Investment is time, energy, or matter spent in the hope of future benefits actualized within a specified date or time frame. Investment has a different meaning in finance from that in economics. In finance, investment is buying or creating an asset with the expectation of capital appreciation, dividends (profit), interest earnings, rents, or some combination of these returns.
Mutual funds offer several such schemes to cater to the needs of different types of investors. They are closely regulated by Securities & Exchange Board of India (SEBI) with a view to protect investors. SEBI (Mutual Funds) Regulations, 1996 sets out the regulatory framework. Association of Mutual Funds in India (AMFI) is an industry body constituted by mutual funds in the country. It works closely with SEBI to address various mutual fund related regulatory issues, and ensure smooth functioning of the industry
Safety
Mutual funds announce the investment objective for every scheme they float, and seek investments from the public. When a scheme is open for investment for a limited period, initially, it is called a New Fund Offer (NFO). Depending on how it is structured, the scheme may be open to accept money from investors only during the NFO (closed-end scheme), or it may accept money post-NFO too (open-end scheme).
The investment that an investor makes in a scheme is translated into a certain number of 'Units' in the scheme. Thus, an investor in a scheme is issued units of the scheme. For example, if an investor has invested Rs. 1,000 in units issued at Rs10, he will be entitled to Rs. 1,000 ÷ Rs. 10 i.e. 100 units
The purchase of units by the investor from the scheme is also called subscription. Refund of money to the investor by the scheme is called redemption.
Under the law, every unit has a face value of Rs10. (However, older schemes in the market may have a different face value). The face value is relevant from an accounting perspective. The number of units multiplied by its face value (Rs10) is the capital of the scheme – its Unit Capital.
The scheme earns interest income or dividend income on the investments it holds. Further, when it purchases and sells investments, it earns capital gains or incurs capital losses. These are called realized capital gains or realized capital losses as the case may be.
Investments owned by the scheme may be quoted in the market at higher than the cost paid. Such gains in values on securities held are called valuation gains or unrealised gains. Similarly, there can be valuation losses or unrealised losses, when securities are quoted in the market at a price below the cost at which the scheme acquired them.
The practice of marking securities to their market value is called marked to market (MTM) valuation. The true worth of each unit of every scheme i.e. its Net Asset Value (NAV) is calculated based on MTM valuation of the investment portfolio. Thus, it captures all the gains and losses, realised and unrealised. Under the regulations, MTM is to be done daily. This is the principal reason the NAV of the scheme fluctuates, even if there is no change in the investments held in the portfolio of the scheme.
A fall in the security values in the market at the end of a day can cause a drop in NAV; the following day, if the market recovers, the NAV too will recover. Thus, while NAV of mutual fund schemes fluctuate, the fluctuation is of little relevance to a long term investor; the investor's actual returns depend on the price at which he buys or sells the units of the scheme, and the dividend he receives from the scheme during the period he holds the units. Running the scheme entails costs viz. scheme running expenses. The expenses pull down the profits of the scheme and the NAV of the units. This brings down the returns for the investors. Therefore, SEBI has restricted the expenses that can be charged to mutual fund schemes. This has helped in positioning mutual funds among the lowest cost investment products in India.
The scheme's investment operation can be said to have been handled profitably, if the following profitability metric is positive: (A) Interest income (B) + Dividend income (C) + Realized capital gains (D) + Valuation gains (E) – Realized capital losses (F) – Valuation losses (G) – Scheme running expenses It may be noted, (D) and (F) are a result of MTM valuation. When the investment activity in a scheme is profitable, the NAV goes up; when there are losses, the NAV goes down
Besides advantages like Tax Efficiency and Transparency, Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. There are several aspects to such professional management viz. investing in line with the investment objective, investing based on adequate research, and ensuring that prudent investment processes are followed
Advantage
Following are the additional advantages of investing in a Mutual Fund :
1. Affordable Portfolio Diversification
Units of a scheme give investors exposure to a range of securities held in the investment portfolio of the scheme. Thus, even a small investment of Rs5,000 in a mutual fund scheme can give investors a diversified investment portfolio. With diversification, an investor ensures that all his eggs are not in the same basket. Even if some investments in the scheme portfolio lose money, other investments in the portfolio can make up for the loss. Thus, diversification helps reduce the risk in investment. In order to achieve the same diversification as a mutual fund scheme, investors will need to set apart several lakh of rupees. Instead, they can achieve the diversification through an investment of a few thousand rupees in a mutual fund scheme.
2. Economies of Scale
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 operation and underlying risks. Individual investors with small amounts to invest cannot, by themselves, afford to engage such professional management. Large investment corpus leads to various other economies of scale. For instance, costs related to investment research and office space get spread across investors. Further, the higher transaction volume makes it possible to negotiate better terms with brokers, bankers and other service providers. SEBI has fixed a limit on the brokerage that the schemes can pay on their purchases and sales of securities in the market. Similarly, there is a cap on the total expenses of every scheme.
3. Liquidity
At times, investors in financial markets are stuck with a security for which they can't find a buyer; worse, at times they can't find the company they invested in! Such investments, whose value the investor cannot easily realise in the market, are technically called illiquid investments and may result in losses for the investor. Investors in a mutual fund scheme can recover the value of the moneys invested, from the mutual fund itself. Depending on the structure of the mutual fund scheme, this would be possible, either at any time (open-end schemes), or during specific intervals (interval fund), or only on closure of the scheme (closed-end schemes). Closed-end schemes are listed in a stock exchange. Thus, before the scheme matures, the investor can sell the units in the stock exchange to recover the prevailing value of the investment.
4. Tax Deferral
Mutual funds are not liable to pay tax on the income they earn. If the same income were to be earned by the investor directly, then tax may have to be paid in the same financial year. Through the growth option in a scheme, the investor can let the moneys grow in the scheme for several years without any incidence of taxation. This helps investors to legally build their wealth faster than would have been the case, if they were to pay tax on the income each year.
5. Tax Benefits
The dividend that the investor receives from any mutual fund scheme is tax-free in his hands.
Investment in specific schemes of mutual funds (Equity Linked Savings Schemes - ELSS) can be reduced from the investor's income that is liable to tax. This reduces their taxable income, and therefore the tax liability.
The Rajiv Gandhi Equity Savings Scheme (RGESS) offers a rebate to first time retail investors with annual income below Rs10 lakh. 50% of the amount invested (excluding brokerage, securities transaction tax, service tax, stamp duty and all taxes appearing in the contract note) can be claimed as a deduction from taxable income in a single financial year. Although any amount can be invested in such scheme, the benefit is only available up to Rs. 50,000. Thus, the deduction is limited to 50% of Rs 50,000, i.e., Rs 25,000. Once an RGESS deduction is claimed in a financial year, no further RGESS deduction can be claimed by that investor in any future years. Mutual funds announce specific schemes that are eligible for the RGESS deduction.
6. Convenient Options
The options offered under a scheme viz. growth and dividend, allow investors to structure their investments in line with their liquidity preference and tax position.
7. Investment Comfort
The Know-Your-Customer (KYC) requirements are centralised across the capital markets, including mutual funds. Therefore, based on a single KYC process, investors can invest across the capital market in shares, debentures, mutual funds etc. Further, once an investment is made with a mutual fund, the investor can make further purchases with very little documentation. This simplifies subsequent investment activity.
8. Systematic Approaches to Investment
Mutual funds also offer facilities that help investor invest regularly through a Systematic Investment Plan (SIP); or withdraw amounts regularly through a Systematic Withdrawal Plan (SWP); or move moneys between different kinds of schemes through a Systematic Transfer Plan (STP). Such systematic approaches promote an investment discipline, which is useful in long term wealth creation and protection.
9. Regulatory Comfort
SEBI has mandated strict checks and balances in the structure of mutual funds and their activities
Mutual funds schemes in India are permitted to invest in securities (including equity shares and bonds / debentures), gold or gold related instruments and real estate assets. Thus Schemes can be classified in various ways, depending on how they are structured and the nature of investments they make
Product List
Mutual Funds are classified as Open-end, Closed-end and Interval Funds
Open-end schemes are open for investors to enter or exit at any time, even after the NFO. Although some unit-holders may exit from the open-end scheme, wholly or partly, the scheme continues operations with the remaining investors. The scheme does not have any kind of time frame in which it is to be closed
Closed-end funds have a fixed maturity. Investors can buy units of a closed-end scheme, from the fund, only during its NFO. The fund makes arrangements for the units to be traded, post-NFO in the stock exchange/s. This is done through a listing of the scheme in one or more stock exchanges. Such listing is compulsory for closed-end schemes
Interval funds combine features of both open-end and closed-end schemes. They are largely closed-end, but become open-end during pre-specified time periods. For instance, an interval scheme might become open-end between January 1 to 15, and July 1 to 15, each year. The benefit for investors is that, unlike in a purely closed-end scheme, they are not completely dependent on the stock exchange to be able to buy or sell units of the interval fund. There is a transaction period (January 1 to 15 and July 1 to 15, in this example), when both subscription and redemption may be made to and from the scheme). Transaction period has to be of minimum 2 working days, as per SEBI Regulations. The gap between two successive transaction periods (January 15 to July 1, in this example) is called interval period. The minimum duration of an interval period is 15 days. Subscription and redemption is not permitted during the interval period.
Funds are further classified on the basis of their management style - Actively Managed Funds and Passive Funds
Actively managed funds are funds where the fund manager has the flexibility to choose the investment portfolio, within the broad parameters of the investment objective of the scheme.
Passive fund invests on the basis of a specified index, whose performance it seeks to track. Thus, a passive fund tracking the S&P CNX Nifty or BSE Sensex would buy only the shares that are part of the composition of that index. The proportion of each share in the scheme's portfolio would also be the same as the weightage assigned to the share in the computation of the index.
The index, on which a passively managed scheme is constructed, is called its benchmark. Similarly, even active schemes have a benchmark – a standard against which scheme performance can be compared. A benchmark is announced when every scheme, active or passive, is launched.
Finally the schemes are classified on the basis of their Asset Class : Equity, Debt & Hybrid Funds
A scheme might have an investment objective to invest largely in equity shares and equity related investments like convertible debentures such schemes are called equity schemes.
Schemes with an investment objective that limits them to investments in debt securities like Treasury Bills, Government Securities, Bonds and Debentures are called debt funds or income funds.
Hybrid funds have an investment charter that provides for a reasonable level of investment in both debt and equity.
How to compare the scheme performance ?
Scheme performances are judged by lot many factors but a common investor can judge the scheme primarily with its past returns and also on the basis of the assigned benchmarking
Following are the assigned benchmarks for various scheme in Mutual Fund :
| # | Benchmark | Relevant for (Type of scheme) | Published By |
|---|---|---|---|
| 1 | S&P CNX Nifty | Diversified equity | National Stock Exchange |
| 2 | Sensex | Diversified equity | Sensex Bombay Stock Exchange |
| 3 | Mumbai Inter-bank Offered Rate (MIBOR) | Liquid | National Stock Exchange |
| 4 | Liquid Fund Index (Liquifex) | Liquid | Crisil.com |
| 5 | Composite Bond Fund Index (Compbex) | Income / Debt | Crisil.com |
| 6 | Balanced Fund Index (Balance Ex) | Balanced | Crisil.com |
| 7 | MIP Index (MIPEX) | MIP | Crisil.com |
| 8 | Short Maturity Gilt Index (Si-BEX) | Gilt schemes of short maturity | ICICI Securities |
| 9 | Medium Maturity Gilt Index (Mi-BEX) | Gilt schemes of medium maturity | ICICI Securities |
| 10 | Long Maturity Gilt Index (Li-BEX) | Gilt schemes of long maturity | ICICI Securities |
| 11 | Composite Gilt Index | Composite gilt schemes | ICICI Securities |
For comparing schemes on the basis of its historic returns and performances , do make the selection and check :
Dividends paid in Mutual Fund Scheme are completely Tax free in the hands of investors. Under growth option, If a unit-holder buys a mutual fund unit (from the scheme or the market) at Rs12 and sells it in the market or offers it to the scheme for re-purchase at Rs15, the difference of Rs15 – Rs12 i.e. Rs3 is treated as capital gain.
Taxation Mutual Funds
Capital Gains Tax
Taxability of capital gains and income in the hands of the investor is as follows:
| Dividend Distribution Tax (DDT): Abolished (Dividends are taxed in unitholder's hands at applicable slab rates) | |||
|---|---|---|---|
| Capital Gain Taxation applicable to Equity Oriented Schemes | |||
| Resident Individual / HUF $ | Domestic Corporates @ | NRI $/# | |
| Long Term Capital Gains (Units held for more than 12 months) | 12.5% (Exempt up to ₹1.25 Lakh per financial year) | 12.5% | 12.5% |
| Tax deducted at Source = NIL | Tax deducted at Source = NIL | Tax deducted at Source = 12.5% + applicable Surcharge + 4% Cess | |
| Short Term Capital Gains (Units held for 12 months or less) | 20% + Surcharge as applicable + 4% Cess | 20% + Surcharge as applicable + 4% Cess | 20% + Surcharge as applicable + 4% Cess |
| Tax deducted at Source = NIL | Tax deducted at Source = NIL | Tax deducted at Source = 20% + applicable Surcharge + 4% Cess | |
Securities transaction tax (STT) will be deducted on equity oriented schemes at the time of redemption/switch to other schemes/sale of units.
$ - Surcharge on LTCG u/s 112A and STCG u/s 111A is capped at 15% for Individuals, HUFs, AOPs, and BOIs.
@ - Surcharge for domestic corporate unitholders is 7% where income exceeds ₹1 crore but is less than ₹10 crores, and 12% where income exceeds ₹10 crores (or 10% under Opted Concessional Tax Regime Sec 115BAA/115BAB).
# - Capital gains tax / TDS will be deducted at the time of redemption of units in case of NRI investors only.
| PERSONAL INCOME TAX STRUCTURE (Default New Tax Regime Sec 115BAC) For Individual, Hindu Undivided Family, Association of Persons, Body of Individuals and Artificial Juridical Persons |
|
|---|---|
| Taxable Income | Tax Rates (%) |
| Up to Rs 3,00,000 | NIL |
| Rs 3,00,001 to Rs 7,00,000 | 5% |
| Rs 7,00,001 to Rs 10,00,000 | 10% |
| Rs 10,00,001 to Rs 12,00,000 | 15% |
| Rs 12,00,001 to Rs 15,00,000 | 20% |
| Rs 15,00,001 and above | 30% |
(a) Under the New Tax Regime, tax rebate under Section 87A is available for resident individuals with total income up to Rs 7,00,000 (resulting in NIL tax liability).
(b) Standard Deduction of Rs 75,000 is available for salaried individuals under the New Tax Regime.
(c) Health & Education Cess is applicable @ 4% on income tax plus surcharge.
(d) Taxpayers have the option to opt for the Old Tax Regime with earlier slab structure and applicable deductions.
| Capital Gain Taxation applicable to Schemes other than Equity Oriented Schemes | |||
|---|---|---|---|
| Category / Holding Period | Resident Individual / HUF | Domestic Corporates | NRI |
| Specified Mutual Funds (Debt schemes with equity ≤ 35% acquired on or after April 1, 2023 - irrespective of holding period) |
Taxed as per applicable Income Tax Slab Rates | Taxed at applicable Corporate Tax Rate (22% / 25% / 30%) | Taxed as per applicable Income Tax Slab Rates |
| Tax deducted at Source = NIL | Tax deducted at Source = NIL | Tax deducted at Source = Applicable Slab Rate + Cess | |
| Long Term Capital Gains (Other Non-Equity/Hybrid schemes held for more than 24 months) |
12.5% without indexation + Surcharge + 4% Cess | 12.5% without indexation + Surcharge + 4% Cess | 12.5% without indexation + Surcharge + 4% Cess |
| Tax deducted at Source = NIL | Tax deducted at Source = NIL | Tax deducted at Source = 12.5% + Surcharge + 4% Cess | |
| Short Term Capital Gains (Other Non-Equity/Hybrid schemes held for 24 months or less) |
Taxed as per applicable Income Tax Slab Rates | Taxed at applicable Corporate Tax Rate | Taxed as per applicable Income Tax Slab Rates |
| Tax deducted at Source = NIL | Tax deducted at Source = NIL | Tax deducted at Source = Applicable Slab Rate + Cess | |
Note: Tax implication on Dividend received by Unitholder:
Dividends distributed by mutual funds are added to the unitholder's total income and taxed at their applicable slab rates. TDS @ 10% is applicable on dividend income exceeding Rs 5,000 in a financial year for resident unitholders.
* - Surcharge rates apply based on total income level.
# - Short term / long term capital gains tax will be deducted at source at the time of redemption in case of NRI investors only.
Health and Education Cess at the rate of 4% applies on tax plus surcharge.
DISCLAIMER: The information set out is neither a complete disclosure of every material fact of the Income-tax Act, 1961 nor does it constitute tax or legal advice. In view of the individual nature of tax consequences, each investor is advised to consult his/her own professional tax advisor.
Capital Gains Calculation Example:
Suppose an investor purchases non-equity/hybrid mutual fund units eligible for long-term capital gains at Rs. 11 per unit and sells them after 24 months at Rs. 14 per unit.
The capital gain per unit is Rs. 14 minus Rs. 11 = Rs. 3 per unit.
Tax is calculated at the statutory rate of 12.5% (without indexation) on the capital gain:
Rs. 3 × 12.5% = Rs. 0.375 per unit (plus applicable surcharge and 4% health & education cess).
The capital gains tax, if applicable, is not deducted by the scheme when paying the redemption proceeds to investors who are resident in India. Resident investors must pay the capital gains tax to the income tax authorities on a self-assessment basis.
You can invest in Mutual Funds in both online and offline method. If you are an existing investor and have already got your KYC then can start investing from here – online In case you do not have your KYC yet, then send your request now ! For more details on investment eligibility and KYC process
How to Invest ?
The following are eligible to purchase Units of most mutual fund schemes:
- Resident Indian adult individuals, above the age of 18. They can invest, either singly or jointly (not exceeding three names)
- Minors i.e. persons below the age of 18 Since they are not legally eligible to contract, they need to invest through their Parents/ Lawful guardians.
- Hindu Undivided Families (HUFs) : Here family members pool the family money (inherited) for investments. The head of the family (called 'karta') invests on behalf of the family. Against his name in the application, he would add the letters "HUF" to show that the investment belongs to the family.
- Non-Resident Indians (NRIs) / Persons of Indian origin (PIO) resident abroad . An Indian citizen, who is working abroad, and his / her family residing abroad are typical NRIs who invest in India.
- Some Indians go on to become citizens of foreign countries such as US, Canada, New Zealand etc. Since India does not permit dual citizenship, they need to give up their Indian citizenship. However, their status as erstwhile Indians, entitles them to invest in mutual fund schemes. As part of the documentation, they will need to provide their PIO (Person of Indian Origin) Card / OCI (Overseas Citizenship of India) Card.
- NRI / PIO resident abroad have the facility of investing on repatriable basis i.e. when they sell the investment, the sale proceeds can be transferred abroad. Alternatively, they can invest on non-repatriable basis, in which case the proceeds from the sale of those investments cannot be remitted abroad. The conditions related to making payments for repatriable investments are discussed later in this Unit.
- Qualified Foreign Investors (QFIs) These are foreigners from certain countries that are permitted to invest in mutual fund schemes (and equity shares). SEBI has detailed the requirements and routes through which such investors, who are not Indians, can invest.
- QFI may also be a non-individual, like a company
- Companies / corporate bodies, registered in India
- Non-individual Investors which includes:
- Registered Societies and Co-operative Societies
- Religious and Charitable Trusts
- Trustees of private trusts
- Partner(s) of Partnership Firms
- Association of Persons or Body of Individuals, whether incorporated or not
- Banks (including Co-operative Banks and Regional Rural Banks) and Financial Institutions and Investment Institutions
- Other Mutual Funds registered with SEBI
- Foreign Institutional Investors (FIIs) registered with SEBI
- International Multilateral Agencies approved by the Government of India
- Army/Navy/Air Force, Para-Military Units and other eligible institutions
- Scientific and Industrial Research Organizations
- Universities and Educational Institutions. Here, the individuals who sign the documents are called authorised signatories and are investing on behalf of organizations / institutions they represent.
KYC Requirements for Mutual Fund Investors
Broadly, mutual fund investors need the following documents:
- Proof of Identity
- Proof of Address
- PAN Card (exempted for Micro-SIP, discussed in next section, and investments upto Rs. 20,000 per investor per mutual fund per financial year)
- Photograph
SEBI has instituted a centralized KYC process for the capital market, including mutual funds. This is a significant benefit for the investor. Based on completion of KYC process with one capital market intermediary, the investor can invest across the capital market. KRAs facilitate this centralised KYC process. So far, SEBI has approved 4 KRAs:
- CDSL Ventures Ltd (www.cvlkra.com)
- NSDL Database Management Ltd (www.ndml.in)
- DotEx International Ltd (www.nsekra.com)
- CAMS Investor Services Pvt Ltd (www.camskra.com)
Where investment is made by a minor, KYC requirements have to be complied with by the Guardian.
At times, investments are made by a Power of Attorney (PoA) holder. For example, father invests on behalf of son who gives a PoA. KYC requirements have to be complied with, by both, investor and PoA holder.
Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. The primary role of mutual funds is to assist investors in earning an income or building their wealth, by participating in the opportunities available in the securities markets.