A

PROJECT REPORT
ON

EQUITY LINKED SAVINGS SCHEME

THE FAVOURITE TAX SAVING INSTRUMENT

SUBMITTED BY
MANISHA THAKUR
MMS/07-09/ROLL NO. 54

Jankidevi Bajaj Institute of Management Studies (JDBIMS)

S.N.D.T. Women's University
Sir Vithaldas Thackersey Vidya Vihar,
Juhu Road, Santacruz (West),
Mumbai - 400 049
Tel. No. : 022-26606626 / 8624 / 8493
Fax No. : 022-26606615
Email : jdbims@rediffmail.com

CONTENTS
TOPIC

PAGE NO.

1. Certificate by organization

2. Acknowledgement

3. Preface

4. Declaration

5. Executive summary

6. Organizational overview

7. The mutual funds industry in India-an overview

23

8. All about mutual funds

40

9. The aspects of income tax

68

10. Tax efficient investment

73

11. ELSS vs. The rest

81

12. ELSS rankings

87

13. Equity-linked savings scheme in a nutshell

88

14. Risk The other side of the coin

89

15. Case study

93

16. Conclusion

98

17. Appendix

103

18. Bibliography

105

ACKNOWLEDGEMENT
My experience as a summer trainee at Karvy Stock Broking Ltd. was not only an enriching
experience on the knowledge and learning part but also on a personal level. I would like to
thank Mr. Ravi Gaikwad (Distribution Head, Karvy Stock Broking Ltd., Pune) for providing
me with an opportunity to work with Karvy Stock Broking limited. Working and gathering
gems of knowledge under his guidance was the best thing that could happen to me during my
internship and without his guidance and immense support, this project would not have been
accomplished at all.
I sincerely appreciate and thank Mr. Sagar Dangre (Relationship Manager, Karvy) and Ms.
Archana S Pengal who helped me in every possible way by providing me with the necessary
information and their valuable suggestions on every aspect of my training.
I also thank Dr. Gulnaar Sharma (Director, JDBIMS, Mumbai) and the faculty of my college
who have sincerely supported me with the valuable insights into the completion of this
project.
Last but not the least, my heartfelt thanks to all the staff at Karvy who were such fun and joy
to be with. Thankyou all for the giving me the best two months of my life.
Manisha Thakur
JDBIMS, SNDT University, Mumbai
MMS/07-09/Roll. No.54

PREFACE

Mutual Funds are going to be amongst the most exciting players in the years to come. Fund
managers of well oiled operations and their clients are in for a terrific experience.

The question in everybodys mind however is, When? When will the investors interest in
Mutual Funds really pick up? When will the infatuations of the small investors with primary
markets end? And when will the mutual fund gain the type of clout in the stock market that
their counterparts in the United States of America enjoy.

The Indian investor, believes in playing the market on his own, and will continue to
do so till the time his perception changes- which they undoubtedly will. Financial institutions
and mutual funds, leaving the small investor with no other option except the mutual fund to
put his savings in., will ultimately dominate the markets but for this to happen, industry will
have to be patient and prove that it can prove investors with better returns than the markets.
Plus they will have to make their operations much more transparent and investor friendly.
Well if we look at the trend and the figure of last one year number it seems the shift has
started to happen towards mutual fund shifting the trend.

DECLARATION

I hereby declare that Summer Training Report submitted as a requirement of fulfillment of

my MMS course is my original work and not submitted for the award of any other degree,
diploma, fellowship or other similar title or prizes.

Manisha Thakur
JDBIMS, SNDT University
MMS/07-09/Roll No.54

EXECUTIVE SUMMARY

The Year 2008 brings with it more work and diligence, especially in the area of tax planning.
And it's that time of the year when one has to be innovative with your investments to save
tax. Instead of opting for the conventional tax-saving instruments like PPF, NSC, RBI bonds,
and LIC policies, a better and remunerative way of investing your hard-earned money is the
ELSS. An Equity Linked Savings Scheme (ELSS) is a tax saving instrument provided by
mutual funds. It offers the benefits of getting equity linked returns and with the additional
benefit of tax saving. Here is an analysis of the nitty-gritty involved in an ELSS, which would
give a perspective as to why it is a better alternative to other tax-saving instruments.

OBJECTIVE

The objective of this project is to facilitate in getting the better understanding from
the investor side about their priorities while investing and how mutual funds actually operate
as well as the various tax saving mutual funds handled by Karvy Stock Broking Ltd.

The project would also reveal the fact that the main priority of any working person while
entering into an investment is to save on taxes, which in turn compels me to present a detailed
study of the tax saver funds or the ELSS funds.
This would help Karvy Stock Broking Ltd. in making marketing strategies specifically to
promote the tax saver funds.

PROPOSED METHODOLOGY

For the accomplishment of this project following steps are recommended:

STEP 1: UNDERSTANDING the product and detail study of the concept mutual funds.
STEP 2: This step comprises of meeting with investors along with the Relationship manager
from Karvy.
STEP 3: Finally analyzing and interpreting the collected data and preparing the final report.

ORGANIZATIONAL OVERVIEW
ABOUT KARVY
Building a heritage of Confidence...
Vision
To achieve & sustain market leadership, Karvy shall aim for complete customer satisfaction,
by combining its human and technological resources, to provide world class quality services.
In the process Karvy shall strive to meet and exceed customer's satisfaction and set industry
standards.
Mission statement:
Our mission is to be a leading and preferred service provider to our customers, and we aim
to achieve this leadership position by building an innovative, enterprising , and technology
driven organization which will set the highest standards of service and business ethics.

Since its inception in 1982, Karvy has demonstrated a dedication coupled with dynamism
that has inspired trust from various segments, corporates, government bodies and
individuals. Karvy has since been performing a pivotal role as the intermediary the interface
between these players.
With Mutual Funds emerging as a distinct asset class, Karvy has made a strategic choice to
leverage the power of latest technology to provide a cutting edge to its services. They, today,
service nearly 40% of the asset management companies (AMCs) across an extensive
network of service centres with assets under service in excess of Rs.2, 27, 033 crores.
Mutual fund services have been undergoing a sea change in the Indian market place and
asset management companies are finding their niche in delivering unique products and
service offerings.
Their ability to mass customize and offer a diverse range of products for a diverse range of
customers has helped mutual fund companies to uniquely position themselves in the market
8

place. These diverse range of services cut across multiple delivery channels, service centres,
web, mobile phones, call centre has brought home the benefits of technology to investors,
distributors, and the mutual funds.
Going forward, they strive to create new products and services, which would address the
needs of the end customer. Their single minded focus in delivering products for customers
has given us the distinguished position of being the preferred provider of financial services
in the country.

ORGANIZATIONAL STRUCTURE

The organization structure of karvy has a board of directors as the supreme governing body ,
the chairman being Mr. C Parthasarthy, Mr. M Yugandhar as the managing director, Mr M.
S.Rramakrishna and Mr. Prasad V. Potluri as directors.
Karvy group being the flagship company looks after the functional departments such as
corporate affairs, group human resources, finance & accounting, training & development,
technology services and corporate quality.
Karvy computershare private limited facilitates mutual fund services, share registry and
issue registry whereas merchant banking is looked after by karvy investor services ltd. Karvy
stock broking ltd heads its another branch too ie. Karvy insurance broking ltd. The services
offered by KSBL are: stock broking, depository, research, distribution, personal client group
and institutional desk. And finally the BPO services are managed by karvy global services
ltd. Summarizing it in a diagram, it can be presented as:

10

KEY PEOPLE

Board of Directors - Karvy Computershare Private Limited

William Stuart Crosby

Chairman

C Parthasarathy

Managing Director

M Yugandhar

Managing Director

M S Ramakrishna

Director

Chandra Balaraman

Director

James Wong

Director

Board of Directors - Karvy Consultants Limited

C Parthasarathy

Chairman

M Yugandhar

Managing Director

M S Ramakrishna

Director

11

Board of Directors - Karvy Stock Broking Limited

C Parthasarathy

Chairman

M Yugandhar

Director

M S Ramakrishna

Director

Akash Mehta

Director

Peter Wing Hung So

Director

Board of Directors - Karvy Investor Services Limited

C Parthasarathy

Chairman

M Yugandhar

Director

M S Ramakrishna

Director

Board of Directors - Karvy Global Services

C Parthasarathy

Director

M Yugandhar

Director

M S Ramakrishna

Director

Board of Directors - Karvy Comtrade Limited

C Parthasarathy

Chairman

M Yugandhar

Director

M S Ramakrishna

Director

Board of Directors - Karvy Insurance Broking Limited

C Parthasarathy

Chairman

M Yugandhar

Director

M S Ramakrishna

Director

12

Mr. William Stuart

In his role as Managing Director - Asia Pacific,

Crosby

Stuart is responsible for Computershare's

Regional Managing

operations in Australia, New Zealand, India and

Director Asia Pacific

Hong Kong.
Prior to his appointment to this position in
2002, Stuart spent two years heading up
Computershare's strategic business
development in continental Europe and Asia.
Before joining Computershare in 1999, Stuart
was ASX's national head of listings (96 - 99).
Stuart has also worked in Hong Kong where he
ran the Hong Kong Securities and Futures

13

Commission's intermediary licensing division

and was a director of enforcement.
Mr. C Parthasarathy

Mr. C Parthasarathy, a leader in the financial

Chairman - Karvy

services industry in India is responsible for

Group

building Karvy as one of India's truly integrated

Financial Services Provider; he is a fellow
member of the Institute of Company Secretaries
of India, a Fellow Member of the Institute of
Chartered Accountants of India and a graduate in
law. As Chairman and Managing Director, he
oversees the group's operations and renders
vision and business direction. His passion and
vision for achieving leadership in the business
made KARVY a leading financial intermediary
ranking them as number one in the registrar,
Share Transfer and IPO Distribution businesses.
He also holds directorship in Karvy Stock
Broking Limited, Karvy Investor Services
Limited, Karvy Computershare Private Limited,
Karvy Commodities Broking Private Limited,
EPR Pharmaceuticals Private Limited and Ocean
Sparkles Limited.

Mr. Y Yugandhar

Mr. Y Yugandhar, Managing Director, founder

Managing Director -

member of Karvy Consultants Limited, has

Karvy Group

varied experience in the field of financial

14

services spanning over 20 years. He is a Fellow

Member of the Institute of Chartered
Accountants of India and was involved in the
statutory and branch audit of banks for 26 years.
Mr. Yugandhar holds directorships in Karvy
Stock Broking Limited, Karvy Investor Services
Limited, Karvy Computershare Private Limited,
Karvy Commodities Broking Private Limited,
Bizpro Technologies India Limited, Pokarna
Limited, Ravindranath G E Medical Associates
Private Limited, Everest Power Private Limited
and Green Infrastructure Private Limited.

Mr. M S

Mr. M S Ramakrishna, Director, founder member

Ramakrishna

of Karvy Consultants Limited is orchestrator of

Director - Karvy

technology initiatives such as the call centre in the

Group

service of the customer. Mr. Ramakrishna is a

member of the Hyderabad Stock Exchange and is
the director of Karvy Stock Broking Limited,
Karvy Investor Services Limited, Karvy
Computershare Private Limited, Karvy
Commodities Broking Private Limited, Nitya Labs
Limited and SAB Nife Power Systems Limited.
He has helped Karvy diversify into the field of
medical transcription leveraging on the company's
core competency of transaction processing. He has
more than 20 years of experience in the financial
services arena.

15

BANK OF
BARODA
MUTUAL FUND

Bank of Baroda Asset

Management Company
Ltd

BENCHMARK
MUTUAL FUND

Benchmark Asset
Management Company
Pvt. Ltd

BHARTI AXA
INVESTMENT
MANAGERS

Bharti AXA Investment

Managers Private
Limited

16

CANARA
REBECO
MUTUAL FUND

Canara Robeco
Investment
Management Services

DEUTSCHE
MUTUAL FUND

Deutsche Asset
Management (India)
Pvt. Ltd

EDELWEISS
MUTUAL FUND

Edelweiss Asset
Management Limited

FRANKLIN
TEMPLETON
MUTUAL FUND

Franklin Templeton
Asset Management
(India) Pvt. Ltd.

J M FINANCIAL JM Financial Mutual

MUTUAL FUND Fund
LIC MUTUAL
FUND

LIC Mutual Fund Asset

Management Company
Ltd

MORGAN
STANLEY
MUTUAL FUND

Morgan Stanley
Investment
Management

MIRAE ASSET
MUTUAL FUND

Mirae Asset Global

Investment
Management (India).
Pvt. Ltd

PRINCIPAL
MUTUAL FUND

QUANTUM
MUTUAL FUND

RELIANCE
MUTUAL FUND

Principal PNB Asset

Management Company
Private Ltd.,

Quantum Asset
Management Company
Pvt. Ltd
Reliance Capital Asset
Management Pvt. Ltd.

17

SAHARA
MUTUAL FUND

Sahara Asset
Management Company
Pvt. Limited.

SUNDARAM
MUTUAL FUND

Sundaram Finance Ltd.

( BO )

TATA MUTUAL
FUND

TAURUS
MUTUAL FUND

UTI MUTUAL
FUND

Tata Asset Management

Company Ltd.

Taurus Asset
Management Company
Ltd.

UTI Asset Management

Company (P) Ltd

Serving Every 20th Citizen of India

Among the top 5 stock brokers in India (4% of NSE volumes)
India's No.1 Registrar & Securities Transfer Agents
ISO 9002 Certified Operations by DNV
Among top 10 Investment Bankers
Largest Distributor of Financial Products

18

To achieve and sustain market leadership, Karvy shall aim for complete customer
satisfaction, by combining its human and technological resources, to provide world class
quality services. In the process Karvy shall strive to meet and exceed Customers' satisfaction
and set Industry Standards.

19

As per the Quality Policy, Karvy will :

Maintain and assess in-house processes that will sustain transparent and harmonious
relationships with its clients and customers to provide world class services.
Aim to set industry standards in customer relations by way of establishing/reinforcing its
human and technological resources and act as a facilitator to suit customised needs of our
clients.
Establish partner relationships with our business associates/clients, investors, other
customers, service agents and vendors, which would help in building customer confidence
Provide high quality of work life for all its employees and equip them with adequate
knowledge & skills so as to meaningfully respond to customers' needs.
Use state of art information technology in developing new and innovative products and
services to meet the changing needs of investors and clients.
Strive to be a reliable source of value added support on products and services offered and
constantly guide individuals and institutions in making judicious choice of same.
Aim to become a leader in the areas of activities being undertaken, by setting industry
standards in efficiency and responsiveness thereby exceeding levels of customer
satisfaction.
Strive to keep all stake-holders (shareholders, clients, investors, suppliers, customers,
regulatory authorities and employees) and business associates proud and satisfied.

20

THE MUTUAL FUNDS INDUSTRY IN INDIA

AN OVERVIEW
BASICS
Mutual Funds in India are governed by the SEBI (Mutual Fund) Regulations 1996 as
amended from time to time.

21

Securities and Exchange Board of India (SEBI) is an autonomous body created by the
Government of India in 1988 and given statutory form in 1992 with the SEBI Act 1992. Its
head office is in Mumbai, and has regional offices in Chennai and Delhi. SEBI is the
regulator of Securities markets in India.
The new chairman of SEBI, Mr.C.B.Bhave took charge on February 16 2008.
FUNCTIONS AND RESPONSIBILITIES
SEBI has to be responsive to the needs of three groups, which constitute the market:
The issuers of securities
The investors
The market intermediaries.
SEBI has three functions rolled into one body quasi-legislative, quasi-judicial and quasiexecutive. It drafts regulations in its legislative capacity, it conducts investigation and
enforcement action in its executive function and it passes rulings and orders in its judicial
capacity. Though this makes it very powerful, there is an appeals process to create
accountability. There is a Securities Appellate Tribunal which is a three member tribunal and
is presently headed by a former Chief Justice of a High court - Mr. Justice NK Sodhi. A
second appeal lies directly to the Supreme Court.
SEBI has had a mixed history in terms of its success as a regulator. It has pushed systemic
reforms aggressively and successively (e.g. the quick movement towards making the markets
electronic and paperless rolling settlement on T+2 basis). SEBI has been active in setting up
the regulations as required under law.
Different investment avenues are available to investors. Mutual funds also offer good
investment opportunities to the investors. Like all investments, they also carry certain risks.
The investors should compare the risks and expected yields after adjustment of tax on various
instruments while taking investment decisions. The investors may seek advice from experts
and consultants including agents and distributors of mutual funds schemes while making
investment decisions.
22

With an objective to make the investors aware of functioning of mutual funds, an attempt has
been made to provide information in question-answer format which may help the investors in
taking investment decisions.
Mutual fund is a mechanism for pooling the resources by issuing units to the investors and
investing funds in securities in accordance with objectives as disclosed in offer document.
Investments in securities are spread across a wide cross-section of industries and sectors and
thus the risk is reduced. Diversification reduces the risk because all stocks may not move in
the same direction in the same proportion at the same time. Mutual fund issues units to the
investors in accordance with quantum of money invested by them. Investors of mutual funds
are known as unit holders.
The profits or losses are shared by the investors in proportion to their investments. 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 Securities and Exchange Board of India (SEBI) which regulates securities markets
before it can collect funds from the public.
Unit Trust of India was the first mutual fund set up in India in the year 1963. In early 1990s,
Government allowed public sector banks and institutions to set up mutual funds.
In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The
objectives of SEBI are to protect the interest of investors in securities and to promote the
development of and to regulate the securities market.
As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual
funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in
1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the
capital market. The regulations were fully revised in 1996 and have been amended thereafter
from time to time. SEBI has also issued guidelines to the mutual funds from time to time to
protect the interests of investors.
All mutual funds whether promoted by public sector or private sector entities including those
promoted by foreign entities are governed by the same set of Regulations. There is no
distinction in regulatory requirements for these mutual funds and all are subject to monitoring
23

and inspections by SEBI. The risks associated with the schemes launched by the mutual
funds sponsored by these entities are of similar type.
A mutual fund is set up in the form of a trust, which has sponsor, trustees, Asset
Management Company (AMC) and custodian. The trust is established by a sponsor or more
than one sponsor who is like promoter of a company. The trustees of the mutual fund hold its
property for the benefit of the unit holders. Asset Management Company (AMC) approved by
SEBI manages the funds by making investments in various types of securities. Custodian,
who is registered with SEBI, holds the securities of various schemes of the fund in its
custody. The trustees are vested with the general power of superintendence and direction over
AMC. They monitor the performance and compliance of SEBI Regulations by the mutual
fund.
SEBI Regulations require that at least two thirds of the directors of trustee company or board
of trustees must be independent i.e. they should not be associated with the sponsors. Also,
50% of the directors of AMC must be independent. All mutual funds are required to be
registered with SEBI before they launch any scheme.
The performance of a particular scheme of a mutual fund is denoted by Net Asset Value
(NAV).
Mutual funds invest the money collected from the investors in securities markets. In simple
words, Net Asset Value is the market value of the securities held by the scheme. 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 Rs 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10
each to the investors, then the NAV per unit of the fund is Rs.20. NAV is required to be
disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of
scheme.
Mutual funds cannot increase the load beyond the level mentioned in the offer document. Any
change in the load will be applicable only to prospective investments and not to the original
investments. In case of imposition of fresh loads or increase in existing loads, the mutual

24

funds are required to amend their offer documents so that the new investors are aware of
loads at the time of investments.
The price or NAV a unit holder is charged while investing in an open-ended scheme is called
sales price. It may include sales load, if applicable.
Repurchase or redemption price is the price or NAV at which an open-ended scheme
purchases or redeems its units from the unit holders. It may include exit load, if applicable.
Assured return schemes are those schemes that assure a specific return to the unit holders
irrespective of performance of the scheme.
A scheme cannot promise returns unless such returns are fully guaranteed by the sponsor or
AMC and this is required to be disclosed in the offer document.
Investors should carefully read the offer document whether return is assured for the entire
period of the scheme or only for a certain period. Some schemes assure returns one year at a
time and they review and change it at the beginning of the next year.
Considering the market trends, any prudent fund managers can change the asset allocation i.e.
he can invest higher or lower percentage of the fund in equity or debt instruments compared
to what is disclosed in the offer document. It can be done on a short term basis on defensive
considerations i.e. to protect the NAV. Hence the fund managers are allowed certain
flexibility in altering the asset allocation considering the interest of the investors. In case the
mutual fund wants to change the asset allocation on a permanent basis, they are required to
inform the unit holders and giving them option to exit the scheme at prevailing NAV without
any load.
Mutual funds normally come out with an advertisement in newspapers publishing the date of
launch of the new schemes. Investors can also contact the agents and distributors of mutual
funds who are spread all over the country for necessary information and application forms.
Forms can be deposited with mutual funds through the agents and distributors who provide
such services. Now a days, the post offices and banks also distribute the units of mutual
funds. However, the investors may please note that the mutual funds schemes being marketed
by banks and post offices should not be taken as their own schemes and no assurance of

25

returns is given by them. The only role of banks and post offices is to help in distribution of
mutual funds schemes to the investors.
Investors should not be carried away by commission/gifts given by agents/distributors for
investing in a particular scheme. On the other hand they must consider the track record of the
mutual fund and should take objective decisions.
Non-resident Indians can also invest in mutual funds. Necessary details in this respect are
given in the offer documents of the schemes.
An investor should take into account his risk taking capacity, age factor, financial position,
etc. As already mentioned, the schemes invest in different type of securities as disclosed in
the offer documents and offer different returns and risks. Investors may also consult financial
experts before taking decisions. Agents and distributors may also help in this regard.
An investor must mention clearly his name, address, number of units applied for and such
other information as required in the application form. He must give his bank account number
so as to avoid any fraudulent encashment of any cheque/draft issued by the mutual fund at a
later date for the purpose of dividend or repurchase. Any changes in the address, bank
account number, etc at a later date should be informed to the mutual fund immediately.
An abridged offer document, which contains very useful information, is required to be given
to the prospective investor by the mutual fund. The application form for subscription to a
scheme is an integral part of the offer document. SEBI has prescribed minimum disclosures
in the offer document. An investor, before investing in a scheme, should carefully read the
offer document. Due care must be given to portions relating to main features of the scheme,
risk factors, initial issue expenses and recurring expenses to be charged to the scheme, entry
or exit loads, sponsors track record, educational qualification and work experience of key
personnel including fund managers, performance of other schemes launched by the mutual
fund in the past, pending litigations and penalties imposed, etc.
Mutual funds are required to despatch certificates or statements of accounts within six weeks
from the date of closure of the initial subscription of the scheme. In case of close-ended
schemes, the investors would get either a demat account statement or unit certificates as these
are traded in the stock exchanges. In case of open-ended schemes, a statement of account is

26

issued by the mutual fund within 30 days from the date of closure of initial public offer of the
scheme. The procedure of repurchase is mentioned in the offer document.
According to SEBI Regulations, transfer of units is required to be done within thirty days
from the date of lodgement of certificates with the mutual fund.
A mutual fund is required to despatch to the unit holders the dividend warrants within 30 days
of the declaration of the dividend and the redemption or repurchase proceeds within 10
working days from the date of redemption or repurchase request made by the unit holder.
In case of failures to despatch the redemption/repurchase proceeds within the stipulated time
period, Asset Management Company is liable to pay interest as specified by SEBI from time
to time (15% at present).
A mutual fund changes the nature of the scheme from the one specified in the offer document.
However, no change in the nature or terms of the scheme, known as fundamental attributes of
the scheme e.g. structure, investment pattern, etc. can be carried out unless a written
communication is sent to each unit holder and an advertisement is given in one English daily
having nationwide circulation and in a newspaper published in the language of the region
where the head office of the mutual fund is situated. The unit holders have the right to exit the
scheme at the prevailing NAV without any exit load if they do not want to continue with the
scheme. The mutual funds are also required to follow similar procedure while converting the
scheme form close-ended to open-ended scheme and in case of change in sponsor.
There may be changes from time to time in a mutual fund. The mutual funds are required to
inform any material changes to their unit holders. Apart from it, many mutual funds send
quarterly newsletters to their investors.
At present, offer documents are required to be revised and updated at least once in two years.
In the meantime, new investors are informed about the material changes by way of addendum
to the offer document till the time offer document is revised and reprinted.
The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on
daily basis in case of open-ended schemes and on weekly basis in case of close-ended
schemes. The NAVs of mutual funds are required to be published in newspapers. The NAVs
are also available on the web sites of mutual funds. All mutual funds are also required to put
27

their NAVs on the web site of Association of Mutual Funds in India (AMFI)
www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place.
The mutual funds are also required to publish their performance in the form of half-yearly
results which also include their returns/yields over a period of time i.e. last six months, 1
year, 3 years, 5 years and since inception of schemes. Investors can also look into other
details like percentage of expenses of total assets as these have an effect on the yield and
other useful information in the same half-yearly format.
The mutual funds are also required to send annual report or abridged annual report to the unit
holders at the end of the year.
Various studies on mutual fund schemes including yields of different schemes are being
published by the financial newspapers on a weekly basis. Apart from these, many research
agencies also publish research reports on performance of mutual funds including the ranking
of various schemes in terms of their performance. Investors should study these reports and
keep themselves informed about the performance of various schemes of different mutual
funds.
Investors can compare the performance of their schemes with those of other mutual funds
under the same category. They can also compare the performance of equity oriented schemes
with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc.
On the basis of performance of the mutual funds, the investors should decide when to enter or
exit from a mutual fund scheme.
The mutual funds are required to disclose full portfolios of all of their schemes on half-yearly
basis which are published in the newspapers. Some mutual funds send the portfolios to their
unit holders.
The scheme portfolio shows investment made in each security i.e. equity, debentures, money
market instruments, government securities, etc. and their quantity, market value and % to
NAV. These portfolio statements also required to disclose illiquid securities in the portfolio,
investment made in rated and unrated debt securities, non-performing assets (NPAs), etc.

28

Some of the mutual funds send newsletters to the unit holders on quarterly basis which also
contain portfolios of the schemes.
There is a difference between Mutual funds and IPOs of a company. IPOs of companies may
open at lower or higher price than the issue price depending on market sentiment and
perception of investors. However, in the case of mutual funds, the par value of the units may
not rise or fall immediately after allotment. A mutual fund scheme takes some time to make
investment in securities. NAV of the scheme depends on the value of securities in which the
funds have been deployed.
Some of the investors have the tendency to prefer a scheme that is available at lower NAV
compared to the one available at higher NAV. Sometimes, they prefer a new scheme which is
issuing units at Rs. 10 whereas the existing schemes in the same category are available at
much higher NAVs. Investors may please note that in case of mutual funds schemes, lower or
higher NAVs of similar type schemes of different mutual funds have no relevance. On the
other hand, investors should choose a scheme based on its merit considering performance
track record of the mutual fund, service standards, professional management, etc. This is
explained in an example given below.
Suppose scheme A is available at a NAV of Rs.15 and another scheme B at Rs.90. Both
schemes are diversified equity oriented schemes. Investor has put Rs. 9,000 in each of the
two schemes. He would get 600 units (9000/15) in scheme A and 100 units (9000/90) in
scheme B. Assuming that the markets go up by 10 per cent and both the schemes perform
equally good and it is reflected in their NAVs. NAV of scheme A would go up to Rs. 16.50
and that of scheme B to Rs. 99. Thus, the market value of investments would be Rs. 9,900
(600* 16.50) in scheme A and it would be the same amount of Rs. 9900 in scheme B
(100*99). The investor would get the same return of 10% on his investment in each of the
schemes. Thus, lower or higher NAV of the schemes and allotment of higher or lower number
of units within the amount an investor is willing to invest, should not be the factors for
making investment decision. Likewise, if a new equity oriented scheme is being offered at
Rs.10 and an existing scheme is available for Rs. 90, should not be a factor for decision
making by the investor. Similar is the case with income or debt-oriented schemes.
On the other hand, it is likely that the better managed scheme with higher NAV may give
higher returns compared to a scheme which is available at lower NAV but is not managed
29

efficiently. Similar is the case of fall in NAVs. Efficiently managed scheme at higher NAV
may not fall as much as inefficiently managed scheme with lower NAV. Therefore, the
investor should give more weightage to the professional management of a scheme instead of
lower NAV of any scheme. He may get much higher number of units at lower NAV, but the
scheme may not give higher returns if it is not managed efficiently.
As already mentioned, the investors must read the offer document of the mutual fund scheme
very carefully. They may also look into the past track record of performance of the scheme or
other schemes of the same mutual fund. They may also compare the performance with other
schemes having similar investment objectives. Though past performance of a scheme is not
an indicator of its future performance and good performance in the past may or may not be
sustained in the future, this is one of the important factors for making investment decision. In
case of debt oriented schemes, apart from looking into past returns, the investors should also
see the quality of debt instruments which is reflected in their rating. A scheme with lower rate
of return but having investments in better rated instruments may be safer. Similarly, in
equities schemes also, investors may look for quality of portfolio. They may also seek advice
of experts.
Investors should not assume some companies having the name "mutual benefit" as mutual
funds. These companies do not come under the purview of SEBI. On the other hand, mutual
funds can mobilise funds from the investors by launching schemes only after getting
registered with SEBI as mutual funds.
In the offer document of any mutual fund scheme, financial performance including the net
worth of the sponsor for a period of three years is required to be given. The only purpose is
that the investors should know the track record of the company which has sponsored the
mutual fund. However, higher net worth of the sponsor does not mean that the scheme would
give better returns or the sponsor would compensate in case the NAV falls.
Almost all the mutual funds have their own web sites. Investors can also access the NAVs,
half-yearly results and portfolios of all mutual funds at the web site of Association of mutual
funds in India (AMFI) www.amfiindia.com. AMFI has also published useful literature for the
investors.

30

Investors can log on to the web site of SEBI www.sebi.gov.in and go to "Mutual Funds"
section for information on SEBI regulations and guidelines, data on mutual funds, draft offer
documents filed by mutual funds, addresses of mutual funds, etc. Also, in the annual reports
of SEBI available on the web site, a lot of information on mutual funds is given.
There are a number of other web sites which give a lot of information of various schemes of
mutual funds including yields over a period of time. Many newspapers also publish useful
information on mutual funds on daily and weekly basis. Investors may approach their agents
and distributors to guide them in this regard.
An investor can appoint a nominee for his investment in units of a mutual fund. The
nomination can be made by individuals applying for / holding units on their own behalf
singly or jointly. Non-individuals including society, trust, body corporate, partnership firm,
Karta of Hindu Undivided Family, holder of Power of Attorney cannot nominate.
In case of winding up of a scheme, the mutual funds pay a sum based on prevailing NAV
after adjustment of expenses. Unit holders are entitled to receive a report on winding up from
the mutual funds which gives all necessary details.
Investors would find the name of contact person in the offer document of the mutual fund
scheme that they may approach in case of any query, complaints or grievances. Trustees of a
mutual fund monitor the activities of the mutual fund. The names of the directors of Asset
Management Company and trustees are also given in the offer documents. Investors should
approach the concerned Mutual Fund / Investor Service Centre of the Mutual Fund with their
complaints,
If the complaints remain unresolved, the investors may approach SEBI for facilitating
redressal of their complaints. On receipt of complaints, SEBI takes up the matter with the
concerned mutual fund and follows up with it regularly. Investors may send their complaints
to:
Securities and Exchange Board of India
Office of Investor Assistance and Education (OIAE)
Exchange Plaza, G Block, 4th Floor,
31

Bandra-Kurla Complex,
Bandra (E), Mumbai 400 051.
Phone: 26598510-13

The procedure for registering a mutual fund with SEBI is simple. An applicant proposing to
sponsor a mutual fund in India must submit an application in Form A along with a fee of
Rs.25, 000. The application is examined and once the sponsor satisfies certain conditions
such as being in the financial services business and possessing positive net worth for the last
five years, having net profit in three out of the last five years and possessing the general
reputation of fairness and integrity in all business transactions, it is required to complete the
remaining formalities for setting up a mutual fund. These include inter alia, executing the
trust deed and investment management agreement, setting up a trustee company/board of
trustees comprising two- thirds independent trustees, incorporating the asset management
company (AMC), contributing to at least 40% of the net worth of the AMC and appointing a
custodian. Upon satisfying these conditions, the registration certificate is issued subject to the
payment of registration fees of Rs.25.00 lakh. For details, see the SEBI (Mutual Funds)
Regulations, 1996.
Once you've decided to invest in the stock market, mutual funds are an easy way to own
stocks without worrying about choosing individual stocks. As an added bonus, you can find
plenty of information on the Internet to help you learn about, study, select, and purchase
them.
But what is a mutual fund? It's not complicated. A dictionary definition of a mutual fund
might go something like this: a single portfolio of stocks, bonds, and/or cash managed by an
investment company on behalf of many investors.
The investment company is responsible for the management of the fund, and it sells shares in
the fund to individual investors. When you invest in a mutual fund, you become a part owner
of a large investment portfolio, along with all the other shareholders of the fund. When you
purchase shares, the fund manager invests your funds, along with the money contributed by
the other shareholders.
32

Every day, the fund manager counts up the value of all the fund's holdings, figures out how
many shares have been purchased by shareholders, and then calculates the Net Asset Value
(NAV) of the mutual fund, the price of a single share of the fund on that day. If you want to
buy shares, you just send the manager your money, and they will issue new shares for you at
the most recent price. This routine is repeated every day on a never-ending basis, which is
why mutual funds are sometimes known as "open-end funds."
If the fund manager is doing a good job, the NAV of the fund will usually get bigger -- your
shares will be worth more.
But exactly how does a mutual fund's NAV increase? There are a couple of ways that a
mutual fund can make money in its portfolio. (They're the same ways that your own portfolio
of stocks, bonds, and cash can make money).

A mutual fund can receive dividends from the stocks that it owns. Dividends are
shares of corporate profits paid to the stockholders of public companies. The fund
might have money in the bank that earns interest, or it might receive interest payments
from bonds that it owns. These are all sources of income for the fund. Mutual funds
are required to hand out (or "distribute") this income to shareholders. Usually they do
this twice a year; in a move that's called an income distribution.

At the end of the year, a fund makes another kind of distribution, this time from the
profits they might make by selling stocks or bonds that have gone up in price. These
profits are known as capital gains, and the act of passing them out is called a capital
gains distribution.

Unfortunately, funds don't always make money. If the fund managers made some investments
that didn't work out, selling some investments for less than the original purchase price, the
fund manager may have some capital losses.
Everyone hates to have losses, and funds are no different. The good news is that these losses
are subtracted from the fund's capital gains before the money is distributed to shareholders. If
losses exceed gains, a fund manager can even pile up these losses and use them to offset
future gains in the portfolio. That means that the fund won't pass out capital gains to
shareholders until the fund had at least earned more in profits than it had lost. (Although you
might want to reconsider your decision to remain invested in a fund that's losing money if the
rest of the market is growing).
33

HOW MUTUAL FUNDS WORK

34

HISTORY OF THE INDIAN MUTUAL FUND INDUSTRY

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at
the initiative of the Government of India and Reserve Bank. The history of mutual funds in
India can be broadly divided into four distinct phases
First Phase 1964-87
Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by
the Reserve Bank of India and functioned under the Regulatory and administrative control of
the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the Industrial
Development Bank of India (IDBI) took over the regulatory and administrative control in
place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988
UTI had Rs.6, 700 crores of assets under management.

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

1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks
and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India
(GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987
followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89),
Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund
(Oct 92). LIC established its mutual fund in June 1989 while GIC had set up its mutual fund
in December 1990.
At the end of 1993, the mutual fund industry had assets under management of Rs.47, 004
crores.

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

With the entry of private sector funds in 1993, a new era started in the Indian mutual fund
35

industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year
in which the first Mutual Fund Regulations came into being, under which all mutual funds,
except UTI were to be registered and governed. The erstwhile Kothari Pioneer (now merged
with Franklin Templeton) was the first private sector mutual fund registered in July 1993.
The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and
revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI
(Mutual Fund) Regulations 1996.
The number of mutual fund houses went on increasing, with many foreign mutual funds
setting up funds in India and also the industry has witnessed several mergers and acquisitions.
As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805
crores. The Unit Trust of India with Rs.44, 541 crores of assets under management was way
ahead of other mutual funds.
Fourth Phase since February 2003
In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated
into two separate entities. One is the Specified Undertaking of the Unit Trust of India with
assets under management of Rs.29, 835 crores as at the end of January 2003, representing
broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified
Undertaking of Unit Trust of India, functioning under an administrator and under the rules
framed by Government of India and does not come under the purview of the Mutual Fund
Regulations.
The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is
registered with SEBI and functions under the Mutual Fund Regulations. With the bifurcation
of the erstwhile UTI which had in March 2000 more than Rs.76, 000 crores of assets under
management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual
Fund Regulations, and with recent mergers taking place among different private sector funds,
the mutual fund industry has entered its current phase of consolidation and growth.
The graph indicates the growth of assets over the years.
GROWTH IN ASSETS UNDER MANAGEMENT

36

Note:
Erstwhile UTI was bifurcated into UTI Mutual Fund and the Specified Undertaking of the
Unit Trust of India effective from February 2003. The Assets under management of the
Specified Undertaking of the Unit Trust of India has therefore been excluded from the total
assets of the industry as a whole from February 2003 onwards.

37

TYPES OF MUTUAL FUNDS

Equity Mutual Funds:

Most mutual funds invest in stocks, and these are called equity funds. While mutual funds
most often invest in the stock market, fund managers don't just buy any old stock they find
attractive. Some funds specialize in investing in large-cap stocks, others in small-cap stocks,
and still others invest in what's left -- mid-cap stocks.
On Dalal Street, cap is shorthand for capitalization, and is one way of measuring the size of a
company -- how well it's capitalized. Large-cap stocks have market caps of billions of dollars,
and are the best-known companies in the country. Small-cap stocks are worth several hundred
million dollars, and are newer, up-and-coming firms. Mid-caps are somewhere in between.
Mutual funds are often categorized by the market capitalization of the stocks that they hold in
their portfolios.
Equity fund managers usually employ one of three particular styles of stock picking when
they make investment decisions for their portfolios. Some fund managers use a value
approach to stocks, searching for stocks that are undervalued when compared to other, similar
companies. Often, the share prices of these stocks have been beaten down by the market as
investors have become pessimistic about the potential of these companies.
Another approach to picking is to look primarily at growth, trying to find stocks that are
growing faster than their competitors, or the market as a whole. These funds buy shares in
companies that are growing rapidly -- often well known, established corporations.
Some managers buy both kinds of stocks, building a portfolio of both growth and value
stocks. This is known as the blend approach.
Before I go deep into classification of funds depending upon market capitalization, let us
converse more about this term.

38

What is "market capitalization"?

When you are talking about mid-cap, small-cap and large-cap stocks, you are talking
about market capitalization.
Market cap or market capitalization is simply the worth of a company in terms of its shares!
To put it in a simple way, if you were to buy all the shares of a particular company, what is
the amount you would have to pay? That amount is called the market capitalization!
To calculate the market cap of a particular company, simply multiply the current share price
by the number of shares issued by the company! Just to give you an idea, ONGC, has a
market cap of Rs.170, 705.21 Cr.
Depending on the value of the market cap, the company will either be a mid-cap or largecap or small-cap company! Now the question is, how do YOU calculate the market cap of
a particular company? You dont! Just go to a website like MoneyControl.com and look up
the company whose market cap you are interested in finding out! The figure in front of Mkt.
Cap will be the market cap value.

Large and Small Cap Funds:

STOCK FUNDS are often grouped by the size of the companies they invest in -- big, small or
tiny. By size we mean a company's value on the stock market: the number of shares it has
outstanding multiplied by the share price. This is known as market capitalization, or cap size.
Big companies tend to be less risky than small fries. But smaller companies can often offer
more growth potential. The best idea is probably to have a mix of funds that give you
exposure to large-cap, midsize and small companies. For more detail on how these different
types of stocks behave, take a look at our Stocks department.
Large-Cap Funds

Large-capitalization funds generally invest in major blue chip companies like Reliance
Industries Ltd which have a market capitalization of greater than ten lac rupees. Large-cap
39

funds are less volatile than funds that invest in smaller companies. Usually, that means you
can expect smaller returns, but lately, large caps have outperformed all others. The last few
years of the 1990s dished up an odd combination of economic stability in the U.S., but
turmoil in Asia, Latin America and Russia. The recent turmoil in the market due to oil price
rise has made the Indian stock market extremely volatile and convinced many investors to run
for the relative stability of large, established companies like Reliance and Tata.
That may not always be the case, but for most investors, a large-cap fund is their core longterm holding, anyway. A good one is a reliable -- but far from stodgy -- place to park your
retirement savings.

Mid-Cap Funds

As the name implies, these funds fall in the middle. They aim to invest in companies with
market values in the $1 billion to $8 billion range -- not large caps, but not quite small caps,
either. The stocks in the lower end of their range are likely to exhibit the growth
characteristics of smaller companies and therefore add some volatility to these funds. They
make the most sense as a way to diversify your holdings.

Small-Cap Funds

A small-cap fund, like HSBC Small Cap Fund, will focus on companies with a market value
below $1 billion. The volatility of the fund often depends on the aggressiveness of the
manager. Aggressive small-cap managers will buy hot growth and technology companies,
taking high risks in hopes of high rewards. More conservative "value" managers will look for
companies that have been beaten down temporarily by the stock market. Value funds aren't as
risky as the hot growth funds, but they can still be volatile.
Because of their volatility, small-cap funds require that you have enough time to make up for
short-term losses. And as we saw during 1997 and 1998, there are times when the market
turns away from small-cap companies altogether for extended periods. (Large caps have

40

taken the spotlight lately due to extreme volatility in the markets; small caps, meanwhile,
have floundered.)
But that's no reason to abandon these funds. History would indicate that small companies will
eventually regain favour as markets settle down. And when they do, they will likely grow
more quickly than their larger cousins -- which can provide a good kicker for aggressive
investors who need to build as much wealth as possible while they're young.

Micro-Cap Funds

We're talking small fries here -- companies with market values below $250 million. These
funds tend to look for start-ups, takeover candidates or companies about to exploit new
markets. With stocks this small, the volatility (read risk) is always extremely high. A good
example of the micro cap fund is the DSP ML micro cap fund. If you have the time and
inclination to pay attention to a fund like this, you might be willing to put some money in.
But beware: Micro-cap funds can rear up and bite you.

Growth and Value Funds:

Every manager is different, but there are three broad archetypes when it comes to investment
strategy: growth, value and blend. The issue here is whether the manager (a) is willing to
chase popular (a.k.a. expensive) stocks, hoping to cash in on their momentum; or (b) is
seeking to "discover" cheap stocks, betting that the market will discover them, too.

Growth Funds

As their name implies, these funds tend to look for the fastest-growing companies on the
market. Growth managers are willing to take more risk and pay a premium for their stocks in
an effort to build a portfolio of companies with above-average earnings momentum or price
appreciation.

41

For example, Reliance, ONGC and SBI are generally considered "expensive" stocks, because
their prices have been bid high relative to their profits. But because they enjoy vibrant
markets and have rapid earnings growth, managers have no qualms paying big prices. They
know that investors crave these super-charged growth stocks and will keep piling into them
as long as the growth keeps up. But if the growth slows, watch out -- the more momentum a
stock has, the harder it is likely to fall when the news turns bad.
That's why growth funds are the most volatile of the three investment styles. It's also why
expenses and turnover (which leads to tax liability) are also higher. For these reasons, only
aggressive investors, or those with enough time to make up for short-term market losses,
should buy these spooky funds.

Value Funds

These funds like to invest in companies that the market has overlooked. Managers search for
stocks that have become "undervalued" -- or priced low relative to their earnings potential.
Sometimes a stock has run into a short-term problem that will eventually be fixed and
forgotten. Or maybe the company is too small or obscure to attract much notice. In any event,
the manager makes a judgment that there's more potential there than the market has
recognized. His bet is that the price will rise as others come around to the same conclusion.
A good example of this type of fund is the UTI Master Value Fund which invests in
companies like KSB Pumps and Kalyani Steels. The big risk with value funds is that the
"undiscovered gems" they try to spot sometimes remain undiscovered. That can depress
results for extended periods of time. Volatility, however, is quite low, and if you choose a
good fund, the risk of doggy returns should be minimal. Also, because these fund managers
tend to buy stocks and hold them until they turn around, expenses and turnover are low. Add
it up, and value funds are most suitable for more conservative, tax-averse investors.
Foreign Stock Funds:
Since the economies of the world's different regions tend to boom and bust in cycles that
offset each other, international stocks can provide excellent diversification for a portfolio
42

heavy on Indian equities. And a fund with a good manager is often the best way to go,
because research is scarce and foreign companies are notoriously hard for individual
investors to track on their own.
Foreign-stock funds allow you exposure to overseas markets at varying levels of risk. Some
are fairly tame. Others can make your hair stand on end. An example of this type is Morgan
Stanley Mutual fund. When the Indian mutual fund sector was opened up for foreign
investment in 1993, Morgan Stanley became the first international fund manager to enter
India with a domestic mutual fund. One of the largest investment banks and fund managers in
the world, Morgan Stanley operates in 28 countries and has $576 billion in assets under
management globally.
Morgan Stanley boasts of a rich expertise of investing in Indian markets. The firm has been
managing offshore India specific funds from 1989. The India Magnum Fund (traded on the
Dublin Stock Exchange) and the India Investment Fund (traded on the New York Stock
Exchange) are the major offshore India funds managed by MSIM.
Morgan Stanley Investment Management India Private Limited is the AMC for the fund. The
fund management is headed by Sridhar Sivaram, a director on the board of the AMC. As of
Aug 2006, the fund has assets of over Rs.2, 688 crore under management. Even when foreign
economies are doing reasonably well, currency fluctuations can have a negative effect on
stock prices.
Of course, economic and currency risk can also swing very strongly in a positive direction.
So, as always, diversification is the key to managing risk. Funds investing overseas fall into
four basic categories: global, international, emerging market and country specific. The wider
the reach of the fund, the less risky it is likely to be.

Global Funds

Global funds are the most diverse of the four categories. But don't be fooled by their
cosmopolitan-sounding name. They're able to invest in any region of the world, including the
U.S., so they don't actually offer as much diversification as a good international fund. A
43

prime example: Idex Global, which is 26% invested in the U.S., 11% in Britain, 8% in
France, 6% in Japan and 6% in Germany. Global funds tend to be the safest foreign-stock
investments, but that's because they typically lean on better-known U.S. stocks. Tata IndoGlobal Infrastructure Fund objective is to generate long term capital appreciation by investing
predominantly in equity and equity related instruments of companies engaged in
infrastructure and infrastructure related sectors and which are incorporated to have their area
of primary activity, in India and other parts of the World.

International Funds

These funds invest most of their assets outside the U.S. Depending on the countries selected
for investment; international funds can range from relatively safe to more risky. An example
is Franklin India International Fund scheme is designed to give you access to a portfolio of
US Government Securities. The scheme invests in units of Franklin US Government Fund, an
international mutual fund scheme from Franklin Templeton, investing predominantly in
securities issued or backed by the US Government. The best thing to do is to choose a fund
with the best balance, or make damn sure the manager has done a good job of moving in and
out of regions profitably.

Country-Specific Funds

These funds invest in one country or region of the world. That kind of concentration makes
them particularly volatile. If you pick the right country -- Britain in 1998, for example -- the
returns can be substantial. But pick the wrong one, and watch out. Only the most
sophisticated investors should venture into this territory. The above example can fit into this
type as well.

44

Bond Funds Explained:

Bond funds are designed to give your portfolio its recommended dose of fixed-income
investments so you don't have to go through the hassle of buying bonds yourself. These, too,
come in various types.
Municipal Bond Funds

Muni-bond funds invest in bonds issued by state municipalities. According to the financial
press, municipalities may soon foray into the local debt market to raise money. The
possibility has arisen on account of rating agencies like Fitch and Crisil opining that some of
the municipalities have strong credit worthiness and hence a decent appetite for mobilising
funds. Their opinion comes in the wake of a Central government initiative under the
Jawaharlal Nehru National Urban Renewal Mission (JNNURM). The government asked the
agencies last year to rate the credit worthiness of the bonds issued by municipalities to
mobilise resources. Obviously, market participants do not expect the municipalities to hit the
market soon, given its current plight. After all, bond issues by municipalities, which are
already rated, have been few and far between. Demand for such bonds is likely to be
relatively low since only a part of the said bonds is tax-free.
Fitch Ratings is due to announce any time now its ratings in respect of 13 of the 21
municipalities it has been entrusted with and the list includes Delhi and Mumbai. The urban
development ministrys nod is holding up the announcement. According to the rating
agencys boss, many cities have sound risk profiles and a good propensity to raise debt.
Between 15 and 20 cities can go to the market and issue bonds right now. The important
factors considered by the agency are the economic profile of the city, its ability to raise taxes,
their extant indebtedness and fixed obligations and their internal management capabilities.
Presently, their indebtedness and fixed obligations are fortunately low, giving them a better
credit appetite. On the other hand, Crisil Ratings has rated all the 16 municipalities it was
asked to rate under JNNURM. The creditworthiness varies across cities some have done very
well in some areas but a few have been very laggard.

45

Since issue of municipal bonds has been in vogue in US for quite some time, it is worth
taking a peek into the US bond market in general and the municipal bond market in
particular. The US bond market can be classified under two major heads, viz, the taxable
bond market and the tax-exempt bond market. Bonds issued by the US government, US
government agencies and sponsored enterprises and corporations are included under the first
head. In the tax-exempt bond market, interest from the bonds issued and sold is exempt from
federal income taxation. However, at the state and local levels, tax may or may not be applied
to interest. For example, interest on US Treasury securities does not attract state and local
taxes although it attracts federal income tax. Hence to classify a bond as tax-exempt, tax
treatment at the federal income tax level is considered.
As of January 2004, the size of the US tax-exempt bond market was USD 1.8 trillion,
according to the Federal Reserve Board. The municipal bond market accounted for 11 per
cent of the domestic bond market, which made the municipal debt the fourth largest sector.
US Treasuries and agencies accounted for 38 per cent of the domestic bond market. The
Mortgage-Backed Securities (MBS) sector came next followed by US corporate debt. The
municipal sector therefore was not an insignificant player in the domestic bond market
although markedly different from the 89 per cent of the bond market that was taxable. The
majority of tax-exempt securities are issued by state and local self-governments and the
entities they create. As a result, municipal bonds and tax-exempt bonds often refer to the
same instrument. Most of the municipal bonds are tax-exempt though.
The major motivations for investing in municipal bonds being the tax carrot, the primary
owners of municipal bonds are individuals. Other investors are mutual funds, commercial
banks and insurance companies. Many a time, the municipal bond market has generated a
higher yield, prompting thereby even such institutional investors as pension funds who do not
need the tax carrot to participate in the said market.
But what could be of greater relevance to India is that in the US, investing in municipal bonds
was considered second in safety only to that of US Treasury securities; but concerns about the
credit risks of municipal bonds started growing, in spite of the bonds being given investment
grade credit ratings by the rating companies. The reasons are not far to seek. Several major
municipal issuers landed in financial crisis.

46

Tax Saving Schemes

These schemes offer tax rebates to the investors under specific provisions of the Income Tax
Act, 1961 as the Government offers tax incentives for investment in specified avenues. e.g.
Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also
offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities.
Their growth opportunities and risks associated are like any equity-oriented scheme.
INVESTMENT STRATEGIES:
1. Systematic Investment Plan: under this a fixed sum is invested each month on a fixed
date of a month. Payment is made through post dated cheques or direct debit facilities. The
investor gets fewer units when the NAV is high and more units when the NAV is low. This is
called as the benefit of Rupee Cost Averaging (RCA)
2. Systematic Transfer Plan: under this an investor invest in debt oriented fund and give
instructions to transfer a fixed sum, at a fixed interval, to an equity scheme of the same
mutual fund.

3. Systematic Withdrawal Plan: if someone wishes to withdraw from a mutual fund then he
can withdraw a fixed amount each month.

To make an investment in the Mutual Funds, a few measures are there which are mandatory
to be observed according to the guidelines laid down by SEBI.
The investor must submit the photocopy of his PAN card. In case of non-photo PAN card in
addition to copy of PAN card any one of the following: driving license/passport copy/ voter
id/ bank photo pass book should be submitted as a proof of identification.
In case of an investment amounting to a sum greater than 50, 000 INR, the investor is
required to submit the KYC form or the Know Your Customer form.

47

Offer document: an offer document is issued when the AMCs make New Fund Offer (NFO).
Its advisable to every investor to ask for the offer document and read it before investing. An
offer document consists of the following:
Standard Offer Document for Mutual Funds (SEBI Format)
Summary Information
Glossary of Defined Terms
Risk Disclosures
Legal and Regulatory Compliance
Expenses
Condensed Financial Information of Schemes
Constitution of the Mutual Fund
Investment Objectives and Policies
Management of the Fund
Offer Related Information.
Key Information Memorandum: a key information memorandum, popularly known as
KIM, is attached along with the mutual fund form. And thus every investor gets to read it. Its
contents are:
1. Name of the fund.
2. Investment objective
3. Asset allocation pattern of the scheme.
4. Risk profile of the scheme
5. Plans & options
6. Minimum application amount/ no. of units
7. Benchmark index
8. Dividend policy
9. Name of the fund manager(s)
10. Expenses of the scheme: load structure, recurring expenses
11. Performance of the scheme (scheme return v/s. benchmark return)
12. year- wise return for the last 5 financial years.

48

FUND STRATEGIES

How to Build a Mutual Fund:

Stick with stock funds. As long as you have five or more years until you need the money,
stock funds will likely provide you with superior returns over any other investment. But you
have to be patient. In the short term, the market is very volatile, so don't fret when the market
drops 10 percent in a week, or your account seems to be worth a lot less than it was last
month. Over five, ten, or 20 years, you'll come out much further ahead by sticking with stock
funds.
Think big. When you invest in the big companies, companies like Reliance, TATA or ONGC,
you don't have to worry much about whether they will be going out of business any time
soon. What's more, these industry leaders have generated outsized returns for their
shareholders over the past decades. Bigger isnt an always better, of course, but large-cap
stock like these, providing plenty of solid returns (over the long-term, of course). Invest in
these stocks by buying a large cap stock fund.
Think international. The world is a big place and getting smaller as we build telephone lines
and Internet connections and satellites that send signals all around the world. Still, somehow,
the stock markets in other countries always tend to go down when the U.S. market is up, and
vice versa. You can take advantage of this trend by including some global stocks in your
portfolio along with big American stocks. You can do this by buying a fund specializing in
large international stocks. Morgan Stanley funds are good picks for international funds.
Think small, too. Every big company once started out as a small company. If you can buy
good companies when they're small, you'll benefit as they get to be big and successful
companies. Trouble is, lots of small companies just get smaller and eventually go out of
business. So small company stocks tend to be a little riskier than big stocks. But here's the
good part -- another funny thing about small stocks is that they tend to do well when big
stocks are doing lousy, and vice versa. So if you own big and little companies in your
portfolio, over the long-term, things will more than balance out in your favour. Do this by
buying a small cap stock fund.

49

Put it all together. Large cap stock fund plus Small cap stock fund plus large cap
international fund. Divide your portfolio into three and put a third in each. Now you've got a
diversified portfolio in which at least one sector will be doing okay (or better than okay)
nearly all of the time.
Consider index funds. The Standard & Poor's 500 is one of the best known stock market
indexes, made up of 500 big American companies from all industries. An S&P 500 index
fund simply invests in the 500 stocks in that fund -- the fund's advisors don't try to pick
stocks that will beat the market. In India, the various index funds invest in companies listed
on indices like NSE and BSE. Index funds always match the performance of the market (or of
the sector that the index tracks), so you don't ever have to worry about your index fund
dogging the market. As a bonus, these funds have low expenses (the fees that the fund's
managers take off the top) and that increases your returns.
Avoid overlap. Sometimes people think that if one large cap fund is good, two or three are
better. When you buy several funds of one type, more likely than not you'll just end up
owning roughly the same set of stocks. Not only will you probably not increase your overall
returns, you'll create more work for yourself by having to track additional funds. Choose one
good fund of each type in your portfolio and, as long as they continue to perform well, stick
with them.
Consider asset allocation funds. Don't want to be bothered with choosing one fund of each
type? Asset allocation funds are "funds of funds," or mutual funds those themselves own
several funds of different types. Bear in mind that you'll pay for t his convenience, however.
These funds generally carry higher expenses and, more often than not, load.
Avoid bond funds. If you have five years until you will withdraw your investment (like for
retirement), then bonds might be appropriate for perhaps 10 to 20 percent of your portfolio,
and increasing to perhaps 40 percent (at most) when you are at retirement age. The problem
that most people have is that they think bonds are "safe" -- but bond returns are still volatile,
and will give you a lower rate of return than stocks over time.
The corrosive effect of fees and taxes is the single biggest disadvantage of investing in
mutual funds.
Our view is that the entire fund industry suffers from a serious cost-control problem that
contributes to the subpar returns posted by too many funds. If you aren't careful, management
50

expenses and capital gains taxes can shave hundreds -- if not thousands -- of dollars from
your returns over the years.
The good news is that it's still possible to find excellent funds with relatively low costs. You
just have to know what to look for. This section discusses the various charges you'll face
when shopping for mutual funds, with guidelines as to acceptable fee levels. We'll also
explain what to look out for in terms of taxes (though this is covered in more depth in our
Taxes and investing course).
One point we would make from the top, however, is that index funds are by nature the
lowest-cost funds because of their lack of active management. As you'll see, they're also the
most tax efficient. If your goal is to get into the market as cheaply and simply as possible,
index funds are probably the ways to go.
Mutual fund people talk a lot about load funds and no-load funds. A "load" is simply a sales
charge tacked onto the price of a mutual fund to compensate the broker or financial adviser
who sells it to you. Loads work in two ways. You pay them either upon buying your shares or
selling them, depending on the fund.
A "front-end load" is charged when you buy your shares. It typically ranges between 2% and
6% of your initial investment, and some funds charge you again for reinvesting your
dividends in new shares of the fund. A "back-end load" is a fee the fund charges when you
sell -- or redeem -- your shares. These deferred fees are essentially a tactic to keep you
invested in the fund for the long term. A typical scenario would work this way: In the first
year of ownership, you'd pay a charge in the range of 4% to 5.75% if you sold out of the
fund. After that, the percentage declines each year until it disappears altogether after about six
years.
The obvious problem with a load is that it immediately trims your investment return. That
might be acceptable if you believe the fund will post such superior returns that the load will
pay for itself over time. But since there are plenty of quality no-load funds out there, why pay
a fee you don't have to? According to the rules of SEBI, the total of entry and exit load cannot
exceed 7%.

51

Taxes
Mutual Funds by their very nature are not tax saving instruments but investment products that
may offer tax concessions. But the question is whether these should be looked at as tax saving
instruments?

EQUITY LINKED SAVINGS SCHEMES

Equity Linked Savings Schemes (ELSS) Are Strong Favourites
ELSS schemes give twice the benefit as compared with diversified equity schemes. They give
you tax sops on investments and are also exempt from long term capital gains tax.
These are special equity funds, which have to invest at least 80% of their corpus in equity,
and investments are locked in for a period of 3 years. Investments can get you benefits under
Section 80 C i.e. investments of up to Rs 1 lakh in such schemes can be reduced from your
gross income.
Hemant Rustagi, CEO, Wise invest Advisors believes that ELSS is the best example of an
investment option that provides you a very simple way of investing in stock market and save
taxes while doing so. Being equity oriented schemes, ELSS has the potential to provide
better returns than most of the options under section 80C. Also, as per the current tax laws, an
ELSS investor is not only entitled to earn tax free dividend but also the long term capital
gains are not taxable, he adds.
Absolute Returns
ELSS

3 Year

5 Year

Assets (Rs in cr)

Magnum Tax Gain Scheme

836.6%

603.1%

464.02

HDFC Long Term Advantage

530.0%

805.9%

348.39

HDFC Tax Saver

562.7%

692.9%

323.28

Pru ICICI Tax Plan

602.9%

671.2%

280.96

Franklin India Tax Shield

390.9%

424.4%

236.51

52

But should an investor go the whole nine yards and put in the entire permissible amount of 1
lakh in ELSS? Probably not!

Ranjeet Mudholkar, Head - Certified Financial Planners Board, cautions that Sec 80 C covers
your principal on housing loan, PF, pension plan, life premiums, so only what is left after that
can give you a benefit if invested in ELSS.
All Smiles from Equity Funds
Apart from ELSS schemes, diversified equity schemes are a good investment
considering that capital gains in equity funds below one year are taxed at a rate
of 10% and over a year are tax-free. This option can be best exercised using a Growth
Plan offered by mutual funds. The primary objective of a Growth Plan is to provide investors
long-term growth of capital.
Dividend paid in Dividend Plans is tax free, and no distribution tax is deducted. However,
every time we buy or sell equity shares a Securities Transaction Tax, STT, of 0.25% is paid
and further when you redeem your investment, again STT is deducted from your redemption
price.
So what strategy will help to reduce the burden of STT to the minimum possible extent?
Investment expert Krishnamurthy Vijayan advises to choose the dividend option, while it
remains tax-free. Though both decisions are by and large tax-neutral, your STT will go
down if your profits have already been taken out by you in the form of dividend, he adds.
Absolute Returns
Equity Diversified Scheme

3 Year

5 Year

Assets (Rs in cr)

HDFC Equity Fund

453.50%

645.50%

2,657.90

Reliance Growth Fund

664.50%

1010.60%

2,496.41

Franklin India Prima Fund

578.10%

933.60%

2,418.55

Franklin India Blue-chip

384.30%

428.70%

2,107.56

Reliance Vision Fund

461.80%

931.40%

1,694.92

Debt Funds Can Benefit From Indexation

53

Debt funds have lost their sheen thanks to falling interest rates and paling tax sops when
compared with equity schemes.
Any fund wherein the average holding in equity is 65% (as per Budget 2006) or below is
treated as a debt fund. If you invest for less than 1 year in the growth option of a debt fund,
you will have to pay Capital Gains Tax on your "profits" at the rate at which you pay income
tax on your income. But, if you stay invested for over a year, you can either pay 10% tax on
the profits or pay 20% after reducing the rate of inflation (indexation benefit). So if you are
invested for three or four years, your tax may become much, much lower than 10%.
Nevertheless for the risk averse, there are ways to reduce the tax burden on returns.
Investors can also benefit from double indexation benefit (when you invest late in one
financial year say on March 28, 2005, and redeem early in the next financial year say on
April 2, 2006, you use the index of both Financial Year ending March 2006 and March 2007
to get this benefit for as little as 366 days) provided the two financial years' index adds up to
more than 10%. (Also read - How to ride the rising interest rate tide?)
In the dividend option, dividend is tax free in your hands. But the dividend distribution tax
deducted at source also comes out of your NAV. So you end up paying a tax of 10%. Further
any increase in NAV over and above the dividend distributed, is taxed as in the case of the
growth option.
Vijayan advises most debt fund investors who have a reasonable horizon to invest for at least
one year or more, in any case and choose the growth option, since by and large this would
prove most tax efficient for retail investors in the lower tax brackets.
The Indian Income Tax department is governed by the Central Board for Direct Taxes
(CBDT) and is part of the Department of Revenue under the Ministry of Finance.
The government of India imposes an income tax on taxable income of individuals, Hindu
Undivided Families (HUFs), companies, firms, co-operative societies and trusts (Identified as
body of Individuals and Association of Persons) and any other artificial person. Levy of tax is
separate on each of the persons. The levy is governed by the Indian Income Tax Act, 1961.
THE ASPECTS OF INCOME TAX
54

Income-tax authorities

There shall be the following classes of income-tax authorities for the purposes of the Act 116,
namely:(a)

the Central Board of Direct Taxes constituted under the

Central Boards of Revenue Act, 1963 (54 of 1963),

(b)

Directors-General of Income-tax or Chief Commissioners of

Income-tax,

(c)

Directors of Income-tax or Commissioners of Income-tax or

Commissioners of Income-tax (Appeals),

(cc) Additional Directors of Income-tax or Additional

Commissioners of Income-tax or Additional Commissioners
of Income-tax (Appeals),
(cca) Joint Directors of Income-tax or Joint Commissioners of
Income-tax.
(d) Deputy Directors of Income-tax or Deputy Commissioners of
Income-tax or Deputy Commissioners of Income-tax
(Appeals),
(e)

Assistant Directors of Income-tax or Assistant Commissioners

of Income-tax,

(f)

Income-tax Officers,

(g) Tax Recovery Officers,

(h)

Inspectors of Income-tax.

Powers of the authorities

For all purposes of the Income-tax Act, the IT authorities are vested with the various powers
55

which are vested in a Court of Law under the Code of Civil Procedure while trying a suit in
respect of any case. More particularly, the provisions of the Code of Civil procedure and the
powers granted to the tax authorities under the code would be in respect of:
1. Discovery and inspection
2. enforcing the attendance, including any officer of a bank and examining him on oath
3. compelling the production of books of account and the documents
4. collection certain information [section 133B-inserted by the finance act, 1986]
5. Issuing commissions and summons
It shall be duty of every person who has been allotted permanent account number to quote
such number in all his returns or correspondence with income tax authorities, in all challans
for the payment of any sum, in all documents prescribed by the board in the interest of
revenue

SECTION 80C

56

Life insurance premia, contribution to provident fund, etc.

Notification under section 80C(2)(v) - Deduction in respect of contributions to provident fund
- In exercise of the powers conferred by clause (v) of sub-section (2) of section 80C of the
Income-tax Act, 1961 (43 of 1961), the Central Government hereby specifies the Public
Provident Fund, established under the Public Provident Fund Scheme, 1968, for the purposes
of the said clause for the assessment year 2006-07 and subsequent assessment years Notification No. S.O. 1559(E), dated 3-11-2005.

Notification under section 80C(2)(ix) - Deduction in respect of Savings Certificate - In

exercise of the powers conferred by clause (ix) of sub-section (2) of section 80C of the
Income-tax Act, 1961 (43 of 1961), the Central Government hereby specifies the National
Savings Certificates (VIII Issue) issued under the Government Savings Certificates Act, 1959
(46 of 1959) as savings certificates for the purposes of the said clause for the assessment year
2006-07 and subsequent assessment years - Notification No. S.O. 1560(E), dated 3-11-2005.

Notification under section 80C(2)(xi) - Deduction in respect of unit linked insurance plan of
the LIC Mutual Fund - In exercise of the powers conferred by clause (xi) of sub-section (2) of
section 80C of the Income-tax Act, 1961 (43 of 1961), the Central Government hereby
specifies the Unit Linked Insurance Plan (formerly known as Dhanraksha 1989) of the Life
Insurance Corporation Mutual Fund for the purposes of the said clause for the assessment
year 2006-07 and subsequent assessment years - Notification No. S.O. 1561(E), dated 3-112005.

Notification under section 80C(2)(xii) - Deduction in respect of annuity plan of the LIC - In
exercise of the powers conferred by clause (xii) of sub-section (2) of section 80C of the
Income-tax Act, 1961 (43 of 1961), the Central Government hereby specifies the New Jeevan
Dhara, New Jeevan Dhara-I and New Jeevan Akshay, New Jeevan Akshay-I and New Jeevan
Akshay-II Plans of the Life Insurance Corporation of India, as filed by that Corporation with
the Insurance Regulatory and Development Authority, as the annuity plan of the Life
Insurance Corporation of India for the purposes of the said clause for the assessment year
2006-07 and subsequent assessment years - Notification No. S.O. 1562(E), dated 3-11-2005.

57

In exercise of the powers conferred by clause (xii) of sub-section (2) of section 80C of the
Income-tax Act, 1961 (43 of 1961), the Central Government hereby specifies the Jeevan
Akshay-III Plan of the Life Insurance Corporation of India, as filed by that Corporation with
the Insurance Regulatory and Development Authority, as the annuity plan of the Life
Insurance Corporation of India for the purposes of the said clause for the assessment year
2006-07 and subsequent assessment years - Notification : No. SO 847(E), dated 1-6-2006.
Notified Scheme under section 80C (2) (xiii) - Equity Linked Savings Scheme, 2005 Notification No. SO 1563(E), dated 3-11-2005.

Clarification on Equity Linked Savings Scheme - Investments in Equity Linked Savings

Scheme, 1992 (ELSS), as amended in 1998, are eligible for tax rebate under section 88 of the
Income-tax Act, 1961, if such investments are made on or before 31-3-2005.
Section 88 has been replaced by section 80C vide Finance Act, 2005. Accordingly, the Equity
Linked Savings Scheme, 2005 has been notified vide S.O. No. 1563(E) dated 3-11-2005 and
subsequently amended vide notification No. 259/2005 dated 13th December, 2005.
In view of this, it is clarified that tax benefit under section 80C of the Income-tax Act will be
available to the investments made on or after 1-4-2005 in the units of a mutual fund or the
Unit Trust if such units are issued under any plan formulated in accordance with the three
schemes viz., ELSS, 1992; ELSS, 1992 as modified in 1998 and ELSS, 2005 - Press release,
dated 13-12-2005.
Notification under section 80C(2)(xiv) - Deduction in respect of subscription to Pension
Fund set up by any Mutual Fund - In exercise of the powers conferred by clause (xiv) of subsection (2) of section 80C of the Income-tax Act, 1961 (43 of 1961), the Central Government
hereby specifies the UTI Retirement Benefit Pension Fund set up by the specified company
referred to in clause (h) of section 2 of the Unit Trust of India (Transfer of Undertaking and
Repeal) Act, 2002 (58 of 2002) as a pension fund for the purposes of the said clause for the
assessment year 2006-07 and subsequent assessment years - Notification No. S.O. 1564(E),
dated 3-11-2005.

Notified housing public sector company under section 80C (2) (a) (xvi) - In exercise of the
powers conferred by sub-clause (a) of clause (xvi) of sub-section (2) of section 80C of the
Income-tax Act the Central Government hereby specifies the Public Deposit Scheme of
58

Housing and Urban Development Corporation Ltd. (HUDCO Bhavan, India Habitat Centre,
Lodi Road, New Delhi) for an amount of rupees one thousand crore for the purposes of the
said sub-clause.
2. The notification shall come into effect on the date of its publication in the Official Gazette
Notification: No. 2/2007 [F. No. 149/299/2005-TPL], dated 11-1-2007.
Scheme notified under section 80C (2) (xxi) - Bank Term Deposit Scheme, 2006SO
1220(E), dated 28-7-2006.

TAX EFFICIENT INVESTMENT

History of ELSS
In 2005, the long awaited Equity Linked Savings Scheme finally arrived. The one single
point focused objective of this scheme is to specifically provide deduction to the tax payers in
terms of section 80C of the Income-tax Act, 1961. It may be recalled here that the Finance
Act, 2005 has introduced a new section 80C to the Income-tax Act which would now provide
a deduction to the extent of Rs.1,00,000/- while computing the total taxable income of the
individual as also Hindu Undivided Family. Gone were the old days of granting tax rebate as
per the old provisions of section 88. The new provisions granting tax deduction under section
80C were investor friendly and the benefit of this deduction is available to assessees of all
income groups till date.
Investment in Equity Linked Savings Scheme more popularly known as "ELSS" is one of the
important option which is made available to the tax payer to enjoy the tax benefit of new
section 80C. Although, there are various investment options available to the tax payer but
because of certain special features of the ELSS investment option a large number of tax
payers are opting for investment of the entire sum of Rs.1 lakh in the Equity Linked
Savings Scheme plans which are made available by different Mutual Funds in the country.

The latest notification

59

From the point of view of saving Income-tax on ELSS investment the latest introduced
Equity Linked Savings Scheme, 2005 has nothing new to offer to the investor. The taxes
saving provisions of ELSS are already contained in section 80C of the Income-tax Act, 1961.
The lock in provision of three year period remains unchanged. Similarly, the total quantum
of investment eligible for tax deduction on ELSS investment together with other investments
continues to be Rs.1.00 lakh. Likewise, the minimum amount of investment in the Equity
Linked Savings Plan of the Unit Trust or of a Mutual Fund shall be in multiples of Rs.500/-.
Thus, the new Equity Linked Savings Scheme, 2005 provides for detailed guidelines to a
Mutual fund particularly with reference to repurchase, transfer, investment pattern of the
funds raised under Equity Linked Savings Scheme, the formula for arriving at the repurchase
price and finally it also provides for the rules and regulations for termination of the plan.
The new Equity Linked Savings Scheme, 2005 has been framed by the Government keeping
in view the powers conferred by clause (xiii) of section 80C (2) of the Income-tax Act, 1961.
While dealing with the provisions concerning investment and repurchase the Scheme
provides that the Investment in the plan will have to be kept for a minimum period of three
years from the date of allotment of units. After the said period of three years, the assessee
shall have the option to tender the units to the Unit Trust or the Mutual Fund, for repurchase.
Presently the subscription to the units of Equity Linked Savings Scheme is open round the
year and thus provides flexibility to the investor to invest on any day. However, the
provisions contained in the new scheme provide that the ELSS plans shall be open for a
minimum period of one month during the financial year 2005-06 and a minimum period of
three months during the subsequent years. Although the investment in the Equity Linked
Savings Scheme is blocked for a minimum period of three years and thus the units issued
under the plan can be transferred, assigned or pledged only after three years of issue but in
the event of the death of the assessee, the nominee or legal heir, as the case may be, shall be
able to withdraw the investment only after the completion of one year from the date of
allotment of the units to the assessee or anytime thereafter.
The present day norms relating to investment of the Equity Linked Saving Funds have been
altered. These norms are to be followed by all Mutual Funds who are raising funds under
ELSS plan. It is good in the interest of the taxpaying public that the strict norms have been
laid out which would ultimately help the investor because no Mutual Fund bringing out ELSS

60

plan can afford to ignore these new investment norms. The following are the main norms for
investment of Equity Linked Savings Funds:(a)The funds collected under a plan shall be invested in equities, cumulative convertible
preference shares and fully convertible debentures and bonds of companies. Investment may
also be made in partly convertible issues of debentures and bonds including those issued on
rights basis subject to the condition that, as far as possible, the non-convertible portion of the
debentures so acquired or subscribed, shall be disinvested within a period of twelve months.
(b)It shall be ensured that funds of a plan shall remain invested to the extent of at least eighty
per cent. In securities specified in clause (a). The Unit Trust and Mutual Fund shall strive to
invest their funds in the manner stated above within a period of six months from the date of
closure of the plan in every year. In exceptional circumstances, this requirement may be
dispensed with by the Unit Trust or the Fund, in order that the interests of the assessee are
protected.
(c)Pending investment of funds of a plan in the required manner, the Unit Trust and Mutual
Fund may invest the funds in short-term money market instruments or other liquid
instruments or both. After three years of the date of allotment of the units, the Unit Trust or
Mutual Fund may hold up to twenty per cent of net assets of the plan in short-term money
market instruments and other liquid instruments to enable them to redeem investment of
those unit holders who would seek to tender the units for repurchase.
Presently the Mutual Funds having ELSS plan are announcing their NAV on daily basis. But
under the new scheme it is provided that the Unit Trust and other Mutual Funds shall
announce the repurchase price one year after the date of allotment of the units and thereafter
on a half-yearly basis.
The new Equity Linked Savings Scheme, 2005 provides that after a period of three years
from the date of allotment of units, when the repurchase of units is to commence, the Trust
and the Mutual Fund shall announce a repurchase price every month or as frequently as may
be decided by them. The scheme also gives clear cut guidelines for calculating the
repurchase price of units of Mutual Fund under ELSS plans. These repurchase rules are
investor friendly. The new rules or repurchase now provide that in calculating the repurchase
price, the Unit Trust and the Mutual Fund shall take into account the unrealised appreciation
61

in the value of the investment of the funds of a plan to the extent they deem fit provided that
it shall not be less than fifty per cent of such unrealised appreciation. While calculating the
repurchase price, the Unit Trust and Mutual Funds may deduct such sums as are appropriate
to meet management, selling and other expenses including realisation of assets and such sums
shall not exceed five per cent per annum of the average Net Asset Value of a plan. At the
time of repurchase of the units by the Mutual fund the same will be purchased by the Mutual
fund at the repurchase price prevailing on the date tendered for repurchase.
Under the new scheme of ELSS there is also a mention about the period of termination. It is
now provided that a plan operated by Unit Trust or a Mutual Fund would be terminated at the
close of the 10th year from the year in which the allotment of units is made under the plan. If
however, ninety per cent or more of the units under any plan are repurchased before
completion of ten years, the Unit Trust and Mutual Fund may at their discretion, terminate
that plan even before the stipulated period of ten years; and redeem the outstanding units at
the final repurchase price to be fixed by them.
Thus, as a result of introduction of the new Equity Linked Savings Scheme, 2005 many
unclear issues have been cleared and obligations are cast on the Mutual Funds to strictly
comply with the norms of investment, repurchase price determination and the termination of
the plan.

What ails ELSS

The new Equity Linked Savings Scheme, 2005 does not contain any reference to the tax
treatment in respect of investment made by the tax payer during the current financial year
2005-06 in the existing ELSS plans. Nearly six lakh tax payers had already invested in the
ongoing schemes of ELSS which were in operation prior to the enactment of the new scheme.
The question that requires to be addressed is whether the investors who had invested in the
existing plans of ELSS would enjoy tax benefit during the current financial year. This
important issue has now been answered by the Government on 11-11-2005 through a
clarification on Equity Linked Savings Scheme, 2005. The relevant extract of this
clarification which is very important and is self explanatory is reproduced below:62

"The Equity Linked Savings Scheme, 2005 has been notified vide S.O. No. 1563(E) dated
3.11.2005. In this context, the Central Board of Direct Taxes has clarified that the Equity
Linked Savings Schemes (ELSS) launched under ELSS 1992 vide Notification No. S.O.
928(E) dated 28th December, 1992, or the ELSS launched under the ELSS 1992 as amended
by the Equity Linked Savings (Amendment) Scheme 1998 vide Notification S.O. No.
1092(E) dated 22nd December, 1998 or the ELSS launched on or after 1st April, 2005 and
complying with the provisions of the Equity Linked Savings Scheme 1992 issued vide
Notification No. S.O. 928(E) dated 28th December, 1992 as amended vide Notification S.O.
No. 1092(E) dated 22nd December, 1998 shall also be eligible for availing tax benefits under
section 80C of the Income-tax Act, for the investments made on or after 1st day of April,
2005." Similar view has also been expressed by Government vide Press Release dated
13.12.2005.
Finally, from the point of tax planning and investment planning the taxpaying individuals and
HUFs should freely opt to invest in the Equity Linked Saving Schemes of various Mutual
Funds.
One should consider investing a part of your investible income in equity linked savings
scheme (ELSS) of mutual funds. ELSS is an efficient investment tool that offers the twinadvantage of healthy capital appreciation and reduced tax burden. In our work-a-day life, we
exert ourselves utmost to save every penny but are exasperated when taxes eat into our
savings.
In order to save on tax, we have the option to invest a maximum of Rs 1, 00,000 in various
tax saving instruments under Section 80C of the Income Tax Act.
The eligible investments for availing Section 80C benefits include contribution to Provident
Fund or Public Provident Fund (PPF), payment towards life insurance premium, investment
in pension plans/ specified government infrastructure bonds/ National Savings Certificates
(NSC)/ Equity Linked Savings schemes (ELSS) of mutual funds, payment towards principal
repayment of housing loan (also any registration fee /stamp duty paid), and payments towards
tuition fees for children to any school or college or university or similar institution (only for 2
children).

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If you do a cost-benefit analysis of ELSS, PPF and NSC, then you will find that ELSS offers
you manifold advantages/ benefits as compared to the other two tax savings instruments.
ELSS has a lock-in of only three years, whereas PPF and NSC have a longer lock-in period of
15 years and six years respectively. PPF and NSC fetch you a return at a compounded annual
growth rate (CAGR) of 8 per cent while the average returns over three years in ELSS, which
allows investors to participate in the India growth story by investing its money in shares, for
the top five schemes as on November 30, 2007 is in the region of 50 per cent.
It would not be out of place at this point to slip in a caveat emptor that in the case of mutual
fund investments past performance may not be sustained in future as equity markets are
affected by events, global as well as domestic.
The maximum investment an individual can make in PPF under Section 80C is Rs 70,000,
whereas it is Rs1, 00,000 in the case of NSC and ELSS. When it comes to reaping taxation
benefits, ELSS scores over PPF and NSC. As per current tax laws if you invest in ELSS, then
dividend and capital gains are tax-free. While interest received in the case of PPF is tax-free,
the same is not true in the case of NSC.
There are two ways to invest in ELSS.
~ Invest a fixed amount every month through systematic investment plan (SIP) in ELSS and
reduce the burden of large investment towards the end of financial year.
~ Invest lump sum at any point of time.
One of the best ways to invest is to save and invest on a regular basis through SIPs. SIP is a
planned investment programme, whereby an investor invests small amounts of his/her
savings in mutual funds at regular intervals.
SIP helps an investor take advantage of the fluctuations in the stock markets by rupee cost
averaging (in a rising equity market an investor gets fewer MF units but when the market is
sliding he/she gets more MF units) and also helps him/ her reap the benefits of compounding.

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A SIP in ELSS offers an investor the best combination of investments -- tax-savings and
capital appreciation -- available to investors. The minimum investment in an ELSS through
the SIP route can be as small as Rs 500.

Of the tax-saving instruments available under Section 80C, equity linked savings schemes
(ELSS) have in the past three years emerged as the most popular, thanks to the rapid rise of
the Indian stock markets over this period. Assets under management of ELSS schemes have
multiplied almost ten times from Rs 1,701 crore in January 2005 to Rs 16,811 crore in
January 2008.

ELSS VS. THE REST

Risk, return, liquidity and tax benefits are the parameters on which any investment instrument
is judged. ELSS scores over tax saving bank deposits, National Savings Certificate (NSC)
and Public Provident Fund (PPF) both in terms of return and liquidity. While no tax is levied
on interest income earned from PPF, its main disadvantage is the lack of liquidity (lock in of
six years). In the case of bank deposits and NSC, withdrawals are permitted after five and six
years respectively. However, the interest income earned from both these instruments does not
enjoy tax waiver, which lowers their effective yield.
Despite the three-year lock-in, what has made ELSS popular is the good returns over the past
three years (though being equity-linked, there is no guarantee that returns will continue to be
good in future).
One of the common ploys used by mutual fund houses to attract investment is to come up
with new fund offerings (NFO) in the ELSS domain, especially in the last quarter of the
financial year. This year has been no different. Five fund houses have launched their taxsaving schemes that are currently open for subscription. However, investing in an NFO that
does not offer a new fund management approach is not a good idea when there are so many
existing ELSS with a proven track record.

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Over the last five years, the Sensex generated a compounded annual return of 38.5 per cent.
Fifteen of the 19 ELSS schemes outperformed the Sensex over this time horizon, with SBI
Magnum Tax gain leading the pack. Over the three-year horizon, even the worst performer,
Canara Robeco Equity TaxSaver, generated a return of 18.9 per cent. Even over this time
horizon, SBI Magnum Tax gain was the leader with a return of 48.4 per cent. The Sensex
generated a three-year compounded annual return of 36.4 per cent. However, a notable point
about the three-year time horizon is that of the 20 funds in existence, only five outperformed
the Sensex. The rest were all laggards.
By investing regularly in ELSS, the problems of wrong timing, wrong stock selection and
burden towards the end of financial year is reduced substantially.
In sharp contrast, open-ended schemes can be likened to an expressway which has an exit
every 500 meters. So, when investors in an open-ended scheme go for redemption, the fund
manager has no choice but to sell stocks which have the potential to grow over a two-three
year period.
While choosing ELSS an investor would do well to keep in mind the size, experience, quality
and consistency of fund houses over a period of time. If you are building a nest-egg and are
conservative, then you should consider channelling your precious resources into ELSS even
as you apportion a small part of your savings to PPF and NSC.
Is ELSS Better Option As A Tax Saving Investment?
The crash of stock market in the month of March is good opportunity for investors to opt for
Equity Linked Saving Scheme because unit price of those schemes shall also be lower on
account of crash in stock market. That is not the only reason for recommending ELSS as an
investment. The other reasons are
1. Claim Deduction up to Rs 1 lakh
Those readers who have still trying to search for an investment option for tax savings, can get
deduction u/s 80C which by virtue of clause 2(xiii) gives deduction up to Rs 1 lakh.

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2. Minimum lock in period.

The PPF or NSC gives you risk free returns but they have locked in period of six years,
whereas ELSS has only 3 years of lock in period. SO, after three years only you can get your
wealth back.
3. Tax free gains
While interest from PPF is tax free, interest from NSC is taxable. Whereas in case of ELSS,
not only tax on the long term capital gains is tax free, even dividends you receive are tax free.

4. Chance of better returns

The prediction about Indian economy makes a case for long term investment in equity.
Therefore there is likelihood of getting much better return out of investment as the equity
market is set to go up in near future again. The tax free gain will be more than the PPF or
NSC. While the PPF or NSC gives you 8 % return, the return from ELSS on average annual
return was more than 30% in last one year.
Tax benefits
Investors making investments in tax saving mutual funds can avail of a deduction of up to Rs
1 lakh under Section 88 from the gross total income. The tax benefit is 33% if the gross
taxable income comes in the highest income tax bracket of 30%. In addition to this, the
capital appreciation you get on your investment will be totally tax-free after one year. Also,
the dividend distributed does not attract dividend distribution tax.
The two most important benefits, which differentiate mutual fund ELSS and conventional
instruments, are holding period and the returns. Today's investors abhor a longer holding
period and lesser returns if invested in PPF and NSC instruments. Investors should be ready
to take certain amount of risk for higher returns and this risk is nullified when invested for
three years.

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APPENDIX
ADVISORY SURVEY FORM

Your valuable suggestions and feedback through this form will be appreciated.

OCCUPATIONAL DETAILS:

Organization: __________________________________________________________________________________________

Designation: ___________________________________________________________________________________________

Monthly expenditure: ___________________________________________________________________________________

Monthly savings: _______________________________________________________________________________________

PAST INVESTMENTS (if any)

Type of investment

Tax Planning
Insurance

Equity Dealing

Financial Planning

Mutual Fund

Commodity Trading

Demat

Portfolio Management Services

Amount of investments

Below Rs. 50,000

Rs. 50,000 Rs. 1 lac
Rs. 5 lac Rs. 10 lac Over Rs. 10 lac

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Rs. 1 lac Rs 5 lac

Have you taken any of the following loans, and if yes, how much EMI do you pay for it?

Home Loan

Car Loan

Education Loan

Personal Loan

Any other (please specify)

Current Financial Advisor (if any) _______________________________________________________________________

How would you rate your Current Financial Advisor?

Very satisfactory

satisfactory

average dissatisfactory

dont know

NEW INVESTMENTS

Which of the following products & services would you be interested in?

Tax Planning
Insurance

Equity Dealing

Financial Planning

Mutual Fund

Commodity Trading

Demat

Portfolio Management Services

PERSONAL DETAILS:
PAN No: _________________________________
Name: _______________________________________________________________________________________________
Correspondence Address: _______________________________________________________________________________
______________________________________________________________________________________________________
Email Id: _____________________________________________________________________________________________
Contact No: Residence: __________________________________Office: _________________________________________
Mobile No.: __________________________D.O.B. ___________________Marital Status: Single/Married
Date __________________________

Signature ______________________________

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BIBLIOGRAPHY
WEBSITES
www.karvymfs.com
www.karvy.com
www.taxsmile.com
www.incometaxindia.gov.in
www.sebi.gov.in
www.outlookmoney.com
www.amfiindia.com
www.mutualfundsindia.com
www.moneycontrol.com
www.morningstar.com
www.yahoofinance.com
www.theeconomictimes.com
www.money.rediff.com
www.investopedia.com
www.google.com

JOURNALS & OTHER REFERENCES:

The Economic Times
Business Standard
The Telegraph
Business India
Fact sheet and statements of various fund houses.

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