History of Mutual Funds - Investment in Mutual Funds, Investing in Stock Markets | Investing in Stock Markets - B Com PDF Download

It been quite a while since mutual funds have come in to existence but there are still investors who are not every clear on the Mutual fund concept. Read this to know the ABC of Mutual fund, how it came in to existence, and what is the structure that we follow in India.

A mutual fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested in capital market instruments such as shares, debentures, and other securities. The income earned through these investments is shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

Investments in securities are spread across a wide cross section of industries and sectors and thereby reduce the risk. Asset Management Companies (AMCs) normally come out with a number of schemes with different investment objectives from time to time. A mutual fund is required to be registered with the Securities and Exchange Board of India (SEBI), which regulates securities markets before it can collect funds from the public.

History of Mutual Funds

Prof K Geert Rouwenhorst in 'The Origins of Mutual Funds', states that the origin of pooled investing concept dates back to the late 1700s in Europe, when "a Dutch merchant and broker invited subscriptions from investors to form a trust to provide an opportunity to diversify for small investors with limited means." The emergence of "investment pooling" in England in the 1800s brought the concept closer to the US shores.

The enactment of two British laws, the Joint Stock Companies Acts of 1862 and 1867, permitted investors to share in the profits of an investment enterprise and limited investor liability to the amount of investment capital devoted to the enterprise. Shortly thereafter, in 1868, the Foreign and Colonial Government Trust was formed in London.

It resembled the US fund model in basic structure, providing "the investor of moderate means the same advantages as the large capitalists by spreading the investment over a number of different stocks." More importantly, the British fund model established a direct link with the US securities markets, helping finance the development of the post-Civil War US economy.

The Scottish American Investment Trust, formed in February 1873, by fund pioneer Robert Fleming, invested in the economic potential of the US, chiefly through American railroad bonds. Many other trusts followed them, who not only targeted investment in America, but led to the introduction of the fund investing concept on the US shores in the late 1800s and the early 1900s. The first mutual or 'open-ended' fund was introduced in Boston in March 1924. The Massachusetts Investors Trust, which was formed as a common law trust, introduced important innovations to the investment company concept by establishing a simplified capital structure, continuous offering of shares, and the ability to redeem shares rather than holding them until dissolution of the fund and a set of clear investment restrictions as well as policies.

The stock market crash of 1929 and the Great Depression that followed greatly hampered the growth of pooled investments until a succession of landmark securities laws, beginning with the Securities Act, 1933 and concluded with the Investment Company Act, 1940, reinvigorated investor confidence. Renewed investor confidence and many innovations led to relatively steady growth in industry assets and number of accounts.

The Mutual Fund Industry In India:

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India (UTI) at the initiative of the Reserve Bank of India (RBI) and the Government of India. The objective then was to attract small investors and introduce them to market investments. Since then, the history of mutual funds in India can be broadly divided into six distinct phases.

Phase I (1964-87): Growth Of UTI:

In 1963, UTI was established by an Act of Parliament. As it was the only entity offering mutual funds in India, it had a monopoly. Operationally, UTI was set up by the Reserve Bank of India (RBI), but was later delinked from the RBI. The first scheme, and for long one of the largest launched by UTI, was Unit Scheme 1964.

Later in the 1970s and 80s, UTI started innovating and offering different schemes to suit the needs of different classes of investors. Unit Linked Insurance Plan (ULIP) was launched in 1971. The first Indian offshore fund, India Fund was launched in August 1986. In absolute terms, the investible funds corpus of UTI was about Rs 600 crores in 1984. By 1987-88, the assets under management (AUM) of UTI had grown 10 times to Rs 6,700 crores.

Phase II (1987-93): Entry of Public Sector Funds:

The year 1987 marked the entry of other public sector mutual funds. With the opening up of the economy, many public sector banks and institutions were allowed to establish mutual funds. The State Bank of India established the first non-UTI Mutual Fund, SBI Mutual Fund in November 1987. This was followed by Canbank Mutual Fund,LIC Mutual Fund, Indian Bank Mutual Fund, Bank of India Mutual Fund, GIC Mutual Fund and PNB Mutual Fund. From 1987-88 to 1992-93, the AUM increased from Rs 6,700 crores to Rs 47,004 crores, nearly seven times. During this period, investors showed a marked interest in mutual funds, allocating a larger part of their savings to investments in the funds.

Phase III (1993-96): Emergence of Private Funds:

A new era in the mutual fund industry began in 1993 with the permission granted for the entry of private sector funds. This gave the Indian investors a broader choice of 'fund families' and increasing competition to the existing public sector funds. Quite significantly foreign fund management companies were also allowed to operate mutual funds, most of them coming into India through their joint ventures with Indian promoters.

The private funds have brought in with them latest product innovations, investment management techniques and investor-servicing technologies. During the year 1993-94, five private sector fund houses launched their schemes followed by six others in 1994-95.

Phase IV (1996-99): Growth And SEBI Regulation:

Since 1996, the mutual fund industry scaled newer heights in terms of mobilization of funds and number of players. Deregulation and liberalization of the Indian economy had introduced competition and provided impetus to the growth of the industry.

A comprehensive set of regulations for all mutual funds operating in India was introduced with SEBI (Mutual Fund) Regulations, 1996. These regulations set uniform standards for all funds. Erstwhile UTI voluntarily adopted SEBI guidelines for its new schemes. Similarly, the budget of the Union government in 1999 took a big step in exempting all mutual fund dividends from income tax in the hands of the investors. During this phase, both SEBI and Association of Mutual Funds of India (AMFI) launched Investor Awareness Programme aimed at educating the investors about investing through MFs.

Phase V (1999-2004): Emergence of a Large and Uniform Industry:

The year 1999 marked the beginning of a new phase in the history of the mutual fund industry in India, a phase of significant growth in terms of both amount mobilized from investors and assets under management. In February 2003, the UTI Act was repealed. UTI no longer has a special legal status as a trust established by an act of Parliament. Instead it has adopted the same structure as any other fund in India - a trust and an AMC.

UTI Mutual Fund is the present name of the erstwhile Unit Trust of India (UTI). While UTI functioned under a separate law of the Indian Parliament earlier, UTI Mutual Fund is now under the SEBI's (Mutual Funds) Regulations, 1996 like all other mutual funds in India.

The emergence of a uniform industry with the same structure, operations and regulations make it easier for distributors and investors to deal with any fund house. Between 1999 and 2005 the size of the industry has doubled in terms of AUM which have gone from above Rs 68,000 crores to over Rs 1,50,000 crores.

Phase VI (From 2004 Onwards): Consolidation and Growth:

The industry has lately witnessed a spate of mergers and acquisitions, most recent ones being the acquisition of schemes of Allianz Mutual Fund by Birla Sun Life, PNB Mutual Fund by Principal, among others. At the same time, more international players continue to enter India including Fidelity, one of the largest funds in the world.

Structure Of Mutual Funds In India:

In India, the mutual fund industry is highly regulated with a view to imparting operational transparency and protecting the investor's interest. The structure of a mutual fund is determined by SEBI regulations. These regulations require a fund to be established in the form of a trust under the Indian Trust Act, 1882. A mutual fund is typically externally managed. It is now an operating company with employees in the traditional sense.

Instead, a fund relies upon third parties that are either affiliated organizations or independent contractors to carry out its business activities such as investing in securities. A mutual fund operates through a four-tier structure. The four parties that are required to be involved are a sponsor, Board of Trustees, an asset management company and a custodian.

Sponsor: A sponsor is a body corporate who establishes a mutual fund. It may be one person acting alone or together with another corporate body. Additionally, the sponsor is expected to contribute at least 40% to the net worth of the AMC. However, if any person holds 40% or more of the net worth of an AMC, he shall be deemed to be a sponsor and will be required to fulfill the eligibility criteria specified in the mutual fund regulation.

Board Of Trustees: A mutual fund house must have an independent Board of Trustees, where two-thirds of the trustees are independent persons who are not associated with the sponsor in any manner. The Board of Trustees of the trustee company holds the property of the mutual fund in trust for the benefit of the unit-holders. They are responsible for protecting the unit-holder's interest.

Asset Management Company: The role of an AMC is highly significant in the mutual fund operation. They are the fund managers i.e. they invest investors' money in various securities (equity, debt and money market instruments) after proper research of market conditions and the financial performance of individual companies and specific securities in the effort to meet or beat average market return and analysis. They also look after the administrative functions of a mutual fund for which they charge management fee.

Custodian: The mutual fund is required by law to protect their portfolio securities by placing them with a custodian. Nearly all mutual funds use qualified bank custodians. Only a registered custodian under the SEBI regulation can act as a custodian to a mutual fund.

Over the years, with the involvement of the RBI and SEBI, the mutual fund industry has evolved in a big way giving investors an opportunity to make the most of this investment avenue. With a proper structure in place, the industry has been able to cater to more number of investors. With the increase in awareness about mutual funds several new players have joined the bandwagon.