A Beginner’s Guide to Mutual Fund Terminologies in India
Understanding the basic concept of mutual funds in India can seem daunting, especially with all the complex terms and jargon often thrown around. Many new investors find themselves overwhelmed, trying to grasp the basic mutual fund concepts. This guide provides straightforward explanations of common mutual fund terminologies, using examples to make each concept clear and easy to understand.
Account Statement
A mutual fund account statement, also known as a Consolidated Account Statement (CAS), summarises an investor’s holdings and transactions within a fund house over a specific period. It provides essential information such as the NAV (Net Asset Value), which indicates the per-unit value of investments, and the market value, reflecting the current worth. The statement also includes details on returns, transaction history, dividends received, a unique folio number, and the statement period. Investors can obtain this statement from the mutual fund company or the Asset Management Company (AMC), and for those with multiple investments, a consolidated statement can be requested from the registrar or depository.
Annualised Returns
The annualised return, or geometric average, indicates the average percentage increase of an investment each year over a set period. It accounts for compounding effects and includes both gains and losses. This measure applies to various assets, such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), commodities, and some derivatives.
Adjusted Net Asset Value (NAV)
Net Asset Value (NAV) represents the per-share value of a mutual fund, calculated by dividing the total value of the fund’s assets by the number of outstanding shares. This metric is usually determined at the end of each trading day, accounting for the market value of the fund’s holdings—such as stocks, bonds, and other assets—minus any liabilities.
NAV per share indicates the price at which investors can buy or redeem mutual fund shares, providing a clear view of the fund’s worth. It reflects the value of each unit of the fund and is a straightforward measure of performance, helping investors track their investments and understand the fund’s financial health over time. Changes in NAV are influenced by the performance of the fund’s assets and any income or capital gains distributions.
Assets Under Management (AUM)
Assets Under Management (AUM) represents the total market value of all assets that an investment firm, such as a mutual fund company, manages on behalf of its clients. This includes investments like stocks, bonds, cash, and other securities held in the firm’s portfolios.
AUM is calculated by summing the market value of all investments the firm manages. It often influences the fees charged by investment firms, as higher AUM generally leads to increased revenue. However, fee structures can vary across different firms and investment products.
AUM also affects fund performance; fund managers may find it more challenging to deploy capital effectively and maintain returns as AUM grows. Larger AUM can also limit the fund’s ability to invest in certain securities due to liquidity constraints. Overall, AUM provides a snapshot of the firm’s size and capabilities, making it a key indicator in evaluating investment firms.
Arbitrage Funds
Arbitrage funds are mutual funds that aim to generate returns by exploiting price differences in different markets or forms of security. They typically buy and sell stocks and derivatives to benefit from the spread between cash and futures markets, offering low-risk returns in stable or volatile markets alike.
Alpha Coefficient
Alpha represents the return a fund generates beyond its benchmark. Funds evaluate their performance relative to this benchmark, which could be a standard index or a customised measure based on the fund’s structure. Positive alpha means the fund has outperformed the benchmark, while negative alpha indicates underperformance.
Applicable NAV
The applicable Net Asset Value (NAV) determines the value at which mutual fund units are bought or sold. Fund houses set specific cut-off times for various fund types. If an application is submitted before the cut-off time, the fund house processes it on the same day. The NAV used for transactions depends on the application time and the fund type.
Asset Allocation Funds
Asset allocation funds are a type of balanced mutual fund where investors allocate their money between bonds and equities. This strategy helps spread risk and potentially boost returns. Many experienced investors use asset allocation to manage their risk exposure and increase their earning potential.
Average Maturity
Average Maturity is a key metric for mutual funds, representing the average time until the securities in a fund’s portfolio mature. It is calculated by taking the weighted average of the maturity periods of all securities based on their values. The average maturity can vary: short-term funds typically have an average maturity of 1 to 3 years, intermediate and long-term funds range from 5 to 10 years or more, and long-duration funds often exceed 36 months. Funds with longer average maturities are generally more sensitive to fluctuations in interest rates.
Asset Allocation
Asset allocation is the process of distributing your investments across various asset classes like stocks, bonds, and cash. This strategy aims to balance risk and returns, as not all assets perform similarly under different market conditions. For instance, while equities may be affected by market volatility, fixed income and cash might provide stability. The right allocation depends on your investment horizon and risk tolerance, which can change over time. By diversifying across multiple asset classes, you can reduce risk, minimise potential losses, and increase the chances of achieving better overall returns.
AMC (Asset Management Company)
An Asset Management Company (AMC) manages pooled funds from individual investors to achieve optimal returns in exchange for a fee. AMCs diversify their portfolios by investing in various assets, including stocks, bonds, real estate, and pension funds. Before selecting investments, AMCs assess factors like industry, market, return, and political risks. For instance, a debt fund focuses on bonds and government securities to minimise risk, while an equity fund invests in shares and stocks with higher risk and potential returns.
Average Credit Quality
The Average Credit Quality assesses the creditworthiness of the debt securities in a fund. It is calculated using a weighted average method, considering each security’s credit rating and its proportion in the portfolio. The fund manager uses a credit rating table to determine this. Government instruments and cash are generally considered AAA-rated. This measure reflects the overall risk of defaults or downgrades within the fund’s portfolio.
Benchmark Index
A benchmark index is one of the terms related to mutual funds that tracks the performance of a market or market segment through a collection of stocks or other instruments. Investors and portfolio managers use these indices to assess how well an investment portfolio performs compared to a specific market or sector. By comparing a portfolio’s returns with a benchmark index, like the Nifty 50 index, investors can determine whether their investments outperform or underperform the market. This comparison helps evaluate the portfolio’s effectiveness and the investment managers’ competence.
Balanced Funds
A balanced fund, also called a hybrid fund, is a type of mutual fund that invests in a mix of stocks and bonds. Its aim is to offer investors both capital growth and income generation. These funds usually maintain a specific allocation between stocks and bonds, such as 70% equities and 30% bonds, to balance potential returns and risks.
Bear Market
A bear market refers to a period of sustained decline in investment prices, typically marked by a drop of 20% or more from recent highs in a broad market index. This phase is often characterised by falling stock prices and negative investor sentiment and can last for several months or even years. In contrast, a bull market is identified by gains of 20% or more.
Benchmark
A benchmark is a standard used to evaluate the performance of financial instruments like securities, mutual funds, exchange-traded funds, or portfolios over time. It sets a baseline for expected returns, helping investors and fund managers assess whether a fund is meeting or exceeding these expectations. Benchmarks serve as a reference point for comparing and positioning funds based on their performance against this standard.
Beta
In mutual funds, Beta is a measure of a fund’s volatility compared to its benchmark index. Volatility reflects the extent of gains or losses a fund might experience. If a mutual fund has a Beta of 1, its returns are expected to mirror those of the benchmark. For instance, if the benchmark gains 10%, the fund is likely to gain 10% as well.
A Beta above 1, such as 1.5, indicates that the fund is more volatile than its benchmark, meaning it could experience greater gains or losses. Conversely, a Beta below 1 suggests less volatility, implying the fund may earn lower returns in a rising market but also face smaller losses in a declining market.
Brokerage
A brokerage fee is a charge paid to a broker for their services, such as acting as an intermediary in transactions. In the context of mutual funds, brokers serve as distributors, selling units of the fund on behalf of the fund house. For this, the fund house pays the broker a fee, usually a percentage of the transaction value, to attract investments from investors. Brokers also connect buyers and sellers in other areas, such as obtaining loans or purchasing real estate.
Credit Rating
Credit ratings in mutual funds provide a measure of the stability of a portfolio, helping investors understand the risk associated with different funds. Mutual funds with a higher credit rating, like AAA, are generally seen as less risky. Funds with lower credit ratings may offer higher interest rates but come with an increased risk of default. Credit ratings assess a borrower’s overall creditworthiness or their ability to meet specific financial obligations.
Crisil
CRISIL Limited, originally known as Credit Rating Information Services of India Limited, is an Indian company specialising in ratings, research, and risk and policy advisory services. It operates as a subsidiary of S&P Global, an American firm. Founded in 1988, CRISIL was the first credit rating agency in India, established through a joint effort by ICICI and UTI, with initial funding from SBI, LIC, and United India Insurance Company. In April 2005, S&P Global acquired a majority stake in CRISIL.
Capital Gains
Capital gains are profits made from selling securities and other assets, such as mutual fund units. These gains are categorised as either short-term or long-term, based on how long the asset is held. Typically, an asset held for more than 12 months is considered long-term, but this definition can vary for certain asset types, like debt funds. The tax treatment of capital gains depends on the type and holding period of the asset. Capital gains represent the profit from selling an asset that has appreciated in value over time. Assets can include both tangible items, such as property or cars, and intangible items, such as shares.
Closed Ended Schemes
Closed-ended mutual fund schemes have a fixed maturity period. Investors can only invest in these schemes during the initial offer period. They can exit the investment either by redeeming the units at maturity or by selling them on a stock exchange if the scheme is listed. The selling price on the exchange may differ from the Net Asset Value (NAV) due to market demand and supply.
Current Yield
The current yield of a mutual fund is the weighted average of the yields from all the bonds in its portfolio. The yield of a bond represents the annual income an investor receives, divided by its current market price. This yield is typically shown as a percentage and is calculated using the formula:
Current yield = Annual interest / Current market p
Corpus Funds
A corpus fund is a consolidated pool of money or investments managed for a specific purpose, such as funding an organisation or sustaining long-term initi In the case of mutual funds, the corpus refers to the total amount collected from investors. Fund managers use this money to invest in a range of securities to achieve the fund’s investment objectives.
Debt Funds
Debt funds, also known as fixed-income funds, are mutual funds that focus on investments in fixed-income securities. These can include government bonds, corporate bonds, or even debentures. The main goal of these funds is to generate regular income for investors through the interest earned on these fixed-income investments.
Direct Funds
Direct funds, or direct mutual funds, are mutual fund schemes provided directly by the fund house or Asset Management Company (AMC). These funds allow investors to bypass intermediaries such as third-party distributors or agents, engaging directly with the AMC. They are easily recognised by the prefix ‘direct’ in their names.
Dividend Schemes
A dividend scheme is a type of mutual fund that pays out a portion of its profits to investors according to the number of units they own. In April 2021, the Securities and Exchange Board of India (SEBI) renamed “dividend” as “IDCW” (Income Distribution cum Capital Withdrawal).
Dividend Yield Mutual Funds are equity funds that invest in shares of companies known for declaring high dividends. Such companies typically distribute high dividends when they achieve substantial profits.
Exit Load
Exit load is a fee imposed by mutual funds when investors withdraw their investments before a specified period, known as the exit load term, expires. Typically, mutual funds apply an exit load to discourage short-term trading, encouraging investors to hold their investments for the medium to long term. This is particularly important as mutual funds are subject to market volatility and are best suited for long-term goals. Liquid funds are an exception, as they do not usually charge an exit load.
Expense Ratio
The expense ratio in mutual funds represents the percentage of a fund’s assets used to cover its operating expenses, such as management fees, administrative fees, and other costs. This ratio, also known as the Total Expense Ratio (TER), helps investors compare the costs of different mutual funds.
ELSS (Equity Linked Savings Scheme)
An Equity-Linked Savings Scheme (ELSS) is a type of mutual fund that offers tax-saving benefits under Section 80C of the Income Tax Act, 1961. By investing in ELSS, investors can claim a tax deduction of up to Rs 1,50,000 per year, potentially saving up to Rs 46,800 in taxes annually. ELSS is the only mutual fund that qualifies for tax benefits under this section.
Equity Mutual Funds
An equity mutual fund is a professionally managed investment fund that focuses on stocks and equity-related instruments. Also known as stock funds, equity funds gather money from multiple investors to invest mainly in shares of publicly traded companies. These funds aim to offer investors the chance to benefit from potential growth in the stock market.
ETF (Exchange Traded Funds)
Exchange-traded funds (ETFs) are investment vehicles that let investors combine their money to buy stocks, bonds, or other assets. Unlike mutual funds, ETFs trade on national securities exchanges throughout the day.
An ETF can track various benchmarks, such as the Nifty 50 index, commodities like gold, bonds, or a range of assets. The first ETF in India, the Nifty ETF Fund, was introduced by Benchmark Mutual Fund in 2001, aiming to follow the Nifty 50 index. Since then, the ETF sector in India has seen gradual, steady growth.
FMP (Fixed Maturity Plan)
A Fixed Maturity Plan (FMP) is a closed-ended debt mutual fund with a set investment period. Investors can only invest during the New Fund Offer (NFO) period, which has specific start and end dates. FMPs invest in debt securities that match the fund’s maturity. For example, an FMP with a 1126-day term will invest in instruments maturing within 1126 days. These funds are listed on stock exchanges and are designed to meet short to medium-term financial goals.
Unlike open-ended funds, FMPs do not accept continuous investments. They are offered only during their NFO period. Once the NFO closes, no further investments are accepted. FMPs typically invest in debt instruments such as money market instruments, certificates of deposit, corporate bonds, and commercial papers. Although similar to fixed deposits in banks, FMPs are mutual funds and may offer different returns based on their investment strategy.
Face Value
In a mutual fund, the face value represents the initial worth of each unit. For instance, if the face value is Rs. 10, each unit is valued at Rs. 10 during the initial offering. The face value helps track the number of units issued. For example, if a mutual fund issues 1,000 units at Rs. 10 each, it collects Rs. 10,000. If the investment’s value rises to Rs. 12,000, the value per unit increases to Rs. 12. New investors would then pay Rs. 12 per unit, which is Rs. 2 above the face value.
Fund Manager
Fund managers are financial professionals who oversee mutual funds, hedge funds, pension funds, and other investment portfolios on behalf of investors. Their role involves making strategic investment decisions to meet the fund’s objectives, balancing risk and reward according to the fund’s mandate.
Fund of Funds
A Fund of Funds (FOF) is an investment strategy that pools money to invest in a portfolio of other mutual funds or investment vehicles rather than directly investing in stocks, bonds, or other securities. In simple terms, the fund of funds scheme primarily invests in units of mutual funds. For example, a FOF might invest in a combination of equity, debt, and international funds, offering investors diversified exposure across various asset classes and geographies.
Growth Option
The growth option in a mutual fund reinvests profits back into the fund rather than paying out dividends to investors. By choosing this option, investors forgo regular income in exchange for potential long-term growth, as the reinvested profits increase the fund’s net asset value (NAV) over time.
This strategy may appeal to investors with a higher risk tolerance seeking long-term capital appreciation and not relying on their investments for regular income. Young investors may find this option suitable as they have a longer time horizon to benefit from the compounding effect.
Gold Funds
Gold mutual funds are investment funds that include assets associated with gold. These assets can range from physical gold, such as gold bars, to financial instruments linked to gold, like stocks of gold mining companies and gold exchange-traded funds (ETFs). In India, gold mutual funds often operate using a fund of fund (FoF) structure, where the primary investments are in other gold-related mutual funds or ETFs rather than directly holding physical gold.
Gilt Funds
Gilt funds are a type of debt mutual fund that primarily invests in government bonds, also known as G-Secs or government securities. These securities are backed by the full faith and credit of the government, making them virtually risk-free. As a result, gilt funds can be considered as the safest among debt fund categories, as they are not exposed to credit risk or default risk.
IDCW Option
Most mutual fund schemes offer two options: the Growth option and the Income Distribution Cum Capital Withdrawal (IDCW) option. While both maintain the same underlying portfolio, they differ in how returns are utilised.
The IDCW option provides regular payouts from your investments, which include income distribution and capital withdrawal. For instance, if you own 1,000 units of a mutual fund and the fund declares a dividend of Rs. 2 per unit, you receive Rs. 2,000 as a payout. In contrast, the Growth option reinvests the returns into the scheme, leading to compounding gains over time without regular payouts.
SIP (Systematic Investment Plan)
A Systematic Investment Plan (SIP) is an investment method offered by Mutual Funds that allows investors to invest a fixed amount at regular intervals, such as monthly or quarterly, rather than a lump sum. With SIPs, investments can start with as little as Rs. 500 per month, similar to a recurring deposit, and can be automated through bank instructions for easy management.
SIPs are a mutual funds concept that are popular among Indian investors for their disciplined approach, helping investors manage market volatility without the need to time the market. They provide a straightforward way to enter long-term investments, with the flexibility to adjust contribution amounts as needed. Starting early and investing regularly through SIPs can help maximise returns, making it a valuable tool for consistent wealth building.
STP (Systematic Transfer Plan)
A Systematic Transfer Plan (STP) is an investment strategy that allows investors to regularly transfer funds between mutual fund schemes within the same asset management company (AMC). Transfers can be scheduled weekly, monthly, or quarterly, and investors can choose a fixed amount to move each time. STPs help manage market fluctuations by shifting investments from one type of fund to another, aiming for better returns during market upswings and protecting investments during downturns.
STPs can be customised to suit individual financial goals and risk tolerance. For instance, investors might shift money from debt funds to equity funds when debt returns rise or switch back when equities perform better. This gradual transfer helps investors avoid investing a lump sum at once, reducing risk and benefiting from cost averaging. STPs act as a form of economic autopilot, steadily reallocating funds from lower-risk to higher-yield options, making them a useful tool for managing investments and building long-term wealth.
SWP (Systematic Withdrawal Plan)
A Systematic Withdrawal Plan (SWP) allows investors to withdraw a fixed amount regularly from their mutual fund investments. You can decide the withdrawal amount, frequency, and whether to withdraw just the gains, keeping your capital intact. On the specified date, the fund house sells the necessary units from your portfolio, and the funds are transferred to your bank account.
SWPs provide a steady income stream, making them particularly beneficial for retirees seeking regular cash flow without selling all their investments at once. This approach helps manage market risks, offering liquidity while maintaining a disciplined withdrawal strategy that prevents rapid depletion of your investments.
Mutual Fund Portfolio
A mutual fund portfolio is a selection of various mutual funds designed to create a diversified investment mix. It allows investors to access professionally managed portfolios of stocks, bonds, and other securities by pooling their capital. The aim is to balance risk and return, spread risk across different investments, and potentially maximise returns. If one investment underperforms, others may compensate, reducing overall risk.
NFO (New Fund Offer)
When an asset management company introduces a new mutual fund, it raises capital through a New Fund Offer (NFO). This process is similar to an Initial Public Offering (IPO) and includes key details such as the portfolio composition, types of securities, and the fund manager.
Investors can purchase units of the mutual fund at a subscription price, usually set at Rs.10 per unit, during the NFO period. Both open-ended and closed-end funds are offered through NFOs, which are available for a limited time. Once the NFO period ends, the mutual funds are traded in the market based on their net asset value (NAV).
According to SEBI regulations, an NFO can remain open for a maximum of 30 days. The revenue raised is used to acquire securities of publicly traded companies listed on stock exchanges.
Rupee Cost Averaging (RCA)
Rupee Cost Averaging (RCA) is a popular mutual fund terminology, which is a strategy that helps mitigate the risks of equity markets by eliminating the need to time the market accurately. Many investors struggle with market timing, often losing capital due to its unpredictability. RCA offers an alternative by spreading investments over time, thus reducing the impact of market fluctuations.
With RCA, investors regularly invest a fixed amount into a mutual fund, regardless of market conditions. This approach results in buying more units when prices are low and fewer when prices are high, lowering the average cost per unit. This method helps investors build wealth and balance investment costs. It is particularly useful for risk-averse, new to investing or have limited time to monitor the market.Like a Systematic Investment Plan (SIP), RCA differs from lumpsum investments in that it spreads out purchases over various periods. This strategy can be beneficial in volatile market conditions. However, RCA may incur higher transaction costs due to multiple charges for each investment.
To Wrap It Up…
In conclusion, grasping the basic terms of mutual funds is vital for anyone looking to navigate the realm of mutual funds successfully. This glossary has outlined key concepts of mutual funds and terms essential for understanding how mutual funds function. By becoming familiar with these basic terms in mutual funds, investors can better assess fund performance, make informed investment decisions, and engage more effectively with financial advisors or fund managers. Investors can explore mutual funds using the Tickertape Mutual Funds Screener and use the 200+ filters to select ones that align with their investment objectives and risk tolerance. You can also explore smallcase if you want to consider a thematic basket of stocks or ETFs!
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