How do I invest in a mutual fund scheme?
Mutual funds usually issue advertisements in the newspapers, announcing the launch of new schemes. Investors can also contact the funds’ agents and distributors for information and application forms. Filled application forms may be deposited with the funds, through the agents or distributors. Of late, post offices and banks have also begun to distribute the units of mutual funds. However, these schemes are merely being marketed by the banks and post offices. The banks and post offices offer no assurance of returns.

What is a prospectus or offer document?
This is a document that all mutual funds are required to provide to investors. As an investor, you should read this document carefully before investing in these funds. Ensure that you are referring to the latest offer document. An offer document must be updated at least annually. The prospectus must contain the following:

• Date of issue: This is the start and end date of new fund offers.
• Minimum investment to be made: Mutual funds prescribe the minimum amount to be invested through new fund offers and multiple amounts in addition to the prescribed minimum.
• Investment objectives: This section details the broad criteria that the mutual fund will follow with regard to investing in a particular security.
• Investment policies: The offer document will also outline the general strategies the fund managers will implement, types of investments, and asset allocation pattern considered appropriate for the fund.
• Risk factors: The offer document is required to describe the risks associated with investing in the fund. You should be familiar with the differences between varieties of risk, why these risks are inherent in particular funds, and how these risks fit in with risks in the overall portfolio.
• Benchmarks used: Check the benchmarks chosen by the fund to ensure that its relative performance is appropriate. Be careful to read the fine print in these sections.
• Fees and expenses: Offer documents are also required to list the limits on fees, including entry and exit loads, switching charges, annual recurring expenses, management fees and investor servicing costs. The prospectus also indicates the impact these have had on fund investment.
• Key personnel: This section details the qualifications and professional experience of the top management in the fund company, including those of the chief executive officer (CEO) and fund managers.
• Tax benefits information: Mutual funds enjoy significant tax benefits. For example, equity funds enjoy no long term capital gains or dividend distribution tax benefits. Careful reading of the tax benefits is essential before you to plan tax benefits so as to enhance post-tax returns.
• Investor services: You have access to the services (such as automatic reinvestment of dividend and systematic investment/withdrawal plans) that are mentioned in the offer document.

Can investors appoint nominees for their investments in mutual fund units?
Yes. Nominations may be made by individuals applying for or holding units on their own behalf, either singly or jointly. Non-individuals including societies, trusts, corporate bodies, partnership firms, Kartas of Hindu undivided families, or holders of power of attorney cannot nominate.

Can non-resident Indians (NRIs) invest in mutual funds?
Yes. The offer documents of schemes provide information on how NRIs may subscribe to mutual fund schemes in India.

What should I look for in offer documents?
The mutual funds are required to provide an abridged version of the offer document to investors; this version contains useful information. Read this version carefully. The application form for subscribing to schemes is an integral part of the offer document. SEBI has prescribed minimum disclosures in the offer document. Due care must be given to portions relating to the scheme’s main features, risk factors, initial issue expenses and recurring expenses, entry and exit loads, sponsor’s track record, performance of other schemes launched by the fund, and the qualifications and experience of key personnel including fund managers.

How are mutual fund issues different from initial public offerings (IPOs) of companies?
Company IPOs may open at prices that are lower or higher price than the issue price, depending on market sentiment and investor perceptions. However, in the case of mutual funds, the par value of units is unlikely to rise or fall immediately after allotment. Mutual fund schemes require time to invest in securities. The value of securities in which the scheme deploys its funds will drive the scheme’s NAV.

How much should I invest in debt and equity-oriented schemes?
That is for you to decide. But remember to factor in your risk-taking capacity, age, and financial position before investing. Schemes invest in a variety of securities, as disclosed in the offer documents, and offer varying returns and risks.

What is the net asset value (NAV) of a scheme?
The NAV denotes the performance of a mutual fund scheme. NAV is the market value of the securities held by the scheme. Since market value changes every day, NAVs of schemes also vary on a daily basis. The NAV per unit is the market value of a scheme’s securities, divided by the total number of units on a given date. If the market value of securities is Rs.200 lakh and the mutual fund has issued 10 lakh units of Rs.10 each to investors, the NAV per unit of the fund is Rs.20. Mutual funds are required to disclose their NAVs on a daily or weekly basis, depending on the type of scheme.

What is a load or no-load fund?
A load fund is one that charges a percentage of the NAV for entry or exit. That is, each time you buy or sell units in the fund, you pay a charge. The fund uses this charge to meet its marketing and distribution expenses. Let’s say the NAV per unit is Rs.10: if the entry and exit load charged is 1 per cent, you would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund get only Rs.9.90 per unit. You should, therefore, take the loads into consideration while investing, as these affect your returns. You also need to factor in the fund’s performance track record and service standards. The efficient funds often offer high returns despite the loads.

A no-load fund is one that does not charge for entry or exit. This means that you can enter the fund or scheme at NAV and no additional charges are payable on purchase or sale of units.

Can mutual funds impose fresh loads or increase loads beyond levels mentioned in offer documents?
No. Changes in load are applicable only to prospective investments and not to original investments. In case of imposition of fresh loads or increase in existing loads, the funds are required to amend their offer documents so that new investors are aware of the loads while investing.

What is a contingent deferred sales charge (CDSC)?
Some funds charge varying loads, depending on the extent of time the investor has stayed with the fund; the longer the investor stays with the fund, the lesser the exit load is likely to be. This is called CDSC.

What do I get as proof of my holdings?
You get an account statement, which is similar to a bank passbook. This is a non-transferable document, which includes details of all purchases and sales, along with the price at which the purchase or sale was made. It also indicates the amount invested and redeemed to date, and the number of units held, helping you track investments.

Fresh account statements will be sent to you reflecting your updated holdings after every transaction. Generally, account statements are sent within three working days on receipt of purchase or redemption request at an investor service centre. The AMC may also issue a non-transferable unit certificate to you within six weeks of the receipt of request for the certificate.

Will I have facilities to switch between funds?
You may switch all or part of your investments in one fund to another available fund. AMCs do not charge fees for such switches. To process a switch, you need to provide clear instructions, by completing a form and submitting it on any business day at an investor service centre, or the office of registrar or transfer agent. The form may also be sent by post. An account statement reflecting the new holdings will be sent to you within three days of completion of transaction.

Who is the custodian?
The custodian is the company responsible for the possession, handling and safekeeping of all securities purchased by the mutual fund.

How can I find out where the mutual fund scheme has invested the money mobilised from investors?
Mutual funds are required to disclose the full portfolios of all of their schemes on a half-yearly basis; these disclosures are published in the newspapers. Some mutual funds even send these disclosures to unit holders.The portfolio disclosures indicate the levels of investment made in each security such as equity, debentures, money market instruments and G-Secs, and their quantity, market value and per cent to NAV. They also disclose the extent of illiquid securities in the portfolio, investments made in rated and unrated debt securities and non-performing assets (NPAs). Some mutual funds also send newsletters to unit holders on a quarterly basis, disclosing these data.

Are mutual funds allowed to indulge in speculation/day trading?
No, they are not. SEBI mandates that all trades done by mutual funds be settled by delivery. The latest budget has allowed mutual funds to short sell, but only when backed by delivery after a lending/borrowing mechanism is in place.

How do I evaluate the performance of mutual fund schemes?
The NAV, disclosed on a daily basis in the case of open-end schemes, and weekly basis in the case of close-end schemes, will help you evaluate performance. The funds are required to publish NAVs in the newspapers. The NAVs are also available on the funds’ web sites. In addition, the funds are required to disclose their NAVs on the AMFI web site (www.amfiindia.com), where you can access the NAVs of all mutual funds. The funds also publish half-yearly results, which include the returns over periods of time; these half-yearly results also provide details such as the percentage of expenses of total assets, which affects yield. You will also receive annual reports or abridged versions of the annual report from the fund at the end of the year.

Studies relating to mutual fund schemes are published by the financial newspapers on a regular basis. Research agencies also publish reports on the performance of mutual funds and rankings of schemes in terms of performance. Such reports and analyses will also help you keep abreast of developments. Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity-oriented schemes with benchmarks such as the BSE Sensitive Index and S&P CNX Nifty. Monitoring the performance of funds will help you decide when to enter or exit a scheme.

How do I choose a scheme for investment from a number of available schemes?
You need to read the offer document of the mutual fund schemes carefully. Remember to evaluate the past performance of the schemes you wish to choose from, provided these schemes have similar investment objectives. Though past performance is not always an indicator of future performance, it is nevertheless an important factor that needs to be considered while making investment decisions. In the case of debt-oriented schemes, you should also evaluate the quality of instruments, as reflected in their ratings. Schemes with lower rates of return, but with investments in higher-rated instruments are safer than those with higher yields, but with investments in lower-rated instruments. In equity schemes too, you will do well to look for the quality of the portfolio. Also, remember to seek the advice of experts you can trust.

If a variety of mutual funds offer schemes in the same category, should I choose the scheme with the lowest NAV?
Some investors prefer schemes that are available at low NAVs. However, remember that in the case of mutual funds schemes, low or high NAVs have little or no relevance. You should choose schemes based on factors such as the fund’s past performance, service standards and level of professional management.

Consider the following example: Scheme A is available at an NAV of Rs.15, while Scheme B is available at Rs.90; both are diversified equity-oriented schemes. You have invested Rs.9000 in each of the two schemes. You would get 600 units (9000/15) in Scheme A and 100 units (9000/90) in Scheme B. If the markets go up by 10 per cent and both schemes perform equally well, the NAV of Scheme A would increase to Rs.16.50, while that of Scheme B would increase to Rs.99. Thus, the market value of both investments would be Rs.9900, and on both investments, you would get identical returns of 10 per cent. Thus, low or high NAVs have little relevance when you are making investment decisions. Likewise, if a new equity oriented scheme is being offered at Rs.10 and an existing scheme is available for Rs.90, their NAVs should not be the overriding factor that influences your investment decision.

It is likely that the better-managed scheme with a higher NAV may give better returns than a scheme that has a lower NAV, but is not managed efficiently. Efficiently managed schemes with high NAVs are unlikely to fall as much as inefficiently managed schemes with low NAVs. Therefore, you will do well to give more weightage to professional management, rather than to the NAV.

How significant are fund costs while choosing schemes?
The costs of investing through mutual funds are not insignificant, and deserve due consideration, especially when you are considering to invest in fixed income funds. Factors such as management fees, and the fund’s annual expenses and sales loads can eat into significant portions of your returns. Also, carefully consider the fees charged by funds for entering or exiting a scheme.

How significant are fund costs while choosing schemes?
The costs of investing through mutual funds are not insignificant, and deserve due consideration, especially when you are considering to invest in fixed income funds. Factors such as management fees, and the fund’s annual expenses and sales loads can eat into significant portions of your returns. Also, carefully consider the fees charged by funds for entering or exiting a scheme.

What are“Fundamental attributes” of a scheme?
The following are classified as "fundamental attributes" as per clause (d) of sub-regulation (15) of regulation 18:
Type of a scheme
• Open ended/Close ended/Interval scheme
• Sectoral Fund/Equity Fund/Balance Fund/Income Fund/Index Fund/Any other type of Fund
Investment Objective
• Main Objective - Growth/Income/Both.
• Investment pattern - The tentative Equity/Debt/Money Market portfolio break-up with minimum and maximum asset allocation, while retaining the option to alter the asset allocation for a short term period on defensive considerations.
Terms of Issue
• Liquidity provisions such as listing, repurchase, redemption.
• Aggregate fees and expenses charged to the scheme.
• Any safety net or guarantee provided.

Can mutual funds alter asset allocations (investment pattern) while deploying the investors' funds?
Considering the market trends, any prudent fund managers can alter the asset allocation (investment pattern) i.e. he can invest higher or lower percentage of the fund in equity or debt instruments compared to what is disclosed in the offer document. It can be done on a short term basis on defensive considerations i.e. to protect the NAV. Hence the fund managers are allowed certain flexibility in altering the asset allocation considering the interest of the investors.

However the trustees shall ensure that no change in the fundamental attributes of any scheme or the trust or fees and expenses payable or any other change which would modify the scheme and affects the interest of unitholders, shall be carried out unless,—
• A written communication about the proposed change is sent to each unitholder and an advertisement is given in one English daily newspaper having nationwide circulation as well as in a newspaper published in the language of region where the Head Office of the mutual fund is situated; and
• The unit-holders are given an option to exit at the prevailing Net Asset Value without any exit load.

Can mutual funds change the nature of schemes from the one specified in the offer document?
Yes. However, no change in the nature or terms of the scheme, known as fundamental attributes such as structure or investment pattern is allowed unless a written communication is sent to each unit holder and an advertisement is published in an English daily with a nationwide circulation and in a newspaper published in the language of the region where the head office of the mutual fund is situated. Unit holders have the right to exit the scheme at the prevailing NAV without any exit load if they do not want to continue with the scheme. The funds are required to follow a similar procedure while converting schemes from close-ended to open-ended or while changing the sponsor.

Offer documents are required to be revised and updated at least once in two years. New investors are informed of material changes by way of addendum to the offer document till the offer document is revised and reprinted.

Are investments in mutual fund units safe?
No stock market related investments can be termed safe with certainty; they are inherently risky. However, funds have varying risk profiles, as stated in their objective. Funds, which categorise themselves as low risk, invest generally in debt, which is less risky than equity. Mutual funds are, however, always safer than direct investments in the stock markets as they have access to the services of expert fund managers.

What are the risks inherent in mutual funds?
Equity Funds are open to market risks; the price of the stocks in which the fund has invested may reduce. Conversely, the prices may go up, enabling the funds to earn profits.

Debts Funds are open to credit and interest rate risks. Credit risks refer to the possibility that the company that has issued the bond or debenture in which the fund has invested may default on interest or on principal payments. Debt fund managers take care of this by investing in bonds with a strong credit rating. Interest rate risks refer to the possibility that the price of the bond in which the fund has invested may go down, because of an increase in interest rates in the economy. In general, it is useful to remember that this is an inverse relationship - bond prices (and therefore, NAVs) go up when interest rates drop, and drop when interest rates rise.

Are mutual fund schemes suitable for small investors?
Mutual funds are meant specifically for small investors. Although small investors may not be able to carefully monitor and analyse investments in the stock markets, the mutual funds are usually equipped to carry out thorough analysis and thus, ensure superior returns to investors.

Is the higher net worth of the sponsor a guarantee for better returns?
The offer documents of mutual fund schemes mention financial performance and net worth of the sponsor for a period of three years. This helps the investor evaluate the track record of the company that has sponsored the mutual fund. However, the sponsor’s high net worth does not mean that the scheme would offer better returns or that the sponsor would compensate investors if the NAV falls.

Are mutual funds insured?
No. Unlike certain types of savings accounts and certificates of deposit, mutual fund units are not insured by the government, or any government agency, and do not have any other type of insurance. There is no guarantee that when you sell your shares, you will receive what you paid for them.

How long will it take for the transfer of units after purchase from the stock markets in the case of close-ended schemes?
According to SEBI Regulations, transfer of units has to be done within 30 days from the date of lodgement of certificates with the mutual fund.

How long will it take for investors to receive dividends/repurchase proceeds?
A mutual fund is required to despatch to the unit holders the dividend warrants within 30 days of the declaration of dividends; redemption or repurchase proceeds are to be sent within 10 working days from the date of redemption or repurchase request made by the unit holder.

In case of failures to despatch the redemption/repurchase proceeds within the stipulated time period, the AMC is liable to pay interest as specified by SEBI from time to time (15 per cent at present).

If mutual fund schemes are wound up, what happens to the money I have invested in them?
If a scheme winds up, the mutual funds pays a sum based on the prevailing NAV, after adjustment of expenses. Unit holders are entitled to receive a report on the wind up from the mutual funds, which provides all the necessary details.

Are ‘mutual benefit’ companies the same as mutual funds?
No. Companies with the tag, ‘mutual benefit,’ in their names are not mutual funds. These companies do not come under the purview of SEBI. Mutual funds, however, can mobilise funds from investors only after getting registered with SEBI.

How do I get my grievances redressed?
The name of the person to contact for redressal of grievances is mentioned in the offer document. Trustees of mutual funds monitor the activities of the funds. The names of the directors of the AMC and trustees are also provided in the offer documents. You can also approach SEBI for redressal of complaints. On receipt of complaints, SEBI takes up the matter with the concerned mutual fund and follows up on these till the matter is resolved.

Money Market Mutual Funds (MMMFs)

What are MMMFs?
MMMFs or liquid funds are open-ended funds that invest solely in money market instruments such as call money, repos, treasury bills, commercial papers, certificates of deposit, and collateralised lending and borrowing obligations (CBLOs). These instruments are forms of debt that mature in less than a year.

What is the aim of these funds?
The main goal of these funds is to preserve principal and maintain high liquidity; they are, therefore, the least volatile among debt funds. Corporates having surplus cash for extremely short periods of time are major investors in such funds.

How do they differ from bank accounts?
Unlike a bank account, returns from MMMFs are not guaranteed; but the risk of not earning interest is minimal as these funds invest in short-term instruments in which risks are negligible. MMMFs offer returns that are usually better than the interest on savings bank accounts. Another difference is the minimum amount that can be invested, which could be about Rs.5000 for a retail plan of a MMMF, but much lower for bank account. MMMFs, however, do not charge any entry or exit load.

What are the tax considerations?
From the tax angle, while interest on bank deposits are taxed at the marginal tax rate applicable to the investor, dividend from MMMFs is tax free for the investor. A dividend distribution tax of 25 per cent is, however, payable on the dividend given out. Short-term capital gains, if any, are also taxable at the marginal income tax rate while long-term capital gains are taxable at the rate of 10 per cent without indexation benefits and at 20 per cent with indexation benefits.

How does one differentiate between MMMFs?
The returns of the leaders and laggards do not vary much; this is because there is not much room for differentiation in their investment styles or scope to add value in such schemes. However, mutual funds differentiate among plans of the same liquid fund schemes based on expense ratios. This is an important indicator since expenses can take away a significant chunk of a scheme’s returns. Liquid funds offer multiple plans under the same scheme such as regular, institutional and super institutional (or institutional plus) plans. The underlying portfolio for the multiple plans is the same. While institutional and super institutional plans are offered to corporates and other institutional customers, the regular plans are offered to retail clients. The differentiation between the plans is based on the minimum investment amount and expense ratios. A higher minimum investment amount and lower expense ratio is offered under the institutional/super institutional plan compared to retail/regular plans. Returns are accordingly higher for institutional plans.

Who should invest?
MMMFs are ideal for investors (individuals/corporates) seeking low-risk investment avenues to park their short-term surpluses and provide one of the best alternatives to low-yield savings bank or short-term bank deposits.

Equity linked saving schemes (ELSS)

What are ELSS schemes?
ELSSs are tax-saving schemes offered by mutual funds and are among the only tax-saving instruments that are allowed to invest in equities. These funds may be open or close ended and may offer dividend and growth options. Individuals, hindu undivided families (HUFs) and corporates can subscribe to ELSS schemes.

What is the tax advantage?
Under Section 80 C of the Income Tax Act, 100 per cent tax deduction up to a maximum of Rs.1 lakh per financial year is allowed for ELSS schemes. To claim tax rebate, the minimum lock-in period is three years, and the units can be sold any time after this initial lock in period, though capital gains will be applicable on the sale.

How do ELSS schemes operate?
ELSS schemes operate much like diversified equity funds, except that the investment is locked in for three years. The lock in enables ELSS funds to attract only long-term investors. For the fund manager, this means a stable asset base, and reduced transaction costs.

How are ELSS schemes different from other common tax-saving instruments?
The biggest advantage of ELSS vis-à-vis fixed maturity tax saving instruments like PPFs, NSCs, and bank fixed deposits are the returns. Investing in equities has always been the best asset class for returns in the long term though the risk elements are higher. Other tax-saving instruments also have longer lock-in periods than ELSS schemes, like six years for NSC, and 15 years for PPF.

Should one invest the entire tax saving limit in ELSS?
Despite the high returns in ELSS, the risk appetite of investors needs to be considered before deciding the quantum of ELSS investments. The 'close-to-optimum' portfolio model for investors depends on factors such as age profile, expected returns, investment time horizons and risk appetites. For instance, the risk appetite of a 25 year old investor with limited responsibilities is generally higher than that of a 40-year-old working executive who has a family to support, which in turn, is generally higher than that of a 55-year old investor approaching retirement, and for whom preservation of capital is of utmost importance. For the youngest, the equity component is likely to be on the higher side and for the oldest, real estate, fixed deposits and cash components would be proportionately higher.

How does one decide the best ELSS scheme?
Deciding which ELSS to invest in is an important factor. Since ELSS comes with a lock in of three years, investment decisions can not be readily reversed. Therefore, investors should choose their funds with utmost care. Funds with a proven track record, and experienced fund managers are more likely to find investors willing to invest in them.

Systematic Investment Plans (SIPs)

What are Systematic investment plans (SIPs) and how are they different from Systematic encashment plans (SEPs)?
SIPs enable investors to overcome the impact of vagaries in the market, and are plans offered by mutual funds to promote regular savings. It is similar to recurring deposits in post offices or banks where one puts in a small amount every month; the difference is that in the case of SIPs, the amount is invested in mutual funds. As opposed to SIPs, an SEP allows investors the facility to withdraw a pre-determined amount or units from his fund at a pre-defined interval. The investor's units will be redeemed at the applicable NAV as on that day.

How does a SIP operate?
The minimum amount to be invested may be as small as Rs.500 and the frequency of investment may be monthly or quarterly. In an SIP, you get fewer units when the market rises and more units when the market falls. An SIP thus allows you to participate in the stock market, without having to second guess its movements. An SIP commits you to investing a fixed amount every month. Let's say you invest Rs.1000 per month; Table 3 indicates the number of units you will receive at a given NAV:

Table 3: No. of units investors will receive on an investment of Rs.1000

What are the advantages of SIPs?
SIPs help you become disciplined in savings, by compelling you to set aside a fixed amount each month. You could either authorise the fund to debit the amount directly from a bank account, or provide post-dated cheques, instead. You receive more units when the NAV drops, and fewer units when it rises; the cost thus averages out over time. This way, you get to tides over the ups and downs in the market. Some mutual funds do not charge an entry load if you opt for an SIP and do not charge an exit load if you exit a year after buying the unit. Therefore, it pays to stay invested for the long-run. Overall, the best way to enter a mutual fund is via an SIP. But to derive the best benefits from an SIP, you need to begin with a minimum timeframe of three years.

Fixed Maturity Plans (FMPs)

What are FMPs?
FMPs as they are popularly known are investment schemes floated by mutual funds and are close-ended with a maturity period ranging from one month to five years. These plans are predominantly debt-oriented, while some may have a small equity component.

What is the objective of FMPs?
The basic objective of pure debt-oriented FMPs is to generate steady returns over a fixed-maturity period, thus protecting the investor from market fluctuations. FMPs are structured to offer capital protection and appreciation without an explicit guarantee.

How do FMPs work?
FMPs are passively managed fixed-income schemes, where the fund manager locks in to investments with maturities corresponding with the maturity of the plan. This effectively reduces what is called price risk or the potential for making a loss on bonds due to pressures to sell them off in the market. FMPs are launched in series, back-to-back, with each scheme replacing the one that has just matured.

Do FMPs provide assured returns?
No, they do not. However, investors are informed the indicative returns their investments are likely to generate, along with the tenure of investment. The prevalent yield, minus the expense ratio, which varies from 0.25 to 1 per cent, will be the indicative return.

Who should invest in FMPs?
Investors targeting a return on their investments over a fixed period of time and are indifferent to market volatility within that period should invest in FMPs.

Where do FMPs invest?
FMPs usually invest in certificates of deposits (CDs), commercial papers (CPs), money market instruments, corporate bonds and sometimes even in bank fixed deposits. The quality of investment typically consists of highest rated paper.

What is the difference between FMPs and bank fixed deposits (FDs)?
FMPs are the equivalent of a fixed deposit (FD) in a bank, with a caveat: the maturity amount of a fixed deposit in a bank is guaranteed, whereas the maturity amount of an FMP is merely indicated.

How do I choose between an FMP and a bank FD?
FMPs hold an advantage over FDs in terms of tax-efficiency. A comparison of a one-year FMP (dividend option) and FD (for individuals) shows that the post tax returns are higher for FMPs than FDs; this is because dividends are tax free for investors though the mutual fund pays a dividend distribution tax of 14.16 per cent (12.5 per cent plus 10 per cent surcharge plus 3 per cent cess). In contrast, interest on FDs is added to the main income and taxed at the applicable income tax rate. For an individual with an income of over Rs.10 lakh, the tax in the case of interest on FDs is 34 per cent (30 per cent plus 10 per cent surcharge plus 3 per cent cess). The post tax returns are thus higher for FMPs as the tax incidence is lower.

Which FMP is more beneficial – one with a growth option or one with a dividend option?
FMPs with dividend options are beneficial for a maturity of less than s year. In the case of FMPs with a growth option and a tenure of more than a year, you may use the benefit of long term capital gains where the tax rate is 10 per cent (without indexation benefits) or 20 per cent (with indexation benefits). You may also avail a double indexation benefit if one invests in an FMP in March 2007 and redeems the FMP in April 2008. In such an event, the incidence of tax is further reduced.

What are the risks of FMPs?
Unless otherwise specified in the objective of an FMP, investments are in risk-free or highly-rated assets for principal protection. However, the following inherent risks exist:

• Interest rate risk: FMPs are designed to protect you from interest rate risk. However, as a plan is launched and money is collected, interest rates can fall before the money is invested and the funds will have to be invested at lower rates.
• Gapping risk: If the fund manager is unable to find assets with a corresponding maturity to that of the plan, this leads to risks of asset liability mismatch.
• Credit risk: The credit portfolio in the plan may suffer if rating agencies downgrade ratings. Downgrades reduce the price of securities as investors demand higher risk premia on the asset.

Capital protection-oriented funds (CPFs)

What are CPFs?
CPFs are funds where the structure of the scheme, with or without external support, ensures protection of the original investment at the scheme’s maturity. In India, capital protection has to be ensured by the scheme’s portfolio characteristics; third party protection is currently not permitted. CPFs are attractive opportunities for investors looking to enhance yield on their portfolios through exposure to risky asset classes such as equity, and yet seeking assurance on the protection of principal. CPFs offer a platform to risk-averse investors who wish to participate in the upturns in equity markets, but at the same time, do not want to suffer erosion in the value of the invested amount. The CPF’s structure and the performance of the debt and equity markets are factors that determine the returns on investments.

What are the highlights of SEBI’s regulation pertaining to CPFs?
SEBI has issued detailed guidelines pertaining to the launch of CPFs in India. SEBI defines a capital protection-oriented scheme as “a mutual fund scheme which is designated as such and which endeavours to protect the capital invested therein through suitable orientation of its portfolio structure.” SEBI stipulates that the CPFs launched be close-ended, and that AMCs do not repurchase units before the end of the maturity period. Debt investments in the case of CPFs must be in the highest-rated investment grade papers. Another pre-condition to the launch of CPFs by AMCs is that the scheme’s units be rated by a registered credit rating agency, from the perspective of the portfolio’s ability to protect the capital invested therein. This rating must be reviewed on a quarterly basis. Further, the trustees are required to continuously monitor the structure of the portfolio of the CPF and report the same in half-yearly trustee reports. The AMC is required to report the same in its bi-monthly compliance test report to SEBI.

How does a CPF’s structure ensure capital protection to investors?
CPFs are schemes with underlying portfolios structured in such manner as to ensure capital protection to investors. There are four broad ways in which capital protection can be ensured. They are:

• Static Hedge: Here, capital protection is provided solely through the debt portfolio. Put simply, the debt portfolio invested matures to the capital value (initial consideration) at the end of the scheme. The remainder (the difference between the capital raised and present value of capital) is invested in equity, which could provide the possible upside to the investors. Investments in debt instruments are typically done on a held to maturity (HTM) basis, thereby negating the impact of market risk on account of interest rate movements. Also, since the debt investments will be in fixed-income securities of very good credit quality, the risk of default is mitigated. Appreciation in the equity component constitutes additional returns to investors.
• Dynamic Hedge: Here, capital protection is provided through a mix of debt and equity. An amount slightly lower than the present value of the protected principal is invested in debt and the remainder, in equity. A combination of the maturity value of the debt portfolio and certain minimum equity component ensures capital protection. In this case, contributions from the equity portfolio are required to ensure capital protection. A covenant to switch back that much equity allocation to debt which together with interest thereon will provide capital protection at maturity on the breach of a pre-determined tolerance level is incorporated. The initial allocation to debt will be lower than in the case of static hedge. The upside will however be higher in the case of dynamic hedge than in the case of static hedge. The downside will be nil in both cases if the scheme warranties are diligently adhered to.
• Constant proportion portfolio insurance (CPPI) is a form of continuous dynamic hedging that was introduced by Fischer Black and Robert Jones of Goldman Sachs in 1986. CPPI is a popular, broadly-applicable and efficient model of portfolio insurance. Globally, the transactions of most hedge fund-linked protection-oriented securities are structured using the CPPI model. Some key advantages of the model are that it does not involve investments in options, is suitable for portfolios consisting of all types of marketable securities, and is relatively simple and easy to understand.

The CPPI strategy maintains a portfolio’s risk exposure at a constant multiple of the excess of wealth in the portfolio over a pre-defined floor level. CPPI allocates portfolio wealth between two assets; a risky asset (assumed to be equity) and a risk-free asset (assumed to be debt), in order to maintain a constant risk exposure. The risk-free asset (consisting typically of high-quality fixed income securities) is expected to earn an acceptable minimum, usually at least the risk-free rate. The risky asset is expected to earn a higher rate of return than the risk free asset. The quantum of exposure to be taken in the risky asset is computed by means of a multiplier. This indicates how many times the excess of wealth in the portfolio over a pre-defined floor level is invested in the risky asset.

Should the risky asset increase in value, more of the portfolio is invested in this asset in an effort to take advantage of the rising asset values. If the risky asset declines in value, the portfolio is rebalanced to reflect an increased weight in the risk free asset. The portfolio’s funds are thus constantly rebalanced (at daily/weekly/fortnightly intervals) to reflect the performance of the risky asset and to maintain a constant risk exposure. The exposure to risky assets is always maintained at levels such that the fund manager can, at short notice, convert the entire risky asset into risk-free investments up to an overall predetermined floor, thus ensuring the minimum, specified payoff at maturity.

• Dynamic Portfolio Insurance (DPI) is a variant of CPPI and allows the fund manager to dynamically change the multiplier, depending on the outlook on the volatility of the risky asset. The multiplier could be low when markets are volatile and high when the markets are stable.

What are capital-guaranteed funds (CGFs)?
CGFs are a variant of CPFs with a guarantee feature embedded in the scheme. In the case of CGFs, the AMC is bound to return the guaranteed amount to the investor if the structure fails to ensure capital protection. This guarantee may also be provided by a third party on payment of a fee. Regardless of how the fund performs at the end of the maturity period, the investor will thus recover at least the guaranteed amount.

Are CGFs permitted in India?
No, SEBI permits no guarantee in India. In its regulations, SEBI states that the orientation towards protection of capital should originate from the scheme’s portfolio structure and not from a bank guarantee or insurance cover. The CPF therefore has to be structured in such a manner that its portfolio constitution ensures protection of the original investment on the scheme’s maturity.

What are the key risks in CPFs?
The key risks in CPFs are the following:

• Credit risk: This refers to the risk of default of the debt instruments held in the portfolio. Current SEBI regulations also restrict CPFs from investing in debt instruments rated below ‘AAA.’
• Reinvestment risk: As interest rates vary, interim cash flows from interest-bearing debt instruments may be reinvested at a lower yield than the original yield.
• Float risk: The structure may have a lower yield than projected if there are delays in deployment, or if the debt instruments are not co–terminus with the scheme maturity.
• Liquidity risk: Liquidity concerns can become impediments in the case of both debt and equity securities.
• Transaction costs: Frequent churning between debt and equity on every rebalancing date, may lead to increased transaction costs.

Is there a surveillance process for CPFs?
Rating agencies will monitor all assigned CPF ratings on a quarterly basis as per SEBI guidelines. As part of this exercise, the rating agencies will seek information from the respective AMCs in a pre-specified format. Using the information thus obtained, the rating agencies will analyse the probability of the portfolio value falling below the initially-contracted principal value, and of investors getting their money back in full.

Gold exchange traded funds (GETFs)

What is an Exchange Traded Fund (ETF)?
ETFs generally are mutual fund schemes that are listed on the stock exchanges and traded like common stock. The traded price of the ETF units on the exchange reflects, before expenses, the value per unit of the underlying assets of the fund.

What is a GETF?
GETFs are open-ended funds and present a relatively cost-efficient and secure way to access the gold market but without the necessity of taking physical delivery of gold. GETFs may be bought and sold on a stock exchange after listing.

How do GETFs work?
GETFs provide returns that, before expenses, closely correspond to the returns provided by the domestic price of gold through physical gold. Each unit will be approximately equal to the price of 1 gram of gold.

How do I invest in GETFs?
Initial investments may be made through a new fund offering (NFO) in the specified form of the mutual fund selling the GETF. Units during NFO will be available at the NAV-based price on allotment date. After the NFO, investors can buy or sell units on an exchange where the GETF is traded.

Who can invest in a GETF?
An individual resident, NRIs, firms, HUFs, companies, banks and trusts.

What type of account is required for trading in a GETF?
You need a trading account with an exchange through its broker and a demat account as GETF units are issued only in demat form.

How is a GETF valued?
According to SEBI, since physical gold and other permitted instruments linked to gold are denominated in gold tonnage, it will be valued based on the market price of gold in the domestic market, and marked to market on a daily basis. The market price of gold in the domestic market on any business day will be arrived at as under:

Domestic price of gold = (London Bullion Market Association AM fixing in US$/ounce X conversion factor for converting ounce into kg for 0.995 fineness X rate for US$ into INR) + custom duty for import of gold + sales tax/octroi and other levies applicable.

Which is the benchmark index for a GETF?
As there are no indices catering to the gold sector or to securities linked to gold, GETF is currently benchmarked against the price of gold.

What are the advantages of GETFs over physical gold?
GETFS have the following advantages:

They are cost effective, because investors hold gold at the prevailing market price without being subject to designing and storage charges and insurance costs
• They carry no impurity risk unlike physical gold
• Their underlying asset, gold, is held by a custodian, and is, therefore, highly secure
They have high liquidity and can be easily sold in an exchange at prevailing prices. Investors can also buy as little as 1 gram of gold through a GETF.

Seven steps to investing wisely in Mutual Funds

Step 1 : Identify your investment needs
Your financial goals will vary, based on factors such as your age, lifestyle, financial independence, family commitments and levels of income and expenses. The first step, therefore, involves assessing your needs. Begin by asking yourself these questions:
• What are my investment objectives and needs?
Your probable answers: I need a regular income/need to buy a home/finance a wedding/educate my children. Or your answer may involve a combination of these needs.
• How much risk am I willing to take?
Your probable answers: I wish to minimise risk/I am willing to accept fluctuations in investment value or even short-term losses in order to achieve long-term potential gains.
• What are my cash flow requirements?
Your probable answers: I need regular cash flows or a lump sum amount to meet a specific need/I do not require current cash flows, but wish to build my assets for the future.

Asking yourself these questions will help you decide what you want out of your investment. It will help set the foundation for a sound mutual fund investment strategy.

Step 2 : Choose the right mutual fund
Having identified your investment needs, you now have to choose the mutual fund and scheme to invest in. The offer document details the scheme’s objectives, and the track record of other schemes under the same fund manager. Here are some factors you may wish to evaluate before finalising a mutual fund:

• The scheme’s performance track record of the last few years in relation to that of similar schemes in the category
• The fund’s organisation structure and its ability to provide efficient, prompt and personalised service
• The fund’s degree of transparency as reflected in the frequency and quality of its communications

Step 3 : Select the ideal mix of schemes
No single mutual fund scheme may meet all your investment needs. You may, therefore, wish to invest in a combination of schemes to achieve your specific goals.

Step 4 : Invest regularly
For most investors, the approach that works best is to invest a fixed amount at regular intervals, say every month. By investing a fixed sum each month, you buy fewer units when the price is high, and more units when the price is low, thus bringing down your average cost per unit. This sort of disciplined strategy of investing in an SIP is called rupee cost averaging, and is a disciplined investment strategy followed by investors the world over.

Step 5 : Keep your taxes in mind
Dividends/income distributions made by mutual funds to investors are currently exempt from income tax (I-T) in the hands of the investors. This is in addition to other benefits available for investments in mutual funds under the prevailing tax laws. Consult your tax advisor for specific advice on how to optimise tax efficiency by investing in mutual funds.

Step 6 : Begin early
It is desirable to begin investing early, and to stick to a regular investment plan. By starting early, you stand to earn more than from investing later: this is because the power of compounding lets you earn income on income, and your money multiplies at a compounded rate of return.

Step 7 : The final step
Get in touch with a mutual fund, agent or broker, and begin investing right away. Begin now, so you can reap the rewards in years to come. Mutual funds are suitable for every kind of investor: for those who are starting out on a career, or those about to retire, for those with high risk appetite, or those who are risk averse, for those who are growth oriented, or those seeking income.

Benefits of Investment

Benefits of diversification
Diversification spreads risks across numerous financial investments, reducing the impact that poor returns from any one investment are likely to have on the overall portfolio. The prices of shares, bonds, listed property and other investments often do not rise and fall in tandem. When one type of investment is on the rise, another may be on the decline. The end result is that your portfolio's overall performance is likely to be less volatile. In other words, your portfolio is likely to undergo lesser price fluctuation than portfolios consisting of just one security or type of security.

Benefits of long-term investing
Long-term investing has turned out be one of the best ways to accumulate wealth in the stock markets. With patience and discipline, investors can take advantage of market rebounds, enjoy superior returns, and experience peace of mind. Timing the market and panicking over short-term losses are strategies that have negatively affected investments.
Investors who frequently revise decisions based on short-term market movements often spend a lot of time and effort unsuccessfully predicting what the market will do next. Market timers may also reactively sell investments as soon as they begin to drop in value. This could lead to panicky investors unwisely selling investments for less than the price they originally paid for them.

Market declines are a normal part of the equity investing cycle. History has shown that negative periods are often followed by strong market recoveries. For long-term investors, a market slump can actually translate into high returns in future. Market downturns can provide investors with buying opportunities that can add to their long-term growth potential.

Inflation
Inflation, an economic concept, is an upward movement in the average levels of price.The rate of inflation is important, as it represents the rate at which the real value of investments are eroded, and the loss in spending power over time. Inflation also indicates exactly how much of a return (in percentage terms) their investments need to make for them to maintain their standard of living.

Inflation reduces the worth of money; therefore, do not keep your money stagnant. If you have Rs.1000 in your safe today, and you keep it there for 10 years or so, it will be worth a lot less then. If you can buy something for Rs.1000 today, you will probably require Rs.1500 to buy it 10 years from now. Therefore, always invest money and ensure that the rates of return on your investment are equal to or higher than the rates of inflation. For instance, if you invested in ABC bond, which returns 10 per cent, and the rate of inflation was 5 per cent, the real return on your investment would be 5 per cent. Thus, you can protect your purchasing power and investment returns (over the long run) by investing in instruments that move with inflation and therefore are immune to inflation risk.