NISM-Series-V-A: Mutual Fund
Distributors Certification
Concept
◦ Mobilize money from investors
◦ Investment in different markets and securities
◦ Common Investment objectives
Role of mutual funds
◦ Investors
Income or wealth building
Large investors can keep a check on the operations of the investee company, their corporate governance and ethical standards.
Concept and role of a mutual
fund
Government
◦ Raise money to invest in various projects ◦ Raise money to pay for various expenses
◦ Higher employment, income and output in the economy boos the revenue collection of the government through taxes and other means.
Companies
◦ Money to invest in various projects and pay for various expenses
Economy
◦ Employment to people
◦ The income they earn helps the employees buy goods and services offered by other companies.
◦ Overall economic development is promoted
◦ Stabilize market by countering large inflows or outflows from foreign investors
Schemes announce investment objectives Seek investments from the public
Structure of the scheme decides whether the
money from investors will be accepted during a limited period or at any time
Units
◦ The investment in a scheme is translated into a certain number of units.
◦ Under the law, every unit has a face value of Rs. 10 (older schemes in the market may have a different face value)
◦ No. of units x face value = Unit capital
How do Mutual Fund schemes
operate?
Earnings:
◦ Interest income
◦ Dividend income
◦ Realized capital gains (or realized capital losses) when investment is sold
◦ Valuation gains (loss): investments are quoted in the market at higher (lower) than the cost
Operating expenses
How do Mutual Fund schemes
operate?
Net Asset Value (NAV) = Unit-holders funds
in the scheme/ No. of units
New Fund Offer (NFO)
◦ Scheme’s first availability
◦ Units are available at face value
Options
◦ Growth
◦ Dividend payout
◦ Dividend re-investment
How do Mutual Fund schemes
operate?
AUM (assets under management)
◦ Relative size of mutual fund companies
◦ Investments increase AUM whereas redemptions decrease AUM
Profitability metric
◦ (+) interest income
◦ (+) dividend income
◦ (+) realized capital gains
◦ (+) valuation gains
◦ (-) realized capital losses
◦ (-) valuation losses
◦ (-) scheme expenses
How do Mutual Fund schemes
operate?
Professional Management
◦ Adequate research
◦ Prudent processes
◦ In line with investment objectives
Affordable portfolio diversification
◦ Can achieve diversification even with Rs. 500
Economies of scale
◦ Professional managers
◦ Cost of research
◦ Negotiation of better terms with brokers, bankers and other service providers.
Advantages of Mutual
Fund
Liquidity
Tax deferral
◦ Not liable to pay tax on the mutual fund income in the same year.
◦ If the income were earned indirectly, tax may have to be paid in the same financial year.
◦ Investor can let their money grow to defer the tax liability.
◦ Investors can legally build their wealth faster than would have been the case, if they were to pay tax on the income each year.
Advantages of Mutual
Fund
Tax benefits
◦ Tax deduction upto Rs. 1,50,000 in a financial year for investment in ELSS.
◦ RGESS (Rajiv Gandhi Equity Savings Scheme offers a rebate to first time retail investors with annual income upto Rs. 12 lakhs.
◦ RGESS:
50% of the amount invested upto Rs. 50,000 can be claimed
as deduction
Investment limit of Rs. 50,000 is applicable for a block of
three financial years starting with the year of first investment.
The maximum deduction that can be made from the taxable
income over the period of three financial years is 50% of Rs. 50,000 i.e. Rs. 25,000.
Advantages of Mutual
Fund
Dividends received from mutual fund schemes are tax-free in
the hands of the investors.
Long term capital gains arising out of sale of some categories
of schemes are subject to long term capital gains tax.
Convenient options
◦ Ability to withdraw only part of the money from the investment account.
◦ Ability to invest additional amounts
Investment comfort
◦ Once an investment is made, further purchases can be made with very little documentation
Regulatory comfort
◦ Mutual fund investors enjoy protection of the regulator
Advantages of Mutual
Systematic approach to investments
◦ Systematic investment plan
◦ Systematic Withdrawal plan
◦ Systematic Transfer plan
Advantages of Mutual
Fund
Lack of portfolio customization
◦ Unitholder cannot influence what securities or investments should the scheme buy.
Choice overload
◦ Over 1800 mutual fund schemes offered by 45 mutual funds and their multiple options
Investor has no control over costs
Open- ended funds
◦ Open for investors to enter or exit at any time after the NFO
◦ When units are acquired, it is known as a sale transaction. It happens at a sale price which is equal to NAV
◦ When investors choose to return any of their units, it is called a re-purchase transaction. This also happens at NAV
◦ Although some unit-holders may exit from the scheme,
wholly or partly, the scheme continues operations with the remaining investors.
◦ The on-going entry and exit of investors implies that the unit capital in an open-ended fund would keep changing on a regular basis
Close-ended funds
◦ Fixed maturity
◦ Units can be bought only during NFO
◦ Post NFO, units are traded on a stock exchange
◦ Listing on stock exchange is compulsory for close-ended schemes
◦ Unit Capital of the scheme remains fixed
◦ The transaction price of the units is likely to be
different from the NAV as the fund is not involved in the transaction
◦ The transaction price depends on the demand and supply of the scheme
Interval funds
◦ Combination of Open-ended and close-ended schemes
◦ Largely close-ended but become open-ended at pre-specified intervals
◦ Investors are not completely dependent on the stock exchange to be able to buy or sell units
◦ Between these intervals, the units have to be compulsorily listed on stock exchanges
◦ Period when an interval scheme becomes open-ended, is called ‘transaction period’
◦ Period between the close a transaction period and the opening of the next transaction period is called ‘ interval period’
◦ Minimum duration of transaction period is 2 days and minimum duration of interval period is 15 days.
◦ No redemption/repurchase of units is allowed except during the specified transaction period
Actively managed funds
◦ Fund manager has the flexibility to choose the
investment portfolio within the broad parameters of the investment objectives
◦ Expenses for running the fund turn out to be higher
◦ These funds are expected to perform better than the market
Passive funds
◦ They track the performance of a specified index and mirror the investment
◦ The composition and the proportion of each share in the scheme’s portfolio is same as the benchmark index
◦ They are not designed to perform better than the market
◦ They are also called ‘Index funds’
◦ Low expenses for running the scheme
◦ The fund manager has no role in deciding on investments
Equity Schemes
◦ Investment objective is to invest largely in equity
shares and equity related investments like convertible debentures
◦ Investment objective is to seek capital appreciation
Debt funds
◦ Investment objective is to limit investments in debt securities like Treasury bills, Government securities, Bonds and Debentures
Hybrid funds
◦ Investment in both – debt and equity
◦ Some of them invest in gold along with debt and equity
Gilt funds
◦ Invest only in treasury bills and government securities which do not have a credit risk
Diversified Debt funds
◦ Invest in a mix of government and
non-government debt securities such as corporate bonds, debentures and commercial paper.
◦ Also known as Income funds
Junk bond schemes / High yield bond schemes
◦ Invest in companies that are of poor credit quality
Fixed maturity plans
◦ Investment portfolio is closely aligned to the maturity of the scheme.
◦ They are close-ended schemes
◦ Little role of fund manager in deciding the investing options
◦ Investors have more clarity on the likely returns if they stay invested in the scheme until its maturity (though there can be no guarantee of such returns)
Floating rate funds
◦ Invest in floating rate debt securities
◦ Interest rate payable by the issuer changes in line with the market
◦ The NAVs of such schemes fluctuate lesser than
other debt funds that invest more in debt securities offering a fixed rate of interest
Liquid schemes
◦ Invest only in short term debt securities (upto 91 days’ maturity)
◦ Liquid schemes are the lowest in price risk among all kinds of mutual fund schemes
Diversified equity fund
◦ Invest in a diverse mix of securities that cut across sectors.
Sector funds
◦ Invest only in a specific sector.
Thematic funds
◦ Invest in line with an investment theme.
◦ More broad based than a sector fund; but narrower than a diversified equity fund
Equity linked savings scheme
◦ Offer tax benefits to investors
◦ Lock-in period of 3 years
Rajiv Gandhi equity savings schemes (RGESS)
◦ Offers tax benefits to first time investors
◦ Investments are subject to a fixed lock-in period of 1 year and flexible lock-in period of 2 years
Equity income / dividend yield schemes
◦ Invest in securities whose shares fluctuate less and the dividend represents a larger proportion of the returns
◦ The NAV is expected to fluctuate lesser than other category of equity schemes
Arbitrage funds
◦ Take opposite positions in different markets / securities such that the risk is neutralized but a return is earned
◦ Most arbitrage funds take contrary positions
between the equity market and the futures and options market
◦ Expected returns are in line with liquid funds
Gold funds
◦ Invest in gold and gold-related securities
Gold Exchange Traded Fund
◦ Like an Index fund that invests in gold, gold-related securities or gold deposit schemes of banks
◦ NAV of such funds moves in line with gold prices in the market
Gold Sector Fund
◦ Invest in shares of companies engaged in gold mining and processing
◦ Prices of these shares are more closely linked to the profitability and gold reserves of the companies
◦ NAV of theses funds do not closely mirror gold prices
Monthly Income Plans
◦ Declare a dividend every month
◦ Invest largely in debt securities
◦ A small percentage is invested in equity shares to improve scheme’s yield
Balanced fund
◦ Invests in both equity and debt simultaneously in one portfolio
◦ Growth through equity and stability (regular income) through debt
Capital protection schemes
◦ Close-ended schemes
◦ Investors get the principal back irrespective of what happens to the market
◦ Investment is made in zero coupon government
securities whose maturity is aligned to the scheme’s maturity
◦ Zero coupon securities are securities that do not pay a regular interest but accumulate the interest, and pay it along with the principal when the security matures
Some of the hybrid funds are launched as Asset
Allocation Funds
Exposure to real estate
Small investors can take exposure to real
estate as an asset class
Although permitted by law, real estate
mutual funds are yet to hit the market in
India
Real Estate Investment Trusts are aimed at
high net worth investors
Commodities, as an asset class, include: ◦ Food crops like wheat and gram
◦ Spices like pepper and turmeric ◦ Fibres like cotton
◦ Industrial metals like copper and aluminium ◦ Energy products like oil and natural gas
◦ Precious metals (bullion) like gold and silver
Gold funds are structures as Gold ETF or gold
sector funds
In India, mutual fund schemes are not permitted to invest
in commodities, other than Gold
Commodity sector funds are a kind of equity fund because
these funds can invest in shares of companies that are into commodities
These funds invest outside the country
A mutual fund may offer a scheme to investors in
India, with an investment objective to invest abroad
This can happen in two ways:
◦ Hire the requisite people who will manage the fund
◦ Tie up with a foreign fund (host fund). If an Indian mutual fund sees potential in China, it will tie up with a Chinese fund. In India, it will launch a feeder fund.
The investment in these funds could be specific to
a country or diversified across countries
Legal restrictions of India and the other country/
countries are applicable
Local investors invest in rupees which are
converted into foreign currency for investing
abroad. They need to be re-converted into
rupees when the money is paid back to local
investor
Since the future foreign currency rates cannot
be predicted today, there is an element of
foreign currency risk
Investor’s total return depends on how the
international investment performs as well as
how the foreign currency performs
Funds that invest in various other funds,
whether in India or abroad are called Fund
of funds
They pre-specify the mutual funds whose
schemes they will buy and/ or the kind of
schemes they will invest in
Open ended funds whose units are traded in a
stock exchange
Only very large investors are allowed to buy
and sell units from the mutual fund
The mutual fund appoints some intermediaries
as market makers, whose job is to offer a price
quote for buying and selling units at all times
Major advantage of the market makers is to
provide liquidity in the units of the ETFs to the
investors
In an ETF, investors can buy and sell their
units in the stock exchange at various
prices during the day rather than a single
NAV on a day in case of regular open-ended
funds
As of July 31, 2014:
◦ 45 mutual funds
◦ AUM of Rs. 10,06,452 crores
◦ 1823 schemes
◦ Mutual fund AUM is about 12.5% of bank deposits
◦ High proportion of AUM in debt
Mutual funds in India
today
Legal structure of mutual funds in India
◦ Mutual funds in india are governed by SEBI (mutual fund) Regulations, 1996
◦ Established as a trust. They are governed by the Indian Trusts Act, 1882
◦ The mutual funds can invest in securities including money market instruments, gold or gold deposits or real estate assets
◦ The units are sold under one or more schemes
◦ SEBI has stipulated the legal structure under which mutual funds in India need to be constituted
◦ The mutual fund trust is created by one or more Sponsors, who are the main persons behind the mutual fund business
Fund Structure and
Constituents
◦ Investors who invest in various schemes are the beneficiaries
◦ The operations of the mutual fund trust are governed by a Trust Deed, which is executed between the
sponsors and the trustees
◦ Trustees play the role of protecting the investors
◦ Either individuals may be appointed as trustees or a Trustee company may be appointed. Individuals are jointly referred to as “Board of Trustees”. A trustee company functions through its Board of Directors
◦ Day to day management of the schemes is handled by an Asset Management Company (AMC) which is
appointed by the sponsor or the Trustees
Legal structure of mutual
funds
The trustees execute an investment
management agreement with the AMC,
setting out its responsibilities
Although the AMC manages the schemes,
custody of the assets is with a Custodian, who
is appointed by the Trustees
Investors invest in various schemes of the
mutual fund. The record of investors and their
unit-holding may be maintained by the AMC
itself, or it can appoint a Registrar & Transfer
Agent (RTA)
Legal structure of mutual
funds
Mutual Fund Trust HDFC Mutual Fund
Sponsor Housing Development Finance Corporation Ltd. Trustee HDFC Trustee Company Limited
AMC HDFC Asset Management Company Limited Custodian HDFC Bank Limited
Citibank N.A.
The Bank of Nova Scotia
RTA Computer Age Management Services Pvt. Ltd
Sponsors: Invest in the capital of the AMC
◦ Should have a sound track record and reputation of fairness and integrity in all business transactions
◦ Should be carrying on business in financial services of 5 years
◦ Should have positive net worth (share capital plus
reserves minus accumulated losses) for each of those 5 years
◦ Latest net worth should be more than the amount that the sponsor contributes to the capital of the AMC
◦ Should have earned profits, after providing for
depreciation and interest, in three of the previous five years, including the latest year
Key Constituents of a Mutual
Fund
Sponsors
◦ Needs to have a minimum 40% share-holding in the capital of the AMC. Anyone who has more
than 40% share-holding in the AMC is considered to be a sponsor and should therefore fulfill the eligibility criteria
Key Constituents of a Mutual
Fund
Trustees: Ensure that the mutual fund complies with
all the regulations and protects the interests of the unit-holders
◦ Every trustee has to be a person of ability, integrity and standing
◦ Sponsor needs to appoint at least 4 trustees
◦ If a trustee company has been appointed, then that company would need to have at least 4 directors on the Board.
◦ At least, two-thirds of the trustees/ directors on the Board of the trustee company would need to be independent trustees i.e. not associated with the sponsor in any way
◦ General Due Diligence and Special Due Diligence responsibilities have been assigned to the Trustees
Key Constituents of a Mutual
Fund
AMC: responsible for day to day operations
◦ The directors of the asset management company need to be person having adequate professional experience in finance and financial services
related field
◦ The directors as well as key personnel should not have been found guilty of moral turpitude
◦ Key personnel of the AMC should not have worked for any AMC or mutual fund or any intermediary during the period when its registration was
suspended or cancelled any time by SEBI
Key Constituents of a Mutual
Fund
AMC
◦ Prior approval of the trustees is required before a person is appointed as director on the board of the AMC
◦ At least 50% of the directors should be independent directors
◦ Needs to have a minimum net worth of Rs. 50 crore. This is immediately applicable to new
AMCs. AMCs in existence in May 2014 have been given 3 years to raise their net worth to Rs. 50 crore. They cannot launch any new scheme until they comply with this requirement
Key Constituents of a Mutual
Fund
AMC
◦ An AMC cannot invest in its own schemes, unless the intention to invest is disclosed in the Offer
Document
◦ The AMC cannot charge any fees for its own
investment in any of the schemes managed by itself
◦ The appointment of an AMC can be terminated by a majority of the trustees or by 75% of the Unit-holders. Any change in the AMC is subject to prior approval of SEBI and the Unit-holders
Key Constituents of a Mutual
Fund
Custodian: settles all the transactions on
behalf of the mutual fund schemes
◦ Is appointed by the mutual fund
◦ Needs to register with SEBI
◦ Unless specific conditions are fulfilled, a custodian cannot be appointed if the sponsor or its
associates control 50% or more of the shares of a custodian
◦ Also tracks actions such as dividends, bonus and rights in companies where the fund has invested
Key Constituents of a Mutual
Fund
RTA: maintains investor records
◦ Appointed by the AMC
◦ Handles the documentation of investor through its various service centres
◦ Not compulsory to appoint a RTA. The AMC can choose to handle this activity in-house
◦ All RTAs need to register with SEBI
Key Constituents of a Mutual
Fund
Auditors: Audit of accounts
◦ Accounts of the schemes need to be maintained independent of the accounts of the AMC
◦ Auditor for scheme accounts needs to be different from the auditor of the AMC
◦ The scheme auditor is appointed by the Trustees
◦ The AMC auditor is appointed by the AMC
Key Constituents of a Mutual
Fund
Fund accountants
◦ Calculate the NAV
◦ AMC can either handle this activity in-house or engage a service provider
◦ Need not register with SEBI to perform this function
Distributors
◦ Sell suitable types of units to their clients
◦ Need to pass the prescribed certification test and register with AMFI
Key Constituents of a Mutual
Fund
Collecting bankers
◦ Investors’ money go into the bank account of the scheme they have invested in. These bank accounts are maintained with collection bankers
◦ These banks enable collection and payment of funds for the schemes
KYC registration agencies
◦ SEBI has mandated a unified KYC for the securities market through KYC Registration Agencies registered with SEBI.
◦ IPV (In-person verification) by a SEBI-registered intermediary is compulsory for all investors
◦ Distributors who have a valid NISM mutual fund distributors certificate and a valid ARN can carry out the IPV if they have completed the KYD process
Key Constituents of a Mutual
Fund
SEBI
◦ Is the regulatory authority for securities markets in India. It regulates mutual funds, depositories,
custodians and registrars & transfer agents
◦ Some segments of the financial markets have their own independent regulatory bodies. Wherever
applicable, mutual funds need to comply with these other regulators also
◦ Mutual fund investors have recourse to the trustees, AMC and SEBI, in that order, for the redressal of their complaints
◦ Anyone who is aggrieved by a ruling of SEBI can file an appeal with the Securities Appellate Tribunal (SAT)
Legal and regulatory
environment
Self regulatory organizations (SRO)
◦ Sometimes regulators empower an industry body to supervise the working of its members. Such bodies are known as Self regulatory organizations
◦ SROs are the second tier in the regulatory structure
◦ A stock exchange is an example of an SRO, registered with SEBI, empowered to regulate the activities of its members
◦ Mutual funds in India have not constituted any SRO for themselves. They are directly regulated by SEBI
◦ AMFI is an association of mutual funds. It is not an SRO. AMFI provides guidelines to mutual funds, but the
regulations are issued by SEBI. The AMFI board is appointed by AMCs and is made up of AMC representatives
Legal and regulatory
environment
AMFI code of ethics
◦ Standards of good practices to be followed by the AMCs
AMFI’s code of conduct for intermediaries of mutual funds ◦ In the event of breach of the code of conduct by an intermediary,
the following sequence of steps is to be followed:
◦ Write to the intermediary and ask for an explanation within 3 weeks ◦ In case explanation is not received within 3 weeks, or if the
explanation is not satisfactory, AMFI will issue a warning letter
indicating that any subsequent violation will result in cancellation of AMFI registration
◦ If there is a proved second violation by the intermediary, the
registration will be cancelled and intimation will be sent to all AMCs ◦ The intermediary has a right of appeal to AMFI
Legal and regulatory
environment
Due diligence process by AMCs for
distributors of mutual funds
◦ SEBI has mandated AMCs to put in place a due diligence process to regulate distributors who qualify any one of the following criteria:
Multiple point presence (more than 20 locations)
AUM raised over Rs. 100 crore across industry in the non-institutional category
Commission received of over Rs. 1 crore p.a. across industry
Commission received of over Rs. 50 lakhs from a single mutual fund
Legal and regulatory
environment
The SEBI regulations provide for various limits to the
kinds of investments that are possible in mutual fund schemes and their limits
Every mutual fund scheme should have an investment
objective
The investment policy describes in greater detail, the
kind of portfolio that will be maintained
Investment strategy goes into details such as
◦ Should the liquidity component be increased in a scheme
◦ Should we go overweight on the steel sector
While the investment objective and investment policy
are part of the offer document, investment strategy is decided more frequently
Investment restrictions for
schemes
Services standards mandated for a mutual fund
towards its investors
◦ Schemes other than ELSS and RGESS can remain open for subscription for a maximum of 15 days
◦ In the case of RGESS schemes, the offering period shall not be more than 30 days
◦ Schemes, other than ELSS and RGESS, need to allot units or refund money within 5 business days of
closure of the NFO. RGESS schemes are given a period of 15 days from the closure of the NFO
◦ In the event of delays in refunds, investors need to be paid interest @ 15% p.a. for the period of the delay. This interest cannot be charged to the scheme
Investors’ rights &
obligations
Open-ended schemes, other than ELSS, have to re-open sale/re-purchase within 5 business days of allotment
Statement of accounts are to be sent to investors as follows:
◦ In the case of NFO – within 5 business days of closure of the NFO (15 days for RGESS)
◦ In the case of post-NFO investment – within 10 working days of the investment
◦ In the case of SIP/ STP/ SWP:
Initial transaction – within 10 working days
Ongoing – once every calendar quarter within 10 working
days of the end of the quarter
Investors’ rights &
obligations
◦ On specific request by investor, it will be dispatched to investor within 5 working days without any cost
◦ Statement of account shall also be sent to dormant investors i.e. investors who have not transacted
during the previous 6 months
◦ If mandated by the investor, soft copy shall be e-mailed to investor every month
Units of all mutual fund schemes held in demat
form are freely transferable
Only in the case of ELSS and RGESS schemes,
free transferability of units is curtailed for the statutory minimum holding period
Investors’ rights &
obligations
Investor can ask for a Unit Certificate for his
unit-holding
◦ A statement of account shows the opening balance, transactions during the period and the closing
balance. A unit certificate mentions the number of units held by the investor
◦ The statement of account is like a bank pass book while the unit certificate is like a balance
confirmation certificate issued by the bank
NAV has to be published daily in at least 2
daily newspapers having circulation all over
India
Investors’ rights &
obligations
NAV and re-purchase price are to updated
on AMFI website and the mutual fund
◦ In the case of Fund of funds – by 10 am the following day
◦ In the case of other schemes – by 9 pm the same day
The investor/s can appoint upto 3 nominees
and also specify the percentage distribution
between the nominees. If no distribution is
indicated, an equal distribution between the
nominees will be presumed
Investors’ rights &
obligations
The investor can also pledge the units to offer
security to a financier
Dividend warrants have to be dispatched to investors
within 30 days of declaration of the dividend
Redemption cheques need to be dispatched to
investors within 10 working days from the date of receipt of transaction request
In the event of delays in dispatching dividend
warrants or redemption cheques, the AMC has to pay the unit-holder, interest at the rate of 15% p.a. This expense has to be borne by the AMC and cannot be charged to the scheme
Investors’ rights &
obligations
Investors can choose to change their
distributor or go direct. This needs to be done
through a written request by the investor. In
such cases, AMCs will need to comply without
insisting on any kind of No objection certificate
from the existing distributor
Investors can choose to hold the units in demat
form
The demat statement given by the Depository
participant would be treated as statement of
account
Investors’ rights &
obligations
The mutual fund has to publish a complete
statement of the scheme portfolio and the
half-yearly unaudited financial results,
within 1 month from the close of each half
year. In lieu of the advertisement, the
mutual fund may choose to send the
portfolio statement to all unit-holders
Unit holders have a right to inspect key
documents
Investors’ rights &
obligations
SEBI has categorized complaints into various
categories. For each complaint category, the mutual fund has to report on the number of complaints, the time period in which they were resolved or will be
resolved. The trustees have to sign off this report and it is to be disclosed on AMFI website, the website of the individual mutual fund and its annual report
The offer document has details of the number of
complaints received and their disposal. Pending complaints can be a ground for SEBI to refuse permission for launch of new schemes
The annual report of the AMC has to be displayed on
the website of the mutual fund.
Investors’ rights &
obligations
The trustees / AMC cannot make any change
in the fundamental attributes of a scheme
unless
◦ A written communication to this effect is sent to each unit holder and an advertisement is issued in an English daily having nation wide circulation and in a newspaper published in the language of the region where the head office of the mutual fund is located
◦ Dissenting unit-holders are given the option to exit at the prevailing NAV without any exit load. This exit window has to be open for at least 30 days
Investors’ rights &
obligations
The appointment of the AMC for a mutual fund can be
terminated by a majority of the trustees or by 75% of the unit-holders of the scheme
75% of the unit-holders can pass a resolution to wind-up
a scheme
Merger or consolidation of schemes is not considered a
change in the fundamental attribute of the surviving scheme if the following conditions are met:
◦ There is no other change in the fundamental attributes of the surviving scheme
◦ Mutual funds are able to demonstrate that the circumstances merit merger or consolidation of schemes and the interest of the unit holders of the surviving scheme is not adversely affected
Investors’ rights &
obligations
Under the law, a trust is a notional entity.
Therefore, investors cannot sue the trust but
they can file suits against the trustees if they feel that the trustees have not fulfilled their
obligations
The principle of caveat emptor (let the buyer
beware) applies to mutual fund investments. The unit-holder cannot seek legal protection on the grounds of not being aware, especially when it comes to the provisions of law and matters fairly and transparently stated in the Offer Document
Limitation of rights of
unit-holders
A prospective investor does not enjoy any
rights with respect to the fund, the AMC or
any other constituent
Fund investors are neither shareholder in
the AMC nor are they depositors with the
fund. Their investments cannot be
protected by any of the regulators under
the Companies Act
Limitation of rights of
unit-holders
The mutual fund has to deploy unclaimed
dividend and redemption amounts in the money market. AMC can recover investment
management and advisory fees on management of these unclaimed amounts, at a maximum rate of 0.50% p.a.
Recovery of such unclaimed amounts by the
investors is as follows:
◦ If the investor claims the money within 3 years, then payment is based on the prevailing NAV.
◦ If the investor claims the money after 3 years, then payment is based on the NAV at the end of 3 years
AMC is expected to make a continuous
effort to remind the investors through
letters to claim their dues
The annual report has to mention the
unclaimed amount and the number of such
investors for each scheme
PAN no and KYC documentation are
compulsory for mutual fund investments.
Only exception is micro-SIPs (where annual
investment does not exceed Rs. 50,000)
Small investors investing in cash upto Rs.
20,000 per mutual fund per financial year
do not need to provide PAN card
Investors need to give their bank account
details along with the redemption request
If some sponsors wish to move out of the business,
they need to bring in come other sponsor, acceptable to SEBI, before they can exit. The new sponsor would need to put in place the entire framework of trustees, AMC, etc. Therefore, mutual funds cannot vanish
The custodian has custody of the investments in a
scheme. The custodian is largely independent of the sponsor and the AMC. This ensures structural
protection of the scheme
In the event of a change in sponsorship than an
investor is not comfortable with, the option of exiting from the scheme with the full NAV is available for a 30-day period
Can a mutual fund scheme go
bust?
New Fund Offer
◦ First time offer
◦ CIO provides inputs on the investment objectives
◦ CMO provides inputs on interest in the market
◦ AMC prepares the OD for NFO which needs to approved by the Trustees and the Board of Directors of the AMC
◦ Document is filed with SEBI for approval. The observations made by SEBI need to be incorporated. After approval by the Trustees, the OD can be issued in the market.
◦ Role of AMC:
To decide a suitable time for issue of the scheme
To launch its advertising and public relations campaign To hold events for intermediaries and the press
To distribute the Offer Document and Application Forms to the investors through intermediaries and otherwise.
Since disclosures in the Offer Document are
prescribed by SEBI, it is a legal document.
Contains the “fundamental attributes” of the
scheme:
◦ Nature of the scheme
◦ Investment objectives
Fundamental attributes of a scheme cannot be
changed without going through specific legal
processes.
An investor is presumed to have read the OD
(principle of caveat emptor)
Two parts:
◦ Scheme Information Document (SID)
Details of the scheme
◦ Statement of Additional Information (SAI)
Statutory information about the mutual fund that is offering the scheme
In practice, SID and SAI are two separate documents. Legally, SAI is part of SID
Both the documents are prepared in the format prescribed
by SEBI and are submitted to SEBI
The contents need to flow in the same sequence as in the
prescribed format
Mutual fund is permitted to add any disclosure, which it
feels, is material for the investor
Offer Document
Offer Documents are ‘vetted’ by SEBI. SEBI
does not approve or disapprove Offer
Documents. It gives its observations
SEBI’s observations need to be incorporated
by the AMC in the Offer Document
Cover page:
◦ Name of the scheme – Open ended/ close ended/ interval
◦ Equity / balanced/ income/ debt/ liquid/ ETF
◦ Face value of the units
◦ Relevant NFO dates (Opening, closing and re-opening)
◦ Date of SID
◦ Name of the mutual fund
◦ Name & Contact information of the AMC and the trustee company
Scheme Information Document
(SID)
Table of content
Highlights
Information about the scheme
Units and offer
Fees and expenses
Rights of unit-holders
Proposed asset allocation mix
Scheme Information Document
(SID)
SID should be read in conjunction with the
SAI and not in isolation
Draft SID is a public document and is
available for viewing on SEBI’s website (
www.sebi.gov.in
) for 21 working days
The final SID (after incorporating SECI’s
observations) has to be hosted on AMFI’s
website (
www.amfiindia.com
) two days
before the issue opens
Scheme Information Document
(SID)
All mutual funds have to label their schemes on the
following parameters for ease of understanding of the investors:
◦ Nature of scheme such as to create wealth or provide regular income in an indicative time horizon (short/ medium/ long term)
◦ A brief about the investment objective (in a single sentence) followed by kind of product (debt/ equity)
◦ Level of risk depicted by colour code boxes:
Blue – principal at low risk
Yellow – principal at medium risk Brown – principal at high risk
◦ The colour codes should be described in text beside the colour code box
Scheme Information Document
(SID)
A disclaimer has to be included that investor
should consult their financial advisors if they
are not clear about the suitability of the
product
The product labels should be disclosed in:
◦ Front page of Key Information Memorandum (KIM) and SID (to be placed in proximity to the caption of the scheme and shall be prominently visible)
◦ Common application form (along with the information about the scheme)
◦ Scheme advertisements (placed in a manner so as to be prominently visible to investors.
Scheme Information Document
(SID)
Regular update:
◦ If a scheme is launched in the first 6 months of the financial year (say April 2010), then the first update of the SID is due within 3 months of the end of the financial year (by june 2011)
◦ If a scheme is launched in the second 6 months of the financial year (say, October 2010), then the first update of the SID is due within 3 months of the end of the next financial year (by June 2012)
◦ Thereafter, SID is to be updated every year
Need-based update
◦ In case of change in the fundamental attributes, the SID has to be updated immediately after the lapse of the time
period given to existing investors to exit the scheme
◦ In case of other changes:
It will be printed on a separate piece of paper (addendum) and
distributed along with the SID, until the SID is updated.
If a change is superseded by a further change (for instance,
change in load), then addenda are not required for the
superseded change i.e. addenda is only required to disclose the latest position
The change is to advertised in an English newspaper having
nation-wide circulation, in a news paper of the language of the region where the head office of the mutual fund is located. The change is to be mentioned in the website of the mutual fund
Update of SID
Information about sponsors, AMC, Trustee
company(includes contact info, shareholding
pattern, responsibilities, names of directors and their contact info, profiles of key personnel),
and contact info of service providers (custodian, registrar & Transfer agent, statutory auditor,
fund accountant and collecting bankers)
Condensed financial information for schemes
launched in last 3 financial years)
How to apply
Rights of unit-holders
Investment valuation norms
Tax, legal & General info
Investor grievance redressal mechanism,
opening and closing number of complaints
for previous 3 financial years and for the
current year to-date
Every mutual fund, it its website, provides
for download of its SAI. Investor have a right
to ask for a printed copy of it.
Regular update is to be done by the end of
3 months of every financial year
Material changes have to be updated on an
ongoing basis and uploaded on the websites
of the mutual fund and AMFI
Is a summary of the SID and SAI
As per SEBI, every application form is to be
accompanied by the KIM
Contents:
◦ Name of the AMC, mutual fund, trustee, fund manager and scheme
◦ Dates of issue opening, closing & re-opening
◦ Plan and options under the scheme
◦ Risk profile of scheme
Key Information
Memorandum
Contents:
◦ Price at which units are being issued and minimum amount/units for initial purchase, additional purchase and re-purchase
◦ Benchmark
◦ Dividend policy
◦ Performance of scheme and benchmark over last 1 year, 3 years, 5 years and since inception
◦ Loads and expenses
◦ Contact information of Registrar for investor grievances
Key Information
Memorandum
KIM is to be updated at least once a year
As in case of SID, KIM is to be revised in
case of change in fundamental attributes.
Other changes can be disclosed through
addenda attached to the KIM
Independent Financial Advisors
Non-bank distributors
◦ Broking firms
◦ Securities distribution companies
◦ Non-banking finance companies
Banks
Internet
Stock exchanges
◦ Close-ended schemes are required to be listed in a stock exchange
◦ ETFs are bought and sold in the stock exchange
Fund distribution and channel
management practices
SEBI has provided for new cadre of distributors since September 2012
◦ Postal agents
◦ Retired government officials
◦ Retired semi-government officials (Class III or above)
◦ Retired teachers and retired bank officers with a service of at least 10 years
Allowed to sell units of simple and performing mutual fund schemes
◦ Simple and performing mutual fund schemes comprise of diversified equity schemes, FMPs and index schemes that have returns equal to or better than their scheme
benchmark returns during each of the last three years
Fund distribution and channel
management practices
The individual needs to pass the Certifying
Examination prescribed by SEBI.
Distributors / employees who were above the
age of 50 years, and had at least 5 years of
experience as on September 30, 2003 were
exempted.
But they need to attend a prescribed refresher
course.
Pre-requisites to become Distributor of a
Mutual Fund
KYD
Requirements:- Document verification and bio-metric process.
Self-attested copy of the PAN card and specific documents as proof of
address to be submitted along with application form at the CAMS- Pos.
Bio-metric process consists of taking the impression of the index finger
of the right hand of the ARN holder.
In case of non-individual distributors, bio-metric process will be
conducted on specified authorized persons.
After passing the examination and completing KYD requirements, the
next stage is to register with AMFI.
On registration, AMFI allots an AMFI Registration Number (ARN).
Pre-requisites to become Distributor of a
Mutual Fund
Request for Empanelment Form to be filled which provides the basic
details:- Personal Information of applicant:-Name of person, age, trade Name, Contact Information, ARN, PAN,
Income tax, category.
Names and contact information of key people handling sales and operations.
Business details. Bank details.
Nominee.
The applicant also needs to sign a declaration.
The scheme application forms carry a suitable disclosure to
the effect that the upfront commission to distributors will be paid by the investor directly to the distributor, based on his assessment of various factors including the service rendered by the distributor.
Two kinds of commission are earned by
distributors:- Initial or Upfront Commission:- The scheme application
forms carry a suitable disclosure to theeffect that the upfront commission to distributors will be paid by the investor directly to the distributor, based on his assessment of various factors including the service rendered by the distributor.
Trail commission, calculated as a percentage of the
net assets attributable to the Units sold by the
distributor
AMCs pay a trail commission for the period the
investment is held in the scheme.
Since trail commission is calculated as a percentage on
AUM, distributors get the benefit of valuation gains in the market
Accounting, Valuation & Taxation
Mutual Funds scheme according to the maturity
period:- A mutual fund scheme can be classified into open-ended scheme or
close-ended scheme depending on its maturity period.
An open-ended Mutual fund is one that is available for subscription
and repurchase on a continuous basis.
These Funds do not have a fixed maturity period.
A close-ended Mutual fund has a stipulated maturity period e.g. 5-7
years.
The fund is open for subscription only during a specified period at
Net Assets Value:- Net Asset Value is the market value of the
assets of the scheme minus its liabilities on day of valuation. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the valuation date.
NAV significant only for open-end mutual funds.
For closed-end funds, share value is determined in the secondary markets .
For open-end mutual funds, NAV is a useful determinant for tracing share price movements.
However, it is not useful for evaluating overall fund performance. The most important thing to keep in mind is that NAVs change
daily and are not a good indicator of actual performance because of the impact yearly distributions have on NAV.
The unit-holders’ funds in the scheme is commonly
referred to as “net assets”.
Let us understand the concept with a simple example. Investors have bought 20crore units of a mutual fund
scheme at Rs 10 each. The scheme has thus mobilized 20 crore units X Rs 10 per unit i.e. Rs 200 crore.
An amount of Rs 140 crore, invested in equities, has
appreciated by 10%.
The balance amount of Rs 60 crore, mobilized from
investors, was placed in bank deposits.
Interest and dividend received by the scheme is Rs 8
crore,
scheme expenses paid is Rs 4 crore , while a further
expense of Rs 1 crore is payable.
If the above details are to be captured in a listing of
assets and liabilities of the scheme, it would read as follows:
Amount (Rs cr.)
Liabilities
Unit Capital (20crore units of Rs10 each) 200 Profits {Rs 8 crore (interest and dividend received)
minus Rs 4 crore (expenses paid) minus Rs 1 crore (expenses payable)}
3
Capital Appreciation on Investments held {10% of
Rs 140 crore} 14
Unit-holders’ Funds in the Scheme 217
Expenses payable 1
Scheme Liabilities 218
Assets
Market value of Investments (Rs 140
crore + 10%) 154 Bank Deposits {Rs60crore (original) plus
Rs 8
crore (interest and dividend received) minus Rs 4
crore (expenses paid)}
64
Scheme Assets 218
Net asset includes the amounts originally
invested, the profits booked in the scheme, as
well as appreciation in the investment portfolio. It
goes up when the market goes up, even if the
investments have not been sold.
A scheme cannot show better profits by delaying
payments. While calculating profits, all the
expenses that relate to a period need to be
considered, irrespective of whether or not the
expense has been paid. In accounting jargon,
this is called accrual principle.
Similarly, any income that relates to the period will
boost profits, irrespective of whether or not it has
been actually received in the bank account.
This again is in line with the accrual principle.
In the market, when people talk of NAV, they refer to
the value of each unit of the scheme.
Higher the interest, dividend and capital gains
earned by the scheme, higher would be the NAV.
Higher the appreciation in the investment portfolio,
higher would be the NAV.
Lower the expenses, higher would be the NAV.
Fees Charged by Investment
Companies:- Investment companies charge investors a wide assortment
of fees.
Mutual funds that are just coming to market, for example,
may set the price for the initial sale of shares slightly higher than the shares NAV to help defray start-up costs.
Ostensibly, these fees help reduce the frequency of trading
in and out of the fund and encourage investors to maintain their positions.
Fees Charged by Investment
Companies:- Although these are one-time charges, it makes sense to look at
them in terms of an investor's time horizon.
So, for example, a front load fee of 4.8% on a $10,000 share
purchase ($480) translates to a per-year cost of $160 when an investor holds the shares for only three years ($480/3).
If the investor holds the shares for 10 years, however, his cost per
year is only $48.
To make fee comparisons easy, services such as Morningstar
calculate the cost of buying and holding $10,000 of a fund's shares over three-, five- and 10-year time horizons.
Sales commissions provide an incentive to the sales force but they
can seriously impact investors' total return.
Entry and Exit Load
Mutual fund incur certain expenses such as brokerage, marketing
expenses, communication expenses. These expenses are known as “Load” and are recovered by fund when it sells the unit to the investors or
repurchases units from with holders.
The difference between the NAV and Re-purchase Price is called the
“exit load”.
Schemes can also calibrate the load when investors offer their units
for re-purchase.
Investors would be incentivized to hold their
units longer, by reducing the load as the unit holding period increased.
Such structures of load are called “Contingent Deferred Sales
Charge (CDSC).
SEBI has banned entry loads. So, the Sale Price needs to be the
same as NAV.
Exit load structure needs to be the same for all unit holders
representing a portfolio.
Initial issue expenses need to be met by the AMC.
There are limits to the recurring expenses that can be
charged to the scheme.
Dividends can be paid out of distributable reserves. SEBI has prescribed a conservative approach to its
calculation.
Key Accounting and Reporting
Requirements:- The accounts of the schemes need to be maintained
distinct from the accounts of the AMC. The auditor for the AMC has to be different from that of the schemes.
Norms are prescribed on when interest, dividend, bonus
issues, rights issues etc. should be reflected for in the accounts.
NAV is to be calculated upto 4 decimal places in the
case of index funds, liquid funds and other debt funds.
NAV for equity and balanced funds is to be calculated
upto at least 2 decimal places.
Investors can hold their units even in a fraction
of 1 unit.
However, current stock exchange trading
systems may restrict transacting on the
exchange to whole units.
Mutual funds are exempt from tax.
However, Securities Transaction Tax (STT) is applicable
on investments in equity and equity mutual fund schemes.
Additional tax on income distributed (Dividend
distribution tax) is applicable on dividends paid by debt mutual fund schemes.
Taxability of capital gains, and treatment of capital losses
is different between equity and debt schemes, and also between short term and long term.
Detailed norms on valuation of debt and equity securities
determine the valuation of the portfolio, and therefore the NAV of every scheme .
Upto 1 year investment holding is treated as short term. There is no Tax Deducted at Source (TDS) on dividend
payments or re-purchase payments to resident investors.
Withholding tax is applicable for some non-resident investors. Setting of capital losses against capital gains and other
income is subject to limitations to prevent tax avoidance.
Investment in mutual fund units is exempt from Wealth Tax.
Mutual funds themselves pay no tax on the incomes they
earn.
They are fully exempt from tax.
If an investor holds units for 12 months or less, any gain
from selling the units is called as short-term capital gain.
Short-term capital gains are taxable at the marginal rate
of taxation of the investor.
If an investor’s holding period is more than 12 months,
any gain or loss from sale is called as long-term capital gain.
Long-term capital gain can be indexed for inflation. Indexing refers to updating of the purchase price,
based on the cost of inflation index published by the CBDT.
The formula for indexation is purchase price X (index in
the year of sale/index in the year of purchase).
Investors can pay either 10% tax (plus surcharge) on
the capital gain tax without indexation or 20% (plus
surcharge) on capital gains after indexation, which ever is lower.
Short Term Capital Gains Tax (holding period <=12 months) Long Term Capital Gains Tax (holding Period > 12 months) Security Transactions Tax(STT) TDS Resident Individual/HU F 15% Nil 0.001% Nil Domestic Company 15% Nil 0.001% Nil Non-Resident
Individual 15% TDS Nil 0.001% Nil
Equity Linked Saving Schemes (ELSS)
advantage:
all about 80C investmentsELSS Advantage over other tax saving instruments
1. Low Lock in period
2. Earn market linked return 3. Tax free returns
Instrument Returns Lock In
Period (in Years)
EPF 8.50% Until Retirement
PPF 8% 15
NSC 8% 6
FD’s – Banks & Post office 5.70 to 8.50% 5
Senior Citizen Savings Scheme 9% 5
Life Insurance Policies 5 to 6% 3
ELSS Market Linked 3
ULIP Market Linked 5
Individual and non-individual investors are permitted
to invest in mutual funds in India.
Since FIIs are permitted to invest, foreign entities
can take this route.
The ‘Who can invest’ section of the Offer Document
is the best source to check on eligibility to invest.
All investments of Rs 50,000 and above need to
comply with KYC documentation viz. Proof of
Identity, Proof of Address, PAN Card and
Photograph.
Micro SIPs i.e. SIPs with annual investment below Rs 50,000
is exempted from the PAN Card requirement. Simplified documentation has been prescribed in such cases.
Besides KYC, non-individual investors need to provide
additional documentation to support their investment.
Demat makes it possible to trade in Units in the stock
exchange.
Full application form is to be filled for a first time investment in
a mutual fund.
Thereafter, additional investments in the same
mutual fund are simpler. Only transaction slip would need to be filled
.
Most mutual fund schemes offer two options – Dividend and
Growth.
A third option which is possible is the Dividend reinvestment
Option.
Each option has different implications on the investor’s bank
account, investor’s taxation and scheme NAV.
In a dividend payout option, the fund declares a dividend from time
to time.
In a dividend re-investment option, as in the case of dividend payout
option, NAV declines to the extent of dividend and income distribution tax. The resulting NAV is called ex-dividend NAV.
The investor does not receive the dividend in his bank account. Dividend is not declared in a growth option.
