Types of Mutual Funds
Mutual funds have become the most popular and convenient way to put your hard-earned money to use. It is the most suitable investment for the investors as it provides an opportunity to invest in a well-diversified, professionally managed basket of securities at a relatively low-cost. Any mutual fund house will either invest in equities, debt or a mix of both. Based on fund structure, mutual funds can be open-ended, close-ended and interval funds.
Contents
Open-ended fund
In an open-ended fund, an investor can enter or exit at any point in time. It is available for subscription and redemption throughout the year. It does not have a fixed maturity period.
Close-ended fund
In a close-ended fund, an investor can enter at the time of New Fund Offering (NFO). Any new investment in the fund is not possible after the closure of the NFO. So, the total number of outstanding units of a closed-ended fund always remains the same. But after the NFO, these funds are listed on the stock exchanges. If you want to buy or sell the units, you have to the stock exchanges. These funds have a fixed maturity period, and you can redeem the units only after the maturity period is over. Only lump sum investment is permitted in these funds, and no Systematic Investment Plan (SIP) is possible.
Interval fund
Interval fund combines the features of both open-ended funds and closing ended funds. They are mainly close-ended but become open-ended at pre-specified intervals. You cannot sell the units at any point in time. There is a transaction period during which you can buy or sell your units. So, it combines the benefits of open-ended and close-ended funds.
Let’s look at the various types of equity, debt and hybrid mutual fund schemes available in the market.
Equity mutual funds
Equity mutual funds invest a major part of its assets in equity and equity-related instruments like stocks of companies. They are usually associated with high risk and high returns. The investment objective of these funds is long-term capital growth. They are further categorized into the following types of mutual funds:
- Large Cap Funds– Large-cap funds invest a minimum of 80% of total assets in equity and equity-related instruments of large-cap companies. Large-cap companies are the topmost 100 companies by market capitalization. They are more stable and well-established companies. Hence, the funds invested in these companies are less risky than Midcap and Small-cap funds. As their growth possibility is less, they give low returns. They are suitable for investors with an investment horizon of 5-7 years.
- Large and Mid-cap funds– These types of mutual funds invest a minimum of 35% of total assets in stocks of large-cap companies and a minimum of 35% of total assets in mid-cap companies’ stocks. So, a total of 70% of assets is allotted towards large and mid-cap stocks. And the remaining 30% of assets are invested as per the fund manager’s decision. They give more returns than large-cap funds and less returns than mid-cap funds. These are suitable for investors with a high-risk appetite than large-cap funds.
- Mid Cap Funds– Mid-cap funds invest a minimum of 65% of total assets in equity and equity-related instruments of mid-cap companies. Mid-cap companies are the top 101-250 companies by market capitalization. These companies are some of the fastest-growing companies. So, these funds give more returns than large-cap funds. They are suitable for investors with an investment horizon of 3-5 years.
- Small-Cap Funds– Small-cap funds invest a minimum 65% of total assets in small companies which are 251st companies onwards by market capitalization. They have the potential to become mid-caps and large-caps in the future. These funds give you the opportunity to participate and get the benefits in their future growth. Therefore, the funds in this category have the highest risk and the highest returns. It is important to note that every company do not succeed in the long run. They are suitable for investors with an investment horizon of 7-10 years.
- Multi-Cap Funds– Multi cap funds have no restriction in size, and they invest across large-cap, mid-cap and small-cap stocks. Therefore, they have a diversified portfolio. They invest a minimum of 65% of total assets in equity and equity-related instruments. The fund manager has the freedom to change their portfolio composition as per the market conditions. S, they are better equipped to take advantage of emerging opportunities. They are riskier than large-cap funds and less risky than small-cap and mid-cap funds. Their returns are also more than large-cap funds but less than small-cap and mid-cap funds.
- Focused Funds– Focused funds invest a minimum of 65% of total assets in equity and equity-related instruments. But there is a limitation; the fund cannot keep more than 30 stocks in the portfolio. These are suitable for investors with high-risk appetite and at the same time, believe in the fund manager’s strategy.
- Sectoral/Thematic Funds– These types of mutual funds invest a minimum of 80% of total assets in a particular sector/theme. A sectoral fund invests their money in a specific sector like infrastructure, automobiles, pharma etc. Similarly, a thematic fund invests in companies following a particular theme like MNC, Rural consumption, ESG, Consumption, Energy etc. These funds give you the opportunity to get the benefit from the growth of a specific sector/theme. As the funds invest in a specific sector/theme, any downturn in the sector/theme can lead to huge losses. Therefore, they are the high-risk funds, and you should only invest if you are optimistic about a particular sector/theme.
- ELSS Funds– ELSS stands for Equity Linked Savings Scheme. It is a close-ended fund having a lock-in period of 3 years. This fund helps you save tax and give you an opportunity to grow your money. It qualifies for income tax exemption under Section 80C of the Income Tax Act. These funds are similar to multi-cap funds, i.e. it can invest in large-cap, mid-cap and small-cap companies. Hence, their risks and returns are also identical to multi-cap funds.
- Dividend Yield Fund- Dividend Yield Fund invests predominantly in dividend-yielding stocks. The stocks which regularly give dividends to the investors are called dividend-yielding stocks. These funds invest a minimum of 65% of total assets in equity.
- Value Fund- These funds invest a minimum of 65% of total assets in equity and equity-related instruments. These funds follow a value investment strategy where the fund manager invests in stocks undervalued in price based on its fundamental characteristics. This strategy’s idea is that the markets have some inefficiencies, which causes some stocks to trade at levels below their actual worth. The fund managers are skilled enough to identify these inefficiencies.
- Contra Fund– These funds invest a minimum of 65% of total assets in equity and equity-related instruments. These funds follow a contrarian investment strategy where the fund manager focuses on investing against the prevailing market trend in assets that are performing poorly and selling them when they perform well. These strategies are far more complex than the value investment strategy.
Debt mutual funds
Debt mutual funds invest their money in fixed income securities like government bonds, corporate debentures, government securities, money market instruments etc. These are less risky as compared to equity and hybrid funds. Based on the maturity period, they are further classified into the following types of mutual funds:
- Overnight Fund– These funds invest in debt instruments, having a maturity of 1 day.
- Liquid Fund– These funds invest in debt and money market instruments with a maturity of up to 91 days only. They are good alternatives for cash in the bank’s savings account as they give slightly more returns than the interest in the bank’s savings account. Its main purpose is temporary cash management, i.e. it is better to keep cash in liquid funds than keeping in the bank’s savings account. They provide good liquidity, i.e. you can withdraw money any time after 7 days without any charges.
- Ultra Short Duration Fund– These funds invest in debt and money market instruments whose Macaulay duration (weighted average duration) of the portfolio is between 3-6 months.
- Low Duration Fund- These funds invest in debt and money market instruments whose Macaulay duration of the portfolio is between 6-12 months.
- Money Market Fund– These funds invest in money market instruments having maturity up to 1 year.
- Short Duration Fund– These funds invest in debt and money market instruments whose Macaulay duration of the portfolio is between 1-3 years.
- Medium Duration Fund– These funds invest in debt and money market instruments whose Macaulay duration of the portfolio is between 3-4 years.
- Medium to Long Duration Fund– These funds invest in debt and money market instruments whose Macaulay duration of the portfolio is between 4-7 yrs.
- Long Duration Fund– These funds invest in debt and money market instruments whose Macaulay duration of the portfolio is greater than 7 years.
- Dynamic Bond Fund– These funds invest in bonds across the varying duration, i.e., 1-year, 5-years, 10-years, or any maturity period.
- Corporate Bond Fund– These funds invest a minimum of 80% of total assets in corporate bonds having the highest ratings. It should be minimum AA+ and above.
- Credit Risk Fund– These funds invest a minimum of 65% of total assets in corporate bonds having ratings below the highest quality bonds, i.e. AA, A, BBB etc.
- Banking and PSU Fund– These funds invest at least 80% of total assets in bonds of Banks, Public Sector Undertakings (PSU), Public Financial Institutions, and Municipal Institutions.
- Gilt Fund– These funds invest a minimum of 80% of total assets exclusively in Government Securities across varying maturities. Government securities have no default risk, or we can say zero risks. The Net Asset Value (NAV) of these funds fluctuate due to a change in interest rates and other economic factors. The returns of these funds are also less.
- Gilt Fund 10-year Constant Duration Fund– These funds invest a minimum of 80% of total assets in Government Securities whose Macaulay duration of the portfolio is 10 years.
- Floater Fund– These funds invest a minimum of 65% of total assets in floating rate instruments.
Hybrid mutual funds
Hybrid mutual funds invest both in equity and debt instruments and offer a diversified portfolio to the investors. These funds are suitable for moderate risk-taker. They are less risky than equity funds and give more returns than debt funds. They are further classified into the following types of mutual funds:
- Conservative Hybrid Fund– These funds invest 75-90% of total assets in debt instruments and 10-25% of total assets in equity and equity-related instruments. They are suitable for risk-averse investors with an investment horizon of 3 years or more.
- Balanced Hybrid Fund– These funds invest 40-60% of total assets in equity and equity-related instruments and 40-60% of total assets in debt instruments. These funds allocate almost equal weight to both the asset classes. These mutual fund schemes are suitable for investors with medium risk appetite having an investment horizon of 3 years or more.
- Aggressive Hybrid Fund– These funds invest 65-80% of total assets in equity and equity-related instruments and 20-35% of total assets in debt instruments. These mutual funds are less risky than pure equity funds and generate higher returns in the long run. They are suitable for investors with a high-risk appetite having an investment horizon of 3 years or more.
- Dynamic Asset Allocation Fund– These funds are also known as balanced advantage funds. These funds do not have a limit on equity and debt instruments, and the investment is managed dynamically. These funds use financial models to decide which equity or debt combinations will give optimal returns in the current market conditions, and then allocate money. They are suitable for risk-averse investors but are willing to take some risk for a marginally higher return over the long term, i.e. 5-7 years.
- Multi-Asset Allocation Fund– These funds invest a minimum of 10% each in three asset classes. It is a combination of equity, debt and one more asset class like Gold, Real Estate, ETF, Preference Shares etc. They are less risky compared to other hybrid funds as the investments are spread across multi-asset classes. They are suitable for investors with an investment horizon of 5 years or more.
- Arbitrage Fund– These funds invest a minimum of 65% of total assets in equity and equity-related instruments. These funds follow the arbitrage strategy, i.e. simultaneously buy securities from the cash market and sell it in the derivatives market to take advantage of price differences. There is no market risk as the buying and selling price is already known to the fund managers. These mutual fund schemes are suitable for investors with an investment horizon of 2-5 years.
- Equity Saving Fund– These funds invest the total assets between equity, debt and hedging instruments. These funds invest a minimum 65% of total assets in equity and equity-related instruments and minimum 10% of total assets in debt instruments. These are the most complex category among the hybrid funds striking a balance between equity, debt and arbitrage. These mutual fund schemes are suitable for investors with an investment horizon of 2-3 years.
There are also certain types of mutual funds like Solution-oriented funds e.g Children’s marriage fund, Children’s education fund etc. and other mutual funds like Index funds etc.
Also Read: