Mutual Funds: Definition, Types, Risks, and More

portfolio, risks, and assets under management of mutual funds in India

The purpose of mutual funds and portfolio management is to invest money to get better returns. Although a mutual fund is a way to invest in the market in an indirect way to make profits, there are significant risks associated with it. This article talks about the risks and assets under the management of mutual funds.

What Is Mutual Fund?

A corporation known as a mutual fund is one that collects money from many different investors and invests it in securities like stocks, bonds, and short-term loans. The overall holdings of the mutual fund make up its portfolio. Investment professionals buy mutual funds. Each share represents a shareholder’s interest in the fund and the earnings it generates.

How Does It Work?

You purchase the right to a share of a mutual fund’s returns when you purchase shares of the fund. The many investments housed in a mutual fund’s portfolio generate dividends and interest for the fund. By selling assets, managers make capital gains (or losses), which they then distribute to investors.

Benefits of Mutual Funds

Mutual funds are popular among investors because they typically provide the following benefits:

  • Professional administration: The fund managers conduct the research on your behalf. They choose the security and keep track of their performance.
  • Diversification, also known as “don’t put all your eggs in one basket”: refers to mutual funds’ investment in a variety of companies and industries. This reduces your risk if one company fails.
  • Affordability: Most mutual funds have a low initial investment and subsequent purchase threshold.
  • Liquidity: Investors in mutual funds can easily redeem their shares at any time for the current net asset value (NAV) plus any redemption fees.

Types of Mutual Funds

The types of mutual funds include:

#1. Stock Funds

Some equity funds are labeled as small-, mid-, or large-cap based on the size of the companies they invest in. Others are included according to their style of investing, such as aggressive growth, income-focused, value, and others. On the basis of the size and future growth potential of the invested stocks, equity funds can be categorized.

#2. Bond Funds

The fixed income category includes mutual funds that produce a minimum return. These funds frequently employ active management and look to acquire bonds that are reasonably discounted in order to resell them for a profit. However, there is risk involved with bond funds, and interest rate risk affects all bond funds.

#3. Index Funds

Because this strategy necessitates less research from analysts and advisors, fewer expenses are passed on to shareholders, and these funds are frequently designed with cost-conscious investors in mind.

#4. Balanced Funds

Balanced funds invest in a hybrid of asset classes, whether stocks, bonds, money market instruments, or alternative investments. The objective of this fund is to reduce the risk of exposure across asset classes. Some funds have a specific allocation strategy that is fixed, while other funds follow a strategy for dynamic percentages.

#5. Money Market Funds

Money market funds are relatively low-risk investments. They are only permitted by law to invest in certain high-quality, short-term investments issued by US corporations and federal, state, and local governments.

#6 Income Funds

Income funds are named by their objective, which is to offer reliable current income. These funds invest largely in high-quality corporate and government bonds, holding them until maturity to produce income streams. Although fund holdings could increase in value, these funds’ main objective is to give investors reliable cash flow. As a result, retirees and cautious investors make up the target market for these funds.

#7. International Funds

A foreign fund, usually referred to as an international fund, only makes investments in assets that are situated elsewhere. Global funds, however, are able to make investments anywhere in the world. Their volatility can be estimated from the distinctive political and economic risks that each nation poses. However, by enhancing diversification, these funds can be included in a well-balanced portfolio because results in foreign nations can not be connected with returns at home.

#8. Specialty Funds

Sector funds are focused strategic funds intended for particular economic sectors, like the financial, technological, or healthcare ones. It is simpler to concentrate on a particular part of the world’s geography thanks to regional financing. Ethical funds only invest in businesses that adhere to their standards or principles.

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Portfolio Management and Mutual Funds

The purpose of mutual funds and portfolio management is the same, i.e., investing money to get better returns. Although portfolio management and mutual funds are ways to invest in the market in an indirect way, there are significant differences between them. Portfolio Management and mutual funds work on different investment models. All investors need to understand the core difference between them so that they can make informed investment decisions.

Differences Between Portfolio Management and Mutual Funds

The differences between portfolio management and mutual funds include:

#1. Fee Schedule

Portfolio management services are much more expensive than mutual funds. Charges in Portfolio Management include a fixed fee, a performance fee, and a fund management fee, whereas charges in mutual funds are fixed and are based on the amount of individual investment.

#2. Risk

Portfolio management is performed on a concentrated portfolio of approximately 30 stocks, making them riskier than mutual funds, which offer diversification by investing in a large number of stocks and different funds.

#3. Investment Size

When choosing an investment product, you must take your own risk tolerance into account. With mutual funds, you can invest as little as Rs. 500 in a systematic investment plan, whereas the minimum investment level for portfolio management is Rs. 25 lahks. Mutual funds offer services to a wide spectrum of investors, whereas portfolio management services are often only available to high-net-worth individuals.

#4. Taxation on Investment

Mutual funds provide plans and have a pass-through condition, which means that fund managers can buy and sell stocks as many times as they want without risking tax. In the case of portfolio management services, you are holding stocks in your name, so every time the portfolio manager sells a share, there is a capital gain or loss.

Read Also: Broker Manager: Job Description, Qualification, Salary & More

Assets Under Management of Mutual Funds

The overall market value of mutual funds is referred to as assets under management. These assets must be managed, and all investment decisions must be made on behalf of the investors by the fund management. AUM is a gauge of a fund house’s size and performance. The assets managed by mutual funds and their performance over time can be simply compared to other comparable schemes.

The returns received by a mutual fund are also included in the asset under management value. It can be held in accordance with the investment mandate, invested in assets, or used to pay investors dividends. Bank deposits, mutual funds, and cash reserves are all included in the actual value of the assets under management.

Impacts of Assets Under Management on Mutual Funds

The bloated AUM of an equity fund can sometimes have a negative impact on its performance. Nonetheless, there is little evidence to suggest that having a higher AUM either hurts or helps fund performance. 

It is the fund manager’s responsibility to recognize market opportunities and enter or exit a stock at the “right” time. A larger asset under management has often hampered the manager’s ability to make quick investment-related decisions. Before investing, consider the fund’s performance in comparison to the benchmark and its competitors.

Should You Think About AUM Before You Invest?

If a fund’s AUM is on the higher side, mutual fund investors are frequently impressed. People think the fund must be a good one if so many people have invested in it. However, there are a lot of reasons why you shouldn’t choose a fund based on this number. The expense ratio, the track record of the fund management, and adherence to the investment mandate are some of the most crucial elements to take into account.

Significance of AUM in Relation to Various Fund Types

#1. Equity Funds

AUM is less significant in this situation than consistency in results and the fund house’s adherence to the investment mandate. By consistency, we mean surpassing the benchmark at both the highs and lows of the market. As a result, an equity fund is determined by the asset manager’s capacity to consistently provide positive returns rather than its popularity or size.

#2. Debt Funds

AUM is a crucial metric to take into consideration if you intend to invest in debt funds. Fixed fund expenses might be split among more investors by a debt fund with additional capital. This can result in a reduced cost per individual and higher fund returns. The fund company can negotiate acceptable interest rates with debt issuers because there are more assets in the fund.

#3. Small Cap Funds

After a certain point, small-cap funds tend to limit cash inflows. The DSP BlackRock Micro Cap Fund is a well-known example. This usually happens when the assets in a mutual fund exceed a certain threshold. If the fund becomes a major shareholder in a company, it may find it difficult to trade its shares when the market fluctuates. This is why small-cap funds frequently avoid lump-sum investments in favor of SIPs.

#4. Large Cap Funds

The profit earned by large-cap funds is mainly determined by the market yields. It usually does not depend on the asset under management. There have been several cases where companies in a smaller asset class have generated significantly more revenue, despite shareholders purchasing significantly fewer stocks in those institutions when compared to companies with larger assets.

Assets Under Management of Mutual Funds in India

The total assets under management of India’s mutual fund industry reached nearly Rs. 25,63,935 crore in August 2019, representing a nearly 2.5% increase over the total in 2014. Mutual fund assets under management surpassed the Rs. 10 trillion mark in 2014, increasing by nearly Rs. 20 million in just two years. The total assets are divided into different mutual fund profiles, totaling 8.53 billion. For the past 63 years, one of the most popular funds has been registered.

Risks of Mutual Funds

Due to their wide range of investments in corporate bonds, debt, and stock, mutual funds are hazardous. Each of these markets exhibits a distinct behavior, with price changes caused by a range of variables that can provide gains or losses. As a result, it’s crucial that you determine your risk tolerance and invest in the best mutual funds. You can accurately manage mutual fund risks and returns by looking at the risk profiles of the funds in advance.

Types of Risks in Mutual Funds

Every investment involves some level of risk. The type of risk varies from investment to investment, making it even more important to understand the various types of investment risks. The types of risks in mutual funds include:

#1. Market Risk

Market risk is something that might affect your investments due to the poor performance of the market. Its performance can depend on a number of factors, such as inflation, recession, or the fluctuation of interest rates. These are some of the most important mutual fund risks to be aware of.

#2. Volatility Risk

Mutual funds are mutual funds that invest in the shares of companies listed on stock exchanges. The value of a fund is directly related to the performance of those companies, which might be affected by prevailing economic conditions. These factors directly impact the price of the stocks of the company and might result in an upward or downward movement in its share value.

#3. Liquidity Risk

When mutual funds have long-term investment goals and strict lock-in periods, liquidity risks arise. It can also happen when a seller is unable to find suitable buyers in the market at the right time. You avoid the liquidity risks of mutual funds with a diverse portfolio.

#4. Credit Risk

Credit risk, also known as default risk, affects mutual funds that invest in bonds and debt instruments. When the bond issuer is unable to pay the promised interest, the issuer has defaulted or committed a credit loss. Companies with high credit ratings pay lower interest rates and vice versa.

#5. Concentration Risk

A diverse portfolio can help minimize risks from the downfall of a single instrument. Concentration risk arises when investors tend to put all their money into a single investment scheme or in one sector. This leads to the concentration of a considerable amount of funds in one particular scheme, which is not considered a good practice.

#6. Inflation Risk

Inflation risks are associated with the rise in the general level of prices of various goods and services. If you do not account properly for inflation in an investment plan, you might fall short of funds to accomplish your goals. This makes it important to make investments in mutual funds that are able to protect your purchasing power.

Related Posts

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  3. ASSET MANAGEMENT: Overview, Groups, Company Stocks

FAQs on Mutual Funds

Do people really earn from mutual funds?

When you invest in mutual funds, you can earn money in two ways: dividends and capital gains. The stock-invested funds pay out dividends based on their market earnings. You earn this amount if you choose to receive these dividends.

How do you start investing in mutual funds?

To invest in a mutual fund, you must first be KYC (Know Your Customer) compliant. One method is to use the physical KYC form. Investors can complete this form and attach a photograph, a copy of their PAN card, and a valid address proof such as an Aadhaar, a copy of their passport, an electricity bill, or bank statements.

Is mutual funds high risk?

Mutual funds are typically less risky than investing in just stocks. However, the level and type of risk depend on what types of investments are in a particular mutual fund.