Mutual Fund Basics

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Mutual Funds

What is as Asset Management Company (AMC)?

An asset management company is an investment management firm that invests the pooled funds of retail investors in securities in line with the stated investment objectives. For a fee, the investment company provides more diversification, liquidity, and professional management consulting service than is normally available to individual investors.

The diversification of portfolio is done by investing in such securities which are inversely correlated to each other. They collect money from investors by way of floating various mutual fund schemes.

What Does Open-End Mutual Fund Mean?

A type of mutual fund that does not have restrictions on the amount of shares the fund will issue. If demand is high enough, the fund will continue to issue shares no matter how many investors there are.
Open-end funds also buy back shares when investors wish to sell.

What Does Closed-End Mutual Fund Mean?

A closed-end fund is a publicly traded investment company that raises a fixed amount of capital through an initial public offering (IPO). The fund is then structured, listed and traded like a stock on a stock exchange.

What is the difference between an open ended and close ended scheme?

Open ended funds can issue and redeem units any time during the life of the scheme while close ended funds can not issue new units except in case of bonus or rights issue. Hence, unit capital of open ended funds can fluctuate on daily basis while that is not the case for close ended schemes. Other way of explaining the difference is that new investors can join the scheme by directly applying to the mutual fund at applicable net asset value related prices in case of open ended schemes while that is not the case in case of close ended schemes. New investors can buy the units from secondary market only.

What does Net Asset Value (NAV) of a scheme signify and what is the basis of its calculation?

Net asset value on a particular date reflects the realizable value that the investor will get for each unit that he his holding if the scheme is liquidated on that date. It is calculated by deducting all liabilities (except unit capital) of the fund from the realisable value of all assets and dividing by number of units outstanding.

Why the need of Diversification?

Diversification in finance is a risk management technique, related to hedging, that mixes a wide variety of investments within a portfolio. It is the spreading out investments to reduce risks. Because the fluctuations of a single security have less impact on a diverse portfolio, diversification minimizes the risk from any one investment.

A simple example of diversification is the following:

On a particular island the entire economy consists of two companies: one that sells umbrellas and another that sells sunscreen. If a portfolio is completely invested in the company that sells umbrellas, it will have strong performance during the rainy season, but poor performance when the weather is sunny. The reverse occurs if the portfolio is only invested in the sunscreen company, the alternative investment: the portfolio will be high performance when the sun is out, but will tank when clouds roll in. To minimize the weather-dependent risk in the example portfolio, the investment should be split between the companies. With this diversified portfolio, returns are decent no matter the weather, rather than alternating between excellent and terrible.
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