MF investment knowledge in practice


Mutual funds are becoming increasingly popular among retail investors because of the number of benefits they offer. This has resulted in the shrinking of direct retail participation in the equity and the debt markets, with mutual funds representing retail investors in both these markets.

As a retail investor using mutual funds, it is imperative for you to understand this investment option in order to be clear about where your money is invested and how safe it is. Enumerated below are five aspects about mutual funds:

MF an investment Option:

When you invest in a mutual fund scheme, the mutual fund in turn, invests your money in equity or debt securities depending on the investment objective of the scheme. For instance if you have invested in an equity scheme, the mutual fund will invest your money in equity shares of companies. A mutual fund is merely an investment route, not an investment product. You are not investing in the mutual fund, but investing through it.

Understand the ‘Legal disclaimer’ properly:

All mutual funds have to display a legal disclaimer stipulated by SEBI, the authority responsible for regulating mutual funds. This disclaimer reads, “Mutual funds are subject to market risks. Please read the offer document carefully before investing�. Don’t take this disclaimer lightly but do read the offer document of the scheme in order to understand how the scheme is structured and its investment objective. Check where and how your money will be invested.

Risk level is different with each scheme:

There are a number of scheme types under both, the equity category and the debt category. Each of these schemes has varying level of risk. Risk inherent in a scheme depends on the following criteria:

>>>The fund manager of the scheme plays an important role in selection of securities and deciding how much of the corpus should be invested in each security. He also has to decide when to buy and when to sell securities. While he has to act within the scheme’s investment objective, he has to use his experience and ability to a large extent. While selecting a scheme, check out the fund managers past track record. You can do that by assessing past performance of the schemes that he has managed

>>>Check out how many sectors the portfolio is spread over. If the portfolio is invested in companies across 3 sectors is more risky than a portfolio that is invested in companies across 7 sectors. However in case of sector funds, this risk forms part of the schemes investment objective and is allowed to invest in only one sector.

>>>Debt funds also face credit risk. This is the risk of the borrower defaulting on repayment of principal and/or payment of interest. However guilt funds (these are debt funds that invest in government securities) don’t face this risk since there is no risk of default where the government is concerned. Check out the credit rating assigned to rated debt securities to asses this level of risk.

All investor’s money is not invested by Mutual funds:

When you invest say Rs 40,000 through a mutual fund, the fund does not end up investing the entire Rs 40,000. A portion of this money goes towards expenses such as administration expenses, marketing and selling expenses, funds management expenses, etc. A portion of this money is retained as cash to help the mutual fund cope with redemptions. However, returns should be calculated on the total investment of Rs 40,000 in order to find out how much earning is realized on the investment.

Services don’t come for free:

Loads are charges levied by mutual fund on its investors. There are two kinds of loads- entry load or an exit load. An entry load is a charge levied when the investor enters the scheme. An exit load is a charged levied when the investor exits from the scheme. Usually, mutual funds charge only one load i.e. either an entry load or an exit load. Entry loads charged presently by equity funds range from 0.5% to 2.25%. Exit load range from 0.5% to 4% depending on when the investors exit from the scheme. An earlier exit results in a higher exit load. Entry load charged presently by debt funds range from 0.5% to 4%. However, most debt funds don’t levy any entry load. Exit load range from 0.1% to 2% depending on when the investor exits from the scheme.

Asset management:

In addition to loads, mutual funds charge an annual asset management charge. This expense is reduced from the corpus of the scheme. Presently, mutual funds are allowed to charge a maximum of 2.5% as asset management charges.