Mutual Funds Overview
Table Of Contents
What Is Mutual Funds?
A Mutual Fund is a trust that collects money from many investors and invest in various asset classes (equity, debt, liquid asset, etc).
It is called "Mutual" because all the profit, loss, risks and dividends from the investments are shared among all the investors according to their contributions.
History Of Mutual Funds
Unit Trust of India (UTI) was the first mutual fund set up in India in the year 1963.
In early 1990s, the 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 established. The objectives of SEBI are
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to formulate policies and regulates the mutual funds
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to protect the interest of investors
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to promote the development of securities market
In 1993, SEBI notified regulations for the mutual funds.
After 1993, Private sector companies started to offer mutual funds.
In 1996, the regulations were completely revised and updated.
Thereafter, SEBI issued guidelines to Mutual Funds from time to time to protect the interest of investors.
Types Of Mutual Funds
There are a variety of mutual funds and it causes confusion to the common people. The following list will help you to understand better.
Types of Mutual Funds by Company Size:
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Large Cap funds
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Mid-Cap funds
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Small Cap funds
Types of Mutual Funds by Structure:
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Open ended schemes
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Closed ended schemes
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Interval schemes
Types of Mutual Funds by Investment Objective:
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Equity schemes
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Income or Debt schemes
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Balanced schemes
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Money Market or Liquid schemes
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Tax saving schemes
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Gilt schemes
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Index schemes
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Sector schemes
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Exchanged Traded Funds
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Fund of Funds schemes
Types of Mutual Funds by Payout:
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Growth schemes
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Dividend Payout schemes
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Dividend Re-investment schemes
A mutual fund is described as combination of the funds mentioned above. For example,
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A large cap open ended equity scheme with growth option
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A small cap open ended debt scheme with dividend option
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A large cap close ended balanced scheme with dividend option
You can see the details about each type of Mutual Funds in the following sections.
Mutual Funds Types By Company Size
By Company Size, mutual funds can be categorised as the following types.
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Large Cap funds
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Mid-Cap funds
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Small Cap funds
Let us see the details of each type.
1) Large Cap Funds:
These funds invest a large portion of their corpus in companies with large market capitalisation.
These funds generally offer stable and sustainable returns over a period of time.
These funds are classified as less volatile, less risk, less returns type.
2) Midcap Funds:
These funds invest a large portion of their corpus in companies with mid size market capitalisation.
These funds generally offer medium returns over a period of time.
These funds are classified as medium volatile, medium risk, medium returns type.
3) Small Cap Funds:
These funds invest a large portion of their corpus in companies with small size market capitalisation.
These funds generally offer more returns over a period of time.
These funds are classified as more volatile, more risk, more returns type.
Mutual Funds Types By Structure
By Structure, mutual funds can be categorised as the following types.
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Open ended schemes
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Closed ended schemes
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Interval schemes
Let us see the details of each type.
1) Open Ended Schemes:
These schemes don't have a fixed maturity period.
You can buy or sell the units at any time of the year as per NAV prices.
The key feature of this scheme is liquidity. You can take out your money whenever you want.
These schemes announce NAV on a daily basis.
2) Close Ended Schemes:
These schemes come with a fixed maturity period.
You can invest in these schemes only at the time of initial issue called "New Fund Offer (NFO)".
You can sell the units only at a specified maturity date.
In addition, these schemes are listed on the Stock Exchange where you can buy or sell units of the fund.
These schemes announce NAV on a weekly basis.
3) Interval Schemes:
These schemes combine the feature of both Open ended and Close ended schemes.
You can buy or sell the units at pre-determined intervals at NAV price.
In addition, these schemes are listed on the Stock Exchange where you can buy or sell units of the fund.
Mutual Funds Types By Investment Objectives
By investment objectives, mutual funds can be categorised as the following types.
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Equity schemes
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Income or Debt schemes
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Balanced schemes
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Money Market or Liquid schemes
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Tax saving schemes
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Gilt schemes
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Index schemes
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Sector schemes
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Exchanged Traded Funds
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Fund of Funds schemes
Let us see the details of each type.
1) Equity Schemes:
These schemes are known as high risk, high return.
These schemes generally invest a majority of their funds in equities (Shares) and hence these are high risk investments.
These schemes aim to provide capital appreciation over long term and hence suitable for long term investors.
These schemes are NOT suitable for those who want regular income or who need money in a short term.
2) Income or Debt Schemes:
These schemes are known as less risk, less return.
These schemes invest a majority of their funds in fixed income securities like Bonds, Corporate Debentures, Government Securities and money market instruments.
These investments are low risk investments.
These schemes aim to provide regular and steady income and hence suitable for short term investors and retired people.
These schemes are NOT suitable for long term investors as there will not be much of capital appreciation.
3) Balanced Schemes:
These schemes are known as medium risk, medium return.
These schemes invest in both equity and fixed income instruments.
These schemes aim to provide a combination of regular income and moderate capital appreciation.
These schemes are suitable for investors looking for moderate growth.
4) Money Market or Liquid Schemes:
These schemes provide easy liquidity.
These schemes invest in safe and short term instruments such as Treasury Bills, Certificates of deposit.
These schemes aim to provide capital protection and moderate income.
The returns from these schemes may fluctuate based on the interest rates in the market.
5) Tax Saving Schemes:
These schemes provide tax benefits to investors as per the Income Tax Act.
For example, Equity Linked Savings Scheme (ELSS) and Rajiv Gandhi Equity Savings Scheme (RGESS).
The aim of these schemes is to provide capital appreciation and tax benefits.
These schemes come with a specific lock-in period.
These schemes invest mainly in equities and hence they are high risk oriented schemes.
6) Gilt Schemes:
These schemes invest exclusively in government securities.
NAVs of these schemes fluctuate due to change in interest rates.
7) Index Schemes:
These schemes represent the portfolio of a particular index such as BSE Index, NSE (Nifty) Index, etc.
These schemes invest in the shares that represent an index.
NAVs of these schemes will rise or fall according to the rise or fall in the index.
8) Sector Schemes:
These schemes invest in shares that are a part of a specific sector.
For example, technology sector schemes will invest in Infosys Technologies, Wipro Technologies, etc.
Returns from these schemes depends on the performance of the chosen sector.
These schemes are high risky compared to diversified equity funds.
9) Exchanged Traded Schemes:
These schemes contain a basket of shares that represent the combination of Index like BSE Index, NSE (Nifty) Index, etc.
Investors can buy or sell the funds anytime during trading hours at the traded price.
This has advantage over the index funds that allows you to buy or sell based on end of the day NAV only.
10) Fund of Funds Schemes:
These schemes invest in other mutual fund schemes.
This helps investors to diversify the risk through one scheme.
The returns depend on the performance of the target mutual fund schemes.
Mutual Funds Types By Payout
By money payout method, mutual funds can be categorised as the following types.
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Growth schemes
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Dividend Payout schemes
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Dividend Re-investment schemes
Let us see the details of each type.
1) Growth Schemes:
As the name implies, Growth option aims for capital appreciation over long term.
The number of units that you bought will remain the same till you sell them.
NAV of the scheme will increase or decrease depending upon the performance of the scheme.
In these schemes, you will get money only when you sell the units.
This is suitable for those who expects a growth over long term and those who is not in need of money during short term.
2) Dividend Payout Schemes:
Dividends are nothing but the profits made by the Mutual Fund scheme.
This scheme pays out dividends to investors from time to time.
But, the amount and the frequency of dividends are not guaranteed.
The number units will remain the same but the NAV of the scheme comes down after the dividends are declared.
This is suitable for those who expect to receive income flow on a regular basis.
3) Dividend Re-investment Schemes:
This scheme declares dividends but it is not paid to the investors.
Instead, they are re-invested into the scheme. This way, you stay invested in the scheme.
NAV gets re-adjusted after the dividends are declared and re-invested.
The number of units will increase as the dividends are re-invested.
Features Of Mutual Funds
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Schemes managed by professional fund managers
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Mutual funds offer a wide variety of schemes that you can choose as per your needs and convenience
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Mutual funds diversify the risks by investing in a number of companies across a broad range of sectors
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Mutual funds have the potential to deliver higher returns over medium to long term
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Mutual funds are relatively less expensive to invest in equities compared to directly investing in share markets
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Some of the mutual funds schemes provide liquidity. It means you can take out the money whenever you want
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Mutual funds provides transparency in the form of disclosing the investment strategy, proportion of asset class for investment, value of your investment and periodic statements
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Mutual funds are regulated by SEBI
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Few mutual fund schemes (like ELSS) provide tax benefits
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Mutual fund schemes provide SIP (Systematic Investment Plan) option for investors to invest small amount of money on regular basis
Risks Or Disadvantages
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Mutual Fund returns is not guaranteed and it may vary based on market conditions
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Mutual fund companies charge investors for various professional fund management tasks. They include transaction charges, exit charges and recurring annual charges. These charges may impact the returns of the scheme.
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Mutual fund companies will continue to charge fees even if the fund gives negative returns
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You can buy or sell mutual funds units only at the end of the day. Not during trading hours
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Mutual fund companies keep a large amount of cash at hand to pay the investors just in case if they sell the units due to various reasons. It means that they need to invest in cash in addition to other asset classes. This may impact the returns.
Income Tax Benefits
You need to know the following things to get a good understanding of income tax benefits in mutual funds.
1) Section 80C Benefits
2) Dividends Payout Tax
3) Capital Gains Tax (CGT)
4) TDS (Tax Deducted at Source)
The details about each item are given below.
1) Section 80C Benefits:
Effective 01-Apr-2020, Section 80C benefits will be available only on the old tax system. They are not available on the new tax system.
ELSS (Equity Linked Savings Scheme) provides tax benefits under Section 80C of the Income Tax Act
Under ELSS scheme, investments up to Rs. 1.5 Lakh in a financial year will qualify for tax deduction under Section 80C
For tax on maturity or withdrawal amount, please refer to "Capital Gains Tax" section below.
2) Dividends Tax:
In the past, for an investor, the dividend received from a Mutual Funds company was completely tax free.
But, for the Mutual Funds company, the dividends declared were taxed and it was known as Dividend Distribution Tax (DDT).
The DDT rate was 10% for equity funds and 28.84% for debt funds.
The Mutual Funds company was responsible for paying DDT to the Government of India. The NAV of the fund came down to the extent of DDT deducted
Effective 01-Apr-2020, DDT will be removed. It means the Mutual Funds company won't deduct DDT while paying dividends.
But, the dividends will be taxable for the investor as per their income tax slabs.
So, if you receive dividends from a Mutual Funds company, then they'll be added to your income and then they'll be taxed as per your income tax slabs.
You need to be aware of this before opting for dividends payout in mutual funds
3) Capital Gains Tax (CGT):
The profit that you get when you sell mutual fund units is known as "Capital Gains" and the tax applied on these gains is known as "Capital Gains Tax".
Capital Gain Tax can be divided into
a) Short Term capital gains tax
b) Long Term capital gains tax
Capital gains tax depends on
a) type of mutual fund (equity or non-equity)
b) investment period
The details about capital gains tax, for each fund type, are given below.
a) Equity Funds - Long Term Capital Gains Tax:
If you invest in equity funds for more than 1 year and make profits, then it is known as "long term capital gain".
From 01-Apr-2018 onwards, there is no tax on profits up to Rs. 1 Lakh. After that, any profit is taxed at 10% (without indexation).
Before 01-Apr-2018, the tax rate was 0% and hence you didn't have to pay any tax on profits.
b) Equity Funds - Short Term Capital Gains Tax:
If you invest in equity funds for less than 1 year and make profits, then it is known as "short term capital gain".
The tax rate is 15% and hence you have to pay 15% tax on your profits.
c) Non-equity Funds - Long Term Capital Gains Tax:
If you invest in non-equity funds for more than 3 years and make profits, then it is known as "long term capital gain".
The tax rate is 20% (with indexation) and hence you have to pay 20% tax on your profits.
d) Non-equity Funds - Short Term Capital Gains Tax:
If you invest in non-equity funds for less than 3 years and make profits, then it is known as "short term capital gain".
The profits will be added to your income under "Income from Capital Gains" and you have to pay tax as per your income tax slabs.
Note: Indexation is the process of increasing the purchase price along with inflation.
4) TDS (Tax Deducted at Source):
In the past, there was no TDS (Tax Deducted at Source) concept in Mutual Funds investments.
But, effective 01-Apr-2020, there will be TDS on dividends paid to the investors.
If the dividend to be paid is more than Rs. 5,000, then the Mutual Funds company will deduct 10% of the dividend amount as TDS.
If excess TDS has been deducted, then you can claim it back at the time of filing your Income Tax Returns.
Who Regulates Mutual Funds?
Mutual Funds in India are regulated by a SEBI (Securities and Exchange Board of India).
The objectives of SEBI are
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to formulate policies and regulates the mutual funds
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to protect the interest of investors in share market
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to promote the development of securities market
SEBI issues guidelines and revises policies from time to time to protect the interest of investors in the equity market.
Who Can Invest In Mutual Funds?
Mutual Funds schemes are open to a wide range of investors including
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resident individuals
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HUF (Hindu Undivided Family)
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NRI (Non Resident Indian)
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PIO (People of Indian Origin)
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Companies
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Trusts
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Co-operative Societies, etc.
What is NAV?
NAV stands for Net Asset Value.
NAV is the current market price of one unit of a mutual fund scheme.
NAV is calculated on a daily basis for open ended schemes and weekly basis for close ended schemes.
NAV is calculated after deducting all the expenses and charges incurred by the fund.
NAV value depends on the performance of the mutual fund scheme.
Transaction Charges In Mutual Funds
Mutual fund investments come with a cost and they are listed below. You need to know these charges before investing in mutual funds.
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Stamp duty charges (while buying)
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Ongoing charges (while holding)
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Exit charges (while selling)
The details about each of the charges are given below.
1) Stamp Duty Charges (while buying)
From 01-July-2020 onwards, investors will need to pay stamp duty charges for any type purchase of Mutual Funds.
The stamp duty charge is 0.005% of the investment amount.
For example, if you invest Rs. 1 lakh, then the stamp duty charge will be Rs. 5 (that is, 0.005% of Rs. 1 lakh).
The stamp duty amount will be deducted before allocating the units.
If you invest Rs. 1 lakh, then Rs. 5 will be deducted first. After that, the units will be allocated for the remaining Rs. 99,995.
2) Ongoing Charges (while holding)
Ongoing (recurring) charges are collected by the mutual fund company for providing various professional fund management services to the investors.
These recurring charges are calculated on daily basis and deducted from the net assets of the fund.
The NAV declared every day is after deducting these recurring charges.
These recurring charges is known as Expense Ratio and it varies from 1.5% to 2.5% depending upon the size of the assets of the mutual fund company and type of funds (equity or debt).
For example, if a equity mutual fund generates returns of 14% and it has expense ratio of 2%, then the effective return will be 12% (14% minus 2%).
The expense ratio affects the returns of the mutual fund scheme and hence you need to consider the expense ratio before investing.
3) Exit Charges (while selling)
Exit charges are like penalty that the investor has to pay if he sells the units before the specific period applicable for a mutual fund scheme.
Exit charges may vary from one scheme to another scheme. Generally, exit charges are from 1% to 3%.
For example, if you are trying to sell the units of an equity mutual fund before 1 year, then 1% will be deducted from the final amount that you are going to receive.
Exit charges are deducted from the scheme's NAV and hence the NAV value will come down resulting in a lesser final amount. This is known as "Redemption NAV".
For example, you invested in an equity mutual fund and you got 1000 units. You are trying to withdraw the entire 1000 units after 10 months. The current NAV is 15. So, exit load of 1% is applied on the NAV and it is 0.15 (1% of 15). So, the redemption NAV is 14.85 (15 minus 0.15). You will now receive Rs. 14,850/- (1000 units multiplied by 14.85). Exit charge in this case is Rs. 150/-.
How To Invest In Mutual Funds?
You can invest in mutual funds through one of the following ways.
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Direct Investment
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Invest through Agents
The details about each type is given below.
1) Direct Investment:
You can approach the Mutual Fund Scheme office directly and invest the money by completing necessary paperwork.
Some mutual fund schemes allow investment through their website and it can be made conveniently from your home.
Advantage with this approach is that you will not be charged any transaction fee or commission fee and your entire amount will be invested.
At the same time, it may be inconvenient to go to each and every mutual fund company if you wish to invest in various mutual fund schemes.
2) Invest through Agents:
There are many Mutual Fund Agents or Brokers and they can help you with various things on mutual funds like investment, redemption, answering your queries, completing necessary paperwork, etc.
By going through the agents, you can invest in various mutual fund schemes. It is like a "one stop" for any mutual fund related things.
But, agents charge you a one time fee for investments above Rs. 10,000.
This will be reflected in the Mutual Fund Statement delivered to you from time to time.
These charges are as per the guidelines issued by SEBI to Mutual Funds companies and Agents office.
Offer Document
Investors should read the Mutual Fund Offer Document before investment and it contains the following details.
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application form for investment
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features of the scheme
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risk factors
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initial issue expenses
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recurring expenses
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transaction and exit charges
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track record of the scheme
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educational qualification and work experience of the fund managers
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performance of other schemes launched by the mutual fund
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pending cases in court, if any
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penalties imposed
Nomination
Nomination facility is available in Mutual Fund schemes.
Nominations can be made only by individuals either singly or jointly.
Non-individuals like Trust, Society, Partnership Firm, Body Corporate, etc can't nominate.
You can nominate up to 3 people as nominees.
In case of multiple nominees, you need to specify the percentage (%) of share for each nominee.
Total percentage of shares should be 100%.
You can nominate a minor as a nominee and in that case you need to provide the name, address and signature of the Parent or Guardian.
Nomination made by an individual will be applicable to all the schemes in the folio.
Nomination is not allowed for a folio that is in the name of a minor.