Mutual Funds are considered to be one of the best investment instruments from a long-term wealth creation perspective. Because these are systematic plans managed by industry experts. Moreover, they provide a wide range of options for investors. Types of mutual funds differ from country to country. Therefore, I planned to list different types of mutual funds in India. This should be helpful for people who want to invest in Indian mutual funds.
Meaning of mutual funds:
What are mutual funds? They are the schemes introduced by Asset Management Companies (AMC). Money is collected from individuals. The collected pool of amount is then further diversified and invested in stocks, bonds, and other investment options. As a result of these investments, the pool of money generates returns. A portion of these returns are then shared with the contributors and the balance is retained by the AMC as a profit. These mutual funds are typically managed by trained fund managers. These fund managers get their share from the returns as a reward/commission for their efforts. This is the concept of mutual funds in a nutshell. In this blog post we will understand the types of mutual funds in India.
Open-ended funds: Before getting in-depth about the types, we need to understand the two broader types. The first one is open-ended mutual funds. Investors can invest as well as withdraw the money at will. There is generally no restrictions/lock-in periods for withdrawals.
Close-ended funds: The second broader type is close-ended funds. Generally, investors have to keep their money locked in for a certain period of time.
Here Are The Different Types Of Mutual Funds In India:
As the name suggests, equity-based mutual funds primarily invest in equity stocks. Now, these can be categorized further into Blue Chip stocks, Large-Cap, Mid-Cap, Small-Cap, etc. The ‘Cap’ refers to Market Capitalization. In order to calculate the market cap, one needs to multiply the no. shares (of a company) by the share price.
Generally, the risk exposure in equity-based mutual funds ranges from Moderate to High risk. Because these are highly affected by the market movements. The returns of these mutual funds are also high because of the risk exposure. The returns also depend on the types of stocks the funds are invested in.
One thing which is common about all mutual funds is the prospectus. This prospectus will have all the required information about the fund, charges, major investments, etc. Therefore, it is IMPORTANT to read and understand the prospectus clearly. This helps in reducing the chances of unexpected losses.
A sub-category of these equity-based mutual funds is Equity Linked Saving Schemes (ELSS). These ELSS schemes are used for tax-saving purposes. Under the old tax regime, an investor can invest in ELSS schemes and claim tax exemption under section 80C. The maximum limit is INR 150,000. There are other components in section 80C and the maximum limit is applied on the aggregate of all those components. But, in theory, if you don’t invest in other components and only invest in ELSS, you can claim exemption on the total invested amount for the financial year (limiting to INR 150,000).
Another reason why ELSS schemes are more attractive because typically they offer the SIP (Systematic Investment Plan) starting from INR 500 per month. Which is super affordable for investors in every tier of society. Therefore, if you are just starting with mutual fund investments, you can look for ELSS schemes that offer the lowest SIP and tax benefits.
Opposite to equity-based mutual funds, debt funds invest in securities that come with a fixed rate of returns. These securities include corporate bonds, government bonds, treasury bills, etc. These types of funds are suitable for investors who have a lower risk appetite. The risk exposure for debt funds usually ranges below the ‘moderate risk’. The returns on the other hand are low compared to the returns of equity-based funds. The prominent justification for lower returns is risk exposure. But unlike the equity-based funds, the debt funds deliver promised returns.
From a volatility perspective, because of the type of instruments the fund invests in, market movements do not affect them. But when you consider inflation to calculate your absolute returns, you will find that even if the notional return is 8% to 10%, after adjusting for inflation (approx. 6%), the absolute return will be only 2% to 4%, and even lower. So, in the long run, the investment’s benefits get nullified by inflation.
But if you prefer to invest in Fixed Deposits or Recurring Deposits then you also consider investing in Debt funds. Because even if the debt funds deliver fewer returns than equity funds, but in general returns are more than FD and RD.
As the name suggests, the mutual funds that invest primarily in the sector(s) are called sectoral funds. These sectors can be Information Technology (IT), Automobile, Consumer Durables, Manufacturing, etc. The reason why these types of funds exist is that some of the investors prefer investing in specific sectors to investing across the sectors. You can call it an investor’s block where they are either obsessed with the sector or find it convenient because they have the knowledge about the sector.
The drawback of the sectoral funds or investing in a particular sector is the nature of business as they are cyclical in nature. Every sector has its season when the production, sales, and profits are high. During the off-season, these companies may deliver fewer profits and as a result, it affects the portfolio as a whole. Therefore, even if investing in sectoral funds sound convenient, one should consider the ups and downs that may come along with each sector.
Thematic funds are equity-based mutual funds, but stocks’ choices to be invested in are based on a certain theme. The AMC can decide these themes by conducting surveys or taking general feedback from potential investors. These themes can be dividend-yield, growth funds (which target growing companies), low or high volatility funds, etc. Unlike the sectoral funds which primarily invest in one specific sector, thematic funds can be diversified across the sectors to capitalize on the opportunities.
Both sectoral funds and thematic funds have high-risk exposure as the funds are invested in equity stock markets. Therefore as an investor, you need to pay more attention to details. Read and understand the Scheme Information Document (SID) thoroughly before investing.
If you visit the stock exchange website like NSE, BSE, NYSE, LSE, etc. You will find a list of indices like NIFTY, SENSEX, BANK NIFTY, NASDAQ, S&P 500, FTSE 100, etc. These indices are made up of selected stocks. From mutual funds’ perspective, these indices serve the purpose of benchmarking. Some of the fund managers show their results in comparison to specific indices to showcase whether they have outperformed the index or not.
Some of the mutual funds (which are not actively managed) take the index into consideration and invest in only those stocks which are included in those indices. This serves two main purposes, first, it removes the active involvement of a fund manager resulting in fewer charges. The second purpose is results, the indices are made by experts after conducting background checks and other groundwork. The funds make almost the same returns as the index. Therefore, for those who want to invest or follow a steady approach without exposing their investment to unnecessary risks then you can choose to invest in index funds.
The last type of mutual fund in India is hybrid funds. These are the type of funds which are actively managed and the investments are diversified among equity and debt instruments. This diversification can be in any proportion like 50–50, 70–30, 80–20, etc. If the equity stocks are going south then the fund manager can move more money towards the debts sector to keep the steady returns coming in. Once the market corrects itself then investments can be made in the equity sector to gain more profits.
These types of hybrid funds are best for investors who want to enjoy the benefits of both sectors. Considering the amount of risk exposure you want in equity and debt, you can choose an appropriate hybrid fund.
These are the types of mutual funds in India. They are one of the best investment instruments as the investors do not need to worry about making the stock selection decision. The fund managers who are experts in their fields do it on behalf of the investors. On the other hand, it takes away the autonomy of investors. If you want to invest in a stock that is not listed in the portfolio of the mutual fund then most probably you cannot do anything about it. In order to do that you may need to look for other mutual funds or directly invest in the stock market by yourself.