Indian investors seem to be getting accustomed to mutual fund investments. They like the idea of seeking to earn potential returns with small investments. This is evident with the growing number of mutual fund portfolios in the past five years.
Source: Securities Exchange Board of India (SEBI)
However, before investing, investors should understand their mutual fund investment or consult their investment advisors. Every time a mutual fund launches a scheme, it has to file a prospectus with the Securities Exchange Board of India (SEBI), known as a mutual fund prospectus. Investors should thoroughly understand this document before making any investment decision.
What is a Mutual Fund Prospectus?
The formal legal document, consisting of information about a mutual fund scheme, is known as a mutual fund scheme. It is also known as a Scheme Information Document (SID). It has several sections regarding risk associated, New Fund Offer (NFO), asset allocation, objectives, etc.
SEBI has prescribed a standard format for this scheme information document. It is a legally binding document. So, investors will find every minute detail of a scheme. However, it is a long document, and investors may find it cumbersome to read. Investors can request a particular scheme’s prospectus via email or access it here: SEBI SIDs.
Key Sections to Focus on in a Mutual Fund Prospectus
1. Scheme summary
The summary for a particular mutual fund scheme consists of information regarding name, category, objectives, plans and options, risk-o-metre, etc. It is a clear overview of the scheme. Investors should understand this section well and analyse whether it aligns with personal investment objectives.
However, investors cannot rely only on this summary. One should understand the whole prospectus before investing in the scheme.
2. Risk factors
Mutual funds are directly or indirectly investing in the stock market, bonds, debentures, government securities, etc. This market exposure may invite market risk along with returns. Risk differs for every mutual fund scheme. As per SEBI’s standard format, the risk factors are divided mainly into two different parts:
Standard risk
It is the common fund house or scheme risk. It includes factors such as volume, liquidity, past performance of the scheme or Asset Management Company (AMC), etc. Investors should determine whether this risk is feasible and match it with personal risk appetite to analyse it.
Scheme specific risk
Investment in a particular scheme is associated with its specific risk. Thus, it differs from scheme to scheme. These risks are as follows:
- Equities scheme: It has the risk of the stock market and its volatility. It may also include derivatives and short-selling risks, for schemes particularly investing in them.
- Bonds scheme: It has risks regarding the credit, liquidity, and other fixed-income asset markets.
- Foreign securities scheme: It has risks of global events, foreign markets, etc.
3. Asset allocation, strategies and benchmark
According to the SEBI categorisation, there are five types of schemes. These five types are further categorised based on fund allocation and holding period. The allocation of funds/assets in different securities affects crucial factors such as taxation.
Fund allocation
SEBI suggests a specific format for disclosure of this fund allocation of a particular scheme. It includes:
- Instrument name
- Maximum and minimum % of allocation
- Risk profile of the instrument – high, medium or low.
Strategies employed
Other than asset allocation, investment strategies followed by a scheme are crucial points to seek suitability. If the scheme invests in risky assets, like derivatives, its basic strategy and risk mitigation plans are mentioned.
Benchmark for the scheme
The fund makes investment decisions according to a benchmark security or market index. It provides investors with better information regarding investment patterns and potential returns of a particular scheme.
Connect with Dezerv today to discover the portfolio management services.
4. Investment requirement and redemption policies
This section seeks to help investors determine the minimum investment required, plans, options and the NFO details.
The NFO details include minimum amount, NFO price per unit, allotment, plans, options, listing, application, redemption policies, etc. As per SEBI, an open-ended fund must have a minimum of 20 investors, and any single investor cannot be more than 25% of the total fund size. Minimum investment, Systematic Investment Plan (SIP) or lump-sum amounts, and frequency should be checked.
Moreover, redemption details should be checked to ensure the fund’s liquidity. These should include its price, units, method, tenure, Net Asset Value (NAV), and the frequency of account statement disclosure.
5. Expense table and load structure
For an NFO, details regarding sources of marketing expense, advertising, bank, printing charges, etc. However, this is not a compulsory disclosure. Apart from this, the annual scheme recurring expense table is a mandatory disclosure. It explains different fees related to the scheme in terms of % of net assets of that scheme. The Total Recurring Expenses (TRE) include management fees, audit fees, brokerage costs, transaction costs, custodial fees, etc.
Entry and exit load of a scheme indicates the amount paid by investors for the purchase or redeem the scheme units, respectively. It is expressed as the % of NAV.
6. NAV computation and scheme performance
There can be two schemes – an NFO and an already-launched open scheme. The NAV computation is explained along with a hypothetical example for investors. It seeks to help investors to determine how their price/NAV would be determined.
The NFOs will not have historical performance data. However, such schemes may have historical performance data of other schemes by that AMC. Investors can analyse this data and understand AMC’s performance.
The open-ended scheme units are available for purchase and sale in the market. So, it is mandatory for such schemes to publish this data in the SEBI-prescribed format. It includes a compounded annualised scheme and benchmark returns for 1 year, 3 years, five years, and since inception.
Moreover, a graph of the scheme and benchmark returns for the past 5 financial years is presented. Investors can analyse this data and decide whether it will match their expectations from a particular investment.
7. Taxation
The taxation of different mutual fund schemes should be explained. It seeks to help investors determine their capital gain tax liability from a particular scheme. SEBI has prescribed a format for taxation, which will disclose tax % for a resident investor, non-resident investor and mutual fund on the following:
- Dividend option or Income Distribution and Capital Withdrawal (IDCW)
- Capital gains: long-term and short-term
Investors should consult their tax advisors for any detailed information regarding this.
Note: Investors should read all information in the scheme information document.
Takeaway
Investors invest their hard-earned money into mutual fund schemes while seeking potential returns. However, for any investment, one should understand its dynamics in detail before investing. Mutual fund prospectus seeks to help investors understand the scheme in detail. The factors mentioned above seek to help investors understand some crucial elements of a mutual fund prospectus. However, investors should consult their investment advisor before making any investment.