Category: Investing Funds

  • Explain How to Investment in Mutual Funds?

    Learn and Study, Explain How to Investment in Mutual Funds?

    Mutual fund companies, also known as Asset Management Companies (AMCs) collect funds from the public (mainly from small investors) and invest such funds in the market and distribute returns/surpluses in the form of dividends. Surpluses can also be reflected in higher Net Asset Value (NAV) of the scheme. In simple words, a mutual fund company collects savings of small investors (pool their money); the fund managers of the concern invest such pool of funds to market (securities); when returns are generated from such investment, passed back to the investors. Also learned, Process of Investment, Explain How to Investment in Mutual Funds?

    This is how a mutual fund works. First, an offer document (containing details of the scheme, its investment horizon, and class (ES) of securities it intends to invest etc.) is issued to the public. Then the collected money is pooled together to constitute a fund. This fund is managed by fund managers of AMC who take major investment decisions. A trust takes care that the mutual fund investments are in accordance with the scheme of the fund and is being managed in the interest of the investors. The returns from such investment activities are distributed in accordance with the scheme of the fund.

    NAV of a mutual fund (or in other words NAV per unit) refers to the total asset managed by the fund at its market value divided by the number of outstanding (issued and sold) units of the fund. For instance, a fund having net asset worth of Rs.100 crores and Rs.10 crore units are outstanding then the NAV per unit of the fund would be Rs.10. The NAV of a scheme depends on the market value of its investments and hence it fluctuates with the fluctuating share prices of its investment. An increase in NAV means capital appreciation for investors.

    Since mutual funds are managed by professionals who have requisite experiences and qualifications in the areas of the stock market, as far as a new entrant in the stock markets is concerned, these funds act as a safe vehicle for investment. Moreover, as mutual funds invest in a number of scrips, the impact of risks associated with individual securities is minimized. To put in financial language, the aim is to diversify the unsystematic risk in the portfolio. Also, since the pooled funds are invested in different sectors and stocks, there is a diversification effect reducing the overall risk of the portfolio.

    Since mutual funds generally trade in a large number of securities at the same time, there is the advantage of economies of scale. In other words, there are savings in transaction costs.

    According to the investment objective, mutual funds can be classified as (a) growth funds, (b) income funds and (c) balanced funds. Growth funds invest the majority of their pooled amount with the objective of achieving long-term capital appreciation. Income funds provide periodic returns to investors in the form of dividends. Balanced funds are a midway between growth funds and income funds. They balance their investment in such a way that investors not only get the periodical return, but their capital also tends to appreciate which is reflected in the higher NAV.

    If you are an investor who seeks for a suitable fund, then it depends on your risk-bearing capacity (your risk profile). If you are a high risk-averse investor who requires the periodic return, then you should always prefer investment in income funds. If you have a high risk taking capability and you have surplus funds to invest, then go for growth funds. If you want a small periodic return along with capital appreciation, then go for balanced funds.

    Investment in mutual funds should never be looked upon from the point of view of return. It is the risk-return paradigm which can help us to optimize our return over a period of time. Another point you should remember is that you should never attempt to compare two schemes of the mutual fund with different investment objectives on the basis of the returns provided by them, if you do so, it would be like comparing apples with mangoes.

    Sharpe ratio and Treynor Ratio are the tools to measure the performance of mutual funds over a period of time. Sharpe Ratio is obtained by dividing the difference between the return of the portfolio and risk-free rate of interest to the standard deviation of the portfolio return. This ratio takes into account surplus return earned by the fund over risk-free rate of interest and then divides it by standard deviation of the portfolio return (which is basically a representative of risk which measures the deviation of actual return of the portfolio with respect to mean return).

    Higher the return better is the fund. Treynor Ratio also takes into account surplus return earned over risk-free return but the measure of risk here is beta (a measure of systematic risk) rather than standard deviation. Thus, Treynor ratio is obtained by dividing the difference between the return of the portfolio and risk-free rate of interest to the beta (market risk/systematic risk) of the portfolio.

    There are some absolute performance measures such as Jenson’s Alpha, Fama’s Measure and Expense Ratio which provide an indication about the performance of a mutual fund as a whole. Jenson’s Alpha Measure helps us in identifying whether the fund has been able to outsmart its expected return.

    The expected return of a security is equal to:

    Re = Rf + β(Rm – Rf)

    Where Rf is the risk-free return, β is the systematic risk and Rm is the return on market index (return earned by the fund).

    Fama’s measure is obtained by the following formula:

    Fama’s Measure = Rp – [Rf + (σp/σm)(Rm – Rf)]

    Where, Rp = actual return of portfolio; Rf = risk free return, Rm = return on market index, σp = standard deviation of portfolio return, σm = standard deviation of market index return.

    Thus, instead of β, which takes into account only systematic risk, this measure takes into account standard deviation of stock return as well as standard deviation of market returns.

    Expense ratio refers to the total amount of expenses of the fund as a percentage of total assets of the fund. The expenses include all the charges in the form of administrative overheads, salary of staff etc. However, expenses do not include brokerage.

    The return on mutual funds is never equal to the return on securities which the investor can earn if he invests directly in those securities since there are front-end load, back-end load and annual expenses which will be deducted from the fund. Front-end fee is charged by the AMC at the time of initial investment in the fund. Exit load is the number of fees charged at the time of redemption (surrender) of the unit. Generally, funds which charge front-end fees do not charge back-end fees/exit load. Moreover, there are expenses which are deducted annually for meeting administrative and other expenses of the fund.

    Mutual fund schemes can be in the form of open-ended schemes or closed-ended schemes. In closed-ended schemes, a fixed number of units are issued by the fund and thereafter this number remains constant till the maturity of the scheme. The option available to the investors, in this case, is that they can buy and sell the units in the secondary market. The open-ended schemes are without any fixed number of outstanding units. Any investor can invest money in accordance with the NAV of the scheme any time. Similarly, investors get an opportunity to redeem their units any time. The logic here is that since there is no fixed total number of units, mutual fund not only accepts money for investment purpose later on after the scheme is launched but also redeems units of holders as and when required by them.

    Finally, there are index funds, ETFs and Fund of Funds, which should also be analyzed. Index funds are those funds which create a portfolio which replicates the composition of a particular index. For instance, an index fund on NIFTY will invest in all those securities which are a part of that index and the proportion is also similar to the weights which the individual securities have in that index. Thus these funds tend to replicate the performance of that index. If we put it in financial language, these funds create a portfolio with a β of 1 which exactly matches the performance of the market.

    For Example:

    When the market i.e. SENSEX moves up by 15% over a time period, the portfolio value also rises by 15% (or rather is expected to rise). This is because the securities which have been purchased by this fund are a part of that index and have been purchased in the same proportion as is the weight of those securities in the index. If an investor intends to have a complete elimination of unsystematic risk, i.e. he wants to earn a return which the index earns irrespective of the performance of individual stocks in the market he should invest in such funds.

    Exchange traded funds or popularly known as ETFs are mutual funds whose units are traded in stock exchanges. Unlike the traditional funds in which units are directly redeemed by the mutual fund itself, the units of these funds are bought and sold in the market just like shares. These funds may be open-ended or closed-ended. The investors of ETFs do need to have a Demat account.

    There are ETFs which are traded on stock exchanges with the underlying asset as gold, known as ‘Gold Exchanged traded Fund’. They provide a convenient and easy vehicle for retail investors to participate in the gold bullion market. Thus the fund issues a certificate for the specified amount of gold to its unitholders. The scheme is listed on a stock exchange and hence investors can buy and sell the units on the stock exchange. The advantage here is that there is no risk of holding physical gold stock and the investor can still have a notional claim over units of gold.

    There are also mutual funds which invest in other mutual funds and these mutual funds are known as the fund of funds. Thus, instead of directly investing in securities of corporates or bonds, these mutual funds invest I other mutual funds in order to get maximum diversification.

  • Explain How to Calculate NAV in Mutual Funds?

    Explain How to Calculate NAV in Mutual Funds?

    Learn, Explain How to Calculate NAV in Mutual Funds?

    The Net Asset Value (NAV) is the market value of the assets of the scheme deducting its liabilities. Simply put, the NAV is what investors are required to pay to buy or sell one share of the mutual fund. Keep in mind any additional fees are not included in this amount. In accounting terms, NAV is also known as the book value of the mutual fund. Also Learned, Mutual Funds, Explain How to Calculate NAV in Mutual Funds?

     

    The net asset value per mutual fund unit on any business day is computed as follows:

    NAV = (Market value of the fund’s investments + Receivables + Accrued income -Liabilities – Accrued expenses)/Number of units outstanding.

    Rules Governing the Mutual Fund NAV Calculation:

    1. Accrued Income and Expenses: The correct accrual of all incomes and expenses is a requirement for computing NAV. In practical terms, these are just estimates. For example, the investment manager’s fees have to be accrued every day for computing NAV but the fee is based on the weekly average of net assets. Changes in NAV due to the assumptions about accruals should not impact NAV by more than 1 %.
    2. Sale and Purchase of Securities and Units: The purchase and sale of securities have to be recorded in the books of the fund, and this impacts the net assets of the fund. Sale and repurchase of units alter the number of unitholders outstanding in the fund and impacts the denominator of the NAV equation.
    3. Initial Expenses: When a mutual fund scheme is launched, certain expenses are incurred. These relate to printing and mailing, advertisements, commission to agents, brokerage, stamp duty, marketing, and administration known as initial or pre-operational expenses, they are linked to the corpus of the scheme. The fund has to give a break up of these expenses in the prospectus.
    4. Recurring Expenses: Apart from the initial expenses, mutual funds incur recurring expenses every year. These expenses include items like the asset management fees, registrar’s fees, and custodial fees and are charged to the profit and loss account of the scheme.
    5. Sales and Repurchase Load: Sales or front-end load is a charge collected by a scheme when it undertakes fresh issue of units or shares. Suppose a mutual fund issues Rs.1,00,000 worth units having a face value of Rs.10 each. The company incurs some initial issue expenses, which may be around 1% of the face value, or in other words, the company may levy an entry load. Schemes that do not charge a load are called ‘No Load’ schemes. Repurchase or ‘Back-end’ load is a charge collected by a scheme when it buys back the units from the unit holders. It is because of the front-end and back-end loads the mutual fund schemes are at a premium and repurchased at a discount to NAV. The repurchase price is usually less than the reissue price.

    Learn how to calculate Net Asset Value with the following examples:

    • Example 1: If the net assets of a fund are $10 million, and the fund holds 2 million shares. Then, the NAV per share = $5 ($10 million / 2 million).
    • Example 2: YTC Corporation has total assets of $3,500,000 (including intangible asset $500,000) and total liabilities of $1,000,000. The calculation for net asset value of ABC corporation is as follows: NAV = total assets – intangible assets – total liabilities = 3,500,000 – $500,000 – $1,000,000 = $2,000,000
    • Example 3: A mutual fund has total assets of $2,800,000, liabilities of $800,000, and 200,000 outstanding shares. Then, the NAV per share = (2,800,000 – 800,000) / 200,000 = $10.
    NAV in Brief:

    The Net Asset Value (NAV) of a mutual fund is the price at which units of a mutual fund are bought or sold. It is the market value of the fund after deducting its liabilities. The value of all units of a mutual fund portfolio is calculated on a daily basis, from this all expenses are then subtracted. The result is then divided by the total number of units the resultant value is the NAV. NAV is also sometimes referred to as Net Book Value or book Value. Let’s discuss its calculation in a bit more detail.

    NAV indicates the market value of the units in a fund. So, it helps an investor keep track of the performance of the mutual fund. An investor can calculate the actual increase in the value of their investment by determining the percentage increase in the mutual fund NAV. NAV, therefore, gives accurate information about the performance of the mutual fund.

    Calculation of NAV:

    Mutual fund assets usually fall into two categories – securities & cash. Securities, here, include both bonds and stocks. Therefore, the total asset value of a fund will include its stocks, cash, and bonds at market value. Dividends and interest accrued and liquid assets are also included in total assets.

    Explain How to Calculate NAV in Mutual Funds - ilearnlot

    Also, liabilities like money owed to creditors, and other expenses accrued are also included.

    Now the formula is:

    Net Asset Value (NAV) = (Assets – Debts) / (Number of Outstanding units).

    Here:

    Assets = Market value of mutual fund investments + Receivables + Accrued Income

    Debts = Liabilities + Expenses (accrued)

    The market value of the stocks & debentures is usually the closing price on the stock exchange where these are listed.

    Some points to note:

    The mutual fund itself and/or certain accounting firms calculate the NAV of a mutual fund.

    Since mutual funds depend on stock markets, they are usually declared after the closing hours of the exchange.

    All Mutual Funds are required to publish their NAV at every business day as per SEBI guidelines.

    Also, NAV is obtained by subtracting the expense ratio of a fund. This expense ratio is the total of all expenses made by the mutual fund annually, including the operating expenses and the management fees, distribution and marketing fees, transfer agent fees, custodian fees and audit fees.

  • What are a Mutual Funds?

    What are a Mutual Funds?

    Learn and Study, What are a Mutual Funds?

    A Mutual Fund is a special type of investment institution which collects or pools the savings of the community and invests large funds in the variety of Blue-chip Companies which are selected from a wide range of industries with the objects of maximizing returns/incomes on investments. Mutual Funds are basically a trust which mobilizes savings from the people and invests them in a mix of corporate and government securities. Money collected by the investors is invested in various issues of primary and secondary markets in order to gain profits on such investments. Also learned, the Process of Investment, What are a Mutual Funds?

    What are a Mutual Funds - ilearnlot

    A Mutual Fund is a Trust, which combines the investments of various investors having similar financial goals. The Trust issues units to the investors in the proportion of their investments. A fund manager then invests these funds in different types of assets, which provide returns in the form of dividends, interests, and capital appreciation. This is distributed to the various investors in the proportion of their contribution to the pool funds. Ordinary investors, who want to invest their savings, neither understand the complexities of financial markets nor have the time to watch, research and analyze different equities, securities or any other investments opportunities that are available in the market.

    At present, all the markets viz. the debt market, the equity market, the money market, real estates, derivatives, and the market dealing with the other assets have now reached a stage where a minimal information affect the markets. Besides this, the economy has opened up and global events influence their performance.

    It is very difficult for a layperson to keep track of various investments, transactions, brokerages etc. In the present scenario, mutual funds are some of the most efficient financial instruments as it offers services like managing investments at a very low cost.

    What is NAV or Net Asset Value?

    NAV of the Fund is the market value of all the assets of the Fund subtracting the Liabilities. NAV reflects the Fund that will be available to the shareholders if the Fund is liquidated and all the liabilities are paid. In the mutual fund industry NAV refers to Net Asset Value per unitholder, which NAV of the Fund divided by the outstanding number of the units.

    It shows the performance of the Fund.

    • Calculation of NAV = Net Asset Value of the fund sum of market value of shares/debentures + Liquid assets/cash Dividends/interest accrued – All liabilities
    • Net asset value per unit =NAV of the fund / Outstanding number of units

    The market value of the shares and debentures is calculated by multiplying the number of shares/units by the closing price of the shares/debentures. The closing price will be of the previous day of the stock exchange from where the shares have been purchased.

    If the shares were not traded on the previous day in that stock exchange, then the closing price of the shares of any other stock exchange is taken where the shares were traded. If the shares were not traded on any stock exchange the previous day, then the closing price of the shares when they were last traded is taken.

    For untraded shares, the value has to be determined by the other methods such as Book Value, comparable company approach, etc. Value of the illiquid bond is estimated on the basis of yields of comparable liquid bonds.

    To many people, Mutual Funds can seem complicated or intimidating. We are going to try and simplify it for you at its very basic level. Essentially, the money pooled in by a large number of people (or investors) is what makes up a Mutual Fund. This fund is managed by a professional fund manager.

    It is a trust that collects money from a number of investors who share a common investment objective. Then, it invests the money in equities, bonds, money market instruments and/or other securities. Each investor owns units, which represent a portion of the holdings of the fund. The income/gains generated from this collective investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV. Simply put, a Mutual Fund is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.