Mutual funds pool money from investors and use it to take exposure in different asset classes like Stocks, Bonds, Commodity (Gold) and Real Estate.
Mutual funds generate good returns in the long term but they cannot generate guaranteed returns.
Mutual funds can be called one stop shop for all your investing needs.
1. Investment Amount is very less. In some schemes you can start investment with Just Rs.100
2. Through mutual funds we can take exposure in almost all asset classes.
3. Even one mutual fund scheme provides you enough diversification as these schemes invest in about 40/50 stocks.
4. Mutual funds provide excellent liquidity. Liquidity refers to the ability to sell the funds without being charged i.e. any time you can sell it (Please be mindful of exit load and taxes applicable) and money will directly come to your account within a few days depending upon the type of mutual fund you have sold.
5. Mutual fund has a solution for almost all investor in terms of Investment Horizon (short term, medium term and long term) and Risk Profile (Conservative,Moderate,Aggressive)
6. They provide professional management at low cost. Most fund managers are highly qualified and with huge experience in financial markets.
Mutual Funds can be closed and open ended :
Closed ended funds - You can invest in these funds only during NFO (New fund offer) period. Once NFO is closed your money will be locked for a certain time period.
If you buy closed ended mutual funds in demat mode then you can buy and sell units during market hours on stock exchanges. But liquidity will always be a problem hence you might not get a good price.
Open ended funds - In these funds even after the NFO period, you can buy and sell units. Most of the mutual funds are open ended funds.
Passive Funds (Index Funds) - These funds are passively managed. They simply replicate the benchmark i.e. They will invest in all stocks of benchmark and in the same proportion. These funds are not actively managed that's why their expense ratio is less as compared to actively managed funds. Please note that Index funds will always generate less return than its benchmark because of expense ratio and tracking error.
Active Funds - These funds are actively managed by fund managers. Active funds also follow a benchmark but here the fund manager will not invest in all the stocks of benchmark like index funds. Here they will select only those stocks which they think will perform better in future. Actively managed funds charge higher expense ratios hence they are expected to beat their benchmark consistently over a long period of time. Ifa actively managed fund is not able to beat its benchmark consistently over a long period of time then we can call it an underperforming fund.
Equity Funds - They primarily invest in equities and equity related instruments. Equity could provide good growth in the long term but could be volatile in the short term. Suitable only for investors with higher risk appetite and longer investment horizon.
Debt Funds - They primarily invest in Government securities, Bonds and other debt instruments. Debt funds have potential for income generation and capital preservation.
Hybrid Funds - They invest in two or more asset classes for reduction of risk and diversification. They seek to find a balance between growth and income by investing in equity, debt and other asset classes.
Now let's' know about these different types of mutual funds in detail :
Equity Funds can be divided in following categories basis their market cap allocation (Large/Mid/Small Cap Stocks) and investment style (Growth/Value/Hybrid) :
Large Cap Fund - At least 80% investment in large cap stocks. Market cap wise top 100 stocks are called large cap stocks.
Mid Cap Fund - At least 65% investment in mid cap stocks. Stocks that are ranked from 101 onwards till 250 based on their market capitalization, are called mid cap Stocks.
Small Cap Fund - At least 65% investment in small cap stocks. Market cap wise all stocks which are below 250 are called small cap stocks.
Large & Mid Cap Fund - At least 35% investment in large cap stocks and 35% in mid cap stocks
Multi Cap Fund - At least 75% of the investment corpus to equity and equity-related instruments. The minimum investment in each category (Large/Mid/Small Cap Stocks) should be at least 25% of the total corpus.
Flexi Cap Fund - At least 65% investment in equity & equity related instruments. These funds can invest in large, mid and small cap stocks in any proportion.
ELSS - At least 80% in stocks in accordance with Equity Linked Saving Scheme, 2005, notified by the Ministry of Finance. ELSS funds have a lock-in period of 3 years. Currently eligible for deduction under Sec 80C of the Income Tax Act up to Rs.1,50,000
Sectoral / Thematic Fund - At least 80% investment in stocks of a particular sector/ theme. They invest in stocks of particular sectors like Financial, Pharma, FMCG, Technology and Themes like PSU, MNC, Consumption. Since these funds focus on just one sector of the economy, they limit diversification, and are thus riskier. Timing of investment into such funds is important, because the performance of the sectors tends to be cyclical.
Focused Fund - Focused on the number of stocks (maximum 30) with at least 65% in equity & equity related instruments. These funds can invest in large,mid and small cap stocks in any proportion.
Contra Fund - Scheme follows contrarian investment strategy with at least 65% in stocks. The portfolios of contra funds have defensive and beaten down stocks that have given negative returns during bear markets.
Value Fund - Value investment strategy, with at least 65% in stocks. Value funds identify stocks that are currently undervalued but are expected to perform well over time as the value is unlocked
Dividend Yield Fund - Predominantly invest in dividend yielding stocks, with at least 65% in stocks.
Debt Funds can be divided in following categories basis their maturity profile/duration, credit rating, issuer profile and investment strategy :
Overnight Fund - Invests in securities having maturity of 1 day.
Liquid Fund - Invests in debt and money market securities with maturity of up to 91 days.
Ultra Short Duration Fund - Invests in debt and money market securities with Macaulay duration of the portfolio between 3 to 6 months.
Low Duration Fund - Invests in debt and money market securities with Macaulay duration of the portfolio between 6 to 12 months.
Money Market Fund - Invests in money market securities with maturity of up to 1 year.
Short Duration Fund - Invests in debt and money market securities with Macaulay duration of the portfolio between 1 to 3 years.
Medium Duration Fund - Invests in debt and money market securities with Macaulay duration of the portfolio between 3 to 4 years.
Medium to Long Duration Fund - Invests in debt and money market securities with Macaulay duration of the portfolio between 4 to 7 years.
Long Duration Fund - Invests in Debt & Money Market Instruments with Macaulay duration of the portfolio greater than 7 years.
Floater Fund - Invests minimum 65% in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/ derivatives). These funds invest in bonds whose interest are reset periodically so that the fund earns coupon income that is in line with current rates in the market, and eliminates interest rate risk to a large extent
Banking and PSU Fund - Invests minimum 80% in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions and Municipal Bonds
Corporate Bond Fund - Invests minimum 80% in corporate bonds only in AA+ and above rated corporate bonds
Credit Risk Fund - Invests minimum 65% in corporate bonds only in AA and below rated corporate bonds
Dynamic Bond - They change the duration (Maturity profile) of their portfolio in line with expectation on interest rates. Duration will be decreased if interest rates are expected to go up and vice versa.
Gilt Fund - Invests minimum 80% in Government securities (G-Sec), across maturity.
Gilt Fund with 10 year constant Duration - Invests minimum 80% in G-sec, such that the Macaulay duration of the portfolio is equal to 10 years
Fixed Maturity Plans (FMPs) - Closed ended funds which invest in securities whose maturity matches with the maturity of the fund. Low mark to market loss as investments is liquidated at maturity.
For liquidity FMPs can be sold on exchanges only if units are bought in demat mode.
Hybrid Funds can be divided in following categories basis their allocation towards different asset classes :
Conservative Hybrid Fund - Invests 10% to 25% in equity & equity related instruments and 75% to 90% in Debt instruments.
Balanced Hybrid Fund - Invests 40% to 60% in equity & equity related instruments and 40% to 60% in Debt instruments.
Aggressive Hybrid Fund - Invests 65% to 80% in equity & equity related instruments and 20% to 35% in Debt instruments.
Dynamic Asset Allocation or Balanced Advantage Fund - They allocate their assets across equity and debt in line with expectation on movement of stock markets and interest rates. They can invest 0% to 100% in equity & equity related instruments and 0% to 100% in Debt instruments.
Multi Asset Allocation Fund - Invests in at least 3 asset classes with a minimum allocation of at least 10% in each asset class. Asset classes like Equity,Debt,Gold (Commodities).This diversity allows portfolio managers to potentially balance risk with reward and deliver steady, long-term returns for investors, particularly in volatile markets.
Equity Savings - Invests minimum 65% in equity & equity related instruments, minimum 10% in Debt instruments and also invests in derivatives (minimum allocation for hedging as to be specified in the SID)
Arbitrage Fund - Arbitrage is the simultaneous purchase and sale of an asset to take advantage of the price differential in the two markets and profit from price difference of the asset on different markets or in different forms. Arbitrage fund buys a stock in the cash market and simultaneously sells it in the Futures market at a higher price to generate returns from the difference in the price of the security in the two markets. They follow an arbitrage strategy with minimum investment of 65% in equity & equity related instruments. Arbitrage funds are considered to be a good choice for cautious investors who want to benefit from a volatile market without taking too much risk.
Now let's look at few more investment options in Mutual Funds
Index Funds - They invest minimum 95% in securities of a particular index. These funds are passively managed. They simply replicate the benchmark. The securities included in the portfolio and their weightage is same as that in the index (benchmark). These funds are not actively managed that's why their expense ratio is less as compared to actively managed funds.
Exchange Traded Funds (ETFs) - ETFs are passively managed like index funds. But unlike regular mutual funds, ETFs are listed on stock exchanges and it trades like a stock on stock exchange.
ETF units can only be bought in demat mode.
Fund of Funds (FOF) - These mutual funds invest in the units of other schemes of the same mutual fund or other mutual funds. Invest Minimum 95% in the underlying fund(s).
International Funds - These mutual funds enable investors to take exposure in international securities like Foreign Equity, Debt, ETFs, Units of mutual funds.
They provide good diversification since global markets have low correlation with Indian markets.
Through these funds you can take exposure in companies which are global leaders in their respective field and are not available for investment in India. These funds can be risky as investors might not be well versed with political and macro-economic factors of other countries. For the purpose of taxation, these funds are considered as non-equity oriented mutual fund schemes.
