Mutual Fund Basics

A Mutual Fund is an investment vehicle that pools the savings of a number of investors who share a common financial goal. It is essentially a diversified portfolio of financial instruments – these could be equities, money market or fixed income instruments. The money collected in the fund is then deployed in investment avenues that help investors meet predefined investment objectives. The income earned through these investments and the capital appreciation realized are shared by its unit holders in proportion to the number of units owned by them.

Access to professionals – Experienced fund managers managing your money .

Diversification – Mutual Funds aim to reduce the volatility of returns through diversification with the goal of reducing an investors risk profile.

Liquidity – Open-ended Funds allow investors to sell their mutual fund units anytime . Most funds offer redemption proceeds within a couple of days where as some funds are highly liquid and also offer a same day redemption facility.

Mutual Fund schemes may be classified on the basis of their structure and their investment objective.

By structure:

Open-ended Funds – An Open-ended Fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices.

Close-ended Funds – Closed-end Funds have stipulated / perpetual life based on the constitutive documents of the funds. These funds open for subscription only during a specified period and investors can initially invest in the funds at the time of the subscription and can buy or sell the fund certificates at the Stock Exchanges.

By Investment Objective:

Equity Funds – Aim to provide capital appreciation over the medium to long term. Such schemes normally invest in equities listed on the stock exchange and thus can be highly volatile. Equity Funds are ideal for investors who have a long-term outlook and are seeking growth over a period of time.

Income Funds – Aim to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as Sukuks and Islamic bank deposits. Income Funds are ideal for capital stability and regular income. Income Funds provide limited capital appreciation though risks are typically lower than that in a equity fund.

Balanced Funds – Aim to provide both capital appreciation and regular income. Such schemes invest both in equities and fixed income securities in the proportion indicated in their offering documents. This proportion affects the risks and the returns associated with the balanced fund – in case equities are allocated a higher proportion, investors would be exposed to risks similar to that of the equity market. Balanced funds with equal allocation to equities and fixed income securities are ideal for investors looking for a combination of income and moderate growth.

Money Market Funds – Aim to provide easy liquidity and moderate income. These schemes generally invest in safer short-term instruments such as Islamic bank deposits and Sukuks with short-term maturities. These are ideal for investors as a means to park their surplus funds for short periods.

There are risks in all forms of investment. The value of a mutual fund’s investment may be affected ( based on the type of fund) by factors affecting capital markets such as price and volume volatility in the stock markets, interest rates, currency exchange rates, foreign investment, changes in government policy, political, economic or other developments.

Some types of risk are classified as :

Market risk – Where prices or yields of the securities in a particular market rise or fall due to factors which affect capital markets. When this happens, the stock prices of both an outstanding, highly profitable company and a fledgling corporation may be affected. This change in price is due to ‘market risk’.

Inflation risk – Where changes in inflation may affect the purchasing power of your money. Whenever the rate of inflation exceeds the earnings on your investment, you run the risk that you will actually be able to buy less, not more.

Credit risk – Is dependent on how stable is the company or entity in which you invested in? How certain are you that it will be able to pay the interest you are promised or repay your principal when the investment matures?

Interest rate risk – Changing interest rates affect both equities and debt instruments in many ways. Prices of debt instruments are influenced by movements in the interest rates in the financial system. Generally, when interest rates rise, prices of the debt securities fall and when interest rates drop, their prices increase.