Three-tier structure

In India, mutual funds are created as trusts. That single choice produces the three-tier structure of sponsor, trust and asset management company (AMC).

Each tier has one job, and the separation is the point:

• The sponsor promotes the mutual fund and sets up the AMC.
• The trust, managed by trustees, holds the property in the beneficial interest of the unit holders.
• The AMC, appointed by the trustees, manages the funds.

The people who pick the securities do not own the assets, and the people who hold the assets do not pick the securities. Investors are the beneficial owners of the investments held by the trust. The structure to be followed is laid down in SEBI's Mutual Funds Regulations.

Tier 1 — Sponsor. The promoter, who sets up the trust and the AMC, appoints the custodian, the board of trustees and the board of directors of the AMC, and seeks SEBI approval. Eligibility includes:

Tier 2 — Trust and trustees. The trust deed is executed by the sponsor in favour of the trustees. Trustees are appointed by the sponsor with SEBI approval, hold the property in trust for the benefit of unit holders, and carry the fiduciary responsibility of protecting them. At least two-thirds of the board of trustees must be independent of the sponsor. Trustees submit Half Yearly Trustee Reports to SEBI.

Tier 3 — AMC. The investment manager, set up by the sponsor and registered with SEBI, structured as a public or private limited company, earning a fee usually set as a percentage of AUM. Its rights and obligations sit in the Investment Management Agreement signed with the trustees. It cannot engage in any business other than financial advisory and investment management, reports quarterly to the trustees, and files a Compliance Test Report with SEBI quarterly.

Around the three tiers sit the other constituents — the custodian, appointed by the trustees and the only constituent not directly appointed by the AMC, which must be independent of the sponsor; and RTAs, bankers and brokers, all SEBI-registered.

An illustrative group; the names are invented.

Prakash Financial Services Ltd, with eight years in financial services and positive net worth in each of the last five, decides to enter the mutual fund business.

Tier 1. As sponsor, it sets up Prakash Asset Management Ltd with a net worth of Rs 150 crore. It must contribute at least 40 percent:

Minimum sponsor contribution = 40% × Rs 150 crore = Rs 60 crore

It also executes a trust deed, appoints the trustees and the AMC's board, and applies to SEBI.

Tier 2. Prakash Mutual Fund is constituted as a trust. Its board of trustees has six members; at least two-thirds — four — must be independent of Prakash Financial Services.

Tier 3. The trustees sign an Investment Management Agreement with Prakash Asset Management Ltd, which launches schemes and manages the money.

The custodian. Prakash Financial Services also has a custody business. It cannot act as custodian for Prakash Mutual Fund, because a sponsor cannot be custodian of its own fund. The trustees appoint an independent custodian.

Now suppose Mrs Reddy has Rs 10 lakh in one of the schemes. The securities her units represent are held in trust for her, in the custody of an independent custodian. The AMC manages them; it does not own them.

Chapter 9 (Structure and Constituents of Mutual Funds) opens with the three-tier structure and Figure 9.1, then takes each constituent in turn: sponsor in section 9.1, trustees in 9.2, AMC in 9.3, custodian in 9.4, and regulation in 9.5. Chapter 8 introduces the mutual fund as a pooled, trust-held vehicle, and Chapter 10 quotes the regulatory definition of a mutual fund as a fund established in the form of a trust. Expect questions on who sets up whom, who appoints the custodian, the two-thirds independence rule and the 40 percent sponsor contribution.

• Sponsor, trust, AMC — not sponsor, AMC, custodian. The custodian is a constituent, not a tier.
• The trust deed is executed by the sponsor in favour of the trustees.
• Trustees are appointed by the sponsor with SEBI approval; the AMC is appointed by the trustees (or the sponsor, if the trust deed so authorises).
• At least two-thirds of trustees independent of the sponsor. The sponsor-disassociation conditions separately require an AMC board of at least two-thirds independent directors.
• The sponsor must contribute at least 40 percent of the AMC's net worth.
• The custodian is the only constituent not directly appointed by the AMC, and a sponsor cannot be custodian of its own fund.
• The AMC cannot run any business other than financial advisory and investment management.
• Which regulations? Section 9.5 says mutual funds are regulated by the SEBI (Mutual Funds) Regulations, 1996, while the opening of the chapter, footnoted to a notification of 16 December 2025, refers to the SEBI (Mutual Funds) Regulations, 2026. The workbook carries both references; know that the rules above are what it teaches under either.