There are various types of mutual funds in India.
Mutual funds are usually classified on:
- Maturity period (Open or closed ended)
- Investment objectives (Equity, debt and liquid)
- Solution based (Retirement and Child plan) and
- Others (ELSS, Index funds)
Equity mutual funds are a part of all of the above
categories of mutual funds.
An equity mutual fund is a fund that invests primarily in
shares of companies.
Since equity mutual funds carry the most risk among all
mutual funds, they also have the potential to generate the highest returns.
For a fund to qualify as an equity mutual fund, it needs to
invest 65% of its corpus in equities at all times.
Only tax saving mutual funds, also known as elss funds need
to invest 80% of its corpus in equities at all times as opposed to 65% for
other equity mutual funds.
Equity mutual funds are better suited for investors with a
long-term horizon, who can stay disciplined and have a higher risk appetite.
Types
of Equity mutual funds
The various types of equity mutual funds in India can be
classified on the basis of:
- Their purpose (tax saving, retirement)
- Market cap restrictions (large cap, small cap, etc.) and
- Thematic and Sectoral mutual funds.
Large
cap mutual funds
A large cap mutual fund by SEBI regulations needs to invest
a minimum 80% of its total aum in the top 100 companies by market
capitalization.
Categorization of companies
Large Cap: 1st -100th company in terms
of full market capitalization.
Mid Cap: 101st -250th company in terms of
full market capitalization.
Small Cap: 251st company onwards in terms of full market
capitalization.
This rule therefore does not allow a large cap mutual fund
to diversify much beyond the top 100 companies.
Large cap mutual funds because of the rule to invest mostly
in the top 100 companies by market capitalization end up with companies that
are leaders in their respective fields.
At times flexi cap mutual funds when their aum becomes
really large convert themselves into a large cap fund, although this is not a
rule but more of a choice.
This is done because liquidity becomes a challenge with
stocks besides large cap stocks.
Case in point Mirae Asset Large cap fund was primarily a
flexi cap mutual fund that was converted to a large cap fund.
Large
& Mid cap mutual fund
A large & mid cap mutual fund is a mutual fund scheme
whereby 35% investments at all times have to be made in each large cap and mid
cap stocks.
This is one of the youngest equity mutual fund category.
It has come into effect only since 2018 once SEBI introduced
new guidelines relating to recategorization of mutual fund schemes.
Most large & mid cap mutual funds are mutual funds that
were converted to a large & mid cap mutual fund after 2018 and did not
originate as a large & mid cap mutual fund.
Large & Mid cap fund allocation
As stated earlier, 35% investments at all times have to be made in each large cap and mid cap stocks.
The remaining 30% can be invested as per discretion of the
fund manager.
Because of this discretion, this category along with flexi
cap category has the most potential for diversity both among returns as well as
investment strategies despite funds belonging to the same category.
Dividend
Yield mutual fund
A dividend yield mutual fund is a mutual fund scheme that
invests in companies that have historically declared dividends perpetually for
a long time.
Therefore, by default it means these mutual fund schemes
invest in companies with strong balance sheets, highly efficient management and
a robust functioning in place.
Additional reading: Click Here to read our complete report on Dividend Yield mutual funds
This is because a company can declare high dividends
only if it makes good profits and it can only make good profits when it
satisfies all the qualifications mentioned above.
It is not enough that these companies pay high dividends
consistently to qualify for a dividend yield mutual fund, they also need to
have a high dividend yield.
Multicap mutual fund
A multicap mutual fund is a mutual fund that would by
mandate need to invest a minimum of:
- 25% in large cap stocks
- 25% in mid cap stocks
- 25% in small cap stocks
The remaining 25% can either be invested in debt,
international equity, cash or any of the above caps or all.
In order to qualify as a multi cap mutual fund, a mutual
fund needs to invest a minimum of 75% in domestic equity divided as described
above.
Flexi cap mutual funds
A flexi cap mutual fund is a mutual fund that would by
mandate need to invest a minimum of 65% into equity at all times.
The remaining 35% can either be invested in debt,
international equity, cash or any of the above caps or all.
This 65% is only minimum which can even go up to
100% in case the fund manager so desires.
Whatever the allocation between 65% to 100%, there
is no restriction with relation to large cap, mid cap or small cap stocks.
Basically, the fund would be run as how erstwhile multicap
mutual funds were being run.
Thematic mutual funds
A Thematic Mutual Fund as the name suggests follows a
particular theme when investing.
A Thematic Mutual Fund can invest across various sectors
that fall within one particular theme.
It is far more diversified than a Sectoral Mutual Fund
since it is not restricted to any one particular sector.
An infrastructure fund is an example of a thematic mutual
fund, it invests only in stocks that are considered to be a part of the
infrastructure story.
An infrastructure fund can invest in companies belonging to
the paint (chemicals), cement, banks, etc sectors
Therefore, infrastructure is the theme in this example.
Sectoral mutual funds
A Sectoral
Mutual Fund as the name suggests invests only in one particular sector.
It is less
diversified than a Thematic Mutual Fund since it is restricted to just one
particular sector.
Think
of Sports as a theme and various disciplines like Football and Basketball like
sectors. Sports constitute both Football and Basketball but Football does not
constitute Basketball and Basketball does not constitute Football.
In the same
manner a Thematic Mutual Fund constitute various sectors but it is not
necessary that various sectors fall within the same theme.
Think of a Pharma
mutual fund scheme, it can only invest in companies belonging to the
pharmaceutical sector.
Tax Saving/ELSS Mutual Funds
Tax saving/elss mutual funds allows you an exemption of up
to 1,50,000 in your taxes under section 80c of the income tax act.
Tax saving funds have the lowest lock in period of 3 years
among the instruments available to avail exemption.
Elss funds need to invest a minimum of 80% of its overall
portfolio into equities.
Additional reading: Click Here to read our complete report on ELSS funds and how they work
In case of sip plans, you have to keep in mind that each sip
instalment completes 3 years in case you wish to redeem.
Unlike other mutual fund schemes, elss mutual funds are
regulated by the government of India and not SEBI.
Focused mutual funds
Focused mutual funds have a concentrated portfolio and do
not invest in more than 30 stocks.
There are less diversified than flexi cap mutual funds but
also have more potential for higher returns.
Despite the limitation of 30 stocks, certain focused mutual
funds invest in even fewer stocks than that.
Invesco Focused fund invests in only 20 stocks whereas Axis
Focused fund invests in only 25 stocks.
Funds besides focused funds also at times apply this
investment strategy even though there are under no obligation to.
These include the following but not limited to these:
- Axis Flexi cap fund
- Axis Bluechip fund
- Parag Parikh flexi cap fund
- Parag Parikh tax saver fund
Mid cap mutual funds
A mid cap mutual fund needs to invest a minimum of 65% into
mid cap companies at all times.
These include companies between 101 to 250 in terms of
market capitalization.
Some mid cap mutual funds investing the remaining 35% into
mid cap companies too whereas others prefer to use large cap stocks for the
remaining 35% for downside protection.
Therefore, knowing your risk profile and aligning it with
the mid cap fund that follows a strategy aligned with your risk profile is
important.
Mid cap mutual funds are more aggressive than large and
flexi cap mutual funds but also have more potential for higher returns.
Small cap mutual funds
A small cap mutual fund needs to invest a minimum of 65%
into small cap companies at all times.
These include all companies beyond 250 in terms of market
capitalization.
A small cap mutual fund is the most risk prone mutual fund
besides thematic mutual funds and yet the most rewarding if you know what you
are doing.
This category includes companies that have potential to be
multi baggers but also companies that are most likely to be plagued by poor numbers,
inefficient management, etc. among other issues.
A small cap mutual fund allows a fund manager a very large
pool of companies to choose from unlike a large and a mid cap mutual fund.
Therefore the
performance of a small cap mutual fund hinges the most on a fund manager and
his ability to avoid certain companies rather than his ability to pick the
right companies.
Most investors sadly who invest in a small cap mutual fund
do so, either due to its high returns potential or the need to do so for
diversification, don’t be one of them.
Value
fund
A value fund is one in which more allocation is made towards
stocks that are trading lower to their intrinsic value.
In a value mutual fund, valuation is more important than
price.
There is no restriction with any caps so value mutual funds
can move anywhere as much as they like.
It invests in companies it feels are presently very
attractively priced but with strong fundamentals.
Unlike other equity mutual funds, a value fund does not have
a buy and hold strategy but rather a buy and sell strategy.
Contra Fund
A contra mutual fund is a mutual fund scheme that invests
uses contrarian ideas.
Meaning it invests in sectors and companies that are
currently not in favour.
A contra fund looks for companies that have strong
fundamentals but may currently not be in favour for whatever reason but look
attractive for a long term horizon.
A contra fund should be a part of your mutual fund portfolio
only if it adds something different from other existing schemes but it should not be part of your core portfolio.
With so many different types of equity mutual funds available
for investors, it becomes more important to know which ones to avoid than which
ones to invest in.
Irrespective of where you invest, the following helps:
- Having a goal
- Having a plan to achieve that goal
- Patience and discipline
- Not paying attention to unsolicited and ‘free’ advice from colleagues, friends, relatives and social media tips.
For portfolio enquiries, email us with your doubts at info@themutualfundguide.com
