mutual funds – Ascent Financial Solutions

Legal Structure of Mutual Funds in India.

Prakash Lohana — Thu, 24 Sep 2015 04:04:48 +0000

In my last article “ All about Mutual Funds. Advantages & Disadvantages of Mutual funds”,I had discussed about basics as well as advantages and disadvantages of Mutual funds. Mutual Funds are very strong and stable vehicle for investing in different asset classes. Most of the investors whether they are investing in Mutual Funds or not, are not very clear about the Legal structure of Mutual Funds in India. This article is an effort to educate investors about the legal structure and functioning of Mutual funds in India. Practically as an investor understanding legal structure of the Mutual Funds will not add much value to your financial life but most of the investors consider Mutual funds as unsafe investments and have lots of misunderstanding about legal structure of Mutual funds, this article will clarify those misunderstandings and will make you understand how safe your money is with Mutual Funds.

Legal Structure of Mutual Funds:

Now we will see what is legal structure of Mutual Funds? & how Mutual fund companies are formed?

Who Regulates Mutual funds?

Mutual Funds are regulated by the Securities & Exchange Board of India in India. SEBI has formed “SEBI MF Regulations 1996” to regulate functioning of Mutual Funds.
Under this regulation Mutual Funds are formed as Public Trust under “The Indian Trust Act, 1882”.
These regulations stipulate a three tired structure of entities – sponsor (creation), trustees, and Asset Management Company (fund management) – for carrying out different functions of a mutual fund, but place the primary responsibility on the trustees.

Who is Mutual Fund sponsor? & What are Roles & Responsibilities of Sponsor?

Mutual fund sponsor is basically promoter of the Mutual Fund Company. Sponsor either on his own or in association with another body corporate establishes a Mutual to earn money from fund management through its subsidiary company which acts as Investment Manager of the Fund.

Sponsors then,

Set up a Public Trust under “The Indian Trust Act, 1882”, and appoint trustees to manage the trust. Gets trust registered with SEBI and also takes all the necessary approvals from the SEBI.
Create an Asset Management Company under “The Companies Act, 1956”.
As sponsor is the main entity promoting a mutual fund company and mutual funds are going to manage public money, SEBI has kept very strict guidelines for the eligibility of the Sponsor.

Registration of Trust & Appointment of Trustees:

Creation of Trust: Sponsors create trust through trust deed in the favour of trustees. Trustees manage the trust and they are primarily responsible to investors in Mutual Funds. They are primarily guardians of Unit Holder’s money.
Appointment of Trustees: Sponsor with prior approval of SEBI appoints trustees. There should be at least four members in the board of trustees with at least 2/3rd independent. A trustee of one mutual fund cannot be trustee of another mutual fund, unless he is an independent trustee in both cases and has the approval of both the boards. The trustees are appointed by executing and registering a trust deed under the provisions of “Indian Registration Act”. This trust deed is also registered with SEBI.
Responsibilities of Trustees: Primary responsibility of Trustees is to see that all the due diligence is done properly and all the regulations are properly followed. All schemes floated by the AMC have to be approved by the trustees. Trustees review and ensure that the net worth of the AMC is as per the regulatory norms. They have to furnish SEBI a report on the activities of AMC on half yearly basis.
Trustees also enter in an agreement with the Asset Management Company.
Trustees can obtain necessary information from the Asset Management Company. All the schemes have to be approved from Trustee before they are launched.
Trustees have to appoint all key personnel like Fund Managers, Auditors, Custodian, Registrar, Compliance Officer etc. and to inform the SEBI about same.

Asset Management Company: Trust will appoint Asset Management Company as Investment Managers through an agreement called “Investment Management Agreement”.

Sponsor creates Asset Management Company and Asset Management Company manages funds of the Trust and against that it charges small fee. The AMC structures various schemes, launches the scheme and mobilizes initial amount, manages the funds and give services to the investors.

Sponsor, Trust and Asset Management Company are the Three Tir system which runs entire Mutual fund Business. Following are some other important entities involved in the functioning of a Mutual Fund.

Custodian: In Mutual funds , Asset Management Company buys different securities in the forms of Shares, bonds, gold etc. in different schemes. These Securities are bought in the name of Trust but they are not kept with the Trust. The responsibility of safe keeping the securities is on the custodian. Securities, which are in material form, are kept in safe custody of a custodian and securities, which are in “De-Materialized” form, are kept with a Depository participant, who acts on the advice of custodian. Custodian performs a very important back office operation. They ensure that delivery has been taken of the securities, which are bought, and that they are transferred in the name of the mutual fund. They also ensure that funds are paid out when securities are bought. Custodian keeps the investment account of the mutual fund. They collect and account for the dividends and interest receivables on mutual fund investments. They also keep track of various corporate actions like bonus issue, rights issue, and stock split; buy back offers, open offer etc and act on these as per instructions of the Investment manager.

Registrar & Transfer Agent: Registrar and Transfer agent is a separate entity. Registrar & Transfer agent has a responsibility of performing many administrative jobs like processing of applications of investors, creating units when new investment is made, removing units when investors made redemptions, keeping full record of investors, processing dividend payout. Mutual fund investors are spread across the country to small cities and towns so it is not possible to provide these services to investors at all these places by Asset Management Company. Registrar & Transfer Agents have their offices spread to these different locations and they work for many Mutual Funds to perform these jobs. So it becomes possible to provide services to unit holders at different locations in a very cost effective manner.

Auditor: Asset Management Companies are required to maintain separate books of accounts for all the schemes and prepare separate Annual reports for all schemes. An Auditor’s role is to examine books of accounts and annual report of all the schemes as an independent auditor. Asset Management Companies are also required to maintain their books of accounts and get the audit done under The Companies Act, 1956. As per rules separate auditors are appointed for Asset Management Company and Schemes.

Brokers: Brokers are registered members of the stock exchange whose services are utilized by AMCs to buy and sells securities on the stock exchanges. Many brokers also provide the Investment Manager (AMC) with research reports on the performance of various companies, sector and market outlook, investment recommendations etc.

Conclusion: From above discussion, it is clear that mutual funds are well regulated by SEBI. SEBI has formed three tired structure between sponsor, Trustee and Asset Management Company to ensure safety of investor’s money. Different agencies are involved in the functioning of the Mutual funds, like custodian is responsible for safe keeping of securities, transfer agent is responsible for creation of units and other services, Auditors verify that accounting is done properly as per regulations. Brokers are members of stock exchanges who provide services of buying and selling of securities. Trustees are responsible to take care of unit holder’s interest and reporting to SEBI. So the entire functioning doesn’t remain with Asset Management Company or Sponsors.

All about Mutual Funds. Advantages & Disadvantages of Mutual Funds.

Prakash Lohana — Wed, 09 Sep 2015 18:24:54 +0000

Mutual Fund is a common pool of money, where large number of investors, invest their money and then that money is invested in stocks, bonds, gold, money market instruments and other types of securities. So Mutual fund is not an asset class in itself like equity, debt or gold but it is a means to invest in different asset classes.

The ownership of the fund is thus joint or “mutual”; the fund belongs to all investors. A single investor’s ownership of the fund is in the same proportion as the amount of the contribution made by him or her bears to the total amount of the fund.

Legal structure of Mutual Funds is that of trust, which accepts savings from investors and invest the same in diversified financial instruments in terms of objectives set out in the trusts deed with the view to reduce the risk and maximize the income and capital appreciation for distribution for the members. A Mutual Fund is a corporation and the fund manager’s interest is to professionally manage the funds provided by the investors and provide a return on them after deducting reasonable management fees.Following chart summarizes advantages and disadvantages of Mutual Funds,Which are explained below.

Let us see advantages of Mutual fund:

1) Portfolio Diversification: As discussed above, Mutual fund is a common pool of money. So when a large number of investors invest their money in a Mutual Fund Scheme, they become joint owners of this scheme and then that scheme will invest in to number of securities as per the objective of the scheme. Mutual funds help investors to get diversified at two levels. First diversification happens at Asset class level because different mutual fund schemes have different objectives, some of them may invest in Equities, some may invest in Gold and bonds. An individual investor can invest into different type of schemes and get diversified into different asset classes easily. The second level of diversification happens at securities level for investors. Like a scheme which is investing into shares and stocks will invest in to shares of many different companies. An Equity mutual fund will generally have a portfolio of around 30 to 40 stocks. So when an investor invests in an equity fund he automatically gets diversified to 30 to 40 stocks. When we invest in 5 equity funds we may get diversified to the shares of more than 100 companies (considering some companies will be common) . It is very difficult for an individual investor to understand prospects of 100 companies and to invest in 100 companies and continuously do a research on them to take decisions of buying selling.

So by investing in Mutual funds an investor gets diversified to different asset classes and securities.

2) Professional Management: Mutual Fund companies appoint highly qualified fund managers and research analyst for continues research and effective management of portfolios of different scheme. Also it uses highly expensive technologies for such research and analysis. When an individual investor carries his own research on different securities for his own investment, it is very difficult that he can meet the same excellence level which those professionals are maintaining due to their education, experience, use of technology and team work. In our day to day life we use services of many professionals like doctors, Chartered Accountants, Lawyers, Architects etc. similarly when it comes to investing in different asset classes and securities we should use services of these professionals. So by simply investing in different mutual funds an investor is getting service of all these professionals. This professional management helps investors to reduce risk and improve on returns.

3) Effective Risk Management: Risk Management is the most important aspect of investing and as discussed above, due to proper diversification and professional management of funds by fund management team in mutual funds, different type of risks reduces significantly. By diversification into different asset classes and securities the risk of investor reduces significantly. On the other hand, professional management by fund managers and research analyst further reduces the risk.

4) Reduction of Transaction Cost: All the type of costs related to fund managers, research analyst, expensive technologies or use of different entities like custodian, Registrar & Transfer agents etc. gets spread over large number of investors and huge amount of investments so their effect to individual investors reduces significantly which helps to reduce overall cost on an individual investor.

5) Liquidity: When individual investors are holding securities and they want to liquidate those securities, sometimes they find it difficult to liquidate them immediately. Whereas in case of mutual funds when an investor wants to sell his units, mutual funds themselves buy them from investors in case of Open-ended schemes. In case of close ended schemes investor can sell them on stock exchanges where that scheme is listed. So mutual funds offer relatively easy liquidity options.

6) 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. All the schemes are approved by SEBI and it continuously monitors functioning of the Mutual Funds.

7) Transparency: Mutual funds operate in a very transparent manner. They have to give different disclousers related to NAV, portfolio of schemes, expense ratios etc. to the investors, as per norms of SEBI. So investors get all the kind of information about their funds.

8) Convenience to Unit Holders: Mutual Funds offer convenience to investors in investing in different asset classes and different kind of securities at one window. All the processes are designed in a manner to provide operational convenience to investors. All the responsibilities like maintaining record of different securities, buying- selling securities timely, collecting interest and dividend of different securities in which schemes have invested etc. is on Mutual funds and not on individual investors. This makes an individual investors life easy.

Disadvantages: Also there are some disadvantages of investing through Mutual Funds, which are listed below.

1) No Tailor-Made Portfolio: Mutual fund is a pool of money so the portfolios of mutual fund schemes are created as per the objectives of the schemes and they a generalized. It is not possible to create a customized portfolio for an investor as per his choice. However, Mutual Funds offer different schemes with different investment objectives like in Equity oriented schemes they offer schemes investing in Large Cap stocks, Mid Cap stocks etc. So investors get a wide choice to select the schemes.

2) No Control Over Cost: Investor has no control over different types of costs incurred by the asset management company. He is charged fund management fees as long as he remains in the schemes. However, these fees are charged as per the regulations formed by SEBI and these fees are not significant against the benefits offered by Mutual funds. On the other hand, if an investor directly tires to higher such professionals for management of his fund the cost will be unbearable. Against that the cost he pays here is reasonable and bearable.

3) Managing a Portfolio of Funds: Due to availability of large number of schemes, investors sometimes get confused in choosing right scheme for themselves. This leads to investing in schemes which may not suit their objectives or investing to large number of schemes which they are not able to track. This can be managed by consulting qualified financial advisers.

4) Dilution: Although diversification is very important but investing in too many securities by mutual fund schemes sometimes leads to over dilution in portfolio which also dilutes the returns. So by investing in mutual fund schemes, portfolio of investors don’t go up sharply when an individual stock or security gives a high returns run but at the same time it doesn’t fall sharply when an individual security or stock falls sharply.

Conclusion: From above discussion it is very clear that mutual funds are effective tools to take allocation to different asset classes and securities. They offer variety of advantages against investing directly in to different securities. There are small disadvantages also which can be managed by consulting qualified financial advisers. So rather than taking allocation to different asset classes and securities directly, investors should take the route of Mutual Fund Schemes.