Mutual Funds & Pension Funds | UGC NET Commerce Preparation Course PDF Download

What are Mutual Funds? 

Mutual funds are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of securities such as stocks, bonds, or money market instruments. This pooling of funds allows individual investors to access a professionally managed and diversified investment portfolio that they may not be able to create on their own.

• Mutual funds enable small investors to start investing even with a small amount of money.
• These funds are managed by professional money managers or large financial institutions who make decisions on which securities to buy or sell.
• Mutual funds have specific investment objectives that cater to the needs of investors, ranging from capital appreciation to regular dividend income.
• Investors need to assess the different types of mutual funds available to choose the ones that align with their investment goals and risk tolerance.
• Fund managers can invest in a variety of assets, including stocks, bonds, and sometimes physical assets, depending on the fund's investment strategy.
• Investors in mutual funds share the gains or losses of the fund proportionally to their investments.

Features of Mutual Fund

Read below the integral features of mutual funds instruments.

• Convenience: Mutual funds provide investors with ease and simplicity. Investors can manage their investments directly from their laptops, following straightforward payment steps. They are relieved from the need to compare various securities on their own.
• Investment Flexibility: Mutual funds offer individuals the choice to invest a lump sum amount or make monthly contributions. This flexibility allows investors to select a fund that aligns with their financial capacity, enhancing payment convenience.
• Liquidity: Mutual funds are characterized by their liquidity. Investors can easily withdraw their funds, halt regular contributions, and typically receive their money within a few days, providing them with quick access to their investments.
• Charges: Mutual funds entail a minimal expense ratio fee that investors need to pay to the fund company, ensuring cost-effectiveness in managing investments.
• Regulation: Mutual funds operate under the monitoring of SEBI, which oversees the activities of different fund companies. Companies are required to register with SEBI before initiating their operations, ensuring regulatory compliance and investor protection.
• Diversification: Mutual funds play a crucial role in reducing investment risks by diversifying across various securities. This strategy aims to enhance investment returns by spreading out the investment across different asset classes.

Functions of Mutual Funds

Mutual funds have specific roles and objectives in India. Let's explore their primary functions in detail:

•  Investment management:  Mutual funds oversee investors' funds, pooling them into various investment avenues.
•  Professional expertise:  Mutual funds offer expert guidance, employing professionals for portfolio management to enhance investment choices.
•  Transparency:  Mutual funds disclose portfolio details to investors, enabling them to comprehend how their finances are invested.
•  Risk management:  Mutual fund companies mitigate risks by diversifying investments across multiple securities, reducing risks for investors.
•  Easy investments:  Mutual funds provide convenient investment options, allowing investors to easily select suitable funds with hassle-free online processes for payments and registrations.

Objectives of Mutual Funds

Mutual fund companies often have various objectives, but there are some general ones common to all funds. Let's delve into them below:

Mutual Fund Asset Diversification

• Mutual funds aim to diversify investments by allowing investors to choose from a variety of securities. Investors only need to invest a set amount, and the fund takes care of diversifying the rest of the assets. This strategy helps in earning from different investment domains.

Income Generation

• Mutual funds assist investors in generating income by providing regular dividends. Some companies offer high dividends, creating a stable additional income source for investors.

Safeguarding Capital

• Mutual funds offer a low-risk option by spreading investments across multiple securities, making them a safer choice for investors. This diversification helps in safeguarding capital.

Initiating Growth

• Capital gains in mutual funds facilitate growth for investors, enabling long-term savings and wealth accumulation.

Promoting Investments

• Mutual funds provide a convenient platform for investors to manage their investments from the comfort of their homes. This accessibility encourages the development of a saving and investment habit among individuals.

Structure of Mutual Funds

Mutual funds come in three primary types based on their structure. Let's delve into each of them:

Open-Ended Mutual Funds

• Open-ended mutual funds allow investors to buy or sell units at any time. The flexibility is high, with unit capital constantly changing due to buying back and selling of existing units by the company. Investors enjoy greater convenience matching their financial needs, enhancing liquidity.

Close-Ended Mutual Funds

• Close-ended mutual funds operate for a fixed duration, often spanning a few years. Investors can only invest during the new fund offer period and cannot buy or sell units afterward. However, some funds might be traded on stock exchanges, providing a limited trading window.

Interval Schemes

• Interval schemes combine characteristics of both open and close-ended funds. Trading is restricted to specific time frames, offering moderate liquidity. These funds may also feature on stock exchanges.

Types of Mutual Funds

The investment market in India offers various types of mutual funds to cater to different budgets and financial goals of investors.

Equity/Growth Schemes

• These mutual funds primarily invest in equity or stock market securities of different companies, making them higher risk investments with the potential for better growth.

Money Market/Liquid Funds

• Money Market/Liquid Funds invest in short-term debt securities, offering reasonable growth potential over a shorter period while carrying lower risk.

Fixed/Debt Funds

• Fixed/Debt Funds invest in debt instruments such as bonds, government securities, and debentures, providing investors with a steady interest income and lower risk.

Balanced Funds

• Balanced Funds maintain a portfolio that includes investments in both equity and debt, adjusting to market conditions. They offer moderate risk levels and the potential for steady returns and growth.

How are Mutual Funds Priced? 

Most mutual funds determine their prices using the Net Asset Value (NAV) method. This method enables them to assess the daily value of the fund because the prices of the fund's underlying shares and securities can fluctuate. Daily trades can have an impact on the mutual fund's price.

Mutual Funds 

• NAV, which stands for Net Asset Value, signifies the price of the mutual fund. It is calculated by adding up the value of the fund's cash and securities and then subtracting any liabilities. The resulting amount is divided by the total number of outstanding shares.
• Changes in NAV directly affect the fund's returns. The mutual fund price can either decrease or increase within a day based on the performance of its underlying securities.
• Some mutual funds may opt to calculate the NAV by averaging the prices over a period, often three days, depending on the fund's specific methodology.

Pros of Mutual Fund Investing

• Advanced Management: Mutual funds are overseen by experienced managers who curate the portfolio, selecting optimal investment opportunities.
• Reinvestment: Mutual funds frequently reinvest dividends, allowing investors to generate additional income from their initial investments.
• Safety: By pooling various investment options, mutual funds offer enhanced safety through diversification, reducing individual risk.
• Convenience: Mutual funds provide a convenient investment option, sparing investors from the need to extensively research individual securities.
• Fair Prices: Mutual funds regularly calculate daily values, aiding investors in understanding the true value of their investments.

Cons of Mutual Fund Investing

Below are the drawbacks associated with investing in mutual funds:

Disadvantages of Mutual Funds

• High Expense: Investors need to be cautious of high expense ratios, as fund companies may charge significant fees.
• Management Abuses: Mutual funds are often subject to the discretion of management, who may manipulate fund performance for a more favorable appearance.
• Tax Inefficiency: Gains from fund value or other sources of income may not provide tax benefits to investors.
• No Guarantees: Mutual funds do not assure safety guarantees; even low-risk funds can lead to monetary losses for investors.
• Cash Drags: Mutual funds frequently hold a higher proportion of cash to meet sales and redemptions, which often remains unutilized and does not generate income.

Examples 

There are various instances of mutual funds in India that can help understand how they work:

• HDFC Equity Fund: Managed by HDFC Bank, this fund primarily invests in stocks (equities).
• SBI Equity Hybrid Fund: This fund is a mix of investments in both debt instruments and the stock market.
• HDFC Liquid Funds: These funds mainly invest in debt securities, offering stability and liquidity.

Summary 

In summary, mutual funds in India, such as HDFC Equity Fund, SBI Equity Hybrid Fund, and HDFC Liquid Funds, showcase different investment strategies and objectives. Each fund serves a specific purpose, be it equity investments, a mix of debt and equity, or a focus on debt securities, catering to various risk appetites and financial goals.