The contents in this can add to your learning for exam . It is not supplement for workbook but a good guide

Concept & Role of Mutual FundsFund Structure and ConstituentsLegal & Regulatory FrameworkSection 1Nuts and Bolts11

Concept of Mutual FundA pool of money contributed by many investors and collectively managed by an asset management companyInvestments made in accordance with stated objectivesA financial intermediary that allows small investors to participate in the securities marketOwnership of the fund is mutual and beneficialAn investor becomes part owner of the funds assets when he buys into the fundThe investor is allotted units for the amount subscribed.

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What it meansInvestorsMarkets(volatile, has fluctuation)Trust (pool of money)Contribute moneyInvest in marketsReceive dividend/capital appreciationReceive interest, dividend or capital growth33

The MF Cycle

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CharacteristicsInvestors own the mutual fundEveryone else associated with the fund earns a feeThings which are mutualPool of moneyInvestment objectiveRisk and returnFunds are invested in a portfolio of marketable securities reflecting the investment objectiveValue of the portfolio and investors holdings change with change in the market value of investments.

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Advantages

66Reduction of RiskPortfolio Diversification Dont put all your eggs in one basketProfessional ManagementHigher return potentialReduction of Transaction CostLiquiditySafety Convenience & FlexibilityTax advantagesTransparencyWell regulated.

DisadvantagesNo Control Over CostsNo Tailor Made PortfoliosManaging a large number of funds/types.

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History of Mutual FundsBirthplace of Mutual Funds USAHistory in India:1964-1987 (Phase I) Growth of Unit Trust of India1987-1993 (Phase II) Entry of Public Sector Funds1993-1996 (Phase III) Emergence of Private Funds1996-1999 (Phase IV) Growth and SEBI Regulation1999-2004 (Phase V) Emergence of large & uniform Industry2004 onwards (Phase VI) Consolidation and Growth.88Link this to information in the Revision Kit.

Describe the following milestones on the white board:

1963: UTI Act; US-64 the 1st scheme; special privileges assured returns, guarantees & loans1987: public sector MFs; SBI the 1st non-UTI/Public-Sector/bank-sponsored MF in India; Canbank, BOB, LIC, PNB etc followed1993: private sector MFs; Kothari Pioneer the 1st; Morgan Stanley (15 year close-ended fund) IPru etc. followed soon1995: AMFI was set up; role 1. internal industry guidelines, code of conduct for distributors (AGNI AMFIs Guidelines and Norms for Intermediaries), 2. investor awareness Making MFs work for you an Investors Guide is an AMFI publication, 3. representation to the govt help the industry grow1996: Comprehensive SEBI Mutual Fund regulations (SEBI set-up in 1992 but significance for MF industry only with these draft regulations1999: Dividend income made tax-exempt in the hands of the investor2003: UTI Act repeated; UTI Split; UTIMF created (US-64 is a scheme of UTI and not UTIMF); level playing field created2004: Consolidation & Growth (AUM at end of 2004-05 appx. INR 153,000 crore)

Types of FundsExisting fundsOpen-ended (OEF) & Close-ended (CEF)Growth, Income and HybridEquity, Debt and BalanceLoad & No-LoadGuaranteed & Non-GuaranteedTax-exempt & Non tax-exemptNew Gen Mutual FundsFund of Fund Commodity fundReal Estate fundAsset Allocation fundExchange-traded fundDerivative fundCapital Protection Oriented Fund.99Load and No Load Funds: Funds that charge front-end (Entry), back-end (Exit) or deferred (Contingent Deferred Sales Charge CDSC) loads are called load funds. Funds that make no such charges are called no-load funds.In India, SEBI has defined a load as the one-time fee payable by the investor to allow the fund to meet initial issue expenses including brokers commission, advertising and marketing expenses etc. As per SEBI definition ONLY those funds that charge an entry load are considered as load funds.

OEF & CEFOEFNo fixed tenorContinuous sale & purchase by the fundSubscription is not mandatory Redemption mandatory, with certain obvious conditionsFund size changes everydayNo secondary market tradingRedemption pressure on fund managers is higherDaily NAV (calc & disclosure)

CEFFixed tenor 1/3/5/7 yearsSale of units only during NFONo subscription after closure of NFORedemption in 2 waysExit window periodically repurchase of units by the fundListing secondary market trading of units, like stocksFund size either constant or decreasesLower redemption pressure on fund managersWeekly NAV (calc weekly but disclosure daily).1010Open-ended funds vs. Closed-ended fundsAn open-ended fund is one that sells and repurchases units at all times. Investor buys into the scheme and redeems from the fund house directly. Subscription at all times is not mandatory.Redemption must be permitted within certain obvious conditions.The corpus changes everydayOEFs are subject to higher redemption pressure.The scheme calculates its NAV on a daily basis.A close-ended fund Close Ended Funds have a fixed tenure of say 1/2/3/4/5 etc years. After the closure of its NFO, no new units of M.F are available for sale from the fund house directly. Exit option is available to investors in two ways: a) exit window or b) listing on a stock exchangeUnits are repurchased by the fund itself through intermittent periodic exit windows.The fund corpus in such a case can only reduce.The units of listed funds are traded usually at discount to its NAV. The Unit capital of such a fund remains constant, thus no redemption pressure.

Equity-orientedDiversifiedSectoralThematic or SpecialtyASEAN fund, Infrastructure FundGrowth & ValueLarge, Mid & Small CapDividend Yield or Equity IncomeIndexELSS

Primary objective: growth or capital appreciation.

1111Equity Funds: A fund that invests primarily in equity (ownership) instruments. Equity Funds can be further classified as:Diversified Equity Fund: investing in a mix of equity from different sectorsIndex Funds: Portfolio replicates a selected IndexSectoral Fund: invests in equity instruments of one sector for eg. Technology Fund, Pharma Fund, Banking Fund etc.Aggressive Growth Fund: target maximum capital appreciation, invest in less researched or speculative sharesGrowth Fund: This fund invests in equities of Growth companies only i.e. the companies which have the potential to grow at higher rate in futureLarge Cap/Mid Cap/Small Cap Fund: These Funds invests in equities of Large/Mid/ Small Cap companies respectively.Specialty (or Thematic) Funds: have a narrow portfolio orientation and invest in companies that meet pre-defined criteria. Eg. Infrastructure Fund or ASEAN FundEquity Linked Saving Scheme (ELSS) an Indian Variant: Investment in these schemes entitle the investor an income tax deduction u/s 80C (max Rs. 1 lakh in year 2007-08). These are open-ended funds but investment in these schemes (including the reinvested dividends) gets locked-in for a period of 3 years.Value Funds: try to seek out fundamentally sound companies whose shares are currently under-priced in the market. These fund add those shares to their portfolio that are selling at low price-earnings ratios, low market to book value ratios and are believed to be undervalued compared to their true potential.Equity Income or Dividend Yield Funds: invest in stocks which have a high Div Yield i.e., Div to Market Price ratio12

Debt OrientedDiversified DebtFocussed/Sectoral DebtGilt FundBond FundFixed Maturity/Term Plan (FMP/FTP)Liquid or Money Market MF

Primary objective: regular income.

1313Debt Funds or (Income Funds): A fund can be classified as Debt Fund, which invests primarily in Debt (loan) Securities. Debts fund can be further classified as:Gilt Funds: invests primarily in Govt Securities or Gilts (Govt. borrowing programme)Diversified Debt: invests in different varieties of Debt Securities i.e. say Govt Securities, Corporate Debts, Securities of different Maturities etc.Income fund: invests in Debt securities so as to provide regular income to Investors.Diversified Debt Fund: a fund that invests in all available types of debt - securities issued by entities across all industries and sectors.Focused Debt Fund: invest only in specified securities and thus have a higher risk than diversified debt funds.High Yield Debt Fund: seek to obtain higher interest returns by investing in debt instruments that are considered below investment grade.Assured Return Funds: an Indian variant, were being offered by erstwhile UTI and now no longer offered.Fixed Term Plan Funds: essentially close-end in nature and usually for term less than a year. Being of short duration they are not listed on the stock exchange. Invest in such securities whose residual maturity is equal to the scheme tenor.

Balance Investment in more than one asset class Debt and equity in various proportions

Primary objective: hybrid (regular income as well as capital appreciation).

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Fund of FundsInvest in other schemes of same or other mutual fundIs considered like a Debt scheme for tax purposes2 advantages:Since FOF is a mutual fund scheme, no tax on income generated from buying and selling securitiesAllows fund managers to rebalance portfolio freelyInvestor need not to decide when to sell units and execute transactionsConvenience to the investor.

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Commodity Fundspecialize in investing in different commodities directly or through shares of commodity companies or through commodity futures contracts. Example - Precious Metals FundsAs of date, Indian MF industry does not have commodity funds except the ones that invest in Gold. 1616

Real Estate FundInvest in real estate directly, or fund real estate developers, or buy shares of housing finance companiesFund to invest min 30 % corpus in real estate projectsBalance in equity, bonds/debentures of real estate cos.Close-ended schemes with secondary market trading Move to bring transparency, documentation and fair valuation of property Allow small investors with small investments to enjoy upswing of property without downside of high stamp duty, legal expenses, high initial investment, element of black money and disposal at the right prices.1717In 2008, SEBI has proposed Real Estate Investment Trust (REIT) Draft Regulations.

Asset Allocation FundFund manager has the flexibility to change the allocation of funds between equity and debt based on perception about direction of the market.1818

Exchange-traded fundPassively managed fund that tracks a benchmark indexAn ETF is like a hybrid financial instrument, a cross between an index fund and a stockAn equity-based ETF would invest in a basket of stocks that reflects the composition of an index, say Nifty or SensexThese funds are freely traded on the stock exchange and derive value from the underlying asset, i.e., stocks.

1919Exchange Traded Funds (ETFs) were first launched in India in December 2001 by Benchmark AMC. Now, a total of five ETFs are available to investors. ETFs are fundamentally different from normal funds and have thus developed something of a reputation for complexity. While some of the details of how AMCs run ETFs are genuinely more complex, that has nothing to do with investors. For the investors, ETFs are a straightforward instrument that offers some interesting features. Let's see what makes ETFs different.ETF are index funds. An index fund is an equity fund, which tracks a particular market index like the BSE Sensex or the Nifty. The index fund holds the same stocks as the underlying index and in the same proportion as the index. From an investment point of view, ETFs are simply index funds thatunlike normal index fundscan be bought and sold at intra-day prices throughout a trading day. In this respect they are more like shares rather than like mutual funds. Normal index funds are, of course, available only at end-of-day NAVs from fund distributors like any other fund. ETFs, since they need to be transacted upon throughout the day, are bought and sold through stockbrokers (using a demat account) just like shares.However, behind the scenes, ETFs are very different from any other kind of fund. Where an ETF really differs from an index fund is the manner in which it is created, bought and sold. In the case of normal mutual funds investors pays cash to the fund, which in turn buys the stocks and bonds which constitute the fund. When ETFs are first set up the initial participants will give the fund the basket of stocks, which constitute the underlying index and take units of the fund in exchange. These market makers will in turn sell these units to investors just like a distributor does. The market maker is usually a broker. Since ETFs are sold through brokers, you will pay brokerage in place of loads. ETFs tend to have lower brokerage than normal funds have loads.The NAV of an ETF is a fraction of the value of the index. Thus the NAV of an exchange-traded fund based on the Nifty can be one-tenth of the value of the Nifty. If the Nifty is at 1500 points the NAV will be Rs 150. Effectively, this fractional pricing means that a basket of stocks like the Nifty can be purchased by an investor with a much lower outlay than it would otherwise be possible. Compare this with trying to replicate the index by purchasing individual shares, where just one share of Infosys costs around Rs 4500. This also enables smaller initial investments than what most index funds offer, which is specially useful if you are just trying out index investing. By comparison, most nifty index funds require a minimum investment of Rs 5000.In the case of other mutual fund schemes the fund buys back and sells units. In a way, an ETF resembles a close-end scheme, where the units are not sold back to the fund and investors buy and sell the fund units on the market. However, there is obviously no discount to NAV like closed end funds. Also, unlike a close-end fund supply can be altered by creating additional units or extinguished by withdrawing existing ones. Trading of the units ensures that underlying stocks do not have to brought or sold. Investors entering and exiting do not also affect existing investors. As a result an ETF has a much lower tracking error than an index fund. Currently the equity ETFs available track the BSE Sensex, the S&P CNX Nifty and the S&P CNX Nifty Junior. The ETF on the Nifty Junior is in fact the only option for passive investing in mid-cap shares. On the debt side a liquid ETF is available.

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Gold ETFGold ETFs invest in physical gold and derive their value from the underlying assetThe price of gold ETFs will be directly linked to the price of gold itself and hence the returns from a gold ETF will more or less equal to returns from gold bars or coinsInvestors can buy or sell units of these schemes, like any other stock listed on the exchange, through brokers.

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Derivative fundHedgingFuturesOptionsArbitragingStock ArbitrageIndex Arbitrage.2222

Capital Protection Oriented fundClose-ended with no exit optionDebt scheme from a tax standpointNo guarantee by the AMC or sponsorCapital protection on account of the structureEg. Debt component of 80 in zero coupon bonds which give 100 on maturity and investment of the balance 20 in equityWith tools such as dynamic portfolio insurance, increase equity component by a multiplierRating of the scheme mandatory.2323

Classification of fundsRiskSectoral funds have higher riskLiquid or Money Market funds have least riskTenorEquity funds require a long investment horizonLiquid funds are for the short term liquidity needsInvestment objectiveEquity funds suit growth objective Debt funds suit income objective.2424

Risk-Return HierarchyLiquid fundsST debt fundsGilt fundsDebt FundsBalanced fundsRisk Index fundsReturnEquity fundsSectoral funds2525Mutual Fund Structure & Constituents

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Structure & Constituents

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MF Structure in IndiaA mutual fund has a 3-tier structureSponsorTrusteeAMCTrust2828

MF Structure in other countriesStructure in USAManagement Company Similar to AMCUnderwriter for SalesManagement Group Similar to SponsorCustodian

Structure in UKOpen Ended - Unit Trusts regulated by Securities and Investment Board + by relevant SROClosed Ended - Investment Trusts like a Company.2929

MF Constituents in IndiaSponsorTrusteeAMCTrustDistributorSEBIR&T AgentSecurities Dealer / BrokerBankerCustodian & DepositorySecurities MarketsInvestor3030

TrustMutual funds in India constituted as a Public Trust under Indian Trust Act, 1882The trust is registered with the Office of Public TrusteeOPT reports to the Charity CommissionerThe trust or the fund has no independent legal capacity itselfActs in relation to the trusts are taken on its behalf by the trusteesTreated as a separate entity and a pass through vehicleHas its own auditors, separate from the AMC.3131

SponsorPromoter of the mutual fundCreates a Trust under Indian Trusts Act, 1882 and registers it with Office of Public TrusteeAppoints Board of trustees/trustee companyCreates AMC under Indian Companies Act, 1956Fulfills necessary formalities and applies to SEBI for registration of the Trust as a Mutual Fund.

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Sponsor CriteriaMin 5 years track record in financial servicesBank, corporate or an FIProfit making in at least 3 out of past 5 years, including the previous yearPositive Net Worth in last 5 yearsAt least 40% of the capital of the AMCNet worth in the immediately preceding year more than the capital contribution to the AMC.3333

TrusteeAppointed by sponsor with SEBI approvalHave Registered ownership of investmentsFormed either as Board of Trustees or Trustee CompanyPower to appoints all other constituentsAppoint AMC through the Investment Management Agreement and delegate powers.3434

Trustee CriteriaMinimum number of trustees is 4 2/3rd should be independent trustees i.e. no connection of profit (what so ever) with the sponsorMeet at least 4 times in a year to review functioning of AMCTrustees hold the unit-holders money in fiduciary capacity All major decisions need trustee approval Right to seek regular information and take remedial action.3535

AMCRequired to be registered with SEBIAppointed as Investment Manager of the mutual fundAppointed by the trustees via an Investment Management AgreementResponsible for operational aspects of the mutual fundNet Worth of at least Rs.10 crore at all timesAt least 1/2 of the board members must be independentMostly, structured as a private limited company where Sponsor and associates hold capitalQuarterly reporting to Trustees.3636

MF ConstituentsSponsorTrusteeAMCTrustR&T AgentSecurities Dealer / BrokerBankerCustodian & DepositoryDistributorSEBISecurities MarketsInvestor3737

Other ConstituentsCustodian & DepositoryBankerSecurities Dealer / BrokerR&T AgentDistributor Investment back-office Purchase and sale of securities Not more than 5% through a related broker Research report to AMC Investor records and transactions Selling & Distributing schemes Providing bank accounts & remittance services3838

Role RestrictionsSponsor of a fund cannot be its custodianSponsor of a fund can be a distributorTrustee of one mutual fund cannot be trustee of another mutual fundException is Independent trustees provided they obtain approval of both the board of trusteesTrustee of one fund cannot be AMC of anotherAMC of one fund cannot be Trustee of anotherAMC cannot have any business interest other than fund advisory.3939

Mergers & TakeoversScheme MergerScheme merged with another scheme of the same AMCAMC TakeoverAMC is taken over by another set of sponsorsAMC MergerOne AMC may merge with another AMCChange of AMC/TrustTrustees decide to change the AMC and handover the scheme to a new AMCScheme TakeoverJust the schemes taken over by another set of trustees.4040

Mergers & TakeoversScheme takeover (HDFCZurich, Birla-Apple)One AMC buys schemes of another AMCOrganic growth in assetsNo change in AMC stakesAMC merger (HB-Taurus)Two AMCs merge Similar to merger of companiesSponsor stakes changeAMC take-over (Zurich-ITC Threadneedle, Birla-Alliance)Stake of one sponsor in a AMC bought out by anotherChange in AMC and sponsor.4141

Mergers & TakeoversInvestor rightsRight to be informed No prior approval requiredOption to exit at NAV without exit load.

4242

Regulatory frameworkMoFSAT Supervisor of both SEBI & RBI Created in 2003 Provide apex appeal mechanism for actions taken by SEBIRegistration of AMC and Trustee CompanyRoC for Compliance RoC is supervised by DCADCA is a part of CLB which is under Ministry of Law and JusticeCLB is the interface for prosecution and penalties.Companies Act4343

Regulatory frameworkOffice of Public TrusteeSROIndustry AssociationCollective industry opinion Guidelines & recommendations Example: Association of Mutual Funds in India (AMFI). Registration of Trust Board of Trustees is accountable to the OPT Complaints against individual trusteesDerive powers from regulatorAbility to make bye-laws Regulate own members in a limited wayExample : Stock exchanges NSE, BSE etc. 4444

Stop Check!Mutual Funds in India are set up asCompanyTrustPartnershipAssociation of personsIssuing additional fresh units and redeeming the existing units of a mutual fund scheme is the role of:The custodianThe transfer agentThe trusteesThe bankersMinimum no of independent directors on the board of the AMC50%25%75%None of the above.4545

4. The Offer Document5. Fund Distribution and Sales Practices7. Investor ServicesSession 2The Process of Investing4646

The process of investingOffer DocumentKIMApplication and form of holdingDistribution channelsInvestors rights & obligations.

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Offer DocumentMost important document for a prospective investorLegal offer from AMC to investorContains vital information about fund and schemesSEBI approved format.

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Offer DocumentContentsConstitution of fundDetails of Sponsor, Trustee & AMC & key personnel financial history for 3 yearsDescription of Scheme & Investment Objective/StrategyTerms of Issue/OfferHistorical StatisticsInvestors Rights and ServicesMandatory Disclaimer clauseStandard and Scheme-specific Risk Factors.4949

Details of Scheme offeredDates of NFO details regarding sale and repurchaseMinimum Subscription and Face ValueInitial Issue Expenses current and past schemesSpecial facilities to investors Eligibility for investing documentationProcedure for applying, and subsequent operations relating to transfer, redemption, nomination, pledge and mode of holding of units.5050

Load, Fee and ExpensesLoad and the annual recurring expenses Proposed scheme and other schemes Comparison with offer document numbersScheme expenses for past 3 yearsCondensed financial information for 3 years.

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Unit holder rightsRights of unit holders Right of proportionate beneficial ownership of schemes assetsRight to timely serviceRight to informationRight to approve changes in fundamental attributesRight to wind up a schemeRight to terminate AMC servicesProtection of rights and problem resolutionDetails of information disclosure and their periodicityDocuments available for inspectionDetails of pending litigation and penalties.5252

Unit holder rightsCannot sue the mutual fundCan complain against AMC, sponsor and Board of Trustees75% unit holders can wind up a scheme seek AMC terminationProspective investor has no rightsRight to redeem without load in case of change in fundamental changes.5353

Due DiligenceSEBI approved format and contentTrustee ApprovalCompliance Officer certifies thatInformation contained therein is true and fairIs in accordance with SEBI regulationsFund constituents are all SEBI registered entitiesThe AMC is responsible for the contents and the accuracy of information.5454

Offer DocumentValidity of ODFor New Schemes - 6 months from the date of receipt by the AMC of the letter containing observations from SEBIRevised at least once every two years for OEFsOD is printed only once for CEFsUpdated for every major changeChange in the AMC or Sponsor of the mutual fundChange in the load structuresChanges in the fundamental attributes of the schemesChanges in the investment options to investors; inclusion or deletion of optionsAfter completion of one year of an OEF, condensed financial information mandatory in the OD & KIM.5555

Fundamental AttributesScheme typeInvestment objectiveInvestment patternTerms of the scheme with regard to liquidityFees and expensesValuation norms and accounting policiesInvestment restrictions.5656

Changes in fundamental attributesApproval from Trustees & SEBIPublic announcement by AMCIn case of OEF - Investors have to be informed and option given to exit at NAV without any exit loadIn case of CEF investor approval is requiredNew OD.5757

KIMAbridged ODKIM is mandatory with every application form.

5858

OD & KIMPrinciple of BUYER BEWARE appliesAn investor who invests without studying the Offer Document cannot subsequently hold the fund responsibleInvestor has no recourse for not having read the OD/KIM.

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Investor Rights & ObligationsInvestors RightsInvestors ObligationsStudy the ODProvide PANMonitor investmentComplaints Redressal BodiesSEBIRoC/DCA/CLB.6060

Sales PracticesNo mandatory guidelines for distributor role & service to investorAMFI recommends certain practices for effective sellingTo be fully aware of the important characteristics of the schemesKnow their clientsIdentify clientsUnderstand each clients needsHelp a client chose his investmentsEncourage regular investmentsProvide personalized after sales serviceDistribution Commissions are paid by fund housesThere are no rules governing the min and maxSEBI (vide Circular dated June 26, 2002) has banned rebating of commissionsAMFI has also prohibited rebating as specified in AGNI.6161

Investor ServicesApplying for & Redeeming unitsCut-off timing of 3:00 pm for same day NAV the next day NAV is applied in case of application received after 3:00 pmin case of liquid funds 11:00 am is cut-off for applying previous day NAVDividend Reinvestment Plan (DRP)Systematic Investment Plan (SIP)Systematic Withdrawal Plan (SWP)Systematic Transfer Plans (STP).

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Investor ServicesTelephone/Internet transactionsCheque WritingPeriodic statement and tax informationLoan against units6363Telephone/Internet transactionsInvestors may redeem or purchase units by calling a fund representative or registrar or investor service centre. Many distribution companies, banks and brokers accept investors instructions by telephone or through internet/e-mail.Cheque writingSome open end mutual funds allow the facility of cheques writing by providing the investor with a cheques book treating his fund account as the equivalent of a bank savings account for this purpose. The fund must have RBI approval in order to offer this service. RBI rules do not permit investors to issue cheques to third parties for other payments.Periodic Statement and Tax InformationAll mutual funds provide periodic statements to investors in the form of financial statements and performance reports. SEBI regulations require funds to send annual financial statements to unit holders within six months of the close of the accounting year.Loans against UnitsSeveral banks lend to the investors against mutual funds units held by them. The amount of loan is usually a percentage of the value of the investors holding in units.

Investment OptionsInvestors can achieve income and growth objectives Growth option Dividend-payout optionRegular Ad-hoc Dividend Re-investment optionMost funds provide multiple options and the facility to switch between options.6464

Stop Check!The front page of on offer document contains:Date of its publicationName and type of fundMajor objectives of the fund1 and 2 aboveThe abridged offer document contains the address of the following:The Trustees of the mutual fundThe Directors of the AMCthe Registrar & Transfer Agents1 and 2 above2 and 3 aboveOffer document has to be updated withinOne year from date of issueTwo years from date of issueSix months from date of issueNone of these6565

6. Accounting, Valuation and TaxationSession 3Accounting, Valuation & Taxation6666

Accounting PoliciesInvestments to be marked to market according to SEBI GuidelinesUnrealised appreciation cannot be distributedProfit or loss on average cost basisDividend on ex-dividend dateSale and purchase accounted on trade dateBrokerage and stamp duties are capitalized and added to cost of acquisition or sale proceeds.

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Reporting RequirementsAudited accounts within 6 months of closure of accountsPublish unaudited abridged accounts within 30 days of the closure of the half-year Summary of the accounts to be mailed to all unit holdersFile with SEBI Copy of the annual report Six monthly unaudited reports Quarterly movement in net assets of the fund Quarterly portfolio statements.6868

Specific DisclosuresComplete portfolio to be disclosed every six months Industry practice is monthly disclosureAny item of expenditure which is more than 10% of total expensesNPAs, provisioning and NPAs as percent of total assetsNumber of unit holders holding more than 25% of unit capital.

6969

Net Asset ValueFrequency of NAVCalculated and published at least every Wed for CEFsCalculated and published daily for OEFsUpdated on AMFI website by 8:00 pm (as per text book) every business dayNAVs are rounded off up to four decimal places for liquid/money market schemes and upto two decimal places for all other schemes.7070

Net Asset ValueNAV = Net Assets of the Scheme/No. of Units OutstandingNet Assets of the Scheme+ Market Value of investments + Receivables + Other accrued income + Other assets - Accrued Expenses - Other payables - Other liabilities.7171

Fees & ExpensesInitial Issues ExpensesRecurring ExpensesInvestment Management FeeEntry & Exit Load.

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Initial Issue expensesExpenses incurred in floating a new schemeMax 6% of funds mobilized charged to scheme; excess borne by AMC/sponsorOnly CEFs are permitted to charge IIE to the fundAmortize on weekly basis until maturityE.g. 6 crores amortized over a 5-year (260 weeks) tenor would mean Rs. 230,769 charged every week as expenseNo-load fund i.e. funds which do not charge initial issue expenses can charge additional investment management fees of 1%

w.e.f. Apr 2006 OEFs cannot charge initial issue expenses to the scheme.7373

Recurring ExpensesInvestment management fees Custodians feesTrustee FeesRegistrar and transfer agent feesMarketing and distribution expensesAudit feesLegal expensesCosts of mandatory advertisements and communications to investors.7474

Expenses that cannot be chargedPenalties and fines for infraction of lawsInterest on delayed payments to unit holdersLegal, marketing and publication expenses not attributable to any schemeExpenses on investment and general managementExpenses on general administration, corporate advertising and infrastructure costsExpenses on fixed assets and software development expensesSuch other costs as may be prohibited by SEBI.

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Recurring ExpensesOverall ceiling on expenses, including Investment management and advisory feesBased on Weekly Average Net Assets (WANA)Equity FundsFirst 100 Crores2.50%100 - 400 Crores2.25%400 700 Crores2.00%Above 700 Crores1.75%For Bond funds, above figures are lower by 0.25%Limit for FOFs is 0.75% of the Weekly Average Net Assets.7676

NumericalQ. An open-ended equity fund has Net Assets of Rs. 3500 crores. What is the limit on recurring expenses?

Q. A Bond fund has WANA of Rs. 850 crore. What is the maximum recurring expenses it can charge to the scheme?

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Investment Management FeeSEBI Limits Investment Management FeeFor the first Rs. 100 crore of net assets: 1.25%For net assets exceeding Rs. 100 crore: 1.00%IMA can be 1% more for no load funds

7878

NumericalQ. A load scheme has Net Assets of Rs. 400 crore. What is the ceiling on the Fund Management Charges (FMC)?

Q. What is the ceiling on Investment Management Fee in case of a no-load scheme with Net Assets of Rs. 1500 crore?7979

LoadsCharged to recover sales and distribution expensesEntry LoadAt the time of sale of units i.e. subscription by investorCharged on NAV and increases the sale priceExit LoadAt the time of repurchase of units i.e. redemption by investorCharged on NAV and reduces the repurchase priceLoad is a charge on the NAVLoad is defined as a percentageCDSC is variable exit load, lower for longer duration of holdingLoads are subject to SEBI Regulations*

* Change expected in Jan 2008 - In case of Direct investment, no entry load to be charged to investor.8080

SEBI Regulations - LoadsOEFsMaximum Exit load or Entry load : 7% of NAVRepurchase price more than or equal to 93% of the Sale price

CEFsMax Entry or Exit Load: 5% of NAVRepurchase price more than or equal to 95% of the Sale Price (NAV in this case)

w.e.f. Apr 2006, CEFs cannot charge entry load.8181

Pricing of UnitsSale and repurchase price are NAV-based

SALE PRICE = NAV + Entry Load

REPURCHASE PRICE = NAV Exit Load8282

Non Performing AssetAn asset classified as non-performing if interest or principal amount not been received or remained outstanding for one quarter from the due dateDeep Discount Bonds (DDBs) are classified as NPAs if,the grade falls to BB or below, OR it is defaulting on other commitments, OR in case of full Net worth erosion of the borrower.8383

Treatment of NPAsAccrual to be stoppedIncome accrued until date of classification to be provided forProvisioning for principal due In graded manner after 3 months of classification.Complete write off in 15 months from classification.8484

Non Performing AssetProvision for NPAs10% of BV - after 6 months past due date of interest20% of BV after 9 months past due date of interest20% of BV after 12 months past due date of interest25% of BV after 15 months past due date of interest25% of BV after 18 months past due date of interest.8585

Valuation of SecuritiesEquityTraded Securities Mark to Market i.e., last quoted closing price on the stock exchange where it is principally tradedThinly Traded Securities Those securities which are traded for less than 5 lacs AND less than 50,000 shares Complex valuation method is used if the security is not traded for more than 30 days otherwise last traded price.8686

Valuation of SecuritiesDebtTraded Securities as quoted in market upto last 15 daysThinly Traded Securities those securities (except GoI securities) where there is no trade in marketable lot of Rs 5 Cr on valuation dateSecurities with maturity upto 182 days are valued on the basis of amortization cost + accrued interest.8787

TaxationMutual Fund is a pass through vehicle hence not taxedMutual funds are exempt from tax under section 10(23D) of Income Tax Act, 1961Taxation for investorDividendCapital GainTaxation as per Equity fund (at least 65% of assets in domestic equity) or Other than Equity fund.8888

Equity Funds (Min 65% domestic equity)

DividendDDTNILInvestorNILCapital GainLong-Term(exceeding 12 months) NILShort-Term(not exceeding 12 months)10% + SC +EC8989

Other than Equity FundsLiquidOther than LiquidIndividual/HUF25% + SC + EC12.5% + SC + ECOthers20.0% + SC + ECCapital GainLong-Term(exceeding 12 months) Indexed Tax RateShort-Term(not exceeding 12 months)Marginal Tax RateDividendDDTAs per grid belowInvestorNIL9090

MF Taxation SummaryEquityDebtShort Term Capital Gains10%As per Income Tax SlabLong Term Capital GainsNo capital gains tax payable. However, securities transaction tax payable at 0.25 percent of the redemption price.20% with Cost Inflation Index benefit or 10% without Cost Inflation Index benefit, whichever is lower Dividend Income in the hands of investorNilNilDividend Distribution TaxNilIndividuals & HUFs 14.16%Others - 22.66%Tax Deducted at SourceNil NilSecurities Transaction TaxPayable at the time of redemption @ 0.25% irrespective of whether a gain has been made or notNot Applicable9191

Other tax aspectsSecurities Transaction Tax (STT) 54ECSection 80CSection 111ADividend StrippingSection 94(7) of the IT act reads If a person buys or acquires securities or units within a period of three months prior to the record date fixed for declaration of dividend and sells or transfers the same within a period of nine months after such record date and the dividend recd is exempt, then the loss if any, arising from such purchase or sale shall be ignored to the extent such loss does not exceed the amount of such dividend income.9292

NumericalQ. Investor buys on March 31, 2005 and sells on April 1, 2007. What is the indexation adjustment factor?2004-05 5202005-06 5482006-07 5822007-08 624 Investor buys on April 1, 2005 and sells on March 31, 2008. What is the indexation adjustment factor?9393

Stop Check!An open-ended fund with 10,000 units outstanding has the following items on the balance sheet:Investment at market valueRs, 1,00,000Other assetsRs. 20,000Other LiabilitiesRs. 25,000Calculate the NAV per unit:Rs. 9.50Rs. 12Rs. 10Rs. 14.5Unit capital of a scheme is Rs. 20 million. The market value of its investments is Rs. 55 million. The number of units is 1 million. The NAV isRs. 20Rs. 75Rs. 55Not possible to say.

9494

Stop Check!An investor bought a unit in 1995 for Rs. 75,000. he sold the units in 1998 for Rs. 125000. the cost inflation index for 1995 and 1998 are 281 and 351. the capital gains chargeable to tax are:64,95731,31750,00075,000Income earned by a mutual fund registered with SEBI is exempt from income tax as per section:10(23D)10(33)Total income is taxable @ 33.2%80C.9595

8. Investment ManagementSession 4Mutual Funds & Securities Markets9696

Mutual Funds & Securities Markets Equity Market and productsAsset classesInvestment stylesValue indicatorsDebtMarket and productsTerminologyInvestment stylesInvestment restrictions.9797The questions are usually on:Value and growth strategyCurrent yieldP/E ratioDividend yieldPrice given yield

Equity investingEquity implies ownershipEquity instrumentsOrdinary sharesPreference sharesConvertible debenturesEquity Warrants.9898

Equity investingClassification of EquityLarge Cap/ Mid Cap/ Small CapGrowth/ Value/ CyclicalEquity terminologyEarnings per ShareMarket CapitalizationRatiosP/E RatioDividend Yield.

9999

Equity portfolio managementApproaches to Portfolio ManagementPassiveActiveInvestment StylesGrowthValueSecurities ResearchFundamental AnalysisQuantitative AnalysisTechnical AnalysisPortfolio Management Organization StructureFund ManagersSecurity Analysts & ResearchersDealers.100100

Approaches to portfolio managementActive managementAim for Out-performance Higher feesSelection and timingPassive ManagementReplicate a chosen IndexLow fees.101101Passive investing does not mean that a portfolio is never re-balanced. For example, when SAIL was dropped from the Sensex, index funds based on the Sensex had to rebalance immediately.

There is a software called basket trade at NSE and BSE, which enables a fund manager to put in a specified amount, and the system will generate orders simultaneously for all the shares in the index, for the given amount.

Growth vs. Valuea. MPS?b. P/E?c. DY?102102GrowthHigh Market price per shareHigh PE ratioLow div yield

ValueLow MPSLow PEHigh DY

Debt InvestingDebt implies lending/loanTypes of debt instrumentsGovt. SecuritiesPSU BondsFI Bonds Corporate BondsDebenturesMoney Market SecuritiesTreasury Bills (T-Bills)Commercial Paper (CP)Certificate of Deposit (CD).

103103

Debt ClassificationClassification of Debt SecuritiesTenor long or shortCredit qualityGovernment Securities/Corporate Securities/FI BondsSecured/UnsecuredMarket Traded/Non-tradedInterest Periodic or DiscountedFixed or Floating (Floater)Call or Put option.

104104

Debt TerminologyPar or Principal or Face ValueCoupon or InterestMaturity or tenorCallable PuttableYield.

105105

Measures of Bond YieldCurrent YieldYield to MaturityYield Curve (TSIR).

106106

Price & YieldIncrease in rates reduces value of existing bondsDecrease in rates increases value of existing bondsPrice and yield are inversely relatedThe relationship between yield and tenor can be plotted as the yield curve.

107107For example, if a 5 year bond was issued at 9%, and after 1 year, interest rates have increased to 10%, there will be no interest in the old bond. Investors will want to sell the old bond and buy the new bond. So the price of the old bond will fall.

Current Yield and YTMCoupon amount as a percentage of current market price

If you bought an 8% bond at Rs. 110, the current yield is, = (8/110)*100 = 7.27%.

108108

Interest Rate SensitivityMeasured by a number called durationIf duration is 5 years, and interest changes by 1%, price of the bond will change in the opposite direction, by 5%

Example: Duration of a bond is 3 years. Yield spreads increases by 1.5%. What is the change in price?= 1.5 *3= -4.5%.

109109A number called duration is a technical measure of the average maturity. Higher the duration greater the risk of the bond. The AMFI exam uses words like yield spread, yield change, but what is intended is simple change in interest rates.

Risk in Bond InvestingTypes of RiskInterest Rate RiskReinvestment RiskDefault/Credit RiskInflation RiskLiquidity RiskCall RiskRisk MeasuresYield Spreads & Credit RatingsDuration.

110110

Credit RiskProbability of default by the borrowerChange in credit rating,downgrade increases the yield & decreases the priceupgrade decreases the yield & increases the price.

111111A downgrade means that risk in the instrument has gone up which is why the price will fall. The fall in price will result in an increase in yield. Yield going up, therefore does not mean better returns. It only means that if this company has to raise funds, it should offer a higher rate.

Debt Portfolio ManagementBuy & HoldPortfolio exposed to interest rate risk Duration Managementincrease duration if rates are expected to fall decrease duration if rates are expected to riseCredit SelectionInvest in low grade bonds that are likely to be upgraded Prepayment Prediction.

112112Credit selection is not a great choice in the Indian market. Low grade bonds do not trade in the market.

Investment PolicyInvestment policy of each scheme dictated by the schemes objective SEBI imposes certain restrictions on mutual funds to ensure investor protectionMinimum 20 investors per schemeNo one to hold more than 25% of the corpusRecord of Investment decisions to ensure transparency.

113113

Minimum Portfolio DiversificationNot more than 10% of NAV in a single companyExceptions: Index & Sectoral funds Rated Investment grade debt of a single issuer cannot be more than 15% of NAV (extendable to 20% with AMC Board and Trustees approval)Un-rated instruments10% of Net Assets for single issuer Overall 25% cap for investment in such securitiesUnlisted shares Max 10% of Net Assets for CEFs Max 5% of Net Assets for OEFs.114114The 10% limit applies when the mutual fund buys the security. If a share bought by a scheme appreciates in value subsequently and it is now more than 10% of the net assets, the fund manager is not required to sell the stock to bring the level back to 10%.

Investment RestrictionsInvest only in marketable securities Investment transactions only on delivery basis Securities have to be bought in the name of the scheme A mutual fund under all its schemes, cannot hold more than 10% of the paid-up capital of a companyEquity with voting rights representing 10% of paid-up capital of one stock.115115Emphasise that questions are asked on these restrictions.

Approved & Unapproved InvestmentsTemporary Investment in Bank FDs Max 15% of NAVADR/GDR investment permittedlower of, 10% of net assets or $200 millioncap for mutual fund industry as a whole $4 billionLimited investment in Treasury Bonds and AAA rated corporate debt issued outside IndiaNo Lending.116116Mutual funds have to keep their reconciliation with custodians up to date, so that they do not sell securities that they do not have, and have money to pay for all that they buy.

UTI can provide loan!

Investment in SponsorNo investment in unlisted securities of sponsor or an associate or group company of the sponsorNo investment in privately placed securities of the sponsor or an associateInvestment in listed securities of the sponsor or associate company permittedMax 25% of the net assets of the scheme.

117117

Inter-scheme transferTransfers only on a delivery basis, at market pricesSuch transfers should not result in significantly altering the investment objectives of the schemes involvedSuch transfer should not be of illiquid securities, as defined in the valuation normsOne scheme can invest in another scheme, up to 5% of net assets. No fee is payable on these investments.

118118

Other RestrictionsMutual funds can borrow up to 20% of net assets for a period not exceeding 6 monthsAny change in investment objectives requires information to investor, and provision of option to exit at NAV, without exit load.

119119Mutual funds may borrow to take care of temporary liquidity needs. There could be a panic in the market due to an event like 9-11. The fund manager may face large redemption pressures. If he sells, he may get very low prices. He may then take a loan and meet the redemption pressure. He can then liquidate the portfolio when the market is normal, and repay the loan.

Stop Check!Current market price of a 9% coupon bond, when other bonds of similar maturities pay 11% will be:Above parBelow parAt parWill be unrelated to other bondsTechnical analysis tries to predict future movement of stock price by analyzing:The financial working of a companyStock price movement of a companyBoth the aboveNone of the above.120120

Stop Check!Mutual Fund scheme can borrow within certain limits,Upto 20% of net assetsFor max 6 monthsBoth are trueNeither is trueUnlisted shares in a schemes portfolio can be a maximum5% of net assets in a CEF10% of net assets in an OEFBoth are trueNeither is true.121121

9. Measuring & Evaluating Mutual Fund PerformanceSession 5Return Concepts122122

Computing ReturnReturn defined as Income earned for amount invested over a given period of timeStandardize as % per annum Sources of returnDividendChange in NAVReturn MethodsChange in NAV or Absolute Return MethodSimple Total Return MethodROI or Return with Dividend Reinvestment MethodCAGR Method.123123

Method 1: Change in NAV MethodSuitable for computing returns between two datesAnnualize using 12/n or 365/n

(NAV at the end of Period-NAV at the beginning of Period)*100NAV at the beginning of Period

124124

NumericalQ. NAV at start of period was Rs. 13.70. at the end of 16 months the NAV was 18.50.Calculate the change in NAV.

= (18.50 13.70) X 100 13.70=35.04%

Annualized return=35.04 X 12/16=26.28%.125125

Simple Total ReturnIn this method, dividends distributed are added to change in NAV to compute total return

(Change in NAV + Dividend)*100 NAV at the beginning of period

126126

NumericalQ. NAV at start of period was Rs. 15.65. At the end of the year it stood at Rs. 21.05. During the year, investor received 10% dividend. Calculate the return earned by the investor.

= ((21.05-15.65)+1.00) X 100 15.65= 40.89%.127127

ROI MethodThe method assumes that dividends are reinvested, at Ex-Div NAV

Value at end of period Value at beginning of period X 100Value at BeginningValue of holdings at the beginning of the period = number of units at the beginning x begin NAVValue of holdings end of the period = (number of units held at the beginning + number of units re-invested) x end NAVNumber of units re-invested = dividends/ex dividend NAV.128128

NumericalQ. On Jan 01, 2007 an investor bought 1000 units at 12.25. He redeemed the investment on 01st Jan 2008 when the funds NAV stood at 19.50. During the year he received dividend at the rate of 10%. The ex-Div NAV was Rs. 15.10.Calculate his ROI.

=Value of holding at start 1000 X 12.25 = 12,250= No of units reinvested 1000 / 15.10 = 66.2252=Value of holding at end 1066.2252 X 19.50 = 20,791.39= ROI (20,791.39 12,250) X 100 12,250=69.73%.129129

CAGRCompound Annual Growth Raterate at which investment has grown from begin point to the end point, on an annual compounding basis

A = P(1+r)nV1 = V0(1+r)nr = ((V1 / V0)1/n) -1

V1 = Amount at the end of PeriodV0 = Principalr = Rate of returnn = Number of periods.130130

NumericalQ. An investor buys 1000 units of a fund at Rs. 24.15 on Jan 07, 2007. On June 30, 2007 he receives dividends at the rate of 20%. The ex-dividend NAV was Rs. 30.60. On Jan 01, 2008 the funds NAV was Rs. 32.25. Compute the CAGR.

131131

SolutionThe value of investment at beginning= 24.15 x 1000 = Rs. 24,150Number of units reinvested = 2000/30.60 = 65.36 unitsEnd period value of investment = 1065.36 x 32.25 = Rs. 34,357.84Holding period = 01/01/08 - 07/01/07 = 359 daysThe CAGR is = (34,357.84/24,150)365/359 - 1 x 100= 43.11%.132132

SEBI RegulationStandard measurements and computationCAGR for funds that are over 1 year oldReturn for 1,3 and 5 years, or since inception, which ever is laterNo annualisation for periods less than a year.

133133returns for periods less than a year cannot be compounded, according to SEBI norms.

Industry PracticeLess then 1 year, simple return without compounding or annualisation Growth Option: CAGR implicit in the change in holding period NAVsDividend Option: CAGR implicit in the change in value over the holding period, assuming re-investment of dividend at ex-dividend NAVSome funds use simple annualised return, without compounding.134134

Evaluating fund performanceEvaluation of a fundrelative to the market as a wholerelative to other mutual fundsrelative to other comparable investment optionsRankings by external agenciesEconomic TimesLipperCRISIL CPRs, RRR, CQRCRISIL Volatility RatingCRISIL Fund Management Practice.135135

BenchmarksRelative returns are important than absolute returns for mutual fundsComparable passive portfolio is used as benchmarkUsually a market index is usedCompare both risk and return, over the same period for the fund and the benchmark.

136136

SEBI GuidelinesBenchmark should reflect the asset allocationSame as stated in the offer documentGrowth fund with more than 60% in equity to use a broad based indexBond fund with more than 60% in bonds to use a bond market indexBalanced funds to use tailor-made indexLiquid funds to use money market instruments.

137137

Other Measures of PerformanceSize and portfolio compositionCredit qualityRating profile of portfolioExpense ratioHigher expense ratio hurts long term investorsTracking errorFor index funds this should be nilPortfolio turnoverHigher for short term & lower for longer term funds.138138

Stop Check!An investor purchased an open-ended fund when NAV was 20. 16 months later, the NAV stood at 22. the percent change in NAV in the fund was:7%8%7.5%8.5%Returns can be annualized and compounded only if the scheme has completed:30 days12 months6 months24 monthsAn equity scheme is 90 days old. To compute its yield, it can useAbsolute returnSimple annualized returnCompounded annualized returnAny of these139139

10. Helping Investors with Financial Planning11. Recommending Financial Planning Strategies to Investors12. Selecting the right Investment Products for Investors13. Helping Investors understand risks in Fund Investing14. Recommending Model Portfolios and Selecting the right fund

Session 6Financial Planning & Mutual Funds140140

Financial Planning & Mutual FundsConcept of financial planningFinancial Planning StrategiesMapping life cycles & wealth cyclesAlternate investment productsUnderstanding RiskAsset allocationModel portfoliosFund selection.

141141

Financial PlanningIt is an exercise aimed at identifying all the financial needs of an individual, translating the needs into monetarily measurable goals at different times in the future and planning the financial investments that will allow the individual to provide for and satisfy his future financial need and achieve his life goals.

142142Just the fact that you put a figure down to what you would need for retirement, your childs education, for buying a house makes you think about savings differently.Savings, instead of a residual habit, becomes a target. For Example, If I save 4000 a month over the next 10 years will result in a corpus of 8.2 lacs (compounded monthly @ 10% p.a.) which might fund a childs medical education.Investment, instead of a panic decision becomes a strategy.

Who is a financial planner?Is a person who uses the financial planning process to help another person determine how to meet his or her life goalsKey functions of a FP is to help people identify their financial planning needs, priorities and the products that are most suitable to meet their needs.

143143

Benefits of Financial PlanningTo clientProvides direction and meaning to financial decisionsHelps understand how decision in one area effects other areasHelps evaluate short and long term effects of decisions on ones life goalsTo PlannerAbility to establish long term relationshipsAbility to build a profitable business.144144Just the fact that you put a figure down to what you would need for retirement, your childs education, for buying a house makes you think about savings differently.Savings, instead of a residual habit, becomes a target. For Example, If I save 4000 a month over the next 10 years will result in a corpus of 8.2 lacs (compounded monthly @ 10% p.a.) which might fund a childs medical education.Investment, instead of a panic decision becomes a strategy.

Financial Planning ProcessEstablish & Define the Client Planner RelationshipDefine the Clients GoalsGather and Analyze DataAscertain the Clients Tax SituationRecommend the appropriate Asset AllocationExecute the PlanReview ProgressDetermine and Shape the Risk Tolerance level145145

Role of participantsFinancialPlannerFundManagerPortfolioInvestmentsDiscussionOf Goals& AssetAllocationChoice ofSchemes& FundManagerMarket Analysis& Choice ofSecuritiesClient146146

Important factorsSet Measurable Financial GoalsUnderstand the Effect of Each DecisionRe-evaluate Financial Situation PeriodicallyStart Planning ASAPSet realistic expectationsClient is in-Charge of the process147147

Classification of InvestorsLife Cycle StagesWealth Cycle Stages148148

Life Cycle StagesChildhood StageYoung Unmarried StageYoung Married StageYoung Married with Children StageMarried with Older Children StagePost family/Pre-retirement StageRetirement Stage.

149149During childhood stage, the main need for children may be to invest cash gifts to provide lump sum when they are adults.During young unmarried stage, there may be urgent short term needs such as saving up to marry and establish a home.During young married stage, it is important to create an emergency fund before committing to long-term plans.The need for life insurance is higher in case only one partner is working.During the young married with children stage, the need for adequate life cover is higher and must be met first.During married with older children stage, provision to provide retirement income is crucial.During post-family/pre-retirement stage, protection from disability and health problems is important as well as the need to maximize investment into pension products.At retirement stage, need for fixed income and capital protection is crucial.A supplementary approach to life stage guide is the wealth cycle guide.The wealth cycle approach is more comprehensive and relevant than grouping investor merely by age or life stage.

Wealth Cycle StagesSowing or Accumulation StageTransition StageReaping or Distribution StageIntergenerational Wealth Transfer ChangeSudden Wealth Surge StageAffluent investorsWealth preservingWealth creating.150150accumulation stage the financial goals are quite some time away and investments can be made for the long-term; clients are looking to build wealthtransition stage one or more of the goals are approaching and clearly in sight; reaping stage the cashing out stage when the goal has arrived; a client about to retire or just retiredintergenerational wealth transfer stage older investors who need to start thinking about how to share their wealthsudden wealth stage significant events such as a sale of shares or business, inheritance or winning from a contest/lottery making the client wealthy.

Other areasConstraints to Financial PlanningGoal-Oriented InvestingPlanning for Affluent InvestorsWealth Creating Individuals: These are aggressive and tend to invest more in equity, maybe even 70% to 80%Wealth Preserving Individuals: Conservative and thus tend to invest majority into income, gilt and liquid funds.

151151An effective mode of investing is goal oriented investing where a specific and separate asset allocation and investment strategy is evolved to meet each individual goal.goal-oriented investing works well for all types of investors.affluent investors is a category of wealthy individuals who do not need financial planning to take care of the normal goals such as retirement income, children education/marriage etcaffluent investors are categorized as:wealth creating those who are willing to take risk to make their net worth growwealth preserving those who are looking to primarily conserve the wealth that they already have

Strategies for InvestorsInvest whenever there is money!Start Planning & Investing EarlyHave realistic ExpectationsInvest RegularlyBuy and Holdmay not be good strategy with stocks but is good in case of a mutual fund for the investor willing to wait out a full market cycleWhen to cash out needs more thought and skillin case of stock sell out as the price rises beyond reason or when fundamentals start to deterioratein case of mutual funds redeem when the goals have arrived and money is needed or if the market appears overvalued in terms of fundamentals and historic valuations.152152

Useful StrategiesPower of CompoundingRupee Cost Averaging (RCA)Value AveragingJacobs combined approach.153153

Power of CompoundingInvesting for the long term Higher the frequency, greater the growthsix-monthly compounding of 100 rupees for 10 years would yield Rs. 321 instead of Rs. 311 with annual compounding

154154

Power of CompoundingFV = PV (1 + r) n

Save MoreEarn MoreStart Early155155

The legend of compoundingAmount Invested = Rs. 10,000Year of investment = 1977Growth rate = 49%Value of holding at the end of 2007 = ???

Which company am I?156156Reliance Industries LimitedDhirubhai Ambanis 1st IPO some 45,000 investors put in appx. 2.5 crores.10K as a one time investment has grown to appx. 157 crores (156,88,73,952)

Rupee Cost AveragingInvest a predetermined amount regularlyPurchase more units when the market is low; less when the markets are highReduces the average cost of purchaseImplemented through SIPDisadvantage it doesnt tell you when to buy, sell or switch.

157157

RCA An ExampleMonthAmount InvestedNAV per UnitUnits boughtCumulative Number of UnitsValue of holding1500010 500.00 500.00 5,000 2500015 333.33 833.33 12,500 3500020 250.00 1,083.33 21,667 4500012 416.67 1,500.00 18,000 550008 625.00 2,125.00 17,000 650005 1,000.00 3,125.00 15,625 Average NAV 11.67 Average Cost/ Unit 9.60 158158

Value AveragingInvest regularly to achieve a predetermined valueBook profits at highs, and add units at the lowsImplemented through SWPReduces the average cost of purchaseSuperior to RCA allows you to redeem at the right opportunity.

159159

VA An ExampleMonthTarget ValueNAV per UnitUnits boughtCumulative UnitsValue of holdingCurrent portfolio value1 5,000 10.00 500.00 500.00 5,000 5,000 2 10,000 15.00 166.67 666.67 7,500 10,000 3 15,000 20.00 83.33 750.00 13,333 15,000 4 20,000 12.00 916.67 1,666.67 9,000 20,000 5 25,000 8.00 1,458.33 3,125.00 13,333 25,000 6 30,000 5.00 2,875.00 6,000.00 15,625 30,000 Average NAV 11.67 Average Cost/ Unit 5.00 160160

VA another exampleMonthTargetValueNAV (Rs)Value ofHoldingUnits to investCum no of units11,000 10.00 100.00 100.00 100.00 22,000 12.50 1,250.00 60.00 160.00 33,000 14.25 2,280.00 50.53 210.53 44,000 11.75 2,473.68 129.90 340.43 55,000 10.50 3,574.47 135.76 476.19 66,000 9.00 4,285.71 190.48 666.67 77,000 8.50 5,666.67 156.86 823.53 88,000 7.65 6,300.00 222.22 1,045.75 99,000 8.80 9,202.61 (23.02) 1,022.73 1010,000 9.25 9,460.23 58.35 1,081.08 1111,000 12.00 12,972.97 (164.41) 916.67 1212,000 15.00 13,750.00 (116.67) 800.00 161161

Jacobs ApproachCombine RCA and VA Use an aggressive growth fund and a money market fund of the same family.162162

Asset AllocationBesides how much and for how long to invest, the important question is where to investEquity, debt and money market products are called asset classes Asset allocation means determining the percentage of investments to be held in equities, bonds and money market/cash instrumentsOver 94% of returns on a managed portfolio come from the right level of asset allocation between stocks and bonds/cashThe approach must incorporate product, investor profile and preferences in the portfolio.163163

Types of Asset AllocationFixed Asset AllocationFlexible Asset AllocationTactical Asset AllocationPortfolio is periodically re-balancedDisciplined approachProfit booking in rising & more investment in a falling market Better if stocks continue to return more than bondsNo re-balancing - proportions can vary when prices changeIf equity returns are higher than debt, equity allocation will go up fasterBetter if bond returns are close to equitymaking changes in asset allocation within the overall percentage holding for extra return.164164Tactical asset allocationE.g. investing in small cap stock more than large cap stock or value stocks over growth stocks.

Asset Allocation ApproachesBenjamin Grahams 50/50 balancea 50/50 split between debt and equityGrahams 50:50 is the basic asset allocation.165165

Grahams PortfoliosPortfolio TypePortfolio MixBasic managed Portfolio50% diversified equity value fund25% Govt Securities fund25% High grade corporate bond fundBasic Indexed Portfolio50% total stock market/index fund50% total bond market portfolioSimple Managed Portfolio85% Balanced 60/40 fund15% Medium term bond fundComplex Managed Portfolio20% diversified equity fund20% aggressive growth fund10% specialty fundReadymade Portfolio100% Single Index fund with 60/40 equity/bond holding166166Accumulation PhaseDiversified EquityIncome and Gilt FundsLiquid Funds5%65-80%15-30%Jacobs Investment Strategies167167

Jacobs Investment StrategiesDistribution PhaseDiversified EquityIncome and Gilt FundsLiquid Funds5%65-80%15-30%168168

Asset Allocation ApproachesBogles ApproachBogle suggested variation to percentages based on age, financial circumstances and objectivesBogles thumb rule debt portion of an investors portfolio equal to investors age.169169

Bogles Asset Allocation StrategyAccumulation StageDistribution StageYounger Investor80% Equity20% Debt60% Equity40% DebtOlder Investor70% Equity30% Debt50% Equity50% Debt170170

Stop Check!The strategy to maximize investment return in the long run is:Buy and hold investments for a long timeLiquidate poor performers from time to timeLiquidate good performers from time to timeSwitch from poor performers to good performersSIP is best example ofRupee Cost AveragingValue AveragingBuy & HoldNone of these.

171171

Alternate Investment Products172172

Alternate Investment ProductsPhysical/Real Assets vs. Financial AssetsPhysical Assets Gold & Real Estate High initial investment, liquidity concernsFinancial AssetsBy class: equity, debt, money marketBy issuer: Govt, FIs, Corporate, BanksGuaranteed vs. Non-guaranteedGovernment - G-Secs, PPF, KVPs, NSCs, RBI Relief BondsPSUs/FIs Bonds Banks - FDsCorporate - Shares, Debentures, Bonds, FDsInsurer - Policies (With Profit or without profit, ULIPs)Mutual Fund a combination asset.173173

Investment ProductsIssuerProductAvailable toBankFixed DepositsInvestor, MFsCorporateSharesInvestor, MFsBonds, DebenturesInvestor, MFsFixed DepositsInvestor, MFsGovernmentGovt. SecuritiesInvestor, MFsPPFInvestorOther personal investmentsInvestorFIsBondsInvestor, MFsInsurersInsurance policiesInvestor174174

Quick WitTenor of RBI Bonds?Min/Max investment in PPF?Who assigns credit rating to Corporate securities?Borrowers with lower rating need to give higher/lower interest?Tax benefit in NSC?Liquidity in Mutual Funds higher/lower than equity?Tax aspects of life Insurance proceeds?175175

Comparison of financial productsConvenienceReturnSafetyVolatilityLiquidityEquityModerateHighLowHighHigh-LowFI BondsHighModerateHighModerateModerateCorp DebenturesLowModerateModerateModerateLowCompany FDsModerateModerateLowLowLowBank DepositsHighLowHighLowHighPPFHighModerateHighLowLow-ModerateLI (Traditional)HighLowHighLowLowLI (ULIPs)HighHighHighModerate - HighLow-ModerateGoldLowModerateHighModerateModerateReal EstateLowHighModerateHighLowMutual FundsHighHighHighModerate-HighHigh176176

Mutual Fund vs. Direct EquityFeatureDirect EquityMutual FundStock selection abilityLowHighFocussed activityLowHighDiversificationLowHighProfessional managementLowHighLiquidityLowHighTransaction cost HighLowConvenienceSwitchesCheque writing facilitiesLowHighInvesting time, knowledge & resourcesHighLow177177

Mutual Fund vs. Bank DepositDeposits Contractual agreement Guaranteed for repaymentNo direct holding of a portfolio of investmentMutual FundNo contractual agreement No guaranteeDirect holding of a portfolioReturn commensurate with risk.

178178

Investor PerspectiveInvestment ObjectiveRisk ToleranceInvestment HorizonEquityCapital AppreciationHighLong TermFI BondsIncomeLowMedium-Long TermCorp DebenturesIncomeHigh-Moderate-LowMedium-Long TermCompany FDsIncomeHigh-Moderate-LowMediumBank DepositsIncomeLowShort-Medium-Long TermPPFIncomeLowLong TermLife Insurance (Traditional)Risk CoverLowLong TermLife Insurance (ULIPs)Risk Cover, Capital Growth, IncomeHigh-Moderate-LowMedium-Long TermGoldInflation hedgeLowMedium-Long TermReal EstateCapital Growth, IncomeLow-ModerateLong TermMutual FundsCapital Growth, IncomeHigh-Moderate-LowShort-Medium-Long Term179179

Why MF is the best optionCombine the advantages of all investment productsflexibility, convenience, affordability, liquidity, potential for high returnsDispense the short comings of the other options liquidity, low return expectation, risk diversificationReturns are adjusted for market movementsCommensurate with level of risk.

180180

Stop Check!An investor in regular need of income should not select:A bank depositA debt fundAn equity growth fundPPFWhich of the following has highest level of liquidityEquityPPFCompany Fixed depositsMutual fundsWhich of the following should not be viewed primarily as an investment option?Mutual fundsEquity sharesLife insuranceNone of the above.181181

Risk in Mutual Fund Investing182182

Risk in MF investingWhat is Risk?Volatility of earnings viz. deviation (+ & - ) from expected earningsPossibility of Financial lossRisk can be built into the investment planning byDefining the risk appetite of the investor and aligning investment objectives to risk toleranceEvaluating and measuring risks of portfolio to keep in line with the investors risk appetiteThe right level of risk tolerance of any investor depends upon age, investable funds, circumstances including income level, job security, family size etc.183183Jacobs recommendation based on risk levelJacobs Recommendation of portfolio sub-allocationLow-Risk (Conservative) portfolio50% G Secs + 50% MMMFModerate Risk (Cautiously Aggressive) portfolio40% in Growth & Income + 30% Govt Bonds + 20% Growth Funds + 10% Index FundsHigh Risk (Aggressive) Portfolio25% Aggressive Growth Funds + 25% International Funds + 25% Sector Funds + 15% High Yield Bond Funds + 10% Gold Funds184184

Type of risk in Equity FundsCompany SpecificSector SpecificMarket RiskCompany and Sector risk can be reduced with diversification but market risk cannot be diversifiedMarket CyclesPortfolio performance over a market cycleEquity more rewarding in the long-term.185185

Measures of RiskRiskStandard DeviationBetaEx-marksAlphaRisk-adjusted returnSharpe RatioTreynor Ratio.

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Standard DeviationBest measure of riskMeasure of absolute or total risk of a portfolioDispersion around meanQuality rating of the averageHigher S.D. indicates more volatile returnsLower deviation means less riskHigh S.D. need not mean poor performanceSachin Tendulkar vs. Harbhajan Singh.VOLATILITY!187187Steps in determining portfolio riskCalculate a fund's monthly performance over a long period of time.Calculate the average for all these monthly performances.If the individual monthly performances are very different from the average, then that fund is risky, delivering high returns in some months and poor returns in others. If they are mostly similar, then the fund is a low risk one, with about the same returns month after month. We calculate exactly how much each month's performance is different from the average and then calculate the average of these differences. This is Standard Deviation.

BetaShows how sensitive a fund is to market movesIf the Sensex moves by 25%, a funds bet number will tell you whether the funds return will be more or less than thisBeta value for an Index is taken as 1Multiplying the beta value of a fund will expected percentage movement of an index gives the expected movement in the fundHigher beta means higher impact of market returns Lower beta means less riskHigher beta funds do well in a rising market, lower beta funds do better in a falling market.SENSITIVITY!188188Beta is a measure of the sensitivity of a fund to its index.Beta is a statistical measure that shows how sensitive a fund is to market moves. If the Sensex moves by 25 per cent, a fund's beta number will tell you whether the fund's returns will be more than this or less.The beta value for an index itself is taken as one. Equity funds can have beta values, which can be above one, less than one or equal to one. By multiplying the beta value of a fund with the expected percentage movement of an index, the expected movement in the fund can be determined. Thus if a fund has a beta of 1.2 and the market is expected to move up by ten per cent, the fund should move by 12 per cent (obtained as 1.2 multiplied by 10). Similarly if the market loses ten per cent, the fund should lose 12 per cent.This shows that a fund with a beta of more than one will rise more than the market and also fall more than market. Clearly, if you'd like to beat the market on the upside, it is best to invest in a high-beta fund. But you must keep in mind that such a fund will also fall more than the market on the way down. So, over an entire cycle, returns may not be much higher than the market.Similarly, a low-beta fund will rise less than the market on the way up and lose less on the way down. When safety of investment is important, a fund with a beta of less than one is a better option. Such a fund may not gain more than the market on the upside, it will protect returns better when market falls.

Ex-Marks or R-SquaredQuality of Beta depends on Ex-marks Beta depends upon the index used to calculate it Beta calculated for large cap fund against a mid-cap index has no meaningHigher ex-marks means more reliable betaMeasures return from a fund and the market index and measures the extent of correlation in their movementLower ex-marks mean lower correlation with market returnsR-squared varies between 0 and 1R-squared of an index fund would be 1 (or Ex-marks 100%).SYMPATHY!189189

Ex-marks comparison

Same beta in both cases190190

AlphaMeasure of a fund manager's performanceTells what the fund has earned over and above (or under) what it was expected to earnThis is the value added (or subtracted) by the fund manager's investment decisions Alpha tells you whether that fund has produced returns justifying the risks it is taking by comparing its actual return to the one 'predicted' by the betaSay, a fund can be expected to earnbased on its betaa return of 15 per cent in a given year. However, it actually fetches you 18 per cent. Then the alpha of the fund is simply 18 - 15 = 3Index funds always haveor should have, if they track their index perfectlyan alpha of zero. 191191Alpha can be seen as a measure of a fund manager's performance. This is what the fund has earned over and above (or under) what it was expected to earn. Thus, this is the value added (or subtracted) by the fund manager's investment decisions. Alpha tells you whether that fund has produced returns justifying the risks it is taking by comparing its actual return to the one 'predicted' by the beta. Say, a fund can be expected to earnbased on its betaa return of 15 per cent in a given year. However, it actually fetches you 18 per cent. Then the alpha of the fund is simply 18 - 15 = 3, that is, 3.This can be clearly seen from the fact that Index funds always haveor should have, if they track their index perfectlyan alpha of zero. Thus, a passive fund has an alpha of zero and an active fund's alpha is a measure of what the fund manager's activity has contributed to the fund's returns. On the whole a positive alpha implies that a fund has performed better than expected, given its level of risk. So higher the alpha better are returns.

Sharpe & Treynor Ratio

192192Named after William Forsyth SharpeHowever, while looking at Sharpe ratio a few points have to be kept in mind to obtain an accurate reading of the fund's performance. Firstly, being a ratio, the Sharpe measure is a pure number. In isolation it has no meaning. It can only be used as a comparative tool. Thus the Sharpe ratio should be used to compare the performance of a number of funds. Alternatively one can compare the Sharpe ratio of a fund with that of its benchmark index. If the only information available is that the Sharpe ratio of a fund is 1.2, no meaningful inference can be drawn as nothing is known about the peer group performance. The Sharpe ratio uses standard deviation as it's risk component, a low standard deviation can unduly influence results. Thus a fund with low returns but with a relatively mild standard deviation can end up with a high Sharpe ratio. Such a fund will have a very tranquil portfolio and not generate high returns. For an investor who puts in all his/her money in a single fund, Sharpe ratio is a useful measure of risk-adjusted return. This is because standard deviation measures total risk and this is the case with a single portfolio. For additional funds in a portfolio, indicators like the Treynor ratio, which use market risk, can be used.Measures such as Sharpe ratio provide an unbiased look into fund's performance. This is because they are based solely on quantitative measures. However, these do not account for any risks inherent in a funds portfolio. For example, if a fund is loaded with technology stocks and the sector is performing then all quantitative measures will give such a fund high marks. But the possibility of the sector crashing and with it the fund sinking is not calculated. In view of these possibilities quantitative tools should be used along with information on the nature of the funds strategies, its fund management style and risk inherent in the portfolio. Quantitative tools can be used for screening but they should not be the only indicator of a fund's performance.The Sharpe ratio is one of the most useful tools for determining a fund's performance. This measure is used the world over and there is no reason why you as an in investor should not use it. So sharpen the analysis of your fund's performance with the Sharpe Ratio.

Returns must be evaluated on a risk-adjusted basisHigher return may be accompanied by higher riskCompute return and risk for both for fund and benchmark and find out return per unit of risk, earned by each of themEg. benchmark return (12%) and S.D. (9%)Fund return (16%) and risk i.e. SD (11%)Then the benchmark has return per unit of risk of (12/9)1.33 and the fund has return per unit of risk of (16/11) 1.45Hence, on a risk adjusted basis, the fund has performed better than the benchmark

The Sharpe ratio is used to characterize how well the return of an asset compensates the investor for the risk taken. When comparing two assets each with the expected return E[R] against the same benchmark with return Rf, the asset with the higher Sharpe ratio gives more return for the same risk. Investors are often advised to pick investments with high Sharpe ratios.

The Treynor Ratio, named after Jack L. Treynor, one of the fathers of modern portfolio theory,

Like the Sharpe ratio, the Treynor ratio (T) does not quantify the value added, if any, of active portfolio management. It is a ranking criterion only. A ranking of portfolios based on the Treynor Ratio is only useful if the portfolios under consideration are sub-portfolios of a broader, fully diversified portfolio. If this is not the case, portfolios with identical systematic risk, but different total risk, will be rated the same. But the portfolio with a higher total risk is less diversified and therefore has a higher unsystematic risk which is not priced in the market.

When is such an indicator useful? In case of well-diversified portfolios, total risk is a more meaningful measure of risk. While for non-diversified portfolios, market risk becomes a relevant measure of risk. This is because for a well-diversified portfolio, the company risk will be low, i.e. the total risk should be close to market risk. In this case the Sharpe and Treynor ratios will rank such funds in same order. But for non-diversified portfolios, the two ratios can give different rankings.Hence, the Treynor Ratio offers another risk adjusted performance measure bringing focus to that element of risk, which is unavoidable. This tries to convey that by investing in another fund you are adding the market risk to your overall portfolio of assets, for which you must be compensated. The ratio thus becomes meaningful if you have investments in more than one fund, but it is of less relevance if you intend to own a single fund.

Stop Check!Ex-marks (R-Squared) of a fund measuresHow much of a funds movement is due to the market index movementHow a fund's movement relates to the market index movementHow much of a fluctuation has occurred in the funds NAV over a historical periodHow many marks a credit rating agency accords to a fundWhich is a better investment option?Ex-marks 75% beta 0.9, gross dividend yield 8%Ex-marks 80% beta 0.9, gross dividend yield 8%Ex-marks 90% beta 0.9, gross dividend yield 9%Either 1 or 3 above.193193

Recommending model portfolios & Selecting the right fund194194

Jacobs Four-Step Program Develop long term goalsInvestment avenues, time horizon, return and riskDetermine asset allocationAllocation to broad asset classesDetermine sector distributionAllocation of sectors of the mutual fund industrySelect specific fund managers and their schemesCompare products & choose actual funds to invest in.195195There is a question on the sequence of these steps in creating a model portfolio

Jacobs Model PortfoliosInvestorRecommended Model PortfolioYoung, Unmarried Professional50% in Aggressive Equity Funds25% in High Yield Bond Funds and Growth and Income Funds25% in Conservative Money Market FundsYoung Couple with two Incomes and two Children10% in Money Market30% in Aggressive Equity Funds25% in High Yield Bond Funds35% in Municipal Bond FundsOlder Couple Single Income30% in Short-term municipal Funds35% in long-term Municipal Funds25% in moderately aggressive equity10% in emerging growth equityRecently retired couple35% in conservative Equity funds25% in moderately Aggressive Equity40% in Money Market Funds196196

Fund Selection Bogles ApproachEquityCategory Diversified, Sectoral, Index etcStrategy Growth and ValuePast Returns Compare with benchmark and with funds in same category over same time framesFund Size, Age, Costs, Managers experience Bigger Size, Longer Age, Lower Costs and Higher Fund Managers experience are betterCharacteristics Lower Cash Position, Low Concentration, Lower portfolio turnover are generally better; Higher Cap assumes less riskRisk Statistics Low Beta, High Ex-Marks, High Div yield are generally better.197197An equity fund should ideally have little by way of cash, as liquid stocks are adequate to meet sudden redemption pressures. A newly floated equity fund may have cash and money market instruments.

Fund Selection Bogles ApproachDebtType Income/Gilt/Liquid etcFund Age & Size higher the age and larger the size, the betterCosts lower the betterLoads lower the betterAverage Maturity higher average maturity means higher interest rate risk Credit Quality More AAA rated securities, more secure the fund.198198Fund age and size actually matter, though AMFI book thinks otherwise. A new bond fund in itself may not be risky as long as the portfolio is not very risky.Total return is made up of accrued interest (coupon income), re-investment of coupons, and capital gains/loss from sale. YTM represents only 2 components of the above return, with the limiting assumption that re-investments are made at the YTM rate.These days, funds are also rated. If some one asks for this, indicate that rating of a fund depends on the same characteristics as listed in the slide.Duration depends on tenor, coupon and ytm. Therefore average maturity is not a great proxy for duration. However, it is a simplistic explanation.Low expense ratios is important as there is a question on that

Fund Selection Bogles ApproachBalancedPortfolio Balance match investors objectiveDebt Portfolio Quality higher the betterCosts lower the betterPortfolio Statistics similar to equity funds.199199

Fund Selection Bogles ApproachMMMFCosts lower the expense ratio the betterYields higher the betterQuality higher is essentialLiquidity and turnover rateShorter term instruments are turned over more frequentlyPrincipal protectionLimited NAV fluctuation due to low duration and low levels of interest rate risk.200200Liquid funds usually have a high churn. Short tenor instruments translate into frequent transactions by fund manager.

The duration of liquid funds is very low, translating into a low level of interest rate risk. Usually NAVs of debt funds are very stable.

Liquid funds do invest in CPs and short term MIBOR linked bonds. Credit quality can thus become very important.

Emphasise the low expense ratio. Ask the class to see the actual expense ratios in the KIM. Point out how liquid funds have lower expense ratios than others. This is actually due to the fact the frequency of investor entry and exit creates a large level of weekly average net assets, while AUM can actually be lower. Remember expense and fees are based on the weekly average net assets.

Stop Check!Which of the following portfolios is more risky?75% equity 25% debt40% equity 60% debt60% equity 40% debt80% equity 20% debtWhat would you suggest a client who has won a lottery of Rs. 1 crore?Invest the entire money in old economy stocks as they are back in favourInvest in an equity index fund since the index is at a historic lowInvest in a safe liquid investment option and take the time needed to work out a financial planInvest in IT stocks, since their valuation is quite attractive.201201

Stop Check!What asset mix would you suggest to a 55 year old who plans to retire at 58?40% equity schemes and 60% balanced scheme40% equity schemes and 60% debt scheme20% equity, 20% liquid funds and 60% debt scheme100% monthly income schemeWhat portfolio would you recommend to a recently retired couple?35% conservative equity, 25% moderately aggressive equity, 40% money market funds30% short-term municipal funds, 35% long-term municipal funds, 25% moderately aggressive, 10% emerging equity50% aggressive equity, 25% high yield bond funds and growth and income funds, 25% conservative MMMFEither 2 or 3.

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Stop Check!For which of the following funds would you consider average maturity as an important factor in selecting the right fund?A debt fundA balanced fundA money market or liquid fundBoth 1 and 2 above.203203

15. Business Ethics and Mutual FundsSession 7Business Ethics204204

Meaning of business ethicsRefers to rules of acceptable and good conduct in businessAll persons engaged in business should comply with rules of good conduct and have strong ethicsThese rules may be set by those who own and manage the business, or by those agencies that have the right to regulate the businessBusiness ethics are hard to enforce, hence desirable that they be self imposed In many countries, laws such as Consumer or Investor Protection Act exist. 205205

Need for business ethicsHave honest and fair business practicesProtect the interests of the customer or investorGood ethics also mean good businessRetention of customer and generates loyaltyTransparency in operations and to ensure that both potential and existing customers are treated at par.206206Need of Business EthicsThese are required to have honest and fair business practices.These are required to insure that the business is not done dishonestly and false promises are not made to the investors.From social angle, business ethics are required to protect the consumers interest.From the angle of business itself, good ethics means good business. Honest and fair practices will insure that the customer remain satisfied, will not feel cheated and the loyalty will increase.They are also required to have transparency in business dealings and insuring that both the existing as well as potential clients and consumers are treated at par.

Objectives of Business EthicsHonest and transparent dealings with customersProtect clients and customer from being exploited or cheatedLevel playing field among all participantsHealthy competition for the benefit of all customers.

207207Need for business Ethics in Mutual FundsMutual funds are vehicles of collective investment managed by asset managed companies for a feeAMC takes help of many entities including distributors and individual financial advisorsAll entities need to abide by the rules of good conductTrustees, Directors of AMC set the rules for distribution and employeesAMFI has also set rules of good conduct for AMCs, its employees and distributors.208208

SEBI ObjectivesFunds always conduct all activities in the best interest of investorsAreas monitored by SEBIFund Structure & GovernanceExercise of Voting Rights by FundsFund Operations.209209

Implementing Business EthicsFund structureFiduciary responsibility for MFsA fund holds the investors money in trustThe money continues to belong to investorsFund managers only manage itStructure designed to protect the investor through a system of checks and balances on the observance of ethical standards by all the industry constituentsEthical and honest behavior on the part of the fund trustees and managers is essential.210210

Implementing Business EthicsFund GovernanceRegulator prime concern is investor protectionProtect the investor through a system of independent controls or check and balancesSeparation of functionsIndependence of organizationsIndependence of personnel.

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Implementing Business EthicsFund OperationsInsider TradingPreferential Treatment to Sele