Chapter 11
11Mutual Fund Basics
Mutual funds pool investor money and invest it according to a stated scheme mandate. This chapter explains the basic measurement language first: NAV, units, AUM, cost, exit load, benchmark, fund manager, and direct versus regular plans.
NAV
Example: two Nifty index funds can have different NAVs because they started at different dates, yet both may hold similar portfolios. The lower NAV is not cheaper; the percentage movement matters.
Net Asset Value is the per-unit value of a mutual fund:
\[ \text{NAV}=\frac{\text{assets}-\text{liabilities}}{\text{units outstanding}}. \]NAV is not expensive or cheap by itself. A fund at NAV 500 is not necessarily costlier than one at NAV 20.
Do not rank by NAV.
- Judge funds by portfolio, strategy, risk, cost, and performance.
- Do not choose funds because NAV is low.
- NAV changes reflect underlying asset movement.
1996 - SEBI mutual fund regulations
SEBI's mutual fund regulatory framework gave Indian mutual funds a clearer structure for scheme operation, disclosure, trusteeship, and investor protection. The modern Indian mutual fund industry should be read through that regulated structure.
Units
Example: investing INR 10,000 at NAV 50 gives 200 units, while investing at NAV 100 gives 100 units. If both rise 10 per cent, wealth rises equally; unit count alone says nothing.
Units represent your share in a mutual fund scheme. Holding value equals units held multiplied by NAV.
When you invest, you receive units according to the applicable NAV. When you redeem, units are reduced.
Track value, not unit count.
- Track units and NAV separately.
- More units do not imply more wealth unless value is higher.
- Redemptions reduce units.
AUM
Example: a tiny index fund may struggle with tracking and liquidity, while a very large small-cap fund may struggle to deploy money efficiently. AUM is context for execution, not a medal.
Assets Under Management is the total money managed by an Indian mutual fund scheme.
AUM indicates scale, but not automatically quality. Very small AUM may create viability or liquidity concerns; very large AUM may reduce flexibility in some strategies.
Use AUM as context.
- Use AUM as a context variable, not a ranking score.
- Be cautious with very small funds.
- For index funds, sufficient AUM helps efficient tracking.
Expense ratio
Example: two similar index funds with different expense ratios will not deliver the same investor return over decades. The lower-cost fund starts each year with a small but certain advantage.
Expense ratio is the annual cost charged by the mutual fund scheme.
Cost is certain
Every rupee of cost directly reduces investor return. Excess performance is uncertain; cost is certain.
Control cost
- Prefer lower cost for similar strategy and quality.
- Direct plans usually have lower expense ratio than regular plans.
- Compare expense within the same fund category.
Exit load
Example: an equity fund may charge an exit load if redeemed within a year. An investor using it for emergency money may discover that liquidity exists but has a cost.
Exit load is a charge for redeeming from an Indian mutual fund before a specified period.
It discourages short-term movement and matters when liquidity or near-term use is possible.
Check exit before entry.
- Check exit load before investing.
- Do not put emergency money in products with inconvenient exit rules.
- Include exit load in return calculations for early redemption.
Benchmark
Example: a large-cap fund should not be celebrated merely for beating a savings account; it should be compared with Nifty 100 or the stated benchmark. The reference frame decides whether performance is meaningful.
A benchmark is the reference index used to judge fund performance, such as Nifty 50, Nifty 500, Sensex, or a debt index.
Without a benchmark, performance has no reference frame. A fund should be compared with the index that matches its mandate.
Use correct reference frame.
- Compare a fund with the correct benchmark.
- Long-term underperformance after cost needs attention.
- Benchmark risk may differ from fund risk if the fund deviates strongly.
Fund manager
Example: a star manager can have weak years even with a sound process, and a lucky year can flatter a weak process. Investors should ask whether decisions are repeatable and within mandate.
The fund manager chooses securities according to the scheme mandate.
In active funds, manager skill and process matter. Even skilled managers can underperform for long periods because markets are noisy.
Judge process, not fame.
- Evaluate process, consistency, and risk control.
- Do not chase a manager after one good year.
- Prefer simple passive funds if manager selection is difficult.
Direct vs regular plan
Example: the same scheme can have a direct plan and a regular plan with different costs. A do-it-yourself investor may keep the cost saving, while an advised investor must judge whether advice earns its fee.
Direct plans are bought without distributor commission and usually have lower expense ratio. Regular plans include distributor commission and may include advice service.
The economic difference compounds over time. Advice has value only when it improves decisions by more than its cost.
Pay only for useful advice.
- Use direct plans if you can choose and manage funds yourself.
- Use regular plans only when advice quality justifies the cost.
- Compare the same scheme's direct and regular expense ratios.
