Mutual Funds

A mutual fund is a professionally managed collective investment scheme that pools money from many investors and invests in stocks, bonds, short-term money market instruments and other securities. Mutual funds have a fund manager who invests the money on behalf of investors.

Mutual Funds

Recently I had a conversation with my friends:
Rahul: I had a great last year!! My Mutual Fund was up 10%.
Rishi: It’s fantastic Rahul!! Mine was 8% up.
Rohan: Is it? Mine was down 1%.
Me: (in my mind) what are mutual funds? Oh yes!! I remember one line ‘’MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY’’ but friends can you help out in understanding what are Mutual Funds?
Rahul: Yes, we can.
explaining mutual funds

What Are Mutual Funds?

what are mutual funds

Thus, Mutual Funds mean a group of people pooling their money to buy stocks or bonds or combination of both which is managed by professional fund manager which is in line with the investment objectives of the scheme.

‘’A mutual fund is a professionally managed collective investment scheme that pools money from many investors and invests in stocks, bonds, short-term money market instruments and other securities. Mutual funds have a fund manager who invests the money on behalf of investors.’’

mutual fund flow cycle

Mutual Funds Units And How is NAV Calculated

Mutual Funds issue UNITS to the investors in proportion to the quantum of money invested by them. Investors in the mutual funds are known as UNIT HOLDERS.


When an investor invests in particular scheme, he is allotted units from the fund company and the value of each unit is called NAV and at the time of selling of units, an investor sell them to at current NAV to a fund company. It is usually calculated each day at the time of the closure of the stock market with the help of below formula:

NAV calculation Let us understand through an example:
  • Units Issued: 30,00,00,000 (30 crore) units
  • Face Value: Rs.10
example of NAV calculation

Above table depicts that XYZ Corp. has made investments in shares, debentures, money market instruments and others accounts that is why they are categorized under ‘Assets Column’ to about Rs. 387.7 crore and company is liable to pay its units capital and other expenses which comes under ‘Liability Column’.

NAV will be adding up all the figures under Asset Column and deduct Accrued Expenditure and Other Current Liabilities, we get Rs.385.7 {387.7- (1.5+0.5)} dividing by 30 (crore) units will give us Rs.12.86 which is our NAV.

net asset value

Asset Under Management (AUM)

AUM is the total market value of assets/capital that a mutual fund holds. It is used to indicate the size of a fund and can refer to the amount of assets managed for all clients.

Let us look at few examples:

Assets under Management (Rs. crore)

asset under management Source:

Structure of Mutual Funds In India

It is very important to understand the structure of mutual funds. Who are the participants in mutual funds and what are their respective roles?
In India, Mutual Fund adopts 3-Tier Structure.
Below Diagram depicts participants in Mutual Fund and their respective roles.
structure of mutual funds in India

Illustration of HDFC Equity Fund

illustration of equity fund

Classification of Mutual Funds

An open ended scheme allows the investors to enter and exit at his convenience, anytime whereas a closed ended scheme restricts the freedom of entry and exit. Whenever a new fund comes in the market it is called New Fund Offer (NFO) which is issued at par value mainly Rs. 10 per share.
  • In case of open ended scheme, investors can buy units even after NFO period is over. Thus, when fund sells units, the investor buys the units from the fund and when the firm wishes to redeem the units, the firm repurchases the units from investors. This can be done even after NFO has closed at NAV.
  • In case of closed ended scheme, investors can buy units and invest during NFO duration only. No entry is possible once NFO has expired and redemption can be done after a stipulated duration of mutual fund.

Difference Between Open Ended And Closed Ended Scheme of Mutual Fund

Open Ended Scheme Closed Ended Scheme
Can be bought anytime Can be bought only during NFO (new fund offer)
Perpetual Fixed duration (e.g. 3 years, 5 years, 7 years & so on)
AUM keeps on changing due to continuous & redemptions and also due to AUM goes up or down only due to Investments change in value of underlying securities
Change in value of underlying securities To cater redemption requests, cash reserve Has to be maintained No cash reserve is required to maintain
Bought/sold at prevailing NAV after completion of predetermined duration Can be bought/sold from fund house only
To discourage redemption, exit load ranging From 0-2% on early exit Redemption not possible
classification of mutual funds
Equity Mutual Funds Explanation
Large-cap If an investor wishes to invest in stocks which have highest market capitalization
Mid-cap Investing in stocks having less market cap compared to large cap
Micro-cap Stocks having least market capitalization as compared to large and mid-cap funds
Multi-cap If an investor wishes to invest in mixer of all the above, then one can go for multi-cap funds
Equity Linked Savings Scheme (ELSS) Provides tax benefit where an investor can claim deduction up to Rs. 1.5 Lacs. with three years lock-in period
Dividend Yield Investing in companies which pay high dividends
Sectoral/Thematic If an investor wishes to invest in a particular sector e.g. Banking, Pharmaceutical, Infrastructure sector etc.

Liquid Funds Specifically investing in money market instruments, if an investor wishes to invest for very short period of time, for example: a day or two
Liquid Funds Plus If an investor wants to invest for slightly higher days, for example: four to five days
Corporate Bond Funds
Short Term In short term, mutual funds invest in corporate bonds with maturity of 3-5 years
Long Term In long term, investing in corporate bonds having maturity of 10-15 years
Gilt Edged Securities An investor can invest in government regulated securities or G-sec, for example: T- Bills, Zero Coupon Bonds

Balanced Funds Where an investor wishes to invest in combination of both equity and debt funds
Monthly Income Plans (MIPs) It is commonly used for retired person where 80-90% amount is invested in debt funds and rest in equity to cover the inflation
Asset Allocation Funds Mutual funds invest in equity, debt, commodities market to hedge risk

Others Explanation
Commodity Funds Investing in commodity market or in stocks where companies engaged in agricultural domain for example: fertilizers, tractors, irrigation companies
Gold ETFs Wherein investors instead of directly investing in gold, they go for mutual funds which invest in various forms of gold or companies engaged in gold mining business
ETFs Scheme under which investors wish to invest in BSE-SENSEX, NIFTY50 through mutual funds.
Global Funds Mutual funds which invest in offshore companies where an investor does not have an access to invest in US or other foreign markets
Funds of Fund Investing in various funds of mutual funds on behalf of investors basically to hedge risk

Costs of Investing In Mutual Funds

cost of investing in mutual funds

Operating Expenses
Mutual Funds usually incur marketing & distribution expenses, investment advisory fees, transaction costs and so on which is to be borne by investors who hold mutual funds. Expense Ratio helps in determining percentage of total assets to be paid as operating expense annually. It is also known as Management Expense Ratio (MER) and is calculated:

calculation of expense ratio Illustration:

A mutual fund scheme has Rs.500 crore average weekly net assets and scheme incurs Rs.5 crore as annual expenses, then expense ratio would be 1% (Rs.5 crore/Rs.500 crore).

Entry Load Entry Load, also known as front-end load, is the commission charged by the mutual scheme at the time of purchase of shares. There are two categories of funds offered:

1. Low-Load Funds where entry-load is up to 3% of amount invested
2. No-Load Funds carries no entry-load.

If a scheme offers Rs.20 per unit having front-end load of 3%, then an investor has to pay Rs. 20.60 (Rs.20 + Rs.0.60) per units multiplying with number of units he wishes to buy.

EXIT LOAD: Exit Load, also called as back-end load, is the redemption charges paid by the investors at the time of selling of shares.


If redemption price is Rs.25 per unit with exit load of 2%, then net sale proceeds will be Rs. 24.50 (Rs.25 – Rs.0.50) multiply with the number of units.

Returns In Mutual Funds

From an investors’ perspective, net return generated from Mutual Funds is calculated as increase/ (decrease) in NAV plus any dividends or capital gain distributions divided by NAV at the beginning of the investment period.

calculate returns in mutual funds Illustration:

A scheme in Mutual Fund has NAV at $20 at the start of the month, generates income distributions of $0.15 and capital gain distributions of $0.05 and NAV at the end of the month stood at $20.10, then monthly rate of return is calculated as:

returns in mutual funds example

Why One Should Invest In Mutual Funds?

reasons to invest in mutual funds
  • Diversification
  • Professionally Managed
  • Higher Returns
  • High Liquidity
  • Transparent Process & Tax Efficient
Points to be taken into consideration:
  • Management & Operating Fees
  • Misleading Advertisements
  • Too many choices

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