Types of Mutual Fund Schemes in India and their Benefits

Saving money without the intention to invest is utter waste. “But where to invest?” is one question we constantly ponder upon. I have heard people saying that, in the olden days, the bank was the only option for those looking for a safe haven for their money. But things have changed a lot now. You have a wide range of options to choose from. A new investment scheme pops up every day. But when you are offered a lot of options, you usually give way to confusion. Mutual funds investment emerges as one of the best options in the market. Mutual funds are investment vehicles that make your ride towards your financial goals easier.

Let’s simplify it.  So what’s the top idea that surfaces in your mind when you are stuck in a difficult situation? You would simply run to an expert or a person who has already dealt with a similar situation before arriving at a solution.

Won’t it be great if that one person proposes to handle your problem on your behalf? Similarly, a mutual fund is an investment option where you put your money in the hands of an expert. The money which is pooled from several other investors just like you is entrusted to a talented fund manager.

He manages your portfolio on your behalf in order to fetch the promised or required results. So all you have to do is fix a financial goal and pick the fund that best suits you.

Benefits of mutual funds

Why should you invest in mutual funds? Here are some reasons as to why you should make a mutual fund investment,

• Mutual funds diversify the risk. So whether the market is up or down your capital won’t be affected entirely.

• As said before your capital will be placed in the hands of a fund manager who manages it for you. So you can remain stress-free and enjoy the returns.

• There is a variety of funds to match your financial goals. And liquidity is never a problem. Whenever you want to sell or buy a fund you can contact the fund office right away.

Just like two sides of a coin mutual fund investment holds a few drawbacks as well. Cons of mutual fund investments include the following.

• You don’t have the power to decide where to invest. All such decisions are made by your fund manager. So if he makes one wrong move, then there is a high possibility that it will affect your capital badly.

• There may be times where your capital gains are eaten by the tax, fund managing expenses, etc. So exercise extreme caution while choosing a fund. Read the fund related documents carefully.

Now it’s time to find out the various types of funds. Every fund you see in the market falls under any of the following categories.

Equity Funds

Equity fund managers invest money in different company's shares/stocks. Fund managers invest the money across various sectors or in varying market capitalizations, to offer the excess returns to their investors. Equity funds are mostly known for their returns as they provide higher returns than any other mutual fund schemes.

However, as it is said, "Higher returns come with a higher risk".

Equity fund schemes also come up with a higher risk as the fund manager invests in various types of markets. Owing to this, as per the market norms, SEBI  (Stock Exchange Board of India) has sub-categorized equity mutual funds in various categories.

Let's walk through them.

Large Cap Funds

In these fund schemes, the fund manager invests at least 80% of their total assets in the shares of the top 100 large companies. This scheme is considered to be steadier than other fund schemes.

Mid-Cap Funds

In this scheme, the fund manager approximately invests 65% of their total assets in the shares of the top companies in the rank between 101-250th place, according to their market capitalizations and performance. This scheme provides a higher return than large-cap funds, but it is also more volatile than large-cap funds.

Small-Cap Fund

The fund manager invests 65% of their total assets in shares of the companies which are ranked above 250, according to their market performance and capitalizations.

In India, approximately 95% of the companies fall in this category. These fund schemes offer higher returns to the investors but come up with high volatility.

Multi-Cap Fund

As the name suggests, in multi-cap funds, the fund manager invests their total assets in the equity portfolio and equity-related shares of the company, which are varying in market capitalizations.

A Multi-cap fund might be a good choice to invest in as the fund manager invests in various sectors according to the market spectrum, which reduces the risk and offers higher returns to the investors.

Dividend Yield Fund

In dividend yield funds, the fund manager approximately invests 70-80% of the total assets in the shares that have higher dividend yields than the market benchmark.

The fund manager selects stocks and analyses, which of them offers higher returns/dividends. This fund is more stable as it has higher cash flows and offers higher dividends.

Value Fund

The value fund follows the value of investing, which is followed by many marketing legends. In this fund, the fund manager purchases stocks that are currently trading at a lower price due to market fluctuation and holds them for the long term to offer higher returns to its investors.

Contra Fund

In contra funds, the fund manager purchases stocks at a lower price compared to the long-run prices of those stocks. When the market goes down, the fund manager purchases stocks and holds them until the demand for those stocks rises.

A contra fund scheme offers more returns in the long term period. For a short-term period, this fund scheme may not be ideal.

Focused Fund

In a focused fund scheme, the fund manager only invests in 20-30 companies that offer higher returns. The fund manager invests in various sectors but only in limited companies in contrast with other fund schemes that invest in 100 companies. This fund tries to offer higher returns to its investors.

Sectoral Fund

In a sectoral fund, the fund manager approximately invests 80% of the total assets in a specific sector of the economy. These sectors can be real-estate, energy, infrastructure, utilities, etc.

Sometimes, a sectoral fund can also invest in shares of companies according to their market capitalization. This fund offers the best stocks of a dedicated sector to its investors.

Equity Linked Saving Scheme (ELSS)

The ELS scheme invests the major portion of its total assets in equity or equity-related instruments with a lock-in period of three years.

This fund is also called the tax-savings fund as it offers tax immunity up to Rs.1,50,000 from the investor's annual tax payable amount under Section 80c under the Income Tax Act.

Index Fund

In index funds, the fund manager invests a heavy portion of the total assets in stocks that emulate the stock market index (NSE Nifty, BSE Sensex, etc.)

These funds are termed as passively managed funds as the fund manager invests in the same securities as the present in the underlying index and in the same propositions, and does not have any impact on the portfolio.

Equity funds are generally known for offering higher returns (around 10-12% before tax). It is a complicated task for the investors to choose the right mutual fund to invest in, as they offer large varieties of funds according to the various preferences of investors.

As an investor, one must know how to identify their financial goals and then categorize them. This will make it easier for them to choose the right fund to invest in, according to their financial goals.

Debt funds 

Debt funds concentrate their investments into debentures. Debt funds are mostly considered as an income-oriented fund. Interest is paid to the investors. The public sector and corporate bonds are the main places of investment in a debt fund. A person nearing retirement is advised to increase his holding in debt funds.

Though they have less potential for growth, they are less risky when compared to equity funds and also fetch a disciplined income in the form of returns. Following are a few types of it, 

• Gilt funds- these funds put the money into government bonds, treasury bills, and securities. 

• Corporate bonds- these bonds make an investment into debt securities issued by corporates. 

• On the basis of the term- on the basis of the time period during which you are going to stay invested in the funds, they are classified into short term, ultra-short-term, medium, and long term funds. 

• Money market funds- these funds direct their investments in short term debts and debt-related securities which are highly liquid.

Debt funds may yield a comparatively lesser return than equity funds. But they are considered to be less risky. An investor who is nearing the age of retirement should increase his debt holdings and reduce his equity funds. Further, among debt bonds junk bonds are said to be of high risk.

Hybrid funds

The hybrid fund which can also be called a balanced fund makes a mixed investment into both debt and equity-based securities. Hence, the risk and returns in such funds totally lie on the basis of allocation. Mostly the allocation is made on the basis of your age.

For example, a target fund is a type of hybrid fund which rebalances the allocation as you get older.  Hybrid funds can either be equity-oriented or debt-oriented. The standard allotment is 60% in equity and 40% in debt.

A person who has a longer working period and fewer dependents will be provided with an equity-oriented scheme which will be reallocated from time to time as he nears retirement. This, by the time of retirement he will be holding a debt-oriented scheme. The risk is moderate here. But the ratio can be altered as per your choice. In such a case the risk also varies.

Funds of funds

Funds-of-funds enable an investor to invest in not just into one scheme but multiple schemes. Picture a fund that allows you to put your money into 5 other funds. In that way the risk is diversified. These funds can make an investment into an international model or domestic model.

Though they are highly diversified, they offer less transparency and can charge high fund management fees. Anyone can make an investment here. However, an individual who is looking to find a less risky avenue can go in for this. These are ideal for small investors.

The Bottom Line

There are a large variety of fund-based investment options, so many that an investor can feel a little lost. These funds, if studied carefully, can still make the selection process a lot easier for the investor. It takes the chore of portfolio rebalancing out of the equation for investors and lets fund managers handle the investment.

However, investors should not think of fund managers as scapegoats and follow an "invest and forget" mentality. The fund type or even the fund itself should be selected after a prudent screening process.