By Mutual funds have surfaced as an eminent investment option, conveniently granting entry into various real-money financial markets, primarily at a lower cost. Mutual fund representation is the pooling of funds from diverse investors, to invest the pooled funds into a diversified portfolio of asset classes ranging from equities, bonds, gold, and real estate, which are professionally managed. The thick variety of mutual funds can be downright confusing for an inexperienced investor, and sometimes for a knowledgeable investor as well.
Understanding the various categories of mutual funds is, therefore, essential for taking enlightened investment decisions in tune with one’s own financial objectives, risk appetites, and investment horizon. The guide here is meant to walk you through the various types of mutual funds while emphasizing their salient features so that you are in a better position to determine which might suit your unique requirements.
I. On the basis of Asset Class:
Mutual funds are basically categorized on the basis of the kind of assets in which they invest. This is the most rudimentary way to separate them.
1. Equity Funds
Equity funds mostly invest in shares (stocks) of companies. They have a high potential for returns but also carry the highest risk because of the highly volatile nature of the stock market. Equity funds are suitable for long-term investors willing to take higher risks.
Types of Equity Funds
Large-Cap Funds: Primarily invest in stocks of large, well-established companies with a decent track record. They are less volatile than mid-cap and small-cap funds.
Mid-Cap Funds: Invest in stocks of mid-sized companies, which, in turn, have the potential for higher growth but might also have higher volatility than large-cap funds.
Small-Cap Funds: Invest in equities of small corporations that possess enormous growth potential but carry the highest risk and volatility.
Multi-Cap Funds: Provide investment coverage across market capitalizations, allowing diversification within equity.
Sector Funds: Focus on specific industries or sectors while investing (e.g., technology, banking, pharmaceuticals). Present the promise of high returns if that selected sector performs well but is highly concentrated with significant sector-specific risks.
Thematic Funds: Invest based on a particular theme or trend (e.g., infrastructure, consumption, digital India). The same high growth opportunity might be offered in terms of risk from thematic perspectives.
Focused Funds: Invest in a limited number of stocks (typically 20-30), giving high concentration but also amplifying the concentration risk i.e. high conviction bets.
Dividend Yield Funds: Primarily invest in high-dividend stocks that would provide regular income and possible capital appreciation.
Value Funds: Invest in stocks that are thought to be undervalued by the market in the hope that their intrinsic value will be realized in due time.
Debt Funds-
Debt funds mainly invest in fixed-income securities such as government bonds, corporate bonds, treasury bills, and other debt instruments. Debt funds are generally less risky than equity funds and recommended for investors looking for stable returns and lower volatility. People prefer debt funds to fulfill short to medium-term investments or just to diversify their portfolios.
Debt Fund Types:
Overnight Funds-invest in very short-term debt instruments where the maturity is of only one day-high liquidity and very low risk.
Liquid Funds-determine a much shorter maturity-term of less than 91 days on the investments in debt instruments-provide high liquidity and relatively low risk.
Ultra Short Duration Funds-invest for a Macaulay duration of 3 to 6 months in debt instruments, which provides slightly more returns than liquid funds and marginally more risk.
Low Duration Funds-invest in debt instruments whose Macaulay duration lies between 6 to 12 months, for the investors with slightly more horizon.
Short Duration Funds-invest in debt instruments with 1 to 3 years of Macaulay duration: availing a certain ratio of risk to return.
Medium Duration Funds-invest in debt instruments between Macaulay duration of 3 to 7 years that carry a moderate risk of interest.
Long Duration Funds-invest in debt instruments with a Macaulay duration of more than 7 years, which are highly reactive to interest rate movements.
Credit Risk Funds: Investments made in lower-rated corporate bonds, which offer the potential for higher returns along with a higher risk of default.
Corporate Bond Funds: Investments specializing in high-rated corporate bonds, providing relatively steady returns with a moderate credit risk.
Government Securities Funds: Invest in the government bonds only, thus ensuring safety yet may provide lower returns vis-a-vis corporate bond funds.
Gilt Funds with Constant Duration: Invests in government securities with a particular maturity profile that mitigates interest rate risk to some extent.
Floater Funds: Invests atleast majority of their assets in floating-rate debt instruments, which adjusts the interest rates as per benchmark rates, thus reducing interest rate risk in typically rising interest rate scenarios.
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Hybrid Funds-
Hybrid funds usually put money in two or more asset classes, most commonly but not limited to equity and debt instruments. Balanced would be growth and stability with respect to holdings, making them ideal for somebody in the moderate-risk tolerance category.
Types of Hybrid Funds:
Conservative Hybrid Funds: Predominantly invested in debt instruments (75-80%) with a smaller fraction in equities (20-25%). These offer low risk with stable returns.
Balanced Hybrid Funds: Asset allocation is relatively even between equity holdings and debts-assets (one between 40-60% of total in each). This will ultimately balance growth with stability.
Aggressive Hybrid Funds: Invest 65-80 percent in equities and 20-35 percent in debt, affording the investor good potential for growth.
Dynamic Asset Allocation Funds (Balanced Advantage Funds): The heavyweight among all mutual funds, these funds dynamically change their asset allocation between equity and debt in order to capture market conditions of buy low and sell high.
Multi-Asset Allocation Funds: Such funds invest in a minimum of three asset classes (equity, debt, gold) in order to achieve wider diversification.
4. Solution-Oriented Funds:
These funds are designed keeping in mind the objectives of the investors and generally have a lock-in period.
Types of Solution-Oriented Funds:
Retirement Funds: Designed so that the parent can save for his retirement. Generally has a lock-in of 5 years or until the retirement age.
Children’s Funds: Designed for parents to save for their children’s future expenses, including education, usually having a lock-in of 5 years or until a specified age of the child.
5. Other Funds:
Commodity Funds: Invest in commodities such as gold, silver, bone oil, etc. Their returns are linked to the price escalation or downturn of these commodities.
Real Estate Funds: Invested in real estate assets or infrastructure projects that tend to yield rental income and capital appreciation.
Index Funds: These funds are in movement to replicate the performance of the given market index (like Nifty 50, Sensex, etc.), by investing into the same stocks in a similar proportion as the index does. It has a lower expense ratio along with diversification.
Exchange-Traded Funds: An index fund that trades on stock exchanges the same way individual stocks do; this gives you greater flexibility when buying or selling.
Fund of Funds: Invest in other mutual fund schemes instead of direct investments in stocks or bonds, with the aim to provide diversification under different fund managers and strategies.
Open-Ended Funds: Allow investors to buy and sell units at any time based on the Net Asset Value (NAV) of the fund. By and large, these types of mutual funds are the most common.
Close-Ended Funds: Have their number of units fixed with a particular period of maturity. Hence, the investor can only get to buy the units during the initial offer period and sell them on a stock exchange after they are listed. Interval Funds: These are hybrid funds, which avail the opportunity to buy and sell units according to some stipulations periods of intervals.
To choose the right mutual fund for yourself, you need to consider the following things:
Financial Objectives: Saving for what? What do you want to achieve? (retirement, getting an education, down payment). They will shape your investment horizon and the types of returns you need.
Risk Tolerance: How do you feel to take a risk of losing some money for the opportunity to have more gain?
Investment Horizon: For how long do you want to invest? Years might be better suited for time-frames considering equity funds, short goals better aligned with debt funds.
Income, expenditure and assets: You should also consider your income, expenses and current investments. Expense Ratio: This is the fee charged by the fund to manage your money annually. The lower-the-better expense ratios.
Historical Performance: This does not mean future returns are ensured, but they do provide some indication of how the fund has trended.
Fund Manager and Fund House: Conduct research about the experience and reputation of the fund manager and the fund house.
In Conclusion:
There is a whole plethora of investment options in the world of mutual funds that meet multiplicity of investment needs and preferences. By knowing how different types of mutual funds vary by asset class and structure, while introspecting about one’s own financial goals, risk tolerances and time horizon of investment, one may easily navigate such a landscape and select the appropriate mutual funds that would most likely contribute to their wise financial goals. Research and utmost thorough study is very much given attention to these kinds of mutual funds before consuming the name. Also in some cases, one might consult a financial advisor before making investment decisions.