One of the best routes to equity investment, it has achieved immense popularity in the recent times. Mutual funds work as a trust wherein the savings of a large number of investors are pooled together and collectively managed by a professional for a fee. This arrangement is particularly suited to investors who either do not have the time or the knowledge to manage their own investments. Equity investment has developed considerably as a science over the years and it requires a fair degree of domain knowledge to make adequate use of opportunities prevailing in the market. The integration of the global markets and the advent of the exotic financial products have made the need of a professional fund manager even more compelling.
Investment through Mutual Funds comprises broadly two categories of funds:
- Equity oriented
- Debt oriented
These funds invest in the stocks of the companies listed in the Stock Exchanges and operate within a universe of 2,500 Stocks that are listed. Within these funds there are schemes that are guided by specific investment philosophy such as defensive, aggressive, large-cap bias, mid-cap bias, etc. There are innumerable combinations to suit every need.
These funds provide higher return as equity as an asset class tends to outperform all the other asset classes over long term. The basis of this argument is very simple. Shareholders represent the owners of the company. If a company raises finance by way of debt, it expects to earn a return greater than the cost that it is paying by way of interest to service the loan. Else it would be futile to raise debt. Hence, the shareholders necessarily have to earn a return higher than what is available to debt holders to justify their business proposition. Over the short term, equity markets are prone to fluctuation as sentiments play a significant role here. However, over the longer term, these distortions even out and lead to wealth creation.
These funds invest in fixed income bearing securities where the rate of interest is fixed. The level of security may vary and so will the interest rate on it. Risk and return always have a direct correlation.
These funds typically invest in Government securities, Corporate papers (CPs), Certificate of Deposits and money market instruments. Though the level of security is very high with these investment avenues, it should in no way be construed to imply capital guarantee.
Under section 80c of the Income Tax Act, certain investments qualify for tax exemption. At present it is capped at INR 1.5 lacs. The various products that qualify for Tax deduction are : Bank Fixed Deposits (specially mandated u/s 80c), Equity Linked Savings Scheme (ELSS), Public Provident fund, National Savings Scheme, INFRASTRUCTURE Bonds, ULIPs, Post Office Senior Citizens Savings Scheme, Kisan Vikas Patra amongst others.
Bonds are fixed income securities issued by organizations against loan. Bonds may be listed or unlisted. Listed bonds are traded on an exchange just like stocks. Generally Banks and other large entities engage in bond trading. Compared to the world market, Indian Bond market is at a nascent stage. The prices of a bond move inversely to the interest rates.
Corporates often tap the Inter Corporate deposits to meet their working capital requirements. These are unsecured in nature and generally for a very short period of 90 - 120 days. The ticket size is relatively large and hence, is more suited to HNIs and Corporates having surplus funds. The interest rate is also higher than other fixed income bearing investments.
When a company raises fund from the general public by issuing equity shares for the first time it is called Initial Public Offering (IPO). A company may also wish to raise finance by tapping the existing shareholders. This is called rights issue. Generally, the rights shares are issued at a discount to the prevailing market price. Existing shareholders are aware about the management's ability and hence, are more likely and forthcoming to subscribe to the shares. A company may also tap the general public after the IPO - called a Follow On Issue.
Fixed deposits yield a fixed rate of return and are generally offered by banks and large corporate houses. The rate of interest varies depending upon the tenure and amount.