Mutual fund schemes announce their investment objective and seek investments from the public. Depending on how the scheme is structured, it may mobilize the money from like minded investors, either during a limited period only, or at any time. The investment that an investor makes in a scheme is translated into a certain number of ‘Units’ in the scheme. Thus, an investor in a scheme is issued units of the scheme.
Under the law, every unit has a face value of Rs10. (However, older schemes in the market may have a different face value). The number of units multiplied by its face value (Rs10) is the capital of the scheme – its Unit Capital.
The scheme earns interest income or dividend income on the investments it holds. Further, when it purchases and sells investments, it earns capital gains or incurs capital losses. These are called realized capital gains or realized capital losses as the case may be.
Investments owned by the scheme may be quoted in the market at higher than the cost paid. Such gains in values on securities held are called valuation gains. Similarly, there can be valuation losses when securities are quoted in the market at a price below the cost at which the scheme acquired them. Investments can be said to have been handled profitably, if the following profitability metric is positive:
Interest income + Dividend income + Realized capital gains + Valuation gains – Realized capital losses – Valuation losses – Scheme expenses
When the investment activity is profitable, the value of a unit goes up; when there are losses, the value of a unit goes down. This value of a unit of the scheme is otherwise called Net Asset Value (NAV) of the scheme. When a scheme is first made available for investment, it is called a ‘New Fund Offer’ (NFO). During the NFO, investors may have the chance of buying the units at their face value. Post-NFO, when they buy into a scheme, they need to pay a price that is linked to its NAV.
The money mobilized from investors is invested by the scheme as per the investment objective committed. Profits or losses, as the case might be, belong to the investors. The investor does not however bear a loss higher than the amount invested by him. Various investors subscribing to an investment objective might have different expectations on how the profits are to be handled. Some may like it to be paid off regularly as dividends. Others might like the money to grow in the scheme. Mutual funds offers various options, such as dividend payout option, dividend re-investment option and growth option. An investor buying into a scheme gets to select the preferred option also. The relative size of mutual fund companies is assessed by their assets under management (AUM). When a scheme is first launched, assets under management would be the amount mobilized from investors. Thereafter, if the scheme has a positive profitability metric, its AUM goes up; a negative profitability metric will pull it down.
Further, if the scheme is open to receiving money from investors even post-NFO, then such contributions from investors boost the AUM. Conversely, if the scheme pays any money to the investors, either as dividend or as consideration for buying back the units of investors, the AUM falls. The AUM thus captures the impact of the profitability metric and the flow of unit-holder money to or from the scheme.
