Concept and Role of a Mutual Fund for NISM certification
A mutual fund pools money from many investors and invests it for them. This chapter explains how the pool works, why investors use it, its limits, and the many kinds of schemes that SEBI's categorisation rules allow.
Mutual FundsSeries V-A61 MCQs5 lessons23 flashcards6 memory tricks
Practise Concept and Role of a Mutual Fund free
What you'll learn
- How a mutual fund works
Explain pooling, units, NAV and AUM in your own words. - Why investors choose mutual funds, and their limits
List the advantages and limitations a distributor should explain. - Open-ended, close-ended and interval schemes
Tell the three structures apart and know where investors buy and sell each. - SEBI's scheme categories
Place a scheme in its SEBI category from its investment rules. - Solution-oriented, passive and other funds; the industry's growth
Recognise the remaining categories and the main milestones of Indian mutual funds.
Key formulas
| NAV per unit | (Market value of assets − liabilities) ÷ units outstanding |
|---|---|
| Units allotted | Amount invested ÷ applicable NAV |
| Value of holding | Units × current NAV |
| AUM | Total market value of the assets a fund or AMC manages |
Concepts explained
NAV and units
NAV is the value of one unit: the scheme's net assets divided by units outstanding. Investors buy and sell units at the applicable NAV.
What it means
- Assets are valued at market prices daily.
- Liabilities include accrued expenses and amounts payable.
- Units allotted = amount ÷ NAV; holding value = units × NAV.
- Assets ₹105 crore, liabilities ₹5 crore
- Net assets ₹100 crore
- Units 8 crore → NAV = 100 ÷ 8
Answer: NAV = ₹12.50
- ₹50,000 invested at NAV ₹25
- 50,000 ÷ 25
Answer: 2,000 units
Related terms
- AUM: total market value of assets managed
- Face value: nominal value of a unit, often ₹10
Exam tip: A low NAV does not make a fund 'cheap': what matters is how the NAV changes.
Open-ended vs close-ended schemes
Open-ended schemes sell and buy back units every business day; close-ended schemes have a fixed maturity and are listed on an exchange for exit; interval schemes open for transactions only at set intervals.
What it means
- Open-ended: variable corpus, no maturity.
- Close-ended: fixed corpus after NFO, compulsory listing.
- Interval: mix of both.
- NAV ₹20, exchange price ₹19
- Seller gets ₹19 per unit
Answer: Sells at a 5% discount to NAV
Related terms
- NFO: first offer of units of a new scheme
- FMP: fixed maturity plan, a close-ended debt scheme
SEBI scheme categorisation
SEBI's 2017 categorisation fixed investment rules for each scheme type so that schemes with the same name invest alike, with one scheme per category per AMC (some exceptions).
What it means
- Large cap: top 100; mid cap: 101–250; small cap: 251 onwards.
- Large cap fund 80% in large caps; mid and small cap funds 65%.
- Multi cap 25% each in large, mid, small; flexi cap any mix (65% equity).
- Focused: up to 30 stocks.
- Fund holds 70% mid caps, 20% large caps, 10% cash
- Mid caps ≥ 65%
Answer: Fits mid cap category
Related terms
- Exceptions to one-per-category: index funds/ETFs on different indices, FoFs, sectoral/thematic funds
Exam tip: Large cap's minimum is 80% but mid and small cap's is 65% — a favourite trap.
Active and passive funds
Active funds try to beat a benchmark through security selection; passive funds copy an index at low cost.
What it means
- Index funds and ETFs must invest at least 95% in the index's securities.
- Tracking error measures how much a passive fund's return deviates from the index.
- ETFs trade on exchanges during market hours; index funds transact at NAV with the AMC.
Related terms
- Tracking error: variability of the difference between fund and index returns
Memory tricks
Large cap = companies ranked 1–100 by full market cap; mid cap = 101–250; small cap = 251 onwards.
Large cap fund: 80% in large caps; mid cap and small cap funds: 65% in their segment.
Multi cap: at least 75% equity with at least 25% each in large, mid and small caps.
ELSS locks in for 3 years; retirement and children's funds lock in for 5 years (or till retirement / majority if earlier).
A focused fund can hold at most 30 stocks.
Overnight funds hold 1-day securities; liquid funds hold securities maturing within 91 days.
Try 3 NISM-style questions
Q1. A multi asset allocation fund must invest at least
- 25% each in large, mid and small caps
- 65% in equity arbitrage
- 10% each in at least three asset classes
- 80% in gold
Show answer
Answer: (3) 10% each in at least three asset classes
Multi asset funds spread across three or more asset classes, at least 10% each.
Q2. Which statement about ETFs is correct?
- ETF units can only be bought from the AMC at end-of-day NAV by all investors
- Most investors buy and sell ETF units on the stock exchange during market hours
- ETFs can't track gold
- ETFs always have higher costs than active funds
Show answer
Answer: (2) Most investors buy and sell ETF units on the stock exchange during market hours
ETFs are listed and trade throughout the day; large investors can create or redeem with the AMC.
Q3. An arbitrage fund mainly earns returns by
- Buying small cap stocks and holding them for long-term growth
- Lending to low-rated companies at high rates of interest
- Holding physical gold
- Exploiting price differences between the cash and derivatives markets
Show answer
Answer: (4) Exploiting price differences between the cash and derivatives markets
It buys in the cash market and sells futures (or vice versa) to lock in the price gap.
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