What Are The Differences Between Equity And Debt Mutual Funds?

Equity mutual funds and debt mutual funds, both, pool money from investors which is then invested in various securities. However, it is the type of securities which these funds invest in that differentiates the two types of mutual funds. To understand the difference between the two, let us first take a look at both mutual fund investment options in more detail

  • What are equity mutual funds?

Equity Mutual Funds typically invest their assets into shares or stocks of different companies across market capitalisation or a particular market capitalisation category. The objective of equity funds is to generate optimal returns over the long run. However, they also involve relatively higher risks (basis the scheme) and can be volatile in nature.

The fund manager of an equity mutual fund scheme could attempt to garner optimal returns by spreading the investment across companies from a variety of sectors. However, the types of securities chosen are usually based on the objective of the mutual fund scheme. Here are the types of Equity funds:

Based on market capitalisation –

  • Large-Cap Funds: These funds typically invest a major part of their total assets in the top 100 large-cap companies listed on the stock market.
  • Mid-Cap Funds: Mid-cap funds invest the major part of their total assets in mid-cap companies which fall between the 101st to 250th place on the stock market.
  • Small-Cap Funds: Small Cap companies hold ranks beyond the 250th place in the market capitalisation on the stock market.
  • Multi-Cap Funds: As is apparent by the name, multi-cap funds spread the investment across categories of large-cap, mid-cap and small-cap companies with limits on investments in each category.
  • Flexi-cap Funds: These types of funds divide assets between companies across market-capitalisation categories without any restrictions.

Based on the Investment Strategy –

  • Sectoral Funds: Equity schemes that invest in a specific sector or industry of the economy such as energy, infrastructure, etc.
  • Thematic Funds: Equity schemes that invest in stocks based on a particular theme. The themes chosen by the schemes may revolve around areas such as defense, commodity etc.
  • Focused Funds: A type of equity fund that follows an investment strategy of having a concentrated portfolio where it invests in a limited number of stocks. As per the SEBI guidelines, a focused fund can invest in a minimum of 30 stocks.
  • What are debt mutual funds?

Debt funds invest in fixed income securities such as corporate and government bonds, money market instruments, etc. In general, they can be considered a safer investment option. You can classify debt funds

On the basis of maturity period –

  • Overnight Fund – which invests in debt securities having a maturity of 1 day.
  • Liquid Fund – which invests in money market instruments having a maturity of maximum 91 days
  • Ultra-short duration fund – which invests in money market instruments and debt securities with a maturity period between three and six months.
  • Low Duration Fund – which invests in money market instruments and debt securities where the maturity of the scheme is between six and twelve months
  • Short Duration Fund – which invests in money market instruments and debt securities with a maturity period between one and three years.
  • Medium Duration Fund – which invests in money market instruments with a maturity period between 3-4 years.

On the basis of debt instruments –

  • Money Market Fund – which invests in money market instruments with a maximum maturity of 1 year.
  • Corporate Bond Fund – which invests at least of 80% of its total assets in highly rated corporate bonds.
  • Banking and PSU Fund – which invests at least 80% of its assets in debt securities offered by banks and Public Service Undertakings (PSUs).
  • Gilt Fund – which invests a minimum of 80% of its assets in government securities.
  • Credit Risk Fund – which invests a minimum of 65% of its assets in corporate bonds that are not so highly rated.

After understanding both options in relative detail, now we can go about comparing them in a more direct manner:

Equity FundsDebt Funds
Equity funds invest a major part of the investment amount in equity shares of companiesDebt funds invest a major chunk of the investment in interest generating securities.
Equity funds may potentially earn higher returns but also be exposed to moderately high or high risk.Debt funds are less volatile than equity funds but they might have a reduced possibility of generating inflation-beating returns.
Equity funds might be better suited for investors with a higher risk appetite and long-term investment goals.Debt funds can be suitable of investors with a lower risk appetite for capital appreciation or interest income.

A balanced investment portfolio could normally include both equity and debt investments based on your goals, risk appetite, and investment horizon. You can invest in debt and equity funds, individually. However, you also have the option of investing in hybrid mutual funds that could potentially reap the benefits of both equity and debt mutual funds in the same scheme.

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Ved holds a Master's Degree in Management Studies in Finance from the ICFAI Business School Mumbai. He is extremely passionate about Equity markets and swears by the age-old maxim of “Time in the market is more important than timing the market”. He has in-depth knowledge & knack of the mutual fund industry and loves working on client portfolios and analyzing Mutual fund schemes on myriad subjective and objective parameters.