The Indian mutual fund industry has already started opening up many of the exciting investment opportunities to Indian investors. We have started witnessing the phenomenon of more savings now being entrusted to the funds than to the banks. Despite the expected continuing growth in the industry, mutual funds are still a new financial intermediary in India.1
1.1 CONCEPT OF MUTUAL FUNDS
As an investor, individual prefers to build their portfolio according to their own ability, knowledge and experience. Right or wrong, experienced or inexperienced, they will no doubt continue to operate in this manner. Investor must have the ability to make his own decisions not only on what to buy and when to buy it, but on what to sell and when to sell it and what to hold. It is almost impossible for an investor to be completely independent. He cannot possibly do all his own research and investigation. Along this he has to watch the trends in the stock market. Many people who do not have the inclination, time or knowledge to handle their own investments, mutual funds provide this service to them.2
A mutual fund is common pool of money into which investors place their contributions that are to be invested in accordance with a stated objective. The ownership of the fund thus joint or ‘mutual’, the fund belongs to all the investors. A single investor’s ownership of the fund is in the same proportion as the amount of the contribution made by him or her to the total amount of the fund.3
The flow chart below describes broadly the working of a mutual fund:
Mutual Fund Operation Flow Chart
A mutual fund uses the money collected from investors to buy those assets which are specially permitted by its stated investment objective. Thus, an equity fund would buy mainly equity assets-ordinary shares, preference shares, warrants etc. A bond fund would mainly buy debt instruments such as debentures, bonds, or government securities. It is these assets which are owned by the investors in the same proportion as their contribution bears to the total contributions of all investors put together.4
The entire income/profits are distributed to the investors in proportion to their investments. Expenses for managing the funds (subject to a maximum limit prescribed by SEBI) are charged to fund. Thus the mutual funds render a very important service to the investors in the general and to those investors who do not have time or knowledge or inclination in particular. Mutual fund units are quoted in the market. Mutual fund is the only financial tool with enough variety to meet most financial goals. Three fundamental strengths of mutual fund are – diversification, convenience and professional management. This three-in-one benefit makes funds preferable to other investment options such as shares and bonds.
Diversity increases potential returns and decreases risk. Mutual funds allow an investor to spread out his money across as few as a handful to as many as several hundred companies at one time. Liquidity - the ability to readily access your money – is another benefit of mutual funds. Units can be sold on any business day at the day’s closing price if the sell order is placed after the market had closed.
Professional management can be both a benefit and a liability of actively managed mutual...