Educated Indians have a lot of myths about Mutual funds…and the regulator needs help! So let me do my bit….

1. Does mutual fund always invest in shares?

A share is a share in the share capital of a company. Normally mutual funds are like a bottle – their value is in what they contain. So look at your mother’s kitchen shelf. A bottle can contain salt, sugar, tea, coffee, – you do not say ‘pass the bottle’. You say pass the salt. What you mean is the ‘salt bottle’.

A mutual fund has various meaning for various people. A company advertises and sells ‘mutual fund schemes’ – the company is called ‘asset management company’. The scheme is named like this “Icici Prudential Value Discovery Fund” – this is a particular scheme which invests only in equity shares. Investors use the word mutual fund interchangeably.

A mutual fund (bottle) can contain debentures issued by companies (Bond fund), Government securities (Gilt fund), Equity shares (equity fund), Gold (Gold fund) or a combination of these (Hybrid or balanced fund).

2. What are the different types of debt funds?

Debt funds are classified on the basis of how much time the underlying investments a) take to mature and b) the level of risk in the fund. So at the lowest maturity you have ‘liquid funds’ and at the other end you have Gilt funds which invest in Government securities with the highest maturity of say 30 years. http://www.subramoney.com/2014/04/debt-products-the-full-range/

3. Why can’t we invest directly in G-secs? (emanating from Gilt funds etc)

You can. It is a very inefficient process, there is no easy way to do it, and the minimum amount is Rs. 5 crores. I have been attending seminars since 1990 about “How to improve retail participation in the G secs and Corporate debt markets’ but nothing comes off such stupid eating sessions. The mutual fund industry could also be subtly opposing it – many people may by pass them.

4. If debt funds are similar (not same) in risk profile as FDs, then how are they sometimes able to offer better rate of returns than bank FDs?

Debt funds NEVER EVER offer better returns. In fact they do not offer any returns, they GET better returns. The debt funds invest in various debt instruments. Debt instruments (like equity) are traded in the market. The market ensures that prices fluctuate – and the reasons why they fluctuate are : a)inflation,  b) expected interest rate changes c) greater demand for money d) currency fluctuations e) liquidity f) growth in the economy g) movement in the equity markets etc. etc. This alters the value of the underlying asset. So apart from the ‘yield’ or ‘return’ that they get, the bond funds also get appreciation / depreciation. This ensures a higher / lower return.

Please understand that a reverse is also possible. If you invest when the interest rates are low and interest rates are going up, your portfolio will depreciate and you will get less returns (capital loss is also possible).

5. What if the underlying company FD, CP etc defaults?

You lose money, what else? Remember the bottle? What happens if the contents are rotten / spoilt? of course you lose money.

 

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  1. Hi Subra,
    Excellent explanation for mutual fund. I have been finding it difficult to explain mutual funds to my brother & sister who don’t understand English. I have to translate all the documents received from AMC into Tamil for them to understand. This correlation will help them easily understand it.

  2. The 4th point is relevant to me. I had this doubt after seeing 19% returns (last year) in one such ICICI bond fund. I was wondering how come the fund returns 19% when the underlying asset returns 9-10%

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