Investments in mutual funds are one of the many available investment avenues. Investments in mutual funds comes with many advantages over other traditional investments but still small savings schemes like bank deposit, fixed deposit, NSC, Kisan Vikas Patra, etc. are very popular among investors. The main reason behind the popularity of small savings schemes are guaranteed interest, no fear of losing the principal and easy investment process. After the IT revolution and reach of the internet to even remote villages, common people's awareness about the stock market is also increasing. Now they know about the stock market, mutual funds and many other investments but not to a level wherein they can decide the correct approach.
There are many types of mutual funds scheme, so it is not correct approach to use generalized term "mutual fund investment means investment in stocks." Mutual fund scheme's objective plays a significant role in deciding the investment of the collected funds. In the next chapter, we will learn more about it.
Whether investments are in small savings schemes or mutual funds or any other type of investments, it is essential to understand the real return after considering the inflation. Inflation itself is not bad but while making investments, not factoring the inflation is not a wise decision.
What is Mutual Funds
There are many definitions available on the internet. I have picked the definition available in Wikipedia.
" A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. These investors may be retail or institutional in nature"
To simplify, mutual fund companies collect money from many investors and then based on the investment objective of the schemes, invests the funds in the market. It is done by the professionals who knows the markets and experience to do so. Here key term is investment objective. It is not that mutual fund companies have the freedom to invest everywhere. They abide by the regulations, any deviation from rules and regulations are not allowed.
Mutual Fund Operation and Trust Structure
Mutual funds are setup as trust. As we know that every trust has beneficiaries so for the mutual fund trust, investors are the main beneficiaries. Mutual fund trust has four main body - Sponsor, Trustees, Asset Management Company and Custodian.
Each of the constituents of a mutual fund has unique roles and responsibilities. Even their setup is as per the SEBI's mutual fund regulations. SEBI's mutual fund regulation is called "Securities and Exchange Board of India (Mutual Fund) Regulations,1996."
Now we know that AMC performs the day to day operations of the mutual fund schemes. Below figure connects the mutual fund setup and mutual fund operation by AMC.
Mutual Fund Setup
Sponsor: Sponsor is a promoter of the mutual funds, so sponsor needs to make an application to SEBI for registration of mutual fund by submitting form A. The sponsor needs to have minimum 40% shareholding in the capital of AMC. Anyone who holds more than 40% stake in the capital of AMC will be deemed as a sponsor, and they will be required to fulfill the eligibility criteria of the sponsor. Sponsor applying for registration of mutual fund should pass the eligibility criteria set in SEBI's mutual fund's regulations,1996.
Trustee: Trustees plays a crucial role in the mutual fund setup. Their primary role is to ensure that the mutual fund complies with the regulations and to protect the interest of the unit holders (investors). Before appointing a trustee, Sponsor has to take prior approval from SEBI.
Asset Management Company (AMC): AMC plays key role in the mutual fund setup. AMC handles day-to-day operation of the fund. Appointment of asset management company can be made by Sponsor or by the trustees if authorized by the trust deed.
Custodian: As defined in the SEBI mutual fund regulations,1996, "Custodian" means a person who has been granted a certificate of registration to carry on the business of custodian of securities under the Securities and Exchange Board of India(Custodian of Securities) regulations,1996.
So basically custodian keeps custody of securities. Trustees appoint custodians, and they entered into the custodial agreement. Custodians need to register with SEBI.