Strategy of operations of mutual funds with special emphasis on debt funds

Summer Internship Project Report on

STRATEGY OF OPERATIONS OF MUTUAL FUNDS

WITH SPECIAL EMPHASIS ON DEBT FUNDS

By

Sudhanshu Gupta
A0101910253

MBA (Class of 2012)

Under the Supervision of

Ms. Lakhwinder Kaur Dhillon
Department of Finance

In Partial Fulfillment of the Requirements for the Degree of
Master of Business Administration – General
At

AMITY BUSINESS SCHOOL
AMITY UNIVERSITY UTTAR PRADESH
SECTOR 125, NOIDA - 201303, UTTAR PRADESH, INDIA
2012

Reliance Mutual Funds Sudhanshu Gupta

DECLARATION

Title of Project Report – Strategy of Operations of Mutual Funds with Special Emphasis on

Debt Funds

I declare

(a) That the work presented for assessment in this Summer Internship Report is my own,

that it has not previously been presented for another assessment and that my debts

(for words, data, arguments and ideas) have been appropriately acknowledged.

(b) That the work conforms to the guidelines for presentation and style set out in the relevant

documentation.

Date: 25th July, 2011 Sudhanshu Gupta
A0101910253
MBA – Class of 2012

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CERTIFICATE

I Ms. Lakhwinder Kaur Dhillon hereby certify that Sudhanshu Gupta student of Masters of
Business Administration – General at Amity Business School, Amity University Uttar

Pradesh has completed the Project Report on ―Strategy of Operations of Mutual Funds

With Special Emphasis on Debt Funds‖, under my guidance.

Ms. Lakhwinder Kaur Dhillon
Department of Finance

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ACKNOWLEDGEMENTS

An undertaking of work life - this is never an outcome of a single person; rather it bears the
imprints of a number of people who directly or indirectly helped me in completing the present
study. I would be failing in my duties if I don‗t say a word of thanks to all those who made my

training period educative and pleasurable one. I am thankful to RELIANCE MUTUAL FUND,
NOIDA for giving me an opportunity to do summer training in the company.

First of all, I am extremely grateful to Mr. Saurabh Kapoor (Relationship Manager) for his
guidance, encouragement and tutelage during the course of the internship despite his extremely
busy schedule. My very special thanks to him for giving me the opportunity to do this project
and for his support throughout as a mentor.

My thanks to Mr. Harsh Chaturvedi (Opulence Services Ltd) and the whole staff of Reliance
Mutual Funds who gave me continuous support in every possible manner to gain practical
knowledge in the Industry.

I would also like to thank all the respondents for giving their precious time and relevant
information and experience, I required, without which the Project would have been
incomplete.

Finally I would like to thank all lecturers, friends and my family for their kind support and to all
who have directly or indirectly helped me in preparing this project report. And at last I am
thankful to all divine light and my parents, who kept my motivation and zest for knowledge
always high through the tides of time.

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TABLE OF CONTENTS

DECLARATION ............................................................................................................................................... ii

CERTIFICATE ................................................................................................................................................. iii

ACKNOWLEDGEMENTS ................................................................................................................................ iv

TABLE OF CONTENTS..................................................................................................................................... v

ABSTRACT..................................................................................................................................................... vi

CHAPTER 1: INTRODUCTION TO THE COMPANY – RELIANCE MUTUAL FUND ............................................. 1

CHAPTER 2: INTRODUCTION TO MUTUAL FUNDS ........................................................................................ 6

CHAPTER 3: INDUSTRY ANALYSIS – MUTUAL FUNDS IN INDIA................................................................... 16

CHAPTER 4: INTRODUCTION TO THE STUDY............................................................................................... 25

CHAPTER 5: INVESTMENT AVENUES FOR MUTUAL FUNDS ........................................................................ 27

CHAPTER 6: FIXED INCOME FUNDS ............................................................................................................ 34

CHAPTER 7: REVIEW OF LITERATURE .......................................................................................................... 40

CHAPTER 8: RESEARCH METHODOLOGY .................................................................................................... 43

CHAPTER 9: DATA ANALYSIS AND INTERPRETATIONS ................................................................................ 45

CHAPTER 10: CONCLUSIONS AND RECOMMENDATIONS ........................................................................... 63

REFERENCES ................................................................................................................................................ 65

ANNEXURES ................................................................................................................................................ 67
Annexure 1 – Copy of Questionnaire ..................................................................................................... 67

Annexure 2 – Demographic Profile of Respondents............................................................................... 71

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ABSTRACT

A mutual fund is a professionally managed type of collective investment that pools
money from many investors to buy stocks, bonds, short-term money market instruments, and/or
other securities. Reliance Mutual Fund ('RMF'/ 'Mutual Fund') is one of India‘s leading Mutual

Funds, with Average Assets under Management (AAUM) of Rs. 101259 Crores and an investor
count of over 66.90 Lakh folios.

Mutual funds have become an invaluable tool for a wide range of investors, from
individuals seeking to save for retirement to sophisticated socialites focused on preserving their
assets and businessman determined to create wealth. Mutual funds have opened new vistas to
millions of small investors by virtually taking investment to their very doorstep. The scientific
investment approach and investor oriented benefits has made the industry grow to over ` 6500
trillion by current estimates.

This report aims at studying the Mutual Fund industry in the Indian economy, understand
its operations and study the regulations and other legal requirements of the industry. The study
also comprises of a survey of retail investors to study their fund selection behavior and extract
the factors affecting their behavior using Principal Component Extraction Method of Factor
Analysis.

As per the study, the most important fund related qualities are Intrinsic Fund Qualities,
Flexibility and Consistency, and Brand Image. Similarly, the most important Investor Related
Services are Transparency in Disclosures, Customer Comfort and Accessibility, and After
Sale Benefits and Services.

MF industry in India has a large untapped market in urban areas besides the virgin
markets in semi-urban and rural areas. This market potential can be tapped by scrutinizing
investor behavior to identify their expectations and articulate investor's own situation and risk
preference and then apply to an investment strategy that combines the usual four: cash and
equivalents, Government-backed bonds, debt, and equity.

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CHAPTER 1: INTRODUCTION TO THE COMPANY – RELIANCE MUTUAL
FUND

Reliance Mutual Fund ('RMF'/ 'Mutual Fund') is one of India‘s leading Mutual Funds,

with Average Assets under Management (AAUM) of Rs. 101259 Crores and an investor count of
over 66.90 Lakh folios.

Reliance Mutual Fund, a part of the Reliance Group, is one of the fastest growing mutual
funds in India. RMF offers investors a well-rounded portfolio of products to meet varying
investor requirements and has presence in 159 cities across the country. Reliance Mutual Fund
constantly endeavors to launch innovative products and customer service initiatives to increase
value to investors. Reliance Capital Asset Management Limited (‗RCAM‘) is the asset manager

of Reliance Mutual Fund. RCAM a subsidiary of Reliance Capital Limited, which holds 93.37%
of the paid-up capital of RCAM, the balance paid up capital being held by minority shareholders.

Reliance Capital Ltd. is one of India‘s leading and fastest growing private sector financial

services companies, and ranks among the top 3 private sector financial services and banking
companies, in terms of net worth. Reliance Capital Ltd. has interests in asset management, life
and general insurance, private equity and proprietary investments, stock broking and other
financial services.

The main objectives of the Reliance Mutual Fund are:

• To carry on the activity of a Mutual Fund as may be permitted at law and formulate and devise
various collective Schemes of savings and investments for people in India and abroad and also
ensure liquidity of investments for the Unit holders;
• To deploy Funds thus raised so as to help the Unit holders earn reasonable returns on their
savings and
• To take such steps as may be necessary from time to time to realize the effects without any
limitation.

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Vision Statement
To be a globally respected wealth creator with an emphasis on customer care and a
culture of good corporate governance

Mission Statement
To create and nurture a world-class, high performance environment aimed at delighting
our customers.

The Sponsor:

Reliance Mutual Fund schemes are managed by Reliance Capital Asset Management
Limited, a subsidiary of Reliance Capital Limited, which holds 92.93% of the paid-up capital of
Reliance Capital Asset Management Limited, the balance paid up capital being held by minority
shareholders. Reliance Mutual Fund (RMF) has been sponsored by Reliance Capital Ltd (RCL).
The promoter of RCL is AAA Enterprises Private Limited.
Reliance Capital Limited is a Non-Banking Finance Company and is one of the India‘s leading

and fastest growing financial services companies, and ranks among the top three private sector
financial services and banking companies in India, in terms of net worth.

SCHEMES OF RELIANCE MUTUAL FUND

The aim of growth funds is to provide capital appreciation over the medium to long-
term. Such schemes normally invest a major part of their corpus in equities. Such funds have
comparatively high risks. These schemes provide different options to the investors like dividend
option, capital appreciation, etc. and the investors may choose an option depending on their
preferences

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Equity/growth schemes

The aim of growth funds is to provide capital appreciation over the medium to long-
term. Such schemes normally invest a major part of their corpus in equities. Such funds have
comparatively high risks. These schemes provide different options to the investors like dividend
option, capital appreciation, etc. and the investors may choose an option depending on their
preferences. The investors must indicate the option in the application form. The mutual funds
also allow the investors to change the options at a later date. Growth schemes are good for
investors having a long-term outlook seeking appreciation over a period of time.

• Diversified large cap
• Diversified multi cap
• Diversified mid cap and small cap
• Index
• Balanced
• Tax saver

Debt/Income Schemes

The aim of income funds is to provide regular and steady income to investors. Such
schemes generally invest in fixed income securities such as bonds, corporate debentures,
Government securities and money market instruments. Such funds are less risky compared to
equity schemes. These funds are not affected because of fluctuations in equity markets.
However, opportunities of capital appreciation are also limited in such funds. The NAVs of such
funds are affected because of change in interest rates in the country. If the interest rates fall,
NAVs of such funds are likely to increase in the short run and vice versa. However, long term
investors may not bother about these fluctuations.

• Ultra short term
• Short term funds
• Monthly income plans

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• Money market funds
• Long term funds

Gold Schemes

Gold is seen as a symbol of security and a sign of prosperity. Indian consumers consider
gold jewelry as an investment and are well aware of gold‘s benefits as a store of value. Gold is

also recognized as a form of money in India, a tradable liquid asset. It is one of the foundation
assets for Indian households and a means to accumulate wealth from a long term perspective.
Gold investment has been in the culture of Indian tradition and has been on rise amongst the
modern investors as well due to the financial uncertainty and inflationary pressures.

• Gold exchange traded funds
• Gold saving funds

THE CORPORATE GOVERNANCE

The Corporate Governance Policy:
Reliance Capital Asset Management Limited has a vision of being a leading player in the
mutual fund business and has achieved significant success and visibility in the market.
However, an imperative part of growth and visibility is adherence to good conduct in the
marketplace. At Reliance Capital Asset Management Limited, the implementation and
observance of ethical processes and policies has helped it in standing up to the scrutiny of its
domestic and international investors.

Management:
The management at Reliance Capital Asset Management Limited is committed to good
corporate governance, which includes transparency and timely dissemination of information to
its investors and unit holders. The Board of Directors of RCAM is a professional body
constituting inter-alia of, well-experienced and knowledgeable independent members. Regular
audit committee meetings are conducted to review the operations and performance of the
company.

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Employees:
Reliance Capital Asset Management Limited has at present, a code of conduct for all its
officers. It has a clearly defined prohibition on insider trading policy and regulations. The
management believes in the principles of propriety and utmost care is taken while handling
public money, making proper and adequate disclosures.

All personnel at RCAM are made aware of their rights, obligations and duties as part of
the Dealing Policy laid down in terms of SEBI guidelines. They are taken through a well-
designed HR program, conducted to impart work ethics, the Code of Conduct, information
security, Internet and e-mail usage and a host of other issues.

One of the core objectives of RCAM is to identify issues considered sensitive by global
corporate standards, and implement policies/guidelines in conformity with the best practices as
an ongoing process.

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CHAPTER 2: INTRODUCTION TO MUTUAL FUNDS

Mutual funds have become an invaluable tool for a wide range of investors, from
individuals seeking to save for retirement to sophisticated socialites focused on preserving their
assets and businessman determined to create wealth.

In its most basic form, a mutual fund is a company that pool money from a group of
people with common investment goals to buy securities such as stocks, bonds, money market
instruments, a combination of these investments, or even other funds. It is a professionally
managed type of collective investment scheme that pools money from many investors and
invests it in stocks, bonds, short-term money market instruments and other securities. Mutual
funds have a fund manager who invests the money on behalf of the investors by buying / selling
stocks, bonds etc. Currently, the worldwide value of all mutual funds totals more than $US 26
trillion.

There are various investment avenues available to an investor such as real estate, bank
deposits, post office deposits, shares, debentures, bonds etc. A mutual fund is one more type of
Investment Avenue available to investors.

Mutual fund is a trust that pools the savings of a number of investors who share a
common financial goal. This pool of money is invested in accordance with a stated objective.
The joint ownership of the fund is thus ―Mutual‖, i.e. the fund belongs to all investors. The

money thus collected is then invested in capital market instruments such as shares, debentures
and other securities. The income earned through these investments and the capital appreciations
realized are shared by its unit holders in proportion the number of units owned by them. Thus a
Mutual Fund is the most suitable investment for the common man as it offers an opportunity to
invest in a diversified, professionally managed basket of securities at a relatively low cost. A
Mutual Fund is an investment tool that allows small investors access to a well- diversified
portfolio of equities, bonds and other securities. Each shareholder participates in the gain or loss
of the fund. Units are issued and can be redeemed as needed. The funds‘ Net Asset value (NAV)
is determined each day.

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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 unit holders.

CONCEPT OF MUTUAL FUNDS

Many investors with common financial objectives
pool their money.

Investors, on a proportinate basis , get mutual fund
units for the sum contributed to the pool

The money collected from investors is invested into
shares, debentures and other securities by the fund
manager.

The fund manager realizes gains or losses, and
collects dividend or interest income.

Any capital gains or losses from such investments
are passed on to the investors in proportion of the
number of units held by them.

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When an investor subscribes for the units of a mutual fund, he becomes part owner of the
assets of the fund in the same proportion as his contribution amount put up with the corpus (the
total amount of the fund). Mutual Fund investor is also known as a mutual fund shareholder or a
unit holder.

Any change in the value of the investments made into capital market instruments (such as
shares debentures etc.) is reflected in the Net Asset Value (NAV) of the scheme. NAV is defined
as the market value of the Mutual Fund scheme's assets net of its liabilities. NAV of a scheme is
calculated by dividing the market value of scheme's assets by the total number of units issued to
the investors.

ADVANTAGES OF MUTUAL FUNDS:

If mutual funds are emerging as the favorite investment vehicle, it is because of the many
advantages they have over other forms and the avenues of investing, particularly for the investor
who has limited resources available in terms of capital and the ability to carry out detailed
research and market monitoring. The following are the major advantages offered by mutual
funds to all investors:

1. Portfolio Diversification: Each investor in the fund is a part owner of all the fund‘s assets,

thus enabling him to hold a diversified investment portfolio even with a small amount of
investment that would otherwise require big capital.

2. Professional Management: Even if an investor has a big amount of capital available to him,
he benefits from the professional management skills brought in by the fund in the
management of the investor‘s portfolio. The investment management skills, along with the

needed research into available investment options, ensure a much better return than what an
investor can manage on his own.

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3. Reduction/Diversification of Risk: When an investor invests directly, all the risk of
potential loss is his own, whether he places a deposit with a company or a bank, or he buys a
share or debenture on his own or in any other from. While investing in the pool of funds with
investors, the potential losses are also shared with other investors. The risk reduction is one
of the most important benefits of a collective investment vehicle like the mutual fund.

4. Reduction of Transaction Costs: What is true of risk as also true of the transaction costs.
The investor bears all the costs of investing such as brokerage or custody of securities. When
going through a fund, he has the benefit of economies of scale; the funds pay lesser costs
because of larger volumes, a benefit passed on to its investors.

5. Liquidity: Often, investors hold shares or bonds they cannot directly, easily and quickly
sell. When they invest in the units of a fund, they can generally cash their investments any
time, by selling their units to the fund if open-ended, or selling them in the market if the fund
is close-end. Liquidity of investment is clearly a big benefit.

6. Convenience and Flexibility: Mutual fund management companies offer many investor
services that a direct market investor cannot get. Investors can easily transfer their holding
from one scheme to the other; get updated market information and so on.

7. Choice of Schemes: Mutual Funds offer a family of schemes to suit your varying needs over
a lifetime

8. Well Regulated: All Mutual Funds are registered with SEBI and they function within the
provisions of strict regulations designed to protect the interests of investors. The operations
of Mutual Funds are regularly monitored by SEBI.

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9. Transparency: You get regular information on the value of your investment in addition to
disclosure on the specific investments made by your scheme, the proportion invested in each
class of assets and the fund manager's investment strategy and outlook.

DISADVANTAGES OF INVESTING THROUGH MUTUAL FUNDS:

1. No Control over Costs: An investor in a mutual fund has no control of the overall costs of
investing. The investor pays investment management fees as long as he remains with the
fund, albeit in return for the professional management and research. Fees are payable even if
the value of his investments is declining.

2. No Tailor-Made Portfolio: Investors who invest on their own can build their own portfolios
of shares and bonds and other securities. Investing through fund means he delegates this
decision to the fund managers. The very-high-net-worth individuals or large corporate
investors may find this to be a constraint in achieving their objectives.

3. Managing A Portfolio of Funds: Availability of a large number of funds can actually mean
too much choice for the investor. He may again need advice on how to select a fund to
achieve his objectives, quite similar to the situation when he has individual shares or bonds to
select.

4. The Wisdom of Professional Management: That's right, this is not an advantage. The
average mutual fund manager is no better at picking stocks than the average nonprofessional,
but charges fees.

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5. No Control: Unlike picking your own individual stocks, a mutual fund puts you in the
passenger seat of somebody else's car

6. Dilution: Mutual funds generally have such small holdings of so many different stocks that
insanely great performance by a fund's top holdings still doesn't make much of a difference in
a mutual fund's total performance.

7. Buried Costs: Many mutual funds specialize in burying their costs and in hiring salesmen
who do not make those costs clear to their clients

FUNDS TYPES

1- Based on structure:

By Structure

Open-Ended Funds Closed-Ended Funds Interval Funds

Mutual funds, or unit trusts, are called open-end funds because they are required to buy
back shares, or units, from the shareholders at any time at a price based on the current value of
the fund‘s net assets. They are available for subscription all throughout the year. These do not

have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV")
related prices. The key feature of open-end schemes is liquidity.

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Closed-end funds, or investment trusts, are another type of fund that issues a fixed
number of shares, as in the case of open-end funds. If the shareholders want to exit the fund they
must sell their shares on the market. A closed-end fund has a stipulated maturity period which
generally ranging from 3 to 15 years. The fund is open for subscription only during a specified
period. Investors can invest in the scheme at the time of the initial public issue and thereafter
they can buy or sell the units of the scheme on the stock exchanges where they are listed. In
order to provide an exit route to the investors, some close-ended funds give an option of selling
back the units to the Mutual Fund through periodic repurchase at NAV related prices. SEBI
Regulations stipulate that at least one of the two exit routes is provided to the investor.

Interval funds are funds that issue or redeem units at pre-specified periods at regular
intervals. These combine the features of both open ended and closed ended funds providing an
optimum mix between stability and flexibility. However, interval funds are not very common in
the Indian mutual fund industry and are not much preferred by investors mainly due to lack of
awareness.

2- Based on nature

By Nature

Equity funds Debt funds Balanced funds Gold Funds

1. Equity Funds:

These funds invest a maximum part of their corpus into equities holdings. The structure
of the fund may vary different for different schemes and the fund manager‘s outlook on different

stocks. The Equity Funds are sub-classified depending upon their investment objective, as
follows:

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 Diversified Equity Funds
 Mid-Cap Funds
 Small Cap Funds
 Sector Specific Funds
 Tax Savings Funds (ELSS)

Equity investments are meant for a longer time horizon, thus Equity funds rank high on
the risk-return matrix.

2. Debt Funds:

The objective of these Funds is to invest in debt papers. Government authorities, private
companies, banks and financial institutions are some of the major issuers of debt papers. By
investing in debt instruments, these funds ensure low risk and provide stable income to the
investors.

3. Balanced Funds:

As the name suggest they, are a mix of both equity and debt funds. They invest in both
equities and fixed income securities, which are in line with pre-defined investment objective of
the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part
provides growth and the debt part provides stability in returns. Further the mutual funds can be
broadly classified on the basis of investment parameter viz, each category of funds is backed by
an investment philosophy, which is pre-defined in the objectives of the fund. The investor can
align his own investment needs with the funds objective and invest accordingly.

4. Gold Funds:

A recent addition to the portfolio of the Mutual funds, Gold funds primarily invest in
Physical Gold and related articles like jewelry, gold-bars, coins etc. A common practice in
today‘s industry is to make FoFs (Fund of Funds) of Gold ETFs so as to open the Gold funds to

retail investors.

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3- Based on investment objective

Type of fund Main Investments

Money market Short-term fixed income securities like treasury bills

Growth or equity Equities like stocks or income trust units

Balanced A mix of equities and fixed income securities

Index Equities or fixed income securities chosen to mimic a specific index,
such as the
S&P/TSX Composite Index
Income Fixed income securities like government bonds and corporate bonds
Tax Saving Schemes Equity Linked Savings Scheme (ELSS)

1. Money Market Schemes:

Money Market Schemes aim to provide easy liquidity, preservation of capital and
moderate income. These schemes generally invest in safer, short-term instruments, such as
treasury bills, certificates of deposit, commercial paper and inter-bank call money.

2. Growth Schemes:

Growth Schemes are also known as equity schemes. The aim of these schemes is to
provide capital appreciation over medium to long term. These schemes normally invest a major
part of their fund in equities and are willing to bear short-term decline in value for possible
future appreciation.

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3. Balanced Schemes:

Balanced Schemes aim to provide both growth and income by periodically distributing a
part of the income and capital gains they earn. These schemes invest in both shares and fixed
income securities, in the proportion indicated in their offer documents (normally 50:50).

4. Index Schemes:

Index schemes attempt to replicate the performance of a particular index such as the BSE
Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks that
constitute the index. The percentage of each stock to the total holding will be identical to the
stocks index weightage. And hence, the returns from such schemes would be more or less
equivalent to those of the Index.

5. Income Schemes:

Income Schemes are also known as debt schemes. The aim of these schemes is to provide
regular and steady income to investors. These schemes generally invest in fixed income
securities such as bonds and corporate debentures. Capital appreciation in such schemes may be
limited.

6. Tax Saving Schemes:

Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time
to time. Under Sec.88 of the Income Tax Act, contributions made to any Equity Linked Savings
Scheme (ELSS) are eligible for rebate.

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CHAPTER 3: INDUSTRY ANALYSIS – MUTUAL FUNDS IN INDIA

The economic development model adopted by India in the post-independence era has
been characterized by mixed economy with the public sector playing a dominating role and the
activities in private industrial sector control measures emaciated from time to time. The
industrial policy resolution was introduced by the government in the 1948, immediately after the
independence. This outlined the approach to industrial growth and development. The last two
decades have seen a phenomenal expansion in the geographical coverage and financial spread of
our financial system. The spread of the banking system has been a major factor in promoting
financial intermediation in the economy and in the growth of financial savings. With this
evolution of the financial sector, the mutual fund industry has also come to occupy an important
place.

Origin

By the early - 1930s quite a large number of close - ended mutual funds were in operation
in the U.S.A. Much latter in 1954, the committee on finance for the private sector recommended
mobilization of savings of the middle class investors through unit trusts. Finally in July 1964, the
concept took root in India when Unit Trust of India was set up with the twin objective of
mobilizing household savings and investing the funds in the capital market for industrial growth.
Household sector accounted for about 80 percent of nation‘s savings and only about one third of

such savings was available to the corporate sector; it was felt that UTI could be an effective
vehicle for channelizing progressively larger shares of household savings to productive
investments in the corporate sector. The process of economic liberalization in the eighties not
only brought in dramatic changes in the environment for Indian industries, corporate sector and
the capital market but also led to the emergence of demand for newer financial services such as
issue management, corporate counseling, capital restructuring and loan syndication. After two
decades of UTI monopoly, recently some other public sector organizations like LIC (1989), GIC
(1991), SBI (1987), Can Bank (1987), Indian Bank (1990), Bank of India (1990), Punjab
National Bank (1990) were permitted to set up mutual funds.

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Current state: Indian Mutual Fund Industry

The Indian mutual fund industry has evolved from a single player monopoly in 1964 to a
fast growing, Competitive market on the back of a strong regulatory framework.

AUM Growth

The Assets under Management (AUM) have grown at a rapid pace over the past few
years, at a CAGR of 35 percent for the five-year period from 31 March 2005 to 31 March 2009

1. Over the 10-year period from 1999 to 2009 encompassing varied economic cycles, the
industry grew at 22 percent CAGR

2. This growth was despite two falls in the AUM-the first being after the year 2001 due to the
dotcom bubble burst, and the second in 2008 consequent to the global economic crisis (the first
fall in AUM in March 2003 arising from The UTI split).

AUM to GDP Ratio

The ratio of AUM to India‘s GDP gradually increased from 6 percent in 2005 to 11

percent in 2009. Despite this however, this continues to be significantly lower than the ratio in
developed countries, where the AUM Accounts for 20-70 percent of the GDP.

Share of Mutual Funds in Household Financial Savings

Investment in mutual funds in India comprised 7.7 Percent of the gross household
financial savings in FY 2008, a significant increase from 1.2 percent in FY 2004. The households
in India continue to hold 55 Percent of their savings in fixed deposits with banks, 18 percent in

P a g e | 18

insurance and 10 percent in currency as of FY 2008. In 2008, the UK had more than thrice the
investments into mutual funds as a factor of total household savings (26 percent), than India had
in the same time period. As of December 2008, UK households held 61 percent of the total
savings in bank deposits, 11.6 percent in equities and 1 percent in bonds.

The Indian Mutual Fund Industry – Key Characteristics

Customers

The Indian mutual fund industry has significantly high Ownership from the institutional
investors. Retail investors comprising 96.86 percent in number terms held approximately 37
percent of the total industry AUM as at the end of March 2008, significantly lower than the retail
participation in the US at 82 percent of AUM as at December 2008.

As per the Invest India Incomes and Savings Survey 2007 of individual wage earners in
the age group 18 to 59 years conducted by IIMS Dataworks, only 1.6 percent invested in mutual
funds. Ninety percent of the savers interviewed were not aware of mutual funds or of investing in
mutual funds through a Systematic Investment Plan (SIP). The mutual fund penetration among
the paid Indian workforce with annual household income less than INR 90,000 was 0.1 percent.
In the last few years, the retail investor participation, in particular, in Tier 2 and Tier 3 towns, has
been on the rise aided by the buoyant equity markets.

Products

The Indian mutual fund industry is in a relatively nascent stage in terms of its product
offerings, and tends to compete with products offered by the Government providing fixed
guaranteed returns. As of December 2010, the total number of mutual fund schemes was 1,182 in
comparison to 11,369 funds in the US.
Debt products dominate the product mix and comprised 49 percent of the total industry
AUM as of FY 2009, while the equity and liquid funds comprised 26 percent and 22 percent

P a g e | 19

respectively. Open-ended funds comprised 99 percent of the total industry AUM as of March
2009. As of December 2008, the US mutual fund market comprised money market funds, equity
funds, debt/bond funds and hybrid funds at 40, 39, 16 and 5 percent of the total AUM
respectively.

Markets

While the mutual fund industry in India continues to be metro and urban centric, the
mutual funds are beginning to tap Tier 2 and Tier 3 towns as a vital component of their growth
strategy. The contribution of the Top 10 cities to total AUM has gradually declined from
approximately 92 percent in 2005 to approximately 80 percent currently.

Industry Structure

The Indian mutual fund industry currently consists of 38 players that have been given
regulatory approval by SEBI. The industry has witnessed a shift has changed drastically in favor
of private sector players, as the number of public sector players reduced from 11 in 2001 to 5 in
2009. The public sector has gradually ceded market share to the private sector. Public sector
mutual funds comprised 21 percent of the AUM in 2009 as against 72 percent AUM share in
200122.

The industry concentration has been stagnant in the four-year period from 2005 to 2008;
the top 5 players comprising 50-52 percent of industry AUM. However, as of March 2009, the
share of Top 5 players increased to 58 percent, as against 38 percent in the US. The AUM share
of the Top 10 players has consistently been in the vicinity of 75 percent.

The mutual fund houses based on product portfolio and distribution strategy, the key
elements of competitive strategy, can be segmented into three categories:

• The market leaders having presence across all product segments

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• Players having dominant focus on a single product segment - debt or equity
• Players having niche focus on an emerging product category or distribution channels.

The market leaders have focused across product categories for a more diversified AUM
base with an equitable product mix that helps maintain a consistent AUM size. Although the
Indian market has relatively low entry barriers given the low minimum net worth required to
venture into mutual fund business, existence of a strong local brand and a wide and deep
distribution footprint are the key differentiators.

Operations

A Mutual Fund is a trust that pools the savings of a number of investors who share a
common financial goal. The money thus collected is then invested in capital market instruments
such as shares, debentures and other securities. The income earned through these investments
and the capital appreciation realized is shared by its unit holders in proportion to the number of
units owned by them. Thus a Mutual Fund is the most suitable investment for the common man
as it offers an opportunity to invest in a diversified, professionally managed basket of securities
at a relatively low cost. The flow chart below describes broadly the working of a mutual fund:

1) Raising of Money – The asset management companies (AMCs) that manage the mutual

funds define avenues where they think profitable opportunities exist. For example,
currently many AMCs believe that small and medium cap stocks will yield significant

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return over the medium to long term. Hence, they launch a 'fund' (called a new fund
offer: NFO) which seeks to bring all those investors together who believe similarly.
The AMC releases a prospectus wherein it details the objective of the fund, the
credentials of the company and the fund manager and the avenues where the money will
be invested. Based on this information, the investor needs to decide whether this fund
meets his objective or not. If the investor (or his advisor) believes that the new fund fits
his required risk-return profile, the investor invests in the fund.

2) Investing – Mutual funds, unlike companies do not take the risk of a business directly.

For example, Reliance faces the risk of change in refining margins and Hindalco faces
the risk of fall in aluminum prices. Companies take the risk head-on and craft strategies
to maximize their competitive position and profits.
Mutual funds, however, take one step back and invest in the companies which take on
business risks. Funds which invest in the shares (or equity) of the company are called
'equity mutual funds.' Funds like PruICICI Power or Reliance Growth are examples of
such funds.
Similarly, funds can invest in government securities (bonds issued by central or state
governments, PSUs or other government entities) or corporate debt (issued by companies
and banks). These funds are called 'debt funds.' Funds like Reliance Income Fund invest
primarily in medium and long-tenor debt. Again, there are funds that invest in very short
term loans (typically overnight to up to three months): these funds are called money
market mutual funds. Examples include HDFC Cash Management - savings plan.
Funds may also invest in Precious metals like gold or silver and also commodities like
copper or magnesium for instance.

While the above four are the basic avenues for the funds to invest, many funds combine
the three types in various proportions and produce 'hybrid or balanced funds.' HDFC
Prudence and SBI Magnum Balanced are examples.

3) Performance and Disclosures - Based on where the funds invest, they expect returns and
have corresponding risks. Equity funds are the most risky followed by gold funds and

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then debt funds; cash funds are considered almost risk less. Based on the standard theory
of finance, the riskiest funds are expected to deliver the highest returns over the long run.

Based on the current value of the investments of the fund, the daily NAV (Net Asset
Value) is declared by most of the AMCs now-a-days. The NAV is calculated on a per
unit basis (i.e. total value of the investment portfolio divided by the total number of
units).

4) Distribution of Returns – Based on the option the investor chooses (growth or dividend),

the profits or surplus cash is used to declare dividends on regular intervals (monthly,
weekly or even daily as specified by the fund). These dividends are then distributed to the
investors by either electronic transmission (direct credit to bank accounts) or shipping of
cheques. The investors may also liquidate their capital appreciations without any exit
load once the mandatory lock-in period (defined in the fund-prospectus) has matured.

The Indian mutual fund industry while on a high growth path needs to address efficiency
and customer centricity. AMCs have successfully been using outsourced service providers such
as custodians, Registrar and Transfer Agents (R&T) and more recently, fund accountants, so that
mutual funds can focus on core aspects of their business such as product development and
distribution. Functions that have been outsourced are custody services, fund services, registrar
and transfer services aimed at investor servicing and cash management. Managing costs and
ensuring investor satisfaction continue to be the key goals for all mutual funds today. However,
there is likely to be scope for optimizing operations costs given the trend of rising administrative
and associated costs as a percentage of AUM.

Regulations
Mutual Funds in India are governed by the SEBI (Mutual Fund) Regulations 1996 as
amended from time to time. The most recent Master Circular regarding the same was issued by
SEBI on January 07, 2011. The Indian mutual fund industry is undergoing a transformation,

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adapting to the various regulatory changes that are coming about. Some of the key ones which
have undergone an amendment, impacting the industry as a whole are highlighted here.
However, all of them primarily would seem to have the interest of the investor in mind.

1) Entry Load
In recent years, the industry regulator, Securities and Exchange Board of India (‗SEBI‘)

has focused more on investor protection, introducing a number of regulations to empower retail
investors in Mutual Funds (‗MFs‘). SEBI began by prohibiting the charging of initial issue

expenses, which were permitted for closed-ended schemes, and mandating that such MF schemes
shall recover sales and distribution expenses through entry load only. These steps aimed at
creating more transparency in fees paid by investors and helping make informed investment
decisions.
Subsequently, w.e.f. August 1, 2009, SEBI banned the entry load that was deducted from
the invested amount, and instead allowed customers the right to negotiate and decide
commissions directly with distributors based on investor‘s assessment of various factors and

related services to be rendered. The objective was to bring about more transparency in
commissions and encourage long-term investment. Though the intent of the amendment was to
benefit the investor, it has hit the margins of the Asset Management Companies (‗AMCs‘).

Further, higher distributor commission on Unit Linked Insurance Products (issued by
Insurance companies) is giving tough competition to the business of mutual funds.

2) No Additional Management Fees on schemes launched on ―no load ‖ basis

SEBI has scrapped the additional management fee of 1% charged by AMCs on schemes
launched on a no load basis leading to a further squeeze in margins earned by the AMC.

3) Direct Tax Code
With the Direct Tax Code (‗DTC‘) on the anvil, taxability of income from mutual funds,

at the hands of investors will also have a bearing on the growth of the mutual fund industry.
Unlike the extant tax provisions, DTC does not provide for any benefit for investment in equity
linked savings scheme, and also proposes to increase the compliance in the hands of MFs by
widening the scope of deduction of tax to include payments made to residents. The code has also

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created an anomaly on the taxability of the MF investors. It is unclear whether the income earned
will be exempt or taxed in the hands of the investors on accrual basis, as stated in the Discussion
Paper on the DTC.

4) Documentation
In December 2009, SEBI had made it mandatory for all AMCs to maintain a copy of full
investor documentation including Know Your Customer i.e. KYC details. Such documentation
was earlier maintained by the respective MF distributors who have now been asked to give a
copy of the same to the fund houses.

5) Disclosure of Investor Complaints in the Annual Report
In order to improve the transparency in the ‗grievance redressal mechanism‘, SEBI has

recently issued a Circular that requires MFs to include details of investor complaints in their
Annual Report as part of the Report of the Trustees, beginning with the annual report for the year
2009-10. MFs provide abridged booklets of the Annual Reports to all the unitholders.

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CHAPTER 4: INTRODUCTION TO THE STUDY

Objectives of the Study –

1) To study the concept of Mutual Funds and its operation and functioning.
2) To analyze the Mutual Fund Industry in India and the competitive position of Reliance
Mutual Funds
3) To understand the importance of Debt Funds and study the functional concerns, issues
and specific management of the same
4) To study the fund selection behavior of individual investors with special reference to
Delhi NCR
a. To assess the savings objectives among individual investors.
b. To identify the preferred savings avenue among individual investors
c. To understand the preferential feature in the savings instrument among individual
investors.
d. To evaluate fund qualities that would affect the selection of Mutual funds.
e. To evaluate investor related services that would affect the selection of Mutual
funds
5) To study the various mutual funds managed by Reliance Mutual Funds with special
reference to FAST.

Context of the study –

In India, though the MF industry has been in existence since 1964, (with the
establishment of UTI), very few major studies have been done regarding the investor behavioral
aspect with specific reference to MFs, in India. It should be noted that the ―expectations ‖ of

investors play a vital role in the financial markets. They influence the price of the securities, the
volume traded and various other financial operations in actual practice. These ‗expectations‘ of
investors are influenced by their ―perception‖ and humans generally relate perception to action.

The beliefs and actions of many investors are influenced by the dissonance effect and
endowment effect.

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In general, rules for investment, the analysis of investment and discussion of financial
behavior tend to assume behavior, which is logical and internally consistent in various ways.
Investor behavior does not; however, always appear to conform to such expectational norms.
Quite the reverse often appears to be the case; Kahneman and Riepe speak of ―Cognitive
Illusion‖ the mental equivalent of optical illusion, the assumption being that just as an optical

illusion might lead to inconsistent physical performance relative to the world outside the
individual, so too cognitive illusion will result in inconsistent decision making with respect to the
outside world. Much of economic and financial theory is based on the notion that individuals act
rationally and consider all available information in the decision making process.
However, in the financial literature, there are no clear models, which explain the
influence of ―perception‖ and ―beliefs‖ on ―expectations‖ and ―decision making ‖.

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CHAPTER 5: INVESTMENT AVENUES FOR MUTUAL FUNDS

Equity and Equity Related Investments

Shares

In equity share, the shareholders of a company are its owners. As owners, they participate
in the management of the company by appointing its board of directors and voicing their
opinions, and voting in the general meetings of the company. At its incorporation, every
company is authorized to issue a fixed number of shares, each priced at par value, or face value
in India. The face value of shares is usually set at nominal levels (Rs. 10 or Re. 1 in India for the
most part). Corporations generally retain portions of their authorized stock as reserved stock, for
future issuance at any point in time.

Shares are usually valued much higher than the face value and this initial investment in
the company by shareholders represents their paid-in capital in the company. The company then
generates earnings from its operating, investing and other activities. A portion of these earnings
are distributed back to the shareholders as dividend, the rest retained for future investments. The
sum total of the paid-in capital and retained earnings is called the book value of equity of the
company.

In India, shares are mainly of two types: equity shares and preference shares. In addition
to the most common type of shares, the equity share, each representing a unit of the overall
ownership of the company, there is another category, called preference shares. These preferred
shares have precedence over common stock in terms of dividend payments and the residual claim
to its assets in the event of liquidation. However, preference shareholders are generally not
entitled to equivalent voting rights as the common stockholders.

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Fixed Income (Debt) Investments

Bonds

Bonds are debt instruments that are issued by companies and governments to raise funds
for financing their capital expenditure. By purchasing a bond, an investor loans money for a
fixed period of time at a predetermined interest rate. While the interest is paid to the bond holder
at regular intervals, the principal amount is repaid at a later date, known as the maturity date.
While both bonds and stocks are securities, the principle difference between the two is that bond
holders are lenders, while stockholders are the owners of the organization.

The main types of bonds are:

Government Bonds: These are fixed-income debt securities issued by the government.
Government bonds are further categorized on the basis of the term (maturity duration).
(a) Government Bills: These are government bonds with a maturity period of less than one
year.
(b) Government Notes: These are government bonds with a maturity period from one year to
ten years.
(c) Government Bonds: These are government bonds with a maturity period that exceeds ten
years.

Corporate Bonds: These are debt instruments issued by a company and backed by its
ability to generate profits or by the current value of its physical assets.

Non-Convertible Debentures

NCDs are secured debt instruments with longer maturity. Non-Convertible simply means
that the bond can‘t be converted into equity of the company. There still could be other options

(call/put) attached to the bond. A callable bond could be called or redeemed by the issuer before

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the maturity of the bond. Issuer will call away the bond when the bond was issued in a high
interest rate environment and interest rates fall subsequently. Investor will lose the high interest
or coupon payments and will be left with redemption proceeds to be invested in a lower interest
rate environment. A putable bond works in an exactly opposite way where the investor can sell
the bond to the issuer at a specified price before the maturity of the bond if the interest rates go
up after the issuance and investor has higher yielding investment options available.

Treasury Bills

T-Bills or treasury bills are largely risk-free (guaranteed by the Government and hence
carry only sovereign risk - risk that the government of a country or an agency backed by the
government, will refuse to comply with the terms of a loan agreement), short-term, very liquid
instruments that are issued by the central bank of a country. The maturity period for T-bills
ranges from 3-12 months. T-bills are circulated both in primary as well as in secondary markets.

T-bills are usually issued at a discount to the face value and the investor gets the face
value upon maturity. The issue price (and thus rate of interest) of T-bills is generally decided at
an auction, which individuals can also access. Once issued, T-bills are also traded in the
secondary markets. In India, T-bills are issued by the Reserve Bank of India for maturities of 91-
days, 182 days and 364 days. They are issued weekly (91-days maturity) and fortnightly (182-
days and 364-days maturity).

Pass through certificates

A PASS through certificate (PTC) is a certificate that is given to an investor against
certain mortgaged-backed securities that lie with the issuer. The certificate can be compared to
securities (like bonds and debentures) that may be issued by banks and other companies to
investors. The only difference being that they are issued against underlying securities.
The interest that is paid to the issuer on these securities comes to the investor in the form of a

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fixed income. Investors in such instruments are usually financial institutions like banks, mutual
funds and insurance companies. In a pass through certificate, interest earned on the receivable is
directly passed to the holders, whereas, in a pay through certificate, interest received from the
receivables is not passed to the holder of the unit. All the PTCs in the market are rated by
agencies like Crisil or Fitch ratings, among others. The ratings tell the investor about the quality
of the underlying securities.

Commercial papers

Commercial papers (CP) are unsecured money market instruments issued in the form of a
promissory note by large corporate houses in order to diversify their sources of short-term
borrowings and to provide additional investment avenues to investors. Issuing companies are
required to obtain investment-grade credit ratings from approved rating agencies and in some
cases, these papers are also backed by a bank line of credit. CPs is also issued at a discount to
their face value. In India, CPs can be issued by companies, primary dealers (PDs), satellite
dealers (SD) and other large financial institutions, for maturities ranging from 15 days period to
1-year period from the date of issue. CP denominations can be Rs. 500,000 or multiples thereof.
Further, CPs can be issued either in the form of a promissory note or in dematerialized form
through any of the approved depositories

Certificates of Deposit

A certificate of deposit (CD) is a term deposit with a bank with a specified interest rate.
The duration is also pre-specified and the deposit cannot be withdrawn on demand. Unlike other
bank term deposits, CDs are freely negotiable and may be issued in dematerialized form or as a
Usance Promissory Note. CDs are rated (sometimes mandatory) by approved credit rating
agencies and normally carry a higher return than the normal term deposits in banks (primarily
due to a relatively large principal amount and the low cost of raising funds for banks). Normal
term deposits are of smaller ticket-sizes and time period, have the flexibility of premature

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withdrawal and carry a lower interest rate than CDs. In many countries, the central bank provides
insurance (e.g. Federal Deposit Insurance Corporation (FDIC) in the U.S., and the Deposit
Insurance and Credit Guarantee Corporation (DICGC) in India) to bank depositors up to a certain
amount (Rs. 100000 in India). CDs are also treated as bank deposit for this purpose.

In India, scheduled banks can issue CDs with maturity ranging from 7 days – 1 year and
financial institutions can issue CDs with maturity ranging from 1 year – 3 years. CD is issued for

denominations of Rs. 1, 00,000 and in multiples thereof.

Gold

Of all the precious metals, gold is the most popular as an investment. Investors generally
buy gold as a hedge or harbor against economic, political, or social fiat currency crises
(including investment market declines, burgeoning national debt, currency failure, inflation, war
and social unrest). The gold market is subject to speculation as are other markets, especially
through the use of futures contracts and derivatives. The history of the gold standard, the role
of gold reserves in central banking, gold's low correlation with other commodity prices, and its
pricing in relation to fiat currencies during the financial crisis of 2007–2010, suggest that gold
behaves more like a currency than a commodity.

In the final analysis, gold is a financial asset. It also is a commodity: The price of gold
rises and falls based on its role as a financial asset, like a currency, a stock or a bond, that
investors buy and sell based on a complex web of factors. More importantly, gold has been a
financial asset, a store of value and an investment that has held its own for five millennia. Gold
has stood the test of time repeatedly and has outlasted all other financial and monetary assets.
Throughout history, gold has served three functions. It has been a financial asset, held by
individual investors as a store of wealth and a portfolio diversifier. It has been a commodity,
used primarily in jewelry but also in electronics, dentistry, and many other applications. Finally,
it has been a monetary asset, used by governments as a reserve asset, as a form of money, and as
a backing for their own currencies.

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Risks associated with Mutual Funds

Most mutual funds are not guaranteed—you could lose money on your investment. The
level of risk in a mutual fund depends on what it invests in. For example, stocks are usually
riskier than bonds, so you would expect an equity fund to be riskier than a fixed income fund.

Different types of investments generally come with different types of risk. This table
shows some of the common types of risk and how they could affect a fund‘s performance:

Type of risk Type of investment affected How the fund could lose money

The value of a foreign investment
declines because of political changes or
Country risk Foreign investments instability in the country where the
investment was issued.
If a bond issuer can‘t repay a bond, it
may end up being a worthless
Credit risk Fixed income securities investment.

Investments denominated in a
If the other currency declines against the
Currency risk currency other than the Canadian Canadian dollar, the investment will
lose value.
dollar
The value of fixed income securities
Interest rate risk Fixed income securities
generally falls when interest rates rise.
The fund can‘t sell an investment that‘s
declining in value because there are no
Liquidity risk All types buyers.
The value of its investments decline
because of unavoidable risks that affect
the entire market
Market risk All types

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1. Country risk: Changes in government policy and political decision can change the
investment environment. They can create a favorable environment for investment or vice versa.

2. Credit Risk: The debt servicing ability (May it be interest payments or repayment of
principal) of a company through its cash flows determines the Credit Risk faced by you. This
credit risk is measured by independent rating agencies like CRISIL who rate companies and their
paper. An ‗AAA‘ rating is considered the safest whereas a ‗D‘ rating is considered poor credit

quality. A well-diversified portfolio might help mitigate this risk.

3. Currency risk: The risk that a business' operations or an investment's value will be
affected by changes in exchange rates. For example, if money must be converted into a different
currency to make a certain investment, changes in the value of the currency relative to the
American dollar will affect the total loss or gain on the investment when the money is converted
back.

4. Interest Rate Risk: In a free market economy interest rates are difficult if not
impossible to predict. Changes in interest rates affect the prices of bonds as well as equities. If
interest rates rise the prices of bonds fall and vice versa. Equity might be negatively affected as
well in a rising interest rate environment. A well-diversified portfolio might help mitigate this
risk.

5. Liquidity Risk: Liquidity risk arises when it becomes difficult to sell the securities
that one has purchased. Liquidity Risk can be partly mitigated by diversification, staggering of
maturities as well as internal risk controls that lean towards purchase of liquid securities.

6. Market Risk: Sometimes prices and yields of all securities rise and fall. Broad outside
influences affecting the market in general lead to this. This is true, may it be big corporations or
smaller mid-sized companies. This is known as Market Risk. A Systematic Investment Plan
(―SIP‖) that works on the concept of Rupee Cost Averaging (―RCA‖) might help mitigate this

risk.

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CHAPTER 6: FIXED INCOME FUNDS

Debt funds are funds which invest money in debt instruments such as short and long term
bonds, government securities, T-bills, corporate paper, commercial paper, call money etc. The
fees in debt funds are lower, on average, than equity funds because the overall management costs
are lower.
The main investing objectives of a debt fund are usually preservation of capital and
generation of income. Performance against a benchmark is considered to be a secondary
consideration. Investments in the equity markets are considered to be fraught with uncertainties
and volatility. These factors may have an impact on constant flow of returns. This is why debt
schemes, which are considered to be safer and less volatile, have attracted investors.
Debt markets in India are wholesale in nature and hence retail investors generally find it
difficult to directly participate in the debt markets. Not many understand the relationship
between interest rates and bond prices or difference between Coupon and Yield. Therefore
venturing into debt market investments is not common among investors. Investors can however
participate in the debt markets through debt mutual funds.

Debt paper is issued by Government, corporates and financial institutions to meet funding
requirements. A debt paper is essentially a contract which says that the borrower is taking some
money on loan and after sometime the lender will get the money back as well as some interest on
the money lent.

Before discussing more about debt fund schemes, a few terms and concepts need to be
seen –

1) Yield to Maturity

The yield to maturity (YTM) of a bond is the IRR that a buyer would receive if they
purchased the bond at the current market price. This is also called the redemption yield.

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As an IRR measure, YTM suffers from the same flaws. The flaws are less serious in this
case, because of the characteristics of bonds: cash flows are always positive, and the variation in
the rates at which income can be re-invested is lower.
YTM is, nonetheless, generally a much better measure than flat yield, and is probably the
most accurate of the commonly used measures of bond yield. A full evaluation of a bond needs
to consider whether the yield spread is sufficient compensation for risk, and how it compares
with alternatives over the same term.

2) Average duration

The sensitivity of a portfolio of bonds such as a bond mutual fund to changes in interest
rates can also be important. The average duration of the bonds in the portfolio is often reported.
The duration of a portfolio equals the weighted average maturity of all of the cash flows in the
portfolio. If each bond has the same yield to maturity, this equals the weighted average of the
portfolio's bond's durations, with weights proportional to the bond prices. Otherwise the
weighted average of the bond's durations is just a good approximation, but it can still be used to
infer how the value of the portfolio would change in response to changes in interest rates.

3) Modified duration

Modified duration is a modified version of the Macaulay model that accounts for
changing interest rates. Because they affect yield, fluctuating interest rates will affect duration,
so this modified formula shows how much the duration changes for each percentage change in
yield. For bonds without any embedded features, bond price and interest rate move in opposite
directions, so there is an inverse relationship between modified duration and an approximate 1%
change in yield.

Modified duration = D ÷ (1+r)

Where D is the duration and r is the interest rate paid per period: coupon payment divided by
price.

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The percentage change in the price is equal to the change in interest rates multiplied by
the modified duration. This is an approximation and becomes less accurate for larger interest rate
changes. Interest rate changes are usually small and the approximation is more than good
enough.

4) Credit Rating and Credit Rating Agencies

A credit rating estimates the credit worthiness of an individual, corporation, or even a
country. It is an evaluation made by credit bureaus of a borrower‘s overall credit history. A

credit rating is also known as an evaluation of a potential borrower's ability to repay debt. Credit
ratings are calculated from financial history and current assets and liabilities. Typically, a credit
rating tells a lender or investor the probability of the subject being able to pay back a loan.
However, in recent years, credit ratings have also been used to adjust insurance premiums,
determine employment eligibility, as a factor considered in obtaining security clearances and
establish the amount of a utility or leasing deposit.

The Credit ratings for corporation are assigned by credit rating agencies. In India,
commercial credit rating agencies include CRISIL, CARE, ICRA and Brickwork Ratings. The
credit bureaus for individuals in India are Credit Information Bureau (India) Limited (CIBIL)
and Credit Registration Office (CRO). These Ratings help an investor assess the credit quality of
a particular scheme before making an investment. Just like IPO grading, mutual fund grading
looks at the past performance of the scheme.

Credit rating agencies (CRAs) assign ratings to all Bonds, NCDs, and other debt
instruments (excluding Public Deposits). The ratings are based on the overall exposure to default
risk, with regard to timely receipt of payments from the investments the scheme has made. CRAs
such as CRISIL, ICRA and CARE have been rating long-term as well as short-term instruments.
So far, the ratings have been based on in-house parameters.

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For long term rating scale (with original maturity exceeding one year) ICRA uses the
grade LAAA, LAA, LA, LBBB, LBB, LB, LC, and LD whereas CRISIL grade them as AAA,
AA, A , BBB, BB, B , C, D and NM.

For short term rating scale ( All instruments with original maturity within one year.)
ICRA use the grade A1, A2, A3, A4 and A5 while CRISIL use P1, P2, P3, P4, P5 and NM.
Credit rating agencies (CRAs) also assign ratings to mutual fund (MF) schemes which
invest entirely, or mostly, in debt. The ratings are based on the overall exposure to default risk,
with regard to timely receipt of payments from the investments the scheme has made. CRAs such
as Crisil, ICRA and CARE have been rating long-term as well as short-term debt mutual fund
schemes. So far, the ratings have been based on in-house parameters. CRISIL rates MF schemes
on a scale of 1 to 5, with 1 considered the best. ICRA uses the grades AAA, AA, BBB and C,
among others, to rate the same schemes.

In July 2011, SEBI asked CRAs to use standardized rating symbols. So now long-term
debt schemes with the highest degree of safety will be rated as AAAmfs. AAmf and Amf mean
they have high and adequate levels of safety, respectively. BBBmfs and BBmfs-rated schemes
carry moderate risk. A Bmf-rated scheme has high degree of risk. A scheme with Cmf rating has
a very high level of risk. Rating companies can use the ‗+‘ or ‗-‘ symbol, along with the rating, to

reflect the comparative standing within the category.
For a short-term debt fund scheme, a rating of A1mfs will be the highest. A2mfs and
A3mfs-rated schemes reflect a strong and moderate degree of safety, respectively. A4mfs-rated
schemes have the least degree of safety.

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Debt Mutual Fund Schemes

1. Fixed Maturity Plans
FMPs have become very popular in the past few years. FMPs are essentially close ended
debt schemes. The money received by the scheme is used by the fund managers to buy debt
securities with maturities coinciding with the maturity of the scheme. There is no rule which
stops the fund manager from selling these securities earlier, but typically fund managers avoid it
and hold on to the debt papers till maturity. Investors must look at the portfolio of FMPs before
investing. If an FMP is giving a relatively higher ‗indicative yield‘, it may be investing in

slightly riskier securities. Thus investors must assess the risk level of the portfolio by looking at
the credit ratings of the securities. Indicative yield is the return which investors can expect from
the FMP.
Regulations do not allow mutual funds to guarantee returns, hence mutual funds give
investors an idea of what returns can they expect from the fund. An important point to note here
is that indicative yields are pre-tax. Investors will get lesser returns after they include the tax
liability.

2. Capital Protection Funds
These are close ended funds which invest in debt as well as equity or derivatives. The
scheme invests some portion of investor‘s money in debt instruments, with the objective of

capital protection. The remaining portion gets invested in equities or derivatives instruments like
options. This component of investment provides the higher return potential. It is important to
note here that although the name suggests ‗Capital Protection‘, there is no guarantee that at all
times the investor‘s capital will be fully protected.

3. Gilt Funds
These are those funds which invest only in securities issued by the Government. This can
be the Central Govt. or even State Govts. Gilt funds are safe to the extent that they do not carry
any Credit Risk. However, it must be noted that even if one invests in Government Securities,
interest rate risk always remains.

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4. Balanced Funds
These are funds which invest in debt as well as equity instruments. These are also known
as hybrid funds. Balanced does not necessarily mean 50:50 ratio between debt and equity. There
can be schemes like MIPs or Children benefit plans which are predominantly debt oriented but
have some equity exposure as well. From taxation point of view, it is important to note how
much portion of money is invested in equities and how much in debt.

5. MIPs
Monthly Income Plans (MIPs) are hybrid funds; i.e. they invest in debt papers as well as
equities. Investors who want a regular income stream invest in these schemes. The objective of
these schemes is to provide regular income to the investor by paying dividends; however, there is
no guarantee that these schemes will pay dividends every month. Investment in the debt portion
provides for the monthly income whereas investment in the equities provides for the extra return
which is helpful in minimizing the impact of inflation.

6. Child Benefit Plans
These are debt oriented funds, with very little component invested into equities. The
objective here is to capital protection and steady appreciation as well. Parents can invest in these
schemes with a 5 – 15 year horizon, so that they have adequate money when their children need

it for meeting expenses related to higher education.

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CHAPTER 7: REVIEW OF LITERATURE

MFs have attracted a lot of attention and kindled the interest of both academic and
practitioner communities. Compared to the developed markets, very few studies on MFs are
done in India. The literature review reveals Investor behavior studies which can be grouped
under two themes –

1) Studies relating to General Financial Behavior of Investors
2) Fund Selection Behavior Studies

1) General Financial Behavior Studies:

Daniel Kahneman and Amos Tversky (1979) originally described ―Prospect Theory‖ and

found that individuals were much more distressed by prospective losses than they were happy by
equivalent gains. Some economists have concluded that investors typically consider the loss of
$1 twice as painful as the pleasure received from a $ gain. Individuals will respond differently to
equivalent situations depending on whether it is presented in the context of losses or gains.

Langer (1983) suggests that when these preferences are based on choices, there is more
ego involvement and attachment to the preferences, suggesting heightened level of preference
bias. This phenomenon is consistent with the prediction from Cognitive Dissonance theory of
Festinger (1957).

Robert J. Shiller (1993) reported that many investors do not have data analysis and
interpretation skills. This is because, data from the market supports the merits of index investing,
passive investors are more likely to base their investment choices on information received from
objective or scientific sources.

Phillip (1995) reported that there is a change in financial decision-making and investor
behavior as a result of participating in investor education programmes sponsored by employees.

P a g e | 41

Hirshleifer (2001) categorized different types of cognitive errors that investors make i.e.
self-deception, occur because people tend to think that they are better than they really are;
heuristic simplification, which occurs because individuals have limited attention, memory and
processing capabilities; disposition effect, individuals are prone to sell their winners too quickly
and hold on to their losers too long (http://www.investorhome.com/psych.htm).

2) Fund Selection Behavior Studies:
Investor fund selection Behavior influences marketing decisions of fund management and
has captured the attention of researchers. The findings are reported below:

Ippolito (1992) and Bogle (1992) reported that fund selection by investors is based on
past performance of the funds and money flows into winning funds more rapidly than they flow
out of losing funds.

Vidyashankar (1990), Agarwal G.D. (1992), Gupta L.C. (1993) Atmaramani (1996),
Madhusudan (1996) and Ajay Srinivasan (1999) and others have conducted extensive research
regarding investor expectations, protection, awareness and fund selection behavior. Few striking
ones among the other studies are given below.

Gupta L.C. (1993) conducted a household investor survey with the objective to provide
data on investor preferences on MFs and other financial assets.

Madhusudhan V. Jambodekar (1996) conducted a study to assess the awareness of MFs
among investors, to identify the information sources influencing the buyer decision and the
factors influencing the choice of a particular fund. The study revealed that income schemes and
open-ended schemes are preferred over growth schemes and close-ended schemes during the
prevalent market conditions. Investors look for Safety of Principal, Liquidity and Capital
Appreciation in order of importance; Newspapers and Magazines are the first source of
information through which investors get to know about MFs / Schemes and the investor service
is the major differentiating factor in the selection of MFs.

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An attempt was made by the NCAER in 1964 to understand the attitude and motivation
for the savings of individuals, for which a survey of households was undertaken. Another
NCAER study in 1996 analyzed the structure of the capital market and presented the views and
attitudes of individual shareholders. SEBI-NCAER survey (2000) was carried out to estimate the
number of households and the population of individual investors, their economic and
demographic profile, portfolio size, and investment preference for equity as well as other savings
instruments. This is a unique and comprehensive study of individual investors, for, data was
collected from 3, 00,000 geographically dispersed rural and urban households. Some of the
relevant findings of the study are: Households preference for instruments match their risk
perception; Bank Deposit has an appeal across all income class; 43% of the non-investor
households (estimated around 60 million households) apparently lack awareness about stock
markets; and, compared with low income groups, the higher income groups have a higher share
of investments in MFs signifying that MFs have not truly become the investment vehicle for
small investors; the number of households owning units of mutual funds is more (9%) than the
investor households owning investments in shares and debentures (8%).

The Review of Literature reveals that in developed markets lot of study has been done,
but developing markets also deserve an extensive research.

P a g e | 43

CHAPTER 8: RESEARCH METHODOLOGY

1) Research Design – Exploratory Research

2) Data Collection Method – Most of the data has been collected secondarily from

published sources. The primary survey was conducted through a structured closed
ended questionnaire.

3) Sampling – The study mainly deals with the financial behavior of Individual

Investors towards Mutual funds in Mumbai city. The required data was collected
through a pretested questionnaire administered on a combination of convenience and
judgment sample of 100 educated individual investors. Judgment sample selection is
due to the time and financial constraints. . Respondents were screened and inclusion
was purely on the basis of their knowledge about Financial Markets, MFs in
particular. This was necessary, because the questionnaire presumed awareness of
some basic terminology about Mutual Funds. The purpose of the survey was to
understand the behavioral aspects of individual investors, mainly their fund selection
behavior, various factors influencing this behavior and also the conceptual awareness
level among individual investors. Sample of the questionnaire is given in Annex. A.
The unit of observation and analysis of survey is only among Individual Investors
whose definition is ―An Individual who has currently invested (i.e. as on May or June

2011) in any Mutual Funds and this does not include high net worth individuals (i.e.,
those who earn above Rs. 10,00,000/- per annum) and institutions. Since it is an
exploratory study no specific hypothesis is formulated.

4) Fieldwork and Data Collection – The field work associated with the survey was

conducted accordingly and data was collected on field.

5) Instruments Used – Questionnaire

P a g e | 44

6) Analysis and Interpretation – The analysis of the data collected has been performed

appropriately and inferences have been drawn. The data collected has been presented
in forms of line graphs and thus the trend arising therefrom has been analyzed. Also
for finding out factors that affect the fund selection behavior of investors, factor
analysis using principal component extraction has been performed. This tool of SPSS
was extensively used to classify a large number of variables into smaller number of
factors. Factor Analysis was used to determine whether there was any common
constructs that represented investor concerns. 25 variables were analyzed using the
Varimax Algorithm of Orthogonal Rotation, the most commonly used method.
Evaluation of the resulting constructs and naming of the factors is largely subjective.
Hence, to identify investors‘ underlying Fund/Scheme selection criteria, so as to

group them into specific factors, which would further identify Investor types, to
enable the designing of appropriate marketing strategies, Factor Analysis was done
using Principal Component Analysis.

7) Limitations of the study –

a. Sample size is limited to 100 educated individual investors in the city of Delhi
NCR. The sample size may not adequately represent the national market.
b. Simple Random and judgment sampling techniques is due to time constraints.
c. This study has not been conducted over an extended period of time having both
ups and downs of stock market conditions which a significant influence on
investor‘ s buying pattern and preferences.

d. The research is only exploratory, no conclusion may finally be drawn from it, but
only direction may be sought.
e. This is an independent study and the observations may not comply with those
would have been made by an experienced professional.

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CHAPTER 9: DATA ANALYSIS AND INTERPRETATIONS

1) Analysis of Various Fixed Income Mutual Funds managed by Reliance Capital Asset
Management Limited

Money Market Instruments includes Commercial Papers, Certificate of Deposits & Treasury Bills. Equity includes index, stock
futures & equity shares. Corporate Debt includes Debenture.
Source: Reliance Mutual Fund

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2) Analysis of investor‘s preferences

The survey conducted to capture investor behavior pattern in selection of MFs, reveals
the following.

a. Savings Objective of Individual Investors

Objective of Savings

Others 2

For purchase of assets 55

For children’s education 24

To meet contingencies 59

For tax reduction 49

To provide for Retirement 29

0 10 20 30 40 50 60

Savings Objective of the majority of Individual Investors is ‗To meet contingencies‘ or
―For Purchase of Assets‖, thus throwing light on the need of capital appreciation and flexibility.

AMC can attract a pool of investors by designing products with flexible investment plans.

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