Mutual fund basics: how a fund actually works

A mutual fund is a way for many people to own the same set of shares or bonds together. You put in money, a professional team buys and holds the investments, and you own a slice of the whole pool. Your slice is measured in units.

This page answers the questions people ask at the start: what a fund is, who runs it, where your money goes, and what the words on your statement mean. It names no scheme and tells you nothing to buy.

What is a mutual fund?

A mutual fund collects money from many people who want roughly the same thing — say, long-term growth from shares, or steady income from bonds — and invests it as one pool. A fund manager and a research team decide what the pool buys and sells, within rules the scheme has already published.

You do not own the shares directly. You own units of the pool, and the value of your units moves with the value of everything inside it.

One fund house usually runs many schemes. A scheme is the actual product you invest in, with its own portfolio, its own costs and its own rules. “Fund” in everyday speech almost always means one scheme.

Who runs a mutual fund?

Four different organisations are involved, deliberately. No single one holds your money, decides what to buy, and keeps the records.

What does the AMC do?

The AMC — the asset management company, or what people call the fund house — employs the fund managers and runs the schemes day to day. It decides what the portfolio buys and sells, publishes the scheme documents and charges a fee for the work.

The AMC does not keep your money in its own accounts. It manages a pool that legally belongs to the people who invested in it.

What do the sponsor and the trustees do?

The sponsor is the company that set the fund up and put in the initial capital. A mutual fund in India is created as a trust, and the trustees are the people whose job is to look after that trust on behalf of investors.

The trustees are separate from the AMC. They are there to check that the AMC follows the scheme’s stated rules and SEBI’s regulations — a built-in supervisor who answers to you, not to the fund house.

Who actually holds my money?

Your money goes to the scheme’s own account, never to a distributor and never to an individual. The shares and bonds the scheme buys are held by a custodian, which is a separate institution whose only job is safekeeping.

What is a registrar, or RTA?

A registrar and transfer agent keeps the records: who owns how many units, in which folio, and every transaction on it. Two of them handle most of the industry between them.

When you ask for a statement, change your bank details or add a nominee, the request reaches the registrar. This is why your records look the same across several fund houses that use the same registrar.

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Who makes the rules?

What does SEBI do?

SEBI — the Securities and Exchange Board of India — is the regulator. It writes the regulations that say how a scheme may be built, what it must disclose, how units are priced, how categories are defined and how quickly you must be paid when you sell.

SEBI registers the mutual funds themselves. It does not endorse any scheme, any fund house or any distributor.

What does AMFI do?

AMFI, the Association of Mutual Funds in India, is the industry body. It runs the code of conduct that distributors sign up to, issues the ARN that every distributor must hold, and publishes industry data and investor education material.

What does an ARN mean?

An ARN is the registration number of a mutual fund distributor. A distributor must tell you their name and ARN, and you can check any ARN yourself on the AMFI website at amfiindia.com.

A distributor helps you transact and service the account, and is paid a commission by the fund house out of the scheme’s expenses. That is a different registration from the one SEBI gives to professionals who charge you a fee to recommend investments. A distributor does not charge you directly, and is not registered to manage your money for you.

Units and NAV

What is a unit?

A unit is your share of the pool. If the whole scheme holds ₹1,000 crore and you own units worth ₹1 lakh, you own one ten-thousandth of everything in it.

Units are held to three or four decimal places, so you are never forced to invest a round number. ₹5,000 simply buys whatever fraction of a unit ₹5,000 is worth that day.

What is NAV?

NAV stands for net asset value: the value of one unit. The scheme adds up what everything in the portfolio is worth at the end of the day, subtracts what it owes, and divides by the number of units outstanding.

Most schemes publish one NAV each business day. Your holding is simply your units multiplied by today’s NAV.

Is a low NAV cheaper than a high NAV?

No. This is the single most common misunderstanding.

Both are worth exactly the same the moment you buy. What matters afterwards is what the portfolio holds, not the number printed next to it.

A new scheme starting at ₹10 is not starting cheap. It is just starting.

When do I get today’s NAV?

You get the NAV of the day the money actually reaches the scheme’s account, not the day you clicked the button. Cut-off times are set by SEBI, and money credited after the cut-off gets the next business day’s NAV.

Weekends and holidays have no NAV, because the markets that value the portfolio are shut. A purchase on a Saturday is processed on the next business day.

Open-ended and closed-ended schemes

What is an open-ended scheme?

An open-ended scheme is always open. You can buy units on any business day and sell them back to the scheme on any business day, and the number of units in existence rises and falls as people come and go. Most schemes people invest in are open-ended.

What is a closed-ended scheme?

A closed-ended scheme takes money only during its initial offer period and has a fixed maturity date. You cannot sell units back to the scheme before then. Such schemes are listed on an exchange so units can change hands, though trading is often thin.

What is a lock-in?

A lock-in means you cannot take the money out for a set period even in an open-ended scheme. Schemes that give a tax deduction come with a lock-in; the clock runs separately for each instalment you put in. Check the lock-in before you invest, not after.

Growth and IDCW

What is the growth option?

In the growth option, nothing is paid out to you. Gains stay inside the scheme, the NAV reflects them, and you realise them only when you sell units.

What is IDCW?

IDCW stands for income distribution cum capital withdrawal. It used to be called the dividend option, and the name was changed because the old one misled people.

A payout is not extra money. It comes out of the scheme’s own value, so the NAV falls by the amount paid. Part of what you receive may simply be your own capital coming back to you — which is exactly what the longer name is trying to say.

Which one should I hold?

That depends on whether you need money to arrive in your bank account, and on how each one is taxed in your hands. The two options hold the identical portfolio; only the treatment of the money differs. Read the tax position for the current financial year, or ask someone to walk you through it, before you choose.

Folios and statements

What is a folio?

A folio is your account number with one fund house, in the same way a bank account number identifies you at one bank. One folio can hold several schemes from that fund house.

You can end up with several folios at the same fund house if your details were entered differently each time. It is not harmful, but it is untidy, and folios can be consolidated.

What is a consolidated account statement?

A CAS is one statement showing every mutual fund holding you have, across all fund houses, pulled together by the registrars from your PAN. It is the single document to look at if you want to know what you actually own.

The scheme documents

What are the SID, SAI and KIM?

Every scheme publishes these. The SID, the scheme information document, is the detailed one: what the scheme may invest in, its costs, its risks, its exit load and its benchmark. The SAI, the statement of additional information, covers the fund house and the trust behind it. The KIM is the short summary attached to the application form.

They are long. The parts worth reading are the investment objective, where the scheme is allowed to invest, the costs, and the exit load.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

What is the riskometer?

The riskometer is a dial SEBI requires on every scheme, with six levels from low to very high. It is reviewed every month and can change when the portfolio changes.

It tells you how much the value may swing, not how likely you are to make money and not how good the scheme is. Two schemes on the same level can behave very differently.

What is an expense ratio?

The expense ratio is what the scheme charges each year to run itself, taken out of the scheme’s value a little each day. You never get a bill; it is already reflected in the NAV you see.

A regular plan includes the distributor’s commission in that ratio. A direct plan does not, and so carries a lower ratio, and comes with no one to call. Both hold the same portfolio.

Can I lose money in a mutual fund?

Yes. No mutual fund promises you a return, and nobody is allowed to tell you otherwise. The value of your units can fall, including below what you put in, and that is true of debt schemes as well as equity ones.

What a scheme does promise is the things written in its documents: what it is allowed to invest in, what it will charge, how quickly it will pay you when you sell, and what it will disclose and how often. Those are the promises worth checking.

Where can I check things for myself?

A sensible next step is not a purchase. It is to pull your consolidated account statement, look at what you already own, and check that every folio on it has a nominee.