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Business News/ Mutual Funds / Beyond basics: 5 lesser-known terminologies in the mutual fund landscape
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Beyond basics: 5 lesser-known terminologies in the mutual fund landscape

Understanding coupon payments, close-ended mutual fund schemes, and options to grow money within a mutual fund scheme are key aspects of exploring lesser-known terminologies in mutual funds.

Explore the unfamiliar terms in the mutual fund landscapePremium
Explore the unfamiliar terms in the mutual fund landscape

A terminology means a word where it will be defined with an explanation. But, today we are going to see some lesser-known terminologies in mutual funds. Here are the following:

Coupon payments

Coupon payments are associated with bonds. Bonds are a kind of debt instrument issued by the government, corporations 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 an 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 give them a 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 semi-annual 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 bondholder will receive a 4% coupon payment every six months until the bonds mature. 

Thus, in this case, each bondholder receives a coupon payment of 40 semi-annually. These semi-annual 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.

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.

Dividend reinvest option

Within a mutual fund scheme, there are three options to grow your money, namely growth, dividend reinvest and dividend payout. In the case of the 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 a bonus. The profits made by the scheme in the form of dividends, interests, gains or bonuses 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.

Switching

Switching refers to the process of shifting your investments from one mutual fund scheme to another within the same mutual fund. You can switch or move your investments from one scheme to another when both schemes are managed by the same AMC i.e. they belong to the same fund house.

To switch funds, the investor needs to fill up a switch form specifying the amount/number of units to be switched from the source scheme and name of the destination scheme. Switching is considered as a sale or redemption for the source scheme and a purchase for the destination scheme.

Hence, one must fulfil the minimum investment amount criteria for both switch-in and switch-out schemes. There may be implications of exit load and capital gains tax while switching since it is a sale transaction for the source scheme. Switching is currently not possible between two schemes belonging to two different fund houses.

Systematic Transfer Plan 

A Systematic Transfer Plan (STP) allows you to transfer a fixed number of units or amounts from your investment in one mutual fund scheme to another scheme managed by the same fund house on a prespecified day every month. You can start an STP by investing a lumpsum amount in a mutual fund scheme and giving instruction to the fund house to transfer a fixed no. of units or amount from this investment to the destination scheme.

As a result, your account balance in the source scheme i.e. the scheme in which you had made the lumpsum investment gradually decreases every month while your investment in the destination scheme increases gradually every month. The STP automatically stops when all the money from the source scheme has been transferred to the destination scheme over a period of time.

STP is best advisable when you have a large sum of money to invest but are not sure how the market will move once you’ve invested your money. So, you gradually move or switch your money from one scheme to another in a phased manner over time.

Rohit Gyanchandani is Managing Director at Nandi Nivesh Private Limited

 

 

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Published: 04 Mar 2024, 09:15 AM IST
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