Training on Mutual Funds for AMFI Certification

ICICI Prudential Mutual Fund AMC

Agenda
Session 1 : The concept & Role of MF Session 2 : Fund Structure & Constituents Session 3 : Legal & Regulatory Framework Session 4 : The Offer Document Session 5 : Fund Distribution & Sales Practices Session 6 : Accounting, Valuation & Taxation Session 7 : Investor Services Session 8 : Investment Management Session 9 : Measuring & Evaluating Mutual Fund Performance Session 10: Financial Planning Session 11: Asset allocation, fund selection & model portfolio Session 12: Business Ethics in Mutual Funds

Session 1
Concept & Role of Mutual Funds

Evolution of Mutual Funds

Phase 1 (1964-87) : Phase 2 (1987-93) : Growth of UTI Entry of Public Sector Funds-S.B.I.,Canara etc.

Phase 3 (1993-96) : Emergence of Private Sector Mutual Funds Joint Ventures between Foreign Funds & Indian Promoters - bringing latest product innovation, investment management techniques, and investorservicing technology Phase 4 (1996-99) : Growth and SEBI Regulation Phase 5 (1999-04) : UTI Act 1963 repealed in Feb 2003 UTI Mutual Fund becomes SEBI compliant Assured Return Schemes of UTI taken over by a special undertaking administered by GOI Emergence of large & uniform industry Phase 6 (2004) :
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Consolidation & Growth 32 Mutual Funds as at 31-03-07

What is a Mutual Fund?

A mutual fund is a pool of money collected from investors and is invested according to stated investment objectives.

Investors

Contribute money

Trust (pool of money)

Receive dividend/capital appreciation

Invest in markets
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Markets (volatile, has fluctuation)

Receive interest, dividend or capital growth

Characteristics of a Mutual Fund

Investors own the mutual fund. Professional managers manage the affairs for a fee. The funds are invested in a portfolio of marketable securities, reflecting the investment objective. Value of the portfolio and investors holdings, alters with change in market value of investments.

Pros and Cons of Mutual Funds

Advantages of Mutual Funds Portfolio diversification Professional management Reduction in risk Reduction in transaction cost Liquidity Convenience and flexibility Disadvantages of Mutual Funds No control over costs No tailor-made portfolios Issues relating to management of a portfolio of mutual funds

Types of Mutual Fund

Mutual Funds can be classified as: Close ended / Open-ended Funds Load Fund / No-Load Funds Tax-exempt / Non-Tax exempt Funds ICICI Prudential Tax Plan Commodity Funds Real Estate Funds Fund of Funds(FOF)
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LOAD FUNDS
Load is one time fee payable by the investor when they enter / exit an open-ended scheme. Loads are charged to recover initial issue expenses including marketing & selling expenses, brokers/agents/distributors commission, advertising costs, printing of OD & Forms & bank charges There can be Entry load or Exit load or both Entry load is also called Front-end load. Exit load is also called Back-end load Load charged over a period of time is Deferred load

Advantage of No Load fund & effect of Load

In a No load fund, marketing and selling expenses are absorbed by the AMC and the investor buys and sells units at net NAV calculated after accounting for management fees and recurring expenses Return on investment to the investor is reduced because of the loads When the investor buys a unit from the MFs, he pays higher amount more than NAV (NAV + entry load) When the investor sells the unit to the MF, he gets less amount than NAV (NAV exit load)
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Types of Funds classified by nature of Investments

EQUITY FUNDS

Pre-dominantly invest in equity markets Diversified portfolio of equity shares Select set based on some criterion Diversified equity funds(ELSS as a special case), Capitalisation based funds, Index funds, Sectoral funds, Value Funds, Equity Income or Dividend Yield Funds, Aggressive Growth Funds, Growth Funds etc
DEBT FUNDS

Predominantly invest in the debt markets Diversified debt funds Select set based on some criterion Income funds or diversified debt funds,Gilt funds,Liquid and money market funds,Serial plans or fixed term plans, High Yield Debt Funds etc
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Hybrid Funds- Quasi Equity/Quasi Debt

BALANCED FUNDS

Growth & Income Funds( strike a balance between capital appreciation & income for the investor) Investment in more than one asset class Debt and equity in comparable proportions Pre-dominantly debt with some exposure to equity Pre-dominantly equity with some exposure to debt ICICI Prudential Balanced Fund Education plans and childrens plans ICICI Prudential Child care Plan- Gift & Study

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Types of Funds classified by Investment Objectives

Growth Funds
ICICI Prudential Growth Fund

Income Funds
ICICI Prudential Income Fund

Value Funds
ICICI Prudential Discovery Fund

Fund of Funds
ICICI Prudential Advisor Series

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Exchange Traded Funds

Exchange Traded Funds (ETFs) combine best features of Open-ended & Close-ended structure It tracks the market index & trades like a single stock on stock exchange Offers diversification & cost efficiency of an index Unlike Index Funds, unit price of this Fund is determined in the market & it keeps on varying during the day as per market movements ETFs are bought & sold through market makers who give two way quotes (Bid & Ask Price) Market makers allow unit holders to exchange units for underlying shares Ex: ICICI Prudential Spice Fund
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Investment Options
Investors can achieve income and growth objectives in all funds Dividend option Regular dividend Ad-hoc dividend Growth option Re-investment option Most funds provide multiple options and the facility to switch between options

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Basis for Classification

Risk Sectoral funds are most risky; money market funds are least risky Tenor Equity funds require a long investment horizon; liquid funds are for the short term liquidity needs Investment objective Equity funds suit growth objectives; debt funds suit income objectives Return Expectation
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Risk and Return

Equity funds Index funds Sectoral funds

Return

Balanced funds Debt Funds Gilt funds ST debt funds Liquid funds Risk

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SESSION 2

FUND STRUCURE & CONSTITUENTS

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MUTUAL FUND Structural Framework

Sponsor

Trustee Company

Asset Management Company

Fiduciary responsibility to the investors

Fund Management

Operations

Marketing Distribution

Registrar

Custodian

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Structure & Constituents

Mutual Funds in India have a 3-tier structure Sponsor , Trustee & AMC or Asset Management Co. The investors money is held in a trust (the mutual fund) In India, the mutual fund is formed as a Trust under the Indian Trust Act, 1882 The board of trustees is accountable to the Office of the Public Trustee, in turn reporting to Charity Commissioner The trust represents the investors themselves and is only a pass-through vehicle In US, mutual funds are formed as investment companies In the UK, MFs have two alternative structures: Openended in the form of Unit Trusts & Close-ended in the form of Corporate Entities
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Structure & Constituents..

SPONSOR Sponsor is the promoter of the Mutual Fund Sponsor creates the AMC and the Trustee company and appoints the directors to these companies with SEBI approval Sponsor should have at least 5 years track record in the financial services business and should have made profit in at least 3 out of the 5 years Sponsor should contribute at least 40% of the capital of the AMC Sponsor could be a bank (SBI, PNB, ICICI) a financial institution (Fidelity, Franklin Templeton) or a Corporate (Reliance, Birla, Tata etc.)
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Structure & Constituents..

TRUSTEES
The role of the Trustees is to safeguard the interest of the investor/unit-holder of the fund Fiduciary Capacity The trustees make sure that the funds are invested according to the investors mandate and objective. The board of trustees is appointed by Sponsor with SEBI approval At least 4 trustees of which at least 2/3rd of the board of trustees should be independent Trustees of one mutual fund cannot be trustee of another mutual fund Right to seek regular information and remedial action All major decisions need trustee approval The board of trustees are required to meet at least 4 times in a year to review the AMC Trust created through a document called the Trust Deed, executed by the Fund Sponsor in favour of the Trustees.
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Structure & Constituents..

ASSET MANAGEMENT COMPANY Registered with SEBI The AMC is also formed as a private limited company Responsible for operational aspects of the MF Investment management agreement with trustees The AMC gets fee for managing the funds according to the mandate of the investors. An AMCs net worth (Share Capital + Reserves & Surplus) should be at least Rs.10 crores at all times At least 40% of AMC capital must be contributed by the Sponsor At least half (50%) of the directors of the AMC must be independent Appoints other constituents - Custodian , Registrar & Transfer Agent Cannot have any other business interest AMC of one MF cannot be trustee/AMC of another MF Quarterly reporting to Trustees An AMC cannot engage in any business other than portfolio advisory and management
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Structure & Constituents..

CUSTODIAN / DEPOSITORY The custodian is appointed for safekeeping of securities and participating in the clearing process The custodian is the guardian of the funds and assets of investors The custodian maintains the accounts of securities, their transaction and balance sheet etc. The custodian and sponsor cannot be the same entity Registrar and Transfer agent manage the sale and purchase of units and keep unit-holder accounts Ex: Karvy and CAMS
Broker

Purchase and sale of securities 5% limit per broker

Auditor

Separate auditor for AMC and Mutual fund

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Session 3
Legal & Regulatory Framework

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Regulators in India
SEBI is Capital Market Regulator with legal powers
SEBI regulates Mutual Funds. All Mutual Funds to be registered with SEBI

Stock exchanges (for listed Mutual Funds) RBI is Money Market Regulator & issues concerning ownership of AMC by banks SEBI is regulator for Liquid Funds Investing in MM instruments MOF supervisory body for RBI & SEBI Security Appellate Tribunal setup in 2003 to hear appeal against SEBI decisions Registrar of Companies(ROC) ensures compliance by AMC & by Trustee Company with the Indian Companies Act 1956 ROC supervised by Department of Company Affairs (DCA)

Mutual Fund Trustees accountable to Public Trustees Public Trustee reports to Charity Commissioner
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Self-regulatory Organisations(SRO)
SROs are second tier in the regulatory structure SRO is an association of Market Participants empowered by apex regulatory authority to exercise pre-defined authority over the regulation of their members. Approval of SRO given by MOF All Stock Exchanges are SROs and are supervised by SEBI Close Ended Funds listed on SE observe listing Agreement Requirements of SEs AMFI was incorporated in 1995 and is not an SRO. Has the power to deny registration to distributors for violating AMFI Code of Conduct(AGNI)
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Mergers & Takeover

APPROVAL High Trustees SEBI Court Merger of Two AMCs Takeover of AMC Takeover of scheme of AMC
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Unit Holders Consent(75% voting rights) Intimation Intimation (option to redeem)

Yes Yes Yes

Yes Yes Yes No Yes No

Session 4
OFFER DOCUMENT

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The Offer Document

Offer Document of a MF scheme is like a Prospectus issued by AMC inviting public to subscribe to units of MF scheme Contains vital information about Fund and schemes SEBI approved format SEBI does not approve or certify the contents of the OD KIM is a mandatorily enclosed to application forms Investor has no recourse for not having read the OD/KIM Close-ended funds issue an OD at the time of the IPO Open-ended funds have to update OD at least once in 2 yrs Trustees approve the contents of the OD and KIM
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Period of Validity
Updated every 2 years for OEFs Regular Addendum for results Updated for every major change

Change in the AMC or Sponsor of the mutual fund. Change in the load structures. Changes in the fundamental attributes of the schemes. Changes in the investment options to investors; inclusion or deletion of options. Management of Funds Offer related information Borrowing policy,NAV and valuation, procedure for redemption Accounting policies, tax treatment, investors rights &services Redressal mechanism for investor grievances,penalties,pending litigations or proceedings

Contents of Offer Document

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Contents of Offer Document

Preliminary information

Summary information about the mutual fund, the scheme and the terms of offer. Mandatory disclaimer clauses as required by SEBI. Glossary of terms in the offer document, which defines the terms used. Standard and scheme specific risk factors pertaining to the scheme being offered Constitution of fund, details of sponsor, trustees and AMC. Financial history of sponsor(s) for 3 years, in summary form. Director of Boards of the trustees and the AMC. Details of key personnel of the AMC. Details of Fund constituents

Fund specific information

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Contents of Offer Document Contd..

Scheme Specific Information

Details regarding IPO, sale and Repurchase Minimum subscription and face value Initial issue expenses current scheme and the past schemes Special facilities to investors Eligibility for investing documentation required. Procedure for applying, and subsequent operations relating to transfer, redemption, nomination, pledge and mode of holding Proposed as well as other schemes for last 3 years Comparison with OD numbers Condensed Financial information for last 3 years

Loads and the annual recurring expenses

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Other Contents in OD
Policy on dividend and inter-scheme transfers Procedure for redemption Disclosure of Valuation of Securities norms and NAV calculation Description of Accounting Policies Tax treatment of Investments as per existing laws Investors rights & Services. Redressal mechanism for investors grievances Penalties, Pending litigations & proceedings

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SESSION 5

FUND DISTRIBUTION & SALES PRACTICES

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Who can invest in a Mutual Funds.

Residents

Resident Individuals / HUF Indian companies Partnership Firms Indian Trusts / Charitable Institutions Insurance Companies Banks Financial Institutions NBFCs Provident Funds Mutual Funds

Non Residents

NRIs & Persons of Indian Origin Overseas Corporate Bodies (OCBs)

Foreign Entities

FIIs registered with SEBI

Foreign citizens / entities cannot invest in MF

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Different Distribution Channels

Direct Marketing By Sales Officers 2. Sending Mailers to existing investors & promoting the schemes, through branch networks & call centers for retail investments
1.

3. 4.

Individual Agents as Distributors and Advisors Institutional Intermediaries

Fund distribution companies Finance Companies Investment Advisory Companies Banks and Institutions Post Offices to cover wider geographical area

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Process of Effective Selling of M F Schemes prescribed for Distributors

Know the important characteristics of scheme Know your client profile (age, risk tolerance, income level, etc.) Understand clients needs (investment objective, return expectation, cash flow requirement, etc.) Assist in making the right choice Encourage regular investment & commitment to invest Personalised after- sales service

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AMFI Code of Ethics for MFs

Funds to be managed in the interest of unit holders Unit holders to be treated equally & fairly Ensure adequate disclosures Avoid conflict of interest Management of fund in accordance with stated investment objective Stick to ethical standards and fairness in dealings High standards of care, diligence, services and professional selling practices

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SEBI Advertisement Code for MFs

Standard measures to compare such as Compounded Annualised Yield, CAGR etc. for scheme in existence for more than 1 year. Annualised yields for at least one, three, five years & since launch For less than 1 year performance, Absolute Return without annualisation except for Liquid Mutual Funds Dividend declared to be mentioned in rupees per unit with face value of each unit and the prevailing NAV at the time of declaration Risk factors prominently stated For comparing performance against benchmarks, appropriate benchmark to be used and identical time periods to be used No add-ons during offer 40 Any ranking of fund to be explained appropriately

Session 6
ACCOUNTING, VALUATIION & TAX ASPECTS

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Investors subscription to a mutual fund are accounted as unit capital, not liabilities or deposits The unit capital account is maintained at face value Assets of a mutual fund are the investments made by the fund Liabilities of a mutual fund are strictly short term in nature The day on which NAV is calculated is called as valuation date All Mutual Funds have to disclose their NAVs everyday, by posting it on the AMFI website by 8:00pm
Open ended Funds are required to compute and disclose NAV daily

Close-ended funds can compute NAVs every week (usually Wed) but disclosures have to be made everyday
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Net Asset Value

(Assets + Income Liabilities Expenses) The NAV of a fund = --------------------------------------------------------no of units outstanding

Assets = Market value of investments+ Receivables + Accrued income + Other Assets ie: (income due but not received) Liabilities = Accrued expenses + Payables + other Liabilities

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Factors Impacting NAV

Sale and purchase of investment securities Cannot impact NAV by more than 2% Sale and repurchase of units Cannot impact NAV by more than 2% Valuation of assets(all investments) Accrual of income and expenses Cannot impact NAV by more than 1%

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Annualizing the Rate of Return

If NAV on Jan 1, 2001 was Rs. 12.75 June 30, 2001 was Rs. 14.35
% age change in NAV = (14.35 12.75)/12.75 x 100 = 12.55% Annualised return = 12.55 x 12/6 = 25.10%

Percentage Change in NAV

Assume that change in NAV is the only source of return. Example:
NAV of a fund was Rs. 23.45 at the beginning of a year Rs. 27.65 at the end of the year.

%age change in NAV = (27.65 23.45)/23.45 *100 = 17.91%

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LOAD
Load is the adjustment to the NAV, to arrive at price Load is used to meet expenses related to sale and distribution of units Load is charged to investor when the investor buys or redeems units Load that is charged when investor buys (or fund sells) units is the entry load or sale load. Entry load increases the price for the investor. To arrive at the sale price, given NAV and entry load, the load is calculated as NAV X (entry load/100) and added to NAV Load that is charged when investor redeems (or fund repurchases) units is the exit load or repurchase load. Exit load reduces the proceeds to the investor An exit load that varies with the holding period of investor is the CDSC (Contingent Deferred Sales Charge). CDSC is lower for longer holding period. To arrive at the repurchase price, given NAV and exit load, the load is calculated as NAV X (exit load/100) and deducted from NAV
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Example on Loads and Returns

Date 1/1/1999 31/12/1999 Action Entry Exit NAV (Rs) 10.00 11.00 Entry Load 2% Exit Load 1%

ROI with Loads Amount invested = 10 + 0.20= Rs.10.20 Amount received = 11 0.11= Rs.10.89 Gain = Rs. 0.69 ROI = (0.69 x 100) /10.20 = 6.76% ROI without loads Amount invested = Rs.10 Amount received = Rs.11 Gain = 1 Rs. ROI=(1 x 100) /10 = 10%
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Contingent Deferred Sales Charge (CDSC)

Exit Charge depending upon how many years investor has stayed with the fund is called Contingent Deferred Sales Charge. Redemption during the first five years from the date of investment
First Year Second Year Third Year Fourth Year Fifth Year Maximum CDSC 4% Maximum CDSC 3% Maximum CDSC 2% Maximum CDSC 1% Nil

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Initial Issue Expenses

The initial issue expenses of a scheme cannot exceed 6% of the funds mobilized. Any amount above this has to be borne by the sponsor or the AMC Initial issue expenses are charged as follows: For Close-Ended Schemes charged over the life of the scheme, on a weekly basis until maturity Eg. if a scheme for 5 years has expenses of INR 5 cr, the weekly expenses are Rs 5 cr / (5 X 52) = Rs. 192,308/For Open-Ended Schemes, the initial issue expenses used to be carried in the balance sheet as deferred revenue expenses and written off over a period not exceeding 5 years Current position: OEFs cannot charge Initial Issue Expenses; OEFs can charge higher loads Expenses incurred in floating schemes No-load fund: Additional mgmt. Fee upto 1 % of weekly average net assets outstanding in the accounting year unamortized portion of initial issue expenses shall be included for NAV calculation- considered as Other assets
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The limit on expenses that can be charged to income from a fund are:
Average Weekly Net Assets On the first Rs.100 crs On the next Rs.300 crs On the next Rs.300crs On the Balance Average Weekly Assets For Equity Funds 2.50% 2.25% 2.0% 1.75% For Bond Funds 2.25% 2.00% 1.75% 1.50%

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The Investment management fee are regulated by SEBI as follows: For the 1st 100 cr of net assets 1.25% For net assets exceeding 100 cr 1% The rates are applied to weekly average net assets of the mutual fund scheme, to determine the AMCs fee. unamortized portion of initial issue expenses shall be included for NAV calculation, considered as Other assets . The Investment Advisory Fee cannot be claimed on this asset, hence have to be excluded while determining the chargeable investment mgmt/ advisory fee.
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Mutual Funds incur the following expenses in carrying out its operations
Investment Management fee to the AMC Custodians fee Trustees fee R&T Agents fee Marketing & distribution expenses Brokerage and transaction costs Audit Fee Legal fee Costs related to funds transfer Costs related to investor communication Cost of providing account statements and cheques/warrants etc Costs of mandatory advertising and communication

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Expenses that cannot be charged

Penalties and fines for infraction of laws. Interest on delayed payments to unit holders. Legal, marketing and publication expenses not attributable to any scheme. Expenses on investment and general management. Expenses on general administration, corporate advertising and infrastructure costs. Expenses on fixed assets and software development expenses. Such other costs as may be prohibited by SEBI.

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Sources of Income
Interest Dividend Profit from sale of investments Other income Extra-ordinary income

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VALUATION OF EQUITY SECURITIES

Valuation of equity shares is done on the basis of traded price (Mark to Market), provided the price is not more than 30 days old. at the last quoted closing price on the stock exchange where it is principally traded Non-traded and thinly traded equity are to be valued in good faith. Traded value in a month is less than Rs. 5 lakhs; and Total volume of shares traded is less than 50,000 shares a month Illiquid securities cannot be more than 15% of the portfolios net assets in OEF and 20% in CEF. Any holding above this limit are to be valued at zero. If individual / illiquid securities are more than 5% of the portfolio, independent valuation to be done

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VALUATION OF DEBT SECURITIES

Valuation of debt securities with : less than 182 days to maturity is done on accrual basis. The accrual is calculated as follows: A security issued at Rs. 90 and redeemable at rs. 100 after 364 days, the accrued interest per day is 10/364 = 0.02747 The value of the security is increased by 2.75 paise every day, so that the security is worth Rs. 100 on the date of maturity If it has to be valued 200 days after issuance, its value is 90+(0.02747*200)= 95.494

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VALUATION OF DEBT SECURITIES

Valuation of other securities(>182d) G-Secs are valued at market prices or using the CRISIL Gilt valuer. Corporate bonds are valued at market prices or using the CRISIL Bond valuer. Both these methods use duration to classify bonds and assign a rate for each duration bucket. A debt security( other than G-Sec) is considered as a thinly traded security if on the valuation date, there is no individual trade in that security in marketable lots( currently Rs.5Cr) on the principal stock exchange / or any other stock exchange

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Yield To Maturity (Y T M)
YTM is the Internal Rate of Return an investor would realize if he bought a bond at a particular price, received all the coupon payments, reinvested the coupons at this same YTM rate and received the principal at maturity. Internal Rate of return is computed based on :
i. ii. iii.

Coupon Rate Purchase Price Period to Maturity

If purchase price is the same as Face Value of Bond,

YTM will be the same as Coupon Rate.

If purchase price is more than the Face Value,

YTM will be lower than the Coupon Rate.

If purchase price is less than the Face Value,

YTM will be more than the Coupon Rate.
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Reporting Requirements
Audited accounts within 6 months of closure of accounts. Publish within 30 days of the closure of the half-year, unaudited abridged accounts. Summary of the accounts has to be mailed to all unit holders. File with SEBI: A copy of the annual report Six monthly unaudited reports Quarterly movement in net assets of the fund Quarterly portfolio statements
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Specific Disclosures
Complete portfolio to be disclosed every six months. Industry practice: monthly disclosure. Any item of expenditure which is more than 10% of total expenses NPAs, provisioning, NPAs as % of total assets. Number of unit holders holding more than 25% of unit capital.

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Non Performing Asset

An asset shall be classified as an NPA, if the interest and/or principal amount have not been received or have remained outstanding for one quarter, from the day such income/installment has fallen due. Such assets will be classified as NPAs, soon after the lapse of a quarter from the date on which payments were due.

Treatment of NPAs
Accrual to be stopped. Income accrued until date of classification to be provided for. Provisioning for principal due In graded manner after 3 months of classification. Complete write off in 15 months from classification

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Accounting Policies
Investments to be marked to market according to SEBI Guidelines. Unrealised appreciation cannot be distributed. Profit or loss on average cost basis. Dividend on ex-dividend date. Sale and purchase accounted on trade date. Brokerage and stamp duties are capitalised and added to cost of acquisition or sale proceeds

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Taxation
Mutual fund is exempt from paying taxes (Section 10 (23D)) Income for investors
Dividend Capital gain

Present position (AMFI examination)

Dividend exempt from tax Fund pays dividend distribution tax at Open end funds with >65% in equity, fully exempt. Tax arbitrage for investors

Security Transaction Tax (STT) is charged as applicable for sale / purchase of units of equity oriented schemes of MF 80 C benefit under ELSS upto Rs. 1 Lac Restriction on dividend stripping
Within 3 months prior to record date of dividend distribution and within 9 months after record date for dividend distribution
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Treatment of Capital Gains

Long term: > 12 months, Short term: < 12 months Long term capital gains subject to indexation benefit 20% +surcharge after indexation 10% + surcharge without indexation Short term capital gains taxed at marginal rate of taxation. No Capital Gain tax payable if entire Capital gain invested within 6 months of transfer in Capital Gain Bonds of NABARD, NHAI, REC U/S 54 EC of I.T Act with a lock-in period of 3 years Long Term Capital Gains are exempt from tax U/S 54 ED if amount invested within 6 months in Equity Shares issued by companies formed & registered in India & offered for subscription to public with a lock-in period for 1 year for Sale / Transfer
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MF Taxation
Equity
Short Term Capital Gains
10%

Debt
Added to Individuals Income, therefore as per Individuals tax bracket 20 percent* with the cost inflation index benefit or 10 percent* without the cost inflation index benefit, whichever is beneficial; Nil 14.025% - Individual/HUF 22.44% - Others (Corporate) (Including a surcharge of 10% & education cess of 2% on the amount of tax plus surcharge)

Long Term Capital Gains

No capital gains tax payable. However, Securities Transaction Tax payable at 0.20 percent of the redemption price. Nil

Dividend Income

Dividend Distribution Tax

NA

Tax Deducted at Source

Nil

Nil

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Indexation - An Example

Investor buys on March 31, 1999 and sells on April 1, 2000. What is the indexation adjustment factor? (1998-99 - 351, 1999-2000 - 386, 2000-01 - 406) Investor buys on April 1, 1998 and sells on March 31, 2001. What is the indexation adjustment factor?

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Session 7
Investor Services

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Application Procedure for Purchase of MF Units

PAN no. to be given if investment is Rs. 50,000/- or more Joint Account can be operated jointly by all NRIs can pay

from FCNR/NRE accounts by demand drafts or cheques to avail the facility with repatriation benefits. payment can be made from NRO/NRNR A/c. without repatriation benefits.

FIIs can remit directly from abroad or pay from special Non Resident Rupee account Offer Documents contains procedure purchasing and redeeming of units Introduction of Multi purpose Application Form
dispenses with the need for existing Investors to fill up full Application Form for making further investments
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Investment Plans and Services

Investment Plans Systematic Investment plan (SIP)
Regular Investment of fixed amount periodically (Rupee Cost Averaging Advantage)

Automatic Reinvestment Plan (ARP)

Reinvestment of Dividend at Ex dividend NAV

Systematic Withdrawal plans (SWP)

Systematic withdrawals on periodic basis

Systematic Transfer Plans (STP)

Transferring a specific amount on periodic basis from one scheme to another of the same fund family by Selling units of one scheme & buying units of another scheme
72

Other Services available under Mutual Funds

Phone Transactions Internet / Email transactions Cheque writing facility for Liquid Funds Periodic statements Periodic statement of Investment Portfolio disclosures Mutual Funds cannot give loan against units Banks can give loan against MF units Nomination facility allowed Units of Close End Schemes can be transferred to another person Transfer in Open Ended Fund happens upon
death of unit-holder or when units are pledged or by operation of law i.e insolvency or winding up of the corporate investor

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Unit Holder Rights

Rights of unit holders services & information protection of rights and problem resolution. Details of information disclosure and their periodicity. Right of proportionate beneficial ownership of schemes assets Documents available for inspection Details of pending litigation and penalties Cannot sue the mutual fund 75% unit holders can wind up a scheme seek AMC termination Prospective investor has no rights Right to redeem for fundamental changes Investors cant sue the Trust but Investor can sue the Trustee In the case of assured return schemes, if the offer document has provided guarantee by a named sponsor, investor can sue the sponsor

74

Investor Rights to Services

Open ended Fund must reopen within 30 days after the NFO period Allotment of units & dispatch of a/c statement within 30 days from the closure of NFO Nomination facility allowed Redemption proceeds to be sent to investor within 10 working days otherwise Penal interest at the rate specified by SEBI for the full period Dividend Warrants to be dispatched within 30 days of dividend declaration by MF

75

Investor Rights to Information

Right of any information that may have adverse bearing on their investment Investors right to inspect documents such as Trust deed, AMC Agreement, Custodian services agreement, Registrars & Transfer agents agreement Balance Sheets of MF Schemes and Balance Sheet of AMC Complete statement of schemes portfolio before one month from the close of each half year unless published.
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Investor Rights to approve changes in fundamental attributes of the scheme

Fundamental attributes
o o o

Type of scheme Investment objective Terms of issue

Also changes in fees and expenses Any other changes which would modify the scheme and affect the interest of the unit holders. This cannot be done unless unit holders are individually informed in writing and given option to redeem their holding without any exit load Advertisement given in English news paper , with nation wide circulation and regional news paper where head office of mutual fund is situated

77

Investors Obligations & Complaint Redressal

Investor should: Read Offer Documents Understand Risk factors Monitor performance of his investments Complaint Redressal Through SEBI intervention Investors cannot seek redressal under Companies Act since fund investors are neither share holders nor depositors in AMC
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SESSION 8

INVESTMENT MANAGEMENT

79

What is Investment Management ?

Investment or Portfolio Management is a specialist function. After collecting and investing an investors money effective portfolio management will have to give acceptable returns to the investor, in order to keep him satisfied and prevent him from moving to any other competitor fund

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Equity Portfolio Management

An equity portfolio managers task consists of two major steps :
Constructing a portfolio of equity shares or equity-linked instruments consistent with the investment objective Managing or constantly rebalancing the portfolio

Stocks will be chosen in accordance with

a) Nature of equity instruments or a stocks unique characteristics b) Investment style or philosophy adopted by fund manager

Types of Equity Instruments

Ordinary Shares Preference Shares Equity Warrants Convertible Debentures Equity Classes

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Equity Portfolio Management

Market Capitalisation
Market Capitalisation is equivalent to the current value of a company. There are Large Capitalisation companies, Mid-Cap companies and Small-Cap companies

Classification in Terms of Anticipated Earnings

Price Earning Ratio Dividend Yield Cyclical Stocks Growth Stocks Value Stocks
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Equity Portfolio Management

Investment Strategies:
Growth and value Active and passive Large and small cap Cyclical stock Stock selection
P/E ratio Dividend yield Undervalued companies

Fundamental analysis Technical analysis Quantitative analysis

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Role of Security Research in Active Fund Management

Fundamental Analysis
Research inputs based upon Operations & finances of the company, to estimate future earnings.

Technical Analysis
Analysis of share market price and traded volumes to recognize market sentiments &trends in supply/demand Recognize pattern in market price behavior & predict the future course of market price of the share.

Quantitative Analysis
Analysis of Sectors and Industries based upon macroeconomic factors

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Equity Portfolio Management Organisation Structure

Fund Manager
Focuses on Asset Allocation, Industry Exposure Selects stocks & ensure investment remains inline with schemes objective Fixes price range for purchase & sale

Analyst
Researches funds Target sectors, companies and overall market recommends buy & sell

Dealer
Executes buy and sell orders with brokers

85

For Successful Equity Portfolio Management

Set realistic returns based on a Benchmark Be aware of the flexibility in managing a portfolio Decide on investment philosophy Develop an investment strategy based upon objectives & time horizons Avoid over diversification of portfolio & have well diversified portfolio Develop a flexible approach to investing

86

Use of Equity Derivatives

Mutual Funds were allowed to make use of Futures & Option contracts in Equities for Portfolio risk management Portfolio Rebalancing Since September 2005 SEBI has also allowed Mutual Funds to trade in Derivative Contracts. To enhance portfolio returns To launch schemes which invest mainly in Futures & Options

87

What are Equity Derivatives?

Equity derivatives instruments are specially designed contracts They derive their value from an underlying asset They are traded separately in F & O segment of Exchange Main derivative instruments are Futures, Options
88

What are Equity Derivatives?

In a future contract you can buy & sell the underlying equity at a specified future date at agreed price Contract can be liquidated before maturity date without taking or giving delivery of underlying asset In option contract the buyer of option contract gets the right to buy or sell the underlying equity at agreed price on a future date only if he exercises the option & for this right he pays a price called Premium. Option contracts are of two types
89

Using Derivatives for Hedging Portfolio Risk

If Fund manager expects the equity market to decline he may not sell the equity in the Cash Market. But can sell the Index Future at the current price for future delivery. If markets fall the equity portfolio value will decline, but future contract will show a corresponding profit, since fund manager has sold future contract at a higher price. If market rises equity portfolio value will rise but future contract will show corresponding loss, since fund manager has sold future contract at lower price This is called Hedging Portfolio Risk
90

Using Derivatives for Hedging Portfolio Risk

Other method of hedging investment portfolio risk is by buying a Put Option (an option to sell the underlying equity at an agreed price) by paying premium. A fund manager can execute the option only if the price falls, since he has right to sell at a higher price. If the price rises he will not execute the option and forgo the premium

91

INVESTMENT MANAGEMENT EQUITY FUNDS

ACTIVE

PASSIVE Index Funds

DIVERSIFIED

NONDIVERSIFIED SECTORAL
Technology fund Services Fund FMCG Fund Infrastructure Fund

GROWTH

VALUE
ICICI PRUDENTIAL DSCOVERY FUND

92

Value vs Growth : Winners Rotate

30%

20%

10%

0%

-10%

-20%
S&P/Barra Value Index S&P/Barra Growth Index

-30% Sep-81

Sep-85

Sep-89

Sep-93

Sep-97

Sep-01

93

Dealer Use Only

Debt Securities: Types

Debt Securities
Government Securities PSU Bonds FI Bonds Bank Bonds Corporate Debentures

Features
Market traded instruments Secured / Unsecured Bonds Interest bearing / discounted or zero coupon bond Fixed rate / Floating rate Debt Securities Rated / Un-rated Debt Securities Listed / Un-listed Debt Securities
94

Money Market Securities

All Debt Securities maturing within one year are called Money Market Securities Money Market Securities (Instruments) are: T-Bills CDs CPs Call Money Repos Basic Characteristics of a Debt Security / Bond Face Value, Par Value Coupon Maturity Date Put/Call options
95

Debt Portfolio Management

Tenor
short and long put and call options

Interest payment
Fixed and floating Periodic v/s Discounted

Credit quality
Gilt, guaranteed, and others

Traded and non-traded

96

Risks of Investing in Debt Securities / Bonds

Interest rate risk Re-investment risk Call risk Default risk Inflation risk Liquidity risk

97

Measures of Bond Yields, Yields Spreads & Credit Risk

Measures of Bond yields are
Current Yield Yield to maturity (YTM)

Yield curve is the graph showing yields for bonds of various maturities. using a benchmark group of bonds, such as GOI Securities Yield Spread is the additional yield over G-sec yield paid by borrower to account for risk of default by borrower. Credit risk is assessed using the ratings by credit rating agencies. Higher the credit rating, lower the spread and vice-versa

98

Price and Yield

Increase in rates reduces value of existing bonds. Decrease in rates increases value of existing bonds Price and yield are inversely related The relationship between yield and tenor can be plotted as the yield curve.

Bond Prices

Interest Rates

99

Current Yield and YTM

Coupon as a percentage of current market price If we bought a 10% bond at Rs. 120, the current yield (10/120)*100 = 8.33% =

Yield to Maturity
Rate at which present value of future cash flows equals the current market price. Given price, YTM can be calculated through iteration. Given YTM, price can be computed, using the YTM rate to discount the future cash flows

100

Duration of a Bond A Measure of Interest Rate Risk

Duration of a Bond is the average maturity period of a Bond as distinguished from the term of the Bond Duration helps to measure the sensitivity to changes in the interest rate Duration measures the % change in Bond Price with a change in yield by 1% If duration is 3 years, and interest changes by 1%, price of the bond will change in the opposite direction, by 3%. Higher the duration of a Debt Portfolio, higher the risk of loss of value of the Portfolio if the rates of interest go up & vice-versa Duration of Bond is less than its term, except for zero coupon bonds Example: Duration of a bond is 4 years. Yield spreads increases by 1.5%. what is the change in price? Change in the Price = 1.5 *4 = -6%
101

Using Derivatives for Debt Portfolio Management

Debt Portfolio Risk arising out of Interest Rate increase can be hedged through interest rate derivatives. Interest rate derivatives are either exchange traded or privately traded in OTC market A Debt Portfolio Manager can sell interest rate futures or buy interest rate put options on an exchange to protect Debt Portfolio Value He can also buy and sell Forward Contracts or Swaps bilaterally with other market players in OTC.

102

Using Derivatives for Debt Portfolio Management

In India Interest Rate Futures are available for trading at NSE since 2004 Interest rate options are not introduced in India in the Exchange Through Swaps fund managers can hedge interest rate risk to Debt Portfolios Since June 2003 SEBI has permitted Mutual Funds to trade in Exchange Traded Debt Derivatives A portfolio manager can sell interest rate futures or buy Interest rate put options, usually on an exchange to protect the value of his debt portfolio. He can also buy or sell forward contracts or swaps bilaterally with other market players on OTC Market.

103

Investment Restrictions
Invest only in marketable securities. Investment only on delivery basis A mutual fund under all its schemes, cannot hold more than 10% of the paid-up capital of a company Not more than 10% of its NAV in a single company
Exceptions: Index Funds and Sectoral funds

Rated investment grade issues of a single issuer cannot exceed 15% of the net assets
Can be extended to 20%, with the approval of the trustees

104

Investment Restrictions Contd...

Investment in unrated securities of one company cannot exceed 10% of the net assets of a scheme and not more than 25% of net assets of a scheme can be in such securities Investment in unlisted shares cannot exceed
5% of net assets for an open-ended scheme, 10% of net assets for a close-ended scheme

Mutual funds can invest in ADRs/GDRs ( As per May 07 Circular)

up to a maximum limit of 10% of net assets managed by them as on March 31st of each relevant year or $200 million, whichever is lower. The limit for the mutual fund industry as a whole is $4 billion

Mutual funds can also invest in a limited manner in treasury bonds and AAA rated corporate debt issued outside India.

105

Inter-scheme Transfer

Such transfers happen on a delivery basis, at market prices. Such transfers should not result in significantly altering the investment objectives of the schemes involved. Such transfer should not be of illiquid securities, as defined in the valuation norms. One scheme can invest in another scheme, up to 5% of net assets. No fee is payable on these investments (Limit does not apply to FOF scheme).

106

Investment in Sponsor Company

A mutual fund scheme cannot invest in unlisted securities of the sponsor or an associate or group company of the sponsor. A mutual fund scheme cannot invest in privately placed securities of the sponsor or its associates. Investment by a scheme in listed securities of the sponsor or associate companies cannot exceed 25% of the net assets of the scheme

107

Other Limits
Mutual funds cannot make loans Mutual funds can borrow upto 20% of net assets for a period not exceeding 6 months. Derivatives can be used only after informing investors Any change in investment objectives requires information to investor, and provision of option to exit at NAV, without exit load.

108

SESSION 9

MEASURING & EVALUATING PERFORMANCE

109

Risk in Mutual Fund Returns

Risk arises when actual returns are different from expected returns. Historical average is a good proxy for expected return. Standard deviation is an important measure of total risk. Beta co-efficient is a measure of market risk. Ex-marks is an indication of extent of correlation with market index.

110

Computing Returns
Sources of return
Dividend Change in NAV

Return = Income earned for amount invested over a given period of time Standardise as % per annum Computing return
-Percentage change in NAV. -Simple total return -ROI or Total return with dividend re-investment -Compounded rate of growth

111

Total Return
Investor bought units of a mutual fund scheme at a price of Rs.12.45 per unit. He redeems the investment a year later, at Rs. 15.475 per unit. During the year, he also receives dividend at 7%. The rate of return on his investment can be computed as =((15.475 12.45) + 0.70)/12.45 x 100 = (3.725/12.45) x 100 = 29.92%

Dividend distributed + Change in NAV NAV at the beginning

X 100

112

Total Return or ROI Method

(Value of holdings at the end of the period - value of holdings at the beginning of the period)/ value of holdings at the beginning of the period x 100 Value of holdings at the beginning of the period = number of units at the beginning x begin NAV. Value of holdings end of the period = (number of units held at the beginning + number of units re-invested) x end NAV. Number of units re-invested = dividends/ex dividend NAV.

113

ROI Method: Example

An investor buys 100 units of a fund at Rs. 10.5 on January 1, 2001. On June 30, 2001 he receives dividends at the rate of 10%. The exdividend NAV was Rs. 10.25. On December 31, 2001, the funds NAV was Rs. 12.25. What is the total return on investment with dividends re-invested?

ROI Method: Solution

The begin period value of the investment =10.5x100= Rs. 1050 Number of units reinvested = 100/10.25 = 9.756 units End period value of investment = 109.756 x 12.25 = Rs. 1344.51 The ROI =[(1344.51-1050)/1050 ]x 100 = 28.05%

114

Compounded Average Growth Rate

CAGR is the rate at which investment has grown from begin point to the end point, on an annual compounding basis. V0(1+r)n = V1 r =((V1/V0)1/n)-1 Where n is the holding period in years.

115

CAGR: Example
An investor buys 100 units of a fund at Rs. 10.5 on January 6, 2001. On June 30, 2001 he receives dividends at the rate of 10%. The ex-dividend NAV was Rs. 10.25. On March 12, 2002, the funds NAV was Rs. 12.25. Compute the CAGR.

CAGR: Solution
The initial value of the investment= 10.5 x 100 = Rs. 1050 Number of units reinvested = 100/10.25 = 9.756 units Final value of investment = 109.756 x 12.25 = Rs. 1344.51 Holding period = 6/01/01 - 12/3/02 = 431 days The CAGR is =[(1344.51/1050)365/431 - 1 ]x 100 = 23.29%

116

Returns: Industry Practice

Growth Option: CAGR implicit in the change in holding period NAVs. Dividend Option: CAGR implicit in the change in value over the holding period, assuming reinvestment of dividend at ex-dividend NAV. Less then 1 year, simple return without compounding or annualisation. Some funds use simple annualised return, without compounding.

117

SEBI Regulations
Standard measurements and computation Compounded annual growth rate for funds over 1 year old. Return for 1,3 and 5 years, or since inception, which ever is later. No annualisation for periods less than a year except for liquid funds.

118

Benchmarks
Relative returns are important than absolute returns for mutual funds. Comparable passive portfolio is used as benchmark. Usually a market index is used. Compare both risk and return, over the same period for the fund and the benchmark. Risk-adjusted return, is the return per unit of risk.

Type of Equity Fund Index Funds Diversified Equity Funds Sector Funds

Name of Benchmark BSE Sensex Index or S&P CNX Nifty Index BSE 100 or 200 Index Sector Specific Index

Mid cap & Small cap funds Mid cap & Small cap index
119

Benchmarks For Debt Funds & Money Market Funds

Type of Debt Fund Gilt Fund Debt Fund Money Market Fund Name of Benchmark Government Security Index Composite Bond fund Index Liquid fund Index of CRISIL NSEs G Sec & Treasury bill index

120

Benchmarks For Debt Funds & Money Market Funds

There are various Indicies for benchmarking of Debt Funds I-Bex Index of I-SEC is used
for tracking Govt. Security performance of various maturities

CRISIL has 8 Debt Indices 4 primary & 4 derived a) primary indices cover:
AAA & AA rated Corporate Bonds, Money Market & Commercial Paper b) Derived indices : Liquid fund index for call market & CP Balanced fund index Composite index tracks return on call G-Sec, AAA, AA Securities & CP

121

Benchmarks For Debt Funds & Money Market Funds

NSE has Govt. Security Index & Treasury Bill Index SEBI requires MF to specify Benchmark for each scheme in OD & KIM

122

SEBI Guidelines
Benchmark should reflect the asset allocation Same as stated in the offer document Growth fund with more than 60% in equity to use a broad based index. Bond fund with more than 60% in bonds to use a bond market index. Balanced funds to use tailor-made index Liquid funds to use money market instruments.

123

Other Measures of Performance

Tracking error Tracking error for index funds should be nil. Credit quality Rating profile of portfolio should be studied Expense ratio Higher expense ratios hurt long term investors Portfolio turnover Higher for short term funds and lower for long term funds Size and portfolio composition

124

SESSION 10

FINANCIAL PLANNING

125

Concept of Financial Planning

Financial planning identifies all the financial needs of an investor and translates the needs into monetarily measurable goals. These goals can be short term, medium term and long term. A Financial Planner plans the financial investments that will allow these goals to be met.

Financial Planning provides direction and meaning to financial decisions. It helps to understand how each financial decision effects other areas of ones finances By viewing each financial decision as part of a whole one can consider its short and long term effects on ones life goals

126

MFs in Financial Planning

Forms the core foundation and building block for any type of FP Variety of products available to suit any need or combination of needs Barring life and property insurance, rest of the product portfolio can be created out of bouquet of MFs A Good Financial Planner Understands: The universe of investment products Risk-return attributes Tax and estate Planning Has the ability to convert life cycles of investors into need and preference based financial products Organised approach to work Excellent communication and interpersonal skills
127

Classification of Investors
Wealth cycle based classification Life cycle based classification

128

Wealth Cycle Stages of Investors

Another method of classifying investors is Wealth Cycle Stage (as against Life Cycle Stage There are 3 Wealth Cycle Stages for Investors Accumulation Stage Transition Stage Reaping Stage Intergenerational Transfer Stage refers to transferring wealth to be done in favour of clients grown up children( balanced combination of growth & income funds), grand children (growth funds)or to a family or to charitable trusts ( Income Funds) The Sudden Wealth Stage refers to winning lotteries, inheritance,sale of business.
129

Categories of Affluent Investors

Affluent investors do not need financial planning for life goals. They can be classified into 2 categories Wealth-Creating Affluent Investors(70-80% allocation to diversified equity & sector funds) Build further wealth Willing to take a risk to make net- worth grow Wealth-Preserving Affluent Investors( conservative portfolio with 70-80% exposure to income, gilt & liquid funds, remaining in low risk diversified equity or balanced fund.)
130

Life Cycle Stages of an Individual

Childhood Stage Young Unmarried Stage Young Married Stage Young Married with Children Stage Married with Older Children Stage Post-family/ Pre-retirement Stage Retirement Stage

131

Life Cycle Stages

I N C O M E

CHILDS MARRIAGE CHILDS EDUCATION

CHILDS BIRTH MARRIAGE

EXPENSES Over 25-30 yrs Retirement

22 yrs Birth & Education

132

38 yrs

Earning Years

Process of FP in Practice
Step I: Establish and define the relationship with the client Step II: Define the clients goals Step III: Analyse and evaluate clients financial status Step IV: Determine and shape the clients risk tolerance level Step V: Ascertain clients tax situation Step VI: Recommend the appropriate asset allocation and specific investments Step VII: Executing the plan Step VIII: Periodic Review
133

Products Available
Physical Assets Gold & Real Estate Bank Deposits Corporate Shares, Bonds, Debentures & Fixed Deposits Government G. Secs, PPF, RBI Relief Bonds and other personal Investments Financial Institutions Bonds, Shares Insurance Companies Insurance Policies

134

Bank Deposits
Available since a long period of time Large geographical network transactions made easy & convenient Fund transfer mechanism available Perception of bank deposits being free of default; Deposits guaranteed up to Rs 1 lakh per depositor Electronic facilities make it liquid and easy to use

135

Public Provident Fund

15-year product Risk-free government obligation Open to individuals and HUFs Only one account permitted per entity Offers tax-free interest of 8% p.a. and contribution up to Rs. 70,000 (min Rs. 500) are eligible for deduction under sec 80C Option to withdraw 50% of 4th year balance in the 7th year Restriction on withdrawal reduces liquidity.

136

RBI Relief Bonds

Issued by RBI on behalf of the Government of India A 5-year investment product with 8% interest offering Interest is currently taxable (used to be tax-free earlier) Free of risk of default Government Securities Long-term government paper Risk-free government obligation Low-return and define the benchmark rate of return on the yield curve Specially appointed Primary dealers deal in G-Secs Generally high ticket investments Best accessible to small investors through mutual funds.

137

Other Government Schemes

Indira and Kisan Vikas Patra Introduced as post office scheme to tap savings in rural India Very popular with urban investors also Current yield is 8% over 6 years, fully taxable IVP permits cash investment and protection of identity Easily transferable and liquid.

138

Life Insurance
Viewed more for investment and tax purposes than a vehicle for risk protection Premium qualify for deduction under section 80C Important to assess need for life insurance with respect to earning potential A Without Profits policy offers the Sum Assured in the event of death only A With Profit policy pays not only the Sum Assured but also bonus declared from time to time In case a policy is discontinued during its tenure, the policys surrender value is paid which is a proportionate value based on premiums paid so far A convergence of insurance and mutual funds is the development of Unit-Linked Insurance products which offers investors choice of asset allocation between debt and equity.

139

Instruments issued by Corporates

Commercial Paper Debentures Equity Shares Preference Shares Fixed Deposits Bonds of FI

140

How to Compare Products

Compare options by nature of investments Characteristics, benefits and risks. Current performance and suitability Taxability, age, risk profile.

Why MF is the Best Option?

Mutual funds combine the advantages of each of the investment products Dispense the short comings of the other options Returns get adjusted for the market movements

141

Strategies for Investors

Harness the power of compounding Start early Have realistic expectations Invest regularly

Useful Strategies
Rupee Cost Averaging Value Averaging Jacobs rebalancing strategy Grahams 50:50 rebalancing strategy
142

Rupee Cost Averaging

Invest regularly a predetermined amount Invests in more units when the market is low; less when the markets are high. Reduces the average cost of purchase

Value Averaging
Invest regularly to achieve a predetermined value Books profits at a high, and adds units at the low, and enables meeting financial goals. Reduces the average cost of purchase
143

Rupee Cost Averaging

Am ount N AV per N u m b e r o f C u m u la tiv e I n v e s te d u n it u n its b o u g h t num ber of (R s) u n its 1000 1 2 .5 8 0 .0 0 8 0 .0 0 1000 1 1 .2 5 8 8 .8 9 1 6 8 .8 9 1000 1 0 .7 5 9 3 .0 2 2 6 1 .9 1 1000 11 9 0 .9 1 3 5 2 .8 2 1000 1 2 .7 5 7 8 .4 3 4 3 1 .2 5 1000 1 3 .3 5 7 4 .9 1 5 0 6 .1 6 1000 1 3 .8 5 7 2 .2 0 5 7 8 .3 6 1000 1 4 .4 5 6 9 .2 0 6 4 7 .5 7 1000 1 3 .8 5 7 2 .2 0 7 1 9 .7 7 1000 1 3 .5 7 4 .0 7 7 9 3 .8 4 A v e ra g e c o s t 1 2 .6 0 V a lu e o f h o ld in g 1 0 0 0 .0 0 1 9 0 0 .0 0 2 8 1 5 .5 6 3 8 8 1 .0 3 5 4 9 8 .4 7 6 7 5 7 .2 2 8 0 1 0 .3 0 9 3 5 7 .3 2 9 9 6 8 .7 8 1 0 7 1 6 .8 6

144

Value Averaging
Target NAV Per Value Of Value Unit Holding 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000
145

12.5 11.25 10.75 11 12.75 13.35 13.85 14.45 13.85 13.5

Units Cumulative To Balance Invest 0.00 80 80 900.00 97.78 177.78 1911.11 101.29 279.07 3069.77 84.57 363.64 4636.36 28.52 392.16 5235.29 57.28 449.44 6224.72 55.98 505.42 7303.25 48.22 553.63 7667.82 96.19 649.82 8772.56 90.92 740.74

SESSION 11
ASSET ALLOCATION, FUND SELECTION & MODEL PORTFOLIO

Asset Allocation and Model Portfolios

Deciding the allocation of funds amongst equity, debt and money market. Incorporating product, investor profile and preferences in the portfolio Equity, debt and money market products are called asset classes. Allocating resources to each of these is called asset allocation.

147

ASSET ALLOCATION

LIQUID

DEBT

BALANCED

EQUITY
INDIRECT

DIRECT

INDIRECT

DIRECT

INDIRECT

DIRECT

SHORT TERM MEDIUM TERM LONG TERM

GILT FUND BOND FUND HIGH YIELD BOND FUND

PASSIVE
INDEX

ACTIVE
DIVERSIFIED NON-DIVERSIFIED SECTORAL

148

Fixed and Flexible Asset Allocation

Fixed ratio between asset classes
Portfolio has to be periodically re-balanced Disciplined approach Enables investor to book profits in a rising market and invest more in a falling market

Flexible allocation
No re-balancing; asset class proportions can vary when prices change. If equity returns are higher than debt returns, equity allocation will go up at a faster rate Low Risk Funds( Money Market & G-Sec Funds), Moderate Risk Funds( Income, Balanced, Growth & Income, Growth,Short Term & Intermediate Bond Funds, Index Funds) & High Risk Funds( Aggressive Growth, International, Sector, Specialized, Precious Metals, High Yield Bond & Commodity Funds)
149

Developing a Model Portfolio

Jacobs Four Step Program Develop long term goals Investment avenues, time horizon, return and risk Determine asset allocation Allocation to broad asset classes Determine sector distribution Allocation of sectors of the mutual fund industry Select specific fund schemes for investment Compare products and choose actual funds to invest in
150

Jacobs Model portfolio

PHASE Distribution or Reaping

Accumulation

Transition

Diversified Equity, Sector & Balanced Funds

65-80% Equity To Cash

15-30%

Income & Gilt Funds

15-30%

65-80%

Liquid Funds & Bank Deposits

5%

5%

151

Model Portfolios for Clients Recommended by Jacobs

Conservative Equity Young Unmarried Professional Young couple with 2 incomes Older Couple Aggressive Equity 50% Emerging Growth Equity Income /Bond 25%

MMF 25%

Municipal Bond

35% 30% 25% 10% LT-35% 25% 10% ST-30%

Recently retired

35%

25%

40%

152

Grahams Model Portfolio

Based on the 50:50 rule. Basic managed portfolio. Basic indexed portfolio. Simple managed portfolio. Complex managed portfolio. Readymade portfolio.

Bogles Strategic Asset Allocation

Combines age, risk profile and preferences in asset allocation Older investors in distribution phase 50% equity;50% debt Younger investors in distribution phase 60% equity; 40% debt Older investors in accumulation phase 70% equity; 30% debt Younger investors in accumulation phase 80% equity; 20% debt

153

Fund Selection
Equity funds: Characteristics Fund category Suitability to investor objective Investment style Growth vs Value Age of the fund Experience preferred to new fund Fund management experience Size of the fund Larger funds have lower costs Performance and risk
154

Equity Funds: Selection Criteria

Percentage holding in cash. Concentration in portfolio. Market capitalisation of the fund. Portfolio turnover. Risk Statistics Beta Ex-Marks Gross dividend yield Funds with low beta, high ex-marks and high gross dividend yield is preferable

155

Debt Funds: Selection Criteria

A smaller or new debt fund may not necessarily be risky Total return rather than YTM is important Expense very important High expense ratios lead to yield sacrifice Credit quality Better the rating of the holdings, safer the fund Average maturity Higher average maturity means higher duration and interest rate risk

156

Money Market Funds

Liquidity and high turnover rate Shorter term instruments are turned over more frequently. Protection of principal invested NAV fluctuation limited due to low duration and low levels of interest rate risk. Credit quality of portfolio Low expense ratio

157

Session 12
Business Ethics for Mutual Funds

158

What is meant by Business Ethics ?

It means rules of acceptable and good conduct Rules may be set my those who own and run a business or by an agency

Need for Business Ethics

In a civilised society business must be conducted in an ethical, disciplined, organized and fair manner. Good ethics is good business. Ethical practices ensure that the customer remains a long term and satisfied buyer Honesty is the Best Policy

159

Objectives
Simply be honest, open and transparent with all your current and potential clients Protect customers from being cheated and exploited Ensure a level field playing among all categories of business participants

Key Terms of Business Ethics

Fair Business Practices Ethical Standards Ethical norms or guidelines A Code of Conduct Ethical Business Practices Conflict of interest in a mutual fund business
160

Business Ethics & Mutual Fund Regulations in India

The main role of SEBI is to protect the interest of the investors. SEBI encourages development of ethical standards among the Mutual Funds SEBI guidelines require Mutual Funds and AMFI to develop Code of Conduct for
Distributors Fund Managers All employees Associated persons of AMC & Trustee Company

SEBI also lays down its own rule of ethics for certain matters incorporated in the Mutual Fund regulations

161

Business Ethics & Mutual Fund Regulations in India

SEBI mandates that all activities are done in the best interest of the investors and it monitors 3 areas
Fund structure and governance Exercise of Voting Rights by Funds Fund operations

Fund Structure
The Mutual Fund structure in India is
a 3 tier structure with sponsor, trustees & AMC as independent bodies

AMCs are supervised by independent Trustees

who have fiduciary responsibility towards the investors.

162

Fund Governance
Separation of Functions There is a separation of functions,
AMC charged with investment of funds and they dont hold asset of the fund. The Trust holds investment assets in fiduciary capacity since beneficial owners are investors. Trustees actually dont hold the trusts assets investment assets are held by the custodians

Independence of Organizations & Personnel By separating ownership, management & custody of assets fraudulent use of assets is prevented. Board of trustees have at least 2/3rd independent directors
thus ensuring independence of organization

AMC board has at least 50% independent directors

thus reducing the influence of the promoter.

163

Exercise of Voting Rights by Funds

The Mutual Funds have to exercise voting rights in the companies
in the interest of fund investors and not in the interest of fund managers or promoters or employees.

It is an ethical but not a legal requirement

164

Ethics in Fund Operations

SEBI expects day to day fund managements to observe ethical business practices.
Insider trading regulations No preferential treatment to selected investors Uniform cut off time for accepting subscription application & for determining applicability of uniform NAVs to all customers Control over Personal Trading by Fund Managers and employees Personal trades to be disclosed by the Fund Managers and the Directors

165

Ethics in Fund Publicity & Advertisement

All forms of advertisements to be as per SEBI Regulations To ensure that they dont mislead the investors. Covered in ethics related regulations, the 6th Schedule to SEBI ( MF) Regulations, 1996 Regulations require AMC to file with the trustees A quarterly statement of dealing in securities by the key personal of AMC Directors of AMC to file quarterly details of transactions in securities which exceed value of Rs. 1 lakh Directors of trustee company also have to file details of transactions in securities with MF when they exceed value of Rs. 1 lakh
166

Ethics in Fund Publicity & Advertisement

Regulations require the trustees of the mutual fund to certify
that the personnel of the AMC do not indulge in Front Running or self dealing.

SEBI has made it mandatory for the AMC to appoint a Compliance Officer
to ensure implementation of laws and Mutual Fund Regulation & voluntary Code of Conduct.

SEBI requires all distributors to follow a Code of Conduct. AMFI has put in place amore detailed Code of Conduct called AGNI (AMFI Guidelines & Norms for Intermediaries Mutual funds have to report any violation of all these regulations

167

Business Ethics & Fund Regulations in the U.S

Fund Governance
The U.S Regulator (Security Exchanges Commission) require at least 75% of the funds board to be independent directors including the Chairman. Independent directors are required meet separately every quarter and make self assessment of their effectiveness

Codes of Ethics for Investment Advisors

SEC requires registered investment advisors to adopt and enforce codes of ethics applicable to their supervised persons, including personal trading Supervised persons have to acknowledge in writing receipt of copy of the Code of Ethics.

168

Codes of Ethics for Investment Advisors

An advisors code will require the advisors supervised persons to comply with applicable Federal Securities Laws.
There is requirement of reporting of personal securities holding & transactions, including transactions in Mutual Funds advised by the advisor. The Code requires access persons to pre clear any personal investments in IPOs Prevention of Disclosure of material non public information about the advisors buy and sell recommendations. Reporting of code violations to the compliance officer

169

Ethical Issues & Responsible Investing

The law requires institutional investors to invest as a Prudent Man would invest. The Mutual Fund managers have also to follow Prudent Man Approach & Responsible Investing Approach even though there is no law. Prudent investment , which refers to quality and safety of investment Responsible Investing means funds manager must invest with a sense of responsibility towards the interest of the investor.

170

Ethical Issues & Responsible Investing

Tools for responsible investing are : Screening of investment a) Investment may pass the business criteria & regulatory norms, yet may be rejected on ethical grounds. b) Some funds in US will not invest in companies manufacturing Cigarettes or alcohol. Share holder activism by fund advisors /managers In the share holders meetings of companies in which the fund has invested , the fund managers & trustees are expected to actively vote for or against the management resolution ,but in interest of the investor Community investing special investment programs aimed at helping small communities or cities in need of development ie: underprivileged communities & cities.

171

Business Ethics & Fund Regulations in the U.S

New Regulations & Fair Business Practices require
AMCs to avoid making special payments to distributors and brokers in return for favourable treatment of specific funds by brokers who advice the investors Uniform cut off time for all funds for NAV calculations

172

Thank you and all the very best!!