About Mutual Funds
A mutual fund is a trust. It pools money from like-minded shareholders and invests in a diversified portfolio of securities through various schemes that address different needs of investors. The pool of money thus collected is then invested by the Asset Management Company (AMC) in different types of securities. These could include shares, debentures, convertible bonds, bonds, money market instruments or other securities, based on the investment objective of a particular scheme. The investment objective is clearly laid down in the offer document for that scheme. The fund adds value to the investment in two ways: income earned and any capital appreciation realised through sale. This is shared by unit holders in proportion to the number of units they own. Setting up a Mutual Fund
A mutual fund is set up in the form of a trust, which comprises a sponsor, trustees, Asset Management Company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like the promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unit holders. The Asset Management Company (AMC), approved by SEBI, manages the funds by making investments in various types of securities. The custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI Regulations by the mutual fund.
SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of the AMC must be independent. All mutual funds are required to be registered with SEBI before they launch any scheme. However, Unit Trust of India (UTI) is not registered with SEBI (as on January 15, 2002). Net Asset Value (NAV) of a Scheme
The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV).
Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value 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 a 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 Rs. 200 Lakhs and the mutual fund has issued 10 Lakh units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs. 20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme.
Sector-Specific Fund Schemes
These are the funds/schemes that invest in the
securities of only those sectors or industries as specified in the offer
documents. For e.g. Pharmaceuticals, Software, Fast Moving Consumer
Goods (FMCG), Petroleum stocks, etc. The returns in these funds are
dependent on the performance of the respective sectors/industries. While
these funds may give higher returns, they are more risky compared to diversified funds.
Investors need to keep a watch on the performance of those
sectors/industries and must exit at an appropriate time. They may also
seek advice of an expert.
Tax Saving Schemes 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. E.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest predominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.
Income other than Capital Gains
Tax Saving Schemes 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. E.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest predominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.
As per the provisions of Section 10(35) of the Act, income received in respect of units of a mutual fund specified under Section 10(23D) of the Act is exempt from income tax in the hands of the recipient Investors.
Tax Deduction at Source In view of the exemption of income in the hands of the Investors, no income tax is deductible at source, on income distribution by the mutual fund, under the provisions of Sections 194K of the Act.
Capital Gains As per Section 2(42A) of the act, units of the scheme held as a capital asset, for a period of more than 12 months immediately preceding the date of transfer, will be treated as a long-term capital asset for the computation of capital gains; in all other cases, it would be treated as a short-term capital asset.
Also, sub-section (7) of Section 94 of the act provides that loss, if any, arising from the sale/transfer of units (including redemption) purchased up to 3 months prior to the record date and sold within 3 months after such date, will not be available for set off to the extent of income distribution (excluding redemptions) on such units claimed as tax exempt by the Investors.
Q. Who should invest in mutual funds?
Mutual funds can meet the investment objectives of almost all types of investors. Young investors, who can take some risk while aiming for substantial growth of capital in the long-term, will find growth schemes (i.e. funds which invest in stocks) an ideal option.
Older investors who are risk-averse and prefer a steady income in the medium term can invest in income schemes (i.e. funds which invest in debt instruments). Investors in middle age can allocate their savings between income funds and growth funds and achieve both income and capital growth. Investors who want to benefit from regular savings, save a small sum every month, can use the Systematic Investment Plan (SIP).
Q. As mutual fund schemes invest only in stock markets, are they suitable for small investors?
Mutual funds are meant for small investors. The prime reason is that successful investments in stock markets require careful analysis, which is not possible for a small investor. Mutual funds are usually equipped to carry out thorough analysis and can provide superior returns.
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