Equity Mutual Funds – What Are Equity Funds, Types, Benefits & Who Should Invest in Equity Mutual Funds

The popularity of equity investments is rising of late. No other investment option has the potential to offer returns as much as the equity instruments do.

What is an Equity Fund?

Equity mutual funds try generating high returns by investing in the stocks of companies across all market capitalisations. Equity mutual funds are the riskiest class of mutual funds, and hence, they have the potential to provide higher returns than debt and hybrid funds. The performance of the company plays a significant role in deciding the investors’ returns.

How do Equity Funds work?

Equity mutual funds invest at least 60% of their assets in equity shares of numerous companies in suitable proportions. The asset allocation will be in line with the investment objective. The asset allocation can be made purely in stocks of large-cap, mid-cap, or small-cap companies, depending on the market conditions. The investing style may be value-oriented or growth-oriented. After allocating a significant portion towards the equity segment, the remaining amount may go into debt and money market instruments. This is to take care of sudden redemption requests as well as bring down the risk level to some extent. The fund manager makes buying or selling decisions to take advantage of the changing market movements and reap maximum returns.

Who should Invest in Equity Funds?

Your decision to invest in equity funds must be in sync with your risk profile, investment horizon, and objectives. Generally, if you have a long-term goal (say, five years or more), then it is better to invest in equity funds. It will also give the fund much needed time to combat market fluctuations.

For budding investors

If you are an aspiring investor who wants to have exposure to the stock market, then large-cap equity funds may be the right choice. These funds invest in equity shares of the top-performing companies whose risk level is low. The well-established companies have historically delivered stable returns over a long period.

For market savvy investors

If you are well-versed with the market pulse and willing to take calculated risks, then you may think of investing in diversified equity funds. These invest in shares of companies across all market capitalisations. These funds provide an excellent combination of high returns at lower risk as compared to equity funds that only invest in small-cap/mid-caps.

Features of Equity Funds

Cost of investment

The frequent buying and selling of equity shares often impact the expense ratio of equity funds. The Securities and Exchange Board of India (SEBI) has capped the expense ratio at 2.5% for equity funds. A lower expense ratio will translate into higher returns for investors.

Holding period

Investors earn capital gains on the redemption of their fund units. The capital gains are taxable in the hands of investors. The rate of taxation depends on how long one stays invested and this period is called the holding period. Equity holdings of less than one year are termed short-term, and short-term capital gains are taxed at 15%. Equity holding of more than a year are termed long-term, and the long-term capital gains are taxed at the rate of 10% if the gains exceed Rs 1 lakh a year.

Cost-efficiency & diversification

By investing in equity funds, you get exposure to several stocks, and you get this benefit by investing a nominal amount. However, your portfolio will face the risk of concentration.

Types of Equity Funds

You can categorise equity funds based on the investment mandate and the kind of stocks and sectors they invest in.  

Based on Sector and Themes

Equity funds that focus investments on a particular sector or theme fall under this category. Sector funds invest in a specific industry such as FMCG, pharma, or technology. Thematic funds follow one specific subject, such as emerging consumer companies or international stocks. As sector funds and thematic funds focus on a particular sector or theme, they tend to be riskier. This is because of their performance face sectoral as well as market risks. However, industry and thematic funds can be diversified in terms of market capitalisation.

Based on Market Capitalisation

Large-cap equity funds: Large-cap companies are well-established, and hence, large-cap funds are capable of offering stable returns.

Mid-cap equity funds: These funds invest in medium-sized companies. Mid-cap equity funds are not as stable as large-cap funds.

Mid-and-small-cap funds: These funds invest in both mid-cap and small-cap funds and have the potential to offer high returns.  

Small-cap funds: These funds invest in shares of small-cap funds. Investors should be aware of the fact that small-cap funds are more prone to market volatility and risk.

Multi-cap funds: Multi-cap funds invest in stocks across all market capitalisations. The fund manager decides to invest predominantly in a particular capitalisation depending on the market condition.

Based on Investment Style

All the funds discussed above follow active investing style, wherein the fund manager decides the portfolio composition. However, there are funds whose portfolio composition imitate a specific index. Equity funds that follow a particular index, such as Sensex, are called index funds. These are passively-managed funds that invest in the same companies, in the equal proportions, making up the index the fund follows.

For example, a Sensex index fund will invest in all Sensex companies in the same proportion in which the companies form part of the index. Index funds are low-cost funds as they don’t require the active management of a fund manager. Example, a Sensex index fund will have investments in all 30 Sensex companies in the same proportion in which the companies form part of the index. Index funds are low-cost funds as they don’t require the active management of a fund manager.

Performance of Equity Funds in India

Among all categories of mutual funds, equity funds generally deliver the highest returns. On average, equity funds have generated returns in the range of 10% to 12%. The returns fluctuate depending on the market movement and overall economic conditions. To earn returns in line with your expectations, you need to choose your equity funds carefully. For that, you have to strictly follow the stock markets and possess knowledge of the quantitative and qualitative factors. ClearTax assists by handpicking the top-performing investment portfolios for you, which suits your financial goals.

Benefits of Investing in Equity Funds

The benefits of investing in mutual funds are many:

• Expert money management
• Low Cost
• Convenience
• Diversification
• Systematic investments
• Flexibility
• Liquidity

The primary benefit of investing in equity funds is that you don’t need to worry about choosing stocks and sectors to invest. Successful equity investing requires a lot of research and knowledge. You need to understand and analyse the performance of a company before you decide to invest. You also need to have an understanding of how a particular sector is expected to perform in the future. Of course, all of this requires a lot of time and effort, which most individuals don’t have. Hence, the solution is to leave the stock-picking to an expert fund manager by investing in an equity mutual fund.  

Taxation of Equity Funds

As mentioned earlier, short-term capital gains (STCG) are taxable at the rate of 15%. The Union Budget 2018-19 brought back the long-term capital gains (LTCG) tax on equity holdings. It is applicable at the rate of 10% if the gains exceed Rs 1 lakh a year.

SIP or lumpsum- which is better? 

Lump-sum

Lump sum investments are apt for those individuals who have a considerable sum to invest. However, not many investors invest via the lump sum route.

Systematic Investment Plan (SIP)

A SIP allows you to invest a fixed sum on a period basis. The frequency of SIP can be weekly, monthly, and quarterly. You give a mandate to the fund company to deduct the investment from your bank account. SIPs give you the benefit of rupee cost averaging. This means that when the markets are high, you will be allotted fewer units. And when the markets are low, you will get more units for the same amount. This way, you invest at different levels of the market. SIPs also inculcate financial discipline and make mutual funds affordable for all. Click here to start a SIP in equity mutual funds.  

Frequently Asked Questions

Which are the best mutual funds to invest in India?

You may consider picking the best mutual fund depending on your investment objectives and risk tolerance. You could check the track record of the mutual fund house and the fund manager before investing in the mutual fund. However, you may invest in the mutual fund only if you are comfortable with the investment style of the fund manager.

You must check the expense ratio before putting your money in the mutual fund. You may find the best mutual funds having a lower expense ratio. However, you must check other important parameters before investing in the mutual fund. You would find the best mutual funds have a lower turnover ratio for the portfolio. You may avoid mutual funds where the fund manager churns the portfolio many times.

You may pick the best mutual funds depending on your investment horizon. You could invest in equity funds only if you have an investment horizon of three years or more. You may invest in debt funds for a shorter time horizon of under three years. Invest in balanced or hybrid funds only if you have an investment horizon of three to five years.

You may measure the performance of mutual funds against a benchmark index to select the best mutual funds. For example, you may check the performance of a large-cap fund against the Nifty 50. Compare the performance of the mutual fund against its peers and also take a look at the consistency of performance. Best mutual funds have a consistent track record of outperforming peers and the benchmark index over five years or more.

You must choose the best mutual fund house with large assets under management (AUM). The fund house may be able to bear sudden redemption pressure if it has large assets under management

How to find the best performing mutual funds in India?

Best performing equity fund:
An equity mutual fund may be the best performer in its category if it consistently beats the benchmark index over some time. The best performing equity fund has a lower expense ratio as compared to peers. You may find the best performing mutual funds doing well across market cycles.

You must check the alpha of the equity fund to identify the best performing mutual fund. It shows the excess return generated by the equity fund above the benchmark index. You can pick the equity fund with a high alpha as compared to the peers.

You must take a look at the beta of the equity fund. It gives you an idea of the volatility of the fund as compared to the benchmark index. An equity fund with a beta less than one is less volatile as compared to a fund with a beta more than one.

Take a look at standard deviation which gives you an idea of the volatility of the equity fund. You may find an equity fund with a higher standard deviation to be riskier as compared to a fund with lower standard deviation. You may pick the best performing equity fund based on risk-adjusted returns. Check the Sharpe’s ratio of the equity fund and opt for an equity mutual fund scheme with a higher Sharpe’s ratio which signifies a higher risk-adjusted return.

Best performing debt fund:
You may consider picking the best debt funds based on the credit quality of the bonds in the portfolio. Credit rating agencies would assign a credit rating to bond-issuers based on their ability to repay the principal and interest amounts. You must invest in debt funds with AAA-rated bonds in the portfolio.

It is a safer investment as compared to bonds of a lower rating which may offer a higher interest rate. However, they could default on both principal and interest payments.

You may select the best performing debt fund based on the expense ratio. You must not pick a debt fund with a high expense ratio. Best debt funds have an excellent track record of performance over three to five years. You may select the best debt fund where the average maturity period matches your investment horizon.

Best performing hybrid fund:
You could pick the best performing hybrid fund with a good track record of performance over three to five years. Select a hybrid fund which has beaten the benchmark index and peers over some time.

You may check the track record of the fund house and the investment style of the fund manager before picking the best performing hybrid fund. Pick a fund house with huge assets under management which can bear the sudden redemption pressure of big investors.

Select the best performing hybrid fund with a low expense ratio. A high expense ratio may eat up the return from the fund. The best performing hybrid funds must match your investment objectives and risk tolerance. Take a look at the portfolio of conservative hybrid funds. It gives you an idea on the credit quality of bonds in the portfolio.

Which is the best way to buy mutual funds in India?

You may buy mutual funds through cleartax invest. Follow these steps to invest in mutual funds.

• You must log on to cleartax invest
• You then select the mutual fund house from the list of fund houses
• Select the mutual fund scheme based on your investment objectives and risk tolerance and click on Invest now
• You must select the amount you plan to invest in the mutual fund scheme and the mode as either One Time or Monthly SIP.
• You must fill up the requisite details such as name, email ID, mobile number and complete the transaction.

Complete your KYC (Know Your Customer) before investing in a mutual fund scheme. You must visit the website of a KRA (KYC Registration Agency) and create your account. You will have to fill the KYC registration form with details such as your name, email ID, mobile number and so on.

Upload copies of your self-attested identity proof such as PAN Card and address proof such as passport, driving license or Voter ID along with a passport size photograph at the KYC Registration Agency. You may complete the IPV (In-Person Verification) through a video call to verify your documents against the originals and also your signature