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Mutual Fund - Concept, Structure and Types

Published on Tuesday, March 01, 2016
Mutual Fund is an investment plan wherein MF pools investors money to invest in pre-determined goals for capital appreciation.

Benefits of Mutual Funds

  • It's safe
  • No need to stay updated with market movements
  • Experts manages the investments
  • Tax saving under section 80(c)
  • Investors can invest in any investment option (For example it's not possible to invest 1 lac in a real estate project, mutual funds makes it possible) 

Structure of a Mutual Fund

  • Sponsor (Promoter)
  • Trustees
  • Asset Management Company
  • Custodian
  • R & T Agent
  • Distributors

Sponsor

Sponsor is the promoter of mutual fund and get MF registered with SEBI. Sponsor forms a trust and appoints board of trustees.

Pre-requisites of a sponsor

  • Minimum 40% shareholding in AMC (Asset Management Company)
  • Must have positive net worth in last 5 years
  • Should be in financial services sector during past years from the date of registration  

Trust

Trust is the owner of mutual fund. It protects the investors money. Trust acts as a watchdog and keeps an eye on investors money. There should be at least 4 trustees and 2/3 of the trustees should be independent. 

Trust signs trust deed with Sponsor

Asset Management Company

ASM pools and invests investor money in pre-stated objective for capital appreciation.
  • In India AMC should be a private limited company
  • Net worth should be at least 10 cr at all times
  • At least 50% directors should be independent

Custodian

  • Custodian is appointed by Trust and it has the custody of assets of Mutual Fund.
  • Sponsor and custodian can never be same
  • Custodian should be registered with SEBI

Registrar and Transfer agents (RTA)

Maintains investors records and handles investors documents. It's not compulsory to appoint an RTA. 

Broad Categories of Mutual Funds

Open Ended Funds

These funds have no fixed corpus  and period . Such fund continuously offer units for sale and is ready to buy  back the units surrendered.
In other words,investors are free to buy from, or sell to , the trust any number if units at any point of time at prices which are liked to the net asset value (NAV) of the units .

Close Ended Funds

In case of these funds, subscriptions from the investors are collected  during a specified  time period and have a fixed corpus. Not a cannot redeem their units till the specified  maturity date. However , to provide liquidity  these are listed on the stock exchange and the investors can purchase and sell through the brokers at the market price without any difficulty .
It may be noted that Unit Trust of India was the first mutual fund started in India as early as 1964.
Later, LIC , GIC  and some nationalised banks also launched their mutual funds with high degree of success. However , during post liberalisation era, many private sector mutual funds have entered the fray. To mention a few . these are: Birla Sun life , HDFC, HSBC,ICICI prudential ,DSP Merrill Lynch , DBS chola mutual Fund.

Major Types of Funds

1. Equity Funds : Equity Funds are considered to be the more risky funds as compared to other fund types , but they also provide higher  returns than other funds. It is advisable that an investor  looking to invest in an  equity fund should  invest for long term i.e. for 3 years or more . There are different types of Equity funds each falling into different  risk bracket.

2. Debt/Income Funds : Funds that invest in medium to long -term debt instruments issued by private companies, banks , financial institution, government and other entities belonging to various sector ( like infrastructure companies etc.) are known as Debt /Income Funds. Debt funds are low risk profile funds that seek to generate fixed current  income (and not capital  appreciation ) to investors. In order to ensure regular income to investors , Debt (or income ) funds distribute large fraction of their surplus to investors. Although debt securities   are generally less risky than equites , they are subject to credit risk (risk to default)  by the issuer at the time or interest or principal payment. To minimize the risk of default , debt funds usually invest in securities from issuers who are rated by credit rating agencies and are considered to be  of "Investment Grade ". Debt funds that target high return  are more risky.

3. Gilt Funds : Also known as Government Securities in India , Gilt Funds invest in government  papers (named dated securities)  having  medium to long term maturity period . issued by the Government of India , these investments have little credit risk (risk of  default) and provide  safety of principal to  the investors . However , like all debt funds , gilt funds too are exposed to interest rate risk.  Interest rates and prices of debt securities are inversely related  and any change in the interest rates results in a change in the NAV of debt/ gilt  funds in an opposite  direction.

4. Money Market/Liquid Funds :  Money market /liquid  funds invest in short -term (maturing  within one year) interest bearing debt instrument . These securities are highly liquid and provide safety of investment, thus making investment option when compared with other mutual /liquid funds are exposed to the interest rate risk. The typical investment  option for liquid funds include Treasury Bills (issued by government ), commercial papers (issued by companies ) and certificates of deposit (issued by banks).

5. Hybrid Funds:  As the name  suggests , hybrid funds are those funds whose portfolio includes   a blend pf equities , debts and money market securities . Hybrid funds have an equal proportion  of debt  and equity in their portfolio.

6. Commodity Funds : Those funds that focus on investing in different commodities (like metals , food grains . crude oil etc.) or commodity  companies or commodity futures commodity  are termed as commodity  funds . A commodity fund that invests in a single commodity or a group  of commodities  is a  specialized commodity fund and a commodity fund that invests in all available commodities is a diversified commodity  fund and bears less risk than a specialized commodity fund . " Precious Metals Fund " and Gold Funds ( that invest in gold, gold futures or shares of gold  mines ) are common example of commodity funds.

7. Real Estate Funds : Funds that invest directly in real estate or lend to real estate developers or invest in shares /securitized assets of housing finance companies , are known as specialized Real Estate funds. The objective of these funds may be generate regular income income or investors or capital appreciation.

8. Exchange Traded Funds (ETF) : Exchange traded funds provided investors with combined benefits of a closed -end  and an open -end mutual fund. Exchange traded funds follow stock market indices and are traded on stock exchange like  a single stock at index linked prices. The biggest advantage offered by these funds is that they offer diversification , flexibility of holding a single share (tradable at index linked prices )  at the same time . Recently introduced in India , these funds are quite popular abroad.


9. Fund of funds :  Mutual funds that do not invest in financial  or physical , but do invest in other mutual fund schemes offered by different AMCs, are known as fund of  funds . Fund of Funds maintain  a portfolio  comprising of units of other mutual fund  scheme, just like conventional mutual funds maintain a portfolio comprising of equity /debt money market instrument or non financial assets . Fund of Funds provide investor with an added advantage of diversifying into different mutual fund schemes with  even a small amount   of investment , which further  helps in diversifying of risks . However , the expenses of fund of funds are quite high on account of compounding expenses of  investments into different mutual fund schemes.
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