Mutual Funds- Meaning, Types, Benefits and Problems
[Finance Notes for AHSEC Class 12 2026 Exam]
Q.1. What is Mutual Funds? What are
its features?
Ans:
‘A mutual fund means pooling the investments of a number of investors by way of
investment in units of equal size’. They are financial intermediaries which
collect funds from the public and invest them in a diversified portfolio of
securities, including equity, bonds debenture and other instruments issued by
business or government undertakings. The purpose of mutual fund is to help
small investors participate in the securities market indirectly with reduced
risk for small investors by diversifying the investment into various types of
securities of different corporations and industry.
According
to Association of Mutual Funds in India (AMFI), “A Mutual fund is a trust that
pools number of savings investors, who shares common financial goal’.
Features
of Mutual Funds:
-
Mutual fund is a trust.
-
Mutual fund pools money from a group of investors called Unit Holders.
-
Mutual funds are professionally managed.
-
Mutual funds are highly liquid.
-
The investors share common financial goals.
-
Mutual Fund Invest the money, collected from small investors into securities
(shares, bonds etc.,). It is called as diversified investment.
-
Mutual Fund use professional expertise (investment management skills) on
investments made.
- Asset classes of investments match the stated
investment objectives of the scheme
-
Incomes and Gains from the investments are passed on to the unit holders based
on the proportion of the number of units they own.
Q.2. What are the advantages and
disadvantages of Mutual funds?
Ans:
Advantages of Mutual Funds for Investors
-
Professional Management: Mutual funds offer investors the opportunity to earn
an income or build their wealth through professional management of their
investible funds.
-
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 Rs 1,000 in a mutual fund scheme can give investors
a diversified investment portfolio.
-
Liquidity: 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, or during
specific intervals, or only on closure of the scheme.
-
Tax Deferral: Mutual funds are not liable to pay tax on the income they earn.
-
Convenient Options: The options offered under a scheme allow investors to
structure their investments in line with their liquidity preference and tax
position.
-
Investment Comfort: Once an investment is made with a mutual fund, they make it
convenient for the investor to make further purchases without any
documentation. This simplifies subsequent investment activity.
-
Regulatory Comfort: The regulator, Securities & Exchange Board of India
(SEBI) has mandated strict checks and balances in the structure of mutual funds
and their activities.
-
Systematic approach to investments: Mutual funds also offer facilities that
help investor invest amounts 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.
Limitations of a Mutual Fund
-
Lack of portfolio customization: Mutual fund unit-holder is just one of several
thousand investors in a scheme. Once a unit-holder has bought into the scheme,
investment management is left to the fund manager. Thus, the unit-holder cannot
influence what securities or investments the scheme would buy.
-
Choice overload: Over 800 mutual fund schemes offered by 38 mutual funds – and
multiple options within those schemes – make it difficult for investors to choose
between them.
-
No control over costs: All the investor's moneys are pooled together in a
scheme. Costs incurred for managing the scheme are shared by all the Unit
holders in proportion to their holding of Units in the scheme. Therefore, an
individual investor has no control over the costs in a scheme.
-
High Management Fee: The Management Fees charged by the fund reduces the return
available to the investors.
-
Diversification: Diversification minimizes risk but does not guarantee higher
return.
-
Diversion of Funds: There may be unethical practices e.g. diversion of Mutual
Fund amounts by Mutual Fund/s to their sister concerns for making gains for
them.
-
Lock-In Period: Many MF schemes are subject to lock in period and therefore,
deny the investors market drawn benefits.
Q.3. What are AMCs? What are its
statutory requirements?
Ans:
Assets Management Company (AMC)
Assets
Management Company (AMC) is a firm which invests the funds collected from
investors in securities with a view to earn high return for investors in
exchange for a fee. Every mutual fund institutions appoints AMC to management
its fund. Asset Management Company (AMC) manages the affairs of the Mutual Fund
in relation to the operation of Mutual Fund schemes. The Asset Management
Company is a key link in the success of the scheme and the interests of the
unit holders. It is expected to maintain a record in support of each investment
decision.
Statutory
Requirements for AMCs:
(i)
SEBI Approval: AMC should be approved by SEBI and cannot be changed, except
unless by a majority of the trustees or by 75% of the unit-holders.
(ii)
Other Conditions:
a)
AMC’s Directors should be persons of standing and suitable professionals.
b)
Chairman of the AMC should not be the trustee of any Mutual Fund.
c)
AMC should have a minimum Net Worth of `10 Crores.
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Q.4. What are various types of Mutual
Funds?
Ans: In order to suit the needs and preferences of
investors, mutual funds institutions are now offering various types of mutual
fund schemes. Mutual funds schemes as per the demand of the investors are
classified into the following broad categories:
|
1. According to ownership |
a) Public Sector Mutual
Funds b) Private Sector Mutual
Funds |
|
2. According to the
scheme of operation |
a) Open-ended Funds b) Closed-ended Funds c) Internal Funds |
|
3. According to portfolio |
a) Income Funds b) Balanced Funds c) Growth Funds d) Stock/Equity Funds e) Debt Funds f) Hybrid Funds |
|
4. According to location |
a) Domestic Funds b) Off-shore Funds |
|
5. According to
management |
a) Active Funds b) Passive Funds |
|
6. Gold funds |
a) Gold Exchange Traded
Funds b) Gold Sector Funds |
|
7. others |
a) Real Estate Funds b) Exchange Traded Funds c) Commodity Funds d) Fund of Funds |
1. According to ownership
According to ownership, mutual funds in India
may be classified as:
a) Public Sector Mutual Funds: Public sector
mutual funds are those which are initiated by UTI and other public sector
banks. For the first time, UTI started public sector mutual fund schemes in the
year 1963-64. In the year 1987, second public sector mutual fund was
established by SBI.
b) Private Sector Mutual Funds: Private
sector mutual funds are those which are initiated by private sector corporate.
In the year 1992, Government of India allowed the private sector corporate to
start mutual fund schemes.
2. According to the scheme of operation
According to the scheme of operation, mutual
funds in India are classified as:
a) Open-ended
funds: Open-ended funds are open for investors to enter or exit
at any time, even after the NFO. In such funds period of maturity is not
specified. Investors can enter and exit at any time. The most important
advantage of open-ended funds is that it offers liquidity to investors.
b) Close-ended
funds: Close-ended funds are those which have a fixed maturity
period. Investors can buy units of a close-ended scheme, from the fund, only
during its NFO. After the close of NFO, investors can buy or sale units of
close-ended fund only through stock exchange where these funds are listed.
c) Interval
funds: Interval funds combine features of both open-ended and
close ended schemes. They are largely close-ended, but become open ended at
pre-specified intervals.
3. According to Portfolio
According to portfolio or objectives of
investment, mutual funds are classified as:
a) Income Funds: These funds aim at providing maximum return
to the investors. These funds mainly invest in low risk financial assets such
as bonds, debentures, Commercial Papers (CPs) etc. These funds distribute the
income earned by them periodically amongst the investors.
b) Balance funds: Balance funds are those which invest in both
high risk financial asset such as equity for higher return and also in fixed
interest/return bearing securities such as debentures, preference shares and
bonds. Balance funds ensure both capital appreciation as well as regular return
in the shape of interest and dividend.
c) Growth funds: Growth funds are those which invest mainly in
those securities which have high potential of appreciation in the long term.
These funds mainly concentrate on capital appreciation of the investors. Due to
too much exposure in equity, these funds are riskier as compared to income and
balance funds.
d) Equity 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.
Types of Equity Funds
1. Diversified equity fund is a category of
funds that invest in a diverse mix of securities that cut across sectors.
2. Sector funds however invest in only a
specific sector. For example, a banking sector fund will invest in only shares
of banking companies. Gold sector fund will invest in only shares of
gold-related companies.
3. Thematic funds invest in line with an investment
theme. For example, an infrastructure thematic fund might invest in shares of
companies that are into infrastructure construction, infrastructure
toll-collection, cement, steel, telecom, power etc.
4. Equity Linked Savings Schemes (ELSS), as
seen earlier, offer tax benefits to investors. However, the investor is
expected to retain the Units for at least 3 years.
5. Equity Income / Dividend Yield Schemes
invest in securities whose shares fluctuate less, and therefore, dividend
represents a larger proportion of the returns on those shares.
6. Arbitrage Funds take contrary positions in
different markets / securities, such that the risk is neutralized, but a return
is earned.
e) Debt funds: 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.
Types of Debt Funds
Gilt funds invest in only treasury bills and
government securities, which do not have a credit risk.
Diversified debt funds on the other hand,
invest in a mix of government and non-government debt securities.
Junk bond schemes or high yield bond schemes
invest in companies that are of poor credit quality.
Fixed maturity plans are a kind of debt fund
where the investment portfolio is closely aligned to the maturity of the
scheme.
Floating rate funds invest largely in
floating rate debt securities i.e. debt securities where the interest rate
payable by the issuer changes in line with the market.
Liquid schemes or money market schemes are a
variant of debt schemes that invest only in debt securities where the moneys
will be repaid within 91-days.
f) Hybrid funds: Hybrid funds have an investment charter that
provides for a reasonable level of investment in both debt and equity.
Types of Hybrid Funds
Monthly Income Plan seeks to declare a
dividend every month. It therefore invests largely in debt securities.
Capital Protected Schemes are close-ended
schemes, which are structured to ensure that investors get their principal
back, irrespective of what happens to the market.
4. According to Location:
Mutual funds can also be classified on the
basis of location from where they mobilise funds, as:
a) Domestic Funds: These are the funds which
mobilise savings of people within the country where investments are made.
b) International Funds: These are funds that
invest outside the country. For instance, a mutual fund may offer a scheme to
investors in India, with an investment objective to invest abroad.
5. According to Management:
On the basis of management, Mutual funds are
divided into two groups:
a) Actively Managed 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. Since this increases the role of the fund manager, the expenses
for running the fund turn out to be higher.
b) Passive Funds: Passive funds invest on the
basis of a specified index; whose performance it seeks to track. Thus, a
passive fund tracking the BSE Sensex would buy only the shares that are part of
the composition of the BSE Sensex. Such schemes are also called index schemes.
Since the portfolio is determined by the index itself, the fund manager has no
role in deciding on investments. Therefore, these schemes have low running
costs.
6. Gold Funds:
These funds invest in gold and gold-related
securities. They can be structured in either of the following formats:
a) Gold Exchange Traded Fund, which is like
an index fund that invests in gold. The structure of exchange traded funds is
discussed later in this unit. The NAV of such funds moves in line with gold
prices in the market.
b) Gold Sector Funds i.e. the fund will
invest in shares of companies engaged in gold mining and processing. Though
gold prices influence these shares, the prices of these shares are more closely
linked to the profitability and gold reserves of the companies.
7. Other Types of Mutual Funds:
In addition to the above mentioned mutual
funds, there are some other types of mutual funds:
a) Real Estate Funds: They take exposure to
real estate. Such funds make it possible for small investors to take exposure
to real estate as an asset class. Although permitted by law, real estate mutual
funds are yet to hit the market in India.
b) Commodity Funds: The investment objective
of commodity funds would specify which of these commodities it proposes to
invest in.
c) Fund of Funds: Such fund invests in
another fund. Similarly, funds can be structured to invest in various other
funds, whether in India or abroad. Such funds are called fund of funds.
d) Exchange Traded Funds: Exchange Traded
funds (ETF) are open-ended index funds that are traded in a stock exchange.
e) Others: Loan Funds, Non-loan Funds, Hub
and Spoke Funds etc.
Q.5. What is open ended and Closed
ended funds? Distinguish between them.
Ans:
Open ended
funds: Open ended funds are those funds which are
open for investors to entry or exit at any time, even after the NFO. In such
funds, maturity period is not specified and investors can enter or exit from
the fund any time they with. The most important feature of this type of fund is
that it offers liquidity to the investors. These funds are not listed on any
stock exchange but investors can redeem their investors directly through the
mutual funds institutions in which they have invested. Entry and exit price of
the units of open ended mutual funds are calculated by dividing net assets
under management of the fund with number of units outstanding.
Features of Open ended funds
a)
It has no lock in period and investors can enter
or exit any time they wish.
b)
The investors can subscribe this fund at any
time.
c)
It provides prompt liquidity to investors.
d)
The investors have an option to redeem their
holding at any time.
e)
These funds are not listed on any stock
exchange.
Closed ended funds: Closed ended funds are those which have a fixed maturity period,
normally three to five years. Investors can buy units of a closed-ended scheme
from the fund only during its NFO. After the close of NFO, investors can buy or
sale units of close-ended fund only through stock exchange where these funds
are listed. These funds are listed on stock exchange where investors can sale
their units of mutual funds at the prevailing market price. Prices of units of
closed ended funds are determined by the forces of demand and supply in stock
exchange. These funds are ideal for long term investors.
Features of Closed ended funds
a) It has a lock in period of 3 to 5 years.
b) The investors can enter into these funds only
through NFO.
c) Closed ended fund can be redeemed only through stock
exchange or at the end of lock in period.
d) These funds are listed on stock exchanges.
e) These funds are suitable for long term investors
only.
Difference between Open Ended and Closed Ended Funds
|
Basis |
Open Ended Funds |
Closed Ended Funds |
|
Lock in
period |
It has no lock in period and investors can enter or exit any
time they wish. |
It has a lock
in period of 3 to 5 years. |
|
Listing |
These funds are not listed on any stock exchange. |
These funds
are listed on stock exchanges. |
|
Entry |
The investors can subscribe this fund at any time. |
The investors
can enter into these funds only through NFO. |
|
Redemption |
The investors have an option to redeem their holding at any
time. |
Closed ended
fund can be redeemed only through stock exchange or at the end of lock in
period. |
|
Investors
perspective |
These funds are suitable for short term investors. |
These funds
are suitable for long term investors. |
Q.6. Write a brief note on the role of
mutual funds in India.
Ans:
Role of Mutual Funds Institutions: Mutual funds Institutions perform different
roles for different constituencies:
1.
Wealth Building: Their primary role is to assist investors in earning an income
or building their wealth, by participating in the opportunities available in
various securities and markets. It is possible for mutual funds to structure a
scheme for any kind of investment objective.
2.
Source of Finance for government and companies: The money that is raised from
investors, ultimately benefits governments, companies or other entities,
directly or indirectly, to raise moneys to invest in various projects or pay
for various expenses.
3.
Corporate Governance and ethical standards: As a large investor, the mutual
funds can keep a check on the operations of the investee company, and their
corporate governance and ethical standards.
4.
Project Financing: The projects that are facilitated through such financing,
offer employment to people; the income they earn helps the employees buy goods
and services offered by other companies, thus supporting projects of these
goods and services companies. Thus, overall economic development is promoted.
5.
Employment creation: The mutual fund industry itself, offers livelihood to a
large number of employees of mutual funds, distributors, registrars and various
other service providers. Higher employment, income and output in the economy
boost the revenue collection of the government through taxes and other means.
5.
Growth of capital market: Mutual funds can also act as a market stabilizer, in
countering large inflows or outflows from foreign investors. Mutual funds are
therefore viewed as a key participant in the capital market of any economy.
6. Protection to Small Investors:
A small investor is not safe in share market. Mutual funds help to reduce the
risk of investing in stocks by spreading or diversifying
investments. Small investors enjoy the benefit of diversification.
7. Tax Benefit: Investors in mutual
funds enjoy tax benefits. Dividend received by investors is tax free. Tax
exemption is allowed on income received on units of mutual funds and UTI.
8. Diversification: Investment in
mutual funds enable investors to spread out and minimise the risks upto certain
extent. Mutual fund invests in a diversified portfolio of securities. This
diversification helps to reduce risk since all the stocks do not fall at same
time. Thus investors are assured of average income which is not possible in
other sources.
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