A mutual fund is a common investment pool that accumulates the savings of several investors who aim towards a common financial goal. The securities comprised in mutual funds are shares, debt securities, money-market securities or a combination of these. These securities are professionally managed by an experienced Fund manager on behalf of the investors.
The returns generated and the capital appreciation realized is thus shared amongst the investors with respect to the number of units possessed by them. Mutual funds therefore provide diversification of a professionally managed basket of securities at a lower cost where investors have the opportunity to spread their risk in terms of choosing different schemes across categories.
Where do Mutual Funds Invest:
Mutual Funds broadly invest in three types of asset classes:
Stocks : Stocks also known as shares represent the ownership or equity in a company.
Bonds: Bonds invest in debt securities from companies, financial institutions or government agencies.
Money market instruments : The maturity period of these securities range from one day to one year and usually invest in treasury bills, certificate of deposits and inter-bank call money.
Working of Mutual Funds:
A Mutual Fund is constituted as a trust. The four individual entities are a part of it, namely sponsor, a board of trustees, AMC, and custodian. Their roles are described as follows:
Sponsor : Known as the promoter of the mutual fund. The sponsor is a person who works alone or in a combination with another body corporate, establishes Mutual Fund. Under the purview of SEBI regulations, the sponsor establishes a trust and appoints a Board of Trustees, and also usually appoints an AMC as the fund manager. Furthermore, the sponsor appoints a custodian for holding the assets of the fund. The sponsor brings in atleast 40% of the net worth of the AMC and holds a sound financial track record over five years before registration.
Board of Trustees : Board of Trustees is a body of individuals or by a Trust Company, which is a corporate body usually manages the Mutual fund or trust. They are the primary guardians of the unitholder's funds and assets, a trustee needs to be a person of high repute and integrity. The portfolio of securities is not directly managed by the trustees. However, the AMC manages the portfolio as per the defined objectives, subject to the Trust Deed and SEBI(Mutual Funds) Regulations.
Asset Management Company(AMC): The sponsor or the trustees are responsible for appointing the AMC and is approved by SEBI, acts like the investment manager of the trust. The AMC operates under the control of its own Board of Directors, and also under the administration of the trustees and SEBI. In the name of the trust, AMC is responsible for floating and managing the different investment schemes subject to the SEBI Regulations and as per the Investment Management Agreement duly signed with the Trustees.
Custodian : A custodian is responsible for holding and safeguarding the securities. Custodian also participates in the clearing system through approved depository.
Mutual Funds can be open-ended and closed-ended. But many people consider all mutual funds to be open-ended, while employing closed-ended funds in another category.
Open-Ended – It means buying and selling the shares whenever you want them to at prevailing NAV from and to the mutual fund, on any business day throughout the year. It provides a high degree of liquidity to investors.
Closed-Ended – These funds have fixed maturity periods. An investor can buy these funds only when New fund offer (NFO) gets released in the market. After that duration, the redemption of units can be made at their fixed maturity date. Investors looking for liquidity can buy or sell already issued units on the exchange where they are listed.
Load : There are some expenses which accrue to float, operate and regulate a fund. These expenses are collected from the investors as a percentage of their total investment which is known as loads. The two types of loads exist: entry load and exit load. The fee which is borne by investors at the time of buying the mutual fund units is known as entry load, whereas the amount borne by investors at the time of selling the units is known as exit load. Entry load is not charged by mutual fund companies whereas exit loads are chargeable from 0.50%-3% based on the holding period by investors.
How do Mutual Funds Make Money:
Whenever you invest in a mutual fund investment scheme in which you invest works according to its investment objective and ascertains what type of securities it buys. A mutual fund can target on particular types of investments. For example : a fund may invest predominantly in government bonds, stocks from large companies or stocks from specific countries or it may invest in an array of investments.
When you buy a mutual fund, your money gets pooled along with other investors. Your money is being put in a mutual fund by buying units or shares of the fund. As maximum people invest, the fund issues new units or shares.
It is the job of a portfolio manager to manage the investments in your mutual fund on a day-to-day basis. Furthermore, the portfolio manager will decide when to buy and sell investments as per the investment objectives of the fund.
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