To Many People, Mutual Funds can be seen as Complicated or risky Investment. We are going to Simplify it for you at the ground level so you can understand what Mutual Funds are in reality.
What are Mutual Funds
Mutual Funds in Simple Term can be understood as a pool of money, where many people come together and Invest a Certain Amount of money, the Money is then Collectively Invested and Profit made is distributed Among its Investors.
For Ex. If Mr X Wants to buy a residential property that is worth Rs.1 Crore and Mr X has only Rs.10 Lakhs. So Mr X Creates a Pool of Money where 9 Other Investors Come and Invest Rs.10 Lakhs in the Pool. Now from the Pool of Money, the Property can be bought. Once the Property is Bought each of the ten investors in the pool is the unitholder in the pool. Suppose the property is sold for Rs 1.2 Crore now all the unitholders will receive Rs.12 Lakhs Against their Original Investment of Rs.10 Lakhs. Thus Making a Profit of Rs.2 Lakhs on their Original Investment Amount of Rs.10 Lakh.
Now let us compare this to Mutual Fund where Mr X is an AMC/ Mutual Fund, the Investors in the Flat are Investors/Unitholders in the Mutual Fund. The Flat was the Investment Objective where in Mutual Funds it can be anything from Shares, Debentures, Bonds, Company Deposits (Depending upon its Mutual Fund type). Investors in the Flat got a Share in the Flat Similarly, Investors of the Mutual Fund get units in the Fund for their Investment. Like the Flat was sold the Investments in the Mutual Funds are sold and Paid to the Unitholders in the Mutual Fund Along with the Profit. The 12 Lakhs Share Value of Each Investor in the Flat Sale Proceeds is Called NAV (Net Asset Value) in the Mutual Fund which represents the Value of Each Unit in a Mutual Fund.
Parties Involved in a Mutual Fund
Now let us understand all the parties that are involved in Mutual Fund
1) Sponsor – The One who Sets up a Mutual Fund or Trust. A Sponsor is similar to the promoter of a Company. The Sponsor Appoints Board of Trustees.
2) Board of Trustees – Board of Trustees are Similar to the Board of Directors in a Company. The Role of Trustees is to see that interest of Investors in the Mutual Fund are Protected. The Board needs to have at least four independent directors.
3) AMC – AMC Stands for Asset Management Company.AMC is the entity who takes the money from us and Invests it on our behalf for a fee.
Ex. of AMC in India is HDFC Mutual Fund, Aditya Birla Mutual Fund, L&T Mutual Fund etc.
4) Custodian – A Custodian is a person who has custody of all the Shares & Securities Invested by the AMC. Custodian is appointed by the AMC.
Commonly Used Terms
1) Mutual Fund Scheme – Each AMC has a different variety of Mutual Fund Schemes to Invest. You can Invest in the Scheme you like its Completely your Choice.
There are different Schemes such as Equity Mutual Fund, Debt Mutual Fund, Hybrid Mutual Funds. There are also Sub Categories in all these Major Types.
2) NAV – NAV Stands for Net Asset Value. NAV is nothing but Value of Each unit of Mutual Fund Scheme. Like Every Share has its value each unit in a Mutual Fund Scheme has its NAV.
Each Scheme has to give an updated NAV after each Trading Day ends. NAV helps you to Calculate your Investment Amount by Multiplying NAV with the Units
3) Units – Units are nothing but a Share of Fund given by the AMC to the Investor. Units in a Mutual Fund are similar to Shares in a Company representing certain ownership in the Fund.
The Units in a Fund are arrived at after dividing NAV with the Investment Amount Ex. If NAV of a Scheme is Rs.40 and Mr.X Invests Rs.1000 then he will get 25 Units in the Scheme at Rs.40 Each.
4) Fund Manager – Fund Manager is the person appointed by the AMC to manage Funds on the behalf of the Investor. Once you invest in Mutual Funds it is the Duty of Fund Manager to Invest the funds and generate returns for Investors.
5) Expense Ratio – Expense Ratio is the Fee charged by the AMC for managing the funds on the behalf of the Investors. Expense Ratio is Charged on the AUM as a percentage.
So the AUM of the Fund is 100 Crore is Expense Ratio is 1%, then 1 Crore would be Charged as the fee.
6) AUM – AUM Stands for Asset Under Management. AUM means the Complete Amount that is managed by the Mutual Fund Ex. IF X Mutual Fund Manages Rs.1500 Crores of its Investors. The AUM is Rs.1500 Crores.
History of Mutual Funds in India
The Mutual Fund Industry in India started in 1963 with the formation of UTI in 1963 by an Act of Parliament and functioned under the Regulatory and administrative control of the Reserve Bank of India (RBI). At the end of 1988, UTI had ₹ 6,700 crores of Assets Under Management (AUM).
In 1987 first Public Sector Mutual Funds were set up by PSU Banks, LIC & GIC. SBI Mutual Fund was set up in June 1987 followed by PNB Mutual Fund, Bank of India Mutual Fund etc. At the end of 1993, the MF industry had assets under management of ₹47,004 crores.
In 1993 erstwhile Kothari Pioneer (now merged with Franklin Templeton MF) was the first private sector MF registered in July 1993. With the entry of private sector funds in 1993, a new era began in the Indian MF industry, giving the Indian investors a wider choice of MF products. The initial SEBI MF Regulations were revised and replaced in 1996 with a comprehensive set of regulations, viz., SEBI (Mutual Fund) Regulations, 1996 which is currently applicable. As at the end of January 2003, there were 33 MFs with total AUM of ₹1,21,805 crores, out of which UTI alone had AUM of ₹44,541 crores.
Source – AMFI Website
Also Read – Mutual Funds: Myth vs Reality
Thank You very much for Reading hope you were able to understand what are exactly Mutual Funds. If you have any question do let us know in the comments section below.