Mutual Funds Full Concept Revision I CA Final SFM

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Hello everyone this is vavik choksi here and i hope you guys are doing great today we would be doing a quick overview of the mutual fund chapter in your ca final sfm it is an important chapter and a scoring chapter as well so let us get started with the concepts of mutual fund so to start with what is a mutual fund a mutual fund is a collective investment scheme

Where we the fund gathers small small investments from a large pool of investors get experts to manage the fund and generate return for the investor so this is very helpful for people who do not have really good investment expertise and do not have as much money to diversify fully so they can invest in the mutual fund and that mutual fund will invest the entire pool

Of money in a diversified group of assets so this is just a general theory for the mutual funds very popular in instrument in india and across the world as well now there are two main types of mutual funds there is the open-ended fund whereby you are the investor can enter the mutual fund whenever they want and exit the mutual fund that is claim redemption also

Whenever the investor wants so these open-ended funds are open for entry and exit whenever the investor desires however there are certain close-ended funds whereby the investor can enter at a particular date by subscribing to units directly and then there is a fixed redemption date where the money can come back now these close-ended units if i want to transfer

Am i stuck well usually yes however these units are traded on the stock exchange and then even the close ended units you may not go to the company the fund and claim redemption but you can sell it to someone uh else as well now for open-ended units we are saying that we can enter the fund whenever we want and exit from the fund whenever we want so that is an

Excellent flexibility available we don’t have to go in search of buyers however at what price will this entry and exit happen this is happening at something called as net asset value or called as nav now the performance of a mutual fund is assessed considering the nav of the fund like in mutual fund there are units for a company you have shares in mutual fund

Error units shares cannot be in decimals but units can very well be in decimals so how will you find the value of these units one of the best methods to consider the value of these units is considered to be the nav how do you calculate the nav well we will take the market value of the investment portfolio what is there in the investment portfolio well you can have

Shares you can have bonds you can have commodities you will take the market value of these investments typically you will be given in exam questions you will be given the cost of these investments let’s say you have invested uh 2000 rupees in listed shares when the sensex let us say was ten thousand let’s say after a year sensex becomes 12 000 that’s at the return

Of 20 percent then how much will your investment be we will say will it be stuck at twenty thousand no it will also increase so if the beta is one for example if the sensex goes up by 20 you will also go up by 20 so that is uh whatever was your investment two thousand plus twenty percent that is equal to two thousand four hundred alternatively you might carry a

Different beta in which case you will have to find the value of your investments accordingly secondly you might also have some other assets apart from investments like cash the complexity in cash maybe you might have to calculate cash balance by considering the issue proceeds you have received the issue expenses that you will have to pay the investments that you

Make the sale proceeds that you generate the money that you pay to the fund manager the distribution that you give to your unit holders after considering all of these adjustments you will get the closing cash balance which is also an asset for the fund and hence it should be a part of net assets value apart from this there can be other assets as well like you might

Have invested in companies or bonds and these companies have announced dividends or announced or time has passed and interest is accrued however you’ve not yet received them and as a result this is a receivable that can also be a part of the net assets so we are just talking about assets are there also liabilities well usually relatively less but there can also

Be liabilities in the form of let’s say fund managers charges which are yet to payable or let us say there are certain partly paid shares where calls have been made and you have to make a payment on the calls so these are all liabilities and after that whatever value you get is the net assets value this is for all the units in the fund you divided by the number

Of units on a particular date and that will give you the nav and this is the nav through which you track mutual fund performance if i want to enter into the fund i will buy at the nav prevailing on a particular date if i want to exit the mutual fund then i will exit at the nav prevailing at a particular date and hence nab is very important a lot of students who

Do their industrial trainings also calculate nav on a daily basis i hope you understand that since the mutual fund portfolio is enlisted shares bonds etc the value of these instruments can regularly change and hence the nav can regularly change so this is about net assets value you do get sums on nav calculation then you have the questions which are on calculation


Of return and the types of funds so first of all in case of a regular income scheme so if i look at the regular income scheme i invest in the mutual fund unit after a specified period of time the nav might appreciate apart from that the mutual fund might give distributions these distributions can take various names and various forms like dividend distribution or

Capital gains distribution or any other form of distribution so how will i calculate the return well in a manner which is very similar to that which what i do in portfolio like in portfolio b tech p1 minus p0 that is price at the end of the first year minus price today plus distributions or dividend upon p 0 into 100 in a similar way instead of p we take nav so

Nav at point n let’s say after one year minus nav that i started with today that is nme 0 plus the distributions during the period so that will give me the total return so let us say start when the nav was 10 at the end of the year nv becomes 11 and during there there’s a 0.5 distribution in which case 11 uh sorry uh 11 minus 10 plus 0.5 that is 1.5 is my return

On an investment of 10 rupees and hence 15 probably is my return 1.5 upon 10 into 100 that i’ve done on a per unit basis like i do in portfolio as well however there are certain special schemes and before we go to those special schemes uh we also need to understand the concept of annualization what do you mean by annualization over here this is a return that you

Have calculated for a holding period let us assume the holding period was one year and hence 15 is a return per annum however what if this holding period was two years in which case the nav becomes 11.5 after two years you invested 10 rupees today and over the two years you got a distribution of 0.5 in which case that 15 percent is written over a two year period

However you are interested in finding a return per annum and hence we would say that okay in such a case this will be 11 minus 10 plus let us say 0.5 upon 10 into 100 into let us say 12 by 24. so 15 per annum is approx 15 over 2 years is approximately equal to 7.5 percent per annum alternatively this could have been the return over six months only so nab went up

To 11 in a matter of six months in which case this is actually the holding period return that is written over six months so 15 percent is actually four six months which means if i want to annualize it i will do 12 by 6 and hence the return will actually become 24 percent thirty percent uh on a per annum basis this is what you call as annualized return in a lot of

Questions you have been asked to do annualized return and hence in such case you have to take the return and then do into 12 by m where m is the number of months in the holding period or 365 by the days as i guess maybe however if the question remains silent or it asks you to calculate the holding period return that is the return for the holding period then you

Don’t need to do the 12 by an adjustment though most of the questions require you to calculate something called as annualized return now this is done on a per unit basis and we usually have no problem in that in case of a regular income scheme or in some other schemes as well like growth schemes but before you go to the schemes we need to understand a very important

Plan that comes a lot of times in your exam which is a dividend reinvestment scheme so what happens over here is mutual funds when they give out schemes they would say that well we might distribute dividend but we don’t know whether you need this dividend or not like you are a successful professional you have enough money so you don’t need a stream of income you

Can reinvest that money or if you’re a senior citizen who needs a regular stream of income human you might need regular dividend so we give a option that whether you want a regular income or you want a dividend reinvestment so what will happen in case of reinvestment for example you have purchased 100 units so if you have purchased 100 units at the start of the

Year you can still find the total return in the exact same manner so over here you can do it on a per unit basis or you can even do it on a total basis so you can say 10 units uh 10 rupees per unit into 100 units that is the total investment let us say of one thousand at the start of the year that becomes at the end of the year 11 rupees into uh 100 units that is

1100 plus you have received during the year 0.5 into 100 that is 50 rupees as dividend you divide this by 1000 your total investment and hence you still get the same let us assume this was a single year return you still get if you calculate 150 divided by 1000 which is 15 percent because you start with 100 units you end at 100 units however what happens in case of

A dividend reinvestment plan well in such cases you need to remember that you can never do the return calculation on a per unit basis because you are assumed that the one unit that you start with is the one unit that at which you end which is not the case you can start at one unit but probably you are having more than one units like for example in this case you can

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Start at one thousand rupees which is made up of 100 units at the rate rupees 10 and at the end of the year you might have more than one thousand so how is it possible well rather than getting a rupees 50 distribution of dividend that is 0.5 into 100 units we said that we wanted new units such a new units will be at what price well new units will be at the price

Which uh price on the date when nav is distributed now we don’t know what the price is probably let us say the price over here for simplicity is 10 only well it can be different it can be 11 as well it can be 12.5 as well so let us say we take a different price altogether let us say 12.5 in which case this is the and this is the nav on the date when dividend is

Distributed so it is like saying that i give you 50 rupees worth of cash you don’t want that guy so you give me 50 rupees back and against those 50 rupees i’m going to give you units those units will be given based on the enemy on the date when the units are allotted which is let us say 12.5 this is somewhere during the year in which is 50 divided by 12.5 probably

This will come to uh four units i guess this will be let us say four units which means that the end of the year i am now having 104 units but i don’t have cash so i cannot add anything because i have not received 50 as cash but i’ve received four units and these 104 units all of them are worth 11 and hence you do 104 into 11 so uh that will come to probably uh i

Mean i might so this is 11 44 if i’m not wrong so maybe there’s some calculation but as a concept this is 1144 divided by a thousand so we are saying that thousand that we started with i did not get any cash i got more units that is four or more units which are worth 11 at the end of the year and as a result you will calculate your return on a totality basis which

May be different from 15 in certain cases it may be higher if the nav is increasing so you got new units at 12.5 and the nav become becomes higher or it may even fall if you got new units at 12.5 and the nav is even lower so but in dividend reinvestment plan you have to do this now sir in exam questions how do we know well the question should usually tell you and

If it does not it might give you hints like you started the year at 100 units and you ended the year or after two or three years you have more units there’s a very typical institute questions where you started at 10 000 units and after two or three years you have eleven thousand two ninety six point something units there is a clear indication that unless you have

Purchased it and the question has not told you that how did the number of units in increase well because you might have taken the dividend reinvestment option so you need to be careful in that workings so this is a dividend reinvestment schemes where dividends declared in each other reinvested by the funds and additional units are distributed these additional

Units will be total dividend divided by the navs on the date of dividend and you need to remember that in such cases their return calculation will be done on a totality basis then there are bonus schemes bonus schemes well you don’t give dividend at all in which case we will say that once the time is right and we have enough results we will give bonus and bonus

Over here for example you read let’s say something like one is to four you read it as newest world which means for 100 old instruments you will get how much 100 into one by four that is equal to 25 even over here the return has to be calculated on a totality basis so you will start at 100 units into rupees 10 and that will become 125 units 100 plus 25 so 125 units

At whatever is the prevailing nav there is no further distribution of dividend divided by thousand and that will give you the return this is on bonus schemes and then lastly you have growth schemes where there is no dividend no bonus so the enemy appreciates you can do this on a per unit basis or even on a totality basis in certain rare questions which institute

Does ask they do tax adjustments they might give you short-term uh capital gains or they might give you stt in which case you remember that your total return total proceeds at the end will be calculated after deducting stt and after deducting the tax as applicable and then you will calculate the return on a post tax basis on an annualized so into 12 by n so if

There are 10 years that is 120 months 12 divided by 120 you will get the paranormal return so you must have seen a couple of sun moon and other types of questions we are not doing it right now but uh that i think you will get perspective of what i’m trying to communicate next there is something of portfolio management which is overlapping comes in portfolio as

Well as mutual funds so this is fund evaluation performance evaluation measures now if i have money and i have three or four fund managers in front of me uh how do i evaluate which of them are better well there are three main ratios that you look at first is a sharp ratio where you take the reward in the numerator that is the actual return minus the risk period

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So even if they don’t bear risk they can we can earn the risk-free rate so your actual reward is the return of fund manager x minus the risk-free rate but that is risky and hence you divide it by the measure of risk so the measure of risk over here is the standard deviation now this is where students make mistake they think sharp ratio means denominator should

Have beta incorrect trainer ratio with the same numerator has a beta denominator because trainer ratio assumes that the portfolio is fully diversified and hence beta is the appropriate measure of a risk sharp ratio on the other hand tests whether the portfolio is diversified or not well if it is fully diversified the standard division would be lower if it is not

The standard division would be higher and hence a fund manager who has not diversified as well should be penalized by a lower sharp pressure because he would have a higher standard deviation and hence sharp ratio is generally considered to be superior to the turner ratio when it comes to general fund manager evaluation the last method is also called as jensen’s

Alpha where you take the actual return of a fund manager and compare that with the required rate of return the actual return over here may be 18 but we say that you should not really compare it with the risk free rate because this is a risky investment okay then based on the risky investment what should be your required rate of return well considering beta you

Can find the required return using capm you have generated 18 the required rate of return on a similar portfolio should have been 16 and hence two percent is the access that you have generated and that is what you call as alpha in all the three cases we prefer managers with higher so higher the better in either of the evaluation technique sharp ratio is generally

Considered to be the most superior among these and the last part over here would involve the fund management strategies fund management strategies can be three strategies there can be something called as buy and hold which is a very simple strategy you buy some bonds you buy some shares and you forget about it so buy and hold second is constant ratio strategy in

Which case you will want to maintain a specific proportion so let us say 50 50 is your desired proportion in which case let’s say you start at 100 in share investment 100 in bond investment and you want to maintain 50 50. one month passes let’s say you want to rebalance after every one month the shares become 120. the bonds continue to remain at 100 your portfolio

Is 220. but 220 is not 50 50 shares and bond so you rebalance you say okay ideally the portfolio should be 110 bonds 110 shares and then you will sell 10 rupees worth of shares and invest that money in bonds you will keep on doing this to maintain the balance till the time uh you think it is appropriate again this rebalancing will be done at specified intervals as

Decided by the manager and after specified thresholds are across so you might always say that okay if this is just a difference of five percent we don’t want to rebalance if it is beyond five percent you want to rebalance so let us this is constant ratio strategy and then there is cppi constant proportion portfolio insurance where you try to assess what is your

Maximum falls so let us say you are making a 100 rupee investment and your maximum in a position to bear a fall of ten percent which means your floor is 90 your portfolio should not go below 90 and hence 100 minus 90 that is equal to 10 rupees maybe your cushion or buffer so this cushion can be invested in equity so probably 10 would be invested in equity but if

I’m slightly aggressive manager i can have a multiplier so i can say okay whatever is the cushion two times of that i want to invest in equity then 10 into 2 that is 20 rupees you can invest in equity in which case the remaining entity will be invested in debt again at the rebalancing date you will assess let us say 20 of equity becomes 40. in which case your total

Portfolio is 80 of bonds plus 40 which means 120 rupees your revised cushion will be 120 minus the floor that is 30 rupees and you can say okay 30 into 2 that is equal to 60 i can still play with equity you have currently had uh let us say 40 rupees in equity now uh let us say you can invest another 20 by selling 20 worth of bonds and so on so this is on cppi that

Largely takes care of the mutual funds there are a couple of other concepts like load entry and exit load like if you in certain funds if you enter the fund you have to pay some load that is transaction cost which is added and if you exit at the time of redemption you will be deducted the proceeds so exit load is deducted other than that there is something called

As dividend equalization for which we have a separate video you can refer the link for the video and that should probably help you uh so that largely takes care of the discussion on mutual funds i hope this video has been helpful uh good luck stay in touch and i’ll come with some other video fairly soon bye bye take care

Transcribed from video
Mutual Funds Full Concept Revision I CA Final SFM By Bhavik Chokshi