ASSET MANAGEMENT

BATCH 2013-2015

Mutual fund& Active Portfolio Management

SUBMITTED By- SUBMITTED To- Abhishek Bora (448), Dr. Rituparna Das Rimzim Kachhawaha (459) Associate Professor, Asst. Dean, Surendra Sharma (461) Faculty of Policy ScienceMBA, INSURANCE IV SEMESTER NATIONAL LAW UNIVERSITYDATE: - 14-04-2015 JODHPUR

ContentsS.No.Topic NamePage no.

1Introduction3

2Formation of Mutual Fund3

3Schemes of Mutual Fund8

4Functioning of the mutual funds10

5Types of Mutual Funds14

6Benefits & Drawbacks of investments in Mutual Funds15

7Active Portfolio Management16

8Comparison between active management and passive management19

9Advantages & Disadvantages of Active Management

22

Introduction:-1Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document.Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time.Mutual fundissues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known asunit holders.The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public.Unit Trust ofIndiawas the first mutual fund set up inIndiain the year 1963. In early 1990s, Government allowed public sector banks and institutions to set up mutual funds.In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of SEBI are to protect the interest of investors in securities and to promote the development of and to regulate the securities market.As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines to the mutual funds from time to time to protect the interests of investors.All mutual funds whether promoted by public sector or private sector entities including those promoted by foreign entities are governed by the same set of Regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes launched by the mutual funds sponsored by these entities are of similar type.Formation of Mutual Fund:-2A mutual fund is set up in the form of a trust, which has sponsor, trustees,assetManagement Company(AMC) and custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of a company. The trustees of the mutual fund hold its property for the benefit of theunit holders. Asset Management Company (AMC) approved by SEBI manages the funds by making investments in various types of securities. Custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The trustees are vested with the general power of superintendence and direction over AMC. They monitor the performance and compliance of SEBI Regulations by the mutual fund.SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be independent. All mutual funds are required to be registered with SEBI before they launch any scheme.Players in Mutual Funds:-

3Sponsor runs the show, akin the promoters of a Company. The SEBI (Mutual Funds) Regulations, 1996, defines sponsor as any person who, acting alone or in combination with another body corporate, establishes a mutual fund. The sponsor forms the Trust and appoints the board of trustees, appoints the AMC as the fund managers and may also appoint custodian to hold the fund assets. As per the SEBI (Mutual Fund) Regulations, 1996, sponsor makes an application for registration of the mutual fund and contributes atleast 40% of the net worth of the asset management company. The sponsor must comply with the eligibility criteria without which the Board may reject the application. Eligibility criteria for grant of certificate of registration are that the sponsor should:-(i) Have a sound track record and general reputation of fairness and integrity in all his business transactions. (ii) the applicant is a fit and proper person (iii) in the case of an existing mutual fund, such fund is in the form of a trust and the trust deed has been approved by the Board; (iv) the sponsor has contributed or contributes at least 40% to the net worth of the asset management company: (v) the sponsor or any of its directors or the principal officer to be employed by the mutual fund should not have been guilty of fraud or has not been convicted of an offence involving moral turpitude or has not been found guilty of any economic offence; (vi) appointment of trustees to act as trustees for the mutual fund in accordance with the provisions of the regulations;(vii) appointment of asset management company to manage the mutual fund and operate the scheme of such funds in accordance with the provisions of these regulations; (viii) appointment of custodian in order to keep custody of the securities or gold and gold related instrument or other assets of the mutual fund held in terms of these regulations, and provide such other custodial services as may be authorized by the trustees Sound track record here means: (i) be carrying on business in financial services for a period of not less than five years; and (ii) the net worth is positive in all the immediately preceding five years; and (iii) the net worth in the immediately preceding year is more than the capital contribution of the sponsor in the asset management company; and (iv) the sponsor has profits after providing for depreciation, interest and tax in three out of the immediately preceding five years, including the fifth year Asset Management Company AMC acts as an investment manager of the Trust. AMCs floated and manage different investment schemes in the name of the Trust. Restrictions on AMC are: Not act as a trustee of any mutual fund Not undertake any activity conflicting with the activities of the mutual fund AMC shall not invest in any of its schemes unless intention to invest has been made in the offer document Obligations of AMCs are: AMC shall not carry transactions with any broker whether associated with sponsor or not; for average of 5% or more; with exceptions Ensure regulatory compliances & approvals when required Liable to mutual funds for the acts of omission & commission Details of directors, their interest in other companies; changes in interest to be submitted to the trustees Fund manager to ensure that the funds of the scheme are invested to meet the objectives of the scheme Due diligence and care in all investment decisions AMC shall not utilize the services of any sponsor or its associates etc AMCs to make half yearly disclosures for: Underwriting obligations Devolvement Subscriptions in the schemes lead managed by associates Subscriptions to debt/ equity issues where sponsors/ associates acted as arranger/ lead manager Trustee Trustees hold unit holders money in fiduciary capacity. Two thirds of the trustees shall be independent persons and shall not be associated with sponsors in any manner. The Eligibility Criteria for a trustee and the rights and obligations of the trustees as stated in the SEBI (Mutual Fund) Regulations, 1996 are as follows: Eligibility criteria for being a trustee:- No person shall be eligible to be appointed as a trustee unless(a) He is a person of ability, integrity and standing; and (b) Has not been found guilty of moral turpitude; and (c) Has not been convicted of any economic offence or violation of any securities laws; (d) Has furnished particulars as specified in Form C. (e) No asset management company and no director (including independent director), officer or employee of an asset management company shall be eligible to be appointed as a trustee of any mutual fund (f) No person who is appointed as a trustee of a mutual fund shall be eligible to be appointed as a trustee of any other mutual fund (g) Two-thirds of the trustees shall be independent persons and shall not be associated with the sponsors or be associated with them in any manner whatsoever (h) In case a company is appointed as a trustee then its directors can act as trustees of any other trust provided that the object of the trust is not in conflict with the object of the mutual fund.

Unit Holder General public that invests in the schemes floated by AMCs. Mutual Fund It is the pass through vehicle, constituted in a form of a Public Trust, which holds the assets of the trust for the benefit of the unit-holders, beneficiaries of the trust Custodian/ Depositories They hold the physical/ dematerialized securities of mutual fund Transfer Agents They are responsible for issuing and redeeming units of mutual funds and provide other related services such as preparation of transfer documents and updating investors records.Schemes of Mutual Fund4A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period.Open-ended Fund/ SchemeAn open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity.Close-ended Fund/ SchemeA close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual funds schemes disclose NAV generally on weekly basis.Schemes according to Investment Objective:A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:Growth / Equity Oriented SchemeThe aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.Income / Debt Oriented SchemeThe aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. TheNAVsof such funds are affected because of change in interest rates in the country. If the interest rates fall,NAVsof such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.Balanced FundThe aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However,NAVsof such funds are likely to be less volatile compared to pure equity funds.Money Market or Liquid FundThese funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.Gilt FundThese funds invest exclusively in government securities. Government securities have no default risk.NAVsofthese schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes.Index FundsIndex Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc.Theseschemes invest in the securities in the sameweightagecomprising of an index.NAVsof such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme. There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges.Functioning of the mutual funds:-5The process of registering/ functioning of mutual funds is:1. A sponsor has to make an application in Form A along with the requisite fees to the Board (SEBI). Grant of certificate of registration is given by the Board in Form B. Thereafter each mutual fund must pay an annual service fee, in case of failure to pay the annual fee, the Board may not permit the mutual fund to launch any scheme2. Mutual Fund has to be established in the form of a Trust and the deed has to be registered under the Indian Registration Act, 1908, the deed being duly executed by the sponsor in the name of the trustees as mentioned in the deeda. The purpose of the trust deed is to safeguard interest of the unit holders and thus states the rights, obligations and liabilities of the trust in relation to the mutual fund or the unit holdersb. The contents of the trust deed will broadly include the following clauses:i. Unit holders would have beneficial interest in the trust property to the extent of individual holdings in the respective schemesii. Liabilities & duties of the trustees, right to appoint/ dismiss asset Management Company.iii. Right to forbid the mutual funds from making investments which are detrimental to the interests of the unit holdersiv. Minimum number of trustees, trusteeship fees, removal of members, number of meetings, quorum for the meeting etc.v. Disclosures of particulars of interests of the trustees in other companies, institution, financial intermediary or anybody corporatec. Appointed trustees need to furnish their details in Form C to the Board - approval of the Board is must for the appointment of Trusteesd. The trustees and/ or the sponsors appoint the Asset Management Company. The trustees and AMC with the prior approval of the Board enter into an investment management agreement (Clauses of the investment management agreement are mentioned in the Fourth Schedule of the Regulation). Application Form D to be submitted to the Board for appointment of AMC3. Scheme to be launched with the approval of the trustees and offer document filed with the Board. Offer document disclosures will include:a. Adequate information to enable investors make investment decisionsb. Application form for investing in units to contain the information memorandumc. Mention of prior in-principle approval of stock exchanges, if listing of units to be carried out4. Advertisement of each scheme to disclose the investment objective of the scheme5. Once units sold, there are restrictions on investments specified in the Regulations6. Valutions of the investments in the portfolio are carried out regularly and published7. Liquidity options are provided both in case of open ended and close ended schemesEvaluating Performance of Mutual Funds:Net Asset Value is the amount a unit holder would receive if the mutual fund were wound up, it is also called the mutual funds calling card. Since the unit holders are part owners of the assets and liabilities of the mutual fund, NAV is the net value of all assets and liabilities, i.e the market value of total assets and market value of total liabilities. What is the peculiar to NAV is:NAV changes dailyNAV is computed as a value per unit holdingReturns to the investor are determined by Cost of Mutual Fund and Net Asset ValueComputation of NAV:NAV = Net assets of the schemeNumber of units outstandingWhere;Net assets of the scheme = Market value of investments + receivables + other accrued income + other assets - Accrued expenses - other payables - other liabilitiesCost component of Mutual Funds: It is quite evident, higher the cost, lower would be return for investors. The cost component can be divided into 2:Initial expenses - incurred for establishing the scheme. These expenses are not charged on the year of expenditure but are amortized over a period of timeo In case of close ended scheme floated on load basis, issue expenses are amortised on weekly basis over the period of scheme o In case of open ended scheme floated on load basis, initial expenses are amortized over a period not exceeding 5 yearsRecurring expenses - also called Operating cost.o Cost of investment analysts/ advisory fees o Administrative cost o Advertisement costManagement expenses ratio: Expenses are measured as a % of the average value of portfolio. The ratio is as follows:Expenses Ratio = ExpensesAverage value of portfolioExpenses can be also be expressed per unit, then the ratio is:Expenses per unit = Expenses incurred per unitAverage net value of assetsSales Charges: Sales charges or sales load are directly charged to the investor and are used to make payment with regard to agents commission and expenses for distribution and marketing. Sales charges are directly collected from the investor as front end load or back end load Front end load: One time fixed fee paid by the investor while buying into the scheme. This helps you determine, how much of the initial investment gets invested. Front end load amount decreases as the initial investment amount increases. Public Offer Price (POP) is calculated in the following manner:Public Offer Price = Net Asset Value(1-Front end load) Back end load: This is fixed fee paid at the time of redemption or selling of the units. The redemption price is calculated in the following manner:Redemption Price: Net Asset Value(1+ Back end load)Contingent Deferred Sales Charges (CDSC): This is a back end load paid when the units are redeemed during the initial of ownership. As per the SEBI (Mutual Fund) Regulations, 1996 CDSC may only be charged for the first four years after purchase of the units. The regulations also provide for the maximum CDSC that can be charged in a particular year. The front end and back end loads cannot be in excess of 7%Limitations of fees & expenses on issue of schemes as per the Regulations: AMCs expenses to be clearly identified and appropriated to the individual schemes and to be disclosed the in the offer document. The advisory fees of the AMC shall be the following:o One and a quarter of one per cent of the weekly average net assetsOutstanding in each accounting year for the scheme concerned, as long as the net assets do not exceed Rs.100 crores, and o One per cent of the excess amount over Rs.100 crores, where net assets so calculated exceed Rs.100 crores. in case of an index fund scheme, the investment and advisory fees shall not exceed three fourths of one percent (0.75%) of the weekly average net assets For schemes launched on a no load basis, the asset management company shall be entitled to collect an additional management fee not exceeding 1% of the weekly average net assets outstanding in each financial year AMC may charge recurring expenses in addition to the above expenses The total expenses of the scheme excluding issue or redemption expenses, including the investment management and advisory fee shall be subject to the following limits (with certain exceptions for specific funds) :(i) On the first Rs.100 crores of the average weeklynet assets2.5%;(ii) On the next Rs.300 crores of the average weeklynet assets2.25%;(iii) On the next Rs.300 crores of the average weeklynet assets2.0%;(iv) On the balance of the assets 1.75%Computation of Returns:-Investors returns are of three types Cash Dividend Capital Gains disbursement Changes in the funds NAV per unit (Unrealized Capital Gain) Thus returns are calculated in the following manner:R = D + CG + UCG x 100or; R = D + CG + (NAVi - NAVo)/ NAVo x 100Where;R = returns D = Dividend CG = Capital Gains UCG = Unrealized Capital Gain = (NAVi - NAV0)/ NAV0 NAV1 = Net Asset Value at the end of period 1 NAV0 = Net Asset Value at the end of period.Types of Mutual Funds: Balanced Funds - A portfolio which has strategic allocation of debt and equity Equity diversified funds - As the name suggests the portfolio has wide array of stocks. There are many types of equity dividend funds: Flexicap/ Multicap funds - the fund is diversified, with defined minimum and maximum level of exposure to each of the market caps o Contra Fund - it is for those investors who want the fund to perform in all types of market environments o Index Fund - fund that tracks the performance of the benchmark market index Dividend Yield Fund - as the name suggests the fund invests in shares of companies having high dividend yield. These stocks are generally less volatile and offer potential for good capital appreciation Equity Linked Tax Savings Scheme (ELSS) - this fund gives investors the option to save taxes under section 80C of the Income Tax Act. The fund has a minimum lock in of 3 years, it helps investors avoid problems of investing lumpsum amount and also helps one get the benefit of averaging Sector Funds - as the name suggests, the fund invests in a particular sector to let investors reap benefit of seasonal returns and industry cycles. These would be riskier than diversified portfolios as they bear a greater risk of a particular sector turning out to be non-performing Thematic Funds - The fund managers invest in a particular sector or industry which is likely to outperform, based on their assessment or industry analysis. The downside of investing in such funds is that one has to rely on the fund managers research and analysis. Arbitrage Funds - these funds provide safety, liquidity, better returns and tax benefits as these funds include mix of derivatives and equity. These funds provide better returns than a typical debt instrument and lower volatility than equity Hedge Funds - There are no hedge funds in India but they are private investment vehicles and are lightly regulated investment funds. The concept is later explained in details Cash Funds - As the name suggests these funds offer higher liquidity and lower volatility as the portfolio includes debt and money market instruments Exchange Traded Funds - these funds are listed on the stock exchange and their prices are linked to the underlying index. The concept has been explained in detail laterFactors to be considered for selecting Mutual Fund: Past performance - The past performance of the mutual fund can be adjudged by growth of the NAV during the referral period. Growth is evaluated in the following manner: Growth = (NAVi - NAVo) + Di/ NAVo Timing - timing for investments made by the mutual fund is critical for maximizing returns, for instance investing in the bullish or bearish market may be vital for the investment and performance of the mutual fund Size of fund - larger the size of the fund, greater would be the risk as there would be more products to be monitored. Small sized funds may not give the much expected return or growth. So investors should be very careful will selecting the fund to invest in. Age of fund - Longevity of the fund would indicated how seasoned the player is in the market and expertise. Fund Manager - He is the fulcrum of the fund, the investors should also have an idea whose hands their money rests in. Expense Ratio - Though there is an upper ceiling imposed on the expenses by the regulators. Lower the expenses higher would be the return PE Ratio - The weighted average PE of the stocks in the portfolio can be used to measure the risk levels of the fund Portfolio turnover - This again is crucial to the return bearing capacity of the fund. High turnover would have greater cost implications, whereas low turnover would mean that the fund manager is not using the market options to the hilt.Benefits of investing in mutual funds:i. Diversification - As discussed above, the portfolio is diversified, so it reduces the riskii. Professionally managed - These funds are managed by skilled professionals, with experience and expertiseiii. Administrative Advantage - Mutual Funds offer services in demat mode, so it saves time investors time and risk of delay in share transfer etciv. Higher Returns - Returns are usually higher than other avenues of investmentv. At relatively low cost - Mutual funds cannot increase the charge beyond 2.5%, any cost over and above the prescribed limit is borne by the Asset Management Company (AMC)vi. Liquidity - In case of an open ended funds, liquidity is provided by direct sales or repurchase by the Mutual Funds and in case of close ended funds, liquidity is provided by listing of the units on Stock Exchange (terms explained later)vii. Transparency - Mutual Funds are regulated by SEBI and have to disclose the portfolio on a half yearly basis. NAVs are calculated on daily basis in case of open ended funds and published in newspapers for investors knowledgeviii. Flexibility - Some Mutual funds provide investors the flexibility of switching from one scheme to other without any loadix. Mutual funds offer the benefit of investing in the portfolio of your choice depending upon the risk/ return you want out of our investments.Drawbacks of investments in Mutual Funds:i. No guarantee on returns - the returns on Mutual Funds investments are not guaranteed. There may be such situation where the proportionate increase in the value of the mutual fund may be the same or less than what an investor would have received had he invested in risk free securities. Sometimes Mutual Funds may depreciate in value as wellii. Diversification - Diversification reduces risks, but too much of diversification can effect returns as welliii. Fund Selection - It the premises for investments are not properiv. Cost Factor - The cost payable to the fund managers may not be related to the performance of the fund. In this case the cost factor would be a drawback for the investors.Active Portfolio Management:-6Active management refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index. In passive management, investors expect a return that closely replicates the investment weighting and returns of a benchmark index and will often invest in an index fund.7Active investing is when one invests in a fund that is actively managed. Active fund managers seek to beat the markets returns as opposed to only giving investors a replication of the markets returns as seen with index-tracking or passive investment funds. Managers following an active investment style use various methods to outperform a given index or benchmark. The essence of their approach is to capitalize on what they believe are pricing inefficiencies in the market. They conduct detailed research on companies and stock prices and compare their valuation of those stocks to that of the market. The majority of this analysis includes evaluating a companys past, current, and future earning capability with forthcoming business and economic conditions. The outcome of their analysis is compared to the companys past, present, and forecasted stock price. The managers intention is to buy a companys stock when they believe it is undervalued, and to sell that stock when it is overvalued, thereby creating a profit for their fund. Managers will also attempt to identify economic trends to help them predict which industries have the best near term prospects and avoid those with a less favorable near-term outlook.The active manager exploits market inefficiencies by purchasing securities (stocks etc.) that are undervalued or by short selling securities that are overvalued. Either of these methods may be used alone or in combination. Depending on the goals of the specific investment portfolio, hedge fund or mutual fund, active management may also serve to create less volatility (or risk) than the benchmark index. The reduction of risk may be instead of, or in addition to, the goal of creating an investment return greater than the benchmark.Active portfolio managers may use a variety of factors and strategies to construct their portfolio(s). These include quantitative measures such as priceearnings ratios and PEG ratios, sector investments that attempt to anticipate long-term macroeconomic trends (such as a focus on energy or housing stocks), and purchasing stocks of companies that are temporarily out-of-favor or selling at a discount to their intrinsic value. Some actively managed funds also pursue strategies such as risk arbitrage, short positions, option writing, and asset allocation.Using the concept of asset allocation, researchers divide active management into two parts; one part is selecting securities within an asset class, while the other part is selecting between asset classes. For example, a large-cap U.S. stock fund might decide which large-cap U.S. stocks to include in the fund. Then those stocks will do better or worse than the class in general. Another fund may choose to move money between bonds and stocks, or some country versus a different one, et cetera. Then one class will do worse or better than the other class.The case where a fund changes its class of assets is called style drift. An example would be where a fund that normally invests in government bonds switches into stocks of small companies in emerging markets. Although this gives the most discretion to the manager, it also makes it difficult for the investor (portfolio manager) if he also has a target of asset allocationThe effectiveness of an actively managed investment portfolio obviously depends on the skill of the manager and research staff but also on how the term active is defined. Many mutual funds purported to be actively managed stay fully invested regardless of market conditions, with only minor allocation adjustments over time. Other managers will retreat fully to cash, or use hedging strategies during prolonged market declines. These two groups of active managers will often have very different performance characteristics.8Active Portfolio Management is portfolio management in which investment decisions of the fund are at the discretion of a fund manager(s) and he or she decides which company, instrument or class of assets the fund should invest in based on research, analysis, market news etc. such a fund is called as an actively managed fund. The fund buys and sells securities actively based on changed perceptions of investment from time to time. Based on the classifications of shares with different characteristics, active investment managers construct different portfolio. Two basic investment styles prevalent among the mutual funds are Growth Investing and Value Investing: Growth Investing Style:-The primary objective of equity investment is to obtain capital appreciation. A growth manager looks for companies that are expected to give above average earnings growth, where the manager feels that the earning prospects and therefore the stock prices in future will be even higher. Identifying such growth sectors is the challenge before the growth investment manager. Value Investment Style:-A Value Manager looks to buy companies that they believe are currently undervalued in the market, but whose worth they estimate will be recognized in the market valuations eventually.Passive Fund Management:-When an investor invests in an actively managed mutual fund, he or she leaves the decision of investing to the fund manager. The fund manager is the decision-maker as to which company or instrument to invest in. Sometimes such decisions may be right, rewarding the investor handsomely. However, chances are that the decisions might go wrong or may not be right all the time which can lead to substantial losses for the investor. There are mutual funds that offer Index funds whose objective is to equal the return given by a select market index. Such funds follow a passive investment style. They do not analyse companies, markets, economic factors and then narrow down on stocks to invest in. Instead they prefer to invest in a portfolio of stocks that reflect a market index, such as the Nifty index. The returns generated by the index are the returns given by the fund. No attempt is made to try and beat the index. Research has shown that most fund managers are unable to constantly beat the market index year after year. Also it is not possible to identify which fund will beat the market index. Therefore, there is an element of going wrong in selecting a fund to invest in. This has led to a huge interest in passively managed funds such as Index Funds where the choice of investments is not left to the discretion of the fund manager. Index Funds hold a diversified basket of securities which represents the index while at the same time since there is not much active turnover of the portfolio the cost of managing the fund also remains low. This gives a dual advantage to the investor of having a diversified portfolio while at the same time having low expenses in fund.

9Active ManagementPassive Management

Fund managerConducts rigorous research and analysis on company stocks. Makes informed investment decisions for the fund. Fulfills an intensive management role.Fulfills a passive management role. No detailed analysis or significant investment decisions required.

PerformanceAims to beat the market or beat a stated benchmark. Has the ability to maximize gains and minimize losses.Does not aim to beat the market or a benchmark. Aims to replicate the performance of a market positive or negative. Cannot make gains greater than the market.

FeesManager fees are higher due to increased levels of skill, knowledge and involvement required on behalf of the manager.Lower management and operating fees.

RiskFund is exposed to manager risk as well as market risk.Fund is exposed to market risk.

StrategiesA range of strategies for investors to choose from including equity funds, bond funds, balanced funds etc.No choice of investment strategy

Arguments in favor of Active Portfolio Management10People in favor of passive management believe that markets are 'efficient', because markets are efficient, it is impossible for an investment manager to outperform consistently and investors therefore should adopt a passive approach. But at any point in time, some markets are likely to be more efficient than others. However, it seems absurd to think that any market is entirely efficient. There are nearly always mispricing opportunities in markets, particularly for investors who are prepared to investigate asset markets thoroughly, and who are equipped to use long-term perspective. A good active manager can add significant value in the fulfillment of clients' investment objectives by selecting appropriate securities and by making favorable asset allocation decisions. Investment managers have the best understanding of financial markets, particularly where a multi-asset orientation means that they evaluate opportunities across the investment landscape as a wholeParadoxically, the efficiency that passive proponents say exists in financial markets is surely attributable (to the extent that such efficiency is ever evident) to the actions of active investors. Without active investors, markets would lack any qualitative oversight and, in that respect, passive managers are dependent on the investment decisions of active managers.Measures of economies and financial markets tend to take the form of averages, for example in relation to readings of gross domestic product, inflation, equity market indices and so on. In reality, all such measures are representative of many different component factors and at any point in time some will be performing better than others. An active investor may add value by looking at the detail of individual companies' fortunes and by taking perspective on long-term opportunities (above all at times when asset markets are driven by short-term factors that overlook those opportunity).A skilled, active investment manager, particularly a multi-asset manager with a holistic understanding of opportunities across different asset classes, is well equipped to make risk and return judgments between the different classes of capital that are issued by individual companies.The use of a passive investment strategy may entrench asset allocation to the detriment of the investor by encouraging a static approach.The argument that risk tend to focus almost exclusively on the security selection risk inherent in active management and very little upon the benchmark risk that is unavoidable in taking a passive approach. To say risk is 'neutralized' for a passive investor is plainly wrong given the absolute volatility exhibited by financial markets. Even if the risk characteristics of passive strategies were to match those of underlying indices, investors would still be exposed to the significant risk that indices themselves would fall.Although there are 'equal-weight' or 'capitalization-weight' indices which seek to obviate the negative implications of mirroring an index without exception, most indices (and the passive funds that track them) are market-capitalization based. That is, the larger a stock's weighting in an index, the greater its impact on the movement of that index (and therefore the greater its contribution to the performance of a tracking fund). This may give rise to significant 'concentration risk' in a passive investor's portfolio.With the performance of the larger sectors and larger stocks having a greater impact on overall performance (regardless of the merits of those sectors and stocks), the market- capitalization-based passive investor will be compelled to buy ever-greater holdings of securities that have already done well (and to hold ever-smaller amounts of those that have done less well). Decisions to buy and sell are brought about thus by changes in index composition, rather than on the basis of the merits of particular stocks. Using this approach passive investors can be hostages to the fortunes of troubled companies, even if they foresee those companies' troubles. A passive approach precludes the investor from making qualitative judgments about the prospects of particular parts of a market.Investors may be prepared to forsake some of their potential return for a less volatile investment approach, but passive management may be inflexible in meeting risk-related requirements. Active investment management has the advantage of permitting, for example, an absolute-return approach to investment returns. Such an approach, by means of its focus on absolute rather than relative returns, allows investors to pursue both risk and return characteristics that are appropriate to them.Volatility in financial markets is not simply a threat; it can also be used to good effect in generating attractive investment returns. However, it must be managed in order to be beneficial to investors. Active approaches are adept at allowing such risk management, but passive approaches are much less so.If all active managers are trying to beat an index-based return, it clearly becomes harder for each of them to exceed that return; the best will do so, but it is unrealistic to expect them all to do so.Passively managed funds generally offer no protection against declines in the indices they track and, for this reason, they may well underperform active funds during downturns. By contrast, active managers are able to use cash and other 'defensive' assets to shield investors from equity market declines. Regardless of market conditions, a multi-asset approach (by contrast with a multi-specialist approach) can be very useful in permitting an investment manager the leeway to switch between asset classes to the benefit of investors.Active investors can engage with companies by voting, by calling meetings and by selling a security (which is the ultimate sanction they possess in expressing a view forcefully about an SRI or corporate governance matter), but passive managers are unable to sell a security, however vehement their opposition to a company's conduct. Furthermore, active managers can decide not to buy a security in the first place if they have concerns about a particular issue. Active managers' 'veto' over purchases and sales of securities strengthens their influence over companies' activities. Passive investors, by comparison, are locked into the universe of stocks in an index and thus do not interact with individual companies.Active investors may benefit in particular from a performance-related arrangement in the incurrence of the costs. The use of such an arrangement should align investors' interests with those of their investment manager, but should serve also to align the fee investors pay for investment management services with the ultimate effectiveness of those services.Advantages of Active Management11An investor may believe that actively managed funds do better in general than passively managed funds.Investors believe that they have some skill for picking which active managers will do better after they have invested.They may be skeptical of the efficient-market hypothesis, or believe that some market segments are less efficient in creating profits than others.They may want to manage volatility by investing in less-risky, high-quality companies rather than in the market as a whole, even at the cost of slightly lower returns.Conversely, some investors may want to take on additional risk in exchange for the opportunity of obtaining higher-than-market returns.Investments that are not highly correlated to the market are useful as a portfolio diversifier and may reduce overall portfolio volatility.Some investors may wish to follow a strategy that avoids or underweights certain industries compared to the market as a whole, and may find an actively managed fund more in line with their particular investment goals. (For instance, an employee of a high-technology growth company who receives company stock or stock options as a benefit might prefer not to have additional funds invested in the same industry.)Investors may gain some psychic benefit from firing a manager that has underperformed, and replacing them with a different manager.

Disadvantages of Active ManagementThe most obvious disadvantage of active management is that the fund manager may make bad investment choices or follow an unsound theory in managing the portfolio. The fees associated with active management are also higher than those associated with passive management, even if frequent trading is not present. Those who are considering investing in an actively managed mutual fund should evaluate the fund's prospectus carefully. Data from recent decades demonstrates that the majority of actively managed large and mid-cap stock funds in United States fail to outperform their passive stock index counterparts.Active fund management strategies that involve frequent trading generate higher transaction costs which diminish the fund's return. In addition, the short-term capital gains resulting from frequent trades often have an unfavorable income tax impact when such funds are held in a taxable account.When the asset base of an actively managed fund becomes too large, it begins to take on index-like characteristics because it must invest in an increasingly diverse set of investments instead of those limited to the fund manager's best ideas. Many mutual fund companies close their funds before they reach this point, but there is potential for a conflict of interest between mutual fund management and shareholders because closing the fund will result in a loss of income (management fees) for the mutual fund company.

END NOTE1http://www.sebi.gov.in/faq/mf_faq.html2http://www.sebi.gov.in/faq/mf_faq.html3http://vinodkothari.com/wp-content/uploads/2014/01/Brief-on-Mutual-Funds.pdf4http://www.sebi.gov.in/faq/mf_faq.html5http://vinodkothari.com/wp-content/uploads/2014/01/Brief-on-Mutual-Funds.pdf6http://en.wikipedia.org/wiki/Active_management7https://www.discovery.co.za/discovery_coza/web/linked_content/pdfs/invest/choose_your_investment/active_and_passive_investment.pdf8https://www.principalindia.com/pdf/downloads/NCFM.PDF9https://www.discovery.co.za/discovery_coza/web/linked_content/pdfs/invest/choose_your_investment/active_and_passive_investment.pdf10http://us.bnymellonam.com/core/library/documents/knowledge/Viewpoints/newtonactivemgmt.pdf11http://en.wikipedia.org/wiki/Active_management

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