What is a mutual fund? and how its created?

 What is a mutual fund?

 

General definition: Mutual fund made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. 

SEBI definition: a fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one or more schemes for investing in securities including money market instruments or gold or gold-related instruments or real estate assets.

How the mutual fund is created?

 

The mutual fund is created by 5 different layers of organization or entities. They act differently with a defined goal. 

 

1. Mutual fund trust
2. sponsor
3. trustee
4. AMC
5. RTA
   

 

Mutual fund trust: 

To create a trust, trustees are appointed. When they are appointed, they are jointly referred as 'Board of trustees' Their role is to protect the interest of investors. the trustees are named in the trust deed. They are governed by the Indian Trust Act, 1882.

 

Sponsors:  

Sponsors are the main people behind mutual fund operations. The application of running a mutual fund is made by sponsors. Therefore they invest in the capital of AMC. Sponsors have to contribute a minimum amount of 1,00,000 at the initial stage of building a corpus for the mutual fund. Sponsors should have experience in financial services for a minimum of 5 years. Sponsors should have carried out business with positive net worth for all 5 years. They must be a fit person for this kind of operations.

Trustee: 

Trustee plays a critical role in the mutual fund industry. They ensure compliance with regulators and protect the interests of investors. The sponsors have to appoint at least 4 trustees. There are important responsibilities assigned to trustees. They shall ensure that the trust property is properly protected, held, and administered. 

AMC (Asset management company):  

Daily operations of asset management are handled by AMC. The AMC is responsible for conducting the activities of the mutual fund. The interacts with service providers, maintains software, engages with employees, provides office infrastructure, and keeps in contact with regulators. AMC is also required to invest seed capital of 1% or 50 lakh INR (whichever is high) in a mutual fund plan through the lifetime of the plan. 

Custodian: 

Custodian keeps the assets of the fund in its custody. Custodians work to take the delivery of funds and do sale transactions of schemes of the fund. Custodian settles all the transaction of funds on behalf of AMC. Custodian ensures the securities held for the schemes for the fund are in appropriate proportion. Custodian needs to be registered with SEBI. Custodian must ensure that securities held by it should be in the interest of investors.

RTA (register and transfer agent): 

RTA is responsible for maintaining the records of investors. Their offices work as an investor service center. The function of RTA is to initiate transactions as per the requests of investors, maintain and update the records, making payment of redemptions. On behalf of AMC RTA update the units of securities, transact according to request, update the record. RTA needs to be registered with SEBI.

This is the structure of the mutual fund. All the layers are independent of each other and function differently on behalf of an investor. The sole purpose of a mutual fund is to give benefit from market to investor. Also, other sub-layers are working simultaneously to keep the system healthy. they are like auditors and SEBI.

Auditors check the health and functionality of the system thoroughly. Finding out loopholes in the system is their main business. Catching irregularities is key. The overall function is to maintain transparency in the system and notify the designated persons.

SEBI is a regulatory body. its full form is Securities and Exchange Board of India. Its function is to regulate the securities market and protect the interest of investors in India. It regulates unfair practices of issuers, intermediaries, and investors. Mutual fund deals with securities so SEBI comes into the picture. Securities complaints are handled by SEBI. This means that mutual fund complaints are also observed and resolved by SEBI. 

Let's take an example to understand the full structure of mutual fund.

Mututal Fund trust: SBI Mutual Fund

Sponsor: State Bank of India

Trustee: SBI Mutual Fund Trustee Company Private Limited

AMC: SBI Fund Management Private Limited

Custodian: SBI-SG Global Securities Services Private Limited

RTA: CAMS (Computer Age Management Services Ltd).

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