Mutual Fund Jargons Simplified

Assets Under Management (AUM) 

AUM or assets under management refers to the recent / updated cumulative market value of investments managed by a mutual fund or any investment firm.

Asset Management Company 

AMC or Asset Management Company is the Investment Manager of the Mutual Fund that manages the pool of investor money on behalf of the investors. An AMC carries out all purchase and sale of securities in the portfolio of various Mutual Fund schemes launched by the Mutual Fund.

Net Asset Value (NAV)

The NAV or the net asset value is the total asset value per unit of the mutual fund after deducting all related and permissible expenses. The NAV is calculated at the end of every business day. It is the value at which the investor enters or exits the mutual fund.

Units

Mutual Fund  units represent the extent of your ownership in the pool of money managed by the fund.

The number of units allotted depend on the money invested and the applicable NAV. If an investor invests Rs 10,000 in a scheme and the NAV for that day is Rs. 100, the investor will be allotted 100 units of the scheme (= Amount invested/Applicable NAV).

NAV of a scheme represents the cost of a single unit of that scheme. The current value of your holding in a scheme can be obtained by multiplying the number of units of the scheme held by you multiplied by the current NAV of the scheme.

Benchmark 

Performance of a Mutual Fund should never be looked at in isolation. It should be evaluated against a standard known as the benchmark. The benchmark for a fund is decided when the fund is launched and the  benchmark is selected based on the investment objective of the fund. This benchmark, is a group of securities, usually a market index, whose performance is used as a standard or benchmark to measure investment performance of mutual funds, among other investments. Some typical benchmarks include the Nifty, Sensex, BSE200, BSE500, 10-Year Gsec.. Hence, you as an investor should expect the scheme to perform better than its benchmark over a given time frame.

 A benchmark helps bring in standardization in the comparison of performance of different funds, following the same benchmark or in evaluating how a fund has performed against its own benchmark.

Credit Quality

While investing in debt funds, investors should gauge the credit quality of the instruments in the portfolio. The credit rating of the instruments indicates the level of default risk. The higher the rating, the safer is the instrument. To check this, investors can go through the offer document and the fact sheets published by fund houses. Generally, a debt fund invests in several instruments, ranging from risk-free government securities to high-risk corporate papers. A fund that has invested a large corpus in a poor quality paper may find it difficult to sell this paper in the market, thereby putting the investor's money at risk. As the safety of capital is of utmost importance to debt investors, they should not opt for funds with a large proportion of low quality investments.

Investment Objective 

The investment objective of a Mutual Fund scheme outlines the financial objective the scheme intends to achieve and indicates the level of risk it is likely to assume, while trying to achieve this objective.

Investment objective of a Mutual Fund scheme helps investors decide,

Close-Ended Schemes 

A close-ended mutual fund is one in which Investors can buy only during the NFO (New Fund Offer) period.

No investor can enter or exit a close-ended scheme until its maturity. However, investors can purchase / sell units on the stock exchanges 

Open-Ended Scheme

An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis.

New Fund Offer (NFO)

When an AMC wishes to launch a new fund in the market it does so by way of an NFO. NFO has a start date and end date. Investors are invited to invest during the NFO period, investments made during the NFO period are considered at face value.

The fund managers use the capital raised during the NFO to buy the initial securities in the new funds portfolio. Open-ended funds open for further subscription a few days post the NFO end date. No new investors can subscribe for close-ended funds post the NFO end date.

Growth Option

A Growth Option focuses on long-term growth of capital. In case of the growth option, you choose not to opt for dividends.

Thus, if you invest in the growth option of a Mutual Fund scheme, you will not receive any payouts from the scheme. In a growth option, all profits made by the fund are reinvested into the scheme. This leads to an increase in the NAV of the scheme, since the profit is retained by the scheme instead of being distributed to the investors. When the scheme makes a profit, NAV of the scheme increases and vice-versa.

IDCW Reinvestment Option

Mutual fund schemes invest in a basket of securities. Some of these securities may pay dividends, interests or bonus. The profits made by the schemes in the form of dividends, interests or bonus can in turn be distributed amongst the investors at the discretion of the fund manager and is called as IDCW. In case of IDCW Reinvestment, the IDCW declared during the course of the investment is re-invested back into the scheme on investor’s behalf.

IDCW Payout option

Mutual fund schemes invest in a basket of securities. Some of these securities may pay dividends, interests or bonus. The profits made by the schemes in the form of dividends, interests or bonus can in turn be distributed amongst the investors at the discretion of the fund manager and is called as IDCW. In case of IDCW Payout, investor receives the IDCW declared during the course of his investment as a payout.

Load

A sales charge assessed by certain mutual funds (load funds) to cover selling costs. A front end load is charged at the time of purchase. A back-end load is charged at the time of sale.

Exit Load

Exit load is charged at the time an investor redeems the units of a mutual fund. The exit load is added to the prevailing NAV at the time of redemption. For instance, if the NAV is Rs 100 and the exit load is 1%, the investor will redeem the fund at Rs 99.

Entry Load

A mutual fund may have a sales charge or load at the time of entry and/or exit to compensate the distributor/agent. Entry load is charged at the time an investor purchases the units of a mutual fund. The entry load is added to the prevailing NAV at the time of investment. For instance, if the NAV is Rs. 100 and the entry load is 1%, the investor will enter the fund at Rs 101.

Indexation Benefit

Indexation is an option available for investors to manage their inflation-adjusted returns. It is a provision in the Indian Income Tax Act, which allows investors to use inflation as a tool to reduce their tax liability from income generated through debt mutual funds and bonds. The indexation benefit applies if such investments are held for more than 12 months. The same does not apply to bank fixed deposits (FDs) and other small savings where the interest earned is taxed as per applicable marginal tax slabs of 10%, 20% and 30%.

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Systematic Investment Plan (SIP)

SIP or systematic investment plan works on the principle of making periodic investments of a fixed sum. It works similar to a recurring bank deposit. For instance, an investor may opt for an SIP that invests Rs 500 every 15th of the month in an equity fund for a period of three years.

Systematic Transfer Plan (STP)

Systematic transfer plan allows investors to transfer the pre-defined amount on a specified date from one particular scheme to another by giving one-time instruction to the fund house. STP is a useful tool to take a step-by-step exposure to equities or to reduce exposure over a period of time. Investors sometimes want to withdraw their money from the equity MF scheme and transfer it systematically to a debt scheme or a money market scheme of the fund house or vice versa.

Systematic withdrawal plan (SWP)

Systematic withdrawal plan helps investors to redeem a fixed amount of their investments from their mutual funds on a pre-determined frequency. The amount withdrawn can be used to meet planned and unplanned expenses as well as to re-invest according to an individual's life stage / asset allocation plan. SWPs ensure one receives the amount in parts rather than the whole so that the spending is planned effectively and are also more tax efficient in case of withdrawals from debt oriented mutual funds in comparison to dividend options and bank FDs.

Diversification

Spreading the risk by constructing a portfolio that contains many different investments whose returns are relatively uncorrelated. Thus, risk levels can be reduced without a corresponding reduction in returns

Asset Allocation

Asset allocation is an investment strategy which aims to spread investor's portfolio across several assets such as equities, bonds, gold and cash according to their age, goals, risk tolerance ability and investment horizon. Mutual fund schemes too follow this strategy, albeit as per their investment objective. For instance, a hybrid mutual fund scheme such as balanced funds typically has an allocation up to 65% in equity, and the remaining in debt and cash equivalents. Investors can, thus, look at the asset allocation of a mutual fund scheme and map it to their individual asset allocation.;

Total Expense Ratio

Apart from risks and returns, investors must look at the costs involved while investing in mutual funds. Though these costs are a small component, they can knock down investors' earnings especially if a scheme does not perform well. TER is an annual charge on AUM in percentage terms and is calculated as (total expenses during an accounting period) * 100 / total net assets of the fund. The ratio includes investment management and advisory fees, sales/agent commissions and ongoing service fees, legal and audit fees, registrar and transfer agent fees, fund administration expenses, and marketing and selling expenses. The NAV of a mutual fund scheme is net of all liabilities including TER and, hence, a lower TER results in higher returns and vice versa. Investors must invest in a scheme which charges a lower TER compared to peers as higher expenses reduce returns of the fund.

Sharpe Ratio

The Sharpe Ratio, named after its founder, the Nobel Laureate William Sharpe, is a measure of risk-adjusted returns. It is calculated using standard deviation and excess return to determine reward per unit of risk.

R-Squared

This term is used to gauge the correlation between the mutual fund scheme and the benchmark index measured in the range of 0 to 100. R-squared of 100 means that the mutual fund moves in tandem with the benchmark index and R-squared of 0 means least correlation.

Index Funds

A mutual fund which invests in a portfolio of shares that matches identically the constituents of a well known stock market index. Hence changes in the value of the fund mirror changes in the index itself.

Growth Funds

Unit trusts or Mutual Funds which invest with the objective of achieving mostly capital growth rather than income. Growth funds are mostly more volatile than conservative income or money market funds because managers invest on shares or property that are subject to larger price movements.

Gilt Funds

Fund that invests exclusively in government securities.

Balanced Funds

Funds which aim to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents.