Mutual Fund Sahi hai !!!

Mutual Fund Sahi hai !!!

Nowadays this video and Audio Campaign is very famous on TV and newspapers. The common man is now used to these two words.”Mutual Fund”. But still, an investor should have a better understanding of the term Mutual funds, its concepts, and terms.

Mutual funds are investment products available to investors through which they can invest in an asset class of their choice such as equity, debt, gold or real estate. An investor who may not want to invest directly in financial markets may instead, get exposure to the same securities through a mutual fund.

What is a mutual fund?

A mutual fund is a professionally managed investment fund that pools investors’ money to purchase securities. A mutual fund is set up by a sponsor, who is a promoter. Trustees are appointed to take care of the interests of the investors in the various schemes launched by the mutual fund. A mutual fund is managed by an Asset Management Company. AMC is responsible for launching a scheme, marketing it, collecting it, investing the funds according to the scheme’s investment objectives and enabling investor transactions. For example, the sponsor of the HDFC Mutual Fund is HDFC and Standard Life Investments Ltd. And trustees are the HDFC Trustee Company Ltd. The AMC is HDFC Asset Management Company Ltd. A mutual fund is managed collectively to earn the highest possible returns.

Concepts and Terms related to Mutual funds:

  • Investment Objective :

A mutual fund scheme is defined by its investment objective. The investment objective will state what the scheme intends to achieve. The asset class that the fund will invest in, the type of securities that will be selected and the the way the fund will be managed will depend upon the investment objective. The risk involved and the return earned by the mutual fund will also depend upon its investment objective.

  • Units

Each investor’s holding in a mutual fund is represented in terms of Unit that is derived from the amount invested. It is the same as the Shares or bonds and debentures. Each unit represents one share of the fund.

For example, A invests Rs 10000 in HDFC Top 100 fund when the price of the unit is rs 10 and B invests Rs 20000 in the same fund at the same price.

The number of units allotted is calculated as

Amount invested / Unit price= No of units.

For A: Rs 10000/10 = 1000 units

For B: Rs 20000/10 = 2000 units

Units are first offered to the investors at the time the scheme is launched through a new fund offer (NFO).

  • Net Assets :

The assets of a mutual fund scheme are the current value of the portfolio of securities held by it. There may be some current assets such as cash and receivables. Together they form the total assets of the scheme. From this fund manager’s fees, charges paid to constituents, regulatory expenses on advertisements and such are deducted to arrive at the net asset value of the scheme. These net assets belong to the investors in the fund who have been allotted units and no other entity has a claim to it.

Net assets of a scheme are not a fixed value but keep on changing with the change in the following factors

  1. Net assets increase when investor buy additional units and decreases when the investor takes out their money by redeeming their units.
  2. Net asset increases when the value of the investments held in the portfolio goes up and decreases when the value of the investments held in the portfolio falls down
  3. Net asset increases when the securities held in the portfolio earns income such as dividends from shares or interest on bonds held. Net asset increases when expenses related to the scheme are accounted for.
  • Net Asset Value (NAV)

Net Asset Value = Net assets/ Number of outstanding units of the scheme.

NAV of the scheme will change with every change in the Net Assets of the scheme. All investors’ transactions are conducted at the current NAV of the scheme.

Study the following scenarios

  1. Net Assets of the scheme is 100000 and Units outstanding is 10000 What is the NAV?
  2. If net assets increased to 120000 and units being the same. What is the NAV?
  3. And in the third scenario investor redeems 1000 units when NAV is the same as of 2nd scenario what will be the Net Assets of the scheme?

a) NAV in the first scenario would be 100000/10000 = 10

b) NAV in the second scenario would be 120000/10000 = 12

c) Net Assets in the third scenario would be 9000*12 = 108000

  • Mark to Market

The current value of the portfolio forms the base of the net assets of the scheme and therefore the NAV. It means that the portfolio was to be liquidated then this would be the value that would be realized and distributed to the investors. Therefore the portfolio has to reflect the current market price of the securities held. This process of valuing the portfolio on a daily basis at current value is called marking to market. The price is taken from the market where the securities are traded.

  • Open-ended and Closed-ended scheme:

A mutual fund offers two types of scheme open-ended or closed-ended scheme

  • An open-ended Scheme allows the investor to invest in additional units and redeem investment continuously at current NAV. The scheme is for the perpetuity unless the investors decided to wind up the scheme. The unit capital of the scheme is not fixed but changes with every investment or redemption made by the investor.
  • A closed-ended Scheme is for a fixed period or It offers units to the investors only during the new offer(NFO). The scheme is closed for the transactions for the investor. The units allotted are redeemed by the fund at the prevailing NAV when the term is over and the fund ceases to exist from the same. In the interim, if the investor wants to exit from the investment he can do so by selling the units to the other investors on the stock exchange where they are listed. The unit capital of the closed-ended the scheme does not change over the life of the scheme since transactions between investors on the stock exchange does not affect the fund.

7. Interval funds :

Interval funds are the variant of the closed-ended funds which become open-ended during specified periods. During these periods investors can purchase and redeem units like in an open-ended fund. The specified transaction period is for a minimum period of 2 days and there must be a minimum gap of 15 days between two transaction periods.

So these are the terms related to Mutual fund.

A mutual fund is an excellent investment vehicle for all types of investors for wealth creation.

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