Mutual Funds – Types and Classification
What are Mutual Funds?
A mutual fund comprises of pool of money collected from various investors who have a common investment objective. The collected pool of money is then used by a fund manager to invest in equities, bonds, money market instruments and other financial assets to help the investors attain their financial goal. It is an indirect way of investing in securities, which is best suited for new investors.
Types of Mutual Fund
Structure-based Mutual Fund Classification
When looked from this perspective, a mutual fund can either be an open-ended fund or a close-ended fund.
Units of an open-ended fund can be bought and sold throughout the year. The transaction is conducted on the basis of a unit’s Net Asset Value (NAV). These funds are highly liquid in nature, which means it can be easily converted in cash.
A fund that can be bought only at the time of New Fund offering (NFO) and redeemed only at maturity falls into this category. People who want to invest a lump sum amount for a set period can opt for close-ended mutual funds. As liquidity of these funds is quite low, a fund house may list its fund on a stock exchange for trading, which provides an opportunity for its investors to exit the fund when they desire.
Asset Class-based Mutual Fund Classification
Securities and Exchange Board of India (SEBI) which regulates the mutual fund industry has broadly classified all mutual funds in India into six categories. The categorization is done to bring homogeneities in the fund offerings. The categories are:
- Equity mutual fund schemes
- Debt mutual fund schemes
- Hybrid mutual fund schemes
- Solution oriented mutual fund schemes
- Other mutual fund schemes
Before we go into detailing the sub-groups of equity schemes, let’s talk in brief about the categorisation of all the companies listed with SEBI based on their market capitalization. From this perspective, all the listed companies can be divided into three categories: Large cap, mid cap, and small cap
Large-cap Mutual Funds
SEBI defines large cap as a company that is a part of top 100 companies by market capitalization, which in common language translates into big established business.
Mid-cap Mutual Funds
A company that makes up into top 101st-250th companies by market capitalization is called mid cap. In a common parlance, a mid-size business.
Small-cap Mutual Funds
A company that fails to make up into top 250 companies are termed small cap.
Equity Mutual Funds
As the problem of categorisation of companies by cap size is out of the way, let’s refocus on types of equity oriented mutual funds.
The funds that invest primarily in the equities or shares of companies listed in India falls in this category. A fund needs to invest at least 65% of its total net assets in equity and equity related instruments of companies listed in India to qualify as equity mutual fund. Such funds fall in the high-risk and high-reward category and are good for wealth creation, over a period. Equity schemes are further subdivided into 1o categories of schemes.
Multi-cap Mutual Funds
It is an open-ended fund that invests at least 65% of its total net assets in equity and equity related instruments of large cap, mid cap, and small cap companies.
It is an open-ended fund that invests at least 80% of its total net assets in equity and equity related instruments of large-cap stocks.
Large & Mid-cap Fund
It is an open-ended fund that invests at least 35% of its total net assets in equity and equity related instruments of large-cap stocks and at least 35% of its total net assets in equity and equity related instruments of mid-cap stocks.
It is an open-ended fund that invests at least 65% of its total net assets in equity and equity related instruments of mid-cap companies.
It is an open-ended fund that invests at least 65% of its total net assets in equity and equity related instruments of small cap stock.
Dividend Yield Fund
The fund should invest at least 65% of its total net assets in stocks that give a regular dividend. It is also an open-ended equity scheme.
An open-ended fund that invests at least 65% of its corpus following a value investment strategy falls into this category.
Value investment strategy is an investment strategy which dictates selecting stocks that are traded at a value less than the actual value of the stock. In the shopping terms, this strategy recommends buying stocks on sale.
An open-ended fund that invests at least 65% of its corpus following a contrarian investment strategy falls into this category.
A contrarian investment strategy, as the name suggests, is the investment strategy that suggests investing against the common sentiment prevalent at the time of the transaction. In other words, it asks an investor to ride against the tide.
An open-ended equity fund that invests its corpus in maximum 30 stocks. The fund needs to inform its investors where the focus of the fund is: large cap, mid cap, small cap, or multi cap.
An open-ended equity fund that invests at least 80% of its pool of money in a particular sector is categorised as a sectoral fund, and when 80% of the pool is invested based on a particular theme, it is called thematic fund.
ELSS (Equity Linked Savings Scheme)
It is an open-ended fund that invests in Equity Linked Saving Scheme (ELSS) in accordance with the Equity Linked Saving Scheme (2005), as notified by the Ministry of Finance. ELSS funds offer tax benefit under Section 80C of the Income Tax Act, and there is a statutory lock-in period of 3 years.
Debt Mutual Funds
A fund that invests in government and corporate bonds, debentures, bank certificates of deposits, commercial papers, treasury bills, and other fixed-income assets falls into this category. The investment is safer than the equity-oriented funds, but the return is less than the equity fund as well. All the debt funds are open-ended in nature. There are 16 types of debt funds available in the market, which can be classified as follow:
The fund has a maturity of just one day.
The fund invests in debt and money market securities and offers a maturity of maximum 91 days.
Ultra Short Duration Fund
The fund invests in debt and money market securities in such a way that the Macaulay duration of the portfolio is between 3 months and 6 months.
Low Duration Fund
The fund invests in debt and money market securities in such a way that the Macaulay duration of the portfolio is between 6 months and 12 months.
Short Duration Fund
The fund invests in debt and money market securities in such a way that the Macaulay duration of the portfolio is between 1 year and 3 years.
Medium Duration Fund
The fund invests in debt and money market securities in such a way that the Macaulay duration of the portfolio is between 3 years and 4 years.
Medium to Long Duration Fund
The fund invests in debt and money market securities in such a way that the Macaulay duration of the portfolio is between 4 years and 7 years.
Long Duration Fund
The fund invests in debt and money market securities in such a way that the Macaulay duration of the portfolio is greater than 7 years.
It invests in dynamic debt schemes for any duration.
Corporate Bond Fund
It invests 80% of its total asset in corporate bonds.
Credit Risk Fund
It invests 65% of its assets in bonds that are not highest-rated (less that AA-rated). It offers a comparatively high return to balance the risk taken by investing in riskier bonds.
Banking and PSU Fund
This fund invests 80% of its assets in debt instruments (like bonds/debentures or bank certificates of deposits) of banks, public financial institutions, and public sector undertakings.
A gilt fund invests 80% of its assets in government bond and securities of varying maturities.
Gilt Fund with 10 Years Constant Duration
A gilt fund invests 80% of its assets in government bond and securities in such a way that the Macaulay duration of the portfolio is equal to 10 years.
Money Market Fund
A fund falling into this category invests in liquid assets like Commercial papers (CPs), and Treasury Bills. These funds are quite safe and have a maturity period of up to 1 year.
This fund invests 65% of its assets in floating rate instruments.
Hybrid Mutual Funds
Replacing the earlier two categories of hybrid funds, namely equity-oriented and debt-oriented hybrid funds, SEBI has recategorized hybrid funds into 6 types.
Conservative Hybrid Fund
A fund that invests 75% to 90% of its assets in debt instruments and 10% to 25% in equity and related instruments fall into this category.
Balanced Hybrid Fund and Aggressive Hybrid Fund
Balanced Hybrid Fund is a fund that invests 40% to 60% of its assets in debt instruments and 40% to 60% in equity and related instruments fall into this category, whereas, Aggressive Hybrid Fund invests 65% to 80% in equity and related instruments and 20% to 35% of its assets in debt instruments. The Balanced Hybrid fund cannot invest in arbitrage.
Dynamic Asset Allocation or Balanced Advantage Fund
The fund manages its equity and debt instrument allocation in a dynamic manner.
Multi-asset Allocation Fund
The fund falling into this category invests in 3 asset classes, allotting at least 10% of its asset into each asset class.
The fund will invest at least 65% of its assets in equities or equity-related instruments and will follow arbitrage strategy.
Equity Savings Funds
The fund will invest at least 65% of its assets in equities or equity-related instruments and 10% in debt instruments in equity, debt, and arbitrage. The fund house needs to state minimum hedged & unhedged investment in scheme information document.
Solution Oriented Mutual Fund
There are 2 solution oriented mutual funds: retirement fund and children’s fund. Both have a lock-in period of 5 years or till the retirement age is attained and the child is matured (whichever is earlier) respectively for the retirement fund and children’s fund.
Other Mutual Funds
Exchange Traded Funds (ETFs) or index funds and Fund of Funds (FoFs) are subsets of this other category. Both are open-ended. ETFs need to at least 95% of its net asset in the securities of a particular index, and FoFs need to invest the same percentage in the underlying funds. FoFs can have domestic as well as global exposure.
Objective Based Mutual Fund Classification
Aggressive Growth and Growth Fund
Investment in these funds offers the highest return. These are primarily equity mutual funds and it comes with its own set of risk as it is exposed to market volatility. The NAV of these funds is responsive to the market condition. It can quickly go up or come down. Difference between aggressive growth and growth fund lies in the risk factor and return potential, which is influenced by market capitalisation of stocks
An income fund gives regular income to its investors while protecting its capital. The rate of return of this fund is lower and so is the risk factor. Debt mutual funds that invest in instruments like bond and debenture in this category.
Balance fund offers the best of both world: growth and income funds. It gives an investor an opportunity to grow her capital over time while giving her a regular income in the present.
As the name suggest, funds that offer high liquidity are classified under this heading. Such funds invest primarily in short-term instruments like Commercial papers, and Treasury Bills. The risk is lower in this kind of mutual funds and so is the reward.
How to Invest in Mutual Funds?
You can invest in these funds both through an intermediary (regular plan) and directly through the fund house’s website (direct plan).
It is always advised that one should opt for a direct plan of any scheme, as it gives 1% additional return over a regular plan of the same scheme. It may look smaller, but over the period this 1% can convert into thousands or lakhs or rupees depending on the investment amount and timeframe.
There are two significant shortcomings of a direct plan:
- You need to visit each fund house website directly to buy and redeem your fund. As there are more than 40 fund houses and 20,000 funds in India, you can understand the amount of work needed.
- As you will not have an intermediary (like broker or brokerage house) guiding you, you will not have access to fund researches suggesting which among the 20,000+ funds to choose.
Fortunately, these loopholes in the direct plan have been plugged by Orowealth. It helps you buy, redeem, and monitor your portfolio’s performance of all kinds of direct mutual funds from one dashboard. It also provides a dedicated mutual fund advisor to help its clients maximize their return on investment by understanding their investment objective, risk appetite, and investment style.