Mutual Funds

1Why mutual funds exist

Investing directly means doing everything yourself: choosing securities, judging price and timing, deciding weights, tracking and exiting, and handling operations. Many people lack the skill, time or interest. A mutual fund does this for a fee.

Key features:

• A pool of investors' money managed by a specialist firm, with the objective stated upfront.
• Investors get units representing their proportionate share of the scheme's assets; they are unit holders.
• The portfolio and its performance are disclosed regularly.
• Units are bought from and sold to the fund, or traded on an exchange if listed.
• Investors bear the portfolio's risk with no guarantee.
• Funds cannot borrow to invest; they may borrow only for temporary liquidity needs such as paying redemptions or dividends. Unit holders are the sole owners of the assets.
• Everything is regulated by SEBI.

Products differ by asset allocation, investment objective, costs and fees, and operational terms.

Remember

• Unit holders own the assets and bear the risk.
• No borrowing to invest.

Practise this concept (3 questions)

2Core terms: pooling, units, NAV and pricing

"Mutual fund" means the common pool held in a trust (investors are the joint beneficial owners, supervised by trustees) and also the fund house. SEBI classifies schemes into five groups: equity, debt, hybrid, life cycle funds and others, and allows only one scheme per category, except index funds/ETFs on different indices, fund of funds with different underlying schemes, and sectoral/thematic funds on different sectors or themes.

• Pooling: profits, losses and costs are shared in proportion to investment.
• Units and unit capital: units usually have a face value of ₹10. Unit capital = units issued × face value.
• Mark to market: securities are valued at current market prices every day.
• NAV = (market value of investments + income − expenses) ÷ units outstanding.

Example Investors put in ₹10,000, ₹20,000 and ₹30,000 (6,000 units at ₹10). The portfolio grows to ₹72,000, with ₹3,000 of dividends and ₹600 of expenses. Net assets = 72,000 + 3,000 − 600 = ₹74,400. NAV = 74,400 ÷ 6,000 = ₹12.40.

Why transactions are priced at NAV: if a new investor paid only the ₹10 face value, NAV would fall to ₹12.05 and existing holders would lose; if a leaving investor got only ₹10, NAV would rise to ₹12.88 at their expense. Buying and selling at NAV keeps everyone fair, so NAV stays at ₹12.40.

• Expenses are charged as a percentage of daily average net assets and are already reflected in the NAV; the total expense ratio (TER) varies by fund type.
• Exit load is a percentage of NAV deducted when you redeem early. Entry loads are banned.
• Relative performance: funds cannot guarantee returns; equity funds rise and fall with equity markets. Funds aim to match or beat an index.
• Diversification across sectors and securities smooths the ups and downs, even for a ₹5,000 investment.
• Pass-through entity: a SEBI-registered mutual fund's income is exempt from tax; investors are taxed instead, so the same income is not taxed twice.

Example NAV ₹12, exit load 1% within one year. Redemption price = 12 − 0.12 = ₹11.88.

Remember

• NAV = net assets ÷ units.
• Transactions at NAV protect existing investors.
• Expenses are deducted inside the NAV.

Practise this concept (18 questions)

3Open-ended, closed-ended and interval funds; growth and IDCW

• Open-ended: no maturity; buy and sell from the fund any business day at NAV-linked prices; may also be listed.
• Closed-ended: units issued only in the NFO; fixed maturity when the fund buys back units; must be listed, and investors trade among themselves.
• Interval: mostly closed, but open for direct buying and selling during set transaction periods (for example three days a quarter); also listed.

Options:

• Growth: gains stay in the fund and raise the NAV.
• IDCW payout (formerly dividend payout): the fund distributes from realised gains. Renamed "income distribution cum capital withdrawal" because part of it can be your own capital.
• IDCW reinvestment: the distribution buys more units.

Remember

• Closed-ended schemes must be listed.
• IDCW can return part of your own capital.

4How a mutual fund is run

The asset management company (AMC) launches schemes, collects money, manages it and charges a fee. Fund managers are its employees. The AMC is supervised by its own board and by the trustees, who meet at least 6 times a year and approve major decisions.

A scheme is first offered in a new fund offer (NFO), with details in the scheme related documents (SID, SAI, KIM). Distribution is through banks, brokers and individual distributors, who earn a trail commission as a percentage of assets for as long as the money stays. Investors can also invest direct.

Minimum investments range from about ₹500 to ₹10,000 (₹5,000 is common). Each investor gets a folio number; RTAs service investor records. Money and securities are held by a custodian, not the AMC. NAV is computed and published every business day; portfolios and accounts are disclosed periodically.

Constituents (registered with SEBI, appointed with trustees' approval): custodian (holds and settles funds and securities), RTA (investor records), banks (collections and payments), auditor, distributors and brokers.

Remember

• Custodian holds the assets, not the AMC.
• Trustees meet at least six times a year.

5SEBI scheme categories: equity

SEBI's categorisation (latest master circular in 2026) standardises schemes so they can be compared. Market cap definitions: large cap = top 100 companies by full market cap; mid cap = 101st to 250th; small cap = 251st onwards (list published by AMFI every six months).

ELSS gives a deduction under Section 80C of up to ₹1.5 lakh a year, but only under the old tax regime.

Remember

• Large cap = top 100; mid cap = 101–250; small cap = 251+.
• Focused fund: at most 30 stocks.
• ELSS: 3-year lock-in, 80C only in the old regime.

Practise this concept (12 questions)

6Debt schemes

Debt securities differ in tenor, credit risk and interest rate (mark-to-market) risk. When rates rise, bond prices fall, and longer bonds fall more. Short-term funds earn mainly coupon income with little MTM effect; long-term funds earn more coupon and gain more when rates fall (and lose more when rates rise). Lower-rated bonds pay higher coupons for higher default risk.

Scheme names cannot stress only returns (no "high yield" or "credit opportunities").

Remember

• Liquid: up to 91 days. Overnight: 1 day.
• Corporate bond = AA+ and above; credit risk = AA and below.

Practise this concept (6 questions)

7Hybrid, life cycle and other schemes

Hybrid funds hold both equity and debt; more equity means more risk.

An AMC may offer either aggressive hybrid or balanced hybrid, not both. Arbitrage funds buy in the cash market and sell futures to lock in the price difference, so they behave like low-risk funds with NAV volatility close to liquid funds. Hybrid funds may put residual money in InvITs (not arbitrage funds), ETCDs and gold or silver ETFs.

Life cycle funds are open-ended with a target maturity and a glide path that becomes more conservative over time. Tenures 5 to 30 years in multiples of 5; at most six open for subscription at a time.

Other schemes:

• Index funds and ETFs: at least 95% in the index securities. ETFs trade on exchanges through brokers, need a demat account and have real-time prices.
• Gold ETFs: each unit typically represents one gram of gold backed by physical gold; silver ETFs are also allowed. Commodity funds need a dedicated fund manager with commodity expertise, and NAV is published daily.
• Fund of funds: at least 95% in the underlying fund(s).
• Fixed maturity plans (FMPs): closed-ended; securities mature with the scheme, so interest rate risk is minimal if held to maturity; the main risk is credit risk. Listed.
• Infrastructure debt funds: closed-ended, at least 5 years, 90% in infrastructure debt, minimum investment ₹1 crore, unit face value ₹10 lakh, NAV at least quarterly.
• Real estate mutual funds: closed-ended and listed.
• ESG schemes sit under thematic equity, using strategies such as exclusion, integration, best-in-class, impact investing, sustainable objectives or transition investments.

Remember

• Index fund / ETF / FoF: 95% minimum.
• Multi asset: 3 classes, 10% each.
• Life cycle: 5–30 years, glide path, max six open.

Practise this concept (11 questions)

8Active versus passive investing

Active funds try to beat their benchmark through research and stock selection, charge higher fees and incur more trading costs; many fail to outperform, especially in developed markets. Passive funds copy the index in the same weights, so fees are lower. The small gap between fund and index return is tracking error, which should be close to zero.

Index funds are bought from the fund at NAV; ETFs trade on the exchange at any time during the day, so investors can use limit orders. SEBI's passive fund rules: direct dealing with the AMC only for ETF trades above ₹25 crore (to push liquidity to the exchange); indicative NAV (iNAV) published continuously during trading; passive ELSS allowed on indices of the top 250 companies; FoFs value ETFs at the exchange closing price.

Remember

• Tracking error should be near zero.
• Direct AMC dealing in ETFs only above ₹25 crore.

Practise this concept (6 questions)

9How to invest: modes, PAN, KYC and FATCA

Investments can be made offline (form and KYC at an AMC, distributor or RTA office, payment by cheque, folio allotted, account statement sent) or online (AMC or RTA website), or through exchange platforms (NSE MFSS, BSE StAR MF) and MF Utilities (an industry shared platform).

• PAN is mandatory, except for individuals investing up to ₹50,000 a year per fund house (lump sum and SIPs together).
• KYC is done once and is valid across funds and capital market intermediaries. It involves in-person verification; Aadhaar-based eKYC with OTP (through CAMS or KFinTech as KYC user agencies) removes the paperwork.
• FATCA and CRS: investors must declare citizenship, place of birth and tax residency outside India; reportable accounts are reported to Indian tax authorities for sharing abroad. Changes must be reported within 30 days.

Remember

• PAN exemption: up to ₹50,000 a year per fund house.
• One KYC works across the capital market.

Practise this concept (5 questions)

10Buying, documents and payment

NFO: scheme documents and the KIM come with the application form. NFOs (other than ELSS) stay open for up to 15 days. Payment by cheque, NEFT, RTGS or ASBA. Units are allotted within 5 business days of NFO closing.

Continuous offer: open-ended funds sell units every business day at NAV-linked prices. New investors use the application form; existing investors use a transaction slip with their folio number, submitted at an official point of acceptance. Units are confirmed in a statement of account.

Scheme related documents (free, in SEBI's format):

• SAI: statutory information about the fund house.
• SID: details of the particular scheme.
• KIM: the key information an investor must know.

The riskometer appears on the NFO form, SID, KIM and advertisements. The monthly factsheet shows objective, category, AUM, benchmark, minimum investment, exit load, riskometer, fund manager details, top 10 holdings, sector allocation, past performance and key ratios.

Units can also be bought and sold through stock brokers who hold an ARN and exchange permission, with units in demat form.

Payment: from a bank account where the first holder is an account holder; cash up to ₹50,000 per fund house; demand drafts only in specified cases. A folio can have up to three joint holders, all completing PAN and KYC; operation is joint (all sign) or either or survivor (any one signs).

Remember

• NFO open up to 15 days; allotment within 5 business days.
• SAI = fund house; SID = scheme; KIM = summary.

Practise this concept (4 questions)

11Redemptions, changes, statements and commissions

Open-ended units can be redeemed any time at the applicable NAV less exit load; closed-ended units only at maturity (or sold on the exchange). Signatures follow the mode of holding.

Example Redeem 500 units, NAV ₹24, exit load 1%. Price = 24 × 0.99 = ₹23.76. Proceeds = 500 × 23.76 = ₹11,880.

Bank details are mandatory and payouts go to the registered account to prevent fraud; up to 5 bank accounts can be registered, with one default. Non-financial transactions (address, bank, joint holders) need a transaction slip with supporting documents; some changes can be made across funds through centralised agencies.

A statement of account follows every transaction. A consolidated account statement (CAS) is sent for each month with transactions, and every six months if there were none; it shows units, NAV, value, average TER and gross commission paid to distributors. Units can be held in demat form, with the investor bearing demat and broker costs.

Distributors are paid a trail commission on the current value for as long as the money stays. Upfront commission is not allowed, except limited upfronting of trail on SIP inflows.

Remember

• Up to five bank accounts per folio.
• CAS monthly if there are transactions; half-yearly otherwise.

Practise this concept (2 questions)

12Systematic plans and switches

Systematic transactions automate purchases, redemptions or transfers: you set the type, period, frequency, date and amount.

• SIP: a fixed amount invested regularly. More units are bought when NAV is low and fewer when it is high, so the average cost falls: rupee cost averaging.
• SWP: a fixed amount redeemed regularly, for income or to book profits. If units run short, the balance is redeemed and the folio closed.
• STP: a fixed amount moved regularly from one scheme to another in the same fund house: an SWP from the source and an SIP into the destination (for example from a liquid fund to an equity fund).
• Switch: a one-time redemption from one scheme (or option) and purchase in another, at applicable NAVs after loads.

Example An SWP of ₹5,000 when NAV is ₹20 redeems 250 units that month.

Remember

• SIP = rupee cost averaging.
• STP works only within one fund house.

Practise this concept (4 questions)

13Information, benefits and costs

Information comes from scheme documents, brochures, monthly factsheets, and the SEBI and AMFI websites, plus rating and research sites.

Benefits: diversification with small amounts (sometimes ₹500); professional management; liquidity; flexibility (lump sum or SIP, IDCW or growth); tax efficiency (the fund itself pays no tax); access to instruments retail investors cannot buy directly, such as wholesale debt.

Costs and limits: fees and expenses; limited control over investment decisions; indirect ownership (securities are held in the trust's name, investors are beneficial owners).

Remember

• Investors own units, not the underlying securities directly.

Practise this concept (1 question)

14Regulation, investor service standards and SIFs

Only entities registered under the SEBI (Mutual Funds) Regulations, 1996 can run a mutual fund. The fund is a trust; trustees ensure the AMC acts in investors' interest; investor money is kept off the AMC's balance sheet. SEBI sets sponsor and AMC eligibility, requires trustee and SEBI approval before a scheme is offered, prescribes document formats, investment limits, valuation and accounting, caps expenses, requires performance reporting against the benchmark, and requires a risk management framework.

Service standards:

• NAV, sale and redemption prices disclosed daily.
• Units allotted within 5 business days of NFO closing, and on the transaction date for ongoing purchases.
• Periodic account statements.
• IDCW paid within 15 days of declaration; redemption proceeds within 10 working days (otherwise the AMC pays 15% a year interest from its own pocket).
• A SEBI investor charter displayed on AMC websites.
• AMFI sets best practices and the code of conduct for AMCs and distributors.
• Funds must vote on specified company resolutions (governance, capital structure, pay, directors, related party transactions).

Specialized Investment Funds (SIFs) are a newer product line under the mutual fund regulations for sophisticated strategies, with a minimum investment of ₹10 lakh.

Remember

• Redemption within 10 working days; IDCW within 15 days.
• SIF minimum ₹10 lakh.

Practise this concept (4 questions)