Different investment avenues are available to investors. Mutual funds also offer good investment opportunities to the investors. Like all investments, they also carry certain risks. The investors should compare the risks and expected returns after adjustment of tax on various instruments and may seek advice from experts while making investment decisions.

With an objective to make the investors aware of functioning of mutual funds, an attempt has been made to provide information in question-answer format which may help the investors in taking investment decisions.

Mutual fund is a mechanism for pooling money by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is diversified because all stocks may not move in the same direction in the same proportion at the same time. Mutual funds issue units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unit-holders.

The profits or losses are shared by investors in proportion to their investments. Mutual funds normally come out with a number of schemes which are launched from time to time with different investment objectives. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) before it can collect funds from the public.

Mutual funds invest the money collected from investors in securities markets. In simple words, NAV is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on day-to-day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is INR 200 lakh and the mutual fund has issued 10 lakh units of INR 10 each to the investors, then the NAV per unit of the fund is INR 20 (i.e.,200 lakh/10 lakh). NAV is required to be disclosed by the mutual funds on a daily basis. The performance of a particular scheme of a mutual fund is denoted by its NAV movement.

The NAV per unit of all mutual fund schemes have to be updated on AMFI‟s website and the Mutual Funds’ website by 9 p.m. of the same day. Fund of Funds are allowed time till 10 a.m. of the following business day to update the information.

Schemes according to Maturity Period:
A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period.

Open-ended Fund/Scheme
An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) per unit which is declared on a daily basis. The key feature of open-end schemes is liquidity.

Close-ended Fund/Scheme
A close-ended fund or scheme has a stipulated maturity period e.g. 3-5 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the new fund offer and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. 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 i.e. either repurchase facility or through listing on stock exchanges.

Schemes according to Investment Objective:
A scheme can also be classified as growth scheme, income scheme or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:

Growth / Equity Oriented Scheme
The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, growth, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.

Income/Debt Oriented Scheme
The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes.
however, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

Balanced/Hybrid Scheme
The aim of balanced schemes is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.

Money Market or Liquid Schemes
These schemes are also income schemes and their aim is to provide easy liquidity, preservation of capital and moderate income.

These schemes invest exclusively in short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared with other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.

Gilt Funds
These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt-oriented schemes.

Index Funds
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index (Sensex), NSE 50 index (Nifty), etc. These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as “tracking error” in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.

These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues, for example, Equity Linked Savings Schemes (ELSS) under section 80C and Rajiv Gandhi Equity Saving Scheme (RGESS) under section 80CCG of the Income Tax Act, 1961. Pension schemes launched by mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.

A scheme that invests primarily in other schemes of the same mutual fund or other mutual funds is known as a FoF scheme. A FoF scheme enables the investors to achieve greater diversification through one scheme. It spreads risks across a greater universe.

ETFs are mutual fund units that investors can buy or sell at the stock exchange. This is in contrast to a normal mutual fund unit that an investor buys or sells from the AMC (directly or through a distributor). In the ETF structure, the AMC does not deal directly with investors or distributors. Units are issued to a few designated large participants called Authorised Participants (APs). The APs provide buy and sell quotes for the ETFs on the stock exchange, which enable investors to buy and sell the ETFs at any given point of time when the stock markets are open for trading.

ETFs therefore trade like stocks and experience price changes throughout the day as they are bought and sold. Buying and selling ETFs requires the investor to have demat and trading accounts.

A Load Fund is one that charges a percentage of NAV for entry or exit and the load structure in a scheme has to be disclosed in its offer documents. Suppose the NAV per unit is INR 10. If the entry as well as exit load charged is 1%, then the investors who buy would be required to pay INR 10.10 (10 + 1% of 10) per unit and those who offer their units for repurchase to the mutual fund will get only INR 9.90 (10 – 1% of 10) per unit. Currently, in India, the exit load charged is credited to the scheme. The investors should take the loads into consideration while making investment as these affect their returns. However, the investors should also consider the performance track record and service standards of the mutual fund which are more important. A no-load fund is one that does not charge for entry or exit. It means the investors can enter the fund/scheme at NAV and no additional charges are payable on purchase or sale of units.

SEBI has mandated that no entry load can be charged for any mutual fund scheme in India.

Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the funds’ daily net assets. Operating expenses of a scheme are administration, management, advertising related expenses, etc.

An expense ratio of 1% per annum means that each year 1% of the funds’ total assets will be used to cover expenses. Information on expense ratio that may be applicable to a scheme is mentioned in the offer document. Currently, in India, the expense ratio is fungible, i.e., there is no limit on any particular type of allowed expense as long as the total expense ratio is within the prescribed limit. For limits on expense ratio, refer to regulation 52 of the SEBI (Mutual Funds) Regulations, 1996.

From 01 October 2016, the Consolidated Account Statement (CAS) issued to investors is required to provide information in terms of total purchase value/cost of investment in each scheme. Further, CAS issued for the half-year (ended September/March) shall also provide the amount of actual commission paid by AMCs/Mutual Funds to distributors (in absolute terms) during the half-year period against the concerned investor’s total investments in each Mutual Fund scheme. The term “commission” here refers to all direct monetary payments and other payments made in the form of gifts/rewards, trips, event sponsorships etc. by AMCs/MFs to distributors. Further, a mention may be made in such CAS indicating that the commission disclosed is gross commission and does not exclude costs incurred by distributors such as service tax (wherever applicable, as per existing rates), operating expenses, etc.

Such half-yearly CAS shall be issued to all MF investors, excluding those investors who do not have any holdings in MF schemes and where no commission against their investment has been paid to distributors, during the concerned half-year period.

Such half-yearly CAS are also required to disclose the schemes’ average Total Expense Ratio (in percentage terms) for the half year period for each schemes’ applicable plan (regular or direct or both) where the concerned investor has actually invested in.

In case of winding up of a scheme, the mutual funds pay a sum based on prevailing NAV after adjustment of expenses. Unit-holders are entitled to receive a report on winding up from the mutual funds which gives all necessary details.