10 Terms you must know while investing in a Mutual Fund Scheme 

With a wide range of mutual fund schemes available for investment, it is always good to be aware of the key features of the schemes you are comparing and ultimately making an investment decision.

Here are some important terms that you ought to know while investing in a mutual fund scheme:

1. Scheme Objective – The scheme objective primarily defines the nature of the mutual fund scheme and the ultimate investment objective the investors can aim to achieve by investing in the specified mutual fund scheme. For example, a blue chip fund may have the following investment objective – “To achieve long term capital appreciation by investing in stocks that are “Leaders” in their respective industries/ sectors/ sub-sectors.” From this statement, the investor can have an idea that this mutual fund scheme will be an equity oriented scheme investing in market leaders i.e. blue chip stocks.

2. Asset Allocation – The asset allocation pattern of the mutual fund scheme defines the broad classification of the fund portfolio across different asset classes. An illustrative asset allocation of an equity fund is as below:

3. NAV – It stands for ‘Net Asset Value’ and denotes the valuation of one mutual fund unit. It is calculated by dividing the valuation of the total assets of the mutual fund scheme (net of all permissible liabilities) by the total units issued under the scheme. Since NAV is the basis for all the mutual fund transactions (purchase/ redemption/ switch) on any business day, NAV of mutual fund schemes is required to be disclosed at the end of each business day & for Liquid & Overnight funds on a daily basis.

4. Exit Load – It is essentially the fee charged by the mutual fund companies when the investor leaves or exits the scheme as an investor. Exit load may be chargeable on certain mutual fund schemes on redemption of mutual fund investments before the specified period. Such exit load is charged to discourage the investors from redeeming their investments at an early stage. Such a period is generally higher for equity mutual funds, while it tends to be lower for debt funds. For funds associated with surplus fund management like liquid funds, overnight funds etc., exit load may or may not be charged. The exit load is deducted from the prevailing NAV at the time of redemption and thus, the investor receives the redemption amount at NAV (net of the exit load applicable). For example, if NAV of the mutual fund scheme is Rs. 1000 and the exit load is 0.50%, the investor will get Rs. 995 in his bank account upon redemption.

5. Total Expense Ratio – This denotes the total expenses being charged to the mutual fund scheme, expressed as a percentage to the Assets under Management (AUM). For example, a scheme earns 16% returns over the period and has a Total Expense Ratio (TER) of 2%, the net returns for the investors will be 14%. So, lower the TER, the better it is, since a lower TER results in higher returns. Mutual funds are required to disclose the scheme-wise TER for all schemes on their website on a daily basis.

6. Benchmark – It refers to the index with which the performance of the mutual fund scheme is compared on a consistent basis. For example, a mutual fund scheme may be benchmarked against NSE Nifty 50, S&P BSE Sensex, CRISIL Composite Bond Index etc. Mutual funds are required to disclose the name(s) of benchmark index/ indices with which the mutual fund scheme performance will be compared in the scheme related documents. SEBI requires that the performance of the mutual fund scheme should be benchmarked to Total Return variant of the benchmark index, commonly referred to as the Total Return Index (TRI). TRI takes into account all dividends/ interest payments generated from the basket of the index constituents in addition to capital appreciation.

7. Fund Manager – Mutual funds pool the money invested by different investors and create a portfolio of securities to generate returns for them. The fund manager is the person who leads the investment team and is primarily responsible for all the investment decisions of a mutual fund scheme. The investment strategy and philosophy of the fund manager plays an important role in the scheme performance, and hence the continuity of the fund manager with the scheme and the overall experience of the fund manager in the industry must also be seen while selecting the mutual fund scheme.

8. Date of Inception – It denotes the date of launch of the mutual fund scheme. So, if the date of inception of a mutual fund scheme is disclosed as 1st March 2009, it means that the mutual fund scheme was launched on that date. The scheme’s performance along with the portfolio growth is also shown over various periods and from the inception date.  

9. Portfolio Holdings – Mutual funds companies are obliged to disclose the portfolio composition of the mutual fund on a monthly basis, which shows the details of the securities held along with their percentage as a percentage of the total AUM. The disclosure of portfolio holdings helps the investors get an idea of the concentration risk to a particular company/ industry/ sector the portfolio is currently carrying.

10. Key Ratios – The disclosure of key ratios of the mutual fund schemes can help the investors to make a quick reference to various qualitative and quantitative parameters other than the scheme performance, which is disclosed separately. The key ratios for an actively managed equity mutual fund are portfolio turnover ratio, average P/E ratio, average P/BV ratio, average dividend yield, portfolio beta, Sharpe Ratio, standard deviation etc. Similarly, for a debt mutual fund, the relevant key ratios are rating profile, average maturity, modified duration, yield to maturity etc.

So, now that you are aware of these basic terms, you can now compare the mutual fund schemes in a much better manner and take an informed decision.