A Mutual Fund is an investment scheme that collects money from people and invests those funds in various assets. The money collected from various investors is usually invested in financial securities like shares and money-market instruments like certificate of deposit and bonds. Equity, debt and money-market instruments are broad classifications of asset classes. These investments may be made for the short term, medium term or long term. The kind of asset invested in also determines the risk factor of the funds.
Structure of a Mutual Fund
Mutual Funds in India are created as trusts. The parties involved are:
- Sponsor – This is the one who sets up the Mutual Fund or trust. A sponsor is similar to a promoter of a company. The sponsor of a Mutual Fund appoints / sets up the board of trustees, the asset management company or fund house and appoints the custodian.
- Board of trustees - The role of the trustees is to ensure that the interests of Mutual Fund holders are protected. The board of trustees also needs to ensure that the fund house complies with all the rules laid down by the Securities Exchange Board of India (SEBI). The board needs to have at least four independent directors. The trustees act according to the Trust Deed executed by the sponsor. The board sees to it that the fund house has established the required infrastructure and ensures that processes are in place to operate and manage the fund effectively. The board appoints the main members of the fund house including the board of directors and fund managers (scheme-wise). They also devise the fund house’s internal control and audit processes including the rules for enrolling and dealing with brokers / agents.
- Asset Management Company (AMC)/Fund house - An AMC or fund house will act as the investment manager for the trust. It will be responsible for the day to day operations. This means that it is be taking care of all the money put in by investors. The AMC or fund house is appointed by the sponsor or the board of trustees. SEBI approval is required for setting up the AMC. 40% of its net worth should be contributed by the sponsor.
- Custodian – A custodian is one who has custody of all the shares and securities invested in by the AMC. The custodian is responsible for the investment account of a fund house.
Types of Mutual Fund schemes
There are different types of Mutual Fund schemes and they are generally classified based on how they invest. However, all schemes are broadly classified as open-ended and close-ended schemes.
Open-ended - Open-ended Mutual Fund schemes are open for investment at any point of time. They offer liquidity to investors since units can be bought and sold freely.
Close-ended - Close-ended Mutual Fund schemes remain open only for a short period of time. Once the scheme is closed, fresh investments cannot be made. In order to provide liquidity, these units are listed on stock exchanges and investors can trade in them.
Interval - Interval schemes are a variation of close-ended schemes that are reopened for redemption for a limited period of time during the scheme’s tenure. Investors are given the option to sell their units back to the fund during this period.
Mutual Funds are then further categorised depending on the investment goal the fund is trying to fulfill. While some investors seek capital protection and safe returns, others have a strong risk appetite and look for high returns.
- Growth funds or capital protection funds
- Income funds – These schemes aim to provide income for the investors.
- Liquid funds – These funds invest in fixed-income securities such as bonds and government securities.
- Balanced funds – These funds invest both in equity as well as fixed-income securities to provide returns while trying to keep the risks to a minimum.
Mutual Funds based on geography
- Domestic funds – These invest in securities traded within the country.
- International or foreign funds
- Global funds Examples: Emerging market funds, Regional funds
These funds are further classified based on the investments made.
- Large-cap / Mid-cap / Small-cap funds
- Aggressive / growth funds
- Value funds
- Dividend-yield funds
- Index funds
- Diversified equity funds
- Sectoral funds
Debt funds / Fixed-income funds
- Income funds
- Gilt funds
- Dynamic bond funds
- Money market funds or liquid funds
- Ultra short-term funds or treasury management funds
- Floating-rate funds
- Short-term / Medium-term income funds
- Corporate bond funds
- Fixed Maturity Plans (FMPs) (they are close-ended)
Hybrid funds / Balanced funds
- Monthly Income Plans (MIPs)
- Capital Protection Funds (these are close-ended)
Other categories include
- Tax-saving funds
- Pension funds
- Fund of funds
- Exchange Traded Funds (ETFs)
- Leverage funds