Knowing Your Mutual Fund Product Better!

When a mutual fund creates an investment product, it offers it for the first time to the investors as a new fund offer (NFO).  A new product is first approved by the trustees, and features are described in a detailed offer document that is filed with SEBI.  After SEBI approves that the document carries all the necessary disclosures in the interest of investors, the mutual fund makes its new fund offer to investors.  Key information about the products is also made available to investors who like to buy units of an open‐ended fund on an on‐going basis. SEBI’s regulation prescribes that information about the fund and the product be disclosed in two sections ‐ Scheme Information Document (SID) and Statement of Additional Information (SAI).  The regulations define specifically all the information that needs to be provided and the format in which this information has to be provided.

The SID contains information that is relevant to a specific mutual fund scheme. Information in the SID includes the type of the scheme, its investment objectives, maximum and minimum allocation to different types of securities, the risks associated with the scheme and the strategies that the fund manager intends to deploy. The fees, expenses and loads that will be charged to the scheme are also given. The document gives details on the operational features such as, such as dividend and growth options and facilities such as switch and systematic investments. The SID also contains information on the price at which the units are being offered, the dates of opening and closing of the NFO, the minimum application amount and the points of acceptance of the application. For investors in the scheme after the NFO, the SID contains information on the past performance of the scheme, the method for calculating the price for purchases and redemptions, the cut‐off time within which the application has to be submitted and the minimum application amount.

The SAI contains information that is common to all schemes of a fund house. This includes information on the constitution of the mutual fund, the details of the constituents such as the trustees and the AMC and their roles and responsibilities. Information on service providers such as the custodian and R&T agent and their contact details are provided. The rights of the unit holders in the mutual fund are mentioned in the document. Information contained in the SID or the SAI may change. Changes in the fundamental attributes of the scheme, such as the type of the scheme or the investment objective, has to be updated in the SID immediately. In case of other changes, the mutual fund will issue an addendum which will be attached to the existing SID. Material changes in the SAI will be updated and uploaded both on the mutual fund and AMFI’s website. The SID and the SAI will be updated once every year and the information in the addendums will be incorporated into the document.

A condensed version of the SID and the SAI called the Key Information Memorandum (KIM) is attached to every application form. It gives brief details about the scheme and its features, loads and expenses that will be charged to the investor and the past performance of the scheme. Investors who require information in greater detail can ask for the SID and SAI. Correct, relevant and timely information is essential for investors to make the right investment decisions. Mutual funds provide the information in a simple and readily available form for investors to access and use.

Importance of Mutual funds in Financial Planning

Few years ago, manufacturers of ready‐to‐eat Indian food were baffled with the poor response to their range of convenience foods.  Beyond young single people, the market refused to expand to families. Their research showed that families were looking at saving time spent in the kitchen.  What was going wrong?  Another research was commissioned, which showed that the woman of the household preferred to add her ‘touch’ however little it may be, before serving the meal. The market for gravies and mixes thus took off.   In managing our finances, several households tend to choose the do‐it‐yourself path, to their disadvantage. There may be a high in whipping up an exotic investment recipe for our households.  But it suffers the same risks that an amateur cook will bring, simply because the off‐the‐shelf solution did not appeal to the ego.

We can take a better approach.  We know our nutrition needs and design meals that cater to the specific needs of the family.  We can exercise our choices in bringing the meal to the table.  We could similarly take hold of the planning of our finances and our specific needs and use pre‐designed portfolios to meet those needs.  Mutual funds offer their portfolio management skills to help households build their portfolios, so that the family’s financial well‐being can be taken care of.  The job of choosing the product and deciding what works for us is still ours on which we could focus.

Financial planning is about taking charge of the long term well‐being of the family.  If we think our child needs a glass of milk a day, we do not indulge in nurturing a cowshed but buy packed milk off the shelves.  If the child needs funding for education and we know this means a large sum of money sometime into the future, we can choose to buy an equity fund that gives us long term growth.  If we think our nutritional needs change as we age, we can buy oats off the shelf.  We make that decision to switch to the oats instead of the craving for the parantha.   But we still pick that oats pack off the super market’s shelves.

 Mutual funds represent that range of pre‐packed products that enable us to implement our financial plans.  What they are made of and how they would contribute to our financial health is pre‐defined.  An equity fund will focus on growth and carry long term benefits and short term risk.  Our decision should be about how much of equity we need to have, given our need.  Just as we decide how many rotis the teenage son will eat, compared to his grandpa. Having made that decision, we buy a well-managed equity fund, rather than wasting our energies in creating an equity portfolio, share by share, on our own.  Mutual funds enable us to focus on our core planning needs, without frittering away our time doing elaborate chores that can be efficiently outsourced.

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Financial Goal Based Investing

When we take our family on a holiday, we make several plans – for travel, stay, sightseeing, equipment, food, and other expenses.   Many of these decisions however depend on a crucial factor – our travel destination.  If we travel to Ladakh we will carry woolens and trekking equipment; if we went to Goa we will pack sun screens and swimming costumes.   Our travel plan is defined by the destination.  Similarly, our investments have to be defined by our financial goals.

We may have a long list of things we like our savings to achieve.  Educating our children, getting them married, planning for a comfortable retired life, owning a home, re‐doing our existing homes, funding our holidays, and so on.  These large ticket items that cannot be met with our regular income require us to set money aside.  But saving alone may not be enough ‐ we need to plan about how to invest those savings, so that we are able to meet the goal we have in mind.  Such an approach is called financial goal‐ based investing, and is a useful way to plan and provide for several critical large expenses that we have to incur.

Consider for example, the education of the children.  We may begin to set aside some money for them when they are young.  But choosing an investment plan requires an understanding of three things.  First, we define the goal in terms of amount of money and time.  Assume that we like to save for the child to pursue a professional course, after 16 years.  We know that it costs, say, Rs.1 lakh a year today.  We need to consider the effect of inflation on this goal. Assume we estimate an inflation of 6%.  That is the minimum rate of return our investment must make, so that the amount grows at least to cover the effect of inflation.  Second, we need to understand how much we can save per year for this goal.  This depends on our income and expense patterns and our seriousness about this goal. Third, we have to choose an investment option that generates enough return to meet the goal.

We either increase the savings or we choose a higher return yielding investment, and balance the two.   Too high savings may be impractical; too high an investment return may be risky.  We therefore have to consider the time on hand.  Longer the time we have, greater is our ability to choose higher return and higher risk investments. If the return on our investment is high, the same goal can be met with lower amount of saving, freeing money for other goals.   A slow train will be less expensive, but take us time to reach.  A flight will reach us to the same place faster but costs more.  We have to make the same choice with our investments, based on the time we have.

Mutual funds aims to fund our financial goals by offering a range of products that help us earn income or achieve growth over a long period of time.   Goals give our investments a purpose and make it easier to choose our investment vehicles.

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