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Mutual Fund FAQ   What are the various types of mutual fund schemes? What are the factors that need to be considered while choosing a fund? What is the cost associated with mutual fund investing? How is the worth of investment in a mutual fund measured? What is NAV? Do mutual funds guarantee safety of capital and returns? What are the various ways in which fund performance can be measured? How relevant is past performance of a fund scheme? Do the fund managers commit to any particular investment philosophy and style? What risks is one exposed to while investing in mutual funds? What is Rupee Cost Averaging? What is an offer document? How does one read the offer document? What are the tax benefits one can avail of by investing in mutual funds? Aren't the recent tax provision of distribution tax biased against the small investors? Mutual fund advertisements make exaggerated claims. What points should one check to avoid being taken in by aggressive advertising and ever obliging salesmen? Where can information about mutual funds be found? Is there any minimum investment amount being stipulated by the scheme? What is the 'switching facility' offered by various funds? What needs to be done to buy units? How does my buy order get processed? What are the various types of mutual fund schemes? You'd be surprised at how many there are, especially if you've always thought mutual funds was one big amorphous entity! Well, there are means and means for classifying them - listed below are some of the most common criteria: Asset Class This classifies funds according to the class of assets they invest in. Investment Sector This segregates funds on the basis of the sub-sector or the special focus area on which the fund's investments are concentrated. Duration This basis uses the maturity time (i.e whether the funds have any specific maturity date or not) as the determinant for classifying the funds. Trading Strategy This classifies funds on the basis of the frequency with which the portfolio is turned over in the market. Investment Strategy This is based on the investment strategy being followed by the fund. Security Selection This classifies funds according to the criteria used by the fund to select securities for its portfolio. Objective of Investment Here the funds are classified on the basis of the investment objective: that is, the purpose for which the investor has invested in that fund, which could be anything ranging from higher education of children to tax-saving. Costs/Loads charged In this case, funds are classified on the basis of whether or not there are any fees charged (that's'load' in the mutual funds jargon!) on the purchase or sale of units. Top What do I need to keep in mind while selecting a fund? It all depends on what you want your money to do - get out there and earn you a large sum of money NOW, stay put and save you taxes, be readily convertible into cash if you're in a tight spot - the list of expectations is long and will vary from person to person. Once you've figured that initial bit for yourself, it'll be worth your while to remember the following points: Investment Needs It is essential to decide - why am I making this investment? To what purpose? This is because depending on your specific need, you can choose a specific investment avenue. For instance if you're investing for some future event like retirement or your children's marriage, and there's plenty of time left for both, it makes sense for you to invest in equity-dominated funds. On the other hand, if you want to invest the lump sum you get on retirement for a regular income that sees you through your retired life, then a fixed income dominated fund would be best for you. Risk Profile How much of a daredevil are you? Does thinking of even the slightest risk or uncertainty make you break out in cold sweat? It is vital that you invest according to your appetite for risk-taking! Thus, if you're the kind who'd rather be safe than sorry, equity funds would not be suitable for you as volatile equity markets can impact fund returns, so you can imagine what effect they'd have on you! Time Frame How long do you want your funds to stay tied up? Are you comfortable waiting for the money to come to you at some future date or would you rather have it as fast as possible? Would you prefer it in a lump sum or in smaller, regular amounts? Different funds meet different time-based needs. Generally, equity funds are considered to be performers over a relatively longer period of time. In the short term, they are prone to market fluctuations. Thus, if you have invested in an equity fund, at the time of withdrawal of your investment, you may not get any returns at all! In such a case, rather than going for an equity fund, you might consider an income fund or a money market scheme instead. Liquidity This is linked to the above point. If the time frame of the investment is short, then it is not really advisable to invest in close-ended schemes. Units of these schemes are generally listed on stock exchanges, and past experience has shown that they quote at a heavy discount to their value. So if you're in a hurry, a close-end scheme may not be your thing. On the other hand, if you're willing to invest for a certain defined period, a close-ended scheme may be perfect. Not just when you'll get your money - but also how well the fund will be able to liquidate its portfolio - that's another thing you should look into before choosing your mutual fund. Service Levels / Expenses With most top funds offering similar returns, service levels have become a major differentiating factor. Choose a fund that offers efficient service in terms of prompt delivery of account statements and quick redressal of grievances. Also consider the charges you'll have to pay and the expense ratios of the funds you propose to invest in. It may sound like a drag, but it's better to be warned beforehand than shocked later! Transparency How much do you know about the fund? For your peace of mind and for the safety of your money, choose a fund that is open about its investments, its investment style, and has a history of clear and direct communication with its investors. Top What are the costs involved in mutual fund investing? Ah - that all-important question - what kind of hole will it burn in your pocket! Well, there are a few charges involved, but if you think of all the bother they're saving you and the money that you stand to earn, you won't mind paying up! In addition to what are called 'loads' (explained below), a mutual fund also charges asset management fees and certain other expenses. These charges compensate the fund for the expenses it incurs in managing assets, processing transactions and paying brokerages. For instance, every redemption request involves not only administrative processing costs but also other costs associated with raising money to pay off the outgoing investor. However, it'll please you to know that there's nothing arbitrary about these charges. For example, regulations stipulate that the difference between the repurchase and the resale price cannot exceed 7 % of sale price, and that recurring expenses cannot exceed 2.5 % of average weekly net assets. The recurring expenses limit is even lower for schemes with a size exceeding Rs. 100 crores in net assets. So if ever you get the feeling that you're being fleeced, don't, because there's somebody making sure that all is fair and square! Loads: Don't look at these as a burden, just think of them as tolls you pay on the highway to big money! Entry Load/Sale Load This is the charge imposed at the time you enter a fund as an investor. You pay for the value of the units plus an additional charge. That additional charge is termed entry/sale load. Exit Load/Repurchase Load The opposite of the above! This is what you cough up at the time of your exit from the scheme. Operationally, therefore, what you get back from the mutual fund will be the value of the units minus the exit charge. Contingent Deferred Sales Charge A mutual fund may not want to charge an exit load in all cases. But it will still need to recover the expenses incurred on the promotion and distribution of a scheme. What it does then is impose a charge based on the time of withdrawal. Thus, a fund that prefers long-term investors may stipulate that the exit charge will keep reducing with the increasing duration of investment. Such a charge is called Contingent Deferred Sales Charge (CDSC). The asset management company is entitled to levy a CDSC for redemption during the first four years after purchase, not exceeding 4% of the redemption proceeds in the first year, 3% in the second year, 2% in the third year and 1% in the fourth year. In order to charge a CDSC, the scheme has to be a no-load scheme as per the regulations laid down by SEBI. Switchover/Exchange Fee This is what you pay if you decide to switch your investment from one scheme of the fund to another scheme from the same fund family. Recurring Expenses: Apart from loads, mutual funds also charge some other expenses, such as: Investment Management & Advisory Fees: As the name suggests, this is meant to remunerate the asset management company for managing the investor's money. Trustee Fees: These are fees payable to the trustees for managing the trust. Custodian Fees: These are paid by the fund to its custodians, the organisation which handles the possession of the securities invested in by the fund. Registrar and Transfer Agents Charges : The fees payable to the registrar and the transfer agents for handling all formalities related to the transfer of units and other related operations. Broker/Dealer Remuneration, Audit Fees, Cost of Funds Transfer, Cost of providing a/c statements, Cost of Statutory Advertisements. But remember, all these are regulated and have an upper limit, so you won't go broke trying to earn money! Top How is the worth of an investment in a mutual fund measured? What is NAV? The current value of your investment can be known from the Net Asset Value or the NAV. The NAV, in effect, measures the value of the net assets (gross assets less liabilities) per unit. Mathematically, the NAV is given by: {(Market Value of the Scheme's Investments) + Other Assets (including accrued interest) + Unamortised Issue Expenses (only in case of schemes launched on a load basis) - All Liabilities except unit capital and reserves)} Divided by the number of units outstanding at the end of the day. [All assets and liabilities valued at the current prices.] Top Do mutual funds guarantee safety of capital and returns? No, not normally. Neither returns nor capital is guaranteed in most mutual fund schemes. While full term assured schemes - both equity and debt - have been launched in the past, they are now being phased out with the maximum period of assurance having been limited to one year. Thus, according to the regulations of SEBI - no mutual fund scheme can assure a return beyond a period of one year. Unlike a fixed deposit in a bank, you cannot expect an assured return from a mutual fund. If that's making you think - why on earth am I considering mutual funds? - take a step back and consider this. Though mutual funds may not offer assured returns, remember that through diversification of investments your risks are drastically lowered. Be it the threat of capital depreciation or erosion of capital, you manage to avoid both. This applies more so in the case of say, income funds. Equity funds are the ones affected by the volatile nature of equity markets so if be selective, you still stand a chance to gain rather than lose in the long run Top What are the various ways in which fund performance can be measured? Well, start with the NAV! That's what serves as the basic material for evaluating the performance of a fund. Some of the methods used are explained below: Relative-To-Benchmark method Under this method, a comparison is made between the returns given by a market index and the fund over a given period of time. If the returns generated by the fund (as measured by changes in NAV over that given period of time) are greater than those generated by the benchmark, then the fund is said to have outperformed the market portfolio. Risk-Return method The Relative-to-Benchmark measure is very simplistic, as it does not incorporate any measure of risk in its calculation. An investor would naturally be interested in finding out the return generated for the risk undertaken, as, in a bid to generate super-normal returns, the fund may go overboard on the risk parameter. Therefore, risk-adjusted measures of return are needed to evaluate the performance of funds. There are several such measures prominent among which are the Sharpe ratio, the Treynor ratio, and Alpha: Sharpe ratio This measure uses standard deviation as a measure to evaluate a fund's risk-adjusted returns. The higher a fund's Sharpe ratio, the better it is. Thus, a fund's returns would be regarded good if the fund returns a high level of Sharpe ratio. Mathematically, it is arrived at by deducting the risk-free returns from the returns generated by the fund and dividing the residual figure by the standard deviation of the fund's returns. One thing that has to be kept in mind while using this measure is that the ratio is not an absolute figure. Its real utility lies in inter-scheme comparison. Treynor's ratio Treynor's ratio also has the same attributes as Sharpe's with the difference that the residual figure in this case is divided by beta rather than the standard deviation, thus reflecting only the systematic risk. Beta of the fund is a volatility measure that quantifies the sensitivity of the fund's return to the benchmark index's returns, i.e., given the movements of the benchmark how much the fund will move. It does not represent unsystematic risk under the assumption that the fund manager can easily wipe out the unsystematic risk by diversifying across a large number of stocks. Alpha Basically, alpha is the difference between the return that would be warranted by its beta (expected return) and the return that is actually generated by the fund. If a fund returns more than what is anticipated by beta, it has a positive and favourable alpha, and if it returns less than the amount predicted by beta, the fund has a negative alpha. Mathematically, Alpha = fund return - [Risk free rate + Beta of fund (Benchmark return - Risk free return)] Top How relevant is the past performance of a fund scheme? That's a difficult one! Fund prospectuses will clearly tell you that "past performance is no indicator of the future", but, on the other hand, many analysts will tell you that sustained performance over a reasonably long period of time is a good criteria. There is truth in both points of view. While past performance reflects the success of the fund manager, the broad investment strategy and related factors, it serves as no guarantee that the strategy will work equally well in the future. A change in the external environment could necessitate a change in investment strategy too. Again, past successes could imply that the probability of future successes is respectably high. So it's one of those issues where you'll have to rely partly on information and partly on intuition! Top Do fund managers commit themselves to any particular investment philosophy and style? Normally fund managers do define the approach they intend to adopt to realise the investment objective of the scheme. In fact, if you want to know what your fund manager's philosophy is, go through the fund offer documents and other communication - that should give you a clear idea of what the fund manager proposes to do with your money, and how! Infact you can analyze any fund on our site Fund Analyzer Top What are the risks involved in investing in mutual funds? As they say, forewarned is forearmed! Go ahead, get acquainted with the types of risk involved: Market risk If the overall stock or bond markets fall on account of macro economic factors, the value of stock or bond holdings in the fund's portfolio can drop, thereby impacting the NAV. Non-market risk Bad news about an individual company can pull down its stock price, which can negatively affect funds holding a large quantity of that stock. This risk can be reduced by having a diversified portfolio that consists of a wide variety of stocks drawn from different industries. Interest rate risk Bond prices and interest rates move in opposite directions. When interest rates rise, bond prices fall and this decline in underlying securities affects the NAV negatively. How bad the damage will be is dependant on factors such as maturity profile, liquidity etc. Credit risk Bonds are debt obligations. So when the funds invest in corporate bonds, they run the risk of the corporates defaulting on their interest and principal payment obligations and when that risk crystallizes, it leads to a fall in the value of the bond causing the NAV of the fund to take a beating Top What is Rupee Cost Averaging? Rupee cost averaging is an investment strategy in which equal amounts of money are invested in a scheme at regular intervals. So, you can buy a lower number of units when the NAV is high and a higher number of units when the NAV is low. What it does, in effect, is eliminate the need to keep a continuous track of the market. Regular investment over a period of time evens out the short term fluctuations associated with the market's volatility, so neither you nor the fund suffers. Top What is an offer document? An offer document is a document that offers you all the information you could possibly need about a particular scheme and the fund launching that scheme. That way, before you put in your money, you're well aware of the risks etc involved. This has to be designed in accordance with the guidelines stipulated by SEBI and the prospectus must disclose details about: investment objectives risk factors and special considerations summary of expenses constitution of the fund guidelines on how to invest organization and capital structure tax provisions related to transactions financial information Top Do I actually have to read the whole offer document? I don't think I'll understand it! Relax, you don't have to punish yourself trying to decode all the legal jargon that's there in offer documents! You needn't read all the sections in such great detail. However the sections you can't afford to miss would be those addressing investment objectives, investment philosophy, expenses, fund management background, sale and repurchase procedures, potential risks, financial highlights, and past records. Once you've familiarised yourself with these basic and vital details, you can consider yourself ready to invest! Top What tax benefits will I get by investing in mutual funds? The investment in mutual funds designated as Equity Linked Saving Scheme (ELSS) qualifies for rebate under section 88. The maximum amount that can be invested in these schemes is Rs.10,000, therefore the maximum tax benefit available works out to Rs.2000. Apart from ELSS schemes, the benefit of Section 88 is also available in select schemes of some funds such as UTI ULIP, Pension Plans, Unit linked insurance schemes etc. The investor in a mutual fund is exempt from paying any tax on the dividend received by him from the mutual fund, irrespective of the type of the mutual fund. This benefit is available under section 10(33) of the I.T. Act. The units of mutual funds are treated as capital assets and the investor has to pay capital gains tax on the sale proceeds of mutual fund units sold by him. For investments held for less than one year the tax is equal to 30% of the capital gain. For investments held for more than one year, the tax is equal to 10% of the capital gains. The investor is entitled to indexation benefit while computing capital gains tax. Some schemes also offered the benefit of section 54EA and 54EB to the investors. This benefit now stands withdrawn and only those investors who have sold off their properties prior to 31st March, 2000 and amount is invested prior to 30th September,2000 are eligible to take advantage of the provision. The mutual funds are completely exempt from paying taxes on dividends/interest/capital gains earned by them. While this is a benefit to the fund, it is the indirect benefit of unit holders as well. This benefit is available to the mutual fund under section 10 (23D) of the I.T. Act. A mutual fund has to pay a withholding tax of 10% on the dividends distributed by it under the revised provisions of the I.T. Act putting them on par with corporates. However an open ended mutual fund which has invested more than 50% of its assets into equity shares is exempt from paying any tax on the dividend distributed by it, for a period of three years, by an overriding provision. This benefit is available under section 115R of the I.T. Act. Top Aren't the recent tax provisions regarding distribution tax biased against the small investors? Yes, in a sense they are. This is because the small investor is no longer in a position to avail the benefit of section 80-L where a deduction could be claimed on dividends received from mutual funds. Now, while the dividend has been made tax-free in the hands of the investors, it is the mutual funds - other than open-ended equity funds - who now have to pay the distribution tax of 10.2% (including surcharge). Therefore, the small investors who were earlier in a position to exhaust the 80-L limit and dilute their tax liability will now not be able to get a tax benefit. What will happen instead is that the investor will get dividend after tax has been deducted(as compared to gross dividend which he used to get earlier), the distribution tax already having been paid by the mutual fund. However mutual funds are exempt from this liability in respect of income distributed to a unit holder of open-ended equity oriented fund. Top Mutual fund advertisements make exaggerated claims. What points should one check to avoid being taken in by aggressive advertising and smooth-talking salesmen? As you already know by now, most mutual funds do not carry any guarantee. Neither are they insured by any bank or government agency. Even a fund carrying a bank's name does not offer guaranteed returns. Knowing all this, if you see an ad which makes promises that seem too good to be true, check out for yourself the basis on which such claims are being made. If what your investigation turns up doesn't match what has been advertised, you know who to believe! Secondly, check out the risk factor. Mutual funds always carry some investment risk or the other depending on the asset allocation of the scheme. Some types carry more risks than others. While you'll find most of the risk factors in the offer document itself, it makes sense to do a bit of background research to uncover all potential risks that may not have been stated upfront. Don't be taken in by claims of spectacular past performance. Like we mentioned earlier, past performance is not a reliable indicator of future performance and there is no guarantee that the fund manager will be able to consistently maintain it. And most importantly, total up how much it'll cost you! All mutual funds carry costs and loads that go on to reduce effective returns. You need to confirm all cost inputs before committing your money, or you might find you've bitten off more than you can chew! Top Where can I get information on mutual funds? Right here! ( Seems like a lot of people have been asking the same question!) Pick up a newspaper, a magazine, a journal, or visit a web site - and there you have it. All the relevant information you're looking for about mutual funds. Sites such as this, and business newspapers such as The Economic Times carry details and provide extensive coverage of mutual funds. Besides these, you can directly contact mutual funds and their agents for detailed, scheme specific information. Top Is there any minimum investment amount stipulated by a mutual fund scheme? Yes, there is indeed a minimum initial and subsequent level of investment stipulated by each mutual fund scheme. These amounts vary from fund to fund, so it'll depend on which one you finally go for. Top What is the 'switching facility' offered by various funds? Many mutual funds offer investors the benefit of mobility within the fund family i.e. unit-holders can move over from one scheme to another with or without the payment of entry/exit charges. The advantage of this is that you can quickly move your investments as and when market conditions change, thereby making the most of it! Top What do I need to do if I wish to buy units? You are in the right place! All you need to do is fill in the simple registration from and sign up the power of attorney and you are on! Having done this once, you can buy and sell Mutual Funds online through Times of Money. To understand in greater detail, read the "Tell me more" section. Top How does my buy order get processed? Most funds price their units on a prospective basis, i.e. you get to buy units at a price to be determined in the future. For this purpose each fund fixes a cut-off time. Applications for purchase or redemption submitted before the designated time are processed at a price linked to the NAV of that day (which, by the way, is announced at the end of that day) while applications submitted after the cut-off time are processed at a price linked to the NAV of the following day. This cut-off time determined varies from fund. So be sure to catch your deadlines! The number of units to be allotted - in case of purchase requests - is determined by dividing the amount invested by the applicable NAV based sale price. Normally, within a week of the purchase transaction, you will receive an account statement in the post confirming the NAV at which your investment has been made. Along with this, the statement will contain all the details you've given while applying for the units, as well as details about the broker. Top     Latest News India strong enough to grow at 8%: PM Mkts set new 2008 lows; how should one trade now? See crude at $4045/bbl in a month: Commodity Warrants Mkts end up 5.5% on short covering, +ve global mkts Don\'t expect mkts to breach past lows: Kotak Mahindra Bank Overall mkt structure getting weaker

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