When it comes to investment, mutual funds offer a variety of options to suit the risk appetite and return expectation of every investor. There are different types of mutual funds which are categorized under different classes and sub-classes. Before you take a plunge in the mutual fund world, it`s important to understand them.
Equity Funds :
Equity funds are composed of shares of companies, as underlying asset. These kinds of funds are aggressive in nature as they not only give superior yield amongst all other market instruments, but are also exposed to high risk owing to market volatility. Usually, investors with a high appetite for returns and risk, invest in these funds.
Equity funds are further divided into large cap funds, mid/small cap funds, diversified funds, sectoral funds, index funds and thematic/specialty funds:
* Large Cap funds are funds which invest a larger proportion of their corpus in companies with a large market capitalization.
* As the name suggest Mid Cap funds typically invest in medium-sized companies with a market capitalization between Rs. 3,000 – 10,000 crores and Small Cap funds invest in companies with market capitalization of Rs. 500 – 3,000 crores.
* Diversified funds invest in equity of companies across sectors and capitalization or size and are flexible in their investment style.
* Sectoral funds limit their investment in a specific industry or a sector (for example, banking).
* Index funds have a stock market index as an underlying asset and any appreciation or fall in the value of fund depends solely on the movement of such index (for example, BSE Sensex).
* Thematic/specialty funds invest in a particular theme instead of a specific sector (for example, an infrastructure fund will comprise of companies dealing in infrastructure, construction, cement, steel and related products/services/projects).
Debt Funds :
Debt funds invest in fixed income securities, and provide regular and steady income to investors. They are relatively more liquid owing to their term as well as nature. They offer a safer avenue for investors who want to earn returns higher than that offered on conventional bank deposits, but are not ready to take high risks by investing in shares or equity.
Debt funds are further classified into income funds, gilt funds, liquid funds, fixed maturity plans (FMPs) and short term funds:
* Income funds invest in corporate debentures, government securities and bonds. The maturity ranges from 1-2 years to 15-20 years.
* Gilt funds invest in papers backed by the state and central government. The maturity ranges from 1-2 years to 15-20 years.
* Liquid funds invest in highly liquid money market instruments such as treasury bills, inter-bank call money market, commercial papers and certificates of deposit. The maturity is usually less than 91 days.
* FMPs invest in schemes with a fixed tenure and similar maturity. The maturity ranges from 3-6 months to 3-5 years.
* Short term funds invest in commercial papers, certificate of deposits and bonds with a maturity 3-12 months.
Balanced/Hybrid Funds :
Hybrid or balanced funds are a mix of equity and debt funds, and mostly the mix of debt-equity is in a pre-specified proportion. They provide a balance between security and high returns. So, investors who want to take advantage of moderate returns while minimizing the risk, can opt for these funds.
Balanced fund are classified into two categories:
* Equity oriented balanced funds where 65% or more of the corpus is invested in equity and the rest in debt.
* Debt oriented balanced funds or monthly income plans (MIPs) where 75-95% of the corpus is invested in debt and rest in equity.
Asset Allocation Funds :
Asset allocation fund invests in a wide variety of investments, including domestic and foreign stocks and bonds, government securities, gold bullion and real estate stocks. It allows ongoing adjustments in the proportions of debt and equity, but keeping them within certain predetermined limits. These funds usually allow 0 to 90% of allocation to equity. This helps investor in taking complete advantage of high returns on equity when the stocks are doing well and save from incurring heavy losses when there is a fall in the stock prices of the portfolio (this is of course dependent on fund manager to move the allocation smartly).
Let us take an example – an investor opts to invest in Fund A by investing 60% in equity and 40% in debt. The fund manager allocates the amount accordingly. The companies forming the portfolio of Fund A experience an upswing in their share prices, which is expected to continue for a couple of months, so fund manager increases the allocation to equity by 20% more making the equity investment 80%. This increase will automatically reduce the allocation in debt instruments to 20%. If the share price falls, the fund manager has the freedom to increase the allocation in debt so as to avoid losses and making moderate gains. All this is always subject to Fund Manager’s prudence and ability to take the right call at right time.
Fund of Funds (FoF) :
Fund of Funds or multi manager investment funds invest in the performance of other investment funds instead of investing directly in bonds, stocks or other securities. They are low on risk as they are widely diversified but carry relatively high management expenses owing to the 2-tier structure.
Exchange Traded Funds (ETFs) :
ETFs are a basket of stocks that reflect an index. It is not your typical mutual fund because it trades like just any other company on a stock exchange. ETFs also have a NAV, however, it fluctuates throughout the day as ETFs trade in real-time. Investors who are looking for diversification of the index as well as flexibility, opt for ETFs.
ETFs can be further classified into six categories:
* Commodity ETFs invest in commodities like gold, silver, oil, livestock and various agricultural products. They help in protection from inflation and enhance diversification to an investor’s portfolio. You don’t have to hold these commodities physically. Among these, Gold ETFs are most popular in India.
* Index ETFs invest in benchmark index funds. For example, Nifty or Sensex ETF.
* Bank ETFs invest in stocks of banks which are part of the banking index it follows.
* Liquid ETFs invest in debt instruments and securities.
* International ETFs invest in foreign based securities.
* Currency ETF invest in currencies such as rupees, dollars, etc. They fluctuate depending on the rise and fall of the currency.
As you can understand, there is a mutual fund for every kind of investors, whether risk-averse or a risk-taker. Before opting for any, do a careful analysis of your investment goals and risk-return trade-off that you prefer. Please do not surrender everything to chance and the fund houses displayed expertise.