4 - Mutual Funds

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Mutual Funds

Business Overview

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Mutual Fund Business OverviewMutual Fund Business Overview

Mutual Fund

A Mutual Fund company is an investment company that pools money from shareholders and invests in a diversified portfolio of securities. The unit of ownership of a Mutual Fund is called a share.

Four basic types of Mutual Funds

Stocks (or Equities)

Where the money is invested primarily in Equity instruments. Also called Growth Funds as focus is on capital appreciation.

Bonds (or Debt)

Where the money is invested primarily in Debt instruments. Also called Income Funds as focus is on income generation.

Hybrid (Mix of Stocks and Bonds)

Where the money is invested in both Equity and Debt instruments. Also called Balance Funds as focus is to minimize risk with capital appreciation.

Money Market (Short term Funds or Cash Investments)

Where the money is invested in interest bearing instruments with short term (90 days or less) maturity as focus is to maintain stable share price and to earn current income.

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Mutual Fund (Cont.)

Three categories of Mutual Funds

Open-End Fund

Shares are initially floated through IPO and are also available for purchase anytime. Shareholder can purchase or redeem at any point of time.

Close-End Fund

Fixed number of shares are floated only once through IPO. Later a shareholder can join the fund only through secondary market transfers.These may have a fixed maturity date.

Interval Fund

After initial offer, purchase and redemption transactions are allowed only in a specified time duration during a period (e.g. first week of every month).

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Who Invests and Why?

An investor in a Mutual Fund is a shareholder who buys shares of the fund, either through initial offer (IPO) or through secondary market or rights issues. The shareholder has the right to elect directors at meetings, must approve material change in terms of fund’s contract with its investment advisor and approve changes in fund’s investment objectives or policies originally laid down in the prospectus.

Before buying

Determine your investment objectives

Children’s education, Retirement finance planning, Buy a house etc. These may change as your age or income changes.

Determine your risk comfort level

You can loose money as the underlying securities in the portfolio rise and fall in value. Mutual Funds are not guaranteed.

Know the risk reward trade-off

The greater the risk, the higher the potential financial reward in terms of return on your investment.

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Structure of a Mutual Fund

AMC

Unitholders

Savings

Units

TrustInvestments

Trust

AMC Custodian

Registrar

SEBI


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Key Features of Mutual Funds

Professional Management

Money accumulated in a Mutual Fund is managed by professional Fund Managers, who decide (on behalf of the shareholders) on investment strategy that best matches the fund’s objective as described in the prospectus.

Decisions are based on extensive knowledge and market research.

Depending on economic conditions, fund may adjust mix of its investment to adopt a more aggressive or more defensive posture.

Diversification

Fund Managers typically invest in a variety of securities seeking portfolio diversification.

It helps reducing risk by offsetting losses from some securities with gains in others.

Thus provide an economical way to average investors to obtain professional money management and diversification of investments, which otherwise would be expensive and difficult for them.

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Key Features of Mutual Funds (Cont.)

Variety

The Mutual Funds represent vide variety of investment objectives, from conservative to aggressive, and investing in a wide range of securities.

A fund can be targeted to a specific segment of population (for females or children or handicapped) or may be investing primarily in a specialized segment of securities market (technology, pharmaceuticals, social criteria funds etc).

Daily Pricing

Mutual Funds calculate price of their shares every business day. The shareholders can redeem their shares on this price anytime.

This share price is called the Net Asset Value (NAV) of the fund. It is the Market value of all fund’s securities Minus Liabilities (expenses), Divided by Number of outstanding shares.

The NAV changes with the values of underlying securities and also as a result of portfolio change.

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Regulation and Disclosure

All US funds are subject to strict regulation and oversight by Securities and Exchange Commission (SEC).

All funds must provide investors with complete disclosure about the fund in a written prospectus having investment objectives, methods, entry and exit criteria and loads, expenses and risk level.

All funds are required to provide their shareholders with annual and semi-annual reports containing latest information about fund’s portfolio, performance and investment goals / policies.

Shareholders Services

Shareholder requested services including consolidated account statement, toll-free 24 hours telephone access, tax information, exchange among funds, automatic investments and withdrawals.

Fund initiated services including distribution of earnings to the shareholders in the form of dividend or capital gains. The shareholders may opt for reinvestment of their dividend and also purchase of additional fund shares against the capital gains.

Funds also provide extensive investor education and shareholder communications, including websites, newsletters, brochures and retirement and other planning guides.

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Fees and Expenses

To be paid by the shareholders.

Over the period it may affect the return on investment.

Shareholder fees - include any commission paid to the broker for buy / sell of shares. These commissions are often described as

Front End Loads - Sales charges when you buy-in

Back End Loads - Sales charges when you sell-off or exit

No load - No sales charges, either on entry or on exit

Annual operating fee - cost of running fund including charges for services of fund manager, record-keeping, printing and mailing. These may also include “12B-1” fees which is deducted from fund assets to pay for marketing and distribution expenses.

Taxes

Income Tax to be paid by the shareholders on the dividends and capital gains distributed by the fund.

By selling shares of a fund, a shareholder may realize a taxable gain.

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Business Key Terms

Fund - Signifies a single investment management company or a single managed portfolio of securities

Fund Group- is a collection of individual investment companies managed by a common management company.

Assets - of a Mutual Fund are calculated every day and consist of the current value of the securities it holds Plus un-invested cash Plus accrued revenue and any other receivable .

Liabilities - of a Mutual Fund are mainly expenses associated with operating the fund.Mostly these are the fees paid to various service providers.

Fund Identifiers

FUND Group / Family

Fund Name

CUSIP - an industry-wide 9 character (AN) identifier assigned by Committee on Uniform Security Identification Procedures.

Symbol - an industry-wide 5 character (A) identifier assigned by NASDAQ once a fund reaches certain minimum thresholds.

Security Number - a 5 character (AN) identifier used internally for ML systems

Fund Code - an identifier of any length assigned and used by Fund Group’s Transfer agents to distinguish between their various funds.

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Business Key Terms

Fund Distributor - is also the principal underwriter, and is usually an affiliate company of the fund.

It markets shares of the Mutual Fund to the investors acting either as a wholesaler (selling shares to security dealers) or a retailer (selling shares directly to public).

It purchases shares from the fund at NAV and the distributes them to investors for a fee.

It also promotes the fund and provide feedback and prospective client enquiry data to the customer service department.

Broker-Dealer - is a company that may act as a securities broker or as securities dealer or both.In Mutual Funds it only plays the role of a dealer and sells Mutual Funds received from its distributors. It does not buy and sell from its own inventory as a security dealer does.

Custodian - is an organization, usually a bank, which holds and protects a fund’s portfolio assets, such as cash, physical certificates, notes, etc.

Transfer Agents - is a company contracted by the fund to maintain the records of its shareholders, to pay dividends and distributions, to resolve any questions or problems with the records and to prepare account statements, tax information and other shareholder notices.

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Asset Manager


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Activity FlowSales PitchDirect/distributor

Client decision

Fund Subscription

Portfolio Management

Market trade through Broker

Back office Trade processing

Custodian

Risk Management Compliance


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Portfolio Mgmt

Asset ManagementSALES

Distributor Administrati

on

Management

Reporting

Commission

Processing

Sales Pitch

Performance Reports

Portfolio Mgmt

Strategy definition

Portfolio Constructio

n

Portfolio Analysis

Interface with Market

data

Order Management

Pre Trade compliance

Pre Trade Risk

Management

Orders execution

and processing

Allocation

Rebalancing ag.

models

Interfaces with market

data

Trade Reporting

Compliance- Pre Trade, Post Trade, Constraint Definition, Deviation Reports, Compliance reporting

Risk Management- Valuation, VaR, Stress testing, Limit/exposure monitoring, Reporting

Back Office

Trade Processing

Interface with

Custodian

Interface with

Accounts

NAV Calculation

MIS

Portfolio Accounting & Reconciliatio

n

Tax Accounting

Positions Keeping

G/L; P/L accounting

Interfaces to Back office

Reconciliation

Audit

Reporting


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Activity Break-upSALES

Sales Pitch

Distributor Administrati

on

Management

Reporting

Commission

Processing

Performance Reports

Promotions, New schemes launch Direct Sales force Distributors

CommissionsSlab systemPromotion expenses

Scheme wiseSales person Branch wiseRegion/Geography

SchemeSales Performance reportsComparison

CommissionsSlab system


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Portfolio Mgmt

Strategy definition

Portfolio Constructio

n

Portfolio Analysis

Interface with Market

data

Rebalancing ag.

models

Overall Investment Policy Fund wise Investment PolicyModel portfolioSimulation over timeWhat-if analysisInterface to historical data

Sectors wiseAsset ClassesSpecific SecuritiesCountry wise/Global

Analyse Complex PortfoliosManage Portfolio is real-timeQuery Holdings / Cash Positions / Transactions any timeCompare portfolios / sub-portfolios to models / reference benchmarks / historical holdings What-if scenarios / Sensitivity AnalysisPersonalise the DSS ( trades, holdings, prices / data)

Interfaces with Market Vendors / Data Picks up data real-time

BuySell Switch

Activity Break-up


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Order Management

Pre Trade compliance

Orders execution

and processing

Allocation

Interfaces with market

data

Trade Reporting

Pre Trade Risk

Management

Limits

Check LimitsAsset, Maturity, Counter-party, Dealer, Deal size, BrokerVaR

Order Entry and Order RoutingOrder Management (Monitors status of the order, tracks results)Complete orders with multiple brokers and calculate average prices for multiple fills. Pricing/Corporate ActionsTrade EntryTrade Execution ProcessingTransaction ProcessingCash Processing, Commission Processing / TrackingMortgage Processing

Position Update and MaintenanceRebalancing Against ModelsRebalance account or group of accounts against criteria

Interface with front office (PMS)Interface with Brokers/ECNs etc.Support for FIXInterface with back office

Commission Analysis, Duration and Maturity Analysis ReportingException ReportingMulti-Currency Reporting, Multi-Language ReportingOrder Listing, Realized Gain/LossesRisk Management ReportsSecurity Cross ReferenceStandard Reporting Package/Third-Party Report-Writer/ Trade Execution Listing

Activity Break-up


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Back Office

Trade Processing

Interface with

Custodian

Interface with

Accounts

NAV Calculation

MIS

Electronic counterparty confirmation generation and reconciliation Calculate margin payable on futures positions as well as on repos and reverse repos, including initial marginCancel/amend deal details, creation of audit trail and posting of accounting entries to reflect the changeFactor and rate resets on all applicable products through live feeds (with the option of manual overrides)Intra-day / EOD revalue all transactions and take into account any netting agreements in the calculationException reports for unconfirmed counterparties as well as limit exceptions Monitoring of overdrawn bank accountsPayment authorization monitoring and controls for all payment servicesPayments generations - SWIFT, CHIPS, FED etc...Reconciliation of currencies in Nostro account

Sending settlement instructions to custodianReconciliation of Cash, trades, portfolio positionUpdating of portfolios based on data received from custodianCorporate ActionsHandling exceptions for failed tradesExposure monitoringViolation reports

Calculate and post interest/discount accruals on a daily, weekly or monthly basisPost trade details-outright/repo, settlement details and updated portfolio positionsUpdate records for interest received, maturity proceeds, call/put exercised, auction bids primary/secondary market dealsUpdate records for brokerage, commissions paidMarked to market reporting

Create blended benchmarks, and Compare performance against the indices Calculate time-weighted or internal rates of return—before or after management fees. Display performance—by portfolios, asset classes, sectors, countries, or regions. Details of trade, portfolio positions, profit & loss, marked to market position, NAV, exception reports, broker limits

Market Value of Investments + Receivables + Other Accrued Income + Other Assets - Accrued Expenses-Other Payables-Other Liabilities--------------------------------------------------------------------------------------------------------------------------No. of outstanding units as of the NAV date


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Portfolio Accounting & Reconciliatio

n

Tax Accounting

Positions Keeping

G/L; P/L accounting

Interfaces to Back office

Reconciliation

Audit

Reporting Balance Sheet, P&L, MIS

Internal, External, Concurrent, Tax

Calculate and post interest/discount accruals on a daily/ weekly/monthly basisGenerate accounting entries based on trades executed Post entries for back-dated and forward-dated transactionsAccount treatment and rules for various activities and related products including appropriate postings to P&L and B/S Accounting reports Entries for brokerage Adjustments for traders with forward settlementsConvert traders P&L into US$Daily/month to date P&LUpdation of portfolio positionsTrader’s P/L

Portfolio and Cash

Reconciliation of Bank/Nostro accountReconciliation with Back office for trades and P&LReconciliation with Custodian

Adherence to: US GAAP rulesAdherence to: FASB 133Adherence to: French GAAP rules

Activity Break-up


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Activity Break-upCompliance

Constraint Definition

Pre-Trade Post Trade

Reporting

Compliance with respect to :Regulatory requirements Pre defined rules (specific to countries)Internal Management Restrictions & Guidelines

Mutual Fund Prospectus

Monitoring (credit /currency / earnings at risk limit/ maturity / position / Counterparty/trader / Losses)Checking violationsProviding extensions, approvals for sameLimit UtilizationCompliance testing at time of order, execution & allocationViolation resolution and supervisory override

Alerts for ViolationsCategory wise

Reporting


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Activity Break-upRisk

Management

Constraint Definition

Pre-Trade Post Trade

Reporting

Define risks / risk groups (e.g. counter parties /groups of counter parties, traders,...)Setup Limits- Counterparty, organisation wise, dealer wise, deal size, security wise, stop loss, maturity bucket etc.

Monitoring (credit /currency / earnings at risk limit/ maturity / position / Counterparty/trader / Losses)Checking violationsProviding extensions, approvals for sameLimit UtilizationCompliance testing at time of order, execution & allocationViolation resolution and supervisory override

Alerts for ViolationsCategory wise

Reporting

Position keeping

Across Entities / Portfolio / Product / Strategy / Trader / Account

Structure

Mark to Market – (automatic price feeds)Valuation

Analysis Sensitivity / Scenario Analysis- Change curve / Duration calculationsNet carry analyticsP&L analytics

VaR, Stress Testing, Extreme Value theory, Sensitivity/Scenario analysisMeasurement


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Thank you !

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4 - Mutual Funds

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