Glossary of Mutual Fund Terms

Assets Under Management (AUM)

Assets Under Management (AUM) is the total market value of the investments (assets) that an asset management company is managing, on behalf of its investors.


Asset Management Company

AMC or Asset Management Company is the Investment Manager of the Mutual Fund that manages the pool of investor money on behalf of the investors. An AMC carries out all purchase and sale of securities in the portfolio of various Mutual Fund schemes launched by the Mutual Fund.


Mutual Fund performance should never be looked at in isolation. The performance of a Mutual Fund or any investment should be evaluated against a standard known as the benchmark. The benchmark for a fund is decided at the time the fund is launched and the selection of the benchmark is based on the investment objective of the fund. This benchmark, comprising of either stocks, bonds, debentures, money market instruments or other securities, indicates the kind of investment choices the fund will make as part of its stated investment objective. Hence, you as an investor should expect the scheme to perform better than its benchmark over a given time frame.

Investors would have no yardstick to compare the performance of different funds, that have different investment objectives, and follow different investment strategy. Thus, a benchmark helps bring in standardization in the comparison of performance of different funds, following the same benchmark or in evaluating how a fund has performed against its own benchmark.

Coupon payments

Coupon payments are associated with bonds. Bonds are a kind of debt instrument issued by the Government, corporates and banks when they want to borrow money from investors to finance big projects. They issue bonds to investors with a certain coupon rate or interest rate. For instance, a power company, Energy Grid Pvt. Ltd., may issue bonds of 5-year maturity with 8% coupon rate. This means Energy Grid will compensate its bond investors at 8% interest rate for the money they are lending to it by buying its bonds. The reason is simple. If investors don’t get an attractive interest rate from these bonds, they would rather invest their money in another bond or other avenues that gives them better return for the same level of risk involved.

Each investor who buys the bonds from Energy Grid will receive 8% interest payment from Energy Grid every year. Since coupon payments are usually semiannual in nature, the bond investors will receive a coupon of say ` 40 if the face value of each bond is ` 1,000. Bonds are always issued at a certain face value. Investors who buy the bonds at the time of issuance pay the face value to own each bond. If the face value of Energy Grid’s bond is ` 1,000, each bond holder will receive 4% coupon payment every six months until the bonds mature. Thus, in this case, each bond holder receives a coupon payment of ` 40 semiannually. These semiannual payments that are promised by the bond issuer are called coupons of the underlying bond.

Most often, the coupons are simply reinvested at the prevailing rates (interest rates) and the accumulated interest / coupon is paid along with the initial principal investment at the time of maturity.

Credit risk

In any payment, there are two parties where one party owes money to the other party. When the payment is not immediate but is supposed to happen in the future, there is a contractual agreement between the two parties. The borrower is supposed to fulfill its payment obligation at some time in the future. The lender being the counterparty faces a risk, that the borrower may not be in a suitable position to return its money back or pay the periodic future interest payments for a variety of reasons. This risk faced by the lender, that the borrower may fail to keep its promise of payment in the future is called Credit Risk.

Credit risk can arise in case of banks disbursing loans or issuing credit cards to its customers. The bank faces the credit risk of its customers failing to make timely loan or credit card payments. Similarly, in case of a bond, the bond issuer has promised to pay the bond investors a fixed or floating interest rate periodically and return their principal when the bonds mature. The bond investors (bond buyers or lenders) face a credit risk that the entity that issued them the bonds may fail to make these payments in future.

Credit risk in case of bond investments can arise due to many factors. The bond issuer may be undergoing a financial crisis due to unfavourable business environment resulting in low profitability or poor business growth. In such a scenario, the bond issuer may not be able to meet its payment obligations of periodic interest or repayment of principal to its bond holders at maturity. Credit risk can also arise when the bond issuer has borrowed money from banks in the form of loans and has to prioritize those payments over payments to its bond holders. Thus, credit risk arises in situations where a bond issuer is not in a sound financial situation to be able to fulfil its payment obligations on the bonds issued by it to investors.

A credit risk can end up in default by the bond issuer subsequently. In case of a default by the bond issuer, the bond issuer fails to either make the periodic coupon (interest) payments or repay the principal invested by bond holders at the time of maturity. Thus, investors must evaluate the credit worthiness of bond issuers before buying their bonds. For instance, debt Mutual Funds investing their pool of investor money in debt instruments must carefully evaluate the credit worthiness of a bond before including it in the fund’s portfolio i.e. before buying such a bond.

You can evaluate the credit worthiness of a bond issuer by looking at the credit rating assigned to its bonds by a reputable credit rating agency. The credit rating is assigned to bond issuers after complete analysis of their financials that includes

  • Balance sheet
  • Cash flows and profitability
  • Ability to pay future debt (borrowing) obligations
  • Past record in fulfilling debt obligations
Close-Ended Schemes

Investors can buy units in Close-Ended Mutual Fund schemes from the fund house only during the NFO (New Fund Offer) period.

Neither can new investors enter a close-ended scheme, nor can existing investors exit the scheme until its maturity. However, for providing interim liquidity to investors, the scheme is listed on a stock exchange post NFO where its units can be traded. The number of outstanding units of a close-ended scheme does not change during buying and selling through the exchange. The units may sell at a premium or discount to the NAV of the fund depending on market conditions, investors’ expectations of the future performance of the fund and demand and supply of units of the fund.


Default risk

Default risk refers to the chances that a borrower will fail to pay its financial obligations under a contract. For instance, if a person who has taken a home loan from a bank fails to make monthly payment of EMIs, we say the customer has defaulted in his payment obligations. The bank is prone to default risk, or risk of its customers failing to make timely payment of its loans.

In case of a bond, which is a debt obligation for the bond issuer, the borrower (bond issuer) can get into a situation where it is unbale to make periodic interest payments or is unbale to return the principal to the bond holders when the bonds mature. If such a scenario occurs, it is said that the bond issuer has defaulted. When investors invest their money in bonds issued by various entities, they are subject to default risk i.e. the likelihood of the bond issuer defaulting in its payments.

Dividend Reinvest Option

Within a Mutual Fund scheme, there are three options to grow your money, namely growth, dividend reinvest and dividend payout. In case of Dividend Reinvestment option, you can reinvest the dividend made by the scheme during the intermediate period back into the scheme. A Mutual Fund scheme invests in a basket of securities like stocks, bonds, gold and even international securities. Some of these securities pay dividends while others may pay interest, while some others may pay bonus. The profits made by the scheme in the form of dividends, interests, gains or bonus can be distributed among the scheme’s investors at the discretion of the fund managers. Fund managers decide when to distribute profits from the scheme among investors.

If a fund manager does decide to distribute the profits, the declared profits in the form of dividends are not paid to investors when they opt for dividend reinvest option but are rather reinvested in buying more units of the fund. Unlike a growth option where the value or NAV of your holding grows, here the number of units held by you grows since the dividend amount is used to buy more units of the scheme.

Dividend Payout

In case of Dividend Payout option, you receive any dividend declared by the companies included in the portfolio of your scheme. Within dividend option, you can either choose to receive the dividend payouts or reinvest the declared dividend back into the scheme. Dividend Payout options lets you receive any profit/surplus declared by the scheme during the time you remain invested in the scheme. Dividend payout option provides a regular cashflow, though there is no guarantee that the scheme will continue to pay you dividend always at regular intervals.

A Mutual Fund scheme invests in a basket of securities like stocks, bonds, gold and even international securities. Some of these securities pay dividends while others may pay interest while some others may pay bonus. The profits/surplus made by the scheme in the form of dividends, interests, gains or bonus can be distributed among the scheme’s investors at the discretion of the fund managers. Fund managers decide when to distribute profits from the scheme among investors. In case of dividend payout option, you will receive the profits made by the scheme whenever the fund manager decides to distribute this profit among investors. The NAV of a dividend scheme falls to the extent of dividend declared on the ex-dividend date i.e. the next business day after the dividend has been declared.

The dividends may stop coming if the scheme makes a loss at any time, or if the fund manager decides to reinvest the profit back into the scheme by buying more assets.

Dividend Stripping

Dividend Stripping is the practice of buying a stock prior to the declaration of dividends and selling it off once the dividend is declared with the objective of saving taxes, by showing a capital loss on the sale transaction. When dividends are declared, the price of a stock falls to the extent of dividend declared. So, when an investor buys a stock just before dividend is to be declared and sells it post the declaration of the dividend, he incurs a short-term capital loss on the sale since the price of the stock has fallen. He can use this capital loss to set off against some capital gain he may have in his overall investment portfolio. He also earns the dividend which is tax-free in the hands of investors.

For instance, an investor may buy a stock of Energy Grid Pvt. Ltd. at ` 100 on 1st Feb. 2018 when it hears about Energy Grid likely to declare dividends to its investors in the news.

On 31st Mar. 2018, Energy Grid declares ` 10 dividend per share.

On 1st Apr. 2018, the stock price of Energy Grid falls to ` 90.

Suppose the investor had invested ` 10,000 in the stock of Energy Grid on 1st Feb. He would have received 100 shares of the company.

On 31st Mar. 2018, the investor receives ` 10 as dividend per share. Thus, he receives a total sum of ` 1,000 as dividend.

If the investor decides to sell his stocks on 1st Apr., he will get a sum of ` 9,000 and record ` 1,000 as capital loss since he had initially invested ` 10,000.

He can use this loss to set-off a capital gain he may have made elsewhere. Thus, he saves tax on the capital gain that is set-off by the loss in his Energy Grid investment and he gets to keep the ` 1,000 dividend income, which is not taxable.

Mutual Fund investors can also indulge in dividend stripping because some Mutual Fund schemes pay dividends to investors under the dividend payout option. Usually HNI investors have an incentive to indulge in such practices, since they hold significant amount of investments that can benefit from the capital loss recorded due to dividend stripping.

In order to discourage dividend stripping, Mutual Funds do not allow the amount of loss incurred due to sale of units in a scheme (where dividend is tax-free) to be used for set-off, against a capital gain, to the extent the gain is equal to the amount of tax-free dividend declared within the following time period:

  • If the investor had bought those units 3 months prior to the record date fixed for dividend declaration and
  • If the units are sold within 9 months after the dividend declaration date