Foundation — From NFO to folio: plans, options, allotment and who may invest

Why this chapter exists

"Mutual fund is an investment vehicle for a large number of investors. In order to provide uniform experience, it is critical that various processes and investor services are STANDARDIZED. Such standardization lends comfort to the investors since they know WHAT TO EXPECT AND WHEN. They also know WHAT NOT TO EXPECT in terms of services."

That last sentence matters as much as the first. A standard is a promise and a boundary.

9.1 The NFO process

"Units in a mutual fund scheme are offered to investors for the first time through a New Fund Offer (NFO)." The steps:

• "The AMC decides on a scheme to take to the market... on the basis of inputs from the Chief Investment Officer (CIO) on investment objectives that would benefit investors, and inputs from the Chief Marketing Officer (CMO) on the interest in the market."
• "An AMC can have ONE fund/scheme in a category. There are defined funds within broad Equity, Debt and Hybrid categories. Hence, the NFO has to be in a category where the AMC does NOT already have a fund/scheme. Alternatively, it has to be in a category where an AMC can have multiple funds/schemes e.g., Sector/Theme, Index or Fund of Funds."
• "AMC prepares the Scheme Information Document... This needs to be approved by the Trustees and the Board of Directors (BoD) of the AMC."
• "The documents are then filed with SEBI. The observations that SEBI makes on the SID need to be incorporated. After approval by the trustees, the same can be issued in the market."
• "The AMC decides on a suitable timetable... The AMC launches its advertising and public relations campaigns... These need to comply with SEBI's advertising code."
• "The AMC holds events for intermediaries and the press... The Scheme Documents and Application Forms are distributed to market intermediaries."

The three dates

"Close-ended Schemes have an NFO Open Date and NFO Close Date. But they have NO Scheme Re-opening Date, because the scheme does not sell or re-purchase units. Investors will need to buy or sell units from the stock exchange where the scheme is listed."

The NFO timelines

"all NFOs can remain open for subscription for a MINIMUM period of THREE WORKING DAYS and NFOs other than ELSS can remain open for subscription for a MAXIMUM of 15 DAYS. Allotment of units or refund of money, as the case may be, should be done within 5 BUSINESS DAYS of closure of the scheme. Further, open-ended schemes have to RE-OPEN for sale/re-purchase within 5 BUSINESS DAYS of the allotment."

And on deployment: "As per Regulation 35(5) SEBI has introduced guidelines requiring mutual funds to specify REALISTIC DEPLOYMENT TIMELINES in the Scheme Information Document (SID)."

9.2 NFO price and ongoing price

"New Fund Offer (NFO) Price is the price per unit that the investors have to pay to invest during the NFO."

"Since there is no entry load as per regulation, SALE PRICE OF UNITS IS SAME AS NAV. REDEMPTION PRICE ALSO IS SAME AS NAV, EXCEPT IF THERE IS EXIT LOAD."

9.3.1 Direct and regular plans

"Since the distribution services involve charges... any investor going direct is assumed to have decided NOT to avail those services. In such a case, the investor may not bear the cost of such services. Each mutual fund HAS TO OFFER TWO PLANS to the investors, viz., REGULAR PLAN and DIRECT PLAN. Both these would have different total expense ratio (TER)."

"The direct plan shall have a LOWER expense ratio EXCLUDING distribution expenses, commission, etc., and NO COMMISSION SHALL BE PAID from such plans. Since the TER is different in both cases, the plans will have SEPARATE NAVs."

"the direct plan is only for those investors, who purchase units DIRECTLY from the fund and the same is NOT available for investors who route their investments through a distributor. If investment (purchase/repurchase) is routed through a distributor, then it is CONSIDERED that one has CHOSEN TO INVEST IN THE REGULAR PLAN."

"Apart from these two plans at different NAVs, the AMC CANNOT offer separate plans based on expense ratio."

9.3.2 Three options, one portfolio

"From April 1, 2021 the dividend option has been renamed to Income Distribution cum capital withdrawal to reflect the actual situation about the income earned by the investor. These are different OPTIONS within a scheme having the SAME PORTFOLIO. Therefore, the PORTFOLIO RETURNS ARE THE SAME for all three options. However, they differ in the structure of CASH FLOWS AND INCOME ACCRUALS... and therefore there is a difference in the unitholder's TAXABILITY, NUMBER OF UNITS HELD and VALUE of those units. The POST-TAX RETURN from each of these options will therefore be DIFFERENT."

Payout. "the fund declares a dividend from time to time. Some schemes (liquid and debt funds with very short-term maturity) even declare a dividend daily, subject to the availability of profits. When a dividend is paid, the NAV of the units FALLS to that extent." The vocabulary: "The reduced NAV, after a Pay-out... is called EX-DIVIDEND NAV. After a dividend is announced, and until it is paid out, it is referred to as CUM-DIVIDEND NAV." And: "The Pay-out... does NOT change the number of units held by the investor."

Reinvestment. "as in the case of pay-out option, NAV declines to the extent of dividend... However, the investor does NOT receive the dividend in his bank account; the amount is RE-INVESTED in the same scheme and ADDITIONAL UNITS are allotted. The reinvestment happens at the EX-DIVIDEND NAV." The worked figure: "if dividend is Rs 2 per unit on a Unit-holder's 100 units, the dividend would amount to Rs 200. Assuming the ex-dividend NAV of the scheme is Rs 20, then Rs 200 ÷ Rs 20 i.e., 10 units will be added... Tax is paid by the unit-holder in the year of receipt."

Growth. "dividend is not declared. Therefore, nothing is received in the bank account... and there is nothing to re-invest... The NAV would therefore capture the FULL VALUE of the portfolio gains... there will be no accretion to the number of units held. The NAV of those units will however be HIGHER."

Table 9.1 — Implications of the three options

Illustration 9.1 — three investors, one scheme

A, B and C each invest in 100 units at NAV Rs 10 — A in growth, B in IDCW payout, C in IDCW reinvestment. The NAV rises to Rs 12 and the fund declares a dividend of 10 percent.

• Dividend amount: "10 percent of the FACE VALUE of Rs 10, Re 1 per unit." Note carefully — dividend percentages are on face value, not on NAV.
• Who gets it: "Investors in the IDCW payout and IDCW reinvestment option, i.e., investor B and Investor C."
• How: "B will be paid out the dividend of Rs 100 (Re 1 × 100 units) while the dividend amount of Rs 100 due to C will be reinvested at the EX-DIVIDEND NAV of Rs 11 (Rs 12 − Re 1)."
• Units for C: "Rs 100 ÷ Rs 11 = 9.09 additional units."
• Values on the ex-dividend date:
  • Investor A: "Rs 1,200 (100 units × Rs 12). Rs 200 is earned as capital gains."
  • Investor B: "Rs 1,100 (100 units × Rs 11). Rs 100 as dividend and Rs 100 as capital gains... The total return earned is Rs 200."
  • Investor C: "Rs 1,200 (109.09 units × Rs 11)... returns are Rs 100 as capital gains on the original 100 units and Rs 100 earned as dividends that is re-invested."

All three earn Rs 200. "The POST-TAX returns to each of the investors will be DIFFERENT since the tax applicable on dividend and capital gains earned are different."

9.4 Allotment of units

NFO. "Since entry load is banned, units in an NFO are sold at the FACE VALUE i.e., Rs 10. Therefore, the investment amount divided by Rs 10 would give the number of units."

"Subject to the receipt of the specified minimum subscription amount, FULL ALLOTMENT is made to all valid applications... The Trustee reserves the right, at their discretion WITHOUT ASSIGNING ANY REASON, to reject any application. Allotment is completed within 5 business days after the closure of the NFO. In case of applicant who have quoted their demat account, the units are credited within 2 working days to the demat account."

"Allotment of units and despatch of allotment advice to FPIs is subject to RBI approval if required. Investors who have applied in non-depository mode are entitled to receive the account statement of units within 5 Business Days of the closure of the NFO Period. For applicants applying through the ASBA mode, on intimation of allotment by CAMS to the banker the investors account is debited to the extent of the amount due."

Ongoing offer. "the price at which units are sold... is the sale price, which in turn is the applicable NAV... an investor who has invested Rs 12,000, in a scheme where the applicable sale price is Rs 12, will be allotted 1,000 units."

Rights issue. "the price at which the units are offered is clear at the time of investment... rights issues, which are common for shares, are LESS MEANINGFUL for units of mutual fund schemes."

Bonus issue. "the investor does NOT pay anything. The fund allots new units FOR FREE. Thus, in a 1:3 bonus issue, the investor is allotted 1 new unit (free) for every 3 units already held. Since the NET ASSETS of the scheme REMAIN THE SAME – only the number of units increases - the NAV will get REDUCED PROPORTIONATELY and the VALUE OF THE INVESTOR'S HOLDING DOES NOT CHANGE as a result of the bonus issue."

Refund. "If application is rejected, full amount will be refunded within 5 business days from the date of closure of NFO. If refunded later than 5 business days, interest @ 15 percent p.a. for delay period will be paid and charged to the AMC."

And a new threshold. "Minimum investment threshold for investment strategies launched under Specialized Investment Funds (SIF) would be Rs 10 LAKHS. This should be the AGGREGATE investment by an investor across ALL investment strategies offered by the SIF, at the PAN LEVEL. Investments made in other mutual fund schemes would NOT be counted for this minimum threshold."

9.5 Account statements

Monthly. "Mutual funds issue the Statement of Account every month IF THERE IS A TRANSACTION during the month. It shows for each transaction... the value of the transaction, the relevant NAV and the number of units transacted... [and] the closing balance of units held in that folio and the value of those units based on the latest NAV."

Annual. "The Mutual Funds provide the Account Statement to the Unit-holders who have NOT TRANSACTED during the last SIX MONTHS... The Account Statement reflects the latest closing balance and value... The account statements in such cases may be generated and issued ANNUALLY."

Consolidated Account Statement (CAS).

• "the asset management company shall ensure that consolidated account statement for EACH CALENDAR MONTH is issued (post/email)... detailing all the transactions and holding at the end of the month ACROSS ALL SCHEMES OF ALL MUTUAL FUNDS, to all the investors in whose folios transaction has taken place during that month."
• "In respect of investors in whose folios NO transaction has taken place during the preceding SIX-MONTH period ending in SEPTEMBER OR MARCH, a consolidated account statement shall be issued on HALF YEARLY basis."
• "The asset management company shall identify common investor across mutual funds by their PERMANENT ACCOUNT NUMBER."

And the definition that catches people out: "the word 'transaction' includes purchase, redemption, switch, dividend payout, dividend reinvestment, systematic investment plan, systematic withdrawal plan, systematic transfer plan and BONUS transactions."

9.6 Who may invest

Individual investors — "Resident Indian adult individuals, above the age of 18: They can invest, either singly or jointly (NOT EXCEEDING THREE NAMES)."

Minors — "Since they are not legally eligible to enter into a contract, they need to invest through their guardians... payment for investment by any mode shall be accepted from the bank account of the MINOR, PARENT OR LEGAL GUARDIAN of the minor, or from a JOINT ACCOUNT of the minor with parent or legal guardian. For existing folios, the AMCs shall insist upon a Change of Pay-out Bank mandate BEFORE REDEMPTION is processed."

HUFs — "family members pool the family money (inherited)... The head of the family (called 'KARTA') invests on behalf of the family. Against his name in the application, he would add the letters 'HUF'."

NRIs / PIOs — "their status as erstwhile Indians, entitles them to invest in mutual fund schemes on full repatriation or non-repatriation basis. As part of the documentation, they need to provide their PIO Card / OCI Card." On repatriable basis "the sale proceeds can be transferred abroad"; on non-repatriable basis "the proceeds... cannot be remitted abroad."

Foreign investors — "They can invest in equity schemes of MFs registered with SEBI after completing the KYC process. Foreign nationals can invest as Qualified Foreign Investors (QFIs). The QFI is a sub-category of Foreign Portfolio Investor... However, they should be from a country that is a member of Financial Action Task Force (FATF) or a member of a group which is a member of FATF, and a country that is a signatory to IOSCO's Multilateral Memorandum of Understanding (MMOU). QFIs can purchase Indian mutual fund units through demat account mode (direct route) and unit confirmation receipt (UCR)."

Non-individual investors — companies and corporate bodies registered in India; registered societies and co-operative societies; trustees of religious and charitable trusts; trustees of private trusts; partners of partnership firms; AoP or BoI, whether incorporated or not; banks (including co-operative banks and RRBs), financial institutions and investment institutions; other mutual funds registered with SEBI; FPIs registered with SEBI; international multilateral agencies approved by the Government of India; Army/Navy/Air Force, para-military units and other eligible institutions; scientific and industrial research organizations; universities and educational institutions.

FPIs meeting KYC requirements can invest by two routes: "Direct route - Holding MF units in demat account through a SEBI registered DP" and "Indirect route - Holding MF units via Unit Confirmation Receipt (UCR)."

And a caution: "in some schemes, only specific classes of non-individual investors are permitted. For instance, some Gilt schemes have specific plans, which are open ONLY for Provident Funds, Superannuation and Gratuity Funds, Pension Funds, Religious and Charitable Trusts and Private Trusts. Therefore, it is a good practice to check the 'Who can Invest?' section of the SID."

9.7 Filling the application form

Plan. "the investor must mention 'Direct' in the space provided... for entering the ARN." Otherwise "the ARN/RIA number and other details have to be provided."

Unit holder information. "A mutual fund investment can have UP TO THREE HOLDERS... The folio is created in the name of the FIRST HOLDER who is the PRIMARY INVESTOR. ALL BENEFITS of the investments such as dividends, redemption payments and TAX BENEFITS WILL GO TO THE FIRST HOLDER." For "FPI/NRI/PIO investors, an overseas address must also be provided."

Minor as a unit holder. "The guardian is typically a natural parent or court appointed legal guardian... documents to establish the natural relationship/legal guardianship (notarized photocopy of the court order) has to be provided... The date of birth of the minor has to be provided... and the proof of age... An investment for a minor CANNOT have joint holders. On attaining maturity, the information of the erstwhile minor investor has to replace that of the guardian... The guardian can no longer operate the folio and the account will be FROZEN for operations till the change of status is updated."

POA as a unit holder. "requires the PoA holder AND issuer to comply with the KYC and PAN requirements and a certified copy of the PoA to be submitted... The GRANTOR or investor CAN CONTINUE TO OPERATE the account despite granting a PoA. The PoA holder can conduct ALL transactions EXCEPT MAKE OR CHANGE NOMINATIONS."

Status and mode of holding. "single/joint/either or survivor... If no selection is made, then the default option is applied... Once a mutual fund folio is created as a jointly held account THERE CAN BE NO CHANGE IN THE JOINT HOLDERS. A joint holder CANNOT be deleted or a new one added, EXCEPT IN THE EVENT OF DEATH can a name be deleted."

"Once the first holder's PAN is validated for KYC, the address provided in the KYC form will OVERRIDE the information provided in the application form."

KYC details. "additional KYC details are mandatorily collected... relating to occupation, gross annual income or net worth and politically exposed persons status for both individual and non-individual applicants."

FATCA and CRS. For those whose "country of birth/citizenship/nationality/tax residency is other than India": place/city of birth, country of birth, country of citizenship/nationality; whether tax residency etc. is other than India; and if yes, all countries of tax residence with the associated Tax ID number.

Bank account details. "It is MANDATORY for investors to provide the bank details of the sole/first holder... the name of the bank... branch and the city, the account number, TYPE of account (current, savings, NRO, NRE, FCNR and others), MICR code and IFSC details." For demat holders the details "should MATCH the details of the bank account that is LINKED TO THE DEMAT ACCOUNT."

If the pay-out account differs from the paying account, supporting proof is needed — "an original cancelled cheque of the pay-out account where the account number and name of the first holder... are PRINTED on the face", or "a self-attested copy of the bank pass book or bank statement showing the first holder's name and account, with entries NOT OLDER THAN 3 MONTHS", or "a letter on the bank letter head."

Investment details. "While the scheme selection is MANDATORY... if the other selections are not made then the DEFAULT option will apply."

Payment details. "The application number or folio number should be mentioned on the REVERSE of the payment instrument. The bank through which the payment is made need NOT be the same as the bank account details provided... to receive dividend and redemption proceeds."

Unit holding option. "physical mode or demat mode"; the KYC "performed by the depository participant will be considered as KYC verification done by the mutual fund"; "A copy of the Client Master Form/demat statement showing active demat account details should be provided."

Nomination. "can be made at the time of application or subsequently at any time. A folio held by a single holder SHOULD have a nomination made in the application... investors subscribing to mutual fund units on or after SEPTEMBER 30, 2023 will have the choice of either provide nomination OR OPT OUT of nomination by providing a SIGNED DECLARATION... the provisions related to compulsorily appoint a nominee or to give a declaration would be OPTIONAL for the mutual fund folios having JOINT HOLDING pattern."

Minimum investment. "The SID and KIM provide information on the minimum application amount. Typically, the limit may be HIGHER for the INITIAL investment... and LOWER for SUBSEQUENT purchases... The application has to be signed by ALL THE HOLDERS IRRESPECTIVE OF THE MODE OF HOLDING."