure, titled FORM-NS,

to the circular IMARP / MF / CIR 06 / 793 /98 dated 31-3-98, effective from

1 st April 1998. The contents are divided in I to XIX parts. The relevant items

that help the decision making as intended in the regulations are listed below.

1. High lights

2. Risk Factors Standard, General and Specific

3. Information about Sponsor, Trustee, AMC, Directors, Key

Personnel and other constituents

4. The Scheme details: Type, Objective,

5. Procedure for investing and exiting the schemes

6. Valuation norms, Accounting policies, Expenses caps

7. Concept of derivatives and other terminologies

8. Summary of past performance

9. Transaction with sponsor and their associates

10. Unitholders information

11. Investor services

The contents cover most of the vital information.

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Key Information Memorandum: It is an abridged form of the offer document.

It is mandatory to be part of every application form. It is contain certain basic

information about the mutual fund. The contents coverage is the same that of

the offer document.

Annual Report: Chapter VII, clause 54 of the SEBI Regulations requires that

every mutual fund shall prepare in respect of each financial year an Annual

Report and annual statement of accounts of the schemes as specified in

ELEVENTH SCHEDULE to the regulations. Clause 51 states that the

financial year for all schemes shall end as of March each year.

Clause 57 requires that every mutual fund, within six months from the date of

the closure of each financial year, shall forward to SEBI a copy of the Annual

Report and other information including details of investments and deposits

held by the mutual fund so that entire schemewise portfolio of the fund is

disclosed. Further, clause 56 requires that the Annual Report or its abridged

summary shall be published through an advertisement. The abridged

summary shall be mailed to all unitholders. The Annul Report shall contain

details as specified in Eleventh Schedule for the purpose of providing true

and fair view of the operation of the mutual fund. The disclosure of the

portfolio must contain detail of investment in group companies of the sponsor.

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The Annual Report shall be accompanied by Auditors' report and the auditors

of the mutual fund shall not be associated with auditors of the asset

management company.

The published Annual Report shall carry note full report shall be available for

inspection for unitholders a copy will be available on payment.

Periodic and continual disclosures: Clause 58 requires the AMC, the

trustees, custodian and the sponsor shall make such disclosures to the SEBI

as may called upon.

Half Yearly disclosures: Clause 59 provides for publication of Half Yearly

i.e. as at 30th September and 31 ST March, unaudited financial results within

two months, in one English daily and one in local news paper where the head

office is situated.

Further, the mutual fund shall also, within one month of the half year, inform

the entire portfolio of investment to all unitholders either individually or by

publishing in English daily and one local newspaper. The format of such Half

Yearly disclosure is prescribed by a circular MFD 1 CIR 19/120/2000 DATED

November 24,2000.

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Other Disclosure to the Investors: Clause 60 of the regulations make

trustees responsible to make such disclosures to unitholders as are essential

in order to keep them informed.

Fifth Schedule to the Regulations contains code of conduct for mutual fund.

The second paragraph is of immense importance, which is reproduced below.

"Trustees and asset management companies must ensure the dissemination

to all unitholders of adequate, accurate, explicit and timely information,

fairly presented in a simple language about the investment policies,

investment objectives, financial position and general affairs of the schemes."

This clause covers al most aspect of the disclosures not only in terms of

contents but also in terms of its quality with respect to accuracy timely ness

and simplicity.

The mutual funds, accordingly, inform the investors through Fact Sheets,

Circulars, handouts, banners communication from the fund managers and the

advertisement. Among these practice Fact Sheets and advertisements are

regular and common mode of disclosures.

All these disclosures can be termed as voluntary one. SEBI guidelines and

circulars issued from time to time cover su'ch disclosures. Some of such

circulars are listed below.

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Gist of the circulars issued that provide for Disclosures:

SL Description Reference of No. circular

1 Use of indicative return (for fixed Income Press release 10 schemes 197 dated

30/1/97 2 Mandatory disclosure in Offer Document for Dated 1/2112000

trading in Derivatives 3 Guidelines for Advertisements 5/6/2000 4 Disclosures of investment in illiquid securities 1819/2000 5 Disclosures of Non Performing Assets (NPA) ---00----

with portfolio 6 Annual Report of Asset Management 24/11/2000

Companies be available to unitholders 7 Common formats for half yearly disclosures ----00----8 Updating of offer document on continuous 9/2/2001

basis 9 Announcement of additional plan under 15112/2001

existing schemes 10 Publication NAV of Closed End Scheme on 28/2/2001

everyVVednesday 11 Publication of audited accounts 14/31102 12 Advertisement by mutual funds 26116/03

4.12 ADVERTISEMENT:

Advertisement influences the people at large in decision making of their

spending. This is also true fro their investment decision. Thus, it is very

important form of disclosures. SEBI Regulation provide for exhaustive rules

and guidelines for all types of advertisements.

Clause 30 of the regulations provides that every advertisement of the

schemes shall be in conformity with the Advertisement Code as specified in

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Schedule VI. It is also required to be submitted to SEBI within 7 days of date

of the issue.

The first sentence of the Advertisement Code states "An Advertisement shall

be truthful, fair and clear and shall not contain a statement, promise or

forecast which is untrue or misleading."

The main provisions of the code are summarised below.

• The term 'misleading' is explained as representation made

about the performance without necessary explanatory statement

and which may give an exaggerated picture of the performance.

Further, an inaccurate portrayal of past performance or

promises the benefits without mentioning material risks are also

considered as misleading statements.

• The advertisement shall be framed so as to exploit the lack of

experience of the knowledge of the investors. It shall be clear,

concise and understandable set out. Excessive use of technical

or legal terminology or complex language should be avoided.

• Every advertisement should disclose the scheme objective.

• Claims about the performance should be supported by relevant

figures.

• Comparison with another fund should not be made unless it is

fair and relevant.

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• Performance for at least past 3 years should be given

• No celebrity should be part of the advertisement.

• All advertisement should state that 'Investments in mutual fund

are subject to market risk and the NA V of the schemes may go

up or go down depending upon the factors and forces affecting

the securities market' ..

Detail Guidelines for Advertisement:

Schedule VI specify the code of conduct. However, SEBI has issued detail

guidelines covering every aspect and contents of all kinds of advertisement

and other form of public addressing vie circular MFD/CIR14/51/2000 dated

June 5, 2000. The guidelines are divided in four sections.

Section I

These guidelines apply to all forms of advertisements, communications and

sales literatures. TV interviews, public speaking, presentations in seminars

and workshops are covered under these guidelines.

The term 'misleading' is further elaborated to cover untrue statement,

omission of material facts, unwarranted or unexplained comparisons, claims

of management capabilities without support of track records.

Section II

Certain standards are prescribed for all types of communication made the

mutual funds. Accordingly;

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• Every communication should be based on fair dealing and good

faith

• It should always bring to the notice of the investors that mutual

fund investment is prone to the risk of NAV fluctuations and

security market,

• Every employee must observe these guidelines while making

any public speech at seminars, interviews, etc.

• It should refrain from exaggerated and unwarranted claims as

well as superlative opinions that cannot be substantiated by

public data

• Statistical information, charts, graphs etc.', should be supported

by the sources

Section III

The section deals with form of the advertisement. They are classified into 3

categories, namely tombstone, product launch and performance.

Tombstone: Such advertisement should contain only general information of

the mutual fund like, name, scheme classification, logo, general services

offered, contact address and telephone numbers It should not, however,

contain information of NAV, performance and promises for future returns,

comparison and ranking.

Product launch: Such advertisements must contain minimum information

name of AMC, scheme classification, investment objective, terms of issue

investors benefits, risk factors logo and entry I exit load structure. Such

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advertisement should not contain NAV or past performance of another

scheme of the same mutual fund or ranking data, unless it comply with

specific guidelines for performance advertisement

Performance Advertisement: The guideline for advertising performance of a

mutual fund or a particular scheme is fairly exhaustive. Some of the points are

summarised below.

• Identify the nature of the scheme

• Dividend declared should be disclosed on 'per unit' basis along with

the face value of unit

• Only compounded annual yield can be advertised

• Performance for last 1, 3 and 5 years as well since inception should be

shown

• The yield should appear in main body of advertisement

• Performance data should be most recent

• The performance must be compared with benchmark return. There are

specific guidelines for standard benchmark according to the nature of

various schemes.

Use of ranking: The mutual fund can published the ranking cO:1ferred by

independent agencies. The ranking agency should not be affiliated to the

asset management company. The advertisement must give full information

about the period and date of ranking, criteria, symbol and its explanation, etc.

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Section IV

Communication, other than advertisement, such as leaflets, newsletters, fact

sheets, mailers, performance reports, etc., should have contents that

substantiated by the information in the offer document. Further, it must be in

conformity with detail guidelines for advertisements for product launch or

performance disclosure.

4.13 SUMMARY

The concept, past and present of the mutual fund industry in India and in US

are described above. The exact structure and constitution of a mutual fund in

the Indian regulatory environment is discussed. The SEBI regulations

especially relating to the disclosures requirement give an idea that there is

sufficient provision for dissemination of vital information to the mutual fund

investors. The preamble to the disclosures norms categorically emphasize on

adequacy of them with an objective to enable the investors to make informed

decision.

As regards the effectiveness i.e. whether the disclosures made by mutual

funds are meeting this requirement, is studied through a survey made

wherein the feedback of the investors is obtained. The purpose of this

primary data collection is to taste whether the various disclosures read by the

investors are meeting the objective of "enabling them to take infonmed

decision. Next chapter contains analysis of the primary data collection.

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Reference:

1. Association of Mutual Fund of India: AMFI WORK BOOK

2. Bharati Pathak:" Indian Financial System"

3. Investment Company Institute- "Fact Book (2003)" 43rd Edition

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