I started my investment journey by investing in a large-cap mutual fund. Sounds safe, right? Not so much. Well, there’s more to mutual funds than you might think. For example, did you know that mutual funds have almost 36 sub-categories as per the SEBI mandate? How to choose the right mutual fund is another topic altogether. Before that, you must be well-versed in the core functions of mutual funds that can help you choose the right one. So, let’s dig into the functions of mutual funds in this blog.
Introduction to mutual funds
The easiest way to define mutual funds is to compare them to your national cricket team- Many players coming together to perform and win for their country, while a team captain is guiding them to victory. Similarly, a mutual fund is a community of investors coming together by pooling their resources to achieve common financial goals. A fund manager works as the captain of this community and is responsible for making investment decisions that work best towards achieving the goals.
Core Functions of Mutual Funds
Now that the base is set, let’s understand the core functions of mutual funds below:
Fund Mobilisation
Mutual funds are responsible for collecting money from the investors, investing it in different asset classes, and strategising investments. Mutual funds are the intermediaries that combine savings from investors and households to mobilise investor capital into different streams of assets, building a strong portfolio. The main idea is to utilise the resources optimally, maximising returns. Overall, this function allows mutual funds to act as a bridge between savers and investors.
Portfolio Construction & Management
The mutual fund manager is responsible for planning, researching, and constructing the portfolio. Fund managers determine the components of the portfolio by conducting strategic allocation analysis. They evaluate risks and investment goals to choose the best investment options for the portfolio. Therefore, investors with limited knowledge and understanding of financial markets benefit from the specialised expertise of these professionals.
For example, a large-cap fund is known to invest in large-cap stocks of well-established companies that are stable and hold a strong reputation. Therefore, investors who have a low risk tolerance may prefer large-cap funds due to their stable nature. Fund managers of these funds construct portfolios keeping in view the interests of investors.
NAV Calculation
One of the key functions of mutual funds is to calculate the Net Asset Value (NAV) of mutual funds. NAV is the fair price of the mutual fund units that is determined at the end of a trading day. As per the SEBI mandate, a mutual fund scheme must disclose its NAV each day. These daily NAV updates help fund managers, analysts, and investors analyse the performance of a mutual fund.
NAV is calculated as,
NAV = (Total Assets – Total Liabilities)/ Number of outstanding units of the fund
Thus, NAV determination is a key function of mutual funds that forms the basis of transactions for investors.
Return Distribution (Dividends / Growth)
Mutual funds also distribute returns in the form of dividends and growth options as per the investors’ preferences. For instance,
- Dividend distribution option: The Income Distribution cum Capital Withdrawal (IDCW) option in mutual funds periodically distributes all the generated income in the form of dividends, interests, etc., either in cash form or reinvested into new assets. Note that the dividend distribution erodes the NAV by the total amount distributed.
- Growth option: The growth option in mutual funds does not distribute any dividends or periodic income. Instead, it reinvests all the generated income back into the scheme. This, in turn, increases the NAV. Investors who invest for the long term consider the growth option as it concentrates on capital appreciation instead of short-term gains.
Investor Services & Reporting
A key function of mutual funds is to regularly update key information that is related to the scheme. Information includes NAV disclosure, portfolio holdings, segregation, assets under management, and more. Prompt reporting on these insights helps investors stay updated with the progress of the mutual fund.
Investor servicing ways like managing transactions, investor queries, and updating KYC details are notable functions of the mutual fund.
Regulatory Compliance & Transparency
The Securities & Exchange Board of India (SEBI) mandates mutual funds to follow guidelines and regulations ensuring investors’ best interests are safeguarded. Fund houses are strictly regulated to disclose NAV regularly, update portfolio holdings, performance tracking, etc., to ensure accessibility and transparency for investors.
Supporting Roles Behind the Scenes
Some other supportive functions powering mutual funds and mutual fund risk management are:
Risk Management & Diversification
Mutual fund managers are responsible for the efficient risk management of the fund’s portfolio. The risk management process includes assessing, examining, and eliminating the risks, thereby maximising returns. Fund managers can utilise various risk management strategies such as diversification, hedging, and active management, among others. Through successful diversification, fund managers can spread the risk among different assets or securities. This ensures that a negative outcome on any one asset or security does not largely impact the performance of the entire portfolio.
For example, a fund manager may choose to invest in technology, healthcare, and finance stocks for the fund’s portfolio. However, technological disruptions in the economy negatively impact the performance of technology stocks. This, however, is compensated for by the decent performance of the other categories, like healthcare and finance stocks. In this way, diversification balances out the risk in the portfolio.
Convenience & Accessibility (SIP, online access)
Mutual funds are convenient and accessible tools for diverse investors. Systematic Investment Plans (SIPs) are a comfortable investing mode for investors that allow them to make periodic fixed investments into any mutual fund scheme. Mutual fund’s SIP convenience promotes discipline in investing, leading to long-term wealth creation through systematic regular investments.
Both large and small investments can be made through SIPs. For instance, an investor contributing ₹20,000 per month and another investing ₹500 per month can both benefit from rupee cost averaging and the power of compounding over time.
Mutual fund investments can be viewed and tracked online through fund houses’ websites, brokers, broker platforms, and other platforms, providing investors with ease of access and convenience.
Tax-Efficient Structuring (e.g., ELSS benefits)
Mutual funds are also known for their tax efficiency. Some tax-efficient mutual funds, such as Equity Linked Savings Scheme (ELSS), are popular tax-saving options. ELSS funds allow investors to claim tax deductions of up to ₹1,50,000 under Section 80C of the Income Tax Act, 1961, applicable under the old tax regime. Additionally, long-term capital gains from equity funds are levied at a relatively low tax rate of 12.5%, which is typically lower than most income tax slab rates.
How These Functions Work Together for Investors
Let me show you how these functions blend to help investors:
| Function | How It Helps Investors | Example/Benefit |
| Fund Mobilisation | Collects resources from many investors to invest professionally into assets, maximising returns. | Inexperienced investors can benefit from the fund mobilisation by professional fund managers. |
| Portfolio Construction & Management | Fund managers ensure thorough research and analysis before portfolio construction. | Investors can invest in a fund that matches their investment profile. For example, a risk-averse investor can invest in large-cap funds that invest in large and established companies. |
| NAV Calculation | Mutual funds update the NAV per unit every trading day. | Investors use NAV to calculate their purchase price, redemption price, etc. |
| Return Distribution (Dividends/Growth) | Mutual funds offer income through dividends or long-term growth through capital appreciation, depending on investor preferences. | IDCW option pays regular dividends; growth option reinvests profits. |
| Investor Services & Reporting | Mutual funds ensure regular reporting of NAV, portfolio holdings, and other key details to ensure investors are updated. | Online mutual fund platforms display all necessary information related to the mutual fund scheme. |
| Regulatory Compliance & Transparency | Mutual funds must adhere to laws and disclosure norms for investor protection and market integrity. | SEBI mandates regular reporting and audits. |
| Risk Management & Diversification | Mutual funds aim to eliminate risk by spreading the investment across different asset classes, securities, geographies, etc., to maximise risk-adjusted returns. | Investing across tech, healthcare, finance, and other sectors to balance portfolio risk. |
| Convenience & Accessibility (SIP, Online Access) | Simplifies investing with the help of SIPs and online portfolio tracking. | Even a ₹500 SIP has the capability of building wealth steadily over a long-term horizon. |
| Tax-Efficient Structuring | Mutual funds are tax-efficient tools that allow capital gains management to optimise returns. | ELSS funds offer deductions under Section 80C of the old tax regime. |
Mutual Funds vs Direct Investments: Functional Comparison
Let’s check how mutual funds fare against direct investments like direct equity and fixed deposits:
| Function | Mutual Funds | Direct Equity | Fixed Deposits (FDs) |
| Fund Mobilisation | Combines resources from various investors to invest in a pool of assets. | Direct investment in a stock | Direct deposit of a fixed investment amount into a bank. |
| Portfolio Management | Professional managers manage the fund. | Either self-managed or through advisors. | No management required. |
| NAV/Valuation | NAV is calculated daily based on market value. | Fluctuating stock prices determine value. | Value remains fixed until maturity. |
| Investor Services & Reporting | Portfolio holdings, NAV, and other key information are updated regularly. | Companies issue financial statements of performance. | The bank provides periodic statements. |
| Regulatory Compliance | Regulated by SEBI; transparent disclosures are mandatory. | Regulated by SEBI, but with higher individual responsibility | Regulated by RBI; highly secure |
| Convenience & Accessibility | SIPs and online tracking make investing easy | Requires active tracking and timing | Simple and easy to open online/offline |
| Tax Efficiency | ELSS funds offer 80C tax benefits; LTCG taxed at 12.5% | LTCG taxed at 12.5%; STCG at slab rate | Interest is fully taxable as per the slab |
| Liquidity | Redeem anytime (except ELSS 3-year lock-in) | High liquidity during market hours | Lock-in period; premature withdrawal penalty |
Conclusion
Mutual funds are convenient investment tools that cater to a diverse base of investors. The key functions of mutual funds are the mobilisation of funds, portfolio management, NAV calculation, return distribution, investors’ services, regulatory compliance, risk management, convenience, and tax-efficient structure. Take advantage of these core functions by investing in a mutual fund scheme that matches your investor profile and risk tolerance.
FAQs
Mutual funds have the following key functions: mobilisation of funds, portfolio management, NAV calculation, return distribution, investors’ services, regulatory compliance, risk management, convenience, and tax-efficient structure.
Mutual funds are required to update the NAV of their mutual fund units regularly, at the end of the trading day. It is calculated daily as (Total Assets – Total Liabilities) / Number of Units Outstanding. This helps investors track performance, determine buy/sell prices, and assess the fund’s fair market value accurately.
A fund manager acts as the decision-maker for the mutual fund. They research markets, select assets, monitor performance, and rebalance the portfolio to achieve optimal returns while managing risks. Essentially, they function like a team captain guiding investors toward their financial goals.
Mutual funds provide investors with services such as portfolio tracking, systematic investment plans (SIPs), dividend payouts, online account access, performance reporting, and investor query support. These services ensure transparency, ease of investing, and continuous monitoring for better investment decisions.
Mutual funds are regulated by SEBI, which mandates regular disclosure of NAV, portfolio holdings, and performance reports. Periodic audits and compliance checks ensure investor protection, transparency, and adherence to fair market practices, maintaining trust and integrity in the investment ecosystem.
Unlike direct stock investments, where investors manage and monitor individual stocks, mutual funds pool money under professional management. They offer diversification, convenience, and reduced risk, whereas direct equity involves higher market knowledge, active tracking, and exposure to concentrated risks.
