MUTUAL FUNDS

TOPIC 7 PART I
Introduction
• Small investors generally do not have adequate time,
knowledge, experience and resources for directly entering
the capital market.
– They depend on an intermediary
• Investors without knowledge of share markets and
companies if invest may loose money
• With little money they cannot enter into big companies
Scope of Mutual Funds
• Mutual funds are financial intermediaries that allow savers
to purchase shares in a portifolio of financial assets,
including stocks, bonds, mortgage and money market
securities.
• Mutual funds raise funds by selling shares to individuals
savers and invests the fund in a portifolio of stocks,
bonds, mortgage and money market instruments.
• Mutual fund collects the savings from small investors,
invest them in government and other corporate securities
Scope of Mutual Funds
• If one has small amount of TZS10,000 he cannot enter
into big companies, but the money of all the investors are
pooled create big fund large enough to invest in variety of
investments.
• It is a form of collective investment, by coming together of
number of investors who transfer their surplus funds to
professionally qualified organization to manage it.
Scope of Mutual Funds
• To get the surplus funds from the investors, Mutual funds
adopt a simple technique:
– Each funds is divided into small shares called units of equal
value.
– Each investor is allocated units in proportion to the size of his
investments.
Scope of Mutual Funds
• The income earned through these investments are shared
by its unit holders in proportion to the number of units
owned by them.
• Mutual funds provides risk sharing benefits by investing in
a variety of securities (diversification)
– All stocks/debts instruments may not move in the same
direction
• Mutual funds offer diversified portifolio of assets.
Scope of Mutual Funds
• E.g, Economic conditions like a rise in interest rates may
cause certain securities in a diversified portifolio to
decrease in value, while other securities in the portifolio
will respond to the same economic conditions by
increasing in value.
• Mutual funds provide diversification with low transactions
costs
Concept
• A Mutual Fund is a trust that pools the savings of number of
investors who share a common financial goal.
• The money collected is then invested in capital market
instruments such as shares, debentures and other securities.
• Mutual funds can thus be considered as financial intermediaries
who collect funds from the public and invest on behalf of the
investors.
– The income earned through these investments are shared by its unit
holders in proportion to the number of units owned by them.
Mutual Fund Operation Flow Chart
How Mutual Fund works?
A vehicle for investing in portfolio of stocks and
bonds
TYPES OF MUTUAL FUNDS
• Based on Structure
– Close-ended funds
– Open-ended funds
– Interval schemes
• Based on Investment objectives
– Income funds
– Growth funds
– Balanced funds
– Money market Mutual funds(MMMFs)
TYPES OF MUTUAL FUNDS
• Based on Special schemes
– Sector specific funds
– Specialized funds
Close-ended funds
• The mutual fund issues a fixed number nonredeemable
shares, which investors may then trade in over the
counter markets.
• The size of the fund and its durations are fixed in
advance.
• Once the subscription reaches the pre determined level,
the entry of investors will be closed.
• After the expiry of the fixed period, the entire investment
is liquidated and the proceeds are distributed to the unit
holders in proportion to their holding.
Close-ended funds Cont....
• Features:
– The period and the target amount of the fund is fixed before
hand.
– Once the period is over, the subscription will be closed -
Investors cannot purchase anymore units.
• You'd have to buy them from the secondary market.
– The main objective is capital appreciation
– At the time of redemption, the entire investment is liquidated
and the proceeds are distributed among the unit holders.
Close-ended funds Cont.......
– Units are listed and traded in stock exchanges.
– The price of share fluctuate with the market value of the assets
- called Net asset value.
– The price of units are quoted at discount or premium relative to
the market value of the asset in the fund.
• Due to differences in the quality of fund management or the liquidity of
the shares.
Open-ended funds
• The mutual funds issue shares that investors can buy
and sell anytime throughout the year.
• The size of the fund and period of the fund is not fixed in
advanced.
• Investors are free to buy and sell any number of units at
any point of time.
• Features:
– The investors are free to buy and sell units anytime throughout
the year.
Open-ended funds Cont....
– There is no time limit.
• The investor can join in and come out from the fund as and when he
desires.
– These units are not publicly traded but, the fund is ready to repurchase
them and resell them at any time.
– The main objective of fund is income generation. The investors get
dividends, rights or bonuses as rewards for their investment.
– Since the units are not listed on the stock market, their prices are linked to
the Net assets value(NAV) of the units. NAV is decided by the fund and
varies from time to time.
– Funds buy back shares when investors wish to sell.
– The investor is offered instant liquidity by selling units on any working day
to the fund.
Interval schemes
• These schemes combine the features of open ended and
close ended schemes and are available for purchase or
sale during a select period.
• These funds combine the features of both open–ended and
close-ended funds wherein the fund is close-ended for the first
couple of years and open-ended thereafter.
• Some funds allow fresh subscriptions and redemption at fixed
times every year (say every six months) in order to reduce the
administrative aspects of daily entry or exit, yet providing
reasonable liquidity.
Income funds
• It concentrates more on the distribution of regular income
and it also see that the average return is higher than that
of the income from bank deposits.
• The investor is assured of regular income at periodic
intervals say half yearly or yearly so.
• The main objective of this type of fund is to declare
regular dividends and not capital appreciation
• This is best suited to the old and retired people who may
not have any regular income.
• It concerns itself with short run gains only.
Income funds Cont........
• The pattern of investment is oriented towards high and
fixed income yielding securities like debentures, bonds
etc.
• Features:
– The investors get a regular income at periodic interval
– The main objective is to declare regular dividends and not
capital appreciation
– It focus on short run gains only
Growth funds
• Growth funds concentrate mainly on long term gains i.e
capital appreciation
• The investment strategy therefore,conforms to the fund
objective by investing the funds predominantly on equities
with high growth potential.
• The fund tries to get capital appreciation by taking much
risks and investing on risk bearing equities and high
growth equity shares
• The fund may declare dividend but its principal objective
is only capital appreciation.
Growth funds Cont....
• This is best suited to salaried and business people who
have high risk bearing capacity and ability differ liquidity.
They can accumulate wealth for future needs.
Balanced funds
• Aims at distributing regular income and capital
appreciation
• This is achieved by balancing investment between the
high growth equity shares and also the fixed income
earning securities.
Money market Mutual funds(MMMFs)
• A mutual fund that invests exclusively in short-term
assets, such as Treasury bills, negotiable certificates of
deposit, and commercial paper.
• These funds are appropriate for corporate and individual
investors as a means to park their surplus funds for short
periods.
Sector specific funds

• These are the funds which invest in the securities of only those
sectors or industries as specified in the offer documents. e.g.
Pharmaceuticals, Software, Fast Moving Consumer Goods
(FMCG) etc.
• The returns in these funds are dependent on the performance of
the respective sectors/industries.
• Generally these funds give higher returns.
• They are more risky compared to diversified funds.
Specialized funds
• They offer a large number of specialized funds so as to
meet the specific needs of specific categories of people
like pensioners, widows etc.
• There are also funds for investments in securities of
specified areas like Japan fund, South Korea fund etc.
– These funds open the doors for foreign investors to invest on
the domestic securities of these countries.
• Again certain funds may be confined to one particular
sector or industry like fertilizers automobiles etc.
leveraged Funds
• These funds are also called borrowed funds since they
are used primarily to increase the size of the volume of
portfolio of a MF.
• When value increases the earning capacity of the fund
also increases
• The gains are distributed to the unit holders.
• This is resorted to only when the gains from the borrowed
funds are more than the cost of borrowed funds.
 Mutual Funds plans

• Growth Plan and Dividend Plan

A growth plan is a plan under a scheme wherein the returns
from investments are reinvested and very few income
distributions, if any, are made.
• The investor thus only realises capital appreciation on the
investment. This plan appeals to investors in the high income
bracket.
Under the dividend plan, income is distributed from time to
time. This plan is ideal to those investors requiring regular
income.
Mutual Funds plans Cont....
• Dividend Reinvestment Plan
Dividend plans of schemes carry an additional option for
reinvestment of income distribution.
• This is referred to as the dividend reinvestment plan.
• Under this plan, dividends declared by a fund are reinvested on
behalf of the investor, thus increasing the number of units held
by the investors.
Mutual Funds plans Cont....
• Automatic Investment Plan
Under the Automatic Investment Plan (AIP) also called
Systematic Investment Plan (SIP), the investor is given the
option for investing in a specified frequency of months in a
specified scheme of the Mutual Fund for a constant sum of
investment.
• AIP allows the investors to plan their savings through a
structured regular monthly savings program.
Mutual Funds plans Cont....
• Automatic Withdrawal Plan
Under the Automatic Withdrawal Plan (AWP) also called
Systematic Withdrawal Plan (SWP), a facility is provided to the
investor to withdraw a pre-determined amount from his fund at
a pre-determined interval.
Importance of mutual funds-Discussion
Why do People Invest in Mutual Funds?
Risks-Discussion
• MFs are not free from risks because the funds raised
have to be invested in the market: