Understanding Mutual Funds

How do Mutual Funds work? – Investor’s perspective

For an investor, the process of investment starts with defining the investment objective, assessing the risk preference and determining the time window of investment. Once this is done, the investor starts looking at investment options that match the objective, risk and time preference. Post narrowing down on a few schemes he checks the scheme related documents as explained below:

The [KIM] [SID] [SAI] of Mutual Funds

One statement that all mutual fund advertisements keep repeating is – ‘Mutual Fund investments are subject to market risks, read all scheme related documents carefully’ What are these ‘scheme related documents’?

As mandated by SEBI, each AMC needs to provide three important documents to inform investors about every scheme:

Scheme Information Document (SID) - It carries important information about the scheme which can help an investor make an informed decision about the scheme. The information includes:

• Investment objective
• Asset allocation pattern
• Investment strategies
• Risk involved
• Benchmark index for the scheme
• Fund Manager’s details
• Fees & expenses

Statement of Additional Information (SAI) – As defined by SEBI, the SAI contains details of the Mutual Fund, its constitution and certain tax, legal and general information.

Key Information Memorandum (KIM) – A KIM is nothing but a summarized version of the SID and SAI. It contains all the information that is absolutely necessary for the investor to know before investing and has been mandated by SEBI.

After assessing and analyzing these documents, he finally chooses the scheme that he wants to invest in. The mutual fund units can be purchased through any of these options:

• Directly from the Mutual fund house (Direct Plan)
• Directly through the AMC
• Through third party online portals
• Through a bank who acts as an intermediary of different AMCs
• Directly using a Demat and Online trading account
• Independent Financial Advisors

The investor is also expected to select one of the three options when filling an investment form:

1. Dividend Pay Out – where the fund house pays the investor dividends or a share from the profits made. While in case of debt funds, the pay-out is usually at regular intervals (monthly, quarterly, half-yearly or yearly), the frequency can be irregular in case of equity funds. It is important to remember that the fund house is not liable to pay any dividend if it does not have distributable surplus
2. Dividend Reinvestment – where the dividend or the share from the profits made by the fund house is not paid to the investor but is reinvested in the same scheme by purchase more units at the current price on behalf of the investor.
3. Growth – where no dividend or the share from the profits made by the fund house is paid. Any profits made by the fund house are reinvested in the scheme leading to an increase in the unit price over time. This means that the investment grows in value.

Investors can choose one of these options,as available, to match their investment objectives. However, it is also advisable to consider the tax implications of each of these options before selecting them.