Over past few years, one of the most popular (market linked) avenue for beginning the investing journey has been “Mutual Fund” We can hardly ever forget the ever-frequent “Mutual Funds – Sahi Hai” advertisement.
Make no mistake irrespective of whether people truly believe “Mutual Fund Sahi Hai!” or not, fund inflow is rapidly increasing. Growth rate of cumulative asset under management (AUM) is at a staggering 31.59%.
There is a very good reason for this though and before we get into that, let me give you a quick overview on how mutual funds work. There are numerous types of mutual funds and by large almost every single one of them works in the same way.
What is a mutual fund?
First, a person / organization who wishes to start mutual fund follows a rigorous process, which can be found here. Without going too much into detail, it has several investor friendly measure to bring in more transparency. The fund is set up in the form of a trust including sponsor, trustee and AMC (Asset Management Company)
The AMC then shares an “Offer for Sale” (OFS) announcement which invites investors to put their money in. OFS usually comprises of a Scheme Information Document (SID). In SID detailed information like the fund investment style, expenses and charges associated with it, risk factor, portfolio style etc. Then the fund is available to purchase, redeem and/or SIP.
Meanwhile, the AMC nominates a fund manager for actively (or passively depending on the type of fund) managing the pooled fund with best interest of stakeholders. He then invests this in the diversified asset classes to get return on investment. He is expected to share a monthly status on where the money is invested along with all necessary details. This ensures that the investor stays up to date.
Why is it advantageous?
1. Leave it to the expert: You are entrusting your fund with a highly trained subject matter expert. He diligently works in the best interest of his / her investors. This protect you from numerous schemes that more likely than not results in your capital erosion.
2. Less Volatility: Since the funds are significantly diversified, the value of your capital remains fairly protected from volatility. Over and beyond this the fund manager tends reallocate portfolio on need basis to ensure overall quality of the investment.
3. Less Monitoring required: You have delegated the management of your money to the fund manager. You simply invest and move on to your day job with the satisfaction that an expert takes good care of your money. Of course, you still have to review your fund manager’s performance frequently. But the frequency can be once in a quarter (if you have invested for long term)
NAV of a mutual fund
At what price do we buy a mutual fund so to speak? Just like how a stock has market price, mutual funds have “Net Asset Value” or NAV. It is at this value the mutual funds transacts in the open market. But, how exactly are NAVs calculated. It is nothing but the total net assets of the fund’s portfolio divided by the total number of outstanding units in the fund.
Again, what is net assets?! After settling all the liabilities, remaining asset is the net asset. Let us say that a fund portfolio has a cash balance (Asset) of ₹10 lakhs and an outstanding expense (Liability) of ₹2 lakhs. Therefore, in this case the net assets of the fund house would be ₹8 lakhs (10-2). It is pertinent to understand that NAV is immune to the demand for the fund. Calculations are irrespective of market forces and only consider the portfolio position of the fund.
All said and done, wide varieties of legislative mandates are in place to safeguard investor interest, mutual funds offer one of well round exposure in current market. Of course, there is a still a likelihood of fund manager being inefficient / inept, but the likelihood of capital erosion is significantly reduced. All this has given high hopes to investors and AMCs alike that the inflow from domestic investors is going to increase over next few years as in India mutual fund investors are still at a measly 2%
Most certainly, the key deciding factor for success however is to choose the best possible fund to ensure that “Mutual fund sahi hai!” claim is a reality. However, that’s a topic for another day