Financial Services: Mutual Funds | Commerce & Accountancy Optional Notes for UPSC PDF Download

Introduction

• Mutual funds serve as financial instruments that pool resources from numerous investors. These pooled funds are subsequently invested in a variety of securities, including shares, bonds, and money market tools. This collective investment approach allows individuals to invest their savings, even with modest amounts, while benefiting from the expertise of professional money managers or large companies who manage the funds. The choice of securities is guided by the fund's objective, which can vary from capital appreciation to regular dividend gains.
• Investors can choose from different types of mutual funds, each offering a range of investment avenues. Mutual fund managers may invest in company shares, debt securities, or physical assets, and investors share in the total profit or loss of the mutual funds based on their investments.

Key Features of Mutual Funds

• Convenience: Investors can easily manage their investments online, without the need to personally evaluate various securities.
• Investment Flexibility: Mutual funds offer investors the flexibility to make lump-sum payments or monthly installments, allowing them to choose a fund that suits their budget.
• Liquidity: Investors can readily access their funds, with the option to stop regular payments and receive their funds within a few days.
• Charges: Mutual funds generally have a small expense ratio fee, which investors pay to the company for managing the fund.
• Regulation: Mutual funds are regulated by SEBI, ensuring that companies adhere to regulatory standards and are registered before commencing operations.
• Diversification: Mutual funds often invest in a range of securities, which helps to lower risks and potentially improve investment gains.

Functions of Mutual Funds in India

Mutual funds in India serve several primary functions:

• Investment Management: Mutual funds effectively manage investors' money by pooling funds and investing them across various options.
• Professional Expertise: Mutual funds provide access to professional portfolio management expertise, helping investors make better investment choices.
• Transparency: Mutual funds share portfolio details with investors, ensuring transparency and allowing investors to understand how their money is invested.
• Risk Management: By diversifying investments across multiple securities, mutual funds help reduce investment risks for investors.
• Easy Investments: Mutual funds offer accessible investment options with straightforward online payment and registration processes.

Objectives of Mutual Funds

While specific mutual fund companies may have varied objectives, some general objectives apply to most funds:

• Asset Diversification: Mutual funds aim to diversify investors' assets by investing in several securities across different domains, thereby mitigating risks.
• Income Generation: Mutual funds can provide regular dividends, offering investors an additional source of income.
• Safeguarding Capital: Mutual funds offer a low-risk investment option due to their diverse portfolio, ensuring capital safeguarding.
• Growth Initiation: Mutual funds can facilitate capital gains, promoting long-term savings and wealth accumulation.
• Investment Promotion: Mutual funds provide an easy platform for investors to initiate and manage their investments, encouraging saving and investment habits.

Mutual Fund Structures

Mutual funds are categorized into three basic types based on their structure:

• Open-Ended Mutual Funds: These funds allow investors to buy or sell units at their convenience. The unit capital fluctuates as the fund may buy back existing units or sell new ones. This flexibility provides better liquidity.
• Close-Ended Mutual Funds: These funds have a fixed duration, usually several years. Investors can only invest during the new fund offer period, and the unit capital remains constant. Investors cannot exit or enter these funds after the offering, although they may be listed on stock exchanges for trading.
• Interval Schemes: These schemes combine features of both open-ended and close-ended funds. Investors can trade units only during specific time frames, offering some liquidity. These funds may also be listed on stock exchanges.

Types of Mutual Funds

Different types of mutual funds cater to various investor budgets and goals:

• Equity/Growth Schemes: These funds invest in equity or stock market securities, usually from different companies. They typically carry higher risks but offer better growth potential.
• Money Market/Liquid Funds: These funds invest in short-term debt securities, offering reasonable growth for a shorter period. They are less risky.
• Fixed/Debt Funds: These funds invest in debt instruments like bonds, government securities, and debentures, providing a steady interest income with lower risk.
• Balanced Funds: These funds have investments in both equity and debt, balancing the portfolio according to market conditions. They offer moderate risk and steady returns.

Pricing of Mutual Funds

• Most mutual funds use the Net Asset Value (NAV) method for pricing, which allows for daily price checks due to fluctuations in securities. The NAV represents the total value of the mutual fund's cash and securities, minus liabilities, divided by the total outstanding shares. 
• The NAV impacts returns, as the mutual fund price can rise or fall based on the securities. Some funds may use an average of prices over three days.

Pros of Mutual Fund Investing

Mutual funds offer several advantages for investors:

• Advanced Management: Mutual funds are often managed by expert portfolio managers who select the best investment options.
• Reinvestment: Mutual funds often reinvest dividends, allowing investors to earn money from their initial income.
• Safety: Mutual funds pool multiple investment options, providing better safety through diversification.
• Convenience: Mutual funds offer an easy option for investors who don't want to research every security individually.
• Fair Prices: Mutual funds calculate daily values, helping investors understand their true price.

Cons of Mutual Fund Investing

Despite the advantages, mutual funds also have some drawbacks:

• High Expense: Investors must watch for high expense ratios, as fund companies may charge significant fees.
• Management Abuses: Mutual funds are often at the management's discretion, potentially leading to window-dressing for a better image.
• Tax Inefficiency: Gains from fund value or other incomes may not be tax-efficient.
• No Guarantees: Mutual funds don't offer safety guarantees, and investors can still lose money even with low-risk funds.
• Cash Drags: Mutual funds often hold a higher cash proportion to fulfill sales and redemptions, which may not earn any income.

Examples

Some mutual fund examples in India include:

• HDFC Equity Fund: Managed by HDFC Bank, this fund invests in equity.
• SBI Equity Hybrid Fund: This fund has both debt and stock market investments.
• HDFC Liquid Funds: This fund focuses on debt securities.

Conclusion

Mutual funds have gained popularity, allowing people to invest even with small savings. They offer a safer option and a range of choices based on risk and budget. However, investors should carefully evaluate funds and their securities before investing.