Let’s begin by understanding the constitution of a Mutual Fund. The following entities make up
a Mutual fund:
The Sponsor of the fund creates a mutual fund trust and sets up the AMC. The sponsor also makes an
application for registration of the mutual fund and contributes at least 40% of the net worth of
the AMC. The trustees are selected by the sponsor too. The trustees oversee the running of the
AMC and ensure compliance with SEBI’s norms. The sponsor or the trustees appoint the AMC
who do the management of funds (buying and selling of securities). The custodian keeps an
account of all the investments of the Mutual Fund. The RTA maintains a record of the investors
and their holdings while constantly updating post buying and selling of units.
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:
- 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
- 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.
- 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.