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A REPORT
ON
COMPARATIVE ANALYSIS OF MUTUAL FUNDS AND CONSTRUCTION OF AN OPTIMISED PORTFOLIO
By:-
SHAREKHAN LIMITED
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A REPORT
ON COMPARATIVE ANALYSIS OF MUTUAL FUNDS AND CONSTRUCTION OF AN OPTIMISED PORTFOLIO By RAJESH KUMAR 09BSHYD0637 SHAREKHAN LIMITED
A Report submitted in partial fulfillment of the requirement of MBA program at IBS Hyderabad
Submitted to:Dr. S. Subramanian Faculty Guide, IBS Hyderabad G.V.L. Narayana Rao (Territory Manager) Company Guide, Sharekhan Ltd. Date of submission: 16 th April, 2010
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Table of Contents
Abstract ......................................................................................................................................................... 1 What are Mutual Funds? .............................................................................................................................. 7 Sponsor ..................................................................................................................................................... 8 Trust/Board of Trustees ............................................................................................................................ 8 Fund Managers/AMC ................................................................................................................................ 9 Custodian .................................................................................................................................................. 9 The Ev olution .............................................................................................................................................. 10 Phase I. Establishment and Growth of Unit Trust of India - 1964-87 ......................................................... 10 Phase II. Entry of Public Sector Funds - 1987-1993 .................................................................................... 10 Phase III. Emergence of Private Secor Funds - 1993-96.............................................................................. 11 Phase IV. Growth and SEBI Regulation - 1996-2004 ................................................................................... 11 Phase V. Growth and Consolidation - 2004 Onwards ................................................................................. 12 Key Events ................................................................................................................................................... 12 Equity funds ................................................................................................................................................ 15 Index funds.............................................................................................................................................. 16 Diversified funds ..................................................................................................................................... 16 Tax-saving funds...................................................................................................................................... 17 Sector funds ............................................................................................................................................ 17 Debt funds................................................................................................................................................... 17 Income funds .......................................................................................................................................... 17 Gilt funds ................................................................................................................................................. 18 Liquid funds............................................................................................................................................. 18 Balanced funds ............................................................................................................................................ 18 Open-ended Funds ...................................................................................................................................... 18 Closed-ended Funds .................................................................................................................................... 19 Interval Funds ............................................................................................................................................. 20 Professional management .......................................................................................................................... 20 Small investments ....................................................................................................................................... 20 Diversified portfolio .................................................................................................................................... 21 Liquidity ....................................................................................................................................................... 21 Low Costs .................................................................................................................................................... 21 3| Page
Transparency ............................................................................................................................................... 21 Flexibility ..................................................................................................................................................... 22 Well Regulated ............................................................................................................................................ 22 Tax breaks ................................................................................................................................................... 22 No assured returns and no protection of capital ........................................................................................ 23 Restrictive gains .......................................................................................................................................... 23 Fees and Commissions ................................................................................................................................ 23 Taxes ........................................................................................................................................................... 24 Management Risk ....................................................................................................................................... 24 Securities and Exchange Board of India (SEBI) ........................................................................................ 24 ASSOCIATION OF MUTUAL FUNDS IN INDIA (AMFI) ................................................................................... 25 Top Management ........................................................................................................................................ 26 Products: ..................................................................................................................................................... 28 Operations .................................................................................................................................................. 28 NAV of a fund: ............................................................................................................................................. 29 Face Value of the fund: ............................................................................................................................... 29 Load: ............................................................................................................................................................ 29 Different options of a scheme: ................................................................................................................... 29 Growth Option ........................................................................................................................................ 30 Dividend Payout ...................................................................................................................................... 30 Dividend Re-investment.......................................................................................................................... 30 Portfolio Making: ........................................................................................................................................ 31 Practical Exposure in dealing with different customers: ........................................................................... 31 Calculations ................................................................................................................................................. 31 Effect on NAV after declaring dividend: ................................................................................................. 32 Investment Plans: ........................................................................................................................................ 33 Systematic Investment Plan (SIP)............................................................................................................ 33 Systematic Transfer Plan (STP) ............................................................................................................... 33 Systematic Withdrawal Plan (SWP) ........................................................................................................ 34 Standard deviation ...................................................................................................................................... 36 Beta ............................................................................................................................................................. 37 R-Squared .................................................................................................................................................... 38 4| Page
Sharpe Ratio ................................................................................................................................................ 38 Treynor ratio ............................................................................................................................................... 39 Why these statistical measures? ................................................................................................................ 40 Data collection ............................................................................................................................................ 40 Primary data ............................................................................................................................................ 40 Secondary data ....................................................................................................................................... 40 Data Analysis ............................................................................................................................................... 40 Top Equity based funds ............................................................................................................................... 41 Reliance Div ersified Power Fund ............................................................................................................ 41 Reliance growth ...................................................................................................................................... 42 ICICI Prudential Dynamic Plan: ................................................................................................................ 42 HDFC Equity Fund ................................................................................................................................... 43 References: ................................................................................................................................................. 46
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Abstract
Risk comes from not knowing what youre doing - Warren Buffet For an investor, investment decision is the most difficult decision. A typical investor does not possess the knowledge, time, or desire to undertake the research necessary to avoid wrong decisions. Investment in mutual funds is one of the solutions to avoid wrong investment decisions but what if investor has to choose these instruments from a large pool. Net Asset Value (NAV) is considered as the most reliable indicator of performance of mutual funds. This paper gives insight how to calculate NAV, returns, sharpe ratio, trenyor ratio, beta, Rsquare and how to use them to rank mutual funds. Five top scheme has been ranked from three mutual fund families. In equity funds, five top funds has been chosen to calculate various statistical tools. It will help to do the ranking and put them in an optimized portfolio according to various parameters. So basically this will help us to know about the top five mutual funds which will give highest returns at optimum risk.
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Introduction
What are Mutual Funds?
A mutual fund is a form of collective investment that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, and/or other securities. The portfolio manager trades the fund's underlying securities, realizing a gain or loss, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors. Mutual Fund is the investment vehicle that is gaining momentum in the Indian ma rket. Institutions known as Asset Management Companies regulate mutual funds in India. Money from the common man is pooled in and is diversified into other investment opportunities. Financial institutions or companies manage these mutual funds. Professionals are hired into these companies to evaluate the Balance Sheet and Profit and Loss accounts of companies to know which of them are perfor ming and will succeed in the near future. Thus bringing high r eturns to the investment. Apart from investments in equities, debentures which are directly linked to the bullish and bearish tr ends in the market, mutual funds are invested in more subtle companies that have a steady growth rate and thus are not much affected by the share market. This is the advantage of mutual funds over banks and other investment options, as they allow investors to invest in safe, low risk and high-risk companies. The investors can invest in different schemes of one fund or in different mutual funds altogether and build up their investment portfolio. The flow chart below describes broadly the working of a mutual fund:
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Trust/Board of Trustees Trustees hold a fiduciary responsibility towards unit holders by protecting their interests. Sometimes, as with Canara Bank, the trustee and the sponsor are the same. For others, like SBI Funds Management, State Bank of India is the sponsor and SBI Capital Markets the trustee. Trustees float and market schemes; and also they secure necessary approvals. They check whether the investments of the AMC are within defined limits, whether the fund's assets are protected, and also whether the unit holders get their due returns.
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Fund Managers/AMC They are the ones who manage the investor s money. An AMC takes investment decisions, compensates investors through dividends, maintains proper accounting and information for pricing of units, calculates the NAV, and provides information on listed schemes and secondary market unit transactions. It also exercises due diligence on investments, and submits quarterly reports to the trustees. The fund manager is a very important person for the successful working of the various schemes of the fund. It is he who decides the portfolio of companies in which the money is to be invested. This portfolio is selected according to the investment objectives of the AMC as well as the investment strategies for that particular scheme.
Custodian It is often an independent organization, and it takes custody of securities and other assets of a mutual fund. Among public sector mutual funds, the sponsor or trustee generally also acts as the custodian.
Sponsors
Custodians
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The Evolution
The formation of Unit Trust of India marked the evolution of the Indian mutual fund industry in the year 1963. The primary objective at that time was to attract the small investors and it was made possible through the collective efforts of the Government of India and the Reserve Bank of India. The history of mutual fund industry in India can be better understood divided into following phases:
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first non-UTI mutual fund in India. SBI Mutual Fund was later followed by Canbank Mutual Fund, LIC Mutual Fund, Indian Bank Mutual Fund, Bank of India Mutual Fund, GIC Mutual Fund and PNB Mutual Fund. By 1993, the assets under management of the industry increased seven times to Rs. 47,004 cror es. However, UTI remained to be the leader with about 80% market share.
(like US-64, Assured Return Schemes) are being gradually wound up. However, UTI Mutual Fund is still the largest player in the industry. In 1999, there was a significant growth in mobilization of funds from investors and assets under management.
Key Events
1963 UTI, India s first mutual fund, launched 1964 UTI launches US-64 1986 UTI Mastershare, India s first true mutual fund scheme, launched 1987 PSU banks and insurers allowed to float mutual funds; State Bank of India (SBI) first off the Block. 1992 Harshad Mehta-fuelled bull market arouses middle-class interest in shares and mutual funds 1993 Private sector and foreign players allowed; Kothari Pioneer first private fund house to start operations; SEBI set up to regulate industr y 1994 Morgan Stanley is the first foreign player 1996 SEBI s mutual fund rules and regulations, which form the basis of most current laws, come into force 1998 Master Index Fund is India s first index fund
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1999 The takeover of 20th Century AMC by Zurich Mutual Fund is the first acquisition in the industry 2000 The industr y s Assets Under Management (AUM) cross Rs. 1,00,000 crore 2001 US-64 scam leads to UTI overhaul 2002 UTI bifurcated, comes under SEBI purview; mutual fund distributors banned from giving commissions to investors; floating rate funds and foreign debt funds debut 2003 AMFI certification made compulsory for new agents 2004 Long-term capital gains exempt from tax for equity funds. Securities transaction tax introduced 2005 The industry s AUM crosses Rs. 2,00,000 crore Section 80C introduced, which allows up to Rs. 1 lakh in Equity-Linked Savings Schemes (ELSS) for deduction from total taxable income 2006 AUM crosses Rs. 3,00,000 crore in October 2007 Mutual funds launch Gold ETFs and schemes that will invest in overseas securities 2008 PAN card becomes mandatory to invest in mutual funds 2009 AMFI committee on introducing different classes of shares in mutual funds
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Mutual funds are categorized by their goal: while some funds are designed to take risks in order to achieve the greatest potential growth, others are designed to maintain value while yet others
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invest heavily into dividend-yielding stocks in order to provide a source of income for mutual fund participants. While the individual investor must ultimately decide what his or her investment profile is, it is generally advised that younger investors take greater risks in order to attempt more dramatic growth, while older investors should invest more conservatively in order to protect their assets. Aggressive growth mutual funds are thus more popular with younger generations, and have a high level of risk with the potential for higher rates of growth. Asset allocation funds are designed to be as diverse as possible, having holdings in different asset classes and in different types of securities. Due to their diversity, asset allocation funds are usually lower-risk. Money market funds invest only in money markets, such as Treasury bills, certificates of deposit, and commercial paper. Money market funds ar e also low-risk, unlike capital appreciation funds which seek maximum growth by taking on ver y high levels of risk. Yet other types of mutual funds are balanced funds, bond funds, international funds, growth funds, stock funds, sector funds, regional funds, and income funds. Each of these types of funds has a different goal and a different investment style, and any mutual fund manager will be able to explain the differences and advise investors on which most closely meets their needs. Every scheme is bound by the investment objectives outlined by it in its prospectus, which determine the classes of securities it can invest in. Based on the asset classes, the different Mutual Funds that operate in Indian can be categorized as follows:
outperformed all asset classes. At present, there are four types of equity funds available in the market. In the increasing order of risk, these are: Index funds These funds track a key stock market index, like the BSE (Bombay Stock Exchange) Sensex or the NSE (National Stock Exchange) S&P CNX Nifty. Hence, their portf olio mirrors the index they track, both in terms of composition and the individual stock weight ages. For instance, an index fund like Magnum Index Fund of SBI MF that tracks the Sensex will invest only in the Sensex stocks. The idea is to replicate the performance of the benchmarked index to near accuracy. Index funds don t need fund managers, as there is no stock selection involved. Investing through index funds is a passive investment strategy, as a fund s performance will invariably mimic the index concerned, barring a minor "tracking error". Usually, there s a difference between the total returns given by a stock index and those given by index funds benchmarked to it. Termed as tracking error, it arises because the index fund charges management fees, marketing expenses and transaction costs (impact cost and brokerage) to its unit holders. Therefore, if the Sensex appreciates 10 per cent during a particular period while an index fund mirroring the Sensex rises 9 per cent, the fund is said to have a tracking error of 1 per cent. To illustrate with an example, assume you invested Rs 1,000 in an index fund based on the Sensex on 1 April 1978, when the index was launched (base: 100). In August, when the Sensex was at 3.457, your investment would be worth Rs 34,570, which works out to an annualized return of 17.2 per cent. A tracking error of 1 per cent would bring down your annualized return to 16.2 per cent. Obviously, the lower the tracking error, the better the Index Fund. Diversified funds Such funds have the mandate to invest in the entire universe of stocks, example Magnum Multicap Fund of SBIMF. Although by definition, such funds are meant to have a diversified portfolio (spread across industries and companies), the stock selection is entirely the prerogative of the fund manager. This discretionary power in the hands of the fund manager can work both ways for an equity fund. On the one hand, astute stock-picking by a fund manager can enable the fund to deliver market-beating returns; on the other hand, if the fund manager s picks languish, the returns will be far lower. The crux of the matter is that the returns from a diversified fund depend a lot on the fund manager s capabilities to make the right investment decisions.
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Tax-saving funds Also known as ELSS or equity-linked savings schemes, these funds offer benefits under Section 88 of the Income-Tax Act. So, on an investment of up to Rs 10,000 a year in an ELSS, one can claim a tax exemption of 20 per cent from his/her taxable income, as in Magnum Tax gain Scheme of SBI MF. One can invest more than Rs 10,000, but won t get the Section 88 benefits for the amount in excess of Rs 10,000. The only drawback to ELSS is that the investor is locked into the scheme for three years. In terms of investment profile, tax-saving funds are like diversified funds. The one difference is that because of the three year lock-in clause, tax-saving funds get more time to reap the benefits from their stock picks, unlike plain diversified funds, whose portfolios sometimes tend to get dictated by redemption compulsions.
Sector funds The riskiest among equity funds, sector funds invest only in stocks of a specific industry, say IT or FMCG like Magnum Contra fund, Magnum FMCG Fund, Magnum IT Fund. A sector fund s NAV will zoom if the sector performs well; however, if the sector languishes, the scheme s NAV too will stay depressed. Barring a few defensive, evergreen sectors like FMCG and Pharma most other industries alternate between periods of strong growth and bouts of slowdowns. The way to make money from sector funds is to catch these cyclesget in when the sector is poised for an upswing and exit before it slips back. Therefore, unless one understands a sector well enough to make such calls, and get them right, sector funds should be avoided.
Debt funds
Such funds invest only in debt instruments, and are a good option for investors averse to taking on the risk associated with equities. Here too, there are specialized schemes, namely liquid funds and gilt funds. While the former invests predominantly in money market instruments such as certificates of deposit (CD), commercial paper (CP) and call money, gilt funds do so in securities issued by the central and state governments. Debt funds are of three types. They are: Income funds By definition, such funds can invest in the entire range of debt instruments. Most income funds park a major part of their corpus in corporate bonds and debentures, as the returns there are the
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higher than those available on government-backed paper. But there is also the risk of defaulta company could fail to service its debt obligations. Example, Magnum Income Fund offered by SBI Mutual Fund. Gilt funds They invest only in government securities and T-billsinstruments on which repayment of principal and periodic payment of interest is assured by the government. So, unlike income funds, they don t face the specter of default on their investments. This element of safety is why, in normal market conditions, gilt funds tend to give marginally lower returns than income funds, Example, Magnum Gilt Fund as offered by SBIMF. Liquid funds They invest in money market instruments (duration of up to one year) such as treasury bills, call money, CPs and CDs. Among debt funds, liquid funds are the least volatile. They are ideal for investors seeking low-risk investment avenues to park their short-term surpluses, Example, Magnum Floating rate plan offered by SBIMF.
Balanced funds
Lastly, there are balanced funds, whose investment portfolio includes both debt and equity. They invest in a pre-determined proportion in equity and debtnormally 60:40 in favor of equity. As a result, on the risk ladder, they fall somewhere between equity and debt funds depending on the fund s debt-equity spiltthe higher the equity holding, the higher the risk. Balanced funds ar e the ideal mutual funds vehicle for investors who prefer spreading their risk across various instruments. For example, Hybrid Schemes offered by SBIMF. Some of the popular schemes are Magnum Balanced Fund, Magnum Children s Benefit plan and Magnum Monthly Income plan.
of the fund is constantly changing as investors sell or buy their shares. Further, the shares or units are normally not traded on the stock exchange but are repurchased by the fund at announced rates. Open-ended schemes have comparatively better liquidity despite the fact that these are not listed. The reason is that investor can approach mutual fund for sale of such units, at any time. No intermediaries are required. Moreover, the realizable amount is certain, since repurchase is at a price, based on declared net asset value (NAV). The portfolio mix of such schemes has to be investments, which are actively traded in the market. Otherwise, it will not be possible to calculate NAV. This is the reason that generally open-ended schemes are equity based. Moreover, desiring frequently traded securities, openended schemes hardly have in their portfolio shares of comparatively new and smaller companies since these are not generally tr aded. In such funds, option to reinvest its dividend is also available. Since there is always a possibility of withdrawals, the management of such funds becomes more tedious as managers have to work from crisis to crisis. Crisis may be on two fronts, one is, that unexpected withdrawals r equire funds to maintain a high level of cash available every time implying thereby idle cash. Fund managers have to face questions like what to sell . He could ver y well have to sell his most liquid assets. Second, by virtue of this situation such funds may fail to grab favorable opportunities. Further, to match quick cash payments, funds cannot have matching realization from their portfolio due to intricacies of the stock market. Thus, success of the open-ended schemes to a gr eat extent depends on the efficiency of the capital market. As a matter of fact all the schemes that SBI mutual funds offer are open ended in nature.
Closed-ended Funds
A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed. Their price is determined on the basis of demand and supply in the market. Their liquidity depends on the efficiency and understanding of the broker entrusted with. Their price is free to deviate from NAV, i.e., there is every possibility that the market price may be above or below its NAV. If one takes into account the issue expenses, conceptually close ended fund units cannot be traded at a premium or over NAV
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because the price of a package of investments, i.e., cannot exceed the sum of the prices of the investments constituting the package. Whatever premium exists that may exist only on account of speculative activities. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor.
Interval Funds
Interval funds combine the features of open-ended and close-ended schemes. They are open for sale or redemption during pr e-determined intervals at NAV related prices.
Professional management
It is very difficult for a new investor to analyze equities. Most of us have neither the skill to find good stocks that suit our risk and returns profile nor the time to track our investmentsbut still want the returns that can be had from equities. That is where mutual f unds come in. When investments are made in mutual funds, the fund manager takes care of the investments. A fund manager is an investment specialist, who brings to the table an in-depth understanding of the financial markets. By virtue of being in the market, the fund manager is ideally placed to research various investment options, and invest accordingly for the investor.
Small investments
Today, if we want to buy government securities, we would have to invest a minimum amount of Rs 25,000. Much the same is the case if we want to build a decent-sized portfolio of shares of blue-chips. Now, that might be too large an amount for many small investors. A mutual fund,
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however, gives us an ownership of the same investment pie at an outlay of Rs 1,000-5,000. That is because a mutual fund pools the monies of several investors, and invests the resultant large sum in a number of securities. Therefore, on a small outlay, we get to participate in the investment prospects of a number of securities.
Diversified portfolio
One of the most-mentioned tenets of portfolio management is: diversify. In other words, don t put all your eggs in one basket. The rationale for this is that even if one pick in the portfolio turns bad, the others can check the erosion in the portfolio value. For example Say, an investor has Rs 10,000 invested in one stock, Reliance. Now, for some reason, the stock drops 50 per cent. The value of the investment will halve to Rs 5,000. Now, say if he had invested the same amount in a mutual fund, which had parked 10 per cent of its corpus in the Reliance stock. Assuming prices of other stocks in its portfolio stay the same, the depreciation in the fund s portfolio and hence, the investmentwill be 5 per cent. That s one of the greatest merits of diversification.
Liquidity
There is a freedom to take the money out of open-ended mutual funds whenever one wants, no questions asked. Most open-ended funds mail the redemption proceeds, which are linked to the fund s prevailing NAV (net asset value), within three to five working days of putting in the request to withdraw.
Low Costs
Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees tr anslate into lower costs for investors.
Transparency
The investor gets regular information on the value of the investment made in addition to disclosure on the specific investments made under the scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook.
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Flexibility
Through features such as regular investment plans, regular withdr awal plans and dividend reinvestment plans, one can systematically invest or withdraw funds according to the needs and convenience.
Well Regulated
All Mutual Funds are r egistered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.
Tax breaks
Last but not the least, mutual funds offer significant tax advantages. Dividends distributed by them are tax-free in the hands of the investor. They also give the advantages of capital gains taxation. For holding units beyond one year, one gets the benefits of indexation. Simply put, indexation benefits increase the purchase cost by a certain portion, depending upon the yearly cost-inflation index (which is calculated to account for rising inflation), thereby reducing the gap between the actual purchase cost and selling price. This reduces tax liability. What s more, taxsaving schemes and pension schemes give added advantage of benefits under Section 88. One can avail of a 20 per cent tax exemption on an investment of up to Rs 10,000 in the scheme in a year.
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Restrictive gains
Diversification helps, if risk minimization is the objective. However, the lack of investment focus also means that we gain less than if we had invested directly in a single security. In the earlier example, say, Reliance appreciated 50 per cent. A direct investment in the stock would appreciate by 50 per cent. But the investment in the mutual fund, which had invested 10 per cent of its corpus in Reliance, will see only a 5 per cent appreciation
Entry Load- Commission paid while purchasing Units of a particular fund. Exit Load- Commission paid while selling back the Units.
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Taxes
During a typical year, most actively managed mutual funds sell anywhere from 20 to 70 percent of the securities in their portfolios. If a fund makes a profit on its sales, one who has invested in it will pay taxes on the income he/she receives, even if he/she reinvests the money he has made.
Management Risk
When one invests in a mutual fund, he/she depends on the fund's manager to make the right decisions regarding the fund's portfolio. If the manager does not perform as well as he had hoped, investor might not make as much money on his investment as he had expected. Of course, if one had invested in Index Funds, he/she foregoes management risk, because these funds do not employ managers.
As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines to the mutual funds from time to time to protect the interests of investors.
Every mutual fund must be registered with SEBI and registration is granted only where SEBI is satisfied with the background of the fund.
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SEBI (Mutual Funds) Regulations, 1996 lays down the provisions for the appointment of the trustees and their obligations. The Regulations have also laid down the provisions for the approval of the AMC and the custodian. Every new scheme launched by a mutual fund needs to be filed with SEBI and SEBI reviews the document in regard to the disclosures contained in such documents. SEBI has also laid down advertisement code to be followed by a mutual fund in making any publicity regarding a scheme and its performance. SEBI has the authority to inspect the books of accounts, records and documents of a mutual fund, its trustees, AMC and custodian where it deems it necessary. SEBI also has the authority to initiate penal actions against an erring MF.
The mutual fund industry has a trade association called Association of Mutual Funds in India (AMFI) modeled on the lines of a Self Regulating Or ganization (SRO) with a view to 'promoting and protecting the interest of mutual funds and their unit-holders, increasing public awareness of mutual funds, and serving the investor s interest by defining and maintaining high ethical and professional standards in the mutual funds industry'. AMFI plays an important role in disciplining members and assist the regulatory authority in protecting investors' inter est. AMFI works through a number of committees, some of which ar e standing committees to address areas where there is a need for constant vigil and improvements and other which are adhoc committees constituted to address specific issues. These committees consist of industry professionals from among the member mutual funds. AMFI has now decided to become a selfregulatory organization since it has worked very effectively as an industry body.
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Company
Sharekhan limited launched online trading portal on Feb 8th 2000. Today it is India s leading online retail broking house with its presence through 800 Share Shops in 300 cities and serving more than 6,50,000 customers across the nation. Share khan deals with wide variety of products namely equities, derivatives, commodities, IPO, mutual fund, research, portfolio management and other structured products. The mission of Share khan is to educate and empower the individual investor to make better investment decision through Quality Advice, Innovative products and superior service.
Top Management
Mr.Tarun ShahCEO, Sharekhan A science graduate from St. Xavier College,Mumbai, started his professional life in sales and marketing in a chemicals company. His approach and experience in sales led him to higher challenges that the capital market provided. In 1987, he joined SSKI (S. S. Kantilal Ishwarlal), a brokerage firm with over five decades of service.. The capital markets at that time was undergoing a sea change in its character and SSKI under the vision and guidance of Shripal Morakhia and the commitment and hardwork of Mr. Shah was able to change and adopt the new business practices to achieve significant growth in a competitive environment. Since then SSKI
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Jaideep Arora, completed his B.Tech from IIT (Kanpur) and his PGDM from IIM Kolkata worked with ICICI for 8 years where his work spanned a gamut of functions, which included project finance, equity sales and broker age, investments etc. During his tenure there he set up and headed the Institutional Equity Brokerage Desk at ICICI Securities & Finance Co. Ltd.
Mr. Shanker Vailaya Director, Operations, Finance and Legal Functions A graduate in commerce from the university of mangalore and an associate of The Member of the institute of Chartered Accountants of India, Mr. Shankar Vailaya heads the operations, finance and legal functions. He is responsible for settlements, depository operations, risk and compliance and regulatory & other legal commitments and Treasury.
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Products:
1. Trade tiger- Cutting edge tools, Charts, 2. Classic Ease of investment, Research advantage, Investment products, 3. Platinum circle - Relationship management, Structured products. 4. Fist step This is for the people who invest for the first time. 5. Equity investment Complete analysis of each stock. 6. Mutual Fund Investment - 400 Mutual funds from 17+ mutual fund families to choose from. 7. Protech It uses the knowledge of technical analysis and the power of the derivatives market to identify trading opportunities. 8. Proprime Ideal for investor s looking at steady and superior returns with low to medium risk appetite. This contains a blend of quality blue-chip and growth stocks ensuring a balanced portfolio with relatively medium risk profile. Investments are selected to give consistent, steady and sustainable returns
Operations
Share Khan offers three modes of trade transaction means. They are Share shops A customer can directly visit any of the share shop to trade . Online trading A customer can trade on his own by using the online trading mode. Dial & trade A customer can ring up to any dealer or the relationship manager and can execute his trade. Thus, based on the convenience of the customer he can choose any of the above modes of transaction.
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Load:
A load is known as charges paid by the customer. There are two types of loads, entry load and exit load. Entry loads are the charges that an investor has to pay at the time of making an investment. This value is deducted from his investment. Exit loads are those charges that an investor needs to pay if redemption is made before specified time period. But in case of tax saving schemes an investor can not withdraw before lock-in period.
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Growth Option In this option the value of NAV goes up or down depending on market performance on daily basis but no of units remain same as that of the time of investment.
Dividend Payout This option gives a certain amount of dividend on the investment made by an investor. This amount is calculated as explained in the following page.
Dividend Re-investment In this option dividend is not paid to the customer but reinvested in the same scheme. Here no. of units increases whenever there is a declaration of dividend.
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Portfolio Making:
Apart f rom doing these projects some other works also have been done in the bank. One of them is making portfolios of different customers. In this portfolio making first calls are made to different AMC to send the statements of investments made by different customers. Then put the important information from the statements to excel sheet. One portfolio is related to one customer, which contains all the investments made by the customer in the mutual funds of different companies. This portfolio basically contains information like amount invested in different funds, whether this investment is made through SIP (Systematic Investment Plan) or one time investment, date of investment, name of the scheme and option, current value of investment etc. Similarly other portfolios are also made.
Calculations
Calculating no. of units It can be explained by taking an example. Suppose a person is making an investment of Rs.10, 000 and NAV for the day of investment is Rs.20. (Considering no entry load) Then Total No. of Units =Total investment made on that day/NAV of the day = 10000/20 = 500 units
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Suppose there is an entry load of 2.25%, then Total No. of Units = [Total Investment-(total investment*2.25/100)]/NAV of the day [10000-(10000 *2.25/100)]/20 = 488.75 units
Calculation of Dividend amount, when a company declares dividend: Dividend is always calculated on the face value. It can be shown by taking an example of SBI Magnum Global Fund. Magnum Global Fund declared a dividend of 50% as on 23rd March 2007. NAV of the fund as on 23rd March was Rs.32.34 and its face value is Rs.10. Suppose a person makes an investment of Rs.10000. No. of units that he would get = 302.257 units Dividend given per unit = 50 * 10/100 = 5 Rs. Total dividend amount given to the investor on the investment of 10000 = Dividend given per unit * Total no. of units = 5 * 302.257 = 1511.285 Rs.
Effect on NAV after declaring dividend: Again let s consider the same example as above. NAV goes down by the amount of dividend declared per unit. After dividend declaring date, value of NAV should be lower by Rs.5 per unit. Hence next day NAV should be Rs.27.34.
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But exact value was Rs.27.27 because it also depends on that day market performance.
Investment Plans:
Systematic Investment Plan (SIP) In this plan the investor is allowed to invest a fixed amount at regular intervals. It gives the investor a way to save and invest. This is a good plan for salar y holders because they can save on monthly basis from their salar y and make investment. Market timings are not required for making an investment in SIP because no of units are averaged on monthly basis hence this plan makes market timings irrelevant.
Systematic Transfer Plan (STP) This plan allows investor to transfer periodically a specific amount from one scheme to another scheme of the same mutual fund. It gives the benefit of switching into a scheme which is performing better than the existing one.
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Systematic Withdrawal Plan (SWP) Here an investor can periodically withdraw from his fund investment accounts. It helps him to get a regular cash flow. Hence in this he can receive regular cash inflows. This is a good scheme for retired people.
Comparative nalysis
A comparative analysis of various funds enables an investor to choose most suitable fund for him. Comparative analysis of mutual fund perfor mance combines data and judgment. The data typically consist of returns on the funds and one or more benchmarks, and the judgment typically involves specifying the benchmarks and their role in defining performance. Investing in mutual funds also combines data and judgment. Rather than accept the standard performance measures at face value, investors can allow their decisions to reflect doubts about either the adequacy of the benchmarks or the stock-picking ability of fund managers. A mutual fund performance often measured by various statistical tool e.g. standard deviation, beta etc. Mutual fund as a short-to-long term investment option is preferred as a suitable investment option by investors.
funds was done by Sharpe (1966) who has developed a composite measure that considers return and he evaluated the performance of 34 open-ended mutual funds during the period 1944-63 by the measures developed by him. It was revealed in his study that good performance was associated with low expense ratio and only low relationship was discovered between fund size and performance. A study performed by Treynor & Mazuy (1966) found no statistical evidence that investment manager of any 57 funds were not able to guess the market movements in advance. To address risk the issue, the authors devise a test of mutual fund historical success in anticipating major moves in the market. They explain that the only way a fund can translate ability to outguess the market into higher returns for shareholders is to var y the fund's volatility systematically in a manner that results in an northwards characteristic line. Rates of return for 57 funds (1953-1962) were employed to investigate whether the volatility of a fund is higher in years when the market does well than in years when the market does poorly. They compute a characteristic line wherein the rate of return for a managed fund is plotted against the rate of return for a suitable market index. There is no evidence of curvature in characteristic lines for any of the funds. From this, they conclude that none of the managers outguess the market and that these managers should not be held responsible for failing to foresee changes in market direction. Amitab Gupta (2001) in his study, the selected schemes were evaluated with respect to the broad based BSE National Index to find out whether the schemes were able o beat the market. It also examined whether the returns were commensurate with the risk undertaken by the fund managers. It used risk adjusted performance. The study also tested the market timing abilities of the fund managers. The results indicate that 38 schemes (52%) earned higher returns in comparison to the market return i.e. beta more than one while the r emaining 35 schemes (48%) generated lower returns than that of the market that means a beta lower than one.
Thus, most of these studies evaluated the performance of mutual funds in India in terms of risk adjusted return parameters. But all did it on the basis of single parameter. So the literature survey reveals that there is still further scope for advanced research in this area where we can use more than one parameter like Beta, Sharpe ratio, R-Squared etc. to facilitate an investor. The present
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study attempts to compare various equity funds in India according to their category and will analyze on the basis of above statistical tools.
Standard deviation
Standard deviation is a r epresentation of the risk associated with a given security, or the risk of a portfolio of securities. Risk is an important factor in determining how to efficiently manage a portfolio of investments because it determines the variation in returns on the asset and/or portfolio and gives investors a mathematical basis for investment decisions. The overall concept of risk is that as it increases, the expected return on the asset will increase as a result of the risk premium earned in other words, investors should expect a higher return on an investment when said investment carries a higher level of risk. For example, you have a choice between two Mutual Funds: Fund A historically returns 5% with a standard deviation of 10%, while Fund B returns 6% and carries a standard deviation of 20%. On the basis of risk and return, an investor may decide that Fund A is the better choice, because Fund B's additional percentage point of r eturn generated (an additional 20% in dollar terms) is
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not worth double the degree of risk associated with Stock A. Fund B is likely to fall short of the initial investment more often than Fund A under the same circumstances, and will return only one percentage point more on average. In this example, Fund A has the potential to earn 10% more than the expected return, but is equally likely to earn 10% less than the expected return.
X = Return; E(X) = Expected Return Calculating the average return (or arithmetic mean) of a security over a given number of periods will generate an expected return on the asset. For each period, subtracting the expected return from the actual return results is the variance. Square the variance in each period to find the effect of the result on the overall risk of the asset. The larger the variance in a period, the greater risk the security carries. Taking the average of the squared variances results in the measurement of overall units of risk associated with the asset. Finding the square root of this variance will result in the standard deviation of the investment tool in question. Use this measurement, combined with the average return on the funds, as a basis for comparing funds.
Beta
Beta coefficient is a measure of volatility of a stock or portfolio in relation to the rest of the financial market. An asset with a beta of 0 means that its price is not at all correlated with the market; that asset is independent. A positive beta means that the asset generally follows the market. A negative beta shows that the asset inversely follows the market; the asset generally decreases in value if the market goes up. Correlations are evident between companies within the same industry, or even within the same asset class.
where ra measur es the rate of return of the asset, rp measures the r ate of return of the portfolio of which the asset is a part and Cov(ra,rp) is the covariance between the rates of return. Beta is also referred to as financial elasticity or correlated relative volatility, and can be referred to as a
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measure of the asset's sensitivity of the asset's returns to market returns, its non-diversifiable risk, its systematic risk or market risk. On an individual asset level, measuring beta can give clues to volatility and liquidity in the marketplace. On a portfolio level, measuring beta is thought to separate a manager's skill from his or her willingness to take risk. The beta movement should be distinguished from the actual returns of the funds. For example, a sector may be performing well and may have good prospects, but the fact that its movement does not correlate well with the broader market index may decrease its beta. However, it should not be taken as a reflection on the overall attractiveness or the loss of it for the sector, or fund as the case may be. Beta is a measure of risk and not to be confused with the attractiveness of the investment.
R-Squared
R-Squared of a fund advises investors if the beta of a mutual fund is measured against an appropriate benchmark. Measuring the correlation of a fund's movements to that of an index, RSquared describes the level of association between the fund's volatility and market risk, or more specifically, the degree to which a fund's volatility is a result of the day-to-day fluctuations experienced by the overall market. R-Squared values range between 0 and 100, where 0 represents the least correlation and 100 represents full correlation. If a fund's beta has an RSquared value that is close to 100, the beta of the fund should be trusted. On the other hand, an R-Squared value that is close to 0 indicates that the beta is not particularly useful because the fund is being compared against an inappropriate benchmark. An inappropriate benchmark will skew more than just beta.
Sharpe Ratio
The Sharpe ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk. This measurement is ver y useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been.
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The Sharpe ratio is calculated by subtracting the risk-free rate - such as that of the 364 days Treasury bills - from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.
RF
P
Treynor ratio
Treynor ratio is a measurement of the returns earned in excess of that which could have been earned on a riskless investment (i.e. Treasury Bill) (per each unit of market risk assumed). The Treynor ratio (sometimes called reward-to-volatility ratio) relates excess return over the risk-free rate to the additional risk taken; however systematic risk instead of total risk is used. Higher the Treynor ratio, better the performance under analysis. R T= where T = Treynor ratio, rp = portfolio return rf = risk free rate = portfolio beta
P
RF
In other words, the Treynor ratio is a risk-adjusted measure of return based on systematic risk. It is similar to the Sharpe ratio, with the difference being that the Treynor ratio uses beta as the measurement of volatility.
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Data collection
Primary data
Sharekhans data base Other financial intermediaries
Secondary data Research Report published by renowned mutual fund distributors. Websites of the leading AMCs and AMFI for inf ormation on product s performance and historical data. Fund fact sheets of various fund houses. Research papers. Journals, magazines.
Data Analysis
After collection of historical data each fund will be compared with other funds within its category on the basis of aforementioned analysis tools. A rating will be given to each fund by each statistical measur e. For example if a fund is having highest Sharpe Ration in its category, it will be given 10 points and second highest will be getting points in proportion to highest Sharpe
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Ratio. Further these rating will form a combined rating by adding all separate rating to suggest investors according to their investment behavior. Three main categories have been taken to compare mutual fundsA. Equity based B. Debt based C. ETF (Exchange traded fund)
Sector Allocation(%)
Banks Construction and Infrastructure Consumer Durables and Electronics 7% 12% 4% 6% 10% 6% Miscellaneous Non Ferrous metals 10% FI Current Assets Engineering and Capital Goods
2% 18% 2% 6% 7% 4% 4%
2%
Petroleum, Gas and petrochemical products Power & Control equipment Manufacturer
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Reliance growth The primary investment objective is to achieve long term growth of capital by investing in equity and equity related securities through a research based investment approach.
Sector Allocation(%)
Agriculture 1% 2% 2% 1% 2% 8% 8% 19% 1% 1% 1% 2% 2% 6% 6% 2% 3% 10% 2% 7% 4% 3% 1% 3% 3% Banks Auto & Auto Ancillaries
Construction and Infrastructure Current Assets Engineering and Capital Goods Fertilizers, Pesticides & Agrochemicals FI
ICICI Prudential Dynamic Plan: Seeks to generate capital appreciation by actively investing in equity and equity related securities. For def ensive considerations, the Scheme may invest in debt, money market instruments and derivatives
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Sector Allocation
1% 1% 13% 2% 5% 10% 12% 3% 1% 2% 1% 1% 2% Fertilizers, Pesticides & Agrochemicals 3% Banks 5% 1% 2% 9% 23% Current Assets
3%
HDFC Equity Fund Aims at providing capital appreciation through investments predominantly in equity oriented securities.
Sector Allocation(%)
1% 0% 2% 0% 2% 11% 11% 6% 1% 4% 1% 3% 6% 6% 2% 1% 3% 3% Chemicals Banks 2% 6% 1% 6% 21% Auto & Auto Ancillaries Airliners
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Reliance Pharma Growth Fund To generate consistent r eturns by investing in equity or fixed income securities of pharma and other associated companies
Sector Allocation
6% 8% 2% 1%
Current Assets Food & Food Processing, Beverages Healthcare services Miscellaneous
83%
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Equit Standard Fund Returns Corelation Deviation Beta Reliance Diversified Power Fund 41.31% 0.74 4.66 0.75 -0.14 -0.85 -0.06 Reliance Pharma Fund 31.96% 0.83 4.01 0.87 -0.06 -0.27 0.39 Reliance Growth Fund 29.75% 0.77 4.7 0.78 -0.14 -0.87 -0.09 HDFC E quity Fund 29.20% 0.86 5.28 0.87 -0.08 -0.51 0.22 ICICI Prudential Dynamic Plan 29.12% 0.79 4.74 0.8 -0.1 -0.61 0.11
Sharpe Ratio
These top five funds will be ranked on the scale of 1-10 on the given parameters like returns, risk and other ratios, similarly other categories funds also be given ranking. Some funds will score more in risk parameters where some will score more in return parameter. At last one final ranking will be done by analyzing the previous rankings and it will be used to construct optimized portfolio. Structure and composition of an optimized portfolio will change according to time and need of investors.
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References:
Motwani, Prateek , Indian Mutual Fund Industry - The Road Ahead!! !! (October 25, 2008). Available at SSRN: http://ssrn.com/abstract=1335257 Latha, Suma, Measuring Competition in the Financial Sector: Analysis of the Indian Mutual Fund Scenario (February 27, 2010). Available at SSRN: http://ssrn.com/abstract=1560343
Dash, Mihir and G., Dinesh Kumar, A Study on the Effect of Macroeconomic Variables on Indian Mutual Funds (December 15, 2008). Available at SSRN: http://ssrn.com/abstract=1316442 Shah Ajay and Thomas Susan, Performance Evaluation of Professional Portfolio Management in India, Center for Monitoring Indian Economy, (working paper) April, 1994. Sapar, Narayan Rao and Madava, Ravindran, Performance Evaluation of Indian Mutual Funds, working paper. Jack L. Treynor, How to rate Management of Investment Funds, Harvard Business Review, 43, No.1, (January-February, 1965), pp. 63-75. Mutual Fund Year Book-2000, Joint Publication of Association of Mutual funds in India and UTI Institute of Capital Markets, 2001, pp. 29-139.
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