A Mutual Fund is one of the rapidly growing investment options for those who want to increase their income by not directly investing in shares and bonds. It collects money from multiple investors and invests it in a diversified portfolio of securities such as equities, bonds, money market instruments, and other assets. Portfolio managers check these investments to ensure the risk and return.
Table of Contents
- What is a Mutual Fund?
- How Does a Mutual Fund Work?
- Advantages of Mutual Funds
- Risks Involved in Mutual Funds
- Key Participants in a Mutual Fund
- Market Intermediaries
- Types of Mutual Fund Schemes
- What is Net Asset Value (NAV)?
- How to Calculate NAV
- What is Holding Period Return (HPR)?
- HPR Formula with Example
- How to Evaluate Mutual Fund Performance
- Frequently Asked Questions
- Conclusion
What is a Mutual Fund?
A Mutual Fund is a trust that collects money from investors with a common financial objective and invests it in a diversified portfolio of assets. Each investor owns units of the fund, representing a proportionate share of the fund’s holdings.
Five Principal Constituents
- Mutual Fund
A Mutual fund established under the Indian Trust Act to raise money through, the sale of units to the public for investing in the capital market. The funds thus collected as per the directions of asset Management company for invested. The Mutual fund has to be SEBI registered. - Asset Management Company (AMC)
Under SEBI (Mutual Fund) Regulations, 1996 every mutual fund is required to have an Asset Management Company (AMC) incorporated in the Companies Act, 1956/2013 to manage the funds of the mutual fund - Sponsor
Sponsor means any person who, acting alone or in combination with another body corporate establishes a mutual fund
4. Trustees
Trustees mean the Board of Trustees or the Trustee Company who hold the property of the mutual fund in trust for the benefit of the unit holders.
5.Unit Holders
A unitholder is an investor who owns the units issued by a trust, like a real estate investment trust or a master limited partnership (MLP). The securities issued by trust/MF are called units, and investors in units are called unitholders. The unit in turn reflect share of the investor in the Net Assets of the fund.
Advantages of Mutual Funds
- Professional fund management: Investors avail the services of experienced and skilled professionals who are backed by a dedicated investment research team which analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme.
- Diversified portfolio: Mutual Funds invest in several companies across a broad cross- section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. Investors achieve this diversification through a mutual Fund with far less money than one can do on his own.
- Lower investment risk: High liquidity (for open-ended funds): In open ended schemes, investors can get their money back promptly at net asset value related prices from the mutual fund itself. With close ended schemes, investors can sell their units on a stock exchange at the prevailing market price.
- Affordable investment through SIPs
- Convenient and transparent investment process: Potential for long-term wealth creation: Over a medium to long term, Mutual funds have the potential to provide a higher return as they invest in a diversified basket of selected securities.
Risks Involved in Mutual Funds
- Excessive diversification of portfolio, losing focus on the securities of the key segments.
- Too much concentration on blue-chip securities which are high priced and which do not offer more than average return.
- Necessity to effect high turnover through liquidation of portfolio resulting in large payments of brokerage and commission.
- Poor planning of investment with minimum returns.
- Unresearched forecast on income, profit and Government policies.
Key Participants in a Mutual Fund
- Sponsor
- Mutual Fund Trust
- Asset Management Company (AMC)
- Trustees
- Unit Holders
Market Intermediaries
- Custodian of Securities
- Custodian means a person who has been granted a certificate of registration to carry on the business of custodian securities under SEBI (Custodian of Securities) Regulations, 1996.
- Transfer Agents
- A transfer agent is a person who has been granted a Certificate of Registration to conduct the business of transfer agent under SEBI Regulations Act, 1993. Transfer agents’ services include issue and redemption of mutual fund units, preparation of transfer documents and maintenance of updated investment records.
- Depository
- A depository facilitates the smooth flow of trading and ensures the investors about their investment in securities.
Types of Mutual Fund Schemes
- Open Ended mutual funds: An open-ended mutual fund is a fund with a non-fixed number of outstanding share/units, that stands ready at any time to redeem them on demand. The fund itself buys back the shares surrendered and is ready to sell new shares. Generally, the transaction takes place at the net asset value which is calculated on a periodical basis.
- Close Ended mutual funds: It is the fund where mutual fund management sells a limited number of shares and does not stand ready to redeem them. The shares of such mutual fund are traded in the secondary markets. The requirement for listing is laid down to grant liquidity to the investors who have invested with the mutual- fund. Therefore, close ended funds are more like equity shares.
What is Net Asset Value (NAV)?
Net Asset Value (NAV) is the market value of one unit of a mutual fund. It is calculated at the end of each business day.
NAV Formula
NAV = Net Assets of the Scheme ÷ Total Outstanding Units
Where:
Net Assets = Market Value of Investments + Receivables + Other Income − Expenses − Liabilities
Holding Period Return (HPR)
Holding Period Return measures the total return earned from holding a mutual fund investment over a specific period.
Formula
HPR = [(Income + (Ending Value − Beginning Value)) ÷ Beginning Value] × 100
Example
- Purchase NAV: ₹17.60
- Current NAV: ₹19.875
- Dividend: ₹2
HPR = [(2 + (19.875 − 17.60)) ÷ 17.60] × 100 = 24.29%
How to Evaluate Mutual Fund Performance
While looking at a mutual fund scheme’s performance, one must not be led by the scheme’s return in isolation.
One must compare the scheme’s return as against its benchmark return.It is important to identify under-performers over the longer time horizon.In addition, one may also consider evaluating the ‘category average returns’ as well.Even the expense ratio of some of the schemes that one could be holding may be high compared to others within the same category.
Frequently Asked Questions
What is a Mutual Fund?
A Mutual Fund pools money from multiple investors and invests it in diversified assets managed by professionals.
What is NAV?
NAV is the per-unit value of a mutual fund calculated daily based on its net assets.
What are the main types of Mutual Funds?
The two primary types are Open-Ended and Close-Ended Mutual Funds.
Is investing in Mutual Funds risky?
Yes. Mutual funds are subject to market and investment risks, but diversification helps reduce overall risk.
What is Holding Period Return (HPR)?
HPR measures the total return from an investment over a specific holding period, including income and capital appreciation.
Conclusion
Mutual Funds offer a simple, diversified, and professionally managed way to invest in financial markets. Understanding concepts such as NAV, HPR, fund types, risks, and performance evaluation helps investors make informed decisions. Whether you’re a beginner or an experienced investor, choosing the right mutual fund based on your financial goals and risk appetite is essential for long-term wealth creation.