What is a Mutual Fund?
A mutual fund is a common investment pool created to raise money from several people and invest it as per a pre-decided goal. The word mutual signifies a vehicle through which the benefits of investment go to all the investors proportionately.
A mutual fund is an ideal investment vehicle for today's complex world as the markets for equity, bonds, derivatives and other assets become mature, complex and information-driven. Price changes in these assets are often driven by global events occuring in faraway places. A common man often lacks the knowledge, skills, inclination and time to keep track of these events, understand their implications and act accordingly. This is where a mutual fund enters the picture.
It appoints qualified and experienced fund managers to manage these functions full time. The large pool of money in the fund allows it to benefit from huge economies of scale. Effectively, a mutual fund exploits these economies of scale in research, investing and transaction processes.
How does it work?
Typically, a mutual fund scheme is initiated by a sponsor which markets the fund. It specifies the investment goal of the fund and the associated risks and the costs involved. It also details the rules for entry into and exit from the fund. The sponsors need approval from the regulator i.e. SEBI (Securities Exchange Board of India).
The sponsor hires an Asset Management Co to invest the funds in line with the investment goals. It also hires another entity as the custodian of the fund assets and a third one to handle the registry work for the unit holders.
So is the mutual fund a separate company?
The mutual fund scheme is a trust registered under the Indian Trust Act and is run by a trustee company promoted by the sponsor. The custodian is responsible for the receipt of all cash and non-cash benefits from investments like bonus, dividends, rights etc. The AMC gets a fee for its services. Besides, AMCs can charge other expenses for managing the fund up to certain limits.
What different kinds of mutual funds are there?
The mutual fund space offers a vast range of plans to suit individual goals i.e. long-term growth, capital protection, regular income etc. Accordingly, we have mutual funds that invest in equities alone, bonds alone, gold, silver or a mix of them (hybrid funds). Recently, some mutual funds have been permitted to start real estate funds too, which primarily invest in commercial properties to benefit from commercial rentals.