Considering to invest in Mutual Funds? It is important that you understand the mutual fund types and their features. Mutual fund types can be classified based on the following characteristics.
1. Based on Asset Class
a. Equity Funds
Primarily investing in stocks, they also go by the name stock funds. They invest the money amassed from investors from diverse backgrounds into shares of different companies. The returns or losses are determined by how these shares perform (price-hikes or price-drops) in the stock market. As equity funds come with quick growth, the risk of losing money is comparatively higher.
b. Debt Funds
Debt funds invest in fixed-income securities like bonds, securities and treasury bills – Fixed Maturity Plans (FMPs), Gilt Fund, Liquid Funds, Short Term Plans, Long Term Bonds and Monthly Income Plans among others – with fixed interest rate and maturity date. Go for it, only if you are a passive investor looking for a small but regular income (interest and capital appreciation) with minimal risks.
c. Money Market Funds
Just as some investors trade stocks in the stock market, some invest in the money market, also known as capital market or cash market. The government, banks or corporations usually run it by issuing money market securities like bonds, T-bills, dated securities and certificates of deposits, among others. The fund manager invests your money and disburses regular dividends to you in return. If you opt for a short-term plan (13 months max), the risk is relatively less.
d. Hybrid Funds
Hybrid Funds (Balanced Funds) is an optimum mix of bonds and stocks, thereby bridging the gap between equity funds and debt funds. The ratio can be variable or fixed. In short, it takes the best of two mutual funds by distributing, say, 60% of assets in stocks and the rest in bonds or vice versa. This is suitable for investors willing to take more risks for ‘debt plus returns’ benefit rather than sticking to lower but steady income schemes.
2. Based on Structure
Mutual funds can be categorized based on different attributes (like risk profile, asset class, etc.). Structural classification – open-ended funds, close-ended funds, and interval funds – is broad in nature and the difference depends on how flexible is the purchase and sales of individual mutual fund units.
a. Open-Ended Funds
These funds don’t have any constraints in a period or a number of units – an investor can trade funds at their convenience and exit when they like at the current NAV (Net Asset Value). This is why the unit capital continually changes with new entries and exits. An open-ended fund may also decide to stop taking in new investors if they do not want to (or cannot manage significant funds).
b. Closed-Ended Funds
Here, the unit capital to invest is fixed beforehand, and hence, they cannot sell a more than a pre-agreed number of units. Some funds also come with an NFO period; wherein there is a deadline to buy units. It has a specific maturity tenure, and fund managers are open to any fund size, however large. SEBI mandates investors to be given either repurchase option or listing on stock exchanges to exit the scheme.
c. Interval Funds
This has traits of both open-ended and closed-ended funds. Interval funds can be purchased or exited only at specific intervals (decided by the fund house) and are closed the rest of the time. No transactions will be permitted for at least 2 years. This is suitable for those who want to save a lump sum for an immediate goal (3-12 months).
3. Based on Investment Goals
a. Growth Funds
Growth funds usually allocate a considerable portion in shares and growth sectors, suitable for investors (mostly Millennials) who have a surplus of idle money to be distributed in riskier plans (albeit with possibly high returns) or are positive about the scheme.
b. Income Funds
This belongs to the family of debt mutual funds that distribute their money in a mix of bonds, certificate of deposits and securities among others. Helmed by skilled fund managers who keep the portfolio in tandem with the rate fluctuations without compromising on the portfolio’s creditworthiness, Income Funds have historically earned investors better returns than deposits and are best suited for risk-averse individuals from a 2-3 years perspective.
c. Liquid Funds
Like Income Funds, this too belongs to the debt fund category as they invest in debt instruments and money market with a tenure of up to 91 days. The maximum sum allowed to invest is Rs 10 lakhs. One feature that differentiates Liquid Funds from other debt funds is how the Net Asset Value is calculated – NAV of liquid funds are calculated for 365 days (including Sundays) while for others, only business days are calculated.
d. Tax-Saving Funds
ELSS or Equity Linked Saving Scheme is gaining popularity as it serves investors the double benefit of building wealth as well as save on taxes – all in the lowest lock-in period of only 3 years. Investing predominantly in equity (and related products), it has been known to earn you non-taxed returns from 14-16%. This is best-suited for long-term and salaried investors.
e. Aggressive Growth Funds
Slightly on the riskier side when choosing where to invest in, the Aggressive Growth Fund is designed to make steep monetary gains. Though susceptible to market volatility, you may select one as per the beta (the tool to gauge the fund’s movement in comparison with the market). Example, if the market shows a beta of 1, an aggressive growth fund will reflect a higher beta, say, 1.10 or above.
f. Capital Protection Funds
If protecting your principal is your priority, Capital Protection Funds can serve the purpose while earning relatively smaller returns (12% at best). The fund manager invests a portion of your money in bonds or CDs and the rest in equities. You will not incur any loss. However, you need a least 3 years (closed-ended) to safeguard your money, and the returns are taxable.
g. Fixed Maturity Funds
Investors choose as the FY ends to take advantage of triple indexation, thereby bringing down tax burden. If uncomfortable with the debt market trends and related risks, Fixed Maturity Plans (FMP) – investing in bonds, securities, money market etc. – present a great opportunity. As a close-ended plan, FMP functions on a fixed maturity period, which could range from 1 month to 5 years (like FDs). The Fund Manager makes sure to put the money in an investment with the same tenure, to reap accrual interest at the time of FMP maturity.
h. Pension Funds
Putting away a portion of your income in a chosen Pension Fund to accrue over a long period to secure you and your family’s financial future after retiring from regular employment – it can take care of most contingencies (like a medical emergency or children’s wedding). Relying solely on savings to get through your golden years is not recommended as savings (no matter how big) get used up. EPF is an example, but there are many lucrative schemes offered by banks, insurance firms etc.
4. Based on Risk
a. Very Low-Risk Funds
Liquid Funds and Ultra Short-term Funds (1 month to 1 year) are not risky at all, and understandably their returns are low (6% at best). Investors choose this to fulfil their short-term financial goals and to keep their money safe until then.
b. Low-Risk Funds
In the event of rupee depreciation or unexpected national crisis, investors are unsure about investing in riskier funds. In such cases, fund managers recommend putting money in either one or a combination of liquid, ultra short-term or arbitrage funds. Returns could be 6-8%, but the investors are free to switch when valuations become more stable.
c. Medium-risk Funds
Here, the risk factor is of medium level as the fund manager invests a portion in debt and the rest in equity funds. The NAV is not that volatile, and the average returns could be 9-12%.
d. High-risk Funds
Suitable for investors with no risk aversion and aiming for huge returns in the form of interest and dividends, High-risk Mutual Funds need active fund management. Regular performance reviews are mandatory as they are susceptible to market volatility. You can expect 15% returns, though most high-risk funds generally provide 20% returns (and up to 30% at best).
5. Specialized Mutual Funds
a. Sector Funds
Investing solely in one specific sector, theme-based mutual funds. As these funds invest only in specific sectors with only a few stocks, the risk factor is on the higher side. One must be constantly aware of the various sector-related trends, and in case of any decline, exit immediately. However, sector funds also deliver great returns. Some areas of banking, IT and pharma have witnessed huge and consistent growth in the recent past and are predicted to be promising in future as well.
b. Index Funds
Suited best for passive investors, index funds put money in an index. A fund manager does not manage it. An index fund identifies stocks and their corresponding ratio in the market index and put the money in similar proportion in similar stocks. Even if they cannot outdo the market (which is the reason why they are not popular in India), they play it safe by mimicking the index performance.
c. Funds of Funds
A diversified mutual fund investment portfolio offers a slew of benefits, and ‘Funds of Funds’ aka multi-manager mutual funds are made to exploit this to the tilt – by putting their money in diverse fund categories. In short, buying one fund that invests in many funds rather than investing in several achieves diversification as well as saves on costs.
d. Emerging market Funds
To invest in developing markets is considered a steep bet, and it has undergone negative returns too. India itself a dynamic and emerging market and investors to earn high returns from the domestic stock market, they are prone to fall prey to market volatilities. However, in a longer-term perspective, it is evident that emerging economies will contribute to the majority of global growth in the coming decade as their economic growth rate is way superior to that of the US or the UK.
e. International/ Foreign Funds
Favoured by investors looking to spread their investment to other countries, Foreign Mutual Funds can get investors good returns even when the Indian Stock Markets perform well. An investor can employ a hybrid approach (say, 60% in domestic equities and the rest in overseas funds) or a feeder approach (getting local funds to place them in foreign stocks) or a theme-based allocation (e.g., Gold Mining).
f. Global Funds
Aside from the same lexical meaning, Global Funds are quite different from International Funds. While a global fund chiefly invests in markets worldwide, it also includes investment in your home country. The International Funds concentrate solely on foreign markets. Diverse and universal in approach, Global Funds can be quite risky to owing to different policies, market and currency variations, though it does work as a break against inflation and long-term returns have been historically high.
g. Real Estate Funds
In spite of the real estate boom in India, many are wary about investing in such projects due to multiple risks. Real Estate Fund can be a perfect alternative as the investor is only an indirect participant by putting their money in established real estate companies/trusts rather than projects. A long-term investment, it negates risks and legal hassles when it comes to purchasing a property as well as provide liquidity to some extent.
h. Commodity-focused Stock Funds
Ideal for investors with sufficient risk-appetite and looking to diversify their portfolio, commodity-focused stock funds give a chance to dabble in multiple and diverse trades. Returns are not periodic and are either based on the performance of the stock company or the commodity itself. Gold is the only commodity in which mutual funds can invest directly in India. The rest purchase fund units or shares from commodity businesses.
i. Market Neutral Funds
For investors seeking protection from unfavourable market tendencies while sustaining good returns, market-neutral funds meet the purpose (like a hedge fund). With better risk-adaptability, these funds give high returns, and even small investors can outstrip the market without stretching the portfolio limits.
j. Inverse/Leveraged Funds
While a regular index fund moves in tandem with the benchmark index, the returns of an inverse index fund shift in the opposite direction. It is nothing but selling your shares when the stock goes down, only to buy them back at an even lesser cost (to hold until the price goes up again).
k. Asset Allocation Funds
Combining debt, equity and even gold in an optimum ratio, this is a greatly flexible fund. Based on a pre-set formula or fund manager’s inferences based on the current market trends, Asset Allocation Funds can regulate the equity-debt distribution. It is almost like Hybrid Funds but requires great expertise in choosing and allocation of the bonds and stocks from the fund manager.
l. Gift Funds
Yes, you can gift a mutual fund or a SIP to your loved ones to secure their financial future.
m. Exchange-traded Funds
It belongs to the Index Funds family and is bought and sold on exchanges. Exchange-traded Funds have unlocked a world of investment prospects, enabling investors to gain extensive exposure to stock markets abroad as well as specialized sectors. An ETF is like a Mutual Fund that can be traded in real-time at a price that may rise or fall many times in a day.