In Part 1 of this series, we saw some basics about the Mutual fund types.
Now, we zoom into more specifics.
Broadly mutual funds could be categorized into 3 types;
- Equity Mutual Funds
- Debt Mutual Funds
- Hybrid Funds
Equity Mutual Funds:
Equity oriented mutual funds where majority of the assets are invested in stocks. To broadly distinguish the Equity and non-equity oriented funds, the income tax department has come up with a definition of equity oriented funds. To qualify as equity oriented fund, the said mutual fund should have invested 65% of average annual net assets in Indian listed equities directly. Any other fund which doesn’t come under this definition would be considered as non-equity fund/debt fund for the purpose of taxation.
Further, equity MFs are sub-divided based on:
By Market Capitalisation:
- Large Cap – Investing primarily into blue chip companies.
- Mid Cap – Investing into companies of medium size;
- Small Cap – Investing into small companies.
- Diversified – Investing into companies of all types of Market capitalisation across different industry sectors.
Sector Funds – invest into Equity shares of companies belonging to a particular sector only such as Banking Companies or Power sector companies, etc.
Index Funds – these are primarily passively managed Funds. They invest into bunch of stocks which represent an index such as NIFTY, BANK NIFTY, etc.
- Diversified Equity Funds: The portfolio of Diversified equity funds is a combination of Large, Mid and Small cap stocks. Majority of the assets in the fund would be invested into Large cap stocks. There is no set standard allocation which diversified equity funds follow; every fund manager would have specific strategy for managing the fund.The other funds like “Opportunities Funds” also come under the category of diversified equity funds. During the bearish phase of the market, a diversified equity fund might invest 85% of the corpus into Large Cap stocks and balance 15% would be allocated between Mid & Small Cap stocks. The fund manager would take a moderate aggressive stand in the bullish market by investing 75-80% in Large Cap and the rest in Mid and Small cap stocks. Diversified equity funds would give stability and consistency of large cap funds by investing predominantly in Large cap and the Mid & Small Cap stocks would act as a returns booster to the portfolio.
- Small Cap Funds: Stocks with market capitalization of less than Rs. 2000 crs is considered as small cap. They are in the large numbers compared to large and mid-cap, hence making the life of a fund manager difficult in choosing the right set of the stocks for the portfolio. “Catch them young”: Small cap stocks carry great potential for multi bagger returns in the long run; it’s like identifying Infosys stock at the initial stages of the company life cycle. But small cap stocks tend to be more volatile compared to Large and Mid-cap stocks and perform only at specific market cycles. Because of this nature, small cap stocks are considered to be riskiest among the three categories.
- Mid Cap Funds: The stocks selected by the fund manager for this category of funds are generally considered as future leaders. One way of identifying mid cap stocks could be 150 stocks beyond large cap stocks are considered as mid cap. Other school of thought defines Mid-cap stocks with a market capitalization between Rs. 2000 – Rs. 10,000 crs. Since the mid-sized companies are not fully grown into large sized companies, these stocks have higher growth potential when compared to large cap stocks. Because of this, mid-cap stocks tend to outperform in bullish markets and vice versa.
- Large cap funds: Money collected under this fund is invested in large sized companies. The size of the company is defined based on the market capitalization (Market Capitalization = no of shares issued by the company X market price per share) of the company. There is no standard definition to categorize the companies based on the size. However, one way of categorizing the companies could be top 50 stocks listed in BSE/NSE are called as “Large Cap”. The other way of categorizing large cap stocks could be, any stock with a market capitalization beyond Rs. 10,000crs. Large cap stocks are generally considered as a safe bet because of that fact that they are less volatile.
- Sectoral Funds: As the name suggests, the money collected under this fund invests in a specific sector for eg: Pharmaceutical, Banking, FMCG etc. Sectoral funds are considered as riskiest funds in equity mutual funds category, because the performance of different sectors is cyclical in nature. Not all the sectors perform at the same time. At any given point of stock market cycle different sectors tend to perform. To make the best out of sectoral funds, an investor would have to enter the fund at the right time. Betting on the right sector, gives the fund manager that extra 1-2 % returns. While betting on the wrong sector, causes the drop in returns.
- Thematic Funds: While sector funds invest in one or two sectors, thematic funds invest in a bunch of sectors that are woven by a common theme, such as infrastructure, consumer spending, fast-moving consumer goods and so on. These are the riskiest of all types of funds as their portfolios are typically very concentrated.
- Index Funds: These are primarily passively managed Funds. They invest into bunch of stocks which represent an index such as NIFTY, BANK NIFTY, etc.
- Tax savings/ELSS: These funds offer tax benefits to investors under the Income Tax Act, 2961. Opportunities provided under this scheme are in the form of tax rebates under section 80 C of the Income Tax Act, 1961. They are best suited for long investors seeking tax rebate and looking for long term growth but come with a 3 year lock-in period.
Debt funds invest only in fixed income securities of different maturity tenures. Depending upon the maturity of the underlying debt securities, they are classified into Long Term, Medium Term, Short Term & Liquid Funds. Debt funds invest in fixed-income yielding instruments.
- Bond funds invest in corporate bonds and partly in government securities. These funds are long-term and short-term in nature. Typically, long-term bond funds carry an average maturity of around three to about five or maybe even 10 years. The longer a debt fund’s average maturity, the riskier it gets because scrips with long maturities take a long time to get wound up and therefore get exposed to market vagaries and volatility for a long time. Depending upon the interest rate environment you must allocate to these funds. If the interest rates are expected to fall, you may allocate more on funds with longer maturity.
- G-Secs: The second type of debt funds is government securities (G-sec) funds. Like bond funds, these too come in long-term and short-term variety. These are mostly seasonal funds as they invest only in government securities; scrips issued by the Reserve Bank of India. Though government securities are the safest debt instruments because they are issued by the government of India and hence come guaranteed, they are also the most volatile because they are the most liquid debt instruments in the debt market. Allocate to these funds when you expect interest rates to fall.
- Liquid and ultra short-term funds are meant to park your surplus cash instead of lying in a savings deposit. While liquid funds are meant to park your cash for up to a month, use ultra short-term funds if you wish to invest your cash for up to three-six months. These are considered to be the least risky because they invest in scrips that mature in a very short time.
Hybrid Funds– the funds belonging to this category is a mix of any of the above categories. Most common hybrid categories are :
- Balanced Funds – These funds invest not less than 65% into Equity shares and the remaining is invested into debt. It provides a ready made diversified asset mix for the investors and are also tax efficient (no tax on Long Term Capital Gains on these funds).
- Monthly Income Schemes – These are debt heavy funds with any where from 70-100% of their corpus invested into debt securities and remaining invested into Equity. These funds provide investors stability along with growth opportunity.
- Gold Funds – Invest into Gold ETFs.
- Fund of Funds – these funds are similar to Gold Funds, except that they invest in funds of any types and not just restricted to Gold. For example, a fund may invest into other funds of different geographies.