Chapter 4: How is a Mutual Fund Formed

By now, you must have understood how a mutual fund works. In this chapter, let’s dive deeper into how a mutual fund actually functions legally in the Indian markets. For this, we need to understand the key constituents of a mutual fund and its organizational structure to know how a mutual fund House is formed and how an AMC is appointed.

We then go on to understand the legal structure of a mutual fund, who the service providers are, and their role in ensuring every mutual fund transaction is carried out smoothly.

You may want to skip this chapter if you already know how a mutual fund functions technically and are aware of its legal framework.

But for those who are beginning their journey into MF investing, you should understand this very carefully as it will give you a lot of confidence and comfort in using MFs as a tool for investing.

A Mutual Fund is a Trust

So, as per the SEBI (Mutual Fund) Regulations, 1996, as amended to date, “A mutual fund” is defined as “a fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one or more schemes for investing in securities including money market instruments or gold or gold-related instruments or real estate assets.”

Further, the regulation states that the firm must set up a separate asset management company (AMC) to run a mutual fund business.

The above definition clearly states that mutual funds are constituted as trusts and are governed by the Indian Trusts Act, 1882. An AMC should be a separate company that manages the money received by the trust through investors.

A trust deed, executed between the sponsors and the trustees, governs the operations of the mutual fund trust.

Sponsors - the guys who run the show

Since a mutual fund is a trust, there’s no owner, of the mutual fund company. A trust is run by a sponsor/s (could be more than one), and these are the main guys who run the mutual fund.

When a trust is formed, there have to be beneficiaries, don’t they? So here, the beneficiaries are the Investors who invest in various schemes of the mutual fund.

Trustees – responsible for protecting the interests of investors.

Any trust acts through its trustees. Trustees are individuals or a group of individuals (aka Board of Trustees) appointed to run the mutual fund company and play the most important role, protecting the interests of the beneficiaries (investors).

The trustees execute an investment management agreement with the AMC, setting out its responsibilities.

AMCs: Day-to-Day Managers

The AMC is appointed by the sponsor or the Trustees and handles the day-to-day management of the schemes for the mutual fund trust.

The record of investors and their unit-holding may be maintained by the AMC itself, or it can appoint a Registrar & Transfer Agent (RTA) to keep the records on behalf of the AMCs.

A very important point here is that although the AMC manages the schemes, the custody of the scheme’s assets (securities, gold, gold-related instruments, and real estate assets) is with a Custodian, who is appointed by the Trustees.

Custodians - Guardians of the Assets

A Custodian, appointed by the trustee, has custody of the fund’s assets. As part of this role, the custodian must accept and deliver securities to purchase and sell the fund’s various schemes.


All custodians need to register with SEBI under the SEBI (Custodian) Regulations 1996 and a custodial agreement is entered into between the trustees and the custodian.

Why a custodian ? to protect the interests of mutual fund investors. Independent custodians ensure that fair practices are adopted, the money is put to the right use and stays protected.

So you see, mutual funds are highly regulated, and the structure designed by our market regulators makes them a highly regulated business.

The 1996 MF regulations by SEBI have ensured that the mutual fund industry is highly regulated at all times. These regulations also lay down various criteria, right from forming a trust to the set of rules applicable while appointing the sponsors, trustees, AMCs, and custodians. Thus, SEBI has a complete regulatory watch on MFs.

The Silent Pillars of Mutual Funds & their Role - the Service Providers

Now that we have discussed the structure of how a mutual fund legally functions in the real world, it’s also important to know about some of the other key service providers, aka the pillars or the ancillary enablers, that aid the AMCs in the ease of doing business and also simplify the life of every investor in Mutual funds.

Fund Accountant
performs the role of calculating the NAV by collecting information about the assets and liabilities of each scheme. The AMC can either handle this activity in-house or engage a service provider.

Registrars & Transfer Agents (RTAs)
RTAs are essentially the backbone of the Mutual fund Industry. They maintain investor records for almost all the AMCs in India ( those without an in-house team). Basically, they are the fund accountants for the AMC, but they are outsourced.

They function through their Investor Service Centres ( ISCs) located in multiple cities across India, which serve the important role of documenting investors’ investments in mutual funds.

The main role of the RTAs is to record all the transactions ( purchase and sale of units, processing transactions, dealing with the funds received and payment made while investors transact and Updating the information in the individual records of the investor, called folios,

They are also responsible for keeping the investor informed about the status of their investment account and all the information related to the investments. Although an AMC can perform all the above activities themselves, they choose a SEBI-registered RTA to outsource this work for convenience. Indeed, it’s a smart choice as these RTAs are SEBI-registered companies that are professionals in handling customer data and processing large transactions smoothly and efficiently.

KYC Agencies – Central KYC Registry Agencies (KRAs)
If you are an existing investor in any of the securities market instruments, you probably know what a KYC (Know Your Customer). KYC is a mandatory process which establishes the complete personal details of an investor, its name and address to establish an identity of an investor.

To invest in a mutual fund , an investor has to be KYC compliant (under the provisions of PMLA – Prevention of Money Laundering Act).

Now, the issue here is that there are roughly 4 crore mutual fund investors currently investing in India ( as of 2024 ). Imagine if all them had to do a KYC every time they decided to invest in a mutual fund. Don’t you think it is a tedious process and a serious hassle for the AMCs to adhere to?

So, to eliminate this repetitive process, SEBI issued regulations for the registration of central KYC Registry Agencies (KRAs) in 2011, introducing a common/ central KYC ( CKYC ) for investors in securities markets.

These KRA firms are registered with SEBI, and they process various details and documents to establish the investor’s identity and assign a number through a letter. ( Referring to getting a CKYC done)

A copy of this letter can be submitted to any SEBI registered intermediary, specifically AMCs, in case of Mutual Funds, with whom the investor wants to transact.

This is a simple solution to a complex problem; kudos to our regulators once again for simplifying the ease of investing across all securities.

Depositories and Depository Participants (DPs)
Consider Depositories as electronic or digital banks of securities. A Depository is an institution that holds securities in dematerialized or electronic form on behalf of investors.

Dematerialization started with shares, and now folios of mutual funds can also be seen in your DEMAT statement issued by the depositories.

There are only 2 Depositories in India –

1. CDSL – Central Depository Services Limited.
2. NSDL – National Securities Depository Limited.

Both do a phenomenal job of digitalizing the investors’ experience and simplifying tracking and monitoring their investments by allowing them to hold all securities in a single consolidated space.

Now, DPs are essentially the branches of these depositories. To overcome the geographical challenges of reaching out to investors by opening offices at multiple locations, these depositories appoint DPs to help onboard the investor.

Investors contact these DPs, and these DPs help investors open a demat account with the said depository.

Auditors – the warriors protecting the investors!
Independent investigators are responsible for auditing the books of accounts of an AMC and raising any red flags if they see any after going through the auditing process.

The auditor appointed to audit the mutual fund scheme accounts needs to be different from the auditor of the AMC.

While the scheme auditor is appointed by the Trustees, another independent auditor ( not related to the AMC in any way ) needs to be appointed to audit an AMC and its operations. This auditor is appointed by the AMC itself.

I’m sure you understand why auditors are important—they constantly monitor AMCs and are responsible for protecting the interests of every mutual fund investor.

Mutual Fund Distributors (MFDs) – the support system for AMCs and Investors
They are in the hands of the AMCs and are responsible for distribution, which means selling mutual fund schemes to retail investors.

In India, an MFD must be certified by the NISM (National Institute of Securities Market) and compulsorily register with AMFI—the Association of Mutual Funds in India—and get an AMFI Registration Code (ARN code). This is a mandate under the regulations of SEBI for mutual funds, without which an MFD cannot perform any selling activity in mutual fund schemes.

After obtaining the certification and the ARN code, an MFD can empanel itself as a distributor with multiple AMCs.

Any individual or institution, such as distribution companies, broking companies, and banks, can be a distributor if it abides by the above-mentioned rules and adheres to a code of conduct, including fair practices, for selling mutual funds to retail investors.

Transaction Platforms / Stock Exchanges – the new age tools for digital India!
With technology disrupting almost every sector, recent tech platforms like Dhan have changed how we invest in mutual funds. From the era of physical filling out and submission of long forms, which took 2 to 3 working days or even a week, to now just uploading the documents, using a video verification and ADHAAR-based validation, opening a mutual fund account, and subscribing to any mutual fund scheme, all within minutes!! We have indeed come a long way!

In fact, Dhan allows its users to invest/purchase, redeem, switch, etc., into mutual funds directly without needing an MFD or the complicated hassle of going to an AMC. In fact, Dhan allows its users to complete any required transactions for multiple AMCs using just the Dhan App (everything in a single app).

Not only does the platform simplify the transaction process for investors, but it also provides great features to help investors make informed decisions.

Investors can also transact in certain closed-ended mutual funds and ETFs that are listed on recognized stock exchanges. Since all closed-ended funds must be listed on the stock exchanges by rule, an exchange allows investors to exit a mutual fund after the NFOs.

This concludes this chapter. In the next chapter, we will decipher mutual fund ads’ most important statutory warnings!