About Mutual Funds

A mutual fund is a trust. It pools money from like-minded shareholders and invests in a diversified portfolio of securities through various schemes that address different needs of investors. The pool of money thus collected is then invested by the Asset Management Company (AMC) in different types of securities. These could include shares, debentures, convertible bonds, bonds, money market instruments or other securities, based on the investment objective of a particular scheme. The investment objective is clearly laid down in the offer document for that scheme. The fund adds value to the investment in two ways: income earned and any capital appreciation realised through sale. This is shared by unit holders in proportion to the number of units they own.

Setting up a Mutual Fund

A mutual fund is set up in the form of a trust, which comprises a sponsor, trustees, Asset Management Company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like the promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unit holders. The Asset Management Company (AMC), approved by SEBI, manages the funds by making investments in various types of securities. The custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI Regulations by the mutual fund.

SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of the AMC must be independent. All mutual funds are required to be registered with SEBI before they launch any scheme. However, Unit Trust of India (UTI) is not registered with SEBI (as on January 15, 2002).

Net Asset Value (NAV) of a Scheme

The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV).

Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on a day-to-day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs. 200 Lakhs and the mutual fund has issued 10 Lakh units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs. 20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme.

Sector-Specific Fund Schemes

These are the funds/schemes that invest in the securities of only those sectors or industries as specified in the offer documents. For e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.

Tax Saving Schemes

These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues. E.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest predominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.

Load or No-Load Fund

A Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time one buys or sells units in the fund, a charge will be payable. This charge is used by the mutual fund for marketing and distribution expenses. Suppose the NAV per unit is Rs.10. If the entry as well as exit load charged is 1%, then the investors who buy would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund will get only Rs.9.90 per unit. The investors should take the loads into consideration while making investment as these affect their yields/returns. However, the investors should also consider the performance track record and service standards of the mutual fund which are more important. Efficient funds may give higher returns in spite of loads.

A no-load fund is one that does not charge for entry or exit. It means the investors can enter the fund/scheme at NAV and no additional charges are payable on purchase or sale of units.

Sale or Re-Purchase Redemption Guide

The price or NAV a unit holder is charged while investing in an open-ended scheme is called sales price. It may include sales load, if applicable.

Repurchase or redemption price is the price or NAV at which an open-ended scheme purchases or redeems its units from the unit holders. It may include exit load, if applicable.

Assured Return Scheme

Assured return schemes are those schemes that assure a specific return to the unit holders irrespective of performance of the scheme.

A scheme cannot promise returns unless such returns are fully guaranteed by the sponsor or AMC and this is required to be disclosed in the offer document.

Investors should carefully read the offer document to ascertain whether return is assured for the entire period of the scheme or only for a certain period. Some schemes assure returns one year at a time and they review and change it at the beginning of the next year.

Tax Benefits of Investing in Mutual Funds

Income other than Capital Gains

As per the provisions of Section 10(35) of the Act, income received in respect of units of a mutual fund specified under Section 10(23D) of the Act is exempt from income tax in the hands of the recipient Investors.

Tax Deduction at Source

In view of the exemption of income in the hands of the Investors, no income tax is deductible at source, on income distribution by the mutual fund, under the provisions of Sections 194K of the Act.

Capital Gains

As per Section 2(42A) of the act, units of the scheme held as a capital asset, for a period of more than 12 months immediately preceding the date of transfer, will be treated as a long-term capital asset for the computation of capital gains; in all other cases, it would be treated as a short-term capital asset.

Also, sub-section (7) of Section 94 of the act provides that loss, if any, arising from the sale/transfer of units (including redemption) purchased up to 3 months prior to the record date and sold within 3 months after such date, will not be available for set off to the extent of income distribution (excluding redemptions) on such units claimed as tax exempt by the Investors.

Long-term and short-term capital gains arising to resident Investors from the transfer of the units of the scheme will be taxable at the following rates:

Tax Rate:

Nature of income	Tax rate*
Short-term capital gains	Rate applicable as per the prescribed slabs in the case of resident individuals and at 35 percent in the case of resident corporate
Long-term capital gains	20 percent with the cost inflation index benefit or 10 percent without the cost inflation index benefit, whichever is lower

Tax Deduction at Source (Capital Gains)

No tax is required to be deducted at source from capital gains arising at the time of repurchase or redemption of the units.

Wealth Tax Benefits

Units held under the schemes are not treated as assets under Section 2(ea) of the Wealth Tax Act, 1957 and are therefore not liable to Wealth Tax.

Gift Tax

The Gift Tax Act, 1958, has ceased to apply to gifts made on or after 1st October 1998. Gifts of Units, purchased under the schemes, would therefore, be exempt from Gift Tax.

Religious and Charitable Trusts

Investments in Units of the mutual fund will rank as an eligible form of investment under Section 11(5) of the Act read with Rule 17C of Income Tax Rules, 1962 for Religious and Charitable Trusts.

Surcharge is levied as under:

Nature of income	Tax rate*
Resident Individuals where the taxable income up to Rs. 8,50,000 per annum	Nil
Resident Individuals where the taxable income in excess of Rs. 8,50,000 per annum	10%
Resident Corporates	2.5%

Non-Resident Accesses

The following summary outlines the key tax implications applicable to Non-resident Indian (NRI)/ Persons of Indian origin (PIO)/Foreign Institutional Investor (FII) based on the relevant provisions under the Income Tax Act, 1961, Wealth Tax Act, 1957 and Gift Tax Act, 1958 (collectively called 'the relevant provisions'), subsequent to the amendments enacted by the Finance Act 2003.

Income other than Capital Gains

As per the provisions of Section 10(35) of the Act, any income received in respect of units of a mutual fund specified under Section 10(23D) of the Act is exempt from income tax in the hands of the recipient Investors.

Foreign Institutional Investors

Long-term capital gains on sale of Units would be taxed at the rate of 10% under Section 115AD of the Act. Such gains would be calculated without indexation of cost of acquisition. Short-term capital gains would be taxed at 30%. The said rates would be subject to applicable tax treaty relief. The above tax rates would be increased by applicable surcharge.

No tax would be deductible at source from the capital gains (whether long-term or short-term) arising to an FII on repurchase/redemption of units in view of the provisions of Section 196D (2) of the Act.

NRIs/PIOs

Long-term and short-term capital gains arising to NRIs/PIOs from the transfer of units of the Scheme will be taxable at the following rates:

Nature of income	Tax rate*
Short-term capital gains	Rate applicable as per the prescribed slabs in the case of NRIs/PIOs at the applicable rates
Long-term capital gains	20 percent with the cost inflation index benefit or 10 percent without the cost inflation index benefit, whichever is lower

Exemption under Long-Term Capital Gains

The long-term capital gains on transfer of units would be exempt from tax under Section 54EC of the Act if the entire capital gain realized is invested within six months of the date of transfer in bonds which are redeemable after three years issued by National Bank of Agricultural and Rural Development, National Highways Authority of India or Rural Electrification corporation Limited. However, if the amount invested in bonds is less than the capital gains realized only proportionate capital gains would be exempt from tax. If the bonds so acquired are sold or otherwise transferred within three years then the amount exempted from tax would become taxable.

The long-term capital gains on transfer of units would be exempt from tax under Section 54ED of the Act if the entire capital gain realized is invested within six months of the date of transfer in public issue of equity shares of a company formed and registered in India. However, if the amount invested in public issue is less than the capital gains realized only proportionate capital gains would be exempt from tax. If the equity shares so acquired are sold or otherwise transferred within one year then the amount exempted from tax would become taxable.

W.e.f. April 1, 2001, the losses arising from the sale of securities or units (in respect of which dividend or income on such securities or units is exempt to tax) would be disallowed under Section 94(7) of the Income Tax, 1961, if such securities or units have been purchased up to 3 months prior to the record date and have been sold within 3 months after such date. The amount of loss to be disallowed will be restricted to the amount of dividend or income on such securities or units claimed as tax exempt by the taxpayer.

Q. Who should invest in mutual funds?

Mutual funds can meet the investment objectives of almost all types of investors. Young investors, who can take some risk while aiming for substantial growth of capital in the long-term, will find growth schemes (i.e. funds which invest in stocks) an ideal option.

Older investors who are risk-averse and prefer a steady income in the medium term can invest in income schemes (i.e. funds which invest in debt instruments). Investors in middle age can allocate their savings between income funds and growth funds and achieve both income and capital growth. Investors who want to benefit from regular savings, save a small sum every month, can use the Systematic Investment Plan (SIP).

Q. As mutual fund schemes invest only in stock markets, are they suitable for small investors?

Mutual funds are meant for small investors. The prime reason is that successful investments in stock markets require careful analysis, which is not possible for a small investor. Mutual funds are usually equipped to carry out thorough analysis and can provide superior returns.

Q. What is the structure of a mutual fund?

Q. How to invest in a mutual fund?

Step 1

Identify your investment needs.

1. What are my investment objectives and needs?
2. How much risk am I willing to take?
3. What are my cash flow requirements?

Step 2

Choose the right mutual fund.

1. The track record of performance over the last few years in relation to the appropriate benchmark and similar funds in the same category
2. How well the mutual fund is organised to provide efficient, prompt and personalised service
3. Degree of transparency as reflected in frequency and quality of their communications

Step 3

Select the ideal mix of schemes

Investing in just 1 scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals.

*Please ask your financial advisor for details and advice.

Q. Which one to buy?

Disclaimer

As the value of securities in the fund increases, the fund's unit price will also increase. You can make a profit by selling the units at a price higher than at which you bought. Although, Mutual Fund does not guarantee the same.