Looking forward to investing in mutual funds for portfolio diversification? Before you process, you must have some idea of the various components of these funds. The structure of mutual funds in India has three basic levels or tiers. Other than these three main levels, other different components play a key role in the working of mutual funds. All mutual funds in India are formed as trusts under The Indian Trust Act 1882. These mutual funds are regulated under the SEBI(Mutual Funds) Regulations 1996.
What is the structure, and what are the components of mutual funds? Why should you be aware of the same? If you are a beginner and new to investing in mutual funds, then you must have an idea about the mutual fund management structure and its different aspects so you can plan your investment after proper market analysis and calculating the risks and the costs that will come along with investing in a particular fund. In this article, we will be looking at the structure of these funds in detail to help you understand each component well.
Fund Sponsor and Management Company
The first level in the structure of mutual funds is known as the fund sponsor. This is a person or an entity who wishes to start a mutual fund. The sponsor needs to have permission from SEBI for the same. SEBI will then verify the experience, the net worth of the company and more details to approve of the same. The fund sponsor is in charge of appointing the board of trustees after setting up a trust and appointing the AMC or the asset management company and fund managers. SEBI also requires the submission of the trust deed, draft memorandum and articles of association of AMC.
As per SEBI’s guideline, to be at the fund sponsor level in the mutual fund management structure, the following criteria must be met:
- The minimum experience of the sponsor in the financial services industry must be five years.
- The business’s net worth in the last five years should be positive.
- The sponsor should contribute a minimum of 40% of the AMC’s net worth.
- In the last three out of five years, the sponsor should have earned profits after deducting tax, interest and depreciation.
- The previous year’s net worth of the sponsor must exceed the capital contribution of the AMC.
Board of Directors or Trustees
The next level in the mutual fund management structure is the board of directors or trustees. As per the guidelines laid by SEBI, the fund sponsor should create trust through trust deeds and the trust company is governed under the Companies Act 1956. The trust is internally managed by the trustees and the board of trustees, and it is governed by the Indian Trust Act 1882. The trustees are not involved directly in managing the securities. Their role is to oversee that the AMC follows all the rules and regulations while launching the fund. There must be four trustees for every mutual fund.
Fund Manager
The third level in the three-tier mutual fund structure is the asset management company (AMC) or the fund manager. The sponsors or the trustees assign asset management companies. Their responsibilities include the fund’s portfolio management and investing in securities, along with risk management. They must adhere to the investment scheme in line with the trust deed. Providing all the relevant information to the unit holders and risk management is also a part of their work. Their board of directors works under trustees and SEBI. AMCs can choose to work on their own or hire an RTA for the same by paying their fees.
Custodian
The next component of the structure of mutual funds is the custodian. The securities purchased by the asset management company are held by the custodian in demat form on its behalf. The custodian function in mutual fund management includes the management of the delivery and transfer of securities. The custodian also completes all the work related to back-office bookkeeping. Ensuring that the money is paid to the seller on time and the earnings in the form of dividends and interest are received.
Shareholders or Investors
People who invest their money in purchasing shares from a particular mutual fund are known as the shareholders or investors in that particular mutual fund management structure. Investors can buy shares directly from the fund or from brokers but not from other investors or shareholders. The price paid by investors is the net asset value per share and any fees that are charged at the time of purchase.
Net Asset Value (NAV)
NAV is another component of a mutual fund organisation. NAV, or net asset value, is the measure of the performance of a mutual fund scheme. NAV per unit of a mutual fund is calculated as the market value of the securities of the scheme divided by the total number of units of the scheme on any particular day. The NAV of any mutual fund scheme changes on a daily basis with the change in the market value of securities. The net asset value of a mutual fund is declared only at the end of each trading day after market closing.
Distribution and Service Fees
The distribution and service fees in a mutual fund refer to the expenses for marketing and selling the mutual funds. Considering the fees and expenses in mutual funds is important for the right financial planning. The distribution and service fees compensate the brokers, pay for advertising of the mutual fund and the printing and mailing of sales literature and mutual funds prospectus.
Prospectus
A document like a brochure or a pamphlet that provides all the necessary information related to a mutual fund scheme is known as the prospectus of the mutual fund. This document should be provided by the fund house free of cost and can be found by you online or by calling the mutual fund company directly. The mutual fund prospectus gives you all the details regarding the fund’s investment objectives, the fees and expenses in mutual funds, the risk factors involved and more.
Frequently Asked Questions
1. Who is responsible for managing a mutual fund?
Mutual funds are managed by the asset management company (AMC) or the fund managers.
2. What is the role of a custodian in a mutual fund?
The role of the custodian in a mutual fund is the management of securities purchased by the AMC; they also ensure timely payments and receiving of earnings.
3. What fees are typically associated with mutual funds?
The fees associated with mutual funds include management fees, distribution and service fees and other expenses like shareholders’ services expenses. In general, the expense ratio of mutual funds falls between 1% to 2%.
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