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Friday, October 5, 2007

Mutual Funds

About Mutual Funds:

What is it about investing that irks you most? Is it the fact that it is time-consuming since it involves researching the market for investment products and then proceeding with the paperwork involved? Or could it be that once you have made your investments, you cannot find the time to monitor them? Like most of us, do you dread a situation wherein you need your money all of a sudden and have no access to it or have to run from pillar to post to get it back?

Do you sometimes hesitate to invest because you are unsure about how well-regulated investment products are? Is your approach to investing constrained by the fact that you possess limited investment capital, which does not allow you to achieve the diversity that you desire?If these are some of the reasons that make you feel disinclined to undertake an investment exercise, consider mutual funds.

This investment vehicle successfully addresses the above concerns and offers other benefits too. Let’s take a look at what exactly a mutual fund is and how it functions. A mutual fund is an entity, which offers a number of investment schemes with different investment objectives. An investor interested in investing in these schemes needs to assess which scheme has an investment objective that matches his, to make his selection from among the available schemes.

Mutual funds are well-structured and closely-regulated entities, which hire investment professionals to invest and manage investors’ funds.

Mutual funds are well-structured and closely-regulated entities, which hire investment professionals to invest and manage investors’ funds.

Mutual funds issue units to each investor based on the amount invested. Units of mutual funds are similar to shares issued by companies. For instance, if an investor invests Rs 5,000 in a new scheme of a mutual fund, which is offering units at Rs 10 per unit, he will receive 500 units in the scheme (Rs 5,000 / Rs 10).

The mutual fund invests the money collected from unit-holders on their behalf. Income earned on these investments is distributed by the mutual fund among its investors in proportion to their holding in the scheme. For instance, taking the above example forward, if the scheme issues a total of 1 lakh units and earns a total income of Rs 1 lakh in a particular period, it would have earned Re 1 per unit issued (Rs 1 lakh / 1 lakh units). The investor, who had applied for 500 units, will be entitled to receive Rs 500 (income earned per unit – Re 1 x 500 units).

Choice of investment strategies:

From just two scheme types (equity scheme and debt scheme) offered when the mutual fund industry was conceived more than four decades ago, today, mutual funds offer a plethora of scheme types with different investment strategies. Consider equity schemes. From just one scheme type, there are, today, more than 10 types of schemes, each offering a unique investment strategy. For instance, an index fund invests in stocks forming a stock market index such as the BSE Sensex or NSE Nifty in order to make gains equivalent to appreciation in the index. A sector fund invests in securities of companies belonging to a specific sector (banking, IT, pharma, etc.) in order to make gains when the sector is prospering.

Similarly, in case of debt schemes, from just a single debt scheme-type, presently, there are more than 6 scheme types. Each debt scheme focuses on specific debt securities with specified tenures. For instance, a long-term gilt scheme will invest in government securities with long tenures (exceeding 7-8 years) while a short-term floating rate fund will invest in debt securities with short tenures (1-3 years) whose coupon rates are reset at regular intervals depending on change in prevailing interest rates.

In addition, there are schemes, which combine debt and equity to adopt different investment strategies (balanced funds, MIPs, etc.).

There are also schemes, which invest in other mutual fund schemes (called Fund of Funds).
In other words, mutual funds have been able to envisage different investment strategies that can be adopted by investors, and have created scheme types to cater to each of these strategies

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