How Mutual Funds Work in India

Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian mutual funds pool the investments of many shareholders and invest them in a variety of securities depending on the goals of the fund. Also like U.S. funds, there is a wide range of different fund types available for purchase depending on the needs and risk tolerance of any given investor. Mutual funds are a popular investment option in India because, like American funds, they offer automatic diversification, liquidity and professional management.

Any type of mutual fund that exists in the U.S. is mirrored in some way in the Indian market. There are mutual funds that invest in equity or stocks, and are managed to achieve a range of goals. Some equity mutual funds are designed to generate long-term capital gains through growth or value investing strategies, like the Birla SL Frontline Equity Fund, while others are focused on generating dividend income for shareholders. Some combine the two, such as the popular ICICI Prudential Equity & Debt Fund.

Indian mutual funds may also invest in bonds and other debt securities with the goal of generating regular interest income. Indian debt funds invest in government or corporate debt instruments and money market securities just like American funds.

There are also Indian balanced funds that invest in both equity and debt instruments to create portfolios that offer a degree of stability without completely ignoring the potential for big gains in the stock market. A good example is the DSP Equity Opportunities Fund. Just like in the American market, the Indian market offers mutual funds that specialize in certain sectors, only invest in government or inflation-protected debt, track a given index or are designed to maximize tax-efficiency.

Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI). Indian mutual funds are subject to stringent requirements about who is eligible to start a fund, how the fund is managed and administrated and how much capital a fund must have on hand. To start a mutual fund, for example, the fund sponsor must have been in the financial industry for at least five years and have maintained positive net worth for the five years immediately preceding registry.

The SEBI regulations include a minimum startup capital requirement of Rs. 500 million for open-ended debt funds and Rs. 200 million for closed-ended funds. In addition, Indian mutual funds are only allowed to borrow up to 20% of their value for a term not to exceed six months to meet short-term liquidity requirements.

The mutual fund sponsor, either an individual, group of individuals or corporate body, is responsible for applying for registry with SEBI. Once approved, the sponsor must form a trust to hold the assets of the fund, appoint a board of trustees or trust company and choose an asset management company.

The board of trustees or trust company is responsible for overseeing the mutual fund and ensuring it operates with the best interests of its shareholders in mind. The asset management company is the entity in charge of managing the fund's portfolio and communicating with shareholders.

If the asset manager wishes to expand the product line, introduce a new scheme or change an existing one, it must first obtain approval from the board of trustees or trust company. In addition, the trustees must appoint a custodian and depository participant who is responsible for keeping track of asset trading activity and safeguarding both the tangible and intangible assets of the fund.