How Do Mutual Funds Work?

How Do Mutual Funds Work?

While you might have heard many experts say that investing in mutual funds is one of the best ways to grow your wealth, it is perhaps even more important to know how mutual funds work. Let’s understand the working of mutual funds right from the time an Asset Management Company (AMC) or fund house decides to launch a mutual fund till it starts giving attractive returns:

1. The process begins when a fund house identifies a potential money-making opportunity in the market subject to key risks.
2. The fund house then weighs the newly identified opportunity against existing investment opportunities and analyses how it can add further value for current investors.
3. The fund house then appoints a fund manager who creates a portfolio of different asset classes including equities, debt and money market securities. The asset allocation of the scheme decides under which mutual fund category the scheme will fall – Equity Fund, Debt Fund or Hybrid Fund.
4. The fund manager then compiles all the details including the scheme’s asset allocation, risk level, etc in a document and files the draft with market regulator SEBI for its approval.
5. After receiving SEBI’s approval, the fund house makes the scheme available to the public for subscriptions through a New Fund Offer (NFO). An NFO generally lasts for 7-10 days.

On the basis of the subscription period, mutual fund schemes can be classified as open-ended and close-ended schemes. An open ended mutual fund scheme allows investors to enter and exit the fund anytime even after the closure of the NFO period. Whereas, a close-ended fund allows investors to enter into the scheme only during the NFO period and does not allow them to exit it until maturity which is typically 3-4 years from the launch date.

1. After receiving the initial subscription, the fund manager manages the scheme actively or passively depending on the scheme’s requirements as well as market/economic conditions.
2. A mutual fund investment provides earning to its investors in the form of dividend payouts and capital gains.