• JUNE 14, 2001

Mutual funds offer document – A must-read

It would be interesting to know how many investors read an offer document before investing in a mutual fund. If some sort of census is taken, the low awareness level among investors should not surprise anyone.

Most investors just see the annual returns, get some ‘hot’ tips from their brokers/agents and dive headlong into the fund. Many of these investors have never heard of an offer document, much less seen one. This report is an effort from personalfn.com to introduce a sense of awareness and familiarity among potential mutual fund investors, to underline its importance and highlight some of its vital points.

What is an offer document?
An Asset Management Company (AMC)/fund sponsor that plans to launch a new scheme is required to formulate the details of the scheme and register it with the Securities and Exchange Board of India (SEBI) before announcing the scheme and inviting the investors to subscribe to the fund. Typically the offer document contains the details of the new scheme is interchangeably called the Prospectus or the Offer Document. An abridged form of the offer document with the application form is called the Key Information Memorandum.

Here are a few very crucial points to be read in the offer document.

  • Risk Factor:
    What does an investor expect before investing in a fund? He believes his funds are in safe hands and he expects to get reasonable, if not spectacular returns over the investment period. However, an offer document clearly states the following points under the risk factor:

    • No assurance or guarantee that the objectives of the schemes will be achieved.

    • Past performance of the fund does not indicate the future performance of the fund.

    • Tax laws may change affecting the returns on investments.

    • In the event of receipt of a very large number of redemption requests or a very large value redemption requests there may be delays in the redemption of units.

    From an investor’s perspective the first two points are most critical. Often investors have come to expect guaranteed/assured returns. They also expect the fund to repeat a ‘good’ past performance every year.

  • Expenses:
    All the funds have to state various expenses related to a particular scheme in the offer document. Here are a few expenses related to a fund.

    • Load: The major expense for an investor while investing in a fund is the load. Load is a charge for entering or exiting a particular fund of a fund house. An investor should make note of the load in the offer document for various schemes of the fund as this affects the returns of the fund. As per SEBI, a fund cannot charge an entry or exit load exceeding 7%. While most of the funds have an entry/exit load ranging from 1%-2%, some funds have neither entry nor exit load, subject to some minimum redemption period.

    • Expense Ratio: The expense ratio is a ratio between the total expenses and the net assets of the fund. This ratio is disclosed in the offer document. An investor should give due consideration to this piece of information before investing in a particular fund. Lower the historical expenses of a fund, higher the returns an investor can expect as these expenses are deducted from the weekly average net asset value (NAV) subject to SEBI regulations, which says that the total expenses charged by the AMC are subject to following limits

      * On the first Rs 1 bn of average weekly net asset – 2.50%.
      * On the next Rs 3 bn of average weekly net asset – 2.25%.
      * On the next Rs 3 bn of average weekly net asset – 2.00%.
      * On the balance of average weekly net asset – 1.75%.

  • Investor Grievance:
    Every fund has to disclose the status of investor grievances in the offer document. The AMC has to reveal the number of queries and complaints received towards a particular scheme and the complaints addressed. This information shows investors how proactive and responsive a fund can be towards investor grievances.

  • Penalties and pending litigation:
    Every fund has to disclose any penalty imposed on the AMC/fund sponsor for any economic offence or violation of any securities laws. Also they have to disclose any pending litigation or proceedings towards the Mutual fund, AMC, Trustees and Associated companies or the directors of the AMC. This piece of information will enable the investor to form a more informed opinion about the credibility of the AMC/Sponsors/Trustees. Obviously a clean chit means high level of credibility.

These were the crucial points that investors need to look out for in the offer document. Investors as a community must strive to rid themselves of ignorance, because while ignorance may be bliss, that’s not really true in the financial world.

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