Mutual funds - Types
A mutual fund is a professionally managed financial vehicle made up of a pool of money collected from several investors in order to invest in securities such as bonds, stocks, money market instruments and other assets. They are operated by financial fund managers who allocate the collected funds in an attempt to create capital gains or income for the investors. These funds allow smaller and individual investors access to professionally managed portfolios and higher chances of profit. They invest in a number of securities and each shareholder participates proportionally in the profits and losses of the fund. Performance of mutual funds is generally tracked as the change in total market cap of the fund – to do this, we aggregate the performance of the investments in the portfolio of the fund. The term ‘mutual funds’ is generally used in the United States of America, India and Canada. In Europe, a similar structure is the SICAV (‘investment company with variable capital’) and OEIC (‘open-ended investment company’) in the United Kingdom. Mutual funds charge annual fees (called expense ratios) and, in some cases, commissions, which can affect their overall returns. The overwhelming majority of money in employer-sponsored retirement plans goes into mutual funds. The value of a mutual fund depends on the stocks it decides to buy. When you buy a unit or a share of a mutual fund, you are buying a portion of the portfolio value. As a result, a mutual fund does not give their holders any voting rights. That is because a share of a mutual fund represents holdings in several different companies and investments not just one. Thus, the price of a mutual fund is also known as the Net Asset Value per share or NAV or NAVPS. A fund's NAV is derived by dividing the total value of the securities in the portfolio by the total amount of shares outstanding. Mutual fund shares can typically be purchased or redeemed as needed at the fund's current NAV, which—unlike a stock price—doesn't fluctuate during market hours, but it is settled at the end of each trading day. Ergo, the price of a mutual fund is also updated when the NAVPS is settled.
Types
of mutual funds
Mutual funds can be
classified in various ways such as:
Based
on asset class
·
Equity Funds: - Equity funds primarily invest in stocks, and hence go by the
name of stock funds as well. They invest the money pooled in from various
investors from diverse backgrounds into shares/stocks of different companies.
Also, equity funds have the potential to generate significant returns over a
period. Hence, the risk associated with these funds also tends to be
comparatively higher.
·
Debt Funds: - Debt funds invest primarily in fixed-income securities
such as bonds, securities and treasury bills. They invest in various fixed
income instruments such as Fixed Maturity Plans (FMPs), Gilt Funds, Liquid
Funds, Short-Term Plans, Long-Term Bonds and Monthly Income Plans, among
others. Since the investments come with a fixed interest rate and maturity
date, it can be a great option for passive investors looking for regular income
(interest and capital appreciation) with minimal risks.
·
Money Market Funds: - Investors trade stocks in the stock market. In the same way,
investors also invest in the money market, also known as capital market or cash
market. The government runs it in association with banks, financial
institutions and other corporations by issuing money market securities like
bonds, T-bills, dated securities and certificates of deposits, among others.
· Hybrid Funds: - As the name suggests, hybrid funds (Balanced Funds) are an optimum mix of bonds and stocks, thereby bridging the gap between equity funds and debt funds. The ratio can either 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. These are suitable for investors looking to take more risks for ‘debt plus returns’ benefit rather than sticking to lower but steady income schemes.
Based on structure
·
Open-ended Funds: - Open-ended funds do not have any particular constraint
such as a specific period or the number of units which can be traded. These
funds allow investors to trade funds at their convenience and exit when
required at the prevailing NAV (Net Asset Value).
·
Close-ended Funds: - In closed-ended funds, the unit capital to invest is
pre-defined which means the fund company cannot sell more than the pre-agreed
number of units. Some funds also come with a New Fund Offer (NFO) period;
wherein there is a deadline to buy units. NFOs comes with a pre-defined
maturity tenure with fund managers open to any fund size. Hence, SEBI has
mandated that investors be given the option to either repurchase option or list
the funds on stock exchanges to exit the schemes.
· Interval Funds: - Interval funds have traits of both open-ended and closed-ended funds. These funds are open for purchase or redemption only during specific intervals (decided by the fund house) and closed the rest of the time. Also, no transactions will be permitted for at least two years. These funds are suitable for investors looking to save a lump sum amount for a short-term financial goal, say, in 3-12 months.
Based on investment
goals
·
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.
·
Income Funds: - Income funds belong to the family of debt mutual funds
that distribute their money in a mix of bonds, certificate of deposits and
securities among others. They are best suited for risk-averse investors with a
2-3 years perspective.
·
Liquid Funds: - Like income funds, liquid funds also belong 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 lakh. A
highlighting feature that differentiates liquid funds from other debt funds is
the way the Net Asset Value is calculated. The NAV of liquid funds is
calculated for 365 days (including Sundays) while for others, only business
days are considered.
·
Tax-Saving Funds: - ELSS
or Equity Linked Saving Scheme, over the years, have climbed up the ranks among
all categories of investors. Not only do they offer the benefit of wealth
maximization while allowing you to save on taxes, but they also come with the
lowest lock-in period of only three years. Investing predominantly in equity
(and related products), they are known to generate non-taxed returns in the
range 14-16%. These funds are best-suited for salaried investors with a
long-term investment horizon.
·
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, one can decide on the fund 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.
·
Capital
Protection Funds: - If
protecting the principal is the priority, Capital Protection Funds serves the
purpose while earning relatively smaller returns (12% at best). The fund
manager invests a portion of the money in bonds or Certificates of Deposits and
the rest towards equities.
·
Fixed Maturity Funds: - Many investors choose to invest towards of 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) – which invest 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 one month to five years (like FDs).
· 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 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.
Based on risk
·
Very Low-Risk Funds: - Liquid funds and ultra-short-term funds (one month to one
year) are known for its low risk, and understandably their returns are also low
(6% at best). Investors choose this to fulfil their short-term financial goals
and to keep their money safe through these funds.
·
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.
·
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%.
· 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 up to 20% returns.
Specialized mutual
funds
Sector Funds: - Sector funds invest 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. Investors are advised
to keep track of the various sector-related trends.
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.
Funds of Funds: - A diversified mutual fund investment portfolio offers a
slew of benefits, and ‘Funds of Funds’ also known as multi-manager mutual funds
are made to exploit this to the tilt – by putting their money in diverse fund
categories.
Emerging market Funds: - To invest in developing markets is considered a risky
bet, and it has undergone negative returns too. India, in itself, is a dynamic
and emerging market where investors earn high returns from the domestic stock
market. Like all markets, they are also prone to market fluctuations.
Foreign Funds: - Favored 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).
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.
Real Estate Funds: - Despite the real estate boom in India, many investors are still
hesitant to invest in such projects due to its multiple risks. Real estate fund
can be a perfect alternative as the investor will be an indirect participant by
putting their money in established real estate companies/trusts rather than
projects.
Commodity-focused Stock Funds: - These funds are 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, however,
may not be periodic and are either based on the performance of the stock
company or the commodity itself.
Market Neutral Funds: - For
investors seeking protection from unfavorable 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 where even
small investors can outstrip the market without stretching the portfolio limits.
Inverse 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 repurchase them at an even lesser cost (to hold until the price goes up
again).
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.
Gift Funds: - Yes, you can also gift a mutual fund or a SIP to your loved ones to secure their financial future.
