mutual fund nepalese perspective

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What Mutual Fund really is... an introduction and an analysis of Nepalese Mutual Funds.

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  • 1. Group: Bulls Eye PowerPlugs

2. Mutual Fund Investment company/financial intermediaries that pools money from many investors and invests the money in different areas Investment can be in stock, fixed income securities, bond and so on Fund is managed by an investment expert known as portfolio/fund manager Investor subscribing the share/unit of mutual fund is known as unit holder Value of each unit is called NetAssetsValue (NAV) 3. Mutual Fund Operation Flow chart 4. Mutual Fund Does not guarantee any dividend. Dividend can be paid only from the revenue income and realized capital gains of the underlying portfolio and NOT from previous profits as in the case of shares. Income earned by through investment and capital appreciation realized is shared by its unit holders in proportion to the number of units owned by them 5. Why should we invest in MF? Professional Management: Managed by expert fund manager Diversification:Automatic diversification is provided. Do not rely on single entity Convenience: Elimination of the need for individuals to perform detailed and ongoing securities analysis. Affordability : Can be initiated with relatively small initial investment 6. Liquidity: Can be liquidated easily and quickly Transparency: Gets up to date information about the value of units , information on specific investment made by the mutual fund and the fund manager strategy and outlook Low transaction cost: : Cost-effective brokerage transactions. Tax benefits:Tax policies on mutual funds have been favorable to investors and continue to be so. Investor protection: SEBON monitors the operations of the mutual fund 7. Disadvantages Dilution: Mutual funds tend to do neither exceptionally well nor exceptionally poorly Fees and expenses: Charge management and operating fees that pay for the fund management expenses and some charge high sales commission Loss of Control: Completely managed by fund manager, no opportunity to customize Poor Performance: Consistently average to below average performance. 8. Type of Mutual Fund Schemes Structure Open Ended Funds Close Ended Funds Interval Funds Investment Objective Growth Funds Income Funds Balanced Funds Money Market Funds Special Schemes Industry Specific Schemes Index Schemes Sectoral Schemes 9. On the basis of structure Open end fund Investor purchase directly from the fund at stated NAV plus any shareholder fees Do not have fixed maturity period Does not have restrictions on the quantity of units the fund offer Cannot be bought or sold in secondary market 10. On the basis of structure Close end fund Sells fixed number of shares at one time initial public offering ( New fund offering) Shares are not continuously offered for sale Shares are typically can be bought and sold only on formal exchange such as NEPSE, NYSE, Nasdaq Price are determined by demand and supply not by NAV 11. Open End VS Close End Description Open End Fund Close End Fund Units Issues units continuously and sell units directly to investors as per demand. Sells limited number of units within defined period after which the offer is closed to new investors. Trading/Liquidity Can be redeemed at anytime during the life of schemes Fund Sponsor/Fund Manager buys back and sells the units as promised in the Offer Document Trades in Stock Exchange NAV Trades in NAV within certain band stipulated by the Regulator NAV is determined by demand and supply , hence can trade above or below NAV Maturity Do not have fixed maturity period. Fund Manager has a discretion to close the fund Have fixed maturity period. 12. On the basis of investment objectives Growth Schemes A diversified portfolio of equities which has capital appreciation as its primary objective with little or no dividend payouts. Mainly consist of equities of companies with above average growth in earnings Comparatively has high risk due its volatility 13. On the basis of investment objective Income Schemes Aim of income fund is to provide regular and steady income to investor Generally invests in fixed income securities such as government securities, preferred stock, money market instruments and dividend paying stocks Less risky compared to growth schemes 14. On the basis of investment objectives Balance Schemes Invests both in equities and fixed income securites in the proportion indicated in their offer documents Combines equities, bonds, debentures and money market instruments in a single portfolio. Aim is to provide both growth and regular income Appropriate for investors looking for moderate growth 15. On the basis of investment objectives Money market Schemes Invest exclusively in safer short term instruments such as treasury bill, commercial paper and government securities Aim is to provide easy liquidity Appropriate for investor who do not want to take high risk 16. On the basis of Special Schemes Index Schemes A fund with a portfolio constructed to match or track the components of a market index such as the Nepse Index Passive form of fund management This schemes would rise or fall in accordance with the rise or fall in the index These funds are well diversified, hence less risky. 17. On the basis of Special Schemes Sectoral specific Schemes Funds which invest in particular sector/ industry e.g Banking, IT etc Since the asset holdings of this type of fund are in the same industry, there is an inherent risk 18. Scheme based on Size of the Companies Large cap funds:Funds that invest in companies whose total market cap is high than $10 billion Mid cap funds: Funds that invest in companies whose market cap is between $2 billion to $10 billion Small cap funds: Funds that invest in companies whose market cap is below $2 billion 19. Mutual Fund by objective Bond Funds Equity Funds International Fund Real estate fund 20. Unit Investment Trust Investment in a portfolio that is fixed for a life of the fund. Typically by brokerage form (Sponsor) Passive Management: Portfolio composition is fixed. Can be equity, bond etc. Investors who wishes to liquidate their holding sell back to trustee. 21. Factors to consider for selection 1) Investment Objective 2) Service Provided 3) Fees and charges 4) Funds Performance 22. Investment Objective Tax Investment horizon Liquidity Cost of investing 23. Services Provided Periodic reinvestment plan Cheque writing privileges Periodic statements Exchange privilege Automatic reinvestment of distribution 24. Fees and Expenses Load charge Management fees Transaction cost Accounting and other miscellaneous costs 25. Funds Performance Holding Period Return The Sharpes Index TheTreynors Index Jensens Alpha 26. Deadly Mutual Fund Myths - The Conventional Wisdom Myth 1. The ConventionalWisdom Myth This is the number one mistake most investors make. Investors look at historic trends reported by Forbes, Kiplingers BusinessWeek and others tend to recommend funds that have already made big gains rather than identify funds that are positioned to make profits in the future. 27. The Diversification Myth 2. If you own at least 10 different mutual funds youll have a diversified portfolio. 28. The Momentum Myth 3. The easiest way to beat the market is to buy last years top-performing funds. 29. The Five-Star Myth 4. The best funds to buy are those rated 4 or 5 Stars by Morningstar. The star system tells you which funds were good, not which ones will be good. Even Morningstar will tell you that their ratings are a measure of past (risk- adjusted) performance, not the potential for future profits. Relying on statistical ratings is no substitute for a thorough examination and analysis of what a fund is doing today. 30. The Market Timing Myth 5. The safest strategy is to move everything into money market funds when the market is declining and switch everything back into stock funds when the market is rising. 31. The Long-Term Performance Myth 6. The best measure of a funds quality is its long-term performance. There is a fair amount of truth to this statement, but too many investors follow some brokers advice to buy this fund, it has a great 10-year record, without asking some key questions. Who earned that record? Is the manager responsible for its returns still at the helm? If not, the record could be meaningless. 32. The New fund Myth 7. You should wait until a fund has at least a 3-year track record before investing. The fact is that brand new funds often enjoy superior gains. New funds from top fund families often show explosive gains in their rookie year. Montgomery Small Cap was up 98.8% in 1991, Oakmark was up 48.9% in 1992, DFA Pacific Rim Small Company was up 92.6% in 1993, and Janus Olympus was up 30% the first 9 months of 1996. 33. NFO Price Price of 1 unit NFO Unit No. of units to be issued Minimum Unit to hold Minimum units to be held in a Scheme by the investor Maturity The date the fund will close (for close end fund) Bench Mark Basis on which performance of the fund will be compared with as disclosed in the Offer Document NFO Expense Issue expenses include printing and publication, advertisement, issue manager commission, allotment fees and other miscellaneous fees at the time of NFO. Important Terminologies 34. Important Terminologies Entry Load Fee that an investor has to pay while purchasing units of a mutual fund Exit Load Fee that an investor has to pay while offloading the units of a mutual fund Fund Supervisors Fees Service fees to be paid to the Fund Supervisor Fund Management Fees Service fees to be paid to the Fund Manager Depository Fees Service fees to be paid to the Depository Other Expenses/Fees Other expenses/fees related to the Scheme as approved by the Regulator 35. Net Assets Value (NAV) Method to calculate the value of the shares Marked to the market- value of the shares vary daily NAV = Market value of assets Liabilities No. of Outstanding shares 36. Example of NAV Total value of portfolio = Rs 120 million Total Liabilities = Rs 5 million No. of outstanding shares = 5 million NAV = 120 5 = Rs 23 per share 5 37. Offering Price and HPR The price at which the investors purchase the share HPR is the total returns earned by the investors Offering Price = NetAssetsValue per share 1 Load fee HPR = NAV1 NAV0 + Dividend + Capital Gains NAV0 38. Performance Evaluations Evaluations based on the level of risk and return Risk adjusted measures of evaluations 3 methods of evaluation The Sharpes Index TheTreynors Index JensensAlpha 39. The Sharpes Index Developed byWilliam F Sharpe January 1996 It measures the total return of the portfolio against the total risk ( ) Also called Reward to variability ratio Sharpe Index = (Rp Rf) p 40. Example Market return = 19.77 % SD of market = 31 % Return of portfolio = 16 % SD of portfolio = 17 % Risk-free rate = 7 % Particulars Sharp Index Market 0.4119 Portfolio 0.5294 41. The Treynors Index Developed by Jack LTreynor Feb 1965 Similar to Sharpe Index but it uses systematic risk instead of total risk Also called reward to volatility ratio Treynors Index = (Rp Rf) p 42. Example Market return = 15 % eta of market = 1.0 Return of portfolio = 18 % eta of portfolio = 1.2 Risk-free rate = 8 % Particulars Treynors Index Market 0.07 Portfolio 0.0833 43. Jenens Alpha Developed by Dr. Michale C Jensen It measure the excess return a portfolio generates over its expected return It also uses Beta as a measure of risk p = (Rp Rf ) - p X (Rm Rf) or = Rp [ Rf + p (Rm Rf) ] 44. Example Market return = 18 % eta of market = 1.0 Return of portfolio = 19 % eta of portfolio = 1.25 Risk-free rate = 6% Particulars Jensens Alpha Market 0 Portfolio -0.02 45. History of Mutual Funds NCM Mutual Fund 2050 Issued by NIDC Capital Market in 1993/94 Open end fund Citizen Unit Scheme, 2052 Issued by Citizen InvestmentTrust Open end fund NCM Mutual Fund 2059 Converted into close end with maturity of 10yrs Traded at NEPSE 46. contd. In 2067, Mutual Fund Regulation 2067 has introduced Siddhartha Mutual fund is the first mutual fund company Siddhartha investment growth scheme I Life 5 years Closed end type 47. Nabil Mutual Fund Nabil Mutual Fund came out with Nabil Balance Fund-I Close end type Maturity period of 5 years FaceValue- Rs 10 per Unit 48. Regulations of SEBON Minimum paid up capital - 1 billion Minimum 5 years of service in relevant field Minimum 3 yrs of continuous profit Appointment of at least 5 Fund Supervisor, a Fund Manager and a Depository License requirement for Fund Manager and Depository 49. Fees and Deposits MF Participant Fees as % of NAV 1. Fund Supervisor 0.5 2. Fund / Asset Manager 2 3. Depository 0.5 Total Cost to Investors 3 5 % of the charges to be submitted to SEBON Asset Manager should submit 0.3 % of the units issued under Open-ended scheme to the SEBON MF application fee NPR 50,000 and Registration fee 10 lakhs License fee for AM 2 lakhs and Depository 50,000 Annual fee AM 1 lakh and Depository 25,000 SEBONs fee: Scheme value up to NPR 1b 0.2 %, 1b -5 b- 0.15, More than 5b- 0.10 % 50. Source: Siddhartha CapitalWebsite NAV of SIGS-I 51. NAV of NBF-I Source: NABIL InvestmentWebsite 52. Bitter Fact The average mutual fund returns approximately 2% less than the stock market in general 53. Why Market Price < NAV Diversification Fees Cash on hand (3-7%): Dead Money Taxation 54. Mutual funds are subject to market risk. Please read the scheme related documents carefully before investment.