Introduction

These days whenever we ask someone for an investment advice the first thing that comes out is mutual funds. People say that mutual funds are smart investments for an investor, but what actually are they and why are MFs good as an investment option.

A mutual fund is an investment vehicle that pools the money of a large group of investors and invests it in stocks, bonds, money market instruments and other types of securities. Through investment in a mutual fund, an investor can get access to markets that may otherwise be unavailable to them and avail of the professional fund management service offered by the asset management companies.

In simpler terms, mutual funds are like baskets. Each basket holds certain types of stocks, bonds or a blend of stocks and bonds to combine for one mutual fund portfolio.

BRIEF HISTORY OF MUTUAL FUNDS

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank of India. The history of mutual funds in India can be broadly divided into four distinct phases

First Phase – 1964-1987

Unit Trust of India (UTI) was established in 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. In 1978

The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988, UTI had Rs. 6,700 crores of assets under management.

Second Phase – 1987-1993 (Entry of Public Sector Funds)

SBI Mutual Fund was the first non-UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990.

Third Phase – 1993-2003 (Entry of Private Sector Funds)

With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI, were to be registered and governed. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996.

The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs. 44,541 crores of assets under management was way ahead of other mutual funds.

Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs. 29,835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India, functioning under an administrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations.

With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs. 76,000 crores of assets under management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place among different private sector funds, the mutual fund industry has entered its current phase of consolidation and growth.

ROLE OF MUTUAL FUNDS

Mutual funds have contributed significantly to the growth of the Indian economy. Indian financial markets have seen a great rise with the coming in of the MFs. It has made a huge and a good impact on our economy in the following ways:

1. It has significantly contributed to the development of the financial sector of India. Mutual fund investments pool resources from investors – small or big – and thus increase the participation in the market. Also, with good return generation attracts new investors to invest and for old ones to reinvest. Thus, overall development of the financial sector.
2. Money markets have also hugely benefitted from the increased Mutual fund investment with the help of The Money Market Mutual Funds (MMMFs). It has also even strengthened the Government securities market to some extent.
3. MFs assists the investors to earn income or building their wealth. With greater awareness amongst the investors about the mutual funds through the ‘Mutual Funds Sahi Hai’ campaign large chunk of investors have started investing in the MFs. One of the major reason behind it is the diversification of the fund schemes that allows more investors to come in and invest.
4.  The money that is raised from investors, ultimately benefits governments, companies and other entities, directly or indirectly, to raise money to invest in various projects or pay for various expenses.
5. The mutual fund industry has given livelihood to many people by generating employment opportunities. The funds that are collected by the companies and the government are invested in various projects, further helping in increasing the employment opportunities.

ADVANTAGES OF MUTUAL FUNDS

1.  Professional management: Mutual funds offer the investors the opportunity to earn income even if they do not have any knowledge about equities and debts. MFs offer professional management, which ensures that there is no need for the investor to give time or track the markets. There are professionals to manage the funds.
2. Affordable portfolio diversification: investing in a diversified portfolio can be very expensive. Mutual funds offer to an investor to invest his money in an affordable diversified portfolio. It gives the investors an exposure to a range of securities. People prefer a diversified portfolio as it ensures that not all eggs are in the same basket, therefore minimizing the risk and also that it gives higher expected returns.
3. Economies of scale: As we know that MFs provide professional management. This professional management comes at a cost and is not affordable by all the individuals. The pooling of large sums of money from so many investors makes it possible for the mutual fund to engage professional managers to manage the investment.
4. Liquidity: At times we get stuck with a security for which we can’t find a buyer. Except for the mutual funds, this problem persists will almost all the securities. Investors in a mutual fund scheme can recover the value of the money invested, from the mutual fund itself. Depending on the structure of the mutual fund scheme, this would be possible, either at any time, or during specific intervals, or only on the closure of the scheme.
5. Tax deferral: in MFs the investor is not required to pay the tax on income from MFs earned every year. Here the investors can let the money grow for several years. MFs helps in the tax deferral.
6. Tax benefits: Specific schemes of mutual funds give investors the benefit of deduction of the amount subscribed (up to Rs.150,000 in a financial year), from their income that is liable to tax. This reduces their taxable income, and therefore the tax liability.
7. Systematic Approach to Investments: Mutual funds also offer facilities that help investor invest amounts regularly through a Systematic Investment Plan (SIP), or withdraw amounts regularly through a Systematic Withdrawal Plan (SWP), or move money between different kinds of schemes through a Systematic Transfer Plan (STP). Such systematic approaches promote investment discipline, which is useful for long-term wealth creation and protection.
8. Investment Comfort: Once an investment is made with a mutual fund, they make it convenient for the investor to make further purchases with very little documentation. This simplifies subsequent investment activity.
9. Regulatory Comfort: The regulator, Securities & Exchange Board of India (SEBI), has mandated strict checks and balances in the structure of mutual funds and their activities. It ensures that the investors are protected.
10. Transparency: The performance of a mutual fund is carefully reviewed by various publications and rating agencies, making it easy for investors to compare the fund to another. As a unit holder, you are provided with regular updates, for example, daily NAVs, as well as information on the fund’s holdings and the fund manager’s strategy.

Disadvantages of Mutual funds

1. Lack of portfolio customization: if you want to manage your own investment portfolio and invest according to your own choices then mutual funds are not for you. If you have invested in mutual funds then you would have no control over what securities are bought or sold. The fund manager takes all the investment decisions.
2.  Overloaded choice: There are nearly over 2000 mutual fund schemes available and this no. is continuously increasing. This makes it difficult for the investors choose among these schemes.
3. No control over costs: All the investor’s money are pooled together in a scheme. Costs incurred for managing the scheme are shared by all the Unit-holders in proportion to their holding of Units in the scheme. Therefore, an individual investor has no control over the costs in a scheme.

WHO CAN INVEST IN MUTUAL FUNDS?

Mutual Funds in India are open to investment by

• Residents including:

1. Resident Indian Individuals
2. Indian Companies
3. Indian Trusts / Charitable Institutions
4. Banks
5. Non-Banking Finance Companies
6. Insurance Companies
7. Provident Funds

•  Non-Residents including:

1. Non-resident Indians, and
2. Other Corporate Bodies

• Foreign entities, viz:

1. Foreign Institutional Investors (FIIs) registered with SEBI.

However, some category of investors are not allowed to invest in particular schemes of certain funds. Besides, the investors who are eligible to invest may still need to follow different procedures.