Different Types Of Mutual Funds in India & Their Benefits in 2022
Importance of asset allocation for a diversified portfolio
An investor should follow an asset allocation based on his/her risk profile. Hence, investing in diverse asset classes like equity mutual funds, fixed income products, gold, etc. Within the equity class also, an investor should diversify further into different types of equity mutual funds. To do that, an investor should have a good understanding of large, mid, small, and multi-cap mutual funds. Therefore, this article will focus on some of the different types of equity mutual funds.
SEBI classification of mutual funds
On a broader level, SEBI has classified mutual funds into the following categories:
- Equity schemes
- Debt schemes
- Hybrid schemes
- Solution-oriented schemes
- Other schemes
SEBI has further classified equity schemes into the following sub-categories:
- Large-cap fund
- Large & mid-cap fund
- Mid-cap fund
- Small-cap fund
- Multi cap fund
- Dividend yield fund
- Value fund
- Focused fund
- Sectoral/thematic fund
- Equity-linked saving scheme (ELSS)
We will discuss some of the above funds based on market capitalisation.
SEBI has defined large-cap companies as 1st – 100th companies in terms of full market capitalisation. A large-cap fund is an open-ended equity scheme that predominantly invests in large-cap companies. A distinguishing characteristic of a large-cap fund is that it has to invest a minimum of 80% of its total assets in equity and equity-related instruments of large-cap companies.
All equity funds carry risk. However, a large-cap fund is relatively less risky as compared to a mid or small-cap fund. This is because a large-cap fund invests in large-cap companies that have proved themselves over time and have generated wealth for its shareholders. In addition, most of these companies are leaders in their respective sectors and have stable earnings. Thus, they are commonly referred to as blue chips.
Large-cap funds are suitable for investors with a risk appetite but relatively lower than a mid- or small-cap fund investor. Accordingly, although good, the potential returns of these funds will be relatively lower than those of mid and small-cap funds.
Large-cap fund example – Mirae Asset Large Cap Fund
The Mirae Asset Large Cap Fund aims to combine the consistency of large-cap companies (> 80%) with some conviction mid-cap ideas (up to a maximum of 20%). The fund’s investment approach is centred around participating in high-quality businesses up to a reasonable price and holding the same over an extended period. The fund has the Nifty 100 as the benchmark index.
|Investment time horizon||Fund returns||Nifty 100 - Benchmark returns||S&P BSE Sensex returns|
As we can see from the above table, the fund has given superior returns as compared to the benchmark (Nifty 100) and the S&P BSE Sensex over various periods of investment (1 year, 3 years, 5 years, since inception). The returns are as of 30th April 2021.
SEBI has defined mid-cap companies as 101st – 250th companies in terms of full market capitalisation. A mid-cap fund is an open-ended equity scheme that predominantly invests in mid-cap companies. A distinguishing characteristic of a mid-cap fund is that it has to invest a minimum of 65% of its total assets in equity and equity-related instruments of mid-cap companies.
A mid-cap fund is relatively riskier than a large-cap fund and relatively less risky than a small-cap fund. A mid-cap fund invests in mid-cap companies that have proved themselves to some extent and have the potential to become large-cap companies in future. These companies have emerged from small-cap companies to mid-cap companies presently and can generate a lot of wealth for their shareholders in the future.
Mid-cap funds are suitable for investors with a moderate risk profile, relatively higher than that of a large-cap fund investor and relatively lower than that of a small-cap fund investor. Accordingly, although good, the potential returns of these funds will be relatively higher than those of large-cap funds and lower than those of small-cap funds.
Mid-cap fund example – Axis Mid Cap Fund
The Axis Mid Cap Fund invests predominantly in mid-cap companies to achieve long-term capital appreciation. The fund has the S&P BSE Midcap Index as the benchmark index and the Nifty 50 as the additional benchmark.
|Investment time horizon||Total amount invested||Market value (as on 30-04-21)||Fund returns (annualised)||Benchmark returns (annualised)|
|Since inception (18-02-11)||12,20,000||34,04,808||19.15%||15.18%|
As can be seen from the above table, a SIP of Rs. 10,000 per month in the fund, over the last 10 years, has given superior returns as compared to the benchmark. The returns are as of 30th April 2021.
SEBI has defined small-cap companies as the 251st company onwards in terms of full market capitalisation. A small-cap fund is an open-ended equity scheme that predominantly invests in small-cap companies. A distinguishing characteristic of a small-cap fund is that it has to invest a minimum of 65% of its total assets in equity and equity-related instruments of small-cap companies.
A small-cap fund is relatively riskier as compared to a large-cap fund and a mid-cap fund. A small-cap fund invests in small-cap companies that are relatively new and are yet to prove themselves. They can become mid-cap companies soon and even large-cap companies in the distant future. These companies have the potential to generate a lot of wealth for their shareholders in future.
Small-cap funds are suitable for investors with an aggressive risk profile, relatively higher than a large or mid-cap fund investor. Accordingly, the potential returns of these funds are good and relatively higher than those of large and mid-cap funds.
Small-cap fund example – DSP Small Cap Fund
The DSP Small Cap Fund predominantly invests in small-cap companies to seek long-term capital appreciation. The fund gives access to investors to a large pool of varied, uncorrelated stocks. The fund invests in niche companies that are under-researched and under-owned. The fund has the S&P BSE Small-Cap Index as the benchmark.
|Investment time horizon||Fund returns||S&P BSE Smallcap - Benchmark returns||Nifty 50 returns|
As we can see from the above table, the fund has given superior returns as compared to the benchmark (S&P BSE Smallcap) and the Nifty 50 in the long run (5 years and 7 years). The returns are as of 30th April 2021.
Multi cap fund
A multi-cap fund is an open-ended equity scheme that invests across large, mid, and small-cap companies. A distinguishing characteristic of a multi-cap fund is that it has to invest a minimum of 75% of its total assets in equity and equity-related instruments. The fund has to invest a minimum of:
25% of its total assets in equity and equity-related instruments of large-cap companies
25% of its total assets in equity and equity-related instruments of mid-cap companies
25% of its total assets in equity and equity-related instruments of small-cap companies
A multi-cap fund is relatively riskier than a large-cap fund and relatively less risky than a mid-cap fund and a small-cap fund. This is because a multi-cap fund invests in large, mid and small capitalisation companies across the spectrum.
Multi cap funds are suitable for investors who want to invest in companies across market capitalisation in a single fund itself.
Multi-Cap Fund example – ICICI Prudential Multi-Cap Fund
The ICICI Prudential Multi-Cap Fund aims at long-term wealth creation by investing in companies across market capitalisation. The scheme has Nifty 500 Multicap 50:25:25 as the benchmark.
|Investment time horizon||Fund returns||Nifty 500 Multicap 50:25:25 - Benchmark returns||Nifty 50 returns|
As can be seen from the above table, the scheme has given better returns than the benchmark in the long run but has under-performed in the short run. The returns are as of 30th April 2021.
Apart from the broad classification of Mutual Funds, they can also be classified on the basis of Asset Class, Investment Goals, funds based on Risks etc. These specific types of Mutual Funds are discussed below.
Mutual Funds Based on Asset Class
An asset class is a collection of investments with comparable characteristics that are governed by the same laws and regulations. As a result, asset classes are formed up of products that often act similarly in the marketplace. Types of Mutual Funds based on asset classes are listed below.
- Equity Funds: Equity Funds are often known as stock funds since they typically invest in equities. They invest the money received from a diverse group of people in the shares/stocks of various companies. The stock market performance of the invested shares determines the gains and losses connected with these funds (price increases or decreases).
- Debt Funds: Debt funds invest primarily in fixed-income securities such as bonds, equities, and Treasury bills. They invest in fixed-income instruments such as Fixed Maturity Plans (FMPs), Gilt Funds, Liquid Funds, Short-Term Plans, Long-Term Bonds, and Monthly Income Plans, among others. Since the investments have a set interest rate and maturity date, they can be a good choice for passive investors looking for consistent income (interest and capital appreciation) with little risk.
- Money Market Funds: Investors buy and sell stocks on the stock market. The money market, often known as the capital market or cash market, is another option for investors. The government manages it by issuing money market assets such as bonds, T-bills, dated securities, and certificates of deposit in partnership with banks, financial institutions, and other enterprises.
- Hybrid Funds: As the name implies, hybrid funds (Balanced Funds) are an ideal mix of bonds and equities, spanning the gap between equity and debt funds. It's possible that the ratio will be constant or changing. In a nutshell, it combines the best features of two mutual funds by allocating 60% of assets to stocks and 40% to bonds (or vice versa).
Mutual Funds Based on Investment Goals
Mutual Funds come in a variety of shapes and sizes, depending on your investment objectives. As every individual has different goals and objectives, there are different types of mutual funds to cater to their interest.
- Growth Funds: Growth funds invest a large portion of their assets in stocks and growth sectors, making them excellent for investors (mostly Millennials) who have additional cash to engage in riskier (but potentially higher-returning) plans or who are excited about the scheme.
- Income Funds: Income funds are a type of debt mutual fund that invests in bonds, certificates of deposit, and other securities. They're suitable for risk-averse investors with a two- to three-year time horizon.
- Liquid Funds: Since they invest in debt instruments and money market funds with a duration of up to 91 days, liquid funds, like income funds, are debt funds. Rs 10 lakh is the maximum amount that can be invested. The method by which liquid funds calculate their Net Asset Value distinguishes them from other debt funds. The NAV of liquid funds is computed for the entire year (including Sundays), but the NAV of other funds is calculated only for working days.
- Tax-Saving Funds: ELSS, or Equity Linked Savings Schemes, have been increasingly popular among all types of investors over time. They offer the lowest lock-in period of only three years, allowing you to maximise your wealth while saving money on taxes. These funds are excellent for salaried investors who want to make long-term investments.
- Aggressive Growth Funds: The Aggressive Growth Fund, which is a little riskier in terms of investing, is designed to make big money. Despite being sensitive to market volatility, a fund's beta (a measure of the fund's movement in respect to the market) may be chosen.
- Capital Protection Funds: Capital Protection Funds might help you achieve your goal of protecting your money while generating lesser returns (12 per cent at best). The fund manager invests a portion of the money in bonds or CDs and the remainder in stocks. Despite the low danger of losing money, it is recommended that you stay invested for at least three years (closed-ended) to protect your money, and the rewards are taxable.
- Fixed Maturity Funds: Many investors choose to invest at the end of the fiscal year in order to benefit from triple indexation and decrease their tax liability. Fixed Maturity Plans (FMP) - invest in bonds, securities, money market funds, and other assets until they reach maturity. They are a wonderful option if you're concerned about debt market trends and hazards.
- Pension Funds: Most scenarios (such as a medical emergency or a child's wedding) can be covered by putting a portion of your income into a chosen pension fund over a lengthy period of time to protect your and your family's financial future after retiring from a regular job. Savings (no matter how large) do not last forever, so relying completely on them to see you through your golden years is not advised. EPF is one example, but there are several lucrative schemes offered by banks, insurance companies, and other financial institutions.
Mutual Funds Based on Risk Appetite
Investors have different risk-taking capabilities which collectively is termed as Risk Appetite. On the basis of risk appetite, an investor has, the different types of Mutual Funds are divided into the following types:
- Very-Low Risk Funds: Since liquid funds and ultra-short-term funds (one month to one year) have a low risk profile, their returns are likely to be small as well (6 per cent at best). Investors that wish to achieve their short-term financial goals while keeping their money safe choose this choice.
- Low-Risk Funds: In the event of a rupee depreciation or an unexpected national catastrophe, investors are unwilling to invest in risky funds. Fund managers recommend investing in a liquid, ultra-short-term arbitrage fund, or a combination of similar funds, in such cases. Returns could be in the region of 6 to 8%, but investors have the opportunity to sell when valuations become more stable.
- Medium-Risk Funds: The risk element is moderate because the fund management invests a portion of the assets in debt and the rest in equity funds. The NAV is not particularly volatile, and average returns of 9-12 per cent are possible.
- High-Risk Funds: High-risk mutual funds necessitate aggressive fund management and are appropriate for investors who have no risk aversion and seek significant interest and dividend returns. As performance reviews are sensitive to market volatility, they must be conducted on a regular basis. On average, you can expect a 15% return on your investment, although most high-risk funds provide returns of up to 20%.
Specialised Mutual Funds
Specialized funds concentrate on very particular industries, such as commodities, geographies, or market segments. These funds include sector funds, balanced funds, asset allocation funds, and target-date funds. Investors can use these funds to get into banking, real estate, chemicals, energy, or telecommunications. Different types of Specialised Mutual Funds that can be traced are given below.
- Sector Funds: Theme-based mutual funds invest primarily in a single industry sector. Since these funds only invest in a few firms in specialised areas, the risk factor is higher. Keeping an eye on the numerous sector-related happenings is a good idea for investors. Sector funds are also very profitable. Some industries, such as banking, IT, and pharmaceuticals, have had rapid and continuous growth in recent years and are expected to continue to do so in the future.
- Index Funds: Index funds are great for passive investors because they invest in an index. It is not managed by a fund manager. An index fund identifies stocks and their related market index ratios, then invests in similar equities in a similar proportion. They play it safe by mirroring the index's performance, even if they are unable to exceed the market (this is why they are not well-liked in India).
- Funds of Funds: 'Funds of Funds,' also known as multi-manager mutual funds, are meant to take advantage of this by investing in a variety of fund categories. In brief, choosing one fund that invests in a variety of funds rather than numerous funds accomplishes diversification while also lowering costs.
- Emerging Market Funds: Investing in developing markets is considered a high-risk venture with a history of negative returns. India is a dynamic and rising economy where domestic stock market investors can make substantial profits. They, like other markets, are subject to market swings. In the long run, developing economies are likely to account for the vast bulk of global growth in the next decades.
- International Funds: Foreign mutual funds, which are popular among investors trying to diversify their portfolios beyond India, can provide strong returns even when the Indian stock markets are performing well. A hybrid technique (say, 60% domestic equities and 40% overseas funds) a feeder approach (getting local funds to invest in foreign stocks) or a theme-based allocation can all be used by an investor (e.g., gold mining).
- Global Funds: Apart from the similar linguistic meaning, global funds and international funds are not the same things. While a global fund primarily invests in global markets, it may also invest in your native country. The International Funds are solely focused on international markets. Global funds, with their diverse and worldwide approach, can be extremely risky due to differing policies, market and currency fluctuations, yet they do function as a hedge against inflation, and long-term returns have historically been good.
- Real-Estate Funds: Despite India's real estate growth, many investors are still afraid to participate in such projects because of the numerous dangers involved. The investor will be an indirect participant in a real estate fund because their money will be invested in established real estate companies/trusts rather than projects. When it comes to purchasing a house, a long-term investment eliminates dangers and legal problems while also providing some liquidity.
- Commodity Funds: These funds are appropriate for investors that have a high-risk tolerance and want to diversify their holdings. Commodity-focused stock funds allow you to experiment with a wide range of transactions. Returns, on the other hand, are not always predictable and are reliant on the stock company's or the commodity's performance. In India, gold is the only commodity that mutual funds can invest indirectly. The rest invest in commodity fund units or shares.
- Market Neutral Funds: Market-neutral funds are ideal for individuals who want to shield themselves from unfavourable market trends while still earning a good return (like a hedge fund). These funds offer strong returns due to their higher risk-adaptability, allowing even modest investors to outperform the market without exceeding their portfolio limitations.
- Inverse Funds: The returns of an inverse index fund move in the opposite direction of the benchmark index, whereas the returns of a conventional index fund move in the same direction. It's simply selling your shares when the stock price falls, then repurchasing them at a lower price (to hold until the price goes up again).
- Asset Allocation Funds: This is a very flexible vehicle that combines debt, equity, and even gold in an optimal ratio. Asset allocation funds can regulate the equity-debt distribution using a pre-determined formula or a fund manager's conclusions based on current market patterns. It's similar to hybrid funds, but it necessitates the fund manager's extensive knowledge in selecting and allocating bonds and equities.
Exchange-Traded Funds: Exchange-traded Funds have given investors access to a whole new world of investment opportunities, allowing them to gain broad exposure to global stock markets as well as specialised industries. ETFs are a sort of mutual fund that can be traded in real time at a fluctuating price throughout the day.
Now that we understand the different types of equity mutual funds based on market capitalisation, let us now understand how investors can benefit by investing in them. Based on asset allocation parameters, an investor can invest in various equity mutual funds as follows:
Risk profile: An investor with an aggressive risk profile can take higher exposure to small and mid-cap funds and lower exposure to large-cap funds.
An investor with a moderate risk profile can invest a majority of his/her equity portion of money in a multi-cap fund. This fund will give him/her balanced exposure to large, mid, and small-cap companies.
An investor with a lower risk profile can take higher exposure to large-cap funds and lower exposure to small and mid-cap funds.
Time left to achieve goals: An investor can also decide his/her exposure to various equity funds based on the time left to achieve financial goals.
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Q1: What are the many types of mutual funds available in India?
A1: On October 6, 2017, SEBI notified the reclassification of mutual fund schemes. It was done to promote uniformity to the mutual fund industry, as many mutual fund schemes had been introduced. SEBI categorises mutual funds into the following groups: Equity Funds like Large Cap, Mid Cap, Small Cap, Large-Mid Cap, Multi Cap etc., Debt Funds like Liquid Fund, Money Market Fund and so on, Hybrid Funds like Balanced Hybrid Funds, Arbitrage Funds and so on Solution Oriented Schemes like Retirement Fund, Children’s Fund, Others (Index Funds & International Funds)
Q2: What can be understood by Open Ended, Closed Ended and Interval Funds?
A2: An open-ended fund is one that can be bought and sold at any moment. Closed-ended funds can only be purchased from the fund house during a new fund offering (NFO) and can only be sold once the closed-ended fund's period has expired. Interval funds have a set of periodic intervals during which they can be bought and traded.
Q3: I will be investing for the first time, what type of Mutual Fun should I start investing in?
A3: When it comes to investing in mutual funds for the first time, it all comes down to risk appetite, or how much risk one is willing to take. If you're not confident about your risk-taking ability, start modest (Rs.500–1000 as a lump sum) and invest in equity mutual funds. Once an investor has understood the nuances of mutual funds and is ready to take greater risks, the amount can be increased as well as the investor can go with the Medium-risk funds.
Q4: What is the difference of risk factor and returns on Mid-cap and Large-cap Mutual Funds?
A4: A mid-cap fund has a higher risk profile than a large-cap fund and a lower risk profile than a small-cap vehicle. A mid-cap fund invests in mid-cap companies that have demonstrated their worth and have the potential to grow into large-cap firms in the future. These companies have progressed from small-cap to mid-cap status, and they have the potential to generate significant value for their owners in the future. Mid-cap funds are appropriate for investors with a moderate risk profile, which is higher than that of a large-cap fund but lower than that of a small-cap fund.
Q5: What type of Mutual Fund is recommended for a shorter term say suppose 2-3 years?
A5: It is critical that the funds chosen for a short-term time horizon of 2–3 years are less volatile and hence provide somewhat predictable returns. Following funds can be advised in this situation: Medium-term debt funds: These funds provide higher yields than bank FDs, as well as liquidity and low volatility. These funds, however, are subject to capital gains tax.
Equities-saving funds are conservative hybrid funds with about 30% exposure to equity and the remainder in debt and debt-like securities (arbitrage). These funds have the advantage of being categorised as equity funds, which means they do not draw long-term capital gains. As a result, after one year, the corpus is tax-free. Balanced funds, which have 65 percent equity and 35 percent debt, are another choice. These funds have larger returns, but they can also be more volatile.