Do you invest in different types of mutual funds?
Which types of mutual funds you have invested your money?
Ok, how many different types of mutual funds are there??
Sure you would be able to answer confidently the first question, may recall the name of few in the second question, and third would be toughest to answer. I have been investing in different types of mutual funds for almost 16 years and yet I need to consult books to keep reminding myself of the different types of funds in the market.
Meaning & Types of Mutual Fund
Mutual funds are one of the most comprehensive & easy ways to create a diversified portfolio to meet various goals of life. Owning to the digitization and the flow of knowledge there has been a massive increase in investment in mutual funds. As per AMFI (association of mutual funds of India) industry AUM (asset under management) stood at massive 26.07 trillion as on 30 June 20.
Just ten years back in 2010 the figure was just 8.09 trillion. The number of folios is also increasing at an increasing rate. As per AMFI for the past 71 months, the folio is rising and stood at 9.04 crores. Over 8 crores have an investment in equity, hybrid, or solution-oriented schemes.
There are different types of mutual funds to meet the need of every individual. It’s just you fail to do proper research and just focus on few facts like
- Am I getting tax benefit on this or
- What would be returned in 1or 2 years?
You have never moved beyond these two common questions. I also use to do the same. Like you and me, lakhs of investors are following the same old traditional approach of mutual fund selection i.e. Advisor would decide. That is good practice indeed, but you should be aware of the basic things.
In this article, I shall try to answer this question only. I will try to mention all types of mutual fund available and their specific use. I am sure to post this article you would be looking at your mutual fund statement.
Primarily mutual funds can be divided based on structure and asset class. On the basis of structure mutual funds would be divided under these three categories:
Open ended funds
In these types of funds, you can enter and exit without any difficulty and can purchase or redemption at any point in time, there is no restriction on these. The value of funds shall be decided by the NAV which gets published daily. If you are looking for liquidity and ease of control then these are the funds to select from.
In close-ended fund a limited number of units are issued. These units get traded on the stock market. Units of closed-ended funds can be purchased only during NFO (New fund offer) though the units can be traded at premium or discount, redemption is allowed only after maturity of the fund, which is generally 3 to 7 years. These funds provide stability, so if you are looking for stability these are best. These funds help fund managers to build a steady asset base and put the right investment strategy in action.
These funds are hybrid of open and close-ended funds. These funds can be purchased or sold only at specific intervals, remains closed for the rest of the time. If you looking for a lump sum amount of saving in a short period of time then these are best.
Now let’s have a look at the mutual funds classification bases on asset classes. Primarily there would be three asset classes i.e. Equity, Debt and money market.
These are the most popular fund schemes and majority of investments gets routed in this only. I am sure you must be having good part of your investment in equity. These scheme allows you to participate in stock market, though not directly. These funds are characterized by high return, high risk. These are suitable for those who have long term horizon. In case you are young or have long time horizon, you should definitely go for these funds.
Even in equity funds there are host of other funds available catering to different segments, Its might possible that you do not want to have 100% equity exposure , you wish to have just 50% or 60% etc. So these sub funds helps in catering that need of yours. When you invest in equity you generally invest in companies of varied size. To make this easier SEBI has defined meaning of Large Cap, Mid Cap and Small Cap based on market capitalization.
- Large Cap: Top 100 companies in terms of market capitalization
- Mid Cap: 101st- 250th companies in term of market capitalization
- Small Cap: 251st company onwards in terms of market capitalization
The Equity funds are subdivided under 10 sub categories, let’s discuss them and understand the benefit of all.
A minimum of 65% of the total assets in multi cap fund would be invested in equity & equity related instruments, the balance shall be in Debt and related. They are open ended funds.
Benefits of Multi cap fund
Multi-cap funds are the most diversified equity funds. Diversification in the fund reduces the risk of the fund to minimal while maintaining the growth potential. This fund has a combination of all large, mid, and small-cap funds and is tilted towards large-cap. Thus it provides stability as well as growth to the fund. You should use them to create long term wealth.
2.Large Cap Fund
Large-cap funds are open-ended mutual funds and have the majority of its investment in large-cap companies’ i.e top 100.
Benefits of Large Cap Fund
The investment of these funds is in stable companies having a proven track record and are top 100 companies by way of market capitalization.
The volatility of the fund is the lowest and has the highest potential for growth. You should invest in these funds for wealth creation over a long period of time.
3.Large & Mid Cap Fund
This fund gives the benefits of investing in both large-cap and mid-cap companies. A minimum of 35% has to be invested in Large cap companies and 35% has to be invested in Mid cap, balance can by split between two.
Benefits of Large & Midcap Fund
These funds offer stability and growth, large cap companies provides stability and midcap provides growth. Owning to midcap in the portfolio the volatility of fund is higher as compare to large cap fund. You should invets in this if you have little risk appetite.
4.Mid Cap Fund
These fund are open ended where in majority is invested in mid cap companies i.e. companies which are 100-250 in term of market capitalization. They need to have minimum 65% invested in mid cap companies. These companies are in growing phase, hence growth potential is high, with high risk.
Benefits of Mid Cap Fund
The mid-cap mutual funds provides higher returns but also have a higher amount of risk due to investment in midcap companies. These companies are relatively more volatile as compare to large cap companies. You should go for these only when you have fairly high risk appetite.
5.Small Cap Fund
These are also open ended scheme with majority of investment in small cap companies. These funds require minimum of 65% of total asset in small cap companies. These companies are with very high volatility and high growth prospect. They have the highest risk but also have the potential to generate the highest returns.
Benefits of Small Cap Fund
The small-cap mutual funds provide higher returns but also have a higher amount of risk due to investment in small-cap companies. These companies provide a high return at cost of high risk, you should only invest if you have very high-risk appetite and only a small portion should be invested to start with.
These are open-ended funds and invest in value companies, i.e companies that are having strong fundamentals and value is down temporarily. In these funds minimum, 65% is invested in equity
Benefits of Value Fund
The value fund helps in creating long term wealth, the investment is in those companies which have strong fundamentals so they are sure to reach their value. You should invest in these funds if you have a relatively long time horizon as the fund might take time to reach the required return.
These are open-ended equity scheme that follows a contrarian investment strategy. The contra strategy involves buying and selling contra or opposite to the present market sentiments. In this fund also a minimum of 65% need to be invested in equity.
Benefits of contra Fund
These funds help in building wealth by following a contrarian strategy. It focuses on changing market conditions. Like any other equity fund, they also require some time to perform and these are good to bet when the market is volatile, not stable. You should take exposure to these funds when the market is volatile.
8. Sectoral/ Thematic Fund
These funds are open-ended equity schemes investing in a particular sector or themes like banking, auto, or IT sector. This fund invests a minimum of 80% of assets in equity or equity-related instruments particularly, particular sector/theme.
Benefits of Sectoral Fund
The sectoral fund has high risk and high return. These are related to the cycle of the economy. You should invest only when you have confidence in some sectors like India is growing economy and a lot many IT companies are going to thrive and perform, so that sector can be looked on and should have space in a portfolio.
9.Equity Linked Savings Scheme (ELSS)
These are open-ended having 80% exposure in equity, the main point of difference is that these funds are eligible for deduction under section 80c ( till 1,50,000 Rs) and locking of three years, meaning you cannot withdraw money before 3 years.
Benefits of ELSS
ELSS investments allow tax deductions of up to Rs. 1.5 Lakhs under the Income Tax Act, 1961. Compared to other tax saving options ELSS have the lowest lock-in period of three years. These funds provide a dual benefit of tax saving and wealth building. In case you want to save on taxes, then it’s the best investment. Also, the time period of 3 years in the form of locking is relatively low as compare to other tax saving instruments.
Example of Equity Fund: HDFC Equity Fund, Tata India Tax Saving Fund, SBI Focused Equity Fund.
Debt Mutual Funds
These Funds invest majority of there funds in debt instruments having fixed coupon or return like government securities, debentures, bonds etc. These instruments are primarily low risk and low return types and suitable for individuals who are looking for steady growth in their portfolio without much volatility.
So if you have low risk then you should opt for these. However they are subject to credit risk. In case of these debt funds TDS is not deducted, hence those earning more than 10,000 need to pay tax. Like equity fund there are 10 different debt funds.
Let’s discuss all the different types of funds in detail.
These are open ended funds that invests primarily in overnight securities. These funds have maturity of 1 day and are highly liquid and offer high security to investment. Example T-Bills, Call Money etc.
Benefits Of Overnight Fund
These funds offer a higher rate of interest as compared to saving a bank account, so in case you have some spare fund for a few days and want to earn few extra bucks, you can safely park your money in the overnight funds.
These are also open-ended funds that invest primarily in highly liquid securities having a maturity of up to 91 days. The securities are usually T-call, call Money, certificate of deposits, etc. These funds also offer high liquidity with high safety, returns are very low. If you wish to invest for a shorter duration with safety as the major concern you should opt for these funds.you can very well park your money for emergency funds in these instruments.
Benefits of Liquid Fund
Since these funds are highly liquid and can be accessed inshort period of time, these funds can be used to park excess money which might not be in use for up-to 3 months. These funds can be used to create emergency funds and also to park your monthly expenses. Higher interest rate as compare to saving account is added advantage. You should put your emergency and monthly expenses in this fund.
3.Ultra Short Duration Fund
These are also open ended short term debt fund and are invested for a period of 3 to 6 months.
Benefits Of Ultra Debt Fund
These funds offer a stable investment
with high liquidity. A little higher duration offers an investor a reinvestment opportunity and income. So if you are planning to buy some new gadget or bike in the next 6 months, consider these funds and park your money here.
4.Money Market Fund
These funds invest the majority of investment in money market funds/instruments like T-bills, certificates of deposits, etc. These funds have higher maturity of up to 1 year. They offer safety with high liquidity.
Benefits Of Money Market Fund
Money market funds offer slight higher return as compare to other short term funds and are suited for those who have short term goals and need to be achieved in next 11-12 month. They also offer safety with liquidity.
5.Short Duration Fund
These are also open-ended funds with a duration of 1 to 3 years. These instruments offer stable investment with high liquidity. The returns are slightly better and are preferred to plan short term and medium-term goals.
Benefits of Short Duration Fund
The investment horizon in these funds is from 1 to 3 years which helps in generating interest income and reinvestment opportunities. These are best suited for conservative investors who want stable income. You should invest in these funds to meet your short term goals like buying a car or jewelry or foreign vacation.
6.Medium Duration Fund
These are also open-ended funds with a slightly high duration of 3 to 4 years. These funds provide stability, flexibility, and good returns. These funds offer capital stability and appreciation. These are good for meeting medium-term goals. The investment is routed in instruments like Government securities, T Bills, etc.
Benefits of Medium Duration Fund
These funds are good for creating a corpus over a short period of time with little volatility. These are best suited for conservative investors. You should have this your portfolio to meet your medium-term goals.
7.Long Duration Fund
These are open-ended funds with investment in debt instruments having a duration of 7 years. These funds perform well in falling interest rate scenarios, as the price of bond instruments inversely proportional to the interest rate. A rise in interest rate would reduce the bond price. These funds generally offer better returns with little higher risk, the investment is in debt instruments like T Bill, CD’s etc.
Benefits of Long Duration Fund
These funds offer slightly higher return at little risk and are good avenues to put money for medium and long term investment. These are good for risk averse investors, who wants stability with little risk.
8.Dynamic Bond Fund
These funds are also open ended with exposure in debt fund, with only exception that duration of various instrument is not same but the investment is done in different duration instruments. These also offers stability with high interest income. The fund can be managed in different market scenario.
Benefits of Dynamic Bond Fund
The fund invests in different durations bonds, hence it provides flexibility to manage the fund. The return is higher with little risk and offer high stability. You should opt for these in case if you have some long term goals and you don’t want to have any high risk.
9.Corporate Bond Fund
These are open-ended funds that invest primarily in corporate bonds having the highest rating of AAA. In this fund minimum, 80% need to be invested in corporate bonds having AAA rating. The instruments include bonds, debentures, commercial papers, and structured obligations.
Benefits Of Corporate Bonds
These are best for those who are looking for stable income. Since the investment is in highest rated bonds the risk is near zero. These best for those who prefer stability over return and investment can be done for a long period of time also.
10.Credit Risk Fund
These are open-ended funds and have exposure in A or AA rated corporate bonds which are not as safe as AAA-rated bonds. A minimum of 65% needs to be invested in debentures, commercials, and bonds of the company having below highest rated instruments. Since the investment is in the below highest rated instrument there is little high risk as compared to corporate bonds.
Benefits of Credit Risk Fund
These are best suited for those who want a steady income with little high risk since the investment is in below highest-rated bonds the chances of defaults are high, also since they are risky they offer high coupon rates. You should only take exposure when you have a little high-risk appetite.
10.Banking and PSU Fund
These are also ended funds having exposure in debt instruments of banks, public sector undertaking, and public sector financial. These funds invest a minimum of 80% in these funds. They are a relatively stable and very little risk. You should invest only when you have trust in PSU and banking.
Benefits of Banking and PSU Fund
These funds are relatively safe and are best for long term investment. The investment in these is stable and with little risk.
Example: Axis Banking and PSU Debt Fund, ICICI Prudential Credit Risk Fund.
11.Money Market Mutual Funds
These funds invest in short-term debt instruments, aiming to have a reasonable return over a short period of time. These funds are suitable for investors with a low-risk appetite who are looking at parking their surplus funds over the short-term.
These are considered to be alternate to saving bank account to park excess money which might be required in the short run. The investment of these funds is generally in liquid assets. Owing to a high degree of liquidity, they are also known as the cash market or capital market.
Government or financial institutions such as banks or corporations form the backbone of money market mutual funds through securities such as bonds, dated securities, and certificates of deposits, T-bills, etc. Normally, it is ideal for those who wish to park their excess money for the short term.
Examples: Reliance Money Market Fund, JM Money Market Fund
These are also known as hybrid funds, these funds have a mix of debt and equity. The proportion keeps on changing based on market conditions. The idea of the fund is to generate moderate returns with substantial low risk. These are suitable for those investors who want to keep their capital safe and want to have a bit of equity in their portfolio. They are generally moderate risk-taker.
Examples: Tata Balanced Adv Fund (G), Kotak Balanced Advantage Fund (G).
A further diversification can be done based on risk appetite of investor or time horizon , based on objectives of based on speciality but they will ultimately gets directed to these funds only.
After having detailed understanding on the mutual fund types one thing that you must appreciate is that there is a different type of mutual for every different need. You need to be aware of your goal or need before finalizing a mutual fund.
An equity mutual fund is best for investors having a long-term investment horizon on the contrary Debt mutual funds are helpful for investors looking for low volatility short-term investment options. A balanced fund is something if you are looking for the best of both worlds, i.e growth and stability. To define your goal, define your time horizon, define your risk appetite, this will help in selecting the best fund.