Chapter 2B: Mutual Fund Jargon
Following are some keywords (Jargon) used daily in the Mutual fund world. These aren’t just jargon; some are concepts every MF investor should know.
AMC - Asset Management Companies
AMCs are the companies vested with the responsibility to collect money from investors and hire asset managers, who deploy these funds by investing through various schemes with a stated objective for investments and investing on the investors’ behalf.
AUM - Asset Under Management
The total amount of money the AMC manages and invests in various schemes of the Mutual Fund House on behalf of its investors is referred to as AUM ( Asset Under Management ).
Mutual Fund Scheme
The AUM is collected under a specific scheme or multiple schemes an investor chooses to invest in. The AMC has multiple schemes that invest in various asset classes, such as stocks, bonds, or a mix of both.
Each scheme, declared at its launch, has a predetermined objective and a set mandate. An Asset Manager appointed by the AMC is responsible for making all investment decisions based on the set objectives and managing the buying and selling activities of securities on behalf of the investors under that scheme.
Face Value
Face value is the default value at which any new fund offering of a Mutual Fund in India launches its schemes for subscription to retail investors. In India, the default face value of any mutual fund scheme starts with Rs 10/– as its face value.
Face values normalize the per-unit base value for subscriptions for retail investors and fund houses during the schemes’ initial launch. Later, based on the increase or decrease of the scheme’s AUM, the per-unit price also changes.
NAV - Net Asset Valeu
In simple words, a scheme’s NAV is the price at which investors buy the Mutual Fund Units.
NAV = Total Market Value of the Scheme at a given date divided by the total number of units issued under that scheme. The performance of a mutual fund scheme is denoted by its NAV per unit.
For example –
Market Value of a Mutual Fund Scheme = 10 Crores
Total Number of Units Issued under the scheme = 50 Lakhs Units ( each units having a face value of rs 10/– )
Therefore, NAV = Total Fund Value / No of Units issued
= ₹100 Cr/ 50 Lakh units.
= ₹20 per unit
Unlike stocks, where the price is driven by the volatility based on minute-to-minute trading, NAVs of mutual fund schemes are declared at the end of each trading day after markets are closed, following SEBI Mutual Fund Regulations.
The NAV of a scheme also varies daily because the market value of the securities also keeps varying during trading hours, hence the variation.
Cut Off Timings
Unlike in stock markets, mutual funds have defined cutoff timings, which decide the price at which the investor is issued the mutual fund units of a scheme.
As we learned, a mutual fund’s NAV is declared at the end of the stock market. According to SEBI regulations, Mutual Funds have to update their NAV based on closing prices.
Cut-Off Timings In Indian Mutual Fund Industry:
| Cot off Timings for | Liquid & Overnight Funds | All Other Schemes |
|---|---|---|
|
Subscriptions |
Before 1.30 pm on a working day |
Before 3 pm on a working day |
|
Redemptions |
Before 3 pm on a working day |
Before 3 pm on a working day |
Applicable NAV
This is an important concept to understand because the NAV applicable to you when you buy or sell mutual funds may not be the same as the NAV of the scheme that you may see on a closing basis.
Every investor who subscribes or redeems their mutual fund schemes should understand which day NAV shall apply to you, meaning –
The same-day NAV will apply if an investor buys (subscribes) or sells (redeems) within the cut-off timings.
If an investor exceeds the time limit to buy (subscribe) or sell (redeem), the next working day will apply. This is what we refer to as the ”applicable NAV “
Sale Price
From an MF investor’s standpoint, the sale price is the price payable per unit by an investor for purchasing units (subscription) and/or switch-in from other mutual fund schemes.
In case of a New Fund Offering, the sale value is the Face value per unit at which the scheme is being issued to investors (usually it’s ₹10/-) mentioned in the Scheme Information Documents – (SID and KIM – we shall study them in detail too in our guide).
Redemption / Repurchase Price
The Repurchase/Redemption Price is the price per Unit at which a Mutual Fund would ‘repurchase’ the units (i.e., buy back units from the investor) upon redemption of units or switch-outs of units to other schemes/plans of the Mutual Fund by the investors. It includes exit load, if / wherever applicable.
Here’s how the redemption price is calculated:
Redemption Price = Applicable NAV*(1- Exit Load, if any)
For Example: If the Applicable NAV is ₹20 and Exit Load is 2%, then the Redemption Price will be = ₹20* (1-0.02) = ₹19.60
Expense Ratio
The expense ratio is the percentage of fees that a mutual fund takes to manage the fund, its schemes, and all administrative expenses that are required to run the mutual fund company. The expense ratio comprises – sales & marketing/advertising expenses, administrative expenses, transaction costs, investment management fees, registrar fees, custodian fees, and audit fees as a percentage of the fund’s daily net assets under management fees. All such costs for running and managing a mutual fund scheme are collectively called the ‘Total Expense Ratio’ (TER).
As an investor, consider the expense ratio as the cost of hiring professional management to manage your investment portfolio systematically.
As per MF regulations by SEBI, every mutual fund house has to mention its expense ratio categorically on the Offered documents for complete transparency. There’s also a cap on the maximum expense ratio that can be charged by a Fund House. The Expense Ratio may vary from scheme to scheme based on how the fund is managed by the portfolio manager.
Open Ended And Close Ended Schemes
Each scheme offered by the mutual fund houses is broadly differentiated by structure into two types: Open-Ended Schemes and Closed-Ended Schemes.
The differentiation indicates an investor has flexibility while subscribing to redeeming the mutual fund units.
Open-ended Schemes are schemes in which an investor can enter or exit at any time. Basically, open-ended funds are always available to investors for investments or redemptions.
whereas Closed-Ended Schemes are schemes in which an investor can buy the mutual fund units after the scheme’s launch (after NFO) and can exit only when the fund’s investment tenure is over. This means close-ended funds are open during the NFO period for investments and can be redeemed after a lock period decided by the Mutual fund AMC.
Entry and Exit Load
Entry and Exit loads are fees that mutual fund houses charge investors when they buy or redeem mutual fund units.
Entry load is a fee charged to an investor when entering into a mutual fund scheme. The Mutual Fund Regulator, SEBI, has banned all mutual fund houses in India from taking any entry load.
Exit load is a fee levied to an investor who redeems before the lock-in period of a particular scheme. Fund management charges exit load to protect their overall return performance, as sudden redemption pressure can severely impact mutual fund performance.
Most investors avoid panic redemption of mutual fund units to avoid exit load fees, which seems like a win-win situation for both the investors and the mutual fund houses.
Lock-In Period
Some Mutual fund schemes are designed to attract a lock-in period. A lock-in period is a stipulated time period within which mutual fund investors are restricted from redeeming their units.
There’s usually a trade-off for investors, for example, tax-free returns on ELSS schemes after 3 years of lock-in. Hence, investors also agree to such lock-ins.
SIP / Lump Sum Investments / STP / SWP
There are 4 ways investors can invest in mutual fund schemes.
1. Systematic Investment Plan (SIP)
The most famous is the SIP, a systematic investment plan that allows an investor to set an amount to invest at regular intervals, be it monthly, quarterly, semi-annually, or annually.
Investors can start with as low as Rs 500 per month, every month on a fixed date, which automatically gets debited from their account (after providing a bank mandate to their bank authorising the AMC to auto debit the fixed SIP amount).
2. Lump Sum Investments
As the name suggests, the lump sum mode enables investors to invest a large amount at once in the selected mutual fund scheme.
3. Systematic Transfer Plan (STP)
This is a hybrid way to invest in mutual fund schemes, combining Lump Sum Investments with SIPs.
An investor first invests a lump sum amount in a particular scheme of a mutual fund house. Then, at each defined regular period/interval (monthly, quarterly, semi-annually, or annually), a fixed amount of capital is directed to another mutual fund scheme of the same fund house.
For example, if Mr. X, CEO of a tech company, receives a bonus of ₹1 crores from his company and wants to invest this bonus in mutual funds, he does not want to invest a lump sum. So, he can choose to do an STP, wherein he can park his 1 Cr in a liquid or any debt fund of a particular AMC and choose a monthly SIP of, let’s assume, 1 lac per month in a large cap fund scheme of the same AMC.
This way, he can systematically invest his savings while still earning some returns on the lump sum amount. A Game changer for investors, isn’t it?
4. Systematic Withdrawal Plans ( SWPs)
An SWP is quite similar to an STP, but there’s one major difference. In the SWP mode, an investor can withdraw his/her funds from an accumulated corpus that is still invested in a particular scheme on an installment basis periodically (monthly, semi-annually, annually).
Let’s take an example: Mr. Y has been investing in mutual funds via SIP mode for over 30 years and has managed to accumulate a corpus of around 2 cars. The goal of his savings is to retire comfortably and support himself when he doesn’t have any source of income post-retirement.
Now, after retirement, Mr Y needs a monthly income of Rs 1 lac to survive. Since he has a lump sum of 2 crores, he can achieve this goal by choosing an SWP mode.
So the 2 cr lumpsum remains invested in, let’s say, a balanced fund that has a mix of debt and equity. Out of that 2 crore corpus every month, some units amounting to 1 lac rupees will be sold, and the amount will be credited to Mr. Y for him to use for his expenses. This is how a SWP works.
All the above modes of investing in mutual funds are smart solutions that deploy savings into mutual funds systematically. They are suitable for different investors and cater to their individual personalized requirements.
Fund Category
As per the SEBI guidelines on Categorization and Rationalization of schemes issued in October 2017, mutual fund schemes are classified into the following categories–
Equity Schemes – funds that invest in equities suitable for higher risk appetite and longer time horizons.
Debt Schemes – Also known as income funds, debt schemes invest in bonds and other debt securities and are suitable for investors seeking income generation and capital protection.
Hybrid Schemes – a mix of equity and debt securities.
Solution-oriented Schemes – invest in a mix of equity and debt securities. They usually involve a lock-in period, and some schemes have withdrawal limitations. These schemes are designed for specific goals, such as Retirement, children’s education, marriage, etc.
Other Schemes – index Funds, ETFs, and Funds of Funds—are basically passive funds that invest in indexes or replicate any underlying.
Every mutual fund must launch its schemes under the above-mentioned categories. Each category has defined permissible allocation limits, which the mutual fund managers must abide by. SEBI has levied strict regulations for any violations by AMCs who fail to obey.
Asset Allocation
Asset Allocation in Mutual Funds refers to the strategic distribution of the pooled money collected from investors into various asset classes, such as equities, debt instruments (including corporate bonds and government securities), and commodities like gold and silver. This allocation is done in predetermined proportions to balance risk and return according to the investment objectives of the mutual fund scheme.
Annual Return
Represents the percentage increase or decrease in the value of the investment over a one-year period. This figure includes all earnings from capital gains, dividends, and interest income, giving investors a comprehensive view of the fund’s performance over the year. Expressed as a percentage, annual returns are crucial for assessing and comparing the performance of various mutual funds.
Benchmark
Benchmarking is a standard or reference point used to measure the fund’s performance in the context of mutual funds. Usually, a specific market index, such as the Nifty 50 or the BSE Sensex, represents the market segment that the mutual fund aims to replicate or outperform.
The benchmark is a yardstick to evaluate the fund manager’s effectiveness and help investors understand how well the fund performs relative to the broader market or a specific sector.