With an objective to make the investors aware of functioning of Mutual Funds, an attempt has been made to provide information in question-answer format which may help investors in taking investment decisions.

What is a Mutual Fund?

A Mutual Fund is a mechanism for pooling resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in the offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual Fund issues units to the investors in accordance with quantum of money invested by them. Investors of Mutual Funds are known as unitholders.

The profits or losses are shared by the investors in proportion to their investments. The Mutual Funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A Mutual Fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public.

What is the history of Mutual Funds in India and role of SEBI in Mutual Funds industry?

Unit Trust of India was the first Mutual Fund set up in India in the year 1963. In early 1990s, Government allowed public sector banks and institutions to set up Mutual Funds.

In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of SEBI are - to protect the interest of investors in securities and to promote the development of and to regulate the securities market.

As far as Mutual Funds are concerned, SEBI formulates policies and regulates the Mutual Funds to protect the interest of the investors. SEBI notified regulations for the Mutual Funds in 1993. Thereafter, Mutual Funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines to the Mutual Funds from time to time to protect the interests of investors.

All Mutual Funds whether promoted by public sector or private sector entities including those promoted by foreign entities are governed by the same set of regulations. There is no distinction in regulatory requirements for these Mutual Funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes launched by the Mutual Funds sponsored by these entities are of similar type. It may be mentioned here that Unit Trust of India (UTI) is not registered with SEBI as a Mutual Fund (as on January 15, 2002).

How is a Mutual Fund set up?

A Mutual Fund is set up in the form of a trust, which has a sponsor, trustees, asset management company (AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like a promoter of a company. The trustees of the Mutual Fund hold its property for the benefit of the unitholders. Asset Management Company (AMC) approved by SEBI manages the funds by making investments in various types of securities. Custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI regulations by the Mutual Fund.

SEBI regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent ie they should not be associated with the sponsors. Also, 50 per cent of the directors of AMC must be independent. All Mutual Funds are required to be registered with SEBI before they launch any scheme.

What is Net Asset Value (NAV) of a scheme?

The performance of a particular scheme of a Mutual Fund is denoted by Net Asset Value (NAV).

Mutual Funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on a day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a Mutual Fund scheme is INR20m and the Mutual Fund has issued ten million units of INR10 each to the investors, then the NAV per unit of the fund is INR20. NAV is required to be disclosed by the Mutual Funds on a regular basis - daily or weekly - depending on the type of scheme.