As per SEBI “Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in the offer document”.
Mutual Fund is a collective investment vehicle established in the form of trust. Mutual Fund offers investors various types of schemes like equity, debt, hybrid and money market mutual funds. Investors subscribe to the units of the mutual fund scheme and their pooled money is invested in the market as per the investment objectives of the scheme. The returns generated from these investments is distributed among the unit holders in the form of dividend.
Mutual Funds launch various types of schemes in the market because investors have different attitude towards risk: E.g.
Further investors have varying needs like:
⮚ Regular Income
⮚ Tax Saving etc.
To satisfy these different requirements several schemes are launched by a mutual fund each having a specific investment objective.
Now, the next big question is- “How does a Mutual Fund work?”
- In India, Mutual Fund is established in the form of trust. Mutual Fund offers various types of schemes to investors where each scheme serves a specific investment objective which may be capital appreciation, regular income, liquidity or tax savings. Investors with similar investment requirements will invest under a particular scheme. The small-small savings of these investors results in a large pool of funds available for investment in the market. Investors are allotted units and are called unit holders of that particular scheme.
- When a new scheme is launched it specifies its investment objectives and collects the pool of funds from the investors under this scheme. The scheme may remain open for subscription all the time or for a limited period only. When an investor invests the funds in the scheme he is issued units. The Face Value of each unit is Rs.10. Face Value is important from the accounting perspective. Face Value multiplied by no. of units issued under a scheme is known as Unit Capital of the scheme.
- Pool of funds collected under a particular scheme is invested by the fund manager in different instruments in the market. Depending upon the investment objective of the scheme, funds may be invested in equity to generate capital appreciation or in debt instruments to generate the regular income or in money market instruments to provide liquidity to the unit holders of that scheme. The scheme’s investment in the market is known as Assets Under Management (AUM). AUM is the measure of size of fund and it fluctuates as per the change in the value of investments. The returns generated on the investments are proportionately distributed among the unit holders of the scheme in the form of dividend.
- Mutual fund schemes may be diversified or sectoral in nature. Diversification means allocating the funds in different sectors in order to reduce the risk. In a normal market all the sectors don’t go down simultaneously. If one sector is performing poorly then a portion of funds allocated in other sectors will ensure that the entire portfolio value doesn’t go down and thus results in risk reduction.
- The investments under the scheme will generate the income in the form of interest or dividend. The increase or decrease in the value of investment will result in capital gain or loss. These returns are passed on to the unit holders in the form of dividend, in the proportion of their investment in the scheme. Unit holders also gain through the increase in the market value of their units also known as Net Asset Value (NAV). If the NAV of these units declines then it results in capital loss for unit holders.
Thus for the small investors who wish to participate in the effluence of capital market and wants to receive higher return on his investments but lacks the knowledge and large amount funds for diversification, mutual funds provides a solution They are suitable for small investors as their small savings are pooled together and such large corpus is managed by best qualified fund managers and invested in the market to generate the higher returns albeit with some risk.