Key Points About Mutual Funds
Believe it or not but there are more than 3000 mutual fund schemes currently operating through various AMCs and fund houses. That’s a large number considering it is impossible for retail investors to put their money in all of them. Most financial advisors will recommend aspiring investors to invest in not more than 2 or 3 mutual fund schemes to avoid over-diversification. Also, it keeps investors at bay from keeping track of multiple schemes as this can become a bit taxing in the long run.
Mutual funds can be rewarding if one is patient with his / her investments and knows how and where to diversify their portfolio.
Here are a few key points about mutual funds that all investors must be aware of –
How a mutual fund comes into existence
Mutual funds are the result of fund sponsors who are individuals that want to start a mutual fund house. They reach out to market regulator SEBI to seek approval to enter the mutual fund spectrum. Upon receiving approval, the fund sponsors build a Trust under the India Trust Act, 1882. The trustees of this Trust appoint an Asset Management Company (AMC) to manage funds of investors investing in the mutual funds.
Fund management matters
Mutual funds might be owned by fund houses, but they are managed by portfolio managers who are also referred to as fund managers. Investors must ensure that they are entrusting their money with a competent team of fund managers with vast industry experience. For some investors, a fund manager handling multiple schemes is a good sign, but it can actually be worrisome considering the pressure these fund managers are working to outperform their peers and generate optimal returns.
Investment objective of the mutual fund scheme
Every mutual fund scheme has an investment objective irrespective of what category it falls under. Be it an equity fund, a debt fund, a gold for, an exchange traded fund, or an index fund, they all have unique investment objectives. Based on this investment objective, the fund manager takes the investment decision and decides how and where to spread the fund’s assets. One must consider investing in a mutual fund scheme whose investment objective aligns with that of theirs. Along with the investment objective, investors must also check for the risk profile of the mutual fund scheme and see if its suits their risk appetite.
Mutual fund performance
In the mutual fund’s Scheme Information Document (SID) you may come across this – ‘past performance of the scheme may not be sustained’. And yes, to some extent the past performance of a mutual fund scheme does not determine its potential to generate returns in the future. But if the fund has a track record of being consistent in driving the alpha, it gives a sense of confidence for the investor as the past performance speaks volumes of the competent fund management handling the fund.
In India, the mutual fund expense ratio is capped at 2.25%. For those who aren’t aware, mutual funds have an expense ratio which is nothing but a percentage of the fund’s assets that goes into taking care of recurring expenses like management fees, operational costs, administrative expenses, etc. When fund managers clock profits for the mutual fund’s portfolio, they pay brokerage fees. These fees are recovered through investors in the form of an expense ratio. Investors must consider a scheme with a low expense ratio.
Capital gains earned from mutual fund investments are taxed. Tax implications for equity and debt funds are different. Also, hybrid funds are taxed in a different manner. Based on the investor’s holding period they will have to pay LTCG tax or STCG tax and it will also vary depending on the category of the scheme.