Types of Mutual Funds in India
For young people, having a sound, thought out financial plan is essential, and investment should constitute a significant part of such a plan. Mutual funds allow investors to diversify their portfolios. Start with a small amount of investment and plan tax savings. For this, it is essential to understand the different types of mutual funds that are available. In addition, the returns that investors receive from their mutual fund investments depend almost entirely on the type of mutual fund you pick.
These mutual fund types could vary based on several factors - asset type, duration, and more. To understand which type of mutual fund you should pick, first understand the different types of mutual funds in the market.
Types of Mutual Funds
Mutual funds can be of various types depending on the principal investments, maturity period, goals of the mutual fund investment, etc.:
Types of Mutual Funds: Based on Principal Investments
- Equity Funds
Among the most popular types of mutual funds in India, with over 325 schemes, the principal investment is in stocks in equity funds. By and large, these funds aim to grow faster, and this often means higher returns. These funds can be further classified based on the size of the companies they invest in.
According to the Securities and Exchange Board of India (SEBI), large-cap funds are the funds that invest in the top 100 companies by market capitalization. Market capitalization refers to the company's worth based on the stock market, the total value of a company's stock.
Mid-cap funds are those funds that invest in companies that rank from 101 to 250 in market capitalization.
Small-cap funds invest in companies that rank beyond 250 in market capitalization.
Equity mutual funds are designed to enable tax savings for investors are known as Equity Linked Savings Schemes (ELSS). These mutual fund schemes invest a major portion of their corpus into equity or equity-related instruments. They allow individual investors to save taxes up to Rs. 1,50,000 under Section 80C of the Income Tax Act. Most ELSS schemes allow investors to begin with relatively low investment amounts and offer a diverse investment portfolio.
- Debt Funds
Equity funds may be extremely popular, but debt funds are no slouch. They outnumber equity funds - with 326 active schemes in India catering to over 7 lakh investors. Debt funds invest in fixed income instruments such as bonds, money market instruments, debt securities. Therefore, they are also called bond funds or fixed income funds. Debt is different from equity since the investors receive a fixed return on their investments. If the debt issuer is liquidated, investors retain first rights to accept the returns.
Therefore, debt funds are low-cost funds with stable returns and reasonably low risk. They are ideal for those investors who are risk-averse and are seeking regular income. Debt funds can be of many types.
- Based on the duration, there can be overnight funds with a maturity of 1 day, ultra-short duration funds for three to six months, low duration funds for 6 months to a year, short-duration funds for 1 to 3 years, medium duration funds, medium to long-duration funds, and long-duration funds for more than seven years.
- In addition to this, corporate bond funds invest a minimum of 80 percent of their assets in corporate bonds. Banking and PSU funds invest a minimum of 80 percent of their assets in debt securities of PSUs and banks. Gilt funds invest similar amounts in government securities.
- Hybrid Funds
Hybrid funds are not limited to a single asset class. Most often, they invest in a combination of equity and debt assets. Other assets, such as real estate and gold too, can figure in their portfolio. These funds rely on strategic asset allocation and diversification. They also involve correlation, which involves the co-movements of the returns of the assets.
As a result, they try to offer the beneficial aspects of both asset classes. Naturally, hybrid funds tend to be riskier as compared to debt funds but safer than equity funds. At the same time, they offer better returns than debt funds but not as high as equity funds. This involves a bit of a trade-off between risk and returns.
Types of Mutual Funds: Based on Maturity Period
- Open-Ended Funds
As the name suggests, open-ended mutual funds allow investors to buy and sell their assets at any point in time. There are no minimum duration restrictions, and the prices are linked to Net Asset Value (NAV). Therefore, these funds have high liquidity. As of September 2020, there are over 980 open-ended mutual fund schemes in India.
- Close-Ended Funds
In contrast, close-ended funds have a stipulated maturity period. Investors have to wait for the NFO (New Fund Order), the initial launch period, to invest in these funds. New mutual fund investments are not allowed once the offer closes. However, there are specific exit options available to investors. Close-ended mutual fund schemes are relatively popular, with nearly 750 active in India as of September 2020.
Other Types of Mutual Funds
- Index Funds and ETFs
Index funds attempt to track a specific index, such as Sensex or Nifty. Often also called passively managed funds, index funds involve buying securities that accurately reflect the constituents of the benchmark/index. They're famous for being relatively risk-free over the long term and for their low expense ratios. There are about 35 index funds currently operating in India backed by nearly 7.5 lakh investors.
Source: Glide Invest, Twitter
ETFs are Exchange Traded Funds that involve a collection of securities and track a particular index, much like index funds. They are similar to mutual funds but are listed on exchanges and trade throughout the day. They generally offer low expense ratios.
- Fund of Funds
As is evident by the name, these are mutual funds that invest in other mutual funds. As a result, they manage to achieve even broader diversification and, therefore, lower risk.
- Solution-Oriented Schemes
A relatively minor category with about 35 active schemes, Solution-oriented mutual fund schemes, targets achieving a specific goal. For example, a Retirement Fund may have a lock-in period of 5 years or up to retirement. A Children's Fund may have a lock-in period until the child comes of age. Many people turn towards mutual funds only for achieving some specific goals. For instance, for 73% of US mutual fund owners, saving for retirement is the primary financial goal.
How to Pick the Right Mutual Funds
For any investor, the right mutual fund will meet their individual needs. However, there are multiple factors that one must look into while picking suitable mutual funds.
- Risk Profile - Investors must assess their risk profile and invest according to their risk tolerance. For instance, debt funds may be more suited for individuals with lower risk tolerance.
- Expense Ratio - This is a measure of the cost of running the fund. The expense ratio must be as low as possible because even slight differences can sometimes significantly impact how one's wealth grows over a long period.
- Diversification of Assets - For those investors who are not well versed with how the markets work, breaking your investment in different asset classes can help mitigate risk. Placing all one's bets on a particular sector or industry can be a high-risk venture.
- International or Domestic Funds - While many investors prefer domestic funds, international funds should be a part of your portfolio. You can hedge their investments against rupee depreciation by investing internationally.
In addition to this, mutual fund investment strategies such as SIP and tips such as buying no-load mutual funds can prove profitable in the long run. Systematic investment plans (or SIPs) are schemes that operate on the principle of dollar-cost averaging. They involve investing a certain amount of money at regular intervals into the same mutual fund scheme rather than making a lump-sum investment. SIPs also make it easier to plan out a budget because a small amount of money can be set apart every month for investing. A good example is that o a retirement plan.
Individuals familiar with statistical knowledge can analyze actively managed mutual funds using statistical tools such as R-squared, Beta, Alpha, Expense Ratio, Sharpe Ratio and Tax Cost Ratio. These methods help to analyze the past performances of mutual funds. While the past performance cannot guarantee similar returns, it can help investors take calculated risks sometimes.
The Indian Scenario
Mutual funds are managed by Asset Management Companies (AMCs) that pool the money invested by clients and invest it in various asset classes. The total market value of all the assets managed by the Asset Management Companies is referred to as 'Assets under Management (AUM).
In India, the largest Asset Management Companies in 2020 based on AUM are as follows.
- ICICI Prudential Mutual Fund
- HDFC Mutual Fund
- Aditya Birla Sun Life Mutual Fund
- Reliance Mutual Fund
- SBI Mutual Fund
The Indian mutual fund industry is segmented based on asset class and source of funds. In recent years, it has seen a growing base of individual investors, with an increasing ticket size. According to a report by Mordor Intelligence, as of June 2019, equity funds accounted for 57.4% of individual investors' AUM, while institutional investors preferred the fixed-income segment. The chart below shows the distribution of mutual fund investments made by retail investors into various asset classes.
Mutual funds in India
In the recent past, mutual funds have become an increasingly attractive investment as financial awareness and inclusion has increased. From 2018 to 2019, the total assets managed by the Indian mutual fund industry has increased from 21.36 to 23.79 trillion INR. As a result, there are likely to be many newcomers looking to start their mutual fund investment journey. For this, sound knowledge about the fundamentals of mutual funds, and their types, is essential. At Glide Invest, we're happy to walk you through those initial steps.