Mutual Funds Basics

This page provides an introduction to Mutual Funds Basics. These are my notes from the Zerodha Varsity course.

Mutual Funds

A mutual fund is an investment vehicle that pools money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities. The fund is managed by professional money managers who make investment decisions on behalf of the investors.

There are two important things to consider when buying a mutual fund:

• Who is the sponsor of the AMC? This is to ensure you are dealing with credible names.
• Who is the fund manager? This is to ensure that your money is being handled by the right person.

info

Asset Management company(AMC), is a company where a fund manager works and manages your money.

Below are some of the mutual funds terminology,

NAV

The Net Asset Value (NAV) of a mutual fund is the per share value of the fund's assets minus its liabilities.
It represents the price at which investors can buy or sell mutual fund shares.

$$\text{NAV} = \frac{(\text{Total Assets} - \text{Total Liabilities})}{\text{Total Number of Outstanding Shares}}$$

Open Ended Funds

When an Asset Management Company (AMC) starts a fund, they have the option to let that fund run for either a fixed period or indefinitely.

For example, I can start a fund today and let it run for three years. At the end of the third year, the fund will cease to exist, and the investor will be obligated to collect their money back, along with any profit or losses.

Funds with such defined timeframes are called closed ended funds. If a fund does not have an expiry date, it is called an open ended fund. For all practical purposes, it is generally better to deal with an open ended fund.

Allotment Date

This is the date from which the fund commenced its operations.

Regular Plan

The mutual fund distributor acts as the middleman between the Asset Management Company (AMC) and the investor. If a mutual fund distributor approaches you and sells you a mutual fund, it is typically a 'regular plan'.

This means the distributor is entitled to receive a commission from the AMC for selling the fund to you. While there is nothing inherently wrong with this, it is important to understand that the commission ultimately comes out of your investment.

Dividend payout

When you buy a stock and the company issues a dividend, you, as an investor, are entitled to receive that dividend. Similarly, when a fund manager buys the stock of a company and the company issues a dividend, the Asset Management Company (AMC) receives this dividend.

Since the funds with the AMC belong to the investors, the dividend ultimately belongs to the investors as well. The dividend you are entitled to from the AMC is proportional to your investment in the fund.

The AMC offers you two options: you can withdraw the dividend, or you can choose to reinvest the dividend amount and buy more units of the fund. The dividend payout option allows you to withdraw the dividend whenever it is paid. This option is now referred to as the “Payout of Income Distribution cum Capital Withdrawal” option.

Exit load

This is the amount of money you will have to pay at the time of withdrawal.

Mutual Fund Categories

Primarily, there are five different categories of mutual funds

Equity Funds

Mutual funds that primarily invest in stocks of various companies to achieve capital growth.

Focused Funds

Equity funds that invest in a limited number of stocks, usually not exceeding $30$, to focus on potential high returns.

Dividend Yield Funds

Equity funds that invest in stocks of companies known for paying high dividends to generate regular income.

ELSS Funds

Equity Linked Savings Schemes that offer tax benefits under Section 80C of the Income Tax Act, with a lock in period of three years.

Debt Funds

Mutual funds that invest in fixed income securities like bonds, treasury bills, and other debt instruments for stable returns.

Index Funds

Mutual funds that replicate the performance of a specific market index, such as the S&P $500$, by investing in the same stocks in the same proportion.

Arbitrage Funds

Mutual funds that exploit price differences between the cash and derivatives markets to generate risk free profits.

Mutual Fund Cheatsheet

Fund	Category	Portfolio	Purpose
Large Cap	Equity	Min of $80\%$ large cap stocks	Long Term Wealth Accumulation
Mid Cap	Equity	Min of $65\%$ mid cap stocks	Long Term Wealth Accumulation
Large & Mid Cap	Equity	Min of $35\%$ large cap + $35\%$ Mid Capstocks	Long Term Wealth Accumulation
Small	Equity	Min of $65\%$ small cap stocks	Long Term Wealth Accumulation
Multicap	Equity	Min of $65\%$ in equity	Long Term Wealth Accumulation
Focused	Equity	Min of $64\%$ in equity and Focused $30$ stock	Long Term Wealth Accumulation
Index	Equity	Fund Tracking index	Long Term Wealth Accumulation
Value	Equity	Fund follows value investment style, has $65\%$ in equity	Long Term Wealth Accumulation
Thematic	Equity	Min of $80\%$ of equity belonging to certain sector	Long Term Wealth Accumulation
ELSS	Equity	Min of $80\%$ equity	Only Tax Saving
Arbitrage	Hybrid	Min of $65\%$ equity and $10\%$ debt	Short term goal
Balanced Advantage	Hybrid	Mix of debt and equity dynamically managed	Asset Allocation of novice
Overnight	Debt	Overnight securities with $1$ day maturity	Capital Protection + Park Money
Liquid	Debt	Debt and Money Market instrument with $91$ days maturity	Capital Protection + Park Money
Ultrashort Duration	Debt	Debt and Money Market instrument with macaulay b/w $3$ to $6$ months	Capital Protection + Park Money
Low Duration	Debt	Debt and Money Market instrument with macaulay b/w $6$ to $12$ months	Capital Protection + Park Money
Short Duration	Debt	Debt and Money Market instrument with macaulay b/w $1$ to $3$ years	Capital Protection + Park Money
Money Market	Debt	Money Market instrument with maximum maturity of $1$ year	Capital Protection + Park Money
Corporate Debt	Debt	Min of $80\%$ of assets in highest rated corporate bonds	Appetite for Riskey Investment
Credit Risk	Debt	Min of $65\%$ of assets in below investment grade bonds	Appetite for Riskey Investment
GILTS	Debt	80% Gsec bonds	FD Like