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Industry profile
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). Second Phase 1987-1993 (Entry of Public Sector Funds). Third Phase 1993-2003 (Entry of Private Sector Funds). Fourth Phase since February 2003
Introduction
STURCTURE
SPONSORS : Sponsor is basically the promoter of the fund.
ASSEST MANAGEMENT COMPANY : A set of Financial professionals who manage the fund TRUSTEES : Professionals who supervise the activities of AMC. CUSTODIAN :A custodian keeps safe custody of Investments TRANSFER AGENTS : Interfaces with customers , issues a funds units e .g CAMS
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Mutual funds usually spread investments across various industries and asset classes, constrained only by the stated investment objective.
Thus, by investing in mutual fund, you can avail of the benefits of diversification and asset allocation, without investing the large amount of money that would be required to create an individual portfolio.
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Professional Management
Mutual funds employ experienced and skilled professionals, who conduct investment research, and analyse the performance and prospects of various instruments before selecting a particular investment.
Thus, by investing in mutual funds, you can avail of the services of professional fund managers, which would otherwise be costly for an individual investor.
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Liquidity
In an open-ended scheme, unit holders can redeem their units from the fund house anytime, by paying a small fee called an exit load, in some cases.
Even with close-ended schemes, one can sell the units on a stock exchange at the prevailing market price. Besides, some close-ended and interval schemes allow direct repurchase of units at NAV related prices from time to time.
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Flexibility
Mutual funds offer a variety of plans, such as regular investment, regular withdrawal and dividend reinvestment plans. Depending upon ones preferences and convenience, one can invest or withdraw funds, accordingly.
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Cost Effective
Since mutual funds have a number of investors, the funds transaction costs, commissions and other fees get reduced to a considerable extent. Thus, owing to the benefits of larger scale, mutual funds are comparatively less expensive than direct investment in the capital markets.
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Well Regulated
Mutual funds in India are regulated and monitored by the Securities and Exchange Board of India (SEBI), which strives to protect the interests of investors. Mutual funds are required to provide investors with regular information about their investments, in addition to other disclosures like specific investments made by the scheme and the proportion of investment in each asset class.
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Systemic risks
Systemic risks or market risks refer to risks that affect the entire market and have an impact on the entire class of assets. The value of an investment may decline over a period of time because of economic changes or other events that affect the overall market. Systemic risks include risks related to interest rates, inflation, exchange rates and political events, etc.
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Non-systemic risks
Non-systemic risks refer to risks associated with investments in a particular sector or industry or stock. Sector-specific schemes invest in equities of a particular industry or sector, owing to which they are subject to higher risks than other diversified schemes.
For example, tax benefits to a particular sector of the economy would affect the shares of companies belonging to that sector and thus, affect the returns of funds investing in that sector Other factors that have a greater impact on the performance of a mutual fund include the skill and experience of the fund manager and the research team, the size of the corpus, redemption pressures, etc.
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BY STRUCTURE
OPEN-ENDED SCHEMES An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices.
CLOSE-ENDED SCHEMES
These schemes have a pre-specified maturity period.
One can invest directly in the scheme at the time of the initial issue. Depending on the structure of the scheme there are two exit options available to an investor after the initial offer period closes. Investors can transact (buy or sell) the units of the scheme on the stock exchanges where they are listed.
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The market price at the stock exchanges could vary from the net asset value (NAV) of the scheme on account of demand and supply situation, expectations of unitholder and other market factors. Alternatively some close-ended schemes provide an additional option of selling the units directly to the Mutual Fund through periodic repurchase at the schemes NAV; however one cannot buy units and can only sell units during the liquidity window.
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SEBI Regulations ensure that at least one of the two exit routes is provided to the investor.
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INTERVAL SCHEMES
Interval Schemes are that scheme, which combines the features of open-ended and closeended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.
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BY NATURE
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Equity fund:
These funds invest a maximum part of their corpus into equities holdings. The structure of the fund may vary different for different schemes and the fund managers outlook on different stocks. The Equity Funds are sub-classified depending upon their investment objective, as follows: Diversified Equity Funds Mid-Cap Funds Sector Specific Funds Tax Savings Funds (ELSS)
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Equity investments are meant for a longer time horizon, thus Equity funds rank high on the riskreturn matrix.
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Debt funds:
The objective of these Funds is to invest in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors.
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Gilt Funds: Invest their corpus in securities issued by Government, popularly known as Government of India debt papers. These Funds carry zero Default risk but are associated with Interest Rate risk. These schemes are safer as they invest in papers backed by Government.
Income Funds: Invest a major portion into various debt instruments such as bonds, corporate debentures and Government securities.
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MIPs: Invests maximum of their total corpus in debt instruments while they take minimum exposure in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the risk-return matrix when compared with other debt schemes. Short Term Plans (STPs): Meant for investment horizon for three to six months. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures.
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Liquid Funds: Also known as Money Market Schemes, These funds provides easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, inter-bank call money market, CPs and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. These schemes rank low on risk-return matrix and are considered to be the safest amongst all
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Balanced funds:
As the name suggest they, are a mix of both equity and debt funds.
They invest in both equities and fixed income securities, which are in line with pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns.
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By investment objective:
Growth Schemes : Growth Schemes are also known as equity schemes. The aim of these schemes is to provide capital appreciation over medium to long term Income Schemes:Income Schemes are also known as debt schemes. The aim of these schemes is to provide regular and steady income to investors Money Market Schemes: Money Market Schemes aim to provide easy liquidity, preservation of capital and moderate income.
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These schemes generally invest in safer, shortterm instruments, such as treasury bills, certificates of deposit, commercial paper and inter-bank call money.
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Other schemes
Tax Saving Schemes
Index Schemes
Sector Specific Schemes Exchange traded funds Fixed Maturity Plans
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Tax saving schemes Such schemes are aimed at offering tax rebates to investors under specific provisions of the Income Tax Act, 1961. For instance, investors of Equity Linked Savings Schemes (ELSS) and Pension Schemes are applicable for deduction u/s 88 of the Income Tax Act, 1961. Index schemes Such funds strive to mirror the performance of specific market indices, such as the BSE SENSEX, CNX Nifty, etc which are called the base index. Investments in such funds are made in the same stocks as the base index and in similar proportion.
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Sector-specific schemes Such funds invest in a specific industry or sector. The investments could be in a particular industry (Banking, Pharmaceuticals, Infrastructure, etc) or a group of industries, or various segments (like A Group shares). Exchange-traded funds Such funds are listed and traded on the stock exchange in a similar manner as stocks. Such funds invest in a basket of stocks and aim at replicating an index (S&P CNX Nifty, BSE Sensex) or a particular industry (banking, information technology) or commodity (gold, crude oil, petroleum).
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Dividends
Income received from units of a mutual fund registered with the Securities and Exchange Board of India is exempt in the hands of the unit holder.
A debt-oriented mutual fund is liable to pay income distribution tax of 12.5% and 20% on the distribution of income to individual / Hindu Undivided Fund and other persons, respectively.
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In the case of money market mutual funds and liquid mutual funds (as defined under SEBI regulations), the income distribution tax is 25% across all categories of investors
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Capital Gains
Long-term capital gains arising on the transfer of units of an equity oriented mutual fund is exempt from income tax, if the Securities Transaction Tax (STT) is paid on this transaction i.e., the transfer of such units should be made through a recognised stock exchange in India. Equity oriented mutual fund means a fund where the investible corpus is invested by way of equity shares in Indian companies to the extent of more than 65% of the total proceeds of the fund.
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Liquid funds/Money Market Funds As per Income Tax Slab Less of 10% without indexation or 20% with indexation
Debt fund/liquid plus Funds As per Income Tax Slab Less of 10% without indexation or 20% with indexation
Nil
Nil
25%*
12.5% 20.0%*
Budget 2011 increased the dividend distribution tax (DDT) for corporate investors to 30%, thus companies can not take advantage of the prevailing tax arbitrage (1st June, 2011 )
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A taxable capital loss (i.e., a transaction on which there is a liability to pay tax if the result were gains instead of loss) can be set-off only against capital gains. An exempt capital loss (i.e., a transaction which is exempt from tax if the result were gains instead of loss) cannot be set-off against taxable capital gains. A taxable long-term capital loss can be set-off only against long-term capital gains. However, a taxable shortterm capital loss can be set-off against both short-term and long-term capital gains
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Tax issues concerning Unit holders I. Equity Oriented Funds - Tax Treatment of Investments A. Tax on income in respect of units As per the section 10(35) of the Act, income received by investors under the schemes of any Mutual Fund is exempt from income tax in the hands of the recipient unit holders.
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B. Dividend Distribution Tax: By virtue of proviso to section 115 (R) (2) of the Act, equity oriented schemes are exempt from income distribution tax. As per section 115T of the Act, equity oriented fund means such fund where the investible funds are invested by way of equity shares in domestic companies (as defined under the Act) to the extent of more than sixty five percent of the total proceeds of such fund.
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C. TDS on income of units : As per the provisions of section 194K and section 196A of the Act, where any income is credited or paid on or after 1st April 2003 by a Mutual Fund, no tax is required to be deducted at source
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ii) Short term capital gains Units held for not more than twelve month's preceding the date of their transfer are short term capital assets. Capital gains arising from the transfer of short term capital assets being unit of an equity oriented scheme which is chargeable to STT is liable to income tax @ 15% under section 111 A and section 115 AD of the Act. The said tax rate is increased by surcharge, if applicable.
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iii) Securities Transaction Tax (STT) As per Chapter VII of Finance (No. 2) Act, 2004 relating to Securities Transaction Tax (STT), with effect from June 01, 2006, the STT is payable by the seller at the rate of 0.25% on the sale of unit of an equity oriented scheme to the Mutual Fund. The STT is collected by the Mutual Fund at source. With effect from 01st April 2008: the deduction under section 88E of the Act has been discontinued, and the amount of STT paid by the assessee during the year in respect of taxable securities transactions entered into in the course of business will be allowed as deduction under section 36 of the Act subject to the condition that such income from taxable securities transactions is included in the income computed under the head Profits and Gains of business or profession.
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Different types of Mutual Funds attract different types of taxes. Here is all you would want to know about taxes applicable on Mutual Funds in India.
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80C benefits through ELSS: Under the current tax laws, you can get an annual income tax benefit of up to Rs. 1Lakh if you invest in Equity Linked Savings Schemes, ELSS. However, the minimum term for these schemes is 3 years and you cannot withdraw your money before that time *The education cess of 3% shall be levied on all investors. *Short Term Capital Gain Tax indicated above is inclusive of education cess **Dividend Distribution Taxes indicated above are inclusive of additional surcharge and cess.
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A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.
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Exchange Traded Funds (ETFs) represent a basket of securities that is traded on an exchange, similar to a stock. Hence, unlike conventional mutual funds, ETFs are listed on a recognised stock exchange and their units are directly traded on stock exchange during the trading hours. In ETFs, since the trading is largely done over stock exchange, there is minimal interaction between investors and the fund house.
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ETFs are either actively or passively managed. Actively managed ETFs try to outperform the benchmark index, whereas passively-managed ETFs attempt to replicate the performance of a designated benchmark index.
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Mutual funds are traded through fund house where as in an ETF, transactions are done through a broker as buying and selling is done on the stock exchange. In conventional mutual funds units can be bought and redeemed only at the relevant NAV, which is declared only once at the end of the day. ETFs can be bought and sold at any time during market hours like a stock.
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As a result, ETF investors have the benefit of real time pricing and they can take advantage of intraday volatility Annual expenses charged to investors in an ETF are considerably less than the vast majority of mutual funds. Most of the mutual funds have an entry or exit load varying between 2.00% and 2.25%. ETFs do not have any such loads. Instead ETF investors have to pay a brokerage to the broker while transacting. which in most cases is not more than 0.5%.
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ETFs safeguard the interests of long-term investors. This is because ETFs are traded on exchange and fund managers do have to keep cash in hand in order to meet redemption pressures
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Cash
Capital Markets
ETF Shares
Securities
Creation Units
Basket of Securities
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FMPs, as they are popularly known, are the equivalent of a fixed deposit in a bank, with a caveat. The maturity amount of a fixed deposit in a bank is 'guaranteed', but only 'indicated' in the FMP of a mutual fund. The regulator does not allow fund companies to guarantee returns, and hence the 'indicated returns' in FMPs.
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Typically, the fund house fixes a 'target amount' for a scheme, which it ties up informally with borrowers before the scheme opens. Since the fund house knows the interest rate that it will earn on its investments, it can provide 'indicative returns' to investors. FMPs are debt schemes, where the corpus is invested in fixed-income securities. The tenure can be of different maturities, from one month to three years.
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They are closed-ended in nature, which means that once the NFO (new fund offer) closes, the scheme cannot accept any further investment. These FMP NFOs are generally open for 2 to 3 days and are marketed to corporate and high net-worth individuals. Nevertheless, the minimum investment is usually Rs 5,000 and so a retail investor can comfortably invest too
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FMPs usually invest in certificate of deposits , commercial papers , money market instruments, corporate bonds and sometimes even in bank fixed deposits.
Depending on the tenure of the FMP, the fund manager invests in a combination of the abovementioned instruments of similar maturity. Say if the FMP is for a year, then the fund manager invests in paper maturing in one year.
The prevalent yield minus the expense ratio, which varies from 0.25 to 1 per cent, will be the indicative return which can be expected from the 76 FMP.
The expense ratio is mentioned in the offer document. The yield can be indicated fairly accurately because these schemes are open only for a short while. The fund received is for a pre-specified tenure and the exit load from this plan is high (usually 1 per cent to 3 per cent, depending on the time of redemption). So, the fund manager has the liberty to deploy most of the funds mobilised under the scheme.
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The actual return can vary slightly, if at all, from the indicated return. Against that, a bank fixed deposit exactly prints the amount which is due to you on maturity on the FD receipt. However, FMPs do earn better returns than fixed deposits of similar tenure. FMPs are classified under the debt scheme category and enjoy certain tax benefits, such as:
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But the mutual fund has to deduct a dividend distribution tax of 12.5 per cent in the case of individuals and Hindu Undivided Families (HUFs), and 20 per cent in the case of corporate.
Long-term capital gains (investment of more than a year) enjoy indexation benefit.
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Short-term capital gains are added to the income of the investor and taxed as per his/her slab, whereas the interest on a bank deposit (except where special 80C approved) is added to the income of the investor and taxed as per his/her slab. The results of all these are quite dramatic. Lets take an example of a 90-day FD yielding 8 per cent, compared with an FMP yielding 8 per cent for an individual investor in the highest tax bracket.
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BANK FD
FMPdividend option
8% 12.88% 6.97%
8% 30.90% 5.53%
Actually, the dividend distribution tax is deducted on the gross yield. So the return from the dividend option can be 10-20 bps higher. But for the sake of simplicity, it is calculated here on net yield. If the tenure of the FMP is more than a year, the growth option gives a higher yield because of the indexation benefit.
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Cost Inflation Index for FY06-07 is 519. The assumption is that the CII for FY07-08 is 567 and for FY08-09 is 592. Clearly, the post-tax return is superior for an FMP.
If you have arrived at an indexed cost, then the long-term capital gain is taxed at 20.6 per cent and if you do not opt for the indexed cost, then the tax is 10.3 per cent.
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2007-2008
2008-2009 2009-2010
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592 632
Indexed Purchase Price = Purchase Price * (CPI for current year / CPI for year of purchase)
2010-2011
2011-12
711
785
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30 Month FMP
Without Indexation 10000 8.30% 30 12,075
With Indexation Amount of Investment (Rs.) Post Expenses Yield (p.a)* Tenor (in months) Approx Maturity Amt 10000 8.30% 30 12,075 10000 8.30% 30 12,075
Gain
Indexed Cost Indexed Gain Tax Rate Tax Post Tax Gain Approx Post Annualised Return Tax NA NA 30.9%
2075
2075
11,406 669 20.6%
2075
NIL NA 10.3% 214 1861
641 1434
138 1937
5.74%
7.75%
7.44%
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BONDS
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The yield curve is a description of a line that connects the yields on various maturities, ranging from 3-month Treasury Bill to 30-year Treasury Bonds It is tool to help track and predict the overall movement of interest rates and the near future of the economy. A normal, or positive, curve is created when longterm bonds produce higher yields than short-term bonds.
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Investors generally seek higher rewards to compensate for the risks involved with investing money for longer periods of time.
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Does the current shape indicate economic slowdown? In December 2005, the yield curve inverted, for the first time since 2000. This inversion brought an unsettling feeling to many economists and banking analysts. The shape of the yield curve has historically been a reasonably accurate and useful indicator of future economic activity
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Typically, a flat curve, when long-term and shortterm yields are the same, predicts economic slowdown. According to the Federal Reserve Bank of San Francisco, each of the six recessions since 1970 was preceded by a yield curve inversion. That statistic, however, conveniently leaves out the two recessions that occurred in the 1950s and 1960s, which were not predicted by an inverted curve.
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BACK UP SLIDES
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NAV = Rs 8
The NAV or price per share of this mutual fund would be Rs 8. A Mutual Fund NAV is calculated on a daily basis, after the stocks markets close for the day.
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Some investors who seek pure capital appreciation may opt for an aggressive growth fund, without dividend payments. The returns then would be solely based on the mutual fund NAV appreciation.
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FUND EXPENSES
Different funds have different expense ratios. However to keep things in check, the Securities & Exchange Board of India (SEBI) has stipulated an upper limit that a fund can charge. The limit stands at 2.50 per cent for equity funds and 2.25 per cent for debt funds.
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The asset management company may charge the mutual fund with the following expenses namely:-
(a) initial expenses of launching schemes. (b) recurring expenses including:-(i) marketing and selling expenses including agents' commission, if any; (ii) brokerage and transaction cost; (iii) registrar services for transfer of units sold or redeemed; (iv) fees and expenses of trustees; (v) audit fees; (vi) custodian fees; and [(vii) costs related to investor communication; (viii) costs of fund transfer from location to location; (ix) cost of providing account statements and dividend/redemption cheques and warrants; (x) insurance premium paid by the fund; (xi) winding up costs for terminating a fund or a scheme; (xii) costs of statutory advertisements;] [ (xiii) such other costs as may be approved by the Board.]
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EXIT LOAD
Exit Load varies for different schemes and is generally charged as a percentage of NAV. The Exit load normally varies between 0.25% to 2% of the redemption value. Some mutual funds however do not charge any exit load. Such mutual funds are referred to as 'No Load Funds'.
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At present, my rate is 13.52% (12.5% dividend distribution tax + 5% surcharge + 3% cess) on income distributed by debt funds other than liquid funds. For liquid funds, I am charged at the rate of 27.04% (25% dividend distribution tax + surcharge and cess).
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Budget 2011 increased the dividend distribution tax (DDT) for corporate investors to 30%, up from 25% a year back in case of liquid funds and up from 12.5% in case of all other debt funds. This is a significant move as it removes the arbitrage opportunity that companies had in parking their surplus cash in MF schemes, especially liquid funds and ultra short-term funds. Since I come at a lower rate in case of MF dividends (25% in case of, say, liquid funds) against tax charged on interest earned from a savings bank account (where I come at the rate of 30%), companies found it tax-efficient to put their excess cash in MFs.
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So far as Dividend Distribution and Income Distribution Tax payable u/s.115O and u/s.115R by companies and Mutual Funds is concerned the rate of surcharge on tax is reduced from 7.5% to 5% w.e.f. 1-4-2011.
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Section 115R:
New rate Particulars Existing rate w.e.f. 1-6-2011
(i)
Income distributed to an individual or HUF by a money market Mutual Fund or Liquid Fund
25%
25%
(ii)
Income distributed to any other person by a money market Mutual Fund or Liquid Fund
Income distributed to an individual or HUF by a Debt Fund Income distributed to any other person by a Debt Fund
25%
30%
(iii)
12.5%
12.5%
(iv)
20%
30%
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. The only restriction is that a long-term capital loss will be available for a set-off against a long-term capital gain only, while a short-term capital loss can be set off either against a long-term capital gain or a short-term capital gain.
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Securities Transaction Tax is applicable at different rates on the value of the taxable securities transaction. Taxable securities transaction, payable by both the buyer and the seller, refers to any transaction of securities entered into in a recognized Stock Exchange in India
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Definition of Securities
As per section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA), Securities includes to: Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; Derivative instruments (like forwards/futures/options on indices, stocks, commodities etc.)
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Units or any other instrument issued by any collective investment scheme to the investors in such schemes; Security receipt as defined in section 2(zg) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; Government securities;
Such other instruments as declared by the Central Government; and Rights or interest in securities.
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