Mutual Funds & AMCs

1. Concept, Origin and Growth of MFs.2. Constitution & Management of MFs-Sponsors, Trustees, AMCs and

Custodians3. Classification of MF schemes.4. Advantages & disadvantages in MF schemes.5. NAV and Pricing of MF units6. Recent trends in MFs in India

What Is Mutual Fund?

• A Mutual Fund is a trust that pools together 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.

Mutual Funds provide facility to small investors to obtain the benefits of portfolio investment under the aegis of professional management.

Initially MFs could invest only in financial assets.

In 2006 they were permitted to invest in physical assets.

In 2006 Gold ETF was launched

Since 2008, MFs have been permitted to invest in real estate . Eg. ICICI Prudential AMC is one of the pioneers in identifying Indian Real Estate Investments as an essential asset class, Kotak Realty Fund.

History of the Indian Mutual Fund Industry

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank.

The history of mutual funds in India can be broadly divided into four distinct phases:

First Phase – 1964-87Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India.

The first scheme launched by UTI was Unit Scheme 1964 (US-64). 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 (LIC) and General Insurance Corporation of India (GIC).

SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987.

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. Kothari Pioneer was the first private sector Mutual Fund.

In 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.

How did US-64 first get into a crisis?In 1998, media reports appeared claiming that things were seriously wrong with US-64. For the first time in its 32 years of existence, US-64 faced depleting funds and redemptions exceeded sales. Between July 1995 and March 1996, funds declined by Rs 3,104 crore.

An ICFAI case study quoted analysts as saying that the depleting corpus coupled with the redemptions could soon result in a liquidity crisis.

Soon, reports regarding the lack of proper fund management and internal control systems at UTI added to the growing investor frenzy. By October 1998, US-64's equity component's market value had come down to Rs 4,200 crore from its acquisition price of Rs 8,200 crore.

The net asset value (NAV) of US-64 also declined significantly during 1993-1996 due to turbulent stock market conditions. One survey cited US-64's NAV at Rs 9.68. The US-64 units, which were sold at Rs 14.55 and repurchased at Rs 14.25 in October 1998, thus were around 50% and 47%, above their estimated NAV.

In June 1999, the government brought out all PSU stocks in the portfolio of US-64 for Rs 3,300 crore, although their market value was only Rs 1,516.74 crore.

For US-64, it was still worse as UTI had bought PSU stocks at a predetermined price and under government diktat during the 1994-95 disinvestment programme.

In 1999, on the recommendations of the specially appointed Deepak Parikh Committee which went into the US-64 controversy, UTI restructured US-64, shuffling 80% of the corpus into 50 top performing scrips.

he US-64 scheme was ranked next to gold in an investors survey done before 2001. Newspapers,the lethargic government in power, corrupt politicians, vested interests all played their part in the downfall of this homespun flagship scheme.

Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was divided into two separate entities.

One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs.29,835 crores as at the end of January 2003. This functions under rules framed by GOI.

The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations.

MFs are liquid• As you would have learnt earlier, liquidity is all about

having access to the money you’ve invested at your convenience. After all, what is the point of getting high returns if you can’t use the funds when you need it? Solid liquidity gives you the advantage of getting your money when you need it the most.

• In open ended funds, where you can buy and sell on any business day, you can get your money back generally within 3 working days. And to make things even better, there is a 15% penalty imposed on the Asset Management Company if you don’t get your money within 10 working days.

MFs reduce transaction Cost

• The power of bargaining lies in buying anything wholesale. The rate of buying in wholesale will obviously be much lesser compared to the retail rates. Now apply the same principal to Mutual Funds and what do you get? With many people pooling in their savings, you get the advantage of the power of bargaining which reduces the overall transaction cost.

Tax Aspect

Gains on investments made for a period less than a year are short-term capital gains while those from longer periods are called long-term capital gains. In the case of equity and equity-oriented instruments, there is no long-term capital gains. However, when exiting in the short term, the short-term gains are taxed at 15 per cent.

One, the Finance Minister seeks to change the definition of 'long term' for debt mutual funds from the present 12 months to 36 months. Once this takes effect, the returns that investors earn on debt funds in the first 36 months will be treated as 'short term' capital gains. This will be clubbed with the investor's income and taxed at his income tax rate. This is contrast to the earlier rule, where only investments held for less than 12 months were 'short term'. As a result of this move, investors who redeem debt fund units within 1-3 years will end up paying a tax of 10-30 per cent on their returns, instead of the 10 per cent they pay now.

Two, the budget also seeks to remove the concessional tax rate of 10 per cent on long-term capital gains made from debt funds. Instead, the long term gains on these funds (held for 3 years), will now be taxed at 20 per cent, after adjusting for indexation.

• What is the tax liability on receipt of Income on Mutual Fund Units?

• As per Section 10(33) of the Income Tax Act, 1961 (‘Act’) income received in respect of units of a mutual fund specified under Section 10(23D) is exempt from income tax in India and the mutual funds are subject to pay distribution tax in debt-oriented schemes. The effective tax (DDT) paid by investor will be 28.33% w.e.f. October 1, 2014.

An arbitrage fund is technically an equity-oriented fund. However, rather than investing only in equity stocks in the cash market, arbitrage funds’ objective is to take advantage of price differentials between the cash and the derivatives market. Some arbitrage funds also take naked exposure in equity over and above the pure arbitrage play.

Eg. Assume an asset currently trades at $100, while the one-month futures contract is

priced at $104. In addition, monthly carrying costs such as storage, insurance and financing costs for this asset amount to $3. In this case, the trader or arbitrageur would buy the asset (or open a long position in it) at $100, and simultaneously sell the one-month futures contract (i.e. initiate a short position in it) at $104. The trader would then carry the asset until the expiration date of the futures contract, and deliver it against the contract, thereby ensuring an arbitrage or riskless profit of $1.

CONSTITUENTS OF MFs

• Fund Sponsor• Trustees• Asset Management Company• Custodians• Registrar and Transfer Agents• Distributors/ Agents

• Mutual funds in India are governed by SEBI (Mutual Fund) Regulations, 1996, as amended till date.

The regulations permit mutual funds to invest in securities including money market instruments, or gold or gold related instruments or real estate assets.

Mutual funds are constituted as Trusts. The mutual fund trust is created by one or more Sponsors, who are the main persons behind the mutual fund operation.

Every trust has beneficiaries. The beneficiaries, in the case of a mutual fund trust, are the investors who invest in various schemes of the mutual fund.

In order to perform the trusteeship role, either individuals may be appointed as trustees or a Trustee company may be appointed.

When individuals are appointed trustees, they are jointly referred to as Board of Trustees. A trustee company functions through its Board of Directors.

The Sponsor:• Sponsor is defined under the SEBI regulations as any person who,

acting alone or in combination with another body corporate, establishes a mutual fund.

• Sponsor is the promoter of the fund.• Sponsor could be a bank, a corporate or a financial institution.• Sponsors then form Trust and appoint Board of Trustees.• The sponsor also appoints Custodian.• Sponsor signs the trust deed with the trustees.• Sponsor creates the AMC and the trustee company and appoints the

board of directors of companies, with SEBI approval.• Sponsor should have at least a 5 year track record in the financial

services business and should have made profit in at least 3 out of the 5 years.

• The AMC’s capital is contributed by the sponsor.• Sponsor should contribute at least 40% of the capital of the AMC.

The Trustees• A mutual fund in India is form as Trust under Indian Trust Act, 1882.• The trust-mf is managed by Board of Trustees.• The board of Directors i.e. Trustees do not manage the portfolio of securities directly

rather they appoint as AMC (Asset Management Company)• Trustees ensure that fund is managed by stated objective and as per SEBI regulations.• Trusts always work for the interest of unit holders.• The trust is created through a document called Trust Deed that is executed by sponsor

in favors of Trustees.• The Trustees being the primary guardians of unit holder’s funds and assets.• Trustees must ensure that the investor’s interests are safeguarded and that the AMC

operations are as per regulation laid down by SEBI.• SEBI mandates a minimum of 2/3rd independent directors on the board of the trustee

company.• Trustees are appointed by the sponsor with SEBI approval.• Trustees are required to meet at least 4 times a yea to review the AMC.• The trustees make sure that the funds are managed according to the investor’s

mandate.

Rights of Trustees:• The trustee appoints AMC with prior approval of SEBI.• They also approve each new scheme floated by AMC.• They have the right to request any necessary information from the

AMC concerning the operations of various schemes.• The trustees may take any necessary action against AMC if they

found AMC operations are not as per the SEBI regulations.• Manages the mutual fund and look after the operations of the

appointed AMC.• Trustees receive fee for their services.• The investments are held by the Trustee• Trustees can seek remedial actions from AMC• Trustees can dismiss the AMC• The trustees shall quarterly review all transactions carried out

between the mutual funds, asset management company and its associates..

Obligations of Trustees:• To ensure that funds transactions as per SEBI regulations• To ensure that the proper key person of AMC has been appointed. And also operations

of other staffs of AMC.• To ensure that the due diligence (care) has been given for empanelment of brokers.• Trustees Manages the Mutual Fund and look after the operations of the appointed AMC• The investments are held by the Trustee• At least 4 members should be there in Board of Trustees.• 2/3 members in the Board of Trustees should be independent.• Sponsors execute and register Trust Deed in favors of Trustees.• Trustee of one MF can not be a trustee of another MF, unless he/she is an independent

trustee in both the cases.• The appointment of all trustees has to be done with prior approval of SEBI.• Trusts are formed through “Trust Deed”• Trust ensures that AMC has not given any undue advantage to any associates.• Trustee ensures that AMC is managing the fund as per SEBI regulations• Meeting of Trustees should held once in every two months.• SEBI categorizes the Obligations of Trustees as

– General Due Diligence &– Specific Due Diligence

• Reliance Mutual Fund [Fund/RMF] has been sponsored and Settled by Reliance Capital Limited (RCL). RCL is a RBI registered Non-Banking Finance Company (NBFC) and has its business interests in Asset Management, Life Insurance, General Insurance, Private Equity, Proprietary Investments, Stock Broking, & other activities in the Financial Services Sector.

• Reliance Capital Asset Management Limited (RCAM) is an unlisted Public Limited Company incorporated under the Companies Act, 1956 on February 24, 1995, having its registered office at

RCAM has been appointed as the Asset Management Company [AMC] of Reliance Mutual Fund by the Trustees of Reliance Mutual Fund vide Investment Management Agreement (IMA) dated May 12, 1995 amended on August 12, 1997, January 20, 2004 and February 17, 2011 in line with SEBI (Mutual Funds) Regulations, 1996

AMCs• The role of AMC is to act as investment manager of trust• The AMC (as appointed by trust/sponsor) require approving by a SEBI• The AMC supervision under its own board of directors and also the directors of

trustees and SEBI• The trustees are empowered to terminate the appointment of AMC and appoint a

new AMC with prior approval of SEBI and unit holders.• Manage different investment schemes as per investment management agreement

with the trustees.• The AMC of a MF must have a net worth of at least Rs.10 Crores at all times.• Director of AMC should have complete finance professional experience.• The AMC always act in the interest of unit holders (investor)• The AMC gets a fee for managing the funds, according to the mandate of the

investors• At least ½ of the AMC’s Board should be of independent members• An AMC can not engage in any business other than portfolio advisory and

management• An AMC of one fund cannot be Trustee of another fund• AMC should be registered with SEBI• AMC signs an investment management agreement with the trustees

Obligation of AMC & its directors

• Investment of the fund according to the SEBI regulation & trust deed.

• They are answerable to the trustees and must submit quarterly reports to them on AMC activities and compliance with SEBI regulations

• Each day NAV is updated on AMFI website by 9 pm• In the event of merger or consolidation of schemes,

the unit holders are intimated through a letter giving them option to exit at prevailing NAV without exit load.

Custodians • For safekeeping of physical securities of MF custodian is appointed by

board of trustees.• The custodian should be registered with SEBI. Dematerialized forms of

securities are held in the custody of Depositories Participant.• The investor’s fund and the investments are held by the custodian, who

is the guardian of the funds and assets of the investors.• Sponsor and the Custodian cannot be the same entity

Function of Custodian• Responsible for the securities held in the mutual funds portfolio• Keep an investment record of the mutual fund• Collect dividends and investment payments due on the

mutual funds investment• Track corporate actions like bonus issues, right offers, offer for sale, buy

back and open offers for acquisition.

Registrars & Transfer Agents• They are responsible for issuing and redeeming units of

the MF and providing other MF related services to investors

• Register and Transfer (R&T) Agents manage the sale and repurchase of units and keep the unit holders accounts.

Functions of Registrars• Process investors application• Record details of investors• Send information to investor• Process dividend payout• Incorporate changes in investor information• Keeping investor information up to date

Distributors• AMC appoints a distributor (also called MF advisor, agent, broker, intermediaries etc) who sells

units MF to investors on the behalf of fund house.• A sponsor or an associate may act as distributors of AMC. For example, Bank which is sponsor

of Mutual Fund Company may act as distributor also for selling its mutual funds products• AMC has the right whether to impanel (appoint) or not distributor for selling his MF scheme.• They also have the right of commission structure which they offer to distributor• You may find different commission structure for different AMC scheme.• A distributor can act for several or all MF• For all employees and distributors of MF, AMFI certification test has been made mandatory by

SEBI• All distributors are required to be registered with AMFI and obtain AMFI Registration Number

(ARN)• The commission received by the distributors is split into initial commission which is paid on

mobilization of funds and trial commission which is paid depending on the time the investors stay with the fund.

Get yourself certified (if not previously certified) by National Institute of Securities Markets (NISM), by taking the NISM Mutual Fund Distributors Certification Examination. National Institute of Securities Markets (NISM) is a public trust, established by the Securities and Exchange Board of India (SEBI), the regulator for securities markets in India. NISM seeks to add to market quality through educational initiatives

MUTUAL FUND DISTRIBUTORS

• Finance Minister, in his Budget Speech announced that "Mutual fund distributors will be allowed to become member in Mutual Fund segment of Stock Exchange so that they can leverage the stock exchange network to improve their reach and distribution.“

• As per the present arrangement, investors can transact in mutual fund schemes at the stock exchange platform through registered brokers/clearing member of a recognized stock exchange who have obtained ARN from AMFI.

Sources

• http://amfitest.blogspot.in/2009/03/chapter-2-fund-structure-and_28.html

• http://www.sebi.gov.in/acts/mfreg96.html

CLASSIFICATION OF MF SCHEMES

9. Offshore funds10. Mid cap funds11. Large cap funds12. Equity MFs13. Arbitrage funds

INDICES and Nifty Midcap 50

CLASSIFICATION OF MF SCHEMES

1. Close-end funds2. Open end funds3. Income funds4. Growth funds5. Balanced funds6. Money Market funds7. Sector funds8. Index fundshttp://www.sebi.gov.in/faq/mf_faq.html

CLASSIFICATION OF Mutual Fund Schemes

• ACCORDING TO THE TIME OF CLOSURE OF THE SCHEME : While launching new schemes, Mutual Funds also declare whether this will be an open ended scheme (i.e. there is no specific date when the scheme will be closed) or there is a closing date when finally the scheme will be wind up. Thus, according to the time of closure schemes are classified as follows :-

• • (a) OPEN ENDED SCHEMES• (b) CLOSE ENDED SCHEMES• • Open-ended Fund/ Scheme• An open-ended fund or scheme is one that is available for subscription and

repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity.

Open Ended Fund- Reliance Small Cap

Reliance Small Cap-Open Ended

Reliance Small Cap-Open Ended

HSBC Mid Cap-Open Ended

HSBC Mid Cap-Open Ended

Close-ended FUND   / Scheme

A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the STOCK    exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended FUNDS    give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual funds schemes disclose NAV on daily basis.

Close ended fund-reliance close ended equity fund

Close ended fund-reliance close ended equity fund

Close ended fund-UTI

Performance of UTI MF

• Mutual Fund Service System (MFSS) is an online order collection system provided by NSE to its eligible members for placing subscription or redemption orders on the MFSS based on orders received from the investors. NSE launched India's first Mutual Fund Service System(MFSS) on November 30, 2009 through which an investor can subscribe or redeem units of a mutual fund scheme.

The value of all the securities in mutual FUNDS    portfolio is calculated daily. From this, all expenses are deducted and the resultant value divided by the number of units in the fund is the funds NAV or its Net Asset Value.

• Income / Debt Oriented SchemeThe aim of income funds is to provide regular and steady income

to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

Entry and Exit LoadEntry load is an upfront charge levied by a mutual fund on an investor on the

purchase of units of mutual fund. w.e.f. 1st august 2008 government has done away with entry load.

Exit Load is a charge levied as a percentage of the existing NAV at the time of exit. Out of the exit load charged, MFs can keep a maximum of 1% for selling and marketing expenses as stipulated by SEBI.

INCOME FUNDS_SBI MAGNUM

INCOME FUNDS_SBI MAGNUM

INCOME FUNDS-Reliance Dynamic Bond Fund

• Bond markets and its dependency on interest rates•

The prices of fixed income securities are governed by the interest rates prevailing in the market. Interest rates and prices of fixed income securities are inversely proportional. If the interest rates increase from the current level, the prices of fixed income securities decrease. Similarly, if the interest rates decrease, the prices of fixed income securities increase.

•For example, consider a 10 year government bond which has a face value of 1000 a coupon rate of 8% i.e. one receives an interest payment of 80. If the lending rate has been increased to 10%, the new bonds with the same face value of 1000 and tenure of 10 years provide a coupon rate of 10%. This makes the existing bonds at 8% coupon rate less attractive and it will be traded below its face value in the market. Let us assume that the existing bond is now being traded at 900. The yield of the bond is increased to 8.89% (80/900 *100) from the initial 8%.

•Similarly, if the interest rates are slashed to 7%, the existing bonds at 8% coupon rate attract more buyers. Now the bond trades at price higher than its face value. If the bond the trades at 1050, the yield on the bond will be 7.62% which is lower compared to the initial rate of 8%. The yield of the bond maintains a direct relation with interest rate and the price of the bonds maintain an inverse relation. A drop in interest rates will create more demand for existing bonds in the secondary market and increases the bond price. Similarly, when the interest rates increase, the existing bonds are traded below their face value.

Growth/ Equity Oriented FundSuch funds aim at capital appreciation by investing in

growth stocks. They build up a portfolio of stocks that yield above average returns. They do not distribute their income regularly but offer substantial capital appreciation in the long run. However, growth funds are more volatile.

Balanced Funds or hybrid funds

The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.

Balanced Funds

Sector Funds-Banking

Sector Funds-Pharma

Fund of Funds

Fund of Funds-Commodity Oriented

• ACTIVE AND PASSIVE Another distinction that is important for the investor is the difference between active and passive

FUNDS. This distinction is based on how the FUND manager views his role. Active funds are those that aim to beat the

MARKET benchmark. A benchmark is a reference point against which fund managers and investors can compare

performance. For example, most equity funds will have either the Sensex or the Nifty as benchmarks. The funds that want

to just mimic an index are called passive funds. Investors who want to have an investment vehicle that they want to

choose once and then just use over their investment lifetimes without worrying about whether their fund manager is going

to stay with the fund or whether he will sustain the performance or not choose passive funds. Investors who want returns

that are ahead of the MARKET and do not mind taking higher risk that comes due to fund manager choose active funds.

Active fund The reason for the existence of an active fund is to beat the benchmark it has chosen to measure its

performance against. Fund managers of active funds believe that they have the ability to select STOCKS and time the

market in a manner that makes the returns on their portfolio higher than what the market (in the form of the benchmark)

gives over a specific period of time. Active funds have fund managers who have the freedom to pick and choose stocks they

want to buy or sell. Of course, the freedom comes in an institutional structure with internal rules. Since fund managers are

actively involved, there are costs on research and transaction. The best performing active funds have beaten their

benchmarks by an average of 6% on a compounded annual growth rate basis over the last 10 years. Passive fund

Also called index funds since their only aim is to mimic an index they choose, passive funds don’t have fund

managers. In fact, they don’t need fund managers to manage them. They simply mimic their benchmark indices.

They INVEST in scrips—and in exactly the same proportion—as they lie in their benchmark indices. They move up and down as much as their benchmarks move. For example, a passive fund on the Nifty index will buy all 50 stocks in the Nifty in the same proportion as are held by the Nifty. Each time a stock is taken out or added to the Nifty index, the fund will do the same. On a day-to-day basis, this makes for lesser work than those managing active funds. Changes in the composition of the index are usually not more frequent than once a year. However, individual weights of scrips in an index change every day and since index funds are mandated to simultaneously change their scrip weights in the last half hour before the equity market closes, by rebalancing their existing portfolios index funds do end up incurring some cost. Investors can expect almost the same return as the index their FUND tracks, though there will be a small difference between an index fund’s performance and that of its benchmark’s. Called the tracking error, this is caused because of the small cash component that every index fund keeps (to face redemption pressures) and also the various costs it incurs (that eventually reduce your fund’s net asset value) such as brokerage, advertising, MARKETING and so on. Costs are lower in a passive fund compared with an active fund. Passive FUNDS are of two kinds—index mutual funds and exchange-traded funds (ETFs). An ETF is a index fund with just one difference from the investor’s point of view. Investors can buy and sell ETFs on the STOCK markets as ETFs need to be listed on a stock exchange. ETFs come with several advantages over an index fund. First, they have lower fees than index funds and lower tracking error. They also allow you the facility of real-time buying and selling, unlike index funds that will give you the price once a day on which you will INVEST. Read more at: http://www.livemint.com/Home-Page/RJ7dH5aKxGvENYlvyeS9SK/Types-of-funds.html?utm_source=copy

Exchange Traded FundsAn ETF is a diversified basket of securities that can be traded in real time like

individual stocks on an exchange. They are bought and sold throughout the trading day like any stock. ETFs invest either in all stocks that comprise the chosen index in proportion to the weightage given to the stocks in the index or a representative sample of stocks that are included in the index.

First ETF- Nifty BeEs- It is based on Nifty 50

GOLD ETF

If you believe that Nifty and Sensex will scale new peaks over the next three-to-five years and are wondering how to bet on them, ETFs and Index FUNDS     are the two options that you can explore. Though both are passively managed FUNDS     and their returns closely track that of the benchmark, they are not the same. Here are the differences.How to buy them?ETFs, as the name suggests, are TRADED     on the exchange and are bought and sold only through the exchange. ETFs being similar to equity shares, you will need demat and broking accounts to buy them. But Index FUNDS     can be bought or sold directly from the fund house, similar to other mutual fund schemes.What about the costs?Just as brokerage is charged on the value of equity shares that you buy or sell, you will have to pay brokerage when you buy/sell ETFs. But in Index funds you will have to pay an annual management fee. The expense ratio in most Index funds may be upwards of 1 per cent, deductible every year. A fund with a lower expense ratio may be desirable.

Are the returns divergent?

Even as both these funds passively track the underlying index, their returns may be divergent. One unit of an ETF is theoretically equivalent to a tenth of the underlying index value. But that is not always the case. Reason: these being exchange-traded, liquidity has a bearing on the ETF’s value and returns.In the case of Index funds, the deviation in returns compared with the underlying index can be much higher.This is because these funds are allowed to hold some portion of their assets as cash — either to meet redemption requests from investors or to cushion against volatility when the MARKETS     are turbulent. This can impact returns. Also, higher expense ratio can eat into the scheme’s gains.Given that the management fee is to be deducted annually, one cannot rule out lower returns for Index funds over the long term, compared with their underlying index and ETFs of the same index.

How to choose?

While choosing an ETF, it is preferable to buy the most liquid ones. If you get stuck with illiquid ETFs, not only will your returns suffer but selling them when you need money may not be an easy proposition.Likewise, when you are looking to invest in an Index FUND    , go for the ones with lower expense ratio, because high expense ratio can eat into your long-term returns.

Charges

ETF - There are no recurring charges in case of ETFs. Apart from the annual maintenance charge (1%) on your demat account the only other charge is transaction charge of maximum 0.5%. Overall charges in an ETF would come to be about 0.5%.

Index FUND    - This is the worst demerit of index FUNDS    compared to ETFs. First there is the fixed transaction fee of Rs 100 for all INVESTMENTS    above Rs 10,000. Second there is a recurring AMC charge called as expense ratio which presently ranges from 1% -1.8%. This is deducted from your INVESTMENT    even if there are no transactions. Finally if you redeemINVESTMENT    before exit period a flat percentage is deducted as exit load. This can be ignored because anyway index funds are supposed to be held long term.

There is however a way to dodge some of these charges in index funds. Direct investment with the AMC does not involve transaction fee and expense ratio of such plans are also lower. Since direct was introduced only in January 2013 we are not sure how much the difference might come to.

Conclusion

Since the great advantage ETFs have over index funds seems to be in cost, we suggest if you have a demat account you invest through ETF. Since SIP is not possible, you’d have to motivate yourself to invest in a disciplined manner. Others can choose SIP in direct plan of index funds of one of the top AMCs.

Kotak PSU Bank ETF

Kotak PSU Bank ETF-Underlying CNX PSU Bank

CNX PSU BANK

ART FUNDS

1. Osian’s 2. Yatra3. Crayon Capital4. Indian Fine Art Fund

Innovative Funds

• ETFs• Gold ETFs• Art Funds• SIPs: Systematic Investment Plan• REMS: Real Estate Mutual funds. Eg. ICICI

Prudential Real Estate Securities Fund - Retail Plan (G)

Advantages of Mutual Funds1. Professional Management2. Diversification3. Lower Transaction Cost4. Liquidity5. Flexibility and Choice6. Good Regulations7. High Returns8. Easy access to information

Settlement in MFs

All requests for subscription and redemption are settled on individual basis and only to the extent of the FUNDS   /units paid in by participants/clients on the settlement day. Receipt and transfer of funds and units for subscription are done on a T+1 day basis. . Receipt and transfer of mutual fund units for redemption is done on T day and is conducted for units in dematerialised form only. The transfer of funds for redemption is carried out on a T+1, T+2 and T+3 basis depending upon the category of funds.

• The net asset value (NAV) of a mutual fund indicates the price at which the units of that mutual fund are bought or sold. It represents the fund's market value after subtracting the liabilities. The NAV per unit is derived after dividing the net asset value of the fund by the total number of its outstanding units.

• The formula for calculating NAV:

• How is NAV calculated?• The value of all the securities in mutual funds

portfolio is calculated daily. From this, all expenses are deducted and the resultant value divided by the number of units in the fund is the funds NAV or its Net Asset Value.

Pricing of Units• Open ended fund should publish the sale and purchase price of units at least once a week in a

daily newspaper with all India circulation. Repurchase price should not be lower than 93% and sale is not higher than 107% of the NAV. The difference between repurchase price and sale price of the units should not exceed 7% of the sale price.

A Mutual Fund should deduct from the repurchase proceeds of close ended scheme launched prior to April 2009 such proportion of initial expenses of the scheme as are attributable to the units being purchased if (i) the scheme is launched after May 2006 but prior to May 2008 and (ii) Initial expenses in respect of the scheme are announced in the books of accounts of the scheme in accordance with the applicable regulations.

Performance Evaluation1. Sharpe Ratio2. Treynor’s Ratio3. Jensen’s Measure

Sharpe Ratio

• =Average return on the portfolio t during a period.

• RFR= Average risk free rate of return during the same period

• = Standard Deviation of the return of portfolio t• is the risk premium

Treynor’s Ratio

• =Average return on the portfolio t during a period.• RFR= Average risk free rate of return during the same

period• = Beta coefficient of the return of portfolio t• is the risk premium• Sharpe ration measure the risk premium of the fund

per unit of systematic risk• A portfolio with higher is preferred.

Beta

= correlation of returns of the fund with market

Beta is a statistical tool, which gives you an idea of how a fund will move in relation to the market. In other words, it is a statistical measure that shows how sensitive a fund is to market moves. If the Sensex moves by 25 per cent, a fund's beta number will tell you whether the fund's returns will be more than this or less.

The beta value for an index itself is taken as one. Equity funds can have beta values, which can be above one, less than one or equal to one. By multiplying the beta value of a fund with the expected percentage movement of an index, the expected movement in the fund can be determined.

Jensen’s Measure

• =Average return on the portfolio jduring a period.• RFR= Average risk free rate of return during the same period• = Systematic risk of portfolio j• = Forecasting ability of fund manager• is the risk premium• = average return of a market portfolio for a specific period

The model attempts to measure if more than expected return are being earned for portfolio’s riskiness. It is a measure of absolute performance of a portfolio on a risk adjusted basis.

QuestionRank the following funds according to (i) Sharpe (ii) Treynor Ratio and (iii) Jensen’s measure. Risk free rate of return is 8%

Fund Average Annual Return (%)

Standard Deviation (%)

Correlation with market

P 22 15 0.75

Q 15 10 0.50

R 19 22 0.35

S 12 7 0.90

Market Portfolio 12 10

Ans (i) 0.93, 0.70, 0.50, 0.57

(ii) Beta values: 1.125, 0.50, 0.77, 0.63; 0.124, 0.14, 0.143, 0.063

(iii)alpha = 0.095, 0.05, 0.0792, 0.0148