Project on Investment in Securities Market
Financial Planing
(Source: SEBI Website - Securities Market Awareness Campaign
Empowering Investors Through Education)

Investment In Securities Market - Investment Options - Mutual Funds

Mutual Funds are entities which collect funds from small investors, pool these funds together and invest into various equity and debt instruments (or even money market instruments and government securities). Mutual Funds employ competent finance professionals who research the markets effectively, which an individual investor might not successfully manage. Further, these entities are taken seriously by a company’s management in view of their large fund base.

Mutual fund schemes can be open-ended or close-ended. Open-ended schemes do not have a fixed maturity. Investors can buy/sell units of such schemes from/to the fund itself at prices determined by Net Asset Value (NAV) plus or minus a load, applied either at the point of purchase or sales by the fund. Liquidity in open-end mutual funds is very high. In case of close-ended mutual funds, liquidity depends on the availability of buyers and sellers in the stock exchange where these units are listed. Thus, liquidity is similar to that of listed shares.

Close-ended schemes may be listed on stock exchanges and traded at listed prices. If it is not listed, regular repurchase facility will be provided by the mutual Funds. These prices could vary substantially from the NAV due to investor perceptions, demand and supply situations, etc. Indian data indicates that listed prices are generally much lower than the NAV.

NAV is a common expression in the mutual fund industry and denotes Net Asset Value. NAV per Unit is equal to:

Market value of the assets of the scheme less liabilities
divided by
Number of units outstanding

Mutual Fund Schemes are floated with objectives that determine their investment pattern. A growth-oriented scheme would predominantly invest in equities and would seek capital appreciation as its major objective. A debt-oriented scheme would predominantly invest in debt instruments and would seek regular income as its major objective. A balanced scheme would invest partially in equity and rest in debt and would balance the objectives of growth and income. Tax Saving Schemes are designed to provide tax shelter to the investors.

Of late, mutual funds are floating innovative schemes like index funds, specific sector funds, money market funds, gilt funds, etc. Index funds seek to invest in index stocks (e.g. only those stocks which are used to determine the Sensex, Nifty, etc.). Specific sector funds seek to invest into specified sectors like pharmaceuticals or software. Money market and gilt funds seek to invest into those markets alone.

Most mutual funds levy an extra charge to investors who enter into or exit from their Funds. Levies at the point of entry are termed ‘Entry Loads’ and those at the point of exit are termed ‘Exit Loads". Typically these loads are pegged at a certain percentage of the NAV –for example – Entry load of 1.5% of NAV. Some funds charge different loads depending on the quantum of investment. For example, the entry load could be 1.5% for investments below Rs 1 lakh and 1% for investments above that level

These funds seek to provide a regular return to investors and would invest in debt instruments where risk levels are lower (relative to equity), and would generate regular returns for the fund and consequently for its investors.

In view of the nature of the fund’s investments, safety levels are relatively high in debt-oriented funds. An investor need not be actively involved in investment management. However, the investor should be watchful about the NAV movements. While generally the returns from debt funds are expected to be steady, there could be NAV volatility if the interest ranges change.

These funds invest in equities and generate capital appreciation. Redemptions are effected within 2-3 days in most mutual fund schemes. Safety levels are low and slightly better than investment in shares directly by the investors, as most funds invest in a basket of equities thus hedging their individual risks partly through the basket approach. Returns in equity funds are volatile and would depend on the market movement in general and investment expertise of the mutual fund in particular. An investor need not be actively involved in investment management. However, the investor should watch the NAV and the load.

These schemes are floated by mutual funds and financial institutions after obtaining government approval for offering specified tax benefits to investors. An investor gets an additional sweetener. Other features of these investment options are on par with the regular features of mutual funds and financial institutional options discussed above.

Futures, options, forwards, warrants and swaps are called derivative products. They derive their value from another asset, index or reference rate.

A forward contract is a customized contract where the settlement takes place at a future date but at prices agreed on the date the contract is written

A futures contract is similar to a forward except that it is standardized and traded on the derivative exchange.An option gives the right and not obligation to the buyer to buy/sell an asset at a future date but at price agreed on the date of writing the contract. A buyer of an option pays a price called premium. An option that gives the right to buy an asset is a call option. When the right given is a right to sell the asset, it is put option. Warrants are long dated call option on equity shares.

The above table is indicative. Attractiveness of each option changes practically every day depending on economic conditions, government policies and other factors.