Investment in Mutual Funds : Some Basic Facts

NRI investors can invest in India through mutual fund route instead of investing directly in stock market.. Mutual funds offer several advatages over investing in individual stocks . The investors in these funds avail expertise and dedicated time of professional manager known as Fund Manager. However , as a word of caution it must be remembered that investment in Mutual funds is subject to market risk as it is subjected to the same ups and down s and risks as the stocks in which such funds invest.

This Article attempts to clear some of the basic terms used while dealing in mutual funds.

What is a mutual Fund ?

A mutual fund is a professionally-managed firm of collective investments that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities. In a mutual fund, the fund manager, who is also known as the portfolio manager, trades the fund's underlying securities, realizing capital gains or losses, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors.

What do mean by the term NAV?

The net asset value, or NAV, is the current market value of a fund's holdings, less the fund's liabilities, usually expressed as a per-unit amount. For most funds, the NAV is determined daily, after the close of trading on some specified financial exchange, butThe value of a share of the mutual fund, known as the net asset value per share (NAV), is calculated daily based on the total value of the fund divided by the number of shares currently issued and outstanding.

What are the various type of funds?

Type of funds

Open Ended funds

The term mutual fund is the common name for an open-end investment company. Being open-ended means that, at the end of every day, the fund issues new shares to investors and buys back shares from investors wishing to leave the fund. These funds have high risk reward ratio.

Close ended fund

The funds which do not contain the characteristics of open ended funds are called close ended funds.

Equity Funds

Equity funds, which consist mainly of stock investments, are the most common type of mutual fund. Equity funds hold 50 percent of all amounts invested in mutual funds in the United States. ^[5] Often equity funds focus investments on particular strategies and certain types of issuers.

Bond funds or Debt Funds

Investment of these funds is in Govt securities , Municipal bonds and central bank /RBI issued bonds .These bonds have a fixed set of time before maturity . Such bonds have lower return but have tax advantage and lower risk . High yield bond funds invest in corporate bonds including junk bonds. Bond funds can vary according to risk (e.g., high-yield junk bonds or investment-grade corporate bonds), type of issuers .

Liquid funds

As the name suggests such bonds invest in daily traded money markets investment papers. Such funds have lower rate of return but are extremely liquid and can be redeemed any time .

Sector Funds

Mutual funds can invest in many different kinds of securities. The most common are cash instruments, stock, and bonds, but there are hundreds of sub-categories. Stock funds, for instance, can invest primarily in the shares of a particular industry, such as technology or utilities. These are known as sector funds. Bond funds can vary according to risk (e.g., high-yield junk bonds or investment-grade corporate bonds), type of issuers (e.g.,

Fund of Funds

Funds of funds (FoF) are mutual funds which invest in other underlying mutual funds (i.e., they are funds comprised of other funds). The funds at the underlying level are typically funds which an investor can invest in individually. A fund of funds will typically charge a management fee which is smaller than that of a normal fund because it is considered a fee charged for asset allocation services.

Hedge Funds

Hedge funds in the United States are pooled investment funds with loose SEC regulation and should not be confused with mutual funds. Some hedge fund managers are required to register with SEC as investment advisers under the Investment Advisers Act. The Act does not require an adviser to follow or avoid any particular investment strategies, nor does it require or prohibit specific investments. Hedge funds typically charge a management fee of 1% or more, plus a "performance fee" of 20% of the hedge fund's profits. There may be a "lock-up" period, during which an investor cannot cash in shares. A variation of the hedge strategy is the 130-30 fund for individual investors.

Growth v/s Dividend option

Growth funds invest in companies that have potential for their capital appreciation . Such funds do not pay dividend but the investors can redeem some of the units held by them to reap capital gain. The capital appreciation reaped by the investor is subject to capital gain tax in India depending upon the time for which investment is held .

Dividend Option funds

As the name suggests such fund distribute a part of their income in the form of dividend. .Such dividends are tax free when received in the hands of investor.

What types of loads and expenses are charged by the funds?

Load and Expenses

Mutual funds bear expenses similar to other companies. The fee structure of a mutual fund can be divided into two or three main components: management fee, nonmanagement expense, and 12b-1/non-12b-1 fees. All expenses are expressed as a percentage of the average daily net assets of the fund.

A front-end load or sales charge is a commission paid to a broker by a mutual fund when shares are purchased, taken as a percentage of funds invested. The value of the investment is reduced by the amount of the load. Some funds have a deferred sales charge or back-end load. In this type of fund an investor pays no sales charge when purchasing shares, but will pay a commission out of the proceeds when shares are redeemed depending on how long they are held. Another derivative structure is a level-load fund, in which no sales charge is paid when buying the fund, but a back-end load may be charged if the shares purchased are sold within a year.

It is possible to buy many mutual funds without paying a sales charge. These are called no-load funds,being available directly from the fund company itself,.

References

1. ^ Frequently Asked Questions About Bond Mutual Funds. Investment Company Institute..
2. ^ Frequently Asked Questions About Bond Mutual Funds. Investment Company Institute.
3. ^ Frequently Asked Questions About Money Market Mutual Funds. Investment Company Institute. Retrieved on 2006-04-11.
4. ^{a b} Sources of Information Invest Wisely: An Introduction to Mutual Funds. U.S. Securities and Exchange Commission (SEC). Retrieved on 2006-04-11.