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Mutual fund is a professionally managed investment instrument which pools money from a group of investors and invests the money in stocks, bonds and other securities.
In simple words, mutual fund collects money from investors like you and me and invest that cumulative money into stocks, bond or mixture of both, This process is done by AMC( Asset Management Company)
What is an Asset Management Company (AMC)?
Asset Management Company is a firm that invests the funds collected from individual investors with the objective to maximize return on their investment, Question arises why we need (AMC)?
These asset management companies have a dedicated workforce which helps them with the required inputs like
Market research and analysis– These research are needed to understand the market patterns, economic factors, and political aspects . which could have an impact on investments.
Allocation of an asset– Usually AMCs diversify the investment to the different asset in order to manage market risk Experts work is to find a balance in investment
Day to day analysis– AMCs are responsible for analysing the performance of the portfolio and informing the customers and regulators
Asset management companies are regulated by the capital market regulator, Securities and Exchange Board of India (SEBI), AMFI (Association of mutual fund of India) is another watchdog in order to protect the interest of investors.
HDFC Mutual fund, Axis Mutual fund, SBI Mutual Funds, etc…. are some of the names present in the market as AMC
What is Net Asset Value (NAV)?
Before moving towards how mutual funds work, a term (NAV), which is very important let’s see what it is
In simple words NAV represents a fund’s per unit market value , it is the price at which investors buy fund units
Let’s understand it with an example Say firm “A” has a scheme “X” and the total size of the scheme is Rs 1,00,000 , Firm has divided it into 10000 units, simply dividing the total value of the asset minus all the liability which firm has to pay as salary’s etc… by total units will give you NAV
In this case NAV = 1,00,000- Liability (assuming liability being’’ 0’’)/10000(Units issued)
NAV comes to RS 10 per unit
How Mutual Funds Work?
Firms “A” Which has a scheme ”X” size of Rs 1 lakh initially decides to invest equally in five company’s let us say HDFC Bank, Reliance Industries Limited, TCS, ICICI Bank and SBI and it buys shares worth RS 18,000 of each company’s at market price on 1st October 2020 By doing this firm has spent RS 90,000 and sitting with cash which is to be spent towards Further Investments, payment of salary or any other expenses which is to be incurred in order to manage the fund, at the end of the month on 31st October 2020 let’s see as an example –
SBI shares appreciated by 10% , the value of Investment comes to RS 19800
HDFC shares appreciated by 5% the value of the investment comes to RS 18900
Reliance shares depreciated by 5% the value comes to RS 17100
ICICI shares appreciated by 10% the value comes to RS 19800
TCS shares have depreciated by 5% the value comes to RS 17100
Out of cash balance say RS 10000 , a management fee which is capped at 0.5% to 1%
Lets try to calculate the NAV in this case –
Value of investment will be: 19800+18900+17100+19800+17100 = 92700
Out of cash of RS 10000 , lets say 1% of the fund Rs 1000 is spent towards salary so remaining cash comes to RS 9000
In this case, Total asset comes to Rs 92700 +Rs 10000 –(Rs1000 outstanding towards salary)/ Number of units that is 10000
Nav in this case comes to Rs 10.17
We can say if someone has bought 1000 units initially of Rs 10 each for Rs 10000 on 1st of October 2020 on 31st October the value of investment comes to Rs 10170, Thus making a gain of 1.7% in a month.
Usually, NAV is calculated on a daily basis, There other charges like “ Exit charges” are charged to discourage investors from exiting the fund in a shorter period this ranges from 1% to 3% out of the amount which is to be received by the investor.
Mutual Fund Types
- Based on the asset class
- Based on structure
Based on asset class a fund can be classified into
Equity funds primarily invest in stocks, and hence also called stock funds, they invest the money pooled from various investors into shares/stocks of different companies.
The gain or loss solely depends upon how shares perform in the stock market, These funds have the potential to generate high returns over a period, the risk associated with these funds are also comparatively higher.
Usually there are several kind of equity funds
In this type the investible corpus is invested into Companies with Larger market capitalization, highly reputed and having an excellent track record of wealth generation, the investment is considered less risky and good return is expected in a longer period.
These funds invest the corpus predominantly in stock of small companies that have the potential to grow, these funds have potential to double or triple over a very short period at the same time these are highly risky .
These are diversified mutual funds which can invest in stocks across market capitalization.
These are the equity funds that invest in mid sized companies across the high growth sectors .
These funds primarily invest in Fixed-income securities such as bonds, securities and treasury bills, these kinds of investments have fixed interest on them which are paid in a timely manner. It can be a great option for passive investors looking for regular income.
These funds are also called balanced funds and are a mixture of stocks and bonds.
Among all Equity funds, they are more popular and have the biggest share in the industry.
Based on structure
It can be divided into two parts:
This type of fund does not have any constraints such as a specific period or number of units which can be traded entry and exit can be done at NAV
For example, In the example above if firm “A” decided that fund “X” would be an open-ended fund The units can be bought and sold continuously It may start with 10000 units but later it could go as higher as the demand is and at the same time corpus also grows with new units bought and sold
A very important term SIP(systematic investment plan) SIP is usually done only in open-ended fund, every month investor invests certain amount that amount is spent in buying more units at NAV and the process goes on , When investor want to sell his units simply he can sell away whatever unit he is holding at NAV
Reverse of that a closed fund has pre-decided units as well as corpus
In the case of firm A decided fund X is a closed-ended fund the total available unit will be 10000 and at NAV Rs 10 the corpus will be Rs 1,00,000.
At the beginning NFO(New fund offer) is done for a specific time period within that period investors can buy fund units and can only be able to redeem after a stipulated time period which is pre-decided, entry and exit in between is not permitted.
Why have mutual funds gained traction?
The mutual fund industry is managing Rs 26,85,982 crore and it is a four-fold increase in the span of last 10 years, as the economy grows the stock market turns out to be the biggest winner,
Buying stock individually pays only when one has the skill to research and analyse stocks, Mutual fund seems to be the solution which specializes through a dedicated team of analysts and people who could understand the market and analyse external political, economic sentiments,
In the Last decade it been seen that disciplined investing through mutual funds have generated wealth.