TERMS OFTEN USED IN MUTUAL FUND SECTOR

TERMS USED IN MUTUAL FUND INVESTING

There are several terms and jargons that are commonly used in the mutual fund industry. An investor will come across most or all of them while investing. Hence, it becomes important to know what these terms actually mean.

LOADS

Loads are an extra charge that investors pay to the mutual fund. This is an additional expense for the investor. Loads are of two kinds - entry loads and exit loads. Mutual funds can charge either of these loads or even both of these loads so one has to check about the features of a particular scheme as the type of loads as well as the amount of load differ from scheme to scheme. A load is usually calculated as a percentage of the NAV.

An entry load is the load that is paid by the investor when they buy units in a mutual fund. The cost for the investor will rise to the extent of the load and they will get a lower number of units than what would have been available had there been no entry load. For example if there is an entry load of 2% in a scheme then an investors who goes out to buy units of the fund when the NAV is Rs 10 will get it at a cost of Rs 10.2.

An exit load is the load that is charged to investors when they withdraw money from a scheme. Here the investors get a price lower than the NAV applicable on the particular date. For example when an investors goes to sell units in a scheme with an exit load of 2% when the NAV is Rs 20 then the investor will get a sale value of Rs 19.6 per unit.

In both the cases these represent an extra charge that is paid by the investors when they make a buy or sell decision in the units of the fund. In this entire process two more terms come into the picture. The first is the repurchase price which is the price paid by the fund to the investor when it buys units from them. The other term is the sale price, which is the price at which the fund sells the units to the investor

SCHEME OPTIONS

After selecting a particular mutual fund and a specific scheme there is still some more work to be done by the investor because they have to select the options available to them within a scheme. There are three such options available and these are the dividend payout, dividend reinvestment and the growth option

In the dividend payout option the dividend declared by the scheme is paid out in cash to the investor. Investors have to be careful and select this as the option when they want the actual payment to be received in cash. One has to note that the dividend declaration is always on the face value of the units and not on the current value. Thus if the NAV of a scheme is Rs 55 and the fund declared a 60% dividend then the dividend declared is Rs 6 per unit because the percentage figure is considered on the face value of Rs 10 and not the current NAV of the scheme.

The dividend reinvestment option is one where the dividend declared by the scheme is then poured down back into the scheme at the applicable NAV. In reality what happens is that the investor first receives the dividend on paper and then the same figure is converted into additional units. An investor might earn Rs 6.000 as dividend but that is not received in cash but will be converted into additional units. Many investors select the dividend option but tick the dividend reinvestment part resulting in no payout coming to them.

EXPENSE RATIO

There are various expenses that are incurred by the mutual fund in respect to its operations. There are two expense ratios that one will read about. The first is the initial issue expense ratio which is the expense incurred at the time of a new fund offering. The other is the expense ratio that is witnessed during the normal operation of the scheme.

There are limits prescribed for various expenses. According to the regulations issued by the Securities and Exchange Board of India (SEBI) the total initial expenses shall not exceed 6% of the initial resources raised under a close ended scheme and any excess over this figure will have to be borne by the asset management company (AMC). There has been a recent change to the provisions of the charging of the initial issue expenses for an open ended scheme and there cannot be any initial issue expenses over and above the entry load on the scheme. The initial issue expenses will include advertising expenses, agent commission, registrar expenses, marketing expenses, bankers fees, legal fees, printing and distribution expenses etc.

There is a bit of calculation involved in terms of the maximum recurring expenses permitted by SEBI as it depends upon the assets under management. The list of such expenses include investment management and advisory fees, trustee fees, custodian fees, marketing and selling expenses, registrar and transfer agent fees, audit fees, communication costs, cost of providing account statements, dividend, redemption warrants, cost of statutory advertisement and other expenses.
Investors need to watch this final figure as this will be the one that will affect them because their earnings, which are linked to the NAV will be the net figure after the scheme has charged off the expense made. While a better performing scheme might have some higher expense one has to look carefully at the total expense figure and how they shape up over a period of time

NET ASSET VALUE (NAV)

The net asset value more popularly known as the NAV is the most important thing for the investor in a mutual fund because all purchases and sales that they make is related to this figure. The NAV will determine the gains or losses that they will make on the investment. Consider the NAV as being similar to the price of a share as both of them play the same role of determining the value of the investment.

There are however big differences between the NAV and the price of an equity share. The first one is that the NAV depends upon the value of the assets being held by the scheme. Thus the value of the NAV can rise only when the value of the underlying holdings go up. In this case mere demand and supply can have no impact on the NAV of the scheme.

The price of a share on the other hand can be affected by demand and supply even when other fundamental factors are constant. Thus one might see a sharp spike in the price of a share even when there is no other movement all around. This will not happen in a NAV and hence investor who mistakes a mutual fund for a share will learn it the hard way that NAV does not just double or triple based on demand for the fund. However if there is large scale churning by short term investors then this can work to the detriment of long term investors not because NAV will suddenly become half but because the long term investors end up bearing a larger part of the cost.

The NAV is the value of all the investments in the scheme plus the current assets of the scheme less the current liabilities of the scheme. This entire figure is then divided by the number of units outstanding in the scheme to get the NAV per unit. This shows the value of each unit of the scheme and it is used for the purpose of buying and selling units by the fund

An important thing is the value of the NAV at a particular point of time does not matter. All that matters is the future growth potential in the scheme, which is based on the change in the value of the assets held by the scheme. Thus for example a Rs 10 NAV if it rises by 20% will go to Rs 12 while the same portfolio held by a scheme with a NAV of Rs 30 will go to Rs 36. In that sense if there is a decision regarding the purchase of a unit in either of the schemes then the actual NAV does not matter but only the growth there does.

The NAV of the scheme is usually calculated as follows

NAV (Rs) = Market or fair value of schemes Investments + Current assets – Current
Liabilities and provisions
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Number of units outstanding under the scheme

NEW FUND OFFER (NFO)

A new fund offer is a new scheme launched by a mutual fund. It is called a NFO to differentiate it from the IPO of a stock because there was large confusion among investors who were being sold new units of mutual fund schemes like a new share offering.

As can be seen by the meaning of the NAV of the scheme there is no way that a NFO will open at double or triple the value of the offer price because the assets of the scheme will have not grown in value by the same extent during the period from which the new offer closed and the scheme then reopened for investment.
There is a difference also within the way in which a new offering has to be evaluated because there cannot be under pricing or overpricing of the issue which can be the case with a share offering and hence one has to be careful in the way in which one is able to evaluate these offerings that are available for the investor. In such offers unlike other mutual fund schemes there is also no track record to measure the past performance of the scheme

SYSTEMATIC INVESTMENT PLAN (SIP)

Systematic Investment Plan is often called SIP and this is a method of investing used by mutual fund investors. In this method there is an investment of a fixed sum on the same day of each month for a period of say 6 months or 1 year by an investor. This ensures that there is a regular investment each month and the idea is to ensure that the highs and lows are averaged out so that the investor is able to get an average price for the units.

The way a SIP plan works is that the investor has to decide on two factors when the decision is made. The first is the amount of investment that one would like to make and this could be something as low as Rs 1,000 or even higher like Rs 10,000 as this can be selected depending upon the profile of the investment and the extent of funds that are to be invested. The next things to decide is the period of the investment and this will be 6 months or a year, which will enable the actual benefits for the investor to flow in.

The benefit for the investor is that when the prices are high there are a few units that are allotted to him but when the prices drop the same amount of money will ensure that there is automatically a higher allocation of units. This ensures that the investor is able to gain in terms of higher allocation when the price is low. This will also ensure that the investor does not face the risk of the one time investment that would be present had the entire investment be made in a lumpsum at a single time point.

SYSTEMATIC TRANSFER PLAN (STP)

Systematic transfer plan is a variant of the SIP that has been explained above. In a SIP the investor makes a direct investment into a scheme on a regular basis. On the other hand in STP there is a regular transfer of money into a particular scheme but this is a transfer from an existing scheme by an investor.

This is useful for any investor who has funds at his disposal and they still do not want to invest the whole amount at one go. What can be done in such a situation is that the funds are first transferred to a debt oriented scheme and from that scheme there is a movement each month amounting to a specific sum into an equity oriented scheme. This will ensure that two objectives of the investor are met. The first is that the funds of the investor are not lying vacant and earning a low rate of return but they will be earning a slightly higher figure in the debt scheme and at the same time there is the benefit of the systematic investment that is available because the money is transferred each month.