Direct & Indirect Taxes, Tax Ready Reckoner, Tax Management, Tax Act. & Rules, Tax Planning & Tax Savings.

Direct & Indirect Taxes, Tax Ready Reckoner, Tax Management, Tax Act. & Rules, Tax Planning & Tax Savings.

Mutual Fund Investment– A Guide before Invest

Mutual Fund are the trust where the individual mutual fund investors who want to invest in market with intention of earning high returns is called a mutual fund which is been managed by market professionals known as fund manager and his team.

Investing in Mutual Funds is normally much easier than buying or selling financial securities like stocks, bonds, or money market instruments. Mutual funds are managed by professional ‘fund managers’ who invest the fund’s capital in various financial securities based on the objective of the fund and attempt to produce capital gains and income for the fund’s investors. These Fund Managers are highly qualified individuals who invest your money based on a lot of backend research. A mutual fund is required to be registered with the your money based on a lot of backend research. A mutual fund is required to be registered with the Securities and Exchange Board of India (SEBI), which regulates securities markets before it can collect funds from the public.

Each investor owns units, which represent a portion of the holdings of the fund. The income/gains generated from this collective investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV”. Simply put, a Mutual Fund is one of the most viable investment option for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

Mutual Fund Investment– A Guide before Invest
Mutual Fund Investment– A Guide before Invest

And what Mutual fund investors get in return of that is the mutual fund unit not the securities and the investment instruments.

Table of Contents

1. Structure of Mutual Funds?

The SEBI regulations need a fund to be recognized in the form of a trust under the Indian Trust Act, 1882. A mutual fund is setup in a form of a trust, which has sponsor, trustees, asset management company and a custodian. It is regulated by SEBI and follows the guidelines of AMFI (Association of Mutual Funds in India).

a. Sponsors:

Sponsors establish the trust; they are like the promoters of any company. The responsibility of the sponsor includes appointing the trustees with the approval of SEBI and setting up an AMC. Example: ICICI Bank and Prudential Plc are sponsors for ICICI Prudential Mutual Fund. Moreover, the sponsor is anticipated to contribute at least 40% to the net worth of the AMC.

b. Trustees:

Board of Trustees/ board of directors who track the performance and maintain the compliance with the rules stipulated by SEBI. They ensure the interest of the unit holders is protected. The sponsor is responsible for either select four trustees or create a trustee company having minimum four independent director. At least two thirds of the trustees or the directors should be independent not associated with the sponsor in any way. Trustee is responsible for get into an investment management agreement with the AMC to describe its operation. They are also liable to appoint CIO, CEO and fund manager. Trustees approve all the scheme of AMC before launched. Example: ICICI Prudential Trust Limited is the company which acts as Trustee for ICICI Prudential Mutual Fund.

c. Asset Management Company (AMC):

AMC or Mutual Fund house is the company responsible to manage the assets of the Mutual Funds and takes care of its day to day operation. The AMC consists of the Chief Investment Officer, the fund managers and analysts, who are together responsible for managing the various schemes launched. ICICI Prudential Asset Management Company Ltd is the AMC of ICICI Prudential Mutual Fund.

d. Custodian:

Custodian is registered with SEBI and has the custody of the all the shares and various other securities bought by the AMC. The custodian is responsible for the safe keeping of all the securities. Most of the mutual fund use banks custodian. HDFC Bank is the Custodian of ICICI Prudential Mutual Fund.

e. Registrar & Transfer Agents (RTA):

The AMC appoints the registrar and transfer agent to the mutual fund. The registrar processes the application form, redemption requests and dispatches account statements to the unit holders. The registrar and transfer agent also handle communication with investors and updates investor records. Registrar of ICICI Prudential Mutual Fund is CAMS.

f. Regulator (SEBI):

The Securities and Exchange Board of India (SEBI) is the primary regulator of mutual funds in India. SEBI’s Regulations called the SEBI (Mutual Funds) Regulations, 1996, along with amendments made from time to time, govern the setting up a mutual fund and its structure, launching a scheme, creating and managing the portfolio, investor protection, investor services and roles and responsibilities of the constituents.

The Association of Mutual Funds in India (AMFI) is the industry body that oversees the functioning of the industry and recommends best practices to be followed by the industry members. It also represents the industry’s requirements to the regulator, government and other stakeholders.

2.   Advantages to Investing in Mutual Funds


An investment fund carries few advantages like:

  1. Diversification
  2. Expert Management
  3. Liquidity
  4. Convenience of Investing
  5. Affordability and
  6. Transparency.

1.     Diversification:

Mutual Fund helps investor to diversify their investment portfolio which in turn hedge the risk or lower the risk for their mutual fund investors like for one stock in mutual fund portfolio goes down then there are other is stocks or asset class we can compensate for the same.

2.     Expert Management

Second point is expert Management which I just talked about like Mutual Fund is managed by highly qualified and experienced professionals in the field of stock market which are they in their out 24/7 busy in researching and analysing and managing the investment instruments which they have invested in for the mutual fund investor, which is generally a very difficult task for a retail investor and does it gives a professional approach to investing buy these expert management team.

3.     Liquidity

Third point is liquidity which is one of the most important benefit for the retail investors because it gives the investor and ease of buying and selling mutual funds whenever they want to redeem, they can do it so liquidity is one of the most important advantages of mutual fund. Mutual funds are good if you want to invest in an easy to liquidate instrument. Investments can be redeemed within 1-3 working days.

4.     Convenience of Investing

Fourth point, Which we discuss here is a convenience of investing and these days investing in mutual fund has become a very easy task there are lots of apps and sites available for the mutual fund investors which provides a secure bank level security and a very user-friendly experience for the mutual fund investors to invest their money in mutual funds and these days there is lot of emphasis is been given on buying direct mutual fund which means that know the customers know the mutual fund investor the retail investor has to pay a very low price for their mutual fund investment which they have to pay for the direct plan in terms of expense ratios which will discuss further. And with the advent of these Commission free platforms, it has become a very easy job for a mutual fund investor who can start investing their money in just 5 minutes some of the examples of these platform are:

  • Paytm Money
  • Kuvera
  • Grow App
  • ET Money App

and many more these are just few examples which I have given which are popular among mutual fund investors not a point to promote any one of them please don’t get me wrong yeah but these are one of the finest things which you can use to invest in mutual funds.

5.     Affordability

Fifth point, Is affordability, which gives power to a small investor to start their investment in stock market which is not even possible with this small amount even sum Mutual Fund allow investor to invest in mutual fund with just rupees hundred. So with this Mutual Fund becomes a very favourable investment option for a small investor who don’t have large saving but they can start investing is a small amount to buy starting SIP or a lump sum payment.

You can start your Mutual Fund investment with as low as ₹500. With that money, you could own assets of many corporations, which otherwise is not possible with such small amounts.

6.     Transparency & Ease of Comparison.

And Sixth point, Transparency which I find myself is one of the most important benefits of investing in mutual fund because when I invest my money and put them into risk and ask someone else to manage my money then I was know what exactly happening with money where management is investing my money into to generate Returns and that’s what I really like about mutual fund because they give data of their investment in stock market and other securities in a very transparent manner and releases fact-sheet on monthly basis, which provides complete details of the current investment of the mutual fund in the stock market and other related securities. And not just that it also provides if there are changes done mutual fund portfolio too.

With lots of benefits, I don’t find any reason for a retail mutual fund investor not to invest in mutual fund, and find it as an ideal investment vehicle to reach their financial goals in long term or short term maybe.

And one More important point which would like to add further is flexibility, yes flexibility is the point which I find is very good for mutual fund investor because each investor is different in terms of their behaviour their investment style their choices their preferences and yes one more important thing is their ability to invest and thus, they have different financial goals. and the mutual fund provide complete flexibility to the mutual fund investors to invest according to them and to choose fund according to their choice and to redeem their capital gains according to their requirement and this is great.

7. Reinvestment of Income:

Mutual funds allow investors to reinvest their dividends and interest in additional fund units. This helps in timely investment of your dividends and interest giving a compounding effect.

8. Range of Investment Options and Objectives:

You can find a mutual fund that matches almost exactly what you are looking for, from an investment. This could be related to both your risk profile and your investment horizon.



3.   Disadvantages to Investing in Mutual Funds

Mutual fund to have disadvantages, they are few in numbers but they have:

Let’s have a look on them; and these are:

  1. Expense Ratio or Management Fees
  2. Market Risk and No Guaranteed Returns
  3. Too Many Schemes to Confuse Mutual Fund Investor
  4. No Control.
  5. Exit Loads

1.     Expense Ratio or Management Fees

The first demerit which we are talking about is expense ratio in mutual fund which is a fees which we need to pay the fund house to manage fund Which means that we need to pay a professional management fees to the fund house to manage of funds to generate Returns.

2.     Subject to Market Risks and No Guaranteed Returns

Second demerit which we are talking about is market risk we all have heard the Famous disclaimer in mutual fund market that is mutual fund returns are subject to market risk please read the documents carefully before you invest. So mutual funds carries various types of market risk such:

(i)               Stock Exposure Risk

(ii)              Sector Exposure Risk

(iii)             Valuation Risk

(iv)             Liquidity Risk

(v)              Business Risk etc.

So, we can see that it carries a lot of risk but at the same time there is a professional fund management team with the fund manager to manage this kind of risk, so we need not to worry a lot about the risk factor and that’s what we are paying the management fees in terms of expense ratio to the fund house.

3.     Too Many Schemes to Confuse Mutual Fund Investor

The third demerit is there are lots of almost 15000 plus schemes are there in mutual fund market to choose so it becomes a very difficult task for mutual fund invest for the retail investor to choose the best fund out of these 15000 scheme it. At this place you can take the help of the financial advisor or the mutual fund advisor to choose and select the right kind of funds for investment portfolio.

And the last one is the lack of choice of selection of stocks in the mutual fund portfolio which of course we don’t have any choice but yeah we have the choice to select the fund which carries the choice of the stocks which you want to invest in according to the objectives of the fund scheme, and of course there are professionals which is engaged in managing your portfolio who are taking informed decisions in selecting the stocks in your portfolio based on Deep research which day in Day Out they are carrying out in their own house and after lots of processes the stocks is been selected to invest in for the mutual fund scheme so I think it’s better we don’t have any choice in selecting the stocks in portfolio let the professionals do it better.

So after discussing all the demerits and merits in my opinion the benefits of mutual funds are on the strongest side and there are few demerits which can be ignored as they have less impact on the mutual fund investment, Of course there is risk involved investment but in long terms this is going to reward you in terms of wealth creation and capital appreciation.

4. Exit Loads:

Many of the Mutual Funds charge an Exit load, which means a penalty if you redeem your investments before a certain time frame. Exit Load varies across fund schemes and can be as high as 2% of total redemption and can also be 0%.

5. No Control:

Investment in Mutual Fund doesn’t give you any control over the choice of securities selected by Fund Manager. You must completely trust his/her judgement. We believe Mutual Funds are the most transparent, efficient and convenient way of investment. Yes, there are risks involved and therefore you should do your research or talk to your financial advisor to select the best fund that suit your needs.

4.   Growth investing, Value Investing & Blend of Growth & Value Investing Style

As far as Indian stock market is concerned according to market capitalization the market is divided into following parts.

  1. 70% of the market is consist of large cap stocks, which includes top 100 companies.
  2. 20% of the market is consist of midcap stocks, which includes next 150 top companies.
  3. And remaining 10% of the market is consist of small cap stocks, which include Meaning of the company and they are almost 5000 + Companies listed on Indian stock market. And all the profit which is been generated by Indian mutual fund are from these 5000 companies only.

Other factor which can be figure out from this investment matrix is the investment style which is further divided into three types of stocks:

  1. Growth investing for growth stocks,
  2. Value investing for value stock,
  3. Mix of growth and value investing for blend/core stocks which means mix of both growth and value stocks.

Which further divide investors also in this category of growth Investors and value investor.

Let us understand what the difference between growth investing and value investing is.

(1)   Investment Growth Stock Mutual Funds

Growth investing is generally done in the growth stocks which has strong growth in earnings and revenue due to the kind of products and services which they have and products and services which they are going to launch in market in near future.

See also  Absolute Returns of Mutual Funds

They are the one who are considered as a Fast Growers in the stock market it is there earning which drive their share prices higher, investors in the market are ready to pay more price for these growth stocks. Due to this growth stocks also have high P/E Ratio due to high demand in stock market.

(2)   Value Investing Mutual Funds

In value investing the companies are considered to be less successful than the growth Stocks and assume to be under achievers in stock market these company generally have slow growth and generally are available at stock market at lower cost as they are less popular than the growth stocks and this happens due to market being pessimistic about the growth of these value stock and Company.

And as a value investor they have a strong belief that when the market will realize their true worth, these value stocks will turn into Multi bigger stocks.

(3)   Core or Blend Mutual Fund Investing Style

And the third is core investing or the blend investing style, which is a mix of both value and growth investing. These are generally the companies which have very short product cycle which means that the product of these companies and the services of these companies get outdated in a very short span of time, so these companies launches the new product in frequently.

Due to this expectation of new launches in these companies the price movement is going to be very high with the launch of new product and the same is going to fade out when the product Life cycle come to an end.

Therefore, to decide whether a Stock is Growth Stock, a Value Stock or a Core Stock, we use several parameters such as P/E Ratio, Dividend Yield, Profitability Ratios, Return Ratios, Leverage Ratio, Liquidity Ratio, Efficiency Ratios and etc.

And once we have determined whether the stock is value growth or core, the stocks which form the major part of the Mutual fund portfolio will be in investment matrix as the same.


If the major stocks allocation in the investment portfolio of mutual fund belongs to the growth category of Stocks, then the investment style of the Mutual Fund will be Growth Investing Style and the same holds true for the Value Investment Style and Blend Investment Style.

5.   Types of Risks Associated with Equity Mutual Funds

Risk arises in mutual funds owing to the reason that mutual funds invest in a variety of financial instruments such as equitiesdebt, corporate bonds, government securities and many more. The price of these instruments keeps fluctuating owing to a lot of factors which may result in losses. Hence, it is essential to identify the risk profile and invest in the most appropriate fund

Due to price fluctuation or volatility, a person’s Net Asset Value comes down, resulting in a loss. In simple terms, NAV is the market value of all the schemes a person has invested in per unit after negating the liabilities. Hence, it becomes essential to identify the risk profile and invest in the most appropriate fund.

Types of Risks associated with Mutual Funds …

  1. Sector Exposure Risk
  2. Stock Exposure Risk
  3. Market Capitalization Risk
  4. Business Risk
  5. Valuation Risk
  6. Liquidity Risk

Now let us understand each risk in detail, by definition in investing world.

(1)   Sector Exposure Risk in Mutual Fund

When you invest a significant portion of your portfolio, typically more than 25%, in a single sector, or in multiple sectors that are highly correlated, your portfolio is subject to sector exposure risk.

Companies in the same sector are likely to be impacted by the same economic factors. Or sometimes the same economic factor adversely impacts multiple sectors.

For example: a sharp increase in interest rates is likely to have a negative effect on both banking and infrastructure sectors. The market reacts and prices fall, sometimes sharply.

Therefore, a large exposure to a single sector, or correlated sectors, could result in a drastic fall in your portfolio market value.

Sector exposure may not always be a bad thing. Taking this risk is justified only when compensated with good returns. For this you must be sure that the sector/companies will bounce back in the time frame you are willing to remain invested and that the current prices are very attractive.

It is best to consult a fiduciary investment advisor before chasing higher returns at the cost of sector exposure risk.

(2)   Stock Exposure Risk in Mutual Fund

Investing a significant portion, typically more than 10% of your portfolio in a single stock, is exposing your portfolio to Stock Exposure Risk.

A stock is exposed to several company specific risks, namely business, balance sheet, valuation or people risk. Therefore, a higher investment in one stock, has a disproportionately large impact on portfolio performance. A 20% drop in a stock that comprises 20% of your portfolio reduces your absolute returns by 4%.

Stock exposure can also occur unintentionally. As a value investor you may have made a sizeable investment in a stock when it was attractively priced. Over time, as a result of both the company performance and the market prices, it can become concentrated in your portfolio. Your dilemma then is should you retain or reduce your holding.

It is not possible to resolve this with a simple yes/no answer and you need to consult your fiduciary investment advisor. However, caution requires you to be aware of this risk, and sooner rather than later, reduce your exposure.

(3)   Market Capitalization Risk in Mutual Fund

An often-overlooked source of risk in a stock is the size of its market capitalization; a measure of what the market thinks the company is worth.

The performance of small companies, some with weak business models, can deteriorate quite easily. Their performance could be affected by economic downturn, spurt in commodity prices, business problems faced by their large customers, lack of resources, etc. There is the additional risk of not knowing enough about the company, since small caps are not studied as closely as large caps. This exposes you to the risk of poor governance and fraud.

However, the potential of high returns from small caps should not be ignored. Small cap companies with a good business model grow faster, which leads to a large rise in their stock prices and results in very good returns.

If you have a moderate risk profile, you should invest not more than 20% in small caps. This will enable you to participate in the potential for growth from small caps, while limiting the market capitalization risk to your overall portfolio. Simultaneously, invest 60% in large caps with low volatility and steady returns.

(4)   Business Risk in Mutual Fund

Companies with poor fundamentals and weak business models are unable to deliver consistent and sustainable profitable growth. Investing in such stocks exposes your portfolio to Business Risk. The company’s poor performance could be the result of low or no sales growth, poor margins, inefficient management, inefficient capital allocation, etc. In the short term, it is possible that even substandard business gives temporary returns. But in the long term, a company’s performance is reflected in its stock returns. As rightly said by Benjamin Graham, the father of Value Investing, “In the short term the market behaves like a voting machine, but in the long term it acts like a weighing machine.”

Invest in a business that behaves like a compounding machine; companies that perform consistently and have sustainable earning power. Such performance will translate into higher market values and earn you compounded returns.

Even large or prominent companies are not immune to business risk. Investing in companies with business risk means you run the risk of loss of value from falling prices. The returns generated by buying healthy companies can be wiped out because of such bad investments.

(5)   Valuation Risk in Mutual Fund

When an asset is overpriced as compared to its fair value, your portfolio is exposed to Valuation Risk. Valuation risk impacts return on investment, as the more overvalued the asset is, the lower the probability of return for the investor.

Over valuation is usually a temporary phenomenon. Sooner or later, due to self-correcting mechanism, the price of such stocks will fall, either gradually or often with a dramatic crash. If you have overpriced stocks forming a large portion of your portfolio, as the price reduces your portfolio value will decrease, even if the correction is only to its fair value.

Don’t believe the myth that you can time the market, sell at the highest price or get out at the peak. If you have access to fair value of the company, compare the CMP. This will help you gauge where the stock stands from a valuation perspective. It is safer to sell overvalued stock and book profits, at least partially. And invest in fundamentally strong companies at attractive prices to continue to earn good returns and avoid valuation risk.

(6)   Liquidity Risk in Mutual Fund

When an asset has low trading volumes and cannot be traded quickly without a significant impact on market price, it exposes you to Liquidity Risk. This is evident for small companies that have a small free float, or any company in which a significant portion of issued shares are held by promoters, government, strategic partners, etc. and not traded regularly.

Since there are not many buyers in the market you cannot sell stock quickly. You will only be able to sell large quantities at rapidly decreasing prices.

If an asset is carrying liquidity risk without other risks, you should start selling gradually. However, if the asset is exposed to liquidity risk accompanied by other risks too, your risk is compounded. It is better to exit such assets immediately.

6.   Risk & Volatility Measures with Important Ratios for Mutual Funds

Here we will understand how common investors can measure Risk for Mutual Funds.

(A)   Risk Measures of Mutual Funds

1.      Alpha Measures of Risk:

Alpha measures the performance of an asset manager. It measures the efforts put in by a fund manager in driving the fund that he or she is managing as against a benchmark index. Alpha’s baseline is 0 in case of mutual funds. If alpha is negative, then it indicates that the performance of the fund manager was underwhelming. If alpha is positive, then it suggests that the fund manager’s performance was overwhelming. Generally, the performance of a mutual fund is compared with that of an index

Alpha measures the difference between a fund’s expected returns based on its beta and its actual returns. A positive alpha indicates the fund has performed better than its beta would predict. A negative alpha indicates a fund has underperformed, given the fund’s beta.

For investors, alpha is useful in determining if a mutual fund is worth investing as it measures the capabilities of the fund manager to generate profits. Therefore, knowing how the fund manager has performed, they can make an informed decision.

The following is the formula to calculate alpha in the case of mutual funds:

Alpha = (End Price – Start Price + DPS) / Start Price

# DPS – Distribution Per Share

2.      Beta Risk Measures:

Beta measures a fund’s sensitivity to market movements. A beta greater than one indicates the investment is more volatile than the market. If beta is less than one, the investment is less risky than the market.

Beta helps investors in understanding how sensitive the mutual fund was when the markets went volatile.

By checking beta of a mutual fund, the investors can decide if the fund that they are deliberating to invest in is suitable or not. Risk-averse investors would like to have the beta on the lower side as it is indicative of steady returns and response to market volatility.

The following is the formula to calculate beta in the case of mutual funds:

Beta = Covariance / Variance

#          Here, Covariance is indicative of how two different stocks vary from one another in different market condition.

#          The Variance shows the variation of a fund’s price from its average and represents the fund’s volatility in its price over a period.

3.      R-Squared (R2) Risk Measures

R-Squared reflects the percentage of a fund’s movements that are explained by movements in its benchmark index. A higher R-squared indicates a more useful beta figure. A lower R-squared (less than 70%) is less relevant to the fund’s performance.

R-Squared is an analytical tool for mutual funds. It helps to determine how identical a mutual fund’s performance is to a given benchmark index. Do take note that R-squared does not measure the performance of the fund. R-squared does not tell us if a particular mutual fund is good to invest or not. It simply compares the performance to a given benchmark’s returns.

R-squared is expressed as a percentage within the 0-100 range.

The value of R-squared is divided into three tiers:

  • 1-40% : low correlation to the benchmark
  • 40%-70% : average correlation to the benchmark
  • 70%-100% : high correlation to the benchmark

R-squared is a technical tool and the formula for R-squared requires us to consider a few statistical metrics like correlation and standard deviation.

R-Squared = Square of Correlation

#          Correlation = Covariance between Benchmark (Index) and Portfolio/ (SD of Portfolio*SD of the benchmark)

[#         SD : Standard Deviation.]

4.      Sharpe Ratio in Mutual Fund

Sharpe ratio is used to evaluate the risk-adjusted performance of a mutual fund. Basically, this ratio tells an investor how much extra return he will receive on holding a risky asset.

Sharpe Ratio plays a significant part in evaluating the performance of an investment. Developed by American economist and Noble laureate William F. Sharpe, the Sharpe Ratio measures the risk-adjusted returns of an investment. Sharpe Ratio can be taken into account before starting investing in any fund. However, it is necessary to understand all the aspects of this ratio before using it for evaluating or comparing mutual funds.

Sharpe ratio indicates investors’ desire to earn returns which are higher than those provided by risk-free instruments like Treasury Bills. As Sharpe ratio is based on standard deviation which in turn is a measure of total risk inherent in an investment, Sharpe ratio indicates the degree of returns generated by an investment after taking into account all kinds of risks. It is the most useful ratio to determine the performance of a fund and you, as an investor, need to know its importance.

The Sharpe Ratio of any mutual fund can be easily calculated using a simple formula or by following these two steps:

  • Subtract the risk-free return of a mutual fund from its portfolio return or the average return
  • Divide the subtracted number, which is called the excess returns by the standard deviation of the fund’s returns.

[Sharpe Ratio = (Average fund returns − Risk-free Rate) / Standard Deviation of fund  returns]

It means that if the Sharpe ratio of a fund is 1.25 per annum, then the fund generates 1.25% extra return on every 1% of additional annual volatility. A fund with a higher standard deviation should earn higher returns to keep its Sharpe ratio at higher levels. Conversely, a fund with a lower standard deviation can achieve a higher Sharpe ratio by earning moderate returns consistently.

What is considered a good Sharpe Ratio?


Sharpe Ratio Risk Rate Verdict
Less than 1.00 Very low Poor
1.00 – 1.99 high Good
2.00 – 2.99 high Great
3.00 or above high Excellent

The table shows the features or parameters of a good Sharpe Ratio. Investments with less than 1.00 Sharpe Ratio do not generate high returns. Contrarily, investment with Sharpe Ratio of 1.00 to 3.00 or above have higher returns subsequently.

5.      Treynor Ratio in Mutual Fund

Jack Treynor, an eminent American economist and one of the founding fathers of the Capital Asset Pricing Model, developed this metric.

Treynor Ratio measures the efficiency with which the fund manager has allocated the fund’s assets to compensate the investor for taking the given level of risk. Treynor Ratio exclusively focuses on how well the portfolio has performed in the backdrop of risks prevailing in the economy. Treynor Ratio of a mutual fund indicates how well you will be rewarded for taking the risk of investing in a particular mutual fund scheme.

This measure gauges the returns from a collection of securities’ above a risk-free rate, adjusted by the beta value.

Thus, the Treynor Ratio (TR) is calculated based on the following formula –

TR = (Portfolio’s returns – Risk-free return rate) / Beta value of the portfolio

Beta is a crucial factor in the Treynor ratio formula that distinguishes this metric. That is because it represents the systematic risk, which is volatility at a macro level. It’s determined by factors that are not influenced by portfolio diversification.

>>        Treynor Ratio example

XYZ is a mutual fund with a rate of return of 15%. Its beta value is 1.3, meaning it’s 30% more volatile than the market. And the risk-free return rate is 3%.

Thus, XYZ’s Treynor ratio = (15% – 3%) / 1.3

Or, XYZ’s TR = 9.23

It’s a measure of risk-reward. Hence, if one were to invest in XYZ mutual fund, their compensation or reward for assuming one unit of risk will be Rs.9.23.

An example would better illustrate how investors can use TR to make investment decisions.

Raj is comparing between two mutual funds, X and Y. X is an equity fund, while Y is a fixed income fund. The rate of return of X is 12%, and that of Y is 7%. Additionally, Y’s beta is 0.5 and X’s is 1.2. It denotes that X is 20% more volatile, and Y is 50% less volatile than the market.

Let’s assume the risk-free return rate is 2%.

Therefore, X’s Treynor Ratio = (12% – 2%) / 1.2

Or, X’s TR = 8.33

The Treynor ratio of Y = (7% – 2%) / 0.5

Or, Y’s TR = 10

If Raj chose to go by such rates of returns, the obvious choice would have been X. However, this conclusion changes when those two options are compared based on Treynor ratio.

It shows that although X provides higher returns, it does not justify the risk such a fund assumes. Y compensates better for the assumed risk, and thus, is a better choice.

6.      Difference between Treynor Ratio and Sharpe Ratio?

The table below demonstrates the differences between these two metrics.

Basis of distinction Treynor Ratio  Sharpe Ratio
Definition It measures the risk-adjusted returns of a portfolio based on its beta. It measures the risk-adjusted returns of a portfolio based on the standard deviation of its gains.
Nature of risk considered It considers the systematic risk of a portfolio, which a fund manager cannot set off by diversifying. It considers the unsystematic risk of a portfolio, which can be set off by diversification.
Suitability It’s more suitable to assess portfolios that are well diversified. It’s more suitable to assess a bevvy of securities that is less diversified.
See also  Debt Mutual Funds – How it works?

Investment decisions go hand in hand with ratio analysis. Thus, having a clear understanding of them and applying metrics correctly can facilitate more effective decisions.

(B)   Market Volatility Measures

1.      Capture Ratio

Capture ratio measures the performance of an investment (like mutual funds) during upward and downward market trends with respect to its benchmark index.

The ratio is essentially a statistical representation of how a fund manager has managed the fund during different market conditions for addressing risk. It is expressed in percentages for a period of 1, 3, 5, 10, and 15 years.

There are two types of capture ratio –

(i) Up-market or Upside Capture Ratio

Up-market or upside capture ratio evaluates the performance of an investment against a benchmark index when the market is bullish.

A mutual fund with an up-market capture ratio above 100 denotes that it has performed better than the benchmark. For instance, if the ratio is 110, it indicates that the fund has outperformed the index by 10%.

The up-market capture ratio is one of the ways for investors to gauge trustworthy products as well as fund managers. It is specifically helpful for those seeking relative returns instead of absolute or with active management of funds.

The up-market capture ratio formula is given by –

Up-market capture ratio = (Fund returns during an upside market/Benchmark returns) x 100 

It shows the ability of the fund to beat the benchmark at the time of bull runs. You get an idea of how much more returns the fund earned as compared to the benchmark. An upside capture ratio of more than 100 indicates that the fund beat the benchmark during the period of the market rally. A fund having upside capture ratio of say 150 shows that it gained 50% more than its benchmark in bull runs.

(ii) Down-Market or Downside Capture Ratio 

Down-market or downside capture ratio is precisely the opposite of the above. It evaluates the performance of an investment against a benchmark index when the market is bearish.

A mutual fund with a down-market ratio of less than 100 indicates that it has performed better than the index. For instance, if the ratio is 90, it denotes that the investment has lost only 90% as much as the benchmark.

The down-market capture ratio is often considered alongside up-market. In some cases, mutual funds with an up-market ratio lower than 100 may still have a favourable down-market ratio.

The down-market capture ratio formula is given as –

Down-market capture ratio = (Fund returns during a downside market/ Benchmark returns) x 100

These ratios can be understood better with the aid of an example –

Following is the current up-market and down-market capture ratio of Axis Bluechip Fund –

1 year 3 year 5 year 9 year
Up-market 77 85 90 93
Down-market 66 63 78 77

The above upside and downside capture ratios indicate that remaining invested in the Axis Bluechip Fund for 5 years will enable individuals to enjoy favourable returns. Contrarily, investing for less than 5 years can lead to a loss.

Please note, Axis Blue Chip Fund has been used just for the purpose of explaining the example. This is not a recommendation. Please conduct your own research and due diligence before selecting a mutual fund.

2.      MDD (Maximum Drawdown)

It is the peak-to-trough decline during a specific recorded period of a fund. It measures the largest percentage drawdown that has occurred in a certain time period.

A Maximum Drawdown (MDD) -or Max Drawdown- is the most observed loss when the funds in a portfolio are measured from their peak to their trough, prior to a new peak forming. As an indicator, maximum drawdown looks at the downside risk over a certain period of time. As a measure, maximum drawdown can be used on a standalone basis, or as an input with other metrics like the “Calmara Ratio” and “Return over Maximum Drawdown.” It is expressed as a percentage value.

To illustrate the meaning of max drawdown better, let’s take a look at the max drawdown formula below.

MDD = (Trough Value — Peak Value) / Peak Value


Let’s assume that an investment portfolio started off with an initial value of ₹5 lakhs. Over a period of time, the portfolio’s value increases to ₹7.5 lakhs before plunging back to ₹4 lakhs in a bear market that is quite brutal. Next investors observe that the value rebounds to ₹6 lakhs it drops down to ₹3.5 lakhs again. Following this, the value suddenly shoots up by more than twice its prior value to ₹8 lakhs. What is the max drawdown of this portfolio?

To find the max drawdown of this, we will pluck the initial peak value and lowest value from the information provided. The initial peak is ₹7.5 lakhs, and the lowest position held by the portfolio is ₹3.5 lakhs. In this case, the maximum drawdown looks like this:

MDD = (3,50,000 – 7,50,000) / 7,50,000 = -53.33%

Take note of the following:

–        For calculating max drawdown, the initial peak of ₹7.5 lakhs will be used. The peak of ₹6 lakhs that is in between the final and initial high positions will not be used since this value does not represent a new peak for MDD.

–        The latest peak of ₹8 lakhs will also not be taken as part of the calculation for the max drawdown as the original drawdown is supposed to consider the first peak only.

–        To calculate MDD, unlike the peak value, the trough value will be cherry-picked for the lowest among all, rather than choosing the first lowest value. In the case mentioned above, this value will be ₹3.5 lakhs, which appeared right before the new peak was formed. Although the first drop that appeared was down to ₹4 lakhs, this value is not considered valid to know the maximum dropdown.

7.   Types of Mutual Funds

After the re-categorization of mutual funds in 2018, now the mutual fund schemes are broadly classified into following groups.

  1. Equity Mutual Fund
  2. Hybrid Mutual Fund
  3. Debt Mutual Fund
  4. Solution Oriented Mutual Funds and
  5. Others Types of Mutual Fund

(1)   Equity Mutual Funds

Equity mutual funds are those Mutual Funds which invest in Equity stocks, and as the value of the stock increases they are getting benefited by the rise in price in from of capital appreciation from this price rise, Not just that equity Mutual Funds are also get the benefit of dividend which the company declares to their investor.

But investing in equity is a very risky task because the equity market is very highly volatile and here the equity Mutual Funds role come into play as they have the professional who can manage this kind of risk and volatility and gain from there price rise in form of capital appreciation.

You will be surprise to know that almost one third of the mutual fund market is been acquired by equity Mutual Funds and almost more than 500+ schemes are there in equity mutual funds which a retail investor can choose to invest.

Investing in equity asset class can be proved to be a great wealth creator for the mutual fund investors to fulfill their financial goals.

Usually it is been seen that for a period of 5 years and more equity as an asset class can do wonders in creating a great wealth.

And again the equity mutual fund class is further divided into following types:

  1. Large Cap Funds
  2. Mid Cap Funds
  3. Small Cap Funds
  4. Multi Cap Funds
  5. Large and Mid Cap Funds
  6. Contra or Value Fund
  7. Focused Funds (Focused Multi Cap)
  8. Dividend Yield Fund
  9. ELSS (Equity Linked Saving Schemes) Tax Saver Funds
  10. Sectoral Funds/Thematic Funds
  11. International Funds

We will discuss each and every category in detail and also discuss about top performing funds and the best performing funds in each and every category so that this book will not only help you to know what this funds are but also wifi become a guide to help you decide which category to invest in and what are the funds in which we can invest for better Returns.

(2)   Hybrid Mutual Fund

Hybrid mutual funds are types of mutual funds that invest in more than one asset class. Most often, they are a combination of Equity and Debt assets, and sometimes they also include Gold or even Real estate.

The key philosophies behind hybrid funds are – asset allocation, correlation, and diversification. Asset Allocation is the process of deciding how to distribute wealth among various asset classes, and correlation is the co-movement of returns of the assets, and diversification is to have more than one asset in a portfolio.

A hybrid fund endeavours to create a balanced portfolio to offer regular income to its investors along with capital appreciation in the long-term. The fund manager creates a portfolio according to the investment objective of the scheme and allocates the funds in equity and debt instruments in varying proportions. Further, the fund manager also buys or sells assets if the market movements are favourable.

Hybrid funds are considered to be riskier than debt funds but safer than equity funds. They tend to offer better returns than debt funds and are preferred by many low-risk investors. Further, new investors who are unsure about stepping into the equity markets tend to turn towards hybrid funds. This is because the debt component offers stability while they test the equity ‘waters’. Hybrid funds allow investors to make the most out of equity investments while cushioning themselves against extreme volatility in the market.

Since every hybrid fund can have a different asset allocation between equity and debt, they can be classified into the following types:

  1. Conservative Hybrid Mutual Funds
  2. Arbitrage Hybrid Mutual Funds
  3. Equity Savings Mutual Funds
  4. Dynamic Asset Allocation / Balanced Advantage Mutual Funds
  5. Multi Asset Allocation Mutual Fund

(3)   Debt Mutual Funds

Debt mutual fund invest in fixed income security which is also known as debt securities, Debt which includes securities and investment option such as money market instruments government securities corporate bonds treasury bills and others.

The capital gain in debt Mutual Fund is been treated as short term capital gain if it is external less than 3 years and long term capital gain if the tenure is greater than 3 years and accordingly it is taxed.

For short term capital gain it is being added to the income of year of Redemption and is being taxed as per the Tax slab.

And for long term capital gain that is more than 36 months the individual has to pay 20% tax on the gains after indexation.

Indexation it means that the adjustment of capital gains with respect to current inflation rate that is removing the impact of inflation on the returns and then paying tax on the rest.

Cost inflation index that is CII is been used to calculate the inflation which is provided by the Income Tax Department for every year.

And formula is for calculating index investment amount

Index investment amount = (CII redemption year/CIT investment year) x Invested amount

After subtracting this indexation in investment amount from the investment amount we get the net taxable amount for the capital gain earn by Debt Mutual Fund.

And the point to be noted here is the benefit of indexation is the most important benefit which Debt Mutual Fund have over fixed deposits of bank because in fixed deposit of banks we don’t get the benefit of indexation.

And again in form of interest which is earned on the fixed deposit of bank if it is more than rupees 10000 TDS will be levied of 10% If the pan card is provided and if the pan card is not provided then 20% tax will be levied for the domestic deposit and in case of NRC deposit the TDS of 3 0.09% is applicable.

And this TDS is charged without any indexation on the entire interest income received from this fixed deposit investment of bank.

And another important point from investment point of view when we compare debt mutual fund to the fixed deposits is that in debt Mutual Fund we pay tax only on the Redemption,

But in case of Bank Fixed Deposit be have to pay tax each year irrespective of whether we redeem our investment or not.

The only benefit or the edge over which fixed deposits have over Debt fund is in case of tax saving fixed deposits, where an individual taxpayer gets a benefit of exemption of up to 1.5 lacs under the section 80c of income tax but this exemption is not possible in debt fund.

But here also there is a twist the returns on the tax saving deposits are tax according to the Tax slab.

Now let’s look at the types of Debt Mutual Fund:

  1. Overnight Fund (Liquid Mutual Fund)
  2. Liquid or Money Market Fund (Liquid Mutual Fund)
  3. Ultra-Short Duration Fund (Liquid Mutual Fund) \
  4. Low duration Fund
  5. Money Market Fund
  6. Short Duration Fund
  7. Medium Duration Funds
  8. Medium to Long Duration Fund
  9. Long Duration Funds
  10. Dynamic Bond Funds
  11. Corporate Bond Funds
  12. Credit Risk Fund
  13. Banking and PSU funds
  14. Gilt Fund
  15. Gilt Fund with 10 Year’s Constant Duration
  16. Floater Fund

If you look at the funds categorization in debt Mutual Fund mentioned above, you can see that the first three funds category in debt Mutual Fund I have mentioned them as liquid Mutual Fund. And first we are going to talk about this liquid mutual fund category as a sub section under debt Mutual Fund and then we will cover the rest of the debt Mutual Fund categories.

Liquid category under that Mutual Funds are the funds which invest into fixed income securities of very short-term tenure like certificate of deposits, treasury bills, commercial papers and others, with maximum maturity period of up to 180 days and not more than.

And that’s why under liquid category 3 Debt Mutual Fund Falls, and they are:

  1. Overnight Fund (Liquid Mutual Fund)
  2. Liquid or Money Market Fund (Liquid Mutual Fund)
  3. Ultra-Short Duration Fund (Liquid Mutual Fund)

And before we move ahead there are few points which are mutual fund investor must know before investing in liquid funds

First of all liquid funds have the lowest expense ratio among all kind of mutual funds and they are the safest debt funds ever,

Returns are not fixed in liquid fund it depends on the market conditions currently prevailing in the country, and the returns are comparable with the savings account return.

And the most important thing did not charge any exit load and that’s why they are very liquid in nature, and that’s why these are the ideal mutual funds to park emergency funds of a mutual fund investor for very short time say for 1—3 months.

The liquid funds as they are one of the debt funds only so they are being taxed as per the taxation of debt funds only.

(4)   Solution Oriented Mutual Funds

After the Re-categorization of 2018 by SEBI, new categories came up into existence under a new category formed by SEBI for mutual funds which is known as solution oriented mutual fund Scheme.

Which primary focus on tool major life financial goals, and they are,

  1. Retirement fund for retirement planning.
  2. Children’s fund for the education and marriage planning of children’s.

In retirement fund there is a minimum lock in period of 5 years or retirement whichever is earlier, and same in the case of children’s fund here also the lock in period is of 5 years or the children becoming a major whichever is earlier. Detection of these two points is based on the equity allocation in this funds. And mostly these mutual funds invest in the way a most hybrid funds do, and that’s why they hold medium to high risk in investment and there is no compulsion or rules of allocation, which leaves the fund manager of these funds with complete freedom of investment in different asset classes in different proportions based on the market conditions and the objective of the Mutual Fund.

Should we Invest in this Funds?

The answer is yes, if you don’t have the habit of being invested in equity for long term safe for 5 years and more than these fund are suitable investment option for the mutual fund investor as it provides a compulsory lock in period of 5 years which gives these funds and the fund manager enough time to stay invested in different securities as per the market conditions and help effect of compounding work in favor of investors in long term.

And these mutual funds also provides much better transparency and Returns, when compared with the retirement and children’s plan of insurance companies which provides Returns ranging from 4% to 7% and also lacks in transparency when it comes to their investment portfolio and objective of investment.

But the most important drawback of these Mutual Funds are the locking period of 5 years which sometime can prove to be disastrous if the fund house doesn’t perform well leaving the mutual fund investor with no choice but to stay invested for 5 years till the lock in period end.

Generally if a fund doesn’t perform well for 3 to 4 quarters is better to switch to some good performing fund to generate better returns which is possible in open ended equity mutual funds. and that’s why if you hold a good knowledge about the investment in mutual fund then it’s better to stay away from these solution oriented funds and invest in normal open ended equity mutual fund which can provide you a much better capital appreciation and returns in long term then these funds.

(5)   Other Types of Mutual Funds

After the Re categorization of 2018 by SEBI there are some other types of mutual fund categories formed for the mutual fund investors. They are ….

  1. ETFs (Exchange Traded Fund)
  2. Index Mutual Funds
  3. Gold ETFs (Exchange Traded Funds)
  4. Gold Saving Mutual Fund
  5. Fund of Funds (FOF) Scheme
  6. Capital Protection Fund
  7. Fixed Maturity Plan Mutual Fund
  8. Real Estate Mutual Funds / Real Estate Investment Trust (REIT)

8.   SIP (Systematic Investment Plan

Systematic investment plan for SIP, approach of investment in mutual fund schemes which allows mutual fund investor to invest in mutual fund with a fixed amount everyday, every week, every month, every quarterly, based on his or her requirement. it is one of the most popular investment approach among mutual fund investors in India and help them to invest in equity market in a discipline manner for long term and also provide benefit of rupee cost averaging to the mutual fund investors, with the same fixed amount during downturn the more number of units are bought in their investment portfolio.

The systematic investment plan is not generally the actual investing but more of a kind of saving, as from the regular savings of a mutual fund investor every month the amount is deducted and being invested in equity market and the debt market through the mutual funds.

See also  Mechanics & Ways of Investing in Mutual Funds – KYC, KYD and Investor Empowerment

And it is many times being misunderstood that SIP is a form of investment among the mutual fund investors, which is actually a mode of investment in a systematic manner in a mutual fund.

SIP is the systematic investment plan which also helps in reducing the overall risk held by the mutual fund investors by investing in mutual funds in their investment portfolio through the help of rupee cost averaging and also help them to gain the benefit of compounding in long term.

Systematic investment plan SIP also gives the mutual fund investors a complete flexibility in investing systematically but to start investment with very low amount of rupees 100 or 500 depending on the various mutual fund houses, and not just that it also helps investor to increase or decrease the SIP amount and also withdrawal partial or the full amount during or after the SIP tenure is over.

And that is why systematic investment plan is the best mode of investing in equity market or debt market through mutual funds, And that’s why various schemes which allows a very small investor also to invest with very low amount in a systematic and disciplined manner for long term for creation of wealth which can lead to success and better return in long term.

And also the systematic investment plan have an edge over lump sum investment as it enjoy the benefit of investing in all market cycles of the market, and also reduces the risk of market volatility with the benefit of rupee cost averaging.

It also helps investor to avoid timing the market and helping them to invest for a long term through systematic investment plan, as the more time you give to the investment in the market the more return are the more wealth is going to create for to the mutual fund investors in long term with the power of compounding.

Taxation in SIP.

The taxation of systematic investment plan is same as the taxation of the mutual fund
investment which can be either equity or the debt Mutual Fund.

9.   STP (Systematic Transfer Plan)

The next systematic mode of investment in mutual fund is STP systematic transfer plan.

As from the name itself it is clear that STP allows a mutual fund investor to transfer a fixed or variable amount of unit of mutual fund at a pre define regular interval of time ranging from weekly, monthly or quarterly.

Systematic transfer plan is generally used by the mutual fund investor for transferring money from debt Mutual Fund to hybrid or equity mutual funds, at the time when market are very much volatile and we are not sure your about the lump sum investment in equities so what a mutual fund investor does here is park their funds in liquid funds in lump sum and give the instruction through systematic transfer plan to transfer certain amount periodically to the desired equity or hybrid mutual funds.

The tax rules are applicable as the rules applicable to the equity and debt Mutual Fund while selling them as this transfer of money from one point to another fund is considered to be a selling only.

And one of the most important restriction which a mutual fund investor must know is that at the STP or the systematic transfer plan can be done within the same fund house schemes not from Mutual fund of the other fund house and it can be done only among open ended Mutual Funds only.

There are basic ally Three Types of Systematic Transfer Plan

  1. Fixed Systematic Transfer Plan —
  2. Capital Appreciation Systematic Transfer Plan —
  3. Systematic Transfer Plan —


10. How to Create Best Mutual Fund Portfolio for Yourself

To create a sensible investment portfolio through mutual fund investment we need keep these 5 rules in mind and these are:

Rule – 1: Know Your Investment Goal

Know Your Investment Goal based on the time frame of your goal, it can be classified as long-term or short-term goals. Goal based investing helps you to draw a proper plan to meet your financial needs within a stipulated time frame.

Rule -2: Know Your Investment Time

Know Your Investment Time frame having a defined time frame for your investments can help you prioritize your goals and helps you stay focused and disciplined.

Rule – 3: Know Your Risk Tolerance

Know Your Risk Tolerance Investing without knowing risk tolerance can give you sleepless nights. Decide your risk-taking ability and stay calm once invested.

Rule – 4: Know Your Asset Allocation

Know Your Asset Allocation It’s necessary to decide Asset Allocation to diversify your investment across Equity, Debt & Gold. Knowing how much to invest across these instruments will help manage risk-reward aptly.

Rule – 5: Know Which Product

Know Which Product to Invest into, invest in a product that suits your investment needs and matches the time horizon of your investment as well as your risk-taking capability.

11. When to Review Your Mutual Fund Investment Portfolio?

The review of mutual fund portfolio must be done every quarter and following factor should be kept in mind while doing the review of investment portfolio.

1.     Don’t take short term decision in haste

do not take a decision in changing your investment portfolio due to a short term incident because in equity market the volatility remains the integral part and the mutual fund it is supposed to show some time negative return also, take care of long term perspective while evaluating investment portfolio in mutual fund investment.

2.     Comparison of returns with benchmark and peers

while evaluating investment portfolio each scheme of the mutual fund must be compare with the benchmark return and the return of the mutual fund of the same category and then try to evaluate the performance of your scheme and through this exercise it will help you to create a better portfolio.

3.     Portfolio overlap

the aim of investing in different categories such as large cap Mid Cap small cap or Multicap is basically done to provide a better diversification to the investment portfolio of a mutual fund investor and to provide all season return. so that portfolio overlap on the existence of same stocks in two different Mutual Funds in the investment portfolio must not exist and Such overlap of greater than 2 5—30% to be avoided which can help you in great deal in creating a diverse portfolio for long term.

4.     Changes in fund schemes

the mutual funds changes their portfolio depending on the market situation prevailing in the current market some changes can really impact your mutual fund Returns, and also can lead to the portfolio overlap due to this changes these changes must monitor timely and accordingly modification in Portfolio must be made if required.

5.     Change in fund manager or fund objective

these two changes can highly impact the returns of your mutual fund portfolio so the changes in management of the fund manager or the objective of scheme must be review.

12.  When to Sell Your Mutual Fund?

Most common question which I faced from my viewers on YouTube about mutual fund is when to sell the mutual fund?

And I also come across the question that if the market is at all time high then we should redeem all mutual fund investment, Remember before you redeem your mutual fund investment ask yourself that is financial goal is it achieved at if the answer is no then you need not to sell your mutual funds. In case of midcap and small cap funds it’s better to stay away from them when the market is overvalued and is at all time high, at that particular time you can switch to large cap mutual funds or Hybrid funds.

The second most common question which is been asked about selling mutual fund and booking profit or loss is when the mutual fund is giving negative return for more than an year compare to Mutual Fund in the same category. And the answer of this question is in short term the market is always volatile and it is generally are roller coaster ride but equity investment are meant for long term purpose so in long term the equity market is going to go upside, for example we can take the case of 2008 crisis the market was down almost 50%, and almost entire one year from then the market was not performing at that time many Mutual Funds were giving negative returns and the mutual fund investor came out of it but just after that in Same mutual fund had given their lifetime high returns almost greater than 60% — 70% or even some funds were greater than 100%. which were giving negative returns of more than 50% also so keeping a short-term view is not good for investing in equity mutual funds.

Keep in mind that only if your goal is reached or another scenario if your Fund is not performing good continuously for 4 to 6 quarters then you need to sell this mutual funds or other book profit or rebalance your portfolio, else stay invested till your financial goal is reached.


13. What are the Growth, Dividend and Dividend Reinvestment options to invest in Debt Mutual Fund?

Basis Growth Option Dividend Option Dividend Re-Investment
Profit Actions Profits are not paid directly to investors; they are reinvested and the lump sum amount is paid at the end. Profits are stepped out of your NAV and given to you periodically, Profits are not paid directly to investors; they reinvested to buy more units for investors
Effect of corn- pounding As the profits are
reinvested immediately, there’s a benefit of corn- pounding on returns until the maturity period.
A part of the profit is paid out, so compounding effect is not there or is at minimal. Same as Growth Option
Choice suits The investors targeting for long term financial goals and looking for long term investment plans should opt for growth option. In Debt Funds — If you are looking for regular income from Dividends and then you can use this option. Growth is better as it can help you in better taxation if you stay invested for 3 years. If planning to invest for less than 3 years, then Growth and Dividend reinvestment option doesn’t differ too much in terms of taxation or returns.
Taxation Only Capital Gain Tax Capital Gains Tax on gains during redemption Dividends are added as part of your income and taxed as per your tax slab. Same as Dividend Option

14. What is AUM? Does the AUM of a Mutual Fund matter us?

As we know a Mutual Fund is where several investors who share a common investment objective pool in their money with the sole intention of earning returns. The market value of this pooled money is known as the Asset Under Management of the scheme. It is an indicator of the size and success of the Fund House. Net assets of any scheme gives fair idea of confidence level of investors in the mutual fund scheme.

AUM of a fund house has direct impact on investors profitability. Every fund house charge their investors through Expense Ratio, it is a management fee levied by fund house which is proportional to the fund size. Generally it is observed that barring a few exceptions most fund houses who have higher AUM charge a lower Expense Ratio, thereby increasing profits in the hands of investor.

In Debt Funds, AUM plays more important role as the funds with high AUM have better chances to grab better (Safe & good yielding) Bonds & Debentures. When good companies look to raise money and come up with a Bond or Debenture, then many Debt Funds compete to grab those bonds or debentures due to limited quantity. In such case, funds with high AUM mostly have better bargaining power to grab such good opportunities. Also, high AUM has no impact on fund’s performance in case of Debt Funds.

15. What is a NAV? How is it calculated?

Net asset value (NAV) is a mutual fund’s price per unit. In other words, it is the value of a single unit of a mutual fund.

It changes once every working day as the value of the bonds, deposits and stocks the fund holds, changes every working day; except ETF, where the NAV changes real time with the change in markets. It is calculated by dividing the total value of all the securities in its portfolio, minus any liabilities, divided by the total number of units of the mutual fund.

The NAV calculation is important because it tells us how much one share of the fund is worth.

How is NAV calculated?

General Net Asset Value Calculation

If you invest Rs 5,000 in a mutual fund with a net asset value of Rs 500, then you can purchase 10 units of the mutual fund. For example, you put Rs 1 lakh in Mutual Fund Scheme A and Mutual Fund Scheme B. The NAV of mutual fund scheme A is Rs 10 and that of mutual fund scheme B is Rs 20.

You have units of mutual fund scheme allocated as follows: Mutual Fund Scheme A : Rs 1,00,000 / Rs 10 = 10,000 units Mutual Fund Scheme B: Rs 1,00,000 / Rs 20 = 5,000 units.

Daily NAV Calculation

All mutual funds compute the market value of the securities after market hours each day. The mutual fund house deducts all the outstanding liabilities and expenses accordingly to calculate the net asset value (NAV) of the day using the given formula.Net Asset Value = [Assets – (Liabilities + Expenses)] / Number of outstanding units

Assets of a mutual fund scheme are divided into securities and liquid cash. Securities include equity instruments, debentures, bonds, commercial paper and other money market instruments.

The fund manager deducts all liabilities and expenses of managing the fund. You would find the NAV calculated by dividing the combined value of cash and securities in the portfolio of a mutual fund minus requisite liabilities and then dividing by the total number of outstanding units.

16. How does a Mutual Fund work? Are they Safe? Do they Guarantee returns?

Suppose a mutual fund invests in ten bonds and total current market value of all the bought bonds is 1.01 Crore. Out of this, the AMC deducts say, 0.01 Crore for operating the fund (this is known as the expense ratio). So, the net value is 1 crore. Now the AMC will divide this 1 Crore into say, 10,000 parts. These parts are known as units. The cost of one unit is 1Cr/10,000 = Rs. 1000. This is known as the Net Asset Value (NAV) of the mutual fund.

Suppose the AMC has set a minimum investment requirement of Rs. 500. Then if you pay Rs. 500, you will get 0.5 units of the fund. Remember that the cost of one unit is the cost when you made the purchase. Suppose after one year, the NAV has fallen to Rs. 700 per unit and you wish to exit the fund (also known as redemption), then you sell your 0.5 units back to the AMC and get 0.5 x Rs. 700 = Rs. 350 back. So, you invested Rs. 500  and got back Rs. 350 – a loss of 150 over a year. The point is, that you buy units at current NAV and sell units (fully or partially) at current NAV. This is how mutual funds work.

Are Mutual Funds Safe? –

A common pickup line for Sales managers is that Mutual Funds give good returns over the long term. But the truth is, there is no guarantee. Same thing with safety of funds. Your capital will always be at risk. It is just a matter of how big or how small risk are you willing to take. But if you are worried that the AMC will run away with your money? Then no, it is highly unlikely that the AMC will do that as there are enough safeguards implemented by SEBI.

As the above example shows, you buy at current market value and sell at the current market value, so anything can happen in between good returns or losses too. So, it is always advisable to accept and learn to minimize the risks before investing in Mutual Funds. Each different fund categories have different type & level of risk – Liquid, Debt, Equity, Hybrid and Gold. Liquid and Debt Funds carry lower risk than Equity and Gold due to the safety provided by their underlying asset (Bonds, Debentures, T-Bills, CP, CDs etc.). Mostly (except in few cases), capital is safe in Debt funds and Liquid Funds as they invest in safer assets.

17. What is NFO? Should I invest in one?

NFO stands for New Fund Offer, under which a First-Time offer is made by the mutual fund house, to newly introduce a mutual fund in the market. A new fund offer is launched in the market to raise capital from the public to buy securities like shares, govt. bonds, etc. from the market.

Where NFO’s are good option to invest for a Closed End Fund, it is better to avoid the option for Open Ended Actively managed Funds due to following reasons:

  1. They have no proven track record.
  2. Most of the times such funds come with higher Expense ratio as their initial marketing cost etc. is higher.
  3. They are not cheaper than already existing funds. This is a myth, that Rs. 10 NFOs are cheaper than their existing peers as the NAV of the later would be higher and hence lesser units would be bought for the same cost. This is totally wrong. Your returns depend only on the percentage growth on NAV, based on the portfolio of that fund. So hypothetically, if there are two funds with exactly same stock portfolio A & B. A is an NFO with NAV of Rs. 10 whereas B has been in the market for 10 years and has NAV of Rs. 200. Then if underlying portfolio increases by 10% in a year, then NAV of A will become Rs. 11 and NAV of B will become Rs. 220. So, no difference in returns.
  4. NFOs are not like IPOs: In NFO the NAV is fixed at Rs. 10 per unit and is not affected due to the demand or other factors. While in IPO the listing price of the stock depends on the demand and market’s expectation of the company.