Mutual funds: an introduction to the types of mutual funds
A mutual fund is a trust managed by the fund manager that pools the savings of thousands of investors who share the same financial goals. The money raised is then invested in capital market instruments, such as stocks or bonds, or a combination of both.
Investing in mutual funds is done by providing different types of investment options that are made available to investors. These generally fall into the following categories: SIP (Systematic Investment Plan), one-time payment, annual, semi-annual, and quarterly payments. SIP was essentially introduced to average investment cost by purchasing a particular number of units at regular intervals, regardless of market movement. This reduces the volatility of the fund. Therefore, if the price of the securities falls, more units are bought and if the price of the securities increases, fewer units are bought.
To invest in mutual funds, one must know the types of mutual funds available in the market. These are: Equity Funds, Debt Funds, Balanced Schemes, Sector Funds, Gold Funds, Index Funds, MIP (Monthly Income Plans), MMF (Money Market Funds) ETF, etc. Each of these schemes follows a different investment strategy. Most schemes have “growth-oriented” or “dividend-oriented” plans, which reinvest or pay the dividend collected from the underlying stocks.
Equity schemes: this type of fund invests mainly in equity shares of companies. Provides returns through capital appreciation. This type of fund is exposed to high risk and therefore returns may fluctuate. As you invest only in stocks, it is riskier than debt funds. Returns will depend on the performance of the company in which the fund invests. However, on the other hand, this fund has a high performance capacity, as equities have historically outperformed all other asset classes. There are several types of action schemes based on different categorization parameters.
1. Large Cap Funds / First Line Funds: Invest in large company stocks, typically the BSE 100 index. Generally low risk investment with moderate returns.
2. Midcap / Small Cap Funds – Midcap and smallcap funds are generally considered riskier because smaller companies have higher business risks. At the same time, they can offer multiple returns because smaller businesses can multiply multiple times if they are successful.
3. Sector funds: These funds are the riskiest among equity funds, investing only in specific sectors or industries. The performance of sector funds depends on the fate of specific sectors or industries. This type of fund maximizes returns when investing in the sector, when the sector is expected to rise and exit before falling. You should invest in these funds only if you really understand the industry and its trends.
4. Index Funds – These funds track a key stock index such as BSE Sensex or NSE S&P CNX Nifty. You will invest only in those stocks that make up the market index, based on the weighting of individual stocks. The idea is to replicate the performance of the benchmark. Ideally, the performance should be better or at least the same as the index in question. The output load of these schemes is usually less than regular schemes.
Debt schemes: Debt schemes invest primarily in income-generating instruments such as bonds, bonds, government securities, and commercial paper. This type of fund basically invests in FD-type instruments that pay interest based on various market factors. Its volatility depends on the economy reflected by factors such as the depreciation of the rupee, the fiscal deficit and inflationary pressures. In general terms, the returns of the pure debt schemes will be in line with the DFs of the banks. There are short, medium and long-term debt funds depending on the time horizon they serve.
1. Gilt Funds: This is a subtype of debt funds, which invests only in government securities and treasury bills. In general, they are considered safer than corporate bonds and are more suited to long-term investments.
2. Monthly Income Plans (MIP): This is basically a debt plan that invests a marginal amount of money (10% – 25%) in stocks to increase the profitability of the plan. This fund will outperform traditional long-term debt plans.
3. Money Market Funds (MMF) – Also known as liquid funds. These funds are debt schemes that invest in certificates of deposit (CDs), interbank call money markets, commercial papers and short-term securities with a maturity horizon of less than 1 year. The objective of the funds is to preserve capital and obtain a moderate return. It is a low risk, low return investment that offers instant liquidity.
Balanced Schemes / Hybrid Schemes: This scheme invests in both equity stocks and income generating instruments in a proportion that balances the portfolio. The objective is to reduce the risk of investing in stocks while also participating in the debt market. It generally offers a reasonable return with moderate risk exposure. There may be hybrid funds that are more equity-oriented (60-70% equity) and there may be debt-oriented hybrid funds (60-70% debt).
Fund of funds: The fund of funds is a secondary fund, which invests in different types of funds depending on market conditions. For example, if the stock markets are in a bearish mood, it would be wise to invest in debt and not stocks. Therefore, this type of fund will sell its shares of stocks and buy units of debt funds from the same fund house. “Asset allocation funds” is also a term used for these types of funds that accept a macro call and invest in stocks, debt, gold, or some other security.
Exchange Traded Funds (ETFs) – These are funds that are traded on the market like regular stocks. You don’t need to pay the exit charge to trade them, but you pay the brokerage just like normal stocks. You can trade intraday with ETFs, which is not possible with regular funds. There are ETFs that are based on Nifty (index), Gold, etc. Generally speaking, they are suitable for short-term traders who want to take a position in the market using underlying securities.