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Mutual funds: Basic structure

Yashodeep Chauhan 
Updated on 02 August 2019

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"Mutual funds are subject to market risks, please read all scheme related documents carefully". Sure you've come across these punchlines 100s of times (in a higher tempo of course).

Investing in mutual funds schemes these days has become very simple and fast because you can invest as low as INR 500/- per month in a SIP scheme and start building your own investment portfolio at the go within minutes. Apart from the attractive CAGR (Compounded Annual Growth Rate) percentiles and quick and above average returns on your investments, many of us do not actually know what a Mutual Fund-as an entity actually is. At most a common man investing in a Monthly investment scheme will know the name of the fund manager and it does not matter if you don't know anything more than this since you are making some good money(most of the times).

But I am of the view that a little extra knowledge never hurt anyone and so I'll try to explain in simple terms how a Mutual Fund is structured and how it functions.

Let's understand what an MF actually does.

1. Take money
2. Invest money
3. Give returns after deducting annual AMC fees.

Simple?

Taking Money

A trust is created in the first place, the trust-a entity that is going to hold the investments on behalf of the investors or say Unitholders. This means the investors are the direct beneficiaries of the investments/assets held by the trust.
The person who creates the trust is called the Settlor of the trust. The person who is responsible for the bonafide use (for the benefit of the investors) of the assets of the trust is called the Trustee.

The trustee is a person of integrity, respect and has a very sound financial position (High net worth individuals, a big corporate business house) since people will trust only such persons who can make good the losses if they do arise in future.

The trustee then appoints an AMC- Asset Management Company. The AMC then collects money from the investors and keeps it into a Bank Account which is owned by the trust. The AMC will consist of many Individual employees just like any other organization, CIO, COO, Fund managers and research analysts.

Investing Money

After the money is collected from the investors, the AMC through its fund managers puts the money in various schemes (Equity, Debt, balanced, government securities, etc.) that the investors have opted for while investing into the mutual fund. These investments in securities can be referred to as a "Basket" and the investors are given their share of the basket in the name of "units".

A mutual fund executes its investment and disinvestment functions through stockbrokers and generally every mutual fund has impanelled, at least 30-45 stockbrokers for effective functions.

Giving Returns

Fund Manager- is a person who manages the "Basket" mentioned above, he is responsible for the money of the unitholders and the returns generated on those investments. A fund manager's exceptionally high pay packages depend directly on his performance (returns generated, risk management, losses minimization, proactive decision making, etc.). Also, the reputation and the market position of a mutual fund depends very much on the ability and actions of the fund managers since they represent the investor-base who have put their money based on his performance, so it's fair to say a mutual fund is very much about its fund/money managers.

A mutual fund investment normally earns returns in form of regular dividends or capital returns. Now that will also depend on the scheme one has opted for while investing into the fund. People who want regular monthly incomes opt for Dividend schemes and others who are looking to grow their investment opt for Growth schemes. For the former, the fund manager invests in equities of good dividend paying companies and pass on the dividend income to the investors. For the latter one investments are made into equities of companies who have strong fundamentals and promising growth capabilities, so the investors will keep enjoying the capital appreciation.

There are also many other intermediaries between the Investors and the mutual fund entities, e.g. A registrar transfer agent (accepts application for subscription and redemption of the mutual fund units), A Depository participant (holds security investments for the trusts and executes the transfer function of the securities), A custodian (a bank that holds money for the trust and carries out transactions in relation of buying/selling of securities).


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