Equity Mutual Funds

Equity mutual fund is one of the major mutual fund categories that invests primarily in equity and equity-related securities, i.e., the shares of the listed companies, with an aim to generate long-term capital appreciation. As these funds are market-linked, their returns can fluctuate with changes in stock prices and broader market conditions. Consequently, they may experience periods of volatility.

Equity mutual funds pool money from multiple investors and use it to build a portfolio of stocks and other permitted securities based on the scheme's investment objective. Here's how they work:

• You invest in a mutual fund scheme - Through a lump sum payment or SIP, you invest in an equity mutual fund scheme.
• The fund manager invests in equities - The fund manager uses the pooled money to purchase the units of equity and equity related instruments based on their applicable NAV and according to the scheme's mandate.
• Your money is spread across multiple securities - Instead of investing your entire amount in one or a few companies, the fund may hold shares of several companies. The extent of diversification depends on the fund category and investment strategy.
• The portfolio value changes with the market - When the prices of stocks held by the fund rise, the value of the portfolio may increase. Similarly, a fall in stock prices can reduce the portfolio value and the fund's NAV.
• Returns can come from capital appreciation and income - The fund may earn through appreciation in the value of its equity holdings and, where applicable, dividends or other income received from investments.
• The fund manager manages the portfolio - In actively managed funds, the fund manager researches companies and decides which securities to buy, hold or sell. In passive funds, the portfolio is designed to track a particular index.

A brief introduction to different types of equity mutual funds is given as follows:

• Large Cap Funds - These funds invest at least 80% of total assets in the equity and equity related instruments of large-cap companies. Large-cap companies are the top 100 companies by full market capitalisation. Such funds usually have lower volatility than mid- and small-cap segments, although they remain subject to equity-market risk.
• Large and Mid Cap Funds - These funds invest at least 35% of total assets in the equity and equity related instruments of mid cap and large cap companies each. These funds offer exposure to the relative stability of established large-cap companies along with the growth potential of mid-cap companies within an equity portfolio.
• Mid Cap Funds - These funds invest at least 65% of total assets in the stocks of mid-cap companies. Mid-cap companies are ranked 101st to 250th by full market capitalisation. These funds can offer higher growth potential but may experience greater volatility than large-cap funds.
• Small Cap Funds - These funds invest at least 65% of total assets in the stocks of small-cap companies. Small-cap companies are ranked 251st onwards by full market capitalisation. These funds can offer higher growth potential but generally carry higher volatility and risk.
• Multi Cap Funds - These funds invest at least 75% of total assets i.e., at least 25% of total assets each in the stocks of large-cap, mid-cap and small-cap companies. The allocation requirement can help ensure that the portfolio remains diversified across market-cap categories.
• Flexi Cap Funds - Invest at least 65% of total assets in equity and equity-related instruments. The fund manager can dynamically allocate across large-, mid- and small-cap companies without a fixed minimum allocation to each segment.
• Dividend Yield Funds - These funds predominantly invest in stocks of companies that have a relatively high dividend yield. They are required to invest at least 80% of their total assets in equity and equity related instruments. The portfolio may offer investors a combination of potential capital appreciation and dividend income from the underlying companies.
• Value Funds - These funds follow a value investment strategy, usually investing in stocks that the fund manager believes are trading below their intrinsic or fundamental value. The fund invests at least 80% of their total assets in equity and equity-related instruments. The strategy aims to benefit if the market eventually recognises the perceived value of these stocks.
• Contra Funds - These funds follow a contrarian investment strategy, investing in stocks or sectors that may currently be out of favour with the broader market but have the potential to recover or perform better over time. They must invest at least 80% of their total assets in equity and equity-related instruments. This approach may involve taking positions that differ from prevailing market sentiment.
• Focused Funds - These funds invest in a concentrated portfolio of up to 30 stocks, with the scheme specifying its investment focus, such as large-cap, mid-cap, small-cap or multi-cap stocks. They must invest at least 80% of their total assets in equity and equity-related instruments. The concentrated portfolio can increase the impact of both gains and losses from individual holdings.
• Sectoral Funds - These funds predominantly invest in the stocks of companies belonging to a specific sector such as banking, healthcare, technology or infrastructure. They must invest at least 80% of their total assets in equity and equity-related instruments of the specified sector. Their performance is closely linked to the growth prospects and market conditions of that sector. As a result, they may carry higher concentration risk than diversified equity funds.
• Thematic Funds - These funds predominantly invest in stocks of companies linked to a specific investment theme, such as manufacturing, consumption or infrastructure. Unlike sectoral funds, a theme can span multiple sectors, but the portfolio remains focused on a common investment idea. They must invest at least 80% of their total assets in equity and equity-related instruments aligned with the chosen theme. Since these funds concentrate on a particular theme, their performance can be significantly influenced by the growth prospects and market conditions associated with it, making them potentially more concentrated than diversified equity funds.
• Equity Linked Savings Scheme (ELSS) - It is an equity-oriented mutual fund category with a 3-year lock-in period. Investments in ELSS qualify for a deduction under Section 80C (in the old tax regime), subject to the applicable tax regime and overall limits. The aggregate deduction available under Section 80C is up to Rs 1.5 lakh in a financial year. ELSS is therefore commonly considered by investors looking for an equity investment option along with tax-saving benefits.

You can invest in equity mutual funds through Paisabazaar app by following these steps:

Step 1: Open the Paisabazaar app and tap on “Mutual Funds”.

Step 2: Compare and select the equity mutual fund of your choice.

Step 3: Choose either lump sum or SIP as the method of investing.

Step 4: Enter the investment amount and complete your KYC.

Step 5: Make the payment to invest in the scheme.

Equity mutual funds may be worth considering if you:

1. Seek a fund that predominantly invests in the equity and equity related instruments
2. Are looking for long term capital appreciation
3. Have a higher risk tolerance

• Market Risk: The value of equity investments can rise or fall based on stock-market movements and broader economic conditions.
• Volatility Risk: Equity funds can experience significant short-term price fluctuations, particularly during periods of market uncertainty.
• Concentration Risk: Sectoral, thematic and focused funds may have higher exposure to specific companies or sectors, which can amplify losses if those investments underperform.
• Liquidity Risk: Some underlying securities may be less liquid, particularly during stressed market conditions, which can affect the fund's ability to buy or sell securities efficiently.
• Fund Management Risk: The performance of actively managed funds can be affected by the fund manager's investment decisions.
• Tracking Error: Passive funds may not exactly match the performance of their benchmark because of expenses, transaction costs, cash holdings and other factors.

For equity-oriented mutual funds, capital gains taxation generally depends on how long you hold the units.

STCG and LTCG

If you sell equity mutual fund units within 12 months of purchase, the gains are generally treated as short-term capital gains (STCG). STCG on qualifying equity-oriented fund units is currently taxed at 20%, subject to applicable conditions.

If you sell the units after more than 12 months, the gains are generally treated as long-term capital gains (LTCG). LTCG on qualifying equity-oriented fund units is currently taxed at 12.5%.

LTCG Exemption

For qualifying equity-oriented investments covered under Section 112A, LTCG of up to Rs 1.25 lakh in a financial year is exempt.

The 12.5% LTCG tax applies to the eligible gains exceeding this annual exemption, subject to applicable provisions.

ELSS

Investments in ELSS can qualify for a deduction of up to Rs 1.5 lakh under Section 80C, subject to the applicable tax regime and overall Section 80C limit.

However, ELSS comes with a 3-year lock-in, meaning you generally cannot redeem the units before completing three years from the date of investment.

The tax deduction under Section 80C and the taxation of gains on redemption are separate matters. ELSS does not make the eventual capital gains tax-free.

Dividend Taxation

Mutual fund dividends are referred to as Income Distribution under the applicable framework and are taxable in the hands of the investor at their applicable income-tax rate.

Therefore, investors should not assume that choosing a dividend-paying option makes the income tax-free.

How SIP Taxation Works: FIFO Rule

Each SIP instalment is treated as a separate investment for taxation purposes.

For determining which units have been sold, the First-In, First-Out (FIFO) method is generally followed. This means the units purchased first are considered sold first.

For example:

• You invest Rs 5,000 through a SIP in January.
• You invest another Rs 5,000 in February.
• You redeem part of your investment in August.

The January units are considered for redemption first under the FIFO method. The holding period of those units determines whether the resulting gain is short-term or long-term.

Therefore, even if your SIP has been running for several years, each instalment has its own purchase date and holding period.