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1Mutual Funds
Project Rationale:
We are going to launch the mutual investment fund in parachinar, remote area of FATA,
Kuram Agency .Our purpose is to facilitate the people of this area financially to improve the
economic condition of their businesses and agricultural products by giving them short term loans
and interest on their respective investments.
How Mutual Fund works?
Our Mutual Fund is a trust that pools the savings of a number of investors who share a
common financial goal. The money thus collected is then invested in capital market instruments
such as shares, debentures and other securities. The income earned through these investments
and the capital appreciations realized are shared by its unit holders in proportion to the number of
units owned by them. Thus a Mutual Fund is the most suitable investment for the common man
as it offers an opportunity to invest in a diversified, professionally managed basket of securities
at a relatively low cost. The flow chart below describes broadly the working of a mutual fund.
Savings form an important part of the economy of any nation. With savings invested in various
options available to the people, the money acts as the driver for growth of the country.
Investment goals vary from person to person. While somebody wants security, others
might give more weightage to returns alone. Somebody else might want to plan for his child‟s
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2Mutual Funds
education while somebody might be saving for the proverbial rainy day or even life after
retirement. With objectives defying any range, it is obvious that the products required will vary
as well.
Types of mutual fund schemes
A wide variety of Mutual Fund Schemes exist to cater to the needs such as financial position,
risk tolerance and return expectations etc. The table below gives an overview into the existing
types of schemes in the Industry.
By structure:
a) open-ended schemes
b) close-ended schemes
c) interval schemes
By investment objective:
a) growth schemes
b) income schemes
c) Balanced schemes
d) money market schemes
Other schemes:
a) Tax saving schemes
b) special schemes
c) index schemes
d) sector specific schemes
Investors Earn from a Mutual Fund in Two ways:
1. Income is earned from dividends declared by mutual fund schemes from time to time.
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2. If the fund sells securities that have increased in price, the fund has a capital gain. This is
reflected in the price of each unit. When investors sell these units at prices higher than
their purchase price, they stand to make a gain.
Advantages of Mutual Funds
1. Professional Management
Mutual Funds provide the services of experienced and skilled professionals, backed by a
dedicated investment research team that analyses the performance and prospects of companies
and selects suitable investments to achieve the objectives of the scheme. This risk of default by
any company that one has chosen to invest in, can be minimized by investing in mutual funds as
the fund managers analyze the companies‟ financials more minutely than an individual can do as
they have the expertise to do so. They can manage the maturity of their portfolio by investing in
instruments of varied maturity profiles.
2. Diversification
Mutual Funds invest in a number of companies across a broad cross-section of industries and
sectors. This diversification reduces the risk because seldom do all stocks decline at the same
time and in the same proportion. You achieve this diversification through a Mutual Fund with far
less money than you can do on your own.
3. Convenient Administration
Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad
deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save
your time and make investing easy and convenient.
4. Return Potential
Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they
invest in a diversified basket of selected securities. Apart from liquidity, these funds have also
provided very good post-tax returns on year to year basis. Even historically, we find that some of
the debt funds have generated superior returns at relatively low level of risks. On an average debt
funds have posted returns over 10 percent over one-year horizon. The best performing funds
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have given returns of around 14 percent in the last one-year period. In nutshell we can say that
these funds have delivered more than what one expects of debt avenues such as post office
schemes or bank fixed deposits. Though they are charged with a dividend distribution tax on
dividend payout at 12.5 percent (plus a surcharge of 10 percent), the net income received is still
tax free in the hands of investor and is generally much more than all other avenues, on a post tax
basis.
5. Low Costs
Mutual Funds are a relatively less expensive way to invest compared to directly investing in the
capital markets because the benefits of scale in brokerage, custodial and other fees translate into
lower costs for investors.
6. Liquidity
In open-end schemes, the investor gets the money back promptly at net asset value related prices
from the Mutual Fund. In closed-end schemes, the units can be sold on a stock exchange at the
prevailing market price or the investor can avail of the facility of direct repurchase at NAV
related prices by the Mutual Fund. Since there is no penalty on pre-mature withdrawal, as in the
cases of fixed deposits, debt funds provide enough liquidity. Moreover, mutual funds are better
placed to absorb the fluctuations in the prices of the securities as a result of interest rate variation
and one can benefits from any such price movement.
7. Transparency
Investors get regular information on the value of your investment in addition to disclosure on the
specific investments made by your scheme, the proportion invested in each class of assets and
the fund manager's investment strategy and outlook.
8. Flexibility
Through features such as regular investment plans, regular withdrawal plans and dividend
reinvestment plans; you can systematically invest or withdraw funds according to your needs and
convenience.
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9. Affordability
A single person cannot invest in multiple high-priced stocks for the sole reason that his pockets
are not likely to be deep enough. This limits him from diversifying his portfolio as well as
benefiting from multiple investments. Here again, investing through MF route enables an
investor to invest in many good stocks and reap benefits even through a small investment.
Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund
because of its large corpus allows even a small investor to take the benefit of its investment
strategy.
10. Choice of Schemes
Mutual Funds offer a family of schemes to suit your varying needs over a lifetime.
11. Well Regulated
All Mutual Funds are registered with SECP and they function within the provisions of strict
regulations designed to protect the interests of investors. The operations of Mutual Funds are
regularly monitored by SECP.
12. Tax Benefits
Last but not the least, mutual funds offer significant tax advantages. Dividends distributed by
them are tax-free in the hands of the investor. They also give you the advantages of capital gains
taxation. If you hold units beyond one year, you get the benefits of indexation. Simply put,
indexation benefits increase your purchase cost by a certain portion, depending upon the yearly
cost-inflation index (which is calculated to account for rising inflation), thereby reducing the gap
between your actual purchase costs and selling price.
Work Breakdown Structure:
The WBS is a deliverable-oriented hierarchical decomposition of the work to be executed
by the project team, to accomplish the project objectives and create the required deliverables.
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The WBS organizes and defines the total scope of the project. The WBS subdivides the project
work into smaller, more manageable pieces of work, with each descending level of the WBS
representing an increasingly detailed definition of the project work. The planned work contained
within the lowest-level WBS components, which are called work packages, can be scheduled,
cost estimated, monitored, and controlled. The WBS represents the work specified in the current
approved project scope statement. Components comprising the WBS assist the stakeholders in
viewing the deliverables of the project.
This is initial WBS of our project. The activities which are enlisted are the major activities
and our entire project consists on these activities. Here bellow a brief detail of all these activities.
S. No Activity Time Cost(M) Objectives1 Feasibility 1 Month 0.1 To provide feasibility report
2 Franchising 1 Month 0.5 Approval of NIT for Franchising
3 Office Establishment 10 Days 0.3 Establish a office on Kurram Raod(PCR)
4 Funds Collection 2 Months 0.1 Collection of funds
5 Funds Investment 2 Months 0 Investment of funds in Stock Market
6 Return 1 Year 0 Return of respective investment
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WBS OF MUTUAL FUND
Report
Feasibility
Re ort
Feasibility
Approval
Franchising
Request NIT
for Franchising
Office Equipment
PCR
Office 1
PCR
Office 2
Funds Collection
Advertisement Promotional
TechniquesPersonal
Contacts
Fund Investment
Stocks Micro Financing
A riculture Small
Business
R
Dividend Capital Gain
Feasibility:
This is the starting activity of our project. The main purpose of this activity is to prepare a
feasibility report after a feasibility study and then take approval in order to establish a mutualfund.
Franchising:
After preparing a feasibility study and approval the next activity which we have to do is
franchising. In franchising we will submit request to establish a franchise of National Investment
Trust (NIT) and will get approval to establish the franchise.
Office Establishment:
After getting approval for franchise we will establish our office at Tall Road Parachinar. The
Office will be equipped with a modern communication system which will connect us to our head
office and also with stock exchange. This modern communication system will also enable us to
see the performance of our diversified investment.
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Funds Collection:
After the office establishment we will move toward the most important and tough activity of our
project which is fund collection. For this we need a lot of effort to convince our potential
customers. We will use different advertisement and promotional techniques along with personal
contacts.
Funds investment:
After getting investment from our customer we will invest that money in diversified stocks. The
purpose of diversification is to minimize risk and maximize the return for our investor. We will
use different evaluation techniques such as CAPM and DDM to evaluate our stocks, so that we
make an investment on proper evaluation. The fundamental and technical analysis will also be
very helpful for us for the evaluation of the stock.
Return:
After funds investment the next is to give return to our valued customers. As we have earlier
mentioned that this return can be in the following ways.
1. Income is earned from dividends declared by mutual fund schemes from time to time.
2. If the fund sells securities that have increased in price, the fund has a capital gain. This is
reflected in the price of each unit. When investors sell these units at prices higher than
their purchase price, they stand to make a gain.
3. If fund holdings increase in price but are not sold by the fund manager, the fund's unit
price increases. You can then sell your mutual fund units for a profit. This is tantamount
to a valuation gain.
We will also have a fix portion of income from all these returns according to the roles and
regulation of Mutual Fund Association of Pakistan and SECP.
Estimated Time Management:
Project Time Management includes the processes required to accomplish timely completion of the
project. The Project Time Management processes include the following activities which are
expressed in following table:
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9Mutual Funds
Activity Definition
Activity Sequencing
Activity Resource Estimating
Activity Duration Estimating
Schedule Development
Schedule Control
S. No Activity Time Frame Cost(millions) Nature
1Feasibility 01-06-2010 to 31-06-2010 0.1
Finish-to-Start
2 Franchising 01-07-2010 to 31-07-2010 0.5 Finish-to-Start
3 Office Establishment 01-08-2010 to 10-08-2010 0.3 Finish-To-Start
4 Funds Collection 10-08-2010 to 10-10-2010 0.1 Start-to-start
5Funds Investment 10-08-2010 to 10-10-2010 0
Start-to-Start
6 Returns 10-08-2010 to 10-08-2011 0 Start-to-Start
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TIME MANAGEMENT MATRIX
We can also manage our activities according to their urgency and importance through
Time Management Matrix as given below
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Important and Urgent
Quadrant 1 represents things which are both urgent and important – labeled “firefighting”. The
activities need to be dealt with immediately, and they are important.
These tasks are the ones that must be done right away, or consequences may result. An example
would be bills that are due today. If we don‟t pay our bills on time, we would incur additional
charges or they might cut off their services to us. Activities belonging to this category need to be
acted upon without delay. We should give them the highest priority.
Important but Not Urgent
Quadrant 2 represents things which are important, but not urgent - labeled “Quality Time”.
Although the activities here are important, and contribute to achieving the goals and priorities -
they do not have to be done right now. As a result, they can be scheduled when they can be given
quality thought to them.
A good example would be the preparation of an important talk, or mentoring a key individual.
Prayer time, family time and personal relaxation/recreation are also part of Quadrant 2.
Urgent but Not Important
Quadrant 3 represents distractions. They must be dealt with right now, but frankly, are not
important. For example, when a person answers an unwanted phone call, - he/she has had to
interrupt whatever he/she is doing to answer it.
Not Important and Not Urgent
Quadrant 4 represents Time Wasting. We might think activities in this section are not worth
people‟s time, so they won‟t engage in these activities much. We would be surprised to know
that people spend most of their time doing things that are both unimportant and non-urgent, such
as watching TV and movies, playing video games, senseless chatting for hours on the phone,
shopping for new clothes, etc.
Of course, it is essential for people to relax and unwind once in a while.
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”All work and no play makes Jack a dull boy,” as they say. But we should be strict in limiting
our time for these activities; that is, if we really want to accomplish a lot in our life.
Treat activities belonging to this section with the lowest priority. If we really want to succeed,
strictly limit our time in doing these activities or don‟t do them at all. Focus on those that will
bring us fruitful results.
Project Cost Management
Our cost management process consist of the following three phases.
Estimate Cost
Determine Budget
Control Cost
1. Estimate Cost:
The costs through which we have to deal are given below:
Variable Cost:
These costs change with the amount of production or the amount of work. Examples include the
cost of material, supplies, and wages.
Fixed Cost:
These costs do not change as production changes. Examples include set-up, rental, etc.
Direct Costs:
These costs are directly attributable to the work on the project. Examples are team travel, team
wages, recognition, and costs of material used on the project.
Indirect Costs:
Indirect costs are overhead items or costs incurred for the benefit of more than one project.
Examples include taxes, fringe benefits, and janitorial services. In our project we have done
bottom up costing in order to determine the cost estimates which will appear in the budget
determination section of the cost management.
2. Determine Budget:
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WP1 WP3 WP2 WP4
In this part of cost management, the total cost of the project needs to be calculated in order to
determine the amount of funds the organization needs to set aside or have available for the
project. To create a budget, activity costs, including costs for risk contingencies, are rolled up to
work package costs. Work package costs are then rolled up to control account costs and finally
into project costs. This process is called cost aggregation. Contingency reserves are added to
achieve the cost baseline, in the final step, the management reserves are added.
Costs are given in Million Rupees (Rs.000000)
In this section we have created a detailed budget for our project. It is starting from activity
estimate ad ends up with cost budget. Basically as earlier mentioned we have divided our project
into six work packages. These are feasibility, franchising, office establishment, funds collection,
funds investment, and return. As funds investment and funds return are directly related to the
customer, so we don‟t need to do any cost on them. So our cost will be basically consists on four
1. Activity Estimates
8. Cost Budget
4. Project Estimates
3. Control Account Estimates
2. Work Package Estimates
7. Management Reserves
6. Cost Baseline
5. Contingency Reserves
Rs 1.25
Rs 1.15
Rs 0.1
Rs 0.9
Rs 0.10
Rs 0.15
Rs 1.00
Rs 0.5 Rs 0.1 Rs 0.3
Rs 0.02Rs 0.02Rs 0.02Rs 0.02Rs 0.02
Rs 0.1
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work packages and their activities. Therefore, here we are only showing these four work
packages for our cost estimates. In this estimates we have also taken some contingency and
management reserves. These contingency and management reserves are put there in order to
meet some unusual situation which we may have face during the completion of our project.
These contingency are kept as 15% of other costs and management reserves are kept as 10% of
other costs.
3. Control Cost:
Cost control can be done only when our work is in progress. Here we compare our actual cost
with estimated cost. So it will tell us that how much under budget or over budget we are. As we
have till not started our project so we can only assume that only one activity is completed which
is our feasibility study. The cost which we have assigned to that activity was 0.1 Million Rupees
and we assume that the actual cost on that activity is 0.11 Million Rupees. Now here we will
apply different formulas of cost control, so that we may come to know that how much under or
over budget we are.
PV (Planned Value) = 0.10 M
EV (Earned Value) = 0.10 M
AC (Actual Cost) = 0.11 M
BAS (Budget at completion) = 1.25 M
EAC (Estimate at completion) = 1.10 M
ETC (Estimate to complete) = 1.00 M
VAC (Variance at completion) = -0.01 M
Name Formula Value Interpretation
CV =EV-AC -0.01 Negative value shows that
we are over budget
SV =EV-PV 0.00 Zero value shows that we
are at the schedule
CPI =EV/AC 0.9090 We are getting 0.9090rupees
SPI =EV/PV 1.00 We are progressing at
100% of the rate originally
planned
EAC =(BAC-EV)+AC 1.26 This shows that we will
complete with a budget
more then planned
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15Mutual Funds
Fund Management Style & Structuring of Portfolio
Factors affecting Management style of Mutual Funds
It‟s one thing to understand mutual funds and their working; it‟s another to ride on this potent
investment vehicle to create wealth in tune with your risk profile and investment needs. Here are
seven factors that go a long way in helping an AMC meet its investor‟s investment objectives.The factors listed below evaluate factors affecting the management style of a mutual fund.
Knowing the profile
Investor‟s investments reflect his risk -taking capacity. Equity funds might lure when the
market is rising and peers are making money, but if you are not cut out for the risk that
accompanies it, don‟t bite the bait. So, check if the investor‟s objective matches yours.
Investors will invest only after they have found their match. If they are racked by uncertainty,
they seek expert advice from a qualified financial advisor.
Identifying the investment horizon
How long on an average does the investor want to stay invested in a fund is as important as
deciding upon your risk profile. Investors would invest in an equity fund only if they are
willing to stay on for at least two years. For income and gilt funds, have a one-year
perspective at least. Anything less than one year, the only option among mutual funds is
liquid funds.
Declare and Inform
Watch what you commit. Investors look out for the Offer Document and Hey Information
Memorandum (KIM) before they commit their money to a fund. The offer document contains
essential details pertaining to the fund, including the summary information (type of scheme,
name of the asset Management Company and price of units, among other things), investment
objectives and investment procedure, financial information and risk factors.
VAC =BAS-EAC -0.01 We will be Rs 0.01 Million
over budgeted at the end of
project
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The fund fact sheet
Fund fact sheets give investors valuable information of how the fund has performed in the
past. It gives investors access to the fund‟s portfolio, its diversification levels and its
performance in the past. The more fact sheets they examine, the better is their comfort level.
Diversification across fund houses
If Investors are routing a substantial sum through mutual funds, they would diversify across
fund houses. That way, they spread their risk.
Chasing incentives
Some financial intermediaries give upfront incentives, in the form of a percentage of the
investor‟s initial investment, to invest in a particular fund. Many amateur investors get lured
into such incentives and invest in such attractive schemes, which may not meet their future
expectations. The ideal investor‟s focus would be to find a fund that matches his investment
needs and risk profile, and is a performer.
Tracking investments
The investor‟s job doesn‟t end at the point of making the investment. They do track your
investment on a regular basis, be it in an equity, debt or balanced fund.
Portfolio Management
Portfolio management is an important foundation of mutual fund business. The performance of
the fund measured by the risk adjusted returns produced by the investor arises largely by
successful portfolio management function. After collecting the investors‟ funds, effective
portfolio management will have to give returns acceptable to the investor; else, the investor may
move to better performing funds.
From the investors‟ perspective, the need for successful portfolio management function is
obviously paramount. However, in the complex world of financial markets, portfolio
management is a „specialist‟ function.
Now how a fund manager manages the portfolio would depend on the type of the fund he is
managing. The funds can be broadly classified as equity funds and debt funds. As there is no
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strong bond and debt market in Pakistan therefore we will only deal with Equity Funds. Our
whole investment will be made in diversified Equity Fund.
Equity Portfolio Management:
When the fund contains more than 65% equity, it is called as an equity fund. Thus such type of a
fund would need equity portfolio management.
An equity portfolio manager‟s task consists of two major steps:
a) Constructing a portfolio of equity shares or equity linked instruments that is consistent
with the investment objective of the fund and
b) Managing or constantly re-balancing the portfolio to produce capital appreciation and
earnings that would reward the investors with superior returns.
How To Identify Which Kind Of Stocks To Include?
The equity portfolio manager has available to him a whole universe of equity shares and other
instruments such as preference shares, warrants or convertible debentures issued by many
companies. Even within each category of equity instruments, shares of one company may be
very different in terms of their potential than shares of other companies. So how does the fund
manager go about choosing the different types of stocks, in order to construct his portfolio? The
general answer is that his choice of shares to be included in fund‟s portfolio must reflect the
investment objective of the fund. more specifically, the equity portfolio manager will choose
from a universe of invisible shares in accordance with:
a) The nature of the equity instrument, or a stock‟s unique characteristics, and
b) A certain „investment style‟ or philosophy in the process of choosing.
Thus, you may see a mutual fund‟s equity portfolio include shares of diverse companies.
However, in reality, the group of stocks selected will have certain unique characteristics, chosen
in accordance with the preferred investment style, such that the portfolio as a whole is consistent
with the scheme‟s objectives.
Ordinary shares:
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Ordinary shareholders are the owners if the company and each share entitles the holder to
ownership privileges such as dividends declared by the company and voting rights at the
meetings. Losses as well as the profits are shared by the equity shareholders. Without any
guaranteed income or security, equity share are a risk investment, bringing with them the
potential for capital appreciation in return for the additional risk that the investor undertakes.
Preference Shares:
Unlike equity shares, preference shares entitle the holder to dividends at the fixed rates subject to
availability of profits after tax. If preference shares are cumulative, unpaid dividends for years of
inadequate profits are paid in subsequent years. Preference shares do not entitle the holder to
ownership privileges such as voting rights at the meetings.
Equity Warrants:
These are long term rights that offer holders the right to purchase equity shares in a company at a
fixed price (usually higher than the current market price) within specified period. Warrants are in
the nature of options on stocks.
Convertible Debentures:
As the term suggests, these are fixed rate debt instruments that are converted into specified
number of equity shares at the end of the specified period. Clearly, convertible debentures are
debt instruments until converted; when converted, they become equity shares.
Equity Classes:
Equity shares are generally classified on the basis of either the market capitalization or the
anticipated movement of company earnings. it is imperative for the fund manager to understandthese elements of the stocks before he selects them for inclusion in the portfolio.
a) Classification in terms of Market Capitalization
Market Capitalization is equivalent to the current value of a company, i.e., current market
price per share times the number of outstanding shares. There are Large Capitalization
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Companies, Mid – Cap Companies and Small – Cap Companies. Different schemes of a fund
may define their fund objective as a preference for the Large or Mid or the Small Cap
Companies‟ shares. For example, the tax plan of ICICI Prudential AMC is essentially a mid-
cap fund where as the tax plan of Reliance is large-cap fund. Large Cap shares are more
liquid and hence easily tradable. Mid or Small Cap shares may be thought of as having
greater growth potential. The stock markets generally have different indices available to track
these different classes of shares.
b) Classification in terms of Anticipated Earnings
In terms of anticipated earnings of the companies, shares are generally classified on the basis
of their market price relation to one of the following measures:
Price/Earnings Ratio is the price of the share divided by the earnings per share and
indicated what the investors are willing to pay for the company‟s earning potential.
Young and fast growing companies usually have high P/E ratios and the established
companies in the mature industries may have lower P/E ratios.
Dividend Yield for a stock is the ratio of dividend paid per share to the current market
price. In India, at least in the past, investors have indicated the preference for the high
dividend paying shares. What matters to the fund managers is the potential dividend
yields based on earning prospects.
Cyclical Stocks are the shares of companies whose earnings are correlated with the
state of the economy.
Growth Stocks are shares of companies whose earnings are expected to increase at the
rates that exceed the normal market levels.
Value Stocks are share of companies in mature industries and are expected to yield
low growth in earnings. These companies may, however, have assets whose values
have not been recognized by investors in general. Funds manager may try to identify
such currently undervalued stocks that in their opinion can yield superior returns later.
Approaches to Portfolio Management (Fund Management Style):
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Mutual funds can be broadly classified into two categories in terms of the fund management
style i.e. actively managed funds and passively managed funds (popularly referred to as index
funds).
Actively managed funds are the ones where in the fund manager uses his skills and expertise to
select invest-worthy stocks from across sectors and market segments. The sole intention of
actively managed funds is to identify various investment opportunities in the market in order to
clock superior returns, and in the process outperform the designated benchmark index. in active
fund management two basic fund management styles that are prevalent are:
i) Growth Investment Style: wherein the primary objective of equity investment is to
obtain capital appreciation. this investment style would make the funds manager pick
and choose those shares for investment whose earnings are expected to increase at the
rates that exceed the normal market levels. they tend to reinvest their earnings and
generally have high P/E ratios and low Dividend Yield ratio.
ii) Value Investment Style: wherein the funds manager looks to buy shares of those
companies which he believes are currently under valued in the market, but whose
worth he estimates will be recognized in the market valuation eventually.
Successful Equity Portfolio Management:
Portfolio Management skills are innate in nature and strong intuitive traits from the portfolio
manager. Nevertheless, there are certain principles of good equity management that any portfolio
manager can follow to improve his performance.
Set realistic target returns based on appropriate benchmarks.
Be aware of the level of flexibility available while managing the portfolio.
Decide on appropriate investment philosophy, i.e., whether to capitalize on economic
cycles, or to focus on the growth sectors or finding the value stocks.
Develop an investment strategy based on the investment objective, the time frame for the
investment and economic expectations over this period.
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Avoid over – diversification. Although diversification is a major strength of mutual
funds, the portfolio manager must avoid the temptation to invest into very large number
of securities so as to maintain focus and facilitate sound tracking.
Develop a flexible approach to investing. Markets are dynamic and it is impossible to buy
„stocks for all seasons‟.
Models for the performance measurement of Mutual Fund
Following three models are used in order to measure the performance of a mutual fund.
Sharpe Ratio p
f p R R
)(
Treynor Ratio
Jensen Measure Rp-Rf = αp + βp (Rm-Rf )
Where:
Rp (Portfolios return)
Rf (Risk free rate
αp (Standard deviation of portfolio)
βp (Beta of the Portfolio)
Rm (Expected Market Return)
Risk Management
)( f p R R
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Risk management is one of the key elements of each and every project. Here first we discuss that
which kind of risks we can face after this we will discuss the mitigation strategies how to
manage these risks.
Market Risk:
Most investors know that investing involves risks as well as rewards and that, generally
speaking, the higher the risk, the greater the potential reward. While it is important to consider
the risks in the context of a specific investment or asset class, it is equally critical that investors
consider market risk.
Depending on the nature of the investment, relevant market risks may involve international as
well as domestic factors. Key market risks to be aware of include:
Interest Rate Risk
It relates to the risk of reduction in the value of a security due to changes in interest rates.
Interest rate changes directly affect bonds - as interest rates rise, the price of a previously
issued bond falls; conversely, when interest rates fall, bond prices increase. The rationale is
that a bond is a promise of a future stream of payments; an investor will offer less for a bond
that pays-out at a rate lower than the rates offered in the current market. The opposite also is
true. An investor will pay a premium for a bond that pays interest at a rate higher than those
offered in the current market.
Inflation Risk
It is the risk that general increases in prices of goods and services will reduce the value of
money, and likely negatively impact the value of investments.
Inflation reduces the purchasing power of money and therefore has a negative impact on
investments by reducing their value. This risk is also referred to as Purchasing Power Risk.
Inflation and Interest Rate risks are closely related as interest rates generally go up with inflation.
To keep pace with inflation and compensate for loss of purchasing power, lenders will demand
increase interest rates. However, one should note that inflation can be cyclical. During periods of
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low inflation, new bonds will likely offer lower interest rates. During such times, investors
looking only at coupon rates may be attracted to investing in low-grade junk bonds carrying
coupon rates similar to the ones that were offered by ordinary bonds during inflation period.
Investors should be aware that such low-grade bonds, while they may to a certain extent
compensate for the low inflation, bear much higher risks.
Currency Risk
It comes into play if money needs to be converted to a different currency to purchase or
sell an investment. In such instances, any change in the exchange rate between that currency
and Indian Rupee can increase or reduce your investment return. These risk usually only
impacts one if one invest in stocks or bonds issued by companies based outside the India or
funds that invest in international securities.
Liquidity Risk
It relates to the risk of not being able to buy or sell investments quickly for a price that
tracks the true underlying value of the asset. Sometimes one may not be able to sell the
investment at all - there may be no buyers for it, resulting in the possibility of one‟s
investment being worth little to nothing until there is a buyer for it in the market. The risk is
usually higher in over-the-counter markets and small-capitalization stocks. Foreign
investments pose varying liquidity risks as well. The size of foreign markets, the number of
companies listed and hours of trading may be much different from those in the India.
Additionally, certain countries may have restrictions on investments purchased by foreign
nationals or repatriating them. Thus, one may:
(1) Have to purchase securities at a premium;
(2) Have difficulty selling your securities;
(3) Have to sell them at a discount; or
(4) Not be able to bring your money back home.
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Business Risk
Risks associated with investing in a particular product, company, or industry sector are called
business or "non-systematic" risks. Common business risks include:
Management Risk
Also called company risk, encompasses a wide array of factors than can impact the value
of a specific company. For example, the managers who run the company might make a
bad decision or get embroiled in a scandal, causing a drop in the value of the company's
stocks or bonds. Alternatively, a key competitor might release a better product or service.
Credit Risk
Also called default risk, is the chance that a bond issuer will fail to make interest
payments or to pay back your principal when your bond matures.
Sociopolitical Risk
It involves the impact on the market in response to political and social events such as a
terrorist attack, war, pandemic, or elections. Such events, whether actual or anticipated, affect
investor attitudes toward the market in general, resulting in system-wide fluctuations in stock prices. Furthermore, some events can lead to wide-scale disruptions of financial markets,
further exposing investments to risks.
Country Risk
It is similar to the Sociopolitical Risk described above, but tied to the foreign country in
which investment is made. It could involve, for example, an overhaul of the country's
government, a change in its policies (e.g., economic, health, retirement), social unrest, orwar. Any of these factors can strongly affect investments made in that country. For example,
a country may nationalize an industry or a company may find itself in the middle of a
nationwide labor strike.
Legal Remedies Risk
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is the risk that if one has a problem with his investment, he may not have adequate legal
means to resolve it. When investing in an international market, one often has to rely on the
legal measures available in that country to resolve problems. These measures may be
different from the ones you may be used to in the India. Further, seeking redress can prove to
be expensive and time-consuming if you are required to hire counsel in another country and
travel internationally.
How to Deal with Risk:
While we cannot completely avoid market risks, we can take a number of steps to manage and
minimize them.
Diversify:
As in the case of business risks, market risks can be mitigated to a certain extent by
diversification - not just at the product or sector level, but also in terms of region (domestic
and foreign) and length of holdings (short- and long-term). One can spread his international
risk by diversifying his investment over several different countries or regions.
Do Homework:
Learn about the forces that can impact your investment. Stay abreast of global economic
trends and developments. If you are considering investing in a particular sector, for example,
aerospace, read about the future of the aerospace industry. If you are thinking about investing
in foreign securities, learn as much as you can about the market history and volatility, socio-
political stability, trading practices, market and regulatory structure, arbitration and
mediation forums, restrictions on international investing and repatriation of investment.
Learn more about the various types of investments options available to you and their risk
levels. Inflation risk can be managed by holding products that provide purchasing power
protection, such as inflation-linked bonds. Interest rate risk can be managed by holding the
instrument to maturity. Alternatively, holding shorter term bonds and CDs provide the
flexibility to take advantage of higher paying instruments if interest rates go up.
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Some investments are more volatile and vulnerable to market risks than others. Selecting
investments that are less likely to fluctuate with changes in the market can help minimize
risks to a certain extent.
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