Different Types of Mutual Funds in India

In recent years, many people have become interested in mutual funds. They are an investment vehicle where money is pooled from different investors to invest it in various other financial assets like stocks, bonds, etc. There are different types of mutual funds. The main advantage of mutual funds is that they are managed by professionals known as fund managers. They charge you a fee to manage the fund, called an expense ratio. The best thing about mutual funds is that they give all types of investors access to investment opportunities.

The Securities and Exchange Board of India (SEBI) oversees the mutual fund business in India. Mutual funds can be categorized in several different ways, though.

For instance, mutual funds can be categorized according to structure, asset class, etc.

Different Types of Mutual Funds Based on Various Parameters:

A. Based on Asset Class

According to asset classes, mutual funds are categorized as follows:

1. Equity Funds

As the name suggests, equity mutual fund schemes majorly invest in equities/stocks. It indicates that these funds are high-risk and have the potential to produce excellent returns in the long run. Equity funds can be further classified into different categories:

Large Cap:

These funds invest at least 80% of their equity holdings in large-cap stocks. i.e., they invest in companies that are between 1 to 100 as per market capitalization.

Mid Cap:

They invest at least 65% of total assets in mid-cap companies, i.e., those ranked between 101 to 250 as per market capitalization.

Small Cap:

They invest at least 65% of total assets in small-cap companies, i.e., these companies ranked above 250 in terms of market capitalization.

Multi Cap:

These schemes invest in stocks across all market cap: large-cap, mid-cap, and small-cap. So, the proportion between these market caps is decided by the fund manager according to the market and economic conditions.

Large and Mid-Cap funds:

These schemes usually invest 35% in large-cap and 35% in mid-cap companies of the total asset value to generate better returns and experience less volatility.

Difference Between Large, Mid, and Small-Cap Funds

Aspect	Large Cap Funds	Mid Cap Funds	Small Cap Funds
Market Capitalization	Invest primarily in large, well-established companies with a large market capitalization.	Invest in medium-sized companies with a moderate market capitalization.	Invest in small, emerging companies with a relatively small market capitalization.
Risk Level	Generally lower risk due to the stability and size of the companies in the portfolio.	Moderate risk, with potential for higher returns than large-cap funds but also higher volatility.	Generally higher risk due to the smaller size and higher growth potential of the companies in the portfolio.
Return Potential	Typically offer moderate returns with lower volatility compared to mid and small-cap funds.	Offer potential for higher returns compared to large-cap funds, but with higher volatility.	Offer the potential for the highest returns among the three categories but come with the highest volatility and risk.
Investment Horizon	Suited for investors with a longer investment horizon seeking stable returns and capital appreciation.	Suited for investors with a moderate risk tolerance and a medium to long-term investment horizon.	Suited for investors with a high risk tolerance and a long-term investment horizon, seeking aggressive growth.
Liquidity	Generally more liquid than mid and small-cap funds, with higher trading volumes and narrower bid-ask spreads.	Moderately liquid, with somewhat lower trading volumes and wider bid-ask spreads compared to large-cap funds.	Less liquid compared to large and mid-cap funds, with lower trading volumes and wider bid-ask spreads.
Market Volatility	Less affected by market volatility compared to mid and small-cap funds, providing more stability during market downturns.	More affected by market volatility compared to large-cap funds, with the potential for larger price swings.	Highly affected by market volatility, with the potential for significant price fluctuations during market downturns.

2. Debt Funds

Debt funds are an excellent investment option for investors who need consistent income. These funds concentrate on debt securities to produce recurring returns on investments until maturity. They invest mainly in fixed-income securities like bonds, treasury bills, etc. These schemes are best for risk-averse passive investors searching for consistent income (interest and capital growth).

Debt funds are further classified as:

Overnight Fund: They invest in securities that have a maturity of 1 day.

Ultra-Short Duration Fund: They invest in debt instruments with a Macaulay Duration of three to six months. They also typically offer greater returns than FDs.

Low Duration Fund: They invest in debt instruments with a Macaulay Duration of six to twelve months.

Short Duration Fund: They invest in debt and money market instruments with a Macaulay Duration of 1 year to 3 years.

Medium Duration Fund: They invest in debt and money market instruments with a Macaulay Duration between 3 to 4 years.

Medium to Long Duration Fund: They invest in debt and money market instruments with a Macaulay Duration between 4 to 7 years.

Long Duration Fund: These funds invest in debt and money market instruments with a Macaulay Duration of more than 7 years.

Others: Various other categories come under debt funds like money market funds, dynamic bond funds, corporate bond funds, gilt funds, etc.

Difference Between Debt Funds and Equity Funds

Aspect	Equity Funds	Debt Funds
Investment Focus	Invest primarily in stocks or equities.	Invest primarily in fixed-income securities such as bonds, treasury bills, and corporate bonds.
Risk Level	Generally higher risk due to market fluctuations and volatility.	Lower risk compared to equity funds.
Return Potential	Potentially higher returns over the long term.	Moderate returns compared to equity funds, but with lower volatility and consistent income generation.
Investor Profile	Suited for investors with a higher risk tolerance and a long-term goal.	Suited for investors seeking stable returns, capital preservation, or income generation, and those with lower risk tolerance.
Tax Treatment	Taxed as per equity investments, subject to capital gains tax rules.	Taxed as per debt investments, with tax treatment varying based on the holding period and nature of income (interest or capital gains).

3. Hybrid Fund

As the name suggests, they invest in two or more asset classes like stocks, bonds, etc. The main goal of these funds is to lower risk by utilizing an effective diversification strategy. Various categories under hybrid funds are:

Aggressive Hybrid Fund: They invest 65% to 80% of their assets in equity and equity-related instruments and the rest in debt and money market instruments. As they have high equity exposure, these funds have the potential to generate higher returns.

Conservative Hybrid Fund: They invest primarily in debt instruments. These funds place between 75% and 90% of their assets in income-producing fixed-income securities such as corporate bonds, T-bills, etc. And the remaining money is invested in equity-related investments.

Dynamic Asset Allocation Fund: As the name suggests, these funds are highly dynamic and invest in equity and debt, depending on the market conditions.

Multi-Asset Allocation Fund: These funds invest in a minimum of three asset classes, with a minimum of 10% in each asset class, and it can change this percentage based on the market condition. These are preferred for their steady and regular profits.

Arbitrage Fund: Arbitrage funds make money by taking advantage of price differences between two markets, the cash and futures markets. These funds buy stocks in the open market and then sell them in the futures market. These schemes invest 0 to 35% of their capital in debt asset classes and 65 to 100% in equity assets.

Equity Savings Fund: By investing in equities, derivatives, and debt, these funds seek to strike a balance between risk and return. This fund can contribute to long-term wealth creation by investing in arbitrage possibilities with significant equity exposure.

B. Based on Structure

Mutual funds are categorized as follows, based on their structure:

1. Open-Ended Funds:These funds have units available for purchase or redemption throughout the entire year. They trade by the current NAV. There are no limits on the amount to be invested and no set maturity date.

2. Closed-Ended Funds: These funds, known as the New Fund Offer (NFO), can only be purchased during its first launch period. Once the offer is closed, you cannot buy any new units, but they can be redeemed once they reach maturity.

3. Interval Funds: So, these schemes are a combination of open-ended and closed-ended funds. These funds are closed the rest of the time and only available for purchase or redemption during predetermined intervals (determined by the fund house).

C. Based on Investment Goals

Mutual funds are categorized as follows, based on the investment goals:

1. Growth Funds:

These funds invest a considerable portion in growth sectors with the primary purpose of capital appreciation. The investor’s wealth is increased by reinvesting earnings/profits from prior investments. This suits investors who have idle money and can take high risks.

2. Income Funds:

They invest in fixed-income instruments like bonds and debentures, aiming to deliver consistent income to investors through dividends or coupons.

3. Liquid Funds:

Invests in money market instruments with a maximum maturity of 91 days. Short-term investments can be made with liquid funds, which often provide better returns than savings accounts.

4. Tax-Saving Funds:

They are popularly known as Equity Linked Saving Schemes (ELSS). These are equity-oriented funds that assist in creating a tax-efficient portfolio. They have a lock-in of 3 years and are eligible for a tax deduction of up to 1.5 lakhs under Section 80 C of the IT Act.

5. Capital Protection Funds:

These are funds that invest a portion of their assets in both the equities and fixed-income markets. The goal of doing this is to protect the invested capital.

6. Fixed Maturity Funds:

These funds invest capital in debt market securities that mature at the same time as the fund itself or at a time that is reasonably close to it. A three-year FMF, for example, will invest in assets with a three-year maturity or less.

7. Pension Funds:

These funds aim to provide regular income after a long period of investment. They are usually hybrid funds with equities acting as the riskier portion of the investment and offering more significant returns. Debt markets balance the risk by providing lower but stable returns. The returns on these investments can be received as a pension, lump payments, or a combination.

D. Based on Management Style

According to management style, mutual funds are categorized as follows:

1. Active fund management:

Fund managers actively rebalance the portfolio to produce returns higher than the benchmark, such as the Nifty, Sensex, etc. They are skilled at timing market fluctuations and are more involved in decision-making, buying, and selling the underlying based on various factors.

2. Passive fund management:

The results of this style resemble benchmark indices, and it uses a buy-and-hold strategy. Fund managers are not involved much in decision-making and are mimicking the specific index. They replicate a particular index and provide returns limited to the tracking index. Exchange-traded funds and index funds follow passive investing.

E. Based on Risk

Mutual funds are categorized as follows, based on their risk:

1. Low-risk funds:

This is suitable for conservative investors who cannot take any risk with their invested money. In such cases, investment is mainly made in debt securities because they are safe and provide stable returns. The investment is made in securities like gilt funds, liquid funds, ultra-short duration funds, etc. The expected average return could range from 6-8%.

2. Medium-risk funds:

These investments present a medium level of risk since the fund manager invests in both equity and debt. The typical returns range from 9 to 12%. These funds may be invested to generate wealth over a longer period.

3. High-risk funds:

These funds are suitable for an aggressive investor willing to take high risks and looking to create a long-term portfolio to build wealth. You can expect 15%, or sometimes even 20%, returns in such funds.

Modes of Investment in Mutual Funds:

Mutual funds are the most versatile investment vehicle since investments can be made via lump sum or Systematic Investment Plan (SIP) methods.

1. Lump Sum:

It is another method where you invest the entire amount in just one go, say Rs. 50,000. This method of investing is advantageous when a fund’s net asset value, or NAV, is low. In this case, a lower NAV enables individuals to purchase more units. A higher NAV, on the other hand, decreases the number of units available to an investor. You must have deep experience and knowledge of the market to benefit from a lump sum investment.

2. Systematic Investment Plan (SIP):

It is the most convenient option to invest in mutual funds. The SIP investment method allows you to invest a set amount regularly. Installments can be made weekly, monthly, or even quarterly, depending upon the investor’s choice. SIPs are open-ended, meaning they can be started or terminated at any time. By investing through a SIP, the investor invests on time without worrying about market dynamics. The fixed sum of money you can invest can be as little as Rs. 500. You can skip or pause the SIP whenever you face any shortage of funds.

Difference between SIP and Lump sum

Parameters	SIP	Lump sum
Flexibility	SIPs are more flexible as compared to lumpsum because the investor has the choice to invest as per their financial situation.	Lumpsum investments lack flexibility.
Cash Flows	You need regular cash flows to invest regularly.	Cash flow is required for one time.
Monitoring of market	Investors should keep a close eye on market performance because they may be exposed to different market cycles while participating in SIPs.	Investors do not need to regularly monitor the market because lump sum investments are typically made for the long term.
Financial Discipline	This investment option can help investors develop financial discipline by getting them into the habit of investing systematically.	It does not instill such discipline because the investment is made all at once.
Risk appetite	SIP risk ranges from low to medium.	Lumpsum risk ranges from medium to high as the investment amount is large.
Dependency on market volatility	SIPs are not solely dependent on market volatility.	The Lumpsum strategy is highly market-responsive.
Investment Horizon	SIPs are better for the short term.	Better for the long term.
Investment amount	It requires a lower investment amount.	It requires a large amount of investment as the payment is made in bulk.
Other Advantages	Power of compounding, rupee cost averaging, automated payments, and convenience.	Capital appreciation in the long run, lowers maintenance and transaction costs.

When to choose the SIP method?

A person with a steady income can choose to invest in SIP. This alleviates the burden of investing a large sum of money simultaneously. The main advantage of investing in SIP is rupee-cost averaging. A SIP allows you to spread your money over time in rising and falling markets. It will enable you to lower the average cost of your investment while also lowering the risk. During tough market times, the lower investment amount does not make you panic. SIPs are ideal for new investors and young professionals, and investors do not have to monitor the market regularly because they are periodic investments.

SIP is highly recommended for investors who want to invest in an equity fund and in addition, SIP investing works well in a downfall market.

SIP Vs Lump Sum: Which is Better?

As we have learned about both the sip and lump sum methods of investing in mutual funds, the decision between the two becomes critical. Before making any investment decision, consider the following factors:

Risk appetite: The primary distinction between lump sum investments and SIPs is the degree of risk involved. SIPs provide excellent capital protection because you only invest a small portion of your corpus.For example, if you want to invest Rs. 5,00,000 into mutual funds, you have an option:
- You can invest Rs. 41,667 monthly through the SIP route. This will not put a strain on the investor’s finances.
- Or, through the lumpsum method, you can invest Rs 5,00,000 in one go.

Returns: The return on both investments depends on the market conditions. SIPs typically outperform in volatile markets, whereas lump sum investments in ELSS generate higher returns when the market is stable or steady.
Lock-in Period: ELSS mutual funds have a lock-in period of 3 years. Lumpsum deposits will mature in 3 years, while SIP bonds will mature one by one after the 3-year threshold is reached (depending on how many months you invested).

Bottom Line

Long-term wealth creation can be achieved through systematic investment plans (SIPs) and lumpsum investments. The method of investing in mutual funds, whether through SIPs or lump sums, is entirely up to the investor’s risk tolerance. Investing in a lump sum can yield better results than investing in SIPs for those who understand the market’s pulse. Those without a lump sum amount or a lot of market knowledge should consider SIPs, which will also instill discipline. Some of the most important factors to consider before choosing any method are- monthly earnings, investment objectives, financial stability, and risk appetite.

Frequently Asked Questions

Q1. How do Large Cap, Mid Cap, and Small Cap Funds Differ?

Ans- Large-cap funds invest in established, stable companies; mid-cap funds target mid-sized companies with growth potential, while small-cap funds focus on smaller, riskier firms with growth prospects.

Q2. How does the Risk-Return Profile vary in Equity Funds?

Ans- Equity funds typically offer higher potential returns but come with higher risk due to market volatility and fluctuations in stock prices.

Q3. How do Balanced and Aggressive Hybrid Funds Differ?

Ans- Balanced funds maintain a fixed asset allocation, while aggressive hybrid funds have a flexible allocation with higher equity exposure.

Q4. What Factors Should I Consider Before Choosing a Mutual Fund?

Ans- Consider investment goals, risk tolerance, fund performance, fees, and management style before choosing a mutual fund. Tailor choices to personal financial objectives.

Q5. What is the Expense Ratio in Mutual Funds?

Ans- The expense ratio in mutual funds is the annual fee fund managers charge to cover operating expenses, expressed as a percentage of total assets under management.

Q6. How Can I Redeem Mutual Fund Units?

Ans- To redeem mutual fund units, access your investment account, select the fund, specify units or amount, confirm the transaction, and receive proceeds in your bank account.

Q7. What are the Different Modes of Investing in Mutual Funds?

Ans- Mutual funds can be invested through lump-sum investments and systematic investment plans (SIPs).

Q8. How Does a Systematic Investment Plan (SIP) Work?

Ans- SIP is a mode of investing where an investor regularly invests a fixed amount at predefined monthly intervals.

Q9. What are the Advantages of SIP over Lump Sum Investments?

Ans- SIPs help in rupee-cost averaging, reduce market timing risk, and make it easier to start investing with smaller amounts.

Q10. Can I Change the SIP Amount or Frequency?

Ans- Yes, most mutual funds allow investors to modify SIP amounts or frequencies based on their financial goals.

Q11. Is There a Minimum Investment Requirement for SIPs?

Ans- Mutual funds usually have a minimum investment amount for SIPs, which can vary among funds.

by Instockbroker Team | May 27, 2024