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CHAPTER 1
INTRODUCTION OF MUTUAL FUND

Mutual funds are very popular all the world and they play an important role in
the financial system of many countries. Mutual funds are an ideal medium for
investment by small investors in stock market. Mutual funds pool together the
investments of small investors for participation in the stock market. Being
institutional investors, mutual fund can afford market analysis generally not
available to individual investors. Furthermore, mutual funds can diversify the
portfolio in the better way as compared with individual investors due to the
expertise and availability of funds.

Mutual funds in India were created in 1963 when the Unit Trust of India (UTI),
a state-sponsored entity, came into being. Until 1987, UTI was the only mutual
fund in the country. Between 1987 and 1993 other entities belonging to public
sector were permitted to offer mutual funds-basically state-controlled banks and
insurer.

As part of financial sector reforms, the mutual fund industry was opened to the
private sector in 1993. Thus, from 1993 onwards, private sector organizations
were permitted to enter the market and the first mutual fund regulations were
promulgated, which were subsequently replaced by SEBI (Mutual Funds)
Regulation of 1996. This private sector organizations compared both Indian and
foreign joint ventures as well as purely Indian firms.

Since then, the expansion of mutual fund business has intensified competition
and led to product innovation. Mutual funds presently offer a variety of options

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to investors such as income funds, liquid funds, gift funds, index funds, and
exchanges traded funds etc.

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CHAPTER 4

SAVINGS AND ALTERNATIVE INVESTMENT OBJECTIVE

OPPORTUNITIES

DEFINITION
An investment that is not one of the three traditional asset types (stocks, bonds
and cash). Most alternative investment assets are held by institutional investors
or accredited, high-net-worth individuals because of their complex nature,
limited regulations and relative lack of liquidity. Alternative investments
include hedge funds, managed futures, real estate, commodities and derivatives
contracts.

Funds can be excellent vehicles for both long-term investment objectives and
short-term goals. Mutual funds pool the resources of many small investors,
providing those investors with the ability to buy dozens--or even hundreds--of
different stocks and bonds. This serves to spread the risk inherent in the stock
and bond markets, protecting investors from specific stock risk and increasing
their odds of a good return over time. There are a number of mutual funds on
the market, and it is important for investors to choose the ones that best meet
their own financial needs.

OBJECTIVE OF SAVING AND INVESTMENT

1. Term Growth

o Long-term growth is important for many reasons, and stock market

mutual funds generally have long-term appreciation of capital as a major
goal. The stock market can be quite volatile over the short-term, but over
longer periods of time the growth rate can be quite dramatic. When

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choosing a mutual fund for long-term growth, it is important to look for

one that is widely-diversified across many different industries. An index
fund that tracks the total stock market or a broad index like the Standard
and Poors 500 is a particularly good choice.

Current Income

o There are many investors who need current income as well as the
prospect for long-term growth. Retirees often use mutual funds that hold
dividend paying stocks and high interest bonds to supplement their
pension and Social Security checks. Other investors might use current
income funds to stretch their savings or pay current expenses.

There are a number of mutual funds that provide current income,

including bond funds and funds that hold dividend paying stocks. When
choosing a fund it is important to consider safety as well as yield. For
instance, high-yield bond funds generally pay more than government
bond funds, but they are also riskier.

Safety

o Investors who want rock solid safety and predictable returns should
choose a money market fund. These funds invest in a variety of short-
term instruments designed to provide safe, predictable interest income.
Money market funds are a good place to hold money between
investments, as well as a good place to put money aside for emergencies.
When choosing a money market mutual fund, it is important to look for
one with extremely low costs, under 0.10% if possible. Since these funds
are designed for safety, the yields can be quite low, although they are still

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often higher than comparable bank money markets. Keeping your costs
low means you keep more of the money you earn

2. Diversification

o Investors are often advised that they shouldn't "put all their eggs in
one basket." Investors who have too high of a percentage of their
assets in one or two stocks can be severely affected if one of the
companies goes belly-up. Most financial experts say investors should
have at least 15 stocks in their portfolios. It takes a lot of time and
effort to keep up with that many companies. Conversely, mutual funds
hold a number of stocks, which gives investors instant diversification
and protects them from a sharp decline in any one holding.

Growth

o Some mutual fund investors are looking for rapid growth in the value
of their funds. Stocks have historically offered the best long-term
returns of any asset class, though it can be an up-and-down ride. Stock
funds that are labeled "growth" typically invest in companies with
bright prospects, while "value" funds target stocks that seem
inexpensive compared with the company's earnings.

Income

o Other fund investors care more about receiving income from their
investments. Numerous stock funds invest in companies with high
dividend payouts. Bond funds also can provide steady income, as can
funds that invest in real estate investment trusts, or REITs. All these
income-focused funds pass the yields along to their investors, usually

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on a monthly or quarterly basis. Yields of 3 percent to 7 percent are

often available with income-oriented mutual funds.

International Exposure

o Some large international firms offer their shares on U.S. markets, but
others don't. For example, individual investors can have a hard time
getting access to shares in the fast-growing Chinese market. But
international-focused mutual funds have an easier time investing in
these shares. Because half the world's corporate value is outside the
U.S., it's important to have some exposure to overseas stocks, and
mutual funds are the easiest way to get this.

Low Fees

o Stock picking can be expensive thanks to broker commissions, but

many "no-load" mutual funds are available that don't charge investors
anything. Many other funds charge investors less than 1 percent a year
for operational fees.

Investors looking for especially inexpensive funds might consider index

funds, which charge fees as low as 0.1 percent per year. These funds
usually hold every stock or bond in a given asset class, which offers
tremendous diversification at a low cost.

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MUTUAL FUND INVESTMENT OBJECTIVES DEFINED

INVESTMENT OBJECTIVE

There are many ways to try to make money from investments. An investor
might take on additional risk to try to profit from potential growth in the value
of the shares of a stock. A retiree might prefer an investment whose chief
benefit is the periodic income payments it offers. Someone else's priority might
be to preserve the value of the original investment, even if that means the
investment doesn't increase much in value over time.

Like all mutual funds, stock funds are managed based on a specific investment
objective. That objective will determine the role a specific fund will play in
your portfolio, and how well it might fit with your overall investing strategy.
The investment objective determines what types of stocks the fund's manager
may decide to purchase. A fund may be broadly based, investing in both large-
and small-cap companies in many different industries. Or it may have a much
narrower focus, concentrating only on blue chips, for example, or stocks in a
single industry.

Typically, a stock mutual fund's objective will be either capital appreciation,

income from equities, or both. For example, a stock fund might have both
growth and income as objectives, or its primary objective might be capital
appreciation, with income as a secondary objective.

A mutual fund's investment objective is not necessarily the same thing as its
investing style, though the two may overlap. In addition to pursuing a fund's
investment objective, a fund manager may adhere to a particular investing style.
For example, a growth fund focuses on stocks that are growing quickly and that

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seem to have greater than average potential for appreciation in share price. By
contrast, a value-oriented fund buys stocks that appear to be undervalued by the
market relative to the company's intrinsic worth. Each may have growth as its
investment objective, but they pursue growth in different ways. Some managers
even blend the two approaches.

Like most mutual funds, a stock fund may be either passively managed, as an
index fund is, or actively managed. It also may be an open-end or closed-end
fund. Before investing in any fund, carefully consider its investment objectives,
risks, fees, and expenses, which can be found in the prospectus available from
the fund. Read it carefully before investing.

Many mutual funds combine an investment objective with a specific category of

stocks. For example, a fund might be an international fund whose objective is
growth, or a growth fund that specializes in small-cap stocks. Here are some
common stock fund types based on their investment objectives:

 INVESTMENT
o Investment refers to current commitment of funds for a specified
time period to derive benefits in future.
o The future benefits derived from an investment are known as ‘
returns ’
 Giving loan : with an expectation to get the principal back
along with the interest at a future date
 Buying gold : with an expectation of appreciation in its value
in future
 Buying an insurance plan : for various benefits derivable in
future &/or in case of an eventuality

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 Buying shares of companies : for dividend &/ or capital

appreciation
 CURRENT SACRIFICE FUTURE REWARD
o As the reward would accrue only in future, it involves ‘risk’ (of
realized return being lower than that expected)

 Objective of an investor
o Maximization of return
o Minimization of risk
o Hedge against inflation (if the investment cannot earn as much as
the rise in price level, the ‘real’ rate of return will be negative)

 INVESTMENT ALTERNATIVES
o FINANCIAL ASSETS
 Equity shares
 Bonds
 Preference shares
 Non- marketable financial assets
 Money market instruments
 Mutual funds
 Life insurance
 Financial derivatives
o REAL ASSETS
 Real estate
 Precious objects


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 EQUITY SHARES
o Represents ownership capital
 They elect the board of directors and have a right to vote on
every resolution placed before the company
 They enjoy the preemptive right which enables them to
maintain their proportional ownership
o Risk: residual claim over income
o Reward: partners in progress
o The amount of capital that a company can issue as per its
memorandum represents authorized capital
o The amount offered by the company to the investors is called
issued capital
o The part of issued capital that is subscribed to by the investors is
called subscribed capital / paid up capital

 EQUITY SHARES
o Par / Face / Nominal value of a share is stated in the memorandum
and written on the share scrip
o Issue of shares at a value above its par value is called issue at a
premium
o Issue of shares at a value below its par value is called issue at a
discount
o The price at which the share currently trades in the market is called
the market value

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 EQUITY SHARES
o Blue chip shares
 Shares of large, well established and financially strong
companies with impressive record of earnings and dividend
o Growth shares
 Shares of companies having fairly strong position in the
growing market and having an above average rate of growth
and profitability
o Income shares
 Shares of companies having fairly stable operations, limited
growth opportunities and high dividend payouts
o Cyclical shares
 Shares of companies performing as per the business cycles
o Defensive shares
 Shares of companies relatively unaffected by the ups and
downs in the general economic conditions
o Speculative shares
 shares of companies whose prices fluctuate widely because
of a lot of speculative trading being done on them

 BONDS
o They are long term debt instruments issued for a fixed time period
o Bonds are debt securities issued by the government or PSUs
o Debentures are debt securities issued by private sector companies
o They comprise of periodic interest payments over the life of the
instrument and the principal repayment at the time of redemption

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o Debt securities issued by the central government , state government

and quasi government agencies are referred to as gilt-edged
securities
o Callable bonds are the ones that can be called for redemption
earlier than their date of maturity. This right to call is available
with the company
o Convertible bonds are the ones that can be converted into equity
shares at a later date either fully or partly. This option is available
with the bond holder
o Coupon rate is the nominal rate of interest fixed and printed on the
bond certificate. It is calculated on the face value and is payable by
the company till maturity

 PREFERENCE SHARES
o Represents a hybrid security that has attributes of both equity
shares and debentures.
o They carry a fixed rate of dividend . However it is payable only out
of distributable profits
o Dividend on preference shares is generally cumulative . Dividend
skipped in one year has to be paid subsequently before equity
dividend can be paid
o Only redeemable preference shares can be issued

 NON-MARKETABLE SECURITIES
o These represent personal transactions between the investor and the
issuer.

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o Bank deposits
 There are various kinds of bank accounts – current, savings
and fixed deposit
 While a deposit in a current account does not earn any
interest, deposit made in others earn an interest
 Liquidity, convenience and low investment risks are the
common features of the bank deposits
 Deposits in scheduled banks are safe because of the
regulations of RBI and the guarantee provided by the
Deposit Insurance Corporation on deposits upto Rs 1,00,000
per depositor of the bank

 NON-MARKETABLE SECURITIES
o Company deposits
 Deposits mobilized by companies are governed by the
provisions of section 58A of Companies Act, 1956
 The interest offered on this fixed income deposits is higher
than what investors would normally get from the banks
 Manufacturing and trading companies are allowed to pay a
maximum interest of 12.5%.
 The rates vary depending on the credit rating of the company
offering the deposit
o Post Office Monthly Income Scheme
 Meant for investors who want to invest a lump sum amount
initally and earn interest on a monthly basis.
 Minimum investment is Rs.1000 in multiples of Rs 1,000

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 The maximum deposits in all the accounts taken together

should not exceed Rs.3 lakh in a single account and Rs.6
lakh in a joint account
 The tenure of the MIS scheme is six years.

 MONEY MARKET INSTRUMENTS

o Debt instruments which have a maturity of less than a year at the
time of issue are called money market instruments
o These are highly liquid instruments
o Treasury bills
 Issued by GOI
 They are of two durations – 91 days and 364 days
 Are negotiable instruments and can be rediscounted with
GOI
 They are sold on an auction basis every week in certain
minimum denominations by the RBI
 They do not carry an explicit interest rate. Instead they are
issued at a discount to be redeemed at par. The implicit
return is a function of the size of discount and the period of
maturity
 They have zero default risk, assured return, are easily
available

 MONEY MARKET INSTRUMENTS

o Certificate of deposits

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 Negotiable instruments issued by banks / financial

institutions with a maturity ranging from 3 months to 1 year
 These are bank deposits transferable from one party to
another
 The principal investors are banks, financial institutions,
corporates and mutual funds
 These carry an explicit rate of interest
 Banks normally tailor make their denominations and
maturities to suit the needs of the investors
o Commercial papers
 Issued in form of promissory notes redeemable at par by the
holder on maturity
 Usually has a maturity period of 90 to 180 days
 They are sold at a discount to be redeemed at par
 CPs can be issued by corporates having a minimum net
worth of Rs 5 crores and an investment grade from credit
rating agencies
 Minimum issue size is Rs 25 lacs

 MUTUAL FUNDS
o Also known as an instrument for collective investment
o Investment is done in three broad categories of financial assets i.e.
stocks, bonds and cash
o Depending on the asset mix , mutual fund schemes are classified
as: Equity schemes, hybrid schemes and debt schemes
o On the basis of flexibility , Mutual fund schemes may be: Open
ended or Close ended

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 Open ended schemes are open for subscription and

redemption throughout the year
 Close ended schemes are open for subscription only for a
specified period and can be redeemed only on a fixed date of
redemption
o On the basis of objective , mutual funds may be growth funds,
income funds, or balanced funds
o NAV of a fund is the cumulative market value of the assets of the
fund net of its liabilities

 FINANCIAL DERIVATIVES
o Derivative is a product whose value is derived from the value of
the one or more underlying assets. These underlying assets may be
equity, index, foreign exchange, commodity or any other asset
o Derivative does not have a value of its own. Rather its value
depends on the value of the underlying asset.
o Derivatives initially emerged as hedging devices against
fluctuations in commodity prices and commodity linked derivatives
remained the sole form of such products. Financial derivatives
emerged post 1970 period.
o Financial derivatives have various financial instruments as the
underlying variables
o Futures and Options are two basic types of derivatives

 FINANCIAL DERIVATIVES

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o Futures is a transferable contract between two parties to buy or sell

an asset at a certain date in the future at a specified price
 It is a standardized contract with a standard underlying asset,
a standard quantity and quality of underlying instrument and
a standard timing of settlement
 It may be offset prior to its maturity by entering into an
equal and opposite transaction
 It requires margin payments and follow daily movements
o Options are of two types:
 Call option gives the buyer of the option a right but not an
obligation to buy a given quantity of the underlying asset, at
a given price, on or before a given future date

Put option gives the buyer of the option a right but not an obligation to sell a
given quantity of the underlying asset, at a given price, on or before a given
future date
Opportunities of Mutual Funds are tremendous specially when investment is
concerned. For any individual who intends to allocate his assets into proper
forms of investment and want to diversify his Investment Portfolio as well as
the risks, Mutual Funds can be proved as the biggest opportunity.

Investors gets a lot of advantages with the Mutual Fund Investment. Firstly,
they are not required to carry on intensive research and detailed analysis on
Stock Market and Bond Market. This work is done by the Fund Mangers of
the Investment Management Company on behalf of the investors. In fact, the
professional Fund Managers who handle the mutual funds of any particular
company, are able to speculate the market trend more correctly than any
common individual. Good Speculation about the trends of stock prices and bond
prices leads to right allocation of funds in the right stocks and bonds resulting in

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good Rate of Returns.

Investors also get the advantage of high Liquidity of the mutual funds. This
means the investors can enjoy easy access to the funds invested in the mutual
funds whenever they require the money. When the investors invest in any
mutual fund, they are given some equity position in that fund. The investors can
any time sell their mutual fund shares to get back the money invested in mutual
funds. The only thing is that the Rate of Return that they will get may not be
favorable as the return depends on the present market condition.

The greatest opportunity that the mutual funds offer is the opportunity of
diversifying their investments. Investment Diversification actually diversifies
the Risk associated with investment. This is because, if at a time, if prices of
some stocks are declining, deceasing the Value of Investment, prices of some
other stocks and bonds may tend to rise and in this way the loss of the mutual
fund is offset by the strength of the stocks whose prices are rising. As all the
mutual funds diversify their investments in various common stocks, preferred
stocks and different bonds, the risk to be borne by the investors are well
diversified and in other terms lowered

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CHAPTER 5
CONCEPT
Mutual fund is a trust that pools money from a group of investors (sharing
common financial goals) and invest the money thus collected into asset classes
that match the stated investment objectives of the scheme. Since the stated
investment objectives of a mutual fund scheme generally forms the basis for an
investor's decision to contribute money to the pool, a mutual fund can not
deviate from its stated objectives at any point of time.

Every Mutual Fund is managed by a fund manager, who using his investment
management skills and necessary research works ensures much better return
than what an investor can manage on his own. The capital appreciation and
other incomes earned from these investments are passed on to the investors
(also known as unit holders) in proportion of the number of units they own.

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When an investor subscribes for the units of a mutual fund, he becomes part
owner of the assets of the fund in the same proportion as his contribution
amount put up with the corpus (the total amount of the fund). Mutual Fund
investor is also known as a mutual fund shareholder or a unit holder.
Any change in the value of the investments made into capital market
instruments (such as shares, debentures etc) is reflected in the Net Asset Value
(NAV) of the scheme. NAV is defined as the market value of the Mutual Fund
scheme's assets net of its liabilities. NAV of a scheme is calculated by dividing
the market value of scheme's assets by the total number of units issued to the
investors.

For example:
A. If the market value of the assets of a fund is Rs. 100,000
B. The total number of units issued to the investors is equal to 10,000.
C. Then the NAV of this scheme = (A)/(B), i.e. 100,000/10,000 or 10.00
D. Now if an investor 'X' owns 5 units of this scheme
E. Then his total contribution to the fund is Rs. 50 (i.e. Number of units held
multiplied by the NAV of the scheme)

ADVANTAGES OF MUTUAL FUND

S.
Advantage Particulars
No.
Mutual Funds invest in a well-diversified portfolio of
Portfolio securities which enables investor to hold a diversified
1.
Diversification investment portfolio (whether the amount of investment is
big or small).

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Fund manager undergoes through various research works

Professional and has better investment management skills which ensure
2.
Management higher returns to the investor than what he can manage on
his own.
Investors acquire a diversified portfolio of securities even
with a small investment in a Mutual Fund. The risk in a
3. Less Risk
diversified portfolio is lesser than investing in merely 2 or
3 securities.
Low Due to the economies of scale (benefits of larger volumes),
4. Transaction mutual funds pay lesser transaction costs. These benefits
Costs are passed on to the investors.
An investor may not be able to sell some of the shares held
5. Liquidity by him very easily and quickly, whereas units of a mutual
fund are far more liquid.
>Mutual funds provide investors with various schemes
with different investment objectives. Investors have the
Choice of
6. option of investing in a scheme having a correlation
Schemes
between its investment objectives and their own financial
goals. These schemes further have different plans/options
Funds provide investors with updated information
7. Transparency pertaining to the markets and the schemes. All material
facts are disclosed to investors as required by the regulator.
Investors also benefit from the convenience and flexibility
offered by Mutual Funds. Investors can switch their
holdings from a debt scheme to an equity scheme and vice-
8. Flexibility
versa. Option of systematic (at regular intervals)
investment and withdrawal is also offered to the investors
in most open-end schemes.

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Mutual Fund industry is part of a well-regulated

investment environment where the interests of the
9. Safety
investors are protected by the regulator. All funds are
registered with SEBI and complete transparency is forced.

DISADVANTAGES OF MUTUAL FUND

S.
Disadvantage Particulars
No.
Costs Control Investor has to pay investment management fees and fund
Not in the distribution costs as a percentage of the value of his
1.
Hands of an investments (as long as he holds the units), irrespective of
Investor the performance of the fund.
The portfolio of securities in which a fund invests is a
No decision taken by the fund manager. Investors have no
2. Customized right to interfere in the decision making process of a fund
Portfolios manager, which some investors find as a constraint in
achieving their financial objectives.
Difficulty in Many investors find it difficult to select one option from
Selecting a the plethora of funds/schemes/plans available. For this,
3.
Suitable Fund they may have to take advice from financial planners in
Scheme order to invest in the right fund to achieve their objectives.

TYPES OF MUTUAL FUNDS

General Classification of Mutual Funds

Open-end Funds | Closed-end Funds

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Open-end Funds
Funds that can sell and purchase units at any point in time are classified as
Open-end Funds. The fund size (corpus) of an open-end fund is variable (keeps
changing) because of continuous selling (to investors) and repurchases (from
the investors) by the fund. An open-end fund is not required to keep selling new
units to the investors at all times but is required to always repurchase, when an
investor wants to sell his units. The NAV of an open-end fund is calculated
every day.
Closed-end Funds
Funds that can sell a fixed number of units only during the New Fund Offer
(NFO) period are known as Closed-end Funds. The corpus of a Closed-end
Fund remains unchanged at all times. After the closure of the offer, buying and
redemption of units by the investors directly from the Funds is not allowed.
However, to protect the interests of the investors, SEBI provides investors with
two avenues to liquidate their positions:
1. Closed-end Funds are listed on the stock exchanges where investors can
buy/sell units from/to each other. The trading is generally done at a discount
to the NAV of the scheme. The NAV of a closed-end fund is computed on a
weekly basis (updated every Thursday)..
2. Closed-end Funds may also offer "buy-back of units" to the unit holders. In
this case, the corpus of the Fund and its outstanding units do get changed.
Load Funds | No-load Funds
Load Funds
Mutual Funds incur various expenses on marketing, distribution, advertising,
portfolio churning, fund manager's salary etc. Many funds recover these
expenses from the investors in the form of load. These funds are known as Load
Funds. A load fund may impose following types of loads on the investors:
1. Entry Load - Also known as Front-end load, it refers to the load charged to

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an investor at the time of his entry into a scheme. Entry load is deducted
from the investor's contribution amount to the fund.
2. Exit Load - Also known as Back-end load, these charges are imposed on an
investor when he redeems his units (exits from the scheme). Exit load is
deducted from the redemption proceeds to an outgoing investor.
3. Deferred Load - Deferred load is charged to the scheme over a period of
time.
4. Contingent Deferred Sales Charge (CDSC) - In some schemes, the
percentage of exit load reduces as the investor stays longer with the fund.
This type of load is known as Contingent Deferred Sales Charge.
No-load Funds
All those funds that do not charge any of the above mentioned loads are known
as No-load Funds.
Tax-exempt Funds | Non-Tax-exempt Funds
Tax-exempt Funds
Funds that invest in securities free from tax are known as Tax-exempt Funds.
All open-end equity oriented funds are exempt from distribution tax (tax for
distributing income to investors). Long term capital gains and dividend income
in the hands of investors are tax-free.
Non-Tax-exempt Funds
Funds that invest in taxable securities are known as Non-Tax-exempt Funds. In
India, all funds, except open-end equity oriented funds are liable to pay tax on
distribution income. Profits arising out of sale of units by an investor within 12
months of purchase are categorized as short-term capital gains, which are
taxable. Sale of units of an equity oriented fund is subject to Securities
Transaction Tax (STT). STT is deducted from the redemption proceeds to an
investor.

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BROAD MUTUAL FUND TYPES

1. Equity Funds
Equity funds are considered to be the more risky funds as compared to other
fund types, but they also provide higher returns than other funds. It is advisable
that an investor looking to invest in an equity fund should invest for long term
i.e. for 3 years or more. There are different types of equity funds each falling

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into different risk bracket. In the order of decreasing risk level, there are
following types of equity funds:
a. Aggressive Growth Funds - In Aggressive Growth Funds, fund managers
aspire for maximum capital appreciation and invest in less researched
shares of speculative nature. Because of these speculative investments
Aggressive Growth Funds become more volatile and thus, are prone to
higher risk than other equity funds.
b. Growth Funds - Growth Funds also invest for capital appreciation (with
time horizon of 3 to 5 years) but they are different from Aggressive
Growth Funds in the sense that they invest in companies that are expected
to outperform the market in the future. Without entirely adopting
speculative strategies, Growth Funds invest in those companies that are
expected to post above average earnings in the future.
c. Speciality Funds - Speciality Funds have stated criteria for investments
and their portfolio comprises of only those companies that meet their
criteria. Criteria for some speciality funds could be to invest/not to invest
in particular regions/companies. Speciality funds are concentrated and
thus, are comparatively riskier than diversified funds.. There are following
types of speciality funds:
i. Sector Funds: Speciality Funds have stated criteria for investments
and their portfolio comprises of only those companies that meet their
criteria. Criteria for some speciality funds could be to invest/not to
invest in particular regions/companies. Speciality funds are
concentrated and thus, are comparatively riskier than diversified
funds.. There are following types of speciality funds:
ii. Foreign Securities Funds: Foreign Securities Equity Funds have the
option to invest in one or more foreign companies. Foreign securities
funds achieve international diversification and hence they are less

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risky than sector funds. However, foreign securities funds are exposed
to foreign exchange rate risk and country risk.
iii. Mid-Cap or Small-Cap Funds: Funds that invest in companies
having lower market capitalization than large capitalization companies
are called Mid-Cap or Small-Cap Funds. Market capitalization of Mid-
Cap companies is less than that of big, blue chip companies (less than
Rs. 2500 crores but more than Rs. 500 crores) and Small-Cap
companies have market capitalization of less than Rs. 500 crores.
Market Capitalization of a company can be calculated by multiplying
the market price of the company's share by the total number of its
outstanding shares in the market. The shares of Mid-Cap or Small-Cap
Companies are not as liquid as of Large-Cap Companies which gives
rise to volatility in share prices of these companies and consequently,
investment gets risky.
iv. Option Income Funds*: While not yet available in India, Option
Income Funds write options on a large fraction of their portfolio.
Proper use of options can help to reduce volatility, which is otherwise
considered as a risky instrument. These funds invest in big, high
dividend yielding companies, and then sell options against their stock
positions, which generate stable income for investors.
d. Diversified Equity Funds - Except for a small portion of investment in
liquid money market, diversified equity funds invest mainly in equities
without any concentration on a particular sector(s). These funds are well
diversified and reduce sector-specific or company-specific risk. However,
like all other funds diversified equity funds too are exposed to equity
market risk. One prominent type of diversified equity fund in India is
Equity Linked Savings Schemes (ELSS). As per the mandate, a minimum
of 90% of investments by ELSS should be in equities at all times. ELSS

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investors are eligible to claim deduction from taxable income (up to Rs 1

lakh) at the time of filing the income tax return. ELSS usually has a lock-
in period and in case of any redemption by the investor before the expiry
of the lock-in period makes him liable to pay income tax on such
income(s) for which he may have received any tax exemption(s) in the
past.
e. Equity Index Funds - Equity Index Funds have the objective to match the
performance of a specific stock market index. The portfolio of these funds
comprises of the same companies that form the index and is constituted in
the same proportion as the index. Equity index funds that follow broad
indices (like S&P CNX Nifty, Sensex) are less risky than equity index
funds that follow narrow sectoral indices (like BSEBANKEX or CNX
Bank Index etc). Narrow indices are less diversified and therefore, are
more risky.
f. Value Funds - Value Funds invest in those companies that have sound
fundamentals and whose share prices are currently under-valued. The
portfolio of these funds comprises of shares that are trading at a low Price
to Earning Ratio (Market Price per Share / Earning per Share) and a low
Market to Book Value (Fundamental Value) Ratio. Value Funds may
select companies from diversified sectors and are exposed to lower risk
level as compared to growth funds or speciality funds. Value stocks are
generally from cyclical industries (such as cement, steel, sugar etc.) which
make them volatile in the short-term. Therefore, it is advisable to invest in
Value funds with a long-term time horizon as risk in the long term, to a
large extent, is reduced.
g. Equity Income or Dividend Yield Funds - The objective of Equity
Income or Dividend Yield Equity Funds is to generate high recurring
income and steady capital appreciation for investors by investing in those

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companies which issue high dividends (such as Power or Utility

companies whose share prices fluctuate comparatively lesser than other
companies' share prices). Equity Income or Dividend Yield Equity Funds
are generally exposed to the lowest risk level as compared to other equity
funds.
2. Debt / Income Funds
Funds that invest in medium to long-term debt instruments issued by private
companies, banks, financial institutions, governments and other entities
belonging to various sectors (like infrastructure companies etc.) are known as
Debt / Income Funds. Debt funds are low risk profile funds that seek to generate
fixed current income (and not capital appreciation) to investors. In order to
ensure regular income to investors, debt (or income) funds distribute large
fraction of their surplus to investors. Although debt securities are generally less
risky than equities, they are subject to credit risk (risk of default) by the issuer at
the time of interest or principal payment. To minimize the risk of default, debt
funds usually invest in securities from issuers who are rated by credit rating
agencies and are considered to be of "Investment Grade". Debt funds that target
high returns are more risky. Based on different investment objectives, there can
be following types of debt funds:
a. Diversified Debt Funds - Debt funds that invest in all securities issued by
entities belonging to all sectors of the market are known as diversified debt
funds. The best feature of diversified debt funds is that investments are
properly diversified into all sectors which results in risk reduction. Any
loss incurred, on account of default by a debt issuer, is shared by all
investors which further reduces risk for an individual investor.
b. Focused Debt Funds* - Debt funds that invest in all securities issued by
entities belonging to all sectors of the market are known as diversified debt
funds. The best feature of diversified debt funds is that investments are

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properly diversified into all sectors which results in risk reduction. Any
loss incurred, on account of default by a debt issuer, is shared by all
investors which further reduces risk for an individual investor.
c. High Yield Debt funds - As we now understand that risk of default is
present in all debt funds, and therefore, debt funds generally try to
minimize the risk of default by investing in securities issued by only those
borrowers who are considered to be of "investment grade". But, High
Yield Debt Funds adopt a different strategy and prefer securities issued by
those issuers who are considered to be of "below investment grade". The
motive behind adopting this sort of risky strategy is to earn higher interest
returns from these issuers. These funds are more volatile and bear higher
default risk, although they may earn at times higher returns for investors.
d. Assured Return Funds - Although it is not necessary that a fund will
meet its objectives or provide assured returns to investors, but there can be
funds that come with a lock-in period and offer assurance of annual returns
to investors during the lock-in period. Any shortfall in returns is suffered
by the sponsors or the Asset Management Companies (AMCs). These
funds are generally debt funds and provide investors with a low-risk
investment opportunity. However, the security of investments depends
upon the net worth of the guarantor (whose name is specified in advance
on the offer document). To safeguard the interests of investors, SEBI
permits only those funds to offer assured return schemes whose sponsors
have adequate net-worth to guarantee returns in the future. In the past, UTI
had offered assured return schemes (i.e. Monthly Income Plans of UTI)
that assured specified returns to investors in the future. UTI was not able
to fulfill its promises and faced large shortfalls in returns. Eventually,
government had to intervene and took over UTI's payment obligations on

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itself. Currently, no AMC in India offers assured return schemes to

investors, though possible.
e. Fixed Term Plan Series - Fixed Term Plan Series usually are closed-end
schemes having short term maturity period (of less than one year) that
offer a series of plans and issue units to investors at regular intervals.
Unlike closed-end funds, fixed term plans are not listed on the exchanges.
Fixed term plan series usually invest in debt / income schemes and target
short-term investors. The objective of fixed term plan schemes is to gratify
investors by generating some expected returns in a short period.
3. Gilt Funds
Also known as Government Securities in India, Gilt Funds invest in government
papers (named dated securities) having medium to long term maturity period.
Issued by the Government of India, these investments have little credit risk (risk
of default) and provide safety of principal to the investors. However, like all
debt funds, gilt funds too are exposed to interest rate risk. Interest rates and
prices of debt securities are inversely related and any change in the interest rates
results in a change in the NAV of debt/gilt funds in an opposite direction.

4. Money Market / Liquid Funds

Money market / liquid funds invest in short-term (maturing within one year)
interest bearing debt instruments. These securities are highly liquid and provide
safety of investment, thus making money market / liquid funds the safest
investment option when compared with other mutual fund types. However, even
money market / liquid funds are exposed to the interest rate risk. The typical
investment options for liquid funds include Treasury Bills (issued by
governments), Commercial papers (issued by companies) and Certificates of
Deposit (issued by banks).

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5. Hybrid Funds
As the name suggests, hybrid funds are those funds whose portfolio includes a
blend of equities, debts and money market securities. Hybrid funds have an
equal proportion of debt and equity in their portfolio. There are following types
of hybrid funds in India:
a. Balanced Funds - The portfolio of balanced funds include assets like debt
securities, convertible securities, and equity and preference shares held in
a relatively equal proportion. The objectives of balanced funds are to
reward investors with a regular income, moderate capital appreciation and
at the same time minimizing the risk of capital erosion. Balanced funds are
appropriate for conservative investors having a long term investment
horizon.
b. Growth-and-Income Funds - Funds that combine features of growth
funds and income funds are known as Growth-and-Income Funds. These
funds invest in companies having potential for capital appreciation and
those known for issuing high dividends. The level of risks involved in
these funds is lower than growth funds and higher than income funds.
c. Asset Allocation Funds - Mutual funds may invest in financial assets like
equity, debt, money market or non-financial (physical) assets like real
estate, commodities etc.. Asset allocation funds adopt a variable asset
allocation strategy that allows fund managers to switch over from one
asset class to another at any time depending upon their outlook for specific
markets. In other words, fund managers may switch over to equity if they
expect equity market to provide good returns and switch over to debt if
they expect debt market to provide better returns. It should be noted that
switching over from one asset class to another is a decision taken by the
fund manager on the basis of his own judgment and understanding of

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specific markets, and therefore, the success of these funds depends upon
the skill of a fund manager in anticipating market trends.
6. Commodity Funds
Those funds that focus on investing in different commodities (like metals, food
grains, crude oil etc.) or commodity companies or commodity futures contracts
are termed as Commodity Funds. A commodity fund that invests in a single
commodity or a group of commodities is a specialized commodity fund and a
commodity fund that invests in all available commodities is a diversified
commodity fund and bears less risk than a specialized commodity fund.
"Precious Metals Fund" and Gold Funds (that invest in gold, gold futures or
shares of gold mines) are common examples of commodity funds.

7. Real Estate Funds

Funds that invest directly in real estate or lend to real estate developers or invest
in shares/securitized assets of housing finance companies, are known as
Specialized Real Estate Funds. The objective of these funds may be to generate
regular income for investors or capital appreciation.

8. Exchange Traded Funds (ETF)

Exchange Traded Funds provide investors with combined benefits of a closed-
end and an open-end mutual fund. Exchange Traded Funds follow stock market
indices and are traded on stock exchanges like a single stock at index linked
prices. The biggest advantage offered by these funds is that they offer
diversification, flexibility of holding a single share (tradable at index linked
prices) at the same time. Recently introduced in India, these funds are quite
popular abroad.

9. Fund of Funds

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Mutual funds that do not invest in financial or physical assets, but do invest in
other mutual fund schemes offered by different AMCs, are known as Fund of
Funds. Fund of Funds maintain a portfolio comprising of units of other mutual
fund schemes, just like conventional mutual funds maintain a portfolio
comprising of equity/debt/money market instruments or non financial assets.
Fund of Funds provide investors with an added advantage of diversifying into
different mutual fund schemes with even a small amount of investment, which
further helps in diversification of risks. However, the expenses of Fund of
Funds are quite high on account of compounding expenses of investments into
different mutual fund schemes.

* Funds not yet available in India

Risk Heirarchy of Different Mutual Funds

Thus, different mutual fund schemes are exposed to different levels of risk and
investors should know the level of risks associated with these schemes before
investing. The graphical representation hereunder provides a clearer picture of
the relationship between mutual funds and levels of risk associated with these
funds:

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CHAPTER 6
CLASSIFICATION

Classification of Mutual Funds in India is done on the basis of their objective

and structure. Classification of Mutual Funds in India has helped to categorize
them into major types such as Funds of Funds, Regional Mutual Funds, Closed-
End Funds, Large Cap Funds, and Interval Funds.

A glance at Mutual fund in India:

Mutual fund in India is a kind of collective investment that is managed

professionally. In Mutual fund in India, the money is collected from a large
number of investors and then it is invested in bonds, stocks, and various other
securities.

The fund manager of Mutual fund in India collects the interest income which is
then distributed among the individual investors on the basis of the number of
units that they hold. Mutual fund's value of a share is calculated on a daily basis
and is known as per share Net Asset Value (NAV).

Various kinds of Mutual funds in India:

Classification of Mutual Funds in India has been done on the basis of their
investment objective and structure. Classification of Mutual Funds in India has
be done into main types such as Income Funds, Sector- Specific Funds, Large

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Cap Funds, Fixed- Income Funds, Interval Funds, Closed- End Funds, and Tax
Saving Funds. Income Funds in India are a kind of mutual fund whose aim is to
provide to the investors with steady and regular income. They usually invest
their principal in securities such as corporate debentures, bonds, and
government securities.

Sector- Specific Funds in India are funds that make investments in specified
sectors only. They give importance to one sector only such as pharmaceuticals,
software, infrastructure, and health care. Large Cap Funds in India are a kind of
mutual fund that makes investment in the shares of large blue chip companies.
Fixed- Income Funds in India makes investment in debt securities that have
been issued either by the banks, government, or companies. They are also
known as income funds and debt funds.

Interval Funds in India are a combination of both the open and close ended
funds. They offer the investors flexibility for they can be sold and repurchased
at the period of time that has been predetermined. Closed- End Funds in India
are a kind of mutual fund that has a maturity period that has been specified and
which usually varies from three to fifteen years. Tax Saving Funds in India
offer tax rebates to the investor under the Section 88, Income Tax Act. They are
also known as equity- linked savings scheme.

Share

There are different types of mutual funds in India available in the market
which an investor can choose depending on his profile, risk taking capacity
and time horizon.

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The classification of mutual funds can be done on either the investment

objective or on structure of the mutual fund.

Let’s go through each one of these classifications by looking at the chart below
and understand what they mean.

Miscellaneous Classification

Open and Close Ended Mutual Funds: A mutual fund can be either Open
ended or Close ended. Open ended funds can buy and sell its units at any time –
so an an investor, you can purchase and sell your holdings in such funds at any
time.

Given this, its corpus keeps changing. On the contrary, close ended funds can
only be bought by investors buying the period they are up for sale – called the
New Fund Offer (NFO) period. Investors can sell them either on the stock
exchanges where it is listed or during special buy back periods which the AMC
(Asset Management Company) schedules.

Growth and Dividend Mutual Funds : Funds that make your capital grow
over a period of time without giving out profits/dividends to you are called
growth funds.

In case you received dividends from them, its called a dividend fund.
Obviously, in the latter case, since the profits are paid out from the fund corpus,
the NAV of the fund will be less while that of the growth option will be more.

Debt Mutual Funds

These invest in commercial papers, certificates of deposits, treasury bills,

corporate bonds, debentures and government bonds among others.

There are other classification of such funds, depending on the maturity of the
paper held, for eg, short-term and medium-term to long-term funds.

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So these invest in predominantly debt securities and their agenda is to generate

stable income for investors with less amount of risk. These shall be covered in a
later lesson in more detail.

Equity Mutual Funds

These invest primarily in stocks of companies – in a sense, you own up ending

a part of the company when you buy into these. These are meant for long term
investments and carry a great deal of risk. Their purpose is capital appreciation
over a long period of time.

Diversified Equity funds invest in a wide selection of stocks across different

companies and market capitalizations so as to reduce the risk for the investor.

Index funds invest in companies that comprise the benchmark index (say NSE
or BSE) and in the same proportion as the index itself. So the returns of these
are in line with the index.

ELSS (equity linked savings schemes) or tax saving mutual funds provide tax
benefit to investors under section 80(C) and also have a lock-in period of 3
years – this means that as an investor, you cannot redeem(sell) your holdings
before three years of buying the mutual fund.

Sector or Thematic funds invest in a particular sector eg, there could be a fund
investing in only the banking sector. Similarly, there could be thematic funds
investing in a particular theme, example, infrastructure.

Large-cap mutual funds invest in large market capitalization companies.

There is no clear definition of what large capitalization means, many AMCs
pick the top 100 companies (based on market cap) on the Sensex and call them
large-cap.

Similarly, there exists mid-cap and small-cap mutual funds – those which invest
in medium market capitalization companies and small market capitalization

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companies respectively. Among these, large-cap carries the lowest risk while
the small cap carries the most risk.

Hybrid Mutual Funds

Balanced Mutual Funds invest in at least 65% equities and the rest 35% in
debt. The debt portion provides stability while the equity portion provides
capital appreciation.

Monthly Income Plans (MIPs) are plans which invest around 15%-25% in
equities and the rest in debt and money market instruments.

Other Types

Gold Mutual Funds are those that invest in gold as the underlying assets.
International Funds invest in companies outside India.

Exchange Traded Funds(ETFs) are those that are traded on the stock
exchange on a real time basis.

Socially responsible mutual funds invest in companies that have social,

environmental or moral beliefs and promote the same.

Fund of Funds do not invest in any companies – instead they put in their
money into other AMC’s mutual funds.

Real Estate Mutual Funds invest in real estate or lend money to real estate
developers.

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Funds: Evaluating Performance

Perhaps you've noticed all those mutual fund ads that quote their amazingly
high one-year rates of return. Your first thought is "wow, that mutual fund did
great!" Well, yes it did great last year, but then you look at the three-year
performance, which is lower, and the five year, which is yet even lower. What's
the underlying story here? Let's look at a real example from a large mutual
fund's performance:

1 year 3 year 5 year

53% 20% 11%

Last year, the fund had excellent performance at 53%. But, in the past three
years, the average annual return was 20%. What did it do in years 1 and 2 to
bring the average return down to 20%? Some simple math shows us that the
fund made an average return of 3.5% over those first two years: 20% = (53% +
3.5% + 3.5%)/3. Because that is only an average, it is very possible that the
fund lost money in one of those years.

It gets worse when we look at the five-year performance. We know that in the
last year the fund returned 53% and in years 2 and 3 we are guessing it returned
around 3.5%. So what happened in years 4 and 5 to bring the average return
down to 11%? Again, by doing some simple calculations we find that the fund
must have lost money, an average of -2.5% each year of those two years: 11% =
(53% + 3.5% + 3.5% - 2.5% - 2.5%)/5. Now the fund's performance doesn't
look so good!

It should be mentioned that, for the sake of simplicity, this example, besides

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making some big assumptions, doesn't include calculating compound interest.

Still, the point wasn't to be technically accurate but to demonstrate the
importance of taking a closer look at performance numbers. A fund that loses
money for a few years can bump the average up significantly with one or two
strong years.

It's All Relative

Of course, knowing how a fund performed is only one third of the battle.
Performance is a relative issue, literally. If the fund we looked at above is
judged against its appropriate benchmark index, a whole new layer of
information is added to the evaluation. If the index returned 75% for the 1 year
time period, that 53% from the fund doesn't look quite so good. On the other
hand, if the index delivered results of 25%, 5%, and -5% for the respective one,
three, and five-year periods, then the fund's results look rather fine indeed.

To add another layer of information to the evaluation, one can consider a fund's
performance against its peer group as well as against its index. If other funds
that invest with a similar mandate had similar performance, this data point tells
us that the fund is in line with its peers. If the fund bested its peers and its
benchmark, its results would be quite impressive indeed.

Looking at any one piece of information in isolation only tells a small portion of
the story. Consider the comparison of a fund against its peers. If the fund sits in
the top slot over each of the comparison periods, it is likely to be a solid
performer. If it sits at the bottom, it may be even worse than perceived, as peer
group comparisons only capture the results from existing funds. Many fund
companies are in the habit of closing their worst performers. When the "losers"
are purged from their respective categories, their statistical records are no longer
included in the category performance data. This makes the category averages

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creep higher than they would have if the losers were still in the mix. This is
better known as survivorship bias. (Learn more about survivorship bias in The
Truth Behind Mutual Fund Returns.)

To develop the best possible picture of fund's performance results, consider as

many data points as you can. Long-term investors should focus on long-term
results, keeping in mind that even the best performing funds have bad years
from time to time.

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Advantages of Mutual Funds

The Advantages of Mutual Funds encourage investors to invest in the same.

The Mutual funds are very popular among investors as it is professionally
managed and it offers a wide variety of advantages.

Advantages of Mutual Funds

The Mutual Funds are one of the best financial instruments offered to the public
by the finance corporations. The Mutual Funds are collective investments, and
use that money as investment in various stocks, bonds, and other securities to
earn interest and disburse dividends.Advantages of Mutual Funds are the
primary reason for the popularity of the mutual funds.

The Mutual Funds offers easy access to invest in the complex financial market.
Major advantages of Mutual Funds are professional management,
diversification and liquidity.

Advantages of Mutual Funds-Overview

 Flexibility: The investments pertaining to the Mutual Fund offers the

public a lot of flexibility by means of dividend reinvestment, systematic
investment plans and systematic withdrawal plans.

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 Affordability: The Mutual funds are available in units. Hence they are
highly affordable and due to the very large principal sum, even the small
investors are benefited by the investment scheme.

 Liquidity: In case of Open Ended Mutual Fund schemes, the investors

have the option of redeeming or withdrawing money at any point of time
at the current rate of net value asset.

 Diversification: The risk pertaining to the Mutual Funds is quite low as

the total investment is distributed in several industries and different stocks.

 Professional Management: The Mutual Funds are professionally

managed. The experienced Fund Managers pertaining to the Mutual Funds
examine all options based on research and experience.

 Potential of return: The Fund Managers of the Mutual Funds gather data
from leading economists and financial analysts. So they are in a better
position to analyze the scopes of lucrative return from the investments.

 Low Costs: The fees pertaining to the custodial, brokerage, and others is
very low.

 Regulated for investor protection: The Mutual Funds sector is regulated

by the Securities Exchange Board of India (SEBI) to safeguard the rights
of the investor.

Mutual funds are currently the most popular investment vehicle and provide
several advantages to investors, including the following:

1. Advanced Portfolio Management

you pay a management fee as part of your expense ratio, which is used to

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hire a professional portfolio manager who buys and sells stocks, bonds,
etc. This is a relatively small price to pay for help in the management of
an investment portfolio.

2. Dividend Reinvestment
As dividends and other interest income is declared for the fund, it can be
used to purchase additional shares in the mutual fund, thus helping your
investment grow.

3. Risk Reduction (Safety)

A reduced portfolio risk is achieved through the use of diversification, as
most mutual funds will invest in anywhere from 50 to 200 different
securities - depending on their focus. Several index stock mutual funds
own 1,000 or more individual stock positions.

4. Convenience and Fair Pricing

Mutual funds are common and easy to buy. They typically have low
minimum investments (some around $2,500) and they are traded only
once per day at the closing net asset value (NAV). This eliminates price
fluctuation throughout the day and various arbitrage opportunities that
day traders practice.

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Disadvantage Mutual Funds

So-Called Disadvantages of Mutual Funds?

 Disadvantage Mutual Funds Have Hidden Fees

If fees were hidden, those hidden fees would certainly be on the list of
disadvantages of mutual funds. The hidden fees that are lamented are properly
referred to as 12b-1 fees. While these 12b-1 fees are no fun to pay, they are
not hidden. The fee is disclosed in the mutual fund prospectus and can be
found on the mutual funds’ web sites. Many mutual funds do not charge a
12b-1 fee. If you find the 12b-1 fee onerous, invest in a mutual fund that does
not charge the fee. Hidden fees cannot make the list of disadvantages of
mutual funds because they are not hidden and there are thousands of mutual
funds that do not charge 12b-1 fees.

 Disadvantage 2: Mutual Funds Lack Liquidity

How fast can you get your money if you sell a mutual fund as compared to
ETFs, stocks and closed-end funds? If you sell a mutual fund, you have
access to your cash the day after the sale. ETFs, stocks and closed-end funds
require you to wait three days after you sell the investment. I would call the
“lack of liquidity” disadvantage of mutual funds a myth. You can only find
more liquidity if you invest in your mattress.

 Disadvantage 3: Mutual Funds Have High Sales Charges

Should a sales charge be included in the disadvantages of mutual funds list?
It’s difficult to justify paying a sales charge when you have a plethora of no-
load mutual funds. But, then again, it’s difficult to say that a sales charge is a
disadvantage of mutual funds when you have thousands of mutual fund
options that do not have sales charges. Sales charges are too broad to be

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included on my list of disadvantages of mutual funds.

 Disadvantage 4: Mutual Funds and Poor Trade Execution

If you buy or sell a mutual fund, the transaction will take place at the close of
the market regardless of the time you entered the order to buy or sell the
mutual fund. I find the trading of mutual funds to be a simple, stress-free
feature of the investment structure. However, many advocates and purveyors
of ETFs will point out that you can trade throughout the day with ETFs. If
you decide to invest in ETFs over mutual funds because your order can be
filled at 3:50 pm EST with ETFs rather than receive prices as of 4:00 pm EST
with mutual funds, I recommend that you sign up for the Stress Management
Weekly Newsletter at About.com.

 Disadvantage 5: All Mutual Funds Have High Capital Gains

Distributions
If all mutual funds sell holdings and pass the capital gains on to investors as a
taxable event, then we have a found a winner for the list of disadvantages of
mutual funds list. Oh well, not all mutual funds make annual capital gains
distributions. Index mutual funds and tax-efficient mutual funds do not make
these distributions every year. Yes, if they have the gains, they must distribute
the gains to shareholders. However, many mutual funds (including index
mutual funds and tax-efficient mutual funds) are low-turnover funds and do
not make capital gains distributions on an annual basis.

In addition, retirement plans (IRAs, 401ks, etc.) are not impacted by capital
gains distributions. There are also strategies to avoid the capital gains
distributions including tax-loss harvesting and selling a mutual fund prior to
the distribution.

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However, there are also disadvantages of mutual funds, such as the following:

1.
2. High Expense Ratios and Sales Charges
If you're not paying attention to mutual fund expense ratios and sales
charges, they can get out of hand. Be very cautious when investing in
funds with expense ratios higher than 1.20%, as they will be considered
on the higher cost end. Be weary of 12b-1 advertising fees and sales
charges in general. There are several good fund companies out there that
have no sales charges. Fees reduce overall investment returns.

3. Management Abuses
Churning, turnover and window dressing may happen if your manager is
abusing his or her authority. This includes unnecessary trading, excessive
replacement and selling the losers prior to quarter-end to fix the books.

4. Tax Inefficiency
Like it or not, investors do not have a choice when it comes to capital
gain payouts in mutual funds. Due to the turnover, redemptions, gains and
losses in security holdings throughout the year, investors typically receive
distributions from the fund that are an uncontrollable tax event.

5. Poor Trade Execution

If you place your mutual fund trade anytime before the cut-off time for
same-day NAV, you'll receive the same closing price NAV for your buy

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or sell on the mutual fund. For investors looking for faster execution
times, maybe because of short investment horizons, day trading, or timing
the market, mutual funds provide a weak execution strategy.

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