Introduction of the Host

Mrs.Geetha Dasaraty is a commerce graduate with a Masters in Business Administration specialising in finance. Her stint with a Coimbatore based company and later with a consulting firm in Chennai has provided her with a decade of experience in project finance and appraisals, accounting and tax laws. She is a freelance writer and money matters are her forte. She is currently pursuing her final course in Company Secretaryship and is doing a course on Vaishnavism. She has a passion for literature and Carnatic music. She is also a violinist.

About the Class
We bring you an online class titled 'Elementary Finance'. This will have 12 lessons - one a month. Each lesson is further subdivided into 4 chapters. And we will give you one new chapter every week.

Chapter 8 Lesson B - Mutual Funds

In this lesson we will get to know mutual funds.
Mutual funds afford the investor the choice of a diversified mix of securities.

What is a mutual fund?
A mutual fund is basically an investment company. These companies are managed professionally by investment managers. The money received from the investors are put together and used for investment purposes. The managers with their expertise invest in a diverse portfolio of investments. The investors get a pro-rata interest on the investments of the fund.

Why invest in a mutual fund?

• Even a small investor can have the benefits of a diversified portfolio, by investing a small sum in a mutual fund, which would otherwise be impossible. A small investment is enough.
• The diversification that a mutual fund affords helps to spread the risk. This way you can get the best of both worlds.
• Mutual funds afford liquidity as the investors can redeem the shares.
• The dividends from the investments can be reinvested. Generally mutual funds do not charge for such reinvestment.
• Money can be withdrawn from the fund when required.

How do you measure the value of a mutual fund share?

The Net Asset Value measures the price of a mutual fund share.

                                         Total assets of the funds-Liabilities
The Net Asset Value = -------------------------------------------
                                      Number of shares outstanding in the fund.

Incomes from Mutual Funds

• Dividends
  These funds have separate laws governing them. The incomes of these funds are exempt from tax and for this the funds have to distribute 90% of their income every year. Dividends of mutual funds are taken as corporate dividends.
• Distribution of Capital Gains
  When mutual funds make a profit out of sale of securities, this profit will be distributed to the shareholders. Some funds invest in speculative stocks of new small companies to procure higher returns.
  Most mutual funds reinvest the dividends in the form of additional shares. So check out the number of shares to your credit from the latest statement and calculate the returns with the help of the net asset value.

Calculating the rate of returns of Mutual Fund Investments
The income from investments in mutual funds takes the form of dividends, price increases and capital gains distribution.

Income = Dividends + Capital Gain Distribution+(Net Asset Value at the end-Net Asset
                Value in the beginning.)
               Beginning Net Asset Value

Net asset Value at the end less Net Asset Value at the beginning represents the increase in price.

Fees on Mutual funds
There are many fees associated with mutual funds. All mutual funds charge fees.

Load: This is a type of commission on sales charged for the purchase of shares from different brokers. This charge ranges from 2 % to 8.5% on the initial investment. This will be added to the Net Asset Value on each share and given as the offer price. Not all the mutual funds add a load on the offer price and this in no way affects the performance of the mutual fund.
Expense and Management Fees: All mutual funds charge management fees. This fee is charged to pay the manager or advisor of the fund for handling the investments. These include the overhead expenses like office expenses and salaries. Fees are also charged to help cover the advertising charges. These give publicity to the funds and help draw in more money for the mutual funds.
Redemption Fees: These are also called exit fees. These fees are charged by some funds where an investor sells his shares.
Deferred sales charges or back-end Loads: These fees are charged when an investor withdraws money from the fund. The main purpose of these fees is to dissuade the investors from frequently trading on the stocks of the fund.

Types of Mutual Funds:

There are different types of Mutual Funds based on the fees charged by them, their
organisation structure , investment strategies and the nature of trading done by them.

• Open-end funds: These funds sell and redeem shares continuously and for an indefinite period of time. Here the shares are bought and sold to the fund itself. The purchase price of the shares will be the NAV+commission and sale price will be NAV-charges for services. These funds charge management fees.
• Closed end funds: Here shares have to be purchased from people selling them and while selling shares a buyer has to be located. Most of these funds sell at a discount. These funds also charge management fees.
• Load Funds: Funds that charge commissions on sales are load funds.
• No load funds: are those funds that do not charge commission on sales.
• Money Market Funds: These are funds that invest in short term securities like certificates of deposits and Government securities that mature within a year. These are no risk investments, which also procure high interest incomes.
• Income Funds: Income funds yield high interest and dividend income. These funds invest in stocks of blue chip companies with a good track record.
• Growth Funds: These funds are good as a long-term investment. The returns increase through capital gains.
• Aggressive Growth Funds: These funds invest in stocks of new companies. They are willing to take risks. You can invest in this if you are keen only on long term gains.
• Growth and income funds: These funds not only provide long term gains but also provide current income.
• Balanced Funds: These funds are a combination of stocks and bonds and like growth and income funds they provide both current income as well as long term growth.
• Bonds and preferred stocks funds: the aim of these funds is more towards income than long term growth. They invest in bonds and preference shares. If you are under the high tax bracket invest in tax-free municipal bonds.
• Sector or Specialised Funds: These funds invest in the stock of one or two industries. These are specialised funds and are a bit risky as the price of the shares will rise and fall depending on how well the industry fares.
• International Funds: These funds invest in stocks and bonds of companies that trade on foreign exchanges.

Different plans in Mutual Funds

• Withdrawal Plan: Under this plan investors can opt for monthly or quarterly payments.
• Accumulation Plans: These plans allow the investors to invest on a monthly basis. These are ideal for long-term investors.
• Dividend reinvestment: Under this plan all the income from dividends and capital gains are reinvested.
• Life insurance -mutual fund plans: These funds combine life insurance with the shares of a particular mutual fund. Under this scheme if the mutual fund does well it will pay the life insurance premium otherwise the investor will have to pay it himself.

Money market funds: These funds invest in short-term securities like Government securities, Certificate of Deposits and commercial paper. These funds are safe and risk free. These funds require low investments and can be used as a parking place while deciding on future investments.

Unit Investment Trusts: These are similar to Mutual Funds in that they allow small investors a diversified investment portfolio. They are ideal for investors who need a regular fixed income. The difference between Unit Trusts and Mutual Funds is that the portfolio here is fixed.

How to choose a Mutual Fund?

• Look at the prospectus. Ascertain the risk factors, management perception and the objects of the scheme.
• Prepare a list of funds.
• Analyse the funds performance in the last three years. Analyse the financial and market performance, and redemption payments for the last three years.
• Confirm about the quality of management, its team record, experience and capability of the Management Company.
• The existing asset portfolio should be analyzed.
• Compare the payment of various fees, sales charges and services offered.

Whether you buy mutual fund shares from the Mutual Fund Company or brokers and intermediaries check out the performance of the fund before you buy.

Questions on Chapter 8 Lesson A
1. What are fixed income securities?
2. What are the different types of bonds?