Beginner’s Guide on What is Fund Management, its Benefits & Importance
We all work hard to earn money. Later, we invest that money so that it works hard and earns returns for us. But, many people are not experts in managing money. They need the help of an expert to manage their funds. This article will serve as a beginner’s guide on what is fund management, its benefits & importance.
What is fund management?
The fund management process involves investing the money in a financial product to earn the best possible returns from it. During fund management, the investor needs to keep in mind the various aspects of investing, such as:
- The risks involved,
- The operational procedures,
- The tax benefits at the time of investment and the taxation at the time of redemption,
- The lock-in period,
- The liquidity aspects, etc.
The above is a long list of aspects of fund management, and it is too much to expect from an individual investor to know about all of them. Hence, you can delegate most of the above responsibilities to an advisor and the fund manager for mutual fund investments.
An investment advisor can guide you on the mutual fund schemes to invest in based on your risk profile, investment time horizon, tax aspects, etc. Once you invest the funds in a mutual fund scheme, the fund manager takes over from there.
Based on the mutual fund scheme objectives, the fund manager can decide:
- Which securities to buy,
- When to buy,
- How much to buy, and
- At what price to buy
Similarly, the fund manager can decide:
- Which securities to sell,
- When to sell,
- How much to sell,
- At what price to sell, and
- What to do with the sale proceeds: whether to reinvest, distribute as dividends, maintain cash reserves, etc.
Importance of fund management
A fund manager handling the mutual fund scheme is well qualified and has good experience in fund management. A fund manager has a research team that identifies which securities to buy and sell based on market opportunities. The research team shares data with the fund manager, based on which the fund manager takes the investment buy or sell decision.
Depending on its objective, every mutual fund scheme has an investment framework or strategy. The fund manager and the research team operate within that framework or strategy.
Advantages of fund management through mutual funds
When you invest your money in mutual funds, you get the following advantages:
Depending on its objectives, every mutual fund scheme usually invests in 20 to 50 securities. The idea is to diversify the risk as much as possible. For example, a large-cap fund invests in companies that are a part of the Nifty 100 Index. The index represents various companies from 20+ different sectors. So, even if some of the companies in the scheme portfolio don't perform well, the outperformance of other companies will make up for them.
A mutual fund scheme allows an investor to make fractional investments. It is not possible to make fractional investments in individual stocks when you are investing in them directly. However, even a low investment of Rs. 100 in a mutual fund scheme can give you fractional exposure to all the scheme portfolio stocks.
Low management cost
As an investor, you get the fund management expertise of a fund manager at a very low cost. SEBI has defined the upper limits on the maximum amount that a mutual fund scheme can charge as an expense ratio. The expense ratio includes all the expenses of the mutual fund scheme, including the fund management charges. The annual expense ratio may range from as low as 0.05% (for some index funds) to 2.50% (for some active funds).
Some equity mutual fund schemes such as the Equity Linked Savings Scheme (ELSS) provide tax benefits in the form of a deduction from taxable income at the time of investment. The maximum deduction allowed in a financial year is the amount invested or Rs. 1,50,000, whichever is lower. The ELSS comes with a lock-in period of three years.
SIP mode of investment
Mutual fund schemes allow you two modes of investment: Lumpsum and systematic investment plan (SIP). The SIP investment mode allows you to invest a small amount regularly every month. Most AMCs allow investors to start SIPs from as low as Rs. 100 a month.
Power of compounding
Mutual funds give you an opportunity to benefit from the magic of compounding. You can start a monthly SIP with a small amount, invest regularly in a disciplined manner for the long term, and create wealth with the power of compounding.
Fund management classification
Mutual funds give you a choice of active and passive (index funds) funds. The fund manager takes all the buy and sell decisions in an active fund. The expense ratio of an active fund is on the higher side. The objective of an active fund is to outperform the benchmark and generate alpha for investors.
In an index fund, the money is invested in all the index constituents as per their weightage in the index. The fund manager has no say in the buy and sell decisions. The expense ratio of an index scheme is lower than active funds. The objective of an index fund is to mirror the index returns.
How to choose a reliable fund manager?
When choosing a mutual fund scheme for investment, it is important to know about the fund manager. You can choose a reliable fund manager by looking at the following parameters:
- Education qualification and overall industry experience,
- The tenure for which the fund manager has been with the current fund house
- How many schemes is the fund manager managing and their performance
- The investment philosophy followed by the fund manager
- How much has the fund manager invested in their own schemes
Fund management is a full-time job and is best left to be managed by the scheme fund manager. Once you choose a reliable fund manager based on the above parameters, you can trust them with your money.