Can a Mutual Fund go bankrupt?
* Source of Pic : lastbull.com
Investors having a diverse portfolio of stocks and shares would have had at least an occasional experience of one or more of the companies becoming insolvent or simply “vanishing” overnight. Kingfisher is the latest addition to the list. As mentioned in the previous article, as many as 19 banks have also gone bust last year.
Like banks and companies, can a Mutual Fund go bankrupt? Actually not!
To understand this better, let us analyze the structure of a mutual fund.
In a mutual Fund, the AMC (Asset Management Company) manages the investments and the assets are held by the custodian. Both the AMC and the custodian are controlled by the trustees who are put in place by the sponsors of the mutual fund.
If one of the sponsors want to move out, they have to bring in another sponsor who will have to put in place a new framework of trustees, AMC etc. And if the investor is not comfortable with the new sponsor, he has an option of exiting from the fund with the full NAV within 30 days.
Moreover, the custodian holding the assets is independent of the AMC or the sponsor. This provides structural protection to the assets and the investors’ interest.
Thus, the structure of a mutual fund ensures that the investor is fully protected from all contingencies like misappropriation of funds, fraud etc.
So, the bank in which you hold your fixed deposits could close down, the company whose shares you have bought could go in to liquidation overnight. But your Mutual Fund investment can trade below par, perform below expectations but can never go bust causing you to lose your entire investment. Yet the share of bank deposits in household savings in India is around 55 %, while the share of Mutual Funds is less than 10 %. Is this ratio justified? Your thoughts and feedbacks are welcome!
A Mutual Fund is not a one size fits all product
Question : “Where have you invested your savings?”
Answer : “X amount in shares, Y amount in Fixed Deposits, Z amount in Mutual Funds”
Question : “What type of mutual funds have you invested in?”
Answer : “I am not exactly sure and don’t remember the names now. But these were recommended by a friend who is very good with finance and I have all the details on an excel sheet”
The second question is likely to evoke similar responses from most people. Over the past few years mutual funds have been growing in popularity, thanks to the aggressive marketing and features like ease of investing, market linked returns and liquidity. While this has ensured that most people have a significant exposure to mutual funds in their portfolio, most of them are not aware of how these mutual funds differ based on their investment objective, liquidity, tax efficiency, risk and return profiles.
Merely investing in a Mutual Fund doesn’t help, it is important to choose the right one for you. The table below is a ready reckoner for the different types of mutual funds and the target audience.
| Fund Type | Risk | Investment Objective | Target Investor | Popular funds in this category |
| Diversified Equity Funds | High | Capital appreciation over long term by investing in equity/stock market across various sectors | Who wants equity exposure but is not bullish about/or favour any particular sector | HDFC Growth Fund, Templeton India Prima Fund, Reliance Vision Fund |
| Sector Funds | Very High | Invest in equity shares of a particular sector | Who is extremely bullish about and wants to invest in a sector | ICICI Pru FMCG Fund, Reliance diversified power, UTI Banking Sector |
| Index Funds | Medium | Follow the same investment pattern as popular market indices like BSE Sensex, NIFTY etc | Who wants equity exposure but with the least amount of risk. | Birla Sunlife Index Fund, SBI Magnum index fund, UTI Nifty Index Fund |
| Tax Saving Funds | Medium | Equity based and offer tax benefits under section 80 C of income tax act. | Seek tax concessions and rebate and a tax free capital appreciation over long term | HDFC Tax Saver, ICICI Pru tax Plan, Fidelity Tax Advantage fund |
| Debt/Income Funds | Low | Invest in high rated fixed income instruments like bonds, Govt. securities etc | Seeks capital preservation and regular income | Birla Sunlife Income Plus, HDFC High Interest, Templeton India Income Fund |
| Gilt | Low | Invest in Central and State Government Securities | Risk averse long term investors | DSP Blackrock Govt. Sec. Fund, Fidelity flexi gilt, HDFC Gilt |
| Balanced Funds | Medium | Invest in equity and debt instruments in some proportion | Who wants steady returns with moderate risk | HDFC Prudence, ICICI Pru Balanced, FT India balanced |
| Liquid/Money Market Funds | Low | Highly liquid money market instruments of a very short duration from 1 day to 90 days | Who wish to park their funds for short term with relatively higher returns than savings bank and short term fixed deposits | Fidelity cash fund, HDFC Liquid Fund, Birla Sunlife cash plus |
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