Different Types of Mutual Funds in India
From your friendly next-door neighbour to a big-shot finance influencer, the most common investment advice is: start investing in mutual funds! While mutual funds offer an easy and flexible way to create a diversified investment portfolio, you need to build a comprehensive knowledge before investing.
There are different types of mutual funds in which you can invest and earn significant returns. Every mutual fund scheme has its own set of unique characteristics, which managers customise according to the needs of their investors. However, the variety of Mutual Funds available in the market may sometimes confuse investors. So, to help investors, this article will illustrate what mutual funds are, how they work, and the different types of mutual funds in india!
What Are Mutual Funds?
Mutual funds are managed by Asset Management Companies (AMCs) that collect money from a number of investors who share a common investment objective. And once individuals pool their money into a mutual fund, the fund manager of the AMC invests the corpus in stocks, bonds, money market instruments and other securities, depending on the fund’s investment objective. Each investor receives units of mutual funds corresponding to their respective investment amount.
And the income generated from the fund’s collective amount is distributed proportionately among the investors by calculating its “Net Asset Value” or NAV. Now you may be curious about what Net Asset Value is. Basically, NAV is the combined market value of the underlying securities in which the fund has invested. And with day-to-day changes in the market value of these securities, the NAV of a scheme also keeps varying.
Any change in NAV gets reflected only at the end of every trading session. The returns generated by each mutual fund plan are either reinvested back into the scheme or gets distributed among the investors as dividends or gains. It serves as an efficient method by which small retail investors can channelise their savings and earn decent returns over the medium to long term.
Mutual funds can be actively managed funds or passively managed funds. In actively managed funds, the fund manager performs market research to align the portfolio with the fund’s objective. On the other hand, passive mutual funds replicate the performance of benchmark indexes like Nifty and Sensex.
What Are the Types of Mutual Funds in India?
There are several subclasses in which mutual funds can be classified. There are primarily three types of mutual funds based on asset class – equity, debt and hybrid. All three of them and their subcategories have been explained below:
In these funds, a minimum of 65% of their corpus is invested in equity-oriented instruments such as shares of different companies listed on stock exchanges to create a portfolio based on the fund’s objectives. These funds can be risky and volatile in the short term, but the risk tends to taper out over the long term.
It is an ideal investment alternative for aggressive investors looking for substantial returns. There are various subcategories under equity mutual funds, which are discussed below:
- Large-cap funds: A large-cap equity fund invests at least 80% of its total corpus in companies with large market capitalisation. These companies rank from 1-100 on stock exchanges, in terms of full market capitalization.
Large market capitalisation companies have an established presence in varied sectors and abide by the highest corporate governance standards. As a result, these schemes come with the least risk in the equity fund category.
- Mid-cap funds: As the name suggests, these mutual fund schemes invest at least 65% of their total corpus in shares of mid-market cap companies. A mid-cap company is such that it ranks between 101st and 250th in terms of total market capitalisation. These offer higher return potential than large-cap funds but also tend to be slightly riskier.
- Small-cap funds: Fund managers of a small-cap MF scheme must invest at least 65% of the total fund corpus in stocks of small market-cap companies. Companies above the 250th rank in terms of total valuation are referred to as small-cap companies.
Small-cap funds are deemed high-risk and are suitable for aggressive investors looking for substantial gains who have a high-risk appetite. These have the highest return potential among all subclasses of equity mutual funds.
- Contra funds: Under this type of mutual fund scheme, the fund manager adopts a contrarian style of investment. This entails investing and taking decisions opposite prevailing market sentiments. A fund manager of a Contra fund will make investment decisions betting on either underperforming or overperforming stocks. For example, if a particular sector, say the energy sector is in a slump, the stock prices fall, however, the fund manager will recognise that the prices will correct over time and purchase stock at this lower price which will provide substantial gain when the market corrects.
As per the requirement of the Securities Exchange Board of India, these schemes must invest at least 65% of the total fund amount in equity or any equity-related instruments. As they swim against the market tide, these schemes can provide an extreme return during bearish markets. However, these are risky decisions and one must evaluate the qualifications and track record of the fund manager of these funds for the best results.
- Multi-cap funds: A multi-cap fund is one of the most diverse mutual fund schemes as fund managers can invest in stocks of large, small and mid-cap companies. It is a type of open-ended fund, meaning that it comes with no maturity date.
It is always open for subscription and redemption. The only requirement that it must follow is that at least 75% of the total corpus must be invested in equity-related instruments. Due to the diversification associated with these funds, it offers stable returns at low to medium risk.
- Dividend yield fund: As the name suggests, these funds invest in stocks of those companies that pay dividends to their investors in a periodic manner. The dividends may be payable either quarterly, half-yearly or annually to the investors.
As per the requirement of SEBI, a dividend yield fund must invest at least 65% of its corpus in dividend-yielding stocks.
- Value fund: A value fund is a type of equity mutual fund in which the fund managers invest in stocks which are undervalued in comparison to a company’s fundamentals. As per SEBI guidelines, at least 65% of the corpus must be invested in equity or related instruments.
The idea behind value investing is that for various reasons, the market has some inherent inefficiencies that allow particular firms to sell at rates below their actual value. Value fund managers are able to identify inefficiencies in these markets. Once these inefficiencies are corrected by the market, the value investor will gain from a share price increase.
- Focused funds: These funds can invest in a limited number of stocks listed on any stock exchange. According to SEBI guidelines, a focused fund can invest in a maximum of 30 stocks across different market capitalisation categories.
The fund manager can invest in either large, mid or small-cap companies according to his/her vision and strategies. As the name suggests, the managers focus on a very small category of stocks which, according to them, will witness significant capital appreciation.
- Sectoral/Thematic funds: A sectoral fund invests at least 80% of its corpus in a particular sector or industry like banking, IT, automobiles, etc. As these funds come with minimum to no industry diversification, the risk component of these funds is relatively higher than other equity funds.
On the other hand, a thematic fund is one which invests in stocks that follow a particular theme. For example, an infrastructure thematic fund will invest in stocks of different infrastructure companies like cement, steel, power, logistics, port, etc.
- ELSS funds: An ELSS or equity-linked savings scheme comes with dual advantages of tax savings and investment gains. Unlike other mutual funds, it has a mandatory lock-in period of 3 years from the date of investment.
Investment in ELSS funds also makes you eligible to claim deductions of up to Rs. 1.5 lakh under section 80C of the Income Tax Act, 1961. According to SEBI guidelines, these funds must invest at least 65% of their corpus in stocks or other equity-related instruments.
- Large and mid-cap funds: These funds invest in equity-related instruments of mid and large stock companies. As per SEBI guidelines, fund managers must invest at least 35% of the total corpus in stocks of large market capitalisation companies and another 35% in stocks of mid cap companies.
- Debt Mutual Funds
A debt mutual fund will invest its fund corpus in different categories of debt instruments such as bonds, treasury bills, certificates of deposits, government securities, etc.
These funds have a moderate risk outlook and seem to be ideal for investors looking for stable returns and capital preservation. The subcategories of debt mutual fund schemes are explained in the next section:
- Overnight funds: It invests in those securities that have a maturity period of one day. The interest rates offered by overnight funds are generally higher than savings interest rates offered by various financial institutions. The biggest feature of this mutual fund scheme is that it comes with high liquidity as you can enter and exit these funds within trading hours.
- Liquid funds: A liquid fund is an open-ended mutual fund scheme that invests in debt instruments having a maturity period of up to 91 days or three months. The fund manager of a Liquid Fund aims to invest only in liquid investments with good credit ratings and a very low possibility of a default.
As the name suggests, these funds come with significant liquidity, and you can access your money within a short span of time after putting in a redemption request.
- Short-duration funds: A short-duration fund is one that invests in the money market or debt instruments having a maturity period of 1-3 years. Therefore, it can be an ideal investment opportunity for individuals looking to fulfil their medium-term investment goals. It offers stable returns to prospective investors and helps in wealth accumulation.
- Long-duration funds: A long duration fund invests in debt securities having a maturity period of more than 7 years. You may consider investing in these debt funds if you are capable of bearing short-term volatility and have long-term financial goals.
- Ultra-short duration funds: An ultra-short duration fund is a debt mutual fund which invests in the money market and debt securities having a Macaulay’s duration of 3-6 months. Macaulay’s duration is the time in which an investor would get back all his invested money in the bond by way of periodic interest as well as principal repayments.
These funds have high liquidity and easy withdrawal and redemption rules.
- Low duration funds: Low duration funds are a type of mutual fund scheme that invests their corpus in debt instruments having a Macaulay maturity duration of 6-12 months.
These types of funds add value to an investor’s portfolio and help him/her meet short-term financial goals. These funds may offer great returns when interest rates are on an upward trajectory.
- Money market funds: As the name suggests, these funds invest in money market instruments like T-bills, Commercial Papers, and Certificates of Deposits. The underlying securities have a tenure of up to 1 year. These funds have the potential to generate higher returns compared to a savings account or fixed deposit.
- Medium duration fund: These funds invest in securities that have a Macaulay duration of about 3-4 years. It offers chances of stable returns to prospective investors by investing in high credit-rating securities.
- Medium to long duration funds: The maturity period of debt securities of these funds ranges from medium to long term. Therefore, as per SEBI guidelines, fund managers of medium to long-tenure funds must invest in debt securities having a maturity period of 4-7 years.
- Dynamic bond funds: The maturity date of these funds is dynamic and varies from one mutual fund scheme to another. Fund managers invest the corpus in corporate bonds, government securities and treasury bills of varying duration. These funds are actively managed by reducing the portfolio maturity in a rising interest rate environment and increasing portfolio maturity in a falling interest rate environment.
- Corporate bond fund: A corporate bond fund will invest in high credit rating bonds of various corporations. As per SEBI regulations, fund managers must invest at least 80% of the total fund corpus in AA+ or above-rated corporate bonds.
However, these come with a moderate interest rate potential and may not be preferred by aggressive investors. As the credit default risk is low, these funds offer higher liquidity to prospective investors.
- Credit risk fund: As per regulatory guidelines, fund managers of credit risk MFs must invest at least 65% of the total corpus in securities having ratings of AA or lower category.
The yield associated with these funds is quite high as compared to other debt mutual fund schemes. You can earn an interest income from these funds in addition to the income earned from capital appreciation in case of an increase in the price of corresponding securities. Credit-risk funds have a higher liquidity risk. For instance, if a bond with lower rating defaults or faces a downgrade, it may be difficult for the fund manager to exit the holding.
- Banking and PSU funds: These are a type of sectoral debt mutual funds that target the government enterprises and financial services sector. This type of fund must invest at least 80% of its total corpus in debt instruments of banking, financial services, PSU companies and municipal bonds.
A banking and PSU fund has a typical investment horizon of 2-3 years. These funds may be influenced by changes occurring in interest rates in the economy.
- Gilt funds: These funds invest 80% of their corpus in government-backed securities, which leads to minimal credit risk. Government securities come with a sovereign guarantee, i.e. the government has guaranteed to pay back the entire sum.
These funds invest in government securities of varying maturities according to the vision and strategy adopted by the fund manager. As the default is very low, gilt funds have a moderate return outlook as well.
- Floater funds: A floater fund is one such mutual fund investment in which the fund managers invest at least 65% of the total corpus in floating-rate instruments. Unlike other debt funds, which come at a fixed rate determined at the start of the investment period, these funds invest in securities whose return is linked to an external benchmark which gets revised periodically.
These are the third type of mutual funds on the basis of asset structure. A hybrid mutual fund scheme can invest in both debt and equity instruments. It is useful for investors who are looking for stability as well as decent returns.
The exposure to equity and debt instruments differs for every hybrid mutual fund plan. The risk proportion in a particular mutual fund depends on the level of equity exposure. The higher the equity exposure, higher the risk level and vice versa.
There are several types of hybrid mutual funds, which have been discussed below:
- Conservative mutual funds: The level of exposure to debt securities is between 75-90%. The remaining 10-25% of the corpus gets invested in equity-related securities.
- Aggressive hybrid fund schemes: Here, the level of exposure in equity is between 65-80%, and the remaining corpus gets invested in debt instruments.
- Arbitrage funds: The fund managers of such funds try to take advantage of the difference in the price of assets in separate exchanges. They purchase an asset in one market and simultaneously sell the same in another market, thus making a profit equivalent to a difference in their prices. However, it comes with a mandate to invest at least 65% of the total corpus in equity instruments.
- Balanced hybrid funds: This type of fund tries to create a balanced portfolio by investing in a nuanced manner in both equity and debt instruments. As per SEBI guidelines, a balanced hybrid fund scheme must invest 40-60% of the total corpus in equity instruments and remaining 60-40% in debt or money market instruments.
- Balanced advantage funds: This is a hybrid mutual fund scheme investing in a mixture of debt and equity instruments. This type of hybrid fund balances its asset allocation between equity and debt based on market situations.
- Multi-allocation fund: These funds invest their corpus in at least three different asset classes with a minimum of 10% investment in each of them. The most common asset classes of multi-allocation funds are equity, debt and commodities segments. They can adjust the portfolio as per current market conditions.
- Equity savings: An equity savings mutual fund scheme invests at least 65% of its total corpus in equity-related instruments, a minimum investment of 10% in debt securities, and a certain portion of its fund in derivatives as a hedging tool.
These funds have low volatility than equity funds and are more tax efficient than debt mutual funds.
Now, let’s move on to the types of mutual funds by structure and understand how they work.
- Open-ended funds
An open-ended fund does not come with any maturity period. It is open for subscription and redemption at any time during a financial year. You can purchase or redeem units of open-ended mutual funds at the prevailing Net Asset Value (NAV). An open-ended fund has high liquidity as it is not bound by any expiry or maturity date.
- Close-ended funds
A close-ended fund has strict entry and exit guidelines. You can buy units of a close-ended mutual fund only during the New Fund Offer (NFO). For close-ended funds, you cannot redeem your investment amount before the completion of the maturity date. Unlike open-ended funds which allow you to invest via SIP as well as a lump sum, these funds require you to invest a lump sum at the time of their launch.
Let’s shift our focus to a type of solution-oriented mutual fund:
As the name suggests, this solution-oriented mutual fund is ideal for covering lifestyle expenses after retirement. The main aim of these funds is to provide long-term capital appreciation and stable income options to subscribers.
It comes with a lock-in period of 5 years or retirement age (whichever of the two comes earlier). Retirement mutual funds can be a source of stable income for senior citizens, who can withdraw their investments conveniently.
- Children’s Mutual Funds
Children’s funds are an open-ended mutual fund with a lock-in period of 5 years or until the child becomes a major. It is suitable for child-specific goals like meeting their educational expenses, relocation, or other essential expenses.
Other Types of Mutual Funds
In addition to the mutual funds mentioned above, there are some other types of mutual funds that work differently than the prevailing mutual fund schemes.
- Index funds
Index funds are a type of mutual funds which replicate or mirror the portfolio of a particular benchmark index like Nifty 50 or Sensex. These are passive mutual funds as managers are required to replicate the returns of the index funds instead of using their personal market perception.
The portfolio of these funds contains all the securities of a particular index in the same proportion or weightage. As per SEBI guidelines, index funds must invest at least 95% of their total corpus in securities of the index it is replicating. The expense ratio of these funds is capped at 1.5%.
An example of this type of fund is the Nifty 50 Index Fund. The portfolio of this fund will contain all the stocks listed on National Stock Exchange at the same weightage. These investment instruments are immensely popular among new-age investors because of their high return potential, low management costs and diversification.
- Fund of Funds
A ‘Fund Of Funds’ (FOF) is a mutual fund scheme that primarily invests in the units of another Mutual Fund scheme. So, instead of directly investing in equities or debt instruments, the fund manager holds a portfolio of other mutual funds. This type of investing is often referred to as multi-manager investment
These schemes offer the investor an opportunity to diversify risk by spreading investments across multiple funds.
Mutual funds are a popular investment alternative for investors who wish to gain substantial returns from stock markets without having to understand the intricacies of day-to-day price fluctuations. Whether you choose a Systematic Investment Plan (SIP) or go for the lump-sum mode of investment, investors are bound to gain returns from different types of mutual fund schemes if they choose their schemes wisely.
Frequently Asked Questions
Is ULIP a mutual fund?
Unit-linked insurance plans do not come under the mutual fund category. It is an insurance product offering the added benefit of market-based investments. The sum assured on the death of the policyholder remains fixed and is not linked to market conditions.
What are two ways of investing in mutual funds?
You can invest in mutual funds via two methods – lump sum or SIP. In lump sum, you make a substantial payment upfront and buy units of mutual funds in one go. On the other hand, in the case of a SIP, you make fixed investments at regular intervals and buy units of mutual funds intermittently.
Who regulates mutual funds in India?
The Securities and Exchange Board of India, the apex capital market regulator, is responsible for making guidelines and regulating the mutual fund sector. Every mutual fund scheme must follow updated guidelines issued by SEBI.