Mutual Funds

A Mutual Fund (MF) is a simple way for investors to pool their money and invest collectively in assets such as shares, bonds and money-market instruments. The pooled money is managed by a professional fund manager according to the objective of the scheme.

In return, investors receive units based on the amount they invest. The value of these units changes according to the performance of the investments held by the fund.

Regulation of Mutual Funds

In India, mutual funds are regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Mutual Funds) Regulations, 1996.

How Do Mutual Funds Work?

The basic working of a mutual fund is straightforward:

• Pooling of Funds: Money from many investors is collected into a common pool.
• Professional Management: A fund manager invests this money according to the scheme’s investment objective.
• Diversification: The money is spread across different securities, sectors or asset classes rather than being concentrated in one investment.
• Units: Investors receive units in proportion to their investment.
• Returns: Any gain or loss in the underlying investments is reflected in the value of the units.

Key Features and Advantages of Mutual Funds

• Diversification: Money is invested across multiple securities, which helps reduce concentration risk.
• Professional Management: Investors benefit from the expertise of professional fund managers.
• Affordable Investment: Investors can start with relatively small amounts, including through SIPs.
• Liquidity: Open-ended schemes generally allow investors to purchase or redeem units on business days, subject to scheme terms.
• Transparency: Mutual funds are required to follow SEBI’s disclosure and reporting requirements.
• Multiple Choices: Investors can choose schemes according to their risk appetite, financial goals and investment horizon.
• Regulated Framework: Mutual funds operate under the regulatory framework prescribed by SEBI.

Types of Mutual Funds

Mutual funds can be classified according to their asset class, structure, investment objective and management style.

Based on Asset Class

• Equity Funds: Invest mainly in shares of companies and generally aim for long-term capital growth.
• Debt Funds: Invest primarily in fixed-income securities such as government and corporate bonds.
• Hybrid Funds: Combine equity and debt investments in a single portfolio.
• Money Market Funds: Invest mainly in short-term money-market instruments such as Treasury Bills, Commercial Papers and Certificates of Deposit.

Based on Structure

• Open-Ended Funds: Investors can generally buy or redeem units on an ongoing basis at the applicable NAV.
• Close-Ended Funds: Have a fixed maturity and are generally available for subscription during the New Fund Offer (NFO) period. Units may subsequently be traded on stock exchanges, depending on the scheme.
• Interval Funds: Allow investors to buy or redeem units only during specified intervals.

Based on Investment Objective

• Growth Funds: Focus primarily on capital appreciation.
• Income-Oriented Funds: Aim to generate income through investments in income-generating securities.
• Liquid Funds: Invest in short-term and highly liquid debt and money-market instruments.
• Tax-Saving Funds (ELSS): Equity-oriented schemes that provide tax benefits under applicable provisions of the Income Tax Act, subject to prevailing rules.
• Retirement/Pension-Oriented Funds: Designed to support long-term retirement-related investment goals.

Based on Management Style

• Actively Managed Funds: A fund manager actively selects securities with the aim of achieving the scheme’s investment objective.
• Passively Managed Funds: Seek to replicate or track a market index such as the Nifty 50 or Sensex.

Active Fund → Fund manager selects investments

Passive/Index Fund → Tracks an index

Modes of Investing in Mutual Funds

• Lump Sum Investment: A relatively large amount is invested at one time.
• Systematic Investment Plan (SIP): A fixed amount is invested at regular intervals, generally monthly, in a mutual fund scheme.

SIP makes mutual fund investing more accessible because investors can start with smaller amounts and invest regularly instead of committing a large sum at once.

Taxation of Mutual Funds

The tax treatment of mutual fund investments depends on the type of fund, nature of income and applicable holding period.

• Capital Gains: These arise when mutual fund units are sold or redeemed at a price higher than their acquisition cost. Tax is generally applicable when the units are sold or redeemed.
• Income Distribution: Taxable income distributed by a mutual fund is generally taxed in the hands of the investor according to the applicable tax rules.

Important Mutual Fund Terminologies

• Assets Under Management (AUM): Total market value of assets managed by a mutual fund or scheme.
• Portfolio: Collection of securities and other assets held by a mutual fund scheme.
• Benchmark: An index or standard used to compare the performance of a fund.
• Expense Ratio: Fee charged for managing and operating the scheme, expressed as a percentage of its assets.
• Exit Load: A charge that may apply when units are redeemed within a specified period.
• Redemption: The process of selling mutual fund units and receiving the applicable proceeds.
• Lock-in Period: A specified period during which units generally cannot be redeemed.
• SIP: A facility through which a predetermined amount is invested periodically.
• Holding Period: The length of time an investor holds mutual fund units, which may also determine the applicable tax treatment.

FAQs

Q1. What is a mutual fund?
A mutual fund pools money from several investors and invests it in assets such as equity, debt and money-market instruments.

Q2. Who regulates mutual funds in India?
Mutual funds in India are regulated by SEBI.

Q3. What is NAV?
NAV is the value of one unit of a mutual fund scheme, based on the scheme’s net assets and total outstanding units.

Q4. What is SIP?
SIP allows an investor to invest a fixed amount at regular intervals in a mutual fund scheme.

Q5. What is the difference between active and passive funds?
An active fund relies on a fund manager to select securities, while a passive fund seeks to track a specified market index.

Q6. Are mutual funds risk-free?
No. Mutual funds are market-linked investments, so their value and returns can rise or fall depending on the performance of the underlying assets.