How do Mutual Fund Investments Work?

Mutual funds are investment vehicles that pool money from multiple investors to buy a diversified portfolio of securities. These investments are managed by experienced fund managers, who use their expertise and resources to generate returns for the fund.

Overview

Here is a brief synopsis of how mutual fund investments work.

• Investors buy mutual fund scheme units and the mutual fund pools money from multiple investors.
• Investors can buy into Mutual Fund schemes through an Asset Management Company (AMC) website, registered distributors/advisors, or banks.
• A team of experienced investment professionals do research and manage mutual fund schemes.
• Depending on the type of Mutual Fund scheme, each scheme makes investments in securities, such as equities, debt, and commodities. Like bank fixed deposits (FDs), Mutual Fund schemes. too, generate returns. However, Mutual Fund scheme returns are subject to market risks.
• The investment value in any Mutual Fund scheme increases or decreases based on the performance of the securities in the Mutual Fund scheme’s portfolio.
• Mutual Fund scheme managers (also called fund managers) aim to maximize the overall return while managing portfolio risks.
• For open-ended schemes, clients can redeem at any time subject to conditions. For closed ended schemes, interval funds and other offerings, the procedure and requirements are different.
• Mutual Funds charge management fee for their service. Note that investors also have to pay stamp duty and other applicable taxes.

Types of Mutual Fund Investments

• Equity Mutual Funds invest primarily in equities and equity related instruments.
• Debt Mutual Funds invest in debt and money market securities.
• Commodity Mutual Funds invest in physical commodities such as gold or silver etc.
• Hybrid Mutual Funds invest in a combination of assets, such as equities, bonds, and commodities.

Example:

Large-cap equity Mutual Fund schemes invest at least 80% of their assets in large-cap stocks. Large-cap stocks (also referred to as equities, or simply, listed companies) are the 100 biggest companies by market cap. The large-cap Mutual Fund scheme’s value goes up if the stock prices of its investee companies go up. Although the NAV (Net asset value) of the mutual fund scheme may or may not move proportionately with respect to the stock price mentioned earlier. Over the course of time, NAV of the mutual fund scheme moves proportionately to the movement in weighted average of individual stock prices of securities in the scheme portfolio.

Note: Mutual fund schemes are charged with different types of fees including management fees.

Example of Mutual Fund Investment Portfolio:

Table 1

Mutual fund portfolio =

Formula 1

Chart 1

Table 1 & Chart 1 (shown above) show a hypothetical Equity Mutual Fund Portfolio consisting of two time periods.
Stock A, Stock B, Stock C, Stock D, and Stock E have 15%, 20%, 8%, 40% and 17% weightages in hypothetical Equity Mutual Fund Portfolio respectively.
In Period 1, Stock A, Stock B, Stock C, Stock D, and Stock E are assumed to be priced as shown in row 1 of Table 1. Subsequently, in Period 2 the assumed prices of stocks change, as shown in row 2 of Table 1.

As per Table 1 & Formula 1 the price of hypothetical Equity Mutual Fund Portfolio is calculated as weighted average price of stocks. This gives the hypothetical Equity Mutual Fund Portfolio a price of 39.21 rupees in Period 1 which subsequently rises to 41 rupees in Period 2.   
The Mutual fund portfolio column of Table 1 illustrate the total market cap.
The price of the hypothetical Equity Mutual Fund Portfolio rises to 41 rupees in Period 2, which results in a return of 4.56%.
An investor investing in the hypothetical mutual fund portfolio in period 1 would have realised a return of 4.56% on their investment by Period 2.

Note: Management fees or any other types of expenses and taxes have not been considered in this example.

Disclaimer:

This is an illustration of a hypothetical mutual fund portfolio consisting of five stocks & two time periods. In reality:

• Equity mutual fund portfolios have well more than ten stocks.
• Net asset values are calculated on a daily basis based on the value of a portfolio. For simplicity, we are showing the total market cap.
• All mutual fund investments are subject to market risks.
• This illustration is for educational purpose only. In reality there may be many different types of assets in a particular scheme.
• The returns shown are exclusive of any taxes, TER, management fees, etc.
• This illustration considers two time periods, but in reality, mutual fund schemes are active for multiple years.
• Returns are neither assured nor guaranteed.

The information contained in this document is for general purposes only and not an investment advice. Readers should seek professional advice before taking any investment related decisions.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.