Question

In 2 to 3 paragraphs, please discuss the following subject matter without going heavy into financial/investment jargon. Thank you Describe the basic features of mutual funds and note what they have to offer as investments; discuss the types of funds available and the variety of investment objectives these funds seek to fulfill?

Answer 1

A Mutual Fund is a financial intermediary that pools the savings of investors for collective investment in a diversified portfolio of securities. A Fund is “mutual” as all of its returns, minus its expenses, are shared by the fund’s investors.

A Mutual Fund serves as a link between the investor and the securities market by mobilising savings from the investors and investing them in the securities market to generate returns.

FEATURES of Mutual Funds

An investor can invest directly in individual securities or indirectly through a financial intermediary.

Professional management : An average investor does not have the knowledge of capital market operations and does not have large resources to reap the benefits of investment. Hence, he requires the help of an expert. Mutual funds are managed by professional managers who have the requisite skills and experience to analyse the performance and prospects of companies. They make possible an organised investment strategy.

Portfolio diversification : An investor undertakes risk if he invests all his funds in a single scrip. Mutual funds invest in a number of companies across various industries and sectors. This diversification reduces the riskiness of the investments.

Reduction in transaction costs : Compared to direct investing in the capital market, investing through the funds is relatively less expensive as the benefit of economies of scale is passed on to the investors.

Liquidity : Often, investors cannot sell the securities held easily, while in case of mutual funds, they can easily encash their investment by selling their units to the fund if it is an open-ended scheme or selling them on a stock exchange if it is a close-ended scheme.

Convenience : Investing in mutual fund reduces paperwork, saves time and makes investment easy.

Tax benefits : Mutual fund investors now enjoy income-tax benefits.

Transparency : Mutual funds declare their portfolio every month. Thus an investor knows where his/her money is being deployed and in case they are not happy with the portfolio they can withdraw at a short notice.

Stability to the stock market : Mutual funds have a large amount of funds which provide them economies of scale by which they can absorb any losses in the stock market and continue investing in the stock market. In addition, mutual funds increase liquidity in the money and capital market.

Equity research : Mutual funds can afford information and data required for investments as they have large amount of funds and equity research teams available with them.

TYPES OF FUNDS AVAILABLE :

Income funds : The aim of income funds is to provide safety of investments and regular income to investors. Such schemes invest largely in income-bearing instruments like bonds, debentures, government securities, and commercial paper. The return as well as the risk are lower in income funds as compared to growth funds.

Growth funds : The main objective of growth funds is capital appreciation over the medium-to-long-term. They invest most of the corpus in equity shares with significant growth potential and they offer higher return to investors in the long-term. They assume the risks associated with equity investments. There is no guarantee or assurance of returns. These schemes are usually close-ended and listed on stock exchanges.

Balanced funds : The aim of balanced scheme is to provide both capital appreciation and regular income. They divide their investment between equity shares and fixed interest-bearing instruments in such a proportion that the portfolio is balanced. The portfolio of such funds usually comprises of companies with good profit and dividend track records. Their exposure to risk is moderate and they offer a reasonable rate of return.

Money market mutual funds : They specialise in investing in short-term money market instruments like treasury bills, and certificate of deposits. The objective of such funds is high liquidity with low rate of return.

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