4.2 Mutual Funds: Structure & Basics

What Is a Mutual Fund?

Quick Answer: A mutual fund (MF) is a pooled investment vehicle that collects money from many investors and invests it in a professionally managed, diversified portfolio of securities. Each investor owns units representing a proportional share of the fund, and the per-unit value is called the Net Asset Value (NAV). Mutual funds in India are regulated by SEBI under the SEBI (Mutual Funds) Regulations, 2026, notified on January 14, 2026 and in force from April 1, 2026, which replaced the SEBI (Mutual Funds) Regulations, 1996.

Pooling delivers three core benefits:

1. Professional management — a full-time fund manager backed by a research team.
2. Diversification — even a small sum is spread across many securities, reducing single-security risk.
3. Liquidity and convenience — open-ended units can be bought and sold at the next NAV.

The Four-Part Structure of an Indian Mutual Fund

An Indian mutual fund is not a single company — it is a trust structure with four distinct roles. SEBI requires these roles to be functionally segregated to protect unitholders.

The separation matters: the AMC decides the trades, but the custodian — not the AMC — holds the assets. The trustee watches both on behalf of unitholders.

NAV Calculation

Quick Answer: NAV = (Total assets − Total liabilities) ÷ Number of units outstanding. For open-ended schemes, SEBI requires NAV to be calculated and published once every business day, based on the closing prices of the underlying securities.

If a fund holds ₹1,000 crore of securities and ₹10 crore of cash, owes ₹5 crore in expenses payable, and has issued 100 crore units:

NAV = (1,010 − 5) ÷ 100 = ₹10.05 per unit.

NAV rises when securities appreciate or income is earned, and falls when expenses are charged or securities depreciate. For open-ended funds, purchases and redemptions happen at the next computed NAV (forward-priced), not at the previous day's NAV.

Open-Ended, Close-Ended, and Interval Funds

Most retail money in India sits in open-ended schemes, because they offer daily liquidity at transparent NAV.

Types of Schemes by Asset Class

• Equity-oriented — invest predominantly (≥65%) in equities; higher risk, taxed as equity.
• Debt-oriented — invest in bonds, G-Secs, corporate paper; lower risk, regular income.
• Hybrid — mix of equity and debt (e.g., balanced, aggressive hybrid, multi-asset).
• Liquid / Overnight — very short maturity (overnight to 91 days); used for parking cash; low volatility.
• Solution-oriented — retirement, children's funds with lock-in.
• Other — index funds, ETFs, fund-of-funds.

The Expense Ratio: TER, BER, and SEBI Caps

The expense ratio is the annual cost of running a scheme, expressed as a percentage of average AUM. It covers the AMC's management fee, distributor commission (in regular plans), and operating expenses.

In the overhaul approved by the SEBI board on December 17, 2025 and notified as the SEBI (Mutual Funds) Regulations, 2026 (in force April 1, 2026), SEBI made the Base Expense Ratio (BER) — the AMC's own fee — the capped metric, replacing the older Total Expense Ratio (TER) cap. The new arithmetic is:

TER = BER + brokerage + regulatory levies + statutory levies

Statutory levies (STT, GST, stamp duty) and regulatory levies are now charged on actuals, over and above the BER, and disclosed separately, and brokerage is separately capped at 6 basis points for cash-market trades and 2 basis points for derivatives. Confirmed BER caps include:

Larger funds therefore carry a lower per-unit cost, but the scheme that suits the investor's goal matters more than a few basis points. Because statutory levies now sit outside the BER, a scheme's headline BER is no longer the whole cost — always read the disclosed total.

Direct vs Regular Plans and Growth vs IDCW

Every open-ended scheme offers two plans and two options:

• Direct plan — bought directly from the AMC; no distributor commission, so a lower expense ratio. Suitable for investors who choose funds themselves.
• Regular plan — bought through a distributor; includes the distributor's trail commission, so a higher expense ratio. The distributor provides advice and service in return.
• Growth option — profits are reinvested; NAV rises over time. Suitable for long-term compounding.
• IDCW (Income Distribution cum Capital Withdrawal) option — previously called "dividend"; payouts are distributed to unitholders. IDCW is not guaranteed income — it is a withdrawal of the investor's own capital, and the NAV falls by the payout amount.

The Role of AMFI and the ARN Distributor

The Association of Mutual Funds in India (AMFI) is the industry's self-regulatory body recognised by SEBI. Its key functions are:

• Issuing the ARN (AMFI Registration Number) — mandatory for any person or entity distributing mutual fund products. To obtain an ARN, an individual must pass the NISM Series V-A examination and be at least 18.
• Assigning the EUIN (Employee Unique Identification Number) to individual salespeople; the ARN and EUIN must be quoted on every transaction form for the distributor to receive commission.
• Enforcing the Code of Conduct for distributors (suitability, disclosure of commission, no mis-selling).
• Maintaining a public investor education programme and a distributor locator.

A distributor empanelled with an AMC earns a trail commission (a small annual percentage of the AUM, paid for as long as the investor stays invested) on the Regular plan. The Direct plan pays no commission. This is the structural reason the Regular plan's expense ratio is higher.