Different Types of Mutual Funds
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. To manage the fund, they charge you a fee, called an expense ratio. The best thing about mutual funds is that they give all types of investors access to investment opportunities.
In India, the Securities and Exchange Board of India (SEBI) oversees the mutual fund business. Mutual funds can be categorized in several different ways, though.
For instance, mutual funds can be categorized according to their 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 amazing 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 which 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., the companies which are 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 are the companies which are 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 with the aim to generate better returns and experience less volatility.
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.
3. Hybrid Fund
As the name suggests, they invest in two or more asset classes like stocks, bonds, etc. These funds’ main goal is to lower risk by utilizing the effective strategy of diversification. 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 both 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 of those asset classes, 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, typically the cash market and the futures market. These funds buy stocks on the open market and then sell them on the futures market. These schemes invest 0 to 35% of their capital in debt asset classes and 65 to 100% of their capital 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 in accordance with the current NAV. There are no limits on the amount to be invested and it also doesn’t have a set maturity date.
2. Closed-Ended Funds:
These funds can only be purchased during its first launch period, known as the New Fund Offer (NFO). Once the offer is closed, you cannot purchase any new units and can be redeemed once it reaches 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 is suitable for investors who have idle money and can take high-risk.
2. Income Funds:
They invest in fixed-income instruments like bonds, and debentures with the main objective to deliver consistent income to investors in the form of 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 which 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 larger returns, and debt markets balancing the risk by offering lower but stable returns. The returns on these investments can be received as a pension, lump payments, or a combination of the two.
D. Based on Management Style
According to management style, mutual funds are categorized as follows:
1. Active fund management:
To produce returns that are higher than the benchmark, such as the Nifty, Sensex, etc. fund managers actively rebalance the portfolio. They are skilled at timing market fluctuations and have more involvement in the decision-making and do buying and selling of 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 don’t involve much in decision-making and mimic the specific index. They just replicate a specific 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 investors who are conservative in nature and cannot take any risk with their invested money. In such cases, investment is mostly made in debt securities because they are safe and provide stable returns. The investment is done 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 types of funds are suitable for an aggressive type of investor who is 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:
In this, the investor can buy as many units as they desire in one go. This approach is typically adopted to generate additional wealth and liquidity. You might choose to make a lump-sum investment if you have a sizeable quantity of cash on hand and a higher risk tolerance.
2. Systematic Investment Plan (SIP):
It has gained a lot of popularity in recent years due to the benefit of the small amount of investment and rupee-cost averaging. Systematic Investment Plan(SIPs) require the investor to make periodic investments of a certain amount of money. This particular sum is deducted from the investor’s bank account on the selected date.
Bottom Line
Different kinds of mutual funds are offered on the market and have assisted many people in achieving their objectives. Choosing the best mutual fund with so many accessible options can be challenging. In that regard, the best advice is to start by identifying your own needs and figuring out your goals. To invest confidently and profitably, choose a reputable fund firm and concentrate on elements such as your risk tolerance, investment horizon, and financial objectives.