What is a Mutual Fund? A vehicle for investing in stocks and bonds A mutual fund is not an alternative investment option to stocks and bonds, rather it pools the money of several investors and invests this in stocks, bonds, money market instruments and other types of securities. Buying a mutual fund is like buying a small slice of a big pizza. The owner of a mutual fund unit gets a proportional share of the fund’s gains, losses, income and expenses.
Basics of Mutual Fund
Net Asset Value or NAV:
NAV is the total asset value (net of expenses) per unit of the fund and is calculated by the AMC at the end of every business day.
How is NAV calculated?
The value of all the securities in the portfolio is calculated daily. From this, all expenses are deducted and the resultant value divided by the number of units in the fund is the fund’s NAV.
Some popular objectives of a mutual fund are:
Fund Objective – What the fund will invest in
Equity (Growth) – Only in stocks
Debt (Income) – Only in fixed-income securities
Money Market (including Gilt) – In short-term money market instruments (including government securities)
Balanced – Partly in stocks and partly in fixed-income securities, in order to maintain a balance in returns and risk
Open- and Close-Ended Funds
(1) Open-Ended Funds:
At any time during the scheme period, investors can enter and exit the fund scheme (by buying/ selling fund units) at its NAV (net of any load charge). Increasingly, AMCs are issuing mostly open-ended funds.
(2) Close-Ended Funds:
Redemption can take place only after the period of the scheme is over. However, close-ended funds are listed on the stock exchanges and investors can buy/ sell units in the secondary market (there is no load).
Some AMCs have sales charges, or loads, on their funds (entry load and/or exit load) to compensate for distribution costs. Funds that can be purchased without a sales charge are called no-load funds.
AMCs charge an annual fee or expense ratio that covers administrative expenses, salaries, advertising expenses, brokerage fees, etc. A 1.5% expense ratio means the AMC charges Rs.1.50 for every Rs.100 in assets under management.
A funds expense ratio is typical to the size of the funds under management and not to the returns earned. Normally, the costs of running a fund grow slower than the growth in the fund size – so, the more assets in the fund, the lower should be its expense ratio.
Each mutual fund has a specific stated objective
The fund’s objective is laid out in the funds prospectus, which is the legal document that contains information about the fund, its history, its officers and its performance.
Two key documents that highlight the funds strategy and performance are:
(1) the prospectus (legal document) and
(2) the shareholder reports (normally quarterly).