A mutual fund is an investment instrument which pools money from multiple investors and invests it in a basket of securities including equity, debt and other money market securities. One of the key features that differentiates different types of mutual funds is that it is a professionally managed investment instrument. Each mutual fund has a designated fund manager who is supported by a team of analysts and takes all the investment decisions of the fund. By investing in a mutual fund, you get a share of the fund’s gains, losses, income and expenses proportional to the amount of your investment. There are various types of mutual funds, however, as per market regulator SEBI (Securities Exchange Board of India), mutual funds in India can be broadly categorised into following five heads based on their asset allocation:
Types of Mutual Funds investing in Equity
A mutual fund scheme which invests a minimum 65% of its assets in stocks/shares of companies is known as an equity scheme. An equity mutual fund enables you to benefit from the diversification of its portfolio as it invests in stocks of around 20-25 companies and has the potential of providing high returns. However all equity fund investments are subject to market risks.
As per SEBI, there are 11 types of equity funds out of which 4 popular types of equity funds are as following:
Large Cap Fund: A large cap fund is an equity scheme which invests at least 80% of its assets in the shares of large cap companies. As per AMFI (Association of Mutual Funds in India), large cap or large capitalisation companies are the top 100 listed companies in terms of their market capitalisation. It is relatively safer to invest in large cap funds than mid cap funds and small cap funds as they invest in bluechip companies.
Small Cap Fund: A small cap fund invests at least 65% of its assets in the stocks of small cap companies. Small cap funds carry a relatively higher amount of risk, however, they do possess the potential of being multibagger funds.
Value Fund/Contra Fund: A value fund invests in the shares of the undervalued companies which have the potential of performing well in near future. Whereas, a contra fund is a fund which follows an investment strategy contrary to what majority of investors are doing in a set of prevailing conditions. The underlying investment belief of a contra fund is that the value of its investments will rise once the the bandwagon effect is over. A fund house is allowed to offer either a value or a contra fund to its investors.
Read more about Equity Funds.
Types of Mutual Funds investing in Debt
A debt mutual fund scheme primarily invests in fixed-income instruments including government securities, corporate bonds, certificates of deposit, etc. They are often considered relatively safer than equity funds and thus have a lower potential of providing high returns in comparison to equity funds. As per SEBI, there are as many as 16 debt scheme. The 4 most popular ones are listed below:
Ultra Short Duration Fund: It is an open-ended debt scheme which invests in fixed-income instruments with which the portfolio has a minimum Macaulay duration of 3 months and a maximum of 6 months. The potentially low risk associated with this type of scheme originates from the short maturity of the securities it is invested in. An investment in this type of
Low Duration Fund: A low duration fund invests in debt and money market instruments with which its portfolio has a Macaulay duration between 6 months to 12 months. It comes with a relatively lower amount of risk than other many other debt schemes which invest in instruments with longer maturity.
Money Market Fund: It is a fund which invests its assets in money market instruments such as certificates of deposit, commercial papers, Treasury bills, Repo, etc. which have a maturity period of maximum 1 year.
Gilt Fund: A gilt fund is a debt scheme which invests a minimum 80% of its assets in government securities. It is a high credit worthy fund since it invests in sovereign securities which have the least chances of default. However, this low risk often results in relatively lower returns as compared to many other types of debt funds.
Read more about Debt Funds.
Common Types of Hybrid Schemes
A hybrid scheme is a mutual fund which invests in two more asset classes including equities, debt instrument, gold, etc. A hybrid fund is ideally placed to hedge its equity risk with the help of debt/money market instruments featured in its portfolio. Market regulator SEBI has categorised 7 types of hybrid funds, the popular ones are as follows:
Dynamic Asset Allocation Fund: A dynamic asset allocation fund is a hybrid scheme which enjoys the flexibility of investing either some portion of its assets in both equity and debt or solely in either of the asset classes. This fund takes positions depending on the performance of equity and debt markets. During favourable equity performance it increases its equity exposure and during impressive performance of debt instruments it gives more weightage to debt in its portfolio.
Arbitrage Fund: This type of mutual fund is mandated to invest at least 65% of its assets in equity and equity related instruments. An arbitrage fund carries a relatively lower amount of risk than an equity fund as it hedges the risk of its equity investments by including various debt instruments in its portfolio.
Balanced Hybrid Fund: A balanced hybrid scheme is required to invest around 40%-60% of its assets in equities and debt each. Such a fund is not allowed to hold arbitrage in its portfolio. In case equity allocation of the scheme exceeds debt allocation, equity mutual fund taxation rules will apply otherwise, debt mutual fund taxation rules will apply. Know more about taxation of mutual funds
Equity Savings Fund: An equity savings scheme invests a minimum of 65% of its assets in equity and equity related instruments and at least 10% of its assets in debt instruments. This is one of most common types of mutual funds sought out by conservative investors.
Read more about Hybrid Funds.
Solution Oriented Schemes
SEBI has categorised retirement fund and children’s fund as solution oriented funds. Both these types of mutual funds feature a lock-in period of 5 years and are aimed at providing a specific solution.
Retirement Fund: An investment in a retirement fund remains locked-in for a period of 5 years or till the investor attains the age of retirement, whichever is earlier. In some cases, retirement funds feature an exit load even if scheme units are redeemed after completion of the 5 year lock-in period.
Children’s Fund: An investment in a children’s fund remains locked-in for a period of 5 years or till the child in whose name the investment is made achieves the age of majority (attains the age of 18 years), whichever is earlier. Even though locked-in this is one of those types of mutual funds that do not offer a tax benefit to the investor.
Other Types of Mutual Funds
SEBI has categorised two passively managed schemes, namely ETFs and FoFs, under this category of mutual fund:
Index Funds: An index fund or Exchange Traded Fund (ETF) is a mutual fund scheme which tracks and replicates the asset allocation of a particular index. These types of mutual funds are required to have an investment portfolio which is at least 95% similar to the index they are tracking. A key benefit of passively managed funds is the low expense ratio associated with them. Though similar in many ways, one major difference between ETFs and Index Funds is that exchange traded funds can be traded on stock markets like shares, index funds cannot.
FOF (Domestic/Overseas): A Fund of Funds (FoF) is a type of mutual fund which invests in other mutual fund schemes (either domestic or international) rather than investing in different asset classes. This is one of the few ways using which an Indian investor can make rupee denominated investments in international markets without special tax clearances or an overseas account.