Mutual funds are investment tools that allow investors to access various asset classes, such as equity, debt, gold, and real estate, enabling diversification with minimal investment.
Key types of equity funds include:
Equity Funds
Invest in a collection of equity shares, with risk and returns similar to direct equity investments.
Passive vs. Active Funds: Passive funds mirror an index, while active funds select stocks to outperform the index.
Diversified Equity Funds: Spread investments across sectors and company sizes to mitigate risk; may be closed-end schemes.
Market Capitalization:
Large-Cap Funds: Invest in stable, blue-chip companies (80% in large-cap firms).
Mid-Cap Funds: Target growth-oriented mid-cap companies (65% in mid-cap firms) but carry higher risk.
Large and Mid-Cap Funds: Allocate at least 35% each to large and mid-cap companies.
Small-cap funds: Focus on companies with smaller market capitalizations (ranked 251 and up), requiring at least 65% of total assets in these firms, with higher potential returns but increased risks.
Multi-cap funds: Invest in large, mid, and small-cap companies, needing at least 75% of assets in equity-related instruments, with a minimum of 25% in each capitalization category.
Flex cap funds: No minimum investment requirements across capitalizations, but must invest at least 65% of the corpus in equities.
Based on Sectors and Industries
Sector funds invest in specific industries, like technology or banking, and carry higher risks due to limited diversification. Their performance is cyclical; for example, the auto sector excels in strong economies but falters during downturns, while banking benefits from low interest rates. Timing is essential for sector fund investments; it's best to invest when favorable conditions are anticipated, as failure to meet expectations can lead to underperformance against market indices. Open-end sector funds must allocate at least 80% of assets to the targeted sector. Examples include the XYZ Banking Fund and ABC Magnum Sector Funds.
Based on Themes
Theme-based funds invest in sectors and stocks aligned with a specific theme, such as infrastructure, including companies in construction, cement, banking, and logistics. They offer more diversification than sector funds but still present concentration risks. An open-end thematic fund must allocate at least 80% of its assets to equity and equity-related instruments in the identified sector.
Based on Investment Style
The fund manager's strategy is crucial for categorizing funds based on investment styles, which affect risks and returns. According to SEBI, open-end equity funds include:
Value Funds: Target companies below their intrinsic value for long-term price gains, requiring 65% asset allocation to equities. They are lower risk but need longer investment horizons.
Contra Funds: Use a contrarian approach to invest in undervalued stocks, aiming for long-term recovery.
Dividend Yield Funds: Focus on high dividend yield stocks for income, investing 65% in equities, typically with stable earnings but limited growth.
Focused Funds: Maintain a concentrated portfolio, limited to 30 stocks, which can increase risk due to less diversification.
Equity Linked Savings Schemes (ELSS)
ELSS, or Equity Linked Savings Scheme, is an open-end equity fund that provides tax deductions under section 80C of the Income Tax Act, up to Rs. 1,50,000 annually. To qualify, it must invest at least 80% in equity securities, and investments are locked in for three years, prohibiting redemption, transfer, or pledge during this period.
Debt Funds
Debt funds invest in various debt instruments like government and corporate bonds, offering a set income stream. Fund managers evaluate credit risk versus interest rate risk based on macroeconomic conditions.
Classification of Debt Funds:
Short Term Debt Funds: Focus on liquidity and principal safety, investing in high-quality, short-maturity securities.
Overnight Funds: Secure one-day maturity.
Liquid Funds: Less than 91 days maturity.
Ultra Short Duration Funds: 3 to 6 months Macaulay duration.
Low Duration Funds: 6 to 12 months Macaulay duration.
Money Market Funds: Instruments maturing within one year.
Long Term Debt Funds: Aim for total returns from interest and capital appreciation, more volatile due to price fluctuations.
Long Duration Funds: Over 7 years Macaulay duration.
Corporate Bond Funds: 80% in AA+ rated corporate debt.
Credit Risk Funds: 65% in AA and below rated corporate debt.
Banking and PSU Funds: 80% in bank and public sector debt.
Open-end Gilt Funds: 80% in government securities, sensitive to interest rate changes.
Gilt Funds invest at least 80% of assets in government securities, maintaining a 10-year Macaulay duration.
Dynamic Bond Funds manage interest rate and credit risk flexibly, without restrictions on security types or maturities, adjusting positions based on yield opportunities.
Fixed Maturity Plans (FMPs) are closed-end funds investing in debt securities that match the scheme's term, redeeming these securities at maturity to return proceeds to investors. They typically have maturities of 3 months to 5 years.
Hybrid Funds
Hybrid funds combine debt and equity securities, with their asset allocation determined by investment objectives. Risk and return vary based on the equity-debt mix. Key classifications include:
Conservative Hybrid Funds: Allocate 75%-90% to debt and 10%-25% to equity, focusing on regular income with low risk.
Balanced Hybrid Funds: Invest 40%-60% in both debt and equity.
Aggressive Hybrid Funds: Invest 65%-80% in equity and 20%-35% in debt, aiming for higher returns.
Additional types include:
Dynamic Asset Allocation Funds: Actively manage equity and debt investments.
Multi-Asset Allocation Funds: Invest in at least three asset classes, adjusting based on performance.
Arbitrage Funds: Exploit price differences between cash and derivatives markets.
Equity Savings Funds invest in equity, debt, and arbitrage opportunities, with a minimum of 65% of total assets allocated to equity and equity-related instruments, and at least 10% in debt investments.
Close-End Hybrid Funds
Capital Protection Funds are closed-end hybrid funds that invest partly in debt instruments to ensure capital preservation while also taking equity exposure through derivatives for potential higher returns.
Solution-Oriented Schemes defined by SEBI include:
Retirement Funds: Designed for retirement savings with a minimum five-year lock-in.
Children’s Funds: Focus on savings for children's needs, with a five-year lock-in until the child reaches adulthood.
Other Funds include:
Fund of Funds (FoF): Invests in other mutual funds, requiring at least 95% of assets in these funds. FoFs analyze fund performance but come with additional costs for investors, and equity FoFs lack tax benefits.
Exchange-Traded Funds (ETFs): Track specific indices, require 95% of assets in the tracked index, and trade like stocks. Their prices fluctuate in real-time, unlike NAV.
Gold/Silver ETFs: Invest in physical gold or silver, with costs leading to potential lower returns than market rates.
Real Estate Mutual Funds: Invest in physical properties or related securities, needing at least 35% in physical assets, structured as closed-end funds.
Infrastructure Debt Schemes: Closed-end schemes focusing on debt from infrastructure companies, requiring 90% of the portfolio in specified securities and a minimum investment of Rs. one crore.
Mutual fund strategies
Systematic Investment Plans (SIP): SIPs allow investors to invest a fixed amount regularly into a mutual fund, benefiting from varying prices over time. This method, known as rupee cost averaging, reduces the average cost per unit by buying more units when prices are low and fewer when prices are high.
Systematic Withdrawal Plan (SWP): SWPs enable investors to receive regular payouts from their mutual fund investments, facilitating recurring redemptions. This approach mitigates price risk by allowing withdrawals at different times, taking advantage of NAV fluctuations.
Systematic Transfer Plan (STP): STPs involve redeeming units from one mutual fund scheme and investing them into another scheme over time. This strategy helps manage risk by transferring funds gradually, especially when moving from a riskier equity fund to a safer option like a short-term debt fund.
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Direct and Regular Plan
A typical mutual fund offers a regular plan, which includes a distribution commission and operational expenses. In contrast, a direct plan allows investors to invest directly with the fund, eliminating distributor involvement, resulting in a lower expense ratio and reduced costs. Both plans have identical portfolios, but the direct plan yields higher net returns due to lower expenses. The regular plan is beneficial for investors needing assistance with investments, while knowledgeable investors may prefer the direct plan for its cost savings, despite lacking distributor support.
There are numerous categories, each containing a variety of different funds. Identifying 3-4 mutual funds that align with your investment goals can be quite challenging. While consulting a professional can be beneficial, arming yourself with the right knowledge will enable you to collaborate effectively with the right advisor.
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