Lesson

Mutual Funds
17

KEY CONCEPTS
n Mutual Fund n Asset Management Company n Sponsor n Trustees n Close-Ended Scheme n Open-Ended
Scheme n Exchange Traded Fund n Fund of Funds Scheme n Money Market Mutual Fund n Real Estate Mutual
Fund Scheme n Unit n Unit Holder n Offer Document

Learning Objectives
To understand:
 Meaning of Mutual Fund
 Trend of mutual funds in India over a period of time
 Structure of a Mutual Fund
 Various schemes of mutual funds
 Advantages and risk involved in Mutual Fund
 SEBI laws governing mutual fund

Lesson Outline
 Introduction  Schemes of Mutual Funds
 Overview of Mutual Funds Industry in India  Code of Conduct of Mutual Funds
 Structure of a Mutual Fund  Advertisement Code
 Classification of Mutual Funds  Restriction on Investment by Mutual Fund
Companies
 Key Players in Mutual Fund Industry
 Pricing of Units of Mutual Fund
 Mutual Fund Terminologies
 Facilitating Transaction in Mutual Fund
 Net Asset Value
Schemes through the Stock Exchange
 Expense Ratio Infrastructure
 Holding Period Return  Provisions pertaining to Mutual Funds under
 Evaluating Performance of Mutual Fund the SEBI (Listing Obligations & Disclosure
 Advantages of Mutual Funds Requirements) Regulations, 2015

 Risks involved in Mutual Funds  Case Law and Case Study

 Lesson Round-Up
 SEBI (Mutual Fund) Regulations, 1996 – An
Overview  Glossary
 Registration of Mutual Funds  Test Yourself
 Constitution and Management of Asset  List of Further Readings
Management Company and Custodian  Other References

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REGULATORY FRAMEWORK
l SEBI (Mutual Funds) Regulations, 1996

INTRODUCTION
As our Economy continues to grow there is a huge amount of wealth creating opportunities surfacing everywhere.
A Mutual fund is a professionally managed form of collective investment that pools money from many investors
and invest in stocks, bonds, short-term money market instruments and other securities.
The major reason investor chooses mutual funds are professional and management diversification. The
investors should compare the risks and expected yields after adjustment of tax on various instruments while
taking investment decisions.
SEBI (Mutual Fund) Regulations, 1996, define “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, money market instruments, gold or gold related instruments, real estate assets and such other
assets as specified by the SEBI.
Mutual Funds are a vehicle that collects money from investors to buy securities. These investors have a common
objective, and this pool of money is advised by the fund manager who decides how to invest the money. With
good fund management, the Mutual Fund Manager (or Portfolio Manager) generates returns for the investors,
which are passed back to investors. Diversification reduces the risk because all stocks may not move in the
same direction in the same proportion at the same time. The mutual funds normally come out with a number of
schemes with different investment objectives which are launched from time to time. A mutual fund is required to
be registered with SEBI before it can collect funds from public.

What is a mutual fund?

As the two words, Mutual connotes getting together and Fund connotes money. Hence by definition, a Mutual
Fund is a vehicle for investing money for investors with a common objective.
A Mutual Fund is a trust that collects money from investors who share a common financial goal, and invest the
proceeds in different asset classes, as defined by the investment objective. Simply put, mutual fund is a financial
intermediary, set up with an objective to professionally manage the money pooled from the investors at large.

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By pooling money together in a mutual fund, investors can enjoy economies of scale and can purchase stocks
or bonds at a much lower trading costs compared to direct investing in capital markets. The other advantages
are diversification, stock and bond selection by experts, low costs, convenience and flexibility.

List of all stakeholders in Indian mutual fund industry is as follows:

l Reserve Bank of India (RBI)
l Securities and Exchange Board of India (SEBI)
l Association of Mutual Funds in India (AMFI)
l Ministry of Finance
l Self Regulatory Organization (SROs)
l Income Tax Regulations
l Investors‘ Associations

OVERVIEW OF MUTUAL FUNDS INDUSTRY IN INDIA

l The mutual fund industry in India began in 1963 with the formation of the Unit Trust of India (UTI) as an
initiative of the Government of India and the Reserve Bank of India. In early 1990s, Government allowed
public sector banks and institutions to set up mutual funds.

l Much later, in 1987, SBI Mutual Fund became the first non-UTI mutual fund in India.

l Subsequently, the year 1993 heralded a new era in the mutual fund industry. This was marked by the
entry of private companies in the sector. Franklin Templeton (erstwhile Kothari Pioneer) was the first of
its kind.

l After the Securities and Exchange Board of India (SEBI) Act was passed in 1992, the SEBI Mutual Fund
Regulations came into being in 1996.

l As the industry expanded, a non-profit organization, the Association of Mutual Funds in India (AMFI),
was established on 1995. Its objective is to promote healthy and ethical marketing practices in the
Indian mutual fund Industry. SEBI has made AMFI certification mandatory for all those engaged in
selling or marketing mutual fund products.

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STRUCTURE OF A MUTUAL FUND

A mutual fund is set up in the form of a trust, which has sponsor, trustees, asset management company (“AMC”)
and a custodian. SEBI prescribes comprehensive set of guidelines in the functioning of a mutual fund through
the SEBI (Mutual Funds) Regulations, 1996. These regulations stipulate that a mutual fund must consist of five
important entities:

1. Sponsor - Sponsor is the principal body, who brings the capital as per the guideline issued by SEBI to
start a mutual fund.

2. Trust & Trustee - Trust is created by sponsor and trustees are appointed to manage the operations of
a trust. The trustees’ job is to ensure that all the funds are managed as per the defined objective and
investors’ interest is protected.

3. Asset Management Company (AMC) - The Trustee appoints AMC to manage the funds of the investors
and, in return, get the fee to manage the fund.
4. Custodian - Custodian job is to the safekeeping of the investors’ fund and securities and to ensure that
it would be used for intended purpose only.

5. Registrar and Transfer Agent (RTA) - RTAs job is to manage the backend operation of the mutual fund
and managing investors’ transaction request and other related services.

Mutual Fund Structure

Mutual Fund Structure - Example

Description Entity
Mutual Fund Trust IDBI Mutual Fund
Sponsor IDBI Bank Limited
Trustee IDBI MF Trustee Company Limited
Asset Management Company IDBI Asset Management Limited
Registrar KFIN Technologies Private Limited
Custodian SBI SG Global Securities Private Limited

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Regulator & Industry Body

Regulator: Securities and Exchange Board of India (SEBI)
l Regulates mutual funds, custodians and registrars & transfer agents.
l The applicable guidelines for mutual funds are set out in SEBI (Mutual Funds) Regulations, 1996; which
are updated periodically.
Industry Body: Association of Mutual Funds in India (AMFI)
l As of now, all 44 AMCs are members of AMFI. (Source: www.amfiindia.com)
l Recommends and promotes best business practices and code of conduct.
l Disseminates information and carries out studies/research on mutual fund industry.

CLASSIFICATION OF MUTUAL FUNDS

Mutual funds come in many varieties, designed to meet different investor goals. Mutual funds can be broadly
classified based on –

Open Ended Close Ended

l Can be purchased on any transaction day l Can be purchased only during NFO

l Can be redeemed on any transaction day [Except l Can be redeemed only at maturity
when units are locked-in in the case of Equity-Linked
Savings Scheme (ELSS) funds]
l High liquidity l Low on liquidity

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Besides these, there are other types of mutual funds also to meet the investment needs of several groups of
investors. Some of them include the following:
(a) Income Oriented Schemes: The fund primarily offer fixed income to investors. Naturally enough, the
main securities in which investments are made by such funds are the fixed income yielding ones like
bonds, corporate debentures, Government securities and money market instruments, etc.
(b) Growth Oriented Schemes: These funds offer growth potentialities associated with investment in capital
market namely: (i) high source of income by way of dividend and (ii) rapid capital appreciation, both
from holding of good quality scrips. These funds, with a view to satisfying the growth needs of investors,
primarily concentrate on the low risk and high yielding spectrum of equity scrips of the corporate sector.
(c) Hybrid Schemes: These funds cater to both the investment needs of the prospective investors – namely
fixed income as well as growth orientation. Therefore, investment targets of these mutual funds are
judicious mix of both the fixed income securities like bonds and debentures and also sound equity
scrips. In fact, these funds utilise the concept of balanced investment management. These funds are,
thus, also known as “balanced funds”.
(d) High Growth Schemes: As the nomenclature depicts, these funds primarily invest in high risk and
high return volatile securities in the market and induce the investors with a high degree of capital
appreciation.
(e) Capital Protection Oriented Scheme: It is a scheme which endeavours to protects the capital invested
in the mutual fund through suitable orientation of is portfolio structure.
(f) Tax Saving Schemes: These schemes offer tax rebates to the investors under tax laws as prescribed
from time to time. This is made possible because the Government offers tax incentive for investment in
specified avenues. For example, Equity Linked Saving Schemes (ELSS) and pensions schemes.
(g) Special Schemes: This category includes index schemes that attempt to replicate the performance of
particular index such as the BSE, Sensex or the NSE-50 or industry specific schemes (which invest in
specific industries) or sectoral schemes (which invest exclusively in segment such as ‘A’ Group or initial
public offering). Index fund schemes are ideal for investors who are satisfied with a return approximately
equal to that of an index. Sectoral fund schemes are ideal for investors who have already decided to
invest in particular sector or segment.
(h) Real Estate Funds: These are close ended mutual funds which invest predominantly in real estate and
properties.
(i) Off-shore Funds: Such funds invest in securities of foreign companies with RBI permission.
( j) Leverage Funds: Such funds, also known as borrowed funds, increase the size and value of portfolio
and offer benefits to members from out of the excess of gains over cost of borrowed funds. They tend
to indulge in speculative trading and risky investments.
(k) Hedge Funds: They employ their funds for speculative trading, i.e. for buying shares whose prices are
likely to rise and for selling shares whose prices are likely to fall.
(l) Fund of Funds: They invest only in units of other mutual funds. Such funds do not operate at present in
India.
(m) New Direction Funds: They invest in companies engaged in scientific and technological research such
as birth control, anti-pollution, oceanography etc.
(n) Exchange Trade Funds (ETFs) are a new variety of mutual funds that first introduced in 1993. ETFs are
sometimes described as mere “tax efficient” than traditional equity mutual funds, since in recent years,

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some large ETFs have made smaller distribution of realized and taxable capital gains than most mutual
funds.
(o) Money Market Mutual Funds: These funds invest in short- term debt securities in the money market
like certificates of deposits, commercial papers, government treasury bills etc. Owing to their large size,
the funds normally get a higher yield on such short term investments than an individual investor.
(p) Infrastructure Debt Fund: They invest primarily in the debt securities or securitized debt investment of
infrastructure companies.
Categories of Mutual Funds

Types of Mutual Fund Plans

Regular Plans Direct Plans

l Sold through a distributor l Sold directly by the Asset Management

Company (AMC)

l Higher Expense Ratio (Due to commissions paid l Lower Expense Ratio (No commission paid to
to distributor) distributor)

l Potentially lower returns to the investor l Potentially higher returns

(Due to higher expenses) (Due to lower expenses)

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KEY PLAYERS IN MUTUAL FUND

A mutual fund is a professionally-managed investment scheme, usually run by an asset management company
that brings together a group of people and invests their money in stocks, bonds and other securities. It is formed
by trust body.
There are five principal constituents and three market intermediaries in the formation and functioning of mutual
fund:

Five principal constituents

l Sponsor
A sponsor is an influential investor who creates demand for a security because of their positive outlook
on it. The sponsor brings in capital and creates a mutual fund trust and sets up the AMC. The sponsor
makes an application for registration of the mutual fund and contributes at least 40% of the net worth
of the AMC.
l Asset Management Company
An asset management company (AMC) is a company that invests its clients’ pooled funds into securities
that match declared financial objectives. Asset management companies provide investors with more
diversification and investing options. AMCs manage mutual funds, hedge funds and pension plans,
these companies earn income by charging service fees or commissions to their clients.
The sponsor or, if so authorised by the trust deed, the trustee, shall appoint an asset management
company, which has been approved by the SEBI. The appointment of an asset management company
can be terminated by majority of the trustees or by seventy-five per cent of the unit holders of the
scheme. Any change in the appointment of the asset management company shall be subject to prior
approval of the SEBI and the unitholders.
l Trustee
A trustee is a person or firm that holds and administers property or assets for the benefit of a third
party. A trustee may be appointed for a wide variety of purposes, such as in case of bankruptcy, for a
charity, for a trust fund or for certain types of retirement plans or pensions.
l Unit Holders
A unitholder is an investor who owns the units issued by a trust, like a real estate investment trust or
a master limited partnership (MLP). The securities issued by trusts/MF are called units, and investors
in units are called unitholders. The unit in turn reflect share of the investor in the Net Assets of the
fund.

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l Mutual fund
A mutual fund established under the Indian Trust Act to raise money through, the sale of units to
the public for investing in the capital market The funds thus collected as per the directions of asset
management company for invested. The mutual fund has to be SEBI registered.
Three market intermediaries are:
l Custodian
A custodian is a person who carries on the business of providing custodial services to the client. The
custodian keeps the custody of the securities of the client. The custodian also provides incidental
services such as maintaining the accounts of securities of the client, collecting the benefits or rights
accruing to the client in respect of securities.
Every custodian should have adequate facilities, sufficient capital and financial strength to manage
the custodial services. The SEBI (Custodian of Securities) Regulations, 1996 prescribe the roles and
responsibilities of the custodians.
The roles and responsibilities of the custodians are to administrate and protect the assets of the clients;
Open a separate custody account and deposit account in the name of each client; Record assets; and
Conduct registration of securities.
l Transfer Agents
A transfer agent is a person who has been granted a Certificate of Registration to conduct the business
of transfer agent under the SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993.
Transfer agents’ services include issue and redemption of mutual fund units, preparation of transfer
documents and maintenance of updated investment records. They also record transfer of units between
investors where depository does not function. They also facilitate investors to get customized reports.
l Depository
A depository facilitates the smooth flow of trading and ensure the investor`s about their investment in
securities.

MUTUAL FUND TERMINOLOGIES

A. Offer Document
l AMC raises money in new schemes through New Fund Offer (NFO)
l Offer document contains key details about the NFO – open and close dates, scheme objective, nature
of the scheme, etc.
l Filed with SEBI
Two parts:
1. Scheme Information Document (SID) - A document that contains the details of the scheme, which the
investor should know before investing. SID has to be updated every year.
Key Contents:
l Scheme name on the cover page, along with scheme structure (open / closed-ended) and expected
scheme nature (equity / debt / balanced / liquid / ETF)
l Highlights of the scheme

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l Risk factors
o Standard
o Scheme specific
l Due diligence certificate issued by the AMC
l Fees and expenses
l Rights of unit holders
l Penalties, litigations, etc.
2. Statement of Additional Information (SAI) - A document that contains statutory information about the
fund house offering the scheme. SAI has to be updated the end of every quarter.
Key Contents:
l Information about sponsor, mutual fund, trustees, custodian and registrar & transfer agents
l Condensed financial information for schemes launched in the last three financial years
l Information on how to apply
l Rights of unit holders
l Details of the fund managers
l Tax, legal and other general information
B. Key Information Memorandum (KIM)
l Essentially a summary of SID & SAI
l As per SEBI regulations, every application form should be accompanied by the KIM
l The KIM has to be updated at least once a year
Contents
l Name of the AMC, Mutual Fund Trust, Trustee, Fund Manager(s) and Scheme details
l Open and close dates of the issue
l Issue price of the scheme
l Plans and options available in the scheme
l Risk profile of the scheme
l Benchmark
l Dividend policy
l Performance of the scheme and benchmark over last 1, 3, 5 years and since inception
l Loads and expenses
l Contact information and registrars
C. Fact Sheets
Usually provided on a monthly basis by AMCs

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Contains the following:

l NAV and Assets under Management (AUM)

l Expense ratio, exit loads, average maturity, yield-to-maturity (YTM), modified duration

l Benchmark & Fund manager details

l Past performance

l Scheme’s allocation & portfolios

l Style box

l Other scheme attributes – like risk category, minimum investment amount, scheme objective, etc.

D. Assets under Management (AUM) What is AUM?

It is the total market value of the assets managed by a mutual fund scheme as on a particular date

Periodic AUM Available

l Month-end

l Quarterly average

E. Know Your Client (KYC) – What is KYC?

l A one-time process made mandatory to invest in mutual funds

l Key details required: PAN, Address proof, contact details, occupation and income details

l With a view to bring uniformity in the KYC requirements for the securities markets, SEBI has initiated
usage of uniform KYC by all SEBI registered intermediaries. In this regard SEBI has issued the SEBI {KYC
(Know Your Client) Registration Agency (KRA)}, Regulations, 2011.

Where can it be done?

l CDSL Ventures Limited KRA

l CAMS KRA

l Karvy KRA

l NDML KRA (wholly owned subsidiary of NSDL)

l NSE Data & Analytics Limited (wholly owned subsidiary of NSE)

F. Foreign Account Tax Compliance Act (FATCA) – What is FATCA?

l Requires that all financial institutions (including Indian mutual funds) need to report financial transactions
of US persons and entities in which US persons hold a substantial ownership

l Enacted to prevent tax evasion through foreign investments

l Key details required: Country of birth, Country of citizenship, country of tax residence, TIN from such
country

l Currently made mandatory for all investors (existing and new) in Indian mutual funds

l For non-individual investors, Ultimate Beneficial Ownership (UBO) details have to be provided.

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G. Modes of Holding
l Single
l Either or Survivor
o Signature of any of the applicants is sufficient for making transactions
l Joint
o Signature of all the applicants is required for making transactions.
H. Nomination
l Nomination is a facility that enables an individual unitholder to nominate a person, who can claim the
Units held by the unitholder or the redemption proceeds thereof in the event of death the unitholder
l Up to 3 nominees can be registered for a folio
l Units get transferred to the nominees (in the proportion specified) in case of the investor’s demise
l Nomination can be updated as and when required by the investor
l A minor can also be nominated, provided the guardian is specified
l If nomination is not registered, in case of death of the investor, the legal heir has to produce documents
such as Will, Legal Heir Certificate, No-Objection Certificate from other legal heirs, etc.

Systematic Investment Plan (SIP) in Mutual Fund

Systematic Investment Plan (SIP) is an investment plan (methodology) offered by Mutual Funds wherein one
could invest a fixed amount in a mutual fund scheme periodically, at fixed intervals – say once a month, instead
of making a lump-sum investment. The SIP instalment amount could be as little as Rs.500 per month. SIP is
similar to a recurring deposit where you deposit a small /fixed amount every month.
SIP has been gaining popularity among Indian MF investors, as it helps in investing in a disciplined manner.
Systematic Investment Plans offered by mutual funds are easily the best way to enter the world of investments
over the long term.

To illustrate, a small amount of `1000 invested every month at an interest rate of 8% for 25 years would give
` 9.57 Lakh. That means investment of just ` 3 Lakh would have grown three times over.

NET ASSET VALUE

The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV). In simple words,
NAV is the market value of the securities held by the scheme.
Mutual funds invest the money collected from investors in securities markets. Since market value of securities
changes every day, NAV of a scheme also varies on day to day basis.
The NAV per unit is the market value of securities of a scheme divided by the total number of units of the
scheme on any particular date.

For example, if the market value of securities of a mutual fund scheme is INR 200 lakh and the mutual fund
has issued 10 lakh units of INR 10 each to the investors, then the NAV per unit of the fund is INR 20 (i.e.200
lakh/10 lakh). NAV is required to be disclosed by the mutual funds on a daily basis.

Unlike stocks (where the price is driven by the market and changes from minute-to-minute), mutual funds don’t
declare NAVs through the day. Instead, NAVs of all mutual fund schemes are declared at the end of the trading

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day after markets are closed, in accordance with SEBI Mutual Fund Regulations. Further, as per SEBI Mutual
Fund Regulations, for all mutual fund schemes, other than liquid fund schemes, the mutual fund Units are
allotted only at prospective NAV, i.e., the NAV that would be declared at the end of the day, based on the
closing market value of the securities held in the respective schemes.
How is it calculated?

Net Asset of the Scheme

Net Asset Value =
Number of units outstanding
Net Asset of the Scheme = Market value of investments + Receivables+ other accrued income+ other assets –
Accrued Expenses- Other Payables- Other Liabilities
Net Asset Value (NAV) – Cut-off Timeline

Type of Scheme Transaction type Cut-off

timings

Liquid Funds & Subscription (including Switch-in from other schemes) 1:30 p.m.
Overnight Funds Redemption (including Switch-in from other schemes) 3:00 p.m.

All other schemes Subscription (including Switch-in from other schemes) 3:00 p.m.
(other than Liquid Funds /
Redemption (including Switch-in from other schemes) 3:00 p.m.
Overnight Funds)

EXPENSE RATIO
l The fees charged by the scheme to manage investors’ money.
What does it contain?
l Fees paid to service providers like trustees, Registrar & Transfer Agents, Custodian, Auditor, etc.
l Asset management expenses
l Commissions paid to distributors
l Other selling expenses including advertising expenses
l Expenses on investor communication, account statements, dividend / redemption cheques / warrants
l Listing fees and Depository fees.
l Service tax.
Under SEBI (Mutual Funds) Regulations, 1996, Mutual Funds are permitted to incur / charge certain operating
expenses for managing a mutual fund scheme – such as sales & marketing / advertising expenses, administrative
expenses, transaction costs, investment management fees, registrar fees, custodian fees, audit fees – as a
percentage of the fund’s daily net assets.
This is commonly referred to as ‘Expense Ratio’. In short, Expense ratio is the cost of running and managing
a mutual fund which is charged to the scheme. All expenses incurred by a Mutual Fund, AMC will have to be
managed within the limits specified under Regulation 52(6) & (6A) of the SEBI Mutual Funds Regulations.
The expense ratio is calculated as a percentage of the Scheme’s average Net Asset Value (NAV). The daily NAV
of a mutual fund is disclosed after deducting the expenses. Thus, the expense ratio has a direct bearing on a
scheme’s NAV – the lower the expense ratio of a scheme, the higher the NAV.

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Illustration:

1. Name of the Scheme XYZ

Size of the Scheme Rs.100 Lakh
Face Value of the Share Rs.10
Number of the outstanding shares 10 Lakhs
Market value of the fund’s investments Receivables Rs.180 Lakhs
Accrued Income Rs.1 Lakhs
Receivables Rs.1 Lakh
Liabilities Rs.50,000
Accrued expenses Rs.50,000
Find NAV per unit?

Solution
NAV per unit = (Investment + Recoverable + Accrued Income – Liabilities – Accrued expenses/No of units
(mutual fund)
= (180 Lakhs + 1 Lakh + 1 – 0.50 Lakh – 0.50 Lakh)/10 Lakhs
NAV = Rs.18.10 per unit
2. ABC mutual Fund has the following assets in scheme XYZ at the close business on 31st March, 2022.

Company No. of Shares Market Price Per Share

N Ltd 25000 Rs. 20

D Ltd 35000 Rs. 300

S Ltd 29000 Rs. 380

C Ltd 40000 Rs. 500

The total number of units of scheme XYZ are 10 Lakh. The Scheme XYZ has accrued expenses of Rs.
2,50,000 and other Liabilities of Rs 2,00,000. Calculate the NAV per unit of the scheme XYZ
Solution

Company No. of Shares Market Price Per Share Value of Assets/ Liabilities

N Ltd 25000 Rs. 20 500000

D Ltd 35000 Rs. 300 10500000

S Ltd 29000 Rs. 380 11020000

C Ltd 40000 Rs. 500 20000000

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Accrued Expenses (250000)

Liabilities (200000)

Net Assets 41570000

No. of Units 1000000

NAV 41.57

3. The redemption price of mutual fund unit is ` 48 while the front end load and back end load charges are
2% and 3% respectively. Compute:
i) NAV per unit
ii) Public offer price of the unit.
Solution:

Redemption Price = NAV Public Offer Price = N A V

(1+ Back End Load) 48 = NAV (1- Front End Load)
(1+0.03) = 49.44
= 48x1.03 (1-0.02)
NAV= ` 49.44 = 49.44
0.98
Public Offer Price = ` 50.45

HOLDING PERIOD RETURN (HPR)

Holding period return is the total return received from holding an asset or portfolio of assets over a period of
time, generally expressed as a percentage. Holding period return is calculated on the basis of total returns from
the asset or portfolio i.e. income plus changes in value. It is particularly useful for comparing returns between
investments held for different periods of time.
Calculation of HPR

Income + (end of period value- original value) x 100

HPR =
Original Value

Illustration: 2 Calculate HPR for a unit holder who bought a unit at ` 17.60 and received a dividend of ` 2 per unit
during the period. Face value of the unit is ` 10and current unit price is `19.875

Dividend+ (NAV at present- NAV at purchase) x 100

HPR =
NAV at purchase
= 2+ (19.875- 17.60) 17.60
HPR = 24.29%

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EVALUATING PERFORMANCE OF MUTUAL FUND

While looking at a mutual fund scheme’s performance, one must not be led by the scheme’s return in isolation.
A scheme may have generated 10% annualised return in the last couple of years. But then, even the market
indices would have gone up in similar way during the same period. Under-performance in a falling market, i.e.
when the NAV of the scheme falls more than its benchmark (or the market), is the time when one must review
his/her investment.
One must compare the scheme’s return as against its benchmark return. It is better to be rid of investment in
a scheme that consistently under-performs as compared to its benchmark over a period of time, from one’s
portfolio. It is important to identify under-performers over the longer time horizon (as also out-performers).
In addition, one may also consider evaluating the ‘category average returns’ as well. Even if a scheme has
outperformed its benchmark by a decent margin, there could be better performers in the peer group. The
category average returns will reveal how good (or bad) is one’s investment is against its peers which help in
deciding whether it is time shift the investment to better performers.
One may be holding a too little or too much-diversified portfolio. Even the expense ratio of some of the schemes
that one could be holding may be high compared to others within the same category.

ADVANTAGES OF MUTUAL FUNDS

The advantages of investing in a mutual fund are:
1. Professional Management: Investors avail the services of experienced and skilled professionals who
are backed by a dedicated investment research team which analyses the performance and prospects
of companies and selects suitable investments to achieve the objectives of the scheme.
2. Diversification: Mutual funds invest in a number of companies across a broad cross-section of industries
and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time
and in the same proportion. Investors achieve this diversification through a Mutual Fund with far less
money than one can do on his own.
3. Convenient Administration: Investing in a mutual fund reduces paper work and helps investors to avoid
many problems such as bad deliveries, delayed payments and unnecessary follow up with brokers and
companies. Mutual funds save investors time and make investing easy and convenient.
4. Return Potential: Over a medium to long term, Mutual funds have the potential to provide a higher
return as they invest in a diversified basket of selected securities.
5. Low Costs: Mutual funds are a relatively less expensive way to invest compared to directly investing in
the capital markets because the benefits of scale in brokerage, custodial and other fees translate into
lower costs for investors.
6. Liquidity: In open ended schemes, investors can get their money back promptly at net asset value
related prices from the mutual fund itself. With close ended schemes, investors can sell their units on
a stock exchange at the prevailing market price or avail of the facility of direct repurchase at net asset
value (NAV) related prices which some close ended and interval schemes offer periodically or offer it
for redemption to the fund on the date of maturity.
7. Transparency: Investors get regular information on the value of their investment in addition to disclosure
on the specific investments made by scheme, the proportion invested in each class of assets and the
fund manager’s investment strategy and outlook.

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RISKS INVOLVED IN MUTUAL FUNDS

The fundamental reason which makes mutual fund risky lies in the fact that it puts money in a variety of
investment instruments – debt, equity and corporate bonds, among others. Since the prices of these investment
instruments tend to fluctuate in response to several factors, investors may be subjected to loss. In a broader
sense, mutual fund risk can be categorized as – systematic risk and unsystematic risk

Types of Risks Cause of Risk

Volatility risk Typically, equity-based funds invest in the shares of companies that are listed on stock
exchanges. The value of such funds is based on companies’ performance, which often
gets affected due to the prevalent microeconomic factors.

Credit risk Credit risk in mutual fund investment often results from a situation, wherein, the issuer of
the scheme fails to pay the promised interest. In case of debt funds, typically, fund managers
include investment-grade securities with high credit ratings.

Liquidity risk Mutual funds with a long-term and rigid lock-in period like ELSS often come with liquidity
risk. Such a risk signifies that investors often find it challenging to redeem their investments
without incurring a loss.

Concentrated This mutual fund risk is also prevalent among investors. It can be described as the situation
risk when investors tend to put all their money into a single investment scheme or in one sector.
For instance, investing entirely in just one company’s stocks often bears a substantial risk
of losing capital if caught amidst bad market situations.

Inflation risk It can be best described as the risk of losing one’s purchasing power, mainly due to the
rising inflation rate. Typically, investors are exposed to the impact of this risk when the rate
of returns earned on investments fails to keep up with the increasing inflationary rate.

Also, Mutual funds may face the following risks, leading to non-satisfactory performance:
1. Excessive diversification of portfolio, losing focus on the securities of the key segments.
2. Too much concentration on blue-chip securities.
3. Necessity to effect high turnover through liquidation of portfolio resulting in large payments of brokerage
and commission.
4. Poor planning of investment returns.
5. Unresearched forecast on income, profits and Government policies.
6. Fund managers being unaccountable for poor results.
7. Failure to identify clearly the risk of the scheme as distinct from risk of the market.
8. Under performance in comparison to peers.

SEBI (MUTUAL FUNDS) REGULATIONS, 1996 – AN OVERVIEW

SEBI (Mutual Fund) Regulations, 1996 has been notified on December 09, 1996 with objective to improve the
working and regulation of the mutual fund industry, so that mutual funds could provide a better performance
and service to all categories of investors and offer a range of innovative products in a competitive manner to
match investor needs and preferences across various investor segments. SEBI (Mutual Funds) Regulations, 1996
deals with 10 Chapters and 12 schedules.

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Important Definitions
“Mutual Fund” means 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, money market
instruments, gold or gold related instruments, silver or silver related instruments, real estate assets and such
other assets and instruments as may be specified by the Board from time to time.
However, infrastructure debt fund schemes may raise monies through private placement of units, subject to
conditions specified in these regulations:
Further, mutual fund schemes investing in exchange traded commodity derivatives may hold the underlying
goods in case of physical settlement of such contracts.
“Unit” means the interest of the unit holders in a scheme, which consists of each unit representing one undivided
share in the assets of a scheme.
“Unit Holder” means a person holding unit in a scheme of a mutual fund.
“Asset Management Company” means a company formed and registered under the Companies Act, 1956 or
Companies Act, 2013 and approved as such by the SEBI under sub-regulation (2) of regulation 21.
“Close-ended scheme” means any scheme of a mutual fund in which the period of maturity of the scheme is
specified.
“Open-ended scheme” means a scheme of a mutual fund which offers units for sale without specifying any
duration for redemption.
“Money Market Instruments” includes commercial papers, commercial bills, treasury bills, Government
securities having an unexpired maturity up to one year, call or notice money, certificate of deposit, usance bills,
and any other like instruments as specified by the Reserve Bank of India from time to time.
“Sponsor” means any person who, acting individually or in concert with another body corporate, establishes
a mutual fund.
“Trustees” mean the Board of Trustees or the Trustee Company who hold the property of the Mutual Fund in
trust for the benefit of the unit holders.
“Offer document” means any document by which a mutual fund invites public for subscription of units of a
scheme.

REGISTRATION OF MUTUAL FUNDS

Eligibility Criteria for Registration of Mutual Funds

For the purpose of grant of a certificate of registration, the applicant has to fulfill the following, namely –
l The sponsor should have a sound track record and general reputation of fairness and integrity
in all business transactions.
Explanation: For the purposes of this clause “sound track record” shall mean the sponsor should, —
(i) be carrying on business in financial services for a period of not less than five years; and
(ii) ensure that the networth is positive in all the immediately preceding five years; and
(iii) ensure that the positive liquid networth is more than the proposed capital contribution of the
sponsor in the asset management company and ensure that in case of change in control of the

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existing asset management company due to acquisition of shares, the positive liquid net worth
of the sponsor or funds tied up by the sponsor is to the extent of aggregate par value or market
value of the shares proposed to be acquired, whichever is higher; and
(iv) have net profit after providing for depreciation, interest and tax in each of the immediately
preceding five years; and
(v) have average net annual profit after depreciation, interest and tax during the immediately
preceding five years of at least rupees ten crore:
Provided that if the requirements specified under Explanation to clause (a) are not fulfilled, the sponsor
shall,-
1. adequately capitalize the asset management company such that the net worth of the asset
management company is not less than rupees one hundred fifty crore; and
2. ensure that the initial shareholding equivalent to capital contributed to the asset management
company to the extent of not less than rupees one hundred fifty crore is locked-in for a period of
five years; and
3. appoint experienced personnel in asset management company such that the total combined
experience of Chief Executive Officer, Chief Operating Officer, Chief Risk Officer, Chief Compliance
Officer and Chief Investment Officer should be at least thirty years; and
4. ensure that in case of acquisition of existing asset management company, the sponsor shall have
minimum positive liquid net worth equal to incremental capitalization required to ensure minimum
capitalization of the asset management company and the positive liquid net worth of the sponsor
or the funds tied up by the sponsor are to the extent of aggregate par value or market value of the
shares proposed to be acquired, whichever is higher; and
5. ensure that in case of acquisition of stake in an existing asset management company, the
shareholding equivalent to at least rupees one hundred fifty crore shall be locked in for five years;
and
6. ensure that other conditions in this regard as may be specified by the Board from time to time are
adhered to.
However, a private equity fund or a pooled investment vehicle or a pooled investment fund may
also be permitted to sponsor mutual funds subject to such other conditions as may be specified
by the SEBI from time to time.
l The applicant is a fit and proper person.
l In the case of an existing mutual fund, such fund is in the form of a trust and the trust deed has been
approved by the SEBI.
l The sponsor has contributed or contributes at least 40% to the net worth of the asset management
company.
However, any person who holds 40% or more of the net worth of an asset management company
shall be deemed to be a sponsor and will be required to fulfill the eligibility criteria specified in these
regulations.
l The sponsor or any of its directors or the principal officer to be employed by the mutual fund should not
have been guilty of fraud or has not been convicted of an offence involving moral turpitude or has not
been found guilty of any economic offence.

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l Appointment of trustees to act as trustees for the mutual fund in accordance with the provisions of the
regulations.
l Appointment of asset management company to manage the mutual fund and operate the scheme of
such funds in accordance with the provisions of these regulations.
l Appointment of custodian in order to keep custody of the securities or goods or gold and gold related
instrument or other assets of the mutual fund held in terms of these regulations, and provide such other
custodial services as may be authorised by the trustees.

Norms for Shareholding & Governance in Mutual Funds

(1) No sponsor of a mutual fund, its associate or group company including the asset management company
of the fund, through the schemes of the mutual fund or otherwise, individually or collectively, directly or
indirectly, have –
(a) 10% or more of the share-holding or voting rights in the asset management company or the trustee
company of any other mutual fund; or
(b) representation on the board of the asset management company or the trustee company of any other
mutual fund.
(2) Any shareholder holding 10% or more of the share-holding or voting rights in the asset management company
or the trustee company of a mutual fund, shall not have, directly or indirectly, -
(a) 10% or more of the share-holding or voting rights in the asset management company or the trustee
company of any other mutual fund; or
(b) representation on the board of the asset management company or the trustee company of any other
mutual fund.
However, in the event of a merger, acquisition, scheme of arrangement or any other arrangement involving
the sponsors of the mutual funds, shareholders of the asset management companies or trustee companies,
their associates or group companies which results in the incidental acquisition of shares, voting rights or
representation on the board of the asset management companies or trustee companies, this regulation shall
be complied with within a period of one year of coming into force of such an arrangement.

Terms and Conditions of Registration

l the trustees, the sponsor, the asset management company and the custodian shall comply with the
provisions of SEBI (Mutual Fund) Regulations, 1996.
l the mutual fund shall forthwith inform the SEBI, if any information or particulars previously submitted to
the SEBI was misleading or false in any material respect.
l the mutual fund shall forthwith inform the SEBI, of any material change in the information or particulars
previously furnished, which have a bearing on the registration granted by it.
l payment of fees as specified in the SEBI (Mutual Fund) Regulations, 1996.

Constitution and Management of Mutual Funds and Operation of Trustees

(i) A mutual fund shall be constituted in the form of a trust and the instrument shall be in the form of a deed
duly registered under the Registration Act.
(ii) The trust deed shall not contain any clause which has the effect of limiting or extinguishing the

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obligations and liabilities of the trusts or indemnifying the trustees/ asset management company for
loss or damage caused to the unitholders by their acts of negligence or acts of commission or omission.

Disqualification from being Appointed as Trustees

l A mutual fund shall appoint trustees in accordance with these regulations. A person shall not be eligible
to be appointed as a trustee unless—
(a) he is a person of ability, integrity and standing; and
(b) has not been found guilty of moral turpitude; and
(c) has not been convicted of any economic offence or violation of any securities laws; and
(d) has furnished particulars as specified in Form C.
l No asset management company and no director (including independent director), officer or employee
of an asset management company shall be eligible to be appointed as a trustee of any mutual fund.
l No person who is appointed as a trustee of a mutual fund shall be eligible to be appointed as a trustee
of any other mutual fund.
l Two-thirds of the trustees shall be independent persons and shall not be associated with the sponsors
or be associated with them in any manner whatsoever.
l In case a company is appointed as a trustee then its directors can act as trustees of any other trust
provided that the object of the trust is not in conflict with the object of the mutual fund.
l In case a company is appointed as the trustee of a mutual funds, the chairperson of the Board of
directors of that trustee company shall be independent director.

APPROVAL OF THE SEBI FOR APPOINTMENT OF TRUSTEE

No trustee shall initially or any time thereafter be appointed without prior approval of the SEBI.

CONSTITUTION AND MANAGEMENT OF ASSET MANAGEMENT COMPANY AND CUSTODIAN

Appointment of an Asset Management Company

l The sponsor or, if so authorised by the trust deed, the trustee, shall appoint an asset management
company, which has been approved by the SEBI.
l The appointment of an asset management company can be terminated by majority of the trustees or
by seventy-five per cent of the unitholders of the scheme.
l Any change in the appointment of the asset management company shall be subject to prior approval
of the SEBI and the unitholders.

Eligibility Criteria for Appointment of Asset Management Company

l in case the asset management company is an existing asset management company it has a sound
track record, general reputation and fairness in transactions;
l the asset management company is a fit and proper person;
l the directors of the asset management company are persons having adequate professional experience
in finance and financial services related field and not found guilty of moral turpitude or convicted of any
economic offence or violation of any securities laws;

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l the key personnel of the asset management company have not been found guilty of moral turpitude
or convicted of economic offence or violation of securities laws or worked for any asset management
company or mutual fund or any intermediary during the period when its registration has been suspended
or cancelled at any time by the Board;
l the board of directors of such asset management company has at least fifty per cent directors, who are
not associate of, or associated in any manner with, the sponsor or any of its subsidiaries or the trustees;
l the Chairman of the asset management company is not a trustee of any mutual fund;
l the asset management company has a net worth of not less than rupees fifty crore.

Appointment of Custodian
l The mutual fund shall appoint a Custodian to carry out the custodial services for the schemes of the fund
and sent intimation of the same to the Board within fifteen days of the appointment of the Custodian.
l However, in case of a gold exchange traded fund scheme, the assets of the scheme being gold or gold
related instruments may be kept in the custody of a custodian registered with the SEBI.
l However, in case of a silver exchange traded fund scheme, the assets of the scheme being silver or
silver related instruments and in case of a real estate mutual fund scheme, the title deed of real estate
assets held by it, may be kept in the custody of a custodian registered with the SEBI.

Agreement with Custodian

l The mutual fund shall enter into a custodian agreement with the custodian, which shall contain the
clauses which are necessary for the efficient and orderly conduct of the affairs of the custodian.
l However, the agreement, the service contract, terms and appointment of the custodian shall be entered
into with the prior approval of the trustees.

SCHEMES OF MUTUAL FUND

Procedure for Launching of Schemes

l No scheme shall be launched by the asset management company unless such scheme is approved by
the trustees and a copy of the offer document has been filed with the SEBI.
l The offer documents shall contain adequate disclosures to enable the investors to make informed
decisions.
l The mutual fund shall pay the minimum filing fee to the SEBI while filing the offer document and the
balance filing fee within such time as may be specified by the SEBI.
l For listing of units of any scheme of a mutual fund on the recognised stock exchange(s), the asset
management company of that mutual fund shall take all necessary steps and obtain the in-principle
approval from the recognised stock exchange.
l Before listing of units of any scheme of mutual fund on the recognised stock exchange(s), the asset
management company of that mutual fund shall execute an agreement with such exchange(s).
l Every close ended scheme, other than an equity linked savings scheme, shall be listed on a recognised
stock exchange within such time period and subject to such conditions as specified by the SEBI.
l No scheme other than the initial offering period of any equity-linked saving scheme can be opened
for subscription for more than 15 days. Further, the minimum subscription and the extent of over

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subscription that is intended to be retained should be specified in the offer document. In the case of
over-subscription, all applicants applying up to 5,000 units must be given full allotment subject to over
subscription.
l The AMC is required to refund the application money if minimum subscription is not received, and also
the excess over subscription within five working days of closure of subscription.

CODE OF CONDUCT OF MUTUAL FUNDS

(i) The schemes should not be organized, operated and managed in the interest of sponsors or the
directors of AMC or special class of unit holders;
(ii) It shall ensure the adequate dissemination of adequate, fair, accurate and timely information of all the
stake holders;
(iii) The excessive concentration of business with the broking firm or associates should be avoided;
(iv) The scheme - wise segregation of bank accounts and securities accounts must be ensured;
(v) The investment should be made in accordance with the investment objectives stated on the offer
documents;
(vi) It must not use any unethical means to sell, market or induce any investor to buy their schemes;
(vii) The high standards of integrity and fairness in all the dealings should be maintained by the trustees
and AMCs;
(viii) The AMCs shall not make any exaggerated statements.

ADVERTISEMENT CODE
(i) Advertisement shall be accurate, true, fair, clear, complete, unambiguous and concise.
(ii) Advertisement shall not contain statement which are false,misleading, biased or deceptive, based on
assumptions and shall not contain any testimonials or any ranking based on any criteria.
(iii) No celebrities shall form part of advertisement.
(iv) No advertisement shall directly or indirectly discredit other advertisements or make unfair comparisons.
(v) Advertisements shall be accompanied by a standard warning in legible fonts which states “Mutual fund
investments are subject to market risks, read all schemes related document carefully.” No addition or
deletion of words shall be made to the standard warning.
(vi) In audio visual media based advertisements, the standard warning in visual and accompanying voice
over reiteration shall be audible in a clear and understandable manner. For example, in standard
warning both the visual and the voice over reiteration containing 14 words running for at least 5 seconds
may be considered as clear and understandable.
(vii) Advertisement shall not be so designed as likely to be misunderstood or likely to be disguise the
significance of any statement.

RESTRICTION ON INVESTMENT BY MUTUAL FUNDS

(i) The schemes shall not invest more than 10% of its NAV in debt instruments issued by a single issuer
which are rated not below investment grade by a Credit Rating Agency.

However, such limit can be increased to 12% of its NAV with prior approval of Board of Trustee and
Board of Directors of AMC.

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(ii) A mutual fund scheme shall not invest in unlisted debt instruments including commercial papers, except
Government Securities and other money market instruments.

However, Mutual Fund Schemes may invest in unlisted non-convertible debentures up to a maximum of
10% of the debt portfolio of the scheme subject to such conditions as may be specified by the SEBI.

(iii) Mutual fund shall not own more than 10% of company’s paid-up capital carrying voting rights.

(iv) The transfer of investments from one scheme to another shall be done only at the prevailing market
price & the securities so transferred shall be in conformity with the investment objective of the scheme
to which such transfer has been made.

(v) A scheme may invest in another scheme under the same asset management company or any other
mutual fund without charging any fees. However, the aggregate inter-scheme investments made by
all schemes shall not exceed 5% of the NAV of the mutual fund. (This shall not apply to funds of funds
scheme)

(vi) The buy and sell by all the mutual funds shall be made on the basis of the deliveries.

(vii) All securities shall be purchase or transferred in the name of the mutual fund scheme.

(viii) No mutual fund scheme shall make any investment in:

(a) any unlisted security of an Associate or Group Company of the Sponsor;

(b) any security issued by way of private placement by an associate or group company of the
sponsor;

(c) the listed securities of group companies of the sponsor which is in excess of 25 per cent of the net
Assets.

(ix) No mutual fund shall make any investment in the funds of fund scheme.

(x) No mutual fund shall invest more than 10% of its NAV in the equity shares or equity related instruments
of any company.

(xi) All investments by a mutual fund scheme in equity shares and equity related instruments shall only be
made provided such securities are listed or to be listed.

Question: What are the avenues available to Indian Mutual Funds for investment abroad?
Answer: Indian Mutual Funds registered with SEBI are permitted to invest in the following:
(i) ADRs and GDRs;
(ii) Equity of overseas company;
(iii) Foreign debt securities;
(iv) Money market instruments;
(v) Government securities;
(vi) Derivative;
(vii) Short - term deposits;
(viii) Units issued by overseas mutual funds.

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PRICING OF UNITS OF MUTUAL FUND

(1) The price at which the units may be subscribed or sold and the price at which such units may at
any time be repurchased by the mutual fund shall be made available to the investors in the manner
specified by the SEBI.
(2) The assets management company shall provide the methodology of calculating the sale and repurchase
price of units in the manner specified by the SEBI.
(3) While determining the prices of the units, the mutual fund shall ensure that the repurchase price is not
lower than 95% of the Net Asset Value.

FACILITATING TRANSACTION IN MUTUAL FUND SCHEMES THROUGH THE STOCK EXCHANGE

INFRASTRUCTURE
SEBI vide its Circulars dated October 04, 2013, and dated December 09, 2014 had permitted mutual fund
distributors to use recognised stock exchanges’ infrastructure to purchase and redeem mutual fund units directly
from Mutual Fund / Asset Management Companies.
Subsequently, SEBI vide its Circular no. SEBI/HO/MRD/DSA/CIR/P/2016/113 dated October 19, 2016 allowed SEBI
Registered Investment Advisors (RIAs) to use infrastructure of the recognised stock exchanges to purchase and
redeem mutual fund units directly from Mutual Fund/ Asset Management Companies on behalf of their clients,
including direct plans.
In order to further increase the reach of this platform, SEBI vide its Circular dated February 26, 2020 had
decided to allow investors to directly access infrastructure of the recognised stock exchanges to purchase and
redeem mutual fund units directly from Mutual Fund/ Asset Management Companies.

PROVISIONS PERTAINING TO MUTUAL FUNDS UNDER THE SEBI (LISTING OBLIGATIONS AND
DISCLOSURE REQUIREMENTS) REGULATIONS, 2015
The provisions of chapter IX of the SEBI LODR Regulations, 2015 applies to the asset management company
managing the mutual fund scheme whose units are listed on the recognised stock exchange(s).

Submission of Documents
The listed entity is required to intimate to the recognised stock exchange, the information relating to daily Net
Asset Value, monthly portfolio, half yearly portfolio of those schemes whose units are listed on the recognised
stock exchange(s) in the format as specified under SEBI (Mutual Funds) Regulations, 1996 and directions issued
there under.
The listed entity is also required to intimate to the recognised stock exchange of:
(a) movement in unit capital of those schemes whose units are listed on the recognised stock exchange(s);
(b) rating of the scheme whose units are listed on the recognised stock exchange(s) and any changes in
the rating thereof (wherever applicable);
(c) imposition of penalties and material litigations against the listed entity and Mutual Fund; and
(d) any prohibitory orders restraining the listed entity from transferring units registered in the name of the
unit holders.

Dissemination on the website of stock exchange(s)

The listed entity shall submit such information and documents, which are required to be disseminated on the
listed entity’s website in terms of SEBI (Mutual Funds) Regulations, 1996 and directions issued thereunder, to the
recognized stock exchange for dissemination.

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CASE LAW

23.05.2006 SEBI Vs. Shriram Mutual Fund Hon’ble Supreme Court

Facts

The respondent was a mutual fund and the asset management company. During the period from June, 1998
to September, 1999, the respondent had conducted business through associated brokers, in excess of the
limits prescribed under regulation 25(7)(a) of the 1996 Regulations on 12 occasions covering 6 quarters. The
respondent had failed to comply with the terms and conditions attached to the certificate of registration
granted to it, inasmuch as it did not exercise diligence to ensure that the transactions by its own asset
management company were confined to the permissible limits. The Adjudicating Officer imposed a sum of
Rs. 5 lakhs as penalty on the respondent No. 2 under section 15E for failure to comply with regulation 25(7)
(a) and Rs. 2 lakhs on the respondent No. 1 for failure to comply with the terms and conditions attached to
the certificate of registration.

The respondents filed appeals before the Securities Appellate Tribunal, inter alia, contending that the
transactions with the associate brokers were related to thinly traded securities, for which there were no
ready markets available through the normal stock exchange, or were relating to securities which did not
have any large volume or trade in the market.

The Tribunal set aside the order passed by the Adjudicating Officer on the ground that the penalty to be
imposed for failure to perform a statutory obligation is a matter of discretion which has to be exercised
judicially and on a consideration of all the relevant facts and circumstances. The Tribunal also held that

the Adjudicating Officer had to be satisfied with the material placed before him that the violation deserved
punishment. The appeal was filed to Supreme Court.

Hon’ble SUPREME COURT JUDGMENT

The Hon’ble Supreme Court set aside the decision of Securities Appellate Tribunal in Shriram Mutual Fund
v. Chairman.

It was held by Supreme Court that the penalty is warranted by the quantum which has to be decided by taking
into consideration the factors stated in section 15J of SEBI Act. In its opinion, mens rea is not an essential
ingredient for contravention of the provisions of a civil act. The penalty is attracted as soon as contravention
of the statutory obligations as contemplated by the Act is established and, therefore, the intention of the
parties committing such violation becomes immaterial. In other words, the breach of a civil obligation which
attracts penalty under the provisions of an Act would immediately attract the levy of penalty irrespective of
the fact whether the contravention was made by the defaulter with any guilty intention or not.

The SEBI was set up to promote orderly and healthy growth of the securities market and for investors
protection SEBI has been monitoring and regulating the activities of Stock Exchanges, Mutual Funds and
Merchant Bankers, etc. to achieve these goals. The capital market has witnessed tremendous growth in
recent times, characterized particularly by the increasing participation of the Public. Investors’ confidence in
the capital market can be sustained largely by ensuring investors protection. That it became imperative to
impose monetary penalties also in addition to other penalties in cases of default.

The Court held that mens rea is not an essential element for imposing penalty for breach of civil
obligations.

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23.10.2017 SAHARA ASSET MANAGEMENT COMPANY P. Hon’ble Supreme Court

LTD & ORS. Appellant(s)
VERSUS
SECURITIES AND EXCHANGE BOARD OF INDIA
& ORS. Respondent(s)

Facts of the case:

SEBI passed an order dated June 23, 2011 against two Sahara group entities namely Sahara India Real
Estate Corporation Ltd. (SIRECL), Sahara Housing Investment Corporation Ltd. (SHICL) and some of their
Directors to refund the money collected through the issue of Optionally Fully Convertible Debentures
(OFCDs) and restrained those Directors from associating themselves with any listed public company and
any public company which intends to raise money from the public till such time the money is refunded to the
investors to the satisfaction of SEBI.
Following these orders against the two Sahara group companies and their Directors SEBI initiated
proceedings by appointing a Designated Authority under the Intermediaries Regulations on June 9, 2014.
This Designated Authority was to enquire into whether there was any violation of the provisions of the
Mutual Fund Regulations, 1996 as well as related SEBI Circulars by the Sahara Mutual Fund, Sahara
Sponsor, Sahara AMC and its Trustees. The Designated Authority submitted the report on October 14, 2014
holding that these entities are no longer fit and proper persons to carry on the business of mutual fund and
recommended cancellation of certificate of registration of Sahara MF.
The impugned order has been issued consequent to the findings by SEBI that Sahara Sponsor is not a ‘fit and
proper person’ because its Promoter-Director is not a fit and proper person and hence the Sahara MF and
Sahara AMC are no longer fit and proper to carry on the business of mutual fund.
Thus, SEBI vide order dated July 28, 2015 had ordered cancellation of Certificate of Registration of Sahara
Mutual Fund with effect from expiry of 6 months from the date of the order.
Subsequently, Sahara MF, Sahara AMC and others had preferred an appeal against the SEBI order dated
July 28, 2015 before the Hon’ble Securities Appellate Tribunal (SAT). The Hon’ble SAT vide order dated
July 28, 2017 disposed of the said appeal, granting a period of 6 weeks to the appellants to approach the
Hon’ble Supreme Court of India.
Sahara MF and others subsequently filed an appeal in the Hon’ble Supreme Court, challenging the aforesaid
order of the Hon’ble SAT.
Hon’ble Supreme Court Order
The said appeal was dismissed by the Hon’ble Supreme Court vide order dated October 23, 2017.

CASE STUDY
Winding up of Six Yield-Oriented Fixed Income Schemes of Franklin Templeton India amid Covid-19- A
Case Study
INTRODUCTION
COVID-19 started showing its impact on the mutual fund industry during pandemic. Though we could attribute
most of that outflow to corporates redeeming funds to meet their quarter end obligations, high volatility and
uncertainty as consequences of the pandemic could have also played a major hand in the redemption
pressure for debt schemes. Foreign Institutional Investors (FIIs) have been redeeming investments heavily in

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equity and debt segment ever since WHO declared COVID-19 a pandemic. In March 2020, FIIs pulled out Rs.
60,375 crore from the debt market.
High redemption and lack of buying interest has made debt mutual fund schemes vulnerable, especially
those with higher exposure to low rated instruments. This instability has claimed its first casualty in debt
mutual funds.
ABOUT FRANKLIN TEMPLETON (INDIA)
Franklin Templeton’s association with India dates back to over 2 decades as an investor. As part of the group’s
major thrust on investing in markets around the world, the India office was set up in 1996 as Templeton Asset
Management India Pvt. Limited. It flagged off the mutual fund business with the launch of Templeton India
Growth Fund in September 1996, and since then the business has grown at a steady pace.
Franklin Templeton (India) is one of the largest foreign fund houses in the country. It manages one of the
most comprehensive ranges of mutual funds catering to varied investor requirements and offering different
investment styles to choose from.
WINDING-UP OF SPECIFIC SCHEMES
The Trustees of Franklin Templeton Mutual Fund (FTMF) in India announced that they have, after careful
analysis and review of the recommendations submitted by Franklin Templeton AMC, and in close consultation
with the investment team, voluntarily decided to wind up their suite of six yield oriented, managed credit
funds effective from April 23, 2020.
In light of the severe market dislocation and illiquidity caused by the COVID-19 pandemic, this decision has
been taken in order to protect value for investors via a managed sale of the portfolio. This action is limited
to the below-mentioned funds, which have material direct exposure to the higher yielding, lower rated credit
securities in India that have been most impacted by the ongoing liquidity crisis in the market.
Details of schemes being wound up

S. Name of the Scheme Scheme Characteristic (based on Macaulay

No. Macaulay duration or credit rating) duration* in years
as stated in the scheme information as on 22 April
document 2020
1. Franklin India Ultra Short Bond Fund Investing in Instruments with Macaulay 0.38
duration between 3-6 months
2. Franklin India Short term Income Investing in Instruments with Macaulay 2.41
Fund duration between 1-3 years
3. Franklin India credit Risk Fund A bond fund focusing on AA and below 2.37
rated corporate bonds (excluding AA+
rated corporate bonds)
4. Franklin India Low Duration Fund Investing in Instruments with Macaulay 1.17
duration between 6-12 months
5. Franklin India Dynamic Accrual Investing across duration 1.95
Fund
6. Franklin India Income Opportunity Investing in Instruments with Macaulay 3.94
Fund duration between 3-4 years

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*Macaulay duration is the weighted average of the time to receive the cash flows from a bond. It is
measured in units of years. Macaulay duration tells the weighted average time that a bond needs to be
held so that the total present value of the cash flows received is equal to the current market price paid
for the bond.

CAUSES FOR WINDING UP THESE SCHEMES

According to a statement to investors from FTMF, Franklin Templeton (India) winding up these schemes
in order to preserve value and secure an orderly and equitable exit for investors in these yield-oriented
schemes. The credit climate was extremely challenging over the last quarter or so, and Covid-19 severely
heightened the pressure resulting in a spike in yields and sharply reduced liquidity. The ongoing global
pandemic has impacted business activity across a wide range of sectors and diminished portfolio companies’
ability to access funds and service existing debt. Mutual funds are facing unprecedented liquidity challenges
during the lockdown which was necessary to address the Covid-19 pandemic.

Factors like rising redemption pressures, mark to market losses, following spike in yields and rising illiquidity
in portfolios, following lower trading volumes have together caused severe and worsening liquidity crunch
for open-end mutual fund schemes. This impact will be long-lasting, and bond market conditions are unlikely
to return to normalcy in the immediate future.

The schemes had to resort to continuous borrowing to fund redemptions during this time, and were unable
to repay the borrowings through sale of portfolio securities due to the prevailing market environment. The
Investment manager did not believe it was prudent to continue funding redemptions through potentially
increasing levels of borrowings.

FTMF follows a high-risk high-return strategy for the above mentioned funds - Meaning a major part of its
portfolio is exposed to lower rated securities (rating below AAA). The market disruption due to the virus
outbreak has impacted these securities the most. Under conditions of high redemption pressure, mutual
funds sell their liquid assets to meet the demand, leaving the portfolio highly exposed to illiquid assets. Thus,
investors who choose to stay invested are at a disadvantage here.

Anticipating continued liquidity stress to the funds, the fund house thought winding up the scheme is the
only viable option for the unit holders to minimize erosion of value.

KEY IMPLICATIONS FOR INVESTORS ON SUCH WINDING UP

a) Suspension of Purchase and Redemption: The six wound up schemes were no longer available
for subscription or redemption, post cut-off time on 23 April 2020. All Systematic Investment Plans
(SIP), Systematic Transfer Plans (STP) and Systematic Withdrawal Plans (SWP) into and from the
abovementioned schemes stand cancelled post cut-off time on 23 April 2020.
b) Distribution of monies from Scheme Assets: Following the decision to wind-up the schemes, Franklin
Templeton (India) will proceed to assist the Trustees with orderly realization and liquidation of the
underlying assets with the objective of preserving value for unit holders, and with distribution of the
proceeds thereof to the unit holders after discharging the liabilities of the schemes.
c) Tax Implications: The amount received by investors are in the form of redemption of units and would,
where such amount or part thereof represents a gain for the investor, be taxed as capital gain in the
hands of investors depending on inter alia the period of their investment in the scheme. Investors can
take advice from a tax expert as impact could vary depending on their status and income.

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SEBI/SAT/SUPREME COURT’S DIRECTION TO FRANKLIN TEMPLETON MUTUAL FUND - KEY BULLETS

l SEBI vide its press release dated May 7, 2020 has advised Franklin Templeton mutual fund (FT) to
focus on returning money to investors, in the context of their winding up six of their debt schemes.
l However, a small number of investors sought the intervention of various courts and winding up of the
schemes were stayed.
l In October 2020, the High Court of Karnataka issued its judgment, in which it upheld the decision to
wind up the Funds and held that there was “nothing wrong with the decision making process,” but
determined that consent of the unitholders u/r 18(15)(c) was required to implement the decision.
l On December 3, 2020, the SC issued an interim order allowing the Trustee to seek unitholder
approval for winding up the six Funds, without prejudice to the right of the parties to argue on the
interpretation of the regulation and other aspects of the appeal.
l The Trustee then proceeded to conduct votes for each of the six Funds, which concluded on
December 29, 2020, and a substantial majority (above 96%) of the voting unitholders of each of the
Funds voted in favor of the winding-up decision. Thereafter, the SC allowed the Trustee to distribute
the cash available in the schemes to the respective unitholders proportionately and appointed SBI
Funds Management Private Limited, a public sector entity, to undertake the distribution.
l Further vide order dated February 12, 2021, the SC upheld the validity of the e-voting exercise and
confirmed the winding-up status of the schemes. With the consent of all the parties, the SC appointed
SBI Mutual Fund Pvt. Ltd as the liquidator to monetize the assets of the scheme and distribute the
proceeds to the unitholders.
l Since the date of the winding up till July 9, 2021, the six schemes have received INR 25,859 crore
from maturities, coupons, sale, and prepayments. The total amount distributed in the winding up
schemes stands at INR 26,783.22 crores amounting to 106% of the AUM as on April 23, 2020.
l SEBI initiated a forensic audit/inspection, with respect to the affairs of the six fixed income schemes
and fund of funds schemes that invested in these six schemes. SEBI had communicated the
observations/findings of the said forensic audit/inspection to the Trustee and the AMC and sought
their comments together with relevant supporting documents/ records. The Trustee and the AMC
had submitted their response to SEBI. Subsequently, SEBI has issued Show Cause Notices (‘SCNs’),
on 24 November 2020 to the AMC and on 27 November 2020 to the Trustee and 8 employees
of the AMC (including an ex-employee), upon consideration of observations in forensic audit /
inspection and responses thereon submitted by the AMC and the Trustee. The Trustee and the AMC
and 8 employees (including an ex employee) had submitted their response to the SEBI on these
SCNs.
l On June 7, 2021, SEBI issued an order against the AMC and on June 14, 2021 a separate joint
order against the Trustee and certain AMC officers and employees, finding violations of certain
regulatory provisions, including – at a high level – with respect to similarity in investment strategies
among the Funds, calculation of duration and valuation of portfolio securities, documentation of
investment diligence and investment terms, and portfolio risk management. SEBI’s orders include, as
applicable, monetary penalties, disgorgement of investment management and advisory fees, and a
prohibition from launching new fixed income funds in India for a two-year period.
l The AMC filed an appeal and an application for stay before the Hon’ble Securities Appellate Tribunal
(SAT). After hearing the parties, the Hon’ble SAT has stayed the operation of the order passed by the
WTM.

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Mutual Funds LESSON 17

LESSON ROUND-UP

l Mutual fund is a trust that collects money from a number of investors who share a common investment
Objective and invests the same in equities, bonds, money market instruments and/or other securities.

l Mutual funds are regulated by the SEBI (Mutual Fund) Regulations, 1996.

l Mutual Fund schemes could be ‘open ended’ or close-ended’ and actively managed or passively
managed.

l There are five principal constituents and three market intermediaries in the formation and functioning
of mutual fund.

l A mutual fund shall be constituted in the form of a trust and the instrument shall be in the form of a
deed duly registered under the Registration Act.

l The mutual fund shall enter into a custodian agreement with the custodian, which shall contain the
clauses which are necessary for the efficient and orderly conduct of the affairs of the custodian.

l No scheme shall be launched by the asset management company unless such scheme is approved by
the trustees and a copy of the offer document has been filed with the SEBI.

l The SEBI (LODR) Regulations, 2015 is applicable to the AMC managing the mutual fund scheme whose
units are listed on the recognised stock exchange.

GLOSSARY

Diversification: The process of investing across different asset classes (equity, debt, property, etc.) and
across different investments within each asset class (for instance, investing across equity shares of various
companies in case of equity) to reduce risk.

Investment objective: Every mutual fund scheme has an investment objective according to which the fund
manager has to make investments for the scheme. For example, in case of an equity fund, the investment
objective may be to invest in large cap companies across a range of sectors in order to give investors capital
appreciation.

Maturity: Some investments such as close-ended funds have a maturity date, which is the date on which the
investor is paid back his principal amount as well as all income due to him on that investment.

Repurchase/ Redemption: When a mutual fund investor wants to exit from his mutual fund investment, he
can sell back the units to the mutual fund and receive cash. The mutual fund ‘repurchases’ his units and the
investor is said to ‘redeem’ his units.

Custodian: Custodian means a person who has been granted a certificate of registration to carry on the
business of custodian of securities under the Securities and Exchange Board of India (Custodian of Securities)
Regulations, 1996.

Networth: Networth means the aggregate of the paid up capital and free reserves after deducting therefrom,
miscellaneous expenditure to the extent not written off or adjusted or deferred revenue expenditure,
intangible assets and accumulated losses.

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TEST YOURSELF

(These are meant for recapitulation only. Answer to these questions are not to be submitted for evaluation)
These are meant for recapitulation only. Answer to these questions are not to be submitted for evaluation.)
1. Elucidate the key players of Mutual funds in the formation and functioning of mutual fund.
2. What do you mean by Net Asset Value? How to calculate NAV?
3. Distinguish between Open ended Mutual Funds and Close ended Mutual funds.
4. What is the Eligibility Criteria for Registration of Mutual Funds?
5. What is the Procedure for Launching of Mutual Funds Schemes?
6. Write short notes on the followings:
a) Asset Management Company
b) Holding Period Return
c) Expense Ratio
d) Code of Conduct of Mutual Fund
7. S is holding 2000 units of a equity-oriented scheme of a mutual fund and 1000 units of a debt scheme
of a mutual fund. On 7th June, 2022 he is interested to redeem these units. Prevailing net asset value
(NAV) of these units are as under :
Date Net Asset Value (NAV)
Equity-oriented scheme (in `) Debt scheme (in `)
6th June 45 35
7th June 46 34
8th June 47 33
He makes an application for redemption of above units on 7th June, 2022 at 2:30 pm. Based on given
information answer the following:
(i) What do you mean by cut-off time? What are the cut-off time for equity-oriented & Debt funds
(except liquid funds)?
(ii) What will be the applicable NAV in his case?
(iii) What will be applicable NAV if application for redemption is made at 3:15 pm?

LIST OF FURTHER READINGS

l SEBI Circulars
l SEBI Notifications
l SEBI Orders
l SEBI FAQs

OTHER REFERENCES (Including Websites/Video Links)

l https://www.sebi.gov.in/

l https://www.amfiindia.com/

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