Introduction to the c oncept of Mutual Fund

1. What is a mutual fund?

A mutual fund is a “pool of money” mobilized from many investors. So when you hear a term like SBI mutual  fund,  it simply means that there is a pool of money which is managed by SBI.

This pool of money is invested in different investment avenues in different markets. Collection of all these securities is called a portfolio.

This pool of money is invested into one single portfolio and not as separate individual portfolios.

This portfolio is created and managed by a team of professional portfolio/fund managers. In practice, this team is formed as a company. Such kind of company is called asset management company.

This portfolio is managed for the benefit of all the investors who contributed to the pool.

The income generated or loss incurred from this portfolio belongs completely to the investors after deducting expenses of managing the investment.

The investors may withdraw their money from the pool any-time they wish. In such a case, their investment amount after adding the gains or deducting the losses, as the case may be, is returned back to them.

2. What is the meaning of “pool of money”?

Pool of money is the total of all the money contributed by investors. If Ram invests Rs.15000, Rahim invests Rs.10000, and Emanuel invests Rs.20000 in a mutual fund, then the mutual fund shall have total pool of Rs.45000 (Rs.15000 + Rs.10000 + Rs.20000), with 3 (three) investors.

The above is just an example for our understanding and the real mutual funds normally have amount in excess of Rs.100 Cr in the pool.

3. Do Ram, Rahim and Emanuel get separate portfolios?

No. The total pool of Rs.45000 is invested in a single portfolio. The income generated is distributed among them in the proportion of their investments. Similarly, the expenses of managing portfolio, also, are apportioned among them in the same proportion.

4. Why pool money and not have separate portfolios for each of them?

The strength of a mutual fund lies in the pooling of money. Pooling makes the fund large.

- The larger fund size allows affordability – as an example, the fund would be able to invest in equity shares of companies like MRF which as on 20 Feb 2015 has a price of Rs.41000 per share, which, otherwise, none among Ram, Rahim or Emanuel would have been able to buy by their own money.

- The larger fund sizes allows investment in a well-diversified portfolio – a portfolio with investments in 50 different stocks is likely to have much lesser risk than one with just a few.

- The larger fund size allows appointment of a professional manager to manager the money. While, individually Ram may find it hard to get someone willing to manage his Rs.15000, there shall be many to manage a pool of a round 100 Cr or more.

- The larger fund size allows expenses to be lower per individual investor. It is impossible for investors like Ram to get a professional manager willing to manage a small investment portfolio like Rs.15000 for a fees of 1%, which is just Rs.150 for a one full year’s management. In comparison, a fund with a pool size of Rs.100 Cr is very tempting for most professional managers even at a fee of say 0.50%, which is Rs.50 lac.

- A larger fund not only means a big fund but also a lot of investors. Existence of a lot of investors ensures that at any point in time, the number of investors desiring to quit the fund shall be very less as compared to the total investors. This helps in providing liquidity to the existing investors, without causing any damage to the portfolio.

5. Who is responsible for creating a pool of money?

This pool of money is mobilized, managed and invested by specialized company. This company has a specific name – Asset Management Company (AMC ). Like any other company, this company has a business — business of managing money. And, like any other company, it has different departments or teams to manage different functions of money management. The product team of AMC creates a mutual fund, the sales team mobilizes money from different investors, their research and fund management team creates and manages the portfolio, the accounting team keeps a record of income and expenses of the portfolio and the operations team handle the interactions with investors. For example, in case of SBI mutual fund, the company formed for managing the mutual fund is SBI Funds Management Pvt. Limited. This company is formed by the State Bank of India (SBI).

6. Different investors have different investment objectives! How can they be in same pool?

Exactly! “Common investment objective” is essential for creation of pool.

Investors differ in terms of their capacity to take risk, holding periods and expectation of returns. Creation of one common pool requires investors to be similar in terms of their expectation of risk and returns. This is achieved by creating different pools, which are called mutual fund schemes . each having an individual investment objective providing investors with choices to invest money in as required by their own objective. Each scheme is run separately and has its own portfolio. The asset Management Company (AMC ) creates this portfolio based on the objective of the scheme. For example

a. If the common objective is “to take risk for higher returns in medium to long term”, the portfolio consists of equity instruments.

b. If the objective is “safety of principal, the portfolio consists of Debt instruments.

7. Where can I get more information about this? Do mutual funds like Reliance Mutual fund or SBI mutual fund explain this?

Most Mutual funds, including SBI mutual fund, in India give a detailed tutorial on the concept of Mutual funds on their websites. One such tutorial by SBI Mutual Fund can be seen here. Also, there is an association of Mutual Funds in India called AMFI. It also gives details on the concept of Mutual Fund which can be accessed here .

8. Do mutual funds like SBI mutual fund or reliance mutual fund give online facility to invest?

Yes SBI mutual fund allows online investment. To understand. how to invest online in SBI mutual Fund. read this. All other mutual  funds have similar processes and offer the facility.

One must remember that pooled portfolio management schemes and unit-linked insurance plans also broadly work on basis similar to that of mutual funds. However, they are different products, regulated by separate regulators and fulfilling different objectives.