Mutual fund

Also called: MF · Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

A mutual fund (MF) collects money from many investors and puts it into shares, bonds or money-market instruments (loans repaid within one year, such as treasury bills). Professional managers decide where the money goes. Investors receive units in return, and the value of each unit is its Net Asset Value (NAV):

NAV = (Market value of assets − Liabilities) ÷ Number of units outstanding

Mutual funds matter because a small investor gets diversification, expert management and liquidity that would be hard to get alone. The steady flow of household money into MFs now supports Indian stock markets when foreign investors sell.

Explanation

How a mutual fund works

Pooling: many small amounts become one large fund.
Three benefits for a small investor:
Diversification means the money is spread over many assets. If one asset does badly, the whole fund is hurt less.
Expert management means trained fund managers pick the investments.
Liquidity means units can be turned back into cash easily.
Units and NAV:
NAV is worked out daily.
Investors buy units at NAV. They also redeem units (sell them back to the fund) at NAV.
Worked example (NAV):
A fund holds securities worth ₹1,050 crore.
It owes ₹50 crore in fees and payables.
It has issued 50 crore units.
NAV = (1,050 − 50) ÷ 50 = ₹20 per unit.
An investor who puts in ₹10,000 gets 10,000 ÷ 20 = 500 units.
Trap: a low NAV does not mean a fund is "cheap". Your return depends on the percentage change in NAV, not on how high or low the NAV is.

The four-layer structure

The work is split among four separate parties, so no single party controls investors' money.

Sponsor: the promoter who sets up the MF.
Trust / trustees: hold the assets for the unit-holders and supervise the AMC.
AMC (Asset Management Company): the company that actually invests the money.
Custodian: keeps the securities safe.
Exam trap: the AMC manages the money, but the custodian holds the securities.

Types of mutual funds

By structure:
Open-ended fund: investors can enter or exit on any day, at NAV.
Closed-ended fund: it runs for a fixed term, and new money comes in only at launch. Its units are listed on a stock exchange, and investors exit by selling them there.
By SEBI category (2017): equity, debt, hybrid, solution-oriented and others.
Why SEBI set these categories:
- investors can compare similar schemes with each other
- one AMC can no longer run many near-copy schemes
Passive funds:
Index fund: it does not pick stocks. It copies an index such as the Nifty 50, so its expense ratio (the yearly fee, charged as a share of assets) stays low.
Exchange-Traded Fund (ETF): it tracks an index, a commodity or a basket of assets, and it trades on a stock exchange like a share.
Fund of funds (FoF): it invests in other funds instead of buying securities directly.

Systematic Investment Plan (SIP) and rupee-cost averaging

SIP means putting a fixed sum into a fund at regular intervals, usually every month.
How rupee-cost averaging works:
The amount you invest stays the same each month.
When NAV is low, that amount buys more units. When NAV is high, it buys fewer units.
So your average cost per unit ends up below the simple average of the NAVs.
Worked example: ₹1,000 invested each month for three months.

Month	NAV (₹)	Units bought
1	10.00	100
2	8.00	125
3	12.50	80
Total	—	305 units for ₹3,000

Average cost per unit = 3,000 ÷ 305 = ₹9.84.
Simple average of the three NAVs = (10 + 8 + 12.5) ÷ 3 = ₹10.17.
The SIP investor paid less per unit than the average price.

In India

History:
UTI (Unit Trust of India), 1963, was India's first MF. The state set it up.
Private MFs were allowed from 1993, as part of the 1990s capital-market reforms.
Law and regulator:
The SEBI (Mutual Funds) Regulations, 1996 govern all MFs.
SEBI is the regulator.
AMFI (Association of Mutual Funds in India) is only the industry body. It is not the regulator.
Size (SEBI Annual Report 2025-26):
MF AUM (assets under management, the total market value of the money funds manage) rose 12.2%. It went from ₹65.7 lakh crore (March 2025) to ₹73.7 lakh crore (March 2026) [1].
Unique investors rose 13.2% to 6.1 crore in 2025-26 [1].
The number of investors in Tier II cities grew 37.6%, and Tier III cities hold the largest share of investors at 55% [1].
There are 27.4 crore folios (investor accounts). Individuals hold 97.7% of these folios and 58.3% of AUM (2025-26) [1].
SIP scale (2025-26):
There were 10.45 crore active SIP accounts [1].
The average net monthly SIP contribution rose 25.8% to a record ₹16,413 crore [1].
Market impact:
FPIs (foreign portfolio investors) kept selling in 2025-26.
Domestic institutional investors (DIIs), which include MFs, absorbed this selling with a record cumulative net inflow of ₹8.5 lakh crore. Steady MF SIPs supplied most of this money [1].
By March 2026, DII equity holdings reached an all-time high of 17%, and FPI ownership fell to a 15-year low of 15.8% [1].
ETF milestones:
Nifty BeES (2001) was India's first ETF.
Gold ETFs started in 2007.
The CPSE ETF (2014) and Bharat 22 ETF (2017) were used for disinvestment (the government selling part of its stake in public-sector companies).
The Bharat Bond ETF (2019) was India's first corporate-bond ETF. It holds PSU bonds.

Don't confuse with

AMFI vs SEBI: AMFI is the MF industry body. SEBI is the regulator under the MF Regulations, 1996.
Index fund vs ETF: you buy an index fund from the AMC at the day-end NAV. You buy an ETF on the exchange at the live market price, and you need a demat account (an electronic account that holds securities).
Alternative Investment Fund (AIF): an AIF is a privately pooled fund for rich, experienced investors. It comes under the SEBI (AIF) Regulations, 2012, and the minimum investment is ₹1 crore. It is not a mutual fund.
REIT / InvIT: these are also pooled, listed trusts (SEBI regulations of 2014). But they own property or infrastructure and must pay out at least 90% of net distributable cash flow. A mutual fund holds shares, bonds and money-market instruments.

Prelims Hooks

MF structure: Sponsor → Trust → AMC → Custodian. The AMC manages the money, and the custodian holds the securities.
NAV = (Assets − Liabilities) ÷ Units outstanding. It is computed daily, and units are bought and redeemed at NAV.
Regulation: SEBI (Mutual Funds) Regulations, 1996. AMFI is the industry body, not the regulator. UTI (1963) was the first MF, and private MFs came in 1993.
SIP → rupee-cost averaging: a fixed amount buys more units when NAV is low. The average cost ends up below the simple average of the NAVs.
Open-ended vs closed-ended: open-ended funds allow entry and exit daily at NAV. Closed-ended funds have a fixed term and are listed on an exchange.
Trap: a low NAV does not mean a "cheap" fund. Returns depend on the percentage change in NAV.

Mains Points

Financialisation of household savings:
Savings are moving from gold and property into MFs. There are 10.45 crore active SIP accounts, and net SIP flows average ₹16,413 crore a month (2025-26) [1].
This steady domestic money let DIIs absorb ₹8.5 lakh crore of foreign selling [1].
Result: Indian markets depend less on "hot" foreign money, so prices fall less sharply when FPIs pull out.
Risk to new retail investors:
Many first-time investors, especially the fast-growing base in Tier II and Tier III cities [1], may not be ready for a long period of falling prices.
This raises the need for investor education and suitability norms (rules that match a product to the investor's needs and ability to bear risk).
Investor protection by design:
The four-layer structure keeps management (AMC) separate from custody (custodian), with trustees supervising.
SEBI's 2017 categorisation stops near-copy schemes.
Together, these build trust. This matters as MFs now carry a large share of household wealth and domestic market stability.

Related concepts

Pooled vehicles, private capital and institutional investors

Sources

1SEBI Annual Report 2025-26, Chapter 1: Introductionsebi.gov.in · tier 1