Mutual funds constitute a unique investment gateway where you can invest a small sum and reap the benefits of a well-diversified portfolio selected by professionals, who are not only accountable to their seniors at the mutual fund but also responsible to you as the investor. The mutual fund as a concept is not new, the foundation of the modern mutual fund laid with the establishment of Massachusetts Investors Trust (now MFS Investment Management) in 1924. In India, the mutual fund story started in 1964 with establishing the Unit Trust of India (UTI) by an Act of Parliament. Subsequently, in the years 1987-1993, public sector funds entered in the fray. In 1993, the first mutual fund regulations came into existence, under which all mutual funds, except UTI were to be registered and governed. This paved the way to private sector funds and international players. The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised set of regulations in 1996. The industry is now governed by the SEBI (Mutual Fund) Regulations 1996.

The composition of mutual fund consists of three entities - sponsors, trustees, and Asset Management Company (AMC).  The sponsors initiate the idea to set-up a mutual fund and arrange/organize capital. Trustees secure the necessary approvals from SEBI to float the schemes. The trustees enter into a management agreement with the AMC to manage the money collected through various schemes. The AMC takes investment decisions, maintains proper accounting and information, calculates the NAV, and provides all relevant information.

Mutual funds offer many types of schemes with the objective of offering many options to the investors to match their investment objectives. These schemes can be broadly divided into following generic categories:

• By structure, such as open-ended/interval/close-ended schemes
• By investment objective, such as growth, income, balanced and money market schemes.
• Other schemes, such as tax-saving schemes, index schemes, and sector-specific schemes

Mutual funds offer many unparalleled advantages in investing, such as professional management, portfolio diversification, low costs, liquidity, transparency, and flexibility.

Criteria of mutual fund selection

There is nothing that can completely ensure that the investor will earn maximum returns but the following fund parameters will help to reduce risk and enhance returns:

• Size of Asset Under Management (AUM): A large-sized AUM not only helps to reduce cost but also puts the fund in a position to absorb risk and liquidity crises in a better way.
• Past Performance: Past performance of a mutual fund does not guarantee anything for the future but it definitely indicates the ability of its fund managers.
• Lower Investment Management Expenses: It is generally favorable for the investor to choose schemes with lower Investment management expenses.
• Low Portfolio Turnover: High portfolio turnover unnecessarily increases transaction cost, hence look for funds with low portfolio turnover to take the cost advantage.
• Evaluation of Indicative Portfolio: An investor should properly evaluate a fund’s indicative portfolio and try to avoid schemes with exposure in underperforming sectors.

Matching Investment Objective with Schemes

Every investor has one goal - to maximize returns subject to his/her risk appetite. Mutual funds give a lot of options to enable one reach or get close to one’s desired goal.

• Corporates/individuals can put idle money in liquid funds rather than savings accounts and earn much better returns. Money can be withdrawn from liquid mutual funds by giving just one day’s notice.
• If an investor plans to earn reasonable returns for a period in the range of three months to more than a year, fixed maturity plans (FMP) are a good option. In case of FMPs of more than one year’s tenure, an investor can also take the advantage of long term capital gains.
• If an investor wants to invest on a recurring basis, a systematic investment plan (SIP) is a good option. Its long duration helps to reduce the impact of bull and bear phases.
• Investors with very high risk appetites and good understanding of the market can always look for equity or equity-oriented mutual funds. If the investor feels that a particular sector will do well, he/she can choose sector-specific schemes. Mutual funds also have the expertise to hedge investments to ensure lesser downside risk.
• If the investor wants to enjoy fixed income with a mix of equity returns, he/she can go for balanced/debt-oriented/equity-oriented mutual fund schemes.
• An investor can choose the dividend/growth option as per his/her requirement of funds. Dividend is tax-free income for the investor.

Final Thoughts

But the bigger fact remains that it is your money, you should not rely on anybody with closed eyes. In the worst scenario, even considerably safe investments like FMPs can give negative returns. You should always be in touch with the market or at least watch the Sensex on a regular basis. An informed investor can always use the option of switching from one particular scheme to a liquid fund and vice versa at appropriate times. However, by investing through mutual funds you can take advantage of expert selection of securities, daily monitoring, risk reduction, lower cost etc. and improve your returns.

Prabhat Varma works as General Manager (Finance), Sahara India Financial Corporation, Mumbai.