SANKSHIPT

An abridged version of NxtGen MFD

Compiled by

Vinod Tantri
Founder, Knowledge Bell

www.Knowledgebell.com
 Welcome to Knowledge Bell,

We thank you for considering us as your mentor in the journey of starting new business as a Mutual
Fund Distributor. While the mutual fund industry offers significant opportunities, it also faces
challenges such as market volatility, regulatory compliance, performance expectations, fee pressure
and technology adoption. Addressing these challenges requires industry stakeholders to stay agile,
adapt to changing market dynamics, enhance investor education, embrace technology, and maintain
strong compliance and risk management practices.

These statistics indicate the growing popularity and acceptance of mutual funds as an investment
avenue among Indian investors. The increasing industry AUM, investor base, number of schemes,
and SIP investments demonstrate the potential and scope of mutual funds in India's financial
landscape.

We at Knowledge Bell, believe in holistic approach of distribution, wherein the financial

intermediary distributes major financial products and serves his clients as “One Stop, Top Shop”
for financial needs. Mutual Fund Distribution is one of the areas wherein we hand hold aspirants to
get Mutual Fund Distribution License at zero cost and start their career in Investment Industry.
In past 2 years more than 800 + aspirants have benefited from above program. Many professionals
have started earning additional income as a Mutual Fund Distributor and some have started career
in Investment Industry.

In addition to the free online training we are sharing you below notes for quick reference. The
pointers are derived from NISM MFD VA Syllabus, edition June 2022. Hope this would be handy
for the exam and for future references.

At your service,
Vinod Tantri – Founder Knowledge Bell

www.Knowledgebell.com 2
 Chapter 1
Investment Landscape

Learning Objectives:

o Investors and their financial goals

o Saving or investment
o Different asset classes
o Investment risks
o Risk measures and management strategies
o Behavioural biases in investment decision making
o Risk profiling
o Understanding asset allocation
o Do-it-yourself v/s taking professional help

Investors & their financial goals

• As leadership guru, and bestselling author Simon Sinek says, “Start with Why”.
• The discussion of investments must start with “why” – the purpose of investment.
• Why is one investing?”

Why Investments?
• Every investor has one or more financial objectives like education, marriage, property,
retirement etc.
• By assigning amounts and timelines to these objectives, it will get converted into financial
goals.

Goal setting steps

• Identify financial events in life.
• Assign priorities
• Assign a timeline as well as amount of funding required
• Identify Short Term, Medium Term and Long-Term Goals

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 Time management matrix
• This looks very similar to the urgent v/s important matrix that Stephen Covey discussed in
his bestseller “The Seven Habits of Highly Effective People”.
• Wisdom suggests that if one plans well for those important and not urgent tasks (and goals),
life changes for the better.
• The matrix is referred in the context of time management:

Goal planning – case study

Sunita is 1 year old. Her dad wants that she pursue MBA degree course. For this the amount
required is Rs. 7,50,000 in today's terms which will increase @ 7% p.a. and the amount is required
after 20 years. How much per year should her father start saving from now on if he gets 8% return
on investment.

Step 1: Calculate the Future Value of Current Cost (Goal Amount)

PV = 7,50,000 Inflation RATE = 7%

Year 0 NPER = Year 20

20

Step 2: Calculate the Investment amount required to achieve the goal

PMT (Investment required) = ??? FV = Result from Step 1

Year 0 NPER = 20 Return RATE = 8%

Savings v/s investing

• The word “saving” originates from the same root as “safe”. The safety of money is of critical
importance here.
• Whereas, when one invests money, the primary objective typically is to earn profits.
• The important point to note here is that there is a trade-off between risk and return.

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 • Saving and investing are not to be considered as two completely different things, but two
steps of the same process. Saving precedes Investing.

Real estate
• Real estate is one of the most important and popular among all the asset classes.
• Individuals usually purchase real estate for self occupation.
• Real estate could be classified into; residential real estate, land, commercial real estate, etc.
• Real estate exhibits certain traits, some of which are listed as under:
• Location is the most important factor in real estate
• Real estate is illiquid
• Real estate is not a divisible asset
• Investment can be done in physical, as well as in financial form
• Apart from capital appreciation, it can also generate rental income
• The transaction costs are quite high.
• The cost of maintenance of the property, as well as any taxes payable are also quite high.

Real estate – investment avenues

Physical Asset
• Residential/ Commercial

Financial Asset
• Real Estate Mutual Funds (REMF)
• Real Estate Investment Trusts (REIT)
• Infrastructure Investment Trust (InvIT)

Commodities
• Regularly, we consume many commodities, like spices, petroleum products, or gold and
silver.
• It may not be possible to invest in most of these, as they are either perishable or consume
storage space.
• There are commodities derivatives available. but we may not call this as “investments” for
two reasons;
• These are leveraged contracts.

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 • These are normally short-term contracts, whereas the investors’ needs may be for longer
periods.
• Many investors are quite familiar with as investment avenues, viz., gold, and silver.
• When someone invests in these commodities, the prices are almost in sync across the world.
• It is easy to understand the prices of gold and silver across countries by simply looking at the
foreign exchange rate between the two countries’ currencies.
• In this manner, these two are globally accepted assets.
• Gold and Silver have been used as investments or storage of value for long as Gold has been
considered by many as a safe haven asset.
• In case of failure of an economy, or a currency, gold is considered to be the final shelter.
• These assets would provide only capital appreciation and do not generate any current income.
• Gold and silver come in varying degrees of purity.
• If we opt for purity certificate, the cost goes up & without one, the risk of getting lower
quality metal is high.

Commodities –investment avenues

• Gold
• Silver
• Gold Funds
• Commodity ETFs

Fixed income
• When someone borrows money, one has to return the principal borrowed to the lender in the
future.
• Interest is payable on such amount borrowed.
• There are various forms of borrowing, some of which are through marketable instruments like
bonds and debentures.
• There are many issuers of such papers, e.g. Companies, Union Government, State
Governments, Municipal Corporations, banks, financial institutions, public sector enterprises,
etc.
• Investors may get regular income through pay-out or accumulate till the date of maturity.
• In case of transaction through secondary market, it may result into capital gains or losses.
• Bonds are generally considered to be safer than equity. However, these are not totally free from
risks.

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 • Bonds can be classified on the basis of issuer type i.e. issued by the government or corporates
or on the basis of the maturity date: short term bonds, medium term bonds, and long term bonds.

Fixed income –investment avenues

• Fixed deposit with a Bank / Post Office
• Recurring deposit with a Bank / Post Office
• Endowment / Money Back Policies
• Public Provident Fund
• Sukanya Samruddhi Yojana (SSY)
• Senior Citizens’ Savings Scheme (SCSS)
• Post office Monthly Income Scheme
• Company fixed deposit
• Debentures/Bonds
• Debt Mutual Funds

Equity
• This is the owner’s capital in a business.
• Someone who buys shares in a company becomes a part-owner in the business.
• This is risk capital, since the owner’s earnings from the business are linked to the fortunes,
and hence the risks, of the business.
• When one buys the shares through secondary market, the share price could be high or low in
comparison to the fair price.
• Historically, equity investing has generated returns in excess of inflation.
• It has also delivered higher returns than other investment avenues, most of the times.
• Since the base year of 1979, Sensex has grown from a level of 100 to around 55,000 in July
2021. This is an appreciation of 16% compounded annually.
• Apart from long term capital appreciation, equity share owners may also receive dividends
from the company.
• Dividends are shared out of the profits that the company generates from its business
operations
• If the company does well, the dividends tend to grow over the years.
• In the long term, the share prices follow the fortunes of the firm.

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 Equity – Investment avenues
• Blue-chip Companies
• Mid-sized companies
• Small-sized companies
• Unlisted Companies
• Foreign Stocks
• Equity Mutual Funds
• Exchange Traded Funds
• Index Funds

Equity – Investment options

Direct Investment Indirect Investment
• Primary Markets • Mutual Funds
• IPO • Insurance – ULIP
• FPO • NPS
• Rights • PMS
• Secondary Markets • ETF
• Stock Exchanges
• Offline Transactions

Major Stock exchanges in India

BSE
• Established in 1875
• Over 5,000 Co’s listed
• Index name: SENSEX
• No. of Index Stock: 30

NSE
• Established in 1992
• Over 2,500 Co’s listed
• Index name: NIFTY
• No. of Index Stock: 50
• The Sensex refers to India's benchmark stock index, which was created in 1986 and
represents 30 of the largest and most well-capitalized stocks on the BSE. The Sensex has been

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 on a growth curve since India opened up its economy in 1991. Most of its growth has occurred
in the 21st century.
• The Nifty meaning is a derivation from the mix of two words, i.e. “National Stock Exchange”
and “fifty”. It is an abbreviation of the National Stock Exchange Fifty. It is a collection of top
performing 50 equity stocks that are actively trading in the index.

Asset class – similarities and differences

• Investor in equity, real estate and commodities is an owner of the asset, whereas an investor in
bonds acts as a lender to someone.
• Except in bonds, in all the other investments, the investor’s cashflows (or receipts) are
unknown, but has the potential to get better returns. Whereas the coupons/interest is fixed in
bonds or Fixed Deposits.

International investing
• One can invest in shares of various companies listed outside India, which provides exposure
to another currency.
• One could also invest in bonds denominated in various currencies other than Indian Rupee,
and one could also buy real estate abroad.
• Foreign investment returns are depending upon asset class performance and currency
fluctuation on these investments.

Other investment avenues

• Rare coins
• Art
• Rare stamps

Investment risks – inflation risk

• Money loses value over time
• Goods gradually become expensive
• This is Inflation
• Inflation increases over time and decreases the value of money

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 Investment risks – liquidity risk
• In case one needs money before maturity of the instruments, there could be some charges or
such an option may not be available at all.
• This risk is also very closely associated with real estate, where liquidity is very low, and often
it takes weeks or months to sell the investment.
• Similarly in the secondary market, if there are no buyers for your investments, it would result
in liquidity risk.

Investment risks – credit risk

• When someone borrows money from other person, he agrees to pay the interest & the
principal on time.
• Following situation may arise after borrow:
1. He honours all commitments in time,
2. He pays the dues, but with some delay,
3. He does not pay principal and the interest at all.
• While the first is the desirable situation, the latter two are not.
• Credit risk is all about the possibility that the second or the third situation may arise.

Investment risks – market risk & price risk

• When securities are traded in an open market, people can buy or sell the same based on their
opinions.
• Since the opinions may change very fast, the prices may fluctuate more in comparison to the
change in facts related to the security.
• Such fluctuations are also referred to as volatility.
• There are two types of risks to a security—Market Risk and Price Risk.

Investment risks – interest rate risk

• Interest rate risk is the risk that an investment's value will change as a result of a change in
interest rates.
• This risk affects the value of bonds/debt instruments more directly than stocks.
• Any reduction in interest rates will increase the value of the instrument and vice versa.

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 Risk Measures And Management Strategies
• Many of the risks cannot be eliminated, and the investor must take some of those, in order to
earn decent returns on one’s investment portfolio.
• One needs to manage the risks that he is taking.
• One may consider the following strategies for management of the investment risks:
1. Avoid
2. Take a position to benefit from some event
3. Diversify

Behavioural Biases in Investment Decision Making

• Investors are driven by emotions and biases.
• The most dominant emotions are fear, greed and hope.
• Some important biases are discussed below:

Availability Heuristic
• Most people rely on examples or experiences that come to mind immediately while analysing
any data, information, or options to choose from
• In investments, this means that enough research is not undertaken for evaluating investment
options

Confirmation Bias
• This is the tendency to look for additional information that confirms to their already held
beliefs or views.
• Investors decide first and then look for data to support their views.
• Investors tend to miss out on many risks.

Familiarity Bias
• People tends to prefer the familiar over the novel, as the popular proverb goes, “A known
devil is better than an unknown angel”.
• This leads an investor to concentrate the investments in what is familiar, which at times
prevents one from exploring better opportunities.

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 Herd Mentality
• “Man is a social animal” – Human beings love to be part of a group.
• This often works against investors interests in the financial markets.
• There are numerous examples, where simply being against the herd has been the most
profitable strategy.

Loss aversion
• Loss aversion explains people's tendency to prefer avoiding losses to acquiring equivalent
gains
• It is better not to lose Rs. 5,000 than to gain Rs. 5,000.
• Such a behaviour often leads people to stay away from profitable opportunities

Overconfidence
• This bias refers to a person’s overconfidence in one’s abilities or judgment.
• This leads one to believe that one is far better than others at something, whereas the reality
may be quite different.

Recency bias
• The impact of recent events on decision making can be very strong.
• This applies equally to positive and negative experiences.
• Investors tend to extrapolate the event into the future and expect a repeat.

Choice paralysis
• Too many choices result in postponed decisions.
• This inability to choose is known as decision paralysis (and also known as choice
paralysis or analysis paralysis) and it is an insidious enemy.

Behaviour patterns
• Different factors influence the manner in which investors save or invest.
• The drive to save more or be regular in investing often come from these personal factors.
• Behavioral tests are very useful in determining and knowing the kind of personality a person
has and this would include whether they are spenders or savers or investors.

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 Interest of the investors
• Many times, the financial and investment decisions are not guided by the fact as to whether
this investment is suitable for a person or not but by the interest of the investor.
• This can lead to the construction of portfolios which are not suitable for specific people.
• For example: Someone working in the Information Technology industry might just have
technology stocks in their portfolio.

Ethical Standards
• The presence of ethical principles in the dealing of individuals also has an impact as far as
their investment behavior is concerned.
• Those following ethical standards are more likely to pay attention to their investments and be
disciplined because they tend to follow the norms.
• This is a big help when it comes to building long term wealth.

RISK PROFILING
• The risk profilers try to ascertain the risk appetite of the investor so that one does not
sell mutual fund schemes that carry higher risk than what the investor can handle.
• In order to ascertain the risk appetite;
• Need,
• Ability, and
• Willingness must be evaluated.

Asset allocation
• The basic meaning of asset allocation is to allocate an investor’s money across asset
categories in order to achieve some objective.
• In many cases, the same would have done without any process or rationale behind it.

Strategic Asset allocation

• This allocation aligned to the financial goals of the individual.
• It considers the returns required from the portfolio to achieve the goals, given the time
horizon available for the corpus to be created and the risk profile of the individual.

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 Tactical Asset Allocation
• The purpose of such an approach may be to take advantage of the opportunities presented by
various markets at different points of time.
• It considers the returns required from the portfolio to achieve the goals, given the time
horizon available for the corpus to be created and the risk profile of the individual.

Rebalancing
• An investor may select any of the asset allocation approach, however there may be a need to
make modifications in the asset allocations.
• The rebalancing approach can work very well over the years, when the various asset
categories go through many market cycles of ups and downs.

Do-it-yourself v/s Taking Professional Help

• Investments can be made in various financial instruments as discussed.
• One option is to manage the investments oneself and the other option is to outsource the entire
job to a professional or a company engaged in such a business, like a Mutual Fund.

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 Chapter 2
Concept & Role of Mutual Fund

Learning Objective

o Concept and Role of mutual funds

o Classification of mutual funds
o Growth of mutual fund industry in India

Concept of mutual funds

• A mutual fund is a professionally managed investment vehicle.
• Practically, one does not invest in mutual fund but invests through mutual funds
• As a mutual fund distributor, it is critical to understand the difference between the two
concepts.
• A pool of money collected from investors with common investment goal. Fund Manager
makes investments according to investment objective of investors.
• Profits or losses in a mutual fund belong to the investors in proportion to their share in the
pool of money.

Role of Mutual Funds

• The primary role is to assist investors in earning an income or building their wealth by
participating in the opportunities available in various securities and markets.
• The money that is raised from investors, ultimately benefits governments, companies or other
entities, directly or indirectly, to raise moneys to invest in various projects or pay for various
expenses
• They offer employment to people outside the mutual fund industry.
• They offer livelihood to a large number of employees, distributors, registrars and various
other service providers.
• Higher employment, income & output in the economy boost the revenue collection of the
government through taxes.
• Mutual funds can also act as a market stabilizer, in countering large inflows or outflows from
foreign investors.
• Thus, mutual funds help in overall economic development of the nation

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 Investment Objectives of Mutual Funds
• Mutual funds seek to mobilize money from all possible investors.
• Since investors have different investment preferences and needs, mutual funds mobilize
different pools of money and each such pool of money is called a mutual fund scheme.
• Every scheme has a pre-announced investment objective.

Examples of Investment Objectives

Investment Objectives Type of mutual fund scheme
The scheme intends to provide Overnight fund
reasonable income along with high
liquidity by investing in overnight
securities having maturity of one
business day.
To generate capital Equity fund
appreciation/income from a portfolio,
predominantly invested in equity and
equity related instruments
The primary objective of the scheme is
to generate long term capital
appreciation by investing
predominantly in equity & equity
related securities of companies across Hybrid fund
the market capitalization. The fund
also invests in debt & money market
instruments with a view to generate
regular income.
The primary objective of the scheme is
to generate a steady stream of income Long Duration fund
through investment in fixed income
securities.

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 MUTUAL FUND FOR EVERY FINANCIAL GOAL

Investment policy of Mutual Funds

• Mutual funds are investment vehicles that invest in different asset categories and the returns
would depend on the returns generated from these underlying investments.
• Once the investment objective is finalized, the mutual fund scheme’s investment policy is
arrived at, in order to achieve the investment objective.
• The investment policy includes the scheme’s asset allocation and investment style.

Important Concepts in Mutual Funds

What is the smallest unit of gold to buy?
Smallest measure for mutual fund = An Unit
Each unit comes with a minimum face value of ₹ 10
The number of units you purchase depends on the total investment made
Face Value
• The face value is the original price of the unit.
• Typically, every unit has a face value of ₹ 10.
• The face value is relevant from an accounting perspective.

Unit capital
• The number of units issued by a scheme multiplied by its face value (₹ 10) is the capital of the
scheme – its Unit Capital.

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 Recurring Expenses
• The fees or commissions paid to various mutual fund constituents come out of the expenses
charged to the mutual fund scheme.
• These are known as recurring expenses.
• These expenses are charged as a percentage to the scheme’s Assets Under Management
(AUM).

Net Asset Value

• The true worth of a unit of the mutual fund scheme is otherwise called Net Asset Value (NAV)
of the scheme.
• When the investment activity is profitable, the true worth of a unit increases.
• When there are losses, the true worth of a unit decreases.

AUM
• The sum of all investments made by investors’ in the mutual fund scheme is the entire mutual
fund scheme’s size, which is also known as the scheme’s Assets Under Management (AUM).
• This can also be obtained by multiplying the current NAV with the total units outstanding.
• The relative size of mutual fund companies/asset management companies is assessed by their
AUM.

Mark to Market
• The process of valuing each security in the investment portfolio of the scheme at its current
market value is called Mark to Market (MTM).
• The mark-to-market valuation is done on a daily basis for calculation of daily NAV of a
mutual fund scheme.
• This results in daily fluctuations in the NAVs of all schemes.
Advantages of Mutual Funds for Investors
• Professional Management
• Affordable Portfolio Diversification
• Economies of Scale (Low Cost)
• Transparency
• Liquidity
• Tax Deferral

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 • Tax Benefits
• Convenient Options (Flexibility)
• Investment Comfort (Less documentation)
• Regulatory Comfort
• Systematic Approach to Investments

Limitations of Mutual Fund

• Lack of portfolio customization
• Choice Overload
• No Control over Cost
• No Guaranteed returns

Types of Funds – By Structure

• Open-Ended Funds
• Close-Ended Funds
• Interval Funds

Open ended funds

• They are open for investors to enter or exit at any time, even after the NFO
• When existing investors buy additional units or new investors buy units of the open-ended
scheme, it is called a purchase transaction
• When investors choose to return any of their units to the scheme and get back their equivalent
value, it is called a re-purchase transaction.
• The sale and re-purchase price is linked to the NAV.
• Although some unit-holders may exit from the scheme, the scheme continues operations with
the remaining investors.
• The scheme does not have any kind of time frame in which it is to be closed.
• The on-going entry and exit of investors implies that the unit capital in an open-ended fund
would keep changing on a regular basis

Close ended funds

• They have a fixed maturity.
• Investors can buy units, only during its NFO.

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 • Post-NFO sale and purchase transactions happen on the stock exchange between two different
investors, and that the fund is not involved in the transaction, the transaction price is likely to
be different from the NAV.
• As per SEBI guidelines, listing of Close-Ended scheme is compulsory.

Interval funds
• They combine the features of both open-ended and close-ended schemes.
• They are largely close-ended, but become open-ended at pre-specified intervals.
• Minimum duration of an interval period in an interval scheme/plan is 15 days.
• No redemption of units is allowed except during the specified transaction period

Types of Funds – By Management

• Passive Funds
• Active Funds

Passive Funds
• These funds invest on the basis of a specified index, whose performance it seeks to track.
• Passive fund tracking the S&P BSE Sensex would buy only the shares that are part of the S&P
BSE Sensex.
• They are not designed to perform better than the market.
• Passive Funds are also called as index schemes.
• Since the portfolio is determined by the index itself, the fund manager has no role in deciding
on investments.
• These schemes have low running costs.

Actively Managed Funds

• These are funds where the fund manager has the flexibility to choose the investment portfolio,
within the broad parameters of the investment objective of the scheme.
• Investors expect actively managed funds to perform better than the market

Exchange Traded Funds

• They are also passive funds, whose portfolio replicates an index or benchmark such as
Sensex, Nifty etc.

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 • Units are issued to the investors during NFO after which they are available for sale and
purchase on stock exchange.
• Units of ETF are bought & sold at real time prices, which are linked to underlying Index.

Mutual fund scheme categorization and SEBI regulation

SEBI has broadly classified open ended mutual schemes into 5 groups:
1. Equity Schemes (11 sub-categories)
2. Debt Schemes (16 sub-categories)
3. Hybrid Schemes (6 sub-categories)
4. Solutions Oriented Schemes (2 sub-categories)
5. Other Schemes (2 sub-categories)

Equity funds
• A scheme might have an investment portfolio invested largely in equity shares and equity-
related investments such as convertible debentures.
• The investment objective of such funds is to seek capital appreciation through investment in
these growth assets.
• Such schemes are called equity schemes.

Market capitalization
• In order to ensure uniformity in respect of the investment universe for equity schemes, SEBI
has defined the market capitalization of shares:
• Large Cap: 1st - 100th company in terms of full market capitalization
• Mid Cap: 101st -250th company in terms of full market capitalization
• Small Cap: 251st company onwards in terms of full market capitalization

Equity funds
Large Cap Fund Minimum Large Cap allocation of 80%
Mid Cap Fund Minimum Mid Cap allocation of 65%
Small Cap Fund Minimum Small Cap allocation of 65%
Multi Cap Fund Equity exposure of at least 75% with a minimum
allocation of 25% each into Large, Mid & Small Cap.
Flexi Cap Fund Minimum equity exposure of 65%, investing across large
cap, mid cap, small cap stocks
Large and Mid- Minimum Large and Mid-Cap allocation of 35% each

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 Cap Fund
Focussed Equity Minimum equity exposure of 65% with maximum of 30
Fund stocks
Dividend Yield Minimum equity exposure of 65% predominately in
Fund dividend yield stocks
ELSS Fund Minimum equity exposure of 80%
Value OR Contra Minimum equity exposure of 65% following Value /
Fund (Anyone) Contra investment strategy
Sector / Thematic Minimum equity exposure of 80% in a particular
Fund sector/theme (No restriction on number of scheme)

Debt market instruments

Money Market Capital Market
1. Call Money 1. G-Sec (Govt of India)

2. CBLO/TREPS 2. Debentures (Companies)

3. Treasury Bills (Govt of India) 3. State Bonds (State Govts)

4. Certificate of Deposit (CD) 4. Municipal Bonds

5. Commercial Papers (CP) 5. Bank Bonds

Less than 1 year
6. PSU Bonds More than 1 year

Mutual fund scheme categorization and SEBI regulation

There can be only one scheme per category, except in the following cases:
1. Index funds and ETFs replicating or tracking different indices,
2. Fund of Funds having different underlying schemes, and
3. Sector funds or thematic funds investing in different sectors or themes

Other schemes (Close Ended): Fixed Maturity Plans

• They are a kind of debt fund where the investment portfolio is closely aligned to the maturity
of the scheme.
• AMCs tend to structure the scheme around pre-identified investments.
• Further, being close-ended schemes, they do not accept moneys post-NFO.

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 Other schemes (Close Ended): capital protection funds
• These are hybrids funds.
• The portfolio is structured such that a portion of the principal amount is invested in debt
instruments, which grows to the principal amount over the term of the fund.
• This provides the protection to the capital invested.
• The remaining portion of the original amount is invested in equity derivatives.

Other schemes (Close Ended): Infrastructure Debt Funds

• They invests primarily in the debt securities or securitized debt instrument of infrastructure
companies or infrastructure capital companies or infrastructure projects or special purpose
vehicles which are created for the purpose of facilitating or promoting investment in
infrastructure, and other permissible assets in accordance with SEBI Regulations or bank loans
in respect of completed & revenue generating projects of infrastructure companies or projects
or special purpose vehicles.
• Only banks and Infrastructure Finance companies can sponsor IDF-NBFCs.

Other schemes: Real Estate Mutual Fund

• Real Estate Mutual Fund scheme invests directly or indirectly in real estate assets or other
permissible assets in accordance with the SEBI.
• Real Estate Investment Trusts (REIT) are trusts registered with SEBI that invest in
commercial real estate assets.
• Infrastructure Investment Trusts (InvIT) are trusts registered with SEBI that invest in the
infrastructure sector.

New type of funds: Smart Beta Fund

• Smart beta funds are an extension of index or Exchange Traded Funds (ETFs) as they change
the basis of the exposure in the portfolio to the index using alternative strategies.
• Smart beta strategies rely less on market cap and this could include things like equal
weightage or exposure based on additional parameters.
• The whole idea of smart beta funds is to improve returns. Increase diversification and reduce
risk.

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 New type of funds: Quant Fund
• Quant funds rely on data analysis and numbers usually undertaken by machines to select the
securities in the portfolio.
• There are pre-determined models that are created & these are derived through analysis of past
data.
• The model then runs through the emerging data to select the holdings and make decisions
about buying and selling.
• This eliminate human element in decision making.

New type of funds: International REITs

• A fund that invests in Real Estate Investment Trusts abroad gives an exposure to the investor
both to international funds plus the commercial real estate sector.
• In India too the number of REITs being listed are increasingly slowly and this kind of fund
provides a different kind of holding to those who need such exposure.

Growth of the mutual fund industry in India

• India witnessed a surge in the mutual fund AUM from Rs. 6.14 lac crores in Mar’ 2010 to Rs.
22.26 lac crores in Mar’ 2020.
• The 10-year growth stands at 13.74% p.a. compounded annually.
• The number of folios has also seen a big rise, from a little over 4.80 crore folios in March
2010 to 8.97 crores in March 2020. A growth rate of 6.45% p.a
• The share of mutual funds in the overall financial investments in India has risen from 10% in
Mar’ 2016 to 12% in Mar’ 2017 and to 14% in Mar’ 2018.
• Compared to this, there has been a drop in the share of bank deposits from 71% to 69% and
then to 65% during the same period.
• At the same time, the growth of Indian mutual fund industry has been stupendous in
comparison to the world.
• The Indian mutual fund industry’s share has gone up from 0.33% in 2008 to 0.60% in 2018.

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 Chapter 3
Legal Structure of Mutual Funds in India
LEARNING OBJECTIVE
o Legal Structure of mutual funds
o Key Constituents of a Mutual Fund
o Organization Structure of Asset Management Company (AMC)
o Role and support functions of service providers of mutual funds

Structure of Mutual Funds in India

SEBI (Mutual Fund) Regulations, 1996 defines Mutual Fund as;
“a fund established in the form of a trust to raise monies 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 or gold or gold-related instruments or real estate
assets.”
• Mutual funds are constituted as Trusts. They are governed by the Indian Trusts Act, 1882.
• The mutual fund trust is created by one or more Sponsors, who are the main persons behind
the mutual fund business.
• 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.
• The operations of the mutual fund trust are governed by a Trust Deed, which is executed
between the sponsors and the trustees.
• The Trust acts through its trustees. The role of protecting the interests of the beneficiaries
(investors) is that of the Trustees.
• In order to perform the trusteeship role, either individuals may be appointed as trustees or a
Trustee company may be appointed.
• Day to day management of the schemes is handled by an Asset Management Company
(AMC).
• The AMC is appointed by the sponsor or the Trustees.
• The trustees execute an Investment Management Agreement (IMA) with the AMC, setting out
its responsibilities.

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 • Although the AMC manages the schemes, custody of the assets of the scheme (securities, gold,
gold-related instruments & real estate assets) is with a Custodian, who is appointed by the
Trustees.
• Investors invest in various schemes of the mutual fund. The record of investors and their holding
may be maintained by the AMC itself, or it can appoint a Registrar & Transfer Agent

Mutual Fund structure - example

Mutual Fund ICICI Prudential Mutual Fund

Sponsor ICICI Bank Limited and Prudential Plc

Trustee ICICI Prudential Trust Limited

AMC ICICI Prudential Asset Management Co. Ltd.

Custodian(s) Citibank N.A. / Deutsche Bank AG / HDFC Bank

Limited / HSBC / SBI-SG Global Securities Services
Private Limited
RTA Computer Age Management Services Ltd

Auditors S. R. Batliboi & Co. LLP

Mutual Fund Nippon India Mutual Fund

Sponsor Nippon Life Insurance Company

Trustee Nippon Life India Trustee Limited

AMC Nippon Life India Asset Management Ltd.

Custodian(s) Deutsche Bank AG

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 RTA K Fintech Private Limited

Auditors Haribhakti & Co LLP

Key Constituents – Sponsor

• The application to SEBI for registration of a mutual fund is made by the sponsor(s).
• Thereafter, the sponsor invests in the capital of the AMC.
• Since sponsors are the main people behind the mutual fund operation, eligibility criteria has
been specified as follows:
• Sponsor should be carrying on business in financial services for not less than 5 years.
• Sponsor should have positive net worth in these 5 years.
• Net worth in the immediately preceding year should be more than the amount that the sponsor
contributes to the capital of the AMC.
• The sponsor should have earned profits, after providing for depreciation and interest & tax, in
3 of the previous 5 years, including the latest year.
• The application to SEBI for registration of a mutual fund is made by the sponsor/s. Thereafter,
the sponsor invests in the capital of the AMC.
• The sponsor needs to contribute a minimum 40% of the net worth of the AMC
• Sponsors have to contribute a minimum of Rs.50 Lacs or 1% of the corpus raised in the NFO,
whichever is lower, as initial contribution to the corpus of the mutual fund.

Key Constituents – Board of Trustees

• The trustees have a critical role in ensuring that the mutual fund complies with all the
regulations, and protects the interests of the unit-holders.
• Every trustee has to be a person of ability, integrity and standing.
• A person who is guilty of moral turpitude cannot be appointed as a trustee.
• A person convicted of any economic offence or violation of any securities law cannot be
appointed as trustee.
• No AMC and no director (including independent director), officer, employee of an AMC shall
be eligible to be appointed as a trustee of a mutual fund.
• No person who is appointed as a trustee of a mutual fund shall be eligible to be appointed as
trustee of any other mutual fund.
• Prior approval of SEBI needs to be taken, before a person is appointed as Trustee.

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 • The sponsor will have to appoint at least 4 trustees.
• At least 2/3rds of the trustees/directors on the trustee board need to be independent trustees
(not associated with the sponsor in any way).
• The trustees shall enter into an Investment Management Agreement (IMA) with the AMC
• The trustees have the right to seek any information they require from the AMC to facilitate
meeting their responsibilities as trustees.
• The trustees shall ensure the legal compliances before the launch of any scheme.

Key Constituents – Mutual Fund Trust

• A mutual fund is constituted in the form of a trust and the instrument of trust is in the form of
a deed, duly registered under the provisions of the Indian Registration Act, 1908 (16 of 1908),
executed by the sponsor in favor of the trustees named in such an instrument.

Key Constituents – Asset Management Company

• Day to day operations of mutual fund is handled by the AMC.
• The sponsor or, the trustees will appoint the AMC with the approval of SEBI.
• The directors of the AMC need to be persons having adequate professional experience in
financial services related field.
• Prior approval of the trustees is required, before a person is appointed as a director of the
AMC.
• At least 50% of the directors should be independent directors (not associated with the
sponsor/trustees)
• The AMC needs to have a minimum net worth of Rs. 50 crore.
• A change in the controlling interest of the AMC can be made with prior approval of the
trustees & SEBI.
• The appointment of an AMC can be terminated by a majority of the trustees, or by 75% of the
Unit-holders.
• Operations of AMCs are headed by a Managing Director, Executive Director or Chief
Executive Officer. Some of the other officers in AMC’s are as follows:
• Chief Investment Officer (CIO)
• Securities Analysts
• Securities Dealers
• Chief Marketing Officer (CMO)
• Chief Operations Officer (COO)

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 • Compliance Officer

Key Constituents – Custodian

• The custodian has custody of the assets of the fund.
• Custodian needs to accept and give delivery of securities for the purchase and sale
transactions of the various schemes of the fund.
• All custodians need to register with SEBI under the SEBI (Custodian) Regulations 1996.
• The Custodian is appointed by the trustees.
• A custodial agreement is entered into between the trustees and the custodian.
• The SEBI regulations provide that if the sponsor or its associates control 50% or more of the
shares of a custodian, or if 50% or more of the directors of a custodian represent the interest of
the sponsor or its associates, then, that custodian cannot be appointed for the mutual fund
operation.
• An independent custodian ensures that the securities are indeed held in the scheme for the
benefit of investors – an important control aspect.

Role & Support function of Service Providers – fund accountant

• The fund accountant performs the role of calculating the NAV, by collecting information
about the assets and liabilities of each scheme.
• The AMC can either handle this activity in-house, or engage a service provider.
• There is no need for a registration with SEBI to perform this function.

Role & Support function of Service Providers – Registrars and Transfer Agents
• The RTA maintain investor records.
• RTA offices serve as Investor Service Centers (ISCs), which perform a useful role in handling
the documentation of investors.
• The appointment of RTA is done by the AMC.
• It is not compulsory to appoint a RTA. The AMC can handle this activity in-house.
• All RTAs need to register with SEBI.

Role & Support function of Service Providers – Auditors

• Auditors are responsible for the audit of accounts.
• Accounts of the mutual fund schemes need to be maintained independent of the accounts of the
AMC.

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 • The auditor appointed to audit the mutual fund scheme accounts needs to be different from the
auditor of the AMC.
• Scheme auditor is appointed by the Trustees, and the AMC auditor is appointed by the AMC.

Role & Support function of Service Providers – distributors

• Distributors have a key role in selling suitable types of units to their clients (Investors).
• A distributor can be empaneled with more than one mutual fund.
• Distributors can be individuals or institutions like distribution/broking companies & banks.
• Distributors need to pass the prescribed certification test and register with AMFI to sell
Mutual Fund Schemes.

Role & Support function of Service Providers – collecting banker

• The investors’ money go into the bank account of the scheme they have invested in.
• These bank accounts are maintained with collection bankers who are appointed by the AMC.
• Leading collection bankers make it convenient to invest in the schemes by accepting
applications of investors in most of their branches.

Role & Support function of Service Providers – Payment Aggregators

• Payment Aggregators like Tech Process, Bill Desk are service providers that facilitate
payment processing in the online market place.
• They enable the users to make the payments online through their bank account in a secured
manner.
• Aggregators allow mutual fund houses to accept debit card and bank transfers without having
to setup a merchant account with the banks.
• The mutual fund pays to the aggregator.

Role & Support function of Service Providers – KYC Registration Agencies

• It is mandatory for all investors in the securities market, to be KYC compliant as per the
provisions of the Prevention of Money Laundering Act.
• The KYC process involves establishing the identity and the address of the investor.
• SEBI has introduced a common KYC for investors investing in securities markets.
• KYC registration firms are registered with SEBI.

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 Role & Support function of Service Providers – Valuation agencies
• SEBI has issued guidelines for the purpose of arriving at fair valuation of debt securities that
are non-traded or thinly traded.
• According to these guidelines, there have to be at least two valuation agencies that provide
valuation matrix.
• The AMCs have to make use of this matrix to arrive at fair valuation of these investments.
• AMFI has appointed CRISIL Ltd. and ICRA Ltd. for the purpose.

Role & Support function of Service Providers – Credit Rating Agencies

• Credit rating agencies rate debt securities issued by various issuers and these agencies assume
an important role in case of debt mutual funds.
• Fund managers consider such ratings as a key input while taking investment decisions.
• In few mutual fund products, credit rating assumes greater importance.
• Certain categories of debt funds such as corporate bond funds, credit risk funds are defined on
the basis of credit rating.

Role & Support function of Service Providers – Depositories & the Depository
Participants
• A depository is an institution, which holds the securities in dematerialized or electronic form
on behalf of the investors.
• Mutual fund units can be held in dematerialized form through a depository participant.
• The depositories reach out to the investors through the depository participants.
• There are two depositories in India, viz., National Securities Depository Limited (NSDL), and
Central Depository Services Limited (CDSL).

Role & Support function of Service Providers – Stock exchanges & transaction
platforms
• The units of close-ended funds and ETFs are compulsorily listed on at least one stock
exchange.
• Units of open-ended funds are also available through special segments on the stock
exchanges.
• At BSE, this segment is known as BSE-StarMF and NSE, it is called NSE Mutual Fund II
Platform.

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 • MF Utilities India is another transaction platform for units of mutual funds.
• Now, investors can also transact directly through stock exchanges.

Role and Function of AMFI

• Association of Mutual Funds in India (AMFI) is the association of all the registered Asset
Management Companies (AMCs).
• The objectives of AMFI are:
• To define and maintain high professional and ethical standards in all areas of operation of
mutual fund industry.
• To recommend and promote best business practices and code of conduct to be followed by
members and others engaged in the activities of mutual fund & asset management agencies
connected or involved in the field of capital markets and financial services.
• To interact with SEBI and to represent to SEBI on all matters concerning the mutual fund
industry.
• To represent to the Government, Reserve Bank of India and other bodies on all matters relating
to the mutual fund Industry.
• To undertake nationwide investor awareness program to promote proper understanding of the
concept and working of mutual funds.
• To disseminate information on mutual fund industry and to undertake studies and research
directly and/or in association with other bodies.
• To regulate conduct of distributors including disciplinary actions (cancellation of ARN) for
violations of Code of Conduct.
• To protect the interest of investors/unit holders.
• A major role of AMFI involves the registration of mutual fund distributors, by allotting them
AMFI Registration Number (ARN), which is mandatory for becoming a mutual fund
distributor.
• An important point to note here is that AMFI is neither a regulatory body nor a Self-
Regulatory Organization (SRO).

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 Chapter 4
Legal and Regulatory Framework

Learning Objective

o Role of regulators in India

o Role of SEBI in regulating mutual funds
o Due Diligence Process by AMCs for Distributors of Mutual Funds
o SEBI Advertisement Code for mutual funds
o Investor Grievance and Redress Standards

Role of Regulators in India

• Reserve Bank of India (RBI) that regulates the banking system, as well as money markets;
• Securities and Exchange Board of India (SEBI) that regulates the securities markets;
• Insurance Regulatory and Development Authority of India (IRDAI) that regulates the
insurance market; and
• Pension Fund Regulatory & Development Authority of India (PFRDA) that regulates the
pension market.
• These regulators come under the purview of the Ministry of Finance.

Role of Securities and Exchange Board of India

• SEBI regulates securities markets in India and other entities like, mutual funds, depositories,
custodians and registrars and transfer agents (RTAs).
• The basic functions of the SEBI is "to protect the interests of investors in securities and to
promote the development of, and to regulate the securities market and for matters connected
therewith or incidental thereto".
• The regulations cover three important aspects to achieve the above objectives:
• Disclosures by issuers of securities, e.g. companies that issue shares or debentures, and mutual
funds that issue mutual fund units
• Efficiency of transactions in the securities markets
• Low transaction costs
• Anyone who is aggrieved by a ruling of SEBI, can file an appeal with the Securities Appellate
Tribunal (SAT).

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 • The regulations cover three important aspects to achieve the above objectives:
• Disclosures by issuers of securities, e.g. companies that issue shares or debentures, and
mutual funds that issue mutual fund units
• Efficiency of transactions in the securities markets
• Low transaction costs
• Anyone who is aggrieved by a ruling of SEBI, can file an appeal with the Securities Appellate
Tribunal (SAT).

Regulatory reforms by SEBI

• SEBI issued the mutual fund regulations in 1996 in the form of SEBI (Mutual Funds)
Regulations, 1996.
• Since then, there have been many amendments through various regulations and circulars.
• In all the cases, the objective has always remained to protect the interests of the mutual fund
investors, and to empower investors to take informed investment decisions.
• The regulations have covered many aspects such as investor services, accounting of NAV,
valuation norms, disclosures and investment norms.

Mutual Funds Regulations

• The applicable guidelines for mutual funds are set out in SEBI (Mutual Funds) Regulations,
1996, as amended from time to time.
• Wherever applicable, mutual funds need to comply with regulations issued by other regulators
also. For instance, RBI regulates the money market and foreign exchange market in the country.
• Therefore, mutual funds need to comply with RBI’s regulations regarding investment in the
money market or investments outside the country.

Investment restrictions for mutual fund schemes – general

• The Mutual Fund will buy and sell securities on delivery basis.
• Securities purchased will be transferred in the name of the Mutual Fund.
• The Mutual Fund shall not advance any loans.
• The scheme will not invest in the unlisted or privately placed securities of any associate or
group company of the sponsor.
• Investment in the listed securities of the group companies of the sponsor will be limited to
25% of the net assets.

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 • The scheme may invest in other schemes of the same Mutual Fund or other Mutual Funds up
to 5% of net assets.
• The Mutual Fund under all its schemes shall not own more than 10% of a company’s paid up
capital bearing voting rights.

Investment restrictions for mutual fund schemes – debt

• The scheme shall not invest more than 10% of its NAV in investment grade debt instruments
issued by a single issuer.
• This can be extended to 12% with trustees prior approval.
• The limit shall not apply to Government Securities, Treasury Bills and CBLO/TREPS.
• A mutual fund scheme shall not invest in unlisted debt instruments including commercial
papers, except G-Sec and other money market instruments.
• Mutual Fund Schemes may invest in unlisted non-convertible debentures up to a maximum of
10% of the debt portfolio.
• Parking of funds in Short-term deposits with all scheduled commercial banks shall be limited
to 15% of the net assets of the scheme. This can be raised to 20% with the approval of the
trustees.
• Open-ended debt funds have to maintain a minimum of 10% of their corpus in liquid assets.

Investment restrictions for mutual fund schemes – equity

• All investments by a mutual fund scheme in equity instruments shall only be in listed or to be
listed securities.
• The ELSS notification requires that at least 80% of the ELSS funds should be invested in
equity & equity-linked securities.
• The Scheme shall not invest more than 10% of its NAV in the equity shares and equity related
instruments of a company
• The limit is not applicable for investments in index/sector/industry specific schemes.

Investment restrictions for mutual fund schemes – REIT/INVIT

• No mutual fund under all its schemes shall own more than 10% of units issued by a single issuer
of REIT and InvIT;
• A mutual fund scheme shall not invest –
• more than 10% of its NAV in the units of REIT and InvIT;
• more than 5% of its NAV in the units of REIT and InvIT issued by a single issuer.

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 • The limits mentioned above are not applicable for investments in case of index funds or sector
schemes.

SEBI Advertisement Code for Mutual Funds

• Advertisements shall be accurate, true, fair, clear, complete, unambiguous and concise.
• Advertisements shall not contain statements which are false, misleading, biased or deceptive,
based on assumption/projections and shall not contain any testimonials or any ranking based on
any criteria.
• Advertisements shall not be so designed as likely to be misunderstood or likely to disguise the
significance of any statement.
• Advertisements shall not contain statements which directly or by implication or by omission
may mislead the investor.
• Advertisements shall not carry any slogan that is exaggerated or unwarranted or slogan that is
inconsistent with or unrelated to the nature and risk and return profile of the product.
• No celebrities shall form part of the advertisement.
• SEBI has permitted celebrity endorsements at industry level for the purpose of increasing
awareness of Mutual Funds as a financial product category.

SEBI Guidelines for Circulation of Unauthenticated News

• Employees/temporary staff/voluntary workers etc. should not encourage or circulate rumors or
unverified information obtained from client, industry, any trade or any other sources without
verification and any market related news received by them either in their official mail/personal
mail/blog or in any other manner, should be forwarded only after the approval of concerned
Intermediary’s Compliance Officer.
• Access to Blogs/Chat forums/Messenger sites etc. should either be restricted under supervision
or access should not be allowed. Logs for any usage of such Blogs/Chat forums/Messenger sites
(called by any nomenclature) have to be treated as records and the same should be maintained.
• If anyone fails to comply with the regulations, then he/she shall be liable for action. The
Compliance Officer shall also be held liable for breach of duty in this regard.

Investors’ Rights & Obligations

• Mutual fund investors are entitled to some important rights which are meant to protect the
investments and bring more transparency to the mutual fund investors.

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 • Right to beneficial ownership
• Right to change the distributor
• Right to Inspect documents
• Right to appoint nominees
• Right to pledge mutual fund units
• Right to grievance redressal
• Rights of investors in context of change in Fundamental Attributes
• Rights to terminate appointment of an AMC
• Right to unclaimed amounts
• Proceeds of Illiquid Securities

Investor Grievance Redress Mechanism

• In the event of any issue with the AMC or mutual fund scheme, the investor can first approach
the investor service center.
• If the issue is not redressed, even after taking it up at senior levels in the AMC, then the
investor can write to SEBI with the complaint details.
• SEBI Complaint Redress System (SCORES) is a web based centralized grievance redress
system of SEBI.
• SCORES enables investors to lodge, follow up on their complaints and track the status of
redressal of such complaints online on the website (http://scores.gov.in).

AMFI Code of Conduct for Intermediaries

AMFI Code of Ethics (ACE)
• The AMFI Code of Ethics sets out the standards of good practices to be followed by the AMCs
and Trusties in their operations and in their dealings with investors, intermediaries and the
public.
• SEBI (Mutual Funds) Regulation, 1996 requires all Asset Management Companies and
Trustees to abide by the Code of Conduct as specified in the Fifth Schedule to the Regulation.
• While the SEBI Code of Conduct lays down broad principles, the ACE sets more explicit
standards for AMCs and Trustees.

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 AMFI’s Code of Conduct for Intermediaries of Mutual Funds
• AMFI has framed a set of guidelines and code of conduct for intermediaries, known as AMFI
Guidelines & Norms for Intermediaries (AGNI), consisting of individual agents, brokers,
distribution houses and banks engaged in selling of mutual fund products.
• In the event of breach of the Code of Conduct by an intermediary, the following sequence of
steps is initiated by AMFI:
• Write to the intermediary (enclosing copies of the complaint and other documentary evidence)
and ask for an explanation within 3 weeks.
• In case explanation is not received within 3 weeks, or if the explanation is not satisfactory,
AMFI will issue a warning letter indicating that any subsequent violation will result in
cancellation of AMFI registration (ARN).
• If there is a proved second violation by the intermediary, the registration will be cancelled, and
intimation sent to all AMCs.
• The intermediary has a right of appeal to AMFI.

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 Chapter 5
Scheme Related Information

Learning Objective
o Mandatory Documents
o Scheme Information Document
o Statement of Additional Information
o Key Information Memorandum
o Non-Mandatory Documents

Mandatory Documents
“Mutual fund investments are subject to market risk. Please read all scheme related
documents before investing.”
• These lines are mentioned in all mutual fund related communications. So, what are the
scheme related documents?
• Investors need to note that their investments are governed by the principle of caveat emptor
i.e., let the buyer beware.
• An investor is presumed to have read and understood the scheme related documents before
investing in a mutual fund scheme.
There are primarily two important documents for understanding about the mutual fund scheme:
a) Scheme Information Document (SID), which has details of the particular scheme
b) Statement of Additional Information (SAI), which has statutory information about the
mutual fund or AMC, that is offering the scheme.
It stands to reason that a single SAI is relevant for all the schemes offered by a mutual fund.
In practice, SID and SAI are two separate documents, though the legal technicality is that SAI
is part of the SID.
Both documents are prepared in the format prescribed by SEBI and submitted to SEBI.
While SEBI does not approve or disapprove the Scheme Related Documents, it gives its
observations. The mutual fund needs to incorporate these observations in these documents.
The Documents in the market are “vetted” by SEBI, and not approved.

Objective of the scheme related documents

• SID and SAI together are the primary source of information for any investor—existing as well
as prospective.

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 • These are the operating documents that describe the product.
• Since the investor is required to make an informed investment decision, these documents
serve the purpose of providing the required information in an easy to understand language.
• The units of the scheme are offered to the investor through the scheme related documents.
• By signing the application form and making a payment, the investor is accepting the offer, and
by issuing units against such an acceptance, the mutual fund then completes the contract.

Scheme Information Document

• The cover page has the name of the scheme followed by its type;
• Open-ended / Close-ended / Interval (the scheme structure)
• Equity / Debt / Liquid / Hybrid (the expected nature of scheme portfolio)
• It also mentions the face value of the Units being offered, relevant NFO dates, date of SID,
name of the mutual fund, and name, contact information of the AMC and trustee company.

SID structure
• Table of Contents
• Highlights
• Introduction
• Risk Factors
• Standard
• Scheme-specific
• Provisions regarding minimum number of investors in the scheme
• Any other special considerations
• Definitions
• Due Diligence Certificate (issued by the AMC)
• Information about the scheme
• Name and type of the scheme
• Investment Objectives and Policies
• Asset Allocation Pattern
• Where will the scheme invest?
• Investment Strategy
• Fundamental Attributes
• Benchmark
• Managers of the Scheme

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 • Investment Restrictions
• Performance track record of the scheme
• Units and Offer
• Fees & Expenses
• Rights of Unit-holders
• General Unit-holder information
• Penalties, Litigation etc.

Scheme suitability – Riskometer

• To enable investors to make an informed decision regarding their investments, a pictorial
representation of the risk to the principal invested in a mutual fund product is depicted using a
‘Riskometer’.
• The pictometer will categorize the risk in the scheme at one of six levels of risk;

Scheme suitability – Riskometer

• The mutual fund has to calculate the risk value of each scheme based on the parameters that
have been provided. Every scheme needs to check the parameters and then determine its risk
for the investor.
• This has to be depicted on the risk-o-meter. If there is any change in the risk level then this has
to be conveyed through a Notice cum addendum and email or SMS to the unitholders.
• The risk-o-meter has to be evaluated on a monthly basis.

Update of SID
• For the open ended and interval schemes, the SID shall be updated within next six months from
the end of the 1st half or 2nd half of the financial year in which schemes were launched, based
on the relevant data and information as at the end of previous month.
• Subsequently, SID shall be updated within one month from the end of the half-year, based on
the relevant data and information as at the end of September and March respectively.

Contents of SAI
• Information about Sponsors, AMC and Trustee Company, their contact information,
shareholding pattern, responsibilities, names of directors and their contact information, profiles
of key personnel, and contact information of service providers {Custodian, R&T Agent,
Statutory Auditor, Fund Accountant and Collecting Bankers}.

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 • Condensed financial information (for schemes launched in last 3 financial years)
• How to apply
• Rights of Unit-holders
• Investment Valuation Norms
• Tax, Legal and General Information (including investor grievance redressal mechanism, and
data on number of complaints received and cleared, and opening and closing number of
complaints for previous 3 financial years and for the current year to-date).
• Every mutual fund, in its website, provides for download of its SAI.
• Investors have a right to ask for a printed copy of the SAI.
• Through AMFI website (www.amfiindia.com) investors can access the SAI of all the mutual
funds.

Update of SAI
• Regular update has to be done by the end of 3 months of every financial year.
• Material changes have to be updated on an ongoing basis and uploaded on the websites of the
mutual fund and AMFI.

Key Information Memorandum (KIM)

• KIM is essentially a summary of the SID and SAI.
• It contains the key points of the offer document that are essential for the investor to know to
make a decision on the suitability of the investment for their needs.
• It is more easily and widely distributed in the market.
• As per SEBI regulations, every application form is to be accompanied by the KIM.

Contents of KIM
• Name of the AMC, mutual fund, Trustee, Fund Manager and scheme.
• Dates of; Issue Opening, Issue Closing and Re-opening.
• Plans and Options under the scheme.
• Price at which Units are being issued and minimum amount / units for initial purchase,
additional purchase and re-purchase
• Benchmark, Dividend Policy, Risk Profile of the Scheme.
• Performance of scheme and benchmark over last 1 year, 3 years, 5 years and since inception.
• Loads and expenses.
• Contact of Registrar for taking up investor grievances.

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 Update of KIM
• KIM shall be updated at least once in half-year, within one month from the end of the respective
half-year, based on the relevant data and information as at the end of September and March and
shall be filed with SEBI forthwith through electronic mode only.

Other Mandatory information/disclosure

• Disclosure of Daily NAV
• Disclosure of Total Expense Ratio
• Scheme-wise dashboard on mutual fund website
• Risk-O-Meter
• Portfolio disclosure
• Financial results
• Annual reports and related disclosures
• Disclosure pertaining to change in control of the AMC

Non-Mandatory Disclosures – Fund Factsheet

• One of the most popular document from the mutual fund.
• This is extensively used by investors, distributors, rating agencies, research analysts and
media to access information about the various schemes of the mutual fund.
• It is not a regulatory requirement to publish the monthly fact sheet, it is a market practice
followed by all the fund houses, on a voluntary basis.
• Since it is a marketing & information document, various SEBI regulations pertaining to
information disclosure are applicable to it.

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 Chapter 6
Fund Distribution & Channel Management Practices
Learning Objective

o Role and importance of mutual fund distributors

o Different kinds of mutual fund distributors
o Modes of distribution
o Pre-requisites to become a MF Distributor
o Revenue of a mutual fund distributor
o Commission disclosure mandated by SEBI
o Due Diligence Process by AMCs for Distributors of Mutual Funds
o Nomination facilities for mutual fund distributors
o Change of distributors

The role and importance of mutual fund distributors

• An investor needs to invest the money in a portfolio of various investment options to achieve
financial goals.
• This process of building a portfolio could be achieved with the help of selection of a basket of
mutual fund schemes.
• However, one may still need help in constructing a portfolio with the help of an expert.
• This expert could be a mutual fund distributor.

Different kinds of mutual fund distributors

• Traditional distribution channels:
• Individuals
• Institutional Channels
• Newer Distribution Channels:
• Internet
• Mobile Phones
• Stock Exchanges
• New Cadre of Distributors

Mode of distribution
• Traditionally, mutual funds, were distributed through the use of application forms printed on
paper.

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 • Many distributors and their investors still prefer the paper mode, whereas the new age Internet-
based businesses, viz. e-commerce platforms, and online distributors operate entirely through
the digital mode.

Mode of distribution – online channel partners

• Stock Exchange Platforms
• MF Utilities
• Computer and Mobile-based Apps offered by distributors
• Electronic platforms created by the AMCs
• New age investment platforms

Pre-requisites to become Distributor of a Mutual Fund

• In order to be eligible to sell or market mutual funds, the following are compulsory:

Obtaining NISM Certification:

• The individual needs to pass the NISM certification examination mandated by SEBI.
• For persons who have attained the age of 50 years or who have at least 10 years of experience
in the securities markets in the sale and/or distribution of mutual fund products as on May 31,
2010, can obtain the certification either by passing the NISM certification examination or
qualifying for Continuing Professional Education (CPE) by obtaining such classroom credits as
may be specified by NISM from time to time.

Know Your Distributor (KYD) Requirements

• In order to streamline the distribution process, AMFI has introduced the KYD process to verify
the correctness of the information provided in the registration documents and to have
verification of the ARN holders.
• The process consists of document verification and bio-metric process.
• Self-attested copy of the PAN card and specific documents as proof of address to be
submitted along with application form at the CAMS-PoS.
• Bio-metric process consists of taking the impression of the index finger of the right hand of
the ARN holder.
• This is done at the PoS (CAMS) at the time of submission of documents.
• In case of non-individual distributors, bio-metric process will be conducted on specified
authorized persons.

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 Obtaining AMFI Registration Number (ARN)
• After obtaining the certification and completing KYD requirements, the next stage is to register
with AMFI.
• On registration, AMFI allots an AMFI Registration Number.
• Individuals from the exempted category (i.e. who have attained the age of 50 years or have at
least 10 years of experience as of May 31, 2010) can obtain the ARN without passing the
certifying examination, provided they have attended the prescribed CPE program.

Empanelment with AMCs

• Armed with the ARN No., the distributor/stock exchange broker can get empaneled with any
number of AMCs.
• Alternatively, they can become agents of a distributor who is already empaneled with AMCs.
• Institutions that are into the distribution of mutual funds need to register with AMFI.
• The employees of these institutions need to clear the NISM Series V-A: Mutual Fund
Distributors Certification Examination and obtain an Employee Unique Identification Number
(EUIN) from AMFI.
Empanelment with an AMC is a simple process. Following details need to be furnished:
• Personal Information of applicant.
• Names and contact information of key people handling sales and operations with EUIN
numbers.
• Business and Bank details.
• Preferences regarding receiving information from the AMC.
• Nominee (for individual distributors).
• The applicant also needs to sign a declaration.

Revenue for a mutual fund distributor

• Distributor earn commission income is in the form of trail commission, which is payable as a
percentage of AUM.
• As per SEBI circular dated October 2018, AMCs shall adopt full trail model of commission in
all schemes, without payment of any upfront commission or upfronting of any trail commission,
directly or indirectly, in cash or kind, through sponsorships, or any other route.
• Upfronting of trail commission is allowed only in case of inflows through Systematic
Investment Plans of up to Rs. 3,000 per month for an investor investing in mutual fund schemes
for the first time.

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 • A point to note is that the commission is payable to the distributors to mobilize money from
their clients.
• Hence, no commission is payable to the distributor for their own investments (self-
business).
• Regulations require distributors to disclose to their investor all commissions in the form of trail
commissions or any other form payable to them from similar competing schemes of different
mutual fund from amongst which the particular scheme was recommended to the investor.

Concept of Trail Commission

• Trail commission is calculated as a percentage of the net assets attributable to the Units sold
by the distributor.
• The commission payable is calculated on the daily balances and paid out periodically to the
distributor as per the agreement entered into with AMC.
• The trail commission is normally paid by the AMC on a quarterly basis or monthly basis.
• Since it is calculated on net assets, distributors benefit from increase in net assets arising out
of valuation gains in the market.

Additional commission for promoting mutual funds in small towns

• With a view to promoting mutual funds in smaller towns, SEBI has allowed mutual funds to
charge additional expenses, which can be used for distribution related expenses, including
distributor commission.
• This means that the distributors mobilizing funds from investors located in B-30 locations
(cities and towns beyond the top 30 locations) would earn higher commission.

Transaction Charges
• Applicable only when the transaction is routed through a distributor and he/she has opted in
for the transaction charges.
• For a new investor Rs. 150 is deducted from the investment
• For an existing investor Rs. 100 is deducted from the investment
• In case of SIP transaction charges are applicable only if total commitments through SIP is Rs
10,000 and above and the Transaction Charge is deducted in 4 equal instalments.
• Investment will be done after deduction of applicable transaction charges.
Applicability of GST on distributors commission

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 • GST is payable by any person making taxable supplies of goods/services and whose annual
turnover exceeds Rs. 20 lakhs.
• On certain goods and services specified by the Government, tax is to be paid by the recipient,
under reverse charge instead of the supplier
• A GST registered mutual fund distributor, would be required to raise an invoice for the
commission, and pay the GST to Government.
• The AMC / MF is liable to pay GST under reverse charge on commission paid to unregistered
distributors

Commission Disclosure mandated by SEBI

• SEBI has mandated Mutual Funds/AMCs to disclose on their respective websites the total
commission and expenses paid to distributors who satisfy one or more of the following
conditions with respect to non-institutional (retail and HNI) investors:
i. Multiple point of presence (More than 20 locations)
ii. AUM raised over Rs. 100 crore across industry in the non-institutional category but including
high net-worth individuals (HNIs).
iii. Commission received of over Rs. 1 crore p.a. across industry
iv. Commission received of over Rs. 50 lakhs from a single Mutual Fund/AMC.
• Mutual Funds/AMCs shall also submit the above data to AMFI.
• AMFI shall disclose the consolidated data in this regard on its website.

Due Diligence Process by AMCs for Distributors of Mutual Funds

• SEBI has mandated AMCs to put in place a due diligence process to regulate distributors who
qualify any one of the following criteria:
i. Multiple point of presence (More than 20 locations)
ii. AUM raised over Rs. 100 crore across industry in the non-institutional category but
including high net-worth individuals (HNIs).
iii. Commission received of over Rs. 1 crore p.a. across industry
iv. Commission received of over Rs. 50 lakhs from a single Mutual Fund/AMC.
• At the time of empaneling distributors and during the period i.e. review process, mutual
funds/AMCs have to undertake a due diligence process to satisfy ‘fit and proper’ criteria.

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 Difference between distributors and investment advisors
• An investment advisor is a person, who for consideration, is engaged in the business of
providing investment advice to his clients or group of clients.
• A distributor of mutual funds is registered with an association of asset management companies
of mutual funds, providing any investment advice to his clients incidental to its primary activity.

Nomination facilities to Distributors and Payment of Commission to Nominee

• AMCs provide nomination facility to the distributors at the time of empanelment.
• Commissions are paid to the nominees or legal heirs of the deceased MFDs.
• The AMCs may require the legal heirs to produce necessary documents evidencing legal
heirship/succession where nomination is not registered.
• Such commission shall be payable till such time the ARN code of the deceased
agent/distributor is not changed by the investor.
• However, no new business is permitted under the ARN code of the deceased MFD.
• Also, no new systematic transactions or changes to existing systematic transactions can be
registered under the ARN code of the deceased MF.
• A nominee/legal heir need not be an ARN holder to claim and receive thecommission.

Change of distributor
• The mutual fund industry allows the investor to change the distributor, without specifying any
reason.
• Investors can choose to change their distributor or go direct.
• This needs to be done through a written request by the investor.
• In such cases, AMCs will need to comply, without insisting on any kind of ‘No Objection
Certificate’ from the existing distributor.
• In case of change of distributor code in a folio, no commission would be payable to any
distributor, neither the old one nor the new one.

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 Chapter 7
Net Asset Value, Total Expense Ratio and Pricing of Units

Learning Objective

o Fair Valuation Principles and relevance for investors

o Computation of Net Assets of mutual fund scheme
o Dividends and Distributable Reserves
o Concept of Entry & Exit Load and its impact on NAV
o Key accounting and reporting requirements applicable to mutual funds
o NAV, Total expense ratio and pricing of units for the Segregated Portfolio

Fair Valuation Principles

• An investor in a mutual fund scheme is the beneficial owner of the units one has bought.
• At the same time, the investors can sell their units and new investors can buy, which results in
ownership change.
• In such a case, it becomes very important that any investor in the scheme gets a fair price for
one’s investments.
• In order to ensure such a fair treatment to all investors, SEBI has laid down certain fair valuation
principles.
1. The valuation of investments shall be based on the principles of fair valuation (realizable value
of the securities/assets).
2. The policies and procedures approved by the Board of the AMC shall identify the
methodologies that will be used for valuing each type of securities/assets held by the mutual
fund schemes.
3. The assets held by the mutual funds shall be consistently valued according to the policies and
procedures.
4. The AMC shall provide for the periodic review of the valuation policies and procedures to
ensure the appropriateness and accuracy of the methodologies used and its effective
implementation in valuing the securities/assets.
5. The valuation policies and procedures approved by the Board of asset management company
should seek to address conflict of interest (if any).

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 6. Disclosure of the valuation policy and procedures approved by the Board of the AMC shall be
made in SAI, on the website of the AMC/Mutual Fund and at any other place where the Board
may specify to ensure transparency.
7. The responsibility of true and fairness of valuation and correct NAV shall be of the AMC,
irrespective of disclosure of the approved valuation policies and procedures made.
8. The AMC shall have policies and procedures to detect and prevent incorrect valuation.
9. Documentation of rationale for valuation including inter scheme transfers shall be maintained
and preserved by the AMC, to enable audit trail.
10. To have fairness in the valuation of debt and money market securities, the AMC shall
consider prices of trades of same security or similar security available in public platform.

Valuation
Valuation of traded Securities other than money market and debt securities:
• The securities shall be valued at the last quoted closing price on the stock exchange.
• When the securities are traded on multiple exchanges, the securities shall be valued at the last
quoted closing price on the principally traded stock exchange.
• Once a stock exchange has been selected for valuation of a particular security, reasons for
change of the exchange shall be recorded in writing by the AMC.
• When on a particular valuation day, a security has not been traded on the selected stock
exchange, the value at which it is traded on another exchange may be used
• When a security is not traded on any stock exchange on a particular valuation day, the value on
the earliest previous day may be used provided such date is not more than 30 days prior to the
valuation date.

Valuation of non-traded Securities other than money market and debt securities:
• When a security is not traded on any stock exchange for a period of 30 days prior to the
valuation date, the scrip must be treated as a ‘non-traded’ scrip.
• Non-traded securities shall be valued “in-good faith” by the asset management company on the
basis of appropriate valuation methods based on the principles approved by the Board of the
asset management company.

Value of Gold: the gold held by a gold exchange traded fund scheme shall be valued at
the AM fixing price of London Bullion MarketAssociation (LBMA) in US dollars per troy

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 ounce for gold having a fineness of 995.0 parts per thousand, subject to the conditions
mentioned in valuation guidelines issued by SEBI in SEBI (MF Regulations), 1996.

Computation of Net Assets of Mutual Fund Scheme and NAV

Let us understand the concept with a simple example:
• Investors have bought 20 crore units of a mutual fund scheme at Rs.10 each. The scheme has
thus mobilized 20 crore units X Rs.10 per unit i.e. Rs.200 Crores.
• An amount of Rs. 140 crore is invested in equities and it has appreciated by 10%.
• The balance amount of Rs. 60 crore, mobilized from investors, was placed in bank deposits
and debt instruments.
• Interest and dividend received by the scheme is Rs.8 crore, scheme expenses paid is Rs.4
crore. A further expense of Rs.1 crore is payable.

Net Asset Value [NAV]

• In the market, when people talk of NAV, they refer to the value of each unit of the scheme.
This is equivalent to;
Unit-holders’ Funds in the Scheme
NAV =
No. of Units
In the above example, it can be calculated as;
Rs. 217 crore ÷ 20 crore = Rs. 10.85 per unit.
From the above, it follows that -
• Higher the interest, dividend and capital gains earned by the scheme, higher would be the
NAV.
• Higher the appreciation in the investment portfolio, higher would be the NAV.
• Lower the expenses, higher would be the NAV.
• The summation of these three parameters gave us the profitability metric
profitability metric
(A) + Interest income
(B) + Dividend income
(C) + Realized capital gains
(D) + Valuation gains
(E) – Realized capital losses
(F) – Valuation losses

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 (G) – Scheme expenses

Calculate the NAV (Q #1)

• Value of stocks: Rs. 150 Crs
• Value of bonds: Rs. 67 Crs
• Value of money market instruments: Rs. 2.36 Crs
• Dividend accrued but not received: Rs. 1.09 Crs
• Interest accrued but not received: Rs. 2.68 Crs
• Fees payable: Rs. 0.36 Crs
• Number of outstanding units: 1.90 Crs
• NAV = (Value of stocks + Value of bonds + Value of money market instruments + Dividend
accrued but not received + Interest accrued but not received – Fees payable) / No. of outstanding
units
• NAV = (150 + 67 + 2.36 + 1.09 + 2.68 – 0.36) / 1.90 = 222.77 / 1.90 = Rs. 117.25

Calculate the NAV (Q #2)

• Value of stocks: Rs. 230 Crs
• Value of money market instruments: Rs. 5 Crs
• Dividend accrued but not received: Rs. 2.39 Crs
• Amt payable on purchase of shares: Rs. 7.5 Crs
• Amt receivable on sale of shares: Rs. 2.34 Crs
• Fees payable: Rs. 0.41 Crs
• No. of outstanding units: 2.65 Crs
• NAV = (Value of stocks + Value of money market instruments + Dividend accrued but not
received + Amount receivable on sale of shares – Amount payable on purchases of shares –
Fees payable) / No. of outstanding units
• NAV = (230 + 5 + 2.39 + 2.34 – 7.5 – 0.41) / 2.65 = 231.82 / 2.65 = Rs. 87.48

Mark to market
• The process of valuing each security in the investment portfolio of the scheme at its current
market value is called ‘mark to market’.
Why is this done?
• The NAV is meant to reflect the true worth of each unit of the scheme, because investors buy
or sell units on the basis of the information contained in the NAV.

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 • If investments are not marked to market, then the investment portfolio will end up being valued
at the cost at which each security was bought.
• Valuing shares of a company at their acquisition cost, say Rs.15, is meaningless, if those shares
have appreciated to Rs. 50. If the scheme were to sell the shares at the time, it would recover
Rs. 50 & not Rs. 15.

Valuation of perpetual bonds

• Mutual funds invest in different types of debt instruments. Some of them have features that
are subordinate to equity which means that they absorb losses before equity.
• Many others are convertible to equity if a specific event is triggered and there has to for
absorption of losses.
• Additional Tier 1 (AT1) and Tier 2 (AT2) bonds that are issued by banks and are perpetual in
nature fall under this category.
• SEBI has imposed limits on the exposure that a fund can take to these bonds.
• No mutual fund shall own more than 10% of such types of bonds issued by a single issuer.
• In addition, a mutual fund scheme shall not invest more than 10% of its assets into such
instruments.
• The scheme should also not invest more than 5% of its assets in such instruments of a single
investor.
• Close ended debt schemes can invest only in instruments that mature before the end date of
the scheme.

Total Expenses in Mutual Fund Scheme

Investment and Advisory Fees are charged to the scheme by the AMC. The details of such
fees are fully disclosed in the Scheme Information Document.
In addition to the aforementioned fees, two kinds of expenses come up in creating and
managing a mutual fund:
• Initial Issue expenses are incurred at the time of launching a scheme in an NFO. It is a one-
time expense. This expenses have to be borne by the AMC.
• Recurring Expenses are the fund running expenses incurred to manage the money raised
from the investors. This can be charged to the scheme.
Recurring Expenses
• Fees of various service providers, such as Trustees, Registrar & Transfer Agents, Custodian
and Auditor.

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 • Brokerage and transaction cost for buying and selling shares in the schemes.
• Marketing and selling expenses including scheme advertising and commission to the
distributors.
• Expenses on statutory investor communication, fund transfer from location to location,
providing account statements and dividend/redemption cheques/warrants.
• Listing fees and Depository fees.
• Insurance premium paid by the fund.
• In case of Gold ETFs, the cost of storage and handling of gold, in case of Capital Protection
funds, the cost of credit rating and in the case of Real estate mutual funds, the cost of insurance
premia and maintenance of real estate assets.
• Winding up costs for terminating a fund or scheme.
There are no sub-limits within the expense ratio. Expenses that are not permitted to be
charged to the scheme shall be borne by the AMC, Trusties or Sponsors.

Recurring Expenses – limits

• In case of close ended and interval schemes: The TER of equity oriented scheme(s) shall not
exceed 1.25% and for scheme(s) other than equity oriented shall not exceed 1.00% of the daily
net assets of the scheme.
• In case of an index fund scheme or ETF: The TER of the scheme including the investment &
advisory fees shall not exceed 1.00% of the daily net asset
• In case of equity oriented fund of funds scheme: The TER of the scheme including weighted
average of the total expense ratio levied by the underlying scheme(s) shall not exceed 2.25%
of the daily net assets of the scheme.
• In case of other than equity oriented fund of funds scheme: The TER of the scheme
including weighted average of the total expense ratio levied by the underlying scheme(s) shall
not exceed 2.00% of the daily net assets of the scheme.
• Brokerage and transaction cost incurred for the purpose of execution of trade and is included in
the cost of investment may be capitalized to the extent of 0.12% for cash market transactions
and 0.05% for derivatives transactions.
• If the new inflows from beyond top 30 cities (B30 cities) are at least;
• 30% of gross new inflows in the scheme or
• 15% of the average AUM (year to date) of the scheme, whichever is higher, funds can charge
additional expense of up to 0.30% of daily net assets of the scheme.

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 • In case inflows from beyond top 30 cities is less than the higher of (a) or (b) above, the
additional total expense on daily net assets of the scheme shall be charged as follows:
Daily net assets X 30 basis points X
New inflows from beyond top 30 cities
-
365 X Higher of (a) or (b) above

Dividends (Income distribution) and Distributable Reserves

• SEBI guidelines stipulate that dividends can be paid out of distributable reserves. In the
calculation of distributable reserves:
• All the profits earned (based on accrual of income and expenses) are treated as available for
distribution.
• Valuation gains are ignored. But valuation losses need to be adjusted against the profits.
• That portion of sale price on new units, which is attributable to valuation gains, is not
available as a distributable reserve.

Dividend option – change in the name

• A certain proportion of the sale price of investments in a mutual fund scheme represents
realized gains that are credited to an equalization reserve that can be used to pay dividends.
• Investors need to be told that their dividend also includes a certain part of their capital.
• The mutual funds also have to clearly indicate the distinction that when a distributable surplus
is paid how much of this is the appreciation of NAV and how much is capital distribution.

Concept of Entry and Exit Load and its impact on NAV

• A distinctive feature of open-ended schemes is the ongoing facility to acquire new units from
the scheme (sale transaction) or sell units back to the scheme (re-purchase transaction).
• In the past, schemes were permitted to keep the Sale Price higher than the NAV.
• The difference between the Sale Price and NAV was called the “entry load”.
• Due to no entry load, the Sale Price is same as the NAV.
• While charging exit loads, no distinction will be made among unitholders on the basis of the
amount of subscription. While complying with the same, any imposition or enhancement in the
load shall be applicable only on prospective investments.
• No exit load will be charged on bonus units and units allotted on reinvestment of dividend.

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 • Exit loads have to be credited back to the scheme immediately i.e. they are not available
for the AMC to bear selling expenses.
• Upfront commission to distributors will be paid by the investor directly to the distributor,
based on his assessment of various factors including the service rendered by the distributor.

Key Accounting and Reporting Requirements

• The accounts of the schemes need to be maintained distinct from the accounts of the AMC.
• The auditor for the AMC has to be different from that of the schemes.
• Norms are prescribed on when interest, dividend, bonus issues, rights issues etc. should be
reflected for in the accounts.
• NAV is to be calculated up to 4 decimal places in the case of index funds, liquid funds and
other debt funds.
• NAV for equity and balanced funds is to be calculated up to at least 2 decimal places.
• Investors can hold their units even in a fraction of 1 unit. However, current stock exchange
trading systems may restrict transacting on the exchange to whole units.

Segregated portfolio
• Segregated Portfolio means a portfolio, comprising of debt or money market instrument
affected by a credit event (default) that has been segregated in a mutual fund scheme.
• AMC may create segregated portfolio in case of a credit event
• Optional and at the discretion of the AMC
• Allowed only if SID has provisions for the same
• A written down policy is a must with the AMC
• No AMC fees can be charged by the AMC
• Allowed only in case of a credit event
• Must be done within 24 hours of the event with specific approval of the fund trustees

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 Chapter 8
Taxation

LEARNING OBJECTIVE

o Applicability of taxes in respect of mutual funds

o Capital Gains
o Dividend Income
o Difference between dividend distribution tax and capital gains tax
o Setting off Gains and Losses under Income Tax Act
o Securities Transaction Tax
o Tax benefits under Section 80 C of Income Tax Act, 1961
o Tax Deducted at Source

Applicability of taxes in respect of mutual funds

Taxation of income earned by mutual fund schemes:
• As per the prevailing tax laws in India, a mutual fund’s income is exempt from income tax,
since mutual funds are constituted as trusts in India for the benefits of the unitholders.
• Section 10(23)(D) of the Income Tax Act exempts all the income earned by the mutual fund
schemes from any tax.

Taxation of income earned by the investors:

• Investor can choose from two options within the scheme, viz. IDCW (dividend) and growth.
• The one who has opted for IDCW may get income in form of dividends, as well as capital
gains (or losses) when he sells the units.
• The investor in growth plan would earn capital gains (or losses) whenever one sells the units
of the scheme.
• Both these have different tax treatment in comparison to the income that one earns through
salary or professional fees and other means.
Applicability of taxes in the hands of investors
The tax rates would vary as under:
Type of income :
• Short Term Gains/(Losses)
• Long Term Gains/(Losses)
Type of mutual fund schemes :
• Equity oriented schemes
• Non-equity oriented schemes

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 Type of Investors
• Resident Individual
• Non Resident
• Non-Individual

Capital Gains Tax

Type of funds Holding Short Term (STCG) Long Term (LTCG)

>65% Equity <12 Months 15%

Holding (Equity) >12 Months 10%
Between 35% to <36 Months As per Tax Slab
65% Equity
Holding <36 Months 20% With Indexation
<35% Equity <36 Months As per Tax Slab
Holding (Debt) >36 Months As per Tax Slab

Classification of Funds for Tax

Domestic Equity – Domestic Equity – Domestic Equity –

0% to 35% 35% to 65% more than 65%
• All Debt Funds • Multi Asset Funds • All Equity Funds
• Gold Funds • Balanced Hybrid • Equity Savings
• International Funds Funds Fund
• Conservative Hybrid • International Funds • Arbitrage Fund
Fund • Funds with 35% to • BAF/DAAF
• Fund of Funds 65% Equity • Aggressive Hybrid
Fund

Indexation
• Under Indexation, investors are allowed to inflate the cost of their asset as per Govt. notified
inflation factor. (Cost of Inflation Index)
• Increase in the inflation rate over a period of time will lead to an increase in the prices of
Assets. That means capital Gains include impact of inflation.
• Inflation index helps the investor to reduce capital gain and thereby the tax also.

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 Indexation formula

Indexed Cost of Acquisition =

Original Cost of Cost Inflation Index (CII) in the year of
Acquisition X Sale
Cost Inflation Index (CII) in the year of
Purchase

Cost inflation index

Financial Year Cost Inflation Index Financial Year Cost Inflation Index
2001-02 100 2013-14 220
2002-03 105 2014-15 240
2003-04 109 2015-16 254
2004-05 113 2016-17 264
2005-06 117 2017-18 272
2006-07 122 2018-19 280
2007-08 129 2019-20 289
2008-09 137 2020-21 301
2009-10 148 2021-22 317
2010-11 167 2022-23 331
2011-12 184 2023-24 348
2012-13 200

INDEXATION BENEFIT - ILLUSTRATION

Date of Investment 15-03-2018 20-12-2015
Date of Redemption 10-01-2023 10-01-2023
Period of Investment 5 Years 8 Years
Amount Invested 1,00,000 2,00,000
Redemption Value 1,50,365 3,91,269
Capital Gain (without indexation) 50,365 1,91,269
Capital Gains Tax Calculation: Investment 1 Investment 2
Redemption Value 1,50,365 3,91,269
LESS: Indexed Cost
(1,00,000 ÷ 272 * 331) 1,21,691
(2,00,000 ÷ 240 * 331) 2,75,833
Capital Gain 28,674 1,15,436
Tax @ 20% after indexation 5,735 23,087
Cost Inflation Index:
CII in the year of investment 272 240
CII in the year of redemption 331 331

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 Setting off of Capital Gains and Losses under Income Tax Act
• The Income Tax Act provides for taxation under 5 heads of income (salaries, income from house
property, profits and gains of business or profession, capital gains, and income from other
sources).
• In the normal course, one would expect that a loss in one head of income can be adjusted (set
off) against gains in another head of income.
• However, there are limitations to such set-off.
• A few key provisions here are:
• Capital loss, short term or long term, cannot be set off against any other head of income (e.g.
salaries).
• Short term capital loss is to be set off against short term capital gain or long term capital gain.
• Long term capital loss can only be set off against long term capital gain.

IDCW (Dividend) income

• Dividend income from mutual funds used to be tax-free in the hands of the investor.
• There was no tax payable at all, irrespective of the amount of dividends earned.
• However, the dividend would be paid to the investor after deduction of dividend distribution
tax (DDT) from the scheme itself.
• In the Union Budget presented by the Finance Minister in February 2020, the DDT has been
done away with.
• Henceforth such distributed dividends would be added to the taxable income of the
assessee for the year.
• This means, the dividends would be taxable in the hands of the recipient at the applicable tax
rate.
• Dividends are taxable under the head Income from Other Sources.

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 • Higher the income slab of the investor, more tax outgo.
• The NAV of the scheme drops to the extent of the dividend distributed.

Stamp Duty on Mutual Fund Units

• With effect from July 1, 2020, mutual fund units issued against Purchase transactions (whether
through lump-sum investments or SIP or STP or switch-ins or dividend reinvestment) would be
subject to levy of stamp duty @ 0.005% of the amount invested.
• Transfer of mutual fund units (such as transfers between demat accounts) are subject to payment
of stamp duty @ 0.015%.

Securities Transaction Tax

• When an investor sells units of an equity fund in the stock exchange, or offers them for
repurchase to the fund, he will have to incur Securities Transaction Tax (STT).
• STT is applicable only on redemption/switch to other schemes/sale of units of equity oriented
mutual funds whether sold on stock exchange or otherwise.
• STT is not applicable on purchase of units of an equity scheme. It is also not applicable to
transactions in debt securities or debt mutual fund schemes.

Tax benefit under Section 80C of the Income Tax Act

• Certain mutual fund schemes, known as Equity Linked Savings Schemes (ELSS) are eligible
for deduction u/s 80C of the Income Tax Act.
• The benefit is available up to Rs. 1.50 lacs per year per taxpayer in case of individuals and
HUFs.
• The scheme has a lock-in period of three years from the date of investment.
• There are also a few retirements oriented funds, which have the benefit of Section 80C.
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 • These funds have a lock-in of 5 years.
• Investing in these funds would also allow the investor to get a Section 80C deduction.
• However, one should check whether a specific retirement fund has this benefit because not all
of them have this Section 80C benefit

ELSS – important points

• ELSS is eligible investments u/s 80C, where the limit is to be shared across the eligible avenues.
If someone has exhausted the limit with some other avenue, investment in ELSS would not get
any additional tax exemption.
• If one is investing in this scheme through SIP, each investment would be locked-in from the
date of the respective investment.
• The tax benefit would be available to the first holder, in case of a joint holding.
• Those who opt for the new tax structure as introduced, in the Union Budget 2020, would not be
able to take the benefit of tax-saving under Section 80C, but the investment would still be
locked-in for a minimum period of 3 years, if they invest in ELSS Schemes.

Tax Deducted at Source

• No TDS in case of Resident Individual investors or domestic companies, in respect of capital
gains.
• NRIs, PIOs, and other foreign entities attract TDS on capital gains from mutual funds.
• Government of India has entered into Double Taxation Avoidance Agreements (DTAA) with
several countries. These agreements too, specify rates for Withholding Tax (TDS).
• The TDS applicable for non-resident investors is the lower of the rate specified in the income
tax regulations or the tax specified in the DTAA of the country where the investor is resident.
• In case of dividends (IDCW) from mutual fund schemes, even for resident Indians, TDS is
applicable.
• The tax is required to be deducted at 10% on the dividend (IDCW) amount, if it exceeds Rs.
5,000 in a financial year.

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 Applicability of GST
AMC can charge GST, as applicable, to the schemes within the limits prescribed under SEBI
(Mutual Fund) Regulations.
• GST on fees paid on investment management and advisory fees shall be charged to the
scheme in addition to the Total Expense Ratio (TER).
• GST on all other fees shall be charged to the scheme within the limit of TER.
• GST on exit load, if any, shall be deducted from such load and the net amount shall be
credited to the scheme.
• GST on brokerage and transaction cost paid for execution of trade, if any, shall be within the
limit of TER.

• The commission payable to the distributors of mutual funds may be subject to GST, as
applicable in case of the ARN holder. Such tax cannot be charged to the scheme.

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 Chapter 9
INVESTOR SERVICES

LEARNING OBJECTIVE

o New Fund Offer Process

o NFO price and on-going price for subscription of mutual fund schemes
o Investment Plans and Options
o Allotment of mutual fund units to investors
o Content and periodicity of Statement of Account
o Mutual Fund Investor
o Application form of mutual funds
o Financial Transactions in MF through online and physical mechanism
o Cut-off timing and Time stamping
o KYC requirements for mutual fund investors
o Different types of systematic transactions
o Operational aspects of Systematic Transactions
o Process of Non-Financial Transactions in Mutual Funds
o Change in Status of Special Investor Categories
o Investor transactions – turnaround times

The NFO process

Units in a mutual fund scheme are offered to investors for the first time through a New Fund
Offer (NFO). The following are a few key steps leading to the NFO:
• The AMC decides on a scheme to take to the market.
• AMC prepares the Scheme Information Document for the NFO.
• This needs to be approved by the Trustees and the Board of Directors of the AMC.
• The documents are then filed with SEBI. The observations that SEBI makes on the SID need
to be incorporated.
• After approval by the trustees, the same can be issued in the market.
• The AMC decides on a suitable time-table for the issue, keeping in mind the market situation.
• The AMC launches its advertising and public relations campaigns to make investors aware of
the NFO. These need to comply with SEBI’s advertising code.
• The AMC holds events for intermediaries and the press to make them familiar with the
scheme, its unique features, benefits for investors, etc.
• The Scheme Documents and Application Forms are distributed to market intermediaries, and
circulated in the market, so that investors can apply in the NFO.

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 Three dates are relevant for the NFO of an open-ended scheme:
1. NFO Open Date – This is the date from which investors can invest in the NFO.
2. NFO Close Date – This is the date up to which investors can invest in the NFO.
3. Scheme Re-Opening Date – This is the date from which the investors can offer their units
for re-purchase to the scheme.
• Close-ended Schemes have an NFO Open and NFO Close Date. But, they have no Scheme Re-
opening Date. Investors will need to buy or sell units in the stock exchange where the scheme
is listed.
• Under the SEBI guidelines, NFOs other than ELSS can remain open for a maximum of 15
days.
• Allotment of units or refund of moneys, as the case may be, should be done within 5 business
days of closure of the scheme.
• Further, open-ended schemes have to re-open for sale and re-purchase within 5 business days
of the allotment.

Pricing of the units

• New Fund Offer (NFO) Price is the price per unit that the investors have to pay to invest during
the NFO (Face Value).
• Ongoing price for purchase, redemption (sale) / switch outs (to other schemes/plans of the
Mutual Fund) by investors is the price at which the investor purchases or receives
redemptions/switch-outs (NAV).

Investment Plans: Direct and Regular

• Investors have a choice of going through the distributors or directly through AMC
• Distribution services involve charges with respect to the various services provided by the
distributor, any investor going direct is assumed to have decided not to avail those services. In
such a case, the investor may not bear the cost of such services.
• Each mutual fund has to offer two plans to the investors, viz., regular plan and direct plan.
• Both these would have different total expense ratio (TER).
• The direct plan shall have a lower expense ratio excluding distribution expenses, commission,
etc., and no commission shall be paid from such plans.
• Since the TER is different in both cases, the plans will have separate NAVs.

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 Investment Options: IDCW and Growth
• Mutual fund schemes offer two options – Income Distribution cum capital withdrawal
(Dividend) and Growth.
• A third option, which is possible, is the IDCW (Dividend) re-investment Option.
• These are different options within a scheme having the same portfolio. Therefore, the
portfolio returns are the same for all three options.
• In a IDCW pay-out option, the fund declares a dividend from time to time. Some debt and
liquid funds even declare a dividend daily, subject to availability of profits.
• When a dividend is paid, the NAV of the units falls to that extent.
• The reduced NAV, after a dividend pay-out is called ex-Dividend NAV.
• After a dividend is announced, and until it is paid out, it is referred to as cum-Dividend NAV.

Implications of different options in mutual funds

Allotment of Units to the Investor

• NFO: Since entry load is banned, units in an NFO are sold at the face value i.e. Rs. 10. So the
investment amount divided by Rs. 10 would give the number of units the investor has bought.
• On-going offer: The price at which units are sold to an investor as part of ongoing sales in an
open-end scheme is the sale price, which in turn is the applicable NAV.
• In a rights issue, the price at which the units are offered is clear at the time of investment.
• In a bonus issue, the investor does not pay anything. The fund allots new units for free.

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 Account statements for investments
Monthly Statement of Account
• Mutual funds issue the Statement of Account every month if there is a transaction during the
month. It shows for each transaction, the value of the transaction, the relevant NAV and the
number of units transacted.
• Besides, it also provides the closing balance of units held in that folio and the value of those
units based on the latest NAV.

Annual Account Statement

• The Mutual Funds provide the Account Statement to the Unit-holders who have not transacted
during the last six months.
• The Account Statement reflects the latest closing balance and value of the units prior to the
date of generation of the account statement.
• The account statements in such cases may be generated and issued annually. Alternately, soft
copy of the account statements is sent to the investors registered e-mail address, instead of
physical statement,

Consolidated Account Statement

• A Consolidated Account Statement (CAS) for each calendar month is sent by post/email on or
before 15th of the succeeding month provided there has been a financial transaction in the folio
in the previous month.
• For the purpose of sending CAS, investors are identified across mutual funds by their PAN.
• Where PAN is not available, the individual account statement is sent to the Unit holder.

Mutual Fund Investors –Eligibility to Invest

Individual Investors
• Resident Indian, above the age of 18, can invest, either singly or jointly (not exceeding three
names).
• Minors (below 18 years of age) are not legally eligible to enter into a contract, they can invest
through their guardians.
• Hindu Undivided Families (HUFs).
• Non-Resident Indians (NRIs)/Persons of Indian Origin (PIO) resident abroad.
• Foreign investors, can invest in equity schemes of MFs.

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 Non-Individual Investors
• Companies / corporate bodies, registered in India
• Registered Societies and Co-operative Societies
• Trustees of Religious and Charitable Trusts
• Trustees of private trusts
• Partner(s) of Partnership Firms
• Association of Persons or Body of Individuals, whether incorporated or not
• Banks (including Co-operative Banks and Regional Rural Banks) and Financial Institutions
and Investment Institutions
• Other Mutual Funds registered with SEBI
• Foreign Portfolio Investors registered with SEBI
• International Multilateral Agencies approved by the Government of India
• Army/Navy/Air Force, Para-Military Units and other eligible institutions
• Scientific and Industrial Research Organizations
• Universities and Educational Institutions
• Foreign portfolio investors who meet KYC requirements to invest in equity and debt schemes
of Mutual Funds can invest through two routes:
• Direct route - Holding MF units in demat account through a SEBI registered depository
participant (DP).
• Indirect route - Holding MF units via Unit Confirmation Receipt (UCR)

Sources of Information on Eligibility to invest

• The eligible individual investors, can invest in any mutual fund scheme.
• However, in some schemes, only specific classes of non-individual investors are permitted.
• For instance, some Gilt schemes have specific plans, which are open only for Provident Funds,
Superannuation and Gratuity Funds, Pension Funds, Religious and Charitable Trusts and
Private Trusts.
• Therefore, it is a good practice to check the ‘Who can Invest?’ section of the Scheme
Information Document (SID), especially for a first time investor.

Filling the Application Form for Mutual Funds

The information required to be provided in the application form:
• Direct Plan and Regular Plan
• Unit Holder Information
• Minor as a unit holder

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 • POA as a unit holder
• Status of the Holder and Mode of Holding
• KYC Details
• FATCA and CRS Details
• Acknowledgement and Signature

Financial Transactions with Mutual Funds

Financial transaction in mutual funds include purchase and/or sale of mutual fund units.
• Initial Purchase: Fresh purchase or initial purchase of mutual fund units in a scheme can be
made during the new fund offer (NFO) period or even subsequently in an open-ended scheme.
• Additional Purchases: Once an investor has a folio with a mutual fund, subsequent
investments with the same mutual fund do not call for the full application form and
documentation. Only a transaction slip needs to be filled giving the folio number, and submitted
with the requisite payment.
• Repurchase of Units (Redemption): The investor in an open-ended scheme can offer the units
for repurchase to the mutual fund. The transaction slip needs to be filled out to effect the re-
purchase. Units held in the demat account can be redeemed by placing the redemption order
through the stock broker.
• Switch: A switch is a redemption from one scheme and a purchase into another combinedinto
one transaction.

Payment Mechanism for mutual fund purchases

Payments for mutual fund purchases need to be made through the banking channel modes that
have been approved by the regulators. The acceptable modes of payments are through online
transactions or different payment mechanism such as cheque, demand draft and cash etc.
• Online Transactions
• Internet Banking (NEFT/RTGS/IMPS)
• M-Banking
• Stock exchange platform and MFU platform
• Unified Payment Interface (UPI)
• Application Supported by Blocked Amount (ASBA) – For NFO investment
• Aadhaar Enabled Payment Service (AEPS)
• National Unified USSD Platform (NUUP)
• Cards (only debit cards are accepted)
• E-Wallets (Up to Rs. 50,000 per investor per financial year)
• One-Time Mandate (OTM) - (NACH/ECS Mandate)
• Cheque/Demand Draft (From investors account only)
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 • Cash Payments – Allowed to the extent of Rs. 50,000 per investor, per mutual fund, per financial
year, from small investors, who may not be tax payers and may not have PAN/bank accounts.
Investment by NRI/PIO:
• NRI/PIO applications need to be accompanied by cheque drawn on an NRO/NRE/FCNR
account (for non-repatriable investment) or NRE/FCNR account (for repatriable investment).
• If Indian Rupee Drafts are purchased abroad or cheques issued from NRE/FCNR account an
account debit certificate from the bank issuing the draft confirming the debit and/or Foreign
Inward Remittance Certificate (FIRC) by investor’s banker shall also be enclosed to certify the
source of funds as remitted from abroad.

Third Party Payments - exceptions:

• Payment by Parents/Grand-Parents/Related Persons on behalf of a minor in consideration of
natural love and affection or as gift for a value not exceeding Rs 50,000/- for each regular
purchase or per SIP installment.
• In such cases, persons who make payment should be KYC compliant and sign Third Party
Declaration form.
• Employer making payments on behalf of employee through payroll deductions, and custodian
on behalf of FPIs are permitted third-party payments.
• Payments by the AMC to its empaneled distributors on account of commissions etc. in the form
of units of the mutual fund scheme managed by the AMC either through an SIP or lump sum.
Payment Mechanism for Repurchase of Units
The investor has various options for receiving the money, due to him from the scheme on
repurchase of units:
• Cheque: This is a traditional approach, where the AMC issues a cheque/pay order in favor of
investor for the redemption/dividend amount.
• Electronic Modes: A Direct Credit from the mutual fund’s account to that of the investor can
be done provided the investor holds an account with a bank with which the mutual fund has an
arrangement to make direct credits. Other electronic modes include RTGS/NEFT/NACH etc.

• Instant Access Facility: AMCs offer IAF in Liquid schemes. The monetary limit under the
IAF is Rs. 50,000 or 90% of latest value of investment in the scheme, whichever is lower. This
limit is applicable per day per scheme per investor.
Cut-off Time and Time Stamping
• The sale and re-purchase prices are a function of the applicable NAV. In order to ensure
fairness to investors, SEBI has prescribed cut-off timing to determine the applicable NAV.
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 • The provisions, are uniformly applicable for all mutual funds, except for NFOs and
International Schemes.
• As a convenience, the distributor may accept the transaction request from the investor, but this
would need to be sent to an Official Point of Acceptance (OPoA) at the earliest.
• When the cut-off timing is applied, the time when it is submitted to the OPoA is relevant–not
the time of submitting to the distributor.
Time stamping
• The precision in setting cut-off timing make sense only if there is a fool proof mechanism of
capturing the time at which the sale and re-purchase applications are received.
• This is ensured through the following - Mutual funds disclose official Points of Acceptance
(PoAs) and their addresses in the SID and their website. All transaction requests need to be
submitted at the POAs. The time stamping on the transaction requests is done at the official
points of acceptance.

Type of Transaction Cut-off Applicable NAV

Scheme Time

Equity and Purchases and 1:30 pm Irrespective of the time of

Debt funds Switch in receipt of application, NAV of
(except liquid the business day on which the
and overnight funds are available for
funds) in utilization without availing of
respect of any credit facility before the cut-
transaction of off time of that day is
any amount applicable.
Liquid and Purchases and 1:30 pm If application received up to the
overnight fund Switch in cut off time on a day and funds
are available for utilization
before the cut-off time, without
availing any credit facility,
whether intra-day or otherwise
then closing NAV of the day
immediately preceding the day
of the receipt of application is
applicable
Liquid and Purchases and 1:30 pm If application received after cut
Overnight fund Switch in off time on a day and funds are
available for utilization on the
same day whether intra-day or
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 otherwise, the closing NAV of
the day immediately preceding
the next business day is
applicable.
Equity Redemption/ 3.00 pm
• Same day NAV if
Oriented Switch out
received before cut off
Funds, Debt
time.
funds (Other
than Liquid • Next business day NAV
funds) for applications received
after cut off time.
Liquid funds Redemption/ 3.00 pm • NAV of day immediately
Switch out preceding the next
business day, if received
before cut off time.
• Next business day NAV
for applications received
after cut off time.

Note: Mutual funds calculate NAV for each calendar day (including holidays) for their
liquid and overnight funds.
Cut-off Time and Time Stamping
1. An investor submits an application on Monday to buy units of an equity mutual fund scheme
for Rs. 3,00,000.
If an application is made on Monday and the fund gets realized on Wednesday by 2 pm, it
will be Wednesday's NAV. If funds are realized or available for utilization on Wednesday by 5
pm, then it will be Thursday's NAV.

2. An investor makes an application to purchase units of a liquid fund

If an application is made on Monday and the fund gets realized by 1 p.m. on Monday, it will
be Sunday's NAV. If it gets realized by 3 pm on Monday, it will be Tuesday's NAV. If it gets
realized by 10 am on Wednesday, it will be Tuesday's NAV.

3. An investor makes an application for redemption of units of equity fund on Monday

If the application is submitted before the cut-off time, the redemption would be processed at
Monday’s NAV. However, if the application is submitted after the cut-off time, the applicable
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 NAV would be of Wednesday. (Remember: Tuesday is a non- business day).

4. Redemption from the liquid fund, application submitted on Monday

If the application is submitted before the cut-off time, the redemption would be processed at
Sunday’s NAV. However, if the application is submitted after the cut-off time, the
applicable NAV would be of Wednesday (Tuesday holiday)

KYC Requirements for Mutual Fund Investors

• All investors, both individual and non-individual, including joint holders, NRIs, PoA holders
and its issuers, & guardians in the case of minors have to be KYC compliant, irrespective of the
investment value.
• The KYC process involves establishing the identity & address of the investor as required under
the Anti-money Laundering Laws.
• The application for investment must be accompanied by the acknowledgement for having
completed the KYC process issued by the KYC Registration Agency (KRA).

KYC Documents
• Permanent Account Number (PAN) Card with photograph is mandatory for all applicants
except those who are specifically exempt from obtaining PAN. This serves as the proof of
identity.
• Proof of Address such as Passport, Voter’s Id, Ration card, Driving License, bank account
statement, utility bill and other specified documents. If address for communication and
permanent address are different then documentary proofs have to be provided for both. The
proof of address in the name of the spouse may be accepted.
• Photograph of the Investor.
The copies of the documents produced have to be self-attested and the originals have to be
provided for verification purpose. In case, the originals are not produced for verification
then the copies of the documents must be attested by persons authorized to do so.

PAN Exempt Investments in Mutual Funds

• Exception in submission of PAN has been made for Micro-SIPs i.e. SIPs where annual

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 investment (12 month rolling or April-March financial year) does not exceed Rs.50,000.
• Similarly, small investors investing upto Rs. 50,000 per mutual fund per financial year do not
need to provide PAN Card. Rs. 50,000 is a composite limit for the small investor’s Micro-SIP
and lump sum investments together.
• Investment by individuals, minors and sole-proprietary firms within the limits specified above
are exempted from the requirement of PAN card.
• However, the KYC norms have to be complied with a SEBI registered KRA.
• Investors must quote the PAN Exempt KYC Reference Number (PEKRN) issued by the KRA
and submit a copy of the letter with the application form.

Identification proof for PAN Exempted KYC

• Voter Identity Card / Driving License / Passport
• Government / Defense identification card
• Photo Ration Card
• Photo Debit Card (Credit card with or without photo is not allowed)
• Employee ID cards issued by companies
• Photo Identification issued by Bank Managers of Scheduled Commercial Banks / Gazetted
Officer / Elected Representatives to the Legislative Assembly / Parliament
• ID card issued to employees of Scheduled Commercial / State /District Co-operative Banks
• Senior Citizen / Freedom Fighter ID card issued by Government
• Cards issued by Universities/deemed Universities or institutes under statutes like Institute of
Chartered Accountants of India, Institute of Cost Accountants of India and Institute of Company
Secretaries of India
• Permanent Retirement Account Number (PRAN) card issued to National Pension System
(NPS) subscribers by CRA (NSDL)
• Any other photo ID card issued by Central Government / State Governments /Municipal
authorities / Government organizations like ESIC / EPFO.

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 Centralized KYC Registration Agencies
• SEBI has instituted a centralized KYC process for the capital market.
• Based on completion of KYC process with one capital market intermediary, the investor can
invest across the capital market.
• KYC Registration Agencies (KRAs) facilitate this centralized KYC process.
• Once a capital market intermediary has performed an In-Person Verification (IPV) of the
investor and other documentation requirements are in place, and the intermediary uploads the
investor’s data to the database of a KRA, the KYC is valid across the capital market.
• The investor can benefit from that KYC to invest in any part of the capital market (not limited
to mutual funds).

KYC through e-KYC service of UIDAI

• e-KYC service launched by UIDAI has also been accepted as a valid process for KYC
verification.
• The information containing relevant client details and photograph made available from
UIDAI is sufficient proof of Identity and Address of the client.
• However, the client shall have to authorize the intermediary to access his data through UIDAI
system.
• Entities in the securities market, as may be notified by the Central Government, shall be
allowed to undertakeAadhaar Authentication under section 11A of the PMLA.
• These entities would be registered with UIDAI as KYC user agency (KUA)

KYC through Intermediaries

• For the units held in demat form, the KYC performed by the Depository Participant will be
considered in compliance with the KYC norms.
• Additional details of the investor, namely occupation, Gross Annual Income/ Networth and
Politically Exposed Persons (PEP) status are also captured in the application form by mutual
funds. This is mandatory information and has to be provided both by individuals and
nonindividuals.
• Centralized KRAs have made the KYC process simpler for investors. Mutual funds,
depositories, registrars and transfer agents, KYD compliant mutual fund distributors and
brokers are authorized to facilitate the KYC documentation of investors.

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 KYC Process
• The requisite form has to be filled-in along with supporting documents, which are verified with
the original documents. Alternatively, the investor can provide a True Copy attested by a Notary
Public, Gazetted Officer or Manager of a Scheduled Commercial Bank.

• After verification the forms and copies of the supporting documents are uploaded in the server
of any centralized KRA.
• The intermediaries are also authorized to perform an In-Person Verification (IPV) of the
investor, which is mandatory.
• The name, designation and organization of the person conducting the IPV has to be recorded
on the KYC form. An IPV performed by Scheduled Commercial Bank is also acceptable for
mutual fund investments.
• Once these processes are completed and the details are uploaded on the KRA’s servers, the KYC
process is complete. The investor does not need any further KYC for dealing in any part of the
securities market.
• In the event of change of address or any other information, the mutual fund investor needs to
fill the standard form and follow the prescribed process only once, with any of the
intermediaries.
• Based on that, the information will be updated with all the mutual funds and other capital market
related parties where the investor has invested.
KYC for Minors
• Where investment is made by a minor, KYC requirements have to be complied with by the
Guardian. The proof of age of the minor has to be provided.

KYC for Power of Attorney holder on behalf of an investor

• In the case of investments by a Power of Attorney (PoA) holder on behalf of an investor, KYC
requirements have to be complied with, by both, investor and PoA holder. A PoA holder cannot
apply for KYC compliance on behalf of the issuer of the PoA.
KYC for NRIs
• For NRI investors PAN is the sole identification number for KYC compliance. A copy of the
passport/PIO card/OCI card and overseas address proof is mandatory.

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 Additional Requirements applicable for Institutional Investors
Since institutional investors are not natural persons, authorised individuals invest on behalf of
the institution. Therefore, the following additional documents are essential:
• Eligibility for the investing institution to invest. For instance, a company/ trust is eligible to
invest under the laws of the country, but the company’s own incorporation documents
(Memorandum of Association and Articles of Association or Trust Deed) may not have
provided for such investments.
• The company/trust cannot invest if its incorporation documents do not provide for investments
of this type.
• Similarly, in some states, permission of the Charity Commissioner is necessary, before
Religious and Charitable Trusts can invest.
• Authorization for the investing institution to invest. This is typically in the form of a Board
Resolution.
• Authorization for the official to sign the documents on behalf of the investing institution. This
again is provided for in the Board Resolution. In case of other nonindividual investors, too the
list of authorized signatories would be required. The mutual fund can allow transactions only if
the transaction form/slip carries the signature of any (one or more, as required) of the authorized
signatories.
• SEBI has mandated that investors other than individuals have to provide details of the ‘Ultimate
Beneficial Owner’ (UBO) of the investments and submit documents to establish their identity
of such UBOs through any of the identity proofs acceptable under the KYC norms. An UBO of
a company is one who owns or is entitled to more than 25% of its shares or profits, more than
15% in case of partnerships and body of persons. In case of a trust, this includes the settler, the
trustees, the beneficiaries who are entitled to 15% or more of the benefits. The UBO
requirements are not applicable to listed companies or subsidiaries of the same.
Legal Information and Mandatory Declarations
• As part of the Client Due Diligence (CDD) process under the PML Act, all categories of
investors except individuals and listed companies or is a majority owned subsidiary of such a
company is required to provide the information to establish and verify the identity of the persons
who beneficially own or control the securities account.
• The proof of identity of the Ultimate Beneficial Owner (UBO) such as Name/s, Address,
PAN/Passport together with self-attested copy and the UBO declaration form has to be
submitted to the AMC/RTA.
• In case there is a change in the UBO then the same should be intimated to the AMC/RTA.

Foreign Account Tax Compliance Act and Common Reporting Standards

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 • To comply with the requirements of Foreign Account Tax Compliance Act (FATCA) and
Common Reporting Standards (CRS) provisions, financial institutions, including mutual
funds, are required to undertake due diligence process to identify foreign reportable accounts
and collect such information as required under the said provisions and report the same to the
US Internal Revenue Service/any other foreign government or to the Indian Tax Authorities for
onward transmission to the concerned foreign authorities.
• The application form requires information to be provided if the citizenship/nationality/place of
birth/tax residency are places other than India for all categories of investors. The countries of
tax residency and respective tax payer reference ID has to be provided.
• Once an investor is identified as covered under the said regulation, the entire investment value
of all the folios held will be reported.
• The identity of the investors and their direct and indirect beneficiaries and controlling persons
will be reported.
• If there is a change in the status of the investor, then the same has to be reported to the mutual
fund within 30 days.

Systematic Transactions -Systematic Investment Plan

• It is considered a good practice to invest regularly, particularly into volatile markets such as
equity markets.
• SIP is an approach where the investor invests constant amounts at regular intervals.
• A benefit of such an approach, particularly in equity schemes, is that it averages the unit-
holder’s cost of acquisition since more units are bought for the same amount of investment
when the price/markets are down and fewer units when the price/markets are up.
• Systematic investing allows investors to buy into a volatile market over time at an average price
without having to predict market movements.

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 Systematic Transactions -Systematic Withdrawal Plan
• Just as investors do not want to buy all their units at a market peak, they do not want to risk
redeeming all their units in a market trough. Investors can therefore opt for the safer route of
offering for re-purchase a constant value of units over a period of time.
• Mutual funds make it convenient for investors to manage their SWPs by registering the amount,
periodicity (generally, monthly) and period for their SWP.
• An investor may opt for SWP for several reasons:
• To minimise the risk of redeeming all the units during a market trough.
• Meet liquidity needs for regular expenses.
• Assuming the scheme is profitable, the re-purchase ensures that some of the profits are being
regularly encashed by the investor.

Systematic Transactions -Systematic Transfer Plan

• This is a variation of SWP. While in a SWP the constant amount is paid to the investor at the
pre-specified frequency, in a STP, the amount that is withdrawn from a scheme (called the
source scheme) is re-invested in some other scheme (called the target scheme) of the same
mutual fund.
• Thus, it operates as a SWP from the source scheme, and a SIP into the target scheme.
• Since the investor is effectively switching between schemes, it is also called “switch” if it is
just one transaction or tranche.
• If there are multiple tranches over a fixed period on pre-defined date of an amount that is
defined ahead, then it is an STP.
• The transfer of funds from the source scheme is equivalent to a redemption.
• Exit loads and taxes will apply like any other redemption transactions.

Systematic Transactions
Switch
• A switch is a redemption from one scheme and a purchase into another combined into one
transaction.

Dividend (IDCW) Transfer Plan

• Dividend (IDCW) Transfer Plan (DTP) is a facility that allows investors to invest thedividend
earned in a mutual fund investment into another scheme of the same mutual fund.
• Investors with a low risk profile can get some benefits of diversification by transferring
dividends earned from debt funds into equity funds.

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 SIP Top-up Facility
• Mutual funds provide an additional facility through an SIP to enhance the disciplined savings
of investors.

• Investors have the option to increase the SIP amount at intervals chosen by them. The increase
can be of a fixed amount or a percentage of the existing SIP amount.
• Investors register for the Top-up facility at the time of enrolling for the SIP.
• An existing SIP investor can also register for a Top-up facility.

Operational aspects of Systematic Transactions

• Mutual funds specify the schemes in which systematic transactions are offered.
• From the available options, the investor can choose the amount of the periodic transaction, the
frequency, the period over which the transaction will be done and the dates.
• A new investor has to submit both the application form as well as the SIP enrollment form to
register for an SIP.
• The details of the bank account that is registered for NACH/Direct Debit/Standing
Instructions for the SIP should be provided in the form.
• The payment modes accepted for SIPs include post-dated cheques and electronic payment
modes such as NACH, direct debit & standing instructions.

Operational aspects of Systematic Transactions

Renewal and Cancellation of SIP
• To renew an SIP, a renewal form has to be submitted giving details of the scheme, plan and
option, SIP amount, SIP date and period.
• An SIP can be cancelled by giving due notice of the same to the AMC by providing details of
the SIP such as folio number, scheme name, option, bank details and mode of payment.
• An SIP may also stand cancelled if there are insufficient funds in the bank account when
payment is due.

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 Registration and Cancellation of SWP
• In case of systematic withdrawals, the investor has to register the SWP with the mutual fund
and specify details such as the scheme, plan, option, amount of withdrawal, frequency and the
period of the SWP.
• The selections have to be made from the options provided by the mutual fund.
• The mutual fund may specify a minimum period before the first withdrawal before which the
enrollment form has to be submitted.
• An SWP will stand cancelled when all the units are redeemed, or on completion of the period
chosen by the investor.

Registering and Cancellation of STP and Switches

• In case of systematic transfers and switches, the source and target schemes have to be selected
at the time of registering the STP or Switch.
• The schemes from and to which transfers and switches can be made are defined by the mutual
fund. The minimum amount of transfer is also fixed by the mutual fund.
• The frequency, number of installments and the dates of the transfer are selected by the
investor in the form for registering the STP.
• Mutual funds will require a notice period for registering and cancelling the STP.

Triggers
• Many a times, investors misses opportunities of buying or selling because they could not give
the requisite instructions in time.
• This is addressed through the trigger option that is offered by some mutual funds.
• For instance, an investor can book profits by specifying that the units would be re-purchased if
the market reaches a particular level. In that case, once the market reaches that level, the units
would be re-purchased, without the need for going through a separate re-purchase
documentation.

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 Non-Financial Transactions in Mutual Funds
Nomination
• Most investors like clarity about what would happen to their unit-holding, in the unfortunate
event of their demise. This clarity can be achieved by executing a Nomination Form, where the
nominee’s name is specified.
• Nomination can be made in favour of a maximum of three nominees.
• Where there are multiple nominees, the unitholder(s) must define the percentage holding for
each nominee making a total of 100%.
• If the percentages are not clearly indicated, then the nomination will be made equally among
the nominees.
• In the case of joint holding, every unit-holder will have to sign the nomination form,
irrespective of the mode of holding.
• The nomination made in a folio applies to all the investments held under the folio.
• Only individual investors can make a nomination.
• Investments by minors cannot have a nomination.
• A Power of Attorney holder cannot make anomination.

• In case of a folio held in the name of a single individual, investor can confirm his intent not to
nominate at the time of making the application.

Nominees
• The nominee can be an individual, including minors and NRIs, central and state governments
and local authorities.
• If the nominee is a minor, then a guardian too can be specified.
• A nomination cannot be made in favor of a trust (except a religious or charitable trust),
society, body corporate, partnership, Karta of an HUF or a Power of Attorney holder.

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 Change in Nomination
• A nomination can be changed or cancelled at any time.
• The death of a nominee will cancel the nomination made.
• If there are multiple nominees, in the event of the death of one or more nominees the
transmission of units will be made in favor of the remaining nominee(s).

Nomination in case of demat holdings of mutual fund

• For units held in dematerialized mode, the nominee made for the demat account will apply.
Such nominations will be governed by the bye-laws of the depository.

Pledge/Lien of Units
• Banks, NBFCs and other financiers often lend money against pledge of Units by the
Unitholder.
• This is effected through a Pledge Form executed by the unit-holder (pledger).
• The form has a provision for specifying the party in whose favor the units are pledged
(pledgee).
• The units that are offered as security for a loan should have completed the lock-in period, if
any (Units which are under lock-in period, can’t be pledged).
• All the unit-holders, irrespective of the mode of holding, of the folio must sign the form
requesting the marking of the lien in favour of the lender.

Demat Account
• Dematerialisation is a process whereby an investor’s holding of investments in physical form
(paper), is converted into a digital record.
• In order to avail this facility, the investor needs to open a demat account with a depository
participant.
• Mutual funds provide investors, the option to hold the units in demat form.
• The option to apply for the units in dematerialized form is provided in the application form.
• The name of the Depository Participant with whom the investor holds the account, DP ID
number and Beneficiary Account Number has to be provided.
• The investor also has the option to convert the demat units into physical form. This process is
called re-materialization.

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 Change in Folio Details
• The personal information of the investor captured under the folio is liable to changes which
have to be updated in the records. Any changes have to be updated with the KRA using the
change form. The KRA will communicate the updated information to all the mutual funds.
• Others, such as change in bank accounts, change in the mode of holding in operating a folio, or
the nominations made in an investment, have to be updated with each mutual fund.
• Investors can register up to 5 bank accounts with a mutual fund for individual investors and 10
for non-individuals.

Transmission of Units
• Transmission is the process of transferring units to the person entitled to receive it in the event
of the death of the unit holder.
• The person entitled to receive it depends upon the folio conditions of joint holding and
nomination.
• If the first holder passes away, the second holder is substituted as first holder.
• In a singly held folio with nominations, the units are transferred to the nominee.
• If a folio is jointly held and has nominations, the right of the joint holder will take precedence.
• If there are no nominations in the folio, the units are transmitted to the legal successors.

Change in Status of Special Investor Categories - Minor turned Major

• Once the minor become major, financial transactions are disallowed in their account.

• However, after a minor becomes major, they can conduct such transactions, only after their
signature is attested by their banker.
• KYC: Minors attaining majority will have to complete all the KYC process by submitting
proof of identity and address.
• When a minor turns a major, he/she needs to submit an application for change in status from
Minor to Major in a prescribed form, along with the prescribed documents.

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 Change in Status of Special Investor Categories - NRI to Resident Indian
• If a person returns to India and forgoes the NRI status, he needs to carry out certain procedures
with respect to his investments and bank accounts.
• Bank Account: Once an NRI becomes a RI, he cannot operate his NRO/NRE/FCNR (B)
accounts. He needs to inform to the bank about the change of status to resident Indian and needs
to open a Resident Rupee Account.
• Demat Account: Just like bank account, the returning NRI needs to inform change of status to
the designated authorised dealer branch through which the investor had made investments in
the Portfolio Investment Scheme, as well as the DP with whom he has opened a demat account.
A new demat account with ‘Resident’ status needs to be opened.

Change in Status of Special Investor Categories - NRI to Resident Indian

• Mutual Fund Investments: The NRI needs to inform the relevant AMCs about the change of
status, change of address and bank details with respect to mutual fund investments.
• KYC change form needs to be sent to the KYC registration agency for change of status,
address and bank details.
• An acknowledgement shall be issued by the KYC registration agency on submission of
request and will carry out the necessary changes in its records.
• Once the investor is flagged as an NRI, TDS will be deducted at source on gains made on
sale/redemption of mutual fund investments by NRIs as applicable.

Change in Status of Special Investor Categories - Change in Karta of HUF

• For change in ‘Karta’ of an HUF, a letter is required from the new Karta stating the reason for
change of Karta in mutual fund records. The respective AMC may have a specific form. Name
of the deceased Karta, folio number, scheme, unit details may be mentioned in the letter signed
by the new Karta. KYC documents of the new Karta and the HUF need to be provided.

• If the HUF is already KYC compliant, the HUF KYC need not be furnished. Along with the
letter and KYC documents, the following must be enclosed:
• Attested copy of death certificate
• Bank certificate stating signature and details of new Karta
• Indemnity bond signed by all co-parceners and new Karta

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 Investor transactions – turnaround times (TAT)

Service provided by Mutual Funds Turnaround Time

NAV Calculation and disclosure Maximum of 15 days

Mutual Fund Schemes NFO period (other Maximum of 15 days
than ELSS)
Mutual Fund Schemes to allot units or Within 5 business days of closure of NFOs
refund money

Re-opening for ongoing sale/re-purchase of Within 5 business days of allotment of

open ended scheme (other than ELSS) units

Dispatch of Dividend (IDCW) warrants to Within 7 working days from the dividend
investors record date (15% int for delay)

Dispatch of Redemption/re-purchase Within 3 working days from the date of

cheques to investors redemption (15% interest for delay)
Scheme-wise Annual Report or an abridged Four months from the date of closure of the
summary to all unit holders relevant accounts year
Statement of portfolio to be sent to all Before the expiry of 10 days from the close
unitholders of each half year (31st Mar & 30th Sep)

A Consolidated Account Statement (CAS) On or before 15th of the succeeding

by post/email
month
Unit certificate To be issued within 5 working days of the
receipt of request for certificate.
Half Yearly Disclosures (unaudited financial Within 1 month from the close of each half
results) on mutual fund website year (i.e. 31st Mar and 30th Sep) [this is
applicable for schemes other than debt and
money market schemes.

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 Statement of Account in case of SIP/ STP Turnaround Time
/ SWP

Initial transaction SIP / STP / SWP within 5 working days

Ongoing SIP/STP/SWP once every calendar quarter (March, June,

September, December) within 10 working
days of the end of the quarter.

On specific request by investor it will be dispatched to investor within 5

working days without any cost.

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 Chapter 10
Risk, Return & Performance of Funds

Learning Objective

o General and Specific risk factors

o Factors affecting mutual fund performance of different schemes
o Drivers of returns and risk in a scheme
o Measures of returns
o SEBI norms regarding return representation of returns by mutual funds in India
o Risks in fund investing with a focus on investors
o Various risk measure
o Certain Provisions with respect to Credit risk

General & Specific Risk Factors

General Risk Factors:
• Investment in mutual fund units involves investment risks such as trading volumes, settlement
risk, liquidity risk, default risk, including the possible loss of principal.
• As the price/value/interest rates of the securities in which the scheme invests fluctuates, the
value of investment in the scheme may increase or decrease.
• Past performance of the Sponsor/AMC/Mutual Fund does not guarantee future performance
of the Scheme.
• The name of the Scheme does not in any manner indicate either the quality of the Scheme or
its future prospects and returns.
• The Sponsors are not responsible or liable for any loss resulting from the operation of the
Scheme beyond the initial contribution made by it towards setting up the Mutual Fund.

General Risk - Liquidity Risk

• The liquidity of investments made in the Scheme may be restricted by trading volumes,
settlement periods and transfer procedures.
• Money market securities, while fairly liquid, lack a well-developed secondary market, which
may restrict the selling ability of the Scheme and may lead to the Scheme incurring losses till
the security is finally sold.
• The liquidity of a bond may change, depending on market conditions leading to changes in the
liquidity premium attached to the price of the bond.

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 • Even though the Government securities market is more liquid compared to other debt
instruments, on occasions, there could be difficulties in transacting in the market due to extreme
volatility leading to constriction in market volumes.

General Risk - Interest Rate Risk

• Fixed income securities such as government bonds, corporate bonds, money market
instruments and derivatives run price-risk or interest-rate risk.
• Generally, when interest rates rise, prices of existing fixed income securities fall and when
interest rates drop, such prices increase.
• The extent of fall or rise in the prices depends upon the coupon and maturity of the security.
• It also depends upon the yield level at which the security is being traded.
• Derivatives carry the risk of adverse changes in the price due to change in interest rates.

General Risk - Re-investment Risk

• The investments made by the Scheme are subject to reinvestment risk.
• This risk refers to the interest rate levels at which cash flows received from the securities in
the Scheme are reinvested.
• The additional income from reinvestment is the ‘interest on interest’ component.
• The risk is that the rate at which interim cash flows can be reinvested may be lower than that
originally assumed.

General Risk - Political Risk

• Investments in mutual fund may be materially adversely impacted by Indian politics and
changes in the political scenario, either at the central, state or local level.
• Actions of the central or respective state governments in the future could have a significant
effect on the Indian economy, which could affect companies, general business and market
conditions, prices and yields of securities in which the Scheme invest.
• Delays or changes in the development of conducive policy frameworks could also have an
impact on the securities in which the Scheme invests.

General Risk - Economic Risk

• A slowdown in economic growth or macro-economic imbalances such as the increase in
central and state level fiscal deficits may adversely affect investments in the country.

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 • The underlying growth in the economy is expected to have a direct impact on the volume of
new investments in the country.

General Risk - Foreign Currency Risk

• The Scheme may be denominated in Indian Rupees (INR) which is different from the home
currency for Foreign Portfolio Investors in the mutual fund units.
• The INR value of investments when translated into home currency by Foreign Portfolio
Investors could be lower because of the currency movements.
• The AMC does not manage currency risk for Foreign Portfolio Investors and it is the sole
responsibility of the Foreign Portfolio Investors to manage or reduce currency risk on their own.

Risks associated with transaction in Units through stock exchange(s)

• In respect of transaction in Units of the Scheme through stock exchanges, allotment and
redemption of Units on any Business Day will depend upon the order processing /settlement by
BSE/NSE and their respective clearing corporations on which the Fund has no control.

Specific Risk Factors - Risk related to equity and equity related securities
• Equity and equity related securities are volatile and prone to price fluctuations on a daily
basis.
• The liquidity of investments made in the scheme can get restricted by trading volumes and
settlement periods.
• Settlement periods may be extended significantly by unforeseen circumstances.
• The inability of the scheme to make intended securities purchases, due to settlement problems,
could cause the Scheme to miss certain investment opportunities.
• Similarly, the inability to sell securities held in the scheme portfolio would result at times, in
potential losses to the scheme, if there is a subsequent decline in the value of securities held in
the scheme portfolio.
• Also, the value of the scheme investments may be affected by interest rates, currency exchange
rates, changes in law/policies of the government, taxation laws and political, economic or other
developments which may have an adverse bearing on individual securities, a specific sector or
all sectors.

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 Specific Risk Factors - Risk associated with short selling and Stock Lending
• Securities Lending is lending of securities through an approved intermediary to a borrower
under an agreement for a specified period with the condition that the borrower will return
equivalent securities of the same type or class at the end of the specified period along with the
corporate benefits accruing on such securities.
• There are risks inherent in securities lending, including the risk of failure of the other party.
Such failure can result in a possible loss of rights to the collateral, the inability of the approved
intermediary to return the securities deposited by the lender and the possible loss of corporate
benefits accruing thereon.
• Short-selling is the sale of shares or securities that the seller does not own at the time of trading.
Instead, he borrows it from someone who already owns it. Later, the short seller buys back the
stock/security he shorted and returns the stock/security to the lender to close out the loan.
• The inherent risks are Counterparty risk and liquidity risk of the stock/security being borrowed.
The security being short sold might be illiquid or become illiquid and covering of the security
might occur at a much higher price level than anticipated, leading to losses.

Specific Risk Factors - Risks associated with mid-cap and small-cap companies
• Investment in mid-cap and small-cap companies are based on the premise that these companies
have the ability to increase their earnings at a faster pace as compared to large cap companies
and grow into larger, more valuable companies.
• However, as with all equity investments, there is a risk that such companies may not achieve
their expected earnings results, or there could be an unexpected change in the market, both of
which may adversely affect investment results.
• As you go down the capitalization i.e. from large to mid-cap and beyond, there are higher risks
in terms of volatility and liquidity.

Specific Risk Factors - Risk associated with Dividend

• Dividend is due only when declared and there is no assurance that a company (even though it
may have a track record of payment of dividend in the past) may continue paying dividend in
future.
• As such, the schemes are vulnerable to instances where investments in securities may not earn
dividend or where lesser dividend is declared by a company in subsequent years in which
investments are made by schemes.

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 • As the profitability of companies are likely to vary and have a material bearing on their ability
to declare and pay dividend, the performance of the schemes may be adversely affected due to
such factors.

Specific Risk Factors - Risk associated with Derivatives

• The mutual fund schemes may invest in derivatives to the extent permitted under the SEBI and
by RBI regulations.
• Derivative products are specialized instruments that require investment techniques and risk
analysis different from those associated with stocks and bonds.
• The use of a derivative requires an understanding not only of the underlying instrument but of
the derivative itself.
• Trading in derivatives carries a high degree of risk although they are traded at a relatively small
amount of margin.
• Derivatives are highly leveraged instruments. Even a small price movement in the underlying
security could have an impact on their value and consequently, on the NAV of the Units of the
Scheme. The risks associated with the use of derivatives are possibly greater than, the risks
associated with investing directly in securities.

Risks related to debt funds - Reinvestment Risk

• Investments in fixed income securities carry re-investment risk as interest rates prevailing on
the coupon payment or maturity dates may differ from the original coupon of the bond.

Risks related to debt funds - Rating Migration Risk

• Fixed income securities are exposed to rating migration risk, which could impact the price on
account of change in the credit rating.
• For example: Downgrade of a AAA rated issuer to AA+ will have an adverse impact on the
price of the security and vice-versa for an upgrade of a AA+ issuer.

Risks related to debt funds - Term Structure of Interest Rates Risk

• The NAV of the Scheme’ Units, to the extent that the Scheme are invested in fixed income
securities, will be affected by changes in the general level of interest rates.
• When interest rates decline, the value of a portfolio of fixed income securities can be expected
to rise.

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 • Conversely, when interest rates rise, the value of a portfolio of fixed income securities can be
expected to decline.

Risks related to debt funds – credit Risk

• Debt and money market securities are subject to the risk of an issuer’s inability to meet interest
and principal payments on its debt obligations.
• Different types of securities in which the Scheme would invest as given in the SID carry
different levels of credit risk. Accordingly, the Scheme’ risk may increase or decrease
depending upon their investment patterns.
• Bonds which are rated AAA are comparatively less risky than bonds which are AA rated

Risks related to debt funds – Risk associated with floating rate securities
• Spread Risk: In a floating rate security the coupon is expressed in terms of a spread or mark
up over the benchmark rate. In the life of the security this spread may move adversely leading
to loss in value of the portfolio. The yield of the underlying benchmark might not change, but
the spread of the security over the underlying benchmark might increase leading to loss in value
of the security.
• Basis Risk: The underlying benchmark of a floating rate security or a swap might become less
active or may cease to exist and thus may not be able to capture the exact interest rate
movements, leading to loss of value of the portfolio.

Risks related to debt funds – Risk factors associated with repo transactions in
Corporate Bonds
• The Scheme may be exposed to counter party risk in case of repo lending transactions in the
event of the counterparty failing to honour the repurchase agreement.
• However, in repo transactions, the collateral may be sold and a loss is realized only if the sale
price is less than the repo amount.
• The risk is further mitigated through over-collateralization (the value of the collateral being
more than the repo amount).

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 Risks related to debt funds – Risks associated with Creation of Segregated
portfolio
• Investor holding units of segregated portfolio may not able to liquidate their holding till the
time recovery of money from the issuer or it may not realize any value.
• Listing of units of segregated portfolio on recognised stock exchange does not necessarily
guarantee their liquidity.
• There may not be active trading of units in the stock market.
• Further trading price of units on the stock market may be significantly lower than the
prevailing NAV.

Risks related to debt funds – Risks associated with investments in Securitized

Assets
• A securitization transaction involves sale of receivables by the originator (a bank, NBFC,
housing finance company, or a manufacturing/service company) to a Special Purpose Vehicle
(SPV), typically set up in the form of a trust.
• Investors are issued rated Pass Through Certificates (PTCs), the proceeds of which are paid as
consideration to the originator.
• In this manner, the originator, by selling his loan receivables to an SPV, receives consideration
from investors much before the maturity of the underlying loans.
• Investors are paid from the collections of the underlying loans from borrowers.
• Typically, the transaction is provided with a limited amount of credit enhancement as stipulated
by the rating agency for a target (rating), which provides protection to investors against defaults
by the underlying borrowers.
• Risks associated with asset class: Underlying assets in securitised debt may assume different
forms and the general types of receivables include commercial vehicles, auto finance, credit
cards, home loans or any such receipts.
• Size of the loan: While a pool of loan assets comprising of smaller individual loans provides
diversification, very small ticket size, may result in difficult and costly recoveries.
• Loan to Value Ratio: The lower LTV, the better it is. This ratio stems from the principle that
where the borrowers own contribution of the asset cost is high, the chances of default are lower.
• Original maturity of loans and average seasoning of the pool: Original maturity indicates
the original repayment period and whether the loan tenors are in line with industry averages

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 and borrower’s repayment capacity. Average seasoning indicates whether borrowers have
already displayed repayment discipline.
• Default rate distribution: This indicates how much percent of the pool and overall portfolio
of the originator is current, how much is in 0-30 DPD (days past due), 30-60 DPD, 60-90 DPD
and so on. The rationale here is very obvious, as against 0-30 DPD, the 60-90 DPD is certainly
a higher risk category.
• Credit Rating and Adequacy of Credit Enhancement: In securitization transactions, it is
possible to work towards a target credit rating, which could be much higher than the originator’s
own credit rating. This is possible through a mechanism called “Credit enhancement”. The
process of “Credit enhancement” is fulfilled by filtering the underlying asset classes and
applying selection criteria, which further diminishes the risks inherent for a particular asset
class. The purpose of credit enhancement is to ensure timely payment to the investors, if the
actual collection from the pool of receivables for a given period is short of the contractual pay-
out on securitization.
• Limited Liquidity & Price Risk: The secondary market for securitized papers is not very
liquid. There is no assurance that a deep secondary market will develop for such securities.
• Limited Recourse to Originator & Delinquency: No financial recourse is available to the
Certificate Holders against the Investors Representative. In addition, the price at which such
asset may be sold may be lower than the amount due from that Obligor.
• Risks due to possible prepayments: In the event of prepayments, investors may be exposed
to changes in tenor and yield.
• Bankruptcy of the Originator or Seller: If originator becomes subject to bankruptcy
proceedings & the court in the bankruptcy proceedings concludes that the sale from originator
to trust was not a sale then an Investor could experience losses or delays in the payments due.
• Bankruptcy of the Investor’s Agent: If Investor’s agent becomes subject to bankruptcy
proceedings and the court in the bankruptcy proceedings concludes that the recourse of
Investor’s Agent to the assets/receivables is not in its capacity as agent/Trustee but in its
personal capacity, then an Investor could experience losses or delays in the payments due.
• Risk of co-mingling: The servicers normally deposit all payments received from the obligors
into the collection account. However, there could be a time gap between collection by a servicer
and depositing the same into the collection account especially considering that some of the
collections may be in the form of cash. In this interim period, collections from the loan
agreements may not be segregated from other funds of the servicer. If the servicer fails to remit
such funds due to Investors, the Investors may be exposed to a potential loss.

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 Risk Factors Associated with Investments in REITs and InvITs
• ReITs and InvITs are exposed to price-risk, interest rate risk, credit risk, liquidity or
marketability risk, reinvestment risk.
• Also, there is a risk of lower than expected distributions.
• The distributions by the REIT or InvIT will be based on the net cash flows available for
distribution.
• The amount of cash available for distribution principally depends upon the amount of cash that
the REIT/InvITs receives as dividends or the interest and principal payments from portfolio
assets.

Managing Market Liquidity Risk

• The Investment Manager selects fixed income securities, which have or are expected to have
high secondary market liquidity.
• There is good secondary market liquidity in government securities. As far as other long dated
fixed income securities are concerned, the endeavor is to invest in high quality securities, for
example bonds issued by public sector entities.
• Market Liquidity Risk will be managed actively within the portfolio liquidity limits.
• The first access to liquidity is through cash & fixed income securities.

Managing Credit Risk

• Credit Risk is managed by making investments in securities issued by borrowers, which have
a good credit profile.
• The credit research process includes a detailed in-house analysis and due diligence.
• Limits are assigned for each of the issuer (other than G-sec); these limits are for the amount as
well as maximum permissible tenor for each issuer.
• The credit process ensures that issuer level review is done at inception as well as periodically
by taking into consideration the balance sheet and operating strength of the issuer.

Managing Term Structure of Interest Rates Risk

• The Investment Manager actively manages the duration based on the ensuing market
conditions.
• As the fixed income investments of the Scheme are generally short duration in nature, the risk
is expected to be small.

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 Managing Rating Migration Risk
• The endeavour is to invest in high grade/quality securities.
• The due diligence performed by the fixed income team before assigning credit limits and the
periodic credit review and monitoring should address company-specific issues.

Re-investment Risk
• Re-investment Risk is prevalent for fixed income securities, but as the fixed income investments
of the Scheme are generally short duration in nature, the impact can be expected to be small.

Market Risk related to equity and equity related securities

• The Investment Manager endeavours to invest in companies, where adequate due diligence
and research has been performed by the Investment Manager.
• In addition to third-party research companies report, the Investment Manager also makes his
own research.
• This involves one-to-one meetings with the management of companies, attending conferences
and analyst meets and also tele-conferences, and making a fundamental analysis.

Other risk factors

Risk associated with floating rate securities
• There is very low liquidity in floating rate securities, resulting in lack of price discovery. Hence,
incremental investments in floating rate securities are going to be very limited.
Managing Risk associated with favourable taxation of equity-oriented Scheme
• This risk is mitigated as there is a regular monitoring of equity exposure of each of the equity
oriented Scheme of the Fund.
Factors that affect mutual fund performance
• Different asset classes have different characteristics. At the same time, different fund managers
may adopt different approaches and strategies, which may also impact the performance of the
schemes.
• Having said that, fund managers take certain risks in order to outperform the respective
benchmark’s performance.
• This means that the schemes may be subject to the risks that an asset class is exposed to, as well
as the risks that the fund manager may choose or avoid.

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 Difference between market/ systematic risk & company specific risk
• The company specific risks can be reduced through diversification across diverse set of
companies. However, the systematic risks cannot be reduced through such diversification.
• Since the unsystematic risk can be reduced through diversification, it is also called the
diversifiable risk. On the other hand, the systematic risk is known as non-diversifiable risk.
• Fund managers cannot reduce the systematic risk except by staying out of the market.
• Thus, some fund managers may tactically move between equity and cash depending on their
view on the broader market.

Mutual fund investments are subject to market risks

• “Mutual fund investments are subject to market risks. Please read the scheme related
documents carefully before investing.” – These lines are part of any marketing communication
by mutual fund companies.
• Unlike most other products, mutual fund is a pass-through vehicle, in which all the investment
risks are passed onto the investor since the investor/unit-holder is the owner of the fund.
• This is not the case when one invests in say a fixed deposit. The company is supposed to pay
the investor only the promised return – nothing more, nothing less.

Drivers of Returns and Risk in a Scheme

• The portfolio is the main driver of returns in a mutual fund scheme.
• The asset class in which the fund invests, the segment or sectors of the market in which the fund
will focus on, the styles adopted to select securities for the portfolio and the strategies adopted
to manage the portfolio determines the risk and return in a mutual fund scheme.
• The underlying factors are different for each asset class.

Factors Affecting Performance of Equity Schemes

• In order to generate returns superior to the benchmark, the fund manager must construct a
portfolio that is different from the benchmark – either entire portfolio or a part of it, and either
always, or at least some times.
• Two primary strategies adopted by the portfolio managers are security selection and market
timing.
• For these purposes, two types of analysis may be used–fundamental analysis and technical
analysis.

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 Fundamental analysis
• Fundamental analysis is a study of the business and financial statements of a firm in order to
identify securities suitable for the strategy of the schemes as well as those with high potential
for investment returns and where the risks are low.
• Fundamental analysis normally ties in well with the security selection strategy and mostly used
for identifying long term investment avenues.

Technical analysis
• Technical Analysts believe that price behavior of a share over a period of time throws up trends
for the future direction of the price.
• Along with past prices, the volumes traded indicate the underlying strength of the trend and are
a reflection of investor sentiment, which in turn will influence future price of the share.
• Technical Analysts therefore study price-volume charts (a reason for their frequently used
description as “chartists”) of the company’s shares to decide support levels, resistance levels,
break outs, and other triggers to base their buy/sell/hold recommendations for a share.

Fundamental v/s Technical Analysis

• Both types of analysts swear by their discipline.
• It is generally agreed that longer term investment decisions are best taken through a
fundamental analysis approach, while technical analysis comes in handy for shorter term
speculative decisions, including intra-day trading.
• Even where a fundamental analysis-based decision has been taken on a stock, technical analysis
might help decide when to implement the decision i.e. the timing.

Fundamental analysis
• Earnings per Share (EPS): This tells investors how much profit the company earned for each
equity share that they own.
• Price to Earnings Ratio (P/E Ratio): When investors buy shares of a company, they are
essentially buying into its future earnings.
• P/E ratio indicates how much investors in the share market are prepared to pay (to become
owners of the company), in relation to the company’s earnings.
• The forward PE ratio is normally calculated based on a projected EPS for a future period (also
called forward EPS)

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 P/E Ratio = Market Price per share ÷ Earnings Per Share (EPS)
• Price Earnings to Growth Ratio (P/E Ratio): This relates the P/E ratio to the growth
estimated in the company’s earnings.
• A PEG ratio of one indicates that the market has fairly valued the company’s shares, given its
expected growth in earnings.
• A ratio less than one indicates the equity shares of the company are undervalued, and a ratio
greater than one indicates an overvalued share.
• PEG Ratio = P/E Ratio ÷ Earnings Growth Rate

Fundamental analysis
Book Value per Share: This is an indicator of how much each share is worth, as per the
company’s own books of accounts.
• The accounts represent a historical perspective, and are a function of various accounting
policies adopted by the company.
Book Value per Share = Net Worth ÷ No. of equity shares outstanding

Price to Book Value: An indicator of how much the share market is prepared
to pay for each share of the company, as compared to its book value.
• The drawback with this is that the book value is an accounting measure and may not represent
the true value of the assets of the company.
• Such financial parameters are compared across companies, normally within a sector.
Accordingly, recommendations are made to buy/hold/ sell the shares of the company.
• Price to Book Value = Market Price per share ÷ Book Value per share

Dividend Yield: This is used as a measure of the payouts received from the company, in
percentage, for each rupee of investment in the share.
• Since dividends are not guaranteed or fixed, investors who are particular about receiving
payouts look at the trend in dividend yields over a period of time.
• Dividend yield is considered as a parameter by conservative investors looking to identify
steady and lower risk equity investments.
• A high dividend yield is the result of higher payout and/or lower market prices, both of which
are preferred by such conservative investors.
• Dividend Yield = Dividend per share ÷ Market price per share

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 Investment Styles – Growth & Value
• Growth investment style entails investing in high growth stocks i.e. stocks of companies that
are likely to grow much faster than the economy
• Value investment style is an approach of picking up stocks, which are valued lower, based on
fundamental analysis

Portfolio building approach – Top down and Bottom up

• In analysing the factors that impact the earnings of company, analysts consider the EIC
framework i.e. the economy, the industry and the company-specific factors.
• Economic factors include inflation, interest rates, GDP growth rates, fiscal and monetary
policies of the government, balance of payment etc.
• Industry factors that are relevant include regulations that affect investment and growth
decisions of the companies, level of competition, availability of raw materials and other inputs
and cyclical nature of the industry.
• Company specific factors include management and ownership structure, financial parameters,
products and market shares and others.

Portfolio building approach – Top down and Bottom up

• In analysing the factors that impact the earnings of company, analysts consider the EIC
framework i.e. the economy, the industry and the company-specific factors.
• Economic factors include inflation, interest rates, GDP growth rates, fiscal and monetary
policies of the government, balance of payment etc.
• Industry factors that are relevant include regulations that affect investment and growth
decisions of the companies, level of competition, availability of raw materials and other inputs
and cyclical nature of the industry.
• Company specific factors include management and ownership structure, financial parameters,
products and market shares and others.
• In a top down approach, the portfolio manager evaluates the impact of economic factors first
and narrows down on the industries that are suitable for investment.
• Thereafter, the companies are analysed and the good stocks within the identified sectors are
selected for investment.
• A bottom-up approach on the other hand analyses the company-specific factors first and then
evaluates the industry factors and finally the macro-economic scenario and its impact on the
companies that are being considered for investment.

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 • Stock selection is the key decision in this approach; sector allocation is a result of the stock
selection decisions.

Factors affecting performance of Debt Schemes

• The yields on debt securities tend to move up as the maturity rises (interest rate risk rises), or
as the credit risk is increased.
• Investment in a debt security, entails a return in the form of interest and repayment of the
invested amount at the end of the pre-specified period.
• The pre-specified period is called tenor. At the end of the tenor, the securities are said to
mature and amount will be redeemed.
• An investor may earn capital gains or incur capital losses by selling the debt security before
its maturity period.
• Debt securities that are to mature within a year are called money market securities.
• The total return that an investor earns or is likely to earn on a debt security is called its yield.
• The yield is a combination of interest paid by the issuer and capital gain (if the sale proceeds
are higher than the amount invested) or capital loss (if the sale proceeds are lower than the
amount invested) relative to the price paid to buy the security.
• Debt securities may be issued by Central Government, State Governments, Banks, Financial
Institutions, Public Sector Undertakings (PSU), Private Companies, Municipalities, etc.
• In a top down approach, the portfolio manager evaluates the impact of economic factors first
and narrows down on the industries that are suitable for investment.
• Thereafter, the companies are analysed and the good stocks within the identified sectors are
selected for investment.
• A bottom-up approach on the other hand analyses the company-specific factors first and then
evaluates the industry factors and finally the macro-economic scenario and its impact on the
companies that are being considered for investment.
• Stock selection is the key decision in this approach; sector allocation is a result of the stock
selection decisions.

Factors affecting performance of Debt Schemes

• The yields on debt securities tend to move up as the maturity rises (interest rate risk rises), or
as the credit risk is increased.
• Investment in a debt security, entails a return in the form of interest and repayment of the
invested amount at the end of the pre-specified period.

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 • The pre-specified period is called tenor. At the end of the tenor, the securities are said to
mature and amount will be redeemed.
• An investor may earn capital gains or incur capital losses by selling the debt security before
its maturity period.
• Debt securities that are to mature within a year are called money market securities.
• The total return that an investor earns or is likely to earn on a debt security is called its yield.
• The yield is a combination of interest paid by the issuer and capital gain (if the sale proceeds
are higher than the amount invested) or capital loss (if the sale proceeds are lower than the
amount invested) relative to the price paid to buy the security.
• Debt securities may be issued by Central Government, State Governments, Banks, Financial
Institutions, Public Sector Undertakings (PSU), Private Companies, Municipalities, etc.
• Securities issued by the Government are called G-Sec or Gilt.
• Treasury Bills are short term debt instruments issued by the Reserve Bank of India on behalf
of the Government of India.
• Certificates of Deposit are issued by Banks (for 7 days to 1 year) or Financial Institutions (for
1 to 3 years)
• Commercial Papers are short term securities (upto 1 year) issued by companies.
• Bonds/Debentures are generally issued for tenors beyond a year.
• Governments and public sector companies tend to issue bonds, while private sector companies
issue debentures.
• Since the government is unlikely to default on its obligations, Gilts are viewed as safe as there
is no credit risk associated with them.
• The yield on Gilt is generally the lowest in the market for a given tenor.
• Since non-Government issuers can default, they tend to offer higher yields for the same tenor.
• The difference between the yield on Gilt and the yield on a non- Government Debt security is
called its credit spread.
• The possibility of a non-government issuer defaulting on a debt security i.e. its credit risk is
measured by Credit Rating agencies.
• The interest rate payable on a debt security may be specified as a fixed rate, say 6%.
• Alternatively, it may be a floating rate i.e. a rate linked to some other rate that may be
prevailing in the market, say the rate that is applicable to Gilt.
• Interest rates on floating rate securities (also called floaters) are specified as a “Base +
Spread”.

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 • For example, 5-year G-Sec + 2%, this means that the interest rate that is payable on the debt
security would be 2% above whatever is the rate prevailing in the market for Government
Securities of 5-year maturity.

Interest Rates
• Suppose an investor has invested in a debt security that yields a return of 8%. Subsequently,
yields in the market for similar securities rise to 9%. It stands to reason that the security, which
was bought at 8% yield, is no longer such an attractive investment. It will therefore lose value.
Conversely, if the yields in the market go down, the debt security will gain value. Thus, there
is an inverse relationship between yields and value of such debt securities, which offer a fixed
rate of interest.
• A security of longer maturity would fluctuate a lot more, as compared to short tenor securities.
• Debt analysts’ work with a related concept called modified duration to assess how much a debt
security is likely to fluctuate in response to changes in interest rates.
• Higher the modified duration of a debt security, greater is the volatility in its prices in response
to changes in interest rates in the market.

Credit Spreads
• Suppose an investor has invested in the debt security of a company. Subsequently, its credit
rating improves.
• The market will now be prepared to accept a lower credit spread.
• Correspondingly, the value of the debt security will increase in the market.
• The investment objective of a debt will define whether the focus of the fund manager will be
on earning interest income (Accrual) or on appreciation or gains in the value of the securities
held.
• Duration management is the strategy adopted by funds with the mandate to do so where the
fund manager alters the duration of the portfolio in anticipation of changes in interest rate
scenario.
• The fund manager will increase the duration of the portfolio by moving into long term maturities
if interest rates are expected to go down and vice versa.
• The risk in the strategy arises from the possibility that the expectation on interest rate
movements may not materialize.

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 Factors affecting performance of gold funds
Global price of gold
• Gold is seen as a safe haven asset class. Therefore, whenever there is political or economic
turmoil, gold prices shoot up.

Strength of the Rupee

• Economic research into inflation and foreign currency flows helps analysts anticipate the likely
trend of foreign currency rates.
Since the gold funds are passive in nature, the fund manager does not take a view on the
movement of gold prices. Such funds simply invest in gold and hence there is no risk related to
the decisions taken.

Factors affecting performance of real estate funds

Unlike gold, real estate is a local asset. It cannot be transported – and its value is driven by
local factors. Some of these factors are:
• Economic scenario
• Infrastructure development
• Interest Rates
SEBI has mandated that the mutual funds employ neutral valuation agencies to determine the
current valuation of the real estate investments. Currently, there are no mutual fund schemes
investing in real estate.

Measures of Returns
Simple Return: Suppose you invested in a scheme at a NAV of Rs. 12. Later, you found that
the NAV has grown to Rs. 15. How much is your return?
Simple Return = (15 – 12) / 12 * 100 = 25%
Thus, simple return is simply the change in the value of an investment over a period of
time.

Annualized Return: Two investment options have indicated their returns since inception as 5%
and 3% respectively. If the first investment was in existence for 6 months, and the second for 4
months, then the two returns are obviously not comparable. Annualisation helps us
compare the returns of two different time periods.

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 Compounded Return: If the two investment options mentioned above were in existence for 6
years and 4 years respectively, then it is not possible to calculate the annualized return using
the above formula
as it does not consider the effect of compounding.
What is compounding?
Suppose you deposited Rs. 10,000 in a cumulative bank deposit for 3 years at 10% interest,
compounded annually.
• At the end of the 3 year period, your principal of Rs. 10,000 would have grown to Rs. 13,310.
• If the bank had calculated interest on simple basis, it would have calculated interest at Rs.
1,000 for each of the 3 years, and given you Rs. 13,000.
• The difference between Rs 13,310 and Rs 13,000 is the effect of compounding.
• Longer the period of investment holding, higher would be the difference, if compounding is
not considered.
• Compounded return can be calculated using a formula:
Compounded Annual Growth Rate: The CAGR calculation is based on an assumption that
the dividend would be re-invested in the same scheme at the ex-dividend NAV.
The following example will clarify the calculation.
• You invested Rs. 10,000 in a scheme at Rs. 10 per unit on June 30, 2019
• On January 1, 2020, the scheme paid out a dividend of Re. 1 per unit. The ex-dividend NAV
was Rs. 12.50.
• On January 1, 2021, the scheme paid out another dividend of Re. 1 per unit. The ex-dividend
NAV was Rs. 15.
Let us calculate the CAGR, which we know captures the impact of both dividend payments and
compounding.

Scheme Returns and Investor Returns

• In the earlier example, the CAGR was calculated with the closing NAV as Rs. 15. However, if
an exit load of 1% was applicable, then the investor will receive only 99% of Rs. 15 i.e. Rs.
14.85 on re-purchase.
• Thus, your return as investor would be lower than the scheme returns.
• Similarly, if the original investment had suffered an entry load of 2%, you would have bought
the units at 102 percent of Rs. 10 i.e. Rs. 10.20. This would have brought down the returns.
(Note: Entry load is no longer permitted).

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 • Loads thus drag down the investor’s return below the scheme return.
• Even taxes would pull down the investor’s post-tax returns.

Pros and Cons of Evaluating Funds only on the Basis of Return Performance
• The primary factor that investors use for selecting a mutual fund for investment is the return
that it has generated.
• To make the selection more robust, it is important to consider the consistency of the return
performance and the performance relative to the benchmark of the scheme and its peer group
funds.
• It is important for an actively managed fund to perform well in rising markets and fall less than
the benchmark in a declining market.
• However, the return number alone is not adequate to make a decision to invest in a scheme or
exit from a scheme.

SEBI Norms regarding Representation of Returns by Mutual Funds in India

• Mutual funds are not permitted to promise any returns, unless it is an assured returns scheme.
• Assured returns schemes call for a guarantor who is named in the SID.
• The guarantor will need to write out a cheque, if the scheme is otherwise not able to pay the
assured return.
• Advertisement Code & guidelines for disclosing performance related information of are
prescribed by SEBI.

Risks in fund investing with a focus on investors

• We have already covered the discussion on various general and specific risk factors in mutual
fund schemes. The same must be seen from the point of view of the investors.
• It is understood that the investor is taking some risks while investing in mutual funds.
• However, in order to sell schemes suitable for the investor’s situation, the distributor needs to
understand the impact of these risks.

Risks in Equity fund

• An investor would be exposed to the risk of price fluctuations in an equity fund. The risk is
likely to go up when one moves from large-cap to mid-cap to small-cap schemes.

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 • In the same manner, the business risk or the risk of failure of a company’s business also tends
to be higher in case of small-cap companies in comparison to mid-caps, and higher in case of
mid-caps in comparison to large caps.
• The liquidity risk is another risk that an equity fund investor must be careful of, although equity
investments are suitable for long term. All these risks increase in a focused fund due to portfolio
concentration.

Risks in Debt fund

• Debt funds or income funds are often used for providing stability to the portfolio or for the
purpose of generating regular income.
• A large number of investors are not exposed to fluctuations in prices of their debt instruments,
especially majority of Indians who invest in non-marketable debt instruments, such as fixed
deposits or small savings schemes.
• On the other hand, debt fund NAVs may fluctuate due to change in interest rates or due to credit
migration. That means the debt fund portfolio may not be as stable as one expected.

Risks in Hybrid fund

• It is widely believed that the arbitrage funds are very safe since they employ arbitrage
strategies that nullify the exposure to any security or the stock markets.
• However, some arbitrage funds have the provision to invest in debt securities, as well as to
employ strategies like “paired arbitrage”, or “alpha hedging”, or “merger arbitrage".
• In all these cases, the fund manager is taking a view on the price movement and not
employing pure arbitrage.
• If the judgment turns out to be wrong, the investor could lose some money, or earn low
returns.

Risk in Gold fund

• As an international commodity, gold prices are difficult to manipulate. Therefore, there is
better pricing transparency.
• Further, gold does well when the other financial markets are in turmoil. Similarly, when a
country goes into war, and its currency weakens, gold funds generate excellent returns.
• These twin benefits make gold a very attractive risk proposition.
• An investor in a gold fund needs to be sure what kind of gold fund it is – Gold Sector Fund or
Gold ETF.

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 • Gold funds have the risk that if the value or price of gold falls then the investor could end up
making a loss too.

Risk in Real Estate fund

• Investment in real estate is subject to various kind of risks.
• Every real estate asset is different; therefore, its valuation is highly subjective.
• Real estate is a less liquid asset class. The intermediation chain of real estate agents is largely
unorganized in India.
• Transaction costs, in the form of stamp duty, registration fees, etc. are high. Regulatory risk is
high in real estate, as is the risk of litigation and other encumbrances.
• The transparency level is low even among the real estate development and construction
companies.

Measures of Risk
• Fluctuation in returns is used as a measure of risk.
• Therefore, to measure risk, generally the periodic returns (daily/weekly/fortnightly/monthly)
are first worked out, and then their fluctuation is measured against the average return.
• The fluctuation or variation may be to the higher or lower side. Both are taken as risky.
• The fluctuation in returns can be assessed in relation to itself, or in relation to some other
index.
• Accordingly, the following risk measures are commonly used.

Variance
• Variance measures the fluctuation in periodic returns of a scheme, as compared to its own
average return.
• Variance as a measure of risk is relevant for both debt and equity schemes.
This can be easily calculated in MS Excel using the following function:
= var(range of cells where the periodic returns are calculated)

Standard Deviation
• Like Variance, Standard Deviation too measures the fluctuation in periodic returns of a
scheme in relation to its own average return.
• Standard deviation is equal to the square root of variance.

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 • Standard deviation is a measure of total risk in an investment.
• As a measure of risk it is relevant for both debt and equity schemes.
• A high standard deviation indicates greater volatility in the returns and greater risk.
• Comparing the standard deviation of a scheme with that of the benchmark and peer group funds
gives the investor a perspective of the risk in the scheme.

Beta
• Beta is based on the Capital Asset Pricing Model (CAPM), which states that there are two kinds
of risk in investing in equities – systematic risk and non-systematic risk.
• Since non-systematic risk can be diversified away, investors need to be compensated only for
systematic risk, according to CAPM. This systematic risk is measured by its Beta.
• The diversified stock index, by definition, has a Beta of 1. Companies or schemes, whose beta
is more than 1, are seen as more risky than the market. Beta less than 1 is indicative of a
company or scheme that is less risky than the market.

Modified Duration
• Modified duration measures the sensitivity of value of a debt security to changes in interest
rates.
• Higher the modified duration, higher is the interest sensitive risk in a debt portfolio.
• A professional investor would rely on modified duration as a better measure of sensitivity to
interest rate changes.

Weighted Average Maturity

• Broadly, it can be said that the extent of fluctuation in value of the fixed rate debt security is a
function of its time to maturity (balance tenor).
• Longer the balance tenor, higher would be the fluctuation in value of the fixed rate debt
security arising out of the same change in interest rates in the market.
• This has led to the concept of weighted average maturity in debt schemes.
• Weighted average maturity of debt securities in a scheme’s portfolio is indicative of the
interest rate sensitivity of a scheme.

Credit Rating
• The credit rating profile indicates the credit or default risk in a scheme.
• Government securities do not have a credit risk.

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 • Investments in corporate issuances carry credit risk.
• Higher the credit rating, lower is the default risk.
• Issuers with a poor credit rating need to offer higher yields to attract investors.
• Credit rating too changes over time.

Certain Provisions with respect to Credit risk

• In the debt markets, the credit risk arises on account of three things, viz., default, delay in
payments, or rating downgrade.
• Any of these may result in fall in prices of the concerned debt securities. Such an event is also
called a credit event.
• Whenever a credit event happens, it may lead to reduction in the trading volume of the
respective paper.
• In such a case, mutual funds may come under stress, if a large part of the scheme is redeemed.
• In order to reduce the impact of such risks, SEBI has allowed two provisions:
1. Gating or restriction on redemption in mutual funds
2. Segregated portfolios or side-pocketing

Gating or restriction on redemption in mutual funds

When:
• Only when there are circumstances leading to a systemic crisis or event that severely
constricts market liquidity or the efficient functioning of market
How long:
• Not exceeding 10 working days in any 90 days period
Amount:
• No redemption requests up to Rs. 2 lakhs shall be subject to such restriction
• For redemptions above Rs. 2 lakhs, the first Rs. 2 lakhs would be redeemed. The restriction
would apply to balance amount

Segregated portfolio or side pocketing

• To ensure fair treatment to all investors in case of a credit event and to deal with the liquidity
risk, in December 2018, SEBI permitted creation of segregated portfolio of debt and money
market instruments by mutual funds schemes.
• “Segregated portfolio” means a portfolio, comprising of debt or money market instrument
affected by a credit event, that has been segregated in a mutual fund scheme.

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 • “Main portfolio” means the scheme portfolio excluding the segregated portfolio.

TER for Segregated Portfolio

• AMC will not charge investment and advisory fees on the segregated portfolio.
• TER can be charged, on a pro-rata basis only upon recovery of the investments in segregated
portfolio.
• The legal charges related to recovery of the investments of the segregated portfolio may be
charged to the segregated portfolio in proportion to the amount of recovery.
• The costs related to segregated portfolio shall in no case be charged to the main portfolio.

NAV of Segregated Portfolio

• The Net Asset Value (NAV) of the segregated portfolio is required to be declared on a daily
basis.
• Adequate disclosure of the segregated portfolio shall appear in all scheme related documents,
in monthly and half-yearly portfolio disclosures and in the annual report of the mutual fund and
the scheme.

Risks Associated with Segregated Portfolio

• Investor holding units of segregated portfolio may not able to liquidate their holding till the
time of recovery of money from the issuer.
• Securities comprising segregated portfolio may not realize any value.
• Listing of units of segregated portfolio in recognized stock exchange does not necessarily
guarantee their liquidity. There may not be active trading of units in the stock market. Further
trading price of units on the stock market may be significantly lower than the prevailing NAV.

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 Chapter 11
Mutual Fund Scheme Performance

Learning Objective
o Concept of Benchmarks and Performance in case of mutual funds
o Difference between Price Returns Index versus Total Returns Index
o Basis of Choosing an appropriate performance benchmark
o Benchmarks for Equity Schemes
o Benchmark for Debt Schemes
o Benchmark for Other Schemes
o Quantitative measures of fund manager performance
o Sources to track mutual fund performance
o Sources of Scheme Performance Disclosures

Benchmarks and Performance

• Mutual fund schemes invest in the market for the benefit of Unit-holders.
• How well did a scheme perform this job?
• It should be in synch with the investment objective of the scheme.
• Most benchmarks are constructed by stock exchanges, credit rating agencies, securities
research houses or financial publications.
• Gaps between the scheme performance, and benchmark, are called tracking errors.

Price Return Index (PRI) or Total Return Index (TRI)

• Earlier, the Mutual Fund schemes were benchmarked to the Price Return Index (PRI).
• PRI only captures capital gains of the index constituents.
• From 01/02/2018, the mutual fund schemes are benchmarked to the TRI.
• The TRI takes into account all dividends/interest payments that are generated from the basket
of constituents that make up the index in addition to the capital gains.

Basis of Choosing an appropriate performance benchmark

• Selection of a benchmark for the scheme of a mutual fund to be in alignment with the
investment objective, asset allocation pattern and investment strategy of the scheme.
• The performance of the schemes of a mutual fund to be benchmarked to the Total Return
variant of the Index chosen as a benchmark.

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 • Mutual funds should use a composite CAGR figure of the performance of the PRI benchmark
(till the date from which TRI is available) and the TRI (subsequently) to compare the
performance of their scheme in case TRI is not available for that particular period.

Benchmarks for equity schemes

Scheme Type
• A sector fund would invest in only the concerned sector; while there are some funds that invest
in all sectors.
• Therefore, funds investing in different sectors need to have a diversified index as a benchmark
index, like S&P BSE Sensex or Nifty 50 or S&P BSE 200 or S&P BSE 500 or Nifty 100 or
Nifty 500 as a benchmark; sectoral/thematic funds select sectoral/ thematic indices such as S&P
BSE BankEx, S&P BSE FMCG Index, Nifty Infrastructure Index and Nifty Energy Index.

Choice of Investment Universe

• Some equity funds investing in different sectors invest in large companies; while there are
others that focus on mid-cap stocks or small cap stocks.
• S&P BSE Sensex and Nifty 50 indices are calculated based on 30 (in the case of Sensex) / 50
(in the case of Nifty) large companies.
• Thus, these indices are appropriate benchmarks for those equity funds that invest in large
companies.
• For mid cap funds mid cap indices such as Nifty Midcap 50 or S&P BSE Midcap are
considered as better benchmarks.

Choice of Portfolio Concentration

• Some equity funds investing in different sectors prefer to have fewer stocks in their portfolio.
• For such schemes, appropriate benchmarks are narrow indices such as S&P BSE Sensex and
Nifty 50, which have fewer stocks.
• Schemes that propose to invest in more number of companies will prefer broader indices like
S&P BSE 100/Nifty 100 (based on 100 stocks), S&P BSE 200/Nifty 200 (based on 200 stocks)
and S&P BSE 500/Nifty 500 (based on 500 stocks).

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 Benchmarks for debt schemes
• As per the SEBI guidelines, the benchmark for debt (and balanced schemes) should be
developed by research and rating agencies recommended by AMFI. CRISIL, ICICI Securities
and NSE have developed various such indices.
• NSE’s MIBOR (Mumbai Inter-Bank Offered Rate) is based on short term money market.
• ICICI Securities’ Sovereign Bond Index (I-Bex) is based on government securities.
• CRISIL has a set of indices for debt schemes.

Benchmarks for debt schemes

Scheme Type
• Liquid schemes invest in securities of up to 91 days’ maturity. Therefore, a short term money
market benchmark such as NSE’s MIBOR or CRISIL Liquid Fund Index is suitable.
• Non-liquid schemes can use one of the other indices mentioned above, depending on the
nature of their portfolio

Choice of Investment Universe

• Gilt funds invest only in Government securities. Therefore, indices based on Government
Securities are appropriate.
• Debt funds that invest in a wide range of Government and Non-Government securities need to
choose benchmarks that are calculated based on a diverse mix of debt securities.

Benchmarks for other schemes

Hybrid Schemes
• Hybrid funds invest in a mix of debt and equity. Therefore, the benchmark for a hybrid fund is
a blend of an equity and debt index.

Gold ETF
• Gold price would be the benchmark for such funds.

Real Estate Funds

• A few real estate services companies have developed real estate indices. These have shorter
histories, and are yet to earn the wider acceptance that the equity indices enjoy.

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 International Funds
• The benchmark would depend on where the scheme proposes to invest.
• A scheme seeking to invest in China might have the Hang Seng Index (Chinese index) as the
benchmark.
• S&P 500 may be appropriate for a scheme that would invest largely in the US market.
• A scheme that seeks to invest across a number of countries, can structure a synthetic index
that would be a blend of the indices relevant to the countries where it proposes to invest

Standard benchmarks
• For the sake of standardization, schemes need to disclose return in INR and by way of CAGR
for the following benchmarks apart from the scheme benchmarks:
• This was proposed in order to bring standardization to the process of benchmarking as well as
comparing the scheme performance with easily available indices.
• These disclosures shall form part of the Statement of Additional Information and all
advertisements of Mutual Funds.

Quantitative Measures of Fund Manager Performance

• If a comparison of relative returns indicates that a scheme earned a higher return than the
benchmark, then that would be indicative of outperformance by the fund manager.
• In the reverse case, the initial premise would be that the fund manager under-performed.
• Such premises of outperformance or under-performance need to be validated through deeper
performance reviews.
• AMCs and trustees are expected to conduct such periodic reviews of relative returns, as per
the SEBI Guidelines.
• Relative returns comparison is one approach towards evaluating the performance of the fund
manager of a scheme.
• An alternative approach to evaluating the performance of the fund manager is through the risk
reward relationship.
• A fund manager, who has taken higher risk, ought to earn a better return to justify the risk
taken.
• A fund manager who has earned a lower return may be able to justify it through the lower risk
taken.
• Such evaluations are conducted through Risk-adjusted Returns.

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 Sharpe Ratio
• Sharpe ratio is a very commonly used measure of risk-adjusted returns.
• An investor can invest with the government and earn a risk-free rate of return (Rf).
• T-Bill index is a good measure of this risk-free return.
• Through investment in a scheme, a risk is taken, and a return is earned (Rs).
• The difference between the two returns i.e. Rs– Rf is called risk premium.
• It is like a premium that the investor has earned for the risk taken, as compared to
government’s risk-free return.
• This risk premium is to be compared with the risk taken. Sharpe Ratio uses Standard
Deviation as a measure of risk. It is calculated as:

Sharpe Ratio = (Rs - Rf) ÷ Standard Deviation

• Thus, if risk free return is 5%, and a scheme with standard deviation of 0.5% earned a return
of 7%, its Sharpe Ratio would be;
(7% - 5%) ÷ 0.5 % = 4.
• Sharpe Ratio is effectively the risk premium generated by assuming per unit of risk.
• Higher the Sharpe Ratio, better the scheme is considered to be.
• Sharpe Ratio comparisons can be undertaken only for comparable schemes. For example,
Sharpe Ratio of an equity scheme cannot be compared with the Sharpe Ratio of a debt scheme.

Treynor Ratio:
• Like Sharpe Ratio, Treynor Ratio too is a risk premium per unit of risk.
• Computation of risk premium is the same as was done for the Sharpe Ratio. However, for
risk, Treynor Ratio uses Beta.
• Treynor Ratio is thus calculated as: (Rs - Rf) ÷ Beta
• if risk free return is 5%, and a scheme with Beta of 1.2 earned a return of 8%, its Treynor
Ratio would be;
(8% - 5%) ÷ 1.2 = 2.5
• Higher the Treynor Ratio, better the scheme is considered to be. Since the concept of Beta is
more relevant for diversified equity schemes, Treynor Ratio comparisons should ideally be
restricted to such schemes.

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 Alpha:
• Non-index schemes too would have a level of return, which is in line with its higher or lower
beta as compared to the market. Let us call this the optimal return.
• The difference between a scheme’s actual return and its optimal return is its Alpha—a
measure of the fund manager’s performance.
• Alpha, therefore, measures the performance of the investment in comparison to a suitable
market index.
• Positive alpha is indicative of outperformance by the fund manager; negative alpha might
indicate under-performance.

Tracking Error:
• The Beta of the market, by definition is 1. An index fund mirrors the index.
• Therefore, the index fund too would have a Beta of 1, and it ought to earn the same return as
the market.
• The difference between an index fund’s return and the market return is the tracking error.
• Tracking error is a measure of the consistency of the out-performance of the fund manager
relative to the benchmark.

Scheme Performance Disclosure

• SEBI has mandated disclosure of performance data by all the asset management companies
(AMCs). These disclosures can be accessed through certain scheme documents and website of
the fund house.

Fund Factsheets
• Apart from information about the schemes themselves, AMCs may also provide periodic
updates on markets and the economy. These are typically part of the factsheets or may be issued
as separate notes.
• It is not mandatory for fund houses to publish factsheets.

Scheme performance available on AMFI website:

• AMFI website (www.amfiindia.com) carries the performance data of all the mutual fund
schemes.

• This is an exhaustive resource and one can access the same for various different periods, and
fund categories.

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 Chapter 12
MUTUAL FUND SCHEME SELECTION

LEARNING OBJECTIVE
o Scheme Selection based on Investor’s need, preferences and risk-profile
o Risk level in mutual fund schemes
o Scheme Selection based on Investment Strategy of Mutual Fund
o Fund performance, fund portfolio, fund age, fund size, portfolio turnover and
scheme expenses.
o Selection of Mutual Fund scheme offered by different AMCs or within the
scheme category
o Selecting options in mutual fund schemes
o Do’s & Don’ts while selecting mutual fund schemes

Scheme Selection based on Investor needs, preferences andrisk-profile

Investor Need
• The selection of a mutual fund scheme for an investor will depend upon the need that the
investor has from the investment.
• The objective could be a financial goal like reaching a certain level of wealth in a specified
period of time; or it could be funding a major expense related to an important life event like
education of one’s children or funding one’s retirement.
• The sight of the goal must never be missed.
• The first step is to set one’s financial goals. The second step is to understand the investor’s
situation and assess the risk appetite.

Risk Profile of the investor

• The investor’s risk appetite is a function of three things—the need to take risks, the ability to
take risks, and the willingness to take risks.
• Thus, an understanding of the risk profile and the investment risks associated with various
mutual fund schemes would be essential for deciding the asset allocation in an investor’s
portfolio.

Asset allocation
• The investor’s need from the investment will determine the asset class that is most suitable for
the investor.

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 • The investor’s asset allocation is a decision regarding how much money should be allocated
to which scheme category (asset class).
• This decision can be taken only after assessing the investor’s risk profile and analysing
investor’s goals and situation.

Age of the investor

• It is popularly believed that younger investors have the potential for taking higher risks
compared to old people.
• This may not be correct as different investors have different financial goals at different age
levels.
• In fact, investors in the same age group may also have different goals.
• Their financial situations may also differ. At the same time, many of the financial goals may
pertain to the whole families and not just an individual.

Investment time horizon

• As against the investor’s age, one may consider the time horizon to the respective financial
goal for which one is investing.
• Longer the horizon to the goal, the ability to take risk is higher, whereas one may avoid risks
when the goal is in the near future.
• An investor may need liquidity in the portfolio for various reasons, even when the
investments are meant for long periods of time.

Core and satellite portfolio

• The core portfolio will be invested according to the long term needs and goals of the investor.
• The satellite portfolio will be invested to take advantage of expected short-term market
movements.
• Ideally the portfolio should be divided into core and satellite portfolios.
• The division between core and satellite portfolios will depend upon each investor’s profile.
• Conservative investors may like a very small proportion of their overall portfolio to be
managed tactically.
• A moderate investor may be comfortable with an 80% allocation to core investments and a
20% exposure to satellite or tactical portfolio.
• An investor comfortable with taking higher risk may have an even higher exposure to tactical
investments.

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 Scheme Selection based on investment strategy of mutual funds
Active Fund v/s Passive Funds
• Passive funds are suitable for investors looking for exposure to an asset class without the risks
associated with fund manager selection and strategies.
• An investor in an active fund is bearing a higher cost for the fund management, and a higher
risk to earn returns better than the benchmark.

Open-ended funds v/s close-ended funds

• The big difference between the open-ended funds and close-ended funds may not be about the
investment objective, or strategy, but about an operational feature i.e. the exit option.
• The significant benefit that open-ended funds offer is liquidity viz. the option of getting back
the current value of the unit from the scheme.

The difference between different equity funds

• The critical difference between diversified funds and sector funds is that the multi-sector
exposure in a diversified fund makes it less risky.
• Focused funds carry higher risk than a diversified fund, due to higher concentration among
smaller number of stocks.
• However, these are less risky than a sector fund.
• Sector funds are risky because of the concentration in one sector.
• Some investors are more comfortable identifying promising investment themes, rather than
specific sectors.
• Such investors can decide on investment themes they would like to buy.
• Thematic funds invest in stocks across a specific themes, and to that extent they fall between
the diversified fund that can invest across the market and sector funds that invest only within
one sector.

Large-cap v/s Mid-cap v/s Small Cap Funds

• Large-cap stocks are of established companies that have stable revenues and profitability and
the financial strength to withstand competition and economic downturn.
• Mid and small cap stocks require careful evaluation and selection.
• It can therefore be risky to invest a large portion of the investor’s portfolio in mid-cap/small
cap funds.

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 • Multi cap funds spread the investments across the market capitalization spectrum in order to try
and benefit from the opportunities across the market, even while keeping the risk lower than
mid-cap and small-cap funds.
• Flexi-cap funds give the fund manager the freedom to invest across market caps.
• Alternatively, one may pick up schemes from large cap, mid-cap, and small-cap separately and
manage the portfolio allocation in his/her way.

Growth or Value funds

• Value strategy seeks to identify stocks that are available at a price that is seen as cheap
relative to the value that could be unlocked in the future.
• A growth fund outperforms in a bull market, while the value orientations helps a value fund
outperform in a falling market.
• Depending on the risk-profile of the investor, both these type of funds can find a place in the
core portfolio of the investor.

International Equity funds

• Investors might consider investing abroad, for any of the following reasons:
• overall returns (international equity plus exchange rate movement) will be attractive.
• an asset allocation call for diversifying investments to reduce the risk.
• such schemes provide a way to benefit from a particular opportunity and therefore are best
suited to be part of the satellite portfolio of the investor, or a very small exposure in the core
portfolio to benefit from the diversification benefits.

Fixed Maturity Plans

• FMP is ideal when the investor’s investment horizon is in sync with the maturity of the scheme,
and the investor is looking for a more predictable return than a debt scheme, and a better return
than in a fixed deposit.
• The credit risk of the portfolio must be considered.
• Investment in FMPs cannot be redeemed before the maturity of the scheme, except through the
stock exchanges.

Short Duration Fund

• Short Duration Funds invest in securities with maturities between 1 year and 3 years.

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 • As such they earn returns in line with the market yields.
• These funds feature low volatility and can form part of the core portfolio of an investor with
low risk-taking ability.
• The liquidity in the schemes makes them suitable for parking funds for the short-term.

Liquid Funds
• An investor seeking the lowest risk ought to go for a liquid scheme.
• These schemes are suitable for investors looking for a product to park their funds for very
short periods (up to 91 days).
• The schemes are highly liquid and there is negligible volatility, which protects the value of the
money parked.

Floater Funds
• Floater funds, invest in floating rate instruments.
• Floating rate debt securities tend to hold their investment, even if interest rates fluctuate, the
NAV of floaters tend to be steady.
• There is also the risk of the fund manager’s call on interest rate direction being wrong, leading
to loss in values.
• Investors must select the fund strategy that they are comfortable with.

Hybrid Schemes
• Investing in a hybrid scheme makes things simpler for the investor, because fewer scheme
selection decisions need to be taken.
• However, the investor would need to go by the debt-equity mix in the investment portfolio of
the schemes.
• Such funds are suitable for investors who want equity exposure but with lower risk.

Gold Funds
• Investors need to differentiate between Gold ETF and Gold Sector Funds.
• The latter are schemes that invest in shares of gold mining and other gold processing
companies.
• The performance of these gold sector funds is linked to the profitability of these gold
companies – unlike Gold ETFs whose performance would track the price of gold.

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 Selection of Mutual Fund scheme offered by different AMCs or within the
scheme category
Matching fund’s portfolio with its investment objective
• Investors should evaluate whether the fund’s portfolio reflects its investment objective, and that
the fund managers follow the strategy and style that the scheme intends to follow according to
its SID.
• Experienced researchers can also identify how true the fund manager is, to the promised
investment style.

Fund Manager
• Long-term watchers of mutual fund performance also develop views on AMCs/Fund
Managers that are more prescient in identifying changes in market trends.
• They believe that it is the portfolio manager that makes a huge difference to the scheme’s
performance.

Fund Performance
• The fund’s performance is a primary criterion in its selection from amongst other schemes.
• The returns that the fund has generated relative to its benchmark are evaluated over a period
of time.
• The fund should ideally have consistently outperformed the benchmark.
• The fund’s performance against the peer group should also be considered to make the right
selection.

Fund Portfolio
• The fund’s portfolio has to be evaluated to determine the risk and return in the scheme.
• In case of equity funds, the level of diversification, the extent of cash held and the conviction
showed in terms of the length of holding in stocks and churn in the portfolio, the strategy
adopted for selecting securities for the portfolio and managing it, have to be considered.
• In case of debt funds, the average maturity and duration of the portfolio, the credit risk profile,
the contribution of interest and capital gains to the total returns of the fund, liquid holding in
the portfolio, need to be evaluated before making an investment decision.

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 Fund Age
• A fund with a long history has a track record that can be studied.
• A new fund managed by a portfolio manager with a lack-lustre track-record is definitely
avoidable.
• A new fund that offers a new investment opportunity should be evaluated for its suitability.

Fund Size
• The size of funds needs to be seen in the context of the proposed investment universe.
• For an equity fund that intends to invest in large cap stocks, a large fund size may be an
advantage, but not for small cap or a sector fund.
• A small sized fund on the other hand is more flexible and better able to take advantage of
market opportunities.

Portfolio Turnover
• Purchase and sale of securities entails broking costs for the scheme.
• Frequent churning of the portfolio would not only add to the broking costs, but also be
indicative of unsteady investment management.
• Portfolio Turnover Ratio =
• Value of Purchase and Sale of Securities during a period ÷
• Average size of net assets of the scheme during the period.

Scheme Running Expenses

• Any cost is a drag on investor’s returns.
• Investors need to be particularly careful about the cost structure of debt schemes, because in
the normal course, debt returns can be much lower than equity schemes.
• Similarly, since index funds follow a passive investment strategy, a high cost structure is
questionable in such schemes.

Selecting options in mutual fund schemes

Growth V/s IDCW (Dividend) Option
• IDCW (Dividend) payout option has the benefit of money flow to the investor; growth option
has the benefit of letting the money grow in the fund on gross basis.
• The dividend pay-out option seems attractive for investors wanting a regular income.

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 • Dividend income is subject to tax as per the applicable tax slab of the respective investor.
• Taxation & liquidity needs are a factor in deciding between the options.

Do’s and Don’ts while selecting mutual fund schemes

Ensuring suitability
• SEBI regulation on Fraudulent and Unfair Trade Practices also apply to sale of mutual fund
units.
• In order to comply with this regulation, the distributor is required to ensure the scheme’s
suitability to the investor’s needs and situation.

Sticking to investor’s asset allocation

• As discussed earlier in the chapter, the asset allocation for the investor is based on the
investor’s situation and goals.
• Therefore, it is a prudent approach to keep the asset allocation at the core of selection of
schemes sold to the investor.

Chasing past performance

• The mutual fund advertisements use the disclaimer: “Past performance may or may not be
sustained in future”.
• As experience has shown time and again, the top performers during one period may not
necessarily remain as a top performer forever or near the other top performers and vice versa.
• Simply buying into a scheme due to good returns in the recent past may not be a wise
approach.

Understanding the investment objective and investment strategy of the scheme

• In order to evaluate various mutual fund schemes, it is important to consider the scheme’s
investment objective and strategy.
• Both of these can help one understand what to expect from the scheme

Keeping an eye on the taxes and loads

• Both taxes & loads reduce investment returns.
• Therefore, it is important for the distributor to consider these two aspects during repurchases /
redemptions.

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 • This means that when there is a need to withdraw money from a scheme, the distributor must
assess the implications of capital gains tax and exit loads.

Developing a consistent methodology for scheme selection

• It would help a mutual fund distributor to have a consistent approach in scheme selection.
• It is also important to keep this methodology in writing so that one stays on course.

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