In the previous article, we tried to give you an introduction to the basics of mutual funds, the legal structure of mutual funds, and the types of mutual fund schemes. Now it is the time to deep dive into the various types of mutual funds.
If you have not gone through the previous article, you can check it out here:
Introduction about Mutual Funds: Everything you need to know
You may have heard someone who has invested in an equity mutual fund or a debt mutual fund etc. In this article, we will try to let you understand the jargon used in the mutual fund industry.
Let us discuss each of these:
Types of Mutual Funds
Equity-oriented Mutual funds:
Investments are done in equity shares and convertible debentures.
These schemes try to earn through an increase in the value of investments. i.e. growth orientation. i.e. capital appreciation and dividends.
Equity-oriented fund schemes can be of various types like diversified equity funds, market capitalisation-based equity funds, sectoral funds, thematic funds, dividend yield funds, value funds, growth funds, focused funds, and ELSS. Let us understand them one by one.
Diversified equity oriented mutual funds:
These funds invest in different sectors and different companies based on market capitalisation
.i.e. the investment of diversified equity funds is done in different sectors (like the cement sector, industrial goods sector, banking, and financial sector, etc) therefore the performance of one sector and the effect of government policy on one sector can affect the performance of diversified funds.
Along with the different sectors, these funds also invest in the companies based on their market capitalisation . i.e. large caps, mid-caps, and small caps.
Market capitalisation-based equity oriented mutual funds:
The companies in the stock markets are divided on the basis of market capitalisation decided by SEBI. There are three types of bifurcations on the basis of capitalisation; large-cap companies, mid-cap companies, and small-cap companies. Any changes in the capitalisation are made on a half-yearly basis.
As per the SEBI categorization;
@ The top 100 companies are considered large-cap companies
@ From 101 to 250th companies are considered mid-cap companies
@ From 251st company onwards are considered as small-cap companies.
Large-cap based equity oriented mutual funds: (Invest in top 100 companies)
These funds invest in blue-chip companies. i.e. the largest companies in the stock market these companies are called blue-chip companies because they are considered the safest large companies on the stock market. They have long-standing and they have proved their business and good governance ability.
Midcap-based equity oriented mutual funds: (Invest in 101 to 250th company)
These are not blue-chip companies but they have the potential to become blue-chip in the future. These companies are not considered as stable as the blue-chip companies and therefore they are affected more by economic situations in the country. The investment made by mid-cap-based equity funds is considered risky in comparison to large caps based funds.
Small-cap based equity-oriented mutual funds: (Invest in 251st company onwards)
These funds invest in small companies and therefore these funds are riskier than large-cap-based equity funds and small-cap-based equity funds. These small companies are considered the least stable.
Sectoral mutual funds (Sector based funds):
These sectoral funds invest in companies in a specific sector like the power and infrastructure sector, banking sector, gold sector, etc.
The funds are more dependent on the government policies in the specific sector to which they are related.
These funds are cyclical in nature, meaning they remain at the top at some time period and go to the bottom at another time period, for example, the sugar sector companies boom at the time of some news or announcement regarding ethanol policy by the government.
These funds are riskier than the diversified funds because the investment of diversified funds is done in companies of different sectors, therefore, it may be possible that one sector is at the bottom and another sector may be at boom so the risk gets diversified in diversified funds which are not so in the case of sector based funds because sector funds are typically dependent on the performance of specific sectors, therefore, they are considered riskier.
Dividend yield-based mutual funds:
These funds make the investment in those companies which pay periodic dividends. The shares of these companies do not fluctuate too much but they have stable earnings. i.e. they show consistent profits and therefore pay a dividend.
Growth based mutual funds:
These funds invest in those companies which are expected to provide higher returns than the returns given by the market index. i.e. Sensex or nifty.
These funds try to provide capital appreciation. i.e. if you invested Rs 1,00,000 and the returns provided by the market index are 10% then these funds try to provide higher returns than 10%.
Value-based mutual funds:
These funds invest in those companies which are available at a price less than their fair value, which means these companies are available cheaper.
These funds have the view that someday the market will recognize the true value of these companies and then the investors will be benefited from the increase in the price of shares.
Equity-linked savings scheme (ELSS):
This scheme is used as a tool to obtain the deduction under section 80 C of the income tax act 1961, the investment made in ELSS has to be locked in for three years as of now the limit for maximum investment is 1.5 lakhs.
Debt-oriented mutual funds:
Before understanding debt-oriented funds let us understand the meaning of debt. Debt is nothing but a loan. In debt-oriented mutual funds once you give your money to the mutual fund and such money is used by the mutual fund to give it on loan to various companies for which the interest is received, such interest is distributed to the unit holders in the proportion of the units of a mutual fund held by the investor.
These debt funds can be of short-term period or long-term periods and the companies in which such money is invested by the mutual fund can be a private company, public company, public sector undertaking, and also the government.
The returns given by the debt mutual fund vary on the basis of the fact that whether the mutual fund has invested the investor’s money in government securities or in the companies
Since you know that the more risk you take, the more returns you expect.
Investment in government securities is considered safe because the companies may fail but the government may not, the investor is exposed to more risk if his or her money is invested in the company and therefore he expects more returns and because of this, the interest earned on the investment made in companies are more than those of the government securities.
The crux of the story of debt mutual funds is that the returns obtained from investment in government securities are less than that of investment in companies.
You may have heard from someone that “he has invested the money in a bond, the bond is the same debt instrument that we have discussed above. The specific rate of interest is mentioned on bond paper which the investor is expected to get on his investment.
There are two types of debt-oriented Mutual Funds (i) Diversified debt-oriented funds (ii) Fixed maturity debt-oriented funds (iii) Floating rate debt funds.
Diversified debt-oriented mutual funds:
It is not necessary that mutual funds only invest in either government securities or non-government securities. i.e. companies but certain funds are diversified and invest in both government and non-government securities these are called diversified funds. The time period of debt funds can be long-term or short-term.
Fixed maturity debt mutual funds:
Certain debt mutual funds schemes have fixed maturity means they invest the money for some particular period of time say five years seven years etc. These mutual fund schemes are close-ended schemes. These schemes are comparable to fixed deposits in banks but it is worth mentioning here that though these are comparable to FD the assurance of returns is not as certain as bank fixed deposits. These are called fixed maturity schemes.
Floating rate debt mutual funds:
The other category of debt mutual funds is floating-rate debt funds, these funds invest in those debt securities in which the interest is linked to the interest payable on government securities.
Let us say that these mutual fund schemes invest in such debt securities which provide that “interest will be payable at the rate of government securities +2%” which means that if the interest on five-year government security is 6% then interest payable under these schemes will be (6%+2% ) equal to 8% and if the interest on five-year government securities become 5% then the interest payable under these schemes will be (5%+2%) equal to 7% due to this reason these funds are called floating rate funds
Till now you have understood equity-oriented funds and debt-oriented funds. Now it is time to take a look at the hybrid funds.
Hybrid Mutual Funds:
Hybrid funds invest in equity as well as debt along with the favorite asset “gold”. Hybrid funds are of two types (1) Debt oriented hybrid funds (2) Equity oriented hybrid funds
Debt-oriented hybrid mutual funds:
The word “debt oriented” is used in the name of these funds because they invest a higher proportion in debt securities and the word “hybrid” reflect the fact that some portion of the money is invested in a segment other than debt, which may be equity.
So the basic purpose of these funds is to get the assurance of returns because of the interest payment on the debt portion and also the increase in value of the investment on the equity portion.
Generally, the proportion of debt in debt-oriented hybrid funds varies from 70% to 95%. The remaining portion can be equity.
Equity-oriented hybrid mutual funds:
In the debt-oriented hybrid fund, as we discussed above, a higher proportion is invested in debt securities while in the equity-oriented hybrid funds higher proportion is invested in equity and some portion of the investment is made in debt so as to ensure the stability of performance because debt assures the fixed percentage of returns.
Balanced funds are the popular category of equity-oriented hybrid funds.
Both debt-oriented and equity-oriented hybrid funds are the best options for investors who want low-risk to their portfolio in comparison to equity-oriented funds because both the debt-oriented hybrid funds and equity-oriented hybrid funds have some percentage of the debt which assure a certain percentage of returns,
While equity does not assure any return because it is totally influenced by Stock Markets.
Specific solution-oriented mutual funds:
These fund schemes target the specific object of investors.
A happy and wealthy retirement and the best education for children are the two most important objects of an individual.
Both the retirement-oriented fund and children’s education fund are long time frame investments with a lock-in period of at least 5 years.
In the case of retirement-oriented funds, the upper time limit is up to the age of retirement. i.e. you can invest in such mutual funds up to the age of retirement.
In the case of children’s education-oriented funds, the upper time limit is up to the age when the children attained the age of majority. i.e. the investment in children’s education-oriented funds can be done up to the time period your child becomes a major.
Other Mutual Funds:
Other than the above-mentioned categories of mutual funds there are other types of mutual funds which are:
- Real Estate Investment Trusts (REITs)
- Real Estate Mutual Funds
- Infrastructure Investment Funds (InvITs)
- Exchange Traded Funds (ETFs)
Let us understand them one by one:
Real Estate Investment Trusts (REITs):
These mutual funds invest in commercial real estate projects.
The money is raised by these trusts through an initial public offering (IPO), right issues, follow on public offers (FPO), and institutional placements.
These trusts are recognised by the stock market regulator SEBI.
Real estate mutual funds:
These mutual funds invest in real estate as well as the securities of companies in real estate or real estate projects.
Real estate means “land and/or building”. It can be commercial or residential.
Infrastructure Investment Funds (InvITs):
These mutual funds invest in infrastructure assets.
Do not confuse it to be real estate only. Real estate is the part of term infrastructure but infrastructure includes transport power telecom etc.
So infrastructure is a broad term in comparison to real estate and InvITs cover a broad segment.
Exchange Traded Funds (ETFs):
These mutual funds invest in the companies which form the composition of the index.
For example, companies forming the Nifty 50 index, Nifty 100 index, etc. These mutual funds invest only in those companies which are part of the index.
Reshuffling of the investments takes place on a timely basis on the change in the composition of the index.
So, after reading the entire article you are well versed in the broad categories of the various types of mutual funds. Next time while entering into a mutual fund scheme just remind yourself of the fact that you understand the broad aspects of mutual funds and take informed decisions. Happy Investing.
In our next article, we will try to inform you about the various risks involved in mutual fund investing. It is because of due to those risks it is loudly said “MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL THE SCHEME-RELATED DOCUMENTS CAREFULLY” ……stay tuned