Mutual Fund: A Collective Investment Scheme Explained

A mutual fund is a type of collective investment scheme (CIS) where money is pooled from individuals and invested in a particular asset or assets. The returns or profits are then shared among the investors, according to a pre-agreed arrangement. While mutual funds are a type of CIS, the two terms are not interchangeable as CIS, on a global scale, can also include other types of schemes. In India, CIS and mutual funds are distinct from each other as per the SEBI Act of 1992.

Mutual funds and CIS: differences and similarities

Mutual funds and collective investment schemes (CIS) are similar in that they both involve pooling money from multiple investors to invest in a particular asset or assets. In both cases, the returns are then divided amongst the investors based on the proportion of their investment and/or the agreement signed by them at the time of investing.

However, there are some key differences between the two. Firstly, mutual funds are regulated by the Securities Exchange Board of India (SEBI), while CIS are regulated by the SEBI (Collective Investment Scheme) Regulations of 1999. Additionally, mutual funds are required to be registered with SEBI before collecting funds from the public, while CIS are exempt from this requirement in India. In fact, according to Section 11AA of the SEBI Act of 1992, mutual funds are specifically excluded from the definition of CIS in India.

Another difference lies in the fees charged. Mutual fund companies charge an annual fee for their operations, whereas CIS can charge up to 2% as initial issue expenses and annual recurring expenses. Additionally, CIS are not allowed to charge performance-based fees for fund management.

In terms of participants, a mutual fund company is called an Asset Management Company (AMC), while a CIS is managed by a Collective Investment Management Company. The individuals who invest in a mutual fund are known as shareholders, while those who invest in a CIS are called unit holders or unitholders.

Furthermore, mutual funds offer easier liquidity to investors compared to CIS. Mutual funds also provide investors with access to a diversified portfolio at lower prices, as the companies invest in varied securities like stocks, shares, or bonds across multiple industries and sectors.

Lastly, CIS have certain requirements that must be met, such as a minimum maturity period of 5 years, a minimum collection of Rs.20 crore to launch a scheme, and a minimum of 20 investors with no single investor holding more than 25% of the scheme. Mutual funds, on the other hand, require a minimum capital of 500 million and 200 million for open and close-ended transactions, respectively.

CIS and mutual funds: tax implications

A Collective Investment Scheme (CIS) is an investment scheme where individuals pool their money to invest in a particular asset. The profits from this investment are then shared among the investors, as agreed upon before the act. Mutual funds are also investment funds that pool money from investors, but they are exempt from CIS in India.

CIS

A CIS is offered to cooperative societies, non-banking financial companies, insurance companies, pension schemes, and more. CIS is better in terms of tax efficiency when compared to mutual funds. However, CISs are required to regularly update investors about the ventures undertaken with their investments, including any potential negative impact.

Mutual Funds

Mutual funds are taxed on both dividends and capital gain distributions if held outside of retirement plans. Mutual fund companies must be registered under the Securities Exchange Board of India (SEBI) before collecting funds from the public. The taxation of mutual funds depends on various factors, including the type of fund, dividend, capital gains, and holding period.

The holding period is the time between the purchase and sale of mutual fund units. In India, if investors hold their investments for an extended period, they will be liable to pay a lower tax amount. Thus, the longer the holding period, the less tax is payable on capital gains.

Mutual funds offer returns in the form of dividends and capital gains, both of which are taxable. Dividends received by investors are added to their taxable income and taxed at their respective income tax slab rates. Capital gains taxes depend on whether they are short-term or long-term, with different rates applied accordingly.

Additionally, the type of mutual fund also impacts taxation. For example, equity funds and debt funds have different capital gains tax rates.

In summary, while CIS is considered more tax-efficient than mutual funds, both investment options have complex tax implications that require careful consideration and consultation with tax professionals.

CIS and mutual funds: regulatory differences

Collective Investment Schemes (CIS) are a type of investment scheme where individuals pool their money to invest in a particular asset. The profits from this investment are then shared among the investors according to a pre-finalised agreement. Mutual funds are included in CIS on a global scale, but the SEBI Act of 1992 in India specifically excludes mutual funds and other schemes.

Regulatory Differences

CIS

A CIS is defined by law under the Financial Services and Markets Act 2000 (FSMA). According to Section 235(1) of the FSMA, a CIS is:

> ...any arrangement with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income.

In other words, a CIS is a vehicle for sharing profits or income through collective investment, and the participants do not have day-to-day control over the management of the property. Establishing or operating a CIS is a regulated activity that requires authorisation from the Financial Conduct Authority (FCA).

The key features of a CIS are:

• No limits on the structure—it can be a contract, partnership, trust, or company.
• The property can be any type and does not need to be investments regulated by the FCA.
• The operator must be FCA-authorised.
• Participants' contributions, income, and profits are pooled.
• A CIS may be regulated or unregulated.

Mutual Funds

Mutual funds, on the other hand, are regulated by the Securities Exchange Board of India (SEBI) and have the following features:

• Money is collected from different investors.
• Funds are operated by money managers who allocate assets and produce income for the investors.
• Investors get access to a diversified portfolio at lower prices.
• The company charges annual fees for its operations.

Differences in Regulation

The main regulatory difference between CIS and mutual funds lies in the authority that governs them. CIS are authorised and regulated by the FCA, while mutual funds fall under the purview of SEBI. This distinction is particularly relevant in the context of India, where mutual funds are specifically excluded from the definition of CIS under the SEBI Act.

In addition, there are differences in the requirements for registration and promotion of CIS and mutual funds. For a CIS to be regulated in the UK, an application must be made to the FCA, and specific requirements must be met. The promotion of CIS units is subject to financial promotion rules, which create exemptions from the general prohibition set out in Section 21 of the FSMA. Mutual funds, on the other hand, must be registered with SEBI before collecting funds from the public.

CIS and mutual funds: investment options

A Collective Investment Scheme (CIS) is an investment scheme in which a group of individuals pool their money together to invest in different options. The primary purpose of a CIS is to provide individuals with access to a diversified portfolio of investments that may be challenging or costly to achieve alone.

CISs are managed by professional fund managers who make investment decisions on behalf of the investors. Each investor owns units or shares in the scheme, proportionate to their investment amount. The combined securities and assets managed by CISs are known as its portfolio.

CISs can be defined as either open-ended or closed-ended. Open-ended funds continually create new units and allow unitholders to redeem their units at the prevailing Net Asset Value (NAV). Closed-ended funds, on the other hand, are usually listed on an exchange (stock exchange) and have a fixed number of units, so investors must purchase units from other investors via a secondary market.

The Securities Exchange Board of India (SEBI) regulates CISs in India, and they exclude mutual funds and other schemes in the country. However, globally, CISs have broader connotations and do include mutual funds.

Mutual funds are a type of CIS that pools money from multiple investors to invest in a diversified portfolio of securities. These funds are also managed by professional fund managers who make investment decisions on behalf of the investors. Each investor owns shares in the mutual fund, representing their proportional ownership of the underlying assets.

Mutual funds must be registered under the SEBI before collecting funds from the public. They have to meet certain requirements, such as having a minimum capital of 500 million for open-ended funds and 200 million for close-ended funds, and the fund manager must have a minimum of five years of experience.

CIS and mutual funds: historical perspectives

The idea of pooling resources and spreading risk has been around for centuries, but the first modern mutual fund was launched in the US in 1924. The oldest mutual fund still in existence is MFS’ Massachusetts Investors Trust (MITTX), which was also established in 1924. Mutual funds are now mainstream investments and form the core of individual retirement accounts.

The first collective investment fund (CIF) was created in 1927, but the stock market crash of 1929 led to severe limitations on these funds. Banks were restricted to only offering CIFs to trust clients and through employee benefit plans. CIFs are unregistered investment vehicles, akin to hedge funds, and are not regulated by the Securities and Exchange Commission (SEC) or the Investment Act of 1940. Instead, they operate under the regulatory authority of the Office of the Comptroller of the Currency (OCC).

Mutual funds became regulated by the Unit Trust of India in 1963. After the Securities Exchange Board of India (SEBI) was established in 1992, the SEBI Mutual Fund regulations of 1996 were put in place.

In India, the SEBI Act of 1992 excludes mutual funds and other schemes from being considered CISs. However, according to the Securities Laws (Amendment) Act of 2014, any funds pooled under any scheme or arrangement that is not approved or registered with SEBI shall be deemed to be a CIS if it involves a corpus amount of 100 crores or more.

A CIS is an investment product whereby investors contribute payments toward a pool of investments (or fund) that is managed by a professional fund manager on their behalf. A person who contributes payments to a fund purchases units within the CIS and is known as a unitholder. CISs can be defined as either open-ended or closed-ended. Open-ended funds continually create new units and allow unitholders to redeem their units, while closed-ended funds are usually listed on an exchange and have a fixed number of units, so investors must purchase units from other investors via a secondary market.

Mutual funds are the mechanism of accumulating money from investors by issuing units to them and investing the funds according to the objectives laid out in the Offer Document. A Mutual Fund Company is called an Asset Management Company (AMC), and the combined funds are referred to as Asset under Management (AUM). The investments are made in varied securities like stocks, shares, or bonds across a wide section of industries and sectors, where the risk is diversified. The profits or losses are shared in proportion to the investors' input. A mutual fund company must be registered under SEBI before collecting funds from the public.

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