1. How do Equity Funds work?
An equity fund invests 60% or more of its assets primarily in equity shares of companies in varying proportions as mentioned in its investment mandate. It might be a purely large-cap fund or a mixture of market capitalization. Moreover, the investing style may be value-oriented or growth-oriented.
After allocating a major portion of equity shares, the remaining amount may be invested in debt and money market instruments. This is done to address redemption requests raised by the investors. The fund manager keeps buying or selling a particular stock to take advantage of the changing market movements.
The expense ratio of equity funds is affected by the frequent buying and selling of equity shares. Currently, SEBI has fixed the upper limit of expense ratio at 2.5% for equity funds and is planning to reduce it further. A lower expense ratio translates into higher returns for investors.
2. Who should Invest in Equity Funds?
Your decision to invest in equity funds needs to be guided by risk appetite and investment horizon. Generally, an investor who can stay invested for 5 years or more, needs to get into equity funds. These won’t be suitable for a relatively short-term owing to stock market fluctuations.
In case you want to save taxes under Section 80C of the Income Tax Act, then ELSS is regarded as the most appropriate investment haven. ELSS has the shortest lock-in period of 3 years and gives higher returns than other investments eligible under Section 80C.
If you are a budding 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 100 companies of the stock market. These are well-established companies known for giving stable returns over the long-term.
In case you are well-versed with the market pulse but want to take calculated risks, you may think of investing in diversified equity funds. These invest in shares of companies across market capitalisation. These give optimum combination of high return and lesser risk as compared to equity funds which invest only in small-cap/mid-caps.
3. What are the types of Equity Funds?
Equity funds is a broad category of funds, but there are several types of equity funds. Equity funds can be further categorised based on their investment mandate and the kind of stocks and sectors they invest in.
A. Based on Sector and Themes
Equity funds that focus their investments on a particular sector or theme fall under this category. Sector funds are those that invest in one particular industry, like FMCG or Pharma or Technology. Thematic funds are those that follow a particular theme, like emerging consumer companies or international stocks.
Since sector funds and thematic funds are concentrated in a particular sector. They tend to be riskier than diversified equity funds because their performance is entirely dependant on the particular sector of the economy.
However, sector and thematic funds can be diversified in terms of market capitalisation.
B. Based on Market Capitalisation
Large-cap equity funds invest primarily in large-cap stocks. Different fund house categorises stocks differently, but large-cap stocks are stocks of the biggest listed companies of the economy. Typically, large-cap companies are well-established companies, which makes large-cap funds stable and reliable investments.
Mid-cap equity funds and small-cap equity funds are funds that invest in mid-sized and smaller companies respectively. There are even funds that invest in both mid-cap as well as small-cap funds. They are called mid- and small-cap funds.
Since smaller companies are prone to volatility, mid-cap and small-cap funds deliver fluctuating returns.
Equity funds that invest across market capitalisation, which is in large-cap, mid-cap and small-cap stocks, are called multi-cap funds.
C. Based on the Style of Investing
All the funds discussed above follow active investing style wherein the fund manager modifies the portfolio composition to suit market movements. However, there are funds whose portfolio composition imitate a specific index.
Equity funds that follow a particular index are called index funds. These are passively-managed funds that invest in the same companies, in the exact same proportions, that make up the index the fund follows.
For 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.
4. Performance of Equity Funds in India
Amongst all other categories of mutual funds, equity funds have found to deliver the highest returns. On an average, equity funds have generated before-tax returns in the range of 10%-12%. These returns may fluctuate as per market movements 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 closely follow the stock markets and possess knowledge of the quantitative and qualitative factors. ClearTax provides assistance by handpicking the top-performing investment portfolios for you which suits your financial goals.
5. Benefits of Investing in Equity Funds
The benefits of investing in mutual funds are many:
a. Expert money management
b. Low Cost
e. Systematic investments
The major benefit of investing in equity funds is that you don’t need to worry about choosing stocks and sectors to invest in. Successful equity investing requires a lot of research and knowledge. You need to dig deep into the financials of a company before you invest in it.
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 common investors don’t have. Hence, the solution is to leave the stock picking to an expert fund manager by investing in an equity fund.
By investing in equity funds you can get exposure to a number of stocks by investing a nominal amount.
For example, if you have Rs 2,000 to invest, you will be able to buy one stock of a large-cap company or one stock of 2-3 mid-cap companies. However, your portfolio will face concentration risk. But with the same amount you can get exposure to a lot many stocks when you invest in equity funds. This allows you to diversify and benefit meaningfully.
6. Taxation of Equity Funds
When you redeem units of equity funds, you earn capital gains. These capital gains are taxable in your hands. The rate of taxation depends on how long you stayed invested in equity funds; such a period is called the holding period.
Capital gains earned on the holding period of up to one year are called short-term capital gains (STCG). STCG are taxed at the rate of 15%. Conversely, capital gains made on holding period of more than 1 year are called long-term capital gains (LTCG). Owing to recent changes in budget 2018, LTCG in excess of Rs 1 lakh will be taxed at 10% without the benefit of indexation.
Equity funds can be tax-saving or non-tax saving. ELSS is a tax-saving equity fund. You can save taxes up to Rs 45000 and avail deduction up to Rs 1.5lac by investing in ELSS. It comes with the shortest lock-in period of 3 years
7. SIP – The best way to Invest in Equity Funds
The most effective way of investing in equity funds is through a systematic investment plan (SIP). A SIP is usually a monthly investment that happens automatically on a pre-decided date. 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 make investing a regular habit. SIPs are automated investments that ensure you save the designated amount every month. This way you can invest before you spend since the SIP date is at the beginning of the month for most investors.
Click here to start a SIP in equity mutual funds.