Types of Mutual Funds – Part 1

There are over 11000 mutual funds. How are they different from each other?

Mutual fund classification

Mutual fund classification

Types of Mutual Funds based on structure:

    • Open Ended Schemes: An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value (“NAV”) related prices. The key feature of open-end schemes is liquidity.
    • Closed Ended Schemes: These funds have a pre-specified maturity period. The ‘Unit Capital’ of such schemes is fixed as it makes a onetime sale of a fixed number of units. After the offer closes, closed ended funds do not allow investors to buy or redeem units directly from funds.
  • Interval Schemes: These combine the features of open-ended and close-ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during predetermined intervals at NAV related prices.

By Investment Objective:

The investment objective governs the entire fund. The fund manager chooses his portfolio based on this objective. He shall not stray from the objective stated in the prospectus.

  • Aggressive growth means that you will be buying into stocks, IPOs which have a chance for dramatic growth and may gain value rapidly. This type of investing carries a high element of risk with it since stocks with dramatic price appreciation potential often lose value quickly during downturns in the economy. It is a great option for investors who do not need their money within the next five years, but have a more long-term perspective. Do not choose this option when you are looking to conserve capital but rather when you can afford to potentially lose the value of your investment.
  • Growth, growth seeks to achieve high returns; however, the portfolios will consist of a mixture of large-, medium- and small-sized companies. The fund portfolio chooses to invest in stable, well established, blue-chip companies together with a small portion in small and new businesses. The fund manager will pick, growth stocks which will use their profits grow, rather than to pay out dividends. It is a medium – long-term commitment, however, looking at past figures, sticking to growth funds for the long-term will almost always benefit you. They will be relatively volatile over the years so you need to be able to assume some risk and be patient.
  • A combination of growth and income funds, also known as balanced funds, are those that have a mix of goals. They seek to provide investors with current income while still offering the potential for growth. Some funds buy stocks and bonds so that the portfolio will generate income whilst still keeping ahead of inflation. They are able to achieve multiple objectives which may be exactly what you are looking for. Equities provide the growth potential, while the exposure to fixed income securities provide stability to the portfolio during volatile times in the equity markets. Growth and income funds have a low-to-moderate stability along with a moderate potential for current income and growth. You need to be able to assume some risk to be comfortable with this type of fund objective.
  • That brings us to income funds. These funds will generally invest in a number of fixed-income securities. This will provide you with regular income. Retired investors could benefit from this type of fund because they would receive regular dividends. The fund manager will choose to buy debentures, company fixed deposits etc. in order to provide you with a steady income. Even though this is a stable option, it does not go without some risk. As interest-rates go up or down, the prices of income fund shares, particularly bonds, will move in the opposite direction. This makes income funds interest rate sensitive. Some conservative bond funds may not even be able to maintain your investments’ buying power due to inflation.
  • The most cautious investor should opt for the money market mutual fund which aims at maintaining capital preservation. The word preservation already indicates that gains will not be an option even though the interest rates given on money market mutual funds could be higher than that of bank deposits. These funds will pose very little risk but will also not protect your initial investments’ buying power. Inflation will eat up the buying power over the years when your money is not keeping up with inflation rates. They are, however, highly liquid so you would always be able to alter your investment strategy.

Active vs Passive Funds:

Actively managed funds differ from the Passively managed funds based upon the day to day involvement of the fund manager in managing the investments of the fund. In case of actively managed fund, the fund manager may regularly churn the stocks held by the fund and try to beat the underlying comparitive index to justify the extra costs associated with managing the funds. On the other hand, passively managed funds are not managed on a day to day basis and hence their cost ratios are lower than actively managed funds. However, their returns are very close to the index which they are tracking.

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Subha Viswanathan

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