When people hear the word ‘mutual funds’ they are either dumbfounded as to what these are and to those who do know about mutual funds are averse to most of its features. So today, we will cover the The Different Types of Mutual Funds in India – on the basis of asset classes, i.e. the type of assets the fund predominantly consist of.
The Different Types of Mutual Funds in India
Equity mutual funds
As the name suggests, equity mutual funds have a larger portion of the collected pool of money invested in the equity asset class. Now equity as an asset class is generally risky, thereby making these funds a little risky. However, a mutual fund has the research and data to observe which sectors of equity are best suited in accordance to the purpose of the fund. Assuming the purpose of the fund is long term capital appreciation (collecting a huge amount of money over a period of time), then the fund will pick shares/stocks that would suit this purpose inorder to meet this Objective. Moreover in a mutual fund the volume involved are at a much higher level.
E.g. Mr.A decides to purchase shares worth Rs. 1 lakh, as he has accumulated these funds from his own savings. Thus the number of shares Mr. A can purchase is limited to this fixed principal of Rs.1 lakh. But in the case of a mutual fund, the fund manager deals with crores of rupees daily, as more and more investors enter the said funds regularly and thus the fund manager can purchase the same or different stocks in much larger quantities.
Another default benefit of mutual funds is diversification. Within equity based mutual funds there are certain funds called ‘diversified equity funds’, wherein the fund manager invests the funds collected from investors in a variety of stocks, across different sectors.
E.g. A typical diversified equity portfolio would not just have a large number of the same stocks but a breakup of many shares across different sectors such as banking, pharma, aviation etc. So the fund would ideally invest in a company like Jet Airways(Aviation), HDFC Bank(Banking), TVS motors(Auto) etc.
Thus, by diversification, the risk of holding a major proportion of the fund in equity as an asset class is literally spread out amongst many such stocks. This can be further controlled to a certain extent depending on the deferability of the money invested. However, certain equity based funds like sector funds or theme funds, select only stocks within that sector or belonging to that theme, thereby making them risker but with a higher potential of growth as the fate of that sector would depend on the market movement in the long run.
Debt mutual funds
Again as the name suggests, debt mutual funds are those funds that predominantly invest the pool of money collected into debt based investments. Now debt as an asset class is less riskier as compared to equity, but it is not totally risk free. This is simply because debt-based investments come with “credit risk” and “interest rate risk”.
Credit risk is the risk of the borrower not being able to repay the said funds received by him or not being able to repay with interest, while interest rate risk is the risk of losing interest in a debt investment due to the decline in interest rates.
So debt based mutual funds are attached to these risks as they invest the portfolio of money into Government or Corporate bonds, Treasury bills, Promissory notes, Commercial papers etc.
However, as these funds have the default advantage of diversification and economies of scale (ability to buy in bigger volumes), they can counter those risks to a certain extent, but not totally.
Debt based funds also have a comparatively better taxation policy as compared to most others, thereby making these funds a slightly favoured option.
Liquidity in Debt mutual funds is also a huge advantage as compared to equity funds, as debt funds have a general purpose of short term goals.
While people can redeem their units from equity funds, it may seem to be counterproductive as the benefits of equity funds are visible only after a long period of time, say 5 to 10 years, whereas debt-based funds provide a stable rate usually equal to or slightly above the inflation rate and also the tenure of the money invested need not be more than 2 to 3 years.
Hybrid mutual funds
Hybrid funds are basically a mixture of equity and debt funds, as they invest in both these asset classes viz. equity and debt. Now depending on the purpose of the fund, the money collected is split up into an equity proportion as well as a debt proportion. The fund manager thus invest in both types of asset classes, thereby maintaining a balance between the two. However, for tax purposes, the fund which has a larger proportion of one asset class will be subject to the taxation policies of that asset class.
e.g. Assuming a fund has more of equity proportion in a hybrid fund, then the taxation for that fund would be the same as that of an equity fund.
These funds are great for combating general inflation as the returns are a weighted average of both, debt and equity asset class. Some funds also provide dividend on a regular basis. However mutual funds aren’t obliged to declare dividends, so totally depending on dividends would not be a parameter for selecting such funds, but yes, they do have an edge over most other investments as the overall return is usually over 10 % (with equity as a higher proportion).
Thus, we have learned the types of mutual funds on the basis of the areas they invest in. In our next article, we will break up mutual funds on the basis of their structure.
About the Author :
Rufino Dsouza is a Certified Financial Planner who specializes in the following Services :
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