Mutual funds and ETFs

Most people in India don’t buy shares or bonds one at a time. They buy a fund that holds dozens or hundreds of them at once. This lesson covers how that works, what you actually own, and what it costs.

What a mutual fund is

A mutual fund pools money from many investors and invests it according to a stated plan: in shares, in bonds, or in a mix. A professional fund manager makes the day-to-day decisions. You own units of the fund, and each unit is an equal slice of everything the fund holds.

Funds in India are run by asset management companies and regulated by SEBI. What a fund owns is held by a separate custodian, not by the company that manages it.

NAV: what a unit is worth

The net asset value (NAV) is the value of everything the fund owns, less what it owes, divided by the number of units. It is worked out once a day, after the market closes. When you buy or sell units, you deal at that day’s NAV, provided your order reaches the fund before its daily cut-off, rather than at a price that moves during the day.

A fund with a NAV of ₹250 is not more expensive than one at ₹15. The NAV only reflects when the fund started and how it has done since. What matters is how it moves from here.

The main kinds

SEBI sorts funds into categories, so that funds doing similar things can be compared with each other:

• Equity funds. Mostly shares: large cap, mid cap, small cap, sector funds and more.
• Debt funds. Bonds and other lending, from overnight and liquid funds to long-dated government bond funds.
• Hybrid funds. A mix of shares and bonds in set proportions.
• Solution-oriented funds. Built around a goal such as retirement or a child’s education, usually with a lock-in.
• Index funds and other passive funds. Below.

Active or passive

An active fund has a manager choosing what to buy and sell, aiming to do better than a benchmark index. A passive fund, an index fund or an ETF, simply holds whatever is in an index such as the Nifty 50, in the same proportions. It makes no attempt to beat the index. It aims to match it, and charges less for doing so.

ETFs

An exchange-traded fund is a fund whose units trade on the stock exchange like a share. You buy and sell during the day at the market price, which stays close to the fund’s NAV, and you need a demat account to hold one. Most ETFs in India track an index, or a commodity such as gold.

What it costs

A fund charges a yearly fee called the expense ratio, or total expense ratio, as a percentage of what you have invested. You never see a bill. It is taken out of the fund a little every day, and the NAV you see is already after it. SEBI caps how much a fund can charge.

Some funds also charge an exit load: a small fee if you sell within a set period after buying.

Direct and regular plans

Every mutual fund in India comes in two versions:

• a regular plan, bought through a distributor or an adviser, who is paid a commission out of the fund’s expenses;
• a direct plan, bought straight from the fund house or through a direct platform, with no commission.

The two hold exactly the same investments and are run by the same manager. The only difference is the expense ratio: the regular plan’s is higher by the commission. What the extra pays for is the distributor’s service, help choosing and keeping track of funds, and whether that is worth it is for you to judge. What follows is only what it costs.

The costs here are examples to drag, not any real fund’s. Each fund publishes its own expense ratios for both plans, and they change from time to time.

Work it out on your own numbers

• Investment return calculatorCompare a return against a benchmark after fees.
• Compound interest calculatorGrowth at any rate and any compounding frequency.

This lesson explains ideas. It is not advice about what to buy, sell or hold.