MUTUAL FUNDS

• What are the advantages of investing in mutual funds?

Professional Management and Informed Decision Making The biggest advantage that mutual funds offer is greater expertise on the markets, be it the stock market or debt market. SRE, with its well organized and structured pool of talent, tracks the economy, companies and stock market happenings on a day-to-day basis, and investment decisions are made on the basis of this research. It would be far more difficult for a retail investor to undertake research of the same magnitude. They have better access to information than individual investors.

Investment Flexibility Mutual fund houses offer various categories of schemes (equity, debt, hybrid etc) with a good number of options such as growth, regular income and so on. You can pick and choose as per your risk appetite, return expectations and overall investment objective.

Portfolio diversity With a comparatively small capital investment in a mutual fund scheme, you can gain exposure to a large variety of instruments. In fact, some instruments which form part of a mutual fund’s portfolio, especially in the debt segment, are totally out of the reach of a retail investor due to high threshold investment limits.

Transparency and Safety No mutual fund guarantees returns but they are transparent in their operations, since they are subject to stringent disclosure norms. SEBI regulates all mutual funds operating in India, setting uniform standards for all funds. In addition, thanks to its three tier structure – clear cut demarcation between sponsors, trustees , conflict of interests can be promptly checked. Lastly, the Association of Mutual Funds in India works towards promoting the interests of mutual funds and unit holders. It also launches Investor Awareness Programs aimed at educating investors about investing in mutual funds.

Tax Benefits Generally, income earned by any mutual fund registered with SEBI is exempted from tax. However, income distributed to unit holders by a closed end or debt fund is liable to a dividend distribution tax. Capital gains tax is also applicable, depending on the type of scheme and the period of holding.

• What are the tax benefits and implications of investing in mutual funds?

The dividend distributed by both debt funds and equity funds is tax-free in your hands. In case of equity funds, no dividend distribution tax is payable by the mutual fund. However, in the case of debt funds, the mutual fund has to pay a Dividend Distribution Tax (DDT) of 14.025 per cent (12.5 per cent tax + 2 per cent education cess + 10 per cent surcharge) on the amount of dividend distributed to individuals.

In the case of short term capital gains (profits that accrue from the sale of units within one year from the date of purchase) earned on the sale of equity mutual funds, tax is applicable at the rate of 11.22 per cent, if your net taxable income is above 10 lakh per annum or 10.2 per cent if your net taxable income is below Rs 10 lakh per annum. Short term capital gains on debt mutual funds attract tax at the personal income tax rate applicable to you.

Long term capital gains (profits that accrue from the sale of units after one year from the date of purchase) earned on the sale of equity mutual funds are tax free in your hands. In case of debt funds, long term capital gains computed without indexation (indexation involves increasing the cost of your investment to account for inflation based on the cost inflation index table published by the government), the tax payable on long term capital gains from debt funds is 22.44 per cent if your income is above Rs 10 lakh per annum or 20.4 per cent if your income is below Rs 10 lakh per annum. You can choose to calculate your long term capital gains with or without indexation, depending on which one results in lower tax payable.

• What are the expenses related to mutual funds?

The Asset Management Company charges an annual fee, or expense ratio that covers administrative expenses, advertising expenses, custodian fees, etc.

A fund's expense ratio is typically linked to the size of the funds under management and not to the returns earned. Normally, the costs of running a fund increase at a slower rate than the growth in the fund size - so, the more assets in the fund, the lower should be its expense ratio. SEBI has prescribed limits for the maximum expense that can be charged to the scheme.

• What are the different types of mutual funds?

Mutual funds based on structure Open-ended schemes These schemes do not have a defined or fixed maturity period. The investors can buy or sell units on any business day at NAV based prices from the fund house. Due to this flexibility offered to unit holders, the overall capital of open-ended schemes can fluctuate on a daily basis.

Close-ended schemes These schemes have a stipulated maturity period and the fund remains open for subscription only during a specified period, at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter, they can buy or sell the units of the scheme on the stock exchange where the units are listed. To provide an exit route to the investors, a few close-ended funds give an option of selling back the units to the fund house through periodic (usually monthly or quarterly) repurchase at NAV related prices. SEBI regulations stipulate that at least one of the two exit routes is provided to the investor i.e., either repurchase facility or listing on stock exchanges.

Load and No Load Funds Some mutual funds charge entry or exit loads (fees) when an investor buys or sells units. These are called "Load funds"?. The load is based on the NAV and is calculated as a certain percentage of the NAV. The load is applied to cover expenses incurred on the scheme’s marketing, distribution, advertisements, etc. Because of these charges, your purchase price is higher and your sale price is lower than the prevailing NAV of the scheme.

Cumulative or growth schemes, dividend reinvestment schemes and dividend payout schemes Mutual funds usually give investors a choice of three ways in which they can receive their profits from a scheme. These are called the dividend payout option, the growth option and the dividend reinvestment option.

Dividend payout option In the dividend payout option, the profits of the scheme are distributed to the investors in proportion to the number of units that they hold. This option is suitable for investors who would like to receive a regular income and for those who would like to use their profits elsewhere.

Growth option In the growth option, the profits are not distributed and accordingly, the value of each unit keeps appreciating as the profits increase. This option is suitable for investors who do not have any immediate need for cash and would prefer to reap better wealth in the long run.

Dividend reinvestment option Lastly, the dividend reinvestment option is similar to the growth option, in that the profits are not distributed. However, here the value of the units is not left to simply appreciate. Instead, each investor’s profits are converted into more units of the same scheme at the NAV of the scheme as on the day of conversion. This option is for those investors who have a medium risk profile and would prefer to see their capital base grow rather than allow their appreciation to be eroded by any fall in the value of the scheme’s portfolio.

Mutual funds based on the Portfolio Allocation