A Mutual Fund is an investment instrument which pools the investments of several investors and invests the monies as per preset objectives. Every Mutual Fund scheme has a pre-defined objective to achieve one or more goals. The funds of the scheme are invested to achieve these goals. This article tries to elaborate on the various types of Mutual Funds and give a clear understanding to readers about which types of mutual funds they have invested in or are about to invest in.
Some of the goals of Mutual Fund schemes include: Growth of capital in the long term, Regular Dividends to generate income for investors, Liquidity – so that investors can withdraw the money within a short period and earn some interest at the same time, safety of investments accompanied by decent returns, etc.
The type of Mutual Fund scheme depends on the objective of investment and the asset class in which the fund invests. A broad list of Mutual Fund categories in mentioned below:
Equity Based:
1. Large Cap Funds: Large Cap stocks are shares of large companies registered on the stock exchange. These companies typically have a market capitalization of over Rs. 10,000 crores. They form the top 70% of the market capitalization of the Bombay Stock Exchange (BSE). Large cap mutual funds invest in the shares of such companies. Since the share prices of large cap companies are stable as compared to mid-cap and small cap companies, the investments in such schemes are less volatile as compared to the overall stock market. On the flip side the returns generated from such schemes can also be less than their small and mid-cap peers during bull markets.
2. Mid Cap Funds: Mid- Cap companies are companies with market capitalization of between Rs.1,000 crores and Rs.10,000 crores. They form 20% of the market capitalization of the BSE. These are medium sized companies and have a potential to grow faster than their large cap peers during favourable economic conditions. During periods of low economic activity they are also susceptible to stagnation and collapse because of their limited financial size. Mid-cap funds invest in the shares of such companies. Their performance reflects the behaviour of the mid-sized companies they invest in. These funds can be quite volatile.
3. Small Cap Funds: Small cap companies are companies with market capitalization of less than Rs.1,000 crores. They form the last 10% of the overall market capitalization of the BSE. These are the smallest companies registered on the stock exchanges and have a potential to grow faster than their large cap and mid cap peers during favourable economic conditions. During periods of low economic activity they are also susceptible to stagnation and collapse because of their small financial size. Small cap funds invest in the shares of such companies. These funds can be highly volatile.
4. Multi Cap Funds: Multi Cap funds invest the shares of all three types of companies. The allocation and flexibility of allocation of funds to each class of companies is predefined in the scheme’s charter. These funds have the flexibility to allocate funds to companies of different market caps depending on the valuation of the share prices and economic and industry conditions.
5. Sectoral Funds: Sectoral Funds invest in shares of companies of a particular industry such as pharmaceuticals, FMCG, Automobiles, Banking, and Cement etc. These funds do not consider market capitalization and may invest in any company from the particular industry which attracts their attention, provided its charter allows for the same.
6. Thematic Funds: Mutual Funds which invest in companies of the same nature, such as Infrastructure, Power, Consumer goods etc. are called thematic funds. The companies in the theme are similar in nature such as cement and construction, automobiles and spare parts, different types of power sector companies, airlines and tourism and so on.
7. Index Funds: Index funds are passively managed funds and invest in a basket of shares exactly similar to the index it tracks. For example, an index fund which tracks the NSE Nifty will have all shares of all the 50 companies which comprise the NIFTY index. The weightage given to each company in the index fund will also be the same as that given in the NIFTY. Such funds do not attempt to outperform the index and their ability to generate the same returns as the index depends on the tracking error. Tracking error is the fractional upside or downside returns that these funds generate as compared to the index they track. Such funds will have low expense ratios as compared to actively managed funds stated above.
Debt Based:
1. Short Term Funds: Short term debt funds are funds which invest in debt instruments of near term maturity, such as less than 5 years. Their modified duration, average maturity and yield to maturity is low as compared to long term funds. These funds can give good returns in a buoyant economy with high inflation rates.
2. Gilt Funds: Gilt funds are funds which invest all the money in debt instruments such as bonds issued by the government of India and state governments. These bonds generally have a maturity period ranging from 1 year to 30 years. The most common government bond is the 10 year Gsec or 10 year Gilt. Gilt funds perform well during periods of low economic activity when short term interest rates are low. As an economic rule bond prices are inversely related to their yield or the interest rates prevailing in the market.
3. Dynamic Bond Funds: Dynamic bond funds invest in short term debt or long term debt based instruments depending on the interest rate scenario in the economy. They have the flexibility to switch their investments between short term, medium term and long term debt instruments and bonds. They usually have high expense ratios as compared to short term funds. However they allow investors the flexibility to remain immune to changing economic cycles.
4. Corporate Bond Funds: Corporate bond funds as the name suggests invest only in bonds and debentures issued by the private and public sector companies. These funds cannot invest in government securities.
5. Fixed Maturity Plans: Fixed Maturity Plans or FMPs are close ended funds which invest in public and private sector securities which mature on or before the maturity of the scheme. Before they mature, such units can only be sold at a stock exchange and the liquidity can be low. If held till maturity FMPs can give good returns as compared to other funds held for the same tenure.
6. Liquid Funds: Liquid funds are funds which invest in money market instruments such as treasury bills issued by the government of India and commercial paper issued by the corporate sector. Money market instruments are debt instruments of less than 1 year maturity. The returns and risks involved in such schemes are both low. Liquid funds are used to park large amount of funds for short duration, from a few weeks to a few months.
7. Credit Opportunities Funds: Credit opportunities funds invest in corporate securities which are below investment grade. The coupon offered on such securities is high as compared to debt securities of good credit rating. It is used by investors to get a higher yield, but their a strong element of credit risk in such funds.
Hybrid or Balanced Funds:
1. Hybrid Equity Oriented: Equity oriented Hybrid funds are also referred to as balanced funds. They allocate about 65% of their resources to equity and the balance in debt based instruments. This allocation can be changed depending upon the economic situation and valuation of equity and debt based instruments. They are a good choice to cushion the volatility of equity and can be used to get regular dividends. Their ability to give regular dividends is better than Monthly Income Plans or MIPs. They can also be used for medium term investments ranging from a few years to the long term. Since a major portion of the fund is invested in equity they are not safe for short term investments.
2. Hybrid Debt Oriented: Hybrid Debt oriented funds invest a major portion of its assets in debt based securities and the balanced in equity instruments. Hybrid debt funds can be conservative or aggressive depending upon the kind of debt securities they invest in. When such funds invest in high yielding debt securities they are considered to be aggressive and otherwise, conservative. The high yields are obtained by investing in debt securities which may not have good credit quality.
International Funds: International funds invest in Mutual Fund schemes operating in foreign countries such the US, Europe, ASEAN region etc. Such schemes are fund of fund schemes and may carry high expense ratio. Such schemes also carry currency risk as the funds are invested overseas and the returns generated by the schemes overseas have to be repatriated to India. This is obviously done by the domestic scheme and the investor does not have to worry about tracking the foreign fund or funds.
Arbitrage Funds: Arbitrage is an activity through which differences in prices between different markets are exploited. This can be between two spot markets or between spot and derivatives markets. A spot market is one in which trades are settled on the same day and derivatives market is one which involves settlement of transactions on a future date. Arbitrage funds seek to exploit such opportunities in equity and debt markets.
